Business context and reporting period
Brown-Forman Corporation, a global beverage-alcohol company, filed this unaudited Form 10-Q for the quarter ended January 31, 2020, the third quarter of its fiscal 2020, and the nine months then ended. Unless noted, financial amounts are in U.S. dollars. “Underlying” results are non-GAAP measures adjusted for specified effects including foreign exchange, acquisitions or divestitures, and estimated distributor-inventory changes.
Financial performance
| Metric | Three months ended Jan. 31, 2020 | Nine months ended Jan. 31, 2020 |
|---|---|---|
| Net sales | $899 million; essentially flat reported, +3% underlying | $2.654 billion; +3% reported and underlying |
| Gross profit / margin | $557 million; 61.9% margin, down 1.2 percentage points | $1.674 billion; 63.1% margin, down 2.2 points |
| Operating income / margin | $304 million, down 5% reported; 33.8% margin | $904 million, down 1% reported and underlying; 34.1% margin |
| Net income | $231 million, versus $227 million | $699 million, versus $676 million |
| Diluted EPS | $0.48, versus $0.47 | $1.45, versus $1.40 |
| Effective tax rate | 18.6%, versus 20.3% | 17.1%, versus 19.2% |
| Operating cash flow | Not separately presented for the quarter | $509 million, versus $577 million |
For the nine months, net sales growth reflected volume growth of 2% and price/mix growth of 1%. U.S. sales rose 7% reported; underlying growth was led by the United States and emerging markets. By category, tequila underlying sales rose 10% and whiskey 5%, while vodka declined 7%; non-branded and bulk sales fell 27% underlying.
Balance sheet, liquidity, and cash flow
At January 31, 2020, cash and cash equivalents were $276 million, total assets $5.518 billion, current assets $2.994 billion, and current liabilities $664 million. Long-term debt was $2.293 billion and short-term borrowings were $4 million. Cash was down $31 million from April 30, 2019. The company reported an undrawn $800 million bank credit facility supporting its commercial-paper program; commercial paper outstanding was $1 million at quarter-end. Approximately 79% of cash was held by foreign subsidiaries whose earnings were considered indefinitely reinvested outside the United States.
Nine-month investing cash outflow was $111 million, including $22 million for the acquisition of The 86 Company (Fords Gin) and $84 million of capital expenditures. Financing cash outflow was $426 million, including $242 million of dividends. Operating cash flow declined $68 million year over year, mainly reflecting a larger working-capital increase, partly offset by higher earnings.
Material changes versus the prior comparable period
- Nine-month net sales increased 3%, but operating income decreased 1%; gross and operating margins contracted, largely because of higher input costs and tariffs.
- Nine-month cost of sales rose 9% reported and 10% underlying. Management estimated that tariffs accounted for more than one-third of the increase in underlying cost of sales.
- Diluted EPS increased 4% for the nine months, benefiting from a lower effective tax rate and lower non-operating postretirement expense, despite weaker operating income.
- Quarterly reported net sales were essentially flat, while underlying net sales grew 3%; reported operating income fell 5%, while underlying operating income grew 5% after the company’s stated adjustments.
- The company acquired The 86 Company, owner of Fords Gin, for $22 million in cash in July 2019. The purchase-price allocation remained preliminary.
Outlook, commentary, and risks
Management revised its fiscal 2020 outlook to reflect tempered expectations in some international markets and the expected effects of COVID-19, particularly in Asia, China, and Travel Retail. It expected fiscal 2020 underlying net sales growth to be below fiscal 2019’s rate; there was no change to its outlook for underlying cost of sales or underlying operating expenses. The filing states the pandemic’s eventual impact was uncertain and could not be predicted.
Tariffs continued to pressure results through lower net prices in some markets and higher cost of sales where the company owned inventory, although the impact began to ease in the quarter. Other cited risks include foreign-exchange movements, economic and geopolitical uncertainty, consumer and channel shifts, input-cost and supply disruptions, distributor inventory fluctuations, regulation, and dependence on continued growth of the Jack Daniel’s brands. The company reported no material changes to the risk factors in its 2019 Form 10-K. It said pending legal matters were not expected to have a material adverse effect and recorded no material loss-contingency accruals. A guarantee for a Russian importer had approximately $6 million of actual exposure and a stated maximum possible exposure of about $10 million; the company expected to collect approximately $13 million in related receivables.
Most important facts for investors to verify
- Whether fiscal 2020 net-sales growth met management’s reduced outlook, especially given COVID-19 effects on China and Travel Retail.
- Whether tariff and input-cost pressures continued to weigh on gross margin and operating income after the reported easing in the quarter.
- The sustainability of U.S. and emerging-market growth, including launches and premium brands, against weakness in Travel Retail, vodka, and non-branded and bulk sales.
- Working-capital trends and operating cash generation, which weakened year over year, alongside inventory growth.
- The final purchase-price allocation and performance of Fords Gin, and developments in the Russian importer guarantee and receivable exposure.