Brown-Forman Corp (BF.B) 2007 Q4 法說會逐字稿

Good morning.

My name is Shanta, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Brown-Forman fiscal 2007 earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speaker's remarks, there will be a question and answer session.

(OPERATOR INSTRUCTIONS) Thank you.

Mr.

Graven, you may begin your conference.

Good morning, everyone.

Thank you for joining us today.

This is T.J.

Graven, the Director of Investor Relations at Brown-Forman.

With me today are Paul Varga, our President and Chief Executive Officer; Phoebe Wood, Vice Chair and Chief Financial Officer; and Jane Morreau, Senior Vice President and Controller.

Phoebe will begin our call this morning with a recap of several milestones accomplished in our recently completed fiscal 2007.

She will then comment in detail on our recent acquisition of Casa Herradura, and follow with a review of our financial performance for the year and our outlook for fiscal 2008.

Paul will then finish our formal remarks with comments on how our activities in this very busy fiscal year represent an extension of our strategy in the continued evolution of our Company.

As always, this morning's conference call contains forward-looking statements based on Management's current expectations.

Numerous risks and uncertainties may cause actual results to differ materially from those anticipated or projected in these statements.

Many of the factors that will determine future results are beyond the Company's ability to control or predict.

You should not place undue reliance on any forward-looking statements, and the Company undertakes no obligation to update any of these statements, whether due to new information, future events or otherwise.

This morning, we issued a Press Release containing our fiscal 2007 results.

The release can be found on our website under the section entitled Investor Relations.

We've listed a Press Release a number of the risk factors you should consider in conjunction with our forward-looking statements.

Other significant risk factors are described in our Form 10-K, Form 8-K and Form 10-Q reports filed with the SEC.

During this call, we will also be discussing certain non-GAAP financial measures.

These measures, and the reasons Management believes they provide useful information to investors regarding the Company's financial condition and results of operations, are contained in the Press Release.

With that, I'll turn the call over to Phoebe.

Good morning, everyone.

Fiscal 2007 was an exceptional year for our brands and our business.

In a minute, we will review our financial results, but before that, I would like to share a few milestones we achieved this year.

During fiscal 2007, Jack Daniel's depletions grew to over 9 million cases annually, and the year marked the largest dollar growth in gross profit in the history of the brand.

Of the total depletion growth of this brand, international markets represented over 70%.

The growth came from many regions as volumes grew in each of the brand's ten largest markets.

In fact, the brand experienced growth in 23 of its 25 largest markets outside of the United States.

While very important to our Company's results, our success is not limited to just Jack Daniel's performance.

We had many brand that's recorded double-digit adjusted gross profit gain, which simply uses depletions rather than shipments as a basis for the calculation of our gross profit growth.

They are Southern Comfort, Finlandia, Jack Daniel's and Cola, Sonoma-Cutrer, Gentleman Jack, Jack Daniel's Single Barrel, Woodford Reserve, Bonterra, Pepe Lopez, and Jekel.

Our company reached another significant milestone in fiscal 2007.

Our total portfolio of cases sold surpassed 30 million nine-liter cases.

Notably, in just 18 short months, we've replaced the revenues provided by the Lenox business, which we sold in 2005, with what we believe to be much higher quality earnings and far better growth potential.

It's important also to note that despite the changes that have taken place as a Company during fiscal 2007, we increased the dividend and announced the return of approximately $204 million to shareholders from the sale of our consumer durables business segment in a manner that was tax efficient for them.

Now, before we turn to the financial results for year, as T.J.

indicated, I'll spend some time talking about one of the significant events for Brown-Forman of last fiscal year; the acquisition of Casa Herradura.

I'll try to answer the questions of why we were attracted to it, what value it brings to Brown-Forman, how long will the earnings dilution last, and in the process, share with you our enthusiasm for the opportunity we have with these brands.

There are many reason that's Brown-Forman was attracted to this acquisition.

First , it has excellent brands in Herradura and el Jimador.

Herradura is a super-premium, and el Jimador is a premium brand.

Created in 1870, in Amatitan, the heart of tequila, Herradura has the reputation for the finest quality, superb taste, and the most authentic tequila.

It's a true icon in the Mexican market.

Second, tequila is the second fastest growing distilled spirits category in the United States, growing at over 10%, but behind Irish whiskey, which is growing at a faster over a small base.

Tequila represents less than 6% of the total U.S.

market ,versus vodka at 28% and whiskey at 26%, and we believe there is significant room to grow.

Growth has been most robust at the premium and super-premium levels in the United States, as consumers have begun to appreciate the versatility of tequila, consuming beyond the traditional margarita and other cocktails, such as tequila mojitos and as a sipping drink, much like fine Bourbon and whiskey.

In Mexico, tequila is the largest distilled spirits category.

While it is more mature then the U.S..

we believe there are pockets of significant growth and opportunity remaining, particularly for substantive, authentic premium brands like el Jimador and Herradura.

While Mexico and the U.S.

accounts for the vast majority of the current global tequila market, we've begun to see the development of a more global market with brands making solid progress in the UK, southern Europe, and Asia.

Third, we were able to acquire distribution in Mexico through this acquisition.

This fits a theme we've had for some time of increasing our influence over the consumers' experience of our brand in the marketplace.

We would acknowledge that these brands are not as well-known in the U.S.

as they should be, and therein lies what we believe is a value that Brown-Forman can bring, especially through marketing, distribution, and pricing discipline.

Through our U.S.

distribution network, we expect to be able to significantly increase the breadth of distribution and rate of sale for these great brands.

Our distributor partners are enthusiastic about the brands and are working very hard to fill any distribution voids to make sure that Herradura and el Jimador are as visible on the shelf as their respective competitive bids.

As for marketing, we've put these brands in the hands of marketers who are experienced in telling the remarkable stories of these brands, which overflow with quality and heritage.

We have the experience and skills to bring the Herradura story to life in compelling, relevant ways around the world.

Just as we have done with Jack Daniel's, Southern Comfort and Brown-Forman for that matter, all of which are 135 years old or more.

We believe that the imaginative communication of Herradura's unique credentials will help us unlock its incredible potential.

Onto the numbers.

One number into which you will not have natural visibility with this acquisition is the amortization of goodwill for U.S.

tax purposes.

This amortization is expected to generate about $15 million per year in positive cash flow for our Company.

One number that does get a lot of visibility is earnings dilution.

Our analysis indicated that we would have some significant early dilution as we've brought these assets into Brown-Forman.

For fiscal 2007, earnings dilution associated with Casa Herradura was approximately $0.13 per share, slightly less than the range of dilution we communicated at the end of our third quarter of $0.14 to $0.18 per share.

The slight improvement is due in part to timing, as well as better than expected results in the U.S.

A little more than half, or $0.07 of the totals earnings dilution for this year represents transition costs, including higher SG&A due to integration activities, higher cost of goods sold associated with a one time GAAP writeup of certain inventories, higher costs associated with inventory purchase in the U.S.

from the previous distributors, and the non-cash amortization of the purchase of distribution rights to the Herradura brand in the U.S.

The remaining $0.06 of dilution reflects the fact that higher interest expense more than offset the profits generated by the business which is hampered by significant destocking of trade inventories in Mexico.

For fiscal 2008, we expect earnings dilution from the Casa Herradura acquisition in the range of $0.13 to $0.18 per share.

We expect the continuation of significant transition and integration expenses typical for a transaction such as this, including costs associated with implementing common processes for accounting, financial reporting and technology necessary for an efficient environment, and one that complies with the requirements of being a publicly listed U.S.

company.

We estimate this to be about $0.05 in fiscal '08.

Cost associated with the purchase of U.S.

distribution rights for the Herradura brand and higher costs associated with inventory purchased from the previous distributors.

We anticipate they will impact earnings per share dilution by roughly $0.06 in fiscal '08, and will drop to approximately $0.03 per year in each of the following three fiscal years.

Additionally there is some projected EPS dilution due to the fact that operating income from the required business won't yet exceed the interest costs associated with the debt used to fund the transaction.

We estimate that roughly two-thirds of the earnings dilution expected in fiscal 2008 represents transition and related expenses.

At the moment, we anticipate that there there will be a couple of cents dilution in fiscal '09 related to Casa Herradura roughly equal to the amortization of the buyout of the U.S.

distribution rights to Herradura, a non-cash charge.

However, our goal is to have this acquisition be earnings accretive in that year.

Now turning to Brown-Forman's financial result for fiscal '07.

Fiscal 2007 reported earnings per share from continuing operation was $3.22, up 1% from the $3.20 reported for fiscal 2006.

Adjusting both fiscal 2006 and fiscal 2007 for timing related and other items, earnings per share grew 11%.

Please note that we've included schedules in this morning's Press Release that reconciles the reported underlying earnings per share, as well as the reasons Management believes these non-GAAP measures to be useful to investors.

Net sales in fiscal 2007 grew by nearly $395 million, or 16%, to $2.8 billion.

4 percentage points of that reported growth were due to structural changes in our distribution model in Australia and Germany.

Favorable foreign currency fluctuations accounted for about 3 points of revenue growth as international sales continue to benefit from a weaker U.S.

dollar.

Sales of acquired brands accounted for another 3 points of growth.

After these adjustments, on an underlying basis, revenues grew approximately 6% for the year.

Gross profit was up $173 million, or 13% for the year.

A weaker U.S.

dollar and our newly acquired brands combined to contribute a little more than 4 points to this growth.

Changes in distribution models and distributor inventory levels accounted for 1 point of growth.

Net of these items, gross profit improved 8% for the year.

Advertising expenses increase $38 million, or 12% for the fiscal year.

The weaker U.S.

dollar and spending behind acquired brands each contributed about 3 points of this growth.

Underlying growth of 6% reflects increases in investments behind Jack Daniel's, Finlandia, Southern Comfort and several of our developing brands.

SG&A expenses were up $68 million, or 14%, due in part to transition expenses and infrastructure expenses associated with the Casa Herradura acquisition, and higher investments in the Company's route-to-market strategy in certain international markets.

particularly Australia, which accounted for 8 points of the growth.

Adjusting for these items, SG&A expenses were up 5% for the full year.

Cash flow from operations for the Corporation was $355 million for the full year.

We funded acquisitions totaling over $1 billion, paid dividends of $143 million, and invested in capital of $58 million from cash flow from operations, cash on hand, and a net increase in debt of $597 million.

During the fourth quarter, we issued $400 million of public bonds consisting of $150 million of a three year floating rate note, and $250 million of five year notes with a coupon of 5.2%.

We also increased our resolving credit facility from $400 million to $800 million.

We believe this added debt capacity will allow us to refinance the bonds coming due in 2008 and give us capacity for growth.

Our priorities for the use of our cash are similar, but now include a payment of debt.

We plan to make capital investments as appropriate behind our existing brands, and would anticipate total capital spending on property plant and equipment for fiscal '08 to be in the range of $70 to $80 million.

We plan to promote our excellent current portfolio, repay debt, seek additional opportunities to grow our business through acquisitions, and continue to evaluate opportunities to return cash to our shareholders, just as we did with the Lenox proceeds last month.

Turning now to our outlook for fiscal 2008.

Global trends for our premium beverage portfolio remains strong.

We anticipate earnings in the range of $3.53 to $3.68 per share for fiscal 2008, excluding estimated earnings dilution of $0.13 to $0.18 per share associated with the Casa Herradura acquisition.

This represents growth of 8% to 13% over comparable fiscal 2007 earnings of $3.27 per share.

Including anticipated dilution from the Casa Herradura acquisition, the Company expects fiscal 2008 earnings of $3.35 to $3.55 per share, representing projected growth of 7% to 13% over comparable 2007 earnings.

Our full year earnings expectations are moderated by a projected higher effective tax rate, anticipated higher raw materials costs, and the absence of $0.06 of interest income earned in fiscal 2007, and proceeds held from the sale of Lenox which was distributed to shareholders on May 10, 2007.

That concludes my prepared remark, and I will now turn the call over to Paul

Thank you, Phoebe, and good morning, everyone.

As you could tell from Phoebe's remarks, we continue to make the necessary adjustments to our GAAP financials in order to give important, additional prospective on our performance.

We appreciate your patience and interest in working through these to get a clearer view of Brown-Forman's underlying progress.

One of the primary reason for these adjustments is that we've had an unusually high number of transactions the last couple of years.

It's certainly rare for our Company to be as busy on the transaction front as we were in FY '07.

Please don't misinterpret our recent buying and selling activities as any significant change in direction or philosophy at Brown-Forman.

Let me elaborate on this a little.

After selling Lenox in FY '06, we simply wanted to complete our exit of the consumer durable segment by selling the remaining entities, Hartmann and Brooks & Bentley, for the exact same reason that we originally sold Lenox; to focus on better opportunities in our beverage business.

Additionally, as part of our on going pursuit to improve our wine brand businesses, we sold our Italian winery operation in FY '07, and announced our intention to sell two additional California wine-related properties.

We believe these moves, combined with a large sales in marketing restructuring and a smaller California wine production reorganization will improve our overall wine cost structure and our wine brand performance going forward.

Also during the last two fiscal years, several distribution-related transactions effected our reported GAAP financials.

Last year, we received significant payments for two distribution buyouts.

One from LVMH for our rights related to distributing the Glen (inaudible) brand, and another from (inaudible) for their decision to depart our Australian distribution joint venture.

And then this year, we bought out the U.S.

distribution rights for the Herradura brand from (inaudible).

Each of these is the (inaudible) of the priority that many companies are placing today on having immediate and direct control of their end market brand building activities.

And finally, two excellent acquisition candidates came along during FY '07, literally within months of each other.

Both Shanbour and Casa Herradura represented opportunities for Brown-Forman to purchase strong brands, participating in the premium and super-premium segments of exciting categories and high priority markets with both acquisitions offering the Company significant volume and margin upside.

In a subsequent small transaction relating to the unwinding of our joint venture with Mexico's Orendain family, we were pleased to acquire the remaining portion of Don Eduardo tequila brand that we did not already own.

Importantly, the Shanbour, Herradura and Don Eduardo brands each have extremely attractive gross profits per case, and we anticipate each having long-term growth rates at or above Brown-Forman's historical rates, thereby strengthening our Company's margins and growth profile.

As with all of our acquisitions, and these are no exceptions, we believe that our discounted cash flow evaluations exceed the prices we paid for the brands.

While each has potential strategic benefits, that is not the basis on which we value them.

We bought them to add to the long-term growth potential of Brown-Forman's earnings and cash flows, and we believe we purchased them at acceptable prices.

Of course, we hope that our long-term work with these brands will show that we purchased them at highly attractive prices, adding even greater value for our shareholders.

Only time will tell.

All of these transactions, the consumer durable sales, the restructuring of our wine businesses, our global distribution network initiatives, and the exciting premium brands we are adding to our portfolio, are intended to achieve the same objective, and that's to prepare Brown-Forman to seize the enormous opportunities for growth and the attractive returns that exist in the global wine and spirits business.

As we look ahead, we derive optimism from many sources, not the least of which is the excellent health of our business today.

The significant financial and business progress that Phoebe reported earlier marks the third consecutive year of organic double-digit growth and operating income and earnings per share from our continuing operations.

We are encouraged by the fact that our Company's historical short, mid and long-term growth rates and earnings per share are all double-digit and compare favorably to the U.S.

equity market as a whole.

The same is also true for our three, five, ten, and 15 year growth rates in total shareholder return.

We believe that beyond the surface of our strong financial performance lies a unique portfolio of brands and a superb and experienced team of brand builders across the world poised to continue Brown-Forman's excellent track record of brand and market development.

Over the last 15 years, we have expanded our international business significantly.

By increasing the international portion of our business from 20% to approximately 50%, while impressively growing our U.S.

business at same time, we have fundamentally changed the distribution of our profitability, and we believe opened up many new possibilities for long-term growth.

With the $300 million U.S.

population being just a small fraction of the $6 billion global population, we can expect our large and growing U.S.

business to become an increasingly smaller percentage of our global business.

Most of our international growth over the last 15 years has come from Europe and Australia, and we continue to anticipate strong growth prospects on both of these continents.

Additionally we have good sized growing businesses today in Asia, Eurasia, Latin America, South Africa and Canada, with each region continuing to offer exciting growth potential.

And of course, we still believe in the incredible long-term potential for our brands in the market that's account for most of the world's population.

China, India, Russia, Mexico, and Brazil.

While we have made progress in these countries, we have only scratched the surface, and today we feel our Company is in a much better position to capitalize on these exciting growth markets.

Considering this vast and growing world market for wines and spirits, the strength and potential of our brands, and the quality and continuity of our people and our partners, we're optimistic about our future and our ability to continue to provide exceptional returns to our shareholders.

Thank you, and we're now happy to answer any questions you might have.

(OPERATOR INSTRUCTIONS) We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Dara Mohsenian with JPMogan.

Hi, guys.

Good morning, Dara.

Paul, international trends for Jack Daniel's and the rest of your portfolio look like they remain pretty strong here.

What do you think are the key drivers there, and can you give us an update on the key geographic markets driving that growth, and then also as a follow-up, domestically it looks like Jack depletions have slowed somewhat, and you're seeing some moderation in your total spirits portfolio at least based on the (inaudible) Nielsen data, so can you give us some perspective on what is driving moderation and domestic trends also.

Sure, I think we reported this morning, the international markets were up double-digit, and they continued to be driven by a wide number of countries, which is one of the most encouraging pieces of the international story, that it's not just one or two or five markets, but it's very widespread.

And I think the one statistic was than 23 of Jack Daniel's' top 25 markets grew, which is just an excellent and consistent performance across the world.

I think as you all well know, the U.K.

continues to be our largest market and it was grows as well.

We also had excellent success, which I think is counter to many of our competition in, throughout Europe where Jack Daniel's continues to grow.

The South Africa, Australia, mostly Australia associated with the RTV brand down there continue to be very strong, and I mentioned just here momentarily, that we're getting nice growth from, obviously, smaller bases in -- what some people would title the emerging markets.

But their beginning to grow to pretty good sized businesses.

Places like China, Korea, Russia, Romania.

A number of those markets are sizeable for the brand and reflect I think a long-term development that's been going on with the company surrounding them.

It's been widespread.

I think beyond Jack Daniel's an important piece is that Finlandia is also contributing significantly to our international development as a Company, with a major focus in eastern Europe, and we think there's great opportunity for that brand not only in that region, but other parts of the world as well.

So the international piece, we're still relatively small on the world market, and I think we just continue to plow ahead with our investments and our brand development out there, and also try to build some of the newer brands that we have purchased, whether Herradura or Shanbour or some of the other whiskey brands in our portfolio.

Now shifting to the U.S.

question, the U.S.

market has shown, it looks like to me with the (inaudible) data maybe a half a point down-tic in the last year in terms of total spirits.

Jack Daniel's, I think was off maybe something more like a full point, and I think one of the contributing factors not only to Jack Daniel's but to the entire U.S.

spirits and wine portfolio that's unique to Brown-Forman was some of the disruptions associated with our reorganization during fiscal year '07.

Anytime to clarify what we did is we merged our wine and spirits operations and basically came up with a new structure for approaching the U.S.

market.

When you have that kind of just multitude of changes and significant change for people, you have natural disruption.

I think that may explain some of what was going on across our entire portfolio in the U.S.

Hopefully having that experience under our belts for the last year will help as we go into FY '08.

Okay.

Great.

Phoebe, if I could slip in one more question.

In terms of fiscal, 2008 guidance, what assumptions have you made from the impact in the UK of the on-premise smoking ban this summer, and also what type of foreign exchange impact is in your guidance?

Okay.

I'll take the last one first.

Foreign exchange.

We have -- in our guidance we have made our assumptions based on a hedging program that is in place for all of our three currencies, and it largely provides upside only and no real downside to it.

So I think if you want to think ahead for fiscal '08, upside only in as much as on the large three currencies in as much as they are largely locked in.

With regard to the U.K., our estimates would take that into account.

The view there is that while there maybe some short-term disruption, long-term is a very good thing.

It would bring more consumers we believe into the pubs, and so we see the smoking ban as maybe some short-term disruption, but long-term very, very good.

Okay.

And in terms of FX, can you give me a specific EPS impact in '08 versus '07?

That's in your guidance right now?

It's in the guidance.

A couple cents, maybe.

Okay.

Thank you.

Your next question comes from Lauren Torres with HSBC.

Good morning.

On Herradura, can you give us a sense of your planned investment or I guess just marketing spend behind these brands this period?

Generally it does appear that you need to make some substantial investments in the U.S.

First, can you give us a sense of that, and I guess just more generally speaking, if you could give us an update on the transition and integration of these brands?

Where are you now, and are you satisfied so far with the progress.

I'll take the second, Paul will take the first.

Okay.

As it relates to stepping up the investments behind, we definitely feel that we need to do that, and during FY '08 we'll see a very noticeable increase in the spending behind both Herradura and el Jimador compared to what the previous owners were spending.

But importantly, during that year, the actual effort we'll be putting forward goes beyond what can be calculated by the increase in A & P.

A huge impact, I think, in FY '08 for us is utilizing the distribution infrastructure we have, particularly in the United States, and to improve things like the, just the base of distribution for the brand, and some of that will, of course, cost promotional dollars, but a lot it is just getting the people focused on the work itself.

So that maybe as big an upside as anything.

Some of the work we will do to start to expose consumers to just base awareness of the brand will come through some of the A&P and some of those distributional efforts, and I also feel it's going to take us the better part of FY '08 to get all of the positioning and some of the primary brand identity elements like packaging, planned and ready for implantation either at the best, probably late in FY '08, more likely into FY '09.

That's really going to be the focus of our efforts on stepping up the efforts behind those brands during FY '08.

Lauren, with regard to integration.

We have a highly dedicated functional team that worked extremely hard to make our January 18th day one seamless.

There was was a huge amount of work that went into that, and that day has come and gone.

Our focus now is really on integrating them into our information technology systems.

We'll start with integrating them in HR human resources, and we'll move quickly on to finance and production.

We're putting them on our SAP system, and we're also working very hard to make sure that we are solving Oxley compliance, so we're documenting all financial processes at the moment.

Those are the general nature of -- from the administrative side on the integration.

There's an intense amount of work to integrate on the marketing side, the production side, the sales side, and those are all functional efforts that are going extremely well.

Our team in Mexico has done a great job of taking the leadership of Casa Herradura and putting it together with the leadership of Brown-Forman, they've been on site, they've been working with key integration leaders and consultants to help really make sure that that is a good blend.

You have three things going on.

You're trying to take a private company and make it into a publicly traded U.S.

company.

You have U.S.

culture to blend with the Mexican culture, and in some cases, you need to deal with translation from English into Spanish.

Those are three translation that's are going on, and I think they're going really extremely well.

It takes time.

It takes a lot of money.

It takes energy, and we've decided to put the investments up front to make this integrated and part of Brown-Forman as quickly as we can.

We think there's value in that.

The other transition progress we've made since acquiring the brand that each month gets better is working on the inventory levels, particularly down in Mexico.

I mean the U.S.

actually had distribution voids that we think FY '08 has a great opportunity to rebuild those.

However, the Mexico situation was that we were very loaded in terms of inventories at almost all channels of the distribution system.

So, the last six months really have been about that, and we've made progress each month.

We've got a couple more months and a little more progress to do.

But I would call that one of the great transition successes we've had so far.

Okay and if I could throw in one more question.

You mentioned that your fiscal '08 expectations are moderated by a higher tax rate and also higher raw materials costs.

If there's any guidance you could provide on those two items, that would be helpful.

Lauren, this is Jane.

On the tax rate, we would recommend it's going to be somewhere between 32.5% to 33%, and with regard to the raw materials cost, the impacts probably are roughly $0.04 in EPS that we're expecting higher cost for grain and related energy costs too.

Okay.

Great, thank you.

Your next question comes from Tim Ramey with D.A.

Davidson.

Good morning, congratulations on a great quarter.

Hi, Tim.

Phoebe, you mentioned that you acquired distribution in Mexico through the Herradura acquisition.

And I've asked before whether that meant that you would be turning over your agency relationships to Herradura that are, I believe, currently with Bacardi.

Has there been any change in your view on that.

We are going to continue to have our relationship with Bacardi.

That's in a contract that runs for an additional year, and so we're going to continue that and honor that contract in a relationship that's very important to Brown-Forman, its relationship with Bacardi.

The longer term?

That decision on what to do after one year has not yet been made.

It's something we're looking at internally.

Terrific.

Tim, we always, just to clarify on that.

We have so many different distribution arrangements that obviously expire.

It's a wide variety of terms and at various times.

Our standard practice is to always look for better ways to do it in every market, no matter what the arrangement is.

So we constantly will be looking at that, and as Phoebe mentioned, a really important piece of our worldwide relationships and distribution fall a lot to Bacardi.

So it's one that we're extra sensitive to.

Would you care to comment on your payments to Sazarkak and why that appears to be spread over a three-year term?

Why wouldn't you just recognize that all as an upfront cost in '07?

--

We would have liked to have recognized that as a, since it was a one term payment but the accounting rules state that we need to amortize that as a distribution, essentially the way we're doing it, and Jane's going to jump in here because she's a better accountant then I am.

But our payment to Sazarkak for the distribution of Herradura, while made at one time, it represents distribution rights over the next five years.

So therefore, those benefits need to accrue to each of those years, and so it's a non-cash charge, and it translates to about $5 million a year, or $0.3 a year.

$5 million a year for each year of the next four?

Roughly, yes.

'08, $5 million going forward.

In December, 2011, when it ends.

But the cash has already been paid, now we're just amortizing it off.

Okay.

That's very helpful.

And then I think you also mentioned that there is about a nickel in what I'm interpreting to be SAP and SAR box in '08, but you didn't use those exact words.

Is that a fair interpretation?

It's greater then Sarbannes-Oxley and SAP, it also includes integration of production.

It's work with human resources.

All of those systems.

It's a comprehensive -- I don't want to say rewiring, but we're integrating, comprehensive integrating into automated systems that will be fully integrated into Brown-Forman.

Okay.

And then just one last one on Herradura.

Paul or Phoebe, if you would care to comment on perhaps the expectation for organic revenue growth, and what would be the puts and takes to that.

Presumably, there's destocking that needs to occur that would be a drag on organic revenue growth, and then some growth relating to expanded distribution in the U.S.

and other things.

What are your expectations there, if we may?

Well, the expectations on that really I'm going to give them to you more long-term.

Deal with, and it's a combination perhaps of both volume progress and pricing potential.

It certainly varies by whether you're talking about the United States or Mexico or any of the new markets around the world where we might be successful expanding it, and of course, to make it even a little trickier, it varies by whether it's Herradura or el Jimador or any other part of the business.

But longer term, I'll tell you that we think, I mentioned in my comments that this business should organically grow at a rate above Brown-Forman.

That's our intention is to make that happen because -- and the greatest, I think, contributor to that is this really strong U.S.

market that exists today where the premium and super-premium segment at those volume in dollars is growing well above the 10% rate that the tequila is growing as a whole, and when you layer in I think great potential for particularly Herradura outside of the United States and Mexico base that it has today, I think we should be able to achieve that ambition.

But no comment specifically about '08?

That would be helpful in modeling.

No.

Thank you.

Your next question comes from Greg Gieber, A.G.

Edwards.

Morning, everybody.

I think you answered part of my -- one of my questions already.

I'm trying to get a sense as you move forward with this acquisition, what sort of guide post you might give us that can be quantified to know whether it's succeeding dramatically, or just falling behind, or whatever.

Is there anything you can give us in the way of guide posts?

Yes.

I think we'll be reporting each quarter to you about the combination of going straight down the P&L, and particularly in these early quarters where the Company and the brand is so new to us, where we'll be reporting to you on the volume metric and gross profit progress perhaps, and maybe even just some of the market share items that will be so important to us.

To just reference the true metric force is going to be how well we can move forward the organic gross profit growth of these.

Early on of course, we'll be investing up front in these first couple of years, I think more dramatically than we would beyond that.

In terms of specific going straight down the P&L and giving you a goal, we're not going to disclose that today.

I hope you take away from this, though, a sense of how pleased we are.

If you look at where we came in, in terms of earnings dilution, it was less than what we had forecast.

So a part of that is big business, and part of that is a little bit of timing, but to think about that and we're also very confident about moving through this transition and integration and getting it to be part of our business, and I think -- I just want to express how pleased we are with the quality of the people and the work and just what we're going to be able to do I think with these brands.

That's the qualitative side that can never show up in a model, but will ultimately show up in the numbers.

Also I was going say in addition to what both Phoebe and Paul said, we did disclose our outlook for EPS dilutions for next year, so to the extent that we were on or off of that, that would certainly be a guide post to you as well.

We've also mentioned our expectations for 2009, while their slightly dilutive in 2009, our goal is to make them accretive.

Once you start hearing some of that, we'll be keeping you up-to-date on how we do with regard to our expectations and EPS dilution.

That's very helpful.

I assume, Paul, from what with you said, if I were just to look at Herradura's market share and impact in the U.S.

market, that's really '09 that we're going to see any sort of the true measure, because this year you're going to spend a lot of time just reformatting?

Actually, that's not -- there's two pieces that will be going on in '08.

One is when we acquired and inherited the distribution in the United States, our lesson from it was that, particularly Herradura had quite a few distribution voids, so we feel like there is a real opportunity in FY '08, and we're beginning to see some of it even at the end of FY '07 for us to go out and build the appropriate distribution and rate of sale as well for the Herradura brand.

Concurrent with that, we'll be working on the positioning and packaging and other elements associated with the primary brand identity, but we expect there on be nice progress on the volume metric side and maybe pricing as well in FY '08 in the U.S.

with Herradura.

Thank you.

If I could ask about your fourth quarter on your revenue, could you -- maybe you gave this and I missed it in my notes, but would be the apples to apples revenue growth or another way, how much did Herradura contribute to revenues in the fourth quarter?

There are several components, Greg, to our 18% increase in revenues of which acquisitions were a piece of it.

Foreign exchange was a piece of it and those were the major two pieces.

When we stripped out both of those items, our revenues were up 5% for the quarter.

Does that help?

That helps, I would like to have it net of the 4X number.

That's net of the FX number, sorry.

(multiple speakers) The acquisition as well as the foreign exchange.

You just stripped out the acquisition?

I stripped out both the acquisition and the foreign exchange impact.

I was trying to get the acquisition for FX separately I guess.

acquisitions--

Jane, why don't you -- (multiple speakers).

We have it.

I think the estimate that we have here is acquisitions are about 9 points, FX about 4.

Okay.

That's precisely why I wasn't too clear.

And then any idea.

if you -- what the impact of the increase foreign sales are, as well as Herradura on your gross margins.

I think it's typically at least -- I believe that's often the lower gross margins and international sales so I could be wrong with that.

It entirely depends on the mix, which makes it very tricky to answer your questions in a broad sense, because -- I'm just saying that the mix of international sales depending upon what country and what brand that there is could have a huge impact so that Jack Daniel's in one country would be very different from Finlandia in another country would be a different then el Jimador in Mexico.

Are you specifically referring -- let me see if I can clarify this.

Are you specifically referring to the margins in the fourth quarter?

Really in the fourth quarter what happened, and I believe you had some -- one time expenditures in cost of goods sold for Herradura.

I was trying to figure out what that impact would be.

Yes.

We stripped that out.

That is exactly right as we've had higher costs due to a GAAP writeup that was required.

And that had -- I want to say about a 3 point impact.

Okay.

That's very helpful, thank you very much.

Thank you.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Bryan Sillane with Banc of America Securities.

Good morning,.

Hi, Bryan.

Just two questions.

One for Phoebe on -- if you could talk a little bit about free cash flow for next year or for fiscal '08, will -- relative to '07, will Herradura be dilutive to your free cash flow?

And I understand that in '07 you also had the -- some one-off events that helped free cash flow, I'm just trying to get an understand of whether or not we look at it on an underlying organic basis whether or not free cash flow will be a little bit lower this year as you go through the transition and then improves in '09.

Specifically, with regard to your question about Herradura's cash flow's for fiscal '08.

Not just Herradura, I'm just trying to get a sense for the whole company, actually.

We have not made any specific prediction about what cash flow it s going to be.

With regard to Herradura, we're expecting that it's cash positive, it's just not able to overcome the interest expense in fiscal '08.

So, I think that we are a highly cash generative business, and I think that we're not anticipating that we're going to have good healthy cash flow, we are not making a specific forecast about what the cash flow is going to be for '08.

Okay.

And Paul, if I could, just, if you loo look at what's happening or what seems to be happening with the -- some of the consolidation that's happening and the potential consolidation in the spirits industry, it seems it's emerging as you really have two types of business models.

One where there's a competitive advantage derived from having scale, and the other is a competitive advantage from having focus on high margin, high value categories and products and brands, and it seems to me that your business model is going to be -- it seems to be more skewed towards the latter as the former.

First if that is sort of your perspective on it.

And then second if that is the case, just how that shapes the way you think about your portfolio going forward, and what types of add-ons you would be looking at.

Would they be more on sort of the niche, or not so much niche, but high end segments as opposed to looking for scale?

I think those are the two that you outlined are certainly two of the viable models.

I may disagree with you a little.

But those are the only two actually consider our company to be almost a hybrid of them.

And actually what we try to do is behind our reorganization last fiscal year where we try to put to use, I would consider to be the influence or importance of size where it's actually a help and of value to the Company, but probably more importantly, even with any size we have, we have a preference toward being focused in our brand building, so that we just have not found that it's our greatest game to go out and be big, strong portfolio sellers.

It's been our experience the best way to build brands is through almost drink by drink, person by person, individual brand effort, and even with the 35 brands we've got in Brown-Forman today, we try to devise organizational structures and brand building plans and models that enable each of the brands to use the scale and portfolio benefits when it's helpful, but very importantly, to have really focused initiatives and efforts behind each brands.

I would consider us a hybrid, and would consider given that model thinking about it really enables us and helps us when you have acquisitions like we've had in the last year with Shanbour, Herradura or Don Eduardo, the last piece, to be able to deploy that same philosophy behind them.

Wherever it makes sense to put brands together where they can help each other, an example maybe Jack Daniel's and Herradura and Finlandia, for example, which are three brands in the United States which we think have -- and el Jimador, of course, which have particularly good opportunities in the Hispanics, the growing Hispanic population, but they wouldn't be in the same category, of course.

For us, it would be more consumer -- in that example, you would have consumer infinite and commonality that you would leverage.

But at the same time, when witness integrate Casa Herradura into our business, we set up its own dedicated, not only global brand team, but also a dedicated brand specialist out in the regions to provide the focus I'm talking about.

So, I think we'll continue to look at all kinds of opportunities as they come along, but I would say that the types of brands that we bought this last year sit well with not only our philosophy but the organizational structure we've got.

Great, thank you.

Sure.

You have a follow-up question from Tim Ramey with D.A.

Davidson.

You've mentioned inventory step-ups a couple of times, but I don't know that you quantified that.

Can you give us any sense of what the inventory step-up cost will be in maybe in '07, '08, '09?

By '09, we should be completed.

It is going to effect fiscal '07 and fiscal '08.

I would say it's a couple of pennies in each fiscal year.

So figure $0.2?

2 to 3.

Okay.

Thank you.

You have a follow-up question from Greg Gieber with A.G.

Edwards.

A little follow-up on Brian's question in acquisitions and in that manner, noting the travel schedule of your major competitor, Paul, have either you or Phoebe taken or plan before the year's out taking any trips to Sweden?

What's there?

We know what's there, I think there's a vodka company, B & F.

It's our policy not to comment on acquisitions, although we would all think at this Company certainly anticipated the absolute brand in fact ever did come for sale, that it would get considerable interest across the industry, and obviously the one consideration for us that we talked about earlier in our comments is that we have a very exciting leading premium brand in Finlandia at our Company today, which we're very pleased with and happens to be growing at a rate noticeably above absolute.

Okay.

I just thought I would ask because it's unusual for anybody to admit as your competitor did that their actually going to talk about an acquisition.

Well, there's been a lot of that it seems like out in the news.

Oh, yes, there has.

Thanks for the question.

Okay.

Ladies and gentlemen, we have reached the end of the allotted time for questions and answers.

Mr.

Graven, are there any closing remarks?

There are no closing remarks at this time, thank you, everyone and have a great day.

Thank you.

This concludes today's conference call.

You may now disconnect.