Natura &Co Holding SA (NTCO) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen. At this time, we would like to welcome everyone to Natura's 2005 fourth-quarter and full-year results conference call. Today with us, we have Alessandro Carlucci, the CEO; Jose David Uba, the CFO; and Helmut Bossert, the Investor Relations.

We would like to inform you that this event is being recorded, and all participants will be in listen-only mode during the Company's presentation. (OPERATOR INSTRUCTIONS).

We have simultaneous webcast that may be accessed through Natura's IR website at www.natura.net/investor. The slide presentation may be downloaded from this website. Please feel free to flip through the slides during the conference call. There will be a replay facility for this call on the website. We remind you that questions, which will be when -- insert during the Q&A session may be posted in advance on the website.

Before proceeding, let me mention that forward-looking statements are being made under the Safe Harbor of the Private Securities Litigation Reform Act of 1996. Forward-looking statements are based on the beliefs and assumptions of Natura management and on information currently available to the Company. They involve risks, uncertainties and assumptions because they relate to future events and therefore depend on certain circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of Natura and could cause results to differ materially from those expressed in such forward-looking statements.

Now I will turn the conference over to Mr. Helmut Bossert, the Investor Relations Manager. Mr. Bossert, you may begin the conference.

Good morning, everyone. I would like to welcome you all to our conference call to discuss the results of the final quarter and full-year 2005. Before we start, I would like to remind you that the questions-and-answers transcription will be available on our site both in Portuguese and in English. I'm going to go very quickly through the slides, and then Alessandro, David and I will be glad to answer any questions you may have.

Let's go directly to the slide 2, where we say that Natura's annual gross revenues grew by 27.7% over 2004, while the final quarter figure climbed 28.5 year on year. In the next slide, we see an EBITDA for the year increase by 30.8% over 2004 to 564 million reais, while that for the last quarter figure moved up 36.5 year on year. The next slide shows the EBITDA margins. The EBITDA margin averaged 24.7% for the year and 26.8% for the final quarter.

Slide 5 shows cosmetics, fragrances and toilet target markets of development. As you can see, the target market grew 16.5% year on year in 2005 through October, in line with average growth between 2000 and 2004. The following slide shows Natura's market share. Here, we can see that Natura's target market share has continued to increase, rising from 18.6% in the first 10 months of 2004 to 20.6% in the same period in 2005, 200 basis points increase.

Now let's move on slide 7, talking about innovation. Investments in innovation also continue to move up strongly. In 2005, it reached 67 million reais, equivalent to 2.9% of net revenues -- almost 3%. In slide 8, we see also the Total Innovation Index that was close to 70%, and 156 new products were launched in 2005.

Next slide, we have our consolidated sales channel. Our consolidated sales consultant number exceeded the 0.5 million mark at year-end, almost 20% up on 2004. Slide 10 in Brazil also at year-end, our Brazilian consultants totaled 483,000 consultants, up by 18.7%.

The next slide deals with productivity. Here, we can see that annual productivity continues to expand averaging 12,300 reais through active consultants in 2005, 6.6% more than in 2004 and almost 1% up in real terms. As you can see from the slide, productivity also increased in the final quarter.

Let's move on growth in the Latin America sales channel on the next slide. At the year-end, consultant numbers in Argentina, Chile and Peru jumped by 37.7 over the close of 2004. The next slide shows the productivity in these markets. Annual consultants' productivity in Latin American operations grew by 6.5% over 2004, reaching $2,700 per consultant.

In the next slide shows -- the next slide shows revenue growth from international operations. Here, you can say that annual growth revenues in dollars jumped by 50% over 2004, and the fourth-quarter growth was even higher, 54% year on year. Slide 15, the results continue to improve in Argentina, Chile and Peru. The operating margin was a -12.9% at the end of 2005.

Slide 16, we have international expansion expenses. International expansion program continued to receive the same attention as in previous quarters. Net expenses stood at 31.8 million reais in 2005 and should reach 35 million reais in 2006.

Now let's move on slide 17, which deals with the CapEx. The annual investments totaled to 112 million reais in 2005. In 2006, we expect a CapEx of 180 million reais, mainly going towards new machinery and logistics, new R&D facility and new projects in IT. And the next slide shows annual cash flow. Gross cash flow came to 482 million reais in 2005, 25.1% up on 2004. After deducting investments in working capital of 35 million reais in CapEx of 112 million reais, free cash flow stood at 336 million reais, 65.2% up on the year before.

Dividends and interest on capital on the next slide. In line with our policy of distributing free cash flow, the Board of Directors approved and will be approved also by the shareholders in the annual meeting. The payment of dividends and interest on capital equivalent to 3.70 reais per share. The Board of Directors also approved that we will also be -- discussed in the annual shareholders' meeting, the splitting of Natura's shares in 1 to 5, so each 1 share starts to be represented by 5 shares beginning in March, 31 this year.

Finally, I would like to comment briefly on certain corporate social responsibility aspects in the next slide. Sales of Crer para Ver is a line of products that generated 8. -- almost 9 million reais in 2005. It is worth noting that these revenues come from spontaneous action of our consultants, and profits are used in social responsibility.

The young and adult education program, EJA, exceeded its 2005 target of 50,000 enrolled students, reaching 66,600. On the environmental front, our life cycle assessment totaled 10.1 million points, and refill sales volumes stood at 17.4% of the total.

That brings us to the conclusion of our presentation, and we are now at your disposal for the question-and-answer session. Thank you all very much.

(OPERATOR INSTRUCTIONS). Benjamin Abramov, Lusight.

First question is -- one of the pleasant surprises I guess over the year has been the growth in number of consultants. What are you guys doing to attract so many consultants, and can you guys keep growing those numbers in the future?

Good morning. It is Alessandro speaking. In fact, we did not change any kind of marketing tool to recruit new consultants compared with the previous year. What we believe that has happened is the fact that our brand continues to be desired and people want to join Natura to sell their products because they like the brand. They believe that we have markets to grow, so they can generate profits like sellers, like consultora -- we call them consultants. So that is why we believe that we are growing. But we did not change anything in our marketing tools to recruit new people.

Do you guys think you can still grow those numbers at least in Brazil at 15% per year?

We believe that if I understood -- are you asking about our growth?

Yes of consultants?

Yes, we don't have any reason to believe that we should see a difference rate in the next years. Even though we have a lot of challenge in the next years and we don't have a guidance to our growth even in the number of new consultants, but there is no reason to believe that we should expect a big change in the rates.

My other question is in regards to the average selling price. It has not been keeping up with inflation. Is it because of product mix or because you guys have not been raising prices to attract more customers?

This is David speaking. We have at least in the last 3 years, we have adjusted our price at least according to our internal inflation rate. But we are not having any real decrease in prices. So any change in the average price is due to mix changes in our sales.

Margaret Kalvar, Harding Loevner Management.

Could you go into a little more detail about the productivity per consultant and whether or not you expect it to continue to grow at the same rate or for its growth to possibly accelerate as new consultants become more seasoned?

No, what we expect is to maintain that productivity growing in nominal terms, not in real terms but to continue to grow. You know that we have had many new consultants adding our channel, so productivity -- it is difficult to maintain the productivity growing in real terms.

Jose Yordan, UBS.

My question is about your working capital. There was a huge difference in the working capital investment from 2004 to 2005. My questions just so if you can help me to understand what the normalized rate of working capital investment is, either as a percentage of your sales or just to help us understand what the level should be going forward on a normalized basis?

This is David speaking. We had some typical variations off our working capital during the year of 2005. But at the end of this year, we are already back to the normal values for the accounts that add up to the working capital. We should grow the working capital in line with sales because the main accounts that add that to the working capital are directly linked to sales like inventory and accounts receivable on the asset side and suppliers on the liability side and taxes to pay as well, which are in our case 9% of our selling taxes -- [DEG] taxes.

The red base is the 35 million investment in '05. Was that a normalized base to grow it based on your sales growth rate?

Yes, from the amount that you're seeing now at the end of 2005, we should grow according to the sales growth for the next year -- if I understood your question.

Lore Serra, Morgan Stanley.

I'm going to ask one question in Brazil and one outside of Brazil, so let me start with Brazil. You gave some data in your press release that talked about market share of about 21%, or 20.6% overall with 33% in cosmetics and fragrances. I know it's probably not fair to think about or talk about sort of market share barriers. I assume you think you can continue to take market share, but as you are getting to pretty high level of share in places -- or things like fragrance -- as you think about 2006, what are some of the things you can help us understand that will be initiatives for you to drive continued productivity on the sales floor side? You had done some things with lower-priced products with the [Aqualerra] line; I think recently you have done a little bit less of that. Can you give us a flavor or some sense of what some of your initiatives are going to be for '06 to drive continued productivity gains?

First of all, I would like to share with you that even though we have 30% in the cosmetic and fragrance categories, if you split those categories and we don't give those split numbers because we don't want to share this part of our strategy with the competitors. But we know that when we split this category that we have different market share between the subcategories included in the cosmetic and the fragrance area. That means, Lore, that we have space to grow, even though we have already 30% of total market share.

What are we planning to do this year? We are planning to continue to innovate in high taxes. Like you see, we have a Total Innovation Index of 70%, and we want to maintain high levels of innovation, new products in this category -- and supported by marketing tools, marketing plans, strong investment in markets, not so different from 2005. But we believe that if we continue to innovate and to support with marketing tools, we can still grow even though we have 30%.

But do you see a need to think about more affordably-priced lines in order to expand your target customer base, which I guess was an initiative of about a year ago. You seem to have done less of that. Or do you think you can continue to grow with sort of more higher priced product lines?

Okay, now, I understood your point. No, we don't believe that we need to grow in the specific price points of the market. We believe and we have new products in the high-value proposition in the lower-priced points of the markets. But we're not fixed in one side of the markets, and we --

Okay, let me ask a question outside of Brazil. You announced in your Board minutes that you're opening offices in the US, UK and Russia I guess. I guess I understand that that's just an initial subsidiary set-up. But can you give us a sense -- I mean you're doing it now I guess for some reason. So can you give us a sense of how your thinking has involved in terms of your international strategy?

You understood well. In fact, we decided to open a small company. What are we going to do in those three countries -- is that we are going to study the market, understand better how is the acceptance of our value proposition by the customers in those countries. But today, we are only going to study. We don't have a decision to start an operation or other things in those markets. And we select those three because they are really different. They are important, but they are really different. So they are going to help us to understand better the internationalization process in Natura.

Our strategy is to base it on open new markets in Latin America. As you know, we started Mexico last year, and we are going to open Venezuela and Colombia till 2007 probably and to continue to invest -- to build the brand in France. We are now developing a new commercial model in France to increase our volume and to expand our operation in France. Even though we have in the middle of the developing of this new model that it is going to be based on the direct selling supported by the Internet, supported by the flagship that we already have in France. This is our strategy -- focus on Latin America and direct selling and study a new way to develop our business in France.

I know you're just starting this study I guess in greater -- with a greater emphasis in the US, in UK and Russia. Do you have a few at this point how long it will take you to assess your potential in those markets?

I don't know. I don't know. I cannot answer your question because it is possible that those studies give us the decision to not go in those markets. We can study for example the US market and decide that we're not going to enter into the market. So it is difficult to say to you when we supposed to start one operation in those markets because we don't know if we are going to really start on operation.

Mr. [Sanchez], Citigroup.

I just wanted to clarify a bit one of the statements made in the press release to see if I understand properly, but what a renowned trademark status means? What practical implications does that have insofar as it is extended to other sectors beyond the cosmetics industry? Can you help us understand that please?

I don't know how it is written in English, but the INPI renowned brand that we received in Brazil is like a trademark. That means that no one in Brazil can use the Natura brand independent of the category or the industry that we're talking.

But did you not have a trademark already, or you had it only for the cosmetics industry before?

We had it only for cosmetics. Now, we have for all the categories and all the industries in Brazil.

Should we take any message from this that there are other categories that you might be looking to enter sooner rather than later now that you finally achieved this? Were you waiting for this I guess? Was that a key part of the strategy?

Oh no, this is not the message. It is only an effort to be sure that we can protect our brand because we are a very well-known brand in Brazil. So it is important for a brand like us to protect even though we are talking about other industries or other categories. But this is not a sign that we want to start new markets.

Okay, but should you decide to, you now have the ability to ensure that you can use your same brand there obviously, correct?

Yes, yes.

Then secondly, can you give us a little bit more -- I know there were a couple questions asked on productivity gains and you addressed the rate of an increase question in terms of the product pricing. But is there a sense -- I mean how you're keeping productivity in line with inflation? Or in this case at least for this particular quarter by my numbers, it grew a little bit in real terms on average for the consultant base. Is it better training? Is it more stringent or continued stringent standards on recruitment? Can you give us a sense for that?

Yes, I understand that you are speaking mainly about the last quarter of last year.

That is correct.

I would say for that particular quarter, it is more a matter of (technical difficulty)-- the market group strategies in the promotion we put in place for the season sales. We would not justify that improvement in productivity by a different process of training or better process of training being the same throughout the year. It is more an impact of our marketing strategy for the last quarter.

Just to follow-up on that same issue, the promotional -- you cited in the results a promotional impact on the gross margin presumably in that revenue line I imagine, right? And if that is the case, can you give us a sense -- is that something you did for competitive reasons? Was there pressure to do that promotion to maintain share, or is it something you're just doing to build the brand further?

Well, that was not a direct response to any pressure from competitors. I said it was just a good planning for the last quarter. It happened that it was worked out very well. It was not in response to any unique (technical difficulty) from the competitors. We just were very happy to organize our plan for the last quarter.

(multiple speakers) For the next year as Helmut mentioned before, we expect in productivity real terms to keep constant in this year, 2006.

Robert Ford, Merrill Lynch.

David, I apologize if this is a redundant question. I could not make out your comments here. Your voice is very muffled unfortunately on my line. But I'm trying to establish a little comfort with respect to the competitive environment. Given the strength of the real, I was surprised to see the gross margin decline. Given these comparisons, even though overall SG&A was down, I was expecting some operating leverage when it came to selling expense. But that was up as a percentage of sales as well. Can you talk a little bit about the competitive environment and what you're seeing in terms of the response from Avon and L'Oreal and possibly others as you take greater market share in Brazil?

You know this is -- I repeat the question. He's asking us about what can the competitors do against our market share that is growing the last year? Of course, they are fighting. They want to grow. But we are not seeing that they must or they are going to change something in their strategy that could affect strongly our business and our goals. But we did not see any main change in the last year, and I don't have reasons to believe that in 2006 we should expect something really different from the competitors. Of course, they are going to fight. They are going to increase in their allowances but nothing so relevant to mention or to share with you.

How do I square that with the gross margin pressure and the higher selling expenses as a percentage of sales?

Would you repeat your question?

David, I'm trying to -- I totally understand what Alessandro is saying, and I think you guys have tremendous momentum behind the brand. But I'm trying to understand how that corresponds with the decline in gross margin given the tremendous strength in the real year on year and the benefit it had to packaging as well as the higher selling expense.

I know there was quite a bit of operating leverage on that fixed component of G&A, but your selling expenses as a percentage of sales are higher too. So I am trying to get comfortable with the domestic environment and your comments. But then you look at the elements within the income statement and it does appear as if there might be a little bit of pressure or response to stepped-up competitor promotions or advertising.

I would say that the fact that we lost 0.1 percentage points on our gross margin in the last quarter of 2005 was more because of a mix -- a different mix in our products and then on a response to a higher pressure from our competitors. The gain that can isolate for the fourth quarter -- the gain from the valuation of the real alone would be -- let me see here in my numbers -- would be combined in the devaluation of the real an increase in domestic prices -- would be 0.6%. What we are seeing here is a lot of 0.1%.

So what would have explained the difference of 0.7% of our net sales, which is very small variation. It can be totally explained by changes in the mix of products. We have different margins; we have different categories. So some small difference in the mix can explain this 0.5% change in our gross margin.

Maybe we can take this off-line, David, because my understanding was that 25% of your cost of goods sold was dollar denominated, and I have got the real up 23.6% on average for the fourth quarter, which would suggest to me almost 6 points of a decline in terms of cost of goods sold. There are timing issues as well. But if you bought it on average in the spot market in the fourth quarter, the pure impact of the real is very big and it would offset quite a bit I guess in terms of packaging. I'm sure there were changes in terms of the dollar cost as well.

Yes, but you should not forget that some other raw materials that are linked to the price of the oil, which increased a lot in 2005, they also have a tremendous impact in our cost of goods sold. So that compensated a little bit for the gains in the exchange rate of the real in 2005. Plastics for instance, which are a large part of our packaging, they increased more in turn on inflation in 2005. And again, do not forget that we adjust our prices in line with the General Price Index in Brazil, actually even a little lower than that.

So all things together what we're saying is that for the last quarter, we did some changes in the mix and also a larger sales of promoted items that that is also through. But the main reason for this change in gross margin comes from the mix in the last quarter of 2005.

Great. I understand it. And then can you give me some comfort on the selling expense trends?

You're talking about selling expenses?

Yes, just selling expenses, not all of SG&A. SG&A as a whole showed some tremendous progress but selling expenses in of themselves were up as a percentage of sales.

We had an increase for the year for 0.8 percentage points, 80 (technical difficulty). The main reason for that, which are in our comments on the results for the last year, are an increase in international expansion efforts. As you know, the new operations really re-expand the sales force at that very high rate in the first years of those operations. So that actually increases the sales expenses of the consolidated sales expenses as a percentage of net sales.

Also, we have here in Brazil something, which is of good news, but in fact refills the saved expenses a little bit. We have a (technical difficulty) the receipts for [fire] from our consultants. They are paying with less delays, and that decreased some revenues from interest rates. We charged them, and they pay out of the (indiscernible). So that decreased those revenues that are being -- usually we get back from the selling expenses.

So this amount that we get back from selling expenses actually decreased in 2005 when compared to 2004. So this is interesting in fact that the net selling expenses increased a little bit because of the receipt for file for our consultants improved in 2005.

Further questions if I may. And one, what do you expect to happen to the ICMS tax rate for cosmetics in Sao Paulo state? My understanding is that is scheduled to return to its prior levels later this year. The other issue is with the trademark that you have obtained. Does it give you any keys to go after Avon in their launch of their copycat product?

Talking about the ICMS, we don't know what is going to happen. In the middle of the year, they are going to decide if they are going to maintain some benefits or not or they are going to change. But today, we don't have any good information to share with you. So about this, we don't have anything to say. I would like to ask you to repeat the second part? I did not understand.

Alessandro, I was talking about the Avon launch, of their Naturals line, which is kind of a copycat. I don't know if your brand protection would actually encompass Avon's Naturals, which seem to be kind of a copycat or a reproduction of some of your existing products.

Well, you know that we are one of the companies that use the biodiversity and natural ingredients to add value to our products. We are sure that even though we are one of the first companies that started to use that kind of technology, we're not going to be the only company. Not only Avon, other companies are starting to use this kind of technology. Of course, we are worried, but I personally don't believe that Avon is going to change their platform, their technology platform to the Naturals. I believe that this is one product; this is one action. So it is part of the marketing war.

So we are taking a look. We are planning some marketing campaigns and launches, but I don't believe that we should be really worried because I don't see today they are changing their technical platform to the Naturals. I'm talking about specific Avon.

Daniela Bretthauer, Banco Santander.

A quick question regarding the increased CapEx for 2006. Is there any implication on your dividend payment policy as a result of the higher CapEx? In 2005, you were able to pay again 80% of the net earnings but 100% of the free cash. With such higher CapEx, can we assume reduction in the payout ratio? Can you comment a little bit on that?

I would not expect any change in our dividend policy or in the payout ratio, even the payout as compared to the net income. As you see in 2006, we are increasing our CapEx to 70 million reais, which is still a small portion of the dividend, the total dividends, we paid for the exit of [Faces] 2005, which is 340. So we are very confident that even with this increase in the CapEx, our payout ratios should be roughly the same. We go on with our policy of paying around 100% of the free cash flow. And we don't expect the CapEx to increase again in 2007 at the same rate it increased in 2006 or it is going to increase in 2006.

But even if dividend, the payout might be slightly smaller in 2006; it should go back to the normal levels in 2007. And even for 2006 this payout if it decreases, it is going to decrease by very small numbers. So I would not change the expectation for our dividend policies in the short-term.

When you say CapEx should go back to normal levels, are you talking about 80 or 100 million reais?

At this moment, I would say it should stay around more 180 than lower than that for the remaining years. Right now, we have identified excellent opportunities of divesting part of our results with very large returns, much higher than our cost of capital sold. It should stay around 180 for the remaining years. But we do not expect any dramatic decrease as we have seen in this 2006 exercise.

So your guidance is that 2007 beyond, we use 180 also for our models -- around 180? Or 180 in 2006 was the peak? I'm a little confused here.

Actually, we are not providing any guidance over many years. I'm just telling you some expectations we have right now; we are still too far. 2007, we did not have our plans for that particular year yet. So what I'm saying is that our expectations I think should not have any big increase for the next years after 2006.

Okay. Just on your pricing as you mentioned in 2005, your price was a little lower than inflation. What is the strategy for 2006? I know that in the beginning of the year is when you carry on your price increase. Can you give us a sense as if you will be in line with inflation, higher or lower, anything on pricing that you can give us in terms of guidance?

Well this in 2006 will be exactly in line with inflation that we had in 2005. So this year will be exactly in line with the general pricing for our consumer products in Brazil.

Congratulations on the fourth-quarter results.

Lore Serra, Morgan Stanley.

Yes, I guess I just wanted to get a bit more of your perspective on market growth. In your presentation, you have a chart with growth in the target market, 16.6% nominal from 2000 and 2004, about 7% real. But I guess the data both for '04 and the year-to-date data that you have presented for '05 show that the real growth has been more on a double digit, 10, 12%, something like that.

If you think about 2006, I mean there is a number of positive indicators we're starting to see in real way just turn positive, a little more employments gains, interest rates coming down. Obviously, that's maybe a little less important for you. But in terms of your target market, would you expect to see growth continue at this double-digit real pace? Or as crazy as it sounds, do you think that there are factors that could cause the market growth to accelerate from the level of the last couple of years?

You are right. We expect the market to grow between I would say 7 and 10% in real terms for the year. And at this moment, we do not have any sign that we should change this perception we have for the current year, for 2006, nor for the next years. So for 2006, we are expecting something below two digits. As we said, we keep our expectation off the target market to grow from 7 to 10 in real terms, not more than that at this moment.

But what I want to understand though is that just being conservative for planning purposes because if I understand the numbers correctly, the growth was more like 11% in the first 10 months of '05 if I did the math right and 13% for '04. So by saying 10 -- maybe I'm grasping at straws here -- but you are kind of saying a bit of a deceleration when one might argue for the opposite and maybe that is just conservatism given the start of the year.

No, we're not just being conservative. We have some signs. We still have to better process those signs and gather some better data to better form our expectation for the year. But we have some evidences that the growth in 2006 might be slightly below the one that we saw in 2005. For the moment, it is something that we still have to better understand because we -- everybody is expecting higher growth for the economy as a whole in 2006. In spite of that, our target market might be growing at a slightly lower rate.

One explanation we might give right now is that the performance we saw in 2005 was still very highly influenced by the growth of the economy in 2004, which was 5%. So now in 2006, we might be suffering a little bit from the lower growth in the economy in 2005, which is one of the lowest growth in the emerging markets as you know. So we still have to wait a little bit. But at this moment by the signs we have, we're not being just conservative. We have some evidence that the market might slow at a lower rate in this year.

Ladies and gentlemen, this concludes today's question-and-answer session. I would like to invite Mr. Bossert to proceed with his closing statements. Please go ahead, sir.

Okay, so we end our conference call. Thank you very much for joining us, and I hope we join you in the next conference call at the end of April. Thank you very much. Good day.

That does conclude the Natura [alger] conference call for today. Thank you very much for your participation. Have a good day.