Coty Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended December 31, 2016 (fiscal Q2 and first half of fiscal 2017). The interim statements are unaudited. Coty manufactures and sells branded beauty products. Comparisons are heavily affected by acquisitions, especially the P&G Beauty Business, acquired October 1, 2016; the company also acquired ghd in November 2016 and had acquired the Brazil business in February 2016.
Key financial results
| Metric | Three months ended Dec. 31, 2016 | Six months ended Dec. 31, 2016 |
|---|---|---|
| Net revenue | $2,296.7 million, up 90% | $3,376.9 million, up 45% |
| Gross profit / gross margin | $1,404.4 million / 61.1%, versus 61.4% | $2,039.8 million / 60.4%, versus 60.8% |
| Operating income (loss) / margin | $(12.7) million / (0.6)%, versus $152.4 million / 12.6% | $33.7 million / 1.0%, versus $234.1 million / 10.1% |
| Net income attributable to Coty | $46.8 million, versus $89.0 million | $46.8 million, versus $214.7 million |
| Diluted EPS | $0.06, versus $0.25 | $0.09, versus $0.59 |
| Adjusted operating income and margin | $308.0 million / 13.4%, versus $233.4 million / 19.3% | $474.4 million / 14.0%, versus $426.1 million / 18.3% |
| Adjusted net income attributable to Coty | $223.3 million, versus $154.2 million | $301.6 million, versus $391.7 million |
| Operating cash flow | Six-month cash flow was $663.4 million, versus $517.1 million | |
| Capital expenditures | Six-month outflow of $198.2 million, versus $78.3 million |
- Reported revenue growth reflects acquisition scale, not underlying growth: excluding acquisitions and foreign-exchange translation, revenue declined 10% in the quarter and 9% for the six months. Quarterly volume rose 103%, but price/mix reduced growth by 8% and currency by 5%.
- Quarterly SG&A was $1,170.2 million, or 51.0% of revenue, compared with 42.6% a year earlier. Acquisition-related costs were $135.9 million for the quarter and $217.4 million for the half year; amortization was $95.2 million and $116.4 million, respectively.
- Adjusted results exclude substantial costs, including acquisition costs, amortization, restructuring and pension settlement charges. Adjusted and GAAP performance therefore diverged materially; adjusted operating margin also fell year over year.
- Six-month cash generation benefited from changes in operating assets and liabilities associated with the P&G acquisition. Investing cash outflow was $342.0 million and financing cash inflow was $299.2 million.
Balance sheet, debt and liquidity
- At December 31, 2016, cash and cash equivalents were $939.2 million, plus $25.0 million of restricted cash. Total debt was $6,582.4 million, compared with $4,170.1 million at June 30, 2016; long-term debt, net, was $6,308.4 million.
- Total current assets were $3,909.3 million and current liabilities were $3,137.8 million. Goodwill was $7,390.1 million and other intangible assets were $8,816.6 million, principally reflecting acquired assets.
- The company reported compliance with its debt covenants at quarter-end. The maximum total net leverage covenant was 5.50-to-1 at December 31, 2016, with a scheduled step-down to 5.25-to-1 through June 30, 2017, subject to acquisition provisions.
- Management said cash, operating cash generation and access to revolving and other credit facilities were sufficient for near- and long-term needs. Interest expense, net, rose to $57.9 million for the quarter and $98.3 million for the half year, largely due to higher average debt and interest rates.
Material changes and management commentary
- The P&G Beauty Business purchase price was $11,570.4 million, comprising $9,628.6 million in equity consideration and $1,941.8 million in assumed debt. It contributed $1,111.2 million of quarterly revenue. Coty reorganized reporting into Luxury, Consumer Beauty and Professional Beauty.
- Legacy-business revenue declined across segments. For the quarter, excluding acquisitions and currency, Luxury declined 10%, Consumer Beauty 15% and Professional Beauty 18%. Management cited pressure in U.S. retail nail and hair color and mass fragrance in Western Europe and the U.S., as well as lower sales from several established brands.
- Management cited integration demands, higher-than-expected P&G trade inventory before closing and management and organizational changes as factors weighing on acquired brands. Coty planned to exit P&G transition services in stages during calendar 2017, which could affect quarterly shipment timing.
- Coty targets approximately $750 million of synergies over four years, with about 20% expected cumulatively through fiscal 2017, 50% through fiscal 2018, 80% through fiscal 2019 and the full amount through fiscal 2020. The company estimated transaction-related operating expenses of approximately $1.2 billion and capital expenditures of approximately $500 million; through December 31, it had incurred about $400 million and $100 million, respectively.
- Management identified non-core brands representing about 6% to 8% of revenue and was exploring alternatives, including divestiture. No specific full-year revenue or earnings guidance is provided in the filing text.
Outlook, risks and unusual items
- Principal stated risks include integration and synergy delivery, continued weakness in Consumer Beauty categories, changing consumer preferences and intense competition, dependence on major retailers, execution in new channels, currency movements, acquisition-related execution and elevated debt and interest costs.
- The P&G integration and reorganization carry execution risk; the company expected to continue incurring integration expenses and capital expenditures through fiscal 2020. The P&G acquired subsidiaries were excluded from the quarter’s internal-control evaluation while Coty continued integrating their controls.
- The quarter’s tax benefit included a $111.2 million U.S. valuation-allowance release associated with the P&G acquisition. Effective tax rates were unusually high and are not representative of a normalized rate. The prior-year periods also included material IRS settlement benefits and foreign-currency contract effects.
- Coty recorded a $15.9 million six-month pension settlement charge and incurred significant acquisition costs. The preliminary purchase accounting for P&G and ghd remained subject to measurement-period adjustments. No impairment was identified in the reporting-unit assessment described in the filing.
- On February 1, 2017, after quarter-end, Coty acquired a 60% interest in Younique for $600 million net of acquired cash and assumed debt; purchase-price allocation work had not yet begun. Coty also announced a quarterly dividend of $0.125 per share payable in March 2017.
- Management said current legal proceedings were not expected to have a material effect, while noting its assessment—particularly for matters related to P&G brands—was ongoing. The filing also describes potential tax indemnification exposure and restrictions on certain corporate actions under the P&G tax matters agreement.
Most important facts for investors to verify
- Whether underlying sales trends improve, particularly in Consumer Beauty, and whether reported acquisition-led growth converts into organic growth.
- Progress against the $750 million synergy target, integration costs and capital spending, and the timing and effects of ending P&G transition services.
- Debt reduction, interest expense, covenant headroom and liquidity after the P&G, ghd and subsequent Younique transactions.
- Final purchase accounting for P&G and ghd, including acquired intangible values, amortization and any subsequent measurement adjustments.
- The sustainability of earnings after acquisition, restructuring, pension and tax items, and the basis and consistency of Coty’s non-GAAP adjustments.
- Potential effects of retailer concentration, foreign exchange, product-category weakness, tax-related obligations and integration of acquired-business controls.