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Avon Products Inc. (NYSE:AVP)

Q3 2006 Earnings Conference Call

October 27, 2006 9:00 am ET

Executives

Andrea Jung - Chairman and Chief Executive Officer

Chuck Cramb - Executive Vice President of Finance and Technology

Renee Johansen - Vice President of Investor Relations

Analysts

Wendy Nicholson – Citigroup

Bill Pecoriello – Morgan Stanley

Filippe Goossens – Credit Suisse

Amy Chasen – Goldman Sachs

Bill Schmitz - Deutsche Bank

Connie Maneaty - Prudential

Nick Moody - UBS

Chris Ferrara – Merrill Lynch

Justin Hott – Bear Stearns

Linda Bolton Weiser – Oppenheimer & Co.

Lauren Lieberman – Lehman Brothers

Alice Longley – Buckingham Research

Sandy Beebee – HSBC

Elena Mills – Atlantic Equities

Presentation

Operator

At this time I would like to welcome everyone to Avon's third quarter earnings conference call. (Operator Instructions) I will now turn the conference over to your host, Andrea Jung. You may begin your conference.

Andrea Jung

Good morning, everyone. Thank you for joining us this morning to discuss Avon's third quarter results. Since some of our remarks today may include forward-looking statements. I refer you to the cautionary statement in today's press release. With me on the call this morning are Chuck Cramb, our Executive Vice President, Finance and Technology; and Renee Johansen our VP of Investor Relations.

I will begin with my thoughts on our current business performance, including a review of our geographies. Chuck is going to follow with his perspective on our cost initiatives and then the two of us will facilitate Q&A.

As we approach the one-year anniversary of the announcement of our turnaround plan, I thought it would be a good idea if I took some time this morning to give you a high level perspective on our overall progress to date with the turnaround. With 9% revenue growth this quarter, the top line has clearly strengthened. Beauty is up 10% and active representatives are up 6%. These are key measures of our brand’s general health.

For the first three quarters of the year, top line growth of 7% is ahead of our expectations for this transition period. This certainly reflects our commitment to aggressively invest in the business. Although several of our markets continue to report year-over-year decline, we are seeing some early positive signs that our turnaround initiatives are beginning to gain traction to restore these markets to health.

While we are only still in year one of a multi-year turnaround effort and there is a lot more work to do, I am confident that our turnaround plan is the right one. I believe we're taking all the right actions to restore us to sustainable growth.

As you recall, we have four turnaround priorities. These are to:

  1. To first commit to brand competitiveness.
  2. Win with commercial edge.
  3. Elevate organizational effectiveness.
  4. Radically transform the cost structure of the company.

So nine months into year one of this multi-year effort, here's a brief report card of results to date, against each of these priorities, and some of our thinking on next steps on our continuing journey to sustainable growth.

In terms of brand competitiveness, we now project that advertising spending will nearly double this year to about $0.25 billion; that's well ahead of the 50% increase we had projected last November. We are already seeing a direct correlation between increased advertising investment and increased representative order size, particularly in skincare.

Skincare sales increased 16% in third quarter with strength in both developed and developing markets. I am particularly pleased that we had a strong double-digit gain in the United States, given the significant step ups in competitive skincare activity. As we look towards 2007, we will continue our advertising support for the skincare category.

We will also begin to implement a comprehensive strategy to reposition and rebrand are color business and restore its flagship role in our portfolio. Over the past nine months, we have laid the groundwork for the revamping of our entire color line, with new product innovation, new packaging, improved merchandising, and new brochure execution.

We have also formed an alliance with a renowned celebrity makeup artist and as these changes began to be implemented in the first quarter, we will support them with a significantly increased advertising investment, which will be tied to the launch of an exciting new advertising campaign.

So just to summarize our progress on brand competitiveness, we are ahead of plan in terms of reinvesting in advertising in year one. In year one, skincare is well on track and color is still a work in progress with a major relaunch planned in 2007.

Turning to the second pillar of our turnaround plan, winning with commercial edge, this is really our direct-selling strategy. As I reflect on our channel now, a year after we first articulated our turnaround plan, it is becoming clearer and clearer that improving the reward and effort equation for our representatives will be a true lever to achieving sustainable growth .

Over the past nine months, we have invested an extraordinary amount of time and money in research to better understand the reward and effort equation that drives the value proposition for our representatives. Through some early tests, we have begun to see the potential power when we improved this value proposition. A detailed payback analysis also shows strong returns on investments in the channel.

Based on our research, we have begun to improve representative economics with a particular focus on markets where we have experienced active representative decline. These early actions include adjustments to compensation threshold, enhancements to selective incentive programs, and targeted bonus brochures. As a result, we are seeing some signs of improving channel health. In North America, for example, active representatives went from down 6% in the first half to down 2% in the third quarter because of actions we took in the U.S. I know that some of you attended our U.S. representative jubilees, so you are aware of some of the changes we've made and I will talk more about these in a moment.

In addition to the U.S., we are also seeing some positive signs in Poland and Japan. Results from these early actions give me confidence that we are on the right track to unleashing our channel health in these markets.

Improving representative economics is only one piece of the representative reward and effort equation. On the effort side, our top priority is representative web enablement, including online ordering, training, recruiting and seller management support. Depending on the market, some of these initiatives have already been implemented and some are still to come.

In the U.S., more than 70% of our representatives order online, but outside the U.S., the numbers are significantly lower. But we had always believed that the receptivity of our representatives to doing business online would parallel Internet penetration in a market. But we have gotten some great surprises. The reality is playing out very differently and positively.

An example from Turkey illustrates the rapid and dramatic change taking place. While less than 15% of the Turkish population has Internet access at home, almost 95% of our orders in Turkey are submitted online. Our representatives place orders through their zone managers or go to Internet cafes. As I have traveled to other emerging markets, Romania for example, I have seen a similar phenomenon unfolding. This to me says that we need to move faster to provide more sophisticated online tools for all our representatives worldwide.

Our IT team has developed a global Internet platform. We have just announced that one of our top executives will lead this effort and we are accelerating our global rollout schedule.

So overall, we are very aggressively focused on delivering a more rewarding and satisfying experience for our Avon representatives. Going forward, we are targeting a significant increase in investments in our channel to strengthen the representative reward and effort equation. Given the strong ROI for our early field investments, I believe we have a huge opportunity ahead. We are committed to fortifying our leadership as the world's number one direct seller.

Turning to our third turnaround priority, organizational effectiveness, here again we have also made good progress. It has taken some time, but we settled the organization down post delayering. As we come into the fall, people are getting comfortable working within the new organizational structure, and our focus now is to unleash the power of a matrix organization. We have built strong global marketing, global supply chains, and global direct selling functions. Their impact is definitely helping us accelerate progress with our turnaround strategies.

In this new environment, we're also paying close attention to the training and development of our people. In fact, next year we will more than double our investment in training, development, and improved analytic tools to build the skills and engagement of our teams all around the world.

Our fourth turnaround priority is to radically transform our cost base. I'm certainly very pleased that the actions we have taken to-date are delivering nearly $100 million in benefits this year, and that we are on track to achieve savings in excess of $300 million through restructuring.

Over and above these benefits, this morning we announced two major new initiatives: product line simplification and strategic sourcing. Both represent large incremental opportunities to drive down costs even further. Chuck is going to talk to you about both of these initiatives in more detail in a minute.

I just wanted to offer my own personal perspective on product line simplification, because this is more than just a simple cost out play. PLS has the potential to truly transformed Avon’s go-to-market strategy and deliver a new level of brand competitiveness. This will be one of the largest single change initiatives we have ever undertaken with the potential to positively impact virtually every dimension of our operating process across the entire product supply chain. So it is a very big and exciting initiative.

So that's a brief summary of our progress with the four-point turnaround plan. One year later, the cost out opportunities are even greater than we thought. We are investing back into the business at even higher levels than we had planned. We have many exciting opportunities ahead of us with our brand, and especially with our channel. So as I said, this is only year one of a multi-year story. There is a lot more work to do, but we are very encouraged by the progress so far.

Before turning it over to Chuck, I just now want to take you through a quick review of the third quarter performance in our major geographies. In North America, my key headline is that active representatives were down only 2% in the third quarter compared with down 6% in the first half and down 7% in the second quarter. This clear change in trend line reflects actions we took in the quarter to improve U.S. representative economics. These include reindexing certain thresholds in our sales leadership programs to make it easier for representatives to achieve higher earnings level; distributing bonus brochures to high-performing groups of representatives where analysis has shown good ROI; and introducing strong incentives to encourage activity amongst new representatives. All of these actions have helped build positive field momentum, especially as we moved through the quarter. We've got additional efforts planned for the fourth quarter. Fuel prices remained a negative factor on representative activity in the third quarter, but to a lesser extent than in the first half.

On the brand side, we saw our advertising strategy play out nicely in the U.S., with a significantly increase in advertising spending against facial skincare, we outperformed the market in this category in spite of aggressive competition. So overall in the U.S., we are beginning to see signs that our turnaround is gaining traction, encouragingly on the field side. We feel we have the right plans to build this business back to health over time.

Turning to Latin America, obviously I'm more than pleased with this region's results with revenues up 28%, they delivered a record performance. Brazil, our second-largest market, was the strongest performance, certainly in the portfolio, they remained a great performer growing almost 40%, 26% in local currency, with increases in both average order size and the number of active representatives. This would certainly be a quarter of market share gains in Brazil.

New product introductions such as metallic lipsticks and a new eyelift performed extremely well, supported by significant advertising and sampling activities. Results also benefited from an exciting promotional tie-in with Coca-Cola.

Here as well, we have taken some early actions in Brazil to strengthen the representative value proposition. These include Internet ordering throughout the country, and not dissimilar to the United States, free brochures to top sellers who met certain targets.

Turning to Colombia, once again this market posted very strong results. Since we have acquired this license last October, we have grown revenue over 40%. This is now nearing a $250 million in revenue business for us. Columbia's performance reflects not only a successful acquisition strategy, but to me, more importantly, effective post-acquisition management. As of this year, we believe Avon will move into the number one position for both beauty and direct selling in Colombia. As we anniversary this acquisition, we expect that Colombia will remain a solid contributor to the region's growth.

A few comments about Mexico. As you know, we've experienced revenue declines in Mexico over a number of quarters. The 4% decline this quarter is less than some of the declines we've seen recently. Mexico's challenges relate to field execution, specifically in terms of our zone managers, these included a lack of structured performance management and a poorly executed redesign of our former helpers program. In terms of our representatives, we had significantly weaker incentive offers than in prior years.

We have an aggressive turnaround plan in place. We have completely reset priorities on performance management and we have invested in greatly-improved incentives and motivation to restore field momentum. We are also substantially increasing our advertising budget in fourth quarter against a strong product line-up, as well as recruiting advertising.

While the problems in this market are fixable, they will take time and there will be some variability. However, as we exited the quarter, we began to see a build back in orders. While small, this is the first sign of order growth posted in this market since fourth quarter 2005. And just as of an overall reminder, even with the current revenue softness, in 2006 Mexico will still be very profitable for us.

Turning to Western Europe, Middle East and Africa, let me just say a few words first about Turkey, where revenues grew nearly 40% in the quarter. Turkey is another example of an acquisition that has paid off handsomely for Avon. Revenues are over 4X as large as they were since we acquired that business just a few years ago. We enjoy leading market share and brand awareness in Turkey and we have further penetration opportunities, as well as geographic white space as we expand eastward.

In the U.K., in this highly competitive market, most critically beauty grew by double-digits in the quarter. This is a direct result of a strong advertising effort, largely again, skincare which also haloed the other beauty categories. On the channel side, the sales leadership program continues to gain traction in this market so I feel we are making good progress in the UK.

In Central and Eastern Europe, active representatives in Russia grew double-digits in the third quarter. We were unable to deliver $15 million of fragrance orders in Russia due to new requirements for imported ethanol-based products. If we had been able to ship those orders, revenues in Russia would have approached 20%. I'm happy to say that this licensing issue is now largely behind us.

Poland continued to show a year-over-year decline in the quarter. However, active representative growth in Poland was up nicely following the successful national rollout of sales leadership. As we enter the fourth quarter, the challenges in color marketing over the past nine months are now responding to actions we took to significantly strengthen our merchandising proposition. So again, I believe that our turnaround plans in Poland are beginning to gain traction.

Turning to Asia Pacific, excluding Japan, regional sales were up for the quarter. Revenue in Japan declined 13% in dollars year-over-year. While we're certainly still not pleased with Japan's performance, this is a significant change from the nearly 30% decline we saw in the first half of the year. The direct-selling side of the business is responding to some early actions we took to improve representative economics. These included the elimination of reinstatement fees and significantly better incentives.

In terms of the direct mail side, while our long-term strategy to rely less on this business segment is the right one, we had cut it back too aggressively; too much, too soon. We have now reinstated some of our more profitable direct mail programs. Just to keep our business in Japan in context, Avon's sustainable growth plan does not rely on this market for growth. Our objective at this point is simply to stabilize it.

Finally, turning to China, direct selling is clearly taking hold. If you exclude the impact of the exit of company-run store counters, we are very encouraged by the strong growth of nearly [70%] that we saw in this market. We ended the quarter with 236,000 licensed sales promoters. As we bring these new sales promoters on board, our focus now is converting them to active representatives through comprehensive training on how to sell and service their customers.

I'm pleased that the percentage of active representatives is in the mid-40s, a very respectable number, particularly in light that we've been in this business just a few months and the number of as [SP]. This percentage has improved sequentially every month. At the same time, the ordering activity of our beauty boutiques continues to be over 90%.

To our knowledge, we remain the only company in China with a national direct-selling license. This is a unique window, a once in a lifetime opportunity. We are moving to capitalize on this opportunity as aggressively as possible. China continues to have the potential to become one of the largest markets in Avon.

So that's a quick summary of our major markets. With that, I'll turn it over at this point to Chuck to give you an update on our progress with restructuring and other cost containment initiatives which are providing us with the financial fuel we need to continue to increase our growth investments.

Chuck Cramb

Thanks, Andrea. I'd like to spend the next few minutes discussing how we're changing Avon's cost structure. When I joined the company roughly one year ago, I knew that there was a significant opportunity to take costs out and that this would enable us to fund a step change investment in growth-driving activities.

During our mid November analyst meeting, we defined the implementation costs of these opportunities as somewhere between $300 million to $500 million. In February, at [CAGMI] we clarified the numbers, and talked about $500 million of cost to implement, which would deliver in excess of $300 million of annualized benefits when fully implemented.

Having been here almost a year now, I have great confidence that the annualized benefits of the various programs that we have identified will exceed $300 million, and that the cost to implement those programs will approximate $500 million.

So, let's start with the restructuring activities that are the basis for these estimates. We are on track with our plan. We have completed our major program called delayering; you have heard us speak of it often. Delayering, by itself, will deliver approximately $200 million of annualized benefits, the run rate of which should be realized by mid-2007. This is some $50 million higher than we had originally estimated. This is an important first step. It has a quick financial payback and therefore, also creates an immediate opportunity for investment funding.

We have announced several actions beyond delayering. They include the closing of unprofitable businesses such as the Avon Salon and Spa, our operations in Indonesia, as well as retail beauty counters and [Up To You] retail brands in China. We are outsourcing some call centers. We are establishing shared service centers, particularly in human resources, finance, and for certain regional marketing activities. We have referenced the realignment of manufacturing and distribution activities, although these areas are still under study. We have reorganized our field management structures in several major countries and we continue to explore new ideas and opportunities, which should come to fruition over the next two to three years.

What has really struck me is that the company has, relatively quickly, shifted its perspective of these events from being a one-time quick fix to really supporting a constant turnaround mentality; a mindset where we continuously evaluate what we do and at what cost, and thereby redirect resources to help drive sustainable top line growth.

ZOG and NOG are quickly becoming a part of the culture at Avon. Remember, ZOG means Zero Overhead Growth where productivity improvements offset inflation. We have started our 2007 budget process and it is apparent that management gets it. I recently attended a Latin American general managers meeting focused solely on budget cost-reduction ideas. There is no question that they get it. On an ongoing basis, to ZOG our departmental overhead costs means offsetting inflationary pressures that run between $75 million to $100 million annually. This is a significant benefit.

As you think about ZOG, it should not be considered as totally additive to restructuring, as some of the announced restructuring activities will help deliver the ZOG objective. Important, however, is that ZOG is definitely an objective, a mindset and a new way of life at Avon. I can remember when we launched ZOG at Gillette and I can tell you that the management team here is just as ready and committed, if not more so, than they were at Gillette.

This morning, we announced to you another key program called the Strategic Sourcing Initiative, or SSI. This changes how we go about procuring direct and indirect materials, goods and services around the world. This is about how to leverage our purchases, not on a material by material or component by component basis, but critically by a vendor or broad class of material basis.

A key feature is that we will work with our suppliers to increase their scale of doing business with us, thereby providing a win-win both for Avon and a significantly reduced number of suppliers. Procurement will become centralized and global, thereby granting us the greatest leverage. We will buy on a supplier basis, not on a component basis. We will buy on a global basis, not on a local basis.

We have brought in new management talent to help lead this initiative, as well as bringing on board some third-party expertise to assist in establishing the process and controls. This will ensure that we will not only get the initial benefits, but that we will build on them going forward. It is too early to forecast the potential savings except to say that our earliest estimate and experiences at other companies suggest that they will be big. Some of the savings will contribute to ZOG, but most will be in product cost. And although some of the benefits will start in 2007, it will probably take three years to yield the full results.

But, I have saved the best for last; an initiative that will be a key game changer for Avon and a major part of how we structure our business going forward. We are starting to attack our size of product line under an initiative that will refer to as a Product Line Simplification, or PLS. While Avon has had programs to reduce its size of line in past years, this initiative will be larger, it will be more comprehensive and it will be far more structured. It is all about defining the right assortment of products to go to market, a much smaller range of better-performing, more profitable, high-volume products.

PLS is more than just identifying the right assortment at a point in time; it is about setting up process and discipline to ensure that we maintain the reduced line. This is important because it means greater focus of our resources on developing our key product ranges, and thereby delivering greater efficiencies in yield. It means a better shopping experience for end consumers through a less cluttered brochure. It means a better selling experience for our representatives with less product confusion, making their jobs easier and more productive. It means less complexity and thus less cost throughout our entire operating system, from forecasting to procurement to manufacturing to warehousing to distribution to invoice collection, all aspects of our business will be favorably impacted. It means improved product profitability as well as more effective decisions on when and how to eliminate a product from the portfolio. It means greater opportunities for both our manufacturing and distribution realignment programs, generating even greater cost reduction opportunity there.

It also means better inventory management, not only in terms of working capital, but also in reducing a significant cost of the Avon business, which is the cost of product obsolescence; a cost which historically has been in the range of $65 million to $85 million annually.

This initiative complements our efforts to reduce promotional discounting, as we will avoid creating this inventory in the first place, as we currently lose millions of dollars through ineffective close-out or clearance sales. And it will clearly leverage our efforts in strategic sourcing as it increases scale against fewer but bigger volume products.

We are working with two outside groups, one that specializes in assortment analysis, to help define what the right go-forward portfolio should look like. And a second firm, specializing in business process to make sure that we have a robust and disciplined internal process to maintain what we get. A discipline of product lifecycle management.

It is the combination of these two elements that will make this initiative different from past ones, which have been more focused on one-time inventory reduction than anything else and have not resulted in sustainable practices. It is too early to dimensionalize both the cost and the financial benefits of this initiative. We had $40 million of initial costs, including a $37 million inventory write-off in Q3, as we have started to identify products we no longer want to maintain in the portfolio.

PLS will happen in stages, resulting in potentially uneven quarterly inventory write-offs. The first of these occurred this quarter. The write-offs will probably continue throughout all of 2007 and maybe into 2008. At the end, we will have a much simpler product line of fewer, bigger, better products. It will mean dramatically fewer underperforming and non-performing products, products that otherwise would be discounted, eroding margin as well as cannibalizing existing core product sales. This will increase our profitability in every aspect of the business. This is a real game changer for Avon.

So, there are significant opportunities remaining to reduce costs at Avon, well beyond what I had originally hoped when I joined. Cost discipline is becoming a new way of life at the company. As a result, we should be able to realize our desire to continue to fund significant incremental investments in programs that will help to ensure long-term, sustainable growth. What is great is that we all feel that even after delivering $200 million in annualized delayering benefits alone, that there are many more opportunities to pursue. This is a multi-year turnaround program with still a long way to go. There will be bumps or ups and downs, but the long-term prognosis is looking healthy. The cost out opportunities are there and let me assure you, that this company is on it.

So that ends our prepared remarks. I will now turn it back to the operator to instruct you on how to conduct the Q& A session. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Wendy Nicholson – Citigroup.

Wendy Nicholson – Citigroup

Andrea, can you address the Product Line Simplification initiative? It sounds awesome, but how does that jive with what we're seeing in the brochure currently? I mean, we went to the Holiday Jubilee and saw a huge amount of jewelry and candles and toys and stuff like that. I am just wondering what your current thinking is in terms of product assortment. Last year we heard you focus more on beauty and skincare. Now it seems to have swung the other way. Is that just a seasonal switch or is that a strategic difference in your thinking?

Chuck Crumb

Wendy, let me pick it up and then Andrea will add a few comments. There's no question the focus in this company is on beauty. That's going to really drive the business as we go forward in the four categories of beauty.

This program is really all about -- we have a lot of what I'm going to call marginal, small and poor performers. They call them SFCs here, think about traditional CPG, it is SKUs. They come in and go out. They are temporary. They don't earn their keep. They confuse, they clutter. It doesn't mean, however, that we are going to walk away from things like the Christmas line that you saw at the Jubilee events. There is always a place for programs like that. It creates excitement for the reps, it’s an energy piece for the program.

But I think what you'll find as we get into this program and really identify how we want to skinny down the portfolio and really focus on the key or the core products, I think you'll find that a lot of really marginal, the non-profit and really non-sales producing products are the ones that are eliminated. As we do that, not only does it eliminate the tail of the problem -- which is how you get rid of them at the end when they are undersold -- but it eliminates the whole administrative problem right from the beginning in terms of thinking about what to put in, procuring inventory. It is just a massive simplification of process.

Andrea Jung

Wendy, I would add and I think Chuck covered it, hopefully the results in the quarter as it relates to the improving beauty trend with 10%, and 16% in skincare is evidence that there is no strategic shift, just more of a double-down on growing beauty. There is no strategic shift in the United States.

The seasonal focus that you probably witnessed at the Jubilee was really to take the retained Christmas line, which we have exited pieces of that, but the retained Christmas line and making sure there's motivation and excitement among representatives going into the fourth quarter. But even in the United States, while the PLS initiative is really one that moves forward into '07, there has been a pretty good control on the size of line in the non-beauty areas. We are focusing on creating excitement with those products that we think will drive energy in the fourth quarter.

Wendy Nicholson – Citigroup

And how much of the PLS initiative is now enabled, if you will, from the new ERP pieces? Is this something you just haven't focused on in the past are now that you have better analytical tools internally, you're better able to change the product lineup?

Chuck Crumb

I wish I could tell you that ERP had been launched broadly enough so that it is a major enabler. There is no question it will be an enabler, particularly in Europe, but this is really coming from a diagnosis of our business of where we are earning and not earning, and some of the problems we had.

I was staggered when I first took a look at seeing an obsolescence charge over the last three years, it was about $75 million a year. It is a nature of the business, but then I also looked at what our inventories were doing, and what was driving those inventories. It became very obvious that we had an assortment issue. So it really comes out of that analytic work more than an ERP system right now. But as we get into this, where the ERP is installed and up and running, sure it will help us in terms of some of our analysis. But that's not the key driver or motivator of change here.

Wendy Nicholson – Citigroup

Thanks so much.

Operator

Your next question comes from Bill Pecoriello – Morgan Stanley.

Bill Pecoriello – Morgan Stanley

Good morning. Andrea you talked about the significant investment in the channel and you gave us some comments in your prepared remarks. You mentioned U.S., Brazil, Poland, Japan. Are you in a position to quantify for us what you see that investment being and also some of these incremental savings from SSI and PLS? Is that going to help fund what that ultimate investment needs to be?

Andrea Jung

Well, I can't put a number on that yet, Bill but let me just say this. If I recall back at CAGNY, we started introducing the thought of where the $300 million benefit stream would be applied back into the business. And that's something that we continue to share across the year, which has some 50% of our savings going back against the consumer, primarily in advertising, and then there was a portion for innovation and market research. But there was also a lion's share of that pie going back against the channel.

I think we're talking more about it now. It was probably more conceptual when we talked about it back last November. I think we have more specificity around some of the brand turnaround initiatives and they are well underway: skincare, advertising, et cetera. But this RVP, our Representative Value Proposition is something that we have really gained a lot more understanding about and clarity on.

Now that the initiatives are becoming very tangible, early signs are showing good early returns, certainly, within that $300 million reinvestment. You'll see and hear more about that and more of the '07 weight of the mix of the reinvestment going back against the channel, not just in those markets that you mentioned, but really in some major parts of the Avon world.

So I do see any additional and incremental investments freed up by PLS, by SSI, ZOG, et cetera, fueling growth in the business now that we understand the levers from the channel point of view.

Chuck Crumb

Bill, we're not going off of our strategy, which is this is will be a growth model. We look to sales to really drive the earnings per share growth with some very minor margin enhancements we've talked to you about before. So it is a reinvestments story in terms of incremental initiatives.

Bill Pecoriello – Morgan Stanley

And then just on the charges, you said the delayering, now that's largely behind, what are the next phases? There was only a $16 million charge in the quarter for the main restructuring program. So what are the next parts of the program that were going to see in the coming quarters?

Chuck Crumb

I think you'll see in the shorter term, you'll see some more what I call reorganizations. You'll see some more downsizing in the structure in the organization and as we get clearer sight of some work we are doing in terms of realignment of facilities and I am talking specifically our manufacturing and distribution facilities, we will start to share that learning with you and there will be charges related to it.

Bill Pecoriello – Morgan Stanley

Thank you.

Operator

Your next question comes from Filippe Goossens – Credit Suisse.

Filippe Goossens – Credit Suisse

I have three questions, if I may, this morning. First, Chuck, in line with the Strategic Sourcing Initiative, kind of two parts here. At this juncture, can you at all quantify what the potential range of savings would be?

Secondly, do you foresee that eventually you could extend that initiative to start looking perhaps at outsourcing of actual manufacturing? I think right now in the industry very few companies are looking at outsourcing of manufacturing. Do you see that as an opportunity?

Chuck Crumb

Sure. In terms of sizing, I'm not going to put a number on it, but it's big. We have done some preliminary work here. In fact, more than just preliminary work in terms of what we're buying, what the size of the opportunity may be like, and it's very, very sizable. We've also got experience, I have experience with not a dissimilar initiative at Gillette. I can tell you that our material purchases, just thinking about products for a minute, our material purchases here at Avon are actually larger than they were at Gillette. This is a big idea. But it's just not right, right now, to put a number on it.

In terms of sourcing our product, in a way, we do outsourcing. We by product, purchased finished goods, PFG, you have heard of this before. I think any company that gets involved in the manufacturing process, there will always be a decision to be made as to whether to source in-house vs. out of house. There are issues with freight and duties and where you want to manufacture, where your growth markets are. So all of those things would fit into the mix of an evaluation in terms of any manufacturing realignment that we undertook.

Filippe Goossens – Credit Suisse

My second question, great results obviously from the acquisitions in Columbia and Turkey. Are there any other larger remaining opportunities or that was basically it? In terms of acquisition?

Chuck Crumb

We will always look at acquisition opportunities, but that's not a key or even a fundamental part of our strategy right now. We've got a lot to do in terms of turning this company around. The whole management team is focused on that. There are occasionally opportunities where we have some distributors that might be attractive to do business with in a different way, e.g. ownership versus distributorship. But right now we're really focused on trying to get the cost outs and reinvesting the money from those cost outs into growing our top line.

Filippe Goossens – Credit Suisse

Andrea, perhaps a question for you I may. With regard to the leadership program, in how many markets have you now rolled out the program and which countries are up next? Secondly, within the U.S., if you could just kind of review for us what changes you have made, if any, to the leadership program? Thank you.

Andrea Jung

We have rolled out leadership in several markets in 2006. Central and Eastern European markets as well as some other markets in Asia, but I would basically tell you that the lion's share of the major markets going national in terms of their implementation would be in 2007.

The major markets that have already implemented leadership are U.S., Canada, U.K., and Germany. As I mentioned, again, we went national in Poland. So that's been rolled out. We have tests going in many of the other major markets in the world which would be Brazil, Mexico, Russia, et cetera, those are in '07.

In terms of the U.S., I think the only major change I mentioned was a re-indexing of leadership thresholds and that is essentially, specifically lowering requirements for some key sales leadership levels, which I think has reinvigorated the sales leadership program and it really resonated with our up line as we rolled that out.

Filippe Goossens – Credit Suisse

Just in conclusion, one final question if I may, Andrea. What are you doing different in Turkey? Spectacular results back to back now, yet your largest competitor was blaming weakness in that market on the economy. What are you doing different to make you successful in that market?

Andrea Jung

I think it's a combination of the very, very strong brand awareness as well as strong rep growth. We still have big opportunities going east in that market. This is another emerging market success story for us.

Just on the brand awareness, this year is the first year we have advertised in Turkey so just to the whole story of total company advertising, even in Turkey, we did up our investment there significantly as we move into the second half and we are getting good ROI on that. I think Turkey is no different than other emerging markets were the Avon brand awareness certainly carries great weight versus competition, and we feel good about that.

I mentioned in my remarks, they have also had a great rate of Internet adoption in that market. So in terms of improving efforts or making it very modern in terms of the representative experience, 95% of our representatives are e-enabled, if you would, in terms of ordering online. So I feel good about that.

Filippe Goossens – Credit Suisse

Thank you so much, Andrea.

Operator

Your next question comes from Amy Chasen – Goldman Sachs.

Amy Chasen – Goldman Sachs

Good morning. Andrea, I apologize, something was wrong with my line, so you might have touched this at the beginning but it was choppy so I don't think I heard everything. You're doing a pretty extensive sales review, and I was just wondering if you could pull together for us maybe the two or three or four core conclusions that have come from that, and the strategies that you're going to put in place as a result of that review?

Andrea Jung

This all comes under what we call the representative value proposition and looking at where we want to change the reward and effort equation. That is not necessarily exactly the same by market, but under the total global umbrella, we are reviewing field compensation. That would include a ASLF and sales leadership, which you know about; representative earnings in terms of discounts, commission levels themselves, fees, which would be a matter of are opportunities against which we could mitigate pressures, whether it be fuel price or whatever on representatives personal economics.

One thing that we are looking at is campaign frequency, Amy, which would be are we having brochures every three weeks versus every four weeks? Central and Eastern Europe would be an example where we have a four-week campaign. We have competition in that market that has a three-week campaign. Most Avon markets are on a three-week cycle. We will be moving to a three-week cycle which would create representative economic energy, et cetera, and that will be at the end of the second quarter of '07. Field Manager compensation would be another piece under the field compensation evaluation.

The second would be the effort equation, Web enablement and that, as I mentioned, I don’t know if you're were listening to this piece or could hear me, it was online ordering, online training, online recruiting and sales management support where markets have leadership. Different markets are at different stages but we have just announced one of our key leaders at Avon to take on this initiative and make sure that again, internationally now, not just in the U.S., that we have a very aggressive rollout of web-enablement as part of the effort improvement for reps worldwide.

Amy Chasen – Goldman Sachs

I guess I was looking for just a little bit more specificity. You were specific about the campaign in Central and Eastern Europe and the web enablement, but what about field comp and representative earnings? Anything specific there you can share in terms of conclusions of the study and what you may be doing differently?

Andrea Jung

I would say at this point, the one area that we are looking at final economics on are improving commission rates in Central and Eastern Europe, Russia as well as some other markets. That would be something when we do the final economics that we would evaluate to implement in the first half of the year. I think in most of our other markets, we've done a lot of evaluation and it is not so much the commission rate but in some cases the accelerated rollout of ASLF or leadership or leadership re-indexing of the thresholds as we've just done in the U.S.

Amy Chasen – Goldman Sachs

Okay. And just one quick one on China. Why were sales up so much more than units?

Andrea Jung

If you exclude currencies, sales in China were up seven and units were only up one.

Chuck Crumb

Amy, that's primarily a mix issue and the strength of our skincare business. There's nothing more to it than that. It's been a great start.

Operator

Your next question comes from Bill Schmitz - Deutsche Bank.

Bill Schmitz - Deutsche Bank

Just in terms of the rep compensation tweaks, maybe I'm wrong here, but isn't that a temporary fix? Ultimately, it's based on the products you have the reps sell. They will make more money if you have the right product line at the right price. Is that not the proper assumption?

Andrea Jung

Bill, I think that you can't separate out commission levels as one major silver bullet here. It is part of an equation. It is part of total field compensation rewards. Is also obviously about the campaign frequency, the product line, the focus on beauty and skincare and net earnings on a skincare product versus a low-price color product. So all things factor into field compensation. I think that we have singled it out though to say that we are evaluating every aspect of field compensation in a way we have not done before, certainly in the last several years, to make sure and ensure that every element that goes into it is what we feel is competitive going forward.

Bill Schmitz - Deutsche Bank

Got you. So the product line is not much more important than the percentage commission rate?

Chuck Crumb

They both have a significant value, and that one of the reasons why we're very excited about the PLS initiative. In the work we've done, we believe that the renewed focus particularly in the beauty area will actually give the leverage that you're kind of talking about. But they do have to go hand-in-hand, Bill.

Bill Schmitz - Deutsche Bank

A couple of housekeeping items. What was the impact of the Columbia acquisition on rep growth in Latin America?

Andrea Jung

Can we get that to you? I'll have Rob or Renee I follow that up with you.

Bill Schmitz - Deutsche Bank

Of course. Is there any way you can allocate the inventory obsolescence charge to the regions, so we can get pro forma numbers? It wasn’t in the 10-Q either, I noticed.

Chuck Crumb

Not right now. If you give us a call back we can give you a sense of it, but I don't think it's a meaningful way to look at it. You're saying that the inventory obsolescence is not by --

Bill Schmitz - Deutsche Bank

We don't get a regional either, in the 10-Q or the press release.

Chuck Crumb

So it can break out separately, I see what you are saying.

Bill Schmitz - Deutsche Bank

Right, because it hard to get the year-over-year comparisons, obviously on the margin side, because those are non-recurring charges, obviously.

Chuck Crumb

I will have to talk to with the folks and see if that is something we can do offline.

Bill Schmitz - Deutsche Bank

Okay, great. I have one more, if I could. The difference between units and price in the U.S., is that also skincare effect? Or is it part of early progress on some of the SKU rationalization work you are doing?

Andrea Jung

That really is the result of a very strong skincare quarter. Product mix, specifically skincare.

Bill Schmitz - Deutsche Bank

Will that trend continue like that, do you think?

Andrea Jung

I think it will be balanced, depending on the roll out of different products and different new innovations, which are not always skincare in a given quarter, but I think that the net or the average order productivity in terms of net per unit is clearly an opportunity as we continue to grow that category over the course of a year, yes.

Bill Schmitz - Deutsche Bank

Great, thanks very much.

Operator

Your next question comes from

Your next question comes from Connie Maneaty – Prudential.

Connie Maneaty – Prudential

On the PLS program, can you give us a sense of, is it an 80/20 rule? Will the size of your product portfolio be 30% of what it is now or 70%? Can you give us some sense of what the ultimate size will look like?

Chuck Crumb

I think it's a little premature to do that, because how you dimensionalize that depends how you measure it. I will tell you that we are looking at anywhere from 25% to a 40% reduction in our SKUs but remember a lot of those are the old in and outs that no one ever made any money on. So I'm not sure that's a good measure to dimensionalize just how far we’re going to take it back. I think that's the best I can do right now on that one, Connie.

Connie Maneaty – Prudential

Because it also sounds like this obviously would result in a positive mix shift.

Chuck Crumb

There will be a positive mix shift. Just think of all elements of our business, right from the very beginning when you start to forecast products, right through manufacturing and how did you manufacture it, how do you warehouse it, how do you distribute it? Every element of our business we think will be favorably impacted, and we are convinced it will be a strong win for our reps as well.

It should be a big win-win.

Connie Maneaty – Prudential

As you go through this process, do you think there is some risk of the loss of marginal sales as you go through the quarters to get this organized?

Chuck Crumb

Yes, that is always the risk and that is why you have to do this thing with an awful lot of analytics and you have to feel your way into it in certain pieces. But we’ve seen some cases of other companies that have done this, and the techniques there, I think we’ll be okay through that.

But you are right, that is a risk we will have to watch.

Connie Maneaty – Prudential

Do you know offhand, just in general, if your more expensive products are your better sellers? Or is it your less expensive products?

Chuck Crumb

It is all over. I think the more important thing is that our skincare business is very strong and has shown tremendous growth this quarter. That is the big news.

Andrea Jung

I think it would be fair, Connie, to say that our more expensive product, certainly in the beauty area, are usually those that have strong innovations behind them, are those that we have really begun to advertise, and they tend to be the more productive and impactful in the line.

Connie Maneaty – Prudential

So you are not worried that by going to a better assortment that you lose a significant number of your customers or representatives?

Chuck Crumb

No.

Andrea Jung

I think one thing that Chuck mentioned was that we are doing the analytics down to the SKU level of impact and halo over other products in terms of a representative behavior, that kind of thoughtful analytics is being done, just to your point, so that that does not happen.

Connie Maneaty – Prudential

Andrea, last year at your November meeting, you said something to the effect that Avon had a lot of data but not much information. A year later, it seems as though the quality of information that you have is far superior than what you understood or what the organization understood about itself a year ago. So besides all of the time, effort and money that have gone in to understanding what's gone on in the organization and with the reps, what are the one or two biggest changes in your understanding of the company and where did those come from? Was it consultants? Was it new technology? Do you understand what I'm asking?

Andrea Jung

Yes, I do understand exactly what you're asking, and I guess it would be a simple answer. Which is, we have significantly beefed up the leadership and structure of a marketing analytics and insight department which has not been a resident at Avon in our history to the degree, certainly, that it is today. We have a terrific group, we have built a large group, an insight and analytics team who are working both on the brand side as well as the channel side doing activity mix analysis on the representative side; doing brand and category usage studies and these investments which are not small in 2006, continue to ramp up as we understand the power of analytics on understanding the growth levers, their return, and therefore how we best fuel the business with the savings and the benefit rates that are going to come forth from all of these cost-outs.

Connie Maneaty – Prudential

Can you tell us how Mark and Wellness did in the quarter?

Andrea Jung

Wellness was flat. I have to get back to you, I don’t have that number here on Mark.

Connie Maneaty – Prudential

Okay, thanks.

Chuck Crumb

They're both about flat. Nothing dramatic.

Operator

Your next question comes from

Your next question comes from Nick Moody – UBS.

Nick Moody – UBS

Good morning. Just two questions real quick. On China, Andrea, what kind of plans do you have in place to improve the productivity of the reps in that market over time?

A second question, in North America, I mean, structurally, it seems like the rep growth obviously is definitely slowing down or, you know, more challenging than it has been in the past. Are you planning on just focusing on mix as you go forward, providing the reps higher margin, higher price point products to sell? Thanks.

Andrea Jung

Let me address China first. And the focus, as I mentioned in my earlier remarks, is on training and development. Obviously, we are more than pleased with the number of sales promoters that are coming into the business. But the focus is on converting them to active representatives. That is with a huge focus of the organization to cascade training and direct-selling skills throughout via a very, very intensive training/seeding program.

Training the field sales force, a large group of district sales managers that we’ve put into place in that market in order to ready ourselves for the opening of direct selling in the early part of this year. We are training all of our key beauty boutiques, on site, for more than three days as they now have a major role in the model, as well as servicing our representatives.

We also are training the sales promoters themselves, and that is a combination of a large training force as well as, again, material so that they can understand and learn the Avon opportunity of selling and servicing customers. So this is a major investment and focus in the organization, and obviously for us the KPI that we would be measuring is improved activity, as well as improved order size.

Nick Moody – UBS

And then on North America?

Andrea Jung

In North America, in terms of U.S. rep growth, while it is still down slightly, I think it is gaining traction. We are seeing the activity rate decline slowing and all of the initiatives in the early days are getting early response from the representative value proposition that we specifically are doing there, which was to reinvigorate the leadership program with re-indexing to give out these bonus brochures, and these are getting some great early response. So I do believe that we have the opportunity to reinvigorate U.S. rep growth and restore this market to sustainable growth.

Nick Moody – UBS

Thanks very much.

Operator

Your next question comes from

Your -- question comes from Chris Ferrara – Merrill Lynch.

Chris Ferrara – Merrill Lynch

Can you talk about the sustainability of Brazil? Obviously, there are some pretty huge numbers there. Can you possibly quantify what the share acceleration may have been in the market so we can get an idea of how long this level of growth can continue?

Andrea Jung

Well we are obviously thrilled with our performance in Brazil. As I said, the strongest performance, in my mind, in the portfolio with this nearly 40% growth. We have to wait to see the polling numbers come out in order to give you the exact share gain in the quarter, but as I said, from what I have seen so far we have certainly gained share in this September quarter.

I think the good news is, if you look at the average order size, it is up as well as the representative count being up, so it is very balanced and very healthy. We have invested heavily in Brazil in advertising this year. You are going to see more of that in 2007. We had extraordinary performance on Eyelift in that market; extraordinary performance on a major color promotion that we did, as well as a joint venture and an alliance.

When you take that, that is before, in my mind, we layer on the representative value proposition’s game-changing initiative which really looked at not so much the commission levels in Brazil, in that market, but as we’ve studied this, really the effort equation with real web enablement; with opportunities to change the representatives’ experience. We have so many of them there. That is where the investment is going to go, capital and otherwise for us, is to ensure our leadership position as it relates to the effort side of this many representatives at this point, in this market.

I think from a marketing point of view, just continued focus on strengthening the brand and a lot more advertising behind it, more than we have ever had in our history in that market, is the answer to maintaining this share.

Chris Ferrara – Merrill Lynch

What is your market share, on average, in Brazil, roughly?

Andrea Jung

I don’t have that number exactly, but you've got categories in the high teens to mid 20s in Latin America. Brazil is no exception. In most of our major categories where we play, with the exception of personal care and hair care where that is a smaller piece of Avon's business, certainly in skincare, color and fragrance we are leading players.

Chris Ferrara – Merrill Lynch

Great, thanks. And obviously you have to be thrilled with Brazil. I just want to look at the rest of it. Because it looks like on average, ex-Brazil, Avon outside of Brazil on a local currency organic basis had sales about 1% on about 2X the advertising budget.

I know skin has been good, but can you just overall give a little color on what your feeling is there, and is that in line with what you would have hoped for?

Andrea Jung

When I look at the business and I think I mentioned, I look at it in two ways. I think that we've talked about a year, a transition year with sales flat to up slightly. We're at 9% in the quarter, 7% year to date, and we knew we had Colombia when we said flat to up, when we talked about that last November.

I can't look at it minus Brazil. I'd have to say we have markets that are healthy. We have got Brazil, Turkey, Columbia, Russia. We have had troubled markets where absolute revenues are still showing year-on-year declines. However, in all of those markets, I hope I was specific enough with all of you today that while early days, we've got plans in place to try to give you some specificity of the traction against, in most of those cases, field health where I think the trend line has changed and/or that we are certainly seeing a shift as we move into the fourth quarter.

So that is how I'm looking at this business as opposed to dissecting the nine. I think we have healthy markets that we're investing against from the savings that we're getting out of delayering in the second half. So it's really an immediate reinvestment, not having to wait until '07. We've got the turnaround markets where we have been just focused on getting rep growth and rep health. I think we're doing all the right things and I'm really feeling like we are getting the traction now.

Chris Ferrara – Merrill Lynch

Thank you very much.

Operator

Your next question comes from Justin Hott -

Justin Hott – Bear Stearns

First question, maybe you can give us some guidance. What do you think is the right number for advertising in the future as a percentage of sales?

Chuck Crumb

We are not going to give quite that kind of guidance. But I think we have ratcheted it up significantly this year. I think the ratio will increase again next year and we are not going to try and do a P&G or Colgate in terms of advertising spend rates. But if you were to say, Chuck, where are you? I would have to say 3% to 4%, heading towards the 4%. That is not a number that I would put into any model and say that is what they committed to.

That is the kind of growth that we are looking at.

Justin Hott – Bear Stearns

Can we touch a little bit more, you mentioned that Japan has improved greatly over the first half of the year. Can you give us some more idea of where Mexico was in the first half of the year in terms of the sales declines?

Chuck Crumb

If you just look at Mexico roughly in the first half of the year, we were down 6% to 7%. So third quarter is significantly less down than the first half of the year was.

Justin Hott – Bear Stearns

Can you just give us some idea of what active reps and units would be without Columbia for the whole company?

Chuck Crumb

We can try. I don't know that I have it right here or not. We have active rep growth of about 2% to 3% without Columbia.

Justin Hott – Bear Stearns

U.S. fuel prices, in your press release you talk about how it's having less of an effect. Have you seen any sort of statistics, can you share any sort of statistical insights on how what we could expect to see on the business if fuel moves around?

Andrea Jung

Well, yes, the activity is still being negatively impacted by the absolute fuel prices. But it is less of a negative impact this quarter, which I think is a direct correlation to the lower fuel prices. I think without being able to predict where fuel prices would go in Q4 or into next year, we would assume that lower fuel prices or continued low fuel prices, even if they go a little bit lower, should positively impact the activity of our representatives.

Chuck Crumb

We can only do that directionally because it's only one piece of a lot of things that are happening, a lot of which are in our control. And remember Andrea’s comments about what we have done with the rep value proposition and enriched the experience; made the effort. You have to put everything together. Directionally, the fuel itself has an element. As it goes down, it gets better, and as it goes up, it will make it a little tougher.

Andrea Jung

I think the good news story is that certainly lower fuel prices will help. The approach though that we are taking is to assume that those fuel prices still stay high; to assume those fuel pressures have an economic impact and have a response plan and an action plan, whether it is bonus brochures, whether it is looking and relooking at fees or fee waiving, that assumes that we want to help in the rewards equation, assuming high fuel prices. All fuel lowering is a benefit. So we're acting as if it doesn't go down.

Justin Hott – Bear Stearns

Okay, thanks. And maybe I missed this, but can you give us some idea, more clarity on China on the number of beauty counters?

Andrea Jung

The number of beauty boutiques is still around 5,500. We are still seeing over 90% activity in our beauty boutiques over time. I don't see that number staying at 5,500 as the ramp up of licensed sales promoters turning into active representatives continues to grow in that business model. But I still think we are going to have a very sizeable infrastructure of not only revenues from beauty boutiques, but very importantly, the required service centers that meet the government regulations and have really helped to give us the advantage all across the country.

Operator

Your next question comes from Linda Bolton Weiser – Oppenheimer & Co.

Linda Bolton Weiser – Oppenheimer & Co.

I was wondering if you could give a little more color on China. You said the percentage of active reps was 40% of the total. Can you give us some idea of the productivity per active rep and just qualitatively how that compares to the productivity in other regions of the world? Is it really at the very low end globally? Are you pleased with what you're seeing so far and what might be the outlook for productivity?

Andrea Jung

I think the productivity is good. It's not at all what we might have got in early days. It's nearer to $70 and $80. It's getting closer to being $100 than not. That would not be that dissimilar. So again, we're focused on productivity, certainly in that market. I don't think we're seeing average order sizes that are hardly alarming; we think there's an opportunity and we’re continuing to focus on it. Activity is the important thing here, at the mid-40s, that does continue to grow each month. That's the important thing.

When I look at other Avon markets in the world, getting to a mid-40s and then hopefully 50% activity rate is a very respectable activity rate, particularly in light of the number of SPs being recruited. So we’ve got a lot of work to do. We have a lot of focus on the training and development, as was mentioned earlier on the call. We love the numbers, certainly, in terms of 236,000 and that number continues to grow. I think the team is just feeling great over there. They are very realistic, though, which is terrific about the focus on productivity, the focus on activity, understanding that it is not about a numbers game, but it is obviously about building a sustainable, productive business.

No question though, that this is going to be one of the biggest markets and the largest markets in Avon.

Linda Bolton Weiser – Oppenheimer & Co.

Okay, great. And just one question about guidance. I know you want to steer away from giving a lot of guidance, but you did make a statement a while back about '07 operating margin performance, the margin being slightly or modestly higher than the '05 base. Is that something you can comment on at this point, whether you still are sticking to that belief?

Chuck Crumb

I won't comment on that. I'll just say that as we construct it, we are doing our budgets now, and as we looked at it, we did make that comment saying that you had to strip out of that the various costs related to the some of these initiatives that we've put in place. So I would still see it heading in a positive direction. But we only said slightly. We're building budgets and one of the things were going to do is we have to invest in opportunities to further solidify the foundation. We're going to go after them and invest in business aggressively.

Linda Bolton Weiser – Oppenheimer & Co.

Okay. Thank you very much.

Operator

Your next question comes from Lauren Lieberman – Lehman Brothers.

Lauren Lieberman – Lehman Brothers

Just getting back to the Product Line Simplification, I just wanted to talk a little bit about your tolerance for pain. Knowing that, at the end of all it does sound great and like it will have a great impact on the business, but if I think back to some of the initiatives you taken in the past, like less seasonal items -- and I know this year it's really a matter of merchandising rather than more SKUs in seasonal to drive sales -- but there are some decisions that you made in the past that when the response wasn’t what you were expecting in the short term, you reverse the decision.

I just want to understand that because I know that Connie asked specifically about risk, but it's got to be bumpy and you definitely acknowledge that, but just how much bumpiness are you prepared to handle? Because this would strike me as something that can cause a lot of disruption among reps.

Chuck Crumb

It could. I think maybe the difference between what was undertaken in the past and what's being undertaken right now is we've got the analytics. We're really understanding better what the potential impacts are. What the halo impacts are if you reduce some of our subcategories or take it out. So you're right. There will be some bumpiness, but we know strategically that where we're heading in terms of what's called here the value chain which is everything you spend money on. We know from our perspective how valuable this initiative is going to be. We know from the reps perspective how valuable it will be for her developing her own business.

We have got some interesting things. We have literally thousands of what we would call duplicated, non-performing products. We have 12 different brands of makeup. We don't need that to generate the business that we need to make in terms of beauty. So as we go through this, to me, the most important thing is we do strategically feel very, very strongly that this is the right way to go. We are willing to take some pain as we get there, but I think the analytics, we have are much stronger than they’ve ever been and that should mitigate a lot of that pain.

Andrea Jung

One of the major things that our representatives are concerned about is the life cycle. As we talk about having fewer, bigger, better products, one of the things that they would scream is have them in longer. I just get a customer who wants it, and then it's not even there anymore because you have this cycle and you're on to the next thing. Some of these products we need to have more space for them and they have got to have a lifecycle management focus, where we can count on less products that are there all the time that are great products, as opposed to all of this in and out stuff.

So I think that the representative experience actually will be embraced by her if we do this carefully, because there is no way she can sell the thousand of less-performing products that are in and out on a seasonal and/or ad hoc basis.

Lauren Lieberman – Lehman Brothers

With Russia, were the $15 million in foregone sales, are these orders placed and you weren't able to ship and you know you're going to ship in the fourth quarter or is it an estimate of what disappeared?

Chuck Crumb

No, those are orders placed that we just weren’t able to meet.

Lauren Lieberman – Lehman Brothers

Okay, great so that will be shifted to Q4?

Chuck Crumb

Yes. I think the only question you had is from a flow point of view, some of the orders that might have been placed in Q4, because we had that delay, might be impacted. But basically, what we have on order will be shipped.

Lauren Lieberman – Lehman Brothers

Okay. Thanks a lot

Operator

Your next question comes from Alice Longley – Buckingham Research.

Alice Longley – Buckingham Research

I have yet another question about Product Line Simplification. Isn’t there a danger in this, even on a longer-term basis that cutting SKUs can be discouraging to the representatives and the customers? In that the product line just has less variety. I think of P&G who has tried the same thing with Cover Girl, trying to work down to the 20% of the line that generates 80% of the profits, and they keep losing share because their product lines just looks skimpier at retail, it has less impact. I'm wondering if that is a similar risk here, just a discouragement because of less variety, less bulk in the product line.

Similarly, if you’re going to be cutting, discounting a lot, doesn't that discourage people in that Avon is kind of a draw to people in part because there are such great discounts?

Chuck Crumb

I think everything is relative. I don't think we're contemplating taking a 80% of the product line away. That may not be a good analogy in our business. I think we are very sensitive to the need for energy in terms of how our reps go to market with our brochures and with our catalogs. So there will be a balance. There will be some give and take in this, but to me that is not going to be a major risk. We've seen enough experiences through some of the consultants we are using to say, hey, there are ways to really manage this as we get into the initiative.

So you are right to point it as a question, as a risk, but I don’t see it as what you mentioned in the P&G example, I don’t see it as that at all.

Alice Longley – Buckingham Research

Just to be clear, they didn't cut the product line 80%, they just cut it a little bit, trying to focus more on the more profitable SKUs, and they keep losing share.

Operator

Your next question comes from Sandy Beebee – HSBC.

Sandy Beebee – HSBC

I have two questions. The U.S. rep compensation changed. If you could give some color on how much of your active rep base right now is in leadership versus non-leadership, and what’s been done to help out the part of the rep base that is in non-leadership?

In terms of the improvement that you have seen in rep trends so far, are you seeing it more on the leadership side?

I had another question just in terms of the color business which you are going to be relaunching in a pretty big way in 2007. Can you give some insight into what changes you are making there, and is that related to the PSI?

Andrea Jung

Let me just start with the color. We are reenergize our largest global brand, Avon Color, in 2007, a pretty aggressive repositioning. It has got several pieces to it. We are restyling, repackaging the brand, supporting some breakthrough product innovation launches that flow throughout the year. We've got strategic alliances with leading style and fashion authorities that are all part of really, unleashing and enhancing the image of the brand. There are significant product upgrades across this.

But this is not additional SKUs, this would be a repositioning of our current Avon Color line, so it is not a new additive line, it is an enhanced, hopefully very much more productive and strong image positioning against our large brand. This would be a worldwide launch.

In terms of leadership, I think that a lot of the lower levels of leadership were impacted by the reindexing. So the vast majority of leaderships changed to get to the next title, if you would, so there was a lot of leadership representatives who were impacted by the changes that we made. As I mentioned before, I think that this has been well-received by the field, certainly well-received by the up line, so that was very important.

We've made changes, though, to non-leadership representatives in terms of the equation as well; bonus brochures, a lot of incentives to the new representative aspect of our business in terms of what we call the D tier, or lower performing representatives. We enhanced some of the programs to them, those who place smaller orders. There are opportunities for them to get more active.

So I think that the representative value proposition initiatives are very evenly based. Obviously, an important aspect is reigniting the leadership engine, but just as much to focus on non-leadership representatives in the equation as well.

Sandy Beebee – HSBC

Can you just give a sense of the split between what reps in your U.S. business between leadership and non leadership at this stage?

Andrea Jung

About half.

Sandy Beebee – HSBC

Just back again on the color relaunch, Is part of what you hope to achieve with the product simplification going to be reflected in this launch?

Chuck Crumb

Yes. I think if you think about this, this will be our main core color line. So you can see this one replacing some of the multiple color lines we have out there now.

Sandy Beebee – HSBC

Thanks very much.

Operator

Your next question comes from Elena Mills – Atlantic Equities.

Elena Mills – Atlantic Equities

I actually have a question about your skincare category, and particularly going back to some earlier comments that you made in the year about wanting to put a little bit more focus behind the Solutions line and bring innovations to that line. I'm wondering, Andrea, if you could give us an update on what you have done in that regard so far and maybe also link that into the PLS initiative?

Andrea Jung

Ageless, the antiaging aspect of Solutions was launched at the end of second quarter, early third quarter. That is on plan. We have always positioned Ageless as I mentioned last year, to be sort of a mid-tier brand underneath the Anew brand. Anew still continues to be the focus of most of the investment, although we did advertise both brands, Ageless did receive advertising in several markets as well. The combination of both drove the 16% gain in the quarter.

In terms of the PLS initiative, though, Solutions is an important brand. It is the second-largest skincare brand in the portfolio. And that is, I think, one of you asked the question before in terms of would those kinds of brands be affected, the answer would be no. I think we’ve got the innovation behind leading skincare brands.

There are other skincare brands, local skincare brands, et cetera, that will be part of the PLS target, but not either Solutions or Anew for sure.

Elena Mills – Atlantic Equities

Thanks, that was very clear. If I could just ask a very quick set of housekeeping questions. Did you say how much growth you had in the beauty category in North America in the quarter?

Andrea Jung

No, we did not. It was down slightly, but again, I think the momentum had changed from the previous quarter, and I would say that as we look into some of the representative value propositions as well as the beauty line up, we've got some strong fragrances in North America that are coming in the fourth Quarter, Crystal Aura, as well Derrick [Jeeter], successful, early trends on the launch of our mascara, Superfull, so I would say that the momentum is shifting both on the representatives side as well as in beauty.

Elena Mills – Atlantic Equities

Just a question on the China representatives you mentioned that the activity level was 40%. In terms of housekeeping, it was then the 94,000 reps that were included in your 6% calculation for total reps?

Andrea Jung

The China active reps accounted for about 1 point. Approximately, not quite, but would round up to about a point of the active rep growth in the company.

Elena Mills – Atlantic Equities

My final question, just in terms of the units globally, were your units down excluding the Colombia acquisition on a global basis?

Chuck Crumb

No, they were not. I'm looking for the number here. I think they were basically flat.

Andrea Jung

We will have Rob follow-up with you.

I think that is the last question. I know that Renee and Rob are available for any other follow-up questions from any of you. I just wanted to wrap it, and then we can get off the call.

I appreciate everybody’s time, I know this has run a little long. I just wanted to make sure that I came back to the headline message that while this is a long, multi-year effort, it is not a quarter to quarter story. I think the top line growth is ahead of our expectations three-quarters of the way through the year, and particularly this quarter. We are pleased, I just would emphasis that we are really pleased at some of the early results we are seeing from our turnaround action in the key markets. There is more work to be done, but we are gaining traction, so I feel good about that.

One of the things we wanted to let everybody know is that we intend to have an investor meeting and host an investor meeting in New York in February after we announce the year end close on February 15th. So investor relations will be getting you the details, but while it's a ways away, we want you to mark your calendars in case others are starting to plan. But February 15th, probably in the morning, Avon will be hosting an investor conference as we move into 2007. We are really trying to dive into more specificity and more visibility for you all, particularly as it relates to the representative value proposition, and more on the cost-out initiatives that Chuck started to talk about today.

So we look forward to see you all then, and I hope everybody has a good quarter. Thank you.

Operator

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

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Source: Avon Q3 2006 Earnings Call Transcript
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