Brown-Forman Corporation — Form 10-Q Summary
Business context and reporting period. This filing covers the quarter and six months ended October 31, 2016, the second quarter and first half of fiscal 2017. Brown-Forman sells spirits and other beverage products globally. Financial statements recast prior periods to present excise taxes net of sales; all share and per-share figures reflect the August 2016 two-for-one stock split.
Financial results
| Metric | Three months ended Oct. 31, 2016 | Six months ended Oct. 31, 2016 |
|---|---|---|
| Net sales | $830 million; down 3% reported, up 3% underlying | $1.491 billion; down 4% reported, up 2% underlying |
| Gross profit / margin | $552 million; 66.5%, down 2.1 percentage points | $1.005 billion; 67.4%, down 2.0 percentage points |
| Operating income / margin | $291 million; 35.1%, down 0.3 percentage points | $504 million; 33.8%, down 0.3 percentage points |
| Net income | $197 million, versus $200 million | $342 million, versus $356 million |
| Diluted EPS | $0.50, up 3% from $0.49 | $0.87, up 1% from $0.86 |
| Cash from operations | Not separately reported for the quarter | $169 million, versus $161 million |
Underlying figures are non-GAAP measures adjusted for foreign exchange, estimated distributor inventory changes, and acquisitions or divestitures. Management says first-half underlying operating income increased 7%; reported operating income declined 5%. First-half net sales growth reflected 1% volume growth and 1% price/mix. Reported results were affected by currency movements and the sale of Southern Comfort and Tuaca.
Cash, debt, and liquidity
- Cash and cash equivalents were $211 million at October 31, 2016, down $52 million from April 30. Operating cash flow was $169 million; investing activities used $344 million, including $307 million for BenRiach; financing activities provided $137 million.
- Capital expenditures were $36 million for the half-year, compared with $65 million a year earlier. Dividends paid were $134 million and treasury-share purchases were $442 million.
- Short-term borrowings were $337 million and long-term debt was $1.917 billion, compared with $271 million and $1.230 billion, respectively, at April 30. The company issued euro- and sterling-denominated notes in July, with carrying values of $326 million and $360 million.
- Current assets were $2.530 billion and current liabilities $904 million. Inventories rose to $1.286 billion from $1.054 billion, including higher barreled-whiskey inventory.
- Management described liquidity as strong. The company had an undrawn $800 million credit facility and an undrawn $400 million 364-day facility; it reported a 21-to-1 EBITDA-to-interest ratio against a 3-to-1 minimum covenant.
Material changes and notable items
- BenRiach was acquired on June 1 for aggregate consideration of $407 million, including $307 million cash paid at closing. The preliminary purchase-price allocation included $182 million goodwill and $65 million trademarks; goodwill is not expected to be tax deductible. BenRiach’s results were not material in the reported periods. Brown-Forman bought the remaining 10% stake on November 17 for $30 million.
- Gross margin fell mainly due to acquisition/divestiture effects, foreign exchange, and weaker mix from declining high-margin used-barrel sales. Management cited higher wood and grain costs; it expected input costs to rise mid-single digits for the rest of fiscal 2017.
- Interest expense increased to $28 million for the half-year from $22 million. The effective tax rate declined to 28.4% from 29.9%, primarily due to a greater benefit from foreign earnings taxed at lower rates and discrete items.
- Foreign-currency translation reduced first-half other comprehensive income by $85 million; total other comprehensive loss was $57 million. The company uses currency derivatives and foreign-currency debt to hedge exposures and does not use derivatives for speculation.
- The Board increased the quarterly dividend from $0.17 to $0.1825 per share, payable January 3, 2017. Under a $1 billion repurchase authorization, approximately $627 million had been spent through November 30, leaving about $373 million available through March 31, 2017.
- The company changed excise-tax presentation and adopted stock-compensation accounting guidance. The latter increased first-half net income and operating cash flow by $3 million; a $10 million cumulative adjustment was recorded to retained earnings.
Management commentary, outlook, and risks
Management attributed underlying growth principally to the Jack Daniel’s family, tequila brands, and Woodford Reserve, while noting pressure from Canadian Mist, Finlandia in Russia, used-barrel sales, and some international Jack Daniel’s markets. Russia and Turkey faced weak economic conditions and geopolitical instability. Management expected SG&A to increase at a low-single-digit rate during the remainder of fiscal 2017; it cautioned that first-half results do not necessarily indicate full-year performance. The filing provides no specific full-year revenue or earnings guidance.
Disclosed risks include foreign-exchange movements, consumer preference shifts, dependence on Jack Daniel’s growth, economic and political conditions, regulatory and tax changes, supply and production disruptions, distributor inventory fluctuations, competition, acquisition integration, litigation, and information-technology failures. Management reported no material changes to the risk factors in the fiscal 2016 Form 10-K and no material adverse effect expected from pending litigation. It recorded no material accrued loss contingencies.
A guarantee supporting a Russian importer’s bank facility had an actual exposure of approximately $11 million and a maximum potential exposure of approximately $22 million; Brown-Forman also had $14 million of receivables from the importer, which it expected to collect in full.
Important facts for investors to verify
- How much of underlying growth reflects consumer demand versus distributor inventory estimates, foreign exchange, and acquisition/divestiture adjustments.
- Whether the acquisition’s preliminary valuation, integration, and expected growth in premium Scotch brands meet management’s assumptions.
- Whether margin pressure persists as input costs rise and used-barrel demand remains weak.
- How borrowing, repurchases, dividends, and working-capital needs affect liquidity and debt levels.
- Whether conditions in Russia, Turkey, and other weaker markets, along with currency movements, materially alter sales or the importer exposure.