Brown-Forman Corporation — Form 10-Q summary
Business context and reporting period: Brown-Forman is a global beverage alcohol company. This unaudited filing covers the fiscal quarter and six months ended October 31, 2018; comparisons are with the corresponding 2017 periods. Dollar amounts are in millions except per-share data.
Financial performance
| Metric | Three months ended Oct. 31, 2018 | Six months ended Oct. 31, 2018 |
|---|---|---|
| Net sales | $910; flat reported, 3% underlying growth | $1,676; up 2% reported, 5% underlying growth |
| Gross profit / margin | $590; 64.8%, down 2.0 percentage points | $1,113; 66.4%, down 1.0 percentage point |
| Operating income / margin | $332; 36.5%, down 1.7 percentage points | $596; 35.6%, down 0.7 percentage point |
| Net income | $249, versus $239 | $449, versus $417 |
| Diluted EPS | $0.52, versus $0.49 | $0.93, versus $0.86 |
| Operating cash flow | Not provided separately for the quarter | $272, versus $218 |
Underlying growth is a non-GAAP measure adjusted for foreign exchange, ASC 606 adoption and estimated distributor inventory changes, as applicable. Quarterly reported operating income fell 5% while underlying operating income was flat; six-month reported operating income was approximately unchanged while underlying operating income grew 4%.
Cash flow and liquidity: For the six months, investing activities used $57 and financing activities used $243, including $152 in dividends and $128 in treasury-stock purchases. Cash declined by $46 to $193. At October 31, current assets were $2,743 and current liabilities $895. Short-term borrowings were $258 and long-term debt $2,288; cash less these borrowings implies net debt of approximately $2,353. The company reported an undrawn $800 bank credit facility supporting its commercial paper program.
Other balance-sheet items: Inventories were $1,477, including $937 of barreled whiskey. Stockholders’ equity was $1,497. The company completed its $200 share-repurchase authorization in November 2018, after repurchasing approximately $122 through October 31 and a further $78 in November.
Material changes versus the prior comparable period
- Six-month net sales increased 2% as reported and 5% on an underlying basis, led by whiskey, tequila and emerging markets. Quarterly underlying sales growth was 3%, with 2% volume growth and 1% net price/mix.
- Cost of sales rose 6% reported and 7% underlying for the six months, outpacing sales growth. The six-month gross margin declined to 66.4%, with higher input costs, tariffs, foreign exchange and ASC 606 effects contributing.
- Six-month diluted EPS increased 8%, mainly reflecting the lower effective tax rate following U.S. tax reform; higher interest expense partly offset the benefit.
- Operating cash flow rose $54 year over year, primarily due to lower U.S. federal income tax payments and lower pension contributions, partly offset by a larger seasonal working-capital increase.
- Financing cash use increased $116 year over year, largely reflecting higher share repurchases and dividend payments.
Outlook, commentary and risks
- Management expected fiscal 2019 underlying net sales growth to be similar to fiscal 2018, with growth in the remainder of the year slightly above the first-half rate. Underlying operating income growth for the remainder was expected to be in line with first-half growth.
- Management expected underlying cost of sales to grow significantly faster than net sales during the remainder of fiscal 2019. Mid-single-digit input-cost increases and higher tariff costs were expected to pressure gross margin. The outlook was unchanged from the prior-quarter filing.
- Retaliatory tariffs on American whiskey were imposed by the EU, Mexico, Canada, Turkey and China. Management estimated tariff-related costs reduced first-half underlying net-sales growth by about one percentage point and underlying operating-income growth by about two points. For the second quarter, tariff-related inventory reductions and tariff costs together reduced underlying operating-income growth by an estimated six percentage points.
- Foreign exchange was a headwind, and management expected that trend to continue based on October 31 spot rates. The company cited exposure to currency movements, commodity and energy costs, tariffs and trade measures, regulation, consumer preferences, competition, supply disruption, distributor inventory changes and reliance on growth of the Jack Daniel’s family of brands.
- The expected full-year effective tax rate was 19.5%–20.5%. The six-month rate was 18.6%, compared with 25.5% a year earlier; Tax Act-related estimates remained provisional.
- The board raised the quarterly dividend from $0.158 to $0.166 per share, payable January 2, 2019. The company intended to repatriate approximately $120 of foreign cash during the quarter ending January 31, 2019, with no incremental tax expected on that distribution beyond tax already recorded.
- No material accrued loss contingencies were reported, and management did not expect pending legal proceedings to materially harm financial position, results or liquidity. A guarantee related to a Russian importer had approximately $7 of exposure; the company also had $11 of receivables from that importer, which it expected to collect in full.
Important facts for investors to verify
- Whether tariff exposure, mitigation measures and customer inventory normalization affect sales and margins as management expected.
- Whether higher input costs and tariff-related costs continue to outpace net-sales growth and compress gross margin.
- How reported results compare with non-GAAP underlying results, including the timing effects of ASC 606 and distributor inventory estimates.
- The effect of foreign exchange, Tax Act measurement adjustments and the expected effective tax rate on subsequent earnings and cash flows.
- Debt, commercial-paper usage, cash conversion, share repurchases and the company’s ability to sustain its increased dividend.
- The timing and tax treatment of the planned foreign-cash repatriation and any future changes to the company’s reinvestment assertions.