Coty Inc. Class A

Good morning, ladies and gentlemen. My name is Maria, and I'll be your conference operator today. At this time, I would like to welcome everyone to Cody's third quarter fiscal 2020 results conference call. As a reminder, this conference is being recorded today, May 11th, 2020. On today's call are Pierre-Andre Therese, Chief Operating and Chief Financial Officer, and Pierre-Louis, Chief Executive Officer. I would like to remind you that many of the comments today may contain forward-looking statements. Please refer to Cody's earnings release and the reports filed with the SEC where the company lists factors that could cause actual results to differ materially from these forward-looking statements. All commentary on like-for-like net revenue reflect the comparison of the business at constant currency in the current and prior year excluding the impact of acquisitions and divestitures. In addition, except for noted, the discussion of our financial results and our expectations reflect certain adjustments as specified in the non-GAAP financial measures section of the earnings release. You can find the bridge from GAAP to non-GAAP results in the reconciliation tables in the earnings release. I will now turn the call over to Mr. Therese.

Thank you, Maria, and good morning, everyone. Welcome to the third quarter conference call of COTI for fiscal 20. I'm together with Pierre, who is in Amsterdam, Olga in New York, and I am myself in Amsterdam. in London and we're very happy to host this exciting conference call. Before we start and we go in the middle of the topic, I just would like to thank COTIIT teams for what they have done and what they have demonstrated for the past few weeks and months now. beyond their hard work to handle the situation from a business standpoint. This crisis has been the opportunity for many associates at COTI to take or contribute to many initiatives which illustrate the role we want and we try to have in this environment. We have been producing hydroalcoholic hand sanitizer in 12 of our plants in 10 different countries. including in France, in the UK, in Germany, in Monaco and in the US and we have donated it to frontline healthcare workers. Our brands on the other hand have been donating gloves and caps or shampoo to local hospitals and everywhere In the group, numerous relief funds have been established throughout COTI to contribute to what has been a huge solidarity. So my main takeaway, in fact, over the past few weeks is the great commitment, the energy and the solidarity which has been shown by your associates. And before we talk of what we are going through and what we are building, I just wanted to publicly thank all of them and each of them for this. Now, moving to the following page, this is the summary of the upcoming call and release. As you have seen with the press release we've posted, we're announcing something which is far more than just earnings today, but rather important initiatives which are going to accelerate the transformation of COTI. The first of them is obviously the announcement of a strategic partnership with KKR. That's a major step with $750 million convertible prefecture subscribed by KKR. improving immediately our liquidity in a strong way. And at the same time, the signature of an MOU for exclusive talks to be held with KKR on a 60-40 partnership on professional beauty and retail hair for an enterprise value, which is basically reflecting pre-COVID conditions at $4.3 billion or $12.3 times fiscal 2019 EBITDA for a scope which does not include Brazil, importantly. The second element is the delivery of life or life net revenues, which are down in Q3 by 20%, and I think that was, I had made that clear a few weeks ago, but with a strong operating deal average. We'll come back on that. And that's been for us very much a call to action. And we are announcing today a comprehensive plan to reduce our fixed cost base by $700 million or 25% to make sure, in fact, we have the right cost structure and we adapt to the new environment fast enough. And the last element is important as well, is the preparation of the restart, which we are going through at the moment. with a focus on what are the most relevant platforms of Coty in this environment. And here we've mentioned Route 3, we'll come back on that, e-commerce, Cali Beauty and Mass Beauty. So let me come back maybe on these different elements and then we'll have a look at the earnings. On the strategic review first, so the third bullet is an important element, we have concluded that Brazil mass beauty operations would remain fully in Coty. They are one of the key assets of our consumer beauty brand unit and we are very happy that they will stay within this unit and keep contributing and helping us building consumer beauty brands. The second element is that the circumstances have in fact created opportunity and a creative option, which is a 60-40 partnership on professional beauty and retail hair, which we call VELA. And that's a creative because that's basically building things which otherwise would have been difficult in the current context, i.e. building continuity. And I think this element of continuity is very important for the business and very important for the partners. And it creates an element of sharing value, i.e. Coty will continue being exposed and benefit from the value creation agenda of this 60-40 partnership. The valuation, as I mentioned, I alluded to, reflects the strategic nature and the resilience of this business at more than 12 times 2019 EBITDA, which, given the current circumstances, is a real sign of strong confidence. We expect that this is going to bring to Coty incremental cash proceeds of $3 billion, so just this part, the 60-40 JV, and that will come in addition with the next part which we are going to see afterward, i.e. the $750 to $1 billion preferred stock investments. We have discussed and agreed the main terms, but obviously that kind of agreement is complex, so beyond the main terms which have been formalized with MOU, we now need to complete the work and agree on everything. That's a work which is going to be taking place in the coming days and weeks with a view to signing at the end of May. So in line with what we had said from the very beginning by summer, we expect a closing of this transaction to take place within six to nine months post signing. So that should be at the very end of 20 or beginning of 21. So that's the conclusion somehow of the strategic review. But the strategic review has carried a second important element, which is the issuance of convertible preferred shares for $750 million, which are extendable to $1 billion upon signing of the Vera deal. And this $1 billion, $750 plus $250, comes on top of the $3 billion I was referring to before. The preferred shares will carry a coupon of 9% and have a conversion price which is 20% above Friday close and therefore is set at $6.24. Beyond the strengthening of Coty balance sheet in a very meaningful manner, this formalizes a broader partnership and Coty will benefit from the presence of two representative of KKR at its board. So that's the obviously key element in the strengthening of our liquidity. Before that and ahead of that, we had announced a few days ago that we had been reaching, concluding an amendment of our credit agreements with our lenders and a one-year holiday of our covenants to reflect the fact that the covenants will be distorted by the crisis. And we had also, at the same time, a bit ahead of that, in fact, decided to suspend the cash dividends until we come back to what we believe is the proper leverage below four times net debt to a big year. So as a result of all that, obviously, liquidity is strong. It was strong at the beginning of Q4 with $1.3 billion in in cash on hand at the beginning of the quarter and we expect it to remain even stronger, in fact to be even stronger at the exit of the quarter with 1.5 to 2 billion at the exit of this quarter and the exit of the fiscal year. So that's really what I wanted to say about the transaction we announced today and the strategic partnership with KKR. The other very important element, next page, thank you, is the amplification of our turnaround and the fixed cost, the reduction of our fixed cost. Altogether, we have designed a plan which aims at reducing our fixed cost by 700 million dollars by 2023. That's going to represent 25% of a base of 3 billion dollars of fixed cost in fiscal 2019 and we are taking fundamentally three initiatives to do so. The first is going to be a revisiting of our end-to-end supply with a view to adapt to the change of demand, to increase our flexibility, extremely important, but also to improve the efficiency and to reduce our costs by an amount of 100 million dollars. I'll come back to that in a minute. The second element is The acceleration of the procurement initiative in two areas, in the area of business services first, but also in the area of commercial expenses where we have not in fact leveraged our scale to lower the cost and we are going to do so. We have started to do so and we are going to complete it and to amplify it. And at the same time, our intention is that part of the savings generated are going to be used to increase the level of support behind our brands and the productive support. The third element is about the completion and the expansion of our O2 program. O2 is the change of organization and the program to get a linear organization which was designed as part of the turnaround. We have been, during the past few months, finalizing the negotiation with the unions. We are now in a position to implement that. We are not only going to implement that, but we are going to see the way we can further simplify the organization by leveraging our processes, reviewing our network, we have many many sites and locations around the world, and at the same time we will be adding compensation. Between the various projects I'm mentioning here, in fact, we have a pool of 850 million dollars, an ambition of 700 because we know that we need to take some headroom. A number of them are quite advanced and we expect to deliver in fiscal 21 more than a third of the savings. So it's not a program which is going to be back-ended. It's a program which is going to start delivering as soon as the coming fiscal year. The goal we have is really to make COTI more efficient, to make it simpler, and to make it fit for growth. The deployment of this fixed cost reduction program, in fact, allows us to confirm our meeting operating margin target by fiscal 23 on the scope, which is a scope post-strategic review. without the 60-40 partnership in professional and heritage. I'll now very quickly go on each of the streams to give you a bit more color on what it is. On the supply side first, our manufacturing footprint consists of 13 factories which are running at an average utilization which is below 40% with a number of complexity, over 30,000 product flow combinations. We have a big complexity of portfolio with more than 50,000 SKUs. You know that. We have a speed to market which is, in our view, suboptimal, and we estimate we need to accelerate that by 20% or more. And altogether, given the downsizing of our business, we estimate that we need to go for a fixed cost reduction of 20%. The base of the cost of supply is higher than $1 billion. 50% of it is fixed, so it means that a reduction of 20% would mean that we are going to target cost savings by $100 million. There's a number of projects which have been visited in the past. Some of them are relevant, some of them are less. The supply team led by Richard is going to put everything together and to design a roadmap which is going to be ready by the end of August for an implementation which will come, which will start shortly after, depending on the topics. So that's the first element. The second one is about procurement. Again, the fragmentation of COTI has prevented us to reduce costs on two important fronts. On the right side of the screen first, our network remained too exploded with many offices around the globe, high travels, high IS costs. We will capitalize on the moves which we have initiated in the past 18 months. And for instance, some of you know that we have been We are downsizing our presence in the Empire State Building. We are going to close our office in Paddington. And we are going to reduce the cost linked to the network, so to continue that movement. In the same way, we are going to reduce the recourse to external services, which are obviously costly by themselves. But on top of that, have been in the past generating an inflation of projects with often a level of delivery which was not high enough. And we expect these various measures to help to save 30% of all non-people costs. That would be, by the way, putting us in the median of comparable companies in terms of cost to revenue, so not in the top quartile and in the best in class, but in the median. So the measures, the possible measures, the possible improvement, as well as benchmark, are clearly showing us that this is possible. On the left-hand side, ANCP, so I just want to be clear here, we are not looking to cut ANCP. What we are looking at is rather to increase the impact. And Pascal, our procurement head, and the teams have already progressed on the organization of media and concluded global negotiation already for a part. They will start delivering in fiscal 21. The second element is that we yet have to platform our marketing materials, furniture, testers, etc. We are very often fragmented and taking initiatives at different costs and generating complexity everywhere. We are starting the project of platforming and here the savings at stake are very, very sizable. We will, in addition, increase the spend accountability and make sure that every expense goes direct to P&L and is not flowing in a different manner, starting from the 1st of July. Now, as I said, we don't want only to get efficiency, but we want as well to increase our impact, and therefore we are going in this program to reinvest 50% of our savings immediately in productive NCP and in working media in The third bucket is about making COTI simpler. We have much to do to make this organization simpler and more effective. So you remember that we have initiated a downsizing of our organization a year ago with a target of $180 million. Now that the negotiations have been concluding with the work partners during the third quarter, we're ready to deploy it. Our new HQ, by the way, in Amsterdam has opened last week and teams are progressively migrating, although obviously COVID has made it slower than planned. One of the elements of this downsizing has been really the writing of the COTI operating system, which is basically the description of accountabilities and interdependency. And this work has evidenced massive opportunities for process simplification and transversal efficiency, and that's going to help us further decreasing our structural costs in the future. In addition to this, we'll be revisiting our compensation system and HR policy with a view to better leverage and grow COTI talents. So to monitor all the above, I mean the three pages and the $700 million program, we are setting today a dedicated governance. I, in my function as CEO, am going to lead the program with a subset of DEC, which is going to be made of people from supply, from procurement, from HR, from finance, from IS, but also the heads of the two regions we have. EMEA and AMAPAC and we have appointed our head of ISIT, Jérôme Ouvinet, Chief Transformation Officer and he will coordinate the various aspects of the transformation. So that's in a nutshell the program on which we are going full speed right now and which I just want to repeat is an expansion of the turnaround and acceleration of the turnaround and is the right the right level of savings we need to be able to address the size of Coty right now and give us flexibility in our growth. I'll now turn to the third quarter results with a first snapshot before I hand over to Pierre. As expected and shared with you earlier in April, our net revenues have declined over the quarter by 20% on the life-on-life basis. And while January and February were showing progresses, in particular on the performance of our brands in consumer beauty, COVID-19 already had impacted our performance in Asia then, in January-February. But obviously, the big turn happened in March with the first lockdowns in Europe, which started in Italy, expanded to other markets pretty quickly. And so not only your net revenues were impacted, but the operating income was impacted even more deeply by this loss of revenue and margin, as well as by some one-off items. And I will come back on that. Obviously, our EPS was impacted as well as a result of this, and our cash flow was negative, as is, by the way, usually the case in the third quarter, but obviously significantly more here given the drop of profit. For the first nine months, on a cumulative basis, our net revenue are now declining by 7% like for like. Our operating income remains in line with that of the first half at 4%. $480 million, and our cash flow is broadly stable. So I'll come back at the end of the presentation on the main profit elements, but I will hand over to Pierre to talk about the top-line trends we have observed, both on the impact of COVID, but also on our performance in terms of sell-out and launch. Pierre, over to you.

Thank you, Pierre-André. As this is my last earnings call with Coty, I want to take a moment to thank everyone on this call for accompanying us on this journey, which continues, of course, as Pierre-André has just indicated. And especially, I want to thank the COTI teams for the tremendous achievement of work and effort that they have put in over the past two years to lay down the foundations for a stronger company. The COTI Associates have demonstrated both in our first phase together and now in these testing times, resilience, as well as an inspiring ability to learn and adopt new ways of working. The aim of this approach, as you may remember, was and is to strike the right balance between creativity and discipline, and we are beginning to see the results of this work materialize across several brands, markets, and initiatives. As you can see on this slide, we had a number of strong innovation successes this quarter. even as COVID began to disrupt the demand picture. Starting with CoverGirl, we continued our laser focus on improving e-commerce fundamentals. As a result, CoverGirl recently surpassed the competitive digitally native brand to become number three mass cosmetics brand on Amazon US. The brand's improved performance both online and offline was in part fueled by the launch of CleanFresh earlier in the quarter. This was the first clean label product line across established mass cosmetics brands and quickly became the number one foundation in launch in mass. Similarly, Rimmel maintained the momentum we have seen in recent quarters, fueled by media support and strong in-store execution and supported by the recent launch of scandalized volume on demand mascara, Rimel has now reached its highest market share in the UK in over five years at 31%. Sally Hansen continues to fire on all cylinders. The brand continues to build on its leading market position, reaching its highest US market share in several years at 45%. This is in part due to the launch of clean label line, good, kind, pure. which has already reached close to 3% of the nail market. In prestige fragrances, we had a number of great launches. Only a few weeks after launch, Both Alive became the number one female fragrance in Germany. Similarly, CK Everyone, our first clean label mainstream fragrance, was seeing strong momentum in multiple markets. As a top three launch at Macy's, and top five in markets like U.S., Canada, and Germany. While the lockdowns are impacting consumer demand and access, these launches, amongst others, have clearly resonated with consumers and will fuel our recovery once retailers begin to open. Moving to our performance by segment. In the Americas, like-for-like revenues declined 18.8% as a result of the lockdowns at the end of the quarter. This resultant operating deleverage pushed operating margins lower to 2.6%. However, building on the progress outlined already last quarter, we continue to see green shoots in the region. For the first time in many years, CoverGirl's market share in brick-and-mortar retail, stabilized and actually expanded, even as the mass cosmetics market has been impacted. Sally Hansen, which was already expanding market share, further accelerated its gain, with share up 100 basis points, and while Clayroll also continues to see improvement in share trends. As the COVID pandemic spreads to the Americas, leading to store closure and stay-at-home orders, We saw consumer shift purchasing online. Our e-commerce sales accelerated beginning in March and remained very robust through April. We saw particularly outsized e-commerce growth within our mass business, which, as you can see on the slide, grew in the US 164%. While not quite as strong, we were also very pleased with a strong sell-out growth within US Prestige, which accelerated meaningfully in April. In the EME region, like-for-like revenues fell 20.1% due to the COVID situation and the resulting lockdowns that were put in place. This like-for-like decline led to an operating deleverage pressuring the margin to minus 2.5%. Despite the COVID-related pressure, we do see evidence of our turnarounds taking hold. Within the mass business, some of our key brands were able to take market share to NQ3. Rimmel, Max Factor, and Bruno Banani all grew market share by 50 or more basis points in brick and mortar during March. On the e-commerce side of our business, we have seen sell-out trends accelerate as store closures and lockdowns were implemented. Similar to the Americas, we have seen particular e-commerce trends within the mass beauty category, with some regions, such as the UK and MEA, growing in excess of 100%. Our prestige e-commerce sales growth was not quite as strong. However, we have seen sell-out trends accelerate through the month of April, as many consumers returned to purchasing prestige beauty after weeks of being locked down. In the APAC region, like-for-like revenue fell 34.8% as the region was one of the earliest hit by COVID during the quarter. Both China and travel retail were hit particularly in Q3. Encouragingly, we are starting to see trends improve in China, though many markets continue to have lockdowns in place. Overall, the like-for-like decline led to very meaningful operating profit delivery in the quarter, pushing our margin down to minus 14.1%. Despite this, we continue to see positive signs that our strategy is having success. As shown here, both Sally Hansen and Clairol gained over 100 and 200 basis points, respectively, of market share in Australia during March. In addition, we also grew market share within the China prestige makeup market. Although our overall market share remains quite small today, we continue to believe the prestige makeup market, particularly within China, will be an important long-term growth driver. Moving to e-commerce, we have experienced very strong growth in recent months, similar to other regions as consumers shifted more spending online. Just to highlight a couple of markets, Australia and Japan, with both experience, e-commerce sell out in excess of 100% during the March and April period. For professional beauty business, like-for-like revenue declined 11.9%. This decline was due to the COVID-19 pandemic, which forced many salons to close, particularly during March. Moreover, the like-for-like decline led to operating margins being pressured falling to 5.4%. However, we continue to be very pleased with the e-commerce strength of the professional beauty business, including GHD, which delivered another quarter of very solid growth. As I just mentioned, many salons were forced to close during the quarter and still remain closed to these days. Despite this, demand for salon services, such as coloring, remains very strong. Based on a survey we conducted in the US and the UK, the majority of respondents want a salon appointment within the first two weeks of salon reopening. We view this as a very encouraging sign that the difficulties many salons are facing are likely to be temporary. Before returning the line back to Pierre-André, I would like to reiterate my thanks to all the Coty associates for the journey that she accomplished together. They all have been truthful in their action and attitude to our vision that to build a bigger business, we needed first to build a better one. I have just shared with you a few of our green shots. There are many others growing currently in the company and many more to come. I know that the current times are very testing, having lived myself through some of these events in the past. Yet, I know also that our people have the skills and the drive to get through this crisis while staying the course of strengthening our fundamentals. I have absolute confidence that the Coty people will not waste this crisis, that they will use it to individually and collectively learn and grow, and that our company will come out of it stronger than ever. Pierre-André, I'm turning the mic back to you.