Brown-Forman Corporation — Form 10-Q Summary
Business and period: Global spirits producer; unaudited quarter and six months ended October 31, 2017 (fiscal 2018 Q2 and year to date). Dollar amounts are in millions unless stated otherwise. Comparisons are with the corresponding 2016 periods.
Financial performance
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $914; +10% reported, +8% underlying | $1,637; +10% reported, +7% underlying |
| Gross profit / margin | $610; 66.8% versus 66.5% | $1,103; 67.4%, unchanged |
| Operating income / margin | $346; +19%; 37.9% versus 35.1% | $590; +17%; 36.0% versus 33.8% |
| Net income | $239 versus $197 | $417 versus $342 |
| Diluted EPS | $0.62 versus $0.50; +23% | $1.08 versus $0.87; +24% |
| Interest expense | $16 | $32 versus $28 |
| Effective tax rate | 27.9% versus 28.6% | 25.5% versus 28.4% |
Underlying measures are non-GAAP and adjust for acquisition/divestiture effects, foreign exchange and estimated distributor inventory changes. Year-to-date underlying net sales growth reflected 6% volume growth and 2% price/mix. Underlying operating income rose 14%.
Cash flow and balance sheet: Six-month operating cash flow was $214 versus $169, with higher earnings partly offset by a larger seasonal working-capital increase. Investing used $65 versus $344, including no repeat of the prior-year $307 BenRiach acquisition payment; capital spending increased to $64 from $36. Financing used $127 versus $137 provided, largely reflecting the absence of prior-year debt proceeds and lower share repurchases. Cash rose $30 to $212.
At October 31, cash was $212; current assets were $2,661 and current liabilities $1,052. Short-term borrowings were $235, current long-term debt $250, and long-term debt $1,719. Total debt on these carrying amounts was $2,204. The company had an $800 commercial paper program and an undrawn $800 five-year revolving facility, amended November 10, 2017, with no financial covenant. Of cash, $183 was held by foreign subsidiaries and expected to be reinvested abroad. The company planned to repay $250 of notes due January 15, 2018 with cash.
Material changes and operating drivers
- Growth was led by the Jack Daniel’s family, premium bourbons and tequila; Woodford Reserve underlying sales rose 21%, and Herradura rose 19%. The United States and emerging markets led geographic growth; Travel Retail underlying sales rose 11%.
- Reported sales benefited from estimated distributor inventory increases, particularly in the United States; management estimated a 2% net sales benefit for the six-month period. Foreign exchange helped reported sales but hurt operating income year to date, partly due to lower foreign-exchange gains in other expense.
- Operating margin expanded as operating expenses grew more slowly than sales. Year-to-date advertising rose 5% underlying, while underlying SG&A declined 1%, supported by lower pension expense and tighter discretionary spending.
- Year-to-date dividend payments were $140. The board raised the quarterly dividend from $0.1825 to $0.1975 per share, payable January 2, 2018. The company retired 67 million treasury Class B shares, materially changing reported share and equity balances; diluted average shares fell to 386.5 million from 393.9 million.
- The prior-year comparison included the BenRiach acquisition and related financing; its purchase-price allocation was finalized with no material changes. Current-period capital investment included construction for Slane Irish Whiskey and Old Forester.
Outlook, risks and contingencies
Management expected slower net sales and operating income growth in the remainder of fiscal 2018 than the first-half rates. It expected slower emerging-market growth and no repeat of the distributor-inventory benefit; cost of sales and operating expenses to grow faster than sales; advertising growth to exceed sales growth; and underlying SG&A to increase. Foreign exchange was expected to become a positive factor. Absent changes from proposed U.S. tax reform, management expected a full-year effective tax rate of approximately 27.5%.
Key risks include consumer preference and category shifts, dependence on continued Jack Daniel’s growth, foreign exchange, regulation and taxation of alcohol, distributor inventory movements, supply and production disruptions, competition, acquisitions, litigation, and cyber or IT failures. The filing reported no material changes to previously disclosed risk factors. Management said pending ordinary-course litigation was not expected to materially affect results, financial position or liquidity; no material loss contingencies were accrued. A guarantee related to a Russian importer had approximately $9 exposure and a maximum possible exposure of about $11, plus $10 of receivables the company expected to collect. The company considered default unlikely.
The company uses currency derivatives and foreign-currency debt to manage exposures, not for trading. A fall below specified creditworthiness levels could permit derivative counterparties to request payment or collateral; derivatives with such requirements were in a net liability position of $21 at quarter-end. Management stated that its liquidity position was strong and sufficient for commitments, while noting potential bank funding risk under extreme market conditions.
Important facts for investors to verify
- Whether sales growth persists without the estimated distributor inventory benefit, and how underlying growth compares with GAAP-reported growth.
- Execution of the outlook, particularly slower emerging-market growth, higher cost/mix and operating expenses, and the expected tax rate.
- Repayment of the $250 notes due January 2018, commercial paper usage, and the company’s cash and debt position.
- Performance of core brands and growth markets, including whether recent gains reflect consumer demand rather than shipment timing, launches or price/mix.
- Potential effects of U.S. tax reform and the treatment of foreign-held cash; the filing’s interim estimate does not quantify any reform impact.