Business context and reporting period
Brown-Forman Corporation, a global beverage-alcohol company, filed this unaudited Form 10-Q for the quarter and nine months ended January 31, 2016 (fiscal 2016 third quarter). Comparisons are with the corresponding periods ended January 31, 2015. Unless noted, financial amounts are in millions of U.S. dollars.
Key financial metrics
| Metric | Three months | Nine months |
|---|---|---|
| Net sales | $1,083; down 1% reported, up 4% underlying | $3,078; down 2% reported, up 5% underlying |
| Gross profit / margin | $555; 51.3%, versus 50.6% | $1,631; 53.0%, versus 52.6% |
| Operating income / margin | $278; 25.7%, versus $272 and 24.9% | $807; 26.2%, versus $795 and 25.2% |
| Net income | $190, versus $186 | $545, versus $543 |
| Diluted EPS | $0.94, up 7% | $2.65, up 4% |
| Interest expense | $12, versus $6 | $34, versus $21 |
| Cash from operations | Not separately stated for the quarter | $448, versus $375 |
Underlying measures are non-GAAP and adjust for foreign exchange, estimated distributor-inventory changes where applicable, and certain Southern Comfort and Tuaca sale-related costs. Reported sales were pressured by the stronger U.S. dollar. Management attributed underlying growth principally to favorable price/mix and the American whiskey portfolio; nine-month underlying sales growth included 1% from volume and 4% from net price/mix.
Balance sheet, cash flow, and capital allocation
- At January 31, 2016, cash and cash equivalents were $317, down from $370 at April 30, 2015. Operating cash flow was $448; investing activities used $90, including $88 of property, plant, and equipment additions; financing activities used $400. Cash declined by $53 during the nine months.
- Total debt was approximately $1,738 at January 31 ($509 short-term borrowings and $1,229 long-term debt), versus $1,183 at April 30. Short-term borrowings included $506 of commercial paper. Debt rose in part following a $500 million-principal, 4.50% note issue in June 2015; $250 million of notes matured and were repaid in January 2016.
- The company reported an undrawn $800 million bank credit facility and a $1 billion commercial-paper program. Management described liquidity as strong and sufficient for future commitments. Its credit-facility interest-coverage covenant was 27-to-1 against a 3-to-1 minimum.
- During the nine months, the company paid $199 in dividends and spent $762 on treasury-stock purchases. It reported returning $961 to shareholders through dividends and repurchases. A quarterly dividend of $0.34 per share was declared, payable April 1, 2016.
- Inventory was $1,031, up from $953 at April 30; barreled whiskey inventory increased to $634 from $571. The company uses LIFO for most inventory; current-cost inventory exceeded reported inventory by $248 at January 31.
Material changes and business performance
- Underlying operating income increased 7% for the nine months, while reported operating income rose 2%. The stronger dollar reduced reported results; underlying gross and operating margins expanded.
- Jack Daniel’s family underlying sales grew 7% for the nine months, led in part by Jack Daniel’s Tennessee Fire, Tennessee Whiskey, and Tennessee Honey. Woodford Reserve underlying sales rose 29%; Herradura rose 12%.
- Underlying sales declined for Finlandia (5%), Southern Comfort (6%), and Canadian Mist (10%). Russia remained weak amid economic pressures and consumer preference shifts toward local products. Management also cited strength in U.S. and European demand for American whiskey.
- Share repurchases reduced weighted-average diluted shares, supporting EPS growth; higher interest expense partly offset the benefit.
Outlook, risks, contingencies, and unusual items
- Management expected input costs to increase in the low single digits for the remainder of fiscal 2016. The filing provides no clear full-year sales or earnings guidance.
- The sale of Southern Comfort and Tuaca to Sazerac closed March 1, 2016, after quarter-end, for approximately $542 in cash, subject to a post-closing inventory adjustment. Brown-Forman expected a one-time operating-income gain of approximately $483 in the quarter ending April 30, 2016; proceeds were intended for general corporate purposes.
- Key risks include foreign-exchange movements, consumer and category trends, dependence on continued growth of the Jack Daniel’s family, competition, regulation and taxation, supply or production disruption, distributor inventory fluctuations, and legal or product-liability matters. The company reported no material changes to the risk factors in its 2015 Form 10-K.
- Management said pending litigation was not expected to have a material adverse effect and recorded no material accrued loss contingencies. A guarantee for a Russian importer had approximately $8 of actual exposure and a maximum possible exposure of approximately $19; the company also had $19 of receivables from that importer, which it expected to collect in full.
- Currency derivatives had $1,274 of notional value at January 31. The company expected to reclassify $45 of deferred net gains into earnings over the following 12 months to offset anticipated hedged exposures. It stated that it did not use derivatives for speculation.
Important facts for investors to verify
- How much of underlying sales and operating-income growth reflects durable consumer demand and pricing versus currency, distributor inventory estimates, and product mix.
- Whether the expected $483 million sale gain and approximately $542 million proceeds are realized as estimated, including the final inventory adjustment and use of proceeds.
- Whether higher debt, interest expense, and commercial-paper reliance remain manageable after the sale and continued repurchases and dividends.
- Whether growth in Jack Daniel’s and premium brands can offset declines in Finlandia, Southern Comfort, Canadian Mist, and weaker markets such as Russia.
- How input-cost inflation, foreign exchange, and the company’s disclosed market, regulatory, and consumer risks affect results in subsequent periods.