Brown-Forman Corp (BF.B) 2004 Q1 法說會逐字稿

I will now turn the call over to Mr. Lawson Whiting.

Sir, you may begin.

Good morning.

This is Lawson Whiting speaking, Investor Relations at Brown-Forman Inc., and I'd like to welcome you to our first quarter fiscal 2004 conference call.

Today Owsley Brown, our Chairman and CEO, will open up the discussion with a brief overview of our recent changes in senior management and review our brand performance in the first quarter.

Phoebe Wood, our Executive Vice President and Chief Financial Officer, will follow with more detail on the financial results of each of our business units and provide some guidance on our expectations for the balance of this fiscal year.

We'll then take questions from investors.

This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

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.

These statements are subject to a number of important risks and uncertainties that could cause our actual results and experience to differ materially from the anticipated results.

These risks include, but are not limited to, deterioration in economic conditions in the principal countries to which we export our beverage products; a further decline in discretionary consumer spending; a decline in demand for tableware, giftware, or leather goods; and the uncertainties of litigation.

Increases in federal or state excise taxes on spirits and wine would also depress our domestic beverage business.

Legal or regulatory measures against beverage alcohol, including advertising and promotion could also adversely affect sales.

These statements are also subject to the factors mentioned in part one item two of the company's form 10-K for the year ended April 30, 2003, which we incorporate here by reference.

Now I will turn the call over to our Chairman and CEO, Mr. Owsley Brown.

Good morning and welcome to our conference call.

I'd like to begin by taking a couple of minutes to discuss the long-term succession plan at Brown-Forman which was announced in late June and took effect on August 1st.

With our President, Bill Street, retiring this fall and my scheduled retirement four years from now, it's appropriate to begin putting in place people who, together, can lead this company through the rest of this decade and into the next.

Our Board of Directors worked with us for well over a year in shaping, reviewing and approving our succession strategy which involves new responsibilities and promotions for a number of key executives.

Recommendations were made to the directors, and the Board's decisions were based on a carefully chosen set of criteria.

These include not only the skills and competencies our leaders will need to guide our company to continued success in the future, but also the traits, styles and values which form the core of Brown-Forman's exceptional culture.

Importantly, the Board focused as carefully on the skills and talents of the executive team as a group as they did on those of each individual member.

Paul Varga has been named President and Chief Executive Officer of Brown-Forman Beverages, with overall responsibility for our worldwide beverage business.

He has been at Brown-Forman for 17 years, most recently as head of global marketing for our spirits brands.

Paul is a major architect of our current marketing programs and brand building initiatives, and also has significant experience with sales.

And importantly, Paul is dedicated to the concept of creating shareholder value.

He is widely respected within the company as a thoughtful and energetic person, and I'm confident he will be a strong leader for Brown-Forman Beverages.

While I won't go through all of the executive changes we made, I will give you a few other outlines.

Jim Bareuther has been named Executive Vice President and Chief Operating Officer of Brown-Forman Beverages.

Jim was most recently President of our Spirits America's group.

He brings a wealth of industry experience and relationships developed over a 30 year career in the wine and spirits industry.

Phoebe Wood, who will speak to you later, recently joined the Board of Directors of Lenox and is now going to take on the additional roll of Vice Chairman of Lenox assisting our Chairman of the Lenox Board, Barry Bramley, in the oversight of this subsidiary.

Phoebe will continue her role as Brown-Forman's Chief Financial Officer, our lead contact with the investment community, and in overseeing the company's Hartmann Luggage subsidiary.

Michael Crutcher and Jim Welch, both of whom have been named Vice Chairmen of the Corporation, are being asked to take on additional corporate responsibilities.

In addition to their present work, they will assume some of Bill Street's former administrative shareholder, civic, and industry responsibilities.

And Don Berg has been promoted to President Brown-Forman Spirits America's replacing Jim Bareuther in the single most important geographic area for our spirits business.

Don has a broad background in finance, sales and marketing and will play a major role in the growth of this critical part of the company in upcoming years.

And more recently we announced that Don Grimes will lead the newly created corporate planning and analysis department.

This position will assume some of the responsibilities which were previously held by Larry Probus including Investor Relations so that I'm sure that many of you will get the chance to meet Don in upcoming months.

As a result of all these changes, many people within Brown-Forman are being asked to assume new responsibilities and challenges.

But I believe that the stability embodied in the many of us, including me, who continue in our present positions, in combination with the freshness brought by those in new roles, gives our company a truly exceptional future.

I'd now like to spend a couple of minutes talking about our recent brand performance.

Jack Daniels is off to a good start this fiscal year.

Quarterly results in the United States were consistent with recent trends with both depletions and pricing up in the low to mid single digits.

Recent consumer take away data have also been encouraging, giving us positive momentum as we enter the important holiday selling period.

The United Kingdom remains the fastest-growing major market in the world for Jack Daniels, with depletions continuing to grow at double-digit rates.

Volumes in continental Europe were weaker however, particularly in Spain and Italy where we've been more aggressive with our price increases.

However, consumer take away trends throughout much of continental Europe remain healthy, and we still anticipate growth in volume this year from this part of the world.

Southern Comfort is also continuing the trends of the past few years.

Although volumes were slightly disappointing in the U.S., sustained price increases and cost reductions are boosting overall profitability.

Similar to Jack Daniels, Southern Comfort is getting very good results in the United Kingdom, but performance in continental Europe is weak.

Results for Finlandia were mixed.

When Brown-Forman acquired its additional 35 percent interest in the brand on December 31, 2002, we added new markets to the distribution agreement which increased our overall volume for the brand.

However, in the United States where the ultra premium vodka market is extremely competitive, our results have fallen below expectations.

As we told you when we acquired or additional stake last year, we'll be significantly increasing our brand building activities this fiscal year.

As part of this program, we'll be introducing a new package for the brand over the next few months.

Although the increase in brand building activities on Finlandia will suppress profits for the next couple of fiscal years, we believe that the long-term payback for our shareholders will be meaningful.

The wine industry in the United States continues to operate in a very difficult environment.

One in which we have been very little improvement so far this fiscal year.

We're working hard to improve the price position of our wine brands, but it's not been easy, particularly for Bolla.

We're seeing (technical difficulty) drop as we try to hold the line on pricing, especially in California where the large retailers have such a commanding percentage of wine sales.

On a positive note, we have reduced field inventories during the past quarter which bodes well for the upcoming holiday season.

With that review of our major wine and spirits brands, I'll turn the call over to Phoebe Wood to provide some more detail on our quarterly results and the outlook for the balance of the year.

Thank you, Owsley, and good morning everyone.

This morning Brown-Forman reported earnings per share of 51 cents, down from the 53 cents earned last year.

Excluding the 11 cents per share onetime charge for the settlement of the Diageo litigation, our earnings per share were 62 cents, up 9 cents over last year.

This story is similar to recent quarters.

Our spirits business remains fairly strong while our wine and consumer durables businesses remain soft.

Higher quarterly earnings were being driven by solid profit growth for both Jack Daniels and Southern Comfort, the resumption of a normal shipment pattern into the UK, which I will discuss in a couple of minutes, higher profits earned on our spirits brands in the United Kingdom due to the new distribution arrangements, and benefits from a weaker U.S. dollar.

A couple of comments regarding the legal settlement with Diageo.

As most of you already know, Diageo is Brown-Forman's former distributor in the United Kingdom.

When our distribution contract expired, Diageo claimed it was entitled to renew the Jack Daniel's contract for an additional three years based on certain performance criteria.

Essentially the case revolved around certain contract performance tests and what statistics should be used for these tests.

Both parties have agreed to end the controversy over the contract and move on to their respective businesses.

As a result, we have included a $10.3 million settlement cost in the first quarter which appears in the "other income and expense" line item on the income payment.

On a positive note, and as Owsley said a few minutes a go, our business in the UK remains solid.

Jack Daniels is continuing its outstanding performance in the UK, and Southern Comfort has significantly improved its overall performance.

We are very pleased with our new distribution arrangements and we are looking forward to continued strong growth in the important UK market.

Now back to the financial statements.

First, I'd like to breakdown our revenue growth.

The headline growth rate for our beverages business was a very strong 18 percent.

However, there are several unusual issues from this past quarter which make the revenue growth appear stronger than it was on an organic basis.

Most of these issues are related to the distribution changes in the United Kingdom.

First, because we now sell directly to the consumer rather than using a third party distributor, the company now records excise taxes for its UK spirits business in both revenue and cost of sales.

In the first quarter, total excise taxes in the UK were about $20 million, which effectively accounted for 6 points of the revenue growth rate.

It also lowered the reported gross margin for the beverages segment by 2.6 percentage points despite the fact that overall profitability is actually significantly higher.

The second major issue related to the UK and our revenue growth rate was the resumption of a normal shipment pattern into that market.

Most of you will remember that during the first quarter of last fiscal year Brown-Forman shipped very few cases into the UK as Diageo sold the cases it already had sitting in its inventory.

As a result, this year's first quarter is being compared against a period of depressed revenues from our second-largest market in the world.

Accordingly this quarter's revenues were about $13 million higher or about 4 points on the revenue growth rate from resuming our normal shipment pattern as well as the higher profits earned on each case sold in that market.

The last issue is foreign exchange.

The weaker U.S. dollar is obviously benefiting our expert business, particularly for the United Kingdom.

We estimated that changes in key foreign exchange rates increase first-quarter revenues by about $12 million, contributing about 3 points to our revenue growth.

However, keep in mind that our foreign exchange exposure has changed somewhat over the past couple of years.

We are currently importing such brands as Finlandia and Bolla, and result in an increasing amount of products for Lenox and Gorham from Germany.

These are all Euro denominated markets.

As a result, a weaker U.S. dollar versus the euro does not enhance our bottom line quite like it used to in those market.

Taking into account our internal natural hedges and our external hedging contracts, we estimate that the weaker U.S. dollar improved quarterly earnings by about $4 million or 4 cents per share.

Beverage advertising expenses were down $1 million during the quarter as increased investments behind our core spirits brands were more than offset by a reduction in wine advertising and promotion activities.

Although advertising investments will probably be down year-over-year for our wine brands, we still anticipate good rates of advertising and promotion increases for our spirits brands.

SG&A expenses were up approximately $15 million in the quarter, an abnormally large increase.

However, there are several items which pushed up the rate of SG&A growth this quarter.

First, the beverage segment incurred $3 million in reorganization costs primarily in our wine division.

Second, we added sales and marketing people in the United Kingdom to support our new distribution arrangement.

Third, we recognized higher pension and insurance costs of about $2.5 million for the quarter.

We expect this to continue throughout the fiscal year.

Lastly, SG&A expenses were higher in Europe due to the consolidation of Finlandia Vodka worldwide and Tuoni e Canepa, maker of (indiscernible) Liqueur following these acquisitions in the second half of fiscal 2003.

Operating income for the beverages segment increased 4 percent to $64 million, but obviously the litigation charge significantly depressed the quarterly result.

Turning to consumer durables.

Results for our consumer durables segment were very disappointing this first quarter.

Net sales were down 9 percent and gross profit decreased 10% sales to both department stores and through the company's retail outlets were weak.

In addition, results in the direct to consumer channel have deteriorated in recent months as response rates in the catalog and direct-mail division continue to decline.

One potentially positive trend for this segment was the recent uptick in same-store sales in our retail outlets.

We have a new management team responsible for our retail channel and early results seem quite positive.

But all in all the segment has not recovered from the cyclical downturn which began two years ago.

It is noteworthy that this is a seasonal business that typically reports a loss in the first quarter.

However, the loss has been larger for part of this year as the segment reported a first-quarter operating loss of $11.9 million compared to a $5.6 million loss during the same period last year.

Let me conclude with our earnings outlook.

Our previous fiscal 2004 guidance of $4.10 to $4.30 per share did not fully anticipate the 11 cent per share cost of the litigation settlement with Diageo, nor the extent of the weakness in consumer durables.

However, continued growth for our core spirits brands, anticipated improved financial performance from wines, and benefits from a weaker U.S. dollar are supporting the company's earnings per share outlook for the rest of the fiscal year.

As a result, Brown-Forman still expects to see earnings in the range of $4.10 to $4.20 per share for fiscal 2004 consistent with previous guidance.

That concludes our prepared remarks.

Now Owsley, Lawson and I will be glad to answer any questions that you may have.

Dara Mohsenian of J.P. Morgan.

Dara Mohsenian Two questions.

First off, can you discuss your ability to maintain full year EPS guidance despite the 11 cent litigation hit from the Diageo settlement?

And I guess what I'm really wandering is if operating results are now expected to fully offset that entire amount and have moved up by 11 cents, or if your guidance stems more from the fact that you had a fairly wide range to begin with?

Then second, can give us some more color on Finlandia, maybe Q1 U.S. depletion trends, and quantify if there was any Q1 EPS dilution from the brand?

And I know you guys don't like to get into quarterly EPS forecasts too much, but I'm wondering if you can at least give us some kind of sense for Q2 and Q3 EPS solution from Finlandia or at least the quarterly flow we should expect on marketing spending behind that brand.

Thank you for your questions.

The range that I provided, $4.10 to $4.30, we are staying with that range and we are not providing any more specific guidance about where in that range we might land for these reasons.

First of all, it's early in the year.

The first quarter is our slowest of all quarters, the smallest of all quarters.

We do not know how to anticipate foreign exchange for the balance of the year.

And we have a full holiday season, which is our strongest time of the year, ahead of us.

We are seeing very nice NAPCA (ph) take-away numbers.

So despite the 11 cents per share Diageo settlement, we are very confident that we will be in the range of $4.10 to $4.30.

It's just too early in the year to make any further changes.

With regard to Finlandia Vodkas, I'm going to turn that to Lawson.

A couple points on Finlandia there.

Depletions were down modestly I would say in the first-quarter, but I think we get some encouragement.

If you take a look at NAPCA data, it's actually getting better.

What I mean by that is the one month's numbers are better than the three months which are better than the 12 months.

So we're starting to see some improvement on the volume side.

We've had to be modestly aggressive on the pricing side to get that, but I think that's working.

We're unveiling a new package in the next couple of months, and you had asked about just sort of the flow of the advertising expenses, there is a big new campaign coming out and that's going to be rolling out over the rest of the fiscal year.

So you will probably be seeing more from Finlandia over the next few months.

Is it fair to assume that not much incremental marketing spending behind Finlandia in the first-quarter, that's more of a trend for the second and third quarters?

That's true.

Great, thank you.

Stuart Rozanski (ph) of Vanguard.

The question I had is, if you could talk a little bit about your cash flow usage and your cash flow expectation for the year?

You're talking free cash flow expectations for the year.

Yes.

We don't give any guidance on free cash flow obviously.

I think we've given guidance on earnings per share basically for the year.

We do not anticipate anything out of the ordinary on the CAPEX, in fact it will be significantly less than last year.

We've told people in the past that we expect CAPEX for the full year to be in the range of $80 to $90 million, and we're sticking with that.

So that's about all I can tell you about the free cash flow expectations.

I guess what I'm really kind of driving at is, with any free cash flow that you have, what are your goals for use of that free cash flow?

If I may just interject here to respond, I think that the wonderful thing about this business is it's highly cash generative.

We use a variety of things to make some investment decisions for our shareholders.

Earlier this year, with the repurchase of our shares, we incurred $600 million of debt and the focus of our cash flow use so to speak for the next few years as we pay off that $600 million of debt -- by the way there are two tranches -- we borrowed $250 million for three years and we borrowed $350 million for five years.

And so our focus really is going to be in using our free cash to pay off that.

It will be fully paid off based on our expectations.

There are shareholder earnings in the company and so the things that we do are going to be oriented toward maximizing the return that comes to shareholders.

We will invest appropriately in our businesses and capital expenditures.

We will continue to provide our shareholders with dividends and also with opportunities such as the share repurchase.

So that's going to be the focus of our use of free cash flow.

Do you have any current authorization for additional share repurchases?

We do not.

Any expectation of putting one in place?

No.

Thank you very much.

Ann Gurkin of Davenport.

I was wondering if you could comment on how your volume went in Europe for June and July?

Let's just get that data.

Volume in Europe for June and July.

I don't have it by a month, but I can tell you in general the UK, as we said, is very solid.

As good, if not a little better than the recent trends.

So I think we feel very good about volume trends there.

Germany has been a little weaker than our expectations, but it's not too bad.

France is kind of flat.

Italy is actually down for the quarter but I think there are some unusual things going on and buying patterns in Italy.

I don't think we feel particularly scared about the performance in Italy.

And in fact, if you look at Nielsen data or IRI data depending on the countries in continental Europe, net debt is actually pretty strong.

We feel pretty good about that.

I think the underlying consumer take away trends throughout most of Europe are pretty much on par with previous trends.

Okay.

And just another question.

Would you all ever consider selling your wine portfolio?

Can you just run through that again?

I'm going to try to answer this question, and Owsley may want to add to it as well.

We consider wine to be a core part of our beverages portfolio, and we do not have any plans for making any changes in that at all.

On the other hand, our wine business is not having an easy time now, and we are very dedicated to taking all sensible steps that will help us not only improve the kind of short-term disappointment that the situation, particularly here and the U.S., is bringing us for wines, but also looking very carefully at the long-term future and the value of the brands that we have and how to bring them to the greatest size and scale we can on behalf of our shareholders.

I think I'd like to just amplify a little on wine since you brought it up.

It gives us the opportunity to say it's a tough, very tough, competitive market out there.

It's been an over supply situation.

It's likely to continue to be in an oversupply situation, despite the fact that last year consumers in the U.S. consumed at the highest level in 16 years.

We're trying very hard to be competitive in that market without harming our brand equity.

In Korbel, the volumes are up and it's doing fine, Bolla and Fetzer are both meeting very tough competition.

Why do we expect improvement in this?

It's because we're really lowering our costs in this business.

That's our focus.

Okay, great.

Thank you.

Graeme Eadie of Deutsche Bank.

The question I have was going to partly answer this before actually.

It's on wine again.

If I could just press the point a bit farther.

I mean obviously in the '90s, wine was the key area of investment for you.

You bought Fetzer; you bought Sonoma-Cutrer; you were quite keen in buying Kendall-Jackson.

You made it pretty clear from the previous answer that wine is still going to be a core part of the overall business, but do you still see yourself expanding in wine in the same way that perhaps characterized the 1990s going forward?

I think that would be pretty unrealistic.

There's a lot for sale out there.

And my guess is that that won't stop so the ability to increase volume will certainly be there and we have the cash flows and the balance sheet to take advantage of those, Graeme, if that ever seems warranted on behalf of our shareholders.

But per se there's no question that the bloom is off of the vine in comparison to the 1990s.

So we are reacting to the period that we are operating in, and I think reacting in an appropriate way.

Okay, thank you very much.

Peter Park of Park West Asset Management.

It's been answered, thank you.

Bryan Spillane of Bank of America Securities.

I've got two questions.

One for you, Phoebe, just with all of the restructuring that you've had over the last two years or so in the durables business, are you a little bit disappointed at this point that you haven't seen at least more margin recovery or more cost-savings sort of help support the business here?

And do you think there's more in front of you as you go foreword or plans to try to squeeze some more margins out of there?

And then the second question I have is for Owsley, there's been some speculation on your potential link up with Allied DEMAC (ph), and if you could just sort of frame for us how you think about acquisitions, especially big acquisitions, what sort of considerations that you and the Board take into account before you'd make a move like that?

Thanks for your questions, Bryan.

I'll take the first one, consumer durables.

Certainly, you can understand that we are disappointed in the results in the first quarter and we're concerned about this business.

We've actually put together a team of Brown-Forman senior executives and Lenox senior executives to look at the business and to make recommendations about how we can improve it and what we should do.

So the new team in the retail with some initial good results.

We are really focused on taking cost out of this business and improving this segment.

Overall, our goal here is to improve the value of this business to our shareholders.

I mean, that is our overall goal and we obviously, with the results that we have, are spending more time and attention on it.

Phoebe, I know you've closed a few plants.

Is there opportunity to move more supply to lower-cost areas -- to Asia I guess, or is more of it now looking sort of further along the supply chain and trying to squeeze some efficiencies out of your relationship with retailers in managing inventories and that sort of thing?

It's probably something all of the above, we've closed three plants.

That's very significant in the durables side.

Very, very significant.

We look at it actually very much on where the value is added in the business.

And, for example, we tend to outsource those things where there is a high percentage of labor content, where labor is at a much higher per dollar rate in this country than it is in some of the other countries where we can outsource.

However, on the other hand, when you get to the high-volume automated, state-of-the-art so to speak factories that we have here in the U.S.

It's not really advantageous for us to move those overseas provided that the volumes are there for us to continue those plants.

Therefore, it's a sharp pencil test.

Okay.

And one last on that is just, is it more of a channel issue here?

Do you need more exposure to places like Wal-Mart and Target and less traditional department stores?

Is that essentially going to be the big fix for this business?

It is a channel issue, but it is also an economic issue.

Okay.

And the channel issue is something that we are very much focused on, and I think the management team at Lenox has been aware of that and adjusting to it for some time.

But (technical difficulty) and they're confident and their interest in purchasing, whether it be giftware in which we specialize or bridal.

You have some changing patterns of, for example, bridal gift giving that affect us as well.

So channel is the easiest and has been a focus of our attention, no question.

Thanks.

I'll pick up on the question of large-scale acquisitions in particular and how we approach them.

I think I'm going to pass the commenting on rumors about any particular company.

I mean rumors are with us at all times.

So we've learned to live with them and I imagine you will after this.

It sounds fair enough.

We have a very disciplined approach to our acquisition work and we really use the same one over a 25-30 year period.

We've worked hard to try to see what the perspective brands or company can fit into our organization, what we can bring to them, and what they can bring to us.

And obviously, particularly in the last 10 or 15 years, where almost all transactions -- most transactions have been done, big transactions on an auction basis, we have to be very, very aware of what the cost is in relation to the values that are brought in the future to our shareholders.

There's no question that when you deal with things of extremely large size.

Brown-Forman has from time to time booked either in conjunction with others or in some cases by ourselves the things that are very large, the standards of things that we have acquired before, we obviously have to look at what the risks are to our balance sheet and equity base in light of what we're getting.

If we think that the rewards and the likelihood of those rewards coming exceed the risks and if we can tolerate those risks, we'll take advantage of that opportunity.

If not, we're really pretty disciplined about knowing where to stop because I think we're just a very shareholder oriented company.

So we want to truly add value to our shares and I think family ownership or a large percentage of family ownership really assures this.

So where we see we can add long-term value to our shareholders, we will use our balance sheet and use our good cash flows to advantage, and where the price is too steep and it doesn't look like we'd be going backwards rather than forwards, we'll stop.

Great, thank you very much.

Dara Mohsenian of J.P. Morgan.

Can you give us an update on the spirits pricing environment in the U.S. and I'm wondering if you think there's been any pricing pressure in the industry or on your portfolio as a result of a weak economy or maybe lower wine pricing?

We'd be happy to do that for you.

We can comment more on our own pricing than we can on everybody else's pricing.

In the U.S., if you look at a comparison with this quarter last year, for our very large global brand we are up in the lower single digit.

We have taken increases in the wine brands to -- I'll say this, it's a brand equity.

There's been so much price deflation there I think, but the change is very modest, but it is in the positive direction.

A few of our other smaller lower margin brands there have been very, very slight decreases.

There have been some slight decreases in pricing from quarter to quarter.

From the premium brand perspective, the trends are pretty much similar to the way they've been for quite a while.

Southern Comfort is continuing to get better price increases than our other brands, but that's a conscious decision to take it up in the market, and it's being successful, it's still going up and that plan is on track.

So it becomes a case of the premium brand being able to maintain stronger price increases than the standard.

I think overall, if you look at the trends, just a steady low single digit increase is sort of our history and how we think about going forward.

Great, thank you.

You bet.

Thank you, Dara.

At this time, there are no further questions.

Mr. Whiting, are there any closing remarks?

No, thank you for joining us on the first quarter conference call.

That's it.

Thank you.

This concludes today's Brown-Forman conference call.

You may now disconnect.