Brown-Forman Corporation — FY2017 Form 10-K
Reporting period: Fiscal year ended April 30, 2017. The filing is an annual report, not a standalone fiscal fourth-quarter filing; it also reports fourth-quarter results. Amounts are in U.S. dollars unless noted.
Business context
Brown-Forman manufactures, markets, and sells spirits, wine, and ready-to-drink beverages in more than 165 countries. The portfolio is led by Jack Daniel’s; the United States represented 48% of FY2017 net sales. The company operates as one reportable segment and is controlled by the Brown family.
Financial performance and liquidity
| Metric | FY2017 | FY2016 |
|---|---|---|
| Net sales | $2.994 billion | $3.089 billion |
| Gross profit / gross margin | $2.021 billion / 67.5% | $2.144 billion / 69.4% |
| Operating income / operating margin | $989 million / 33.0% | $1.533 billion / 49.6% |
| Net income | $669 million | $1.067 billion |
| Diluted EPS | $1.71 | $2.61 |
| Cash from operating activities | $639 million | $524 million |
| Cash and cash equivalents at year-end | $182 million | $263 million |
| Total debt at year-end | $2.149 billion | $1.501 billion |
Reported net sales fell 3%, while management’s non-GAAP underlying net sales rose 3% after adjustments for acquisitions and divestitures, foreign exchange, and estimated distributor inventory changes. Underlying operating income increased 7%; adjusted diluted EPS was $1.72, up 5% from $1.63. These measures are not GAAP and may not be comparable with similarly named measures at other companies.
The reported FY2016 comparison includes a $485 million pretax gain from selling Southern Comfort and Tuaca, which contributed about $0.88 to FY2016 diluted EPS. Excluding acquired and divested businesses, management reported adjusted operating income of $988 million in FY2017 versus $990 million in FY2016. FY2017 gross margin declined 1.9 percentage points, reflecting acquisition/divestiture effects, foreign exchange, and higher underlying costs. Interest expense, net, increased 29% to $56 million; the effective tax rate was 28.3% in both years.
Operating cash flow increased by $115 million, primarily because FY2016 included a $125 million tax payment related to the brand sale. Capital expenditures were $112 million. The company reported total current assets of $2.351 billion and current liabilities of $970 million. Year-end debt included $211 million of short-term borrowings, $249 million current long-term debt, and $1.689 billion long-term debt. The $800 million revolving credit facility was undrawn; the company reported an 18-to-1 EBITDA-to-interest covenant ratio against a minimum of 3-to-1. Cash dividends paid were $274 million, and share repurchases were $561 million. The declared annual dividend was $0.705 per share.
Material changes and operating trends
- Jack Daniel’s family underlying net sales grew 3%; Woodford Reserve underlying net sales grew 19%, Herradura 14%, and el Jimador 8%. Canadian Mist underlying net sales declined 12%; Finlandia declined 1%.
- Underlying sales growth was driven by volume and price/mix, including American whiskey and tequila. Declines in used-barrel sales, Canadian Mist, and some international markets partly offset growth.
- Reported results were adversely affected by the stronger U.S. dollar and estimated net reductions in distributor inventories. The U.S. dollar’s strength against the Mexican peso, euro, and British pound was particularly relevant.
- In June 2016, Brown-Forman acquired BenRiach, adding three Scotch whisky brands and related distilleries. The acquisition’s FY2017 results were not material; goodwill recorded was $183 million and was not expected to be tax-deductible.
- The company changed its presentation of excise taxes to exclude them from sales, recasting prior periods for comparability. A two-for-one stock split occurred in August 2016; share and per-share figures are split-adjusted.
Outlook, commentary, and risks
Management expressed optimism about growth in net sales, operating income, and diluted EPS in FY2018 but gave no specific growth-rate guidance. It expects volume to be the main sales-growth driver, led by Jack Daniel’s, premium bourbons, tequila, and portfolio additions including Jack Daniel’s Tennessee Rye, Scotch brands, and Slane Irish Whiskey. The company expected input costs to rise in the low single digits, advertising to grow at a rate similar to sales, SG&A to be approximately unchanged, and total operating expenses to grow more slowly than net sales. FY2018 capital expenditures were expected to reach up to $140 million.
A multiyear productivity and cost-saving initiative announced in June 2017 is intended to generate sustainable savings and support incremental advertising and promotion. Management expected foreign exchange to be less adverse in FY2018 than in FY2017. The filing estimates that a 10% change in the dollar’s average value against significant currencies would change FY2018 operating income by approximately $18 million after considering hedges.
Key risks include dependence on the Jack Daniel’s brands; changing consumer preferences and competition, including craft spirits; foreign-exchange exposure; alcohol-related regulation, taxes, and changes in social acceptance; disruption at production facilities or in supply chains; availability and cost of grains, agave, water, glass, and barrels; and uncertainty in forecasting aged-product demand. The company noted that whiskeys and some tequilas require years of maturation. It also cited geopolitical and trade uncertainty, including Brexit-related uncertainty. Management said pending litigation was not expected to have a material adverse effect and recorded no material loss contingency at year-end. The company’s financial statements and internal controls received unqualified audit opinions; BenRiach was excluded from the internal-control assessment following its acquisition.
Important facts for investors to verify
- Reconcile reported performance with management’s non-GAAP underlying and adjusted measures, particularly the FY2016 $485 million divestiture gain and FY2017 foreign-exchange and distributor-inventory effects.
- Track debt, refinancing needs, interest expense, and the planned use of cash given higher year-end debt and ongoing dividends and repurchases.
- Assess whether growth in Jack Daniel’s, Woodford Reserve, and tequila can offset weaker brands and used-barrel sales, and whether new product launches deliver sustained demand.
- Monitor aged-whiskey inventory, production capacity, input costs, and the integration and returns of the BenRiach acquisition.
- Compare FY2018 outcomes with management’s stated assumptions on sales drivers, costs, capital spending, productivity savings, and foreign exchange.
- Consider the company’s 2017 excise-tax presentation change and stock split when comparing reported historical figures and per-share data.