Coty Inc. Class A

Good morning, ladies and gentlemen. My name is Brittany, and I will be your conference operator today. At this time, I would like to welcome everyone to Cody's second quarter fiscal 2022 results conference call. As a reminder, this conference call is being recorded today, February 8, 2022. On today's call are Sue Nobby, Chief Executive Officer, and Laurent Mercier, Chief Financial 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 in the SEC where the company lists factors that could cause actual results to differ materially from these four looking statements. In addition, except where noted, the discussion of Cody's financial results and Cody's expectations reflect certain adjustments as specified in the non-GAAP financial measures section of the company's release.

Ladies and gentlemen, with the completion of the first half of fiscal 22, it's clear that we are delivering on our short-term objectives while simultaneously strengthening the foundations to achieve the medium-term objectives we outlined during our November investor day. As you recall, our objective is to make Coty into a true beauty powerhouse, which includes sustainably growing ourselves ahead of the beauty market, growing our profit ahead of sales, and steadily leveraging our balance sheet. The results of the last six months confirm that we are well on track with these ambitions as we enter the virtuous cycle where strong revenue growth combined with gross margin and cost initiatives simultaneously fuel profit expansion and strategic reinvestments which in turn drive future growth momentum. There are a few takeaways I want you to live with. First, our first half fiscal 22 revenues and sellouts both grew in the mid-teens, consistent with our expectations. We had flagged last quarter that our focus in Q2 was on driving sellouts as revenue trends in Q1 and Q2 were impacted by the timing of launch pipe fill And this is exactly what has played out. Importantly, the growth we've achieved in the past six months was fully supported by strong growth in consumer beauty as we saw clear signs of turnaround in our key mass cosmetics brands. Second, we had great performance on profit and cash. We saw exceptional growth in our gross margin this quarter. with close to 600 basis points of growth year on year and over 100 basis points of growth versus the first quarter. Achieving this against an increasingly difficult inflationary backdrop speaks to the strength of our business model and the many levers we have at our disposal to steadily drive our gross margin higher in the coming years. At the same time, our strong focus on cash generation and the leveraging has allowed us to reach leverage below five times ahead of expectations. Third, we continue to execute and make progress across each of our six strategic growth pillars. The particular highlight this quarter was consumer beauty, where for the first time in five years, the business grew market share on a global basis. Additionally, as part of our strategic focus on becoming a leader in sustainability, I'm honored to share that we've recently completed our first production run using sustainable upcycled ethanol, putting us ahead of schedule against our goal to integrate sustainable ethanol into a majority of our fragrance portfolio by 2023. I will share more details on our progress across each of our strategic pillars later on the call. Fourth, the strong and steady sell-out growth in the mid-teens through the first half of 2022 sets the stage of our revenue growth to accelerate in the second half of 2022, and we are already seeing this payout in the quarter-to-date sales trend in Q3. This, in turn, drives our increased fiscal 2022 sales outlook coupled with higher EPS. I will now take a few moments to cover our revenue trends during the quarter before Laurent takes you through our financials. Then I will finish with an update on our strategic progress and our outlook. Our Q2 revenue grew 12% like for like, in line with our guidance, following the strong Q1 pipe field when we launched our key initiatives Gucci Flora, Gorgeous Gardenia, and Burberry Hero. As we discussed on the last earnings call, while the revenue trend was expected to be choppy, the underlying sellout trends were consistent, and our goal was to step up our investment in the highest ROI opportunities during the critical Q2 holiday period to fuel acceleration in our sellout and prepare for a strong Q3. The results played out as expected. Our overall sell-out improved from the low to mid-teens in Q1 to mid to high teens in Q2, resulting in full alignment between our first half fiscal 2022 sell-in and sell-out in the mid-teens. And these sell-in and sell-out results were achieved even as we continued to reduce low-quality sales. Underpinning this six-month trend is 21% like-for-like growth in prestige, fueled by the tremendous success of Gucci across fragrances and makeup, Burberry, and Marc Jacobs. The sales growth level we saw over the past six months in prestige brings us on par with other key prestige beauty players, showing that Coty is executing on par with the industry even as we remain under-indexed to skincare and China. At the same time, consumer beauty also registered strong 8% like-for-like growth in the first part of 22, driven by broad-based growth and the clear turnaround of our key cosmetic brands, CoverGirl, Rimmel, Sunny Hansen, and Max Factor. Moving to sales by region. We saw growth across all regions over the past six months, though travel retail in the U.S. and China continued to outperform. The Americas region grew 15% like-for-like in the first half and 9% in Q2, supported by strength in the U.S., Canada, and Mexico. ENESA rose 14% like-for-like in the first half and 13% in Q2, with growth in all key markets as well as local travel retail. The Asia-Pacific region increased 22% like-for-like in the first half and 16% in Q2, fueled by China and local travel retail. It's worth noting that we have now a new growth engine materializing in Asia-Pacific as Chloé Atelier des Fleurs is becoming a key brand next to Gucci in Asia-Pacific travel retail. As a reminder, the pipe field phasing dynamics in Q1 and Q2 impacted the quarterly sales dynamics in each of our regions as well. I will now hand the call over to Laurent to take you through our financial results. Thank you, Soub. I am very pleased with our second quarter results, which continued our strong pace of profit delivery, with EBITDA coming in nicely ahead of our guidance. This quarter, again, demonstrates the virtuous circle we set out to create. Starting with gross margin. Our Q2 adjusted gross margin of 64.6% increased by nearly 600 basis points from last year and 120 basis points from last quarter. This marks our fourth consecutive quarter of gross margin above 60%. Our gross margin performance was driven by margin improvement in both the prestige and consumer beauty businesses, which were supported by favorable mix, pricing and revenue management, productivity and E&O improvements, and higher absorption on the increased sales volume. As we have previously detailed, we continue to be very focused on further driving gross margin expansion both this year and in the years to come. However, please note that we do not expect to experience a similar level of gross margin expansion in the back half of the year as we did in the first half for a number of reasons. First, seasonally, the second half is a lower gross margin period given the lower British sales volumes as compared to the first half. Second, in the H2, we will be lapping one-time gross margin benefits of over 100 basic points that we don't expect to repeat this year. And finally, as indicated before, we expect inflation impact to step up in the back half of the year. Despite this, our multi-year gross margin attack plan is in place, while We also expect further benefits from positive channel, category, and regional mix shifts. Growth margin expansion remains key towards driving the virtuous cycle we have created. I would like to now give a brief update on the topics of inflation and supply chain. COTI continues to successfully navigate this uncertain environment. In fact, since we last spoke, our outlook remains largely unchanged with strong mitigation efforts in place on both components and any potential supply chain bottlenecks. On this point, I am proud to share that Walgreens has awarded COTI the 2021 Supply Chain Award, speaking to the exceptional coordination between our supply, operations, and commercial teams in a difficult environment. On freight, The majority of our freight is under contract and not reliant on spot markets, while our teams also proactively increase transportation lead time and secure capacity in advance. Meanwhile, we are mitigating the impact of materials inflation through pricing actions, as well as through our material cost reduction program. Importantly, These actions resulted in a very solid Q2 service level in the low 90s, while also delivering revenues in line with our guidance and gross margins that were up 590 basis points. As highlighted last quarter, we continue to expect the impacts of inflation to be higher during the second half. However, we remain confident that the actions we continue to take will allow us to deliver on our higher fiscal year 22 sales outlook while also delivering growth margin expansion for the year. Moving to our marketing investments in the quarter. During Q2, we further stepped up our AMCP investment to approximately 30% of sales, which is in line with the plan we discussed last quarter. our ANCP level was increased to capitalize on the strong momentum of our key brands in both prestige and consumer beauty. This was undoubtedly the right decision as evidenced by the strong sell-out performance Sue described earlier. The increase in ANCP continued to be driven by working media, which more than doubled year on year. Importantly, We also invested behind the highest ROI opportunities while maintaining flexibility to reallocate investment as needed. Specifically, we continue to invest behind our key innovations, which are already successful, such as Burberry Hero and Gucci Floral. We also continue to expand into white space opportunities, such as Prestige Makeup and China, where we grew six times the market rate. we also invested behind our key consumer beauty brand, resulting in a true turnaround of the business. As we head into the second half, we fully intend to keep this momentum going with a high 20% ANCP level. During Q2, we continue to execute our cost reductions program, which is another lever allowing us to fund marketing and rise profit growth. Specifically, our fixed cost declined by 5% year-over-year in Q2. We achieved over 14 million of cost savings in the quarter, with the primary drivers being gross margin and lower fixed costs. For fiscal 22, we remain on track to achieve over 90 million of net savings which we have fully delivered in the first half. Given the very strong front-loaded savings we have achieved year to date, I want to explain the dynamics of our cost savings program in H2. As we discussed last quarter, we expect mutual net savings in second half of fiscal 22 as our cost savings initiatives were concentrated in the first half. However, beginning in fiscal 23, a number of new savings initiatives will start to kick in. At the same time, we expect to more than offset the increased inflationary impact in H222 through portfolio mix and pricing actions. Importantly, even as we monitor the inflationary impacts on different areas of our P&L, We remain on track to achieve our fiscal 24 savings target of $675 million as we continue to implement our all-in-to-win savings program, coupled with one-stop mix and pricing initiatives in fiscal 23 and beyond. Moving to our profit delivery in Q2 and S1. For the quarter, adjusted EBITDA increased to 311 million with a flat EBITDA margin, which is particularly strong in light of ANCP increasing by 10 percentage points and reaching 30% of sales. For the first half of fiscal 22, our adjusted EBITDA delivery was exceptionally strong, rising 30% year over year to 590 million with a margin of 20%. This significant improvement in profit was a result of strong sales growth, robust growth margin expansion, and continued fixed cost leverage. The performance we delivered this quarter and in H1 demonstrates our virtuous cycle and the improved financial trajectory we are now on. Now moving to our EPS, which included the following drivers. Adjusted EBITDA for Q2 of 311 million, depreciation of 76 million, net interest of 61 million, income tax expense of 16 million, equating to a tax rate of approximately 10%, which was below our expectation due to a revelation of deferred tax assets stemming from a change in Dutch tax law, and 2 million of adjusted preferred dividends. As a result, our Q2 diluted adjusted EPS ended at 17 cents, which includes 2 cents from the aforementioned certain tax benefits. For the first half of fiscal 2022, the diluted adjusted EPS totaled 26 cents. While not included in our adjusted EPS, During the quarter, Vela's fair market value rose by 128 million. Looking ahead to Q3 and the remainder of fiscal 22, I would like to provide some more context on the different drivers of our adjusted EPS. First, we continue to expect interest expense in the mid-200 million for fiscal 22, reflecting a lower net debt balance offset by somewhat higher cost of debt post the recent refinancing. Second, we anticipate an adjusted effective tax rate for fiscal 22 in the low 20 percentage level, an increase from the 18% effective tax rate in H1-22, as we anticipate some discrete tax costs that will hurt EPS by approximately one cent in H2-22. However, we know there is a high degree of uncertainty with effective tax rate projections in the current environment. Third, on the preferred dividend, following the full exit of KKR's ownership, only 146 million of preferred shares are outstanding. Assuming no further conversion of these preferred shares, we expect a roughly 3 million quarterly run rate for the preferred dividend going forward. Moving to free cash flow. I am very pleased to say the free cash flow delivery in Q2 and during the first half was exceptional. In addition to the strong profit delivery, we made improvements across receivables, inventory, and payables, all keyword strings of the Cash Olympics program. We continue to have very strict management of capex and our one-time costs. As a result, Q2 free cash flow came in at $408 million, while free cash flow for the first half was $649 million. During the second half of fiscal 22, many of these work streams will remain in place with others set to commence, which should partially mitigate the typical seasonal cash outflow. Moving on to our capital structure. We ended Q2 with a financial net debt of approximately 4.45 billion, which is a decline of about 500 million from Q1. This decline was driven by two key factors. The strong free cash flow generation, as well as approximately 170 million of cash generated primarily from the sale of real estate assets and to a lesser extent, receipt of contingent consideration related to Vela business tax credit after finalization of the purchase price throughout related to the Vela business sale. As a result, we ended calendar 2021 with a leverage of 4.9 times. I am proud to say this came in ahead of initial target which was to end the calendar year with leverage towards five times. Factoring in our 26% stake of Vela at quarter end, valued at approximately 1.18 billion, we ended the quarter with economic net debt of around 3.28 billion. While I believe we have numerous work streams that will allow us to reach our four times leverage target organically, I am pleased to say that entering Q3, Vela has completed a refinancing of its existing debt in order to fund a shareholder distribution. We expect this will result in approximately $175 million of cash proceeds to COTI. We intend to utilize this distribution plus excess cash on the balance sheet to redeem our 2023 Euro 550 million unsecured bonds in full, following the time that the bond called premium drops to par on April 15th, 2022. This is clearly a significant step in helping us reach our next leverage target of approximately four times by the end of calendar year 22. This moves us further towards our ultimate goal of two times by calendar 25. Before I hand the call back to Sue, I want to briefly provide an update on the partial Brazil IPO we have been exploring. In light of the current economic volatility and adverse financial market conditions in Brazil, we have decided to withdraw from the IPO registration application process for the time being. We will continue to monitor market conditions, evaluating future possibilities to proceed with the partial IPO in Brazil in a new opportune window. I will now turn the call back to Sue. Thank you, Laurent. We continue to make strong, tangible progress across our six strategic pillars in Q2 with many additional initiatives in the works. Let's start with our first strategic pillar, stabilizing and growing our consumer beauty brands. I think the charts on this slide perfectly encapsulate the lightning speed with which we are turning around this business, something that few would have anticipated a year ago. For the first time in five years, which is as far as our internal data goes, but likely much longer, the Coty consumer beauty business has not only stabilized share, but is gaining market share on a global basis. This is underpinned by strong momentum in our color cosmetics brands, which together account for roughly two-thirds of our consumer beauty business. While the global mass cosmetics category grew in the low to mid-single digits, our sellout grew over 10% in mass cosmetics and high single digits in the mass beauty overall. As a result, over the past three months, we have gained roughly 60 basis points of share in the mass color cosmetics category globally and close to 100 base points of share in November and December. At the same time, our Brazil business maintained momentum with double-digit sale-out growth supported by key new innovations behind Monange body care and Risqué Nail Color. While the path to sustain consumer beauty expansion may not be linear, These exceptional results confirm that our consumer beauty brands are as relevant as ever, and with the right products, communication strategy, in-store execution, and the right teams, we can truly excel. Drilling a bit deeper into the momentum we are seeing in mass color cosmetics. While we began our consumer beauty turnaround with our biggest brand, CoverGirl, I am proud to say that our four biggest color cosmetics brands, CoverGirl, Rimmel, Sally Hansen, and Max Factor, are now all gaining market share on a global basis. As you know, we relaunched CoverGirl in March of 2021 with new communication assets, new brand ambassadors, and doubling down on CoverGirl's heritage in clean makeup and skinified makeup. Now, roughly 10 months into the launch, CoverGirl has gained market share in 26 of the last 40 weeks. On Remap, we began the brand repositioning over the summer with a new brand activist at Boa a Boa and a new communication. Our revamped communication and execution are clearly resonating with consumers in key markets, as Remap is now winning shares globally, led by share momentum in the UK, Australia, Spain, and Poland. As a next step, we have leveraged the Cover Your Playbook for REMAIL with the recent launch of REMAIL's clean and vegan makeup line called Kind and Free. However, it's important to note that the line began appearing on textures in key markets in January, with the TV media support beginning now in February, so the benefits to REMAIL market share momentum from the revolutionary launch will only come in our fiscal Q3. On Sally Hansen, the brand was already successful over the past couple of years, and we have continued to fuel this trend through innovative launchers like It Takes Two and supporting key franchises like Miracle Gel and InstaDry. As a result, Sally Hansen is gaining share across the UK, where it has recently overtaken SE, as well as gaining share in Australia and Spain. Finally, Max Factor's repositioning began in the fall, with Priyanka Chopra Jonas as the new brand ambassador. The revamped communication and in-store execution, coupled with the revamped Safefinity Foundation, have returned Max Factor to market share gains globally, led by the UK, Spain, Poland, and Russia. To reiterate, while we do not anticipate a linear path of share gains for every brand and every market in every month, what is quite clear is that we have developed the right formulas and playbooks to turn around our consumer beauty business. And less than a year into our execution, we are already seeing strong success. Turning to the second pillar of our strategy, accelerating our luxury fragrance business. It's important to highlight here that the market backdrop for prestige fragrances remains quite favorable, even as trends vary by region. Specifically, we estimate the global prestige fragrance market is up double digits in Q2, both year on year and versus 2019. This is supported by very strong momentum in the U.S. and China. Importantly, while we are monitoring the U.S. market closely as we start lapping the high growth figures of the prior year, we have not yet seen any signs of slowdown. In China, the fragrance growth is being driven by Chinese consumers truly discovering the fragrance category, which is often viewed as an extension of luxury fashion. We see the fragrance momentum in China continuing for many years to come, given the incredibly low fragrance penetration in the market, and see a clear path for China to move from the number five fragrance market today to the second market in the next few years. On the other hand, while prestige fragrances are up solidly in Europe year on year, the category is only now stabilizing versus 2019, suggesting that as the European markets reopen, There is more momentum in store for the fragrance category in Europe. Similarly, in travel retail, while the year-on-year growth remains robust, the two-year trends are still negative, which will also provide another leg of growth for fragrances in the coming years. Against this attractive backdrop, Coty is launching market-leading innovation. Gucci Flora Gorgeous Gardenia is performing exceptionally well and resonating globally. While the fragrance was only launched in early fall 2021, Gucci Flora Gorgeous Gardenia is officially the number one fragrance launched in the US and Canada for all of calendar 2021. This marks the second consecutive year where Coty has claimed the number one fragrance launched in the US with Marc Jacobs Perfect holding the number one spot in calendar 2020. Gucci Flora has also truly resonated with Chinese consumers becoming the number seven CMS fragrance on Tmall in December. On the May fragrance side, Burberry Hero, which also launched in early fall, has claimed the fourth spot in the U.S. amongst May fragrances launches in all of calendar 2021. And similarly on Tmall, the line became the number seven May fragrance on Tmall in December. It's clear that Gucci Flora and Burberry Hero are on track to become global fragrance icons, and this speaks to the new capabilities and operational discipline we have built within Gucci over the last year and a half with a team of experts identifying the right scent profiles and pipeline of innovation and rigorously testing all fragrances to reach above industry leading scores before launching in markets. I'm confident these enhanced capabilities in our fragrance business will assure that as a leader in fragrances, Coty's success rate for launches will be higher than the industry's and Coty's success rate historically. Part of the second strategic figure is also becoming a key player in prestige makeup, and we are making very strong strides here. Our prestige makeup sales in the first half of 22 approximately doubled year on year, led by Gucci Makeup and Kylie Cosmetics. As you can see in the video on this slide showing the Burberry Beauty Store in China, we are rapidly growing our footprint for our prestige makeup brands with eye-catching distinctive stores and counters, differentiated packaging and communication, and locally relevant designs such as the Red Tiger to coincide with Chinese New Year. As a result of this momentum, Prestige makeup grew from less than 3% of our total sales in the first half to over 4% of our sales in the first half of 22, and we continue to target approximately 10% penetration by fiscal 25. Focusing on our biggest opportunity in prestige cosmetics, Gucci makeup. Both in Q2 and in first half 22, Gucci makeup sales more than doubled year on year. And as we discussed at our investors' day, our focus is on growing our prestige makeup business in a profitable way by opening highly productive flagship stores in the highest traffic locations and supplementing this with robust e-commerce sales. Our Gucci makeup business in the U.S. is a clear example that this strategy is working. In recent months, we have doubled year on year the number of Gucci makeup doors But we are also seeing that comparable store sales are doubling as well with Ecom accounting for over 50% of the sales. And in China, Gucci remains a highly desired brand as evidenced by the long lines you can see in this photo outside of one of our Gucci beauty locations. Our strong activations have driven our Gucci makeup sales in China to triple year on year. In fact, as we advance our strategy of building Gucci into a truly two-axis brand, Gucci makeup sales in China now exceed Gucci fragrance sales. To turn into our third pillar, building out our skincare business. As we highlighted during our investor day, we see fiscal 23 as the year of skincare acceleration for Cooke. In the meantime, we are laying the foundation For strategic skincare initiatives, let me start with our strategic focus brand, Lancaster. As you know, our strategy to turn Lancaster into a scientific skincare brand excelling in repair and protection is focused first on Hainan and mainland China. We have been actively opening Lancaster counters and pop-ups in Hainan with beautiful fixtures such as the one you see here. we hosted VIP events with leading dermatologists, celebrities, and key opinion leaders, while also engaging consumers with entertainment. And we are seeing the effort translate to sell out. Since opening the initial three doors in Hainan in May 2021, Lancaster's monthly sales there have nearly doubled as of December. This confirms our view that with the right support and activation, the Lancaster brand equity and product crunch truly resonates with Chinese consumers. At the same time, in mainland China, Lancaster has become China's Sephora's second exclusive brand with strong double digit sellout growth in the recent period. We are also progressing our skincare ambitions with the next key milestone, the launch of CoverGirl Skincare. As you recall, we first announced the launch of CoverGirl's first-ever skincare line in November, at the same time as we announced America Ferrera as the newest CoverGirl brand ambassador. Last week, we formally unveiled the new dual-language campaign with America Ferrera in both English and Spanish to coincide with the national rollout of the CoverGirl SkinFresh skincare line wherever the brand is sold. Let's take a look at the new campaign video now.

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