Natura &Co Holding S.A. (NYSE:NTCO) Q3 2022 Earnings Conference Call November 10, 2022 8:00 AM ET
Company Participants
Antonio Luiz da Cunha Seabra – Founder and Co-Chairman
Roberto de Oliveira Marques – Executive Chairman and Group CEO
Fábio Barbosa – Chief Executive Officer
Guilherme Castellan – Chief Financial Officer
Jao Paulo Ferreira – Chief Executive Officer of Natura &Co Latin America
Conference Call Participants
Guilherme Vilela – JP Morgan
Andrew Ruben – Morgan Stanley
Gabriela Moraes – Itaú BBA
Irma Sgarz – Goldman Sachs
Operator
Welcome to Natura &Co.’s Third Quarter 2022 Earnings Call. On this call today are Fábio Barbosa, CEO of Natura &Co and Guilherme Castellan, CFO of Natura &Co. Jao Paulo Ferreira, CEO of Natura &Co Latin America will join for the Q&A session.
The presentation that will be referred to during this call is available on the Natura &Co Investor Relations website. Please limit yourself to one question each in the Q&A session, so we can allow more people to ask questions. Thank you for your understanding and cooperation on this.
I will now hand over to Fábio Barbosa. Please go ahead.
Fábio Barbosa
Good morning or good afternoon to all of you and thank you for joining us today. I’m very happy to be with you again. And Guilherme will comment on the results shortly, so I will limit myself a more qualitative commentary.
We continue to operate in third quarter in a challenging environment, marked by high global inflation that is affecting discretionary spending, rising energy costs and foreign exchange impacts, as well as a geopolitical fallout resulting from the war in Ukraine. In this context Natura &Co posted results that were in line with what we had for [indiscernible] in the previous quarter, with top line training better growing by 2.2% at constant currency, while adjusted EBITDA margin, which was stable at the 8.6% continued to be pressured by the external factors I just mentioned, notably on costs.
We saw some reasons for satisfaction in the past quarter. Natura &Co Latam posted a solid performance driven by the Natura Brand and Avon in the CFT segment. Aesop recorded another strong quarter of double digit sales growth at constant currency. Avon International continued to show a sequential improvement in results and in key channel performing indicators such as activity and productivity.
The Body Shop continued to post challenging results channel, the results channel with decline in the At Home segment and slower franchise recovery. Clearly, we are not satisfied with this and we are working on implementing measures to improve performance on which Guil will give you more color.
We have also made progress on the Group organization that we announced last quarter. We have significantly reduced by 50% compared to 2021 costs at the holding company level, and we started to implement steps to give each brand and business more autonomy and responsibility as mentioned when we started this process. The steps are also advancing. We are further accelerating the integration of the Avon and Natura business in Latin America, the so-called Wave 2 starting in 2023 with Peru and Colombia, and then followed by Brazil.
This new phase aims at harmonizing the distribution and sales systems and optimizing the product portfolio. We have already started to optimize our geographic footprint at Avon International with significant change in market, including already India and Saudi Arabia. We also announced the closing of Avon’s Suffern R&D facility in the United States, which should result in considerable savings on a recurring basis beginning next year.
Also, as announced in the material fact published on October 17th, we continue to analyze strategic opportunities for Aesop. It is worth highlighting that we have never considered selling a 100% of Aesop to third parties, and the strategic opportunities that we are analyzing are focused on accelerating growth and unlocking value. This is a strategic change. The potential alternative for Aesop under study and our expectation of a continued challenging and uncertain micro environment in some markets, led us to withdraw the three-year guidance released to the market in April, 2021 and further modified in November, 2021 and May, 2022.
We are continuing our ongoing work to improve the fundamentals of our brands and business, and notably the underperforming regions, which we regard as our principle challenge, but also our main upside driver. Our priority remains very clear. We are strongly focused on improving margins and generating cash flow, and the teams in the BUs are all mobilized and incentivized to achieve these goals. The aim is to deliver sustainable shareholder return and achieve our ambition of making Natura &Co. the best beauty company for the world. We’ll keep you updated on the progress.
With that, let me now hand over to Guil to comment on our third quarter performance in greater detail. Guil?
Guilherme Castellan
Thank you Fábio, and hello to everyone. I’ll start with Natura &Co.’s consolidated revenue on Slide 5, which grew by 2.2% in constant currency improved sequentially despite the challenging micro environment. In reais sales were down 5.7%. We’ll look at the performance by BU shortly, but in a nutshell, we posted solid growth at Natura &Co. Latam with a strong performance by the Natura brand enabled CFT and Aesop continues to post double digit growth at constant currency.
Avon International improved sequentially, but its performance was still impacted by the war in Russia. The Body Shop had another difficult quarter from a decrease in the Body Shop At Home, while retail recovers slowly from the pandemic.
We turn to adjusted EBITDA margins Slide 6, which was stable at 8.6% in Q3. This reflected different moving parts. First, the main positive impacts are an important improvement of holding expenses, which are down nearly 50% year-on-year. This is the result of our efforts to create a leaner and simpler organization.
Also an improving margin at Natura &Co. Latam driven by strong top line performance, strict cost control, we continue to deliver cost efficiencies in SG&A across all BUs, which are more than compensating for commodities and FX pressures in gross margin. These benefits were offset by the conjunction of continued sales leverage at The Body Shop and also continuing investments for sustainable growth at Aesop.
On Slide 7, we focus on net income and underlying net income. Net income in Q3 was negative BRL 560 million. This was due mainly to lower EBITDA and higher net financial expenses, partially offset by some tax credits associated to Brazil’s tax on foreign income related to 2021. Let me remind you that Q3 2021 net income had also benefited from even higher tax gains related to credit recoveries in Brazil.
Underlying net income was a negative BRL 198 million, and this line shows you the bridge from net income. The difference between the two comes from transformation costs of BRL 163 million, BRL 76 million from discontinued operations, and a PPA effect from the acquisition of Avon for BRL 124 million.
On Slide 8 we focus on free cash flow, which as we have communicated before, is one of our biggest priorities. We record an outflow of nearly BRL 129 million as action taken to improve cash conversion are starting to take effect. This shows an improvement of more than BRL 400 million from the Q3 2021 outflow of nearly BRL 543 million. This was driven by improvement in working capital efforts, which was a positive BRL 353 million compared to unfavorable BRL 268 million in Q3 2021, driven mainly by sharply improved inventory efficiencies and account payables. Finally, it is worth mentioning that despite these two challenging outcome and leverage position, which we will comment more on the next slide, the improvements already delivered allow us to post an almost flat free cash flow to firm.
On Slide 9, we look at our liquidity profile. We ended the quarter with a cash position of BRL 4.6 billion. Our net debt-to-EBITDA ration is 2.85 times at quarter end, up from 2.46 times in Q2 and 1.83 times in Q2 of last year. This leverage ratio reflects a lower EBITDA given FX and cost pressures jointly with a higher integration cost.
You’ll see on the second graph, our cash position of BRL 4.6 billion is higher than the total of our debt payments through 2027. The average maturity of our debt is 6.8 years, and we face limited debt repayments until 2028. In line with the Group’s liability management plan to improve its capital structure, Natura Cosméticos issuance on September 19th BRL 500 million in commercial notes maturing 2025, guaranteed by Natura &Co. Holding.
The funds were used primarily to repay the maturity of the ninth issuance of debentures of Natura Cosméticos, which mature on 21st of September. And in October, 2022, Natura Cosméticos completed the issuance of a little over BRL 1 billion in Real State Receivables Certificate maturing between 2027 and 2032.
Let’s turn now to our performance by business unit beginning on Slide 11 with Natura &Co Latam, which poster another solid performance. Total net sales were up by a solid 10.2% in constant currency. This was driven by double digit growth at the Natura Brand, which grew by 18.5% at constant currency, while the Avon brand was also up slightly in constant currency, thanks to the growth in beauty. The Natura Brand gained momentum over the previous quarter and posted a year-on-growth of 19.3% in Brazil, supported by an acceleration in consultant productivity up by 21.4% in Q3.
In Hispanic Latam net revenue was up 17.3% at constant currency and 0.3% in reais. Growth was mainly driven by Argentina and Colombia. Excluding Argentina, sales in Hispanic markets were down in low single digits at constant currency, impacted by a weaker performance in Mexico and a decline in Chile. At the Avon brand in Latam, net revenue grew by 0.7% at constant currency.
In Brazil trends continued the sequential improvement we have seen every quarter since Q3 2021. In Q3, net revenues declined by 1.4%. It is important to highlight that the Beauty segment actually grew by 11%, which was offset by a 26% sales contraction in Fashion & Home. The Beauty segment in Brazil saw a double digit gain in consultant productivity.
In Hispanic markets, net revenue was up 2.3% at constant currency, mainly driven by Ecuador and Argentina, but impacted by a decrease in Mexico and Chile. The Beauty category grew 9% in cost currency, but this was mostly offset by a drop in Fashion & Home. Total number of available representatives improved sequentially and was up 6% versus Q2 2022, but is still down 9.6% year-on-year.
On Slide 12, we turn to Natura &Co Latam’s Q3 adjusted EBITDA margin. As shown on the graph adjusted EBITDA increased significantly by 22.7% while margin at 11.3% was up 170 bps. This result was supported by strong top line performance by the Natura Brand. Strict financial discipline, however this was partially offset by the impact of selling expenses increasing as a percentage of net sales reflecting Natura Brand investments combined with a deterioration in gross margin. The deterioration is many due to value added input price dynamics which are pressured by rising energy prices, wage inflation, and foreign exchange.
Let’s now move to Avon International on Slide 14. Revenue was down 8.1% at constant currency and 19.8% in reais. This drop was strongly impacted by the situation in Ukraine. Excluding that, sales were down limited 3.1% at constant currency and continued to improve sequentially since Q1. Sales also reflected lower purchase power in Europe. Fundamentals continued to show improvement and the new commercial model now implemented in 20 markets for more than in the previous quarter, result in better rep productivity, digitalization.
Q3 adjusted EBITDA margin is 3.6%, down 30 bps versus the same period last year. This was due to gross margin dynamics, but partially offset by more efficient SG&A as a percentage of sales, given the transformational savings. Adjusted EBITDA margin was also impacted by the war in Ukraine. Excluding that impact, adjusted EBITDA margin would have shown a significant improvement year-on-year.
On Slide 16, we now move to The Body Shop. Q3 net revenue declined 19.5% at constant currency and 29.8% in reais. Foot fall to stores continued to show signs of recovery with store sales up 7.7% year-on-year, but it is lower than anticipated as inflation and cost of living has impacted the consumer confidence. The improvement is not enough to offset the drop in the At Home channel and high product inventory levels held by our franchisee partners during the year.
However sell sales at the franchisee partners are improving, which are leading level of stocks to approach pre-pandemic levels. Core business distribution channels, in other words own stores e-commerce and franchisee combined were up 0.6% on a same-store sales base, showing sequential improvement. Q3 adjusted EBITDA margin was 6.3%, down 11.7 percentage points from Q3 2021 resulting from sales deleverage and gross margin pressures.
It is also worth remembering that Q3 2021 EBITDA margin benefits from the government aid that ended in 2021. In the face of these numbers, management is looking closely at the business and continued to act on all the fronts under our control. We have enacted strict cost containment, minimizing discretionary spend and rightsizing the overhead structure in some channels. Also, we are stimulating demand from head franchisees by taking advantage of opportunities to manage inventory levels and focusing on positioning for peak fourth quarter sales. A new global structure was installed to provide support to head franchises.
Finally, we continue the store footprint optimization and deployment of the new workshop store, which is showing a 15 percentage point uplift on sales compared to the traditional model. Furthermore, a 103 franchise stores have also been refitted.
On Slide 18 Aesop again recorded an excellent performance with another quarter of double digit growth in constant currency, up 21.5%. Revenue in reais was up 8.9%. All regions delivered double digit growth except for Europe. Aesop continues to consistently post superior sales growth on a like-for-like basis, while continuing to roll out new stores. Aesop is also continuing to see channel rebalancing as consumer behavior normalizes post COVID.
China entry plans are on track for launch by the end of 2022 with the opening of physical stores as well as the launch of an online platform and a domestic Tmall operation. Q3 adjusted EBITDA margin was 16.8%, down to 180 bps compared to Q3 2021. This reflects planned investments to deliver sustainable long-term growth in such areas as technology, supply chain and sustainability. As closing Material Fact published on October 17th, we are studying strategic alternatives for Aesop and we will maintain the market updated in respect to such studies.
Let me now hand back to Fábio.
Fábio Barbosa
Thank you, Guil. I will conclude now on Slide 20 with our key takeaways. First, structural steps such as accelerating the integration of Natura and Avon Latin America are in motion aiming to boost our performance. Second, the Group reorganization is progressing in order to strike the right balance between brand autonomy and accountability. We will maintain the market updated regarding our plans related to Aesop. Third, our immediate focus and that of our business units is on defending margin and generating cash flow. The whole organization is mobilized and incentivized to achieve these goals. And fourth, all the actions we have outlined aim at improving capital and resource allocation and thus delivering better sustainable shareholder returns.
Thank you very much for your attention and Guil, Jao Paulo and I are now happy to take your questions.
Question-and-Answer Session
Operator
[Operator Instructions] And our first question will come from Guilherme Vilela of JP Morgan. Please go ahead.
Guilherme Vilela
Hi, Fábio, Jao Paulo, Guilherme and thanks a lot for taking my questions. First, I’d like to have an idea of the impact in terms of margin that the outsourcing of Avon’s IT infrastructure can bring for the division? Also what that can allow in terms of data analytics and digitalization for Avon? And secondly and more rapidly, I’d like to get color on Natura Brand Brazil. How much of the 19% growth was volumes and how much was price or mix? Thanks a lot again.
Fábio Barbosa
Guilherme thanks for your question. I’m going to ask you please to repeat your first question because we were not able to hear very well, so if you can please repeat your first question, that would be great.
Guilherme Vilela
Oh, no, no problem. I would just like to have an idea of the impact in terms of margin that the outsourcing of Avon’s IT infrastructure can bring for the division, and also what that can allow in terms of data analytics and digitalization for the brand?
Guilherme Castellan
Perfect, thank you Guilherme for the questions. I think as you probably saw right, not only this quarter, but in the last few quarters Avon is investing a lot in its transformational programs, right, and aiming to deliver significant SG&A savings across the world. So it’s both a strategy in terms of top line as Fabio mentioned, right? Not only boosting its new commercial model, but also revisiting the footprint or some unprofitable markets, but also strategy focused in the bottom line with the transformational costs and as we mentioned, if excluding the Russia, Ukraine war, the margins even with the sales leverage will be significantly higher in Q3 of this year.
I think there are two things to highlight for Avon International in this particular quarter related to the transformation. The first one is the closure of the Suffern facility. Basically as we close, which was again, a facility that Avon had in the U.S. for basically R&D and that basically boosts generates significant savings on an annual basis. And the second one is related to the outsourcing of IT, which is also a key program for Avon’s transformational program. Right? There are significant results that we’re aiming to get from both of these initiatives with a quite compelling payback in terms of investments and returns. However, we don’t disclose necessarily the necessary return for those investments.
As you can see in this quarter though, what we can say is that most of the transformational savings for Avon, is related to the outsourcing of the IT program. So most of the costs that we are going through this quarter in terms of transformational savings as you can see in the table of adjusted EBITDA is related to this, and as I said before, both Suffern and the outsourcing of IT, both of them, they have a pretty compelling payback that we expect to flow into the bottom line of Avon starting in 2023.
Now, on the digitalization program, basically I’m going to start talking a little bit Avon International then I’m going to pass to Jao to mention a little bit about Latam. But we continue to evolve Avon International as planned, of course, with some description in different countries with a few countries evolving more than the others. But as you look in our research, the penetration of the Avon app basically measured by the active reps, right, who log in at least once in the last three campaigns, reached almost 20% this quarter. Right? Which is a 7 percentage point increase compared to the previous one. So we continued very much focus on that. As I mentioned, some countries are evolving more than the others, but this is one of the key pillars for Avon going forward.
I’m going to pass to Jao, so he can mention a little bit about Latam.
Jao Paulo Ferreira
So Guilherme to your question on top line growth of Natura Brand in Brazil, it came both from price and volume growth. Okay?
Guilherme Vilela
That’s pretty much clear. Thanks a lot.
Operator
The next question comes from Andrew Ruben of Morgan Stanley. Please go ahead.
Andrew Ruben
Hi, thanks very much for the question. I was just hoping to clarify on the guidance, so understanding the withdrawal of the 2024 targets, but as it pertains to the synergies, I’m curious with the withdrawal, how you’re thinking about the synergy opportunity if there’s any change fundamentally about the opportunities between the companies and any updates on how you might be tracking there? Thank you.
Jao Paulo Ferreira
So, just making sure that I understood the question correctly, the question is about the withdrawal of the guidance and in more particular, the synergy guidance, right? Is that correct?
Andrew Ruben
That’s exactly it. Thank you.
Jao Paulo Ferreira
Okay, perfect. Yes, sorry the — I mean the — we’re hearing some background noise here, so the sounds is not perfect, so sorry that I’m repeating every question. But look, yes, as Fabio explained, and I reiterate that point with the new strategic program going on, starting with basically the holding restructuring, right? Followed by the acceleration of the integration in Latam. Right?
And formally, was Wave 2, and the strategic options that we are analyzing for Aesop based on the material fact that we issued last month, and of course, given the uncertain scenario as well, we thought that will be a good moment for us to withdraw the — all the guidances that we have, especially because again, we’re not planning to give any midterm guidance anymore. Right? So it didn’t make sense for us to keep just a synergy, basically guidance when we are also withdrawing the EBITDA guidance and revenue guidance when you know that everything is combined to the same thing.
What I can say though, is that the synergies were on track, so the synergies delivered by Wave 1 in Latam, they were on track. Part of those synergies, of course, they were consumed by the very high and charging inflationary pressures that we faced in the last in the last couple of years. But the plan was on track and we continued to work on the plan and the delivered synergies. Now we are entering into a new phase for Latam. As Guilherme can explain more we are entering for the acceleration of Wave 2, which of course brings different benefits for us, both in the top line and bottom line. And we thought that, again, didn’t make sense for us to keep basing and leading the market in the previous guidance, given everything that is going on, and as I mentioned new opportunities ahead of us with the Wave 2 in Latam.
Andrew Ruben
Great, very clear and I appreciate you clarifying that. Thank you.
Operator
The next question comes from Gabriela Moraes of Itaú BBA. Please go ahead.
Gabriela Moraes
Hello, guys. Good morning. Thank you so much for taking my questions. We would like to make one question regarding Aesop. So we have been the company making successful efforts to enter in China, and because of that, we have been seeing a partial pressure in the division profitability as expected. But we would like to get more color on how these entering process into China has been going on so far, and also to get a better view on the decision for stability how to look going forward? That’s basically it guys. Thank you.
Guilherme Castellan
Gabriela, thanks for your question. Yes we’re quite excited with another strong quarter of Aesop results and quite excited, as you mentioned with our plans for China entry, which as we mentioned in the Q2 results and now also in the Q1 results are planning to happen before year end. So we’re still planning to open two stores in Shanghai by 2022 and we’re quite excited with the progress that the team has made there with the retail and of course how the business is evolving in terms of product registration and everything else. So we are quite excited with that. China has been in, again, in the plans for Aesop for already a couple of years and finally it’s happened.
Just to put a little bit more color on how important this is for Aesop, Asia is the largest market for Aesop in the world. As you’ll probably recall in a couple of calls before we had mentioned how important is the Japan and the South Korea market for Aesop, both of those markets being the largest markets for Aesop in the world. Asia continued to deliver very strong double digit growth in Q3. So the brand continues with a very pace on a same-store sale basis, but also with a new store launch our fragrances are doing extremely well as well in the region specifically in South Korea.
And needless to say, there is a big halo impact, especially for the Guangdong Province when you look at China, for other regions in Asia, Hong Kong and other countries. So quite excited with that. We are following basically urban center approach in the beginning. So as I said, the focus in the beginning will be in Shanghai, but the team is already making plans to, to expand that to other urban centers after that. And we truly believe that in in a few years, China will be a key market for Aesop in the world and continue to push ahead the APAC sales in the future.
Gabriela Moraes
That’s very clear, Guil. Thank you.
Operator
The next question comes from Irma Sgarz of Goldman Sachs. Please go ahead.
Irma Sgarz
Yes, hi. Thank you. I was curious just to hear a little bit about cost pressures going forward. Obviously we are seeing some commodity price pressures abating, but as you commented in the release and your earlier remarks, there’s obviously still inventories to work through, and given that you buy a lot of sort of finished product is obviously like longer cycle until that works its way into your cost line. So I was just curious, help us understand a little bit maybe how we should think about cost pressure into 2023? Can this turn already along the next year from a headwind into a tailwind in your mind?
And maybe if related to that, if you could just make some comments on, it feels like you’ve seen maybe somewhat Aesop aide, but then in pretty much all markets you’ve seen gross margin pressure from cost inflation. So just sort of showing that you weren’t able to pass all of that through, I was just curious to sort of, to see some differences in pricing power that you feel given the economic backdrop across the different brands, if you could just sort of outlay where you’ve seen more pricing power versus where it’s just been a little bit more difficult? Thank you.
Guilherme Castellan
Thank you, Irma. Thanks for your question. Yes, look, I mean, we’ve been talking a lot about this pressure of commodities and FX, right? Let’s not forget FX especially for a company like Natura that operates in several countries, not only you’re facing constant transactional FX challenges, but also translational effects challenges, right? As country mix plays a big role in this equation. So look, Q3, like if you, I’m going start talking a little bit about Q3 just to set up the stage here and making sure that we understand a little bit of the past going forward. But Q3 as you can see, we had different dynamics for each one of our BUs, right?
So putting Aesop aside, which again, didn’t face any pressure in terms of gross margin, as you can see, Latam only had 40 bps pressure compared to previous years, right? And that was mainly because of the revenue management program, because the cost pressure was significant. And when I say revenue management, it’s very important to distinguish that this is not only a price increase game, but also a mix game. Right? And we had a very good quarter for Latam in terms of mix as we were able to adapt the selling which compared to the sellout and we see mix improving across the board.
For Avon International, which was again one of the big negative impacts in gross margin, it’s very important for us to highlight that. Yes, part of that was commodities, but the main issue there was also FX, right? We saw big FX translational impact and mix impacting the overall gross margin of the company. And needless to say, keep in mind that the war in Russia, Ukraine also impacted the gross margin of the company. But yes, you should expect gross margin to be under pressure going forward because again, as we have always said, and not only Avon International, but all the other BUs as well, we buy the value added material, right? So it’s not only a matter of commodity prices, which you are right, they are reducing from the peak in several categories, but also it’s the labor inflation, the energy prices and so on, which of course, in a few markets, continues to sky rock, right?
Finally, The Body Shop, just to mention The Body Shop, again though we are also significantly impacted in terms of cost pressure, I think The Body Shop, as we had also mentioned in Q2 hasn’t passed fully the price increases to the consumers given the level of inventories, but it’s planning to do so over the next few quarters. Right? So what to expect in the future? I think, as we mentioned in Q2 right, we’ll continue to see the pressure in our margins at least in the short term. Right? We mentioned that in Q2 for the full second half, not only for Q3. So you should expect that to continue. We still have the inventory cycle and again, we still have some contracts that we have to renew basically in the first quarter of last year, which we should see again, depending on the market conditions, some benefits flowing into our P&L later in 2023.
So I continue and to repeat what we set in Q2, our expectations is for our top line to continue to trend better going forward. We’re seeing that basically across the business, and we’re excited to have a very strong Q4, which as you know, is our strongest quarter in terms of seasonality. But we should continue to expect to see margins pressure especially gross margin and especially the SG&A that is impacted by labor inflation.
Irma Sgarz
Great. Thank you so much. Maybe just one followup there, when you talk about the FX pressures impacting Avon International is that because you’re producing in some countries and then transferring into other countries, and you just have a big mix of — bigger mix of sort of revenue pool in country, and the production is concentrated in a few locations, and you probably also had to move some of those around given the war in Russia and Ukraine?
Guilherme Castellan
Irma, let me make just one quick clarification, right? If we can distinguish the transactional FX risk and the translational effects risk, right? The transactional FX risk is the risk that we have, again that impact our margins, right in a direct way. And that is to your example, when we buy basically from one country to the other, when we buy the raw material from one particular country, just to be clear, that transactional risk we hedge for most of the countries, especially in the short-term. So that is hedging of course. It is hedged, the hedge only basically gives us time to react and protection in the short-term, because as you know, we should basically adjust the prices depending on the markets, right?
But that risk is a risk that is hedging of course depending on the impact of the currencies that risk will flowing through our hedges. Now, what I meant before, which is very important, is the mix of countries, and that is represented by the translational FX, right? So as we have some countries in Avon International that operates with higher gross margins than the others and those countries, they may be growing less or declining more than the others. We have a mix impact that is reflecting the translational FX, and again, the overall mix of countries Avon, and that’s where, again, we can see some, some headwinds in the short-term as well.
So it is both, but I just want to make the clear distinguishment that for the transactional FX, we have a hedging program in place, but of course, we don’t hedge the translational impact of FX in our results.
Irma Sgarz
Yes, perfect. That was what I was trying to understand. Thank you.
Operator
The next question comes from Gustavo Sunday [ph] of XP. Please go ahead.
Unidentified Analyst
Hi, good morning guys. Thank you for the question. My first question is regarding working capital. So inventories played an important role for improving working capital in the quarter, but on top of the year end seasonality, how are you guys seeing inventory levels so far? Are you comfortable with your current inventory levels for the year end? And can we expect Q4 cash generation as strong as last year’s?
And my second question if I may is regarding Avon International’s footprint. You mention in the release, you left Albania and launched partnerships in some other countries. So can we expect more moves similar to that in the coming quarters? And what would be an optimal footprint in terms of numbers of countries Avon International operates in? Thank you.
Guilherme Castellan
Thank you, Gustavo, for your question. I’m going to start here and of course Fábio and Jao, they can add anything they feel is relevant. We’re comfortable with the level of inventories, right? Keep in mind that when we say we’re comfortable it doesn’t mean that we’re not happy, because even though Q3 there is a natural seasonality for us to build inventories, so for inventories to increase in the balance sheets, therefore, for you to have a negative impact in your free cash flow due to the seasonality and that impact is significantly less last year. Keep in mind that we are coming from a position of high inventory, right?
As we have also discussed in the best [indiscernible]. So it is moving in the right direction. I think that the actions that the BUs have taken to improve inventory management is starting to take effect as we mentioned. And we believe that we are again in a good position for Q4, even though, again, in some countries we still see some supply chain issues that may impact our results. But we are quite comfortable with that and we’ll continue to work on optimizing inventory and optimizing our accounts of working capital to improve the cash conversion going forward.
Now, your second question was, can you remind me? The footprint of Avon, yes, thank you. Yes, look, this is no news, right? And Fabio had mentioned a little bit about that in Q2 and also in this quarter, right? It is not only, let me be clear, it’s not only about Avon, right? I mean, we are of course revisiting all the countries that we operate that are not profitable in the world, right? So as Avon operates in more than 40 countries around the world internationally, you should expect that we have some quite profitable countries there and other countries that are not that profitable and operate with losses. So I think that has been the focus is basically to tackle those markets first. So, as you mentioned, we exit a few markets. We change the operating model in other markets, and we’ll continue to do so if there is a market that is not profitable. We’ll continue to look for alternatives in those markets.
So I’m going to Fabio to see if he has anything to add, but basically that in a nutshell, I think that’s the essence of it.
Fábio Barbosa
Yes, Gustavo, Thank you. Not much to add, but I just want to say that we are, I’m trying to say revisiting every country. I mean, Avon’s presence has different levels. It can be a full presence, it can be through distributor, it can be through a head franchisee. So we are also revisiting the model in which we operate to make that more profitable. So we are going through it as India and Saudi Arabia, we have already made a change as Guilherme just mentioned. But of course, we are going through every country, especially the ones that are not profitable and seeing how we can readjust. Is it a matter of investing for a full presence? Is it a matter of having distribution at franchisee and how to, I mean, adjust everything so that we can have profitability in those countries. Thank you.
Unidentified Analyst
Thank you.
Operator
This concludes today’s question-and-answer session. I would like to invite Fabio Barboza to proceed with his closing statements. Please go ahead.
Fábio Barbosa
Thank you all very much for being with us today. As you saw from the presentation, we are all operating a very challenging environment, but we have clearly defined our priorities. We are mobilized to deliver them, and we are optimistic that we can see for evidence that change made and focus revisited are starting to make the difference. Thanks for your attention and have a great weekend. Thank you.
Operator
That concludes the Natura &Co. audio conference for today. Thank you very much for your participation, and have a good day.
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