Coty Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended December 31, 2018. Coty manufactures and sells beauty products globally across Luxury, Consumer Beauty and Professional Beauty. Figures are in U.S. dollars; millions except per-share data. The company adopted ASC 606 on July 1, 2018, so reported current-period results use the new revenue standard while prior periods were not restated.
Financial performance
| Metric | Three months ended Dec. 31, 2018 | Six months ended Dec. 31, 2018 |
|---|---|---|
| Net revenue | $2,511.2; down 5% year over year | $4,542.5; down 7% |
| Gross profit / margin | $1,554.5 / 61.9%, versus 61.1% | $2,776.7 / 61.1%, approximately unchanged |
| Operating income (loss) / margin | $(804.6) / (32.0)%, versus $175.2 / 6.6% | $(825.3) / (18.2)%, versus $204.7 / 4.2% |
| Adjusted operating income / margin (non-GAAP) | $322.3 / 12.8%, down 7% from $348.3 / 13.2% | $463.1 / 10.2%, down 15% from $544.2 / 11.2% |
| Net income attributable to Coty / diluted EPS | $(960.6) / $(1.28), versus $109.2 / $0.15 | $(972.7) / $(1.30), versus $89.5 / $0.12 |
| Adjusted net income attributable to Coty / diluted EPS (non-GAAP) | $181.9 / $0.24, versus $237.2 / $0.32 | $262.4 / $0.35, versus $313.5 / $0.42 |
Quarterly gross margin improved about 80 basis points, supported by product mix and lower raw-material and manufacturing costs; supply-chain freight costs and Consumer Beauty inventory charges partly offset the benefit. Six-month SG&A declined in dollars but rose to 53.0% of revenue from 51.5%, as revenue fell faster than expenses.
Segments and revenue drivers
- Luxury: Revenue rose 7% in the quarter and 6% for six months; operating income was $113.6 million and $162.3 million, respectively. Burberry and selected Calvin Klein and Gucci launches contributed, while supply constraints affected Hugo Boss.
- Consumer Beauty: Revenue fell 15% in the quarter and 18% for six months. Excluding license exits/divestitures, revenue declined 11% and 14%, respectively. Shelf-space and market-share losses, supply disruptions, retailer inventory adjustments and weaker Younique sales weighed on results. Reported operating losses included major impairment charges.
- Professional Beauty: Revenue fell 4% in both periods; operating income increased to $73.8 million for the quarter and $78.8 million for six months. Supply disruptions and lower OPI launch activity offset gains from ghd and Wella products.
For the quarter, reported revenue also reflected the termination of Guess and divestitures of Playboy and Cerruti. Excluding these items, total revenue declined 3%; volume was down 7%, foreign exchange reduced revenue 4%, and price/mix added 8%. For six months, excluding acquisitions and divestitures, revenue declined 6%.
Cash flow, balance sheet and debt
- Six-month operating cash flow was $237.7 million, down from $307.8 million. Investing cash outflow was $300.1 million, including $259.3 million of capital expenditures; financing cash inflow was $153.7 million. Operating cash flow less capital expenditures was negative $21.6 million.
- Cash and cash equivalents were $417.5 million at December 31, 2018, up from $331.6 million at June 30; restricted cash was $27.5 million. Cash, cash equivalents and restricted cash totaled $445.0 million.
- Total debt was $7.906 billion, up from $7.623 billion at June 30; long-term debt, net, was $7.561 billion. The $3.25 billion revolving facility had $2.466 billion of remaining capacity. The company reported compliance with debt covenants; the covenant leverage ceiling was 5.50-to-1.00 for the December quarter and tightens over time.
- Current assets of $3.714 billion were below current liabilities of $3.865 billion. Interest expense, net, was $68.3 million for the quarter and $132.4 million for six months.
- Dividends paid in the six months totaled $188.4 million, or $0.25 per common share. A further $0.125 quarterly dividend was announced February 8, 2019.
Impairments, outlook and risks
- Coty recorded $965.1 million of impairment charges in the quarter and $977.7 million for six months. The six-month charges included $832.5 million of Consumer Beauty goodwill, $90.8 million of indefinite-lived intangibles, $22.8 million for the philosophy trademark, $12.6 million related to a terminated pre-existing license, $7.0 million of finite-lived intangibles and a $12.0 million corporate equity investment impairment.
- Consumer Beauty goodwill was left with no excess fair value over carrying value. Management said a 1% lower forecast annual revenue growth rate could cause a further $464.3 million impairment; a 0.5 percentage-point higher discount rate could cause $156.1 million. Some other trademarks also had limited valuation headroom.
- Management said the strategic review under new leadership is intended to establish a roadmap for consistent, profitable growth, emphasizing gross-margin improvement. No quantified financial guidance is provided in the supplied filing text.
- Supply-chain disruptions from distribution-center consolidation and component shortages hurt all divisions. Coty modified its consolidation plan and expected a moderate impact to continue through fiscal 2019. The final principal P&G integration step was expected in the second half of fiscal 2019.
- Through December 31, 2018, P&G integration activities had incurred approximately $1.26 billion of operating expenditures and $400 million of capital expenditures; Coty expected approximately $1.4 billion total operating expenditures and $500 million total capital expenditures. About $30 million of additional approved integration restructuring charges were expected over the next two fiscal years. The separate 2018 restructuring program had $250 million of expected total costs, with $77.2 million incurred to date.
- Key risks include continued Consumer Beauty share and shelf-space losses, supply and integration execution, foreign exchange, changing consumer and retail trends, high leverage and variable-rate exposure, license renewals, and the outcome of legal and tax matters. A Brazilian tax assessment of approximately $64.1 million was contested; Coty had not accrued a loss because management did not consider one probable. Management said current legal proceedings were not expected to have a material effect, while noting outcomes remain uncertain.
Important facts for investors to verify
- Whether Consumer Beauty revenue and market share stabilize, and whether the impairment assumptions or further write-downs change.
- Whether supply-chain performance improves as planned and integration milestones, costs and synergies meet expectations.
- Debt reduction, interest costs, covenant headroom and the company’s ability to generate cash after capital expenditures, dividends and restructuring payments.
- Whether adjusted results translate into sustainable GAAP earnings; adjusted measures exclude significant recurring or acquisition-related costs and are not GAAP results.
- Developments in the Brazilian tax assessment and the valuation headroom of remaining goodwill and trademarks.