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BF-B > SEC Filings for BF-B > Form 10-Q on 28-Aug-2014All Recent SEC Filings

Show all filings for BROWN FORMAN CORP

Form 10-Q for BROWN FORMAN CORP


28-Aug-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
You should read the following discussion and analysis in conjunction with both our unaudited condensed consolidated financial statements and related notes included in Part I, Item 1 of this Quarterly Report and our 2014 Form 10-K. Note that the results of operations for the three months ended July 31, 2014, do not necessarily indicate what our operating results for the full fiscal year will be. In this Item, "we," "us," and "our" refer to Brown-Forman Corporation.

Volume and Depletions
When discussing volume, unless otherwise specified, we refer to "depletions," a term commonly used in the beverage alcohol industry. We define "depletions" as either (a) our shipments directly to retailers or wholesalers or (b) shipments from our third-party distributor customers to retailers and wholesalers. Because we generally record revenues when we ship our products to our customers, our reported sales for a period do not necessarily reflect actual consumer purchases during that period. We believe that our depletions measure volume in a way that more closely reflects consumer demand than our shipments to third-party distributor customers do.
Volume is discussed on a nine-liter equivalent unit basis (nine-liter cases) unless otherwise specified. At times, we use a "drinks-equivalent" measure for volume when comparing single-serve RTD or ready-to-pour (RTP) brands to a parent spirits brand. "Drinks-equivalent" depletions are RTD and RTP nine-liter cases converted to nine-liter cases of a parent brand on the basis of the number of drinks in one nine-liter case of the parent brand. To convert RTD volumes from a nine-liter case basis to a drinks-equivalent nine-liter case basis, RTD nine-liter case volumes are divided by 10, while RTP nine-liter case volumes are divided by 5.
Non-GAAP Financial Measures
We use certain financial measures in this report that are not measures of financial performance under GAAP. These non-GAAP measures, which are defined below, should be viewed as supplements to (not substitutes for) our results of operations and other measures reported under GAAP. The non-GAAP measures we use in this report may not be defined and calculated by other companies in the same manner.
We present changes in certain income statement line-items that are adjusted to an "underlying" basis, which we believe assists in understanding both our performance from period to period on a consistent basis, and the trends of our business. Non-GAAP "underlying" measures include changes in (a) underlying net sales, (b) underlying cost of sales, (c) underlying excise taxes, (d) underlying gross profit, (e) underlying advertising expenses, (f) underlying selling, general and administrative expenses and (g) underlying operating income. To calculate each of these measures, we adjust for (a) foreign currency exchange and (b) if applicable, estimated net changes in distributor inventories. These adjustments are defined below.
• "Foreign exchange." We calculate the percentage change in our income statement line-items in accordance with GAAP and adjust to exclude the cost or benefit of currency fluctuations. Adjusting for foreign exchange allows us to understand our business on a constant dollar basis, as fluctuations in exchange rates can distort the underlying trend both positively and negatively. (In this report, "dollar" always means the U.S. dollar unless clearly denoted otherwise.) To eliminate the effect of foreign exchange fluctuations when comparing across periods, we translate current period results at prior-period rates.

• "Estimated net change in distributor inventories" refers to the estimated net effect of changes in distributor inventories on changes in our measures. For each period being compared, we estimate the effect of distributor inventory changes on our results using depletion information provided to us by our distributors. We believe that this adjustment reduces the effect of varying levels of distributor inventories on changes in our measures and allows to understand better our underlying results and trend.

Management uses "underlying" measures of performance to assist it in comparing and measuring our performance from period to period on a consistent basis, and in comparing our performance to that of our competitors. We also use underlying measures as metrics in management incentive compensation calculations. Management also uses underlying measures in its planning and forecasting and in communications with the board of directors, stockholders, analysts and investors concerning our financial performance. We have provided reconciliations of the non-GAAP measures adjusted to an "underlying" basis to their nearest GAAP measures in the tables below under "Results of Operations - Year-Over-Year Period Comparisons" and have consistently applied the adjustments within our reconciliations in arriving at each non-GAAP measure.


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Important Information on Forward-Looking Statements:
This report contains statements, estimates, and projections that are "forward-looking statements" as defined under U.S. federal securities laws. Words such as "aim," "anticipate," "aspire," "believe," "continue," "could," "envision," "estimate," "expect," "expectation," "intend," "may," "plan," "potential," "project," "pursue," "see," "seek," "should," "will," "will continue," and similar words identify forward-looking statements, which speak only as of the date we make them. Except as required by law, we do not intend to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. By their nature, forward-looking statements involve risks, uncertainties and other factors (many beyond our control) that could cause our actual results to differ materially from our historical experience or from our current expectations or projections. These risks and other factors include those described in Part I, Item 1A. Risk Factors of our 2014 Form 10-K and those described from time to time in our future reports filed with the Securities and Exchange Commission, including, but not limited to:
• Unfavorable global or regional economic conditions, and related low consumer confidence, high unemployment, weak credit or capital markets, sovereign debt defaults, sequestrations, austerity measures, higher interest rates, political instability, higher inflation, deflation, lower returns on pension assets, or lower discount rates for pension obligations

• Risks associated with being a U.S.-based company with global operations, including commercial, political and financial risks; local labor policies and conditions; protectionist trade policies or economic or trade sanctions; compliance with local trade practices and other regulations, including anti-corruption laws; terrorism; and health pandemics

• Fluctuations in foreign currency exchange rates

• Changes in laws, regulations, or policies - especially those that affect the production, importation, marketing, sale, or consumption of our beverage alcohol products

• Tax rate changes (including excise, sales, VAT, tariffs, duties, corporate, individual income, dividends, capital gains) or changes in related reserves, changes in tax rules (e.g., LIFO, foreign income deferral, U.S. manufacturing and other deductions) or accounting standards, and the unpredictability and suddenness with which they can occur

• Dependence upon the continued growth of the Jack Daniel's family of brands

• Changes in consumer preferences, consumption, or purchase patterns - particularly away from brown spirits, our premium products, or spirits generally, and our ability to anticipate and react to them; bar, restaurant, travel, or other on-premise declines; or unfavorable consumer reaction to new products, line extensions, package changes, product reformulations, or other product innovation

• Decline in the social acceptability of beverage alcohol products in significant markets

• Production facility, aging warehouse, or supply chain disruption

• Imprecision in supply/demand forecasting

• Higher costs, lower quality, or unavailability of energy, input materials, labor, or finished goods

• Route-to-consumer changes that affect the timing of our sales, temporarily disrupt the marketing or sale of our products, or result in higher implementation-related or fixed costs

• Inventory fluctuations in our products by distributors, wholesalers, or retailers

• Competitors' consolidation or other competitive activities, such as pricing actions (including price reductions, promotions, discounting, couponing, or free goods), marketing, category expansion, product introductions, or entry or expansion in our geographic markets or distribution networks

• Risks associated with acquisitions, dispositions, business partnerships or investments - such as acquisition integration, or termination difficulties or costs, or impairment in recorded value

• Insufficient protection of our intellectual property rights

• Product recalls or other product liability claims; product counterfeiting, tampering or product quality issues

• Significant legal disputes and proceedings; government investigations (particularly of industry or company business, trade or marketing practices)

• Failure or breach of key information technology systems

• Negative publicity related to our company, brands, marketing, personnel, operations, business performance, or prospects

• Our status as a family "controlled company" under New York Stock Exchange rules

• Business disruption, decline, or costs related to organizational changes, reductions in workforce, or other cost-cutting measures, or our failure to attract or retain key executive or employee talent


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Summary of Operating Performance

Three months ended July 31,     2013       2014      Reported Change    Underlying Change1

Net sales                     $  896     $  921                3  %             3  %
Excise taxes                     210        216                3  %             3  %
Cost of sales                    209        210                -  %            (1 )%
Gross profit                     477        495                4  %             5  %
Advertising                      103         99               (4 )%            (4 )%
SG&A                             156        170                9  %             8  %
Operating income              $  217     $  221                1  %             7  %

Gross margin                    53.3 %     53.7 %          0.5pp
Operating margin                24.2 %     23.9 %        (0.3)pp

Interest expense, net         $    6     $    7                7  %
Effective tax rate              32.4 %     29.8 %        (2.6)pp
Diluted earnings per share    $ 0.66     $ 0.70                5  %

1See "Non-GAAP Financial Measures" above for details on our use of "underlying changes" for net sales, excise taxes cost of sales, gross profit, advertising expenses, and SG&A expenses, including how these measures are calculated and the reasons why we think this information is useful to readers. Overview
For the three months ended July 31, 2014, compared to same period last year, we grew underlying net sales 3% (3% reported), increased underlying operating income 7% (1% reported), and delivered a 5% increase in diluted earnings per share. These operating results were driven by the continued global growth of our American whiskey portfolio, led by the Jack Daniel's family of brands. We maintained our strong financial condition while continuing to invest in our capacity expansion projects and returning $74 million to shareholders during the quarter through dividends and share repurchases.


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          RESULTS OF OPERATIONS - FISCAL 2015 YEAR-TO-DATE HIGHLIGHTS
Brand Highlights
The following table highlights the worldwide results of our largest brands for
the three months ended July 31, 2014, compared to the same period last year. We
discuss results of the brands most affecting our performance below the table.
Unless otherwise indicated, all related commentary is for the three months ended
July 31, 2014 compared to the same period last year.
Major Brands Worldwide Results

                                                     Percentage change versus prior year
Three months ended July 31     Volumes                                     Net Sales1
                                                                                Net Chg in Est.
                                                                                  Distributor
Brand family / brand        9L Depletions        Reported     Foreign Exchange    Inventories       Underlying *
Jack Daniel's Family               4 %                4 %           (1 %)               2 %                5 %
Jack Daniel's Tennessee
Whiskey                            - %                1 %           (1 %)               3 %                2 %
Jack Daniel's Tennessee
Honey                             31 %               35 %           (1 %)              (5 %)              29 %
Other Jack Daniel's
whiskey brands2                    7 %               10 %            - %               (2 %)               9 %
Jack Daniel's RTDs/RTP3            6 %                6 %           (2 %)              (1 %)               3 %
Southern Comfort                  (4 %)              (8 %)          (1 %)               2 %               (7 %)
Finlandia                        (15 %)             (10 %)          (1 %)              (2 %)             (13 %)
El Jimador                         9 %               20 %            2 %               (7 %)              15 %
New Mix RTDs                      62 %               63 %            5 %                - %               67 %
Herradura                         19 %               25 %            2 %               (8 %)              20 %
Woodford Reserve                  26 %               35 %            - %               (6 %)              29 %
Canadian Mist                     (7 %)              (8 %)           - %                1 %               (7 %)


* Totals may differ due to rounding

1See "Non-GAAP Financial Measures" above for details on our use of "underlying change" in net sales, including how this measure is calculated and the reasons why we think this information is useful to readers.
2In addition to the brands separately listed here, the Jack Daniel's family of brands includes Gentleman Jack, Jack Daniel's Single Barrel, Jack Daniel's Sinatra™ Select, Jack Daniel's No. 27 Gold Tennessee Whiskey, Jack Daniel's 1907 Tennessee Whiskey, Jack Daniel's Tennessee Rye Whiskeys and Jack Daniel's Tennessee Fire.
3Jack Daniel's RTD and RTP products include all RTD line extensions of Jack Daniel's, such as Jack Daniel's & Cola, Jack & Ginger, Jack Daniel's Country Cocktails, and the seasonal Jack Daniel's Winter Jack RTP.
• Jack Daniel's family of brands grew underlying net sales 5% (reported 4%) and was the most significant contributor to our underlying net sales growth for the three months ended July 31, 2014. Here are details about the performance of the Jack Daniel's family of brands in the first quarter:

• Jack Daniel's Tennessee Whiskey (JDTW) accelerated volume growth in emerging markets during the first quarter, while volumes declined in several developed markets - largely driven by retail- and wholesale-trade inventory reductions - including in the United States, the United Kingdom and Germany. Higher pricing for JDTW in the United States and France were important contributors to sales growth in the quarter.

• The continued global expansion of Jack Daniel's Tennessee Honey (JDTH) contributed significantly to our underlying net sales growth as several recently-launched international markets added volume while existing markets, including the United States, continued to grow.

• Among our Other Jack Daniel's whiskey brands, the most significant contributor to underlying net sales growth was Jack Daniel's Sinatra Select, which benefited from a favorable comparison to a low sales base in the same period last year in the United States.

• Germany and Mexico led the growth of Jack Daniel's RTDs/RTP. Net sales growth in Mexico benefited from volumes of a recent line extension, Jack Daniel's Apple.

• New Mix RTDs grew underlying net sales 67% (reported 63%) as volumes benefited from a favorable comparison to very weak sales in the same period last year. In the first quarter of fiscal 2014, volumes of New Mix RTDs were unusually low because of high customer inventories following a price increase late in fiscal 2013.


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• Woodford Reserve led the growth of our super- and ultra-premium American whiskeys with underlying net sales growth of 29% (reported 35%). In the United States, Woodford gained share of super-premium bourbon category and sustained double-digit volume growth. The brand continued its international expansion and increased sales in both France and the United Kingdom.

• Underlying net sales for Southern Comfort declined 7% (reported declined 8%). Net sales declined in the United Kingdom, Australia, and the United States as the brand faced consumer challenges. In the United States, the brand continued to be affected by negative on-premise channel trends affecting liqueurs generally.

• Underlying net sales for Finlandia declined 13% (reported declined 10%) driven predominately by lower volumes in Poland. In Poland, volume declined more than 30% in the first quarter due to high retail- and wholesale-trade inventories and weaker consumer demand following an excise tax hike and our related price increases in fiscal 2014.

Market Highlights
The following table provides supplemental information for our largest markets
for the three months ended July 31, 2014, compared to the same period last year.
We discuss results for the markets most affecting our performance below the
table. Unless otherwise indicated, all related commentary is for the three
months ended July 31, 2014 compared to the same period last year.
Top 10 Markets1 - Fiscal 2015 Net Sales Growth by Geographic Area

                                                        Percentage change versus prior year period
Three months ended July 31, 2014                                        Net Sales2
                                                                              Net Chg in Est.
                                                                                Distributor
Geographic area                               Reported      Foreign Exchange    Inventories         Underlying
United States                                    (2 %)             - %                2 %                 - %
Europe:
United Kingdom                                   (9 %)            (5 %)               - %               (13 %)
Germany                                         (11 %)            (3 %)               - %               (14 %)
Poland                                          (16 %)            (5 %)               - %               (21 %)
Russia                                            - %             14 %                3 %                17 %
France                                           51 %             (6 %)               3 %                48 %
Turkey                                           26 %             13 %                - %                38 %
Rest of Europe                                    8 %             (2 %)               - %                 6 %
Europe                                            1 %             (1 %)               - %                 - %
Australia                                        13 %             (6 %)               - %                 7 %
Other:
Mexico                                           16 %              4 %                - %                20 %
Canada                                            7 %              5 %               (1 %)               10 %
Rest of Other                                     9 %              2 %                7 %                17 %
Other                                            11 %              3 %                4 %                18 %
TOTAL                                             3 %             (1 %)               1 %                 3 %

1Top 10 markets as ranked based on percentage of total Fiscal 2014 Net Sales. See 2014 Form 10-K "Results of Operations - Fiscal 2014 Market Highlights" and "Note 13. Supplemental Information."
2See "Non-GAAP Financial Measures" above for details on our use of "underlying change" in net sales, including how this measure is calculated and the reasons why we think this information is useful to readers.

• United States. Underlying net sales in the United States were flat while reported net sales declined 2%. Underlying net sales growth was driven by JDTW pricing, and volume growth for Woodford Reserve, JDTH, and el Jimador but was offset by lower volumes for JDTW, Korbel Champagnes, and Canadian Mist. JDTW volumes were negatively affected by retail-trade inventory reductions compared to the same period last year. Last year in the first quarter, retail-trade inventories were higher because of their purchases ahead of price increases not repeated to the same extent this year.


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• Europe. Underlying net sales growth in France, Turkey and Russia was fully offset by declines in the United Kingdom, Germany and Poland.

•            In France, net sales growth from pricing was driven by our
             comparatively higher direct-to-trade prices and the inclusion of
             excise taxes in net sales, both of which resulted from our fiscal
             2014 route-to-consumer change. In addition, net sales growth from
             volume was driven by JDTH, which was introduced in the second half
             of our fiscal 2014.


•            In Russia, while underlying net sales grew 17% in the first quarter,
             reported net sales were flat due to the negative effect of a much
             weaker Russian ruble compared to the same period last year and an
             estimated net reduction in distributor inventories. We believe that
             there is increasing risk to consumer sentiment and spending in
             Russia given the deteriorating economic situation there, including
             slowing GDP growth, inflationary pressure and a weaker currency. In
             addition, our business faces risks related to uncertainty about how
             local laws may be interpreted and enforced in Russia. Please refer
             to Part I, Item 1A. Risk Factors of our 2014 Form 10-K for a
             description of these risks and other factors which could materially
             affect our business, financial condition, or future results.


•            In Germany and the United Kingdom, retail- and wholesale-trade
             inventory reductions contributed to the declines.


•            In Poland, the decline in underlying net sales was driven largely by
             weaker consumer demand for Finlandia following an excise tax hike
             and our related price increases in fiscal 2014. We believe that
             higher pricing has weakened consumer demand generally for vodkas,
             including Finlandia.


•      Australia. In Australia, underlying net sales growth was driven by (a)
       volume growth of a third-party brand that we began distributing in July
       2013, and (b) higher volumes for JDTW.


•      Other. Higher consumer demand was the primary driver of growth for our
       brands in Brazil, Canada and for our travel retail customers. Growth in
       Mexico was helped by comparison to a prior-year period when net sales were
       negatively affected by higher customer inventories.


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           RESULTS OF OPERATIONS - YEAR-OVER-YEAR PERIOD COMPARISONS
NET SALES

Percentage change versus the prior year period ended July 31     3 Months
Change in reported net sales                                        3  %
Foreign exchange                                                   (1 )%
Estimated net change in distributor inventories                     1  %
Change in underlying net sales                                      3  %

Change in underlying net sales attributed to:
Volume                                                              1  %
Net price/mix                                                       2  %

For the three months ended July 31, 2014, net sales were $921 million, an increase of 3% or $25 million compared to the same period last year. Underlying net sales grew 3% after adjusting reported results for the positive effect of foreign exchange and the offsetting negative effect of an estimated net reduction in trade inventories. The positive effect of a stronger Australian dollar on reported net sales more than offset the negative effect of weaker European currencies. An estimated net reduction in our U.S. distributors' inventories compared to the same period last year, when distributors increased purchases ahead of our price increases, was the most significant factor driving the negative effect on reported results of estimated changes in distributor inventories.
The primary factors contributing to the 3% growth in underlying net sales were:
a. Higher sales of JDTW driven by volume growth across most emerging markets and by higher pricing in the United States and France.

b. Higher volumes for JDTH in the United States and across many markets where the brand was recently introduced, including France.

c. Higher volumes for New Mix RTDs and Herradura tequila in Mexico, both of which benefited from comparison to the prior-year period when net sales were negatively affected by higher customer inventories.

d. Higher sales of Woodford Reserve globally, driven primarily by higher volumes in the United States.

The primary factors partially offsetting underlying net sales growth were:
a. Lower volumes for JDTW in the United States and in many developed-economy markets in Europe, including the United Kingdom and Germany, where wholesale and retail trade customers reduced inventory levels compared to the same period last year.

b. Lower volumes for Southern Comfort in the United Kingdom, Australia and the United States, driven by lower consumer demand in the on-premise channel.

c. Lower volumes for Finlandia Vodka driven primarily by declines in Poland, where we believe that higher pricing has weakened consumer demand generally for vodkas following an excise tax increase last fiscal year.

COST OF SALES

Percentage change versus the prior year period ended July 31     3 Months
Change in reported cost of sales                                    -  %
. . .
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