Business context and reporting period
Brown-Forman Corporation, a beverage-alcohol company with brands including Jack Daniel’s, reported unaudited results for the three and nine months ended January 31, 2011, compared with the same periods of fiscal 2010. Its fiscal year ends April 30.
Financial performance
| Metric | Three months ended Jan. 31, 2011 | Nine months ended Jan. 31, 2011 |
|---|---|---|
| Net sales | $962.4 million; up 12% | $2,613.0 million; up 5% |
| Gross profit / margin | $463.5 million / 48.2% | $1,301.1 million / 49.8% |
| Operating income / margin | $225.5 million / 23.4% | $633.1 million / 24.2% |
| Net income | $140.7 million; up 30% | $406.1 million; up 8% |
| Diluted EPS | $0.96; up 32% | $2.77; up 10% |
| Effective tax rate | 35.6% | 33.8% |
| Cash from operations | Not separately provided | $399.5 million, down from $424.5 million |
For the quarter, net sales growth reflected 7% underlying growth, 3% estimated distributor-inventory change, and 2% foreign exchange. For the nine months, growth comprised 4% underlying growth and 1% foreign exchange. Stronger brands included Jack Daniel’s, el Jimador, Herradura and Woodford Reserve; Fetzer and some other brands offset growth. Distributor inventory changes and foreign exchange contributed materially to reported quarterly results.
Liquidity, debt and capital allocation
Cash and cash equivalents were $278.6 million at January 31, 2011, up $47.0 million from April 30, 2010. Nine-month investing cash use was $16.8 million; financing cash use was $338.4 million. Cash from operations declined, principally due to increased pension funding and working-capital changes.
Total debt was approximately $759.8 million, including $756.7 million long-term debt, $3.0 million current long-term debt and $0.1 million short-term borrowings; total debt was approximately $698.3 million at April 30, 2010. The increase included $248.4 million of proceeds from 2.5% notes due 2016. The company reported an unused $800 million credit facility and a 29-to-1 EBITDA-to-interest covenant ratio against a 3-to-1 minimum. Management considered liquidity sufficient for foreseeable commitments.
Nine-month dividends declared were $2.24 per share, including a $1.00 special dividend; $1.92 per share was paid. The company repurchased approximately $117.1 million of shares under its authorization.
Changes, outlook and notable matters
- Quarterly gross margin rose 50 basis points year over year; nine-month gross margin rose 30 basis points. Operating margins also improved. Quarterly operating income growth included the absence of the prior-year $11.6 million Don Eduardo brand impairment, inventory effects and currency benefits.
- Nine-month selling, general and administrative expense rose 9%, partly from higher pension and postretirement costs, route-to-market changes and expenses related to the planned wine-asset sale. Management expected pension expense to remain higher in the fourth quarter.
- Fiscal 2011 diluted EPS guidance was raised to $3.35–$3.45, excluding the anticipated Fetzer sale gain. Management expected mid-single-digit underlying operating-income growth, continued underlying sales trends, current foreign-exchange rates, a lower effective tax rate and moderated SG&A.
- On March 1, 2011, Brown-Forman agreed to sell Fetzer Vineyards and related brands and facilities for $238 million cash, subject to working-capital adjustment, regulatory clearance and customary conditions. Closing was expected in April 2011; the company anticipated a net gain of $0.20–$0.30 per share.
- Key risks include economic and consumer-spending weakness, competition and pricing, distributor inventory and route-to-market changes, foreign exchange, commodity and agricultural costs, regulation and litigation, and pension assumptions. The company reported no material accrued loss contingencies.
- Herradura’s estimated fair value exceeded its $124.2 million book value by only about $2 million. Management said a 50-basis-point increase in cost of capital could reduce fair value by $12 million and trigger a non-cash impairment.
Important facts for investors to verify
- Whether reported sales and profit growth are sustained by underlying demand, rather than distributor inventory movements and foreign exchange.
- Delivery against the $3.35–$3.45 diluted EPS outlook and the assumptions on tax rate, expenses and currency.
- Completion, final proceeds and gain from the Fetzer transaction, including regulatory approval and working-capital adjustments.
- Debt levels, refinancing and access to the credit facility, as well as cash flow after dividends, repurchases and pension contributions.
- Herradura impairment sensitivity and the trend in pension expense and funding requirements.