Brown-Forman Corp (BF.B) 2008 Q1 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to the Brown-Forman Investor Relations first quarter fiscal 2008 conference call.

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

After the speakers' remarks, there will be a question-and-answer session.

(OPERATOR INSTRUCTIONS) Thank you.

Mr.

Graven, you may begin your conference.

Thank you.

Good morning, everyone.

Thanks for joining us today.

This is T.J.

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

Joining me on the call 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.

This mornings 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 any undue reliance on our forward-looking statements and the company undertakes no obligation to update any of these whether due to new information, future events, or otherwise.

This morning we issued a press release containing our results.

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

We have listed in the press release a number of 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 the call we'll also be discussing certain non-GAAP financial measures.

These measures and the reasons we believe they provide useful information to investors regarding the company's financial condition and results of operations are contained in our press release.

With that I would like to turn the call over to Phoebe Wood, who will discuss our first quarter results.

Thank you T.J.

Good morning everyone.

Thanks for joining our call today.

If our press release this morning, we reported earnings per share of $0.77 per our quarter, up 1% over the $0.76 earned last year.

This includes all of the affects of our recent acquisition of Casa Herradura.

Looking at the underlying earnings per share, they grew at a rate of 10%, a very strong start to the fiscal year a continuation of the growth trend we've seen over the last three years.

Before I talk of the business trends, I'll clarify the adjustments we've made to reported earnings in this quarter and in the prior year quarter to yield this underlying earnings growth rate.

Schedule A of our earnings release lists them, and they are as follows.

A $0.05 per share dilutive affect associated with acquisitions, which I'll discuss in more detail later, a $0.04 per share quarter over quarter benefit from favorable foreign currency fluctuation, a $0.01 per share of interest income earned last year in the first quarter on proceeds from the sale of Lenox before it was distributed to shareholders, and a net $0.04 per share impact of changes in global trade inventory levels.

I'll spend a little more time on this last item to explain why we believe this adjustment is important to provide better visibility to the underlying growth of our business, particularly because there was a relatively large net difference between the comparable periods.

We generally recognize revenue when we ship to our trade customers, that is wholesalers, distributors, importers.

Equally important for us to track are depletion, the movement of inventory from wholesalers to retailers, is commonly used as an approximation of consumer demand.

At the end of the first quarter this year, our distributor inventory levels were up, meaning we shipped more product than was depleted.

However, they were up less than last year's first quarter.

The impact of changes in inventory levels in both quarters resulted in adjustments to reported earnings.

We have shown those adjustments in our underlying growth calculations.

Our estimate of inventory levels at the end of July appears to be balanced.

Not too long, not too short.

However, that doesn't mean we won't have quarterly fluctuations in this dynamic and growing business.

As we have done for several quarters, we plan to continue how those fluctuations affect our reported results.

Now shifting to our business results by brand, Jack Daniel's global depletions were up at a mid-single digit rate with double digit international growth and low single digit growth rate in the United States.

Southern Comfort volumes also grew at a mid-single digit rate globally on double digit expansion internationally, led by the U.K.

and Germany.

Finlandia depletions grew more than 25% in the first quarter, led by exceptional performance in international markets.

The brands' robust global growth rate is substantially above the overall vodka category's rate of growth and is due to improved marketing and promotional activities, better brand building execution, and a healthy consumer environment, particularly outside of the United States.

Finlandia's growth in Poland following a price increase remains excellent and has accelerated recently.

Depletions for our super-premium brand developing portfolio, which includes brands such as Woodford Reserves, Sonoma Cutrer, Tuaca, Appleton Rum, and Chambord increased at a double digit rate in the quarter.

Volumes for our mid-priced regional brands were up at a mid-single digit rate behind solid growth for Fetzer Valley Oaks, Korbel, and Bonnterra, which more than offset declines for Canadian Mist, Bolla, and Early Times.

Now, general business trends established during the last half of fiscal 2007 continued through the first 90 days of this fiscal year.

Solid growth in consumer demand and profits behind Jack Daniel's, Southern Comfort, Finlandia, and most of our super-premium developing brands continued in the quarter.

Our premium global brands continue to grow exceptionally well in international markets.

In the United States, our brands continued their trend of profitable growth, all be it many growing at rates below their 2007 growth rate.

Notably, several U.S.

retailers have highlighted a softening consumer environment in their recent earnings announcement.

Declining home prices, the collapse of the subprime lending market, higher gas prices, and a volatile stock market have likely tempered consumer confidence.

While our results don't reflect a significant weakening of the trading environment for distilled spirits domestically, we're cautious, like virtually everyone else doing business in the U.S.

today, regarding our outlook.

We're very pleased with the progress of the integration of the Herradura business acquired in January.

We met our expectations for the first quarter.

In the United States we completed the transition of the El Jimador and Herradura brands into our U.S.

distribution network.

Our progress to date is on track and results are in-line with our targets.

While our performance in Mexico was a bit softer than we anticipated in the quarter, as we continued to work to reduce trade inventory levels, our full-year outlook for earnings dilution remains unchanged at $0.13 to $0.18 per share.

Now the $0.05 of dilution registered in the first quarter is indicative of the highly seasonal nature of tequila sales.

The heavy selling season for tequila begins in September.

Mexican Independence Day is in that month and continues through the end of the calendar year.

We expect earnings delusion to follow a similar seasonal pattern, meaning we anticipate less dilution in the second and third quarter than in the first.

Our brand builders on both sides of the border continue to make excellent progress as they continue to carefully evaluate the positioning, pricing, and packaging of the brand.

One of the results of the addition of the Herradura business in addition to higher reported sales, gross profit, and operating expenses, is that it has been dilutive to the company's gross margins in the quarter.

While the gross profit margin for Herradura and El Jimador Tequila sales in the United States are at or above our company's overall margins, gross margins on sales in Mexico, which include agency brands and New Mix, which is the tequila-based ready to drink product are considerably lower.

As the mix of our business shifts more towards U.S.

tequila-driven revenue, and as we increase prices on our Tequila brands in Mexico, we expect the gross margin to improve.

One other factor suppressing gross margins in the quarter is the higher cost of goods associated with the one-time GAAP write-up of certain inventories and higher costs associated with Tequila inventory purchased in the U.S.

from previous distributors.

Now turning to our outlook for the remainder of the this year, our full-year earnings outlook remains unchanged at $3.35 to $3.55 per diluted share, representing growth of 7% to 13% over comparable prior-year earnings of $3.14 per share.

This outlook includes projected earnings dilution of $0.13 to $0.18 per share associated with the cost of the Herradura acquisition, which is also unchanged.

With that summary, we'll take your questions.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Lauren Torres with HSBC.

Good morning.

Hi, Lauren.

Phoebe, you just mentioned, as far as improving margins based on Herradura sales, you're looking to raise prices in Mexico and also have it more known here in the U.S.

as far as selling those brands.

Can you give us a sense of how long that could take or at least your expectations for doing something like that?

I wish I knew the exact answer to that question.

We're certainly going to work very hard on getting our margins and prices in-line with what we think they're going to be.

There are two things, one is pricing and the other is mix.

The question is, we can work on the pricing over time.

You can't correct that instantly.

The second thing has to do with the mix, and the faster we get more sales in the U.S., where we think there's great potential for the brands, that's going to change the mix and we'll certainly tip it over towards definitely higher gross margin.

I don't think that we can expect anything instantaneous in that.

I can't predict by any stretch that it would happen necessarily in the course of a year.

But our key brand builders and our key team are working very hard to work at that.

I think it's just going to be -- I don't even know what time frame to put on it because I don't know how quickly the traction will gain in the U.S., and that's really the key to it.

Lauren, some of it is occurring with initial shipments in the U.S., part of the Mexico issue is, we just -- we haven't even hit, really, the seasonal part of the year where we would even see an impact from mostly the sale of tequila in general, but secondary any improvements in prices that we're able to get.

So a lot of it's going to be, if any at all, back-loaded to the last two-thirds of the year.

There's just such a heavy selling season the way the Mexico business is conducted between September and December that it's one of the reasons that the margins are actually depressed in this first quarter.

But we're working on it.

It's a basic part of getting our hands around the overall positioning of both Herradura and El Jimador.

This is Jane.

I would also add another part.

If you're looking at the full year and thinking it's all in the first quarter to Paul's point, you will not see that large of a difference in our margin.

We do not expect the margin to be down like it was in the first quarter due to Paul's points he made a moment ago, as we sell more tequila sales in the next nine months of the year.

Okay, that helps.

And then I could also just touch upon your performance here in the U.S.

Once again we saw that low single digit growth rate for Jack Daniel's and you mentioned that Southern Comfort declined modestly in the quarter.

Can you just give us more color behind trends what you're seeing behind those two brands here?

Yes.

I think part of it is the U.S.

environment, that everybody knows about, my take on the -- part of the results we've seen through sort of July would indicate distilled spirits seems to be down as much as a point and a half versus 12 months ago.

So that may be having an impact.

I think on Southern Comfort, it's because of some of the basic continuation of the price repositioning and we've been doing a lot more work on the 175 size, our largest size.

That's the value size.

So a lot of people who are in the consumer franchise who have been seeing what I would call price value from Southern Comfort consumption of the big size when the prices are going up, some of them will leave you.

I think some of that is actually occurring and has been for a few of the months here on Southern Comfort.

Of course, the gross profits and the dollar sales on Southern Comfort are far better than the units that we're reporting here, because we've been working on the pricing, actually for quite some time.

On Jack Daniel's, it's actually a bit of a different story.

Obviously, the total distilled spirit dip can impact Jack Daniel's as well.

I do think Jack is a unique brand in the U.S.

distilled spirits market.

I've talked about it before.

It's one of only a couple of brands in the entire distilled spirits industry in the U.S.

that has above a $20 price point on the 750 size and also has several million cases.

It's very difficult, often times, for brands priced over $20 a bottle to sell even 1 million cases, much less something close to 5 million.

The only way you can accomplish that, to have both high volume and high price is to draw on a really broad demographic and socioeconomic consumer franchise.

When you have the pinch that I think is going on right now in disposable income, it will really hit people who really reach to buy Jack Daniel's as an affordable luxury.

And so, I think we're seeing that in some of the Jack Daniel's numbers.

And it's part of the byproduct of being both a big volume and high volume brand but also having the high pricing and premium pricing.

What we're doing is just continuing to work on the basics of pricing programming.

We're continuing to take the modern price increases that Jack Daniel's has traditionally taken.

We're continuing to work on our programming and pricing in a way that actually can address another small piece that's been occurring over the last year, which is Jack Daniel's has also been crossing some of those psychological price points that are important not only to trade promotion but to consumer psychology.

Those are like $20 on the 750 and even $30 and $40 on some of the bigger sizes.

There's handful of things going on with Jack Daniel's, but I think it's -- part of it's a byproduct of the extremely large size that the brand has and the broad demographic and socioeconomic group it sources from.

So despite the market environment, there's been no change to your pricing strategy nor do you expect there to be?

No.

When you see dips in the economy and things like that, we double our efforts at the intense work we do on pricing by size, by market, and really looking at that to make sure that you're hitting the right price points.

To be honest with you, that is something that we do all the time.

You get maybe a little bit of extra effort going on that, but, no, I don't see us -- this is a wonderful time, I think, to really be focused -- we've got a number of brands in the United States market that are fundamentally working on their price position.

And this goes -- obviously, Southern Comfort is one of them, but Canadian Mist and a number of other brands have been working on that and this becomes an actually a very nice time to be able to position yourself relative to competition by taking those continued moderate price increases.

Okay.

Thank you.

Thanks, Lauren.

Your next question comes from the line of Kaumil Gajrauala with UBS.

Thanks.

Good morning, everybody.

Good morning.

Good morning.

A couple questions.

First, Phoebe, you talked about the tequila inventory purchases and the impact on COGS from that.

Is that pretty much behind us and would you be able to give us a little more color on how big the impact had been from that?

Yes.

Let me answer that directly.

It's just a few months left of that.

We have -- when we acquired the U.S.

inventory from the prior distributor in the United States, we needed to write up the profit margin, so to speak, of that distributor and we need -- while that's in the purchase price has to be amortized,and so it's just amortized, and we have that coming through.

Jane will maybe give me the exact time.

It's going to end --

Actually, in the U.S., we're done.

Yes, first quarter.

We're finished in the U.S.

Okay.

The only thing left is our GAAP writeup, and I would say that will be finished by the end of the calendar year.

Yes.

Yes.

So you're seeing more of a pronounced affect early on in this fiscal year and it will recede very quickly.

Margins -- that's one reason we're talking about margins too.

Margins will --

Be absent of that.

Right.

I also wanted to ask a little bit on the U.K., just what you think is behind some of the growth there.

You clearly seem to be bucking some of the trends in the region, so I would be interested if you could talk a little bit more about whether it's the rollout of Southern Comfort or if it's Jack Daniel's or what's behind some of that growth?

Sure, I'll take that.

I think it's just why we may be performing nicely in the U.K.

relative to maybe the market.

I think some of it is actually the same story we've talked about before, which is we've got quite strong brands that are at earlier stages of development in some respects than a lot of the competition, which maybe had their growth cycle a couple decades ago.

And so, what's really been encouraging, a year ago in the U.K., the environment was quite, if I remember, that we were low single digits on Jack Daniel's in the U.K.

and now we're more like high single digits.

So we've seen a nice recovery on Jack Daniel's.

Southern Comfort's in sort of the mid-single digit growth rates, which is nice and interestingly there as well, Finlandia is beginning to add to the mix in the United Kingdom.

So I think the combination of the stage of development, the strong brands we've gotten, and the final part I would say, just our route to market has really strengthened there over the last couple of years.

What I mean by that is the partnership we got in cost sharing with Bacardi, and that's been in play now for a few years and seems to be working quite well for us.

Okay, great.

Just one last question on COGS.

Which is, if you were to exclude everything from Herradura, what did the year-over-year COGS margins look like, for the gross margins year-over-year?

I'm not sure I understand the question.

Let me sure that I can just repeat the question.

You're saying cost of goods, if you were to take out the affects of Casa Herradura, how much would cost of goods sold have increased for the first quarter?

Is that your question?

Yes, yes.

Back to a margin question.

Just the cost of goods piece of it.

Yes.

So if you take out everything from Herradura on the COGS line.

Okay.

We're just looking at a piece of paper and we'll give you --

As opposed to the question of how much cost of Herradura itself diluted the margins in the quarter, you're asking just the cost piece of it?

Just the cost side, yes.

Yes.

Just the cost piece of the one-time writeups and so forth like that, that's about three tenths of a point.

Okay.

That's great.

Thank you.

Thank you.

Your next question comes from the line of Tim Ramey with D.A.

Davidson and Company.

Good morning.

Hi, Tim.

Phoebe, I wonder if you could give us a better breakdown of the 17% gain in sales, just volume, acquisitions, currency pricing.

Is there any way to do that?

It's a big number, but there are a lot of moving pieces there.

I have it broken down by percent increases.

Let me just make sure that I'm looking at the right page here.

Acquisitions are certainly about, let's say, 18 -- excuse me, 8%.

Sorry, mistake on my part, of the 17%, they're about 8% of the 17%.

Foreign exchange is about 4% of that.

And then you have the rest, the difference is just the change in inventory.

Which offsets, goes the other way --

Which goes the other way.

Yes.

So your reconciliation, Tim, between 17% and 7% is 8 points of acquisition, 4 of foreign exchange, offset by 2 in the inventory changes.

Okay.

So pricing and volume together would be up 9%, is that right?

7%.

Okay.

Okay.

If we were to look at that at what we would call an underlying or organic basis, we would say it was up 7%.

Okay, terrific.

Maybe Jane or Phoebe, the breakdown of the dilution items from Herradura, inventory step up, amortization of the SASAR Act, can you break those a little finer so we kind of know whether to treat them as operating or one time?

Yes.

If you look at the nickle of dilution in the quarter, about half of it -- so about $0.025 are related to the base business.

That relates to both what we earned in the business and the interest associated with the acquisition.

The remaining $0.025 cents, you break it down about a third of it came from transition-related expenses and the remaining two-thirds was non-cash.

So that would be your SASAR Act and the GAAP write-ups we just talked about.

Okay.

The SASAR Act amortization, that hits every quarter or just in the December quarter?

That will hit every quarter over the next five years.

Right.

Okay

Okay.

Thank you.

Thanks, Tim.

Your next question comes from the line of Ann Gurkin with Davenport and Company.

Good Morning.

Hi Ann.

Just wondering if I can get an update on the Asian markets, where we are with those markets and are they profitable?

Can I just get an update on them?

Yes, Ann.

They remain profitable.

We've been profitable out in Asia for quite some time.

Mostly on the heels -- we've had a very nice Japanese business for a long time.

So there's a little bit of a mixture going on.

The Southeast Asian markets remain very solid.

The two, I think best performing markets up in Asia the last 12 months or so have been Japan and Korea, which has bounced back nicely for us, both growing double digit.

We've talked about China, I think, basically on every call.

Some of the challenges that we've had there either competitive or counterfeiting.

And the last few months seem to be getting better on that front, although they're not back to the big double big digit growth rates we were seeing before.

The only other thing I would add out in that part of the world, we also incorporate our Australian business out there, which continues to be really, really strong on the heels, mostly, of the growth of our RTD business in Australia, but also on the parent brand Jack Daniel's continues to do mid- to high single digit growth as well.

Okay.

Then in terms of inventory, are we done with adjustment, or do we have more coming?

Obviously Phoebe said in her sort of opening remarks, that it looks like we're in pretty good balance right now, but just the way that seasonal buying patterns are, or the way that you may have pricing or (inaudible) changes or you can have new distributors or partners, all those things influence some of these fluctuations we report to you in terms of shifts in inventory.

So I suspect for a growing big and almost dynamic business like ours, we'll continue to tell you about the things that shift away from what we would consider to be the underlying, both when it's a help to reported earnings and as a hurt to us.

Okay.

Then what is your forecast for performance of the overall domestic liquor market?

And then can we segment that into premium brands versus value brands?

Well, I mean, we don't naturally do a forecast for the whole market.

It looks like -- I said it just a minute ago, it looks like the distilled spirits business as a whole in the last 12 months may have come down maybe as much as a point and a half sort of from the 4.5% maybe down closer to the 3% range.

That's the latest look I've seen at some of the NABCA data.

So I think it's still growing and the 3% growth rate is very nice.

I think the pricing and the mix issues that's been continuing trading up that's been going on is happening.

In this environment, you would expect it to maybe happen at a lower rate.

Maybe not as rapidly as it was.

For some of the reasons, I mentioned when I was talking about Jack Daniel's.

It all depends, I think, on some of the environment in the U.S.

as to how the rate of growth either accelerates or decelerates, but from what we see right now, the best indicator is that it's growing at about a 3% volume and when you consider mix and pricing, maybe the overall sales -- at the sales line, maybe more like a 5% or something like that growth rate for the U.S.

One thing that's nice as far as the brands that are in the 21 to 34 year old segment -- 21 to 29 as well -- you do see favorable demographics there, which is another positive thing.

So I think we haven't forecasted that anything other than what I would call growth for the U.S.

market, but it sure looks like here in the last 12 months, that growth down about a point and a half.

Okay, And the premium segment, what do you look for that growth?

A lot of it, it depends on how premium your going.

I think up at that stratospheric level where there's $30 and $40 a bottle, they are generating business from a pretty narrow demographic and also a pretty small base, typically.

So, I think that will continue to grow in the 15s and 25%.

It's some of the other larger volumes that you tend to focus on a little more during pinches in these disposable income levels.

But I think the super-premium, and I think sometimes it's called ultra-premium will continue to grow along because they're such small bases.

Okay.

That's great.

Thank you.

Your next question comes from the line of Bryan Spillane with Banc of America Securities.

Hi.

Good morning, everyone.

Hi, Brian.

Hi Brian.

A couple of questions.

Just first on, were your U.S.

depletions positive in the quarter?

Yes.

Yes.

Okay.

I think --

In the aggregate?

Let me just -- I'm trying to think through on every -- we tend not to look at it -- I'm trying to think.

I think they probably were in the aggregate.

Let's put it this way, they were, I know on the Jack Daniel's, Southern Comfort, and Finlandia brands we talked about they were --

If you include every wine brand.

Yes, let us do that, let us look at the aggregate, and we'll tell you before the end of the call.

Okay.

That's fine.

You had a competitor this morning talking about the U.S.

spirit's markets.

I guess essentially what they've said is -- echoed your comments in terms of seeing a slowdown in the overall growth rate, down to closer to that 3% level.

One of the things they talked about was that the premium segment has held up, the value segment is sort of where the decline or the deceleration in volume has come from.

And I guess what I'm trying to understand and would love to get your perspective on is how much of the slowdown in the market do you think is related to consumers trading just out of alcohol in general.

So consumers consuming less, maybe because of cost pressures or whatever else, and how much of it may be some of the share of stomach may be slipping back into beer?

Because we have seen the total beer industry growth rates tick-up over the same time frame.

Yes.

I think -- I think it's kind of logical to assume that during the times we're looking at right now that people might trade down into beer.

It makes sense from the standpoint of out of pock.

I think that may explain a part, if -- I don't know, I haven't study it close enough to know if it explains on a liter basis some of the trade-offs, but sometimes we see these fluctuations as well.

If you go back and look at the movements in growth, distilled spirits, they'll move on you a point and then bounce back.

So you do -- you can't just take it as a directional change that's going to continue.

But I think it's perfectly logical to think that people might trade down to some of the popular-priced beers out of spirits and I do think the premium end of it, particularly the high end, as I said, Bryan, holds up pretty well in this arena mostly because it's a pretty narrow demographic and socioeconomic group that's providing that volume.

They get pinched less by things like gas prices and a raise in the interest rate.

So I think it makes sense that some of it could be going to beer.

Great.

Thanks, guys.

Okay.

Your next question comes from the line of Justin Maurer with Lord Abbett and Company.

Good morning, guys.

Good morning.

Just a question as it relates to inventory on the Herradura side.

Given the disruption with the acquisition and whatnot, are you guys -- do you feel that things are in pretty good shape from an inventory standpoint to the extent that the former owners, if they had channel loaded it somewhat, I know you talked about that down in Mexico that you need to work that down somewhat.

It sounds like from your comments that that may still need to go down a little bit more.

But even in the U.S., do you it feel like you've had a full shot, if you will, to get sell-in back to normal levels, or is that still being worked off?

Actually, I think the standpoint of working through what you would term the channel stuff in advance of us getting it, I think down in the Mexico market, particularly, we're toward the end of it.

I really do.

I think, which was our goal was in advance of the prime selling season to get things in balance and everything we've looked at here in the last several weeks would say that we're back in balance.

We're at a stage on this entire acquisition where we're just -- you still, you just remember we're within six or seven months of having made the acquisition and I kind of call it we're still at that stage where we're getting our hands around it all, whether it's the inventory and trade practices and relationships of the Mexico market or the tequila production side and getting our own approach to the supply/demand planning, the work that a lot of brand people are doing as it relates to positioning and pricing and marketing which you don't get to -- you don't roll it out the minute you get it.

So it takes the better part of sometimes of a year to get your ideas and implementation in place and we're actually seeing it right now on Chambord in some ways.

We're about a year past the integration of Chambord and we're already seeing this year how when you have your own programming and pricing and comparing to your own historical depletions and financials, you just have a lot more confidence in how you're going to the market with the brand.

So we're in that stage with Herradura, but I think most of the inventory rebalancing on Herradura has gone on.

If anything, as I look ahead to the next 12 to 18 months, I would think that particularly in the United States that we may be able to have inventories go ahead of depletions, because we've actually found stock outs during the transition in the United States that the brand is under distributed and one of the reasons we think it will do well in our hands is because we can get it exposed in the right way to a broader part of the U.S.

market.

So what the timing and specifics of that will be, I think we probably have a couple of years to work on that.

Just on the Mexico side, I know you guys are working with Bacardi down there, how has that manifested itself from an inventory perspective, to the extent that the former owners were using the same distribution that you guys are currently using, so were the folks at Bacardi telling you, when you were closing the transaction, that hey, we've got plenty of inventory here that we need to work off and you guys of course being proactive, said okay, we're going to back off for the better part of a year and try to let that work its way through.

Is that mechanically how it's kind of gone?

Well, just to clarify, on the tequila business, Bacardi really wasn't involved.

That was the Casa Herradura operation had their own sales and marketing operation.

So the transition on the tequila side of our business in Mexico has been with our own acquired company.

Right, okay.

Our choice.

Bacardi had nothing to do with it.

The Bacardi partnership that we've got there, which has been business as usual dealt with the non-tequila brands, that Brown-Forman was selling in the Mexico market, and that's continued to go along nicely.

Got you, got you.

Okay.

As it relates to Jack Daniel's -- I think you addressed it, but given your thoughts of consumer softness, it doesn't sound like you guys are going to do anything tactically.

If people are pulling back somewhat from the premium spirits business --

I think what you tend to study during these times, at the heart of what I was talking about is a consumer's evaluation of what they're got in their pocket, the price for the value they're getting and sometimes it's just not affordable, but other times the difference can be the value they perceive.

You always go back and look at your marketing efforts, making sure they're strong and dealing with those sources of value perceived by the consumer.

I think we can do things, particularly when I mentioned a crossing of key price points.

You really want to go back and also look at your price programming and the way you get retail support and ad support to make sure you're doing an excellent job on that.

I think you really want to do the blocking and tackling of merchandising extremely well.

One of the things that I'm optimistic about is a year ago, we were going through a reorganization in the United States and so it would have been naturally disruptive on that front and it's our expectation that as each month you get past that, which we're now a full year past it, you have a better capacity to do your own blocking and tackling and price programming and merchandising at the levels you expect.

So I think it's more that kind of stuff than it is thinking about stopping your price increases or rolling back prices.

We've been through these -- actually, I recall it very vividly crossing the $10 price point and the $20 price point quite some time ago and the trade dynamics and consumer dynamics you deal with.

It shouldn't take away from the courage you've got with the price leadership that Jack Daniel's provides in the market.

Yes.

And just lastly on the hit to gross margins from the acquisition, the $0.05, can we assume that all of that basically flowed through gross margins, whether it's the inventory step up, or the SASAR Act, amortization, or is that not the right way to look at it?

Actually, I assume you're talking about the $0.05 delusion.

Yes.

That includes everything up and down the P&L.

It's not all through gross profit, of course not.

Actually, gross profit would be -- we earn money at a gross profit level despite the fact of having some one-time hits from inventory.

So it's up and down the P&L.

Includes the interest income -- or interest expense, excuse me.

It includes the spending, it includes everything.

Okay.

So I know you said earlier that you had a 30 basis points impact from the inventory step up.

I guess I'm trying to figure out what would be the apples to apples gross margin, either on the base business or if you were to think of a pro forma with Herradura a year ago?

Yes.

Again, I think I mentioned this a little bit ago, just the piece of the loss margin are the U.S.

GAAP write-up of inventory, it attributed just about three tenths deterioration of our margin in the quarter.

But the bigger impact is the mix of the business that we had from Herradura in the quarter.

We had a high mix business of new mix and agency brands which we do not expect in the next few quarters.

That's where we ramp up and have heavy volumes from our tequila business.

Got you.

Okay.

Thank you very much.

Your next question comes from the line of Thomas Russo with Gardner Russo Gardner.

Hi.

Good morning.

Hey, Tom.

How are you?

Just fine.

First, congratulations on Finlandia.

I was impressed by those numbers and look for a little more color, if you could, Paul.

It sounds like Phoebe said you were up and you've increased volumes in Finland even with a price increase, so can you just give us some color on Finlandia?

Sure.

Finlandia has really been on a roll.

It's been running in approximately the 20% rate for a while now and Poland has clearly been the driver.

We're doing extremely well there and have been for the last couple of years.

We've really staked out the premium position in that market.

But it really does go beyond Poland.

It's interesting, the performance on Finlandia is more widespread than that.

We're doing -- we're continuing to grow and do nicely off a nice base in South America.

The brand up and down throughout Eastern Europe, even beyond Poland in places like Czech, where the brand is doing quite well, we continue to do well still from a relatively small base, but it's getting bigger in a place like Russia, Israel, even in Germany and the U.K., as I mentioned, Finlandia is beginning to do quite well.

The thing that's been encouraging to us is it's n singularly in the country of Poland, as exceptional as that performance has been.

And we're still doing some of the early work on the brand out in a place like China as well, where we think there's some real potential for it.

It's been a -- I mean it's one thing that creates some internal competition within Brown-Forman that Finlandia volumetrically surpassed Southern Comfort on a rolling 12 month basis here in the last couple of months, and so it's our second largest volumetric brand right now.

It's been a real help for us, and actually it's a really interesting story, you know most of the brands Brown-Forman historically has developed were larger first in the United States and that was their business, and then we went out and built them internationally.

This one is a very different brand.

It's a much, much larger brand out in the international markets than it is in the United States.

And do you find -- excuse me.

Have you found that you've had any assistance from Finlandia's presence in Poland with Brown-Forman's other brands, helping to move those to the market?

Absolutely.

Even from tiny, tiny bases, we're starting to see stuff on even Southern Comfort.

I think we talked about it before where Jack Daniel's is growing extremely well in the Polish market and is crossing through milestones every six months or so.

It's doing quite nice there.

And once you have the kind of infrastructure and expertise in the market that we've got in Poland around Finlandia and start building Jack Daniel's Southern Comfort, you also see opportunity for brands like Herradura or Chambord and some of these other ones where you can actually start to use the route to market strength you've got there to actually improve the business on some of these smaller developmental brands.

So Poland's become a really important market for us, increasingly beyond Finlandia.

Thank you.

And Phoebe, when the estimate for this year's -- this full year profit of $3.35 to $3.55 is presented, how do you work in the range of $0.13 to $0.18 of -- I think that was the dilution from Herradura.

Do you take $0.18 off the $3.35 estimate and $0.13 off the top end estimate or how do you do that.

That's exactly how we do it, as you described it.

Okay, so the range without Herradura would be something like $3.53 to $3.68, adjusting for those dilutions?

I think that's right.

Yes, that's right.

Okay, Paul, on the Jack Daniel's observations, the domestic depletions of Jack Daniel's, accepting the breadth of the economic and demographic customer base, as you described, are you comfortable with your observation that the drag has been more from those who, for circumstances are probably less likely to be able to reach for the upper limit on prices, or is there loss at the high end of consumers who are looking elsewhere for the brands that they can afford, but attribute their aspirational value to otherwise than Jack Daniel's.

Is it more the former, or could you see some of the latter half?

How have you analyzed that?

Well, I think -- there's certainly competition up and down for a brand like Jack Daniel's.

We even see it within our own portfolios to how well brands like Woodford Reserve and Gentleman Jack and brands above the Jack Daniel's price point are doing, and it's a reminder about why Jack Daniel's needs to make sure it retains its premium pricing.

But I think when you see it in this -- I think, Tom, where you see the onslaught of the disposable income sort of figures and the logic that goes around that, I think it's more a possibility that people under normal circumstances see Jack as that affordable luxury, they're in casual dining environment, buying Jack Daniel's at the bar, and when they have a pinch, they're maybe at home drinking out of a 175 and trying to spread their dollar across more beverage alcohol.

It's not that they exclusively shift from one brand to another.

I think it's an occasion-based thing.

So that's the theory, as we've looked at it.

When I've looked at some of the consumer tracking data, which gets into the way people feel about Jack Daniel's, those numbers are as strong as they've ever been.

I think that piece of it makes us feel really good about how healthy and strong the perceptions are of Jack Daniel's, and that it maybe more related to some of the environment.

Great.

Thanks for the update.

Thank you.

Let me add one thing to an earlier question.

One of the questions that was raised was the U.S., Bryan, I think raised it related to the U.S.

volume for the quarter.

And somebody just handed me this.

For the quarter, we were up in the U.S.

approximately a point and a half, volumetrically.

Globally, too, just to add to that, our depletions, if you look at the three months, you would expect they would be up very substantially because of the addition of Herradura, but even if you take that out there, very significant.

Yes.

mid-single digits.

Mid-single digits.

So for the question that was raised, that is the answer.

Thank you.

Our next question comes from the line of Andrew Sawyer with Goldman Sachs.

Hi, guys.

Just two quick ones.

The first one is kind of building on the question about the U.S.

consumer.

I was wondering if you could slice it more by channel and maybe give us a sense if you're seeing a difference in how consumers are behaving on premise versus off premise?

Yes.

I think some of the on premise numbers we've seen have continued to be softer than they were a year ago or 18 months ago.

There's a lot.

You may all have visibility to some of the traffic numbers that you hear from casual dining, the public companies, so that's out there.

I think within the retail channel, I think it varies by the type.

There's of course, in our industry, the independent stores and the Nielsen types.

As we've studied that, I think it literally varies market by market we market.

What we've been trying to study more in terms of the performance of our company has been more the geographic, not necessarily within certain channels.

I think the channel mix holds up -- even though it might shift a little bit, you don't see dramatic things, but you can see quite considerable shifts in performance when you go to study a market like a California or a Texas or a New York or Florida and I think a lot of the industry has seen softness in a market like Florida.

California is one of the markets that I think it's really particularly, in my view, impacted by the types of things that are hurting disposable income, which is higher interest rates and higher fuel prices.

People just drive a long way from point to point in California, and it costs a lot to buy real estate out there.

So when there's a pinch out there and we've got big business out there, you'll see California, perhaps, get soft.

So I think we've been studying it more, trying to link up territorial performance probably more so than channel, but clearly when you have large chains promoting, you really want to pay attention to what they're promoting in their ad pricing has always been a significant indicator to me.

And I haven't studied that here recently to see if they're promoting higher price brands, lower price brands, or mid-priced brands because that can be a tell-tale sign as to what they're seeing with their customer traffic.

My second question is back to Herradura.

I was wondering if you could talk a little bit, just broadly you've had the business now for six or seven months.

What have been key learnings, where have you been surprised positively, where have you been negatively surprised as you looked at the business a little closely.

Well, I could probably talk for a long time on this one, but I think the most important -- I've been pleasantly surprised at the trade and consumer equity, particularly in of course Mexico and the United States, but even the opportunity that is being signaled from some of our non-U.S.

and Mexico markets about the potential for the brand.

There is just -- there's an awareness and a knowledge of its credentials and it's quality, and yet it doesn't show up in the, what I would call the distribution numbers of the brand.

So I think one of the reasons we were so interested in it is we thought there was this latent brand equity, and if anything, I feel like the early stuff we've learned from consumer and trade interviews and research is that the brand may have even more than we thought.

The issue is going out and getting it and getting it the right way.

I do think that we're also working to -- I mentioned it earlier, a lot of the things related to our larger presence, we continue to learn the Mexico market.

We just weren't an active player on the ground in the way that we are now in the Mexico markets.

I know the team that's down there, which is an excellent team, each week is learning something new about how to conduct business in Mexico.

And then I mentioned this earlier as well, it's just this is a pretty significant manufacturing operation.

So our teams who are trying to work their way through the entire supply chain of Herradura and how to be thinking about the supply and demand planning and doing that the right way, all of those are areas where we're learning things by the day, but I actually think -- I've said I think the last call, if anything we're more excited about it.

It's going to take us time to get in and realize all the potential that we see in it.

But as a core brand proposition, we're pretty excited with what we've bought.

As far as building it out in both the U.S.

and I guess you're now saying in other potential international markets, should we expect to see that as you move past the one-year mark.

Are we going to start to see more distribution for these brands in the U.S.?

And what kind of time horizon is it to start launching it into other markets if there is the latent equity?

Yes, and actually I think we've already started to do some of that international.

It's at a kind of low level, because the distribution base outside the United States in Mexico has not been that large.

We've already begun some of that.

The U.S., I hope it doesn't take a year.

We've already begun to -- part of it is just trying to get your distributors -- new distributors and get the basically your sales infrastructure and the programming behind it in place.

I think we're getting close to being at that stage with Herradura in the United States and I'm hopeful that a lot of the distribution gains will begin in the latter half of this fiscal year.

That we'll actually be out there seeing point to point distribution increases across the United States.

Thanks a lot, guys.

Sure.

You have a follow-up question from the line of Lauren Torres with HSBC.

Just a quick follow-up on your tax rate in the quarter.

It came in a little bit higher than we were expecting and higher than your full-year tax rate guidance.

I was just wondering if there's any change there on your guidance for the full year?

Can I put a little color, Lauren, on the quarter?

On the quarter, it's important to note that our effect -- we booked an effective rate for the quarter, which is about 32.8%.

What you saw in the quarter, why it was a little bit higher than that, 33.9%, is because we had some addition to existing tax contingencies and additional interest, so really our expectation for the year would be in the 32.5% to 33% range.

Okay.

So no change?

Right.

Okay.

And if I could just ask one more general question about how you're thinking, maybe, Paul, about your business going forward.

You stressed the international opportunities and you also stressed the growth behind your super-premium developing brands.

I was hoping you could talk about maybe a couple years down the line, how you're thinking about your geographic mix and product mix from a sales perspective or maybe better yet a profitability perspective?

I think it would be a common theme, but we for sure from a percentage mix will increasingly become more international.

That's been occurring over the last 15 years of the company.

I don't see that changing.

We have -- the U.S.

is only 5% of the world's population and we get roughly half of our business from it.

So you would expect to see, even as the U.S.

grows for Brown-Forman, you would expect to see it decline as a percentage because we just have so much opportunity outside the United States.

And then I think, another continuation of something's that's been occurring at Brown-Forman, I think you'll see the mix within the portfolio continue to go up toward more premium and super-premium brands.

Part of it is, if you look at our last several acquisitions, whether it was Herradura or Chambord, Tuaca, or Sonoma Cutrer, I mean all of them have been in these higher price points.

I think we've been really happy with the progress of Finlandia and where it starts to, as I mentioned, when Tom asked, I think getting new markets developed opens up a whole world of opportunity for other Brown-Forman brands.

It's not always on the heels of Jack Daniel's.

It can be other brands as well.

And so, I think we'll -- if there's a trend in the mix, it'll be more international, it'll be more premium.

But, honestly, when we look across the say, top 12 to 15 brands in terms of growth rate of our company, every single one of them, we think, has still really, really nice growth potential.

Of course, the smaller ones have more than the larger ones because they're just a small basis.

But on Jack Daniel's Finlandia, even Southern Comfort is still here.

We think there's wonderful growth potential for all of them around the world.

Thank you.

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

Davidson and Company.

Hi.

Just a couple more follow-ups on Herradura.

Sorry to fixate there.

Paul, you mentioned heavy selling season as we get into the 2Q, but there was a bit of a load last year.

Is it going to be a less than sort of normal, but greater than the 1Q?

Is that how we should think of it?

Well, I think you almost have to throw out, in my view, the seasonalization that was occurring in the Herradura business throughout the last half of last year, because it was my understanding that what was actually occurring versus prior years is they were actually bringing inventories down in part during the heavy selling season because there was -- a lot of their heavy selling had been occurring over the prior 12 months.

So they had a lot of inventory balancing they had already begun to do and we had talked about back that throughout the winter.

I do think, though, there were still some -- just the trading patterns and then I think it was referred to as the channel stuffing.

When we got in, the first thing that we thought we could do to add value was to get it into balance.

I think we're in a balance now -- I would hope we would have a better holiday selling season because we're in a balanced inventory position down in Mexico than we saw last holiday season.

But I'll feel a lot better about it when we're comparing to our own numbers versus somebody else's.

Got it.

In your opening remarks, you kind of said we're treating Herradura and El Jimador generically, but when you say you're going to grow the brand and distribution in the U.S., are you primarily talking about the Herradura brand or as well the El Jimador brand?

Both of those brands, Tim.

They're very recognizable by Mexicans who have recently come into the United States.

They're not as well known to people who haven't traveled in Mexico and been exposed to those brands, and that's our job of introducing these great brands to an American populous who has not had exposure to them in Mexico.

To anyone who's been in Mexico or from Mexico, both brand name are instantly recognizable.

And they are under distributed, both of them.

Right.

And then back to the dilution, I'm sorry.

You mentioned that there's sort of only then about $0.02 of non-cash.

Is the inventory step up in there as well as the SASAR Act?

This is Jane.

When I was going through the break down of the dilution again, the $0.025, I think I said, was the base business and included interest.

The remaining $0.025 does include Herradura -- does include SASAR Act and the GAAP write-up.

If you were to break the two pieces apart for that $0.025, about two-thirds of that $0.025 is non-cash.

Which would include the GAAP write-up, the loss margin, as well as the SASAR Act.

Okay.

Thank you.

Thanks.

You have a follow-up question from the line of Thomas Russo with Gardner Russo Gardner.

Paul, your comments about the growth -- the continued growth among your ten strongest brands impressed me.

Particularly the fact that in some markets you think you may have peaked out, they show the greatest growth, have they -- particularly with Southern Comfort in the United Kingdom and Germany.

These were the two markets that were the pillars of Southern Comfort 15 years ago.

And then Phoebe mentioned those were the two markets showing the best growth in Southern Comfort this year.

Talk a bit about what you've done -- what's going on particularly to keep that brand so robust in two markets where they certainly would have been considered longstanding staples to those markets.

I think some of it is, if you go back a little while on it, the constant work on things like packaging, the product and how it's promoted in drinks, but really importantly in particularly the U.K.

Southern Comfort is a brand that needs I would call it more consistent attention to it.

A lot of liquors are this way, in order to stimulate the business and get the people to keep it top of mind, get the system to keep it top of mind.

That's very different.

A lot of times with brands like Jack Daniel's, or these really strong category related call brands, once you get them going, they tend to feed themselves at some point.

Southern Comfort really benefits from a strong effort in the distribution system.

There's no doubt that what we've done in the United Kingdom in terms of getting closer to the marketplace and the partnership we have struck with Bacardi has really helped Southern Comfort's performance.

I would say the same thing has helped in Germany and the other market -- there's two other markets that have long been good Southern Comfort international markets.

That's Australia and South Africa.

And the same dynamic is true there, where we've become closer to the end market promotional and brand building efforts and Southern Comfort has responded.

And all of those markets are growing very nicely on a 12-month basis and it's one of the benefits of having a global brand.

Even when the U.S.

business is in the low single digits, with those carrying the weight, you can actually get a stronger overall global performance.

But mainly it would be the benefit from controlling -- increasing the control over your communication with end users to keep it top of mind?

You got it.

I never like to use the word control, it's much more the way we exert influence over the end market brand building activity.

And there's various tools you can use.

An example is, the one in Australia.

In addition to that, we are very much a participant in the RTD business down there.

It's not near the size that Jack Daniel's is, but that RTD brand helps keep Southern Comfort top of mind down in the Australian market in addition to the commercial benefit we get from it.

So, there's all kinds of tools you can use, but those are just a few of them.

Thank you.

Sure.

At this time there are no further questions.

Mr.

Graven, are there any closing remarks?

No closing remarks.

Thanks for joining us and have a wonderful holiday weekend.

This concludes today's conference.

You may now disconnect.