Natura &Co Holding SA (NTCO) 2010 Q2 法說會逐字稿

Good morning, ladies and gentlemen. At this time, we would like to welcome everyone to Natura's 2010 Second Quarter Conference Call. Today with us we have Alessandro Carlucci, the CEO; Roberto Pedote, the CFO; and Helmut Bossert, 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. There will be a replay facility for this call on 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 [1995]. 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. Allesandro Carlucci, the CEO. Mr. Carlucci, you may now begin.

Good morning, everyone, and welcome to our earnings conference call for the second quarter of 2010.

Natura recorded solid results in the quarter. Consolidated net revenues increased 24% to BRL1.3 billion, while EBITDA grew by 32.2% to BRL332 million for an EBITDA margin around 26%. We believe these numbers show that we are on the right path in terms of our business strategies and our management of the Company.

In our Brazilian operations, net revenue increased 24% to BRL1.2 billion on the second quarter and 23% in the first half of the year, achieving BRL2.1 billion.

According to the Brazilian CFT Association, in the first two months of the year, Natura's market share stood at 23.7%, expanding by 90 basis points from 22.8% share in the same period last year. Data for the months of March and April have yet to be disclosed, but we will pass the information on to you as soon as we receive it. As you can see, CFT market in Brazil is growing steady, and we expect to continue amplify our market share.

Factor's explaining Natura's revenue growth include new product launches, the sales strategy adopted for a commemorative date, and the expansion of the channel. Natura's innovation remains high, with the launch of important, new products which allowed the innovation index to stand at 68% in the quarter, slightly up from 64% in the same period a year ago. In the second quarter, we launched 38 new products, which, combined with the products launched in the first quarter, brings the total number of products launched in the first half of the year to 52.

Of the various products launched in the quarter, I would like to mention a few - first, the "Kaiak Pulso" fragrance, which set record sales in the launch cycle of almost 2 million units; the "Chronos" line, our skin care line, which was completely reformulated with new packaging and new sales structure combining age and skin types to ensure a better understanding by our consumers; and, lastly, the "Tododia Inverno" line, which features a line of six bath and body products and offers innovative moisturizing solutions for the winter.

I would also like that, in line with our strategy to continually reduce the environmental impact of our packaging, we are going to use a green plastic. We recently announced a partnership with Braskem to produce the first cosmetic product with the packaging made from green polyethylene, which is also called green plastic. Made from sugar cane, a renewable plant source, this innovation will help to reduce the level of greenhouse gases. The green polyethylene will be gradually rolled out starting at the end of the year, beginning with the [Avodoce] refill.

Our consolidated sales channel expanded by 19.2% in the quarter to reach over 1.1 billion consultants.

In our international operations, net revenue in the quarter grew by 40% in weighted local currency to reach BRL93 million. The operations in consolidation - Argentina, Chile, and Peru - registered gains with EBITDA of BRL5.3 million in the second quarter and of BRL1.8 million in the first six months of the year. As you may remember, in the first quarter this year, we had a non-recurrent effect in those three operations, especially the earthquake in Chile and FX effects in Argentina.

Meanwhile, the operations in implementation - Mexico and Colombia - posted loss with an EBITDA loss of BRL6.4 million in the quarter, which compares with EBITDA loss of BRL14 million in the second quarter of 2009.

As already disclosed, we are implementing a strategy to increase the level of customization in our Latin America operations with a focus on innovation sales model, the operation and logistic model, and our corporate behavior. And we are doing this to accelerate the growth and to be profitable in the region.

The sales channel in the international operations continued to grow at strong rates. In the period from 2007 to 2009, weighted growth was 36%. In the first six months of 2010, we reached 178,000 consultants in our Latin America operations, excluding Brazil, for growth of 28%. The number of relationship managers in all countries has stabilized at around 830, which means that today we have 213 Natura consultants per manager for growth of 28% on the previous year.

After comparing these numbers with the Brazil operation, where we have 900 relationship managers and 1,050 consultants per manager, we can see that our international operations already has an installed base of relationship managers of sufficient size to support growth in the consultant base over the coming years and help fixed-cost dilution.

We want to implement the Natura super-consultant model, the CNO, in the Latin America operations, adapting the model to individual cultures of the country and the region. And we expect to implement the model between 2011 and 2012.

In the area of operations and logistics in Latin America, excluding Brazil, we have determined that we will outsource locally the production of a portion of our portfolio. And we estimate we will work with partners in three countries. By the end of this year, we expect to outsource in at least one country. And, in 2011, we plan to expand the share of local production and the number of lines produced. We are not planning to build our own manufacturing plants outside Brazil. As I mentioned, we are going to use outsource, third parties.

Our corporate behavior is the most rated in the region by the higher penetration of our sales in the product line (inaudible), which currently stands at 12%, and by the 14% contribution from product [Refuze] to our revenue. The coordination and execution of this strategy in Latin America is supported by the strong effort to develop leaders in each country, as well as by the corporate team 100% dedicated to the Latin America operations that works out of the head office established in Buenos Aires. This team is formed by executives from Brazil and other countries who have long experience in the industry, extensive knowledge of Natura and markets.

Lastly, I would like to reinforce that we are confident in the continuous expansion of our business and markets in Brazil and in the various countries in Latin America in which we have operations.

Those are the points that I wanted to comment for this quarter. I will now hand the call over to Roberto, who will present details on our financial results.

Good morning, everyone.

In the second quarter, we recorded solid results in both our operations in Brazil and in our international operations. Consolidated net revenue grew 24% to BRL1.3 billion, while EBITDA margin was 25.9%.

The net income in the quarter was 14% higher than a year earlier due to the normalization of the effective income tax rate, given the end of goodwill amortization, as we have commented before.

The 1.6 basis point improvement in EBITDA margin was basically due to the productivity gains resulting from our logistic process and dilution in sales and administrative expense, despite higher investment in margin.

Gross margin decreased by 200 basis points in the quarter in relationship to the second quarter of last year. This gross margin compression was due to inventory losses due to the higher share of Mother's Day and Valentine's Day [dip] in sales and the negative currency impacts in the international operations. Inventories have already risen to the same coverage levels as in the middle of last year, and we are optimistic on the path of margins in the international operation and in our promotion strategy in Brazil.

I would like also to comment on our successful debentures issued in May this year. Demand exceeded the issue by twofold, and we raised it to BRL350 million with a term of three years. Note that Standard & Poor's (technical difficulties) rating to both Natura Cosmeticos and its debenture issued. The transaction was made to lengthen our debt profile. And, today, two-thirds of our debt is long term.

Meanwhile, free cash generation improved by 70% between the two six-month periods, mainly due to better management of working capital. Inventories, as mentioned earlier, declined in the number of coverage days, returning to the same levels as in the end of June 2009.

Regarding the improvement in the quality of the service provided for our consultants, we are working to continually improve the services by implementing structural measures that seek to reduce the delivery time of products to final consumers. On this front, in the next few months, we will inaugurate two new distribution centers - one located in Belem and the other one in Uberlandia.

In closing, I would like to comment that the board of directors approved, [as referring the annual shareholders meeting to be held next year], the payment of dividends and interest on equity for the first six months of this year in the amount of BRL0.66 per share and which will be paid on August 11 to shareholders of record on July 27.

That concludes the main points I wanted to cover today. Thank you very much. Let's go now to the question and answer session.

(Operator instructions). Reinaldo Santana, Deutsche Bank.

I have two questions. First one-- We saw increases in cost as a percentage of sales in raw materials and packaging in the quarter. You explain higher inventories and also a negative FX translation effect in the international operations. But I would like to know if, in addition to this, you saw any specific pressures in raw materials. And what's the outlook for the second half of the year in terms of cost inflation?

And, second, in the past years, Natura's number of SKUs have slightly decreased. But it appears that the new launches have increased this year. Should we expect a reversal of that trend in terms of SKUs? Thank you.

Just to mention about the cost pressures, we usually don't see any important cost pressure looking forward that was not contemplated by our price increase that we have already done in the beginning of the year. As we mentioned, there are specific reasons to reduce the gross margin in the quarter, but they are not structural reasons. And we don't see any important cost pressure looking forward.

And, Reinaldo, regarding the number of SKUs, depending the quarter and the cycle, because sometimes you have a launch of makeup, for example, with a lot of SKUs that increase a little bit. Sometimes you have a launch of a fragrance that is only one. You are going to see some variations. But this is not a change in the strategy. We want to keep the total number of SKUs around 650 and 750. So, in other words, this is the level of SKUs that we would like to manage. But this is-- We can see a variation between the quarters. So this is nothing-- It's totally normal.

Great. Thank you.

Andrea Teixeira, J.P. Morgan.

I just want to ask something different about the international operations. I know you're not giving guidance on that business yet. But we see, from what we spoke before, the movements that you're looking at is the CNO implementation, and, also, in your prepared comments, you said like 2011 and 2012 and also having local production.

These two movements-- One is probably going to increase your expenses a bit, which is the CNO. And the other one will likely to reduce your costs from producing locally by third parties.

The combination of both forces and the other initiatives to do the regionalization of the management teams and all of that will likely lead to a worsening of the margins? In other words, we're going to get worse before it gets better? Or you're still going to see improvements in margins because the local production will reduce your costs dramatically?

And, if you can talk about what you expect in terms of penetration of the CNOs improving your sales-- In other words, you're going to accelerate-- You expect to accelerate growth in sales in the international operations in '11? Or we should see the same kind of pace of growth that has been already very strong? Thank you.

We expect that, in the beginning in the consolidation operations, you are going to see better and better margins because they have already enough scale and the right size of sales force and structure. So we should expect better margins for the future. So you are not going to see something worse and then something better.

In the implementation operations, where we still need to invest in the sales force and also in the brand, maybe you are going to see some investments in the next two or three years because we need yet to reach the same kind of scale that we have already reached in the other countries.

And, regarding the CNO implementation in the region, of course, we expect that the CNO can accelerate the channel growth. That's why we are implementing. And, also, we believe that we can dilute some fixed costs in the sales force, as we saw in Brazil.

But you must not forget that, when you grow a lot, you need to compare with bigger size-- a bigger base. So, in other words, if we keep growing the same CAGR that we grew in the last year, this is a huge effort because we are bigger than we used to be three or four years ago.

So, in other words, we want to implement the CNO to accelerate the expansion. But keep in mind the size that we have already today in the region.

Okay. Wonderful, Allesandro. Thank you very much.

Joaquin Ley, Santander.

I have two questions, actually. The first one is regarding the negative impact that you had on your gross margin due to, I understand, inventory losses. Could you please elaborate a bit more on that? Which product line is that? Do you think you've been conservative enough by marking down already those products internally or recovered the risk of seeing a complete write-off going forward?

And the second question is about when you talk about the expansion of the EBITDA margin. One of the positives is more efficient logistics. Could you provide us with some example about that please?

Related to inventory, what we are talking here is, when we do a provision for losses, we have a continuous process here that we always evaluate all the products that we have in stock and if there are plans to sell them. As we increase a little bit the stocks in the end of last year and we increased the coverage in the promotions in the end of last year to guarantee a very good Christmas, we had some products that were not sold in some specific lines. We don't open which lines.

But we can say that, generally, through the portfolio. And then what we do is that we-- Every month and every quarter, we do the provision for losses for these products that we don't have yet a plan to do something with them. And this is a moving number. It's not like one moment it happened.

What we had this quarter is that, in comparison to the same quarter last year, we have an important increase in this provision. And we expect that this provision will decline. With a better process, with a lower stock coverage that we have today, then we believe that this amount will decline to comparable levels as previous year and even to lower levels in the future because we are doing a lot of things to improve the quality of this process.

The second question was about what's happening in the logistics. Basically, one part is the orders through internet that, today, we have already 84% of all the orders from our consultants through internet. The second part is freight. We've been renegotiating in the beginning of this year and end of last year the freight with several suppliers.

And we have important benefits from that. I think that, so far, these are the two main reasons for our improvement.

Thank you.

Lore Serra; Morgan Stanley; Analyst

I actually have a couple questions. Let me try to ask them one at a time. In terms of the gross margin question that you were just addressing, I think you mentioned in the earlier call that some of that was from kits that weren't sold in the fourth quarter. Does that imply that, if you've written those off, that in future quarters we should see a gross margin benefit if you sell them?

There are two different impacts here, Lore. First is that what we sell is that we have not kits but, generally speaking, some promotion and some products that we made a higher provision for losses because we didn't sell all the promotion in that specific line from one product. And this is what we do a provision. In the end, if we have a good plan to sell this, we revert the provision. But this is the way that we work.

The second comment is that we had a very good Mother's Day and Valentine's Day. And then we sell much more kits than we were expecting. And we were able to sell them. And the kits-- they have a lower gross margin than the regular products. And this was the effect versus the same period of last year. The kits increased-- The kit sales increase was higher than the average. That means that we have a mix effect in the gross margin in the quarter.

These are the two different effects that we have specifically--

I understand that. But does the first one imply that, if you recover-- that you'll recover some of that in the future quarters or not? Your provision-- You're sort of implying that your provision levels on existing inventories may be higher than they need to be. Is that correct? Or are they where they should be?

No. They are exactly where they should be. But what happened is that, next quarter, we are going to see what are the products that-- What are the plans that you have to sell these products? Plus, what are the new products that we still don't have plans to sell? This is the way. It's a moving provision.

We expect that the net of this provision will reduce because, as we mentioned, we had a much higher stock coverage last year that produced a position that's higher than that. We have-- Every quarter, we have a provision for losses. But, especially the second quarter, it was higher. And we expect to be lower in the following quarters.

Okay. Thanks. And, then, you've had a very high margin in the first half of the year. I mean, it's 25%. Your goal is 23%. A lot of that sort of excess margin versus your goal has come from the SG&A line. And it seems to be coming from some of the things that you mentioned before, like freights and logistics that are, arguably, sustainable. So, should we think about this year as a year where your EBITDA margin will be sort of higher than your long-term average? Or is there a reason to think that investment levels will go up materially into the second half of the year to cause that margin to gravitate more to your guidance level?

First of all, we are keeping the guidance of a minimum of 23% of EBITDA margin. In other words, that means that could be a little bit higher or could be 23%. It's a minimum.

And second is you must take care because, when you look at a quarter, sometimes you have a phasing effect, especially in marketing and sometimes in project expenses. So probably in the next quarters, we are going to expend a little bit more in marketing, a little bit more in projects. And that's why we are keeping the guidance of a minimum 23% of EBITDA margin. That, again, could change a little bit. It could be a little bit higher. But we keep the guidance because we don't have any structural change, even though, as you saw in the last years, we are growing top sales. We are working hard to have productivity gains in the logistics area. And those two effects are affecting positively the margin.

But, reinforcing what we've been saying to you and to all the investors and analysts, we want to keep pressing the Company to grow. If we have any opportunity to invest to grow the Company, we are going to do this.

So this is the answer I hope that can help you.

Thanks. And just a last question. You're now at the point in Brazil where you've sort of lapped the rollout of the CNO project. And I understand that you have the capacity to grow your consultants a lot with the existing CNO rep. But I wonder if you could give us any color on how difficult or easy it is for the CNOs to recruit additional reps. The pace of reps growth has been pretty extraordinary in the past year. But now that you're starting to get into the second year or more of this program, is it getting harder to recruit new reps, or should we continue to see the kind of absolute level of rep growth-- I don't know-- quarterly that we've been seeing in the last year or so?

First of all, it's important to remind that, in this quarter, we can compare the last quarter that was fully implemented the CNO. So we have, how can I say, a better comparison this quarter because, in the second quarter of 2009, we were already operating with the CNO model fully implemented. So it's a better quarter to compare the channel growth.

In other words, what I'm saying is that you have in the first three to six months a higher impact in the implementation. Even though we expect that the CNO is still pushing the channel growth, we don't expect to see a relevant decrease in the sales or, especially, the channel growth in the next years.

It is not going to be the same as the first three to four months of the implementation. But it is going to be high. And you must remember that, even though we still have space to grow with the actual CNOs, with the 9,000 CNOs that we have, the model allows us to open new groups of CNOs. So there is still room to grow using the CNO model.

Thanks very much.

(Operator instructions). Celso Sanchez, Citigroup.

Most of my questions actually have been answered. Just to go back to the inventory question in terms of thinking about the trend, big picture over the last few years, I know that it's a bit choppy within quarters. Or, within the year from one quarter to the next, there might be more absolute levels of write-downs than others. But, in general, as a percentage of sales, is the idea that--? Is the way to look at it as a successful progression is to lower the inventory write-downs as a percentage of sales, which is what I thought would be sensible a few years ago? Or is the thought now that the benefits from that actually are outweighed by the opportunity to have fewer stock outs? So, if you had more stock outs, as perhaps you did in the past, you lose more sales. And the value of that loss is greater than the cost of carrying inventories that you might be writing down. Is that a way to think about it? Or it really is a percentage of sales? We should see write-downs go down because that was more important than the incremental benefit of avoiding stock-outs?

You are right with the logic that, if we need to choose in any moment between sales and stocks, we will choose higher stocks to guarantee sales. And this is exactly what we did in the second semester last year, because the two that were available for us was to increase stocks in order to avoid sales loss, not to mention that we had much more structural plan now in our planning system. And we are doing field investments, also thinking about our forecast system and integration of information and the way that we operate with logistics.

What we want in the future-- The first thing is to increase the service level and to deliver faster, to have a shorter cycle from the consumer perspective. This is what drives our main objectives.

At the same time, we believe that we can operate with lower stock coverage because the way that we are putting together all the pieces of this architecture of our logistics and our planning system allows us to expect a decrease in the stock, especially (inaudible) sales-- a gradual decrease, not anything-- not radical. But we are in the direction to have a lower stock coverage-- a gradually lower stock coverage and a better service level that will avoid us to lose any sales due to stock.

Okay. Thank you.

Irma Sgarz, Goldman Sachs.

You referred in your earlier comments to the number of relationship managers in the markets outside of Brazil. And you mentioned a number of 830 there, and relationship to number of sales reps is something around 213 at this point. Now it's around 900 or around 1,000, actually, in Brazil, that same number. Are these numbers comparable when you think about the two models? Or do you think because you'll be implementing a localized version of the CNO model, we should think differently about this relationship between numbers of managers to numbers of sales reps? Thanks.

I think it's a very good question. And, even though we are going to adjust and to localize some of the CNO model for the needs of the Latin America operations, I think that the numbers are comparable. In other words, if you compare Brazil with Latin America-- or the other countries in Latin America, you can see the potential of fixed cost dilution in the sales force and also the potential for growth. So, even though they are going not to be the same, I think that you can compare those two numbers.

Okay. Great. Thanks.

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

Before closing, I would like to say once again that we remain confident in the evolution of our operations in Brazil, as well as in our international operations. Competition remains strong in all countries where we have operations. We respect a lot the competition. And we look for the movement. But our value proposal, our brand, and our corporate behavior lead us to believe that we have all the conditions in place in order to maintain our position in the industry and launch more products, build the value proposition, and keep growing high rates in those markets.

Once again, I would like to thank you all for participating in this conference call. And I look forward to our next meeting in October to discuss the results for the third quarter. Thank you, and have a good day.

That does conclude Natura's [half-year] conference call for today. Thank you very much for your participation, and have a good day.