Business context and reporting period
Brown-Forman Corporation’s unaudited Form 10-Q covers the three and six months ended October 31, 2013 (fiscal 2014), compared with the corresponding 2012 periods. The company sells beverage alcohol brands, including Jack Daniel’s, Finlandia, Southern Comfort, and Woodford Reserve. Management uses constant-currency and “underlying” measures; underlying results exclude currency effects and estimated changes in distributor inventories.
Financial performance
| Metric | Three months ended Oct. 31, 2013 | Six months ended Oct. 31, 2013 |
|---|---|---|
| Net sales | $1.079 billion; +6% reported, +8% underlying | $1.975 billion; +4% reported, +7% underlying |
| Gross profit / gross margin | $576 million; 53.4% (up 1.7 percentage points) | $1.053 billion; 53.3% (up 1.0 point) |
| Operating income / operating margin | $311 million; 28.8%; +19% reported, +21% underlying | $528 million; 26.7%; +9% reported, +13% underlying |
| Net income | $206 million; +19% | $349 million; +9% |
| Diluted EPS | $0.96; +19% | $1.62; +9% |
| Effective tax rate | 32.4%, versus 32.8% | 32.4%, versus 32.5% |
For the six months, operating cash flow was $201 million, compared with $165 million a year earlier. Capital expenditures were $60 million, versus $39 million, largely reflecting construction of a cooperage facility in Decatur, Alabama. Financing activities used $153 million, including $109 million in dividends and $49 million in treasury-share purchases. Cash declined $12 million to $192 million.
At October 31, 2013, total debt was approximately $1.004 billion: $997 million long-term, $1 million current portion, and $6 million short-term borrowings. Cash was $192 million. Current assets were $2.033 billion and current liabilities $542 million. The company reported an 800-million-dollar bank credit facility, then unused, and a 26-to-1 EBITDA-to-interest covenant ratio against a 3-to-1 minimum.
Material changes and operating drivers
- Reported sales growth trailed underlying growth: management attributed the difference primarily to unfavorable foreign exchange and lower estimated distributor inventories. For the six months, these effects reduced reported sales growth by approximately three percentage points in total.
- Growth was led by Jack Daniel’s, including Tennessee Whiskey and Tennessee Honey, and by super-premium brands such as Woodford Reserve. Price increases and favorable product mix contributed to margin gains; management estimated better price/mix accounted for about three percentage points of underlying sales growth.
- Southern Comfort sales declined amid weaker consumer demand, competition from flavored spirits, and weakness in the U.S. on-premise channel. New Mix RTD sales also fell, affected by elevated customer inventories at the start of the year following prior-year price-related buy-ins.
- Advertising increased 8% for the six months as the company invested across its brands. SG&A rose 3% reported (4% underlying), including higher compensation and staffing ahead of a France route-to-consumer change.
- Interest expense increased, which management attributed to higher average net debt. Six-month diluted EPS nevertheless rose 9%.
Outlook, risks, and contingencies
Fiscal 2014 diluted EPS guidance remained $2.80–$3.00. Management continued to expect high-single-digit underlying net sales growth and underlying operating income growth of 9%–11%. Guidance includes an expected $0.06-per-share adverse effect from lower inventories associated with the France route-to-consumer transition planned for January 1, 2014, and anticipates somewhat higher second-half operating expense growth.
Key risks cited include foreign-exchange and commodity-price changes, economic and geopolitical conditions, regulation and taxation of beverage alcohol, changing consumer preferences, dependence on Jack Daniel’s growth, competition, supply-chain disruption, distributor inventory movements, route-to-consumer changes, litigation, product quality, and information-technology failures. The company reported no material accrued loss contingencies and said litigation was not expected to materially adversely affect its financial position, results, or liquidity. It guaranteed a third-party importer’s facility, with approximately $45 million current exposure and a $47 million maximum; default was considered unlikely.
Cash held by foreign subsidiaries included $102 million that the company expected to reinvest indefinitely outside the United States; repatriation could trigger U.S. taxes. The board increased the quarterly dividend from $0.255 to $0.29 per share after quarter-end. A share repurchase authorization of up to $250 million ran from October 1, 2013, through September 30, 2014; $47 million had been repurchased by October 31.
Important facts for investors to verify
- Whether underlying sales and profit growth translate into reported results as distributor inventories and foreign-exchange effects change.
- Progress and costs of the France route-to-consumer transition, including its inventory and EPS effects.
- Continued momentum in Jack Daniel’s and premium brands, and whether weakness in Southern Comfort and New Mix persists.
- Capital spending, debt and cash trends, share repurchases, and the sustainability of the raised dividend.
- Potential tax, currency, commodity, litigation, and importer-guarantee exposures.