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Executives

Amy Low Chasen

Sherilyn S. McCoy - Chief Executive Officer and Director

Kimberly A. Ross - Chief Financial Officer and Executive Vice President

Analysts

William Schmitz - Deutsche Bank AG, Research Division

Christopher Ferrara - BofA Merrill Lynch, Research Division

Ali Dibadj - Sanford C. Bernstein & Co., LLC., Research Division

Constance Marie Maneaty - BMO Capital Markets U.S.

Mark S. Astrachan - Stifel, Nicolaus & Co., Inc., Research Division

Timothy A. Conder - Wells Fargo Securities, LLC, Research Division

Javier Escalante - Consumer Edge Research, LLC

Avon Products (AVP) Q3 2012 Earnings Call November 1, 2012 8:30 AM ET

Operator

Good morning. My name is Holly, and I will be your conference operator today. At this time, I would like to welcome everyone to Avon's Third Quarter 2012 Earnings Conference Call. [Operator Instructions]

I'll now turn the conference over to Amy Chasen, Group Vice President, Investor Relations. Ms. Chasen, you may begin your conference.

Amy Low Chasen

Thank you. Good morning, and thank you for joining us to review Avon's third quarter results. With me today on the call are Sheri McCoy, Avon's CEO; and Kimberly Ross, our Executive Vice President and CFO. Sheri will provide an update as well as our goals for future performance. Kimberly will then review third quarter results and provide further color on our outlook. Then we'll have our usual Q&A session.

With that, I refer you to the cautionary statement in today's earnings release, as well as to our non-GAAP reconciliations, which is available on the Investor Relations section of our website. As usual on the call, we'll focus on these adjusted non-GAAP financial measures.

I'll now hand the call over to Sheri.

Sherilyn S. McCoy

Good morning, and thank you, all, for joining us, and a special thanks to those of you joining us from the New York-New Jersey area. I recognize that many of you are still dealing with some challenging circumstances, so thank you for being here.

By now, you've seen the press release with our third quarter results, which remained disappointing. It is clear that Avon faces a challenging situation. I spent the past 6 months visiting major markets, meeting with our management teams and representatives to gain a good understanding of our strengths and weaknesses. I am confident that we have identified and started implementing actions critical to moving Avon toward a measured and steady recovery.

This morning, I will take you through some of these actions, including our plans to drive top line growth and aggressively manage our cost base. We need to do both in parallel to succeed. Kimberly will then take you through details of our third quarter results, and then we will open the line for Q&A.

I recognize you would like to hear me present a magic bullet or a quick fix. But our business is complex. As I've said in our earlier calls, the challenges Avon is facing developed over time, not overnight, and the solutions will take time as well. We still have a tremendous amount of work to do to address issues that Avon has wrestled with for years: the complexity of our model, consumer access to our products, the impact of technology and the best approach to representative earnings opportunity. Six months in, I don't have all the answers yet, but I can share my thinking on how we will approach these longer-term and substantive issues. And I will tell you today that we have identified and begun to take the necessary actions critical to stabilize the company and return to growth.

We are taking an aggressive yet very reasonable approach. Our goal is to achieve mid-single-digit revenue growth and a low-double-digit operating margin over the next 3 years. I believe this is both reasonable and achievable for a number of reasons.

We compete in large and growing categories and geographies with a strong developing market footprint. The global beauty industry is projected to grow 6% annually, with most of the growth expected to come from developing markets where Avon has a strong presence. As you know, the global direct selling industry has been growing at 4% to 5%. And advice from friends and word of mouth, 2 attributes of the Avon business model, are still the most powerful drivers of purchase consideration. Also historically, Avon's growth was in line with our competitive set, and once we stabilize, it should return to this level.

In the past, our growth exceeded our revenue growth -- our cost exceeded our revenue growth. This will not happen again. Cost is something that we can and will control. We've already instilled increased clarity and discipline in the 2013 budget process. Historically, our operating margins have been in the low double digits. And given where the business is today and the nature of Avon's competitive set in our key markets, we believe that returning to low double digits is a reasonable objective.

All told, we have the brand, we have the products, we have the scale and we will build the capabilities. We know what we need to do to get there. We must execute, and I am holding us accountable to deliver.

In our last call, I outlined 5 priority areas for the company: stabilize and drive top line growth, improve income by a more effective cost structure and cash generation, invest in our people and build a culture of accountability, use technology to better serve our representatives and connect with consumers and build a strategic roadmap for our future. In my early months, we've organized our internal efforts against these priorities. Examining our plans against these priorities has helped us better understand how and why Avon underperformed in the past and what we need to do differently as we move forward.

First, let's discuss driving top line growth. From my early days at Avon, it was clear to me that we need to put the representative and consumer back at the center of our business. It's quite simple. We can't succeed in direct sales without our representatives and we won't succeed in beauty unless we know who our consumers are and what they need. We must understand and execute against both the push and pull in each market. This requires both a mindset change for the organization as well as an alignment of resources.

The push comes from representatives who are engaged and motivated as ambassadors of Avon. They gain personal satisfaction from being part of the Avon family. More important, they are confident to reach out to consumers and their peers to drive sales and to recruit because they believe in the products and the proposition. I've met representatives in all our key markets, and whether I'm in Dallas or Sao Paulo, Istanbul or Mexico City or Manila, there is a common chorus: our representatives love Avon and they love Avon products.

But they've also been very direct with me about what we need to do to improve the ease of doing business with Avon and help them succeed. I've heard them loud and clear. These are businesswomen who are looking at the overall value proposition. Are we creating the right products for their consumers? Do we have the right systems so they can do business with us in a simple and optimal way? And do we deliver a competitive earnings opportunity?

Avon's growth depends on our representative's success. And we will view all our actions through the lens of putting them at the center of our business and creating a push force in the market.

In the past, we overemphasized some of the individual aspects of the relationship, incentives for example, without fully understanding all of the elements that drive representative engagement and productivity. Representatives also care deeply about Avon's ability to activate consumers and create energy and excitement around our brand and our products.

The pull in market comes from consumers who want our products. There's a lot of work to be done restoring and strengthening the pull of Avon products and some of that work is already underway. We are more attuned to local insights so we can deliver relevant products at the right price. And we are paying closer attention to quality and packaging. We are more focused on the need for consumer market segmentation and we are learning how to better connect with consumers using social media and mobile.

One good example is Russia where activation and creating pull in the market is a priority. The team in Russia is very focused on the consumer proposition and this has led to improvements in the brochure, product pricing that is more aligned with the market, better local advertising and expanded use of social media. We are watching results in Russia closely in order to assess their effectiveness and share learnings globally. But I firmly believe that consumer activation in each market needs to be improved.

For over 100 years, Avon succeeded because of the surprise and delight our products gave consumers when they discovered a high-quality product they loved at a great price. We need to consistently deliver that again, and we will.

So the push of engaged and motivated representatives and the pull of great products, these are the fundamentals. With that as context, we will focus on 3 key drivers to accelerate top line growth.

The first driver of growth is restoring field health. My personal observation is that we need to define what field health means. It's not simply the number of Active Representatives, it's about the broader experience that representatives have with Avon.

Our Latin American team has done comprehensive work to better understand the current satisfaction level of representatives and what we need to do to drive field health. They found that there are many components to representative motivation and retention. This includes satisfaction with earnings, title and recognition. It also includes product availability, service and delivery. These data are driving the region's strategy on field health and all members of the Latin American leadership team have specific performance goals tied to improving field health. We need to get the same clarity across the company.

Clearly, the earnings opportunity is critical, particularly for our sales leaders. In several of our markets, we are making progress through an improved Sales Leadership model with a multilevel marketing approach. In the Philippines where we already have a multilevel approach, we are testing a next-generation model that provides higher earning opportunities for top sales leaders. In Russia, we are optimizing the field model to simplify the proposition and ensure that the model is aligned to drive sales growth. This includes more titles, easier title progression and a structure that is simple and clearly communicated and understood. We are taking a market-by-market approach to assess the current state of field health and are making adjustments where we know they are required.

Earlier, I mentioned some of the longer-term and substantive issues that we need to address to ensure long-term sustainable growth. Creating a consistent approach to our direct sales model is one of them. Currently, our markets are a mix of single-level, hybrid and early multilevel marketing. This diversity and inconsistency in our commercial model adds complexity, increases cost and reduces effectiveness. This is an issue that we must address and we will develop and execute a plan to consistently implement and improve the Sales Leadership model around the world.

The second driver for growth is the successful execution of our Beauty product category strategies. We can and will be competitive in each of our 4 categories: Color, Fragrance, Skincare and Fashion and Home. We continue our work to develop fully articulated category plans. And across all categories, we are taking a much more rigorous approach to execution. This includes a focus on our core consumers, better understanding of the global local dynamic and a disciplined approach to quality. Let me touch quickly on each of these categories.

Color is a must-win category for us. We need to stay true to our core consumers and deliver the right quality and innovation she demands at the right price. Based on consumer insights, we are strengthening our portfolio across all segments: value, math and premium. We need to realign innovation resources to deliver high-unit movers. And across all campaigns, we must improve activation and execute integrated marketing programs.

Fragrance. Our growth in fragrance will be built by optimizing local relevance. Fragrance is the largest category in our Beauty portfolio. It has performed well but we see weakening in some areas. Fragrance is an important product category in many markets but we've prioritized the Latin American region and are currently driving a new fragrance approach in Brazil where the local and global teams are working in concert.

We are improving our new product process, and one good example of this is the recent launch of Blue Rush Paradise. This product made it to market in 6 months rather than the typical 2 years and is well aligned with Brazilian consumer demands. The team identified a fragrance juice that has been prequalified through consumer testing, so they knew it would appeal to Brazilian consumers. They adopted standard components and packaging to avoid costly and time-consuming development. And they created the product as a flanker to our successful Blue Rush line rather than an entirely new brand. This enabled them to strengthen and build a sub-brand within the portfolio. This focus on creating products that address local olfactory preference and supporting that with effective local marketing campaign is important for Fragrance in every market, not just Brazil.

Next, Skincare. To improve Skincare, we must deliver the right innovation at the right price and provide meaningful and consistent marketing support. We have great products and innovation, but we have been inconsistent with our marketing approach and have been underperforming in this category for years. We need to build our sub-brands consistent with the premium, mass and value segments, balance line extensions with new and stop cannibalizing our own products.

So in Skincare, we're very focused on getting the cost value equations right, improving product awareness to drive both push from our representatives and pull from our consumers and improving convenience and access to our products. One recent example that highlights the appeal of our skincare products when they are truly innovative, priced right and we see solid marketing support is AF-33 in the U.K. While the U.K. results overall were disappointing, the AF-33 launch has provided good learnings on consumer and representative activation. The U.K. team launched AF-33 Pro Line Eraser Treatment with a fully integrated and resourced marketing program built around meaningful and important consumer benefits. The team effectively drove both push and pull with a very creative prelaunch sampling campaign and a strong social media component. The results are impressive. The initial launch strategy created a waiting list of more than 60,000 customers in the U.K., and AF-33 has over-performed in the U.K. against all projections, more than doubling anticipated sales over 2 campaign cycles. This was our biggest skincare launch in the U.K. in over 10 years.

And finally, Fashion and Home. This is a category Avon has struggled with in the past, but we have determined that Fashion and Home is a competitive advantage when it's linked closely to our Beauty strategy. Fashion and Home drives consumer engagement, brings new shoppers into our store and is an important incremental earnings opportunity for representatives. We are rebuilding this category with a focus on jewelry, intimate apparel, handbags and accessories and seasonal products. These are products that are meaningful to our consumers and representatives and clearly linked to our broader Beauty position. We have strengthened operational processes and enhanced our merchant capabilities, including vendor, cash and inventory management. Having clarified our strategy and strengthened our execution, Fashion and Home plays a key role in creating both push and pull.

So on the product side, we're competing to win in the 4 key product categories. We are seeing early signs of success, but these are individual products and campaigns. We need to create these wins more consistently and across all categories and all markets.

The third driver of top line growth is restoring the health of our key geographic markets. As you know, we already have recovery in -- recovery plans in place in our key markets. We will continue working against those plans where we are showing signs of improvement. And in markets where we are not seeing progress, we will course-correct as needed. I am taking a very hands-on approach with our regional business leaders as we work to get our key markets back on track. This is a management-intensive business and we need to develop strong leaders who understand local market dynamics.

In every market, we must take an integrated approach to improve our overall performance rather than chase a single symptom. This includes a consistent strategy for measuring and building field health and utilizing local consumer insights.

We also need to do a much better job at getting the marketing and incentive mix right to consistently create healthy market dynamics that activate consumers and motivate representatives, creating the push and pull I discussed earlier. This requires finding the most effective mix of advertising, social media, digital, public relations and the activities that we currently bucket under RVP. Kimberly will take you through more specifics on our key market performance, but I want to provide you with a high-level update on the U.S. and Brazil.

In the U.S., we are making progress with the new sales model but we have not yet seen an improvement in overall sales performance. We will continue to give the sales force time to complete the transition to the new model. At the same time, we are challenging the status quo in every other aspect of the U.S. business. This includes evaluating whether we can better support the market's return to growth through improved consumer activation, better marketing support and a more relevant product portfolio. We are also looking at ways to reduce campaign complexity and accelerate recruitment. We are committed to taking whatever steps necessary to return the U.S. to -- market to health.

In Brazil, the team is making progress, but it will take time. Some inherent issues still persist and the market operates with a high level of complexity. The team is working hard to address these known issues, particularly around service and improving the representative experience and opportunity overall. They are also working to drive down costs and improve inventory management. At the same time, they are taking actions to drive top line growth, including development of the right product portfolio across critical categories, including Fragrance and Color. And they have a renewed focus on consumer activation, including expanded local advertising and PR activities which drive word-of-mouth.

So to summarize, we will drive growth by getting and keeping representatives at the center of our business, defining and restoring field health, delivering products that are relevant to our consumers and taking an integrated approach to restore health to key geographic markets. It may seem like a very basic approach, but in my experience, getting the fundamentals right is always the best place to start.

Our second priority is cost management. While we are implementing our plans to drive top line growth, we will also simplify our business and aggressively manage down SG&A cost, which has grown to an unsustainable level. We are looking at all cost drivers, with a focus on headcount, indirect and direct costs at the corporate, regional and local levels. We are acting with urgency to restore Avon to a position of financial health and we'll take substantial action starting in 2013. We are committed to achieving cost reductions of at least $400 million over the next 3 years. I'm determined to identify and implement short-term actions where possible. And as an organization, we must resolve the longer-term substantive issues and we will continue to challenge the status quo on an ongoing basis.

Simplification is high on my agenda as we look to Avon's future. Cost savings will only be sustainable if we implement them in a way that simplifies our business and creates clear lines of decision-making. And every action we take will be measured against building complexity out of the system, not in.

Also as you have seen from our press release this morning, we made the difficult decision to reduce the dividend. This is part of an overall review of our capital structure and is consistent with our earlier stated intent to align the dividend with current operating performance as well as our peer group. We also have work underway to improve working capital, which Kimberly will cover in more detail.

So a big effort underway on our first 2 priorities: driving top line growth and managing costs. We've also made progress on our third priority area, talent and culture.

I brought in some key leadership talent in human resources, legal and communications. We have also hired a new Chief Marketing Officer and we'll be announcing the specifics on that in mid-November. The CMO is a critical role with responsibility for strengthening brand health, improving our marketing approach and enhancing our product portfolio. We're also working internally at strengthening the capabilities of our senior and line management teams. We are identifying key capability gaps and filling those gaps through training and recruitment both internal and external.

You've also heard me reference the need to build a strong culture of accountability and discipline. Our senior leadership team is being given clear expectations for behavior and performance and will be held accountable for delivering on their commitments.

The fourth priority area is using technology to better serve our representatives and connect with consumers. As I've stated in the past, we have under-invested in our IT infrastructure. We are planning for an incremental spend of approximately $150 million to $200 million over the next 3 years. We expect this investment to be spent on internal systems to streamline and improve decision-making. We are also investing to improve the representative experience, including ordering, delivery and billing. We're also developing mobile solutions to give representatives better access to Avon, and we will be launching our first mobile programs in the first half of 2013.

We are building the knowledge and skill sets to use social media across all of our programs to better inform, engage and enable representatives and consumers. As mentioned before, this work has been fast-tracked, and we are making good progress.

The fifth priority area is developing a long-term strategy for the future. I am more confident than ever that Avon can be returned to growth and explore new strategic opportunities in the future. But we will do this in due course and will not let the organization be distracted from the important work at hand. As I've said, Avon's situation did not have a single cause and will not have a single solution, but we are on our way to solving these problems and we are squarely focused on taking the necessary steps to return Avon to a position of operational and financial health and to improve our competitive position.

One last item. Before I hand it off to Kimberly, as you know, we are working to resolve the pending FCPA government investigation. Jeff Benjamin, who joined Avon in September as General Counsel, is responsible for coordinating these efforts, and I'm working closely with Jeff on this matter. You will note in the 10-Q we filed this morning that we updated our disclosures on these matters to reflect recent developments and our current thinking about the potential outcome of the investigations. We will continue to provide updates on this matter as appropriate.

Kimberly will now take you through a review of our third quarter results.

Kimberly?

Kimberly A. Ross

Thank you, Sheri, and good morning to all. I will start with comments about the quarter and the regions and then I'll talk about how we're thinking going forward about cost savings in the capital structure, including the dividend, CapEx and working capital.

Our constant dollar revenue was up 1% for the quarter. Currency had a significant negative impact, resulting in a reported sales decline of 8%. Positive growth in Latin America offset weakness in North America, Asia and Europe. Units rose 1% driven by growth in Latin America and Europe, offset by declines in North America and Asia. Price mix was flat.

Active Representatives were down 1% largely due to the double-digit decline in North America where we continue to feel the impacts of the redistricting. In addition, representative count declined in Asia primarily due to China, which I'll discuss a bit later.

Gross margin was down 280 basis points to 61.2% due to unfavorable price mix. Higher supply chain costs primarily due to higher obsolescence cost and the negative impact from foreign exchange were also factors.

Adjusted operating margin was down 440 basis points to 5.9% in the quarter as our business remains challenged. In addition to the gross margin pressure, operating margin was impacted by increases in overhead cost primarily due to higher employee compensation cost. The negative impact from foreign exchange was also a factor. This was partially offset by lower advertising spend. With that said, let me move to the regional discussion.

Starting with Latin America. Sales rose 6% in constant dollars, with growth in all major markets. Representative growth, units and average order were all up.

Brazil was up 2% on a higher unit growth. This was driven by Fashion and Home, which rose 9%, benefiting from the price adjustments we recently implemented and the flowing of excess inventory. We are encouraged with the improvement in this area. Representative growth in Brazil was up as we saw some success in reenergizing the field. In fact, we had record appointments in Q3 as the result of some of these programs and we're now focusing on retention as we move into Q4 and next year. Nonetheless, Brazil results are still being pressured by service challenges and competition, and we're still losing share.

So all in all, I'd characterize Brazil's results as better but not where we need to be. Brazil remains our top priority and we continue to work to regain momentum across all key metrics, including product proposition, marketing and representative satisfaction, including service.

Also in Latin America, Mexico continues to perform well, rising 10%. Growth was driven by strengths in Active Representatives as the result of a special summer retention program to keep representatives engaged.

Argentina was up driven by pricing to keep up with inflation and we also made progress working through the import restrictions in that market. Venezuela was up, but growth slowed significantly. The economy was much weaker ahead of the elections given the political and economic uncertainties. In addition, inflation was lower, resulting in less pricing.

Latin America adjusted operating margin was 11.2%, down 110 basis points largely due to lower gross margin. Gross margin was negatively impacted by an unfavorable price mix, including the planned initiative to flow excess inventories in the quarter. Currency was also a factor. The gross margin weakness was partly offset by planned lower advertising and lower incentives in Brazil. Bad debt and variable compensation expenses were also lower.

Now looking at Europe. Sales declined 2% in constant dollars, impacted by approximately 200 basis points from a VAT benefit we had in last year's Q3. Growth in Active Representatives offset a decline in average order. U.K. sales declined 23% in constant dollars. The decline was partly driven by the VAT comparison, which negatively impacted U.K. revenue by approximately 12 points. The underlying sales decline was due to weakness in both average order and Active Representatives.

While Sheri highlighted the success of AF-33, as we told you last quarter, market conditions remain difficult and we have executional challenges in that market as well. We need to improve the energy in the brochure, as well as adapt the assortment to the current consumer trends to drive consumer uptake and representatives' earnings.

Russia rose 1% due to higher average order, partly offset by a decline in representative. The growth was driven by better execution on high-unit movers as well as strength in Fashion and Home where we added a new flyer, which has been successful.

Turkey saw a sharp reversal from second quarter, rising 14%, but this business remains volatile and so we aren't ready to draw conclusions based on this quarter. Simply put, our execution this quarter was good on the brochure, product offering and representative recruitment, but we invested a significant amount to obtain this growth.

South Africa continues to grow. However, growth remains slower than in the past due to our decision to implement a new tighter credit policy.

Adjusted operating margin in Europe was 8.5%, down 710 basis points partly due to do the VAT benefit in the year ago period which had a 200-basis-point negative impact. In addition, gross margin was down due to price investments to drive volume in key markets and negative supply chain overhead leverage. Operating margin was also negatively impacted by higher year-over-year compensation expenses and increases in advertising and incentive. Sheri and I have challenged the teams in EMEA to achieve a better balance between driving sales and getting a better return on investment on a sustainable basis.

North America. Sales were down 8% -- or 6%, excluding Silpada. We are seeing a continuation of recent trends with weakness in Active Representative count, which is more than offsetting growth in average order. While we are seeing fewer orders overall, average order in North America, excluding Silpada, is up 6% driven by better performance in Fashion and Home which is continuing to outperform Beauty. Given the higher price point, this is helping average order.

In addition, representative mix is influencing the average order as we continued to lose lower-tier and less-productive representatives. Frankly, at this point in the redistricting, we would have expected to see more progress. The good news is that virtually all of the appointments are coming in through leadership which was a key goal of the new model.

However, we're disappointed with our results and our team is fully engaged to identify and address these issue -- the issue. We are putting plans in place to accelerate representative recruitment to replace the loss of some of our lower-tier representatives. In addition, we are looking very carefully at district sales manager performance as we are still seeing pockets where performance isn't as good as it needs to be. Given the smaller number of districts, any underperforming district has a greater impact on the total.

As you saw, Silpada continues to disappoint, with sales down 25% due to lower average order as well as a decline in representative. Our Silpada team is focused on improving its product proposition and field productivity to help stem the decline.

Adjusted North America operating loss was $12 million, with margin down 460 basis points. The operating margin decline was partly due to weaker gross margin, which was impacted by product mix and higher obsolescence. In addition, we had increased investments in the Sales Leadership commissions and incentives in support of the new model in the U.S. and higher brochure cost.

As Sheri said, we are committed to taking all necessary steps to return the U.S. market to health, and clearly, we are not happy with the profitability of the North American region.

Looking at Asia. Sales declined 7% due to weakness in China, which was down 31%, partially offset by a positive performance in the Philippines. Active Representatives declined 12% primarily due to China where we no longer include as representatives those individuals who place their orders through retail locations. This has resulted in lower Active Representative count. Today, our business is predominantly retail. Resolving the future strategy for China is another key priority for Sheri and me.

The Philippines is up 4% due to growth in Active Representatives driven by our strengthened field management process and successful marketing initiatives.

Operating margin at minus 14% for the region was negatively impacted by 20.4 points due to an impairment charge for China goodwill. Based on the continued decline in revenue performance, we've lowered our long-term growth estimates and therefore completed an impairment assessment, which resulted in a goodwill write-down of $44 million.

Adjusted operating margin for the region was 6.6%, down 230 basis points largely due to weaker gross margin which was hurt by mix and foreign exchange, along with higher bad debt.

Moving on to cash flow. Cash from operations was $220 million, down $27 million from last year as a result of lower net income. This has been partially offset by working capital improvements as well as lower contributions to the U.S. pension plan and a payment in 2011 associated with a long-term incentive compensation plan.

Working capital improved 20 -- by 20 operational days. Inventory and accounts payable were the key drivers, each declining 10 days operationally. We saw inventory improvement in all regions. Some of the improvement was a function of the planned flowing of excess inventory in markets like Brazil and South Africa. We also had some one-off benefits in the quarter that won't repeat. But we experienced underlying progress as well, which is encouraging.

Not yet reflected in our performance is an initiative that we have put in place to drive continued improvement in working capital and, specifically, inventory days. We have put together a project team which is focused on reducing the lead time on raw materials and finished goods from the supplier all the way through to the representative. This links all key supply chain and business functions and allows us to more quickly respond to changes in demand rather [ph] than waiting for updated forecast. We've been piloting this initiative with a select number of SKUs in North America and we have had very good results. We will be rolling this program out more broadly within North America and into Brazil. We hope to have it rolled out globally by the end of next year.

We also continued to improve our payable days as we renegotiated our payment terms in several markets as part of our indirect sourcing initiative whereby we are revisiting all indirect categories and suppliers to reduce cost. In short, we are starting to make progress in improving working capital days. But as I said before, sustainability is key, and one quarter of improvement does not make a trend. We will continue to update you as we move forward.

Now let me talk a bit about our cost-savings measures. In the past, I've spoken with you about the need to drive a constant cost-reduction mentality within the organization, and that remains the case.

Since joining Avon, we have analyzed the cost structure and have taken some conservative action. However, in light of our current results and the outlook for a multiyear recovery, we are now taking a more aggressive approach to cutting costs. We are now targeting annual cost savings of at least $400 million over the next 3 years, and we expect there will be charges associated with some of these cost initiatives. The annual cost savings will largely be driven by SG&A reduction. We will be taking actions to address these areas of savings starting in 2013. But given the nature of the initiatives, we do not expect to start seeing savings until late 2013 or early 2014.

In addition to going after indirect costs and headcount, we are focusing on reducing complexity and identifying ways to do business differently, which means we will be evaluating some long-standing business practices such as the distribution networks, our Sales Leadership model and the complexity created by our campaign cycle. We've been challenging the entire organization to think differently and put all options on the table to reduce cost and complexity.

Moving to our capital structure. In evaluating the capital structure, we considered a number of items, including our dividend, our CapEx spend, our working capital and our debt structure. Let's start with the dividend.

Last quarter, we said we would evaluate the dividend with the objective of better aligning it with our operating performance and our peer group. The outcome of the dividend review led to the announcement earlier today that we have reduced the dividend by approximately 75%, which is a necessary step given our recent financial performance and our outlook for a multiyear turnaround. This brings our payout ratio in yields more in line with our current performance and our peer group. It also reflects our commitment to target an investment-grade credit rating.

We understand the importance of the dividend to our shareholders. And as the business stabilizes, we will continue to evaluate the dividend taking into account the performance of the business, the strength of our balance sheet and our peer group.

CapEx. As Sheri noted last quarter, we need to invest in our IT infrastructure, and consequently, we will be increasing our CapEx spend by approximately $150 million to $200 million over the next 3 years.

Working capital. We will continue to be vigilantly focused on working capital. And we are targeting at least $100 million improvement over the next 3 years. Inventory remains our biggest opportunity.

As for the debt structure. As part of optimizing our capital structure, we are evaluating our levels of cash on hand, our access to capital markets and our bank group as sources of liquidity to address our upcoming debt and revolving credit facility maturities. A key objective will be to further extend the maturity profile, the first step of which we took last quarter when we successfully executed a $550 million term loan to refinance our commercial paper. Additionally, we will continue to focus on optimizing the ratio of fixed and floating rate debt.

With regards to the outlook for Q4. We said last quarter that you should expect more of the same for the rest of this year. We are taking the necessary steps to get to a sustainable performance. However, it will take time. And consequently, you should not expect a significant change for Q4.

So as Sheri said, we will define success over the next 3 years as mid-single-digit local currency sales growth and a low-double-digit operating margin. While this may be below your expectations, we feel that it is reasonable and appropriate given where we are today. It's worth reiterating that stabilizing our business remains the most urgent priority for our team.

I've said to you in the past that you may not always like what we have to say but that we will be realistic in our assessment and our outlook. That's what we are providing to you today. To be clear, these will not be easy targets to meet and we have a lot to do to achieve them. But our teams are energized and focused on getting Avon back on track and in a position where we can focus on driving long-term, consistent and sustainable growth.

With that said, I'll turn it back to Sheri for a few closing remarks.

Sherilyn S. McCoy

Thank you, Kimberly.

This morning, we outlined for you our 3-year performance goals and the actions we're taking to drive top line growth, manage costs and improve our working capital.

Our goal of achieving mid-single-digit revenue growth and a low-double-digit operating margin over the next 3 years is based on the historical performance of both Avon and our peers, external market dynamics and our ability to return SG&A to a sustainable level. Again, we are taking an aggressive yet a very reasonable approach.

We're going to open the line for your questions, but I first want to say: Avon is a great company. Avon enables millions of women to build a more secure economic future for themselves and their families. We have great products that help women find true beauty, and we're a powerful force on social issues. But at the end of the day, the only way to rebuild credibility and trust with our stakeholders is to deliver consistent performance and compete effectively. We know what the problems are. They are solvable. And my team and I are committed to delivering.

Thank you. And now I will turn it to the operator for questions and answers.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Bill Schmitz.

William Schmitz - Deutsche Bank AG, Research Division

Deutsche Bank. How long do you think this sort of P&L clean-up phase lasts in terms of the inventory obsolescence to kind of get the working capital in the right place? And I have a follow-up question.

Sherilyn S. McCoy

Well, I think -- a few things with regards to working capital. So I wouldn't call it necessarily just a clean-up. And I mean, obviously, we -- I've stated before that we need to improve our forecasting capabilities throughout the process, which part of this new initiative that we're putting in place on working capital will achieve. But also, to your point, we still need to reduce down the inventory levels that we have, particularly Latin America and, to somewhat of a lesser extent, in Europe. And so the key thing is to get the sustainable processes in place so we get those reduced down. So I won't give you an exact time frame for it because it is a process that we're working through, but obviously, the key objective here is to get to a lower level of working capital and to make sure that it's sustainable.

William Schmitz - Deutsche Bank AG, Research Division

And I just -- my follow-up is -- I know you kind of hinted on the capital structure and the debt structure. I mean, the sort of funding required to do the restructuring investment [ph] in CapEx. Is that predicated on continuing to access the commercial paper markets? Because the one thing that concerns me a little bit is that you're kind of getting dangerously close to that downgrade which probably preempts you from accessing commercial paper.

Sherilyn S. McCoy

Yes, just to give you a feel, when we put in place the term loan last quarter, we reduced down quite a bit our reliance on commercial paper. So to answer your question, this is not predicated on reliance on commercial paper. And we continue to look on ensuring that we have -- that we're less reliant on commercial paper, going forward.

Operator

Your next question comes from the line of Chris Ferrara.

Christopher Ferrara - BofA Merrill Lynch, Research Division

Bank of America. I just want to understand what seems like a little bit of a change in tone, I guess. Last quarter, it sort of felt like you were kind of far away from being able to give long-term targets, and today, you gave them. You gave that double-digit target. But you also -- you threw a couple of disclosures in the 10-Q that are talking about costs and FCPA and access to commercial paper. You still have service issues in Brazil, right? You're saying the U.S. is not bouncing on the One Simple Sales Model, like you thought it would? I guess, when you're saying the savings are late '13, early '14 thing, I guess, what drives the confidence in that margin target? And why, give it at this stage of the turnaround when the individual pieces of what you're talking about seem to suggest that, that will be a back-end loaded target? Any color would be great.

Kimberly A. Ross

Yes. Well, you had lot of questions in one there. So let me see if I can try to dissect it down a little bit. Obviously, we've been spending a lot of time understanding what's going on in the business and putting our thoughts together. Since the day Sheri walked in, we've been aggressively putting together the thoughts on how to move this forward, so I -- as we committed to you before, that we will give you more color as we envisioned it and as we got our thinking together. So looking at the target itself, as Sheri said, we took into account the historical performance of the company, and also we've analyzed the cost structure of the organization. And we've already started to have the discussions about some initiatives on getting the costs down, and also looking at essentially the performance of markets in Beauty going forward for top line. So as we analyzed all those pieces together, we feel comfortable that going for a low-double-digit margin is the right place to be for the organization. Now to your point, we're going to be looking on the cost savings side on things that can be done in the short term and can be done quickly. But there are also some structural things that we'll be looking at. And as I said from historical business practices in Avon and those will be tougher to tackle. But we feel it's critical and there's a real sense of urgency from the management team to get the SG&A costs down in the organization, while at the same time ensuring that we're driving the top line. Sheri, do you want to add something...

Sherilyn S. McCoy

Sure. The other comment I would make, Chris, is just that, as we look at our position from an SG&A perspective, we cannot sustain that level. And some of it is clear, that we can make aggressive actions and take action now to get us into a better place. Certainly, as we looked at the top line, it was driven by competitiveness. Looking at where we are in the different markets, we do have a very strong brand. We have strong products. And so it's really trying to get the organization focused on making sure we drive the top line. But at the same time, we can't do that at any cost. And so we needed to put a stake in the ground relative to we need to get back to historical operating margins because that will allow us to be competitive moving forward and allow us to continue to invest for the future.

Christopher Ferrara - BofA Merrill Lynch, Research Division

And will it take structural change to get that SG&A down? I mean, I know what you're saying. It's something that you're considering, but do you think it's a necessity to really dig into some of those historical normal fees [ph] at Avon to get that SG&A down?

Sherilyn S. McCoy

One of the areas of focus for me is on simplification. We have a lot of complexity in our model and some of it has to do with our selling model, it has to do with how we go to market from a campaign perspective. And we are challenging the status quo to look at that because that does drive cost. And the fact that we're not consistent globally, not that it's a "one size fits all" approach, but we really need to look at those. So I think there are some things we can do in a shorter term. As Kimberly mentioned, you'll see some things in 2013 and -- the end of 2013, those are the shorter-term things. But I think, fundamentally, to be at a sustainable level and be able to continue to invest the way we want to invest, we need to address some of the core issues as it relates to complexity.

Operator

Your next question comes from the line of Ali Dibadj.

Ali Dibadj - Sanford C. Bernstein & Co., LLC., Research Division

I'm from Bernstein. So if you could help out with where you are today on your debt covenant ratio and actually give those numbers. And what the implications would be given some of the Venezuela disclosures, the FCPA disclosures, the charges required to cut the cost and the investments. You clearly need -- and have laid out that you need to fix the business going forward. So what are the implications on that? And I guess the underlying question I have is, what really is the risk that you trip the covenants [indiscernible] after you fixed the business, or externalities, like Venezuela and the bribery, and that you end up needing new sources of capital, maybe a secondary or maybe something else? Can you help with that?

Kimberly A. Ross

Yes. So first of all, let me start with -- our covenants, unlike those of many other companies, do not exclude non-cash charges. So therefore, when we took the impairment charge for Silpada in quarter 4 last year, that has, coupled with the business performance, impacted us for quarter 3 because it's a 4-quarter rolling covenant. So therefore, you may require -- remember in the disclosure last quarter, we disclosed that we had obtained a waiver for quarter 3 because we had concerns about the compliance with the covenants. Now that Silpada charge rolls off as of quarter 4. But with that said, our covenants do not allow for items, as I said, non-cash charges, so should we have -- be it large restructuring non-cash charges or be it impairment charges. And to your point, it's -- a massive devaluation in Venezuela or something like a settlement with FCPA, depending on the size and magnitude on those, they would potentially trip our covenants. So what we would do is we would seek a waiver, just as we did for quarter 3. So that's essentially where we are. Obviously, we're looking at the overall financing, in light of the fact that we have our revolver coming up for renewal next year, as well as we have some debt maturities coming up. So we're looking at the overall financing of the organization and the structure of our debt covenants going forward.

Ali Dibadj - Sanford C. Bernstein & Co., LLC., Research Division

So what are the ratios today? And where do you anticipate them going or at least a range of that? And what's your confidence that those waivers will be granted? And again if you could touch on the need for other sources of capital, that'd be helpful.

Kimberly A. Ross

Yes. You can see the exact ratios in the 10-Q. That information is in there. You can look at that. And as I said, we'll be working on the refinancing of our upcoming debt maturities.

Ali Dibadj - Sanford C. Bernstein & Co., LLC., Research Division

Your current ratios are in there?

Kimberly A. Ross

Yes, they are.

Operator

Your next question comes from the line of Connie Maneaty.

Constance Marie Maneaty - BMO Capital Markets U.S.

BMO Capital. Could you address how the U.S. really fits into the portfolio going forward? Because for those of us who've followed Avon for a long time, it's always been in secular decline. And I'm wondering why -- what your thoughts are on Silpada, what it contributes, how the change in your SG&A will affect U.S. profitability. Will it return the cost of capital? Will it ever be a source of free cash for the company?

Sherilyn S. McCoy

Sure. Thanks, Connie. Certainly, we're -- as we look at the U.S., it's not where we need to be, but we feel that it's a very important market for us both from a home headquarters perspective, the Avon brand name. And we believe it's a very competitive and exciting skincare market. So we're very committed to the business. We recognize that we have some challenges, and I think about them in 3 areas. One is the field. So we're dealing with some field challenges. The second is what I would classify or categorize as consumer activation. And the third is the complexity of the model. So as we look at it from a field perspective, as we said, the redistricting, we're still managing through that and we have 2 key issues there. One is we have some district sales managers that aren't performing at the same level that we need them to be because it's a significant change in what we're asking them to do. We're also -- as a result of the redistricting, we're losing some of the lower-tier representatives and we need to get the recruiting engine back in place. And so that's where the team is aggressively today. As I talk about pull in my talk this morning and you look at consumer activation, this is an area where the Avon brand is known but we have an opportunity to continue to make it relevant and look at how we continue to make sure we have the right products and really get the brand in consideration set of the U.S. consumer, which has to do with social media and other things. And so the team is really challenging the status quo there. And as we look at complexity, which gets to your question around the margin and what we look at there, obviously, we're disappointed where we are this quarter. We need to look at the complexity that is inherent in the U.S. business in terms of how do we go to market with our campaign cycle and some of the other things. Those are the critical areas that we will be looking at. But we see the U.S. as important in our portfolio and we'll continue to challenge the status quo and take -- course-correct as needed. And so we will keep you updated as we go and let you know where we end up from a U.S. perspective. As it relates to Silpada, again, certainly disappointing performance. We've been very clear with the team about what their objectives are. And we will continue to work closely with them and keep you updated. Thanks Connie.

Operator

Your next question comes from the line of Mark Astrachan.

Mark S. Astrachan - Stifel, Nicolaus & Co., Inc., Research Division

Stifel, Nicolaus. One follow-up. So your double-digit long-term margin targets, does that include a potential devaluation in Venezuela? And then more broadly, just looking at Brazil, it seems that, over the first, call it, 6 to 9 months in this year, that overall category growth for Beauty has accelerated while you and your principal competitor down there is a -- sales results have remained challenged. I guess I'm sort of wondering if, that fear, that's always sort of been out there that retail branded marketing companies will eventually come in and take share from direct selling? I'm wondering if that has sped up here. Any sort of comments you can make about whether you're really starting to see encroachment there by some of these other companies will be helpful.

Kimberly A. Ross

Okay, I -- maybe I'll start with Venezuela and then I'll hand it over to Sheri to talk about Brazil. With regard to devaluation of Venezuela. We haven't forecasted it and I think in part because we don't know how much to forecast or when it's going to happen. So with that said, we are managing the business assuming that there is a potential devaluation taking place there. I mean, clearly, the situation in Venezuela remains quite challenging and so -- and as we've seen already quite a bit of slowdown just in this quarter due to the economy there. So we're taking steps to try to mitigate the impact of a Venezuela devaluation both to the balance sheet as well as to our earnings numbers going forward. Sheri?

Sherilyn S. McCoy

As we look at Brazil, certainly a very, very attractive skincare market, and the projections for growth are strong. So we're very happy to be in that market. With that said, it's a very, very competitive market and we see retailers actually trying to come in to direct selling, so O Boticário particularly in the fragrance area is coming into direct selling. So direct selling remains strong and very attractive. Word-of-mouth is still critically important. And if you look at the opportunity, our challenge has been really around driving share. We have the opportunity to continue to make sure that we have relevant products. And so the team has been very focused on looking at how we have local advertising, local approaches to make sure that our products are relevant and our marketing approach is relevant to the Brazilian consumers. So as I look at it, it's really our opportunity to drive share growth because I do believe that we can be competitive. It is going to be a more difficult market because it's a very attractive market, but there's no reason that Avon can't get back to a stronger position.

Operator

Your next question comes from the line of Tim Conder.

Timothy A. Conder - Wells Fargo Securities, LLC, Research Division

Tim Conder, Wells Fargo Securities. Sheri, you alluded to some investments in IT, which again you've talked about in the past. And clearly, there's been a significant under-investment for multiple years here. How does your go-to campaign fit within this framework that you outlined on IT and, specifically, digitization of the catalogs and then also the length of campaign?

Sherilyn S. McCoy

Yes, I think that it's an interesting question because, as you think about where the world is going today, there's many people online. I think there's an opportunity to sync the online approach with the offline approach. And so as we look at some of the IT solutions from a representative standpoint, we need to make sure that we're investing so it's easy for her to see how she's ordering, how she gets products, how she wants to ship products. So there's an element there that, I think, is critically important. And as you think about the campaign cycle, people go on and shop differently online than they do through a brochure. So trying to marry that as we look at some of the markets. That's an area that we're going to continue to evaluate. We already have some of our smaller markets today, like Romania, evaluating that. But that's an area that, as we look at some of our bigger markets, is trying to understand that. I will say also that markets are in different place in terms of online. So we have some markets that we see a lot of ordering online. We have a lot other markets, just because of where the Internet is or where mobile is, they're a little bit behind. So we're also taking that into account as we look at solutions moving forward. So it's not a "one size fits all" which also creates a little bit of complexity as we move forward.

Timothy A. Conder - Wells Fargo Securities, LLC, Research Division

I guess, just pulling that back a little bit further, then, how does that importance at the front end with the representatives and the digitization feed into what you and Kimberly lined out as far as the supply chain and the plans there, here over the next 1, 2 years?

Sherilyn S. McCoy

Yes. One of the big areas that we're working on is a program that looks at giving representatives access so that she can see what is available, what's in stock and how she wants to ship things to customers, whether it's directly to customers or whether she wants to receive it and deliver it to her customers. That's something that is critically important and it's something that, as we talked to representatives, is very important to them moving forward. So we need to be able to customize that. And we're putting some significant money behind that approach to make sure that the front-line ordering talks to the back lot -- back-line -- back-end supply chain component.

Operator

Your next question comes from the line of Javier Escalante.

Javier Escalante - Consumer Edge Research, LLC

Consumer Edge Research. Question for you with regards to -- you made a couple of comments with regards to your peer group both when you were talking about operating margins and delivering yield. So if you can tell us how you see your peer group, is it direct sellers or other kind of companies? And within this peer group question, I would like to understand how -- what is your assessment right now of your normalized operating margins, so to speak. Because if you look at into the release, you talk about increases in overhead cost. I was expecting deleverage because of the weak sales, but I wasn't expecting increasing in overhead cost. And also if you can comment, if possible, what is the impact of gravitating back to lower-margin categories like Home Care and Fashion in order to stabilize? What is the impact on margins of gravitating back to those categories in order to stabilize the retention of the reps? What is the impact on margins, if any, of any increase in RVP spending to retain reps? I didn't read anything on RVP, but I just would like to see whether you did increase it and if there is that impacting your margins. I know that you caught AMPs. So if you can tell us exactly how the business mix, spending in RVP, this increasing overhead basically made your underlying operating margin smaller than it actually would be. And then what is this peer group that you are talking about?

Kimberly A. Ross

Okay. So maybe if I'll start with the peer group. Essentially, what we look at is CPG and direct sellers. So they do tend to behave differently, especially when you look at with regards to dividend when you look at the percentage of free cash flow payout as well as if you look at the earnings payout. So they -- there are differences between the 2, I think, when it comes to dividend yield, that's one where they're probably more aligned. But so we look at CPG as well as direct sellers. If -- you then -- talking about some of the overhead costs, I think you will see in our earnings release that we had some higher compensation costs and that's because we had some reversals of accruals last year that -- and this year, they were less so than they were last year. So that was one of the things that really impacted us there. And then if you look at RVP spend for the quarter, it was up slightly in constant dollars but down with regard -- but it was down -- but down with regards to floating. And I think, really, the way to be looking at that is looking at overall SG&A. That's how we're going to be looking at it going forward versus just looking at RVP in itself. So looking at all the components of SG&A, and that takes into account the advertising, what we've been traditionally calling RVP, as well as the other components of SG&A, going forward.

Javier Escalante - Consumer Edge Research, LLC

The questions is that, if you -- if the 6%, 5.9%, 6% operating margin is what you would consider to be a normalized level in operating margins given these sales growth of 1%? Or is it there because you didn't mention this, what is the impact of the increases in overhead. I mean, is that significant? It's not fixed [ph] with the 8 [ph]. I mean, I just would like to try to understand what is the underlying operating margin to see -- to assess how much margin needs to spend going forward to hit your 2016 target. Is that -- that's what I'm trying to get at.

Kimberly A. Ross

I think the way to look at it, Javier, is to really look what we set out, which is that we're going to target the low-double-digit margin. So that's what you need to look at. And that's what we're going to get measured against, as we work to deliver that over the next few years here.

Amy Low Chasen

It's Amy. Thank you, all, for your time and for allowing us to reschedule this call. We're going to end the call now given that you all have another call to jump onto. I know that there are some of you who still have questions, and I'll be around all day for any follow-ups. Thanks.

Kimberly A. Ross

Thank you.

Operator

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

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