Brown-Forman Corporation — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended October 31, 2014; unaudited. Financial amounts are in millions of U.S. dollars except per-share data. Comparisons are with the prior-year periods.
Financial performance
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $1,135; up 5% reported and 7% underlying | $2,056; up 4% reported and 5% underlying |
| Gross profit | $609; up 6% reported and 9% underlying | $1,104; up 5% reported and 7% underlying |
| Gross margin | 53.6%, versus 53.4% | 53.7%, versus 53.3% |
| Operating income | $303; down 3% reported, up 5% underlying | $523; down 1% reported, up 6% underlying |
| Operating margin | 26.6%, versus 28.8% | 25.4%, versus 26.7% |
| Net income | $208, versus $206 | $358, versus $349 |
| Diluted EPS | $0.97, up 1% | $1.67, up 3% |
Underlying measures are non-GAAP and adjust for foreign exchange and, where applicable, estimated distributor-inventory changes. Gross-margin improvement reflected pricing and favorable mix. Operating-income growth on an underlying basis was more than offset in reported results by unfavorable foreign exchange, including revaluation of largely euro-denominated net assets, and higher advertising and SG&A.
Cash flow, balance sheet, and capital returns
- Six-month operating cash flow was $70, down from $201 a year earlier. Management attributed most of the decline to higher income-tax payments and normal working-capital timing. Investing activities used $63, including $59 of property, plant, and equipment additions; financing activities used $201.
- Cash and cash equivalents were $235 at October 31, down $202 since April 30. Inventories were $971, versus $882 at April 30; receivables were $761, versus $569.
- Short-term borrowings were $124, including $119 of commercial paper; long-term debt was $998. Total reported borrowings were therefore $1,122, compared with $1,005 at April 30. The commercial paper averaged a 0.15% rate and six-day maturity at period-end.
- Liquidity included an undrawn $800 credit facility maturing in November 2018 and a $1 billion commercial-paper program. The company reported a 36-to-1 EBITDA-to-interest ratio against a 3-to-1 minimum covenant.
- During the six months, the company returned $329 to shareholders through dividends and repurchases. It completed a prior $250 repurchase program in September and began a new authorization of up to $250 through October 14, 2015. The board subsequently raised the quarterly dividend from $0.29 to $0.315 per share, payable December 30, 2014.
Business trends and material changes
- Growth was led by the Jack Daniel’s portfolio, including Tennessee Whiskey and Tennessee Honey, and by Woodford Reserve and Herradura. Management cited stronger U.S. performance, international brand expansion, pricing, and favorable product mix.
- Underlying six-month net sales rose 5%, with volume contributing 2% and net price/mix 3%. Reported growth was reduced by weaker currencies, especially in Europe.
- Southern Comfort and Finlandia declined. Management cited competitive pressure and weaker demand for Southern Comfort, and weaker vodka demand in Poland following an excise-tax increase and related price increases. Australia also showed weaker consumer demand and increased competition for Jack Daniel’s.
- Advertising rose 14% underlying in the quarter and 5% for the half; SG&A rose 12% and 10%, respectively. Higher compensation, consulting, and contract-service costs included expenses related to establishing the company’s distribution operation in France.
- Reported effective tax rate declined to 29.9% from 32.4%. Management attributed the decrease to tax benefits associated with an intercompany asset transfer, domestic manufacturing tax benefits, and discrete tax items.
Outlook, risks, and contingencies
- The filing provides no specific full-year earnings or revenue guidance and cautions that first-half results do not necessarily indicate full-year performance. Management planned a U.S. rollout of Jack Daniel’s Tennessee Fire in the fourth quarter of fiscal 2015 after favorable test-market feedback.
- Management identified foreign-exchange exposure, consumer-demand shifts, competition, distributor inventory movements, regulation and taxation, supply-chain disruption, and reliance on continued growth in the Jack Daniel’s brands among relevant business risks. It specifically noted heightened economic, currency, consumer-spending, and legal-enforcement uncertainty in Russia.
- Currency derivatives had $1.063 billion notional value at October 31. The company expected to reclassify $25 of deferred net hedge gains into earnings over the next 12 months, generally offsetting the anticipated impact of the hedged exposures. Derivatives are used for risk management, not speculation.
- The company guaranteed an importer’s bank-facility obligations in Russia: maximum possible exposure was approximately $45, with actual exposure of approximately $11; related receivables were approximately $31. Management expected collection and considered default unlikely.
- Management said pending litigation was not expected to have a material adverse effect; no material loss contingencies were accrued. It reported no material changes to previously disclosed risk factors and no material change in internal controls.
Important facts for investors to verify
- Whether underlying sales growth and brand demand persist, particularly for Jack Daniel’s, Woodford Reserve, and Herradura, and whether declines in Finlandia and Southern Comfort stabilize.
- How foreign-exchange movements, distributor inventories, and Russia’s economic and regulatory conditions affect reported sales and operating income.
- Whether higher advertising and SG&A spending converts into growth and margins, and how the France distribution investment develops.
- Working-capital and tax-payment timing, cash generation, increased short-term borrowing, and the pace of repurchases and dividends.
- The importer guarantee and receivable exposure, plus the timing and earnings effects of derivative settlements and deferred tax benefits.