Avon Products Q3 2007 Earnings Call Transcript

Avon Products, Inc. (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 Strategy Officer

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 - Sanford C. Bernstein

Nik Modi - UBS

Presentation

Operator

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

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

Andrea Jung

Thank you. Good morning, everyone. Thanks for joining us to discuss Avon's third quarter 2007 results. Since some of our remarks may include forward-looking statements, I refer you to the cautionary statements in this morning'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 performance before turning it over to Chuck for some additional comments. Because I know you've all read the press release, I'm not going to go through all the numbers again in detail, but instead just provide some overall qualitative comments to give you a better understanding of where I believe we are at this point in the turn around.

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

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

Active representatives grew a very strong 10%, reflecting continued progress with the implementation of initiatives to improve the Representative Value Proposition, or RVP, as we're calling it. Certainly we're very encouraged with how rapidly the business has responded to the acceleration of our investment in growth.

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

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

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

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

Increased brochure frequency is helping our representatives grow their sales and earnings, and I'll talk more about that impact of the change in the region in 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 were extremely pleased to see that the extensive actions we've taken over a number of quarters to improve the value proposition for our representatives are delivering results.

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

In addition to this progress with RVP, we're equally pleased with our beauty performance in North America. Encouragingly third quarter beauty sales increased slightly ahead of overall sales as a result of continued 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 a significant acceleration of investment in the key levers for growth in the business.

Turning to Latin America, this region continues to produce exceptional results. Beauty increased 22%, and active representatives grew 11% in the quarter. Brazil turned in another stellar performance with revenue increasing over 30%. Beauty in Brazil grew in line with overall sales, with standout performances in all beauty categories.

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

Overall, our bold moves over the past year in this market to gain share are clearly paying off. We also continue to make steady progress rebuilding field fundamentals in Mexico in the quarter. Third-quarter revenue was flat with prior year, but importantly, active representatives increased mid-single digits.

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

Turning to Central and Eastern Europe, our investments in growth are delivering positive results. Beauty was up 23%, with strong performances in fragrance, personal care and color. Active representatives in the region increased 17%, as we implemented a number of major 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, I think it's still early days in terms of understanding the full top-line impact of this change and it will probably take another quarter or so before we are at our full run rate.

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

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

We're continuing to invest at a significant level in both advertising and RVP there; we've seen some early strong trends for the launch of our Christian Lacroix fragrance. And as I said, we've just started to run recruitment advertising. So, overall we feel very good about the progress in this high-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 selling cycle and other RVP efforts, also at the end of the quarter after some extensive analysis, we introduced a change to Poland's commission structure, which will increase the top commission band to 40% and this should further positively impact the Representative Value Proposition in this market as we go forward.

Finally, turning to China, with revenue growth of 23% our business continues to perform strongly in this priority market. Beauty increased in line with overall sales. Units sold were 32% higher, active representatives were up 44% versus the prior year.

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

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

In terms of recruiting, we had 677,000 sales promoters in China at the end of September, and we're continuing to fuel the pipeline, adding about 40,000 sales promoters each month on a pretty steady basis. As we indicated, we've introduced and are now implementing a new policy to remove inactive representatives.

For the next period of time, as we clean up the inactive base, we expect removal will roughly match additions, supporting our continued focus on building 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 hybrid model of beauty boutiques and sales promoters continues to give Avon a competitive advantage.

China remains a huge priority market for us going forward and we will continue to invest 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 geographies during the third quarter. It was a strong quarter for us. Our investments in advertising and RVP are accelerating growth across the portfolio.

Beauty and active representatives are growing double-digits as we continue to fuel the business and build a strong foundation of future sustainability. We remain 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 be approaching the right level of investment spending to support sustainable growth over the long term.

Accordingly, our investments next year will grow roughly in line with revenue growth, which means that we will see smaller increases across both these 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 solid learning under our belts, we now have a comprehensive understanding of media pay backs by market, by category, and by media type.

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

Of course we're going to continue to monitor our overall investment levels carefully and remain prepared to adjust spending as necessary should market conditions change, but for the short-term we feel very comfortable that we are approaching the requisite level of spend to sustain competitive growth in our model.

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

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

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

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

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

Equally important, we're on track with our cost transformation efforts, providing the fuel for continued investment while also delivering margin improvements 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 bold and rapid implementation of our plans.

And as we said we're managing this business for the long term. We're using this opportunity to truly write Avon's business model for 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 now who 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 quarter P&L versus last year. Our revenue growth of 14% was broad-based. Half of our top 14 markets grew revenue by over 20%.

Sales in the beauty category increased 16%, with each of the four categories in beauty growing. Our gross margin improved 160 basis points. This improvement reflects lower obsolescence expenses associated with our Product Line Simplification initiative.

Also, on a smaller scale, supply chain efficiencies contributed to help offset inflationary impacts on materials and labor. We strategically increased our 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 to implement restructuring programs.

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

Despite this increased investment, our overall SG&A expenses were held roughly flat with prior year as a percentage of sales. This resulted from our zero overhead growth philosophy and the benefits of our various restructuring programs as well as the favorable impact of the unmatched $21 million U.K. VAT key settlement last year.

Our variable SG&A expenses, things like commissions, distribution, and shipping expense, grew in line with the yield. The net financial result was an operating 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, net interest expense increased as a result of higher interest rates and higher debt. We had a favorable swing in foreign exchange, due primarily to unmatched transaction losses incurred in Venezuela in 2006.

Our tax rate of 33% for the quarter was significantly lower than the 41% we had in 2006. This was primarily due to the unfavorable tax impact of foreign earnings 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 initiatives totaled about $27 million dollars. This included costs for a major new initiative to outsource a significant portion of our IT applications development and our IT applications maintenance work.

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

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

About $130 million dollars of that is incremental to what we realized in 2006, when we had benefited by about $100 million dollars. The actions implemented to date resulted in savings of approximately $60 million dollars in the third quarter of 2007.

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

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

These fall outside of the original $500 million dollar restructuring program. We moved ahead on both initiatives in the quarter. We remain on track with PLS. We incurred very little costs in the quarter, but expect to see a significant charge in the fourth quarter, as we finished the bulk of our PLS work.

Our total costs to implement PLS in 2007 are now projected to substantially exceed $100 million dollars. As you might recall, the analyses are done first at a market, and then a regional level. Recommendations are then reviewed across regions and then globally to ensure that we're continuing to move towards a harmonized global product line.

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

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

This process includes determining the financial implications of each of the exits, and we have many exit options for each product, such as selling at a discount, donations, liquidations, or destructions, and each has its own financial 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 the fourth quarter. So we're moving right along, and as I shared with you in our February meeting, we expect to deliver annualized benefits in excess of $200 million dollars by the end of 2009.

We still anticipate some benefits of this program starting in the second half of 2008, though they will not be large. We expect the benefits to continue to grow throughout 2009, reaching the annualized run rate of $200 million dollars by the end of 2009. We should then deliver the full $200 million dollars plus in 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 of paper and logistics. Once a review wave is completed, it takes time to capture all of the targeted benefits.

New contracts need to be negotiated. Existing contracts have to be completed or 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 of around $15 million dollars. This expands to about 50% of the expected total program benefits in 2008 and then we expect the benefit stream to continue to grow through 2009.

The annualized benefits from this initiative are projected to be in excess of $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 to your attention.

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

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

As we've discussed before, we do have a number of structural initiatives that are expected to reduce inventory levels over the long term. Initiatives such 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 the organization, 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 through nine months of 2007. This compares to net cash provided by operating activities of $439 million dollars in the same period last year.

Working capital, particularly for inventories, incentive compensation payments over 2006 performance, and lower non-cash expenses, such as restructuring accruals, account for most of the year-over-year variance, and we expect fourth quarter cash flow provided by operations to be substantially higher than in the corresponding 2006 quarter.

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

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

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

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

And along with increased costs to implement our restructuring, added over 300 basis points of costs as a percent of revenues, yet we held our overall SG&A to the same percent of sales.

Despite inflation, our absolute period expenses were roughly flat, excluding the impact of exchange. And restructuring benefits increased $25 million dollars to $60 million dollars in the quarter. This resulted in an operating profit increase of $56 million dollars, or 33%, and earnings per share of $0.32, up almost 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 very solid strong quarter. We feel good about the acceleration of the top line and the investments that are paying off. The analytics are guiding our investment decision, 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 are working and feel very good at this point in the turn around. So, with that I'll just 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 very compelling ads, so congratulations on that effort.

The two questions I have for Brazil today is, are you back to the profitability and sales levels that you saw when you peaked in that country? And number two, more from a strategic/competitive perspective, with so many new entrants 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 selling channel as we're starting to see more a build-out of the more traditional retail 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. Just in terms of profit, we're not going to give specific guidance or a discussion about profit by country, but all I would just say is that the sales growth is certainly there and this is a very profitable market for the region, and for the company.

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

So I love Brazil but I love the channel in Brazil and 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 significant increases in competitive spending in beauty care sector around the world and we have 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 compete with in terms of them stepping up the competitive spending to kind of replicate some 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 of 2005 when we announced the turn-around plan, I just go back to that thought in terms of our analysis as we started the turn around that the competitive spend was 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 taking costs out, restructuring the value chain, and fueling those levers that we believed would return us to brand competitiveness and channel competitiveness.

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

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

Chuck mentioned some of the run rates that we think the benefits will deliver as we go out will allow us to continue to fuel this business at a very competitive level for this model and still achieve the sustainable market growth. So I feel very good about these very accelerated levels that we're at now, 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, the example she has given in the past, with Turkey in particular. In how many American markets right now do you allow your reps to order as the other internet and how does it stack up versus your competition because 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 talk about web enablement, it's well grounded in many of our markets. But our roll-out program, where we originally had an objective over the next two years to launch web enablement tools throughout the top 25 markets, the appetite that we've created in our business and the success of that, of those initial rollouts, has actually moved us up to near 30 markets now.

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

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 can give us a sense now that you made the decisions on what lines you're going to be exiting, how much of that is in beauty versus non-beauty and whether we should expect to see any sort of volatility or lumpiness, if you will, in your sales growth, particularly in the back half of '08, as you start to implement PLS?

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

Chuck Cramb

In terms of lumpiness, it is a program that we, I want to say moved into gradually, it is not a big bang type program. Its timing involved in terms of having 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 times in terms of catalog layouts, merchandising, printing, pricing, so we don't expect to see any significant volatility as we really phase into what I'm going to 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 the non-beauty, but there will be a rationalization and harmonization of the beauty products, as well. But if you were just to try to look at overall counts, it's a little bit heavier on non-beauty. But it really, we're not going to be taking the maiden product lines or products out. It's really some of the things we do on the periphery which create issues in terms of merchandising, in terms of product exposure, in terms of discounting activity.

Wendy Nicholson - Citigroup

And just as a quick follow up to that, has there hasn't obviously been any communication with the reps yet in terms of this is coming down the pike? I mean, 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've had from representatives back and forth I know Andrea's talked to a few and we're actually encouraged to move forward on this. It's one of these; I can do my job much better selling Avon products once you simplify that product line.

Andrea Jung

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

If you discontinue that SKU tell me the product from an optimized point of view that has a similar benefit from a formula point of view or improved. And as long as you give me that direct communication of what SKU I should be recommending 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, was about ZOG or NOG, and Chuck, you specifically mentioned both that the bulk of restructuring savings this quarter were from de-layering, but also that ZOG is really what helped with the overall reported SG&A numbers. So did you actually achieve ZOG this quarter, ex- the de-layering, if it's possible to look at it that way?

Chuck Cramb

No, because de-layering is one of the elements that helps contribute to having zero overhead growth. So when we look at it, we look at the period expense 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 would grow at least with inflation. So you then use all of the programs in terms of trying 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 there are a lot of things. Let me pick a simple one. If you think about, oh, what would be a good one, some of the outsourcing that we've done, that's another initiative, 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 terms of 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 attack each one of your expense items with this idea of we've got to keep those costs down.

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

Andrea Jung

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

Lauren Lieberman - Lehman Brothers

If we fast-forward a year, though, when you've lapped the benefits from de-layering because 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 to be yes, so with the mind set you're seeing and with some of the results you're seeing and the plans that are laid out for 12 months from now, do you think ZOG is 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 call investment decisions that may take the numbers outside of an absolute zero overhead growth. Also, it's something you cannot do forever, because there are times when you have to invest in infrastructure, particularly when you have a strong growth business.

But to me, the more important thing isn't whether the numbers absolutely balance out or not, it's the attitude of all of our managers and all of our employees to really challenge every expense year in and year out and that gets you 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, please state 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 on this one, but if I do the math again on ZOG it looks like it didn’t work. It was up like 12% year-over-year and currency was only five. And so, am I doing something wrong?

Chuck Cramb

Yes, you're doing something wrong but I don't know what it is and I bet we can'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 time and I walked through some of the stuff with Renee and it still looks like the fixed overhead 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 on exchange, Bill.

Bill Schmitz - Deutsche Bank

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

Andrea Jung

Well you really get it for the first full year through the end of the third quarter '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, please state 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 in inventory and I'm assuming that that's not yet PLS kicking in and what the drivers of that decline were and whether this is now the start of a sustainable period 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 how we're declining, it's why haven't we been able to get greater traction. I have to say that the inventory initiative here is taking longer than I originally thought it would.

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

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

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

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

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

And thinking on it, I think our program at Avon will take longer. It's more complex, because of some of the infrastructure things we have to put in place. Also, our business model is more complex in terms of the number of SKUs that we operate with, the rapidity and the size of our new product 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 manufacturing point 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 in complexity.

But at the same time I say that, the size of the prize I think can actually be greater here. So, I'm looking over the next three or four years to see us be able to gradually bring those inventories down, maybe three, four, five days each 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 it was 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 her confidence and I assume it's your confidence as well in terms of how the turn around is going and how it's proceeding and your comments about '08 and being able to achieve that margin target.

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

Chuck Cramb

Gee, share repurchase is one of our cash management tools. I think, we have stepped it up pretty much this year. I think, we've spent almost $600 million dollars for 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 just what the pace of repurchase will be. I've always said I'm not afraid to take on a little more debt and you've seen us take on a little more debt in terms of balancing 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, back to inventory. Do you have an optimal level of inventory in mind or an optimal number 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 to five days out over three to five years, we'd be talking somewhere in the vicinity of 15 to 20 days less than what we operate now, which should be in the 80s.

Connie Maneaty - BMO Capital

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

Chuck Cramb

Because of the size of our fourth quarter business and there is a seasonal business 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 be recording in the fourth quarter? Are the charges limited to the fourth quarter or will there be more in 2008?

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

Chuck Cramb

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

What all we know right now is that this year in total, the inventory charge will 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 $68 million dollars.

But I can't give you anything more detailed than that, because I really don'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 charges flowing into 2008, but we think we'll have the bulk of it behind us with the decision 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 some further charges but I don't expect them to be substantial. In terms of the SKUs versus where we are today, we think we'll run the business and this is, it varies by market and there's some wild swings market by market, but we think that the number of SKUs, in terms of reduction for running the business, on average, on a market by market basis, will be in the 20% range, with some real outliers 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 about 20%?

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 beginning part of the fourth quarter and the beginning part of 2008. What I think you should focus on is that the pipeline continues to be strong and we're very pleased that we have this stabilized approximate 40,000 in the flow.

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

Chuck Cramb

Connie, the number that you should pay the most attention to probably is the average active reps that we'll be reporting, because that really gives you the metric 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, please state 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 the other way the previous quarter?

Andrea Jung

Mix, Justin. It really was about very strong, very, very strong category performances, other than skin care was strong but the others were much stronger and 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 Mexico versus 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 of quarters, 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 playbook here that we should be really paying attention to that the reps come back first and then really the sales start to accelerate above the rep growth and that's what 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 first indicator that we've been spending a tremendous amount of time on now for a couple of years now, as you know.

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

But I think, just forgetting about any kind of guidance on exactly which quarter, the thought is right that we continue to do the right things, the rep growth is healthy and Mexico is 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 the advertising growth start to kick in or has that been something we've been seeing continuously?

Andrea Jung

Yeah, I think the thought here was you don't want to investment a tremendous amount in brand advertising until the field fundamentals are right, so obviously the majority of the advertising in Latin America has been going to Brazil and Columbia as it should because the field fundamentals are so strong.

But over time again, the playbook is not the wrong thought in terms of stabilized 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 you look at Latin America in general, as I look at it, we've had just quarter-after-quarter of outstanding growth with a flat or declining Mexico for a couple of years.

So, when Mexico turns as it relates to the top line with the kind of profit it generates and it's not a small market, that's a very good thing for Latin America, 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 I guess coming into the system, and the U.S. consumer's showing some weakness, do you still feel comfortable about the company'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 a 180-degree shift to Elixir and Christian Lacroix. I think, we are, have our offering 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 the board the reaction to the $54 price points and the $32 price points are very strong, again developed markets or emerging markets. But at the same time, I think, we've gotten a very well balanced portfolio with affordability and I think that that bodes well for the pricing tier.

Chuck Cramb

I also think as -- I think about it, that right to price is supported not just by pricing but by the technology and innovation we're putting in the products, so when you look at Elixir and the promise that it has, whether it's in the delivery system or in the contents, that creates that opportunity.

And even in some of the endorsement areas on the fragrances, there's an additional 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 absolute revenue, the lion share of our business is not being sold at those price points. But I think it does create the leading technology thoughts as well as the image enhancements.

Justin Hott - Bear Stearns

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

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

Andrea Jung

Say that again? I‘m sorry.

Justin Hott - Bear Stearns

Advertising more toward being a multi-level organization as opposed to just putting it behind the products? And obviously I would assume "Hello Tomorrow'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 the stepped-up increase has been about brand competitiveness and this is not about an either or.

This has been about, I think, a really healthy balance, we have been very pleased with the response to representatives, recruiting advertising, and the pay backs on those in the handful of markets that we've begun to do that in 2007, and that will continue in 2008.

But we're not walking away by any stretch from the brand advertising, which is 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 putting less time into the business.

Andrea Jung

Yes, I mean, I just would say, and I just go back to the break through quarter 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 speaks to months of analytical work that really gave us the understanding of the accelerators of growth, both on the brand side as well as the channel side, and the pay backs.

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

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

And those who were given free brochures in some of our incentives are actually purchasing more now that they've seen the impact of what it does, what it helps when the company helps them go out and reach more customers. So I think this rep economic switch, where we've been able to increase their value proposition, 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 state your 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't really near, or didn't seem to be near the point where you didn't need to increase spending any more.

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

Andrea Jung

Yes, Chris. I just want to go back and say what we said in the second quarter. 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 year average is 50%, so there's obviously a little bit less of an increment year-on-year in 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, is that. I'll just use a couple of examples but we've learned so much about mix efficiency, by country, by category, and by media type, so in China, for instance, where we spend more in advertising and skin care. I think that we're reaching, not exactly there, but reaching more of a saturation point than we are in color, where our business is very good but we haven't advertised very much 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 a 15-second spot and in some parts of China 15-second spots are very, very effective, great paybacks obviously, and we can get more penetration that way. So it's going to inform and guide reallocation where we don't think we'll lose anything but we'll, in fact, be able to have a better 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 high paybacks because we haven't done much that yet, and so we've done it now for the second round, so it's allowing us to reallocate.

So I feel good about the fact that this concept of near scale and growing approximately 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 sales growth? And I guess, the idea is what, someone gets into the business, but I just, I was hoping you could explain a little bit better.

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

Andrea Jung

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

I think, you can see instances in the past where you can have higher sales than rep growth and a lot of that is driven by marketing mix. A lot of that can be 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 have fundamental growth in reps, and you've got strong field fundamentals. And a good morale in your sales force, again, that stability usually has a very tight link with the health of your business.

So that's why, when we look at something like several quarters now, in the United 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 on field fundamentals and the representative value proposition has been such the heart of our business model.

Chris Ferrara - Merrill Lynch

So is it an efficiency thing? Is it that you get reps into the business and when they first show up in your new rep count that the sales aren't necessarily there 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 and longevity with reps who are non-new. Obviously, there's focus on new representatives, but it's once you've been here, length of association, past six campaigns or a year, whatever it is, given by market, you see dramatic productivity changes, and obviously much lower turnover, etcetera, once representatives 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 the impact 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 my head. We kind of prorate it on the straight exchange movement, but because of the dollar-based costs, which tend to be a bit higher, it's probably not terribly 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, please state your affiliation and then proceed with your question.

Ali Dibadj - Sanford Bernstein

Hi, guys. I'm from Sanford Bernstein. A couple of questions, one, I just really quickly wanted to go back to one of previous questions around not accelerating RVP and advertising spend ahead of sales. So you're expecting then, and your analytics suggested it sounds like that you have enough to have optimized your spend and to not increase it, and not have an impact on your top line? Is that a fair statement?

Andrea Jung

Yes.

Ali Dibadj - Sanford Bernstein

Yes?

Andrea Jung

Yes.

Ali Dibadj - Sanford Bernstein

Okay, okay. interesting. Okay. The second thing is around just operating margin. It looks like it was roughly 100 basis points lower than what's implied by 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 bit slower, in fact it is a little bit slower than in my experiences and I know in Chuck's experience, as well likely, and I'm grappling with we're in a turn-around, it's been about two years now, what we've substantially seen is essentially de-layering of bunch of people whose salary, fringe and benefits are roughly just under $50,000.

And so I'm just trying to grapple with what the progress is towards this goal of reaching 2005 numbers here, particularly SSI, I guess, because that feels 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 first started this turn around, and that only has, I'm going to say, become of age towards the end of last year in terms of an idea that is has now grown into a program.

The $15-odd million dollars that we quoted for this year, when you think about SSI you also have to think about, hey, most of it is going to be in materials, it goes into product costs. You may save money, but you don't get it until the following year because of inventory builds. Also you save money on things 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 an appropriate objective for Avon in terms of what we do from a materials point of view 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 to 2007. However, as we look forward, the analytics say that more or less increasing in line with sales give or take that we can do things to increase our effectiveness and the mix of those, the components of both of those, RVP and advertising investments, that is the way to go forward.

I think there are benefits coming in that are substantial in 2008 from continuous restructuring activity, and initially you saw that SSI will have a significant step-up. The other piece is the costs that we incur to implement our restructuring programs, the costs we incur for PLS, those will be substantially less in 2008.

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

Ali Dibadj - Sanford Bernstein

Okay, all right. A couple of questions, just switching gears a little bit about China, one is just doing quick math on the number of sales promoters that aren't going to be there going forward, if you're going to remove them, if you look 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 anything and 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 a full-time job than it is elsewhere in the world, how should we think about that 30% 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 was just and continues to be the pipeline in, and so the number, by anybody's standards, of having so close to 700,000 on staff, is a great number. The focus though, is on activity, and that's why we want everybody to focus on the growth in active reps year-on-year, now that we have 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 so this is what we want to measure and can give us, obviously the meaningful growth that we expect going forward.

So it's the right removal policy and the number probably on the absolute. I don't think we would have expected to have that many sales promoters, even though we always knew it was going to be a good opportunity, it's been extremely encouraging how many women want to join the Avon opportunity in China.

Ali Dibadj - Sanford Bernstein

And so again, was it your expectation that you'd lose more than a third over the 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 - Sanford Bernstein

Okay, okay. Last question again about China is just around the fact that 80% of your sales, it sounds like are from non-urban areas, which suggests that less penetration obviously in the urban areas. 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 retail infrastructure gets blown out in some of these emerging markets how does that affect you? And I'm just looking at the 80% number being from rural China as 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 Avon model 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 the retail infrastructure in St. Petersburg and Moscow.

So I think the thought speaks to the strength of the direct selling market and 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 retail infrastructure growth outside top two cities, top four cities.

I think take Brazil, take Venezuela, take Columbia, take any of our go to markets that are 50 years plus that are developing where you started these large markets, but our ability to still, I think, be ahead of retail infrastructure growth when you have that much distribution and penetration across all the parts of a geography, is what makes our model strong in these kind of markets.

So I think there is going to be, I read what you read, about how many more Wal-Marts or how many more big box stores are going to be in China to the top 50 cities instead of the top 20 cities, but you're still talking about hundreds of towns and villages that, whether it's China or it's Russia that Avon services because of the model.

Ali Dibadj - Sanford Bernstein

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 busy morning.

Operator

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

Nik Modi - UBS

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

And then the second question is, in Poland with the compensation changes at the higher end do you plan to use that strategy in any other markets going forward 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's inclusive in our $375 million projection, does include recruiting advertising in 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're seeing good paybacks and as I said that will be one piece of the analytics informing us exactly whether it's a recruiting advertising or a color cosmetic advertising, and where to put the money and that would be a geographic question as well, or be answered by the analytics. But we feel very good about net-net where 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 a change to the commission top rate. We also did it in Hungary. We really started with Central Europe. And again, it's a top-rate change, which is a big motivator and makes us very competitive, and we'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 talked about everybody about one aspect of RVP would be where necessary, or where we want to be competitive, commission rate changes. And that may be something as we learn through and continue to evaluate Eastern Europe as 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 rep growth to revenue growth this quarter and this quarter's rep growth was obviously very nice. Do you expect a similar type of follow through into the fourth quarter or is there something we should be aware of that could perhaps change that dynamic?

Andrea Jung

Well, in a no-guidance environment all I would say, Nik, is that this turn-around is gaining traction. I am very pleased with beauty sales and the channel 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 with IR and Renee and the team will be there today. So thanks, everybody for your support and we'll talk to you soon. Bye-bye.

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