Brown-Forman Corp (BF.B) 2008 Q3 法說會逐字稿

Good morning, my name is Cathy and I will be your conference operator today.

At this time, I would like to welcome everyone to the third quarter fiscal 2008 conference call.

(OPERATOR INSTRUCTIONS) Thank you.

Mr.

Graven, you may begin your conference.

Thank you.

Good morning, everyone.

Thank you for joining us today.

This is T.J.

Graven, Vice President of Investor Relations at Brown-Forman.

Joining me today on the conference call are Paul Varga, our President and Chief Executive Officer, Phoebe Wood, Chief Financial Officer and Jane [Morrow] Senior Vice President and Controller.

Before we get started this morning, a brief note on our press release.

In our first version this morning there was a wording error in the second sentence of the second paragraph.

We issued a corrected version which is already on the wire, and that should read net sales and gross profit gains benefited from the edition of Casa Herradura and a weaker dollar partially offset by changes in global trade inventories.

We apologize for that wording error.

As usual, our comments this morning will contain forward-looking statements based on management's current expectations.

Numerous risks and uncertainties may cause our actual results to differ materially from those anticipated in these statements and many of the factors that will determine future results are beyond our ability to control or predict.

You should not place undo reliance on any of our forward-looking statements and we undertake no obligation to update them, whether new information, future events or otherwise.

A press release containing our results can be found on the website under the section titled Investor Relations, and we have listed in that press release a number of risk factors to consider in conjunction with our forward-looking statements.

Other risk fathers are described in form 10-K or form 8-K and form 10-Q reports.

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 results are contained in our press release.

I will turn the call over to Phoebe Wood.

Good morning, everyone.

Thank you for joining us.

This morning, Brown-Forman reported operating income for the third quarter ending January 31, 2008, of $182 million, up $13 million or 8% compared to the same period last year.

Performance in the quarter reflects improved U.S.

results, continued solid international growth, the edition of Casa Herradura and the additional benefits from a weaker U.S.

dollar.

On an underlying or organic basis, operating income grew 7% in the third quarter.

This represents an improvement over our second quarter growth rate of 6% and is equal to the organic growth rate in the first half.

We believe this is a strong rate of growth, particularly in the context of challenging economic conditions in the U.S.

market.

10 years ago, a U.S.

economic softening, like we're experiencing, would have resulted in a much lower rate of growth for our overall business; however, these results reflect continued healthy international business, which now contributes more than half of our total net sales.

We expect the growth in our international business to be significant to the overall growth of the company over the next several years.

During the third quarter, we improved our net sales growth rate over the second quarter for many of our brands in the U.S., reflecting a modest increase in volume and the benefit of higher prices.

Jack Daniel's volumes were up in the low single digits in the United States in the quarter and when combined with low-single digit price increases, net sales for the brand were up at a mid-single digit rate.

The super premium Jack Daniel's brand expression, Gentleman Jack, is the fastest growing brand in our portfolio, growing volumes and net sales more than 40% in the quarter in the U.S.

Annual depletions now exceed 200,000 cases globally and the brand's new and appealing package, which has been in the market for roughly a year, has received an exceptional consumer response .

We will also note that a fair amount of growth for Gentleman Jack is coming at the expense of Jack Daniel's Tennessee Whiskey volumetric growth, but at a higher price point and consequently higher margins.

Notably, the three super premium bourbon brands in our portfolio, including Gentleman Jack, Jack Daniel's single barrel and Woodford Reserve represent over 400,00 9-liter cases and are growing at more than a 20% rate.

In the U.S., these brands together have a mark share of nearly 50% of the super premium priced American whiskey category, that is brands price above $25 a bottle at retail.

Southern Comfort experienced softness in volume trends for the quarter with low single digit decline globally.

Over the past year, unlike many brands in its competitive set, Soco has taken aggressive price increases in the U.S.

and more modest increases in many of the brands key international markets.

Economic softening in these key markets, weakness in the on-premise channel, which is important to this brand, and an ineffective promotion effort in the quarter contributed to the decline in volume.

As we finish out the fiscal year, we have efforts underway that will address some of these issues.

To finish our discussion of the U.S., net sales improved for several other brands, including but not limited to Sonoma-Cutrer, Woodford Reserve, Tuaca and Bontera reflecting higher volume and higher pricing.

Outside of the United States, Jack Daniel's international were up mid-single digits in the quarter.

Jack Daniel's and Cola, our ready-to-drink brand extension in Australia, continued to grow at a healthy double digit rate, well above the ready-to-drink category.

Finlandia Vodka's net sales grew at a double damage it rate, reflecting the benefit of volume and price increases.

These gains were driven by continued robust growth in consumer demand in eastern Europe.

Perhaps most impressive is the breadth of this brand growth in the entire region with solid double-digit gains in Poland, the Czech Republic, Hungary, Romania and Russia where, according to official import statistics, Finlandia is now the largest imported vodka.

We are particularly pleased with our progress behind the development of Finlandia internationally.

Since we took majority control of the business in 2003, we added over 1 million cases to its base volume.

In fact, in the last 12 months the brand has grown by more than 400,000 cases, making it an increasingly important component of the company's overall growth.

Last fiscal year, we made two significant acquisitions, both in the premium and of the spirits category, Chombord and Casa Herradura using some leverage from our health balance sheet to add great brands with exceptional growth potential and excellent margins to our portfolio.

During the last few weeks of the quarter, we cycled the anniversary of our acquisition of Casa Herradura and results for the business this year remain in line with our expectations.

Our brands fared well in both Mexico and the U.S.

during our first important holiday season.

As a result of new trade practices we implemented over the last year in Mexico and our work to reduce abnormally high levels of trade inventories there, we believe our brands are in a much healthier positions compared to where that were 12 months ago.

I would like to mention we had much stronger-than-expected performance for our el Jimador ready-to-drink brand extension, called New Mix, which is the largest in the Mexican market and continues to outperform the category.

The Herradura and el Jimador tequila brands in the U.S.

are going well.

We continue to focus the efforts in two areas.

One, increasing points of distribution with the brands more readily available and, two, doing the basic marketing work, positioning, research that must be done to build the brands effectively in this important market.

The integration of Casa Herradura into Brown-Forman is progressing as planned.

Our efforts are on track and we are scheduled to achieve a notable milestone tomorrow, March 1, with the merging of their processes and systems into Brown-Forman's established systems.

Earlier this month, members of the Casa Herradura team attended an awards ceremony in New York hosted by one of the industry's noted trade publications at which Herradura was the first tequila maker to win the prestigious award at the 2007 best distillery of the year.

We salute all the employees at Casa Herradura for that fine accomplishment.

A brief note on our progress with Chambord.

Net sales globally for the brand were up double digits in the quarter and we're encouraged with the progress we made improving our revenue and cash contribution for this brand versus our original expectations and the consumer opportunity we continue to see in the U.S.

We're also pleased with the strong growth we're experiencing in high potential markets such as Australia and the U.K.

Notably, we're now selling Chambord in more than 30 countries around the world.

Now, turning to our cash flow.

The first nine months of this year, cash from operations is more than $397 million compared to $278 million in the same prior-year period.

Solid earnings growth and working capital improvement, including a one-time refund of VAT totaling more than $30 million related to the acquisition of Casa Herradura, contributed to the strong cash generation year-to-date.

This cash from operations and our healthy cash balances enabled the company to use nearly $443 million this fiscal year for the following: To pay dividends of $117 million, to distribute 204 million of proceeds from the sale of our consumer durables business to our shareholders, and to repurchase $122 million worth of shares in the quarter.

The shares repurchased were part of a $200 million authorization by our board of directors.

As of yesterday, the program was nearly complete.

Since the inception of the plan, we have repurchased 2,974,900 shares for $199.847 million leaving only a couple hundred thousand dollars remaining under the board's authorization.

We believe this was an excellent investment in a time when both interest rates and our stock price were both at attractive levels.

We are narrowing the range of our full year earnings outlook for fiscal 2008 from $3.42 to $3.54 per diluted share to a range of $3.42 to $3.50 per share representing forecasted growth of 9% to 11% over comparable prior year earnings of $3.14 a share.

We expect in the fourth quarter to have continued global growth for the company's brands, a lower tax rate and modest additional benefits from favorable foreign exchange.

This outlook is tempered slightly by a challenging economic environment and our expectations of higher energy and grain costs.

With that, I will turn it over to Paul

Good morning, everyone.

As you heard from Phoebe, our 7% underlying profit growth represents a slight improvement over the 6% underlying growth we reported in our last quarter and it equals our year-to-date growth.

We continue to grow our net sales and gross profit at a mid-single digit growth rate while growing our operating profit at a higher rate due to lower growth rates and operating expenses, most notably SG&A, despite what we see is a challenging environment compared to a year ago.

As we look ahead, we will continue to aim for high single digit growth and operating income over the long-term.

We have a strong track record of delivering this consistently while naturally producing results that are, at times, both slightly above and slightly below this range.

Over the next year or so, we believe that our year-to-date profit growth rate can be improved upon as we focus on the best top-line and bottom-line initiatives available to us in this noticeably more competitive environment.

Specifically in the U.S., we continue to make appropriate shifts in our Jack Daniel's and Southern Comfort investment mix toward activities that we expect to be more relevant in today's environments.

Examples of this include spending more for expand our in-store presence, particularly display activity as the consumer shifts some of their purchasing from on to off premise.

Allocating more dollars to value-added packages where the consumer receives promotional material such as branded glassware that can strengthen their affinity toward our brand, and ensuring our brands are promoted both on and off premise with competitive frequency and at competitive prices without compromising brand equity or operating margins.

While we still anticipate having strong investments behind longer-term awareness and image building vehicles like advertising and event marketing, we believe this environment calls for an investment bias toward brand-building program that have a potential to simulate a more near-term consumer response.

Looking at our most recent Nielsen data ending in early February, we're encouraged that Jack Daniel's outperformed the largest two whiskey competitors, Crown Royal and Jim Beam, and it's second largest non-whiskey competitor, Cuervo on a $1 sales basis for the 12, 3 and 1-month period.

Importantly, we have seen slight improvement in the recent period.

In addition to these results, we're encouraged by the potential for our Casa Herradura brand.

We expect them to become a more important part of our growth story, initially in the U.S.

and Mexico and later in other countries around the world.

In the U.S., these premium and super premium tequila brands give us a meaningful position in the fastest-growing segment of one of the industry's fastest-growing categories.

Our historically small position in the fastest growing segments of the U.S.

business, namely vodka, rum and tequila, have been a contributing factor at times to our corporate performance relative to competition.

The Casa Herradura brand, therefore, represents a great opportunity for Brown-Forman to improve our overall U.S.

performance and position.

Further important growth potential is signaled by our recent milestone of generating more than 50% of our company sales from outside the United States.

This is a direct result of many, many years of consistent effort across our company and we believe that this will continue to be the most significant long-term growth opportunity.

Alongside this potential and international market, we believe our prospects for growth in the U.S.

remain substantial and have a 5% share of the U.S.

market and see much more room for growth here at home.

The fact is that despite our wonderful success over the last two decades, we're still a relative newcomer in most markets and many categories and we believe our long-term growth potential around the world remains enormous and with the U.S.

environment somewhat softer today than in prior years, we expect to place more of our incremental investments in international markets to help spur the company's overall growth rate.

Additionally, we expect lower increases in SG&A to be a source of leverage and another contributor to our future growth rate.

This is partially a reflection of the environment in which we're operating.

This is also due to the fact that we anticipate fewer incremental investments in the near-term behind our worldwide infrastructure.

After steadily and successfully investing to strengthen our route to market over the last five to seven years, we now can seek additional productivity from the earlier investments.

And finally, while we do expect a higher grain cost to persist, we do anticipate some lower wine costs over the next year or so to provide some offsetting relief.

Hope this additional commentary has given you some further perspectives on our business and we're happy to answer any questions you may have.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of (inaudible) with UBS.

Thank you.

Hi, Phoebe.

Hi, Paul.

Morning.

As you look at the economy and talk about the economy, are you more concerned about potential trading down or is it that there might be a decreasing volume but the consumer stays within the brands that they are in?

I guess a little of both.

As you look at the numbers over the last couple of years, I think this is a comment about the U.S., we have seen, I think, we have highlighted this in our last call, some shifts from the on premise to the off premise, which we think has a tendency to encourage some of the trade damage you're referencing there.

Overall, I think our take on the performance in the U.S.

at the spirits level is that it may be down about a point and a half versus a year, may be a year or two ago and so it's maybe a combination of both factors.

And when you say down a point, the growth rate is a point and a half slower.

Yes.

Still growing.

If we were running 4.5% growth, it's down to about 3.

Okay.

That is all I have.

Thank you.

Thanks.

Thank you.

Your next question come comes from Lauren [Torres] with HSBC.

Good morning.

Hi, Lauren.

Hi.

Question on Jack Daniel's in the U.S.

We saw the sequential improvement in the quarter.

If you could put more framework around what we're seeing there.

Last quarter you talked about improving execution, you talked about competitive pricing activity in the market.

If can you kind of break down the changes you have seen in that respect and how that helped you actually see some improvement in depletion growth in the quarter?

I think you just referenced it.

I think some of this stepped up execution and some of the promotional activities gear more toward the off premise that I referenced in my comments.

I think they were contributing factors as were some gift packs that were out during the holiday period contributing factors to some of the quarterly stronger sales.

Looking at it longer-term, I think, I cited in my comments there that we really are looking closely at the comparative performance relative to other premium whiskeys or other whiskey brands, also to other non-whiskey brands and I am reasonably encouraged that here in the last three months Jack Daniel's volumes and dollars are growing at a rate than the three planned brands I referenced in my opening comments.

So I think some of this is still early days, but I think the early work we did here over the last really 60 to 90 days, seem to bare a little bit of fruit and we'll keep on with that activity.

And then your comments, you said something about pricing activity or changes.

OEM thinking about pricing and I don't know if that was referenced to the Jack Daniel's brand.

What are your thoughts there as far as your pricing strategy?

I know you have been relatively consistent.

Do you expect any changes there?

I'll tell you, Lauren.

I think what we -- we still think Jack Daniel's particularly, but across a number of our brands, we can take modest price increases and consistent ones like we have done.

The references I was making to pricing there and what I did last quarter deal with sort of the promotional frequency where Jack Daniel's made promotional pricing in the store particularly, sometimes on ad often accompanied by displays and often times in this industry what we call blocking and tackling.

That was the executional comments I was talking about as well, making sure we're getting our fair share and being competitive with that.

I think you, our front-line pricing has to continue as it has historically.

Just making sure in this environment, particularly with the broad consumer franchise that Jack Daniel's has, that we're getting our fair share of in-store promotion and, where appropriate, the right sort -- right sort of pricing to the consumers makes the brand attractive to them.

And just lastly, a clarification or just to check up on your guidance, it still includes the same dilution related to Herradura and also the same tax rate guidance?

Yes.

Okay.

Thank you.

The next question comes from Tim [Ramey] with D.A.

Davidson .

Good morning.

Morning, Tim.

Phoebe, just a little bit more clarification.

The non-cash dilution piece, is that still running about $0.02 in the quarter?

Yes, it is.

Okay.

And if we think about the degradation and growth margin some comes with mix from Herradura, some comes from cost pressure.

Have you done any work to trying to parse those two factors out?

Yes, we looked pretty closely and tried to segregate out what was happening in the gross margins, and when you look at it, the main reason is the affect of the Casa Herradura.

It's a mixed change in the lower margin from adding in the Casa Herradura brand.

There are other changes so you have some advantages from foreign exchange.

Those offset the cost increases that we have and so we have looked, yes, at many different components of that.

If you're to summarize it and look at what stands out, it's the mixed change because of the Casa Herradura brand.

The base business is not down.

In the quarter, Tim, I think there was some shift in the geographic mix where it makes sense to you, brands like Finlandia are growing.

It's growing faster say than Jack Daniel's, which it is, or you're getting some of the, where we're seeing strength in Jack Daniel's is in eastern Europe and growing faster than the United States and United Kingdom.

You'll get some geographic mix.

If you spread it out over the full fiscal year to date so far, it's less consequential but on the quarter, there was a little of that.

Right.

Okay, Paul, one more, if I may.

One of the big arguments a year ago was the change in the structure and how that might lever growth in brands throughout the world as you reorganize from, into a product sort of function organization.

Can you talk about that?

Was there -- is that strategy working for you?

Or are you disappointed with results on that?

I think I referenced it the last quarter.

I think the time that it's taking us to acclimate, this is the U.S.

comment, to the activities that we ended up focusing on I think in a better way during the third quarter was something that I think would say was disappointing not just to me but to all of us.

It took us longer to get in the flow of new organization than we might have all hoped, but I think it's not just one single structural change that defines our approaches to the distribution strategy and route to market.

I am seeing more people comfortable with roles and responsibilities and even so much in this last quarter we announced an expansion in the U.S.

of this partnership we have with Bacardy and Remi and working with some of our U.S.

distributors, which I think can be a nice edition to the U.S.

I think it's not just the structural changes that we made a couple of years ago that defines what we're trying to do in the U.S.

Outside of the U.S., it's a really different story.

Our portfolio is quite a bit smaller.

We tend to focus on three to six brands whereas in the U.S.

you have upwards of 25 and so it's a different exercise.

We have done a lot of work on this route to market and our approach to distribution and we'll continue to do it both strategically and tactically and I think we're in, as I said in my comments, I think we're in a settled state right now as it relates to that and it is a great time for us to make what we have invested out there and work real hard for it.

Thank you.

Sure.

Your next question comes from Ann [Gurkin] with Davenport & Co.

Good morning.

Hi, Ann.

I want to ask you about the change in your inventory statement.

Is there an inventory build somewhere?

Can you comment on that?

If you look carefully at the schedule a and you look at it, you can see that if you look at year-to-date, essentially we are -- there is no inventory effect.

What we have been trying to be very clear about and to disclose is when there is an inventory build.

We have had a slight inventory build in the first half, first quarter, there was destocking.

If you look at it, entire full year-to-date, there is no impact from any inventory changes.

But in your statement offset by changes and global trade inventories?

Sounds like a negative to me.

Yes.

There was some destocking in the international in the quarter.

Okay.

And we would have -- at the end of the second quarter that we were slightly ahead on our shipments versus depletion and we kind of keep a balance running for you all as we go through each quarter in the statement and so the adjustments that we announced today on the third quarter brings a full year-to-date and 9 months into that balance.

Okay.

Great.

And I just would be curious as to any comments regarding further industry consolidation, whether among spirit companies globally or beer and spirits.

I would be curious to your current thoughts on that.

There is always a lot written out there.

I mean you can probably tell from our comments how we focus these days on building our business organically and we'll always stay alert to good possibilities for acquisitions that would do well with Brown-Forman.

Are you in a position to take on more acquisitions at this time?

Oh, sure.

I think from a investment and balance sheet standpoint, I mean the things we tend to focus on is how well we can do with the brand, what potential prices you would end up paying and then also for us, too, we're always looking at what we're working on that we have and what sort of, how to make room if you're focusing in a particular market on a couple of brands and how you get the sales and marketing and focus that you need in order to build anything you acquire.

There are a lot of considerations that we look at and we'll remain open to all of them.

Great, thank you.

Your next question comes from Bryan [Spillane] with Banc of America Securities.

Good morning, Paul, Phoebe.

Hey, Brian.

Hello, Brian.

A couple of questions.

First, in terms of the guidance, Phoebe, does the guidance assume for the fourth quarter that there is any benefit from the share repurchase?

It does --

Or put another way, will that be additive to EPS?

It's certainly within the range of guidance that we have provided.

We estimate that the fourth quarter affect of our earnings, on our earnings is about $0.01.

Okay great and it will be, it should be more -- it should contribute more as we look into fiscal '09.

Indeed.

Fiscal '09 mean $0.04, something like that.

Okay.

All right.

That is something we can disclose and talk about F '09.

Okay, and also in terms of raw material costs, was there a change, I guess were you contracted at all, was there some change in the prices you were paying for raw materials in the third quarter and/or what kind of volatility, I guess should we expect there?

I think it's going to be all over the board, Bryan.

Some of our import costs, raw material costs are under contract.

Okay.

If we're under long-term contract or something, those prices are going to stay stable, whether they're unusually high, low or perfectly normal.

Where, and we do have pretty good hedging programs in place for something like corn, for example, and so you're going to -- you're going to have some effect but they're muted in any particular quarter.

Nonetheless, is a clear march upward in terms of grain costs and we've tried to be very clear about what that is going to be.

I think that if you look at those grain costs, we see that they have been probably as much as 7 million year to date and we think for the full fiscal year will be about 0 million.

Wow.

That is just the affect on us.

Again, there are all kinds of input costs, that just happens to be one that there is a national way to track that because you can look up in the Wall Street Journal every day what the grain price is trading for.

And it's very, on a March upwards.

Sure.

Okay.

And while we're talking about it, glass or packaging costs, have those moved up as well?

Again, these depend upon contracts and in the case of glass, we have a contract and so you don't see any short-term effects.

You're going to have more set function changes but you are not necessarily going to have immediate changes in the stock market.

You have some -- those long-term contracts act almost like hedges in the traded commodity.

Sure.

Okay and in the quarter, just any commentary you have on or color can you give on how you performed in the U.K.

Given now that we're, I guess, six months into smoking bans and it seems like the on-premise channel has been somewhat weak for some of your other competitors.

Just any color you have as to how you performed in the U.K.

would be great.

We had actually a pretty nice November, December and softer January within the quarter in the U.K.

and it was, I would say, because we were able to go for Jack Daniel's particularly, get some additional business out of the off-premise and as you mentioned, the on-premise when it's soft in the U.K., it could really get Jack Daniel's and Southern Comfort because we get a large percentage of our business out of the that channel.

Everything we're seeing we're seeing from the brand, health monitors and things like that they remain healthy.

We still had growth, particularly on Jack Daniel's, for the quarter in the U.K., but it was -- it was muted some by a softer January.

Okay.

And finally, Paul, when you think about promotions for, in the U.S.

for Jack Daniel's, I guess it kind of strikes me what might be different today versus previous economic downturns is that the spirits industry is probably merchandised more like other consumer packaged goods that has been the case historically.

So, as you think about that, are you looking for and you're going to shift some of your spending, sort of more push instead of pull, is it more frequency of promotions?

Is it bigger depth of promotion when Jack Daniel's is on deal?

Just how do you think that is going to sort of manifest itself?

We're looking at both of those.

I think, I mean Jack Daniel's has a wonderful, normal basis, it has a wonderful frequency of promotion.

In these environments, you're always looking to get your fair share and more.

On the depth, I think I mentioned this in the last call where Jack Daniel's has such a broad demographic and socioeconomic consumer franchise that we really want to work to get value in the consumer's hands and in the environment where they will appreciate that particular type of value, and so in an environment like this, we tend -- it's a subtle shift and not like some wholesale alteration to your marketing mix.

It's where you take on the margin sometimes 10 or 15% of your spending mix and you try to move it toward things that can simulate, as I said in the moments, a near-term response where as things like advertising and other things like event market and even the on-premise promoting from time to time, they have less of an impact on your near-term consumption and purchasing, whereas the off-premise stuff it is.

It's like the environment of the packaged goods.

You will see, I think, it's not just us, but I think all the companies are out there playing a more competitive gain in that off-premise, but I would also qualify by making sure it's not the kind of activity.

We still consider it to be added to brand building for Jack Daniel's and Southern Comfort and not coming at the expense of any long-term brand equity or even the operating margin.

Sure.

Okay.

Thanks, Paul.

Sure.

You bet.

Your next question comes from Justin (inaudible) with Lord Abbott.

Good morning, guys.

Hello.

A few housekeeping things.

A similar question on the tax rate to the earlier question on the share repurchase for the fourth quarter, just an order of magnitude, what do you expect in there just to the benefit of EPS?

Let me give you some additional facts.

The full-year tax rate is expected to be between 32.5 and 33%.

That contrasts with last fiscal year which is 31.7%.

If you take what we have done year-to-date, which is 34.1%, that implies a 28% tax rate for the fourth quarter.

What you're seeing here is a lot more volatility because of the adoption of Fin 48 and when you have changes in your tax rate that are event-driven, and we happen to have more fourth quarter event-driven kinds of things.

We're trying to provide a lot more detail here and I will let your models figure out what the EPS effect is.

Again, full-year we're expecting between 32.5 and 32% tax rate.

And was that, I don't remember on the notes in front of me.

Was that what you were thinking coming into the year that it would be at that level?

32 1/2 to 33?

Yes, indeed.

That is what we said last quarter.

Okay.

That is helpful.

Secondly, on the gross margin question and you guys answered that, most of it is related to Herradura.

Does foreign exchange factor into that at all, meaning are you guys being hurt by that currently?

I presume most of the cost is in dollars but sales are in foreign currencies, or is there a hedge there?

Foreign currency is definitely included and favorable and so if you think about it, we have got -- we've already talked about the mix of business that has certainly changed.

We think that it's primarily Casa Herradura and favorable foreign exchange and the price increases worth, we use those facts and foreign exchange and how we've done our price increases to offset higher costs from grain and energy.

So we think again for full-year, just to kind of give an idea, it's probably about a point decline for the full-year effects.

About 66 is where we think it's going to be.

We think we'll recover a little bit from where we are year-to-date.

Again, yes the foreign exchange is in there and it is favorable to us and we use that to offset the higher costs.

Got you.

Okay.

And on the grain cost, is there a way for us on the outside to calibrate.

I appreciate the color to the 7 year to date and 10 million, in terms of directional way to monitor that and then a sense that I presume the contemplation of some of the price increases by product, you kind of take that into account as opposed to the average 5% price increase per year what have you, so you have been able to offset that through the gross margin through additional price increase, if you will.

No questions that the cost pressure is a big piece of how we're thinking about it.

Just to answer your question, sorry, Paul.

Yes.

I think if you want to think about the future and cost prices, it's really to look at the cost of corn and what is going to happen there.

You won't have visibility to what the affects and hedges are that we put on and we won't know the effects of those hedges until they actually occur, but it's best commodity business and can be certainly tracked.

As an input, it's a large one but certainly our spending, our other expenditures on brands, building and on people far outweigh our costs certainly for any changes in grain.

Sure.

Something else to add to that is that the, if you go back several years to be safe, three years ago or so, the types of price increases we would have been taking more for sure would be falling into our margin and the bottom line than we're seeing here so a portion of what we're doing is being absorbed by the higher costs.

As a result, a couple of things we're working on, you can imagine not only our company but I imagine every company is looking at their supply chain and cost inputs that they have far greater control over to try to find savings in other places and I said in my opening comments that one area down the road here over the next year or so we see some offset higher grain costs is coming from some lower grape costs.

That is one thing for us that could be a help down the road and we're going to continue to look at all kinds of cost projects that can be helpful and when you in the environment where these grain costs are going up so much.

Okay.

Our production team is very active in what we call blocking and tackling.

Trying to get those costs as low as possible and get the process as efficient as possible given the environment of higher input and higher raw materials cost.

Philosophically on hedging, have you thought more defensively about hedging as costs, say for corn continue to escalate, meaning you're more concerned with locking that in today than you were a couple of years ago or conversely you are saying we think our experts think corn prices are artificially too high right now; therefore, we're not going to lock in as much for fear we're locking in at high prices.

We look each year at some of the things that can fluctuate.

Foreign exchange, grain costs, interest rates and we try to take a point of view, a steady point of view on what is appropriate.

An actively managed program, such as corn and foreign exchange rates, typically what we have done in many cases is to lock in a floor and then allow yourself to be able to benefit from changes in foreign exchange rates to our favor if you have that particular point of view.

Yes.

And that is very typical approach, it's an informed approach.

When it comes to grain, I think it is to, part of it is to make sure you do not only ride the commodity market so that you actually do lock in something, you have some certainty about what your input costs are going to be for the coming year and I think that is -- we're going to continue to look at managing those market fluctuating pieces of our costs all the time.

Okay and my last question, sorry to ask so many.

This is really the big one.

Paul, you made the comment in your prepared remarks that the profit growth this year, kind of 7% year-to-date and historically it's been about 9 and you hope to get back to that next year, whether it's the grain discussion we just had or your point about may be what was 4 1/2% growth is maybe not 3 in the U.S.

and there has been issues some have made about marginal share losses with some of the brands.

How should we think about how you get to that type of number, not to try to nail you down on '09 guidance right now, but the thought that profits in '09 could grow faster than what you seen in '08?

I think it's back to the opening remarks.

It's some combination as you look ahead to the international growth of what we would consider to be hopefully a better performance going forward built off this last quarter here in the United States.

We, as I said, I think that the Casa Herradura piece can be a more important part of our growth story in the year, next couple of years going ahead and intentionally put in so you could all understand this focus we put placing on, one, leveraging the infrastructure we have built over the last several years and trying to make it more productive versus having those costs go up at a rate that would be higher in my view than we would be smart to invest in right now, and then the second piece would be some of these cost projects.

Some combination of that.

We'll be updating you guys in the next quarter on the full year.

We are sort of looking ahead.

I think you have to be looking at that stuff today so that you can get a feel for what the environment might look like going ahead.

Got it.

Okay.

Appreciate that.

(OPERATOR INSTRUCTIONS) Your next question comes from Tim Ramey with D.A.

Davidson & Co.

Thanks for the followup.

Phoebe, are you using mark-to-market accounting for hedges?

Yes.

Were there any mark-to-market gains or losses in this quarter?

Jane [Morrow] is here and is going to answer that question for us.

We do use mark-to-market, Tim, and the amount of the gain, there was some small gain in the quarter.

It was not material.

Thank you.

And then also on the global destocking, is it safe to assume that most of that is Casa Herradura or is there some going on elsewhere in the world?

None, it's Casa Herradura.

Okay.

Yes, it's all main brand.

Great.

Okay and then Paul, on the -- two or three times alluded to economic impact.

Are you mainly seeing that in terms of weak on-premise consumption or would you perceive, it doesn't seem like you're perceiving much tradedown, particularly like the Gentleman Jack anecdotal evidence.

Well, that is -- you have to bring it a perspective of a small base of Gentleman Jack where you're still building everything from initial distribution, certain accounts to the ability to grow it within a more narrow consumer franchise.

When I talk about the trade down effect, and I was looking at some of the numbers that go back, just thinking back two years and when I look at the growth or the changes in the growth rate for many of the major brands in the United States, all of the changes in the growth rates, this is at a consumer takeaway level, look to be down more than the growth rate as the industry as a whole.

What I mean by that is you will see most of the leading brands as they were growing, 8%, they're down more and like 3%.

If that you were growing at 12, they're down 7.

A lot of the ones that were 6 are down in the 1s in 2s.

The industry as a whole might be down say 4 1/2 to 3.

So what that tells me and a lot of the brands I'm talking about are the most leading brands are a lot of the premium and super premium brands.

It tells me there has to be some trading down in order for that math to work, and so I think it is and I think it's attributable to what I talked about last time and what you referenced, which is some of it deals with lower discretionary income and shows up in different ways.

A part of it is people drinking a little more at home than on premise.

Thanks.

Sure.

Your next question is a followup from Lauren [Torres] with HSBC.

Thanks, underlying advertising and SG&A growth seem to slow a bit in the third quarter.

Is this more of a timing issue in the third quarter versus the first half or is there some slowdown there versus how you think thinking about the expenses?

We expected the SG&A to come down in the second half and I talked about that in the prior second quarter call.

On the A&P, I think it's one thing to help with A&P piece.

It was higher going into the first half, but a lot of people expect these growth rates to peak sometimes during what we all call our holiday period and just remember in this international business of ours, a large piece of it still is on premise which is not particularly driven by holiday promoting and so you don't see as much of the incremental investments coming like they used to to our company during the holiday period.

During the U.S., I would call it a more moderate increase in the investment because of the environment we felt we were in.

Lauren, if you just look at our quarterly advertising, if you just were to look, for example, at last year's quarterly, we had one quarter at 4%.

So, again, longer-term trends are appropriate I think to look at here.

And we tried, so you know, we tried on the A&Ps, I've been making comments on the SG&A.

The A&P piece, I think you want to approximate your growth in gross profit.

We're going to need to be competitive both in advertising and promoting above the line but also in some of the areas below the line.

So, as it relates to leverage in the income statement, I see more opportunity to do that in SG&A right now than A&P.

Just one question on Araduri.

You talked about incoming distribution and penetration in the U.S.

Is there any feeling you gave us or just kind of an idea of how that is progressing versus what we talked about maybe just a quarter ago?

Seems like it's been active on that front.

Same story.

We're continuing to build points of distribution.

There is not a lot of new news on it and I would categorize all the work as early days, it really is.

We're pretty pleased with the work we're doing.

Some of it was the natural cleanup that goes on post transaction, but these last few months we're starting to see the brand with a better overall presence, particularly in the United States, and while we are continuing to do some of this other work that is helping us think about positioning and packaging and all the other stuff.

Basically the same story and more points of distribution and I think, as I said, as we get the broader base of distribution and get some of the I call sales and marketing tool kits filled up with our ideas, I think we will see these brands add more to our profit story going forward.

Okay, thank you.

Sure.

Your next question comes from Thomas Russo with Gardner Russo.

Hi, Paul and Phoebe, how are you?

Hey, Tom.

Good, good.

I heard a lot of questions about grain and corn and about rising commodity costs.

I wonder if you have run the numbers yet to find out whether you might not do well by launching a Jack Daniel's branded line of ethanol.

Maybe take Jack Daniel's to the pump that we're going to convert at a higher margin selling ethanol than we do whiskey these days in light of the commodity pressures driving across your industry.

In honesty, the Herradura question just asked reminded me of Phoebe's earlier comment that you're doing at the same time rollout distribution that you are a review of the brand's equity and possibly package and market it.

I wonder to what extent if part of the brand's story is going to be one of scarcity and hard-to-get and premium position.

The rollout before establishing that brand's attribute might end up working against you if you want to have it be more confident and hard-to-get brand at the start, at least.

It's a good question.

I think to qualify what -- in no way do we intend to overdistribute this brand.

Yes.

One of the early stages of the brand's development is catching up the distribution with what appears to be a natural interest, particularly in the U.S.

Yes.

For both el Jimadora and Herradura, so I still see about a year's worth of distribution work to catch up to the brand equity that exists today and you want to do that in a measured way.

If you overdistribute many of these brands, not just the tequila ones, you can hurt yourself long-term.

So, does that help?

Yes.

Yes.

That is the story and then, Paul, another question.

When you talk about absorbing well-spent inventory, the infrastructure route to market investments made abroad historically starting to get some leverage off of that.

How do we make sure that it's not also a reduction in marketing and promotion overseas that drives the improved operating income that might result from what you said ought to take place naturally now that you have grown into some of those structures?

I don't think they will.

That is what I was trying to refer to.

I see us still trying to put the dollar resources behind A&P where the growth is and the example of it would be, I love this example of what is going on in Poland these days where it was initially almost exclusively a Finlandia story then on the back end of it here in the last couple of years we've seen a wonderful development story and Jack Daniel's and starting to see some of the other brands in Brown-Forman's portfolio.

That is a great example of the kind of ways you can use the structure you built up on, often times behind one brand and then extend it over to another.

You still need the A&P portion to go into those markets to help fuel the consumer interest and get the promotional effort behind it.

But you can leverage the initial investments you made in the infrastructure through SG&A.

Thank you very much.

Okay.

Thank you, Tom.

Yes.

Your next question is a followup from Justin [Maher] with Lord Abbott.

This is my last question.

A philosophical thought on on-premise versus off-premise.

There is a lot of gnashing of teeth I guess as it relates to fears of weakness of the on-premise sales.

If you look at a fully-loaded dollar profit of an on-premise sale versus an off-premise, is it meaningfully different?

Intuitatively, I would say yes, but at the same time I would wonder with the selling costs and distribution costs and everything that goes into the on-premise sale, in matter of fact does it end up being not too far different if it's off-premise?

I think it would depend on how you allocate it in all of your investments because they're all intended.

I hate to give you an it depends.

If you were directly promoting within an individual and singular on-promise account, you are going to see the cost per case is relatively higher, of course.

Because you sell more volume metrics out of the retail environment, the off-premise, but if you spread it across the entirety of the universe, it's a difficult thing to pin down and would depend heavily on how you're allocating your media costs and all kinds of things like that.

The one thing I do know, I think the on-premise environment, while it is, you have seen the figures.

There is some of the traffic down.

They are a little bit softer but it is still an incredibly important environment to our business and still particularly in the key target audience for a number of the brands, LDA to 29 continues to be vibrant in the right places.

Part of it is not thinking about some total and fundamental shift away from on-premise to off-premise, as much as it is doing the right sort of targeting to make sure you're in the right accounts even in the right cities at the right time to promote your brand.

I didn't want you all to misinterpret the way we are turning up our efforts to be more competitive in the off-premise, meaning we're not going to be really active in promoting the on-premise as well.

I guess everyone's fully aware of the traffic problems at the -- that the casual diners are seeing, down mid-single digits and even the food companies that supply food service are saying they have seen a meaningful weakening in the business, hence, the fear for spillover into your business and if you guys are somewhat agnostic as to whether you're selling a case to an off-premise channel versus on-premise, doesn't matter that much at the end of the day.

That's what I was asking.

They're both, as you would expect, they incredibly important to us and I think it's got, obviously, a less direct impact to us than the food suppliers but for us, it just goes to show the power of how even an individual consumer who might have an individual drink one day a week when you add all of those up, sometimes they can have a modest impact on the business as a whole and I think some of that not only is going on now, I think it has been going on for a while and we'll stay alert to it and see what the environment shows.

Know when to get back in and you have to be creative.

Doesn't mean the business is not there, you have to be creative about how you go get it.

Got it.

Okay.

Thanks a lot.

Thank you.

Thanks, justin.

At this time, there are no further questions.

Do you have any closing remarks?

We do not, thank you, everyone.

Have a great weekend.

Thank you all.

Thank you.

This concludes today's conference call, you May now disconnect.