BROWN FORMAN CORP - Quarter Report: 2019 October (Form 10-Q)

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ASU 2016-02: Leases. This update, codified along with various amendments as Accounting Standards Codification Topic 842 (ASC 842), replaces previous lease accounting guidance. Under ASC 842, a lessee should recognize on its balance sheet a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. ASC 842 permits an entity to make an accounting policy election not to recognize lease assets and liabilities for leases with a term of 12 months or less. It also requires additional quantitative and qualitative disclosures about leasing arrangements.

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ASU 2018-02: Reclassification of Certain Effects from Accumulated Other Comprehensive Income (AOCI). This new guidance allows a reclassification from AOCI to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act enacted by the U.S. government in December 2017. We elected to make the reclassification, which increased retained earnings and decreased AOCI as of May 1, 2019, by $43 million.

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•	Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities.

•	Level 2 – Observable inputs other than those included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in inactive markets; or other inputs that are observable or can be derived from or corroborated by observable market data.

•	Level 3 – Unobservable inputs supported by little or no market activity.

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“Acquisitions and divestitures.” This adjustment removes (a) any non-recurring effects related to our acquisitions and divestitures (e.g., transaction costs and integration costs), and (b) the effects of operating activity related to acquired and divested brands for periods not comparable year over year (non-comparable periods). By excluding non-comparable periods, we therefore include the effects of acquired and divested brands only to the extent that results are comparable year over year.

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“Foreign exchange.” We calculate the percentage change in certain line items of the statements of operations in accordance with GAAP and adjust to exclude the cost or benefit of currency fluctuations. Adjusting for foreign exchange allows us to understand our business on a constant-dollar basis, as fluctuations in exchange rates can distort the underlying trend both positively and negatively. (In this report, “dollar” always means the U.S. dollar unless stated otherwise.) To eliminate the effect of foreign exchange fluctuations when comparing across periods, we translate current-year results at prior-year rates and remove transactional and hedging foreign exchange gains and losses from current- and prior-year periods.

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“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.

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•	“Developed International” markets are “advanced economies” as defined by the IMF, excluding the United States. Our largest developed international markets are the United Kingdom, Australia, Germany, France, and Japan. This aggregation represents our net sales of branded products to these markets.

•	“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.

•	“Whiskey” includes all whiskey spirits and whiskey-based flavored liqueurs, ready-to-drink (RTD), and ready-to-pour products (RTP). The brands included in this category are the Jack Daniel’s family of brands, Woodford Reserve, Canadian Mist, GlenDronach, BenRiach, Glenglassaugh, Old Forester, Early Times, Slane Irish Whiskey, and Coopers’ Craft.

•	“American whiskey” includes the Jack Daniel’s family of brands, premium bourbons (defined below), and Early Times.

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“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, Jack Daniel’s Bottled-in-Bond, and Jack Daniel’s Tennessee Apple (JDTA).

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“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.

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“Depletions.” We generally record revenues when we ship our products to our customers. Depletions is a term commonly used in the beverage alcohol industry to describe volume. Depending on the context, depletions means either (a) our shipments directly to retail or wholesale customers for owned distribution markets or (b) shipments from our distributor customers to retailers and wholesalers in other markets. We believe that depletions measure volume in a way that more closely reflects consumer demand than our shipments to distributor customers do. In this document, unless otherwise specified, we refer to depletions when discussing volume.

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“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.

•	Unfavorable global or regional economic conditions and related low consumer confidence, high unemployment, weak credit or capital markets, budget deficits, burdensome government debt, austerity measures, higher interest rates, higher taxes, political instability, higher inflation, deflation, lower returns on pension assets, or lower discount rates for pension obligations

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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

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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

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•	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

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•	Lower net sales. Certain customers paid the incremental costs of tariffs, and we compensated these customers for these incremental costs by reducing our net prices, which lowered our net sales.

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

•	We delivered reported net sales of $1.8 billion, an increase of 5% compared to the same period last year. Excluding an estimated net increase in distributor inventories (primarily driven by the October launch of JDTA in the United States), we grew underlying net sales 3%.

◦	From a brand perspective, our underlying net sales growth was driven by the Jack Daniel’s family of brands (excluding JDTW); our premium bourbon brands, fueled by Woodford Reserve; and our tequila brands. Declines of JDTW were partially timing related and somewhat offset this growth.

◦	From a geographic perspective, the United States led the underlying net sales growth with emerging and developed international markets also contributing. These gains were partially offset by a decline in the underlying net sales in our Travel Retail channel due in part to the timing of customer orders in the same period last year.

•	We delivered reported operating income of $600 million, an increase of 1% compared to the same period last year. Excluding (a) an estimated net change in distributor inventories and (b) the positive effect of foreign exchange, underlying operating income declined 5% driven by tariff-related costs and higher input costs.

•	We delivered diluted earnings per share of $0.97, an increase of 5% compared to the same period last year due to higher reported operating income and a lower effective tax rate.

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United States. Reported net sales increased 10%, while underlying net sales grew 6% after adjusting for an estimated net increase in distributor inventories (primarily driven by the October launch of JDTA). The underlying net sales gains were driven by the growth of (a) the Jack Daniel’s family of brands (launch of JDTA); (b) our premium bourbons, led by Woodford Reserve and Old Forester (continued strong consumer takeaway trends); and (c) tequilas, led by volume gains of Herradura.

•	Developed International. Reported net sales increased 1%, while underlying net sales grew 2% after adjusting for an estimated net decrease in distributor inventories. Underlying net sales growth was led by France, Taiwan, Australia, Spain, and Italy, partially offset by declines in the United Kingdom.

◦	The United Kingdom’s underlying net sales decline was driven by lower volumes in one channel and unfavorable mix of JDTW compared to the same period last year.

◦	Australia’s underlying net sales growth was driven by higher prices and increased volumes of JDTW, partially offset by declines of JD RTDs.

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◦	Germany’s underlying net sales were flat as lower volumes of JDTW, due in part to timing associated with order patterns of certain customers, were offset by the continued volume growth of JD RTDs.

◦	France’s underlying net sales growth was driven by higher volumes of JDTH and the launch of JD RTDs, partially offset by JDTW declines.

◦	Japan’s underlying net sales were flat as volumetric growth was offset by unfavorable price/mix.

◦	Underlying net sales in the Rest of Developed International increased due to (a) volume growth of GlenDronach in Taiwan largely reflecting timing associated with customer buying patterns, (b) higher volumes in Spain and Italy, and (c) volumetric growth of JDTW in Korea.

•	Emerging. Reported net sales increased 4%, while underlying net sales grew 5% after adjusting for an estimated net decrease in distributor inventories. Underlying net sales growth was led by Russia, China, and Mexico.

◦	Mexico’s underlying net sales growth was fueled by higher pricing of Herradura and el Jimador, with Herradura also benefiting from higher volumes. These gains were partially offset by volume declines of New Mix.

◦	Poland’s underlying net sales decline was driven by lower volumes and net prices of Finlandia along with lower JDTW volumes due to timing of customer order patterns. These declines were partially offset by volumetric growth and favorable price/mix in the rest of the Jack Daniel’s family of brands.

◦	Russia’s underlying net sales growth reflected higher volumes of JDTW and Finlandia due in part to easy comparisons to the late fiscal 2018 route-to-consumer change as well as strong consumer demand in the current year.

◦	Brazil’s underlying net sales growth was fueled by higher volumes of JDTW and JDTF.

◦	Underlying net sales in the Rest of Emerging increased as growth of JDTW in China, Turkey, and Southeast Asia was partially offset by declines of the brand in sub-Saharan Africa.

•	Travel Retail. Reported net sales declined 9%, while underlying net sales were down 8% after adjusting for the negative effect of foreign exchange. The underlying net sales decline was driven by lower volumes of the Jack Daniel’s family of brands largely due to the timing of customer orders in the same period last year, partially offset by Woodford Reserve volume growth.

•	Non-branded and bulk. Reported net sales declined 21% and underlying net sales also declined 21% after adjusting for the negative effect of foreign exchange. Declines were driven by lower volumes and prices for used barrels along with a decrease in bulk whiskey and contract bottling sales.

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•	Whiskey brands grew reported net sales 7%, while underlying net sales grew 4% after adjusting for an estimated net increase in distributor inventories (primarily driven by the launch of JDTA in the United States). The underlying net sales gain was driven by the growth of the Jack Daniel’s family of brands and Woodford Reserve.

◦	The Jack Daniel’s family of brands underlying net sales growth was driven by the launch of JDTA in the United States and broad-based growth of JD RTDs and JDTH, partially offset by declines of JDTW.

▪	JDTW underlying net sales declines were due to lower volumes in certain developed international markets and Travel Retail. These declines were partially offset by growth in emerging markets led by Russia and China.

▪	The increase in underlying net sales growth for Jack Daniel’s RTD/RTP was driven by volumetric gains in Germany, the United States, and the United Kingdom along with the fiscal 2020 RTD launch in France. These gains were partially offset by lower volumes in Australia.

▪	JDTH increased underlying net sales with broad-based volume growth led by France, the United States, and Poland, partially offset by lower volumes in Travel Retail.

▪	Gentleman Jack increased underlying net sales with broad-based international growth led by the United Kingdom and Poland, partially offset by declines in the United States that were largely related to timing.

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▪	The growth in underlying net sales of JDTF was led by increased volumes in Brazil and Poland, partially offset by lower volumes in Travel Retail.

▪	The underlying net sales growth of Other Jack Daniel’s whiskey brands was fueled by the launch of JDTA in the United States.

◦	Woodford Reserve continued to lead the growth of our premium bourbons as the underlying net sales gains were fueled by the United States where volumetric growth was supported by continued strong consumer takeaway trends.

•	Tequila brands grew reported net sales 10%, while underlying net sales grew 11% after adjusting for an estimated net decrease in distributor inventories and the negative effect of foreign exchange.

◦	el Jimador grew underlying net sales reflecting (a) volumetric growth in the United States as consumer takeaway trends remain strong, (b) higher pricing in Mexico, and (c) volume growth and higher pricing in a number of other international markets.

◦	Herradura grew underlying net sales driven by higher volumes and prices in the United States and Mexico.

•	Reported net sales for Finlandia declined 8%, while underlying net sales decreased 7% after adjusting for an estimated net decrease in distributor inventories. The decrease in underlying net sales was driven by lower volumes and net prices in Poland, which was somewhat offset by volume growth in Russia.

•	Reported net sales of our wine brands declined 5%, while underlying net sales increased 2% after adjusting for an estimated net decrease in distributor inventories. The increase in underlying net sales was driven by volume growth of Sonoma-Cutrer and Korbel Champagne in the United States.

•	Rest of portfolio reported net sales increased 15%, while underlying net sales grew 1% after adjusting for (a) the positive effect of foreign exchange, (b) the effect of our acquisition of The 86 Company (Fords Gin), and (c) an estimated net increase in distributor inventories. The increase in underlying net sales was driven by volume growth in the United States.

•	Non-branded and bulk. Reported net sales declined 21% and underlying net sales also declined 21% after adjusting for the negative effect of foreign exchange. Declines were driven by lower volumes and prices for used barrels along with a decrease in bulk whiskey and contract bottling sales.

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•	the launch of JDTA in the United States;

•	higher volumes of Woodford Reserve in the United States and Travel Retail and volumetric growth and favorable price/mix of Old Forester in the United States;

•	broad-based international growth of JDTW led by Australia, Turkey, the United Kingdom, and China;

•	broad-based volume growth of JDTH led by the United States, France, and the United Kingdom;

•	growth of our tequila brands led by (a) volumetric growth and higher pricing of Herradura in the United States and Mexico, (b) higher volumes of el Jimador in the United States, and (c) higher pricing of el Jimador in Mexico;

•	higher volumes of JD RTDs in Germany and the United States along with favorable price/mix and increased volumes in the United Kingdom; and

•	higher volumes of GlenDronach in Taiwan.

•	JDTW declines due to lower net pricing in the United States and volume declines in sub-Saharan Africa;

•	lower volumes and prices for used barrels sales along with decreased bulk whiskey sales;

•	unfavorable price/mix and lower volumes of Finlandia in Poland and Travel Retail;

•	volume declines and unfavorable price/mix of Gentleman Jack in the United States;

•	volume declines of JD RTDs in Australia; and

•	lower volumes of New Mix in Mexico.

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•	Reported advertising expense increased 10% for the three months ended October 31, 2019, while underlying advertising expenses increased 11% after adjusting for the positive effect of foreign exchange. Underlying advertising expense was higher reflecting the investment to support the launch of JDTA as well as increased spending on JDTH, Woodford Reserve, and Gentleman Jack.

•	Reported SG&A expense declined 1% for the three months ended October 31, 2019, while underlying SG&A also dropped 1% after adjusting for the positive effect of foreign exchange and the effect of our acquisition of Fords Gin. The decrease in underlying SG&A was largely timing related.

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Reported advertising expense grew 2% for the six months ended October 31, 2019, while underlying advertising expenses increased 4% after adjusting for the positive effect of foreign exchange. Underlying advertising expense was higher reflecting the investment to support the launch of JDTA as well as increased media spend on JDTW in the United States, partially offset by the timing of spending on the rest of the Jack Daniel’s family of brands.

•	Reported SG&A expense decreased 2% for the six months ended October 31, 2019, while underlying SG&A expenses decreased 1% after adjusting for the positive effect of foreign exchange. The decrease in underlying SG&A was driven by lower compensation-related costs. Looking ahead to the remainder of fiscal 2020, we expect underlying SG&A to increase.

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