Brown-Forman Corporation — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended January 31, 2019. Unless noted, amounts are in millions of dollars. Comparisons are with the prior-year comparable period.
Business context and performance
Brown-Forman sells beverage alcohol products globally. Management reported growth in underlying sales led by the Jack Daniel’s family, premium bourbon, and tequila, while retaliatory tariffs and higher input costs pressured gross profit and margins. “Underlying” measures are non-GAAP and adjust for items including foreign exchange, distributor inventory changes, and adoption of ASC 606.
Key financial metrics
| Metric | Three months ended Jan. 31, 2019 | Nine months ended Jan. 31, 2019 |
|---|---|---|
| Net sales | $904; up 3% reported and 4% underlying | $2,580; up 3% reported and 5% underlying |
| Gross profit | $571; down 3% | $1,684; approximately flat reported, up 3% underlying |
| Gross margin | 63.1%, down 3.7 percentage points | 65.3%, down 1.9 percentage points |
| Operating income | $320; up 4% reported and underlying | $916; up 2% reported and 4% underlying |
| Operating margin | 35.3%, up 0.4 percentage points | 35.5%, down 0.3 percentage points |
| Net income | $227, versus $190 | $676, versus $607 |
| Diluted EPS | $0.47, up 20% | $1.40, up 12% |
| Effective tax rate | 20.3%, versus 34.4% | 19.2%, versus 28.5% |
Quarterly sales grew 3% in the United States and 3% in emerging markets; tequila and whiskey were notable product-category contributors. For the nine months, reported whiskey net sales were $2,017 and tequila net sales were $200. Tariffs and higher wood and agave costs drove cost-of-sales growth above sales growth and compressed gross margin. Lower operating expenses supported operating income.
Cash flow and liquidity: Nine-month cash from operations was $577, compared with $582. Capital expenditures were $84; cash used in investing activities was $86. Cash used in financing was $458, including $231 of dividends and $206 of treasury-stock purchases. Cash increased $21 to $260. At January 31, current assets were $2,755 and current liabilities $895. Debt comprised $207 of short-term commercial paper and $2,301 of long-term debt. The company had an undrawn $800 bank credit facility supporting its $800 commercial-paper program.
Material changes and unusual items
- Retaliatory tariffs on American whiskey reduced sales pricing and increased cost of sales. Management estimated they reduced underlying sales growth by about one percentage point year to date and increased underlying cost-of-sales growth by about three percentage points.
- Quarterly gross margin fell to 63.1% from 66.8%; management attributed about 2.7 percentage points of the quarterly decline to tariff effects.
- A $13 pension settlement charge was recorded in non-operating postretirement expense after a significant increase in lump-sum pension payments.
- Lower tax rates, including the effect of U.S. tax reform, contributed to EPS growth; higher interest expense and the pension charge partly offset that benefit. Interest expense was $67 year to date versus $49.
- ASC 606 adoption reduced retained earnings by $25, net of tax, at May 1, 2018. Its reported effect on nine-month net income was a $2 reduction; the quarterly effect was a $4 increase. Management said the timing change was not expected to have a significant full-year effect.
- The company completed its $200 share-repurchase authorization in November 2018. It repurchased approximately 4.23 million shares during the program.
Outlook, risks, and contingencies
- Fiscal 2019 outlook was unchanged: underlying net-sales growth was expected to be similar to fiscal 2018; underlying operating-income growth was expected to decelerate from fiscal 2018, largely due to tariffs.
- Management expected underlying cost of sales to grow significantly faster than net sales over the remainder of fiscal 2019, citing tariffs and high-single-digit input-cost increases. It expected lower gross margin for the remaining period and a modest negative foreign-exchange effect.
- The expected full-year effective tax rate was 19.0%–20.0%.
- Risks include tariffs and trade retaliation, currency movements, changes in consumer preferences, supply-chain and input-cost pressures, distributor inventory changes, regulation, and dependence on the Jack Daniel’s family of brands. The filing reported no material changes to the risk factors in the 2018 Form 10-K.
- Management said existing legal contingencies were not reasonably expected to materially affect financial position, results, or liquidity; no material loss contingency was accrued. A guarantee for a Russian importer had approximately $6 of actual exposure and a maximum possible exposure of about $10; related receivables were approximately $8 and expected to be collected in full.
- Management stated that liquidity was sufficient to meet financial commitments. Approximately $210 of cash was held by foreign subsidiaries whose earnings were indefinitely reinvested outside the United States. The company repatriated about $120 from one subsidiary during the quarter and said future repatriations could entail additional taxes.
Important facts for investors to verify
- Whether tariff levels, mitigation actions, and input costs evolve as assumed in the fiscal 2019 outlook.
- Underlying versus reported sales and operating-income trends, including the effects of distributor inventories, foreign exchange, and ASC 606.
- Whether gross margins recover after the reported tariff- and input-cost-related compression.
- Cash generation, debt and commercial-paper usage, capital allocation, and any additional share repurchases or foreign-cash repatriations.
- The final full-year tax rate and any subsequent changes to tax, legal, or importer-guarantee exposures.