Coty Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2021, the three months ended September 30, 2020; comparisons are with the three months ended September 30, 2019. Amounts are in U.S. dollars unless noted.
Business context
Coty manufactures and sells fragrance, cosmetics, hair-care, and skin- and body-care products. The quarter was heavily affected by COVID-19, particularly reduced mall traffic and travel retail. The Wella, Clairol, OPI, and ghd businesses are presented as discontinued operations because Coty agreed to sell the Professional and Retail Hair business to KKR for a stated $4.3 billion cash- and debt-free valuation. Coty expects to retain a 40% interest in the separately managed business; closing was expected in fiscal Q2 2021.
Financial results and liquidity
| Metric | Q1 FY2021 | Q1 FY2020 |
|---|---|---|
| Continuing-operations revenue | $1,124.1 million | $1,411.2 million |
| Gross profit / margin | $659.2 million / 58.6% | $849.3 million / 60.2% |
| Operating income (loss) / margin | $(66.0) million / (5.9)% | $64.0 million / 4.5% |
| Adjusted operating income (non-GAAP) | $81.1 million / 7.2% | $65.4 million / 4.6% |
| Net income attributable to Coty Inc. | $221.4 million | $52.3 million |
| Operating cash flow | $42.6 million | $39.9 million |
Continuing-operations revenue fell 20.3% year over year; excluding acquisition and divestiture effects, it declined 19%, reflecting a 5% volume decrease and a 14% negative price-and-mix impact. Reported net income included a preliminary $220.5 million tax benefit related to the transfer of assets and liabilities following the relocation of Coty’s principal location from Geneva to Amsterdam. The benefit is subject to finalization with tax authorities and materially affects the earnings comparison.
SG&A was $583.4 million, down from $806.7 million, and declined to 51.9% of revenue from 57.2%, primarily reflecting lower advertising and promotional spending. Cost of sales as a share of revenue rose to 41.4% from 39.8%, reducing gross margin by approximately 160 basis points. Restructuring costs were $30.1 million and Wella-related divestiture costs were $46.3 million. Interest expense, net, was $62.1 million.
Cash and cash equivalents were $535.7 million at September 30, 2020; immediate liquidity, including available revolver borrowings, was $1,721.7 million. Investing activities used $81.5 million, including a $37.6 million payment to terminate cross-currency swaps; financing activities provided $264.2 million, including $227.2 million of net proceeds from the second Series B preferred issuance. Total debt was $8,400.2 million, compared with $8,156.3 million at June 30, 2020. The balance sheet reported $8,134.8 million of long-term debt, net, plus $195.4 million of short-term debt and current maturities.
Material changes and segment performance
- Revenue declines were broad-based: Americas decreased 4%, EMEA 22%, and Asia Pacific 35%. EMEA and Asia Pacific were especially affected by travel restrictions, store closures, and prestige-product weakness. E-commerce growth and reopening-related recovery provided partial offsets.
- Americas operating income improved to $21.3 million from a $17.5 million loss, while EMEA operating income fell to $13.0 million from $28.2 million and Asia Pacific swung to a $19.0 million loss from $8.5 million of income.
- Continuing-operations GAAP operating results were also affected by higher amortization, restructuring, and Wella transaction costs, and by the prior-year $84.5 million Younique divestiture gain.
- Wella discontinued-operations revenue was $566.4 million, up from $531.6 million; net income was $104.7 million versus $39.5 million. Coty attributed improved operating income in part to the absence of depreciation and amortization on assets held for sale and lower selling costs.
- Cash dividends on common stock remain suspended. Coty issued the remaining $250 million of Series B preferred stock to KKR in July; the preferred stock accrues dividends at 9% annually, and $20.8 million of preferred dividends was accrued in the quarter.
Outlook, risks, and unusual items
Management said COVID-19 was expected to continue pressuring sales, with recovery gradual and uneven as restrictions, travel disruptions, and consumer behavior evolve. The company reported improving volumes versus fiscal Q4 2020 but revenue remained below the prior-year quarter. Management highlighted e-commerce, innovation, skincare, China, and digital capabilities as priorities, alongside cost control and debt reduction. No specific consolidated revenue or earnings guidance is provided in the supplied filing text.
The Transformation Plan aims to stabilize and gradually accelerate revenue, improve margins and cost control, and deleverage. Coty said it plans to reduce fixed costs by 25%; it expects approximately $140 million of additional restructuring charges over the next three fiscal years for approved actions. The company had incurred $187.8 million of cumulative restructuring charges under the plan by September 30, 2020.
The credit agreement provided a net-leverage covenant holiday through March 31, 2021, but requires at least $350 million of liquidity during that period and restricts certain investments, restricted payments, and additional secured debt. Coty reported compliance with its covenants. It said Wella sale proceeds through March 31, 2021 generally must reduce debt, except up to $500 million available to fund operations.
Risks include the continuing pandemic, execution of the Transformation Plan and Wella separation, high debt and refinancing needs, volatile consumer demand and foreign exchange, and legal and tax matters. Brazilian tax assessments totaled approximately $206.4 million, including estimated interest and penalties; Coty is contesting them, believes it has meritorious defenses, and has not recognized a loss because management did not consider one probable. The filing also describes shareholder litigation and states that potential losses could not then be reasonably estimated.
Important facts for investors to verify
- Whether the Wella transaction closed on the expected timetable, final proceeds and adjustments, and how proceeds were applied to debt.
- Whether the $220.5 million tax benefit is finalized following negotiations with tax authorities, and the resulting future tax rate and cash-tax effects.
- COVID-19 recovery, particularly travel retail and prestige demand, and whether e-commerce and new product launches can offset persistent weakness.
- Progress against the 25% fixed-cost reduction goal, restructuring cash costs, and whether savings improve underlying margins without impairing growth.
- Debt balances, interest costs, covenant liquidity requirements, and the ability to refinance or deleverage, including the cost of the 9% Series B preferred stock.
- Developments in the Brazilian tax assessments and shareholder lawsuits, for which outcomes and potential losses remain uncertain.