Avon Products Q3 2007 Earnings Call Transcript

Oct.30.07 | About: Avon Products, (AVP)

Avon Products, Inc. (NYSE:AVP)

Q3 2007 Earnings Call

October 30, 2007 9:30 am ET

Executives

Andrea Jung - Chairman and Chief Executive Officer

Charles W. Cramb – Vice Chairman, Chief Finance and StrategyOfficer

Renee Johansen - Vice President of Investor Relations

Analysts

Philipe Gusen - Analyst

Wendy Nicholson - Citigroup

Lauren Lieberman - Lehman Brothers

Bill Schmitz - Deutsche Bank

Amy Low Chasen - Goldman Sachs

Connie Maneaty - BMO Capital Markets

Justin Hott - Bear Stearns

Christopher Ferrara - Merrill Lynch

Ali Dibadj - SanfordC. Bernstein

Nik Modi - UBS

Operator

Good morning. My name is MaryAnn and I will be your conference operatortoday. At this time, I would like to welcome everyone to Avon'sThird Quarter Earnings Conference Call. All lines have been placed on mute toprevent any background noise. After the speakers' remarks, there will be aquestion-and-answer session (Operator Instructions).

I will now turn the call over to your host, Andrea Jung. Ms. Jung, you maybegin your conference.

Andrea Jung

Thank you. Good morning, everyone. Thanks for joining us to discuss Avon'sthird quarter 2007 results. Since some of our remarks may includeforward-looking statements, I refer you to the cautionary statements in thismorning's press release. With me are Chuck Cramb, our CFO, and Renee Johansen,our Vice President of Investor Relations.

I'm just going to begin with my perspective on our third quarter performancebefore turning it over to Chuck for some additional comments. Because I knowyou've all read the press release, I'm not going to go through all the numbersagain in detail, but instead just provide some overall qualitative comments togive you a better understanding of where I believe we are at this point in theturn around.

Overall, we're extremely pleased with our results this quarter. EPS, as youread, was $0.32 per share compared with $0.19 per share in the prior-yearquarter, an increase of almost 70%. Most important for us at this juncture inthe turn around is that we continued to gain traction re-igniting the top line.

Revenue growth accelerated again this quarter, up 14%, on broad-basedstrength across the portfolio, with seven of our top 14 markets growing 20% ormore. Growth was fueled by strength in both beauty and active representatives.Beauty sales grew 16%; that's the fifth consecutive quarter of double-digitgrowth, with increases in all four major beauty categories.

Active representatives grew a very strong 10%, reflecting continued progresswith the implementation of initiatives to improve the Representative ValueProposition, or RVP, as we're calling it. Certainly we're very encouraged withhow rapidly the business has responded to the acceleration of our investment ingrowth.

Fueling our positive results again this quarter was a 44% increase inadvertising, with the lion share to support innovation in the color, skin care,and fragrance categories. After lagging the market in 2005, and 2006, our colorcategory is now posting consecutive mid-teens growth as we continue to rebrandthis category and infuse it with innovation.

The launch of a new clinical line in wrinkle corrector contributed to ourperformance in skin care. We also saw very positive early trends for a newultimate night cream and elixir, our next technology break-through, whichlaunches in the fourth quarter. And in fragrance, we saw growth at all pricepoints and we continue to benefit from celebrity and designer alliances withpositive early trends for the Christian Lacroix fragrances, which began sellingin late September in several markets.

As part of our advertising spend, we continued to invest in representativerecruiting advertising in the quarter. This includes a second slide in the United States, as well as recruitment advertisingin other high-priority markets, including Brazil,Columbia, and Russia.

Our investments in the quarter also included an incremental $37 million forinitiatives to improve the Representative Value Proposition. To driverepresentative earnings, we continue to invest in many of the programs thatwe've been talking to you about in recent months; the global rollout of salesleadership, targeted incentives for top producers and commission adjustments,and in the third quarter we also successfully executed a major business processchange with the move from a four-week to a three-week brochure selling cycle inCentral and Eastern Europe.

Increased brochure frequency is helping our representatives grow their salesand earnings, and I'll talk more about that impact of the change in the regionin a moment.

Against this backdrop of investments in advertising and RVP in the quarter,let me just highlight our performance in several of the key geographies. In North America, this was really a break-through quarter for the region.We posted 6% growth in both revenues and active representatives, and we wereextremely pleased to see that the extensive actions we've taken over a numberof quarters to improve the value proposition for our representatives aredelivering results.

Improvements to representative earnings through leadership re-indexing, freebrochures, and reduced fee programs has more than offset gas prices as well asother external economic headwinds. New online business tools are also making iteasier for our representatives to do business with us and we're seeing a directcorrelation between web-enablement and increased activity rates.

In addition to this progress with RVP, we're equally pleased with our beautyperformance in North America. Encouragingly thirdquarter beauty sales increased slightly ahead of overall sales as a result ofcontinued advertising plus strong merchandising overall.

So great progress on all fronts in North America,reflecting the culmination of many months of analytical work coupled with asignificant acceleration of investment in the key levers for growth in thebusiness.

Turning to Latin America, this region continues toproduce exceptional results. Beauty increased 22%, and active representativesgrew 11% in the quarter. Brazilturned in another stellar performance with revenue increasing over 30%. Beautyin Brazil grewin line with overall sales, with standout performances in all beautycategories.

Active representatives increased double digits, driven by strong fieldincentive programs as well as the new recruitment ads that began airing inSeptember. So we're seeing a very healthy balance in Brazilbetween productivity and order growth.

Overall, our bold moves over the past year in this market to gain share areclearly paying off. We also continue to make steady progress rebuilding fieldfundamentals in Mexicoin the quarter. Third-quarter revenue was flat with prior year, butimportantly, active representatives increased mid-single digits.

This business is stabilizing as we projected and we're seeing some healthyindicators of progress as we continue to move forward with the turn-around inthis still very profitable market.

Turning to Central and Eastern Europe, ourinvestments in growth are delivering positive results. Beauty was up 23%, withstrong performances in fragrance, personal care and color. Activerepresentatives in the region increased 17%, as we implemented a number ofmajor RVP programs guided by in-depth analytical work over a number of months.

I mentioned earlier that all of the markets in Central and Eastern Europe moved to a shorter selling cycle in the quarter. Overall, Ithink it's still early days in terms of understanding the full top-line impactof this change and it will probably take another quarter or so before we are atour full run rate.

We have already seen a healthy lift in revenues in those markets where we'vebeen able to complete training for our representatives on how to adjust theirselling behavior to match the new shorter cycle.

In Russiathe training will take slightly longer, just given the large number ofrepresentatives in that market and the country's vast geographic expanse. Thatsaid we were very pleased with the 25% revenue growth in Russiain the quarter in a highly competitive environment.

We're continuing to invest at a significant level in both advertising andRVP there; we've seen some early strong trends for the launch of our ChristianLacroix fragrance. And as I said, we've just started to run recruitmentadvertising. So, overall we feel very good about the progress in thishigh-growth market with more to come.

I also just want to comment briefly on our performance in Poland.Active representatives in Poland increased double digits in the third quarter,a clear trend line shift in this indicator, as a result of the shorter sellingcycle and other RVP efforts, also at the end of the quarter after someextensive analysis, we introduced a change to Poland's commission structure,which will increase the top commission band to 40% and this should furtherpositively impact the Representative Value Proposition in this market as we goforward.

Finally, turning to China,with revenue growth of 23% our business continues to perform strongly in thispriority market. Beauty increased in line with overall sales. Units sold were32% higher, active representatives were up 44% versus the prior year.

And now that we have a meaningful base of comparison, going forward we’llfocus on the percent change in active representatives in Chinaon a quarterly basis, as we do for all of our commercial business units, givingyou one consistent KPI across the entire company.

In the month of September, Avon Chinahad approximately 130,000 sales promoters who fit our definition of activerepresentatives. This number reflects a program that made it more advantageousfor representatives with small orders to delay their orders until October, soas a consequence, we expect the number of active representatives during Octoberto be closer to the 200,000 level, and this shift in orders had no significantimpact on revenues in either the third or the fourth quarters.

In terms of recruiting, we had 677,000 sales promoters in Chinaat the end of September, and we're continuing to fuel the pipeline, addingabout 40,000 sales promoters each month on a pretty steady basis. As weindicated, we've introduced and are now implementing a new policy to removeinactive representatives.

For the next period of time, as we clean up the inactive base, we expectremoval will roughly match additions, supporting our continued focus onbuilding ordering activity and also increasing productivity.

Lastly, in terms of the strength of our business model in China,I'm very pleased that our beauty boutiques are stable, and that the hybridmodel of beauty boutiques and sales promoters continues to give Avona competitive advantage.

Chinaremains a huge priority market for us going forward and we will continue toinvest in both the resources and the talent necessary for long-term success.

So, that's a snapshot of the performance of some of our key geographiesduring the third quarter. It was a strong quarter for us. Our investments inadvertising and RVP are accelerating growth across the portfolio.

Beauty and active representatives are growing double-digits as we continueto fuel the business and build a strong foundation of future sustainability. Weremain on track to achieve, as planned, a full-year advertising spending of$375 million, as well as an incremental investment of $100 million in RVP.

With this foundation in place, our analysis shows us that we will beapproaching the right level of investment spending to support sustainablegrowth over the long term.

Accordingly, our investments next year will grow roughly in line withrevenue growth, which means that we will see smaller increases across boththese dimensions as we move forward.

Our investment decisions will continue to be informed by detailed analytics.For example, in terms of our marketing investments, with two years of solidlearning under our belts, we now have a comprehensive understanding of mediapay backs by market, by category, and by media type.

And this is going to enable us to really fine tune our marketing investmentmix, targeting spender for even greater efficiency. And this same analyticalrigor is also being applied to our investments in RVP.

Of course we're going to continue to monitor our overall investment levelscarefully and remain prepared to adjust spending as necessary should marketconditions change, but for the short-term we feel very comfortable that we areapproaching the requisite level of spend to sustain competitive growth in ourmodel.

A more stabilized level of spending against advertising and RVP, based onanalytics, will be one factor in improving our operating margin next year. Atthe same time, savings from our restructuring program will continue to increasein 2008.

We will also see benefits from Strategic Sourcing and early benefits fromProduct Line Simplification.

In addition we will have lower cost to implement all of these programs, andgiven the combination of these factors we're confident that we can achieve anoperating margin in 2008 that approaches 2005's level, confirming the company'sprevious guidance.

So, these are some of my key takeaways in the quarter. As we come to the endof the second year of the turn around we feel great about the progress we'vemade against all aspects of the plan.

The rapid acceleration of the top line confirms that our decision to investahead of growth was the right one, the analytics have guided our investmentdecisions, these investments are paying back even ahead of my own expectations,and we will continue to become even more efficient with our spending goingforward.

Equally important, we're on track with our cost transformation efforts,providing the fuel for continued investment while also delivering marginimprovements next year, as planned.

So the road map for sustainability is in place. Our strategies are working.Our focus, as we close out 2007 and move into 2008, remains the continued boldand rapid implementation of our plans.

And as we said we're managing this business for the long term. We're usingthis opportunity to truly write Avon's business modelfor the future and deliver sustainable, profitable growth going forward.

So, that's my key summary this morning and I'll turn it over to Chuck nowwho will give you some additional perspective on the quarter. Chuck?

Chuck Cramb

Thank you, Andrea. Let me start off with a review of the third quarterP&L versus last year. Our revenue growth of 14% was broad-based. Half ofour top 14 markets grew revenue by over 20%.

Sales in the beauty category increased 16%, with each of the four categoriesin beauty growing. Our gross margin improved 160 basis points. This improvementreflects lower obsolescence expenses associated with our Product LineSimplification initiative.

Also, on a smaller scale, supply chain efficiencies contributed to helpoffset inflationary impacts on materials and labor. We strategically increasedour investments, in both advertising and the Representative Value Proposition.

We spent $29 million more on advertising in the quarter and an incremental$37 million dollars on RVP. We also had $12 million dollars of higher costs toimplement restructuring programs.

Together, these items increased our SG&A as a percent of revenue by morethan three full percentage points.

Despite this increased investment, our overall SG&A expenses were heldroughly flat with prior year as a percentage of sales. This resulted from ourzero overhead growth philosophy and the benefits of our various restructuringprograms as well as the favorable impact of the unmatched $21 million U.K. VAT keysettlement last year.

Our variable SG&A expenses, things like commissions, distribution, andshipping expense, grew in line with the yield. The net financial result was anoperating profit of $224 million dollars, which increased $56 million dollars,or 33%, over the third quarter in 2006.

The operating margin was 9.5% for the quarter. Below operating profit, netinterest expense increased as a result of higher interest rates and higherdebt. We had a favorable swing in foreign exchange, due primarily to unmatchedtransaction losses incurred in Venezuelain 2006.

Our tax rate of 33% for the quarter was significantly lower than the 41% wehad in 2006. This was primarily due to the unfavorable tax impact of foreignearnings repatriations during 2006. The 2007 rate is pretty much in line with,or even slightly higher than what we would expect on an ongoing basis.

For the third quarter our costs to implement restructuring initiativestotaled about $27 million dollars. This included costs for a major newinitiative to outsource a significant portion of our IT applicationsdevelopment and our IT applications maintenance work.

It also included spending for initiatives already under way. Examplesinclude our outsourcing of human resource delivery systems, the outsourcing offinancial transaction processing, and project deliver, our program to realignthe U.S.distribution network.

We are successfully executing our overall restructuring program that weannounced at the end of 2005. We expect to deliver annualized savings in excessof $300 million dollars upon full implementation of all programs. This includessavings of roughly $230 million dollars this year.

About $130 million dollars of that is incremental to what we realized in2006, when we had benefited by about $100 million dollars. The actionsimplemented to date resulted in savings of approximately $60 million dollars inthe third quarter of 2007.

Most of that was associated with de-layering. This compares to 2006, whenthe benefits in the quarter were approximately $35 million dollars. That meansan increase in benefits of $25 million. In both years, the largest contributorhas been de-layering.

Now, let's take a look at the progress of our two major strategicinitiatives, Product Line Simplification and Strategic Sourcing.

These fall outside of the original $500 million dollar restructuringprogram. We moved ahead on both initiatives in the quarter. We remain on trackwith PLS. We incurred very little costs in the quarter, but expect to see asignificant charge in the fourth quarter, as we finished the bulk of our PLSwork.

Our total costs to implement PLS in 2007 are now projected to substantiallyexceed $100 million dollars. As you might recall, the analyses are done firstat a market, and then a regional level. Recommendations are then reviewedacross regions and then globally to ensure that we're continuing to movetowards a harmonized global product line.

We're now essentially complete with the analysis and review process todetermine the optimal product line. We are now deeply involved in developingthe exit strategies for the products that will not be part of our improvedproduct assortment.

Our objective is to be operating with the optimal and most productiveproduct line as soon as we can.

This process includes determining the financial implications of each of theexits, and we have many exit options for each product, such as selling at adiscount, donations, liquidations, or destructions, and each has its ownfinancial implication.

Most of these exit decisions will be made in the next couple of months.Thus, we expect to see the significant charge for inventory obsolescence in thefourth quarter. So we're moving right along, and as I shared with you in ourFebruary meeting, we expect to deliver annualized benefits in excess of $200million dollars by the end of 2009.

We still anticipate some benefits of this program starting in the secondhalf of 2008, though they will not be large. We expect the benefits to continueto grow throughout 2009, reaching the annualized run rate of $200 million dollarsby the end of 2009. We should then deliver the full $200 million dollars plusin 2010.

We're beginning to see some results from our Strategic Sourcing initiative.We captured a small amount of benefit in the quarter, primarily in the areas ofpaper and logistics. Once a review wave is completed, it takes time to captureall of the targeted benefits.

New contracts need to be negotiated. Existing contracts have to be completedor canceled. So, the flow of benefits from SSI will look something like this.

The savings from SSI should grow over time, with benefits this year ofaround $15 million dollars. This expands to about 50% of the expected totalprogram benefits in 2008 and then we expect the benefit stream to continue togrow through 2009.

The annualized benefits from this initiative are projected to be in excessof $200 million dollars by the end of 2009, with a full-year benefit in 2010.

Now, I'd like to call some specific balance sheet and cash flow items toyour attention.

Our cash and cash equivalents totaled just over $800 million dollars. Thatcompared to $1.2 billion dollars at the end of 2006. The total debt hasincreased to $2.2 billion dollars, from $1.8 billion dollars at year-end. As aresult, our net debt has increased by close to $800 million dollars, primarilyin higher commercial paper borrowings.

Our total inventories totaled $1.2 billion dollars compared to $900 millionat year-end. Some of this higher level is attributable to normal seasonality aswell as a planned increase in inventory coverage, which did yield a sharpimprovement in order fill rates for representatives.

As we've discussed before, we do have a number of structural initiativesthat are expected to reduce inventory levels over the long term. Initiativessuch as our Product Line Simplification, enterprise resource planning,Strategic Sourcing, and a new sales and operations planning process.

Inventory reduction remains a significant opportunity across theorganization, and these initiatives will all fundamentally address this issue,and help us to not only achieve but also to sustain our targeted improvements.

Our net cash provided by operating activities was $63 million dollars throughnine months of 2007. This compares to net cash provided by operating activitiesof $439 million dollars in the same period last year.

Working capital, particularly for inventories, incentive compensationpayments over 2006 performance, and lower non-cash expenses, such asrestructuring accruals, account for most of the year-over-year variance, and weexpect fourth quarter cash flow provided by operations to be substantiallyhigher than in the corresponding 2006 quarter.

However, on a total-year basis, cash flow from operations will be somewhatlower than that of the full-year 2006. We continued to repurchase stock in thethird quarter, with our total for the quarter nearly $150 million dollars.

As of today, we have less the $150 million dollars left on theauthorization, which we began in late 2005. Our board earlier this monthapproved a new $2 billion dollar five-year authorization, which will start uponcompletion of the current program. Share repurchases continue to be an activecomponent of our overall cash management strategy.

To really highlight our operating performance this quarter, I'd summarize itas follows.

We had strong sales growth, particularly in the beauty category. Our grossmargin improved 160 basis points, due in large part to the absence ofsignificant PLS obsolescence. We significantly increased our investments inadvertising and Representative Value Proposition.

And along with increased costs to implement our restructuring, added over300 basis points of costs as a percent of revenues, yet we held our overallSG&A to the same percent of sales.

Despite inflation, our absolute period expenses were roughly flat, excludingthe impact of exchange. And restructuring benefits increased $25 million dollarsto $60 million dollars in the quarter. This resulted in an operating profitincrease of $56 million dollars, or 33%, and earnings per share of $0.32, upalmost 70% from last year.

Now I'll turn the call back to Andrea.

Andrea Jung

Okay, so thanks, Chuck. Again, as we just look at the quarter, it was a verysolid strong quarter. We feel good about the acceleration of the top line andthe investments that are paying off. The analytics are guiding our investmentdecision, which makes us feel very good about the margin improvement in 2008.

So, again, we're on track with strategies that I'm very confident areworking and feel very good at this point in the turn around. So, with that I'lljust have the operator open it up for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Philipe Gusen. Mr.Gusen, you may state your affiliation and then pose your question.

Philipe Gusen - Analyst

First one, obviously, is very strong results in Brazil.I've seen your ads on TV for eye mascara and Christian Lacroix. It is verycompelling ads, so congratulations on that effort.

The two questions I have for Brazil today is, are you back to theprofitability and sales levels that you saw when you peaked in that country?And number two, more from a strategic/competitive perspective, with so many newentrants coming into Brazil,and I'm referring now to more traditional vendors such as Unilever and L'Oreal.

Are you starting to see more challenges as it relates to the direct sellingchannel as we're starting to see more a build-out of the more traditionalretail formats the way we know them in the U.S.?

Andrea Jung

Okay. I'm just going to take each piece of this, Philipe. Good morning. Justin terms of profit, we're not going to give specific guidance or a discussionabout profit by country, but all I would just say is that the sales growth iscertainly there and this is a very profitable market for the region, and forthe company.

In terms of any impact or are we seeing challenges from sort of non-directsales, I just come back to, I think direct selling continues to be a verystrong channel in Brazil. And we're verypleased obviously, with our performance over this last year or so, when I thinkthe bold moves we have made to invest in both advertising and theRepresentative Value Proposition are clearly paying off in terms of share gain.

So I love Brazilbut I love the channel in Braziland I think we're doing all of the right things there.

Philipe Gusen - Analyst

Wonderful, my second question this morning, A.G. (CEO, Proctor & Gamble) mentioned that he has seen significantincreases in competitive spending in beauty care sector around the world and wehave seen some of that impact on the margins of Oriflame and Natura.

Have you seen any meaningful impact in terms of the people that you competewith in terms of them stepping up the competitive spending to kind of replicatesome of the great things that you guys are doing?

Andrea Jung

Philipe, I think that if I just go back to 2005 for a minute, the end of2005 when we announced the turn-around plan, I just go back to that thought interms of our analysis as we started the turn around that the competitive spendwas ramping up, and that would be from direct sellers as well as CPG companies.

And what the company had to do was just focus very, very intently on takingcosts out, restructuring the value chain, and fueling those levers that webelieved would return us to brand competitiveness and channel competitiveness.

If anything, I think, the returns on that investment have been better than Ieven thought they would be, particularly when you look at some of ourdeveloping and emerging markets in terms of the response and the payback onadvertising and these levers of RVP.

But as I said, we take the advertising and we ramp it up from $136 millionto $375 million in two years, and so I think, that we are more than wellpositioned, assuming that it’s a competitive category and it's a competitivechannel. And I think, what we've done and the programs that we have from a costtransformation point going forward from '08 to '10.

Chuck mentioned some of the run rates that we think the benefits willdeliver as we go out will allow us to continue to fuel this business at a verycompetitive level for this model and still achieve the sustainable marketgrowth. So I feel very good about these very accelerated levels that we're atnow, as you know, but we can really mine for efficiencies going forward.

Philipe Gusen - Analyst

Then moving on to web enablement, obviously making very good progress, theexample she has given in the past, with Turkeyin particular. In how many American markets right now do you allow your reps toorder as the other internet and how does it stack up versus your competitionbecause I think you're ahead of the competition by quite a margin there, no?

Chuck Cramb

Yes, I don't know the exact number, Philipe, but I do know that when we talkabout web enablement, it's well grounded in many of our markets. But our roll-outprogram, where we originally had an objective over the next two years to launchweb enablement tools throughout the top 25 markets, the appetite that we'vecreated in our business and the success of that, of those initial rollouts, hasactually moved us up to near 30 markets now.

So yes, it is a great tool, its generating better activity and participationand productivity of our reps, and you'll see us accelerate those rolloutprograms.

Philipe Gusen - Analyst

Great, and then my final question for you, Chuck, for the PLS charge in Q4,how much of that do you expect to be cash versus non-cash?

Chuck Cramb

It'll almost all be non-cash.

Philipe Gusen - Analyst

Okay, great. Thanks so much, Chuck and Andrea.

Chuck Cramb

Thanks, Philipe.

Operator

Your next question comes from the line of Wendy Nicholson. Ms. Nicholson,please state your affiliation, and then pose your question.

Wendy Nicholson - Citigroup

Hi, from Citigroup. My first question had to do with PLS and whether you cangive us a sense now that you made the decisions on what lines you're going tobe exiting, how much of that is in beauty versus non-beauty and whether weshould expect to see any sort of volatility or lumpiness, if you will, in yoursales growth, particularly in the back half of '08, as you start to implementPLS?

Or are you hoping that for everything you don't sell, because youdiscontinued it, you're just going to replace that with the sale of new productor something different?

Chuck Cramb

In terms of lumpiness, it is a program that we, I want to say moved intogradually, it is not a big bang type program. Its timing involved in terms ofhaving made the exit decisions, and how do we actually process those?

And to think about catalog timing, you've got four to six-month lead timesin terms of catalog layouts, merchandising, printing, pricing, so we don'texpect to see any significant volatility as we really phase into what I'm goingto call the optimal line decisions. What was the other part of the question,Wendy? I'm sorry.

Wendy Nicholson - Citigroup

Which product categories are most of that are going to be…?

Chuck Cramb

Oh, right. In terms of SKU counts, it's going to be heavier on thenon-beauty, but there will be a rationalization and harmonization of the beautyproducts, as well. But if you were just to try to look at overall counts, it'sa little bit heavier on non-beauty. But it really, we're not going to be takingthe maiden product lines or products out. It's really some of the things we doon the periphery which create issues in terms of merchandising, in terms ofproduct exposure, in terms of discounting activity.

Wendy Nicholson - Citigroup

And just as a quick follow up to that, has there hasn't obviously been anycommunication with the reps yet in terms of this is coming down the pike? Imean, the hope is that it's sort of a seamless transition in their eyes is,that right?

Chuck Cramb

It should be a transition and a phase, yes. In fact, the little bit we'vehad from representatives back and forth I know Andrea's talked to a few andwe're actually encouraged to move forward on this. It's one of these; I can domy job much better selling Avon products once yousimplify that product line.

Andrea Jung

I think the key that we're working on, which is going to take just a lot ofdetailed execution, is just the communications plan, Wendy. I think that theconcept of the, there's so many products here; give us a little bit less of aproduct line so that we can have simpler communication is well received. It'sjust about if you're going to discontinue that shade, please tell me thereplacement shade.

If you discontinue that SKU tell me the product from an optimized point ofview that has a similar benefit from a formula point of view or improved. Andas long as you give me that direct communication of what SKU I should berecommending as a replacement, then you'll help me make this very easy.

Wendy Nicholson - Citigroup

Wonderful, sounds great. Thank you.

Operator

Your next question comes from the line of Lauren Lieberman. Ms. Lieberman,please state your affiliation and then proceed with your question.

Lauren Lieberman - Lehman Brothers

Great, thanks. It's Lehman Brothers. We have two questions. The first, wasabout ZOG or NOG, and Chuck, you specifically mentioned both that the bulk ofrestructuring savings this quarter were from de-layering, but also that ZOG isreally what helped with the overall reported SG&A numbers. So did youactually achieve ZOG this quarter, ex- the de-layering, if it's possible tolook at it that way?

Chuck Cramb

No, because de-layering is one of the elements that helps contribute tohaving zero overhead growth. So when we look at it, we look at the periodexpense base that we call fixed, that's the roughly $2.5 billion dollars.

Lauren Lieberman - Lehman Brothers

Yes.

Chuck Cramb

And that, if we did nothing you'd have to assume that $2.5 billion dollars wouldgrow at least with inflation. So you then use all of the programs in terms oftrying to reduce and eliminate that inflation to hold that $2.5 billion at a$2.5 billion base at a go forward basis.

De-layering would be one of the elements that would be in there, but thereare a lot of things. Let me pick a simple one. If you think about, oh, whatwould be a good one, some of the outsourcing that we've done, that's anotherinitiative, we call restructuring but that's driven our costs down.

Move outside of restructuring opportunities, and you think about things like,well simple, travel and entertainment and conferences. What do you do in termsof your policy? We've tightened up on our policy in terms of class of flight.We've tightening up on our policies in terms of how much travel. So you attackeach one of your expense items with this idea of we've got to keep those costsdown.

To me, zero overhead growth, it's really a way of life. It's a way ofthinking about cost structure. It's a way of thinking about investing in thebusiness, where you spend your money. And the excitement at this company, andit's throughout the whole company, is gee whiz, for every $100,000 the companysaves in overhead costs, it has the opportunity to reinvest those to generatesales growth. And that has definitely taken off and that's where I think we'vereally succeeded within Avon.

Andrea Jung

It's become a verb here. I was with some general managers and the firstthing they say to Chuck is. We're zogging, Chuck, we're zogging, so now it's averb.

Lauren Lieberman - Lehman Brothers

If we fast-forward a year, though, when you've lapped the benefits from de-layeringbecause that is there's a part of that that you get that benefit once…

Chuck Cramb

Sure.

Lauren Lieberman - Lehman Brothers

…from having let people go, so with it, sounds like the answer is going tobe yes, so with the mind set you're seeing and with some of the results you'reseeing and the plans that are laid out for 12 months from now, do you think ZOGis now comfortably within your reach, once you've lapped the benefit from de-layering?

Chuck Cramb

I think so. We will make some conscious decisions sometimes what I callinvestment decisions that may take the numbers outside of an absolute zerooverhead growth. Also, it's something you cannot do forever, because there aretimes when you have to invest in infrastructure, particularly when you have astrong growth business.

But to me, the more important thing isn't whether the numbers absolutelybalance out or not, it's the attitude of all of our managers and all of ouremployees to really challenge every expense year in and year out and that getsyou to much greater overhead productivity than we've had in the past.

Lauren Lieberman - Lehman Brothers

Okay, that's great. Thank you.

Operator

Your next question comes from the line of Bill Schmitz. Mr. Schmitz, pleasestate your affiliation and then proceed with your question.

Bill Schmitz - Deutsche Bank

Hi, it's Deutsche Bank. Chuck, I know you're going to get angry with me onthis one, but if I do the math again on ZOG it looks like it didn’t work. Itwas up like 12% year-over-year and currency was only five. And so, am I doingsomething wrong?

Chuck Cramb

Yes, you're doing something wrong but I don't know what it is and I bet wecan't do it on the phone.

Bill Schmitz - Deutsche Bank

No, no, no. We can do follow up later, but I took your assumptions last timeand I walked through some of the stuff with Renee and it still looks like the fixedoverhead piece is up about 12% year-over-year.

Chuck Cramb

No, I don't think so. The only thing I think of is you've a miss onexchange, Bill.

Bill Schmitz - Deutsche Bank

Okay, and I took the instruction. Okay, that's fine. And then, Andrea, withthe change in the calendar in Central and Eastern Europein terms of frequency of campaigns, how long is the tail for the benefit fromthat?

Andrea Jung

Well you really get it for the first full year through the end of the thirdquarter '08.

Bill Schmitz - Deutsche Bank

Okay, got you, all right, thank you.

Operator

Your next question comes from the line of Amy Chasen. Ms. Chasen, pleasestate your affiliation and then proceed with your question.

Amy Chasen - Goldman Sachs

Goldman Sachs. Chuck, can you just talk a little bit about the decline ininventory and I'm assuming that that's not yet PLS kicking in and what thedrivers of that decline were and whether this is now the start of a sustainableperiod of inventory day declines or declines in inventory days?

Chuck Cramb

Amy, when I think about inventories, I guess, my position isn't so much howwe're declining, it's why haven't we been able to get greater traction. I haveto say that the inventory initiative here is taking longer than I originallythought it would.

It's more complex, really, than I anticipated in moving the inventoriesdown. And if you look at our numbers, they're actually up in terms of days andthat's because, I think, our first priority that we set as we went into thisyear and particularly went through the year, was to improve the service levelsto our representatives.

And we wanted to protect those as we were putting significant investmentsbehind RVP. Net result, there's been a significant increase in order fillrates, so that part of the program has paid off.

In terms of the inventories and what we've talked about in the past, itreally is a long-term fix. There are structural issues that really are going todrive the change. It's not going to be any short-term opportunities.

And those include our sales and order processing, I'm sorry, sales andoperational planning initiatives, ERP, SSI, PLS, all the acronyms. All of themhave an impact in terms of how we plan and build inventories.

I was asked a question recently, “Gee, Chuck, your inventory performancedoesn't seem to be moving as quickly as it did at Gillette. What do you thinkabout that?”

And thinking on it, I think our program at Avon willtake longer. It's more complex, because of some of the infrastructure things wehave to put in place. Also, our business model is more complex in terms of thenumber of SKUs that we operate with, the rapidity and the size of our newproduct cycle that we used to really create energy within the catalog.

And then the balance in terms of what we do from a third-party manufacturingpoint of view. So, am I frustrated by the progress to date? No, I really just,I think, I didn't really appreciate just how long it would take just incomplexity.

But at the same time I say that, the size of the prize I think can actuallybe greater here. So, I'm looking over the next three or four years to see us beable to gradually bring those inventories down, maybe three, four, five dayseach year. So that's how I feel about the inventory performance.

Amy Chasen - Goldman Sachs

Okay. Just so you know, we look at average inventory in the quarter and itwas actually down year-over-year.

Chuck Cramb

Due to two points in time, right?

Amy Chasen - Goldman Sachs

An average of the end of the quarter and the beginning of the quarter…

Chuck Cramb

Yes.

Amy Chasen - Goldman Sachs

Versus the year ago.

Chuck Cramb

Right.

Amy Chasen - Goldman Sachs

Anyway just, Chuck, last question. Now, given Andrea's comments about herconfidence and I assume it's your confidence as well in terms of how the turnaround is going and how it's proceeding and your comments about '08 and beingable to achieve that margin target.

Do you have any further thoughts on your willingness to potentially step upshare repurchase here?

Chuck Cramb

Gee, share repurchase is one of our cash management tools. I think, we havestepped it up pretty much this year. I think, we've spent almost $600 million dollarsfor the first nine months of the year. And we've got that new authorization for$2 billion dollars.

But really, it's going to be our cash flow that's going to help dictate justwhat the pace of repurchase will be. I've always said I'm not afraid to take ona little more debt and you've seen us take on a little more debt in terms ofbalancing the share repurchase program and that's the strategy going forward.

Amy Chasen - Goldman Sachs

Great, thanks.

Operator

Your next question comes from the line of Connie Maneaty. Ms. Maneaty,please state your affiliation and then proceed with your question.

Connie Maneaty - BMO Capital

Hi, it's Connie Maneaty at BMO Capital. I have a couple of questions, backto inventory. Do you have an optimal level of inventory in mind or an optimalnumber of days that you're targeting as a strategy?

Chuck Cramb

I think, if you think in terms of what I've said, which is taking four tofive days out over three to five years, we'd be talking somewhere in thevicinity of 15 to 20 days less than what we operate now, which should be in the80s.

Connie Maneaty - BMO Capital

And I think, I know the answer to this, but why do inventories seasonallypeak in the third quarter?

Chuck Cramb

Because of the size of our fourth quarter business and there is a seasonalbusiness flow at Avon.

Connie Maneaty - BMO Capital

Okay.

Chuck Cramb

Holiday giving.

Connie Maneaty - BMO Capital

On to PLS, what is the order of magnitude of the charge you think you'll berecording in the fourth quarter? Are the charges limited to the fourth quarteror will there be more in 2008?

And also, how much of the, what's the percentage decline in the number ofSKUs as the line gets simplified?

Chuck Cramb

Okay. That's a lot of questions. In terms of PLS and the overall charge, allwe've said we have to make the decisions on what our exit strategies are andwe're making those now, and until you make the decision, you can't book acharge.

What all we know right now is that this year in total, the inventory chargewill be substantially higher than $100 million dollars and through nine months,we booked about, I think in terms of just the obsolescence piece it's about $68million dollars.

But I can't give you anything more detailed than that, because I reallydon't know until we make the decisions on how we're going to exit.

In terms of the charges in the future, there may be some minor chargesflowing into 2008, but we think we'll have the bulk of it behind us with thedecision flow that we're looking at over the next couple of months.

But that doesn't mean to say there won't be some refinements and somefurther charges but I don't expect them to be substantial. In terms of the SKUsversus where we are today, we think we'll run the business and this is, itvaries by market and there's some wild swings market by market, but we thinkthat the number of SKUs, in terms of reduction for running the business, onaverage, on a market by market basis, will be in the 20% range, with some realoutliers that have a lot lower percentages, and some that have a lot higher,but in general, around 20%.

Connie Maneaty - BMO Capital

Just to clarify, that means the SKU reductions on average would be about20%?

Chuck Cramb

On average, yes.

Connie Maneaty - BMO Capital

Okay. If I could ask a question about China,you mentioned that for the next period, as you weed out the inactive reps,they're pretty much going to offset the new recruits.

How many months or quarters, do you think that will last?

Andrea Jung

It is a little hard to tell, but I think certainly through the beginningpart of the fourth quarter and the beginning part of 2008. What I think youshould focus on is that the pipeline continues to be strong and we're verypleased that we have this stabilized approximate 40,000 in the flow.

We continue to run the recruiting advertising and the interest in joining Avonis very strong, so that's a very nice, solid number. The match of removals isas we kind of implement this removal policy after the large inflow that webrought in, so this is something that I would say for the next couple ofquarters.

Chuck Cramb

Connie, the number that you should pay the most attention to probably is theaverage active reps that we'll be reporting, because that really gives you themetric year-on-year.

Connie Maneaty - BMO Capital

Okay. Thank you very much.

Operator

Your next question comes from the line of Justin Hott, Mr. Hott, pleasestate your affiliation and then proceed with your question.

Justin Hott - Bear Stearns

Bear Stearns. Can we talk a little bit more on China,the switchover, I guess, between unit growth and sales growth this quarter?

Andrea Jung

Yes, in terms of what?

Justin Hott - Bear Stearns

I believe sales units grew a lot more than sales and I think it was theother way the previous quarter?

Andrea Jung

Mix, Justin. It really was about very strong, very, very strong categoryperformances, other than skin care was strong but the others were much strongerand when you look at that mix, that's really what did it.

Justin Hott - Bear Stearns

And Andrea, as we think about what's going on in Mexicoversus what's going on in the U.S.,in the U.S.,we've seen a lot of, we've seen strong rep growth for the last couple ofquarters, which is leading the sales, growing in line with rep growth.

In Mexico,we're starting to see the rep growth come back. Is there some sort of playbookhere that we should be really paying attention to that the reps come back firstand then really the sales start to accelerate above the rep growth and that'swhat we should expect from Mexico?

Andrea Jung

Yeah. I wouldn't look at it exactly in terms of the same number of quarters,but the thought is correct. It's a healthy indicator, and it's the firstindicator that we've been spending a tremendous amount of time on now for acouple of years now, as you know.

We're really focusing on the field fundamentals and this is a very healthycorrect fundamental that's driving the rep growth up to single digits. Therevenues, which are stable, is exactly, what we said they would be. We'repleased that it's the second quarter of stable revenues and we do haveproductivity, if you would, lagging rep growth.

But I think, just forgetting about any kind of guidance on exactly whichquarter, the thought is right that we continue to do the right things, the repgrowth is healthy and Mexicois on a good road in terms of the turn around.

Justin Hott - Bear Stearns

Do you start your advertising, now that the fundamentals are fixed, does theadvertising growth start to kick in or has that been something we've beenseeing continuously?

Andrea Jung

Yeah, I think the thought here was you don't want to investment a tremendousamount in brand advertising until the field fundamentals are right, soobviously the majority of the advertising in Latin Americahas been going to Braziland Columbia as it should becausethe field fundamentals are so strong.

But over time again, the playbook is not the wrong thought in terms ofstabilized representative growth, investment in the Rev Value Proposition,which is your first course of order, and then obviously brand competitiveness,which is an opportunity in that market.

I mean, this is still a very profitable market for us and I think, when youlook at Latin America in general, as I look at it, we've had justquarter-after-quarter of outstanding growth with a flat or declining Mexico fora couple of years.

So, when Mexico turns as it relates to the top line with the kind of profitit generates and it's not a small market, that's a very good thing for LatinAmerica, which is already good to begin with without it.

Justin Hott - Bear Stearns

As we go on to the fourth quarter with some high-priced initiatives, and Iguess coming into the system, and the U.S.consumer's showing some weakness, do you still feel comfortable about thecompany's right to price and ability to gain pricing coming up?

Andrea Jung

Yes, I think that we've been very balanced. This has not have been about a180-degree shift to Elixir and Christian Lacroix. I think, we are, have ouroffering is really broadly based across all tiers and that is why I think,we're really beginning to win beauty market share.

I'm very pleased that, in spite of the environment, just about across theboard the reaction to the $54 price points and the $32 price points are verystrong, again developed markets or emerging markets. But at the same time, Ithink, we've gotten a very well balanced portfolio with affordability and Ithink that that bodes well for the pricing tier.

Chuck Cramb

I also think as -- I think about it, that right to price is supported notjust by pricing but by the technology and innovation we're putting in theproducts, so when you look at Elixir and the promise that it has, whether it'sin the delivery system or in the contents, that creates that opportunity.

And even in some of the endorsement areas on the fragrances, there's anadditional value added to it and that helps support that pricing right.

Andrea Jung

It's still a small part of the portfolio. If you took a look at absoluterevenue, the lion share of our business is not being sold at those price points. But I think it does create the leadingtechnology thoughts as well as the image enhancements.

Justin Hott - Bear Stearns

Thanks, Andrea. One last question. Can you talk about something we heardfrom, we heard out in Dallas a couple of months ago, about how maybe Avon hasswitched the organization more toward understanding the advertising towardbecoming a multi-level organization.

Can you talk a little bit about that and maybe how "HelloTomorrow" ties into that and maybe what else you have going on in thatrespect?

Andrea Jung

Say that again? I‘m sorry.

Justin Hott - Bear Stearns

Advertising more toward being a multi-level organization as opposed to justputting it behind the products? And obviously I would assume "HelloTomorrow's" a big part of it. Can you talk...

Chuck Cramb

Are you talking about…

Andrea Jung

Okay. I think that we still have a huge part of the increase over thestepped-up increase has been about brand competitiveness and this is not aboutan either or.

This has been about, I think, a really healthy balance, we have been verypleased with the response to representatives, recruiting advertising, and thepay backs on those in the handful of markets that we've begun to do that in2007, and that will continue in 2008.

But we're not walking away by any stretch from the brand advertising, whichis the lion share of the $375 million.

Justin Hott - Bear Stearns

And your ability to make more money easier, to make more money and easier,more initiatives on the way?

Andrea Jung

In terms of multi-level?

Justin Hott - Bear Stearns

In terms of anything for the rep where they can make more money with puttingless time into the business.

Andrea Jung

Yes, I mean, I just would say, and I just go back to the break throughquarter that I think we had in North America, where you saw, again, revenues,active reps and beauty all growing very much in line, and I think that speaksto months of analytical work that really gave us the understanding of theaccelerators of growth, both on the brand side as well as the channel side, andthe pay backs.

And the headline here is, that, look,gas prices are high, they've been high, and that was the one leading activitydepressor that we were seeing that we have more than contracted with theability to give them more tools to open stores or reach more countries and thatincludes E-rep tools so, that again, technology can help them reach morecustomers.

And then one specific one would be if, because in the past, they werepulling back on brochures or not driving to see customers, because of the majorchanges we met, we have made that we've initiated, the targeted brochures thatwere free, are actually one great thing that I've been looking at is that afterthey get free brochures, the representatives, in fact, are seeing such impactin pay back from that that they're buying more.

And those who were given free brochures in some of our incentives areactually purchasing more now that they've seen the impact of what it does, whatit helps when the company helps them go out and reach more customers. So Ithink this rep economic switch, where we've been able to increase their valueproposition, is really very sustainable.

Justin Hott - Bear Stearns

Thanks for answering all my questions.

Andrea Jung

Okay.

Operator

Your next question comes from the line of Chris Ferrara. Sir, please stateyour affiliation and then proceed with your question.

Chris Ferrara - Merrill Lynch

Hi, it's Merrill Lynch. Just wanted to talk a little bit about advertising.I guess, last quarter it seemed like you guys were saying that you weren'treally near, or didn't seem to be near the point where you didn't need toincrease spending any more.

Now this quarter, you're saying that it looks like ads and RVP will growwith sales and I'm just wondering, I understand that your analytics areprobably a discounted cash flow of what you're seeing going forward, but isthere any way to squeeze into layman's terms what the inflection point is?Andwhere you're seeing a difference in what your analytics are saying that tellsthat you that '08 doesn't need to see incremental spend can as a percentage ofsales?

Andrea Jung

Yes, Chris. I just want to go back and say what we said in the secondquarter. I think, we saw a very big ramp-up in the first half of the year, 70%,80%, and while it's still high, and we feel good about that. The total yearaverage is 50%, so there's obviously a little bit less of an increment year-on-yearin the second half of '07 versus the first half of '07.

One of the things that we're really seeing and I think, I mentioned this, isthat. I'll just use a couple of examples but we've learned so much about mixefficiency, by country, by category, and by media type, so in China, forinstance, where we spend more in advertising and skin care. I think that we'rereaching, not exactly there, but reaching more of a saturation point than weare in color, where our business is very good but we haven't advertised verymuch in that country, so we're seeing very, very high paybacks there.

We're seeing the difference in paybacks on a 30-second spot versus a15-second spot and in some parts of China15-second spots are very, very effective, great paybacks obviously, and we canget more penetration that way. So it's going to inform and guide reallocationwhere we don't think we'll lose anything but we'll, in fact, be able to have abetter effectiveness.

In the U.S.,again we're looking at everything and so the categories, reallocating category,higher skin care paybacks and color paybacks, rep advertising, very highpaybacks because we haven't done much that yet, and so we've done it now forthe second round, so it's allowing us to reallocate.

So I feel good about the fact that this concept of near scale and growingapproximately in line with revenues, on top of this $375 million dollars level,I think that we can mine for efficiency and be very effective.

Chris Ferrara - Merrill Lynch

Great. Thank you.

Andrea Jung

Is that helpful?

Chris Ferrara - Merrill Lynch

Yeah, that was helpful. Thank you. I also wanted to ask you about something,I guess it is somewhat intuitive, right? So why does rep growth lead salesgrowth? And I guess, the idea is what, someone gets into the business, but Ijust, I was hoping you could explain a little bit better.

Is it, I guess when someone comes into the business what drives them beingmarked as an active rep is them actually accelerating their sales or actuallybuying product, right? So can you just walk through the process of how the repgets into the business, when rep count runs, and then eventually when salesrun?

Andrea Jung

Well, I was going to answer this slightly differently because that's a verycomplicated, that's a long, it's just the process of recruiting and thenproductivity, but the way I would look at the question about why overtime in aplay book, rep growth should be followed by revenue growth.

I think, you can see instances in the past where you can have higher salesthan rep growth and a lot of that is driven by marketing mix. A lot of that canbe about timing of a promotion, a very strong or in a given quarter, launch,and those things have some unevenness.

One thing that, I think, would be true would be that when you havefundamental growth in reps, and you've got strong field fundamentals. And agood morale in your sales force, again, that stability usually has a very tightlink with the health of your business.

So that's why, when we look at something like several quarters now, in theUnited States, not surprised that the revenues are now matching rep growth.Same thing down the road in any of the markets and that's why the focus onfield fundamentals and the representative value proposition has been such theheart of our business model.

Chris Ferrara - Merrill Lynch

So is it an efficiency thing? Is it that you get reps into the business andwhen they first show up in your new rep count that the sales aren't necessarilythere yet and you wait for them to begin to order more? Is that basically it?

Andrea Jung

I think that there is, obviously you've got much more productivity andlongevity with reps who are non-new. Obviously, there's focus on newrepresentatives, but it's once you've been here, length of association, pastsix campaigns or a year, whatever it is, given by market, you see dramaticproductivity changes, and obviously much lower turnover, etcetera, oncerepresentatives get into the system. So there is that lag time when you're new.

Chris Ferrara - Merrill Lynch

Got it and just one other thing, Chuck, any chance you can give what theimpact of currency was on your operating income?

Chuck Cramb

It's less than the impact on, no, I'd rather not do that off the top of myhead. We kind of prorate it on the straight exchange movement, but because ofthe dollar-based costs, which tend to be a bit higher, it's probably notterribly different from the sales impact.

Chris Ferrara - Merrill Lynch

Got it, thanks a lot, guys.

Operator

Your next question comes from the line of Ali Dibadj. Mr. Dibadj, pleasestate your affiliation and then proceed with your question.

Ali Dibadj - SanfordBernstein

Hi, guys. I'm from Sanford Bernstein. A couple of questions, one, I justreally quickly wanted to go back to one of previous questions around notaccelerating RVP and advertising spend ahead of sales. So you're expectingthen, and your analytics suggested it sounds like that you have enough to haveoptimized your spend and to not increase it, and not have an impact on your topline? Is that a fair statement?

Andrea Jung

Yes.

Ali Dibadj - SanfordBernstein

Yes?

Andrea Jung

Yes.

Ali Dibadj - SanfordBernstein

Okay, okay. interesting. Okay. The second thing is around just operatingmargin. It looks like it was roughly 100 basis points lower than what's impliedby consensus, and certainly implied by us. We, part of that to us is SSI.

Want to understand the speed of SSI, because it feels it's a little bitslower, in fact it is a little bit slower than in my experiences and I know inChuck's experience, as well likely, and I'm grappling with we're in aturn-around, it's been about two years now, what we've substantially seen isessentially de-layering of bunch of people whose salary, fringe and benefitsare roughly just under $50,000.

And so I'm just trying to grapple with what the progress is towards thisgoal of reaching 2005 numbers here, particularly SSI, I guess, because thatfeels a little bit lighter?

Chuck Cramb

Well, let me talk about SSI first but then let me talk about margins second.In terms of SSI, that was not in the original scope of activities when we firststarted this turn around, and that only has, I'm going to say, become of agetowards the end of last year in terms of an idea that is has now grown into aprogram.

The $15-odd million dollars that we quoted for this year, when you thinkabout SSI you also have to think about, hey, most of it is going to be inmaterials, it goes into product costs. You may save money, but you don't get ituntil the following year because of inventory builds. Also you save money onthings that aren't necessarily a direct expense in terms of capital items.

I think the pace that we've projected for ourselves to achieve better than$200 million dollars by the end of 2009, which means run rate 2010, is anappropriate objective for Avon in terms of what we do from a materials point ofview and what we do from in-directs.

I think in terms of the over-all margin, in terms of approaching 2005, yes,think in terms of the Rep Value Proposition investments and the advertising,those are substantial step-ups, which deteriorated margin, both in 2006 to2007. However, as we look forward, the analytics say that more or less increasingin line with sales give or take that we can do things to increase oureffectiveness and the mix of those, the components of both of those, RVP andadvertising investments, that is the way to go forward.

I think there are benefits coming in that are substantial in 2008 fromcontinuous restructuring activity, and initially you saw that SSI will have asignificant step-up. The other piece is the costs that we incur to implementour restructuring programs, the costs we incur for PLS, those will besubstantially less in 2008.

And then that whole mentality about holding those overhead, period overheador fixed overhead growth down, the zero overhead growth mentality, they allcontribute to a profile that gives us pretty good confidence that we shouldstart to approach the '05 levels in '08.

Ali Dibadj - SanfordBernstein

Okay, all right. A couple of questions, just switching gears a little bitabout China, one is just doing quick math on the number of sales promoters thataren't going to be there going forward, if you're going to remove them, if youlook back between 2006 numbers and current numbers, roughly it looks like 30%or 40% of the sales promoters that originally signed up didn't sell anythingand are being removed over the past year.

Can you give us a sense of how is that versus your expectations,particularly given that, I think, that the model in China is much more of afull-time job than it is elsewhere in the world, how should we think about that30% or 40% number broadly speaking, and how is it versus your expectations?

Andrea Jung

Well, I think, that one thing that probably exceeded our expectations wasjust and continues to be the pipelinein, and so the number, by anybody's standards, of having so close to 700,000 onstaff, is a great number. The focus though, is on activity, and that's why wewant everybody to focus on the growth in active reps year-on-year, now that wehave this meaningful base.

I think that the removal policy is the right one. And I think that again,given that number and given the focus on productivity, I think much more sothis is what we want to measure and can give us, obviously the meaningfulgrowth that we expect going forward.

So it's the right removal policy and the number probably on the absolute. Idon't think we would have expected to have that many sales promoters, eventhough we always knew it was going to be a good opportunity, it's beenextremely encouraging how many women want to join the Avonopportunity in China.

Ali Dibadj - SanfordBernstein

And so again, was it your expectation that you'd lose more than a third overthe year or did you have no sense? I'm just trying to get a feel for that,percentage-wise.

Andrea Jung

I think we're pretty much in line with where we thought we would be.

Ali Dibadj - SanfordBernstein

Okay, okay. Last question again about Chinais just around the fact that 80% of your sales, it sounds like are fromnon-urban areas, which suggests that less penetration obviously in the urbanareas. How much of that is related to retail infrastructure in the urban areas?

Kind of going back to one of the questions earlier on, as retailinfrastructure gets blown out in some of these emerging markets how does thataffect you? And I'm just looking at the 80% number being from rural Chinaas possibly an indication of that. How do you think about that going forward?

Andrea Jung

Well, I think, I mean it's obviously not inconsistent with the Avonmodel in emerging markets. I think we would have higher penetration in Russia,in all the eastern-time zones, than a lot of people who are dependent on theretail infrastructure in St. Petersburgand Moscow.

So I think the thought speaks to the strength of the direct selling marketand the direct selling model in emerging markets where, as long as you believe,which we do, that eyes wide open that there will be continued retailinfrastructure growth outside top two cities, top four cities.

I think take Brazil, take Venezuela, take Columbia, take any of our go tomarkets that are 50 years plus that are developing where you started theselarge markets, but our ability to still, I think, be ahead of retailinfrastructure growth when you have that much distribution and penetrationacross all the parts of a geography, is what makes our model strong in thesekind of markets.

So I think there is going to be, I read what you read, about how many moreWal-Marts or how many more big box stores are going to be in China to the top50 cities instead of the top 20 cities, but you're still talking about hundredsof towns and villages that, whether it's China or it's Russia that Avonservices because of the model.

Ali Dibadj - SanfordBernstein

Okay, thanks for your answers, very helpful. Thanks.

Andrea Jung

Okay, I think we have time for one more question. I know you have a busymorning.

Operator

Your next question comes from the line of Nik Modi. Mr. Modi, please stateyour affiliation and then proceed with your question.

Nik Modi - UBS

Thanks, UBS. Good morning, just two quick questions for me, one on the adsfor the recruitment. Can you just give us some texture on the velocity goingforward into the fourth quarter and maybe in '08?

And then the second question is, in Poland with the compensation changes atthe higher end do you plan to use that strategy in any other markets goingforward and would that be part of RVP or would that be incremental? Thanks.

Andrea Jung

In terms of the actual recruitment, fourth quarter advertising, if it'sinclusive in our $375 million projection, does include recruiting advertisingin some key markets, continuation in the region in the U.S., Russia, Columbia,Brazil, so we're pleased about that.

In terms of 2008, 2008 will also include recruiting advertising. We'reseeing good paybacks and as I said that will be one piece of the analyticsinforming us exactly whether it's a recruiting advertising or a color cosmeticadvertising, and where to put the money and that would be a geographic questionas well, or be answered by the analytics. But we feel very good about net-netwhere recruiting advertising is coming out and how it is paying back.

Poland, yes,we are introducing as you know, we introduced at the end of this quarter achange to the commission top rate. We also did it in Hungary.We really started with Central Europe. And again, it's atop-rate change, which is a big motivator and makes us very competitive, andwe'll continue to evaluate that. It came with a tremendous amount of analysis.

I think we started talking about it probably last February when we talkedabout everybody about one aspect of RVP would be where necessary, or where wewant to be competitive, commission rate changes. And that may be something aswe learn through and continue to evaluate Eastern Europeas an opportunity, but at this point it is just those two markets.

Nik Modi - UBS

And one last question, Andrea. You had very good follow through on repgrowth to revenue growth this quarter and this quarter's rep growth wasobviously very nice. Do you expect a similar type of follow through into thefourth quarter or is there something we should be aware of that could perhapschange that dynamic?

Andrea Jung

Well, in a no-guidance environment all I would say, Nik, is that thisturn-around is gaining traction. I am very pleased with beauty sales and thechannel health with the accelerated metrics, and so we feel very good. Okay.

Nik Modi - UBS

Okay. Thank you.

Andrea Jung

Okay. So that's it and if you have any other questions, just follow up withIR and Renee and the team will be there today. So thanks, everybody for yoursupport and we'll talk to you soon. Bye-bye.

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