Brown-Forman Corporation — Form 10-Q Summary
Business context and period: Brown-Forman reported its fiscal 2020 first quarter, the three months ended July 31, 2019, compared with the same quarter in 2018. The company sells spirits, wine, and related products, including the Jack Daniel’s family, Woodford Reserve, and Herradura. Unless noted, amounts are in U.S. dollars.
Financial performance
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Sales | $978 million | $987 million | Down 1% |
| Net sales | $766 million | $766 million | Flat |
| Gross profit | $498 million | $523 million | Down 5% |
| Operating income | $248 million | $264 million | Down 6%; underlying down 8% |
| Net income | $186 million | $200 million | Down 7% |
| Diluted EPS | $0.39 | $0.41 | Down 6% per management |
| Operating cash flow | $72 million | $126 million | Down $54 million |
Margins and costs: Gross margin fell to 64.9% from 68.2%, a 3.3 percentage-point decline; operating margin fell to 32.4% from 34.5%. Cost of sales rose 10% to $268 million, while operating expenses fell 3% to $250 million. The stated effective tax rate was 18.2%, versus 17.4% a year earlier.
Liquidity and debt: Cash was $307 million at both April 30 and July 31, 2019. At July 31, short-term commercial paper borrowings were $220 million and long-term debt was $2.267 billion. The company had an undrawn $800 million revolving bank facility supporting its $800 million commercial paper program. It said liquidity was sufficient for future financial commitments. Inventory increased from $1.520 billion to $1.609 billion during the quarter.
Cash flows: Investing activities used $43 million, including $22 million for the acquisition of The 86 Company and $21 million of capital spending. Financing activities used $26 million, including $79 million of dividends paid; short-term borrowings increased by $67 million.
Material changes and management commentary
- Reported and underlying net sales were flat. Management estimated that prior-year tariff-related customer inventory build-ups and current tariff-related costs reduced underlying net sales growth by approximately 3 percentage points.
- Tariffs and higher input costs—particularly agave and wood—pressured cost of sales and margins. Management estimated roughly half of the increase in underlying cost of sales was attributable to tariffs. Tariffs were expected to continue weighing on results while in effect.
- U.S. net sales grew 6% reported and 4% underlying; underlying sales declined 3% in developed international markets and 14% in Travel Retail. Emerging-market underlying sales grew 3%.
- Brand results were mixed: Woodford Reserve underlying sales grew 15%, tequila grew 12%, and Jack Daniel’s Tennessee Whiskey underlying sales declined 4%. Finlandia underlying sales fell 5%.
- The company acquired The 86 Company, owner of Fords Gin, for $22 million in cash on July 3. Purchase-price allocations were preliminary and included $11 million of goodwill and $12 million of indefinite-lived intangible assets, net of deferred tax liabilities.
Outlook, risks, contingencies, and unusual items
- The filing provides no quantified full-year earnings or revenue guidance. Management cautioned that interim results are not necessarily indicative of full-year results.
- Key risks include tariffs and trade actions, foreign exchange, raw-material and energy costs, consumer and market shifts, distributor inventory fluctuations, supply-chain disruption, and reliance on continued growth of the Jack Daniel’s brands. Management reported no material change to the risk factors in the 2019 Form 10-K.
- Operating cash flow declined, which management attributed largely to tariffs, higher wood and agave costs, weaker operating results, and increased inventory costs. About 82% of cash was held by foreign subsidiaries whose earnings were described as indefinitely reinvested outside the United States; future repatriation could entail additional taxes.
- Brown-Forman guaranteed a Russian importer’s bank facility. Actual exposure was approximately $5 million at July 31, with a maximum possible exposure of approximately $10 million; it also had $8 million of receivables from the importer, which it expected to collect in full.
- No material accrued loss contingencies were recorded, and the company did not expect pending legal proceedings to have a material adverse effect.
- Adoption of lease accounting standards resulted in recognition of $54 million of lease liabilities and right-of-use assets at adoption; the July 31 balance sheet showed $50 million of each. The company stated adoption did not materially affect results, equity, or cash flows. A separate accounting-standard adoption reclassified $43 million from accumulated other comprehensive loss to retained earnings without changing total equity.
Important facts for investors to verify
- How tariff costs and prior-year distributor buy-ins affect reported and underlying sales, margins, and comparisons in subsequent quarters.
- Whether higher agave, wood, and other input costs continue to pressure gross margin and cash generation.
- Distributor inventory trends and the underlying demand trajectory for Jack Daniel’s Tennessee Whiskey, Woodford Reserve, and tequila.
- Inventory growth, operating cash flow, and use of commercial paper and the revolving credit facility.
- Final purchase-price allocation and the contribution of Fords Gin following the acquisition.
- Foreign cash deployment and any potential tax consequences of repatriation, as well as the Russian importer guarantee and receivable exposure.