Coty Inc

NYSE:COTY

Earnings Call Transcript 2018-Q2

[Operator]

Good morning. My name is Crystal and I will be your conference operator today. At this time, I would like to welcome everyone to Coty's Quarterly Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

I will now turn the conference over to Mr. Monaco. Mr. Monaco, you may begin your conference.

[Kevin Monaco, Coty, Inc.]

Good morning and thank you for joining us. On today's call are Camillo Pane, Chief Executive Officer; and Patrice de Talhouët, Executive Vice President and Global Chief Financial Officer.

I would like to remind you that many of our comments may contain forward-looking statements. Please refer to our press release and our reports filed with the SEC, where we list factors that could cause actual results to differ materially from these forward-looking statements. All commentary on organic net revenues reflect the comparison of combined net revenues at constant currency in both the current and prior-year periods, excluding the impact of acquisitions other than the acquisition of the P&G Beauty Business.

In addition, except where noted, the discussion of our financial results and our expectations reflect certain adjustments as specified in the Non-GAAP Financial Measures 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 Camillo.

[Camillo Pane, Coty, Inc.]

Thank you, Kevin, and welcome, everyone, to our fiscal 2018 second quarter earnings call. Q2 was a very strong quarter marked by Coty's return to organic top line growth. We delivered excellent growth in Luxury, an acceleration in positive momentum in Professional Beauty and a significant improvement in Consumer Beauty. This healthy net revenue performance, coupled with continuous improvement on the cost structure, resulted in significant improvement in profits.

I'm very pleased with these achievements and the progress made so far. However, there is still much work to be done before we achieve the consistent results that we seek, as we still need to relaunch many brands, deliver our synergies, and continue with our integration of the P&G Beauty Business.

Moving on to our divisional performance, the Luxury division delivered outstanding 8.1% organic net revenue growth, marking the fourth consecutive quarter of very strong growth. This excellent performance was fueled by the continued success of our innovation pipeline, including several new launches, leading to growth in all geographies, particularly in travel retail and ALMEA.

We continue building on two successful major new products introduced in the first quarter: Gucci Bloom and Tiffany's debut fragrance. I'm extremely proud that Gucci Bloom was one of the top-ranked fragrance launches in the Middle East, Africa, and Asia. In China specifically, Bloom was the number one fragrance launch in the country. In the U.S., Bloom also continued its excellent performance, achieving a nation of top 10 women's fragrance ranking in terms of sellout during the week of Christmas.

Our debut, Tiffany's fragrance, continue to perform exceptionally across all regions, achieving a top 3 new products ranking in most of the doors we launched, an incredible accomplishment for a new brand just introduced into the market last quarter. Tiffany's strong results, particularly in the U.S., Asia and travel retail, are extremely encouraging.

Separately, I'm thrilled to announce the philosophy purity-pore-extractor-mask was the number one prestige skincare launched in the U.S. in 2017. This is another tremendous accomplishment by the Luxury team. Other highlights in Luxury include successful campaigns for Chloé Signature and CK ETERNITY with strong sell-through in several major markets. Our strong performance demonstrates Coty's expertise in developing and bringing Luxury beauty brands to market and speaks to our ability to successfully execute our strategy.

The acquisition of the iconic Burberry brand closed this quarter complements Coty's already strong Luxury portfolio. Our go-to-market strategy for Burberry is evolving as we move the brand from a third-party distributor network to a direct go-to-market strategy in most markets. As expected, we have a high level of inventory that we have to work down, so the second half is anticipated to be a period of transition as we continue to integrate the brand into our Luxury portfolio.

In our Professional Beauty division, net revenue increased 2% organically, marking the fifth consecutive quarter of positive growth. OPI returned to growth globally, growing double-digit in every geographic region. Both gel and lacquers (5:15) grew as a result of a very encouraging initial restage of our gel products line and the launch of a new color collection. Wella Professional sustained its positive performance benefiting from the recent Wellaflex launch. ghd also posted solid organic results boosted by strong e-commerce performance in its main holiday selling season.

In Consumer Beauty, net revenues declined 1.3% on an organic basis, a significant improvement from the prior quarter and year and further evidence of a stabilizing trend for the business. It's worth reminding you though that Consumer Beauty benefited from a favorable comparison this quarter as the prior-year period performance was negatively impacted by transitional issues in parts of the P&G business.

This improved performance against the still weak global mass beauty market provides reassurance that the combination of brand initiatives, improving market execution and consumer-focused communications strategy is supporting the gradual improvement in Consumer Beauty revenue trends. And it's important to keep the focus of the organization on recovering the market share that has been lost over the last several quarters.

Consumer Beauty in North America remained under pressure, driven by the planned winding down of inventory in advance of our pending relaunches, as well as distribution losses from last year, which will anniversary in the second half of fiscal 2018. Our European business improved, primarily as a result of stabilization in the base business. ALMEA grew strongly and continues to be a standout, with double-digit growth across the majority of key geographies.

In Australia, we saw growth in color cosmetics and a return to growth in hair, driven by excellent in-store execution. In Mexico, we continue to gain share in retail hair, achieving the highest share in three years as well as category captaincy in about 80% of the retailers where we are present. In Brazil, we also continue to gain share despite aggressive pricing strategy from competitors. China above-the-market growth is attributable to our new route-to-market strategy, to our own affiliate structure, the pipeline of country-specific innovation and a strong focus on e-commerce.

We have strong plans for several Consumer Beauty brands in the second half of fiscal 2018, including COVERGIRL, Clairol, Max Factor amongst others. For COVERGIRL, the products and fixtures are just now beginning to be rolled out in the different retailers across the U.S. As a reminder, most of the U.S. retailers begin their annual spring (8:05) in mid-January and continue to our fiscal fourth quarter. It's important to note that all of our plans will be set in tune with the trade windows that are prepared by the retailers. Over the next few months, consumers will see new positioning, new creative, new packaging, new innovations, and new store appearance for COVERGIRL.

In the second half of our fiscal year, we're also undertaking a profound relaunch of the Clairol brand and its key pillar, Nice 'n Easy. The relaunch includes revisiting and refocusing a compelling and consumer insight-driven purpose in line with the roots of the brand, launching a new damage blocking technology, revising the architecture of the brand portfolio, and addressing growth segments such as maintenance and artistry. The early feedback is very positive so far, and I look forward to sharing additional updates with you in the second half of fiscal 2018 as new products and fixtures are fully rolled out into shelves. So, though Q2 has shown improvements for Consumer Beauty, it will still take time for the full recovery of the Consumer Beauty business, and results are likely to be uneven from quarter-to-quarter.

Now, I would like to provide a brief update on the key growth pillar from new Coty, which is the acceleration of our end-to-end digital transformation, including e-commerce. With Beamly's help, Coty continues to push the envelope on innovation in digital. In the second quarter, we launched artificial intelligence power tools on boots.com in the UK, which help consumers select fragrances. And as of yesterday, on covergirl.com in the U.S., users are now able to try on products virtually before purchasing them.

Secondly, we have teamed with Amazon to launch Let's Get Ready, a new visual skill designed for Amazon Echo Show. Let's Get Ready is a personalized beauty offering tool that can deliver up to over 2,000 unique combinations of hair, eye, and skin color curated looks and visual tutorials along with recommended products from Coty Consumer Beauty portfolio the users may add directly to their Alexa shopping list. Lastly and most importantly, all three divisions have seen strong and accelerating double-digit growth in e-commerce revenues year-to-date ahead of the market growth.

Younique continued very strong performance with double-digit sales growth in the quarter with several countries increasing at triple-digit rates, including France, Germany and Spain. As of December, Younique had over 230,000 active presenters, an over 20% increase versus the prior year. Now in its fifth year, Younique continue to distinguish itself as a destructive peer-to-peer pure-play e-commerce beauty platform with a highly scalable technology platform.

Across each of our businesses, we continue to see the positive results directly linked to our growth strategy, as discussed in previous quarters. This strategy includes relaunching key brands, actively engaging with retailers to amplify the in-store shopping experience to drive category growth, working on accelerating our time to market with on-trend collection of new products, accelerating our end-to-end digital transformation and driving our e-commerce efforts.

I told you that fiscal 2018 will be a year of stabilization and this is what our results have shown so far. There is still much to do as we need to relaunch many brands, deliver our synergies and continue with our integration of the P&G Beauty Business. We still have work to do here. I remain confident that the real progress we have seen year-to-date, coupled with our commitment to our growth strategy, will continue to move Coty gradually into the path of full recovery.

Based on the much improved results to-date, we have refined our revenue growth objectives for the remainder of the fiscal year. While revenue recovery will not be a straight line, we now aim to deliver positive, but modest, organic net revenue growth for the second half of the year. For margin, we continue to aim for a healthy improvement in the second half of the year versus the prior year, with most of the impact coming in Q4 as we continue to deliver on our merger synergies.

I will now turn the call over to Patrice.

[Patrice de Talhouët, Coty, Inc.]

Thank you, Camillo, and good morning, everyone. Q2 was another quarter with solid results that gives us tangible signs that our strategy is starting to bear fruit. Our second quarter net revenues were $2.6 billion, a 14.8% increase versus last year, including our acquisition, with our organic net revenue growing a good 2.8% versus prior.

Adjusted gross margin was 61.6%, a 200 basis point decrease year-over-year attributable to the positive momentum in our emerging market Consumer Beauty Business, which has lower gross margin, as well as the comparison to favorable impact in the second quarter of fiscal 2017 following the P&G Beauty Business acquisition.

Fixed cost control continues to be a priority of the company. As a result, our efforts continue to show progress and, combined with the good revenue momentum, is fueling an adjusted operating income of $347.5 million, or a 12.8% increase year-on-year, which represents a profitability of 13.2% of net revenues. We have recorded this quarter an adjusted effective tax rate of 10.3%, which has been positively impacted by $41.8 million of tax benefits upon settlement of certain tax positions.

And now a few words on the Tax Cuts and Job Act which was enacted in December. Our current mix of profitability across the regions means that we expect a neutral impact from the tax rate change. As a result, we expect the adjusted effective tax rate for fiscal 2018 to remain at approximately 27% excluding any onetime items. It is fair to say that in the future, the average tax rate could be positively impacted if the profits in the U.S. improve. We estimate that the onetime deemed repatriation tax to be neutral for Coty for both cash and P&L purposes through the use and revaluation of deferred tax assets and liabilities.

The adjusted minority interest of $17.3 million reflects the positive momentum of our partnerships, especially Younique that we expect to continue in the second half. All of the above resulted in adjusted net income of $237.2 million or an equivalent adjusted earnings per share of $0.32. Despite the high season that is usually working capital-intensive for us, our continuous focus on cash is driving a healthy free cash flow generation of $196 million this quarter, which bodes well for our intention to deleverage the business over time. During the quarter, we used existing cash on hand to acquire the Burberry Beauty license as well we repaid more than $320 million in debt.

Let me add a few details on our performance per division. First, in Luxury, our gross margin has improved year-on-year, thanks to our creative innovation and good productivity improvement in the supply chain. This, combined with the tight management of our cost structure, resulted in an operating income increase of 28.6% versus prior year despite the initial cost incurred for our Burberry license acquisition. Our Consumer Beauty division has lifted its profitability by 19.4% versus last year to $131.9 million or 11.6% of net revenues, thanks to the good contribution of Younique as well as strong cost discipline.

As far as our Professional division is concerned, the operating margin has been very healthy in Q2 at 16.5%, on the back of a strong holiday season for ghd as well as tight cost structure management for the overall division. It is also worth mentioning that the operating income decline in Professional of 9.8% versus prior year is due mainly to go-to-market changes in OPI to strengthen our position in some key European markets.

We are still very much focusing on progressing on the integration of the P&G Beauty Business and realizing our synergies. I am pleased with the overall progress of the integration efforts as this is helping us to become much more efficient and will simplify our operating model. I am also pleased to report that our synergy delivery is on track to reach our $750 million target over time.

Regarding our rationalization program, whether via divestiture or via discontinuation, it is fair to say that we are making progress, and we are on track with our expectation to announce before the close of fiscal 2018. As already mentioned, this initiative should help to improve our revenue growth trajectory over time while being dilutive to our profitability on a short-term basis. We will elaborate further in due time.

To conclude, although there is still much work to be done, this quarter has been another milestone in the right direction with good financial performance that give us confidence in our objective to deliver modest organic net revenue growth for the second half, as well as healthy operating margin improvement in the second half of the year versus the prior year, with most of the positive impact in Q4.

Thank you. We will now open the call for questions.

[Operator]

Thank you. Please note you will be limited to one question and a related follow-up question until all callers in the queue have posed their question. Once you have asked your related follow-up question, your line will be muted once again. And our first question will come from Olivia Tong from Bank of America Merrill Lynch. Your line is open.

[Olivia Tong, Bank of America Merrill Lynch]

Thanks. Good morning. I want to start with sales. I understand the revenue progression won't be a straight line, but it's nice to see the fragrance acceleration and the changing Consumer Beauty nonetheless. So, first, on Luxury, were there any particular areas that stood out? Obviously, we know that Gucci and Tiffany were very strong, but was there a surge in travel retail or China or another area relative to your expectations or was there a fairly strong performance across the board?

And then on Consumer, obviously lots going on in terms of the COVERGIRL launch. Is there any need to clear inventory? As you've had discussions with retailers regarding COVERGIRL, what are they thinking? Are they swapping out the old for the new? Have you been able to get incremental shelf space in your existing doors or back into your doors that you've lost in the first place? And also, do you expect to grow the market while you do this? Thanks so much.

[Camillo Pane, Coty, Inc.]

Thanks, Olivia, for the question. Regarding the first one on Luxury, we feel very pleased with the performance of the quarter. The growth has been, I would say, positive and very good across all regions, all the three regions. The one that standout, actually, ALMEA, so our emerging markets and travel retail. China has been clearly a country where we had a very strong performance both with some of the brands that we have in the portfolio, like Marc Jacobs and Chloé, but especially with the launches.

So Bloom, I mentioned in the call that it's one of the top launch, actually, in China. And what I can tell you that actually Tiffany in China was launched just 11 days ago because of the Chinese New Year, and the team just informed me that actually Tiffany, in the last 11 days, clearly, with investments because we're in the launch period, but it's the number two fragrance brand in China in the last 11 days. So, this clearly speaks very high about the strength of the brand, but also the quality of the launch that the team is having on Luxury.

And travel retail is also another area where we continue to have a very strong performance in Luxury, ahead of how the market is performing in travel retail. So, that's definitely another highlight. Your second question was about COVERGIRL. So, look, we are in the middle of basically resetting the shelves. So, we have new positioning, new creative, new packaging and new set of innovations. And we now have reset the shelf in three of our four top retailers in the U.S., and the last one is going to start in late February, early March. But the shelf reset initially just happened from mid-January onwards. So it's just a couple of weeks.

And what I just want to mention is that the overall shelf space for COVERGIRL will remain flat, which for us is a positive news after many years of shelf space and distribution declining, all decision which were taken prior to the merger. And we are excited about the plans that we have on COVERGIRL, not only for the innovation but also for the repositioning so, how COVERGIRL will look on the shelf, the new media, the new creative.

Early signs are encouraging. We only have a week of data and a couple of customers but, clearly, we have seen some improvement in the performance. And, therefore, we are, of course, encouraged by that. And the other elements that I can say is that when we went on air with the new creative in the month of November and December, although the shelves reset had not happened, we saw a significant spike in the sales of the product franchises which were put on air. So, again, it's another positive sign that encourages for the coming months. It's clear that we expect an improvement more towards the end of the second half of 2018 for COVERGIRL.

[Operator]

Thank you. Our next question comes from Joe Lachky from Wells Fargo. Your line is open.

[Joe B. Lachky, Wells Fargo Securities LLC]

Hi. So, first, I just wanted to clarify your outlook on the top line. Previously, you had said flat organic sales growth and, in the release, you're calling for modest net revenue growth. So, you're kind of going from organic to net. And I don't know, Camillo, maybe you mentioned organic, Patrice, you mentioned net revenue. I'm just, ultimately, is there any change to your organic sales outlook here in the second half? Thanks.

[Camillo Pane, Coty, Inc.]

Thanks, Joe, for the question. Yes basically, based on the improved results that we have seen in Q2, we have slightly refined our organic net revenue growth objectives for the remainder of the fiscal year. And although net revenue coverage will not be a straight line, we now aim to deliver organic positive, but modest net revenue growth for the second half of the year. So, from a top line point of view, we have slightly refined our objective for the second half and, yes, on an organic basis, just to clarify your question.

On the other side, on margin, we just continue to aim for a healthy improvement in second half versus the prior year, with most of the impact coming in Q4, because it's in Q4 that we will continue to deliver on our merger synergies. And this objective has not really changed versus what we mentioned in the prior call.

[Joe B. Lachky, Wells Fargo Securities LLC]

Okay. Thanks. That's very helpful. And then, I guess, my main question on Consumer Beauty, obviously, much improved this quarter. Can you quantify maybe how much of that was like a comp issue, just the easier year-over-year comparison, because it doesn't seem to be much improvement in the U.S. tracked channel data? So, I was just wondering if you have any confidence that underlying results are improving here and you could see continued improvement in the second half. Thanks.

[Camillo Pane, Coty, Inc.]

Yeah. Okay. Look, to answer your question, Consumer Beauty declined 1.3%. We believe this is an improvement versus prior quarter and also versus year ago, and the business is stabilizing and is having improvements in several areas. Absolutely, what you mentioned is correct, which is that we do have a favorable comparison versus the previous quarter, which was negatively impacted by the P&G transitional issues. But at the same time, this quarter, we have intentionally held back sales on a couple of big brands, like COVERGIRL and Clairol in the U.S., because we wanted to make way for retailer shelves to replenish a bit of stock before our relaunches. So, if you consider these two factors, we believe that we had sequential improvements this quarter versus the previous quarter in Consumer Beauty.

[Operator]

Thank you.

[Camillo Pane, Coty, Inc.]

Now, there is another point, I think, you made, which is the Nielsen data in the U.S. What I would like to point out is that the U.S. data from Nielsen represents around 10% of total Coty consolidated net revenues. So, this is because, clearly, of the size of our U.S. consumer business, of the coverage and also the fact that Nielsen doesn't fully cover online and some specialty channels which continue to grow. So, if you look at this fact, we do have 90% of the company net revenues which are not covered by Nielsen U.S. data. And also, I think, we should also point out that we are growing double-digits in ALMEA, in our emerging markets, across all the three divisions. And ALMEA is not really covered properly by Nielsen, or NPD as a matter of fact.

[Operator]

Thank you. And our next question comes from Faiza Alwy from Deutsche Bank. Your line is open.

[Faiza Alwy, Deutsche Bank Securities, Inc.]

Thanks. Good morning. So, just a couple of questions from me. First of all, Camillo, could you talk about the increase in the organic growth estimate for the back half and if there's one particular thing that's driving it or if it's a combination of several factors? So, is it sort of your improved outlook on COVERGIRL? Is it ALMEA? Is it Luxury? Sort of what's sort of driving that improved outlook in the back half?

And then, just secondly, if you could comment broadly on how you think about direct-to-consumer, because I thought it was curious sort of the new website that you launched yesterday for COVERGIRL, the Try It website, that you decided to go with Walmart for that particular item. I just thought that was curious. If you could maybe comment on that and just how you think about DTC broadly? Thank you.

[Camillo Pane, Coty, Inc.]

Yeah. Thanks, Faiza. Regarding the outlook, as you know, we don't give outlook by division. But, I think it's fair to say that to achieve our overall objectives, to have modest positive growth in the second half, this relies on Consumer Beauty having sequential improvement in the second half of fiscal 2018. So, I think that's probably sufficient to explain, also, if you consider the continued growth in Luxury and Professional Beauty and you look at what I just said on Consumer Beauty, that probably explains why we have slightly refined our outlook for the second half.

Regarding the direct-to-consumer, I think what is important to point out is that we are definitely seeing a much stronger focus on e-commerce since we have announced, now, a few months ago that we were going to change drastically the focus on e-commerce within the organization. So, we're seeing, actually, an acceleration and double-digit growth ahead of the market in all the three divisions in e-commerce. And we are working very hard on digital innovation, which is an area in which we're putting a lot of focus with the help of our agency, Beamly.

And what we announced for COVERGIRL is absolutely a way to increase connection with consumers and clearly, also, conversions. And the partnership with Walmart is a very strong partnership. Walmart is a very important customer for us. And in the case of this innovation on COVERGIRL, we have struck this partnership for the virtual makeup look try-on on the new COVERGIRL website. But as I mentioned in my script, we have another partnership on fragrance with boots.com. And clearly, we have many others with our customers, which we'll not mention at this time, but they are in the works. So, I would say it's a wider type of acceleration on digital innovation.

[Operator]

Thank you. Our next question comes from Wendy Nicholson from Citi Research. Your line is open.

[Wendy C. Nicholson, Citigroup Global Markets, Inc.]

Hi. Good morning. I know you talked a little bit about the moving pieces of gross margin versus operating margin, but can you just remind us, number one, do you have a long-term target for gross margin? And sort of directionally, obviously, we know the margin split on the operating margin side across the segments, but how different are the gross margins by segment as well? Thank you.

[Patrice de Talhouët, Coty, Inc.]

So, thanks for the question. So, on the gross margin, first, we don't give any indication of gross margin by division, and we don't, also, give any indication on our long-term target. This being said, it's fair to say that if you want to achieve the high teens of operating margin that we have declared already a few quarters ago, we're going to have to work on our gross margin, and it will be positively impacted by the synergies, also.

Now, on this specific quarter, what I would like to point out is a couple of things. First, this quarter is not indicative of our future gross margin expectation, particularly as our synergies are realized. Second, there is a decrease of the gross margin by 200 basis points, which is attributable to the positive momentum as we said of our emerging market in Consumer Beauty business but also as a comparison to favorably impact in fiscal 2017. What I mean by this is that we inherited from our balance sheet a positive manufacturing variance due to the very high volume that was triggered in Q1 last year, and that we released in the Q2 fiscal 2017 books of Coty. And so that has created a positive impact in the gross margin in fiscal 2017. So, that's really the two bulk of the explanation.

There is also a small explanation that has to do with the fact that we are doing all these new launches in Consumer Beauty, especially COVERGIRL that has a slight effect on the gross margin with the reset. But once again, it's very important to point out that this quarter is not indicative of future gross margin expectation.

[Wendy C. Nicholson, Citigroup Global Markets, Inc.]

And just following up on that, so as the COVERGIRL relaunch and we get Clairol and Max Factor and other things as we go through the course of the year, is the promotional activity expected to tick up? I'm just wondering how much of a pressure on gross margin that might be in the second half.

[Camillo Pane, Coty, Inc.]

Look, we have strong promotional plans for, I would say, the three major brands we're relaunching, which is the one you mentioned, so the COVERGIRL, the Clairol and the Max Factor. But we don't expect overall the total company to have an effect on gross margin that is significant by the, I would say, additional strong effort. Without any doubt, what we expect is really a strong investment behind these brands for the second half of 2018, as you would expect, we'll all relaunch them across different markets and in different parts of the brand itself with the retailers and therefore there will be strong investment.

[Operator]

Thank you. Our next question comes from Shannon Coyne from BMO Capital Markets. Your line is open.

[Shannon Coyne, BMO Capital Markets (United States)]

Hi. Thanks for taking my question. Can you talk about the progress you're making with the influencer community? Specifically in COVERGIRL, I know you're replacing 25% of the product line with new products. Do you think that's enough? Have you gotten any feedback from the influencer community on that? And then secondly, I was just wondering if you could give us an update on any entry into the prestige cosmetics market with Gucci and Burberry in China or in the U.S. Thanks.

[Camillo Pane, Coty, Inc.]

In terms of the innovation that we have on COVERGIRL, we have strong feedback in general from consumers. As you can imagine, we do extensive testing as well before deciding where to allocate our investments and, of course, what to lunch. And so, when I think about the Vitalist Foundation or the Katy Kat Lip Gloss or the Peacock Flare Mascara, they're all being received positively and that includes also influencers. Within our process, we always work with influencers. And actually, we are strengthening our effort to partner with influencers in the preparation of launches as well as of course in our communication strategy. Regarding the prestige cosmetic market, so in Luxury, we have two brands where we're playing in prestige cosmetics, so that's Gucci prestige cosmetics. And now, we also have Burberry within our portfolio. And it's fair to say that we're going to work on strengthening our plans on these two brands over the next quarters.

[Shannon Coyne, BMO Capital Markets (United States)]

Okay, thanks.

[Operator]

Thank you. Our next question comes from Mark Astrachan from Stifel. Your line is open.

[Mark Stiefel Astrachan, Stifel, Nicolaus & Co., Inc.]

Yeah, thanks and good morning everybody. Wanted to ask about how we should think about current debt levels and the timeline for deleverage including, if you could give some color into expectations as we head into next year? I mean maybe relative to some of the investments that you had outlined about a year ago in terms of how to think about cash conversion. And then I guess more broadly even with some pay down, debt levels are still going to be pretty high relative to perhaps some other companies, I suppose. How do you think about that from a flexibility standpoint to go out and do meaningful M&As you've talked about? And would you consider creative solutions, I suppose, in terms of being able to pay down debt or do deals in the future?

[Patrice de Talhouët, Coty, Inc.]

Thanks for your question, Mark. So as you know, we are not going to comment on our M&A journey and on potential structure. What I can comment is on our current level of debt and the leverage. So, first you will have noticed that in Q2 we have already paid down $320 million of debt. So this is a clear signal that we are sending, that we are very much focusing on deleveraging the business. This being said, the current leverage that we have is at 4 times. That give us still some flexibility, but it's very important to point out, as I've already mentioned in the previous quarters, that one of our focus for the time being is to deleverage the business. And so we have started to that in Q2, and we keep on doing that in the coming years.

[Operator]

Thank you. Our next question comes from Lauren Lieberman from Barclays. Your line is open.

[Lauren Rae Lieberman, Barclays Capital, Inc.]

Great. Thanks. Good morning. I wanted to ask a little bit about emerging markets. So, the performance this quarter was obviously great, and some of it, I think, this hasn't really been discussed much before as an enormous area of focus. So, I was hoping, one, if you could share with us roughly how big China is now. I know Max Factor launched on JD.com in the fall. Was Max Factor a well-established brand already in China, or was that really kind of the brand's launch? And then, also for Bourjois, which I think is going on JD well. Same kind of question, is that already an established brand, or is that really a new launch? And then in Brazil, you had mentioned price competition. And I was just curious if that was from other local players or from more global brands in the market. Thanks.

[Camillo Pane, Coty, Inc.]

Thanks, Lauren. Yes. We're having a very strong growth in emerging markets. We're very pleased with it. We have decided to focus much more with our merger on specific countries, and we're seeing very interesting fruits from our investments and the changes we made. I think if I focus on China for a second, first of all, I would like to remind that we have changed go-to-market strategy, moving from distributor network to affiliates, so our own organization, in both Luxury and Consumer Beauty, at the time of the merger in both divisions which was a very bold move, but definitely is paying the results. And so, we're seeing accelerated growth in both divisions actually, as a matter of fact, in all the three division in China.

Going to your question regarding Consumer Beauty, Max Factor was an established brand in China, but clearly was not necessarily performing well, under previous management or ownership, let's say, because also the distributor network that I was mentioning before. So, under the stewardship and leadership of our team it's now performing incredibly well, including an acceleration in e-commerce, because we have strengthened the capabilities in the area.

On the other side, Bourjois is a new brand which has just got launched in China just few weeks ago. So, this is all new and we have encouraging results from the first couple of weeks. We have seen, we have new in-store execution in different department stores and different malls and so far, we're seeing encouraging results. And I also want to mention in the Luxury division, philosophy which is also a new brand in China. We have launched it on Tmall three months ago, I think it is now, and we also opened a store in Shanghai and results are ahead of expectations. So, it's a mix of revitalizing established brands and launching new ones.

Regarding Brazil, the comment that I made in terms of competitive pressure on pricing, it was referred to the deodorant segments where we have been enjoying very high level of growth and market share gain which clearly has made our competitors both multi-nationals and local react to our strategy. And this is two particularly brand, but the main one is called Monange which I have highlighted in the press release.

[Lauren Rae Lieberman, Barclays Capital, Inc.]

Okay. That's great. And then assuming that the standout performance in emerging markets this quarter is something that is more the beginning of a trend, and you mentioned it as a pressure point on gross margins, why wouldn't that continue, or was it anything particular to the quarter with the mix of emerging markets growth that it was more of an issue?

[Patrice de Talhouët, Coty, Inc.]

So, first, Lauren, good morning. So, on that specific question on the pressure in emerging market, that is true. This being said, what you need to factor into the equation is that you're going to start to see all the synergies for manufacturing footprint, and logistic footprint kicking in. And this is going to provide quite some support in terms of gross margin, point one. Point two, we are gradually premiumizing our business with innovation, and you see that for instance, in the Luxury segments where the innovations are quite accretive from a gross margin standpoint. Some of our acquisitions, also, are quite accretive from a gross margin, if I think about Burberry, for instance. So, these are things that we are currently building to make sure that we have a premiumization on our gross margin going forward.

The other point that I'd like to mention is on this emerging market infrastructure. We have deliberately made the decision to take some hits in some of the previous quarters in terms of cost structure because we were convinced that, from a long-term standpoint, we have to capture the (42:47), and especially in emerging markets. And we didn't have the right infrastructure. As a result of that, we have built the right infrastructure, either by acquisition with (42:56) or organically by going to affiliates, and this is now starts to pay off. So, it's very, very important that everybody factor that into the equation.

[Operator]

Thank you. Our next question comes from Andrea Teixeira from JPMorgan. Your line is open.

[Andrea F. Teixeira, JPMorgan Securities LLC]

Thank you. I just wanted to focus on the advertisement on the back end of this year. And so, are you going to see more reinvestment of the synergies in marketing to support the brands relaunch? And can you give us an update on the pace of the synergies? I understand it's going to be more back-loaded into the fourth quarter, but it will be helpful to see how you're going to be seeing that either reinvested or flowing to the bottom line.

And also, on a clarification on the previous question, you said you're maintaining shelf space intact for COVERGIRL, which is obviously positive. But can you comment, also, on the other brands, like Sally Hansen, Rimmel, and also including the hair color, and if Coty as a whole has been able to maintain shelf space or if there will be some of the other color cosmetics brand losing space in order to give more shelf to COVERGIRL? Thank you.

[Camillo Pane, Coty, Inc.]

Thanks, Andrea. Regarding the advertising for the second half, it's fair to say that, especially on COVERGIRL and Clairol and Max Factor, we will invest more heavily in Q3 and Q4. But overall, when you look at our overall portfolio, we don't expect our advertising investments to drastically go up versus the level that we mentioned in the past of 25%, 26%.

The second point that I will cover is shelf space, and then I'll give – Patrice, will cover synergies. When I look at the shelf space for total Coty, actually, in the U.S., we expect our shelf space to be overall flat. And you mentioned a couple of other brands, so I'll cover that as well. On Clairol, we now know clearly, because we are in February, all the shelf resets have been decided, let's say, although not fully implemented. But on Clairol, we also expected our shelf space to be flat. The same is on Sally Hansen, and probably it'll be a slightly decline on Rimmel, but it's very minimal. It's driven mainly by one customer, which doesn't represent a big percentage of the brand globally, and also in the U.S. And Rimmel, I want to remind that 85% of the sales in Rimmel are clearly made in Europe and in emerging markets where Rimmel is a very large brand.

So, overall, in total, Coty, as I said, is flat. And for me, this is a good performance. And I'm pleased with the achievement of the team because this comes after, especially on the ex-P&G brands, for many years of shelf space reduction and distribution losses; and, as I said, decisions which were taken prior to the merger, which in the space of 14 months, 15 months, we have been able to revert and stop this decline through the work of the team on the product campaigns and positioning and so on. Patrice, synergies?

[Patrice de Talhouët, Coty, Inc.]

Yes. So, on the synergies, so the phasing is still the same. So, we are going to achieve 50% of the synergies by the end of fiscal 2018, 80% by the end of fiscal 2019 and 100% afterwards, by 2020. So, this is not changing. What we said, also, is that the Q4 is going to be positively impacted by the synergies being realized. Now, on the way, our investment thesis is that the synergies would fall bottom line. But it could be that one quarter or a couple of quarters, we're going to dial it up in order to be able to fuel the top line. We've done that in the past, and this is the right thing to do. So, we are going to remain opportunistic. This being said, it's clear that, from an annual trend standpoint (46:54) is still roughly at 25%, 26%. But we are going to keep on being opportunistic quarter-after-quarter depending on how we see the innovation and in order to further fuel the top line if we think this is the right thing to do.

[Andrea F. Teixeira, JPMorgan Securities LLC]

Thank you.

[Operator]

Thank you. Our next question comes from Steph Wissink from Jefferies. Your line is open.

[Stephanie Wissink, Jefferies LLC]

Hi, good morning, everyone. Just a quick clarification question on the Luxury segment. I know you talked about several fragrance launches over the last couple of quarters. Can you give us some insight into the pipeline for the second half of the fiscal year? And then, I wanted to also follow-up on the comments regarding your direct-to-consumer. I think that was largely focused in the Consumer segment and, potentially, Luxury, but how about the Professional segment? Is that an area where you could leverage some of that platform investment and build maybe a direct-to-professional business like some of your peers? I'm thinking about brands like Wella. Are there opportunities to go direct and maybe work around the traditional distributor network? Thank you.

[Camillo Pane, Coty, Inc.]

Thanks, Steph. So, regarding the Luxury pipeline for the second half, we believe – I personally believe that this is strong. We just announced the launch of Chloé Nomade. And we just launched actually, Gucci Guilty Absolute for female where we have encouraging results from travel retail, but also from several department stores. We have a new campaign on a CK ONE, which just got launched, and we have the continuation of the ETERNITY campaign which is going well. So, there is a lot of things going on and clearly there will be more announcement to come, which I will not disclose in this call over the end of Q4.

Regarding the direct-to-consumers, as I mentioned, we are seeing accelerated double-digit growth ahead of the market across the three divisions. Now, focusing on the profession which is the one you mentioned, we have two areas where we are investing which are giving us encouraging and significant results. One is MyWellaStore.com, which is our B2B platform where we engage directly with stylers and hair dressers, and we are seeing significant growth in this platform not only in the U.S. but also in other European markets and other markets where we are launching that. And we, of course, continue to with the rollout – we plan to continue with the rollout. And the second one is ghd. ghd has a significant percentage of sales and their revenue is coming from B2C. And in Q2, this part, or this channel, the e-commerce sales, both on the ghdhair.com but also in the e-retailers and few players it's been very positive. So, the combination of both is helping the e-commerce for Professionals to go well as well.

[Stephanie Wissink, Jefferies LLC]

Thank you.

[Operator]

Thank you. And our next question comes from Jonathan Feeney from Consumer Edge. Your line is open.

[Jonathan Feeney, Consumer Edge Research LLC]

Good morning. Thank you very much. Just in Consumer Beauty, is it fair to say that your North America versus international business, just focusing in on North America, was better than your expectations because of the factors you've cited in a couple – despite some of the actions you took in advance of the COVERGIRL refresh? And as part of that, as we look to the second half of the year, would you expect that at some point to inflect positive, because it sounds like you have, in effect, pushed out some sales. So, should that North America piece really start to turn positive at some point in the next couple of quarters? Thank you.

[Camillo Pane, Coty, Inc.]

So thank you, Jonathan. The North American sales for Consumer Beauty in Q2 were definitely affected by an intentional decrease of our inventory. And we decided to do this, which I had mentioned it already in the previous call, so it was in our plans to make space and reduce the inventory ahead of the relaunch of COVERGIRL and Clairol as well. We did that because clearly we wanted to accelerate the arrival of the new packaging and the new innovation on shelf across all the different retailers. That said, it's important to remember that we are not doing a hard cutover across all the SKUs for COVERGIRL. We're doing that just for around 25%, which is the innovation. So, the rest is going to be a gradual phase-in, which will take time. So, we don't expect to have all the new SKUs of COVERGIRL with the new packaging, the new look to be across all retailers before Q1 fiscal 2019, just to clarify that.

So, that was your one question. The second part is, if we do expect North American sales improving, yes, of course, we are relaunching the two major brands that we have in North America. So, COVERGIRL and Clairol, and we do expect a sequential improvement of North America Consumer Beauty in the second half of 2018.

[Jonathan Feeney, Consumer Edge Research LLC]

But would you expect them to be up year-over-year?

[Camillo Pane, Coty, Inc.]

As you know, we're making several relaunches in the same time. So, we are putting a lot of investment behind many changes in the same time. But this sequential improvement, we expect at some point on specific brands, to bring some of the brands to positive growth. But I'm not going to comment on the overall North American business, which is a much larger business than these specific brands.

[Operator]

Thank you. And I am showing no further questions from our phone lines. I would now like to turn the conference back over to management for any closing remarks.

[Camillo Pane, Coty, Inc.]

I would like to thank everybody for having attended the call. Thank you very much.

[Operator]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a wonderful day.