Brown-Forman Corporation — Form 10-Q Summary
Reporting period: First quarter of fiscal 2011, the three months ended July 31, 2010. Financial statements are unaudited. Brown-Forman sells beverage alcohol brands, including Jack Daniel’s, Southern Comfort, Finlandia, and el Jimador.
Financial performance
| Metric | Quarter ended July 31, 2010 | Prior-year quarter | Change |
|---|---|---|---|
| Net sales | $744.9 million | $737.9 million | +1% reported; +3% underlying |
| Gross profit / gross margin | $378.8 million / 50.9% | $380.1 million / 51.5% | Gross profit essentially flat; margin down 0.6 percentage points |
| Operating income | $172.7 million | $192.0 million | -10% |
| Income before taxes | $166.5 million | $184.9 million | -10% |
| Net income | $111.4 million | $121.4 million | -8% |
| Diluted EPS | $0.76 | $0.81 | -6% |
| Effective tax rate | 33.1% | 34.4% | Down 1.3 percentage points |
Reported net sales were reduced by approximately $5 million by the stronger U.S. dollar and by lower estimated trade inventories. Underlying sales growth was partly offset by these effects. Foreign exchange reduced gross profit by approximately $10 million and operating income by approximately $12 million.
Cash flow, balance sheet, and capital allocation
- Operating cash flow: $96.6 million, down from $117.8 million a year earlier, primarily reflecting $23.8 million more cash used to fund pension obligations.
- Investing cash flow: $3.5 million provided, including $11.0 million of property-sale proceeds; capital expenditures were $6.9 million and software expenditures were $0.6 million.
- Financing cash flow: $67.4 million used, including $47.8 million for treasury-stock purchases and $44.0 million of dividends; short-term borrowings increased $21.3 million.
- Cash: $260.8 million at July 31, versus $231.6 million at April 30; cash increased $29.2 million during the quarter.
- Debt: At July 31, short-term borrowings were $208.8 million, current long-term debt $2.9 million, and long-term debt $508.8 million. Total reported debt was approximately $720.5 million. The filing reports the fair value of long-term debt at $551.2 million, versus its $508.8 million carrying amount.
- Liquidity: The company reported an unused $800 million bank credit facility expiring April 30, 2012, and stated that liquidity was strong and sufficient for foreseeable commitments. Its minimum EBITDA-to-interest covenant was 3:1; the reported ratio was 26:1 at quarter-end.
- Shareholder returns: The quarterly dividend was approved at $0.30 per share, payable October 1, 2010. Under a repurchase authorization of up to $250 million through December 1, 2010, 799,101 shares had been repurchased for approximately $47 million by July 31.
Material changes and management commentary
- Underlying sales and gross profit each grew 3%, but underlying operating income declined modestly. Higher brand investment, increased pension expense, route-to-market transition costs, currency effects, and lower estimated trade inventories weighed on reported results.
- Selling, general, and administrative expense rose $14.7 million, or 13%, including a $4.6 million increase in pension expense. Management expected the higher pension expense to recur in each remaining quarter of the fiscal year. Route-to-market transition costs related primarily to planned changes in Germany and Brazil.
- Brand performance was mixed. Jack Daniel’s Tennessee Whiskey global depletions rose 3% (up 9% internationally and down 4% in the U.S.); Jack Daniel’s ready-to-drink products and el Jimador posted strong growth. Southern Comfort sales declined amid competition and continued weakness in on-premise channels. Sales also varied by geography, with growth in markets including Australia, Spain, Mexico, the U.K., and Turkey, partly offset by declines in the U.S., France, and Poland.
- The company adopted new fair-value disclosure guidance during the quarter; it had no material impact on the financial statements. Management reported no material accrued loss contingencies at July 31.
Outlook, risks, and contingencies
Fiscal 2011 diluted EPS guidance remained unchanged at $2.98 to $3.38. Management anticipated mid-single-digit underlying operating income growth for the year, while emphasizing uncertainty around macroeconomic conditions and consumer spending, particularly in the U.S. and Western Europe; Southern Comfort performance; consumer response to innovation; route-to-consumer changes; and foreign exchange rates.
Other disclosed risks include competitive pricing and promotions, regulation and taxation of beverage alcohol, changes in consumer preferences and purchasing behavior, input availability and costs, pension assumptions and returns, litigation or government investigations, product quality or reputation events, and potential asset impairment. The company uses currency, commodity, and interest-rate derivatives for risk management, not trading; outstanding exposures included $378.0 million in foreign-currency contracts and corn contracts covering four million bushels. Management said counterparty-default risk was immaterial. It noted that a decline in creditworthiness could trigger payment or collateral requirements; the relevant derivatives in a net liability position totaled $1.1 million.
The filing also disclosed a possible net increase of approximately $0.7 million in gross unrecognized tax benefits over the next 12 months. No material loss contingencies were accrued. The quarter’s results were not considered indicative of full-year performance.
Important facts for investors to verify
- Whether underlying sales and operating-income trends continue after the quarter, including the effects of trade inventories and currency movements.
- Progress on Germany and Brazil route-to-market changes, related costs, and any sales or distribution disruption.
- Whether increased pension expense persists as expected and how pension assumptions affect future results.
- Performance of Southern Comfort and other challenged brands, alongside the durability of growth in Jack Daniel’s and el Jimador.
- Delivery of fiscal 2011 EPS guidance and the planned share-repurchase program, including funding needs and remaining authorization.
- Developments in tax examinations, derivative exposures, credit-facility access, and disclosed legal or regulatory risks.