Item 1. Business
Item 1. Business.
Overview
Coty Inc. is one of the world’s largest beauty companies with a rich entrepreneurial heritage and an iconic portfolio of brands across fragrance, color cosmetics, hair color and styling, and skin and body care. Founded in 1904, Coty has grown into a multi-segment beauty company with market leading positions in both North America and Europe. Through targeted strategic transactions, we have strengthened and diversified our presence across the countries, categories and channels in which we compete, building a strong beauty platform. The recent King Kylie transaction and the pending transaction with Kim Kardashian West complement our existing portfolio. As we continue to transform our Company, we are focused on the fragrance, color cosmetics and skin care categories, in both our prestige and mass beauty businesses.
Following a strategic review, we announced, on June 1, 2020, the entry into a definitive agreement with Rainbow UK Bidco Limited (“KKR Bidco”) (an affiliate of funds and/or separately managed accounts (“KKR Funds”) advised and/or managed by Kolberg Kravis Roberts & Co. L.P. and its affiliates (“KKR”)), regarding a strategic transaction (the “Wella Transaction”) for the sale of Coty’s Professional and Retail Hair business, including the Wella, Clairol, OPI and ghd brands (together, “Wella Business”). Pursuant to a related separation agreement (the “Separation Agreement”), the Wella Business will be separated from Coty as a stand-alone, separately managed business, of which KKR Funds will own approximately 60% and Coty will own the remaining approximately 40% . As part of the separation, through a separate transitional service agreement and related agreements to be entered into at closing of the sale (the “Wella TSA”), Coty will provide ongoing financial, distribution, operations and other services for the Wella Business, in certain cases for up to 24 months following the closing of the sale, subject to an extension for a period of up to three months for certain transition services. In addition, KKR Rainbow Aggregator L.P. (“KKR Aggregator”) (an affiliate of KKR Funds) has in a separate transaction invested an aggregate of $1 billion directly into Coty through the issuance of convertible preferred stock. Assuming full conversion of these shares of convertible preferred stock and no other changes in capitalization, JABC would remain Coty’s largest shareholder, with approximately 50% ownership in the Company. KKR Aggregator would be the second largest shareholder, with an approximate 17% stake. The Wella Business is presented in our financial statements as discontinued operations. Unless otherwise noted, the discussion in this Annual Report only focuses on results of continuing operations.
Building on the multi-year turnaround plan launched in July 2019 (the “Turnaround Plan”), we are implementing a comprehensive transformation agenda (the “Transformation Plan”) which aims to stabilize and gradually accelerate revenue growth, improve our profitability through gross margin growth and cost control, optimize our operating model for speed and agility, accelerate e-commerce and digital growth, and deleverage our balance sheet. In 2020, we made organizational changes to reduce geographic fragmentation and costs. In response to the COVID-19 pandemic, in May 2020, we expanded the Turnaround Plan to implement a 25% reduction of our cost base, which does not vary with revenues, by the end of fiscal 2023, including reprioritizing projects providing larger cost reduction benefits, organizational restructuring, an adaptation of our supply network and organization as well as a reduction of certain discretionary expenses. We are continually reviewing ways to accelerate and amplify the transformation of the Company, including through the implementation of additional initiatives in connection with our T ransformation Plan.
All dollar amounts in the following discussion are in millions of United States (“U.S.”) dollars, unless otherwise indicated.
Segments
Operating and reportable segments (referred to as “segments”) reflect the way the Company is managed and for which separate financial information is available and evaluated regularly by the Company’s chief operating decision makers (“CODM”) in deciding how to allocate resources and assess performance. The Company has designated its Chief Executive Officer as the CODM.
In connection with our Turnaround Plan, the Company's CODM changed the reporting structure used to allocate resources from the previous category focused organizational structure that included three operating and reportable segments: Luxury, Consumer Beauty and Professional Beauty, to a structure based on regional commercial business units. These changes were implemented during the three months ended March 31, 2020.
For segment financial information and information about our long-lived assets, see Note 5— Segment Reporting in the notes to our Consolidated Financial Statements, and for information about recent acquisitions or dispositions, see Note 4—Business Combinations, Asset Acquisitions and Divestitures in the notes to our Consolidated Financial Statements.
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Brands
The following chart reflects our iconic brand po rtfolio:
Mass Beauty Prestige Professional Beauty
Adidas Alexander McQueen Clairol Professional*, **
Beckham Burberry ghd (good hair day)*, **
Biocolor* Bottega Veneta Kadus Professional*, **
Bozzano* Calvin Klein Londa Professional*, **
Bourjois* Cavalli Nioxin*, **
Bruno Banani Chloe O P I*, **
Clairol*, ** Davidoff Sassoon Professional, **
CoverGirl* Escada* Sebastian*, **
Enrique Gucci System Professional*, **
Jovan* Hugo Boss Wella Professional*, **
Max Factor* Jil Sander WeDo Professional*, **
Mexx Joop!*
Monange* Kylie Jenner
Nautica Lacoste
Paixao* Lancaster*
Rimmel* Marc Jacobs
Risque* Miu Miu
Sally Hansen* Nikos
Stetson philosophy*
Wella*, ** Tiffany & Co.
007 James Bond
* Indicates an owned beauty brand.
** Indicates brand included in Wella Transaction
Marketing
We have a diverse portfolio of over 75 brands (including brands associated with the Wella Business which will be transferred to the standalone entity in the Wella Transaction), some owned and some licensed, and we employ different models to create a distinct image and personality suited to each brand’s equity, distribution, product focus and consumer. For our licensed brands, we work with licensors to promote brand image. Each of our brands is promoted with logos, packaging and advertising designed to enhance its image and the uniqueness of each brand. We manage our creative marketing work through a combination of our in-house teams and external agencies that design and produce the sales materials, social media strategies, advertisements and packaging for products in each brand.
We promote our brands through various channels to reach and engage beauty consumers, through traditional media, through in-store and in-salon displays, on digital and social media, and through collaborations, product placements and events. In addition, we seek editorial coverage for products and brands in both traditional media and digital and social media to drive influencer amplification and to build brand equity. We also leverage our relationships with celebrities and on-line influencers to endorse certain of our products. Our marketing efforts benefit from cooperative advertising programs with retailers, often in connection with in-store marketing activities designed to engage consumers so that they try, or purchase, our products, including sampling and “gift-with-purchase” programs designed to stimulate product trials.
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We have dedicated marketing and sales forces in most of our significant markets. These teams leverage local insights to strategically promote our brands and product offerings and tailor our creative marketing to fit local tastes and resonate with consumers most effectively.
We utilize in-depth brand and market data analytics to develop branding, merchandising and marketing execution strategies to maximize the consumer experience and build a better business. We have begun to shift working media resources to a select number of brand/country combinations, which we believe represents a significant opportunity for revenue and gross margin improvement, and to implement a tactical, in-store strategy for the others.
Distribution Channels and Retail Sales
We market, sell and distribute our products in over 150 countries and territories, with dedicated local sales forces in most of our significant markets. We have a balanced multi-channel distribution strategy which complements our product categories. Our mass beauty brands are primarily sold through hypermarkets, supermarkets, drug stores and pharmacies, mid-tier department stores, traditional food and drug retailers, and dedicated e-commerce retailers. The prestige products are primarily sold through prestige retailers, including perfumeries, department stores, e-retailers, direct-to-consumer websites and duty-free shops. The Professional Beauty division primarily sells products to nail and hair salons, nail and hair professionals and professionals’ stores, through both direct sales forces and e-commerce platforms. Due to the impact of COVID-19, we have focused on expanding our e-commerce and direct-to-consumer channels. We also sell our products through third-party distributors. In fiscal 2020, no retailer accounted for more than 10% of our global net revenues; however, certain retailers accounted for more than 10% of net revenues within certain geographic markets and segments. In fiscal 2020, Walmart, our top retailer, accounted for approximately 7% of total Coty Inc. net revenues from continuing operations.
Innovation
Innovation is a pillar of our business. We innovate through brand-building and new product lines, as well as through new technology. Our research and development teams work with our marketing and operations teams to identify recent trends and consumer needs and to bring products quickly to market.
We are continuously innovating to increase our sales by elevating our digital presence, including e-commerce and digital, social media and influencer marketing designed to build brand equity and consumer engagement. We have also focused our efforts on meeting evolving consumer shopping preferences and behaviors, both on-line and in-store. We have introduced new ways to customize the consumer experience, including using artificial intelligence-powered tools to provide personalized advice on selecting and using products, and augmented reality tools that invite customers to virtually try products with curated looks, tutorials and product recommendations.
In addition, we continuously seek to improve our products through research and development. Our basic and applied research groups, which conduct longer-term and “blue sky” research, seek to develop proprietary new technologies for first-to-market products and for improving existing products. This research and development is done both internally and through affiliations with various universities, technical centers, supply partners, industry associations and technical associations. A number of our products incorporate patented, patent-pending or proprietary technology. In addition, several of our products and/or packaging for our products are covered by design rights protections.
Our principal research and development centers are located in the U.S. and Europe. See “\Item 2—. Properties.”
We do not perform, nor do we commission any third parties on our behalf to perform, testing of our products or ingredients on animals except where required by law.
Supply Chain
During fiscal year 2020, we continued to manufacture and package approximately 80% of our products (including the Wella Business products), primarily in facilities located in the United States, various countries in Europe including Russia, Brazil, China, Mexico and Thailand. We recognize the importance of our employees at our manufacturing facilities and have in place programs designed to ensure operating safety. In addition, we implement programs designed to ensure that our manufacturing and distribution facilities comply with applicable environmental rules and regulations. To capitalize on innovation and other supply chain benefits, we continue to utilize a network of third-party manufacturers on a global basis who produce approximately 20% of our finished products. As part of our ongoing Transformation Plan, we are exploring options to further optimize our supply chain operations.
The principal raw materials used in the manufacture of our products are primarily essential oils, alcohols and specialty chemicals. The essential oils in our fragrance products are generally sourced from fragrance houses. As a result, we realize material cost savings and benefits from the technology, innovation and resources provided by these fragrance houses.
We purchase the raw materials for all our products from various third parties. We also purchase packaging components that are manufactured to our design specifications. We collaborate with our suppliers to meet our stringent design and creative criteria. We believe that we currently have adequate sources of supply for all our products.
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We have experienced disruptions in our supply chain from time to time, including in connection with our past restructuring efforts, and we work to anticipate and respond to actual and potential disruptions.
Competition
There is significant competition within each market where our products are sold. We compete against manufacturers and marketers of beauty products, hair care, salon professional and personal care products. In addition to the established multinational brands against which we compete, small targeted niche brands continue to enter the beauty market. We also have competition from private label products sold by retailers.
We believe that we compete primarily on the basis of perceived value, including pricing and innovation, product efficacy, service to the consumer, promotional activities, advertising, special events, new product introductions, e-commerce initiatives, direct sales and other activities (including influencers). It is difficult for us to predict the timing, scale and effectiveness of our competitors’ actions in these areas or the timing and impact of new entrants into the marketplace. For additional risks associated with our competitive position, see “Risk Factors—The beauty industry is highly competitive, and if we are unable to compete effectively, our business, prospects, financial condition and results of operation could suffer”.
Intellectual Property
We generally own or license the trademark rights in key sales countries in Trademark International Class 3 (covering cosmetics and perfumery) for use in connection with our brands. When we license trademark rights we generally enter into long-term licenses, and we are generally the exclusive trademark licensee for all Class 3 trademarks as used in connection with our products. We or our licensors, as the case may be, actively protect the trademarks used in our principal products in the U.S. and significant markets worldwide. We consider the protection of our trademarks to be essential to our business.
A number of our products also incorporate patented, patent-pending or proprietary technology in their respective formulations and/or packaging, and in some cases our product packaging is subject to copyright, trade dress or design protection. While we consider our patents and copyrights, and the protection thereof, to be important, no single patent or copyright, or group of related patents or copyrights, is material to the conduct of our business.
Products representing 59% of our fiscal 2020 net revenues from continuing operations are manufactured and marketed under exclusive license agreements granted to us for use on a worldwide and/or regional basis. As of June 30, 2020, we maintained 27 brand licenses.
Our licenses impose obligations and restrictions on us that we believe are common to many licensing relationships in the beauty industry, such as paying annual royalties on net sales of the licensed products, maintaining the quality of the licensed products and the image of the applicable trademarks, achievement of minimum sales levels, promotion of sales and qualifications and behavior of our suppliers, distributors and retailers. We believe that we are currently in material compliance with the terms of our material brand license agreements.
Most brand licenses have renewal options for one or more terms, which can range from two to ten years. Certain brand licenses provide for automatic extensions, so long as minimum annual royalty payments are made, while renewal of others is contingent upon attaining specified sales levels or upon agreement of the licensor. Five of our brand licenses are up for renewal during fiscal 2021, of which only four license renewals require licensor approval and together accounted for less than 2% of fiscal 2020 revenues from continuing operations. Additionally, none of our top 9 licenses expire within the next five years, other than one with an automatic renewal that is not contingent upon licensor consent nor specified sales levels.. For additional risks associated with our licensing arrangements, see “Risk Factors—Our brand licenses may be terminated if specified conditions are not met, and we may not be able to renew expiring licenses on favorable terms or at all” and “Risk Factors—Our failure to protect our reputation, or the failure of our partners or brand licensors to protect their reputations, could have a material adverse effect on our brand images”.
Employees
As of June 30, 2020, we had approximately 18,260 full-time employees in over 46 countries, including approximately 5,900 employees of the Wella Business. In addition, we typically employ a large number of seasonal contractors during our peak manufacturing and promotional season. During fiscal year 2020, we adjusted our workforce through furlough or other reduction as we implemented our response to COVID-19. We expect our overall headcount, as well as the use of seasonal contractors, to decrease as we continue our efforts to restructure and rationalize our business in connection with our Transformation Plan.
Our employees in the U.S. are not covered by collective bargaining agreements. Our employees in certain countries in Europe are subject to works council arrangements and collective bargaining agreements. We have not experienced a material strike or work stoppage in the U.S. or any other country where we have a significant number of employees.
We recognize the importance of our employees to our business and believe our relationship with our employees is satisfactory.
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Government Regulation
We and our products are subject to regulation by various U.S. federal regulatory agencies as well as by various state and local regulatory authorities and by the applicable regulatory authorities in the countries in which our products are produced or sold. Such regulations principally relate to the ingredients, labeling, manufacturing, packaging, advertising and marketing and sales and distribution of our products. Because we have commercial operations overseas, we are also subject to the U.S. Foreign Corrupt Practices Act (the “FCPA”) as well as other countries’ anti-corruption and anti-bribery regimes, such as the U.K. Bribery Act.
We are subject to numerous foreign, federal, provincial, state, municipal and local environmental, health and safety laws and regulations relating to, among other matters, safe working conditions, product stewardship and environmental protection, including those relating to emissions to the air, discharges to land and surface waters, generation, handling, storage, transportation, treatment and disposal of hazardous substances and waste materials, and the registration and evaluation of chemicals. We maintain policies and procedures to monitor and control environmental, health and safety risks, and to monitor compliance with applicable environmental, health and safety requirements. Compliance with such laws and regulations pertaining to the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had a material effect upon our capital expenditures, earnings or competitive position. However, environmental and social responsibility laws and regulations have tended to become increasingly stringent and, to the extent regulatory changes occur in the future, they could result in, among other things, increased costs and risks of non-compliance for us. For example, certain states in the U.S., such as California, and the U.S. Congress have proposed legislation relating to chemical disclosure and other requirements related to the content of our products. For more information, see “Risk Factors—Changes in laws, regulations and policies that affect our business or products could adversely affect our business, financial condition and results of operations.”
Seasonality
The Company’s sales generally increase during the second fiscal quarter as a result of increased demand associated with the winter holiday season. Financial performance, working capital requirements, sales, cash flows and borrowings generally experience variability during the three to six months preceding the holiday season. Product innovations, new product launches and the size and timing of orders from the Company’s customers may also result in variability. The Wella Business also generally experiences an increase in sales during its fourth fiscal quarter as a result of higher demand prior to the summer holiday season. However, the mix of product sales can vary considerably as a result of changes in seasonal and geographic demand for particular types of products, as well as other macroeconomic, operating and logistics-related factors, as evidenced by the impact of the COVID-19 pandemic.
Availability of Reports
We make available financial information, news releases and other information on our website at www.coty.com. There is a direct link from our website to our SEC filings via the EDGAR database at www.sec.gov, where our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge as soon as reasonably practicable after we file such reports and amendments with, or furnish them to, the SEC. Stockholders may also contact Investor Relations at 350 Fifth Avenue, New York, New York 10118 or call 212-389-7300 to obtain hard copies of these filings without charge.