Brown-Forman Corporation — Fiscal 2018 Third-Quarter 10-Q
Reporting period: Quarter and nine months ended January 31, 2018; the filing was signed March 7, 2018. The company produces and markets beverage alcohol brands. Unless noted, figures are in millions of dollars. “Underlying” growth is a company-defined non-GAAP measure adjusted for foreign exchange, distributor inventory changes, and, where applicable, acquisitions or divestitures.
Financial performance
| Metric | Quarter ended Jan. 31, 2018 | Change year over year | Nine months ended Jan. 31, 2018 | Change year over year |
|---|---|---|---|---|
| Net sales | $878 | +9% reported; +6% underlying | $2,515 | +9% reported; +7% underlying |
| Gross profit / margin | $587 / 66.8% | +9%; margin +0.4 percentage points | $1,690 / 67.2% | +10%; margin +0.2 percentage points |
| Operating income / margin | $304 / 34.6% | +11% reported; +5% underlying | $894 / 35.5% | +15% reported; +11% underlying |
| Net income | $190 | +$8 | $607 | +$83 |
| Diluted EPS | $0.39 | +4% | $1.25 | +17% |
| Cash provided by operations | Not separately provided | — | $562 | +$117 |
Quarterly net sales growth reflected 3% volume growth and 3% price/mix on an underlying basis. Nine-month underlying growth was 5% from volume and 2% from price/mix. Growth was led by the Jack Daniel’s family, premium bourbon, and tequila brands; Woodford Reserve and Herradura were notable performers. The U.S. market grew 5% underlying in the nine-month period, while Japan declined 7% underlying.
Cost of sales rose 7% in the quarter and 9% year to date; higher volumes, wood and other input costs, and value-added packaging contributed. Nine-month advertising expense increased 8% reported (5% underlying); SG&A increased 2% reported and was flat underlying. Operating margin gains reflected expense leverage and favorable price/mix, partly offset by higher costs.
Cash, debt, and liquidity
- Cash and equivalents were $287 at January 31, 2018, up from $182 at April 30, 2017.
- Nine-month operating cash flow was $562; investing used $101, including $100 of property, plant, and equipment additions; financing used $380. Capital spending supported distillery and cooperage projects.
- Short-term borrowings were $327 and long-term debt was $1,770 at January 31, 2018. The company repaid $250 of notes at maturity in January. Short-term borrowings included $320 of commercial paper.
- The company had an undrawn $800 revolving credit facility, expiring in 2022, and an $800 commercial paper program. Management stated current liquidity was sufficient for financial commitments. Approximately 78% of cash was held by foreign subsidiaries whose earnings were expected to remain reinvested abroad, subject to reassessment following U.S. tax reform.
Material developments, outlook, and risks
- Tax reform: The Tax Cuts and Jobs Act produced a provisional $43 net transition tax charge in the quarter, comprising a $91 repatriation tax charge and a $48 deferred-tax benefit. A separate approximately $20 benefit from the lower tax rate was recorded. The nine-month effective tax rate was 28.5%; management expected approximately 28% for the full fiscal year, including known discrete items. Estimates remained provisional.
- Outlook: Management expected underlying net sales growth for the remainder of fiscal 2018 generally in line with the nine-month rate. It anticipated higher cost-of-sales growth than sales growth, higher operating-expense growth, and slower operating-income growth than in the first nine months. Foreign exchange was expected to remain a benefit, while the distributor-inventory benefit was expected to moderate slightly.
- Capital deployment: The company declared a $1.00-per-share special dividend, expected to total about $480 after the stock split and payable April 23, 2018. It also approved an additional $120 pension contribution and planned a $60–$70 charitable foundation contribution. Management anticipated funding these actions with incremental debt. A five-for-four stock split was distributed February 28, 2018.
- Contingencies and risk: The company reported no material accrued loss contingencies and did not expect pending litigation to materially affect its financial position, results, or liquidity. A guarantee for a Russian importer had approximately $6 of actual exposure and a maximum possible exposure of about $12. Key disclosed risks include foreign exchange, consumer and category trends, reliance on continued Jack Daniel’s growth, supply and input-cost pressures, distributor inventory fluctuations, regulation, and execution of route-to-consumer changes. No material change to previously disclosed risk factors was reported.
Most important facts for investors to verify
- Whether underlying sales growth is sustained and is supported by consumer demand rather than distributor inventory increases, particularly in the U.S. and Russia.
- Whether rising input costs and management’s forecast for higher cost growth pressure gross margins and slow operating-income growth.
- The final accounting and cash-tax effects of the Tax Act, including the provisional repatriation charge and future treatment of foreign earnings.
- The financing and balance-sheet impact of the special dividend, pension funding, and planned foundation contribution.
- Commercial paper levels, foreign-exchange exposures, and the company’s ability to maintain liquidity while funding investment and shareholder distributions.