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EX-32 - EXHIBIT 32 - BROWN FORMAN CORPbfb-01312017xex32.htm
EX-31.2 - EXHIBIT 31.2 - BROWN FORMAN CORPbfb-01312017xex312.htm
EX-31.1 - EXHIBIT 31.1 - BROWN FORMAN CORPbfb-01312017xex311.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, 2017
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. 001-00123

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 28, 2017
Class A Common Stock ($.15 par value, voting)
169,051,360

Class B Common Stock ($.15 par value, nonvoting)
214,849,206








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,
 
2016
 
2017
 
2016
 
2017
Sales
$
1,083

 
$
1,059

 
$
3,078

 
$
2,969

Excise taxes
274

 
251

 
718

 
670

Net sales
809

 
808

 
2,360

 
2,299

Cost of sales
254

 
272

 
729

 
758

Gross profit
555

 
536

 
1,631

 
1,541

Advertising expenses
107

 
102

 
317

 
291

Selling, general, and administrative expenses
167

 
162

 
507

 
488

Other expense (income), net
3

 
(1
)
 

 
(16
)
Operating income
278

 
273

 
807

 
778

Interest income

 
1

 
1

 
2

Interest expense
12

 
16

 
34

 
44

Income before income taxes
266

 
258

 
774

 
736

Income taxes
76

 
76

 
229

 
212

Net income
$
190

 
$
182

 
$
545

 
$
524

Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.47

 
$
0.47

 
$
1.33

 
$
1.35

Diluted
$
0.47

 
$
0.47

 
$
1.33

 
$
1.34

Cash dividends per common share:
 
 
 
 
 
 
 
Declared
$
0.3400

 
$
0.3650

 
$
0.6550

 
$
0.7050

Paid
$
0.1700

 
$
0.1825

 
$
0.4850

 
$
0.5225

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,
 
2016
 
2017
 
2016
 
2017
Net income
$
190

 
$
182

 
$
545

 
$
524

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Currency translation adjustments
(30
)
 
(25
)
 
(58
)
 
(110
)
Cash flow hedge adjustments
8

 
(7
)
 
20

 
14

Postretirement benefits adjustments
5

 
6

 
15

 
13

Net other comprehensive income (loss)
(17
)
 
(26
)
 
(23
)
 
(83
)
Comprehensive income
$
173

 
$
156

 
$
522

 
$
441

See notes to the condensed consolidated financial statements.

4



BROWN-FORMAN CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in millions)
 
April 30,
2016
 
January 31,
2017
Assets
 
 
 
Cash and cash equivalents
$
263

 
$
197

Accounts receivable, less allowance for doubtful accounts of $9 and $9 at April 30 and January 31, respectively
559

 
611

Inventories:
 
 
 
Barreled whiskey
666

 
858

Finished goods
187

 
175

Work in process
116

 
116

Raw materials and supplies
85

 
89

Total inventories
1,054

 
1,238

Other current assets
357

 
331

Total current assets
2,233

 
2,377

Property, plant and equipment, net
629

 
669

Goodwill
590

 
746

Other intangible assets
595

 
636

Deferred tax assets
17

 
16

Other assets
119

 
156

Total assets
$
4,183

 
$
4,600

Liabilities
 
 
 
Accounts payable and accrued expenses
$
501

 
$
478

Dividends payable

 
70

Accrued income taxes
19

 
25

Short-term borrowings
271

 
308

Current portion of long-term debt

 
249

Total current liabilities
791

 
1,130

Long-term debt
1,230

 
1,669

Deferred tax liabilities
101

 
150

Accrued pension and other postretirement benefits
353

 
336

Other liabilities
146

 
131

Total liabilities
2,621

 
3,416

Commitments and contingencies

 

Stockholders’ Equity
 
 
 
Common stock:
 
 
 
Class A, voting, $0.15 par value
13

 
25

Class B, nonvoting, $0.15 par value
21

 
43

Additional paid-in capital
114

 
74

Retained earnings
4,065

 
4,326

Accumulated other comprehensive income (loss), net of tax
(350
)
 
(433
)
Treasury stock, at cost (59,143,000 and 70,749,000 shares at April 30 and January 31, respectively)
(2,301
)
 
(2,851
)
Total stockholders’ equity
1,562

 
1,184

Total liabilities and stockholders’ equity
$
4,183

 
$
4,600

 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,
 
2016
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
545

 
$
524

Adjustments to reconcile net income to net cash provided by operations:
 
 
 
Depreciation and amortization
40

 
42

Stock-based compensation expense
12

 
10

Deferred income taxes
12

 
(11
)
Changes in assets and liabilities, excluding the effects of acquisition of business
(161
)
 
(120
)
Cash provided by operating activities
448

 
445

Cash flows from investing activities:
 
 
 
Acquisition of business, net of cash acquired

 
(307
)
Additions to property, plant, and equipment
(88
)
 
(71
)
Computer software expenditures
(2
)
 
(2
)
Cash used for investing activities
(90
)
 
(380
)
Cash flows from financing activities:
 
 
 
Net change in short-term borrowings
319

 
(24
)
Repayment of long-term debt
(250
)
 

Proceeds from long-term debt
490

 
717

Debt issuance costs
(5
)
 
(5
)
Net payments related to exercise of stock-based awards
(8
)
 
(5
)
Excess tax benefits from stock-based awards
15

 

Acquisition of treasury stock
(762
)
 
(561
)
Dividends paid
(199
)
 
(203
)
Repayment of short-term obligation associated with acquisition of business (Note 14)

 
(30
)
Cash used for financing activities
(400
)
 
(111
)
Effect of exchange rate changes on cash and cash equivalents
(11
)
 
(20
)
Net decrease in cash and cash equivalents
(53
)
 
(66
)
Cash and cash equivalents, beginning of period
370

 
263

Cash and cash equivalents, end of period
$
317

 
$
197

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, 2016 (2016 Form 10-K).

In our opinion, the accompanying financial statements include all adjustments, consisting only of normal recurring adjustments (unless otherwise indicated), 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 2016 Form 10-K, but made the following changes during fiscal 2017:

Effective beginning May 1, 2016, we changed our presentation of excise taxes from the gross method (included in sales and costs) to the net method (excluded from sales). As a result, the amounts presented as “net sales” in our financial statements now exclude excise taxes. We believe the change in presentation to the net method is preferable because it is more representative of the internal financial information reviewed by management in assessing our performance and more consistent with the presentation used by our major competitors in their external financial statements. Prior period financial statements have been recast to conform to the new presentation.

We adopted new guidance related to certain aspects of the accounting for stock-based compensation, including the income tax consequences. Under the new guidance, we recognize all tax benefits related to stock-based compensation as an income tax benefit in our statement of operations, and include all income tax cash flows within operating activities in our statement of cash flows. Under the previous accounting guidance, we recognized some of those tax benefits (excess tax benefits) as additional paid-in capital and classified that amount as a financing activity in our statement of cash flows. We adopted these provisions of the new guidance on a prospective basis as of May 1, 2016. As a result, our net income and operating cash flows for the nine months ended January 31, 2017, include excess tax benefits of $4 million. Prior period financial statements have not been adjusted.

Also, under the new guidance, we recognize the excess tax benefits during the period in which the related awards vest or are exercised. Under the previous accounting guidance, we recognized those benefits during the period in which they reduced taxes payable. We adopted this provision of the new guidance on a modified retrospective basis with a cumulative-effect adjustment of $10 million to retained earnings as of May 1, 2016.

Also, as discussed in Note 12, our Class A and Class B common shares were split on a two-for-one basis during August 2016. As a result, all share and per share amounts reported in the accompanying financial statements and related notes are presented on a split-adjusted basis.


7



New accounting pronouncements to be adopted. The Financial Accounting Standards Board (FASB) has issued new accounting guidance on various topics that may impact our financial statements upon our adoption of the new guidance. The following table shows the date by which we must adopt the new guidance for each topic and the permitted method(s) of adoption:
Topic
 
Date
 
Method(s)
 
 
 
 
 
Revenue from contracts with customers
 
May 1, 2018
 
Retrospective or modified retrospective
Classification of certain cash receipts and cash payments on statement of cash flows
 
May 1, 2018
 
Retrospective
Income tax consequences of intra-entity transfers of assets other than inventory
 
May 1, 2018
 
Modified retrospective
Leases
 
May 1, 2019
 
Modified retrospective
Credit losses
 
May 1, 2020
 
Modified retrospective
We are currently evaluating the potential impact of the new guidance on our financial statements. While we have not yet determined our plans for adoption, we do not currently expect to adopt any of the new guidance prior to the required adoption date.

2.    Inventories 
Inventories are valued at the lower of cost or market. Some of our consolidated inventories are valued using the last-in, first-out (LIFO) method, which we use for the majority of our U.S. inventories. If the LIFO method had not been used, inventories at current cost would have been $248 million higher than reported as of April 30, 2016, and $264 million higher than reported as of January 31, 2017. 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 28.7% for the nine months ended January 31, 2017, is based on an expected tax rate of 31.0% 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.

As discussed in Note 1, we adopted new accounting guidance for stock-based compensation, including the income tax consequences. As a result, our effective tax rate for the nine months ended January 31, 2017, reflects the impact of $4 million of tax benefits related to stock-based compensation that we recognized as discrete items during the period.

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. We calculate that dilutive effect using the “treasury stock method” (as defined by GAAP).


8



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)
2016
 
2017
 
2016
 
2017
Net income available to common stockholders
$
190

 
$
182

 
$
545

 
$
524

Share data (in thousands):
 
 
 
 
 
 
 
Basic average common shares outstanding
402,365

 
384,520

 
408,483

 
388,884

Dilutive effect of stock-based awards
2,416

 
2,646

 
2,668

 
2,812

Diluted average common shares outstanding
404,781

 
387,166

 
411,151

 
391,696

 
 
 
 
 
 
 
 
Basic earnings per share
$
0.47

 
$
0.47

 
$
1.33

 
$
1.35

Diluted earnings per share
$
0.47

 
$
0.47

 
$
1.33

 
$
1.34


We excluded common stock-based awards for approximately 750,000 shares and 2,231,000 shares from the calculation of diluted earnings per share for the three months ended January 31, 2016 and 2017, respectively. We excluded common stock-based awards for approximately 956,000 shares and 1,780,000 shares from the calculation of diluted earnings per share for the nine months ended January 31, 2016 and 2017, 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 existing 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, 2017.

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 $23 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, 2017, 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 $10 million at January 31, 2017, 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.

9




6.    Debt
Our long-term debt (net of unamortized discount and issuance costs) consists of:
(Principal and carrying amounts in millions)
April 30,
2016
 
January 31,
2017
1.00% notes, $250 principal amount, due January 15, 2018
$
249

 
$
249

2.25% notes, $250 principal amount, due January 15, 2023
248

 
248

1.20% notes, €300 principal amount, due July 7, 2026

 
318

2.60% notes, £300 principal amount, due July 7, 2028

 
369

3.75% notes, $250 principal amount, due January 15, 2043
248

 
248

4.50% notes, $500 principal amount, due July 15, 2045
485

 
486

 
1,230

 
1,918

Less current portion

 
249

 
$
1,230

 
$
1,669

We issued senior, unsecured notes with an aggregate principal amount of 300 million euros in July 2016. Interest on these notes will accrue at a rate of 1.20% and be paid annually. As of January 31, 2017, the carrying amount of these notes was $318 million ($321 million principal, less unamortized discounts and issuance costs). These notes are due on July 7, 2026.
In addition, we issued senior, unsecured notes with an aggregate principal amount of 300 million British pounds in July 2016. Interest on these notes will accrue at a rate of 2.60% and be paid annually. As of January 31, 2017, the carrying amount of these notes was $369 million ($375 million principal, less unamortized discounts and issuance costs). These notes are due on July 7, 2028.
As of April 30, 2016, our short-term borrowings of $271 million included $269 million of commercial paper, with an average interest rate of 0.53% and a remaining maturity of 26 days. As of January 31, 2017, our short-term borrowings of $308 million included $307 million of commercial paper, with an average interest rate of 0.89% and a remaining maturity of 12 days.

10




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. Information about similar international plans is not presented due to immateriality.
 
Three Months Ended
 
Nine Months Ended
 
January 31,
 
January 31,
(Dollars in millions)
2016
 
2017
 
2016
 
2017
Pension Benefits:
 
 
 
 
 
 
 
Service cost
$
6

 
$
6

 
$
19

 
$
19

Interest cost
9

 
9

 
26

 
26

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

 

 
1

 
1

Net actuarial loss
7

 
6

 
21

 
19

Settlement loss
$

 
$
1

 
$

 
$
1

Net cost
$
12

 
$
12

 
$
37

 
$
35

 
 
 
 
 
 
 
 
Other Postretirement Benefits:
 
 
 
 
 
 
 
Service cost
$

 
$

 
$
1

 
$
1

Interest cost
1

 
1

 
2

 
2

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

 

 
1

 

Net cost
$

 
$

 
$
2

 
$
1


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 inactive markets; 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.

11



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, 2016:
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Currency derivatives
 
$

 
$
19

 
$

 
$
19

Liabilities:
 
 
 
 
 
 
 
 
Currency derivatives
 

 
10

 

 
10

Short-term borrowings
 

 
271

 

 
271

Long-term debt
 

 
1,293

 

 
1,293

January 31, 2017:
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Currency derivatives
 

 
42

 

 
42

Liabilities:
 
 
 
 
 
 
 
 
Currency derivatives
 

 
11

 

 
11

Short-term borrowings
 

 
308

 

 
308

Current portion of long-term debt
 

 
249

 

 
249

Long-term debt
 

 
1,686

 

 
1,686


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.

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 currency derivatives 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, 2016
 
January 31, 2017
 
Carrying
 
Fair
 
Carrying
 
Fair
(Dollars in millions)
Amount
 
Value
 
Amount
 
Value
Assets:
 
 
 
 
 
 
 
Cash and cash equivalents
$
263

 
$
263

 
$
197

 
$
197

Currency derivatives
19

 
19

 
42

 
42

Liabilities:
 
 
 
 
 
 
 
Currency derivatives
10

 
10

 
11

 
11

Short-term borrowings
271

 
271

 
308

 
308

Current portion of long-term debt

 

 
249

 
249

Long-term debt
1,230

 
1,293

 
1,669

 
1,686


12



10.    Derivative Financial Instruments and Hedging Activities
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 had outstanding currency derivatives, related primarily to our euro, British pound, and Australian dollar exposures, with notional amounts totaling $1,265 million at April 30, 2016 and $1,122 million at January 31, 2017.

During the nine months ended January 31, 2017, we used some currency derivative forward contracts and foreign currency-denominated long-term debt as after-tax net investment hedges of our investments in certain foreign subsidiaries. Any change in value of the designated portion of the hedging instruments is recorded in AOCI, offsetting the foreign currency translation adjustment of the related net investments that is also recorded in AOCI. As of January 31, 2017, $520 million of our foreign currency-denominated debt was designated as a net investment hedge. Our net investment hedges are intended to mitigate foreign exchange exposure related to non-U.S. dollar net investments in certain foreign subsidiaries against changes in foreign exchange rates. There was no ineffectiveness related to our net investment hedges during the periods presented in this report.

We do not designate some of our currency derivatives and foreign currency-denominated debt 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 instruments in earnings.

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 in June 2015 of an aggregate principal amount of $500 million of the 4.50% notes, due July 15, 2045, 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.

13




The following tables present the pre-tax impact that changes in the fair value of our derivative instruments and non-derivative hedging instruments had on AOCI and earnings:
 
 
Three Months Ended
 
 
January 31,
(Dollars in millions)
Classification
2016
 
2017
Derivative Instruments
 
 
 
 
Currency derivatives designated as cash flow hedges:
 
 

 
 

Net gain (loss) recognized in AOCI
n/a
$
29

 
$
5

Net gain (loss) reclassified from AOCI into income
Net sales
17

 
15

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

 

Currency derivatives designated as net investment hedge:
 
 
 
 
Net gain (loss) recognized in AOCI
n/a

 

Currency derivatives not designated as hedging instruments:
 
 

 
 

Net gain (loss) recognized in income
Net sales
5

 

Net gain (loss) recognized in income
Other income
(2
)
 
(5
)
Non-Derivative Hedging Instruments
 
 
 
 
Foreign currency-denominated debt designated as net investment hedge:
 
 
 
 
Net gain (loss) recognized in AOCI
n/a

 
(5
)
Foreign currency-denominated debt not designated as hedging instrument:
 
 
 
 
Net gain (loss) recognized in income
Other income

 
4

 
 
 
 
 
 
 
Nine Months Ended
 
 
January 31,
(Dollars in millions)
Classification
2016
 
2017
Derivative Instruments
 
 
 
 
Currency derivatives designated as cash flow hedges:
 
 

 
 

Net gain (loss) recognized in AOCI
n/a
$
66

 
$
57

Net gain (loss) reclassified from AOCI into income
Net sales
46

 
34

Interest rate derivatives designated as cash flow hedges:
 
 
 
 
Net gain (loss) recognized in AOCI
n/a
8

 

Currency derivatives designated as net investment hedge:
 
 
 
 
Net gain (loss) recognized in AOCI
n/a

 
8

Currency derivatives not designated as hedging instruments:
 
 

 
 

Net gain (loss) recognized in income
Net sales
9

 
3

Net gain (loss) recognized in income
Other income
2

 
(13
)
Non-Derivative Hedging Instruments
 
 
 
 
Foreign currency-denominated debt designated as net investment hedge:
 
 
 
 
Net gain (loss) recognized in AOCI
n/a

 
19

Foreign currency-denominated debt not designated as hedging instrument:
 
 
 
 
Net gain (loss) recognized in income
Other income

 
6


We expect to reclassify $23 million of deferred net gains on cash flow hedges recorded in AOCI as of January 31, 2017, 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, 2017, the maximum term of our outstanding derivative contracts was 36 months.

14





The following table presents the fair values of our derivative instruments:

(Dollars in millions)


Classification
 
Fair value of derivatives in a gain position
 
Fair value of derivatives in a
loss position
April 30, 2016:
 
 
 
 
 
Designated as cash flow hedges:
 
 
 
 
 
Currency derivatives
Other current assets
 
$
23

 
$
(2
)
Currency derivatives
Other assets
 
3

 
(2
)
Currency derivatives
Accrued expenses
 
4

 
(8
)
Currency derivatives
Other liabilities
 
3

 
(9
)
Not designated as hedges:
 
 
 
 
 
Currency derivatives
Other current assets
 
1

 
(4
)
January 31, 2017:
 
 
 
 
 
Designated as cash flow hedges:
 
 
 
 
 
Currency derivatives
Other current assets
 
30

 
(3
)
Currency derivatives
Other assets
 
19

 
(4
)
Currency derivatives
Accrued expenses
 
2

 
(6
)
Currency derivatives
Other liabilities
 
1

 
(2
)
Not designated as hedges:
 
 
 
 
 
Currency derivatives
Accrued expenses
 

 
(6
)

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 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 $8 million at April 30, 2016 and $10 million at January 31, 2017.

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:

15



(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, 2016:
 
 
 
 
 
 
 
 
 
Derivative assets
$
34

 
$
(15
)
 
$
19

 
$
(6
)
 
$
13

Derivative liabilities
(25
)
 
15

 
(10
)
 
6

 
(4
)
January 31, 2017:
 
 
 
 
 
 
 
 
 
Derivative assets
52

 
(10
)
 
42

 
(1
)
 
41

Derivative liabilities
(21
)
 
10

 
(11
)
 
1

 
(10
)

No cash collateral was received or pledged related to our derivative contracts as of April 30, 2016 and January 31, 2017.

11.    Goodwill and Other Intangible Assets
The following table summarizes the changes in goodwill and other intangible assets during the nine months ended January 31, 2017:
(Dollars in millions)
Goodwill
 
Other Intangible Assets
Balance at April 30, 2016
$
590

 
$
595

Acquisitions (Note 14)
182

 
65

Foreign currency translation adjustment
(26
)
 
(24
)
Balance at January 31, 2017
$
746

 
$
636


Our other intangible assets consist of trademarks and brand names, all with indefinite useful lives.

12.    Stockholders’ Equity
The following table summarizes the changes in stockholders’ equity during the nine months ended January 31, 2017:
(Dollars in millions)
Class A Common Stock
 
Class B Common Stock
 
Additional Paid-in Capital
 
Retained Earnings
 
AOCI
 
Treasury Stock
 
Total
Balance at April 30, 2016
$
13

 
$
21

 
$
114

 
$
4,065

 
$
(350
)
 
$
(2,301
)
 
$
1,562

Cumulative effect of change in accounting principle (Note 1)
 
 
 
 
 
 
10

 
 
 
 
 
10

Net income
 
 
 
 
 
 
524

 
 
 
 
 
524

Net other comprehensive income (loss)
 
 
 
 
 
 
 
 
(83
)
 
 
 
(83
)
Cash dividends
 
 
 
 
 
 
(273
)
 
 
 
 
 
(273
)
Acquisition of treasury stock
 
 
 
 
 
 
 
 
 
 
(561
)
 
(561
)
Stock-based compensation expense
 
 
 
 
10

 
 
 
 
 
 
 
10

Stock issued under compensation plans
 
 
 
 
 
 
 
 
 
 
11

 
11

Loss on issuance of treasury stock issued under compensation plans
 
 
 
 
(16
)
 

 
 
 
 
 
(16
)
Stock split
12

 
22

 
(34
)
 
 
 
 
 
 
 

Balance at January 31, 2017
$
25

 
$
43

 
$
74

 
$
4,326

 
$
(433
)
 
$
(2,851
)
 
$
1,184



16



Stock split. On May 26, 2016, our Board of Directors approved a two-for-one stock split for our Class A and Class B common stock, subject to stockholder approval of an amendment to our Restated Certificate of Incorporation. The amendment, which was approved by stockholders on July 28, 2016, increased the number of authorized shares of Class A common stock from 85,000,000 to 170,000,000. The amendment did not change the number of authorized Class B common shares, which remains at 400,000,000.

The stock split, which was effected as a stock dividend, resulted in the issuance of one new share of Class A common stock for each share of Class A common stock outstanding and one new share of Class B common stock for each share of Class B common stock outstanding. The stock split was also applied to our treasury shares. Thus, the stock split increased the number of Class A shares issued from 85,000,000 to 170,000,000, and increased the number of Class B shares issued from 142,313,000 to 284,626,000. The new shares were distributed on August 18, 2016, to shareholders of record as of August 8, 2016.

As a result of the stock split, we reclassified approximately $34 million from additional paid-in capital to common stock during the quarter ended July 31, 2016. The $34 million represents the $0.15 par value per share of the new shares issued in the stock split.

All share and per share amounts reported in the accompanying financial statements and related notes are presented on a split-adjusted basis.

Dividends. The following table summarizes the cash dividends declared per share on our Class A and Class B common stock during the nine months ended January 31, 2017:
Declaration Date
 
Record Date
 
Payable Date
 
Amount per Share
May 26, 2016
 
June 6, 2016
 
July 1, 2016
 
$0.1700
July 28, 2016
 
September 1, 2016
 
October 3, 2016
 
$0.1700
November 17, 2016
 
December 2, 2016
 
January 3, 2017
 
$0.1825
January 24, 2017
 
March 6, 2017
 
April 3, 2017
 
$0.1825

Accumulated Other Comprehensive Income. The following table summarizes the changes in each component of AOCI, net of tax, during the nine months ended January 31, 2017:
(Dollars in millions)
Currency Translation Adjustments
 
Cash Flow Hedge Adjustments
 
Postretirement Benefits Adjustments
 
Total AOCI
Balance at April 30, 2016
$
(131
)
 
$
11

 
$
(230
)
 
$
(350
)
Net other comprehensive income (loss)
(110
)
 
14

 
13

 
(83
)
Balance at January 31, 2017
$
(241
)
 
$
25

 
$
(217
)
 
$
(433
)



17



13.    Other Comprehensive Income
The following tables present the components of net other comprehensive income (loss):
 
Three Months Ended
 
Three Months Ended
 
January 31, 2016
 
January 31, 2017
(Dollars in millions)
Pre-Tax
 
Tax
 
Net
 
Pre-Tax
 
Tax
 
Net
Currency translation adjustments:
 
 
 
 
 
 
 
 
 
 
 
Net gain (loss) on currency translation
$
(30
)
 
$

 
$
(30
)
 
$
(27
)
 
$
2

 
$
(25
)
Reclassification to earnings

 

 

 

 

 

Other comprehensive income (loss), net
(30
)
 

 
(30
)
 
(27
)
 
2

 
(25
)
Cash flow hedge adjustments:
 
 
 
 
 
 
 
 
 
 
 
Net gain (loss) on hedging instruments
29

 
(11
)
 
18

 
5

 
(3
)
 
2

Reclassification to earnings1
(17
)
 
7

 
(10
)
 
(15
)
 
6

 
(9
)
Other comprehensive income (loss), net
12

 
(4
)
 
8

 
(10
)
 
3

 
(7
)
Postretirement benefits adjustments:
 
 
 
 
 
 
 
 
 
 
 
Net actuarial gain (loss) and prior service cost

 

 

 
2

 
(1
)
 
1

Reclassification to earnings2
7

 
(2
)
 
5

 
7

 
(2
)
 
5

Other comprehensive income (loss), net
7

 
(2
)
 
5

 
9

 
(3
)
 
6

 
 
 
 
 
 
 
 
 
 
 
 
Total other comprehensive income (loss), net
$
(11
)
 
$
(6
)
 
$
(17
)
 
$
(28
)
 
$
2

 
$
(26
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended
 
Nine Months Ended
 
January 31, 2016
 
January 31, 2017
(Dollars in millions)
Pre-Tax
 
Tax
 
Net
 
Pre-Tax
 
Tax
 
Net
Currency translation adjustments:
 
 
 
 
 
 
 
 
 
 
 
Net gain (loss) on currency translation
(57
)
 
(1
)
 
(58
)
 
(99
)
 
(11
)
 
(110
)
Reclassification to earnings

 

 

 

 

 

Other comprehensive income (loss), net
(57
)
 
(1
)
 
(58
)
 
(99
)
 
(11
)
 
(110
)
Cash flow hedge adjustments:
 
 
 
 
 
 
 
 
 
 
 
Net gain (loss) on hedging instruments
74

 
(26
)
 
48

 
57

 
(23
)
 
34

Reclassification to earnings1
(46
)
 
18

 
(28
)
 
(34
)
 
14

 
(20
)
Other comprehensive income (loss), net
28

 
(8
)
 
20

 
23

 
(9
)
 
14

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

 

 

 
2

 
(1
)
 
1

Reclassification to earnings2
23

 
(8
)
 
15

 
19

 
(7
)
 
12

Other comprehensive income (loss), net
23

 
(8
)
 
15

 
21

 
(8
)
 
13

 
 
 
 
 
 
 
 
 
 
 
 
Total other comprehensive income (loss), net
$
(6
)
 
$
(17
)
 
$
(23
)
 
$
(55
)
 
$
(28
)
 
$
(83
)
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 no information is presented in Note 7 due to immateriality).


18



14.    Acquisition of Business
On June 1, 2016, we acquired The BenRiach Distillery Company Limited (BenRiach) for aggregate consideration of $407 million, consisting of a purchase price of $341 million and $66 million in assumed debt and transaction-related obligations that we have since paid. The acquisition, which brought three single malt Scotch whisky brands into our portfolio, included brand trademarks, inventories, three malt distilleries, a bottling plant, and BenRiach’s headquarters in Edinburgh, Scotland.
The purchase price of $341 million included cash of $307 million paid at the acquisition date for 90% of the voting interests in BenRiach and a liability of $34 million related to a put and call option agreement for the remaining 10% equity shares. Under that agreement, we could choose (or be required) to purchase the remaining 10% for 24 million British pounds ($34 million at the exchange rate on June 1, 2016) during the one-year period ending November 14, 2017.
The purchase price of $341 million was preliminarily allocated based on management’s estimates and independent appraisals as follows:
(Dollars in millions)
June 1,
2016
Accounts receivable
$
11

Inventories
159

Other current assets
1

Property, plant, and equipment
19

Goodwill
182

Trademarks and brand names
65

Total assets
437

 
 
Accounts payable and accrued expenses
12

Short-term borrowings
59

Deferred tax liabilities
25

Total liabilities
96

 
 
Net assets acquired
$
341

Goodwill is calculated as the excess of the purchase price over the fair value of the net identifiable assets acquired. The goodwill resulting from this acquisition is primarily attributable to the following: (a) the value of leveraging our distribution network and brand-building expertise to grow global sales of the existing single malt Scotch whisky brands acquired, (b) the valuable opportunity provided by the combination of the rather scarce identifiable assets to develop new products and line extensions in the especially attractive premium Scotch whisky category, and (c) the accumulated knowledge and expertise of the organized workforce employed by the acquired business. None of the preliminary goodwill amount of $182 million is expected to be deductible for tax purposes.
The initial allocation of the purchase price was based on preliminary estimates and may be revised as asset valuations are finalized and further information is obtained on the fair value of liabilities.
BenRiach’s results of operations, which have been included in our financial statements since the acquisition date, were not material for the three-month or nine-month periods ended January 31, 2017. Pro forma results are not presented due to immateriality.
On November 17, 2016, we purchased the remaining 10% interest in BenRiach for cash of 24 million British pounds ($30 million at the exchange rate on that date) by exercising the call option described above. That cash payment is classified as a financing activity in the accompanying statement of cash flows.

19



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 2016 Form 10-K. Note that the results of operations for the nine months ended January 31, 2017 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.

As discussed in Note 12 to the accompanying financial statements, our Class A and Class B common shares were split on a two-for-one basis during August 2016. As a result, all share and per share amounts reported in the following discussion and analysis are presented on a split-adjusted basis.

Volume and Depletions
When discussing volume, unless otherwise specified, we refer to “depletions,” a term commonly used in the beverage alcohol industry. Depending on the context, “depletions” means either (a) our shipments directly to retailers or wholesalers, or (b) shipments from our distributor customers to retailers and wholesalers. We generally record revenues when we ship our products to our customers, so 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 gross profit, (d) underlying advertising expenses, (e) underlying selling, general, and administrative (SG&A) expenses, and (f) underlying operating income. To calculate these measures, we adjust, as applicable, for (a) foreign currency exchange; (b) estimated net changes in distributor inventories, and (c) the impact of acquisition and divestiture activity. 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.
“Acquisitions and divestitures.” On January 14, 2016, we reached an agreement to sell our Southern Comfort and Tuaca brands and related assets to Sazerac Company, Inc. The transaction closed March 1, 2016, for $543 million in cash, which resulted in a gain of $485 million in the fourth quarter of fiscal 2016. On June 1, 2016, we acquired The BenRiach Distillery Company Limited (BenRiach) for aggregate consideration of $407 million, consisting of a purchase price of $341 million and $66 million in assumed debt and transaction-related obligations that we have since paid. The acquisition, which brought three single malt Scotch whisky brands into our portfolio, included brand trademarks, inventories, three malt distilleries, a bottling plant, and BenRiach’s headquarters in Edinburgh, Scotland. See Note 14 to the accompanying financial statements for additional information. This adjustment removes (a)

20



transaction-related costs for the acquisition and divestiture and (b) operating activity for the acquisition and divestiture for the non-comparable period, which is fiscal 2016 activity for Southern Comfort and Tuaca and fiscal 2017 activity for Southern Comfort, Tuaca, and BenRiach. We believe that these adjustments allow us to understand better our underlying results on a comparable basis.
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 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 2016 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

21



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

22



Summary of Operating Performance
 
Three months ended January 31
 
Nine months ended January 31
 
 
2016
 
2017
 
Reported Change
 
Underlying Change1
 
2016
 
2017
 
Reported Change
 
Underlying Change1
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net sales
$
809

 
$
808

 
%
 
4
%
 
$
2,360

 
$
2,299

 
(3
%)
 
3
%
 
Cost of sales
254

 
272

 
7
%
 
5
%
 
729

 
758

 
4
%
 
4
%
 
Gross profit
555

 
536

 
(3
%)
 
3
%
 
1,631

 
1,541

 
(6
%)
 
2
%
 
Advertising
107

 
102

 
(4
%)
 
10
%
 
317

 
291

 
(8
%)
 
4
%
 
SG&A
167

 
162

 
(3
%)
 
(2
%)
 
507

 
488

 
(4
%)
 
(2
%)
 
Operating income
$
278

 
$
273

 
(2
%)
 
3
%
 
$
807

 
$
778

 
(4
%)
 
5
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross margin
68.7
%
 
66.4
%
 
(2.3)pp

 
 
 
69.1
%
 
67.0
%
 
(2.1)pp

 
 
 
Operating margin
34.4
%
 
33.8
%
 
(0.6)pp

 
 
 
34.2
%
 
33.8
%
 
(0.4)pp

 
 
 
Interest expense, net
$
12

 
15

 
22
%
 
 
 
$
33

 
42

 
27
%
 
 
 
Effective tax rate
28.8
%
 
29.4
%
 
0.6pp

 
 
 
29.5
%
 
28.7
%
 
(0.8)pp

 
 
 
Diluted earnings per share
$
0.47

 
$
0.47

 
1
%
 
 
 
$
1.33

 
$
1.34

 
1
%
 
 
 
Note: Totals may differ due to rounding

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
1See “Non-GAAP Financial Measures” above for details on our use of “underlying changes”, including how these measures are calculated and the reasons why we think this information is useful to readers.
Overview
For the nine months ended January 31, 2017, compared to the same period last year, reported net sales declined 3% and reported operating income declined 4%, while diluted earnings per share increased 1%. Excluding the impact of acquisitions and divestitures, reported net sales increased 1% and reported operating income increased 3%. After also adjusting for the negative effect of foreign exchange, we grew underlying net sales 3% and underlying operating income 5%. Our underlying operating results were driven by the Jack Daniel's family of brands, our tequila brands, and Woodford Reserve. In addition, our underlying operating results benefited from the reduction of underlying SG&A expenses.
Our financial condition remained strong. We received proceeds of $717 million from the issuance of long-term debt in July 2016, purchased BenRiach in June for aggregate consideration of $407 million (see Note 14 to the accompanying financial statements for additional information), continued to invest in our capacity expansion projects, and returned $764 million to shareholders during the nine months ended January 31, 2017 through ordinary dividends and share repurchases.

23



RESULTS OF OPERATIONS – FISCAL 2017 YEAR-TO-DATE HIGHLIGHTS
Market Highlights
The following table provides supplemental information of our largest markets for the nine months ended January 31, 2017, 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, 2017, compared to the same period last year.
Top 10 Markets1 - Fiscal 2017 Net Sales Growth by Geographic Area
 
Percentage change versus prior year period
Nine months ended January 31, 2017
Net Sales2
Geographic area
Reported
Acquisitions & Divestitures
Foreign Exchange
Net Chg in Est. Distributor Inventories
 
Underlying
United States
(1
%)
6
%
%
%
 
4
%
Europe
(8
%)
3
%
5
%
3
%
 
2
%
United Kingdom
(12
%)
11
%
5
%
%
 
4
%
Germany
(2
%)
2
%
5
%
%
 
4
%
Poland
5
%
(1
%)
4
%
%
 
8
%
France
6
%
(1
%)
4
%
%
 
9
%
Turkey
(28
%)
%
18
%
%
 
(11
%)
Russia
(50
%)
%
2
%
45
%
 
(4
%)
Rest of Europe
(5
%)
%
3
%
%
 
(2
%)
Australia
(1
%)
5
%
(4
%)
%
 
%
Other geographies
%
%
5
%
(2
%)
 
3
%
Mexico
(2
%)
%
16
%
%
 
14
%
Canada
(10
%)
4
%
2
%
5
%
 
1
%
Remaining geographies3
2
%
(1
%)
(1
%)
(4
%)
 
(4
%)
Travel Retail4
1
%
3
%
1
%
2
%
 
7
%
Other non-branded5
16
%
(37
%)
%
%
 
(22
%)
Total
(3
%)
3
%
2
%
%
 
3
%
Note: Totals may differ due to rounding
 
 
 
 
 
 
 
 
1Top 10 markets are ranked based on percentage of total Fiscal 2016 Net Sales. See 2016 Form 10-K “Results of Operations - Fiscal 2016 Market Highlights” and “Note 14. 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.
3Remaining geographies represents over 110 countries with the largest being Japan, Brazil, and South Africa.
4Travel Retail represents our sales to global duty free and travel retail customers.
5Other non-branded includes used barrel, bulk whiskey and wine, and contract bottling sales.
United States. Reported net sales declined 1%, while underlying net sales increased 4% after adjusting for the absence of revenues associated with Southern Comfort and Tuaca, which were sold last March. Underlying net sales gains were driven primarily by (a) the growth of our American whiskey portfolio, led by Jack Daniel’s Tennessee Whiskey (JDTW), Woodford Reserve, and Old Forester; (b) our tequila brands, led by Herradura and el Jimador; (c) Sonoma-Cutrer; and (d) Korbel Champagne. This growth was partially offset by declines in Canadian Mist.
Europe. Reported net sales decreased 8%, while underlying net sales increased 2% after adjusting for (a) the net effect of acquired and divested brands, (b) the negative effect of foreign exchange driven by the strengthening of the dollar against the British pound, euro, and Turkish lira, and (c) an estimated net decrease in distributor inventories in Russia. Underlying net sales gains in France, Poland, the United Kingdom, and Germany were partially offset by declines in Turkey and Russia, which both suffered from geopolitical instability and weak economic conditions.
In the United Kingdom, underlying net sales growth was driven by higher volumes of JDTW, Jack Daniel’s ready-to-drinks (JD RTDs), and Chambord and higher prices and favorable mix of JDTW.

24



In Germany, underlying net sales growth was driven by higher volumes of JD RTDs and Jack Daniel’s Tennessee Honey (JDTH), and the introduction of Jack Daniel’s Tennessee Fire (JDTF). JDTW volumes declined, although consumer takeaway trends remain solid.
In Poland and France, underlying net sales growth was driven by higher volumes of JDTW. France also benefited from the expansion of JDTF.
In Turkey, which has suffered from political and economic instability, the decline in underlying net sales was driven by lower volumes of JDTW.
In Russia, underlying net sales declines were driven primarily by lower volumes of JDTW, partially offset by price increases on Finlandia and JDTW intended to mitigate the effect of the devaluation of the ruble. We believe that the declines in the Russian market are driven by weak economic conditions, consumer trends favoring local products, and the reduction in the purchasing power of consumers for premium imported brands given the significant currency devaluation. Russia returned to growth in the third quarter primarily driven by Finlandia, as the market began to improve.
The decline in underlying net sales in the rest of Europe was driven by lower volumes of JDTW in Belgium, the absence of sales for lower-margin agency brands that we no longer distribute in Czech Republic, and lower volumes of JDTW in Austria. These declines were partially offset by growth in Ukraine, driven by JDTW and Finlandia.
Australia. Reported net sales decreased 1%, while underlying net sales were flat after adjusting for the negative effect of the absence of revenues resulting from the the sale of Southern Comfort and Tuaca and the positive effect of foreign exchange. Recently launched Jack Daniel’s RTD products and the expansion of JDTF were offset by declines in the rest of the Jack Daniel’s family of brands, including Jack Daniel’s & Cola.
Other geographies. Reported net sales for our other markets were flat, while underlying net sales collectively increased 3% after adjusting for the negative effect of foreign exchange driven by the strengthening of the dollar against the Mexican peso and the estimated net increase in distributor inventories. Underlying net sales growth was led by Mexico and Japan, the latter of which benefited from buy-ins ahead of price increases. These gains were partially offset by declines in China and Brazil.
Travel Retail. Reported net sales increased 1% and underlying net sales increased 7% after adjusting reported results for (a) the absence of revenues resulting from the sale of Southern Comfort and Tuaca, (b) the negative effect of foreign exchange, and (c) an estimated net decrease in distributor inventories. Following declines in the same period last year, underlying net sales growth was led by higher volumes of JDTW, distribution gains on Woodford Reserve, and the expansion of JDTF into Europe.
Other non-branded. Reported net sales increased 16%, while underlying net sales declined 22% after removing the net effect of acquired and divested businesses (primarily bulk whiskey and contract bottling sales). The reduction in underlying net sales was due primarily to declines in used barrel sales reflecting lower prices and volumes as a result of weaker demand from blended Scotch industry buyers and pricing pressures due to the increased supply of used barrels in the market.

25



Brand Highlights
The following table highlights the worldwide results of our largest brands for the nine months ended January 31, 2017, 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, 2017, compared to the same period last year.
Major Brands Worldwide Results
 
Percentage change versus prior year period
Nine months ended January 31, 2017
Volumes
 
Net Sales1
Brand family / brand
9L Depletions
 
Reported
Foreign Exchange
Net Chg in Est. Distributor Inventories
 
Underlying
Jack Daniel’s Family
4
%
 
1
%
2
%
%
 
3
%
Jack Daniel’s Tennessee Whiskey
1
%
 
%
2
%
%
 
2
%
Jack Daniel’s Tennessee Honey
5
%
 
1
%
2
%
%
 
3
%
Other Jack Daniel’s whiskey brands2
9
%
 
5
%
1
%
(2
%)
 
4
%
Jack Daniel’s RTDs/RTP3
7
%
 
2
%
4
%
%
 
5
%
New Mix RTDs
8
%
 
%
16
%
%
 
16
%
Finlandia
%
 
(10
%)
2
%
6
%
 
(1
%)
Canadian Mist
(8
%)
 
(11
%)
%
%
 
(12
%)
El Jimador
2
%
 
%
5
%
2
%
 
7
%
Woodford Reserve
19
%
 
15
%
1
%
4
%
 
20
%
Herradura
14
%
 
11
%
8
%
(1
%)
 
18