Natura &Co Holding SA (NTCO) 2006 Q1 法說會逐字稿

Good morning, ladies and gentlemen. At this time, we would like to welcome everyone to Natura’s 2006 first quarter results conference call. Today with us, we have Alessandro Carlucci, the CEO; Jose David Uba, the CFO; and Helmut [Bossart], the Investor Relations. We would like to inform you that this event is being recorded. [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, and 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 answered during the Q&A session may be posted in advance in the website.

Before proceeding, let me mention that forward-looking statements are being made under the Safe Harbor of the 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 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 Bossart, Investor Relations Manager. Mr. Bossart, you may begin the conference.

Good morning, and welcome, everyone. Let’s begin our conference call on the Company’s earnings for the first quarter of 2006. Let’s move on the slides quickly, and then Alessandro, David and I will be available for any questions should be considered necessary.

Let’s move on to slide number 2. In the left side of this slide, we see that the target market grew 9% in the first two months of 2006 when compared to the same period of 2005. In the right side of this slide, we have the Company’s market share, which increased to 21% in the first two months of 2006 from 18.6% in 2005, an increase of 240 basis points.

Slide number 3. On the left side we see that the cosmetics and fragrances market increased 9.6% in the first two months of 2006 compared with the same period 2005. In the right side, Natura’s market share has increased from 33.3% in the first two months of 2005 to 38.6% in 2006, which means a 530 basis point increase.

Let’s move to the next slide, number 4. The personal hygiene market increased by 8.7% between the first two months 2005 and 2006, as we see in the left side. And, in the right side, Natura’s market share has increased to 10.3% in 2006 from 9.8% in 2005.

Slide number 5. We can see Natura’s gross revenues have increased 18.3% in the first quarter of 2006 when compared with the first quarter of 2005. Despite the fact that it was below the average growth reported in the previous years, it is still an important performance for Brazilian scenario. Next, we have the EBITDA that reached 113 million reais in the quarter. That is 191 basis points higher than reported in the previous year.

In the next slide, we present EBITDA margin that has increased-- has reached 22.1% when compared with 22.3% in the first quarter of 2005. Just repeat again. 22.1% in 2006 and 22.3% in the first quarter of 2005.

On the next slide, we will comment on the Company’s innovating performance in the first quarter of this year. Innovation investments continued to grow expressively in 2006, recording 15 million reais and representing 3% of net revenue.

Let’s move on slide number 9, where we see that the total innovation index decreased from 72% in the first quarter of 2005 to almost 64% in this quarter.

Next, we’ll talk a little bit about the channel. The number of consultants reported an expressive growth of 17.7% in the first quarter of 2006. We have reached 529,000 consultants in consolidated terms.

On slide 11, we have the same [inaudible] to Brazil. By the end of March, there were 492,000 consultants in Brazil, a 16.4% increase compared with March 2005.

Next, we’ll see the productivity that grew 30 basis points in the first quarter of 2006, reaching 2,540 reais by the medium consultant average.

In Latin America, on the next slide, in Argentina, Chile and Peru, the channel presented impressive 38.5% growth in March in a year-on-year comparison.

In the next slide, we have the figures of the productivity in those operations. The consultants’ productivity in Latin America grew 300 basis points over this same quarter of the previous year, reaching 590 dollars per consultant.

Next slide we present the evolution and the gross revenue for the international operation. As we can see, operations in Argentina, Chile and Peru continue to grow. In the first two months of 2006, revenues grew-- growth has reached 51.2%.

In slide number 16, we have the results of these operations. Their operating loss has decreased to a negative margin of 19.5% in the first quarter of 2006 from 24% when compared with the first quarter of 2005.

Slide number 17 we have the total net expenses for the international expansion. The international expansion continued to receive the attention we point out in the previous quarter. Net expenses in the first quarter of 2006 amounted to 10.2 million reais and are expected to reach 35 million reais in 2006, as previously announced.

Next slide. CapEx totals 26 million reais in the first quarter 2006, an almost 63% increase over the first quarter of 2005. I would like just to remind you that CapEx is estimated at 180 million reais for 2006, and the main investment will be concentrated in new machinery, new R&D, facility, a distribution center and IT investments.

And, let’s move to the final slide, talking about cash flow. The gross cash generated in the first quarter of 2006 reached 107 million reais, 12.3% higher than that generated in the first quarter of 2005. After the 63 million invested in working capital in CapEx of 26 million reais, the free net cash generated reached 18 million reais, a 74% decrease over the same quarter of 2005.

With this slide, I close this brief presentation. Let’s move now to the Q&A session. Thank you.

Thank you. [OPERATOR INSTRUCTIONS]. Our first question comes from Ms. Juliana Rozenbaum with Deutsche Bank.

Can you just help me confirm the market share figure for cosmetics and fragrances at the end of the year of 2005?

At the end of the year, Juliana-- We don’t have here exactly now, but I can send you by e-mail. I send to everybody that’s connected.

Okay. Was it around 35% or 36%? Right? I have like the ten months but not really the year end. I was just wondering; if I got the right data, then, it’s a significant increase from the end of the year to the 38.6% that you are reporting for the first two months of the year. So, I’d just like to understand if you see any different competitive dynamics that would explain the jump.

Juliana, the first explanation we have-- this market share is seasonal. There are some differences between direct sales in the first quarter compared with the [organized] retail system. So, there is a seasonality, specifically in the cosmetics and fragrances categories.

One of the reasons, Juliana, is that we have higher sales volume on the seasonal dates of the year, like Mother’s Day and Christmas. We sell relatively more on those [cubes] than the retail.

Sure, but you increased the market share in a seasonally weak couple of months. I’m just assuming that’s a good thing because even in a seasonally weak-- there was no big date of Mother’s Day that you have.

Juliana, it’s Alessandro speaking. We should take care about deep conclusions when we see only two months of market share because sometimes you have some campaigns from one company or from other big companies that could change the market share if you take a look only in a two-month basis. So, we should take some care about some [inaudible] conclusion about the market share only taking care the first two months of this year.

Okay. On a similar subject, how about the reaction from your--? Did you see any reactions in terms of Avon’s new campaign or new product line that appeals to the nature components of cosmetics? Did you get any sense of that?

You know that we are always aware about the competition actions and strategy, and they are doing their best efforts to increase their market share. So, of course, they are fighting. But, I can’t share with you some specific action that impacted us in a different way. They are developing nice marketing strategies, nice marketing campaigns. We respect them. But, I don’t have any one specific to share with you to say we have received a huge impact on this or on that of that action.

Okay. That alone is a good thing; right? If you had perceived a huge impact, that wouldn’t be a good thing. So, that’s great. And just another quick question. Can you more or less provide a distribution of CapEx throughout the year? Will it really be concentrated on the second half of the year, or in the next three quarters we expect more or less a linear distribution?

Usually, it’s more concentrated on the second half of the year, and it should be the same for this year.

Okay; that’s perfect. Thank you.

Our next question comes from Lore Serra of Morgan Stanley. Please go ahead.

I have a question-- a couple of questions. Let me first start out with the market growth. Taking your comments to be careful about extrapolating from short periods of data, I guess I’m inferring from the market data you guys have presented that since, let’s say, November of last year through February, the market has decelerated fairly dramatically toward a rate of, I guess, around 9% or 10% from what had been sort of at the start of ’05 something more like 18% or even a little higher than that growth rate. So, my question for you is-- That’s a fairly sharp deceleration in the final months of the year. As you think about that deceleration, is there something that you think--? I know the economic factors, and I’m sure the environment, for sure, is in terms of the consumer slowdown at the end of ’05. But, I’m wondering if there is anything else you would think that would help explain that kind of a sharp deceleration.

The market growth in 2006 may be more volatile than previous years in terms of market growth. As we will have presidential elections and the soccer, World Cup, credit availability has grown considerably in Brazil recently. And, financial institutions and retail stores have provided consumers with a substantial offer of credit lines, most of it driven towards real estate and durable goods. In 2006, we will host the soccer World Cup, and we are Brazil. Brazilians become naturally attracted towards TV sets and similar equipment. While this scenario maybe affect the share of pockets of potential consumers, it is too soon to conclude about future expectations because, so far, we only have a narrow figure, first two months of what has happened in the market. So, those things we can share with you about what can happen in our market this year, but it is too soon to conclude something about the market growth in this year.

But, if I understood correctly, when you reported the fourth quarter, you reported ten months of data, and you didn’t report the last couple of months of the year. That’s when you had started to talk about in the fourth quarter conference call there being a concern about the slowdown. I guess you have that data now. So, could you just at least fill us in? What do you think the market growth rate was in November and December of last year? I’m inferring from the data that it is at that 9% to 10% level, so you have four months at that lower rate for the industry. Maybe that’s wrong. You have the data.

Lore, you are right. There is a deceleration of the growth rate in the market during the 2005, at the end of 2005 mainly and, too, in this first quarter of ’06. We started 18% in the first semester of 2005, and the growth rate in the last semester of last year was only 12%, and now it’s around 10%. So, it’s very clear a deceleration in the growth rate for the market. The reason for that, that this more is obvious. It’s also the decrease in the growth rate of the GDP in Brazil last year. In 2004, it was 5%, and we dropped it to a little bit above 2.5% in 2005. There is a lag effect on the CFT market, but surely what we’ll see now is a direct impact and slower economy last year as compared to 2004. As this year, there are some strong expectations that the economy should go again at least at 4%. We might expect again higher growth rate for the CFT market, maybe starting in the second half of this year - maybe. But, the reason is a slowdown in the economic growth last year. That’s the main reason.

Okay. So, I guess this is a question that is going to be hard to ask because you don’t want to give specific thoughts in terms of growth. But, I guess the idea that there’s a certain range of thoughts about what you should do in terms of growth this year that people like myself have. Do you think that those rates of growth are realistic, if the market growth decelerates to the extent that it has?

You were right when you said it’s a very tough question for us; probably difficult to answer. What can I say? Let me give you some elements of the scenario, and then make some discussions. The CFT market might grow again at high rates in the second half of this year. But, let’s not forget that it’s a very volatile year because of World Cup, because of the presidential elections at the end of the year. We probably will be increased in government expenses also this year. That might drive consumption a little bit. We are now changing for 2.5% GDP growth to probably 4% or 4.5% again. So, all these combined result in a very volatile, unstable scenario for the CFT market. Although we should not have real growth-- real; I mean after inflation below 5% this year. So, this year it will be a little bit harder to estimate our sales growth as compared to at least the last two years. But, there is nothing else that we can give to you to help you.

Okay. That’s helpful. Let me ask a bit more tangible question that you probably can answer. The first quarter we saw a big increase in your administrative expenses on a year-on-year basis. I guess what’s never been clear to me is that when we look at your numbers on a quarterly basis, we see a lot more fluctuations on a quarterly basis than maybe a lot of other companies. So, as we think about the higher expense levels on admin in the first quarter, should we think about now you’re sort of evening out to 80 million reais a quarter, so the first quarter was the last quarter of maybe catch up? I don’t know if that’s the right way to say it. Or, should we think about the admin costs continuing to build over the course of ’05?

Let me see; how can I answer this question to you? First of all, a large portion of our administration expenses are discretionary expenses that fluctuate along the year according to the intensity of our projects, R&D activities and also IT investments. So, they can fluctuate along the year. That’s [inaudible]. What I can tell you is that they’ll be a little bit higher than 2005 because they are-- there’s a strong impact on these expenses. From a strategic [slice] as R&D expenses, IT investments and international expansion strategy for the Company. They will be higher than 2005, but probably they will fluctuate from quarter to quarter to quarter, as we did in the last year.

Okay. Thanks very much.

Our next question comes from Robert Ford of Merrill Lynch. Please go ahead.

I wanted to ask a question that was completely unrelated to financials. Alessandro, when I look at the fragrance category, for example, it just seems to be kind of impossible to really innovate in. Right? But, then, this [Amore] launch looks really intriguing. I know I’m not the average Brazilian consumer, but when I look at the positioning and the little vignette behind the products, it just appears incredibly compelling in terms of the proposition. Can you talk a little bit about what the take up has been on Amore in the initial sales and what the innovation pipeline looks like in terms of potentially offsetting not just the seasonal factors that are play in this next quarter, but also some very successful innovation that you had last year, like [inaudible] or the elimination of animal fats in the hand soaps?

Let’s talk about the recent launch that we had in the fragrance area. That is Natura [Huma]. Even though we are not sharing specific number, I can say to you that we are really happy with this new launch. It’s a new way to develop fragrance with concepts with history with a nice marketing campaign. Even though the large part of this launch is not included in the first quarter because it was launched in the March 12, the most part of Natura Huma is going to be in the second quarter of the year. Even though, we are really happy, it’s a launch with a lot of success in our opinion. Of course, we are talking about the first impressions should be developing in the first six months, not only in the first month. So, it’s soon to conclude. We are happy.

Talking about the pipeline, we are developing our pipeline as well. In the first quarter, we had less new products than we had in the first quarter of 2005, first of all, because in 2005, we have maybe in a typical big number of new launches and probably in this year we have fewer ones [that] we would like to have. But, nothing structural and nothing that can be a problem in the future. Our pipeline is developing well, and we are sure that we can launch new products in the last part of the year.

Okay. Then, just lastly, if I might, Alessandro, can you talk a little bit about what the response has been to the change in the [inaudible]? I’ve got your number six cycle, the [havista]. Is it fair to assume that from this point forward, the [vatrine] is kind of gone and you’ve gone to the new magazine approach? And, can you talk a little bit more about the circulation changes that you made in terms of the quantities? I understand that the one I’m holding probably had a double in terms of the circulation in the launch. You’re not going to be printing that many every cycle. But, my sense is that you’re bringing out or beefing up the distributions. Is that correct?

Yes, Bob. First of all, again, we-- As you said, we launched the magazine, and to our magazine we are calling like this, 20 days ago. So, it’s too soon to conclude again. But, we are receiving well comments. Our sales force is very happy. Some clients are saying that this new magazine represents more our brands and our value proposition. So, we are really happy with the first results, more in a quality way than in a quantity way, because it’s a little bit soon to conclude how this magazine is going to impact our sales in the short term. Personally, I believe that the evolution of our magazine is going to impact in the medium term and not in the short term because it’s going to help us to build the brand. You are right, then, in the first cycle-- In the first campaign, we increased the quantity. But, again, we didn’t finish this cycle, the number six, to conclude if you are having more or less impact in the sales. Again, this action is not based on the fact that we believe is going to help the brand construction and then to increase in the short term sales.

And, just one last question. This is completely ridiculous. But, when I look at this magazine, am I seeing a lot more subliminal advertising, or am I just becoming completely neurotic?

I don’t know, really, how to answer the question. We don’t intend to do some subliminal advertising. What we really intend to do is to share some values, to share some opinions and to help people to try to build a better world, taking care of the nature, taking care of themselves, to their families, to the society. So, it’s not subliminal. If you-- It’s directly objective opinion and value proposition about our brand.

Okay. I’ll e-mail David some pages numbers and some remarks, and he can be my benchmark on my level of neurosis. But, thank you very much.

Our next question comes from Jose [Yordan] of UBS.

My question goes back a little bit to the growth in the market. When you look at the productivity domestically, the items per reseller, and even the number of reais per reseller, there’s a marked slowdown in the first quarter. My question was do you think this is all related to the slowdown in the market, or do you think that the quality of the additional consultants is beginning to come down and is something that’s more structural-- of a structural concern? Or, is this just a temporary issue with the market growth? Help me think about what the cause of this decline is.

We are not seeing a best quality of the new consultants, and we don’t think that there is something structural in the productivity. In fact, there are some combined effects that I can share with you. We must first consider that we have been growing the number of consultants, and the market share is very substantial. No [raise] in the last three years. So, it’s not obvious to expect that the average productivity will grow at similar rates when compared to recent years. This is the first point. Secondly, we grew more than 40% in the last two years the number of Natura consultants. We are talking about 140,000 consultants more than two years ago. And, we know that newer consultants have less productivity than old ones. That doesn’t mean that they are bad, and the old ones are good. That means only that they sell less than the old ones because they have less clients, and they know less about Natura and our value proposition. Finally, a certain frustration from lower sales in this quarter may have caused some impact on productivity as well. So, there isn’t a structural problem in the productivity. It’s a combined effect of those things that I mentioned.

But, in a way, what you’re saying is that as the number of consultants grows that there’s basically more saturation of consultants, and there’s just fewer opportunities for them to exploit out there over time. Is there any way to--? What’s your estimate of penetration? Is this wall, let’s say, going to be hit in the next two or three years, or is it something that could be much further out in terms of-- When consultants start knocking on doors, will they get more-- increasingly get the answer, “I already do business with someone else.” Thank you very much.

Marginally, of course the more consultants you have, the more saturation is going to be the markets. I have difficulty to share with you how long can we increase the number of new consultants and grow or maintain the productivity. This is difficult to share with you. This is not something mathematic to share. There are two points to share with you that, in my opinion, are important. First of all, we strongly believe that we are far from a saturation point. That means that we cannot have a new one consultant that all the new sales going to be stolen-- to stole from another one. So, we believe that we are far from this point. The second one is the fact that a main competitor in Brazil, Avon, they have more than 1 million reps. So, we believe that we are far from a saturation point. Even though, as I said, marginally, more consultants you have, the more they are going to share the market and probably compete with another one. But, we are far from the saturation point.

Okay. Thanks a lot.

[OPERATOR INSTRUCTIONS]. Our next question comes from [Selso] Sanchez of Citigroup. Please go ahead.

Just following on that theme a little bit about the saturation and consultants, can you update us on any thoughts you have on the [orient avora] strategy that we talked-- that we’ve heard about. I know it was on a limited trial basis. Have you seen better results that make it more encouraging that you might move up the implementation to that, or if you have a horizon for when you might see more markets on trial for that structure? That’s the first question, please.

Selso, this is David speaking. What we’re doing now is running a project on this experiment - a pilot project on this experiment. It’s too soon for announcing any results. We are very, very careful with any experiments affecting the structures of our sales distribution. We are careful the relationship with our consultants, with our sales force, and therefore, we want to be absolutely sure that the model that we are redesigning, that we’re testing, are absolutely strong [and similar] before we start to spread it throughout the market. We do not expect to have any final conclusion on this model in the short term. We might have it by the end of this year or the first half of next year. But, right now, we’re working in improving it, testing the new versions of it before we can announce the final conclusions or even start spreading it. Okay?

That’s great. Thank you. That’s helpful. The second question. Just from Avon’s results this morning, they mentioned the doubling of advertising spend in the region. They obviously aren’t more specific than that. I know that you remarked that you’ve seen a lot more activity from them over the few months. Is there any thought to-- If this stays at this level, is there something that you think might change your communication strategy at all? And, I guess on a bigger picture sense, is this something you think is more heavily concentrated perhaps in Brazil, or do you see it-- I know it’s early days in Mexico and perhaps even in Venezuela, where you’re ramping up now, I suppose. Thank you.

Selso, we really don’t know if it’s more concentrated in Brazil or in other countries in Latin America. In Brazil we saw a bigger effort in the advertising campaign. But, I don’t believe that this is individually an important point to us because, as you know, for a direct selling company like Natura, advertising is a part of our marketing effort. We invest a lot in training. We invest a lot in recognition. We invest a lot in the magazine, the new one. This is the most effort that we are doing in the beginning of this year. And, we spend some money in advertising, different from the retailers’ advertising. It’s a part of our marketing effort. It’s not as important as for the traditional channel. So, I don’t believe that these efforts specific in advertising from the competitor should affect so much our strategy or our results.

Okay. Thanks very much.

Our next question comes from Ms. Juliana Rozenbaum with Deutsche Bank.

Just a follow-up question. You mentioned previously that you were slightly disappointed with sales growth in the quarter, and that was one of the reasons behind the increasing inventories. Can you give us some color on if that was concentrated in any specific product line or things like high-ticket items instead of low-ticket? Any color to help us understand why you were disappointed or why you were expecting something higher than the actual growth that you saw?

When you take a look deeply in the frustration, you are right. It’s concentrated in some products or categories, but not because of their characteristic but because they were involved in those marketing campaigns that didn’t reach the results that we expect. So, yes; are concentrated, but not because lower tickets or because we are talking about makeup and colors, but only because they were involved on those marketing campaigns. Unfortunately, we are not sharing which one [inaudible] because this is strategic information. The most important thing to share with you is the fact that we know where are the opportunities, and we [sew] them for the future.

Okay. Thank you. But, if I--? If I’m wrong-- This was actually the first time where you were disappointed. Is there any reason why your marketing campaigns-- because they didn’t really change. So, why your marketing campaigns didn’t provide you with the results that you were expecting? Could you at least identify what happened? What was different on this quarter?

Well, Juliana, I would start saying that we are not free of mistakes. Sometimes we can make some mistakes. Part of the explanation is that we make some mistakes. Our second one, which is not very important but also might explain a little bit, is that we are undergoing right now some structure changes in the Company because of the growth, because of our strategy of international expansion. So, there is a lot of different processes - some changes in the organization. This might also have increased a little bit the variability of making some mistakes. But, you know; we have tens of different initiatives in our marketing efforts. It’s absolutely possible that we make some mistakes sometimes. We are not so desperate because of that. We regard that as a natural aspect of the business. We identified the mistakes, we corrected them, and we might have some in the future. We’re not infallible.

And, adding something, Juliana, even though we are a little bit disappointed, we consider that we had a good result in the first quarter, especially when you compare with the market growth. So, we are here to look for all the opportunities, but we are not sad with the results. We believe that we could do better, but when you compare our growth with the market growth, we are not upset.

No. Absolutely; don’t take me wrong on that. It wasn’t what I was trying to imply. But, thank you, anyway. Very helpful.

Our next question comes from Selso Sanchez of Citigroup. Please go ahead.

Just a quick follow up. In the Paris operation, or the France operation, I understood that there might be demand for a broader selection of products - that you’re getting some positive feedback on that. If that’s correct, would you consider a larger number of SKUs for the Ekos line, or do you think other product lines might even be useful in that operation? Thanks.

Selso, you are right. We are being demanding, and we want to increase the number of SKUs in our France operation, not only in Ekos line but probably launching new lines and sub-brands of Natura. Even though, we don’t have a specific defined time to do it, but we-- Yes. We want to increase the value proposition of Natura in the France operation. Let me share with you something important. Two months ago, we launched an extension of Ekos line, an important extension - a skin care line in Ekos. This is very important for the France operation. So, it’s the first time since we opened the store that we are offering skin care products under the Ekos line.

Right. When you say new line that you’d like to launch there, I would assume they are lines that already exist in Brazil, or would they be potentially entirely new lines specific to the French market?

Sorry. Could you repeat, Selso?

You said that obviously you’d like to grow beyond just perhaps Ekos in France. Would you consider launching entirely new lines, or would they be lines from Brazil that will now be represented in France?

We are planning to launch new lines, probably existing in Brazil, with some kind of adaptation for the French market. But, we are planning to launch existing lines in Brazil, completely new for the French market.

Of course. Okay. Thank you.

This concludes today’s question and answer session. I would like to invite Mr. Bossart to proceed with his closing statements. Please, sir, go ahead.

Thank you very much. I think it was a very good conference call today. I hope I see you in the next conference call again. Thank you. Have a good day.

That does conclude the Natura [inaudible] conference call for today. Thank you very much for your participation, and have a good day.