Coty Inc. — Form 10-Q Summary
Business context and reporting period
This filing covers Coty’s first fiscal quarter of fiscal 2018, the three months ended September 30, 2017, compared with the three months ended September 30, 2016. Coty manufactures and sells global beauty products through Luxury, Consumer Beauty and Professional Beauty segments.
Results are substantially affected by acquisitions completed after the prior-year quarter, particularly the October 2016 acquisition of P&G’s Beauty Business. The filing says that acquisition generated 46% of current-quarter revenue; ghd and Younique together contributed another 6%. Consequently, reported year-over-year growth is not a like-for-like comparison.
Financial performance and liquidity
Amounts below are in millions of dollars except per-share data and percentages.
| Metric | Q1 FY2018 | Q1 FY2017 |
|---|---|---|
| Net revenue | $2,238.3 | $1,080.2 |
| Gross profit / gross margin | $1,364.0 / 60.9% | $635.4 / 58.8% |
| Operating income / margin | $28.7 / 1.3% | $46.4 / 4.3% |
| Net income (loss) | $(16.1) | $9.8 |
| Net income (loss) attributable to Coty Inc. | $(19.7); $(0.03) per share | $0.0 |
| Adjusted operating income (non-GAAP) / margin | $195.1 / 8.7% | $166.4 / 15.4% |
| Adjusted net income attributable to Coty (non-GAAP) | $76.3; $0.10 per diluted share | $78.3; $0.23 per diluted share |
| Net cash used in operating activities | $(8.9) | $(15.0) |
| Capital expenditures | $111.4 | $86.8 |
Revenue increased 107% as reported, while revenue excluding acquisitions and currency translation declined 2%. Organic results varied: Luxury revenue grew 5%, Consumer Beauty declined 4%, and Professional Beauty declined 1%, excluding acquisitions. Reported gross margin improved about 210 basis points, but reported operating margin fell about 300 basis points. Adjusted operating income rose 17%, while adjusted margin fell to 8.7%, mainly reflecting higher adjusted selling, general and administrative costs.
Cash and cash equivalents were $919.2 at September 30, 2017, plus $25.4 of restricted cash. Cash and restricted cash increased $373.9 during the quarter, primarily as financing cash flow included $628.4 net proceeds from revolving facilities. Operating activities used $8.9, and investing activities used $116.0.
Total debt was $7,838.6, up from $7,215.6 at June 30, 2017; long-term debt, net, was $7,541.9. Cash less total debt implies net debt of approximately $6,919.4. Interest expense, net, increased to $66.4 from $40.4. Coty reported compliance with debt covenants at quarter-end; the applicable maximum leverage covenant was temporarily 5.95-to-1 following the Younique acquisition. Current assets were $4,249.5 and current liabilities $3,948.5.
Material changes and management commentary
- Acquisition-driven reported growth masked pressure in legacy operations. Management described a challenging market, with declines in U.S. retail nail, color cosmetics and hair color, and mass fragrance in Western Europe and the U.S.; Consumer Beauty also faced competition, reduced distribution and shelf-space losses.
- Luxury’s organic growth was supported by fragrance launches and skin-care improvement. Consumer Beauty’s organic decline reflected, among other factors, lower Sally Hansen, Astor and Playboy sales. Professional Beauty’s organic revenue was nearly flat.
- Management reported approximately $750 million of targeted P&G acquisition synergies through fiscal 2020. It expected to achieve cumulatively about 50% in fiscal 2018, 80% in fiscal 2019 and the full amount in fiscal 2020; approximately 20% had been realized in fiscal 2017. These are targets, not guarantees.
- Global Integration Activities had incurred approximately $900 million in operating expenditures and $275 million in capital expenditures through September 30, 2017. The filing also states approximately $150 million of additional restructuring charges are expected over the next two fiscal years. The remaining recorded program accrual was $308.5.
- Coty identified non-core brands representing approximately 6%–8% of annual revenue and was exploring alternatives, including divestiture. It said TSA-related shipment timing had reduced first-quarter revenue after benefiting the prior-year fourth quarter, with no further impact expected.
- On October 2, 2017, Coty acquired global Burberry Beauty license rights and related assets for approximately $248.3 million. On November 8, it amended credit agreements to extend the period for including certain synergies and cost savings in covenant calculations.
Outlook, risks and unusual items
- The filing does not provide specific consolidated revenue, earnings or cash-flow guidance. Management cautions that first-quarter results are not necessarily indicative of the full fiscal year. Sales and cash flows are seasonal, typically rising in the second fiscal quarter around the holiday season.
- Net loss attributable to Coty was partly offset by a $25.3 income-tax benefit; the reported effective tax rate was 61.1%. Management attributes tax-rate variability to the geographic mix of income and losses, among other factors.
- Foreign-currency translation generated $239.1 of other comprehensive income, contributing to comprehensive income of $223.6 despite the net loss. This is not operating profit.
- Goodwill and other intangible assets were substantial: $8,738.0 and $8,493.9, respectively, at quarter-end. Their valuation and impairment assessments depend on management estimates.
- Risks include integration and synergy execution, competitive and consumer-preference changes, acquisition-related liabilities, restructuring and systems integration, leverage and covenant requirements, foreign-exchange exposure, and legal, regulatory and tax matters. Management said current legal proceedings were not expected to have a material effect, while noting outcomes are uncertain.
- Disclosure controls were judged effective at a reasonable-assurance level; the evaluation excluded controls relating to the acquired P&G Beauty Business, ghd and Younique. Integration of controls at those businesses was ongoing.
Important facts for investors to verify
- Whether organic revenue trends stabilize, especially in Consumer Beauty, and how much reported growth remains acquisition-related.
- Progress toward the $750 million synergy target, including costs required to achieve it and whether projected timing is maintained.
- Debt reduction, operating cash generation and covenant headroom, particularly given increased revolving borrowings and scheduled maturities.
- Whether elevated SG&A and amortization continue to constrain reported margins, and how non-GAAP adjustments reconcile to GAAP results.
- Future impairment testing, acquisition purchase accounting, restructuring cash expenditures, and any material developments in legal, tax or other contingencies.
- Integration of acquired-business financial controls and the performance and economics of the Burberry Beauty business.