Brown-Forman Corporation — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended January 31, 2013; comparisons are with the periods ended January 31, 2012. The filing is unaudited. Share and per-share figures reflect the 3-for-2 stock split.
Business context and results
Brown-Forman sells spirits and other beverage products, including the Jack Daniel’s, Southern Comfort, Finlandia, Herradura, and Woodford Reserve brands. Quarterly sales growth reflected underlying demand and a weaker U.S. dollar, partly offset by lower trade inventories and the absence of sales from the previously sold Hopland wine business. Nine-month sales growth was driven by volume and pricing, partly offset by currency and the Hopland comparison.
Key financial metrics
| Metric | Three months | Nine months |
|---|---|---|
| Net sales | $1,026.9 million, up 7% | $2,918.8 million, up 4% |
| Gross profit / margin | $506.7 million / 49.3%; margin up 2.3 percentage points | $1,495.3 million / 51.2%; margin up 2.4 points |
| Operating income / margin | $237.0 million / 23.1%; income up 15% | $721.1 million / 24.7%; income up 13% |
| Net income | $157.6 million, up 18% | $478.0 million, up 17% |
| Diluted EPS | $0.73, up 18% | $2.22, up 18% |
| Effective tax rate | 31.3%, versus 33.1% | 32.1%, versus 33.7% |
For the nine months, cash from operations was $367.2 million, compared with $341.7 million; capital expenditures were $59.1 million, compared with $31.1 million. Cash and cash equivalents increased $48.5 million to $386.8 million. At January 31, current assets were $2,046.4 million and current liabilities $807.3 million.
At January 31, long-term debt was $996.6 million and its current portion was $253.7 million; short-term borrowings were $10.6 million. The company issued $750 million principal amount of long-term notes in December 2012, with maturities from fiscal 2018 to 2043. The $800 million bank facility was available through November 20, 2017; the company reported a 35-to-1 EBITDA-to-interest ratio against a minimum covenant of 3-to-1.
Material changes and drivers
- Quarterly underlying net sales grew 8%, with a 2% foreign-exchange benefit, partly offset by a 1% estimated trade-inventory decline and a 2% Hopland comparison. Nine-month underlying sales grew 8%, offset by a 1% currency headwind and a 3% Hopland comparison.
- Higher pricing, volumes, favorable brand and market mix, and lower value-added packaging costs supported margins. Management attributed the reported margin improvement in part to the absence of the lower-margin Hopland wine business.
- Nine-month advertising expense rose 4% reported (7% excluding currency and Hopland effects); SG&A rose 8%, including higher pension expense, salary and benefit inflation, and investment in organizational capabilities.
- Nine-month net interest expense fell $4.4 million, principally after repayment of $250 million of 5.2% notes in April 2012. The quarterly tax-rate improvement primarily reflected a higher mix of foreign earnings at lower tax rates.
- Financing cash flows included $1,008.0 million of dividends paid, including $854.1 million for a $4.00-per-share special dividend, partly funded by the December notes issuance. The filing reports declared and paid dividend per-share amounts that include the special dividend.
Outlook, risks, and unusual items
Management narrowed fiscal 2013 diluted EPS guidance to $2.60–$2.68 from $2.58–$2.70 and continued to expect high-single-digit underlying net sales growth and low-double-digit underlying operating income growth. It expected no further gross-margin expansion in the fourth quarter, citing higher costs and the diminishing benefit from the Hopland comparison. It anticipated low-single-digit increases in transportation, corn, and glass costs over the balance of the year.
On February 25, 2013, after the reporting date, Brown-Forman redeemed its $250 million 5% notes due fiscal 2014 using cash and short-term borrowing. It expected approximately $9 million of pre-tax fourth-quarter redemption costs, partly offset by lower pre-tax interest expense of approximately $2 million in fourth-quarter fiscal 2013 and $8 million in fiscal 2014.
No material accrued loss contingencies were recorded, and management did not believe known contingencies would materially adversely affect financial position, results, or liquidity. A review found no impairment among brand names tested; however, Chambord’s estimated fair value exceeded its $116.5 million book value by only approximately $9.8 million. A 50-basis-point increase in the cost of capital assumption would reduce estimated fair value by $13.4 million and could result in a non-cash impairment charge.
Key risks include economic and consumer-demand weakness, competition and pricing, product and brand execution, regulation and taxes, foreign-exchange movements, commodity and supply-chain costs, and litigation. The company said liquidity was sufficient for foreseeable commitments; $246.0 million of cash was held by foreign subsidiaries and expected to remain invested abroad. Repatriation could incur U.S. taxes.
Important facts for investors to verify
- Whether underlying sales and operating-income growth convert into reported results as trade inventories, currency, and the Hopland comparison change.
- Progress against fiscal 2013 EPS and underlying growth guidance, including the stated lack of expected fourth-quarter margin expansion.
- The Chambord brand valuation assumptions and any subsequent impairment indicators.
- The all-in cost and interest savings from the February 2013 note redemption, and the effect of added borrowing on leverage and liquidity.
- The sustainability of cash generation and dividends after the special dividend and substantial increase in debt.