Business context and reporting period
Brown-Forman Corporation’s unaudited Form 10-Q covers the three months ended July 31, 2016, the first quarter of fiscal 2017. The company sells spirits and other beverage alcohol products internationally. Unless noted, financial amounts are in U.S. dollars in millions.
Comparative statements recast excise taxes to present net sales excluding excise taxes. Share and per-share amounts are presented on a two-for-one split-adjusted basis; the stock dividend was distributed in August 2016.
Financial performance
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Net sales | $661 | $699 | (5%) reported; 2% underlying |
| Gross profit / margin | $453 / 68.5% | $491 / 70.3% | (8%) profit; margin down 1.8 percentage points |
| Operating income / margin | $213 / 32.2% | $227 / 32.5% | (6%) reported; 6% underlying |
| Net income | $144 | $156 | (8%) |
| Diluted EPS | $0.36 | $0.37 | (2%) |
| Cash provided by operations | $128 | $147 | Down $19 |
Underlying measures are non-GAAP and adjust, as applicable, for foreign exchange, estimated distributor inventory changes, and acquisitions or divestitures. Underlying net sales growth comprised 1% volume growth and 1% price/mix growth. Underlying operating income benefited from lower underlying advertising and SG&A, much of which management described as timing-related.
Cash, debt and liquidity
- Cash and cash equivalents were $459 at July 31, versus $263 at April 30. Operating activities provided $128; investing activities used $324, including $307 for BenRiach; financing activities provided $398. The net cash increase was $196.
- Short-term borrowings were $288 and long-term debt was $1,953 at quarter-end. Long-term debt rose from $1,230 at April 30, reflecting issuance of €300 million of 1.20% notes and £300 million of 2.60% notes in July. Commercial paper outstanding was $285, at a 0.66% average rate and with a 12-day remaining maturity.
- The company reported access to an undrawn $800 million credit facility and an undrawn $400 million 364-day facility. Its $800 million facility requires a minimum EBITDA-to-interest ratio of 3:1; the reported ratio was 22:1. Management said liquidity was strong and sufficient for future commitments.
- Cash dividends paid were $67. The company repurchased $201 of shares during the quarter. As of August 26, it had repurchased about $349 under a $1 billion authorization, leaving about $651 available through March 31, 2017.
Material changes and business drivers
- On June 1, 2016, Brown-Forman acquired 90% of The BenRiach Distillery Company for approximately $307 in cash. Aggregate consideration, including assumed obligations, was approximately $407. The acquisition added three single-malt Scotch brands and related assets; preliminary purchase accounting recorded $182 of goodwill and $65 of trademarks and brand names. BenRiach’s results were not material for the quarter.
- Reported results were affected by the prior sale of Southern Comfort and Tuaca, foreign exchange, and estimated distributor inventory changes. Underlying growth was led by the Jack Daniel’s family, Woodford Reserve, and tequila brands. Woodford Reserve underlying net sales rose 24%, Herradura 18%, and el Jimador 10%; Canadian Mist declined 17% and Finlandia 4%.
- Currency translation reduced other comprehensive income by $67, contributing to a $52 net other comprehensive loss and comprehensive income of $92.
- Inventory increased to $1,262 from $1,054 at April 30, including barreled whiskey of $835 versus $666; the BenRiach acquisition added $159 of inventory.
Outlook, commentary and risks
- No full-year earnings or sales guidance is stated in the supplied filing text. Management cautioned that quarterly results do not necessarily indicate full-year results.
- Management expected input costs to increase in the low single digits. Underlying cost of sales rose 3%, reflecting volume, higher wood and grain costs, value-added packaging, and mix, partly offset by lower freight.
- Management cited weak economic conditions and geopolitical instability in Turkey and Russia, weaker demand for used barrels, and foreign-exchange effects. Other disclosed risks include consumer preference shifts, dependence on Jack Daniel’s growth, supply disruptions, regulation and taxation, competition, acquisition integration, and legal or product-liability matters.
- The company said pending litigation was not expected to have a material adverse effect and recorded no material accrued loss contingencies. A guarantee related to a Russian importer had approximately $12 of actual exposure and a maximum possible exposure of about $21; default was considered unlikely.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The filing stated there were no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Reconcile the 2% underlying sales and 6% underlying operating-income growth to GAAP results, including the effects of currency, distributor inventories, and the Southern Comfort/Tuaca divestiture.
- Track BenRiach integration, final purchase-price allocation, the potential purchase of the remaining 10% interest, and the acquired inventory and goodwill.
- Monitor the rise in debt and interest expense, refinancing and commercial-paper needs, and the company’s liquidity and covenant headroom.
- Assess whether reported margin pressure and expense reductions described as timing-related persist, alongside expected low-single-digit input-cost inflation.
- Consider foreign-currency exposure, cash held abroad, and the potential U.S. tax consequences if foreign earnings are repatriated.