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EX-32 - EXHIBIT 32 - BROWN FORMAN CORPbfb-01312016xex32.htm
EX-31.2 - EXHIBIT 31.2 - BROWN FORMAN CORPbfb-01312016xex312.htm
EX-31.1 - EXHIBIT 31.1 - BROWN FORMAN CORPbfb-01312016xex311.htm
United States
Securities and Exchange Commission
Washington, D.C.  20549

FORM 10-Q
(Mark One)
 
  þ
QUARTERLY REPORT  PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended January 31, 2016
OR
  o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________

Commission File No. 002-26821

Brown-Forman Corporation
(Exact name of Registrant as specified in its Charter)

Delaware
61-0143150
(State or other jurisdiction of
(IRS Employer
incorporation or organization)
Identification No.)
 
 
850 Dixie Highway
 
Louisville, Kentucky
40210
(Address of principal executive offices)
(Zip Code)

(502) 585-1100
(Registrant’s telephone number, including area code)
 
N/A
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ   No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ   No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  þ
Accelerated filer o
Non-accelerated filer  o  (Do not check if a smaller reporting company)
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o     No  þ
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  February 29, 2016
Class A Common Stock ($.15 par value, voting)
84,530,209

Class B Common Stock ($.15 par value, nonvoting)
115,518,459








2



PART I - FINANCIAL INFORMATION
 
Item 1.  Financial Statements (Unaudited)


BROWN-FORMAN CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in millions, except per share amounts)

 
Three Months Ended
 
Nine Months Ended
 
January 31,
 
January 31,
 
2015
 
2016
 
2015
 
2016
Net sales
$
1,093

 
$
1,083

 
$
3,149

 
$
3,078

Excise taxes
280

 
274

 
754

 
718

Cost of sales
260

 
254

 
738

 
729

Gross profit
553

 
555

 
1,657

 
1,631

Advertising expenses
112

 
107

 
334

 
317

Selling, general, and administrative expenses
163

 
167

 
512

 
507

Other expense (income), net
6

 
3

 
16

 

Operating income
272

 
278

 
795

 
807

Interest income

 

 
1

 
1

Interest expense
6

 
12

 
21

 
34

Income before income taxes
266

 
266

 
775

 
774

Income taxes
80

 
76

 
232

 
229

Net income
$
186

 
$
190

 
$
543

 
$
545

Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.88

 
$
0.94

 
$
2.56

 
$
2.67

Diluted
$
0.87

 
$
0.94

 
$
2.54

 
$
2.65

Cash dividends per common share:
 
 
 
 
 
 
 
Declared
$
0.630

 
$
0.680

 
$
1.210

 
$
1.310

Paid
$
0.315

 
$
0.340

 
$
0.895

 
$
0.970

See notes to the condensed consolidated financial statements.

3



BROWN-FORMAN CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Dollars in millions)
 
 
Three Months Ended
 
Nine Months Ended
 
January 31,
 
January 31,
 
2015
 
2016
 
2015
 
2016
Net income
$
186

 
$
190

 
$
543

 
$
545

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Currency translation adjustments
(62
)
 
(30
)
 
(108
)
 
(58
)
Cash flow hedge adjustments
34

 
8

 
61

 
20

Postretirement benefits adjustments
4

 
5

 
20

 
15

Net other comprehensive income (loss)
(24
)
 
(17
)
 
(27
)
 
(23
)
Comprehensive income
$
162

 
$
173

 
$
516

 
$
522

See notes to the condensed consolidated financial statements.

4



BROWN-FORMAN CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in millions)
 
April 30,
2015
 
January 31,
2016
Assets
 
 
 
Cash and cash equivalents
$
370

 
$
317

Accounts receivable, less allowance for doubtful accounts of $10 and $9 at April 30 and January 31, respectively
583

 
630

Inventories:
 
 
 
Barreled whiskey
571

 
634

Finished goods
200

 
203

Work in process
121

 
113

Raw materials and supplies
61

 
81

Total inventories
953

 
1,031

Current deferred tax assets
16

 
11

Assets held for sale

 
48

Other current assets
332

 
368

Total current assets
2,254

 
2,405

Property, plant and equipment, net
586

 
621

Goodwill
607

 
589

Other intangible assets
611

 
582

Deferred tax assets
18

 
14

Other assets
112

 
122

Total assets
$
4,188

 
$
4,333

Liabilities
 
 
 
Accounts payable and accrued expenses
$
497

 
$
498

Dividends payable

 
68

Accrued income taxes
12

 
17

Current deferred tax liabilities
9

 
8

Short-term borrowings
190

 
509

Current portion of long-term debt
250

 

Total current liabilities
958

 
1,100

Long-term debt
743

 
1,229

Deferred tax liabilities
107

 
138

Accrued pension and other postretirement benefits
311

 
305

Other liabilities
164

 
144

Total liabilities
2,283

 
2,916

Commitments and contingencies

 

Stockholders’ Equity
 
 
 
Common stock:
 
 
 
Class A, voting (85,000,000 shares authorized; 85,000,000 shares issued)
13

 
13

Class B, nonvoting (400,000,000 shares authorized; 142,313,000 shares issued)
21

 
21

Additional paid-in capital
99

 
114

Retained earnings
3,300

 
3,561

Accumulated other comprehensive income (loss), net of tax
(300
)
 
(323
)
Treasury stock, at cost (18,613,000 and 26,160,000 shares at April 30 and January 31, respectively)
(1,228
)
 
(1,969
)
Total stockholders’ equity
1,905

 
1,417

Total liabilities and stockholders’ equity
$
4,188

 
$
4,333

 See notes to the condensed consolidated financial statements.




BROWN-FORMAN CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in millions)
 
Nine Months Ended
 
January 31,
 
2015
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
543

 
$
545

Adjustments to reconcile net income to net cash provided by operations:
 
 
 
Depreciation and amortization
38

 
40

Stock-based compensation expense
9

 
12

Deferred income taxes
(8
)
 
12

Changes in assets and liabilities
(207
)
 
(161
)
Cash provided by operating activities
375

 
448

Cash flows from investing activities:
 
 
 
Additions to property, plant, and equipment
(92
)
 
(88
)
Acquisition of brand names and trademarks
(3
)
 

Computer software expenditures
(1
)
 
(2
)
Cash used for investing activities
(96
)
 
(90
)
Cash flows from financing activities:
 
 
 
Net change in short-term borrowings
1

 
319

Repayment of long-term debt

 
(250
)
Proceeds from long-term debt

 
490

Debt issuance costs

 
(5
)
Net payments related to exercise of stock-based awards
(7
)
 
(8
)
Excess tax benefits from stock-based awards
18

 
15

Acquisition of treasury stock
(271
)
 
(762
)
Dividends paid
(190
)
 
(199
)
Cash used for financing activities
(449
)
 
(400
)
Effect of exchange rate changes on cash and cash equivalents
(17
)
 
(11
)
Net decrease in cash and cash equivalents
(187
)
 
(53
)
Cash and cash equivalents, beginning of period
437

 
370

Cash and cash equivalents, end of period
$
250

 
$
317

See notes to the condensed consolidated financial statements.

6



BROWN-FORMAN CORPORATION
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

In these notes, “we,” “us,” and “our” refer to Brown-Forman Corporation.

1.    Condensed Consolidated Financial Statements 
We prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the U.S. Securities and Exchange Commission for interim financial information. In accordance with those rules and regulations, we condensed or omitted certain information and disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP). We suggest that you read these condensed financial statements together with the financial statements and footnotes included in our annual report on Form 10-K for the fiscal year ended April 30, 2015 (the 2015 Form 10-K).

In our opinion, the accompanying financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of our financial results for the periods covered by this report.

We prepared the accompanying financial statements on a basis that is substantially consistent with the accounting principles applied in our 2015 Form 10-K, although during the first quarter of fiscal 2016 we adopted new guidance for the presentation of debt issuance costs. Under the new guidance, debt issuance costs are presented as a direct deduction from the debt liability rather than as an asset. In adopting the new guidance, we retrospectively adjusted our balance sheet as of April 30, 2015. As a result, the carrying amounts of other assets (noncurrent) and long-term debt have decreased by $5 million from the amounts previously reported as of that date.

In May 2014, the Financial Accounting Standards Board (FASB) issued new guidance on the recognition of revenue from contracts with customers. As issued, the new guidance would have become effective for us beginning fiscal 2018. However, the FASB has since deferred the effective date until our fiscal 2019, though permitting voluntary adoption as of the original effective date. The FASB has also proposed further amendments to the new guidance. We are currently evaluating the potential impact of the new guidance and the proposed amendments on our financial statements.

In November 2015, the FASB issued new guidance that will require all deferred tax assets and liabilities to be classified as noncurrent on our balance sheet. The new guidance will become effective for us beginning fiscal 2018, although we may voluntarily adopt the new guidance prior to that fiscal year. We have not yet determined the period in which we will adopt the new guidance.

On February 25, 2016, the FASB issued new guidance on accounting for leases. The new guidance will become effective for us beginning fiscal 2020, although voluntary adoption during an earlier period will be permitted. We are currently evaluating the potential impact of the new guidance on our financial statements.

2.    Inventories 
We use the last-in, first-out (LIFO) method to determine the cost of most of our inventories. If the LIFO method had not been used, inventories at current cost would have been $234 million higher than reported as of April 30, 2015, and $248 million higher than reported as of January 31, 2016. Changes in the LIFO valuation reserve for interim periods are based on a proportionate allocation of the estimated change for the entire fiscal year.

3.    Income Taxes
Our consolidated interim effective tax rate is based upon our expected annual operating income, statutory tax rates, and income tax laws in the various jurisdictions in which we operate. Significant or unusual items, including adjustments to accruals for tax uncertainties, are recognized in the quarter in which the related event occurs. The effective tax rate of 29.5% for the nine months ended January 31, 2016, is based on an expected tax rate of 29.6% on ordinary income for the full fiscal year, as adjusted for the recognition of a net tax benefit related to discrete items arising during the period and interest on previously provided tax contingencies. Our expected tax rate includes current fiscal year additions for existing tax contingency items.

7



4.    Earnings Per Share 
We calculate basic earnings per share by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share further includes the dilutive effect of stock-based compensation awards, including stock options, stock-settled stock appreciation rights, restricted stock units, deferred stock units, and shares of restricted stock. We calculate that dilutive effect using the “treasury stock method” (as defined by GAAP).

The following table presents information concerning basic and diluted earnings per share:
 
Three Months Ended
 
Nine Months Ended
 
January 31,
 
January 31,
(Dollars in millions, except per share amounts)
2015
 
2016
 
2015
 
2016
Net income available to common stockholders
$
186

 
$
190

 
$
543

 
$
545

Share data (in thousands):
 
 
 
 
 
 
 
Basic average common shares outstanding
211,126

 
201,182

 
212,189

 
204,242

Dilutive effect of stock-based awards
1,480

 
1,208

 
1,512

 
1,334

Diluted average common shares outstanding
212,606

 
202,390

 
213,701

 
205,576

 
 
 
 
 
 
 
 
Basic earnings per share
$
0.88

 
$
0.94

 
$
2.56

 
$
2.67

Diluted earnings per share
$
0.87

 
$
0.94

 
$
2.54

 
$
2.65


We excluded common stock-based awards for approximately 359,000 shares and 375,000 shares from the calculation of diluted earnings per share for the three months ended January 31, 2015 and 2016, respectively. We excluded common stock-based awards for approximately 363,000 shares and 478,000 shares from the calculation of diluted earnings per share for the nine months ended January 31, 2015 and 2016, respectively. We excluded those awards because they were not dilutive for those periods under the treasury stock method.

5.    Commitments and Contingencies
We operate in a litigious environment, and we are sued in the normal course of business. Sometimes plaintiffs seek substantial damages. Significant judgment is required in predicting the outcome of these suits and claims, many of which take years to adjudicate. We accrue estimated costs for a contingency when we believe that a loss is probable and we can make a reasonable estimate of the loss, and then adjust the accrual as appropriate to reflect changes in facts and circumstances. We do not believe it is reasonably possible that these loss contingencies, individually or in the aggregate, would have a material adverse effect on our financial position, results of operations, or liquidity. No material accrued loss contingencies are recorded as of January 31, 2016.

We have guaranteed the repayment by a third-party importer of its obligation under a bank credit facility that it uses in connection with its importation of our products in Russia. If the importer were to default on that obligation, which we believe is unlikely, our maximum possible exposure under the existing terms of the guaranty would be approximately $19 million (subject to changes in foreign currency exchange rates). Both the fair value and carrying amount of the guaranty are insignificant.

As of January 31, 2016, our actual exposure under the guaranty of the importer's obligation is approximately $8 million. We also have accounts receivable from that importer of approximately $19 million at January 31, 2016, which we expect to collect in full.

Based on the financial support we provide to the importer, we believe it meets the definition of a variable interest entity. However, because we do not control this entity, it is not included in our consolidated financial statements.

8



6.    Debt
Our long-term debt (net of unamortized discount and issuance costs) consisted of:
(Dollars in millions)
April 30,
2015
 
January 31,
2016
2.50% notes, due in fiscal 2016
$
250

 
$

1.00% notes, due in fiscal 2018
248

 
249

2.25% notes, due in fiscal 2023
247

 
247

3.75% notes, due in fiscal 2043
248

 
248

4.50% notes, due in fiscal 2046

 
485

 
993

 
1,229

Less current portion
250

 

 
$
743

 
$
1,229

We issued senior, unsecured notes with an aggregate principal amount of $500 million in June 2015. Interest on the notes will accrue at a rate of 4.50% and be paid semi-annually. As of January 31, 2016, the carrying amount of the notes was $485 million ($500 million principal, less discounts of $10 million and issuance costs of $5 million). The notes are due on July 15, 2045.
We repaid our $250 million of 2.50% notes on their maturity date of January 15, 2016.
As of April 30, 2015, our short-term borrowings of $190 million included $183 million of commercial paper, with an average interest rate of 0.17% and a remaining maturity of 13 days. As of January 31, 2016, our short-term borrowings of $509 million included $506 million of commercial paper, with an average interest rate of 0.61% and a remaining maturity of 37 days.

7.    Pension and Other Postretirement Benefits 
The following table shows the components of the pension and other postretirement benefit cost recognized for our U.S. benefit plans during the periods covered by this report. Information about similar international plans is not presented due to immateriality.
 
Three Months Ended
 
Nine Months Ended
 
January 31,
 
January 31,
(Dollars in millions)
2015
 
2016
 
2015
 
2016
Pension Benefits:
 
 
 
 
 
 
 
Service cost
$
5

 
$
6

 
$
16

 
$
19

Interest cost
8

 
9

 
25

 
26

Expected return on plan assets
(10
)
 
(10
)
 
(31
)
 
(30
)
Amortization of:
 
 
 
 
 
 
 
Prior service cost

 

 
1

 
1

Net actuarial loss
6

 
7

 
17

 
21

Net cost
$
9

 
$
12

 
$
28

 
$
37

 
 
 
 
 
 
 
 
Other Postretirement Benefits:
 
 
 
 
 
 
 
Service cost
$

 
$

 
$
1

 
$
1

Interest cost
1

 
1

 
2

 
2

Amortization of:
 
 
 
 
 
 
 
Prior service cost
(1
)
 
(1
)
 
(1
)
 
(2
)
Net actuarial loss

 

 
1

 
1

Net cost
$

 
$

 
$
3

 
$
2



9



8.    Fair Value Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. We categorize the fair values of assets and liabilities into three levels based upon the assumptions (inputs) used to determine those values. Level 1 provides the most reliable measure of fair value, while Level 3 generally requires significant management judgment. The three levels are:
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 markets that are not active; or other inputs that are observable or can be derived from or corroborated by observable market data.
Level 3 Unobservable inputs that are supported by little or no market activity.
The following table summarizes the assets and liabilities measured or disclosed at fair value on a recurring basis:
(Dollars in millions)
 
Level 1

 
Level 2

 
Level 3

 
Total

April 30, 2015:
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Currency derivatives
 
$

 
$
59

 
$

 
$
59

Liabilities:
 
 
 
 
 
 
 
 
Currency derivatives
 

 
18

 

 
18

Short-term borrowings
 

 
190

 

 
190

Current portion of long-term debt
 

 
253

 

 
253

Long-term debt
 

 
735

 

 
735

January 31, 2016:
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Currency derivatives
 

 
77

 

 
77

Liabilities:
 
 
 
 
 
 
 
 
Currency derivatives
 

 
1

 

 
1

Short-term borrowings
 

 
509

 

 
509

Long-term debt
 

 
1,256

 

 
1,256


We determine the fair values of our currency derivatives (forward contracts) using standard valuation models. The significant inputs used in these models, which are readily available in public markets or can be derived from observable market transactions, include the applicable exchange rates, forward rates, and discount rates. The discount rates are based on the historical U.S. Treasury rates.

The fair value of short-term borrowings approximates their carrying amount. We determine the fair value of long-term debt primarily based on the prices at which similar debt has recently traded in the market and also considering the overall market conditions on the date of valuation.

We measure some assets and liabilities at fair value on a nonrecurring basis. That is, we do not measure them at fair value on an ongoing basis, but we do adjust them to fair value in some circumstances (for example, when we determine that an asset is impaired). No material nonrecurring fair value measurements were required during the periods presented in these financial statements.

10




9.    Fair Value of Financial Instruments 
The fair value of cash, cash equivalents, and short-term borrowings approximate the carrying amounts due to the short maturities of these instruments. We determine the fair value of derivative financial instruments and long-term debt as discussed in Note 8. 

Below is a comparison of the fair values and carrying amounts of these instruments:
 
April 30, 2015
 
January 31, 2016
 
Carrying
 
Fair
 
Carrying
 
Fair
(Dollars in millions)
Amount
 
Value
 
Amount
 
Value
Assets:
 
 
 
 
 
 
 
Cash and cash equivalents
$
370

 
$
370

 
$
317

 
$
317

Currency derivatives
59

 
59

 
77

 
77

Liabilities:
 
 
 
 
 
 
 
Currency derivatives
18

 
18

 
1

 
1

Short-term borrowings
190

 
190

 
509

 
509

Current portion of long-term debt
250

 
253

 

 

Long-term debt
743

 
735

 
1,229

 
1,256


10.    Derivative Financial Instruments 
Our multinational business exposes us to global market risks, including the effect of fluctuations in currency exchange rates, commodity prices, and interest rates. We use derivatives to help manage financial exposures that occur in the normal course of business. We formally document the purpose of each derivative contract, which includes linking the contract to the financial exposure it is designed to mitigate. We do not hold or issue derivatives for trading or speculative purposes.

We use currency derivative contracts to limit our exposure to the currency exchange risk that we cannot mitigate internally by using netting strategies. We designate most of these contracts as cash flow hedges of forecasted transactions (expected to occur within three years). We record all changes in the fair value of cash flow hedges (except any ineffective portion) in accumulated other comprehensive income (AOCI) until the underlying hedged transaction occurs, at which time we reclassify that amount into earnings. We assess the effectiveness of these hedges based on changes in forward exchange rates. The ineffective portion of the changes in fair value of our hedges (recognized immediately in earnings) during the periods presented in this report was not material.

We do not designate some of our currency derivatives as hedges because we use them to at least partially offset the immediate earnings impact of changes in foreign exchange rates on existing assets or liabilities. We immediately recognize the change in fair value of these contracts in earnings.

We had outstanding currency derivatives, related primarily to our euro, British pound, and Australian dollar exposures, with notional amounts totaling $1,212 million at April 30, 2015 and $1,274 million at January 31, 2016.

We use forward purchase contracts with suppliers to protect against corn price volatility. We expect to physically take delivery of the corn underlying each contract and use it for production over a reasonable period of time. Accordingly, we account for these contracts as normal purchases rather than derivative instruments.

During May 2015, we entered into interest rate derivative contracts (U.S. treasury lock agreements) to manage the interest rate risk related to the anticipated issuance of fixed-rate senior, unsecured notes. We designated the contracts as cash flow hedges of the future interest payments associated with the anticipated notes. Upon issuance of the notes in June 2015 (see Note 6), we settled the contracts for a gain of $8 million. The entire gain was recorded to AOCI and will be amortized as a reduction of interest expense over the life of the notes.

11




The following table presents the pre-tax impact that changes in the fair value of our derivative instruments had on AOCI and earnings during the periods covered by this report:
 
 
Three Months Ended
 
 
January 31,
(Dollars in millions)
Classification
2015
 
2016
Currency derivatives designated as cash flow hedges:
 
 

 
 

Net gain (loss) recognized in AOCI
n/a
$
71

 
$
29

Net gain (loss) reclassified from AOCI into income
Net sales
16

 
17

Derivatives not designated as hedging instruments:
 
 

 
 

Currency derivatives – net gain (loss) recognized in income
Net sales
19

 
5

Currency derivatives – net gain (loss) recognized in income
Other income
11

 
(2
)
 
 
 
 
 
 
 
Nine Months Ended
 
 
January 31,
(Dollars in millions)
Classification
2015
 
2016
Currency derivatives designated as cash flow hedges:
 
 

 
 

Net gain (loss) recognized in AOCI
n/a
$
118

 
$
66

Net gain (loss) reclassified from AOCI into income
Net sales
20

 
46

Interest rate derivatives designated as cash flow hedges:
 
 
 
 
Net gain (loss) recognized in AOCI
n/a

 
8

Derivatives not designated as hedging instruments:
 
 

 
 

Currency derivatives – net gain (loss) recognized in income
Net sales
31

 
9

Currency derivatives – net gain (loss) recognized in income
Other income
5

 
2


We expect to reclassify $45 million of deferred net gains recorded in AOCI as of January 31, 2016, to earnings during the next 12 months. This reclassification would offset the anticipated earnings impact of the underlying hedged exposures. The actual amounts that we ultimately reclassify to earnings will depend on the exchange rates in effect when the underlying hedged transactions occur. As of January 31, 2016, the maximum term of our outstanding derivative contracts was 36 months.


12



The following table presents the fair values of our derivative instruments as of April 30, 2015 and January 31, 2016.

(Dollars in millions)


Classification
 
Fair value of derivatives in a gain position
 
Fair value of derivatives in a
loss position
April 30, 2015:
 
 
 
 
 
Designated as cash flow hedges:
 
 
 
 
 
Currency derivatives
Other current assets
 
$
42

 
$
(2
)
Currency derivatives
Other assets
 
20

 
(3
)
Currency derivatives
Accrued expenses
 

 
(6
)
Currency derivatives
Other liabilities
 

 
(6
)
Not designated as hedges:
 
 
 
 
 
Currency derivatives
Other current assets
 
3

 
(1
)
Currency derivatives
Accrued expenses
 
1

 
(7
)
January 31, 2016:
 
 
 
 
 
Designated as cash flow hedges:
 
 
 
 
 
Currency derivatives
Other current assets
 
52

 

Currency derivatives
Other assets
 
24

 
(1
)
Currency derivatives
Accrued expenses
 

 
(1
)
Not designated as hedges:
 
 
 
 
 
Currency derivatives
Other current assets
 
5

 
(3
)

The fair values reflected in the above table are presented on a gross basis. However, as discussed further below, the fair values of those instruments that are subject to net settlement agreements are presented in our balance sheets on a net basis.

In our statement of cash flows, we classify cash flows related to cash flow hedges in the same category as the cash flows from the hedged items.

Credit risk. We are exposed to credit-related losses if the counterparties to our derivative contracts default. This credit risk is limited to the fair value of the contracts. To manage this risk, we contract only with major financial institutions that have earned investment-grade credit ratings and with whom we have standard International Swaps and Derivatives Association (ISDA) agreements that allow for net settlement of the derivative contracts. Also, we have established counterparty credit guidelines that are regularly monitored and that provide for reports to senior management according to prescribed guidelines, and we monetize contracts when we believe it is warranted. Because of these safeguards, we believe we have no derivative positions that warrant credit valuation adjustments.

Some of our derivative instruments require us to maintain a specific level of creditworthiness, which we have maintained. If our creditworthiness were to fall below that level, then the counterparties to our derivative instruments could request immediate payment or collateralization for derivative instruments in net liability positions. The aggregate fair value of all derivatives with creditworthiness requirements that were in a net liability position was $18 million at April 30, 2015 and $0 at January 31, 2016.

Offsetting. As noted above, our derivative contracts are governed by ISDA agreements that allow for net settlement of derivative contracts with the same counterparty. It is our policy to present the fair values of current derivatives (i.e., those with a remaining term of 12 months or less) with the same counterparty on a net basis in the balance sheet. Similarly, we present the fair values of noncurrent derivatives with the same counterparty on a net basis. Current derivatives are not netted with noncurrent derivatives in the balance sheet. The following table summarizes the gross and net amounts of our derivative contracts.

13



(Dollars in millions)
Gross Amounts of Recognized Assets (Liabilities)
 
Gross Amounts Offset in Balance Sheet
 
Net Amounts Presented in Balance Sheet
 
Gross Amounts Not Offset in Balance Sheet
 
Net Amounts
April 30, 2015:
 
 
 
 
 
 
 
 
 
Derivative assets
$
65

 
$
(6
)
 
$
59

 
$

 
$
59

Derivative liabilities
(24
)
 
6

 
(18
)
 

 
(18
)
January 31, 2016:
 
 
 
 
 
 
 
 
 
Derivative assets
81

 
(4
)
 
77

 
(1
)
 
76

Derivative liabilities
(5
)
 
4

 
(1
)
 
1

 


No cash collateral was received or pledged related to our derivative contracts as of April 30, 2015 and January 31, 2016.

11.    Accumulated Other Comprehensive Income
The following table summarizes the changes in each component of accumulated other comprehensive income (AOCI), net of tax, during the three months ended January 31, 2015 and 2016:
 
Currency Translation Adjustments
 
Cash Flow Hedge Adjustments
 
Postretirement Benefits Adjustments
 
Total AOCI
 
 
 
 
 
 
 
 
Balance at October 31, 2014
$
(40
)
 
$
23

 
$
(174
)
 
$
(191
)
Net other comprehensive income (loss)
(62
)
 
34

 
4

 
(24
)
Balance at January 31, 2015
$
(102
)
 
$
57

 
$
(170
)
 
$
(215
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at October 31, 2015
$
(136
)
 
$
40

 
$
(210
)
 
$
(306
)
Net other comprehensive income (loss)
(30
)
 
8

 
5

 
(17
)
Balance at January 31, 2016
$
(166
)
 
$
48

 
$
(205
)
 
$
(323
)

14



The following table presents the components of net other comprehensive income (loss) during the three months ended January 31, 2015 and 2016:
 
Pre-Tax
 
Tax
 
Net
Three Months Ended January 31, 2015
 
 
 
 
 
Currency translation adjustments
$
(65
)
 
$
3

 
$
(62
)
Cash flow hedge adjustments:
 
 
 
 
 
Net gain (loss) on hedging instruments
71

 
(28
)
 
43

Reclassification to earnings1
(16
)
 
7

 
(9
)
Postretirement benefits adjustments:
 
 
 
 
 
Net actuarial gain (loss) and prior service cost

 

 

Reclassification to earnings2
6

 
(2
)
 
4

Net other comprehensive income (loss)
$
(4
)
 
$
(20
)
 
$
(24
)
 
 
 
 
 
 
Three Months Ended January 31, 2016
 
 
 
 
 
Currency translation adjustments
$
(30
)
 
$

 
$
(30
)
Cash flow hedge adjustments:
 
 
 
 
 
Net gain (loss) on hedging instruments
29

 
(11
)
 
18

Reclassification to earnings1
(17
)
 
7

 
(10
)
Postretirement benefits adjustments:
 
 
 
 
 
Net actuarial gain (loss) and prior service cost

 

 

Reclassification to earnings2
7

 
(2
)
 
5

Net other comprehensive income (loss)
$
(11
)
 
$
(6
)
 
$
(17
)
1Pre-tax amount is classified as net sales in the accompanying consolidated statements of operations.
2Pre-tax amount is a component of pension and other postretirement benefit expense (as shown in Note 7, except for amounts related to non-U.S. benefit plans about which information is not presented in Note 7 due to immateriality).

The following table summarizes the changes in each component of AOCI, net of tax, during the nine months ended January 31, 2015 and 2016:
 
Currency Translation Adjustments
 
Cash Flow Hedge Adjustments
 
Postretirement Benefits Adjustments
 
Total AOCI
 
 
 
 
 
 
 
 
Balance at April 30, 2014
$
6

 
$
(4
)
 
$
(190
)
 
$
(188
)
Net other comprehensive income (loss)
(108
)
 
61

 
20

 
(27
)
Balance at January 31, 2015
$
(102
)
 
$
57

 
$
(170
)
 
$
(215
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at April 30, 2015
$
(108
)
 
$
28

 
$
(220
)
 
$
(300
)
Net other comprehensive income (loss)
(58
)
 
20

 
15

 
(23
)
Balance at January 31, 2016
$
(166
)
 
$
48

 
$
(205
)
 
$
(323
)

15



The following table presents the components of net other comprehensive income (loss) during the nine months ended January 31, 2015 and 2016:
 
Pre-Tax
 
Tax
 
Net
Nine Months Ended January 31, 2015
 
 
 
 
 
Currency translation adjustments
$
(113
)
 
$
5

 
$
(108
)
Cash flow hedge adjustments:
 
 
 
 
 
Net gain (loss) on hedging instruments
118

 
(45
)
 
73

Reclassification to earnings1
(20
)
 
8

 
(12
)
Postretirement benefits adjustments:
 
 
 
 
 
Net actuarial gain (loss) and prior service cost
14

 
(5
)
 
9

Reclassification to earnings2
18

 
(7
)
 
11

Net other comprehensive income (loss)
$
17

 
$
(44
)
 
$
(27
)
 
 
 
 
 
 
Nine Months Ended January 31, 2016
 
 
 
 
 
Currency translation adjustments
$
(57
)
 
$
(1
)
 
$
(58
)
Cash flow hedge adjustments:
 
 
 
 
 
Net gain (loss) on hedging instruments
74

 
(26
)
 
48

Reclassification to earnings1
(46
)
 
18

 
(28
)
Postretirement benefits adjustments:
 
 
 
 
 
Net actuarial gain (loss) and prior service cost

 

 

Reclassification to earnings2
23

 
(8
)
 
15

Net other comprehensive income (loss)
$
(6
)
 
$
(17
)
 
$
(23
)
1Pre-tax amount is classified as net sales in the accompanying consolidated statements of operations.
2Pre-tax amount is a component of pension and other postretirement benefit expense (as shown in Note 7, except for amounts related to non-U.S. benefit plans about which information is not presented in Note 7 due to immateriality).


12.    Dividends Payable
On January 28, 2016, our Board of Directors declared a regular quarterly cash dividend of $0.34 per share on our Class A and
Class B common stock. Stockholders of record on March 9, 2016, will receive the cash dividend on April 1, 2016.

13.    Assets Held for Sale / Subsequent Event
During the quarter ended January 31, 2016, we reached an agreement to sell our Southern Comfort and Tuaca brands to Sazerac Company, Inc. The total book value of the related business assets as of January 31, 2016, was $48 million, and consisted of the following:
 
 
January 31, 2016
(Dollars in millions)
 
 
Inventories
 
$
10

Goodwill
 
16

Other intangible assets
 
22

 
 
$
48


The total book value is presented as assets held for sale in the accompanying condensed consolidated balance sheet as of January 31, 2016.

On March 1, 2016, we completed the sale to Sazerac Company, Inc. for approximately $542 million in cash (subject to a post-closing inventory adjustment). As a result of the sale, we expect to record a one-time operating income gain of approximately $483 million during the quarter ending April 30, 2016.


16



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 2015 Form 10-K. Note that the results of operations for the nine months ended January 31, 2016 do not necessarily indicate what our operating results for the full fiscal year will be. In this Item, “we,” “us,” and “our” refer to Brown-Forman Corporation.

Volume and Depletions
When discussing volume, unless otherwise specified, we refer to “depletions,” a term commonly used in the beverage alcohol industry. We define “depletions” as either (a) our shipments directly to retailers or wholesalers, or (b) shipments from our distributor customers to retailers and wholesalers. Because we generally record revenues when we ship our products to our customers, our reported sales for a period do not necessarily reflect actual consumer purchases during that period. We believe that our depletions measure volume in a way that more closely reflects consumer demand than our shipments to distributor customers do.
Volume is discussed on a nine-liter equivalent unit basis (nine-liter cases) unless otherwise specified. At times, we use a “drinks-equivalent” measure for volume when comparing single-serve ready-to-drink (RTD) or ready-to-pour (RTP) brands to a parent spirits brand. “Drinks-equivalent” depletions are RTD and RTP nine-liter cases converted to nine-liter cases of a parent brand on the basis of the number of drinks in one nine-liter case of the parent brand. To convert RTD volumes from a nine-liter case basis to a drinks-equivalent nine-liter case basis, RTD nine-liter case volumes are divided by 10, while RTP nine-liter case volumes are divided by 5.
Non-GAAP Financial Measures
We use certain financial measures in this report that are not measures of financial performance under GAAP. These non-GAAP measures, which are defined below, should be viewed as supplements to (not substitutes for) our results of operations and other measures reported under GAAP. The non-GAAP measures we use in this report may not be defined and calculated by other companies in the same manner.
We present changes in certain income statement line items that are adjusted to an “underlying” basis, which we believe assists in understanding both our performance from period to period on a consistent basis, and the trends of our business. Non-GAAP “underlying” measures include changes in (a) underlying net sales, (b) underlying cost of sales, (c) underlying excise taxes, (d) underlying gross profit, (e) underlying advertising expenses, (f) underlying selling, general, and administrative expenses (SG&A), and (g) underlying operating income. To calculate each of these measures, we adjust for (a) foreign currency exchange; (b) if applicable, estimated net changes in distributor inventories; and (c) with respect to underlying SG&A and underlying operating income, the transaction-related costs from the sale of Southern Comfort and Tuaca. We explain these adjustments below:
“Foreign exchange.” We calculate the percentage change in our income statement line items 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-period results at prior-period rates.
“Estimated net change in distributor inventories.” This measure refers to the estimated net effect of changes in distributor inventories on changes in our measures. For each period being compared, we estimate the effect of distributor inventory changes on our results using depletion information provided to us by our distributors. We believe that this adjustment reduces the effect of varying levels of distributor inventories on changes in our measures and allows us to understand better our underlying results and trends.
“Sale of Southern Comfort and Tuaca.” On January 14, 2016, we announced that we had reached an agreement to sell our Southern Comfort and Tuaca brands and related assets to Sazerac Company, Inc. The sale closed March 1, 2016 for approximately $542 million in cash (subject to a post-closing inventory adjustment), which we expect will result in an estimated one-time operating income gain of approximately $483 million in the fourth quarter of fiscal 2016. This adjustment removes transaction-related costs for this sale from our results. We believe that this adjustment allows us to understand better our underlying results after the sale of these brands.
Management uses “underlying” measures of performance to assist it in comparing and measuring our performance from period to period on a consistent basis, and in comparing our performance to that of our competitors. We also use underlying measures as metrics in connection with management incentive compensation calculations. Management also uses underlying measures in its planning and forecasting and in communications with the board of directors, stockholders, analysts, and investors

17



concerning our financial performance. We have provided reconciliations of the non-GAAP measures adjusted to an “underlying” basis to their nearest GAAP measures in the tables below under “Results of Operations – Year-Over-Year Period Comparisons” and have consistently applied the adjustments within our reconciliations in arriving at each non-GAAP measure.

Important Information on Forward-Looking Statements:
This report contains statements, estimates, and projections that are “forward-looking statements” as defined under U.S. federal securities laws. Words such as “aim,” “anticipate,” “aspire,” “believe,” “continue,” “could,” “envision,” “estimate,” “expect,” “expectation,” “intend,” “may,” “plan,” “potential,” “project,” “pursue,” “see,” “seek,” “should,” “will,” and similar words identify forward-looking statements, which speak only as of the date we make them. Except as required by law, we do not intend to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. By their nature, forward-looking statements involve risks, uncertainties, and other factors (many beyond our control) that could cause our actual results to differ materially from our historical experience or from our current expectations or projections. These risks and uncertainties include those described in Part I, Item 1A. Risk Factors of our 2015 Form 10-K and those described from time to time in our future reports filed with the Securities and Exchange Commission, including:
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
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; 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, capital gains) or changes in related reserves, changes in tax rules (for example, LIFO, foreign income deferral, U.S. manufacturing, and other deductions) or accounting standards, and the unpredictability and suddenness with which they can occur
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 smaller distilleries or local producers, or away from brown spirits, our premium products, or spirits generally, and our ability to anticipate or react to them; bar, restaurant, travel, or other on-premise declines; shifts in demographic 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 products 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 implementation-related or fixed costs
Inventory fluctuations in our products by distributors, wholesalers, or retailers
Competitors’ 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, or 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 product quality issues
Significant legal disputes and proceedings; government investigations (particularly of industry or company business, trade or marketing practices)
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

18



Summary of Operating Performance
 
Three months ended January 31,
 
Nine months ended January 31,
 
 
2015
 
2016
 
Reported Change
 
Underlying Change1
 
2015
 
2016
 
Reported Change
 
Underlying Change1
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net sales
$
1,093

 
$
1,083

 
(1
%)
 
4
%
 
$
3,149

 
$
3,078

 
(2
%)
 
5
%
 
Excise taxes
280

 
274

 
(2
%)
 
8
%
 
754

 
718

 
(5
%)
 
7
%
 
Cost of sales
260

 
254

 
(2
%)
 
%
 
738

 
729

 
(1
%)
 
4
%
 
Gross profit
553

 
555

 
%
 
4
%
 
1,657

 
1,631

 
(2
%)
 
5
%
 
Advertising
112

 
107

 
(4
%)
 
1
%
 
334

 
317

 
(5
%)
 
1
%
 
SG&A
163

 
167

 
2
%
 
5
%
 
512

 
507

 
(1
%)
 
4
%
 
Operating income
$
272

 
$
278

 
2
%
 
5
%
 
$
795

 
$
807

 
2
%
 
7
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross margin
50.6
%
 
51.3
%
 
0.7pp

 
 
 
52.6
%
 
53.0
%
 
0.4pp

 
 
 
Operating margin
24.9
%
 
25.7
%
 
0.8pp

 
 
 
25.2
%
 
26.2
%
 
1.0pp

 
 
 
Interest expense, net
$
6

 
$
12

 
93
 %
 
 
 
$
20

 
$
33

 
70
 %
 
 
 
Effective tax rate
30.0
%
 
28.8
%
 
(1.2)pp

 
 
 
29.9
%
 
29.5
%
 
(0.4)pp

 
 
 
Diluted earnings per share
$
0.87

 
$
0.94

 
7
 %
 
 
 
$
2.54

 
$
2.65

 
4
 %
 
 
 
 
 
1See “Non-GAAP Financial Measures” above for details on our use of “underlying changes” for net sales, excise taxes, cost of sales, gross profit, advertising expenses, SG&A expenses, and operating income, including how these measures are calculated and the reasons why we think this information is useful to readers.
Overview
For the three months ended January 31, 2016, compared to same period last year, we grew underlying net sales 4% (reported declined 1%), increased underlying operating income 5% (reported increased 2%), and delivered a 7% increase in diluted earnings per share.
For the nine months ended January 31, 2016, compared to the same period last year, we grew underlying net sales 5% (reported declined 2%), increased underlying operating income 7% (reported increased 2%), and delivered a 4% increase in diluted earnings per share. These operating results were driven by the continued global net sales growth of our American whiskey portfolio, led by the Jack Daniel's family of brands, including significant contributions from Jack Daniel’s Tennessee Fire (JDTF) and Woodford Reserve. Foreign exchange negatively affected our reported operating income as the dollar strengthened against most currencies.
Our financial condition remained strong. We received proceeds of $490 million from the issuance of long-term debt in June 2015, while continuing to invest in our capacity expansion projects and returning $961 million to shareholders during the nine months ended January 31, 2016, through dividends and share repurchases. On January 14, 2016, we announced that we had reached an agreement to sell our Southern Comfort and Tuaca brands and related assets to Sazerac Company, Inc. The sale closed March 1, 2016 for approximately $542 million in cash (subject to a post-closing inventory adjustment), which we expect will result in an estimated one-time operating income gain of approximately $483 million in the fourth quarter of fiscal 2016. (See Note 13 to the accompanying financial statements.)


19



RESULTS OF OPERATIONS – FISCAL 2016 YEAR-TO-DATE HIGHLIGHTS
Market Highlights
The following table provides supplemental information for our largest markets for the nine months ended January 31, 2016, 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 nine months ended January 31, 2016, compared to the same period last year.
Top 10 Markets1 - Fiscal 2016 Net Sales Growth by Geographic Area
 
Percentage change versus prior year period
Nine months ended January 31, 2016

Net Sales2
Geographic area
Reported
Foreign Exchange
Net Chg in Est. Distributor Inventories
 
Underlying *
United States
5
%
%
2
%
 
7
%
Europe
(4
%)
11
%
(2
%)
 
5
%
United Kingdom
7
%
3
%
%
 
9
%
Germany
(9
%)
10
%
%
 
1
%
Poland
(14
%)
15
%
%
 
%
France
3
%
11
%
%
 
14
%
Turkey
(6
%)
24
%
%
 
17
%
Russia
(20
%)
40
%
(30
%)
 
(10
%)
Rest of Europe
(8
%)
12
%
(2
%)
 
2
%
Australia
(13
%)
17
%
%
 
4
%
Other
(11
%)
13
%
1
%
 
3
%
Mexico
(11
%)
18
%
%
 
7
%
Canada
(2
%)
13
%
(5
%)
 
7
%
Rest of Other
(12
%)
10
%
2
%
 
%
Total
(2
%)
8
%
%
 
5
%
* Totals may differ due to rounding
 
 
 
 
 
 
 
1Top 10 markets are ranked based on percentage of total Fiscal 2015 Net Sales. See 2015 Form 10-K “Results of Operations - Fiscal 2015 Market Highlights” and “Note 13. Supplemental Information.”
2See “Non-GAAP Financial Measures” above for details on our use of “underlying change” in net sales, including how this measure is calculated and the reasons why we think this information is useful to readers.

United States. Underlying net sales growth was driven primarily by the Jack Daniel’s family of brands, led by higher volumes for JDTF and Jack Daniel’s Tennessee Whiskey (JDTW), the former of which was introduced nationally in late fiscal 2015. Continued double-digit volume growth of our American whiskey portfolio, led by Woodford Reserve, Gentleman Jack, and Old Forester, also contributed to the underlying net sales growth, while lower volumes for Southern Comfort and Canadian Mist partially offset these gains.
Europe. Underlying net sales grew in nearly all markets, most notably in the United Kingdom, France, and Turkey. These gains were partially offset by declines in Russia, which remains challenged by the economic environment resulting in lower consumer demand. Reported net sales were hurt across Europe by foreign exchange as the dollar strengthened against most currencies compared with the prior-year period.
In the United Kingdom, underlying net sales growth was driven by higher volumes of the Jack Daniel’s family of brands, primarily in the off-premises channel, driven by strong consumer demand.
In France, underlying net sales growth was driven by higher volumes of JDTW and Jack Daniel’s Tennessee Honey (JDTH), as the Jack Daniel’s family of brands continued to gain market share in the world’s third largest whiskey market.
In Turkey, underlying net sales growth was driven by higher volumes and beneficial customer mix for JDTW.

20



In Germany, underlying net sales growth was led by volume gains for JDTH, Southern Comfort, and Woodford Reserve, and improved price/mix for JDTW, partially offset by volumetric declines in JD RTDs. Year-to-date results slowed in the third quarter, as Germany cycled against strong results in the prior-year third quarter due to timing of customer purchases ahead of price increases.
In Poland, underlying net sales were flat as higher volumes of JDTW, and to a lesser extent, JDTH and Finlandia were offset by the absence in volume for a lower-margin brand that we have discontinued in fiscal 2016.
In Russia, underlying net sales declines were driven primarily by lower volumes for Finlandia. We believe that these declines in the market are driven by challenging economic conditions and consumer trends toward local products.
Australia. Underlying net sales growth was driven by volumetric gains of JD RTDs and JDTW. Continued volume declines for Southern Comfort and a decline in agency brand volumes partially offset the gains. After a slow first quarter, underlying net sales have grown in the subsequent two quarters.
Other. Underlying net sales growth was led by Mexico, Brazil, and Africa, which all increased due to volumetric gains. Decreased volume in travel retail and southeast Asia partially offset the overall growth in this grouping.
Brand Highlights
The following table highlights the worldwide results of our largest brands for the nine months ended January 31, 2016, compared to the same period last year. We discuss results of the brands most affecting our performance below the table. Unless otherwise indicated, all related commentary is for the nine months ended January 31, 2016, compared to the same period last year.
Major Brands Worldwide Results
 
Percentage change versus prior year
Nine months ended January 31, 2016
Volumes
 
Net Sales1
Brand family / brand
9L Depletions
 
Reported
Foreign Exchange
Net Chg in Est. Distributor Inventories
 
Underlying *
Jack Daniel’s Family
5
%
 
(1
%)
7
%
%
 
7
%
Jack Daniel’s Tennessee Whiskey
2
%
 
(3
%)
7
%
%
 
4
%
Jack Daniel’s Tennessee Honey
10
%
 
2
%
6
%
2
%
 
11
%
Other Jack Daniel’s whiskey brands2
45
%
 
25
%
6
%
6
%
 
38
%
Jack Daniel’s RTDs/RTP3
4
%
 
(9
%)
12
%
%
 
4
%
New Mix RTDs
17
%
 
4
%
21
%
%
 
25
%
Finlandia
(13
%)
 
(17
%)
14
%
(2
%)
 
(5
%)
Southern Comfort
(7
%)
 
(10
%)
3
%
1
%
 
(6
%)
Canadian Mist
(11
%)
 
(11
%)
%
1
%
 
(10
%)
El Jimador
(5
%)
 
(7
%)
10
%
2
%
 
4
%
Woodford Reserve
27
%
 
30
%
2
%
(3
%)
 
29
%
Herradura
6
%
 
%
12
%
%
 
12
%
* Totals may differ due to rounding
 
 
 
 
 
 
 
 
 
1See “Non-GAAP Financial Measures” above for details on our use of “underlying change” in net sales, including how this measure is calculated and the reasons why we think this information is useful to readers.
2In addition to the brands separately listed here, Other Jack Daniel’s whiskey brands includes Gentleman Jack, Jack Daniel’s Single Barrel, Jack Daniel’s Single Barrel Barrel Proof Tennessee Whiskey, Jack Daniel’s Sinatra™ Select, Jack Daniel’s No. 27 Gold Tennessee Whiskey, Jack Daniel’s 1907 Tennessee Whiskey, Jack Daniel’s Tennessee Rye Whiskeys, and Jack Daniel’s Tennessee Fire.
3Jack 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, JD Double Jack, and the seasonal Jack Daniel’s Winter Jack RTP.
Jack Daniel’s family of brands grew underlying net sales 7% (reported declined 1%) and was the most significant contributor to our underlying net sales growth. Reported net sales were hurt by foreign exchange due to the strengthening of the dollar. The following are details about the underlying performance of the Jack Daniel’s family of brands:

21



JDTW had broad-based underlying net sales growth led by the United States, the United Kingdom, Turkey, Brazil, France, Mexico, and Australia. These increases were partially offset by declines in many emerging markets, particularly southeast Asia, and travel retail.
JDTH grew underlying net sales due to volumetric growth in Brazil, France, the United Kingdom, Germany, and the Czech Republic. These gains were partially offset by declines in the United States where takeaway trends have weakened due to increased competition.
Among our Other Jack Daniel’s whiskey brands, the most significant contributor to underlying net sales growth was JDTF, launched nationally in the United States at the end of fiscal 2015 and rolled out in a few international test markets in fiscal 2016, most notably, the United Kingdom. JDTF delivered about 30% of the underlying net sales growth in the Jack Daniel’s family of brands for the nine months ended January 31, 2016.
Jack Daniel’s RTDs/RTP overall volumes increased driven by gains in JD RTDs in Australia and the United Kingdom, partially offset by declines in Jack Daniel’s Winter Jack in the United States and the United Kingdom.
Woodford Reserve led the growth of our super- and ultra-premium American whiskeys with underlying net sales increasing 29% (reported 30%). Most of this growth came from the United States, where the brand continued its volumetric growth and on-premise trends remained strong. International growth was led by the United Kingdom.
Underlying net sales for New Mix RTDs increased 25% (reported 4%) driven by low trade inventories at the beginning of fiscal 2016, as well as higher consumer demand.
Underlying net sales of Herradura increased 12% (reported was flat) driven primarily by improved price/mix and increased volumes in the brand’s largest markets, Mexico and the United States.
Underlying net sales for Finlandia decreased 5% (reported declined 17%) driven predominately by lower volumes in travel retail, Russia, and most European markets. In Poland, the brand’s largest market, Finlandia grew modestly compared to last year but continued to suffer from generally weak consumer demand for premium vodkas in this competitive marketplace. In addition, Finlandia RTDs were discontinued in Mexico.
Underlying net sales for Southern Comfort declined 6% (reported declined 10%). Net sales declined in all three of Southern Comfort’s top markets—the United States, the United Kingdom, and Australia. These declines were offset slightly by gains in the brand’s next two largest markets, Germany and South Africa. In the United States, the brand continued to be affected negatively by competitive pressure from other flavored whiskey competitors and continued weakness in the on-premise channel. In January 2016, we reached an agreement to sell our Southern Comfort brand and related assets to Sazerac Company, Inc. The sale closed March 1, 2016.


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RESULTS OF OPERATIONS – YEAR-OVER-YEAR PERIOD COMPARISONS
NET SALES
Percentage change versus the prior year period ended January 31
 
 
3 Months
 
 
 
9 Months
Change in reported net sales
 
 
(1
%)
 
 
 
(2
%)
Foreign exchange
 
 
6
%
 
 
 
8
%
Estimated net change in distributor inventories
 
 
(1
%)
 
 
 
%
Change in underlying net sales*
 
 
4
%
 
 
 
5
%
 
 
 
 
 
 
 
 
Change in underlying net sales attributed to:*
 
 
 
 
 
 
 
Volume
 
 
(2
%)
 
 
 
1
%
Net price/mix
 
 
6
%
 
 
 
4
%
* Totals may differ due to rounding
 
 
 
 
 
 
 
For the three months ended January 31, 2016, net sales were $1,083 million, a decrease of 1% or $10 million compared to the same period last year. After adjusting reported results for the negative effect of foreign exchange and the positive effect of an estimated net increase in distributor inventories, underlying net sales grew 4%.
The primary factors contributing to the 4% growth in underlying net sales for the three months ended January 31, 2016 were:
Net price/mix driven by:
Growth of higher priced brands’ share of the total mix, led by JDTW, Woodford Reserve, and JDTF;
Higher pricing for our tequila brands in Mexico; and
Declines of Finlandia in Russia and certain travel retail markets where the relative price is lower.
A 2% reduction in volume for the three months ended January 31, 2016 partially offset the growth attributable to price/mix for the period. The Jack Daniel’s family of brands grew volumes led by JDTF, JDTW, and JDTH. These gains were more than offset by volume declines for Finlandia, Southern Comfort, and Canadian Mist. In addition, there was a decrease in volumes for agency brands, including lower-margin agency brands that we no longer distribute.
For the nine months ended January 31, 2016, net sales were $3,078 million, a decrease of 2% or $71 million compared to the same period last year. After adjusting reported results for the negative effect of foreign exchange, underlying net sales grew 5%.
The primary factors contributing to the 5% growth in underlying net sales for the nine months ended January 31, 2016 were:
Net price/mix driven by:
JDTW higher share of total mix, led by the United Kingdom;
Higher pricing for our tequila brands in Mexico;
Growth of higher priced brands, such as JDTF and Woodford Reserve;
Higher prices for our used barrels driven by higher demand and tight supply; and
Declines of Finlandia in Russia and certain travel retail markets where the relative price is lower.
Volume driven by:
JDTF, following its nationwide launch in the United States in the fourth quarter of fiscal 2015;
JDTW, led by increases in the United States and the United Kingdom; and
JDTH, led by gains in Europe, particularly in France.
The primary factors partially offsetting underlying net sales growth for the nine months ended January 31, 2016 were lower volumes for Finlandia, Southern Comfort, and Canadian Mist, and a decrease in volumes for agency brands, including lower-margin agency brands that we no longer distribute.

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COST OF SALES
Percentage change versus the prior year period ended January 31
 
 
3 Months
 
 
 
9 Months
Change in reported cost of sales
 
 
(2
%)
 
 
 
(1
%)
Foreign exchange
 
 
3
%
 
 
 
6
%
Estimated net change in distributor inventories
 
 
%
 
 
 
%
Change in underlying cost of sales*
 
 
%
 
 
 
4
%
 
 
 
 
 
 
 
 
Change in underlying cost of sales attributed to:*
 
 
 
 
 
 
 
Volume
 
 
(2
%)
 
 
 
1
%
Cost/mix
 
 
2
%
 
 
 
4
%
* Totals may differ due to rounding

 
 
 
 
 
 
 
Cost of sales for the three months ended January 31, 2016 was $254 million, down 2% compared to the same period last year. Underlying cost of sales was flat after adjusting reported costs for the favorable benefit of foreign exchange as higher input costs, including wood and grain, were offset by a reduction in volumes.
Cost of sales for the nine months ended January 31, 2016 was $729 million, a decrease of $9 million, or 1%, compared to the same period last year. Underlying cost of sales increased 4% after adjusting reported costs for the effect of foreign exchange reflecting higher input costs, including wood and grain, and an increase in volume. Looking ahead for the remainder of the fiscal year, we expect that input costs will increase in the low single digits.
GROSS PROFIT
Percentage change versus the prior year period ended January 31
 
 
3 Months
 
 
 
9 Months
Change in reported gross profit
 
 
%
 
 
 
(2
%)
Foreign exchange
 
 
6
%
 
 
 
7
%
Estimated net change in distributor inventories
 
 
(2
%)
 
 
 
%
Change in underlying gross profit*
 
 
4
%
 
 
 
5
%
* Totals may differ due to rounding
 
 
 
 
 
 
 
Gross profit of $555 million increased $2 million for the three months ended January 31, 2016. Underlying gross profit grew 4% after adjusting reported results for the negative effect of foreign exchange and the positive effect of an estimated net increase in distributor inventories. The increase in underlying gross profit resulted from the same factors that contributed to the increase in underlying net sales and the comparable combined increase in underlying cost of sales and underlying excise taxes.
Gross margin improved to 51.3% for the three months ended January 31, 2016, up approximately 70 basis points from 50.6% in the same period last year reflecting a favorable mix shift, partially offset by increases in underlying cost of sales.
Gross profit of $1,631 million decreased $26 million, or 2%, for the nine months ended January 31, 2016. Underlying gross profit grew 5% after adjusting reported results for the negative effect of foreign exchange. The increase in underlying gross profit resulted from the same factors that contributed to the increase in underlying net sales and the comparable combined increase in underlying cost of sales and underlying excise taxes.
Gross margin improved to 53.0% for the nine months ended January 31, 2016, up approximately 40 basis points from 52.6% in the same period last year, reflecting a favorable mix shift, partially offset by increases in underlying cost of sales.
ADVERTISING EXPENSES
Percentage change versus the prior year period ended January 31
 
 
3 Months
 
 
 
9 Months
Change in reported advertising
 
 
(4
%)
 
 
 
(5
%)
Foreign exchange
 
 
5
%
 
 
 
6
%
Change in underlying advertising*
 
 
1
%
 
 
 
1
%
* Totals may differ due to rounding
 
 
 
 
 
 
 

24



Advertising expenses of $107 million decreased $5 million, or 4%, for the three months ended January 31, 2016 compared to the same period last year. Underlying advertising expenses increased 1% after adjusting reported results for the benefit of foreign exchange.
Advertising expenses of $317 million decreased $17 million, or 5%, for the nine months ended January 31, 2016 compared to the same period last year. Underlying advertising expenses increased 1% after adjusting reported results for the favorable effect of foreign exchange. The increase in underlying advertising expense for both the three and nine months ended January 31, 2016 was driven by (a) higher spending for the Jack Daniel’s family of brands, particularly JDTF related launch spending in the United States and a few global test markets; and (b) higher spending for the Woodford Reserve family of brands. Lower spending for Southern Comfort and Finlandia partially offset the increase.
SELLING, GENERAL, AND ADMINISTRATIVE (SG&A) EXPENSES
Percentage change versus the prior year period ended January 31
 
 
3 Months
 
 
 
9 Months
Change in reported SG&A
 
 
2
%
 
 
 
(1
%)
Sale of Southern Comfort and Tuaca
 
 
(2
%)
 
 
 
(1
%)
Foreign exchange
 
 
4
%
 
 
 
5
%
Change in underlying SG&A*
 
 
5
%
 
 
 
4
%
* Totals may differ due to rounding
 
 
 
 
 
 
 
SG&A expenses of $167 million increased $4 million, or 2% for the three months ended January 31, 2016, while underlying SG&A expenses grew 5% after adjusting reported results for transaction-related costs from the sale of Southern Comfort and Tuaca and the favorable effect of foreign exchange.
SG&A expenses of $507 million decreased $5 million, or 1% for the nine months ended January 31, 2016, while underlying SG&A expenses grew 4% after adjusting reported results for transaction-related costs from the sale of Southern Comfort and Tuaca and the favorable effect of foreign exchange. The increase in underlying SG&A for both the three and nine months ended January 31, 2016 was driven primarily by higher compensation and related expenses, partially offset by the absence of non-recurring costs incurred in the same prior-year periods.
OPERATING INCOME
Percentage change versus the prior year period ended January 31
 
 
3 Months
 
 
 
9 Months
Change in reported operating income
 
 
2
%
 
 
 
2
%
Sale of Southern Comfort and Tuaca
 
 
1
%
 
 
 
%
Foreign exchange
 
 
6
%
 
 
 
5
%
Estimated net change in distributor inventories
 
 
(4
%)
 
 
 
%
Change in underlying operating income*
 
 
5
%
 
 
 
7
%
* Totals may differ due to rounding
 
 
 
 
 
 
 
Operating income of $278 million increased $6 million, or 2%, for the three months ended January 31, 2016 compared to the same period last year. Underlying operating income grew 5% after adjusting for (a) transaction-related costs from the sale of Southern Comfort and Tuaca, (b) the negative effect of foreign exchange, and (c) the estimated net increase in distributor inventories. The same factors that contributed to the growth in underlying gross profit also contributed to the growth in underlying operating income.
Operating margin improved 80 basis points to 25.7% for the three months ended January 31, 2016 from 24.9% in the same period last year. The same factors that drove the increase in our gross margin benefited our operating margin. Additionally, operating expenses, which grew at a slower rate than gross profit, contributed to the increase in our operating margin for the period.
For the nine months ended January 31, 2016, operating income of $807 million increased $12 million, or 2% compared to the