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Aug. 28, 2019, 3:32 p.m. EDT

10-Q: BROWN FORMAN CORP

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(EDGAR Online via COMTEX) -- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion and analysis in conjunction with both our unaudited condensed consolidated financial statements and related notes included in Part I, Item 1 of this Quarterly Report and our 2019 Form 10-K. Note that the results of operations for the three months ended July 31, 2019 do not necessarily indicate what our operating results for the full fiscal year will be. In this Item, "we," "us," "our," "Brown-Forman," and the "Company" refer to Brown-Forman Corporation and its consolidated subsidiaries, collectively.

Presentation Basis

"Estimated net change in distributor inventories." This adjustment refers to the estimated net effect of changes in distributor inventories on changes in certain line items of the statements of operations. For each period compared, we use volume information from our distributors to estimate the effect of distributor inventory changes in certain line items of the statements of operations. We believe that this adjustment reduces the effect of varying levels of distributor inventories on changes in certain line items of the statements of operations and allows us to understand better our underlying results and trends.

We use the non-GAAP measures "underlying change" to: (a) understand our performance from period to period on a consistent basis; (b) compare our performance to that of our competitors; (c) calculate components of management incentive compensation; (d) plan and forecast; and (e) communicate our financial performance to the board of directors, stockholders, and investment analysts. We provide reconciliations of the "underlying change" in certain line items of the statements of operations to their nearest GAAP measures in the tables under "Results of Operations - Year-Over-Year Comparisons." We have consistently applied the adjustments within our reconciliations in arriving at each non-GAAP measure.

1Operating expenses include advertising expense, SG&A expense, and other expense (income), net.

Definitions

"Emerging" markets are "emerging and developing economies" as defined by the IMF. Our largest emerging markets are Mexico, Poland, Russia, and Brazil. This aggregation represents our net sales of branded products to these markets.

"Travel Retail" represents our net sales of branded products to global duty-free customers, other travel retail customers, and the U.S. military regardless of customer location.

"Non-branded and bulk" includes our net sales of used barrels, bulk whiskey and wine, and contract bottling regardless of customer location.

Brand Aggregations.

"American whiskey" includes the Jack Daniel's family of brands, premium bourbons (defined below), and Early Times.







                  "Jack Daniel's family of brands" includes Jack Daniel's Tennessee
                  Whiskey (JDTW), Jack Daniel's RTD and RTP products (JD RTD/RTP), Jack
                  Daniel's Tennessee Honey (JDTH), Gentleman Jack, Jack Daniel's
                  Tennessee Fire (JDTF), Jack Daniel's Single Barrel Collection (JDSB),
                  Jack Daniel's Tennessee Rye Whiskey (JDTR), Jack Daniel's Sinatra
                  Select, Jack Daniel's No. 27 Gold Tennessee Whiskey, and Jack Daniel's
                  Bottled-in-Bond.
                  "Jack Daniel's RTD and RTP" products include all RTD line extensions of
                  Jack Daniel's, such as Jack Daniel's & Cola, Jack Daniel's & Diet Cola,
                  Jack & Ginger, Jack Daniel's Country Cocktails, Gentleman Jack & Cola,
                  Jack Daniel's Double Jack, Jack Daniel's American Serve, Jack Daniel's
                  Tennessee Honey RTD, Jack Daniel's Cider (JD Cider), Jack Daniel's
                  Lynchburg Lemonade (JD Lynchburg Lemonade), and the seasonal Jack
                  Daniel's Winter Jack RTP.
                  "Premium bourbons" includes Woodford Reserve, Old Forester, and
                  Coopers' Craft.
        


"Tequila" includes el Jimador, Herradura, New Mix, Pepe Lopez, and Antiguo.

"Vodka" includes Finlandia.

"Wine" includes Korbel Champagne and Sonoma-Cutrer wines.

"Non-branded and bulk" includes our net sales of used barrels, bulk whiskey and wine, and contract bottling regardless of customer location.

Other Metrics.

"Consumer takeaway." When discussing trends in the market, we refer to consumer takeaway, a term commonly used in the beverage alcohol industry. Consumer takeaway refers to the purchase of product by consumers from retail outlets as measured by volume or retail sales value. This information is provided by third parties, such as Nielsen and the National Alcohol Beverage Control Association (NABCA). Our estimates of market share or changes in market share are derived from consumer takeaway data using the retail sales value metric. We believe consumer takeaway is a leading indicator of how consumer demand is trending.

Important Information on Forward-Looking Statements:

Risks associated with being a U.S.-based company with global operations, including commercial, political, and financial risks; local labor policies and conditions; protectionist trade policies, or economic or trade sanctions, including additional retaliatory tariffs on American spirits and the effectiveness of our actions to mitigate the negative impact on our margins, sales, and distributors; compliance with local trade practices and other regulations, including anti-corruption laws; terrorism; and health pandemics

Fluctuations in foreign currency exchange rates, particularly a stronger U.S. dollar

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

Tax rate changes (including excise, sales, VAT, tariffs, duties, corporate, individual income, dividends, or capital gains) or changes in related reserves, changes in tax rules or accounting standards, and the unpredictability and suddenness with which they can occur

The impact of U.S. tax reform legislation, including as a result of future clarifications and guidance interpreting the statute

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

Changes in consumer preferences, consumption, or purchase patterns - particularly away from larger producers in favor of small distilleries or local producers, or away from brown spirits, our premium products, or spirits generally, and our ability to anticipate or react to them; legalization of marijuana use on a more widespread basis; shifts in consumer purchase practices from traditional to e-commerce retailers; bar, restaurant, travel, or other on-premise declines; shifts in demographic or health and wellness trends; or unfavorable consumer reaction to new products, line extensions, package changes, product reformulations, or other product innovation

Decline in the social acceptability of beverage alcohol in significant markets

Production facility, aging warehouse, or supply chain disruption

Imprecision in supply/demand forecasting

Higher costs, lower quality, or unavailability of energy, water, raw materials, product ingredients, labor, or finished goods

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

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

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

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

Inadequate protection of our intellectual property rights

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

Significant legal disputes and proceedings, or government investigations

Failure or breach of key information technology systems

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

Failure to attract or retain key executive or employee talent

Our status as a family "controlled company" under New York Stock Exchange rules, and our dual-class share structure

Overview

Higher cost of sales. In markets where we own inventory, we paid the incremental cost of tariffs, which increased our cost of sales.

The combined effect of these tariff-related costs, whether arising as a reduction of net sales or as an increase in cost of sales, is hereafter referred to as "tariff-related costs."

From a brand perspective, the Jack Daniel's family of brands (excluding JDTW); our premium bourbon brands, fueled by Woodford Reserve; and our tequila brands all positively contributed to underlying net sales. Declines of JDTW, resulting from prior-year tariff-related buy-ins and tariff-related costs, offset this growth.

From a geographic perspective, growth in the United States and emerging markets was offset by declines in developed international markets and Travel Retail. Declines in developed international markets were driven by prior-year tariff-related buy-ins and tariff-related costs. Travel Retail's underlying net sales were down primarily related to timing of customer orders in the same period last year.

We delivered reported operating income of $248 million, a decrease of 6% compared to the same period last year. Excluding (a) the positive effect of foreign exchange and (b) an estimated net change in distributor inventories, underlying operating income declined 8% driven by prior-year tariff-related buy-ins, tariff-related costs, and higher input costs.

We delivered diluted earnings per share of $0.39, a decrease of 6% compared to the same period last year due to the decline in our reported operating income.







        Summary of Operating Performance
                                            Three Months Ended July 31,
        (Dollars in millions)                2018                  2019           Reported Change      Underlying Change1
        Net sales                     $          766         $          766               - %                   - %
        Cost of sales                            243                    268              10 %                  11 %
        Gross profit                             523                    498              (5 %)                 (5 %)
        Advertising                               98                     92              (6 %)                 (4 %)
        SG&A                                     168                    164              (2 %)                 (1 %)
        Operating income                         264                    248              (6 %)                 (8 %)
        Total operating expenses2     $          259         $          250              (3 %)                 (2 %)
        As a percentage of net sales3
        Gross profit                            68.2 %                 64.9 %          (3.3 )pp
        Operating income                        34.5 %                 32.4 %          (2.1 )pp
        Non-operating postretirement
        expense                       $            2         $            1             (32 %)
        Interest expense, net         $           20         $           19              (7 %)
        Effective tax rate                      17.4 %                 18.2 %           0.8  pp
        Diluted earnings per share    $         0.41         $         0.39              (6 %)
        Note: Totals may differ due
        to rounding
        


1See "Non-GAAP Financial Measures" above for details on our use of "underlying change," including how we calculate these measures and why we think this information is useful to readers.







        Results of Operations - Fiscal 2020 Year-to-Date Highlights
        Market Highlights
        The following table provides supplemental information for our largest markets
        for the three months ended July 31, 2019, compared to the same period last year.
        We discuss results for the markets most affecting our performance below the
        table. Unless otherwise indicated, all related commentary is for the three
        months ended July 31, 2019, compared to the same period last year.
        Top 10 Markets1 - Fiscal 2020 Net Sales Growth by Geographic Area
                                                       Percentage change versus prior year period
        Three months ended July 31,
        2019                                                           Net Sales
                                                                             Est. Net Chg in
                                                                               Distributor
        Geographic area2                   Reported       Foreign Exchange     Inventories         Underlying3
        United States                           6 %               - %                (1 %)                4 %
        Developed International                (5 %)              1 %                 1 %                (3 %)
        United Kingdom                        (21 %)              7 %                 - %               (14 %)
        Australia                              (2 %)              3 %                 - %                 1 %
        Germany                                (6 %)             (3 %)                - %                (9 %)
        France                                  7 %              (1 %)                - %                 6 %
        Japan                                  11 %              (3 %)              (12 %)               (3 %)
        Rest of Developed
        International                          (1 %)             (1 %)                5 %                 2 %
        Emerging                                1 %               - %                 2 %                 3 %
        Mexico                                  6 %              (2 %)               (1 %)                3 %
        Poland                                (15 %)              1 %                 - %               (14 %)
        Russia                                 34 %               2 %                27 %                62 %
        Brazil                                 14 %              (2 %)               (5 %)                7 %
        Rest of Emerging                       (3 %)              - %                 3 %                 - %
        Travel Retail                         (15 %)              1 %                 - %               (14 %)
        Non-branded and bulk                  (22 %)              1 %                 - %               (21 %)
        Total                                   - %               - %                 - %                 - %
        Note: Totals may differ due to
        rounding
        


1"Top 10 markets" are ranked based on percentage of total fiscal 2019 net sales. See 2019 Form 10-K "Results of Operations - Fiscal 2019 Market Highlights" and "Note 9. Net Sales."

Developed International. Reported net sales declined 5%, while underlying net sales were down 3% after adjusting for (a) the negative effect of foreign exchange (reflecting the strengthening of the dollar primarily against the British pound) and (b) an estimated net decrease in distributor inventories. The decline in underlying net sales was driven primarily by the United Kingdom and Germany, largely reflecting tough comparisons against prior-year tariff-related buy-ins. Buy-ins in advance of regulatory changes in Korea and growth in France only partially offset these declines. We estimate that prior-year tariff-related buy-ins and tariff-related costs reduced our underlying net sales growth in this geographic area by approximately six percentage points.

In the United Kingdom, the underlying net sales decline was driven by lower volumes and unfavorable channel mix of JDTW, partially due to prior-year tariff-related buy-ins as well as timing associated with order patterns of certain customers in the same period last year.

In Australia, the underlying net sales growth was driven by favorable price/mix of JD RTDs, mostly offset by declines of JDTW due to a buy-in ahead of the August 1, 2018 price increase.

In Germany, the underlying net sales decline was driven by lower volumes of JDTW, partially due to (a) prior-year tariff-related buy-ins and (b) timing associated with order patterns of certain customers in the same period last year. These declines were modestly offset by volume growth of JD RTDs.

In France, the underlying net sales growth was driven by the launch of JD RTDs and higher volumes of JDTH, which was partially offset by volume declines of JDTW due to prior-year tariff-related buy-ins.

In Japan, the underlying net sales decline was driven by unfavorable price/mix of JDTW, partially offset by volumetric gains of Early Times.

Underlying net sales in the Rest of Developed International increased as volume growth of JDTW in Korea, due to buy-ins in advance of regulatory changes, was partially offset by prior-year tariff-related buy-ins in certain other European markets not listed above.

Emerging. Reported net sales increased 1%, while underlying net sales grew 3% after adjusting for an estimated net decrease in distributor inventories, primarily in Russia. Underlying net sales growth was led by Russia and China, partially offset by declines in Poland. We estimate that prior-year tariff-related buy-ins and tariff-related costs reduced our underlying net sales growth in this geographic area by approximately three percentage points.

In Mexico, the underlying net sales growth was led by higher prices and volume growth of Herradura, partially offset by volume declines of JD RTDs and New Mix.

In Poland, the underlying net sales decline was driven by lower volumes of JDTW, partially due to prior-year tariff-related buy-ins, and lower volumes and prices of Finlandia due to the competitive retail environment for vodka.

In Russia, the underlying net sales growth reflected higher volumes of JDTW and Finlandia due in part to easy comparisons to the late fiscal 2017 route-to-consumer change as well as strong consumer demand in the current year.

In Brazil, the underlying net sales growth was fueled by higher volumes of JDTF and JDTW.

Underlying net sales in the Rest of Emerging were flat as growth of JDTW in China and Southeast Asia was offset by declines of JDTW in Turkey and Romania due to prior-year tariff-related buy-ins.

Travel Retail. Reported net sales declined 15%, while underlying net sales were down 14% after adjusting for the negative effect of foreign exchange. . . .

Aug 28, 2019

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