科蒂集團 (COTY) 2019 Q1 法說會逐字稿

Good morning, ladies and gentlemen.

My name is Kristi, and I'll be your conference operator today.

At this time, I would like to welcome everyone to Coty's Fiscal First Quarter 2019 Results Conference Call.

(Operator Instructions) As a reminder, this conference call is being recorded today, November 7, 2018.

On today's call are Camillo Pane, Chief Executive Officer; and Ayesha Zafar, Interim Chief Financial Officer.

I would like to remind you that many of the comments today may contain forward-looking statements.

Please refer to Coty's press release and reports filed with the SEC, where the company lists factors that could cause actual results to differ materially from these forward-looking statements.

All commentary on organic net revenue reflect a comparison of the business at a constant currency in the current and prior year periods, excluding the impact of acquisitions and divestitures.

In addition, except where noted, the discussion of our financial results and our expectations reflect certain adjustments as specified in the non-GAAP financial measure section of our earnings release.

You can find the bridge from GAAP to non-GAAP results in the reconciliation tables in the earnings release.

I will now turn the call over to Mr. Pane.

Thank you, Kristi, and welcome everybody to Coty Fiscal 2019 First Quarter Conference Call.

We're very disappointed with the supply chain disruptions we have experienced over the last quarter and the resulting poor Q1 financial performance.

While we had anticipated some level of disruption in the first quarter from warehousing and planning consolidation, the increased scope of the disruption resulted in much weaker results than previously expected.

We've been working hard to remedy the supply chain issues and expect the temporary headwinds in the second quarter, and have them be substantially resolved in the third quarter.

Although we do not expect to fully recover the Q1 financial impact in the balance of fiscal '19.

As a result of these disruptions, we have decided to modify our distribution center consolidation plan for the remainder of the year to minimize business impacts.

With a healthy synergy delivery already in Q1, these modifications should have no impact to our commitment of $225 million of synergies in fiscal '19 and $750 million of synergies by the end of fiscal '20.

By division, underlying consumer demand in Luxury and Professional Beauty remain strong, but the underlying performance of Consumer Beauty remains challenged.

Our immediate focus in the business right now is threefold.

First, to resolve the supply chain disruption; second, to improve underlying performance in Consumer Beauty; and third, to improve cash flow generation.

So let's get into the results.

First quarter revenues declined 7.7% on a like-for-like basis, as we encountered temporary supply chain headwinds.

Alongside the previously flagged supply chain issues affecting Consumer Beauty and Professional Beauty, our Luxury division was also impacted in Q1 by a disruption in European warehouse, by the U.S. hurricane and by component shortages at certain external suppliers.

All of these factors cumulatively impacted our top line by close to 5% and without the drag of the disruption, we believe that our underlying net revenue would only have declined by about 2.5%.

The adjusted gross margin of 60.4% decreased by 120 basis points in the first quarter, primarily driven by the impact of supply chain disruption on both Consumer Beauty and Luxury.

Our A&CP investment remain in the range of 23% of net revenue in the quarter, only modestly below last year and consistent with our targeted trend.

Importantly, we have made significant progress in the past few months in addressing our fixed cost base, with controllable fixed cost down mid-single digits during the first quarter versus the prior year on the back of the synergy programs.

This support the delivery of an adjusted operating income of $141 million, a decrease of 28% versus the prior year, which was driven by the net revenue gross margin contraction, as well as the 4% headwinds on exchange rate.

The synergies delivered in the first quarter were in line with our target, but were more than offset by the supply chain-related headwinds, which we estimate impacted operating income by about $60 million despite the underlying deterioration in Consumer Beauty.

Total EPS for the quarter was $0.11, which reflects 10% growth versus last year, driven by favorable tax outcome, which added $0.04 to EPS.

Before moving to divisional results, I want to elaborate on the supply chain disruption that meaningfully impacted our performance this quarter.

I would like to remind you that our end stage design for our supply chain is intended to ensure a streamlined, agile and efficient organization, not only fit for future growth, but one which will serve as a long-term foundation for best-in-class operational efficiency.

To this end, during the last 24 months, we have shut down 3 factories, restructured a fourth one, consolidated several supply chain planning locations into 3 planning hubs, consolidated 6 distribution centers and exited TSA agreements in over 30 countries.

From a regional perspective, the changes to our supply chain footprint implemented so far represent about 80% of the planned supply chain transformation following the merger.

Frustratingly, towards the end of the fourth quarter of fiscal '18, we started to encounter several supply chain challenges in 2 of our key locations in the U.S. and Europe, which includes the ramp-up of the Consumer Beauty planning hub and manufacturing plant in the U.K. and the consolidation of a professional beauty distribution center in the U.S. Additionally, in mid-September, we discovered a partner issue related to the consolidation of a Luxury distribution center in Europe.

Today, I want to focus my comments on the actual plans we'll put into place to address each of these issues and contain the duration of the impact.

We are working strictly to confine the majority of the impact of these temporary disruptions to the first half of fiscal '19, although we expect some residual impact in the third quarter.

Specifically, in the U.K., we took action to move volume to other Consumer Beauty plants.

And we expect the service level to be restored in the second quarter of fiscal '19.

In North America, we had implemented an action plan with our third-party warehouse partner to improve service level while we prioritize key clients.

And we also expect this to be largely resolved during the second quarter.

The Luxury warehouse issue is related to tight capacity and initial integration challenges, particularly impacting the travel retail channel.

By using another warehouse nearby and prioritizing key customers, we expect to have largely restored service level by the end of the second quarter.

These internal headwinds, which account for about 2/3 of the supply chain-related profit impact in the first quarter were compounded by 2 external factors that mainly affected the Luxury division.

We are addressing the shortage of component parts in 2 key Luxury suppliers that provide pumps and glass bottles and expect to resolve this issue during the third quarter of fiscal '19.

The impact of Hurricane Florence, which hit the U.S. in September and constrained our ability to move products to and from our distribution center in North Carolina, is expected to fully reverse in the second quarter.

We estimate that the total impact of these supply-related headwinds was about $100 million on top line and approximately $6 million on operating profit.

Although we clearly took a calculated risk by making many fundamental changes to our footprint over a short period, these latest disruptions have made us realize that we must carefully balance our remaining integration plans with the needs our business and customers.

As a result, we have decided to modify our distribution center consolidation plan for the remainder of fiscal '19 to minimize this disruption.

With a healthy synergy delivery already in Q1, this consolidation modification should have no impact on our commitment of $225 million of synergies in fiscal '19 and $750 million by the end of fiscal '20.

That said, we acknowledge the synergies captured during the first quarter did not allow for profit conversion as the supply chain disruption coupled with weakness in Consumer Beauty developed markets, more than offset the synergies captured.

We expect the conversion rate of synergies into profits to increase in the remaining quarters of fiscal '19.

While the impact of these factors has been significant to our first quarter results, I want to emphasize that the supply chain headwinds are a temporary setback in achieving our financial targets.

Our confidence is underpinned by strong underlying consumer demand in Luxury and Professional Beauty, where market share remain healthy.

And the fact that both divisions where we reported solid net revenue growth in Q1, consistent with their full year 2018 trend, if it were not for the supply chain disruptions.

However, underlying results for Consumer Beauty are not where they should be and we are accelerating a number of strategic interventions, which I will cover in a moment.

To that end, let me briefly remind you of the earnings model that underpins all of our strategic choices.

Our target is to deliver flat-to-modest top line growth, combined with our ongoing focus on reducing costs, even after the synergies are fully delivered, and this underpins our medium-term target of achieving a high-teens adjusted operating margin over the next 5 years.

We believe that each of our division plays a unique role in helping us to achieve this margin structure and profit growth.

Specifically, we look for Luxury to sustain its above-market top line expansion, fueled by our strong innovation capabilities, geographic expansion and ongoing development of our Prestige skincare and color cosmetics offerings.

In Professional Beauty, we look to accelerate our growth by maximizing the untapped potential of OPI and ghd, while capitalizing on the market-leading position of Wella, our largest portfolio brand with over $1 billion in revenues.

In Consumer Beauty, we aim to initially stabilize the division's top line and improve the margins, and I will get into further details shortly.

Our strategy to drive growth continues to be focused on 4 distinct pillars, which are equally relevant for all 3 divisions.

It includes focusing on brands which matter and have potential, on driving innovation and in-store execution much harder, on rapid expansion in the emerging ALMEA markets and on digital transformation.

On this last point, we saw continued momentum in e-commerce across all 3 divisions in the first quarter.

Now let me dig deeper into our performance by division.

Luxury net revenue declined by 2.1% like-for-like.

This was fully driven by the internal and external temporary supply headwinds we experienced.

Excluding these factors, we estimate Luxury like-for-like net revenue in the quarter would have grown close to 5%, consistent with fiscal '18 performance.

Despite the supply chain headwinds, Luxury was still able to deliver 15% profit growth and 100 basis points of adjusted operating margin improvement.

It's important to, again, emphasize the e-market performance of our brands, confirms our view that momentum for our Luxury brand portfolio remains robust.

Sell-through of our brand during the quarter was strong, and we are particularly pleased by the share gains we saw in Europe and across several brands including Gucci, Tiffany, Marc Jacobs and Chloe.

Despite the fact that Gucci and Tiffany lapped strong launches from the first quarter of last year.

As we entered second quarter, we had 2 important innovations hit in the market, including Hugo Boss The Scent and Burberry Her, both of which are off to a promising start.

It's worth noting that Q2 will be the first quarter when Burberry is in included in our like-for-like numbers.

Finally, I'm pleased with the very strong momentum we saw in Luxury e-commerce with significant growth across nearly all of our leading brands.

In Professional Beauty, we experienced a similar dynamic as in Luxury, with the supply chain issues masking the stronger market fundamentals of our brand portfolio.

Professional Beauty net revenues declined 2.6% like-for-like in the quarter, with the disruption of service level at our North America distribution center having a significant negative impact on our North American hair and nail businesses.

Without these headwinds, we estimate like-for-like net revenue would have increased about 1.5% in the quarter relatively consistent with the trend in the last 7 quarters.

We see no underlying change to customer demand for our brands in North America, which remain strong.

We continue to see selling momentum in other parts of the division, with low single-digit growth in Europe and high single-digit growth in ALMEA and ghd.

I'm very pleased with how the Professional Beauty team capitalized on a number of strong innovation in the quarter, including the restage of Wella Koleston Perfect with the breakthrough ME+ color technology, which was just launched in Europe and will roll out in other parts of the world over the course of fiscal '19.

We're also excited about the review of ghd Platinum+ styler of our first 3 corporate predictive technology to consumers' hair types and styling approaches.

Despite the supply chain headwinds, which impacted OPI's momentum, we are pleased with the strong performance of the brand's recent collections.

We continue to see strong momentum in our e-commerce business, including the rollout of our new D2C platform mywellastore.com in the U.S., and coming soon in several countries in Europe.

From a profitability standpoint, despite the supply chain disruptions, Professional Beauty grew adjusted operating income by 41% and delivered 190 basis points of margin improvement.

The combination of several internal and external factors drove a very good results in Consumer Beauty as the 14% like-for-like net revenue decline, included growth of 5% of headwinds from the supply chain disruption.

Excluding this, top line would have declined by about 9%, a result that is still much weaker than our ambition for the division.

The sequential deterioration in Consumer Beauty business trends reflected the knock-on effect of the supply chain disruption.

As we invested more with our customers, including increased promotional activity, which we used in our revenues.

However, results were partly impacted by the continued weakness in U.S. and Europe mass beauty categories, with previously flagged distribution losses leading to a deterioration in share.

The net result of these top line headwinds was that the first quarter adjusted operating income was $14.8 million, a significant decline versus the prior year period, with a disappointing adjusted operating margin of 1.8%.

Set against these overall results, there are a number of commercial highlights that I want to call out in the quarter.

Despite the supply chain disruption, with hampered Rimmel and Max Factor sales in all geographies, the ALMEA region was modestly positive.

And importantly, our brands continue to gain share in these regions, including our Brazilian business continuing to grow share and delivering strong top line growth, while driving a significant improvement in gross margin.

By category, in retail hair, our largest brand, Wella, experienced solid net revenue growth and share gains in a number of emerging markets, fueled by hair color and hairstyling products.

Our color cosmetics category experienced the biggest contraction in Q1, reflecting the significant impact of supply chain disruption and ongoing pressure on home sales group.

As we continue to strengthen COVERGIRL after our relaunch, the brand improved its leadership position in face with TruBlend Matte Made becoming the #1 face launch of the season and showed progress in earned media value, or EMV, in recent months, a key brand health indicator.

As we announced on Monday, COVERGIRL became the largest cosmetic brand to earn the gold standard Cruelty Free certification by Cruelty Free International.

This is a compelling proposition for our consumers, and we have received very positive feedback from our customers.

And last but not least, we're looking forward to the opening of our COVERGIRL flagship store in Times Square at the end of this month.

For Younique, while sales trend improved sequentially, first quarter profit performance was below the business's long-term trajectory as strong presenter sponsorship and growth in overall revenues were more than offset by increased promotional activity and compensation plan adjustments.

While these adjustments have not translated into improved presenter retention at the pace initially expected, we believe the traction in the new subscription and loyalty programs, factored compensation plan refinements and the continued broadening of the Younique portfolio will support strong momentum in Younique in the coming years.

In total, performance in the Consumer Beauty division remains well below our goals of stabilization and predictability.

We are taking decisive action with a significant sense of urgency to shore up the division in the short term.

The critical first half year is strengthening operational discipline.

We'll particularly focus on restoring service level in the coming quarters, fortifying our innovation focus on execution and driving discipline in trade and promotional spend, particularly once supply chain headwinds abate.

Beyond that, we are first refocusing investment from the mainly low priority brand-country combinations to a smaller subset of higher-potential combination.

Not surprisingly, this includes COVERGIRL in the U.S., and our strong Wella business in ALMEA among others.

We believe this reallocation will allow us to earn a higher return in our investments.

Second, we are continuing to drive these cost savings in line with the division top line trajectory.

Third, we are accelerating investments towards new growth channels, including improvements to our e-commerce capabilities by adapting our supply chain, product assortment and creative assets.

We expect a positive impact from these actions over the course of fiscal '19, though turnarounds are rarely linear and much work needs to be done to stabilize and ultimately expand shares in Consumer Beauty.

I've already covered the most significant drivers of the operational results, so let me briefly touch on the other financial metrics, in particular, the drivers of EPS and the increase in our leverage.

Our first quarter adjusted net income of $80.5 million grew 6% versus the prior year, primarily due to a onetime $32 million tax benefit in the quarter, coupled with lower interest expense, which was tied to higher euro borrowings during the first quarter.

In Q1, net cash provided by operating activities was negative $82 million and free cash flow was negative $215 million, primarily driven by continued pressure on working capital and over $15 million increase in onetime cash cost.

It's important to emphasize the impact of our supply chain headwinds on our net working capital as the need to shift production and build up safety stock pressured our inventories, while customer relationship were strained making trade terms optimization more difficult.

As we work to quickly remediate the effects of the supply chain disruptions and drive profit improvement, we will expect our free cash flow and net working capital balances to improve over the course of the year.

Net debt of $7.6 billion on September 30, 2018, increased by $370 million from the balance of $7.292 billion on June 30, 2018, resulting in a last 4 months net debt to adjusted EBITDA ratio of 5.8x compared with our June 30, 2018, ratio of 5.3x.

This net debt increase, which we had flat last quarter, reflects negative free cash flow, the dividend payment of $94 million and the payment for the Escada license of $41 million.

Let's now turn to the outlook and how we see our business evolving in the second quarter and remainder of the year.

In the second quarter, we expect underlying net revenue trends to improve versus first quarter across all 3 divisions, inclusive of expected supply chain headwinds.

Specifically, we look for Luxury and Professional Beauty to return to like-for-like net revenue growth in the second quarter, while Consumer Beauty like-for-like trends should improve to a high single-digit decline.

On adjusted operating income, we expect Q2 adjusted operating income to be moderately lower versus a year ago, driven by the remaining supply chain impacts and FX headwinds.

The second quarter adjusted EPS comparison versus prior year will be pressured with a $42 million positive tax settlement recorded in Q2 of last year.

Looking to fiscal '19, despite the supply chain headwinds, we continue to expect operating profit and margin growth in fiscal '19, driven by significant progress in fixed cost reductions and synergy delivery.

However, we need more time to assess the financial impacts of the continuing supply disruptions, and at this stage, we're not providing any further guidance, but expect to provide an update on our outlook on the next earnings call.

Deleveraging remains a top priority in fiscal '19 and beyond.

We remain committed to our target of achieving a net debt to adjusted EBITDA ratio of below 4x by the end of calendar '20, and we expect positive free cash flow in the remaining quarters and overall in fiscal '19.

Our liquidity position is substantial with significant flexibility from over $2 billion of revolver availability.

Our midterm goals remains one of delivering consistent, modest net revenue growth with continued margin expansion.

This, coupled with our dividend payout, should drive a superior total shareholder return.

To conclude, Q1 was a setback in achieving our financial targets and bold strategic goals, driven by our temporary supply chain headwinds.

However, we remain absolutely convinced that our fast-paced and ambitious transformation agenda, including comprehensive changes to processes, systems, culture and people, is ultimately building a much stronger Coty for the long term.

As we overcome the internal supply headwinds and complete all other major integration-related milestones, we will increasingly shift our focus from being largely internal to fully external, and we will be able to see improved performance across all areas.

I'm proud of how the team is addressing the challenges with a very strong ownership mindset, and I see tremendous potential for Coty to create significant value for our shareholders and consumers in the coming years.

Now I will turn the line back to Kristi to open up the line for Q&A.

(Operator Instructions) And our first question is from Lauren Lieberman of Barclays.

I wanted to ask first just about the profit impact of these supply chain issues, because if I recall coming into the fiscal year, we had talked about there being almost $100 million headwind from just the integration-related issues on supply chain.

And this quarter, you called out it being around $60 million.

So is part of this -- and any of this ties to the discussion of it being casted -- forecasted financial impacts, but was there some almost delay in things have slowed down, but the cost is taking longer to work through it?

There does seemed to be a bit of a gap in how we're thinking about the impact on operating profits, what you said it was and what we expected it to be was the first question.

The second was on the Luxury componentry issue.

Is there any reason to tie this to some of your cost savings efforts?

So whether it's the choice of suppliers, things that you've done and how you're working with those suppliers that ultimately had a knock-on effect on your ability to access the necessary componentry?

Lauren, looking at the -- your first question, which is the supply chain.

What we said in the previous quarter, so at the end of 2018 in August is that we were expecting an overall full year impact from supply chain headwinds of $50 million on [OI].

What happened in reality is that we had $60 million just in Q1, and the reality is that at the time of the '18 earnings we knew of some of the supply chain disruptions and -- which, of course, drove our outlook that we gave.

What happened is sequentially we learned of new supply chain issues in the Luxury warehouse in Germany, and we were also impacted by U.S. hurricane in mid-September.

Both of these were not known to us and together represents almost 60% of the impact that we suffered in Q1.

So out of the $60 million almost 60% comes out of these 2 headwinds, which we were not aware.

We also need to remember that September is a peak demand month for Luxury, and clearly, this further exacerbated the impact of the supply chain disruption.

We have to replace a lot of actions, of course, to address and contain the duration of the impact.

We are rebalancing the supply chain.

We are rebalancing the production and the logistics within our network.

We're working with our supply base better to ensure sufficient component supply and I'll mention in a second your question there.

And one of the things we have done because of the disruptions and the magnitude of disruption in Q1, is that we have made modifications to our consolidation plans for the remainder of the year.

And we have delayed or modified pre-planned consolidations that we are going to add, and were going to add in the second part.

And, of course, we did this to balance better the need of finalizing the integration with the need of our customers and then consumers until we minimize the business impact.

And this is why we said that although it's possible that there might be some residual disruption in the second half, we're working swiftly to basically confine the impact of this disruption to the first half.

Looking at the -- at your second question, which is the component issues.

I think it's driven by a couple of things.

Yes, it is true that we have, of course, streamlined our supply base because that's part of our journey to become more efficient, agile and to decrease our cost base.

But in this case, I would say, the majority of problems came from twofolds.

One is our increased demand.

We're going well in Luxury, and therefore, we are increasing demand of our components.

And then second, there are a couple of key suppliers specifically for pumps and bottles entered into problems, into shortages, not only with us, but also in general with the industry.

And the combination of our higher demand and these shortages from the suppliers meant that we're now having an impact, which we didn't really realize that it would have been this significant.

Your next question is from Robert Ottenstein of Evercore ISI.

Two questions.

Can you talk a little bit about how you're thinking about promotions on the consumer retail side?

On the one hand, if it doesn't seem like you have the products, then why are you doing the promotions or is it just to accelerate the cleanup of the old inventory in the U.S. mass retailers?

And then just kind of stepping back in terms of the whole consumer business, can you give us a little bit more of a sense of what the performance was on the top line for U.S. retail, European retail or Younique in Brazil?

Thanks, Robert, for the questions.

When I look at the promotional intensity, this is driven by a couple of issues.

One is, yes, we do have supply chain headwinds and problems.

And that basically means that we have more of a distributor issue with the retailers, which leads to penalties, because we're not able to maintain the service level that we're supposed to.

So that's one of the driver of the increased spend.

The second one is that we wanted to increase the support to our brands in store, while we were seeing the issue in the supply chain, but it's not like the supply chain issues were across the entire portfolio.

And this is why you have these effects.

In terms of the Consumer Beauty performance in the different regions that you mentioned, let me start with the U.S. U.S. is a mix situation because we do have an improvement in COVERGIRL.

COVERGIRL continues to have performance in the mid-single-digit decline while the rest of the brands is more of a high single-digit decline in the U.S. And when I look at COVERGIRL, there is a lot of also positive things, which are happening on the brand, which are moving the performance, progressively and sequentially towards a better and slower decline versus the past.

And I can potentially talk later about this.

And in Europe, no.

In Europe, clearly, we suffered, the majority of the supply chain headwinds did happen in Consumer Beauty in Europe because this is the stronghold region for both Max Factor and Rimmel and the issue we have in our planning hubs in the U.K. were mostly related to Rimmel and Max Factor.

So again high single-digit decline in Europe because of most of the supply chain.

Brazil is a different story.

Brazil, we're doing well.

We are growing twice as fast our second competitor, and we are the fastest-growing multinational company in beauty in Brazil.

Our strategy of -- that we -- that really impacted our results in 2018 is absolutely working because our market share continued to be very healthy.

We're growing share across most categories, but at the same time now, we had a much improved gross margin, which was absolutely our strategic intention, when we had the pricing intervention in 2018.

And lastly, regarding Younique.

Younique trends have improved this last quarter, but from a profit point of view, we were disappointed by the results because what happened is, we did implement new compensation plan adjustments, and it takes time for the presenters to adapt their behavior and clearly have an impact on presenter recruitment through the new compensation plan.

At the same time, while doing this, the new compensation plan is in place and it clearly cost a lot of money.

Now to offset this, we have 2 programs, which are doing very well in Younique.

One is the loyalty program, which is helping to increase retention of presenters.

And the second one is a subscription program, which we launched just in mid-August.

And in just a couple months, we have more than 70,000 consumers that had subscribed to our new subscription program for mascara.

And of course, these 2 programs give us also a lot of confidence for returning Younique to a very strong performance in the coming quarters because, of course, they do improve loyalty and predictability of the business over time.

Your next question comes from Mark Astrachan of Stifel.

I guess, couple sort of housekeeping questions.

So if you're going to get back much of the supply chain-related disruptions to the top line, why not keep the sales targets that you had outlined in conjunction with fourth quarter results?

And then sort of related to that, how do you think about given some of the challenges in Consumer Beauty that these supply chain disruptions don't have a more permanent impact on the business?

And then the same sort of comment on the Luxury business.

So you say, you're getting that back, but obviously, this part of the year is a pretty key part of the year.

So why does that not have more of an impact on the business?

And then just lastly, also somewhat related, given seasonality in the business and the profitability, cash flows in the first half of the year is part of the withdrawal of guidance in the sort of talking about updates next quarter because basically this year is now a wash as you consider it that you can never get back that level of profitability.

So we're basically looking at fiscal '20 now as kind of the first year out where results meet whatever your expectations would be.

Thanks, Mark.

I'll try to answer all your questions in the order that you gave to me.

The first one is for the outlook of 2019.

Of course, we are working very hard to contain the impact of the supply chain disruption to the first half, but there is potential for seasonal impacts in the second half and, therefore, we have limited visibility to the overall impact on 2019 revenues and profits.

And we want to take more time to have this assessment.

And this is why we told you that we would like to come back next quarter.

Despite the headwinds, we continue to expect operating profit and margin improvement and growth in 2019 because we do see significant progress in fixed cost reductions, and we are delivering the synergies.

And that's why we are just saying that we will come to the next quarter.

Now when I look at the specifics in the divisions, the first one, I think, you asked is Luxury.

It is true, absolutely, that we are entering into the highest season and -- but we do have safety stock, and it's not like that the supply chain headwinds that we're having will stop us from having a strong season.

And this is why we have reaffirmed that we will grow revenues and profits in Q2 in Luxury and, of course, we believe in the underlying strong demand for the Luxury business.

And of course, we got impacted by the headwinds and the hurricanes of both internal and external and the component shortages, but the underlying demand is strong, and we believe we'll be able to deliver on our outlook.

In Consumer Beauty, as I said, the supply chain really impacted Rimmel and Max Factor.

So it is different.

This is a mix of supply chain issues and underlying performance of our business.

And I've mentioned a lot, what are the extra plan that we are doing to turn around the Consumer Beauty.

We need to be focus absolutely on strengthening operational discipline in Consumer Beauty.

That's our first focus, plus doing those other strategic changes that I mentioned, including reallocating capital.

Now in terms of profitability, your last question was -- I think I answered your last question in terms of why we're not giving guidance and we're going to wait one more quarter because we will understand the profit.

And it's the same for cash flow at the end of the day.

So the 2 things are related.

They are very much interlinked.

So we do expect positive free cash flow in the next 3 quarters and, of course, positive free cash flow in 2019, but because of the impacts, we want to wait to give specific level of details, and we will do it next quarter.

Your next question comes from Faiza Alwy of Deutsche Bank.

So just 2 questions for me.

One is on the ALMEA performance within Consumer Beauty.

So Camillo, I'd love your take on, was that in line with expectations?

Because it seems to me that, that business may have decelerated a little bit.

And if you could just focus your comments on outside of Brazil?

And then my second question is just around, like, I understand the specific supply chain issues, but it seems to me that since the P&G acquisitions have been a number of, like, integration-related distractions.

So I wonder if you've put any new like internal processes, changes, anything, like, is there a specific team that's now going to be responsible for some of these execution integration actions?

Because it seems to me that there has been a lot of focus on just synergy realization and perhaps less so on just the execution.

And I understand that you've delayed some of these.

You've modified your plans and delayed some of this transition.

But how do we know that when you do go forward with these consolidation plans, you are not going to encounter sort of similar issues?

So just would love your perspective on both those things.

Thanks, Faiza.

Looking at ALMEA, I think I mentioned Brazil quite extensively.

So we're very pleased with that.

Look the -- actually, the driver of ALMEA was moderately positive, so we grew in ALMEA in Consumer Beauty in the quarter and with a couple of different dynamics.

Brazil was very good, as I mentioned.

Mexico was also very good.

We continue to grow share, especially in hair color, which -- in Wella, which remains our stronger brand there.

And Middle East, also we had very good growth there.

There we have Bourjois, which is the #1 cosmetic brand in Middle East.

And we're doing a lot of very strong things there.

And also, we grew in China, but in China, we had the deceleration of growth, but we're -- we continue to remain confident on our business in China.

I think the overall health of our Chinese business across all divisions actually is very strong.

And we have a size there that allows us for a lot of opportunities in the future.

One of the countries which slowdown in ALMEA, which is actually a very sizable country for us, is Australia.

This is where Australia performed very, very well in 2018.

But Q1 '19, I think some executional issues didn't allow Australia to grow in the country with a decline there.

And Australia is actually quite sizable for us, so this is driving down the performance of ALMEA in Consumer Beauty.

We believe this is temporary because we have high level of confidence on the health and the potential for continued growth -- healthy growth in ALMEA in Consumer Beauty as we mentioned in our earnings model and also in our previous call in August.

Looking at the supply chain integration disruption, I think what is important is, first, to really remind what we're trying to build is really a streamlined, agile, very strong supply organization, which would be -- really gives us a foundation for best-in-class operational efficiency.

So we are always going to keep in mind the complexity and the ambition of the journey.

And the fact that I'm still having these last 3 internal issues that I mentioned in the call, we really did a lot of complex integration things without having any issue.

Now looking at the current issues, the 3 headwinds that we're having in Q1, absolutely, we are reviewing the entire planning process of the company to make it much stronger and more robust and fit for an organization that has many new people because we don't have to forget that we've also many new people that came from the outside because we had to stand up some of the organization during the merger.

Now with this, where we are right now is that we have done 80% of the integration.

So it's a quite large platform and for the remaining 20%, as you mentioned, we have decided to do some modification and to derisk some of the consolidation.

Based on the new plans, we're actually confident that we're going to see the integration of our fiscal '19 with a much lower level of risk.

Regarding your question about specific teams, we do, yes, have specific teams that now are in clearly looking this training process and the consolidation plan with the level of details and scrutiny that clearly we have never had before.

Your next question is from Olivia Tong of Bank of America Merrill Lynch.

First, just s clarification in terms of your supply chain issues.

And I'm a bit confused on how -- you have all these supply chain issues that have cropped up more recently.

You're delaying some of the consolidation in terms of the manufacturing.

You're delaying some of the consolidation, yet it doesn't impact the delivery of synergies.

Why is that the case?

Thanks, Olivia, for the question, because out of the -- first of all, as we said, we have done 80%.

It's remaining 20%.

Out of the remaining 20%, the one that we have the risk, they were mostly driving the simplification rather than having a lot of cost savings attached to it.

Not every single project has large cost saving attached to it, but many of the projects are to drive simplification for us, but also for our customers because we are trying to achieve, what we call internally, 1-1-1, which is one order, one invoice and one distribution point -- one shipments point.

And so because of the -- basically that's the answer to your question.

It's the simplification, the growth there that is driving some of these plans and the impact on synergies is truly minimal, and it completely gets absorbed by the older problems that we are absolutely delivering on target.

Got it.

And if I can just follow-up with 2 more unrelated.

I know you've jettisoned a lot of the challenged fragrance brands and made a lot of portfolio changes, but does there need to be more paring back of the portfolio to get to where you want to get to?

And then just one housekeeping, if you could help us in terms of your updated expectations on all your interest expense and tax rates?

Olivia, can I ask you to repeat the question, because you were -- unfortunately, your line is not the best.

I couldn't hear you very well.

Can you repeat again?

Yes.

Okay, I just picked up my phone.

But the first one was just around your portfolio, because I know you've obviously gotten rid of quite a few of the challenged fragrance brands, but does there need to be more paring back of the portfolio in order to get to where you want to get to?

And then just the housekeeping one was around your updated expectations for the full year on interest expense and tax rate?

Okay, so on the portfolio, I think we have done our portfolio rationalization.

As you mentioned, we have pulled back some of the fragrance brand, and we don't expect to have any more rationalization at this point.

We're happy with our portfolio.

And our focus is absolutely to drive -- to continue to drive strong growth from Luxury and Professional Beauty and to -- and the focus clearly is to turnaround the Consumer Beauty with the action plan that I mentioned before.

So in terms of interest rates and tax rate, so the first one is -- from a tax rate, we expect in the low 20s, around 22%.

So that's our estimate we have given as we begin -- in the last earnings call, and we continue to be committed to this.

And in terms of interest expense, we're putting in our model around $310 million.

Next question is from Steph Wissink of Jefferies.

I want to come back to Mark's earlier question on the guidance and just the pass line or the track line here.

And your second quarter, Camillo, you're expecting Lux and Pro to return to positive.

And I think you mentioned down high single digits in consumer.

Can you just help us bridge the transition from Q1 to Q2 on what's remediation of supply chain versus what your expectations are for underlying improvement?

And then also update us on any shelf-space changes or adjustments to your planned promotions or programs and any impact from the supply chain?

Yes, so from a guidance point of you, you're -- yes, you're correct.

So we expect the Luxury and Professional Beauty to go back to more or less approximately be the same trend that we have in 2018, basically to revert to growth because the supply chain headwinds will abate, although we will still have some supply chain headwinds in Q2, but we believe that our underlying strong demand will be able to offset that one, and we're confident with that.

Consumer Beauty is, we say -- we're saying about high single-digit decline.

This is driven by -- first of all, the solution or the improvement of the supply chain headwinds which, of course, will benefit Consumer Beauty as well from a service level point of view.

Plus we are putting in place this action that I mentioned before, and one important one is clearly a much stronger management for our trade spending and gross-to-net.

As you could imagine gross-to-net was -- as I mentioned before, impacted by the penalties with the customers by -- were impacted by all these additional promotional activities.

Once the promotion -- once the supply chain headwinds will abate, we will be able to manage better the trade spending.

And then, of course, we'll have a positive impact on the net revenue decline.

And then, of course, is being our turnaround kind of Consumer Beauty that I mentioned before.

So the operational discipline, the reallocation of investments, the stronger growth of e-commerce that I mentioned before.

And all this will be -- will also benefit from lesser headwinds on supply chain.

I don't think we should underestimate the impact on the commercial organization from supply chain headwinds of the nature that we've be dealing with.

And this will reverse, will improve in Q2, and will eventually reverse in the second half of 2019.

Regarding your second question, which I think was about shelf space.

I want to go back to what I said in the last earnings call, because -- so first of all, our focus is on driving consumption productivity on shelves.

And one thing I'm going to say which is positive is the fact that we've seen actually positive progression in productivity and innovation performance, especially in COVERGIRL, but also in Rimmel in the U.S.

COVERGIRL productivity, if we exclude the distribution losses, actually has been improving and growing across most of the customers in the U.S. for practically 4 months in a row.

And this is really, really positive.

Now this productivity growth is very good news, and it shows that the brand is reacting to all the programs that we're putting behind into the relaunch.

But this productivity growth is still insufficient to offset the distribution headwinds.

And this is why we have already flagged that distribution headwinds will continue in the remaining of the year and also in the second half of 2019, where there will be the shelf reset by most of the retailers.

And our objective is truly to continue increasing the productivity in our brands.

That's the way that we're going to, at some point, of course, stop these distribution losses and stabilize our business in North America.

And of course, reassure that by what I'm seeing in COVERGIRL and Rimmel, but there is a lot of -- much more to do.

I think one of the problems that I want to mention is the Cruelty Free, so it is the certification by Cruelty Free International that we received for COVERGIRL.

Tons of work has gone behind it because we had a full external audit of our supply chain, including all our suppliers in order to obtain this certification.

So this is truly the gold standard in cruelty free certification, and we also committed to a regular audit every year, which again is another sign of strict control and a commitment to this.

And we also have committed to have another brand that will become certified by CFI, the Cruelty Free International, by the fiscal 2020.

The reaction of the customers to this new certification trend has been really, really positive.

So we're encouraged by this.

Of course, we just announced it just few days ago, but it's another program that we believe will help COVERGIRL to return, of course, to continue to be the top leader in color cosmetics in the U.S., but also to return to much better performance.

Your next question is from Joe Lachky of Wells Fargo Securities.

I was hoping you could talk to your free cash flow, and how much you think the supply chain issues impacted your working capital in the quarter?

And then thinking about free cash flow for the full year, I guess, how confident are you in getting growth in free cash flow -- positive free cash flow for the full year?

And then considering the challenges facing you regarding cash flow and your need to focus on deleveraging, how committed are you to the dividend?

So, thanks, Joe.

I think the first question is about the free cash flow.

Yes, the impact of the net working -- on the net working capital from the supply chain is actually quite severe.

If you think about it, we are going to manage better our inventories, but at the same time, we got to restore safety stock because our service level got hit by the supply headwinds.

That's a very difficult task for the teams to manage better the inventory when we're building new ones, so -- when we're building safety stock.

Second one is on receivable.

As you can imagine, improving our trade terms becomes more challenging for all our commercial teams when we are having debates and discussions because of the service level not being where it should be.

So without any doubt, the net working capital got hit severely by the supply chain headwinds, and consequentially, the ability to deliver the free cash flow, of course, gets impacted.

Now despite that, we are truly focusing the organization on cash, which is something that was not as pronounced strong in the past, especially during the first year or 2 of the integration.

And that's why we believe that we're going to have positive free cash flow in the remaining quarter and in the total year.

We're confident also because we're having a big attention to our CapEx and to our one-off, although all these product, of course, has started a while ago, we are focusing organization much more on that.

And we will change the incentive scheme of all our leaders to make sure the net working capital, cash one-off and CapEx are now included in their incentive.

The dividends.

I think you asked about the dividends.

Well, the dividends is -- well, my opinion is that we believe capping the dividend sends a signal to the market that we have a terminal cash flow problem, which is absolutely not the case.

Free cash flow, as I said, should improve in the remainder of 2019.

And also, in 2020, we will have a material positive benefit by the fact that CapEx and especially onetime cash cost will drop, will decrease significantly.

And this is why I think it's important to underline that it's just a temporary problem and not a permanent one.

Your next question is from Jonathan Feeney of Consumer Edge Research.

I just wanted to maybe follow up on the line of questioning earlier about -- I guess, what gives you the confidence that the supply chain issues haven't really setback the sales process, especially as it relates to Consumer Beauty.

You talked about that being contained to 1 and Q2, maybe Q3, but can you talk to me about what retailer feedback has been?

And how do you go about positioning like this execution issue convincing people that it's not something that's ongoing?

Even though you have the great analytics and the products performing on shelf, how do you get the retailer comfortable it's going to be there?

I think it's a matter of building strong partnerships with the retailers.

First of all, I'd say, it's about transparency as well.

I think we are being very transparent with the retailers, explaining the type of issues we were dealing with and doing it in a very timely manner.

The one that we knew that I already mentioned in the August call, where I completely disclosed, of course, to the retailers with a different time line of returning the 2 proper service level.

And the one in Luxury that we had was through the hurricane and through the late warehouse issues.

To be honest, we went to the retailers and explained the situation because this was unexpected for us as well.

But at the end of the day, it's all about partnership.

It's all about transparency.

It's all about having strong programs to drive consumer demands.

And just going back in Luxury and Professional Beauty, our consumer demand is very strong.

So of course, it's incredibly frustrating for everybody, for us and for the retailers, for the customers, but they do know that our customer demand is strong.

And if we show them plans of restoring service level in the next 2, 3 months, retailers do understand that.

We've build together plans on how we deal with the shortages and really adjust the promotional plans or the launch plans in a way that could get -- taking consideration of the headwinds.

In Consumer Beauty, it's clearly more difficult because this is a mix between the supply issues, but also the fact that some of the brands are not performing where they are, and this is why we need to do better in the prominent reporting that took place in the execution of innovation in the discipline that I mentioned before, and that is absolutely a big, big focus and priority for me and for the Consumer Beauty, absolutely.

Your next question is from Linda Bolton-Weiser of D.A. Davidson.

So I was curious if you could just update us on the CFO search and how is that going?

And also, how is the morale in the company?

Because you've brought in a lot of new executives anyway, and then you have these issues developing.

So how is the morale in the company?

Yes.

So look, CFO search, what I can -- I think is that we have a lot of very strong candidates that we've been evaluating.

And we are between the middle and towards the end of our selection processes.

So we'll be able to update you soon on this one, but we are pleased with the quality of the candidates.

They have very high level of interest into our journey.

And a lot of candidates really with very strong background, they fit with our needs in our journey.

In terms of morale, it's different within division to be crystal clear because in Luxury and Professional Beauty, we do have 2 very high performing business beating the market growth rate and beating expectations.

In Consumer Beauty, we do have clearly a mixed morale because, of course, the performance has not been, I would say, close to the expectations now for a while.

But this is something that we are working with the leaders.

I mean, yes, we do have a new leadership team that is quite recent or quite new into Consumer Beauty.

We'll continue to drive for the right cultural fit and the right skills to perform the turnaround.

And when I look at the morale, one of the things that we have done is that we have changed these vest increases of some of our LTI program to progress investing within 3, 4 and 5 years, which I think will also help with the retention of key talent.

So overall, what is important is that we do focus on the turnaround of Consumer Beauty, which remains our priority, and there is a huge belief in the company, in our partners, in our long-term journey.

And this is also very, very reassuring for me and for my colleague in the [industry].

We continue to see very, very high level of loyalty and believe in our journey because everybody is aware that these are temporary headwinds that we are dealing with, within a very complex integration, but the benefit of the new Coty and the value that we're creating for the future is absolutely not in doubt.

Thank you.

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