Business context and reporting period
Brown-Forman Corporation, a global beverage alcohol company, reported its first quarter of fiscal 2018, the three months ended July 31, 2017. Comparisons are with the three months ended July 31, 2016, unless otherwise noted. The unaudited interim statements use GAAP; management also presents non-GAAP “underlying” changes adjusted for acquisitions and divestitures, foreign exchange, and estimated distributor inventory changes.
Financial performance
| Metric | Q1 FY2018 | Prior period | Change |
|---|---|---|---|
| Net sales | $723 million | $661 million | +9% reported; +6% underlying |
| Gross profit / margin | $493 million / 68.1% | $453 million / 68.5% | Profit +9%; margin down 0.4 percentage points |
| Operating income / margin | $244 million / 33.7% | $213 million / 32.2% | Income +14%; margin up 1.5 percentage points; underlying income +12% |
| Net income | $178 million | $144 million | +24% |
| Diluted EPS | $0.46 | $0.36 | +27% |
| Cash provided by operations | $102 million | $128 million | Down $26 million |
| Cash and cash equivalents | $238 million at July 31, 2017 | $182 million at April 30, 2017 | Up $56 million |
| Total debt, including short-term borrowings | Approximately $2.23 billion | Approximately $2.15 billion at April 30, 2017 | Up approximately $79 million |
Underlying net sales growth comprised 4% volume growth and 2% price/mix. Cost of sales rose 11% reported and 6% underlying; management cited higher volume, mix, value-added packaging, and wood costs. Interest expense, net, was $15 million versus $12 million. The effective tax rate was 22.1%, compared with 28.2%.
Operating cash flow was reduced by a larger seasonal working-capital increase, partly offset by higher earnings. Investing cash use was $28 million, versus $324 million, which included $307 million of acquisition spending in the prior-year period. Financing used $31 million, compared with $398 million provided previously. Capital expenditures were $28 million; dividends paid were $70 million.
Material changes and business drivers
- Reported net sales benefited from foreign exchange and estimated distributor inventory growth; after the company’s adjustments, underlying net sales grew 6%. Distributor inventory increases were estimated to reduce the reported-to-underlying comparison by 3 percentage points.
- Jack Daniel’s family brands, tequila brands, and Woodford Reserve were key growth drivers. U.S. underlying net sales rose 5%; Europe rose 4%; Travel Retail rose 12%. Developed markets overall grew less than 1%. Japan declined, while the U.K. also faced underlying declines.
- Gross margin fell 40 basis points, principally due to foreign exchange. Operating margin increased 150 basis points, with lower underlying SG&A as a key contributor.
- Brown-Forman acquired BenRiach during the first fiscal quarter; its purchase price allocation was finalized June 1, 2017, with no material changes reported. The company’s underlying measures exclude acquisition/divestiture effects and specified non-comparable periods.
- Cash dividends declared were $0.365 per common share in total for the quarter; $0.1825 per share was paid during the period. The Board declared a further $0.1825 quarterly dividend payable October 2, 2017.
Outlook, risks, and contingencies
- Management expected full-year effective tax to be approximately 28%, reflecting known discrete items; the ordinary-income tax rate assumption was 29.0%.
- Management expected input costs to continue increasing in the low single digits. The filing provides no broader quantified full-year sales or earnings guidance.
- Liquidity was described as strong and sufficient for commitments. The company had $238 million cash and an undrawn $800 million bank credit facility supporting its commercial paper program. Commercial paper outstanding was $253 million at July 31, with an average rate of 1.29% and remaining maturity of 17 days. The facility matures November 20, 2018; its EBITDA-to-interest covenant minimum is 3:1, versus 17:1 at quarter-end.
- Foreign exchange, commodity and interest-rate exposures are managed in part through hedging; derivative contracts are not held for speculation. Foreign currency derivative notional amounts were $1.225 billion. A decline in creditworthiness could trigger payment or collateral demands; derivatives subject to such requirements had a net liability fair value of $26 million.
- Management cited risks including economic and currency changes, regulation and taxation, consumer preferences and alcohol-market trends, dependence on Jack Daniel’s growth, supply-chain disruption, competition, acquisitions, litigation, product liability, and information technology. No material changes to the prior annual report’s risk factors were reported.
- The company reported ordinary-course litigation, no material accrued loss contingencies, and no expectation that pending cases would materially harm its financial position, results, or liquidity. A Russian importer guarantee had approximately $5 million actual exposure and an approximately $11 million maximum exposure; related receivables were approximately $4 million and expected to be collected in full.
Important facts for investors to verify
- How much of reported growth reflects underlying consumer demand versus distributor inventory movements, foreign exchange, and acquisition/divestiture adjustments.
- Whether the 6% underlying sales growth and 12% underlying operating-income growth persist beyond the quarter, including in developed markets and Japan.
- Working-capital trends and cash conversion, given operating cash flow declined despite higher net income.
- The trajectory of margins against rising input costs and foreign-exchange effects, and the assumptions behind the approximately 28% full-year tax-rate outlook.
- Debt and refinancing needs, including commercial paper reliance, the January 2018 note maturity, and the November 2018 credit-facility maturity.
- BenRiach’s contribution and integration, and the company’s stated adjustments used in non-GAAP underlying comparisons.