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COTY > SEC Filings for COTY > Form 10-Q on 8-Nov-2013All Recent SEC Filings

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Form 10-Q for COTY INC.


8-Nov-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of the financial condition and results of operations of Coty Inc. and its majority and wholly-owned subsidiaries, should be read in conjunction with the information contained in the Condensed Consolidated Financial Statements and related notes included elsewhere in this document, and in our other public filings with the Securities and Exchange Commission ("SEC"), including our Annual Report on Form 10-K for the fiscal year ended June 30, 2013 ("Fiscal 2013 Form 10-K"). When used in this discussion, the terms "Coty," the "Company," "we," "our," or "us" mean, unless the context otherwise indicates, Coty Inc. and its majority and wholly-owned subsidiaries. The following discussion contains forward-looking statements. See Part II - Item 1A. Risk Factors of our Fiscal 2013 Form 10-K for a discussion on the uncertainties, risks and assumptions associated with these statements. Actual results may differ materially from those contained in any forward-looking statements. The following discussion includes certain non-GAAP financial measures. See "Overview-Non-GAAP Financial Measures" for a discussion of non-GAAP financial measures and how they are calculated.

All dollar amounts in the following discussion are in millions of United States ("U.S.") dollars, unless otherwise indicated.

OVERVIEW

We are a leading global beauty company. We manufacture and market beauty products in the Fragrances, Color Cosmetics and Skin & Body Care segments with distribution in over 130 countries and territories across both prestige and mass markets. We continue to see softening in developed markets due to global economic uncertainties and volatility in certain European countries, Japan and for our Skin & Body Care segment in China. A significant part of our strategy is to expand our geographic footprint into emerging markets and diversify our distribution channels within existing geographies to increase market presence. As part of our expansion efforts, we entered into agreements to broaden distribution in Brazil, Thailand and Taiwan in fiscal 2013, as well as Asia and South Africa during fiscal 2014.

Components of Results of Operations

Net Revenues

We generate revenues from the sale of our products in our Fragrances, Color Cosmetics and Skin & Body Care segments to retailers, distributors and direct sales to end users through e-commerce and other forms of direct marketing. Net revenues consist of gross revenues less customer discounts and allowances, actual and expected returns (estimated based on returns history and position in product life cycle) and various trade spending activities. Trade spending activities primarily relate to advertising, product promotions and demonstrations, some of which involve cooperative relationships with retailers and distributors.

Cost of Sales

Cost of sales includes all of the costs to manufacture our products. For products manufactured in our own facilities, costs include raw materials and supplies, direct labor and factory overhead. For products manufactured for us by third-party contractors, costs represent the amounts invoiced by the contractors. Cost of sales also includes royalty expense associated with license agreements, shipping costs and depreciation expense related to manufacturing equipment and facilities. In order to provide essential business services in a cost-effective manner, in some cases we outsource functions or parts of functions that can be performed more effectively by external service providers. For example, we have outsourced significant portions of our logistics management for our European business and for a component of our U.S. business, as well as certain technology-related functions, to third-party service providers.

Selling, General and Administrative Expenses

Selling, general and administrative expenses include advertising and consumer promotion costs, fixed costs (i.e., personnel and related expenses, research and development costs, certain warehousing fees, non-manufacturing overhead, rent on operating leases and professional fees), share-based compensation and other operating expenses.

Selling, general and administrative expenses also include the expense or benefit relating to our share-based compensation plans that are accounted for as liability plans through our initial public offering and as equity plans thereafter.

Income Taxes

The provision for income taxes represents federal, foreign, state and local income taxes. The effective rate differs from statutory rates due to the effect of state and local income taxes, tax rates in foreign jurisdictions and certain nondeductible expenses. Our effective tax rate will change from quarter to quarter based on recurring and nonrecurring factors including, but not limited to, the geographical mix of earnings, enacted tax legislation, state and local income taxes, tax audit settlements and the interaction of various global tax strategies. Changes in judgment from the evaluation of new information resulting in the recognition, derecognition or remeasurement of a tax position taken in a prior annual period are recognized separately in the quarter of the change.

Non-GAAP Financial Measures

Adjusted Operating Income, Adjusted Income Before Income Taxes, Adjusted Net Income Attributable to Coty Inc. and Adjusted Net Income Attributable to Coty Inc. per Common Share are non-GAAP financial measures which we believe better enable management and investors to analyze and compare the underlying business results from period to period.

These non-GAAP financial measures should not be considered in isolation, or as a substitute for or superior to, financial measures calculated in accordance with GAAP. Moreover, these non-GAAP financial measures have limitations in that they do not reflect all the items associated with the operations of our business as determined in accordance with GAAP. We compensate for these limitations by analyzing current and future results on a GAAP basis as well as a non-GAAP basis, and we provide reconciliations from the most directly comparable GAAP financial measures to the non-GAAP financial measures. Our non-GAAP financial measures may not be comparable to similarly titled measures of other companies. Other companies, including companies in our industry, may calculate similarly titled non-GAAP financial measures differently than we do, limiting the usefulness of those measures for comparative purposes.

Adjusted Operating Income, Adjusted Income Before Income Taxes, Adjusted Net Income Attributable to Coty Inc. and Adjusted Net Income Attributable to Coty Inc. per Common Share provide an alternative view of performance used by management and we believe that an investor's understanding of our performance is enhanced by disclosing these adjusted performance measures. In addition, our financial covenant compliance calculations under our debt agreements are substantially derived from these adjusted performance measures. The following are examples of how these adjusted performance measures are utilized by management:

• senior management receives a monthly analysis of our operating results that are prepared on an adjusted performance basis;

• strategic plans and annual budgets are prepared on an adjusted performance basis; and

• senior management's annual compensation is calculated, in part, using adjusted performance measures.

Adjusted Operating Income

We define Adjusted Operating Income as operating income adjusted for the following:

• Following June 12, 2013, the effective date of the share-based compensation plan amendments, the component of share-based compensation expense represents the difference between equity plan accounting using the grant date fair value and equity plan accounting using the June 12, 2013 fair value. Prior to June 12, 2013, the component of the share-based compensation expense included the difference between share-based compensation expense accounted for under equity plan accounting based on grant date fair value, and under liability plan accounting based on reporting date fair value; and

• Other adjustments, which include:

• asset impairment charges;

• restructuring costs and business structure realignment programs;

• acquisition-related costs and certain acquisition accounting impacts; and

• other adjustments that we believe investors may find useful.

Adjusted Net Income and Net Income per Common Share Attributable to Coty Inc.

We define Adjusted Net Income Attributable to Coty Inc. as net income attributable to Coty Inc. adjusted for the following:

• adjustment made to reconcile operating income to Adjusted Operating Income, net of the income tax effect thereon (see Adjusted Operating Income);

• certain interest and other (income) expense, net of the income tax effect thereon, that we do not consider indicative of our performance; and

• certain tax effects that are not indicative of our performance.

Adjusted basic and diluted Net Income Attributable to Coty Inc. per Common Share is calculated as:

• Adjusted Net Income Attributable to Coty Inc. divided by

• Adjusted weighted-average basic and diluted common shares using the treasury stock method.

Constant Currency

We operate on a global basis, with the majority of our net revenues generated outside of the U.S. Accordingly, fluctuations in foreign currency exchange rates can affect our results of operations. Therefore, to supplement financial results presented in accordance with GAAP, certain financial information is presented excluding the impact of foreign currency exchange translations to provide a framework for assessing how our underlying businesses performed excluding the impact of foreign currency exchange translations ("constant currency"). Constant currency information compares results between periods as if exchange rates had remained constant period-over-period. We calculate constant currency information by translating current and prior-period results for entities reporting in currencies other than U.S. dollars into U.S. dollars using constant foreign currency exchange rates. The constant currency calculations do not adjust for the impact of revaluing specific transactions denominated in a currency that is different to the functional currency of that entity when exchange rates fluctuate. The constant currency information we present may not be comparable to similarly titled measures reported by other companies.

RESULTS OF OPERATIONS



The following table is a comparative summary of operating results for the three
months ended September 30, 2013 and 2012:



                            Three Months Ended
                               September 30,
(in millions)               2013          2012
NET REVENUES
By Segment:
Fragrances                $   704.5     $   702.5
Color Cosmetics               311.5         347.7
Skin & Body Care              162.2         162.9
Total                     $ 1,178.2     $ 1,213.1
OPERATING INCOME (LOSS)
By Segment:
Fragrances                $   152.8     $   134.3
Color Cosmetics                36.8          73.2
Skin & Body Care               (3.5 )        (4.5 )
Corporate                     (20.5 )       (37.1 )
Total                     $   165.6     $   165.9

The following table presents our Statements of Operations, expressed as a percentage of net revenues:

                                                                 Three Months Ended
                                                                   September 30,
                                                               2013              2012
Net revenues                                                      100.0 %          100.0 %
Cost of sales                                                      40.1             39.3
Gross Profit                                                       59.9             60.7
Selling, general and administrative expenses                       43.8             45.2
Amortization expense                                                1.9              1.8
Restructuring costs                                                 0.1                -
Operating Income                                                   14.1             13.7
Interest expense, net                                               1.5              1.4
Income Before Income Taxes                                         12.6             12.3
Provision for income taxes                                          3.9              4.5
Net Income                                                          8.7              7.8
Net income attributable to noncontrolling interests                 0.4              0.3
Net income attributable to redeemable noncontrolling
interests                                                           0.4              0.4
Net Income Attributable to Coty Inc.                                7.9 %            7.1 %

Discussed below are our consolidated results of operations and the results of operations for each reportable segment.

NET REVENUES

In the three months ended September 30, 2013, net revenues decreased 3%, or $34.9, to $1,178.2 from $1,213.1 in the three months ended September 30, 2012. Foreign currency exchange translations had an immaterial impact on total net revenues. The decrease was primarily the result of a decline in unit volume of 8%, partially offset by a positive price and mix impact of 5%.

Net Revenues by Segment



                     Three Months Ended
                        September 30,
(in millions)        2013          2012         Change %
NET REVENUES
Fragrances         $   704.5     $   702.5           0%
Color Cosmetics        311.5         347.7          (10%)
Skin & Body Care       162.2         162.9           (0%)
Total              $ 1,178.2     $ 1,213.1           (3%)

Fragrances

In the three months ended September 30, 2013, net revenues of Fragrances increased $2.0, to $704.5 from $702.5 in the three months ended September 30, 2012. Foreign currency exchange translations had an immaterial negative impact on net revenues in Fragrances. Unit volume for the three months ended September 30, 2013 was in line with the three months ended September 30, 2012, and price and mix had an immaterial impact on the segment. In fiscal 2013, we divested one of our licenses and a certain North American service agreement expired and was not renewed ("2013 Ceased Activities"). Excluding the impact of foreign currency exchange translations and the impact to net revenues of $5.9 from the 2013 Ceased Activities, net revenues of Fragrances increased $6.1, or 1%. Segment growth was primarily driven by increased net revenues from Roberto Cavalli, Chloé, Davidoff and Calvin Klein, in part due to the launches of Just Cavalli for him, Just Cavalli for her,

Roses de Chloé, See by Chloé, Davidoff The Game, Davidoff Cool Water Woman Sea Rose and Calvin Klein Downtown. Segment growth was also driven by incremental net revenues from the newly established brand Katy Perry Killer Queen. Partially offsetting this growth were lower net revenues from Lady Gaga and Beyoncé due to a lower level of new launch activity for these two brands in the three months ended September 30, 2013 compared to the three months ended September 30, 2012, the expiration of certain licenses and customer orders in the U.S. that were received in the three months ended September 30, 2012, but which we anticipate receiving in the three months ended December 31, 2013, as retailers are taking a cautious approach to the upcoming holiday season in the face of a slowing retail environment.

Color Cosmetics

In the three months ended September 30, 2013, net revenues of Color Cosmetics decreased 10%, or $36.2, to $311.5 from $347.7 in the three months ended September 30, 2012. Foreign currency exchange translations had an immaterial impact on net revenues in Color Cosmetics. The decrease was primarily the result of a decline in unit volume of 9% and a negative price and mix impact of 1%. The decline in the segment was primarily driven by lower net revenues of Sally Hansen and OPI in the U.S. The decrease from Sally Hansen was in part due to several key U.S. mass retailers significantly reducing their inventory on hand in response to the sudden decline in consumer demand for nail products, resulting in lower replenishment orders in the three months ended September 30, 2013 compared to the three months ended September 30, 2012. Net revenues for Sally Hansen were also negatively affected by an increasingly competitive retail environment. Also contributing to the decline in Sally Hansen were lower net revenues from Sally Hansen Salon Effectsand Sally Hansen Magnetic Nail Color, which generated stronger net revenues in the three months ended September 30, 2012 as new launches, partially offset by higher net revenues from gel nail color category products in the three months ended September 30, 2013. The decline in OPI in the U.S. primarily reflects the discontinuation of a particular product line sold exclusively by a large retailer, and lower net revenues of products sold through the professional nail salon chain. Lower net revenues in N.Y.C. New York Color, Astorand Manhattan also contributed to the decline in the Color Cosmetics segment. Partially offsetting the decline in the segment was an increase in Rimmel primarily reflecting the success of new launches Rimmel Scandal'eyes Retro Glam mascara and Rimmel Apocalips lip lacquer. The negative price and mix impact for the segment was primarily driven by unit price declines in most key brands within the segment primarily driven by a promotionally competitive retail environment.

Skin & Body Care

In the three months ended September 30, 2013, net revenues of Skin & Body Care decreased $0.7, to $162.2 from $162.9 in the three months ended September 30, 2012. The decrease was primarily the result of a decline in unit volume of 11% offset by a positive price and mix impact of 9% and a positive impact of foreign currency exchange translations of 2%. Excluding the positive impact of foreign currency exchange translations, net revenues of Skin & Body Care decreased 2% driven by lower net revenues from TJoy, partially reflecting the impact of commencing our distribution network reorganization. Partially offsetting the decline were higher net revenues from philosophy, primarily driven by higher orders from customers in the U.S. and higher net revenues from the direct-to-consumer distribution channel, along with increased net revenues from expanded international distribution. Net revenues increased slightly for adidas primarily driven by growth in Latin America and Eastern Europe, reflecting our strategy of accelerated growth in emerging markets, partially offset by lower revenues in Southern Europe and the U.S. The positive price and mix impact for the segment was primarily driven by higher relative volumes of higher-priced philosophy products.

Net Revenues by Geographic Regions

In addition to our reporting segments, management also analyzes our net revenues by geographic region. We define our geographic regions as Americas (comprising North, Central and South America), EMEA (comprising Europe, the Middle East and Africa) and Asia Pacific (comprising Asia and Australia).

                  Three Months Ended
                     September 30,
(in millions)     2013          2012         Change %
NET REVENUES
Americas        $   468.6     $   530.6          (12%)
EMEA                569.0         544.9           4%
Asia Pacific        140.6         137.6           2%
Total           $ 1,178.2     $ 1,213.1           (3%)

Americas

In the three months ended September 30, 2013, net revenues in the Americas decreased 12%, or $62.0, to $468.6 from $530.6 in the three months ended September 30, 2012. Excluding the negative impact of foreign currency exchange translations of 1% and the impact of net revenues related to the 2013 Ceased Activities of 1%, net revenues in the Americas decreased 10% primarily driven by lower net revenues in the U.S. The decline in the U.S. was primarily driven by lower net revenues in Color Cosmetics, primarily due to a decline in Sally Hansen and OPIas described under "Net Revenues by Segment-Color Cosmetics" above, and Fragrances, primarily reflecting the negative trend of the U.S. mass fragrance markets, lower net revenues from Lady Gaga and Beyoncé, due to a lower level of new launch activity in the three months ended September 30, 2013 compared to the three months ended September 30, 2012, and the expiration of certain licenses. In addition, customer orders that were received in the three months ended September 30, 2012, but which we anticipate receiving in the three months ended December 31, 2013, have also negatively affected net revenues for Fragrances in the U.S. as retailers are taking a cautious approach to the upcoming holiday season in the face of a slowing retail environment. Partially offsetting the decline in the Americas were higher net revenues in Latin America, reflecting our strategy of accelerated growth in emerging markets. Increases in Brazil, Chile and Argentina contributed to this growth.

EMEA

In the three months ended September 30, 2013, net revenues in EMEA increased 4%, or $24.1, to $569.0 from $544.9 in the three months ended September 30, 2012. Excluding the positive impact of foreign currency exchange translations, net revenues in EMEA increased 2%. Net revenues related to the 2013 Ceased Activities had an immaterial impact on the region. Growth in EMEA was primarily driven by the U.K., our travel retail business in the region and the Middle East, primarily reflecting strong growth in Fragrances from new launches within the Roberto Cavalli, Davidoff and Chloé brands. Higher net revenues in the U.K. also reflect earlier holiday orders, incremental net revenues from new launches Katy Perry Killer Queen and Vera Wang Be Jeweled and growth in Sally Hansen and philosophy. Growth in our travel retail business in the region and the Middle East also reflect higher net revenues in Color Cosmetics, primarily reflecting expanded distribution of OPI. Partially offsetting growth in the region were lower net revenues in our Southern European markets, particularly in France and Spain. The decline in Southern Europe primarily reflects difficult economic conditions and a competitive retail environment that is sensitive to pricing. Net revenues in Germany, our largest market in the region, were positively affected by foreign currency translations. Excluding the impact of foreign currency translations and the net revenues related to the 2013 Ceased Activities, net revenues in Germany were in line with the prior year.

Asia Pacific

In the three months ended September 30, 2013, net revenues in Asia Pacific increased 2%, or $3.0, to $140.6 from $137.6 in the three months ended September 30, 2012. The negative impact of foreign currency exchange translations of approximately 5% was predominantly driven by the devaluation of the Australian Dollar and Japanese Yen. Excluding the negative impact of foreign currency exchange translations, net revenues in Asia Pacific increased 7%. Growth in Asia Pacific was driven by all countries in the region, with the exception of China. Higher net revenues in Australia led growth in the region primarily reflecting higher net revenues from Fragrances brands, such as Calvin Klein, Joop! and Beyoncé, and incremental net revenues from the newly established brand Katy Perry Killer Queen, partially offset by lower net revenues from Lady Gaga, due to a lower level of new launch activity in the three months ended September 30, 2013 compared to the three months ended September 30, 2012. Higher net revenues in Singapore, our travel retail business and Hong Kong also contributed to growth in Asia Pacific, primarily driven by growth in prestige fragrances. Our travel retail business in the region also reflects higher net revenues from OPI. Growth in the region also reflects incremental net revenues from newly established subsidiaries in Taiwan, Thailand, Korea and Southeast Asia. The decline in China was primarily driven by lower net revenues of TJoy, partially offset by growth in adidas, Lancaster, Davidoff and Balenciaga.

COST OF SALES

In the three months ended September 30, 2013, cost of sales decreased $4.4, to $472.0 from $476.4 in the three months ended September 30, 2012. Cost of sales as a percentage of net revenues increased to 40.1% in the three months ended September 30, 2013 from 39.3% in the three months ended September 30, 2012, resulting in a gross margin decline of approximately 80 basis points. This decrease in gross margin primarily reflects the negative impact of higher customer discounts and allowances necessary to compete in the difficult market environment and the negative impact of foreign currency exchange transactions, partially offset by continued contribution from our supply chain savings program.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

In the three months ended September 30, 2013, selling, general and administrative expenses decreased $32.5, to $516.4 from $548.9 in the three months ended September 30, 2012. Selling, general and administrative expenses as a percentage of net revenues decreased to 43.8% in the three months ended September 30, 2013 from 45.2% in the three months ended September 30, 2012. This decrease of approximately 140 basis points primarily reflects lower share-based compensation expense and lower advertising and consumer promotion spending, partially offset by higher administrative costs. Lower share-based compensation expense primarily reflects the accounting modification from liability plan accounting for the three months ended September 30, 2012 to equity plan accounting for the three months ended September 30, 2013. The decrease in advertising and consumer promotion spending in part reflects a change in the type of promotional spend, resulting in expenses being recorded as a reduction to net revenues versus selling, general and administrative expenses. In total, promotional spend as a percentage of net revenues increased slightly reflecting our commitment to invest behind our brands. The increase in administrative costs primarily reflects higher rent and lease expense related to the real estate consolidation program and higher insurance expense. Excluding the negative impact of foreign currency exchange translations, administrative costs decreased slightly reflecting lower compensation expense primarily driven by management incentive programs and our focus on cost containment. This decrease in administrative costs was not enough to offset the decline in net revenues, resulting in an increase of administrative costs as a percentage of net revenues.

OPERATING INCOME

In the three months ended September 30, 2013, operating income decreased $0.3, to $165.6 from $165.9 in the three months ended September 30, 2012. Operating margin, or operating income as a percentage of net revenues, increased approximately 40 basis points to 14.1% of net revenues in the three months ended September 30, 2013 as compared to 13.7% in the three months ended September 30, 2012. This increase reflects margin improvement of approximately 140 basis points driven by lower selling, general and administrative expenses, partially offset by a decline in margin of approximately 100 basis points related to higher cost of sales in Color Cosmetics and Skin & Body Care partially offset by lower cost of sales in Fragrances, and higher restructuring expense and amortization expense.

Operating Income by Segment



                            Three Months Ended
                               September 30,
(in millions)                2013          2012       Change %
OPERATING INCOME (LOSS)
Fragrances                $    152.8      $ 134.3            14 %
Color Cosmetics                 36.8         73.2           (50 %)
Skin & Body Care                (3.5 )       (4.5 )         (22 %)
. . .
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