Attached files

file filename
EX-32 - EXHIBIT 32 - BROWN FORMAN CORPbfb-10312017xex32october.htm
EX-31.2 - EXHIBIT 31.2 - BROWN FORMAN CORPbfb-10312017xex312october.htm
EX-31.1 - EXHIBIT 31.1 - BROWN FORMAN CORPbfb-10312017xex311october.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 October 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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
þ
 
Accelerated filer
¨
Non-accelerated filer
¨
(Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
 
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:  November 30, 2017
Class A Common Stock ($.15 par value, voting)
169,061,063

Class B Common Stock ($.15 par value, nonvoting)
215,276,608








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
 
Six Months Ended
 
October 31,
 
October 31,
 
2016
 
2017
 
2016
 
2017
Sales
$
1,055

 
$
1,166

 
$
1,911

 
$
2,095

Excise taxes
225

 
252

 
420

 
458

Net sales
830

 
914

 
1,491

 
1,637

Cost of sales
278

 
304

 
486

 
534

Gross profit
552

 
610

 
1,005

 
1,103

Advertising expenses
107

 
111

 
190

 
200

Selling, general, and administrative expenses
163

 
163

 
326

 
324

Other expense (income), net
(9
)
 
(10
)
 
(15
)
 
(11
)
Operating income
291

 
346

 
504

 
590

Interest income
1

 
1

 
1

 
2

Interest expense
16

 
16

 
28

 
32

Income before income taxes
276

 
331

 
477

 
560

Income taxes
79

 
92

 
135

 
143

Net income
$
197

 
$
239

 
$
342

 
$
417

Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.51

 
$
0.62

 
$
0.87

 
$
1.08

Diluted
$
0.50

 
$
0.62

 
$
0.87

 
$
1.08

Cash dividends per common share:
 
 
 
 
 
 
 
Declared
$

 
$

 
$
0.3400

 
$
0.3650

Paid
$
0.1700

 
$
0.1825

 
$
0.3400

 
$
0.3650

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
 
Six Months Ended
 
October 31,
 
October 31,
 
2016
 
2017
 
2016
 
2017
Net income
$
197

 
$
239

 
$
342

 
$
417

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Currency translation adjustments
(18
)
 
(25
)
 
(85
)
 
9

Cash flow hedge adjustments
9

 
7

 
21

 
(16
)
Postretirement benefits adjustments
4

 
3

 
7

 
6

Net other comprehensive income (loss)
(5
)
 
(15
)
 
(57
)
 
(1
)
Comprehensive income
$
192

 
$
224

 
$
285

 
$
416

See notes to the condensed consolidated financial statements.

4



BROWN-FORMAN CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in millions)
 
April 30,
2017
 
October 31,
2017
Assets
 
 
 
Cash and cash equivalents
$
182

 
$
212

Accounts receivable, less allowance for doubtful accounts of $7 at April 30 and October 31
557

 
753

Inventories:
 
 
 
Barreled whiskey
873

 
895

Finished goods
186

 
242

Work in process
119

 
117

Raw materials and supplies
92

 
105

Total inventories
1,270

 
1,359

Other current assets
342

 
337

Total current assets
2,351

 
2,661

Property, plant and equipment, net
713

 
740

Goodwill
753

 
756

Other intangible assets
641

 
659

Deferred tax assets
16

 
15

Other assets
151

 
147

Total assets
$
4,625

 
$
4,978

Liabilities
 
 
 
Accounts payable and accrued expenses
$
501

 
$
556

Accrued income taxes
9

 
11

Short-term borrowings
211

 
235

Current portion of long-term debt
249

 
250

Total current liabilities
970

 
1,052

Long-term debt
1,689

 
1,719

Deferred tax liabilities
152

 
139

Accrued pension and other postretirement benefits
314

 
287

Other liabilities
130

 
134

Total liabilities
3,255

 
3,331

Commitments and contingencies

 

Stockholders’ Equity
 
 
 
Common stock:
 
 
 
Class A, voting, $0.15 par value (170,000,000 shares authorized; 170,000,000 shares issued at April 30 and October 31)
25

 
25

Class B, nonvoting, $0.15 par value (400,000,000 shares authorized; 284,627,000 shares and 217,627,000 shares issued at April 30 and October 31, respectively)
43

 
33

Additional paid-in capital
65

 
49

Retained earnings
4,470

 
2,063

Accumulated other comprehensive income (loss), net of tax
(390
)
 
(391
)
Treasury stock, at cost (70,540,000 and 3,311,000 shares at April 30 and October 31, respectively)
(2,843
)
 
(132
)
Total stockholders’ equity
1,370

 
1,647

Total liabilities and stockholders’ equity
$
4,625

 
$
4,978

 See notes to the condensed consolidated financial statements.

5



BROWN-FORMAN CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in millions)
 
Six Months Ended
 
October 31,
 
2016
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
342

 
$
417

Adjustments to reconcile net income to net cash provided by operations:
 
 
 
Depreciation and amortization
28

 
31

Stock-based compensation expense
7

 
9

Deferred income taxes
(7
)
 
(10
)
Changes in assets and liabilities, excluding the effects of acquisition of business
(201
)
 
(233
)
Cash provided by operating activities
169

 
214

Cash flows from investing activities:
 
 
 
Acquisition of business, net of cash acquired
(307
)
 

Additions to property, plant, and equipment
(36
)
 
(64
)
Computer software expenditures
(1
)
 
(1
)
Cash used for investing activities
(344
)
 
(65
)
Cash flows from financing activities:
 
 
 
Net change in short-term borrowings
6

 
21

Proceeds from long-term debt
717

 

Debt issuance costs
(5
)
 

Net payments related to exercise of stock-based awards
(5
)
 
(7
)
Acquisition of treasury stock
(442
)
 
(1
)
Dividends paid
(134
)
 
(140
)
Cash provided by (used for) financing activities
137

 
(127
)
Effect of exchange rate changes on cash and cash equivalents
(14
)
 
8

Net increase (decrease) in cash and cash equivalents
(52
)
 
30

Cash and cash equivalents, beginning of period
263

 
182

Cash and cash equivalents, end of period
$
211

 
$
212

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, 2017 (2017 Form 10-K). We prepared the accompanying financial statements on a basis that is substantially consistent with the accounting principles applied in our 2017 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.

The BenRiach acquisition occurred during the first fiscal quarter of 2017 and the purchase price allocation was finalized as of June 1, 2017. There have been no material changes to the purchase price allocation.

New accounting pronouncements to be adopted. In May 2014, the Financial Accounting Standards Board (FASB) issued a new revenue recognition standard that, along with various amendments issued in 2015 and 2016, will replace substantially all existing revenue recognition guidance in U.S. GAAP. The core principle of the standard requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to in exchange for those goods or services. The new standard also requires significantly more financial statement disclosures than existing revenue standards do.

The new standard can be adopted using either of two transition options: a full retrospective transition method or a modified retrospective method. Under the full retrospective method, the guidance would be applied to each prior reporting period presented. Under the modified retrospective method, the cumulative effect of initially applying the new guidance would be recorded as an adjustment to the opening balance of retained earnings for the annual reporting period that includes the date of initial application.

We are continuing to assess the potential impact of the new guidance on our financial statements. Based on our assessment to date, we currently expect our accounting for certain customer incentives to be the area most likely affected by the new recognition requirements. We also expect to disclose additional information about revenues under the new standard. As we progress in our assessment, we are also identifying and preparing to make any changes to our accounting policies and practices, systems, processes, and controls that may be required to implement the new standard. We currently expect to choose the modified retrospective method in transitioning to the new standard, which we will adopt effective May 1, 2018.

We are also currently evaluating the potential impact on our financial statements of the additional new accounting pronouncements described below:
In February 2016, the FASB issued a new standard on accounting for leases. Under the new standard, a lessee should recognize on its balance sheet a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. The standard permits an entity to make an accounting policy election not to recognize lease assets and liabilities for leases with a term of 12 months or less. The standard, which also requires additional quantitative and qualitative disclosures about leasing arrangements, will become effective for us beginning fiscal 2020. It is to be applied using a modified retrospective transition approach for leases existing at the beginning of the earliest comparative period presented in the adoption-period financial statements.
In August 2016, the FASB issued new guidance on the classification of certain cash receipts and cash payments on the statement of cash flows. The new guidance, which addresses eight specific cash flow classification issues, is intended to reduce diversity in practice. It will become effective for us beginning fiscal 2019 and is to be applied retrospectively.
In October 2016, the FASB issued revised guidance that requires the recognition of the income tax consequences (expense or benefit) of an intercompany transfer of assets other than inventory when the transfer occurs. It maintains

7



the existing requirement to defer the recognition of the income tax consequences of an intercompany transfer of inventory until the inventory is sold to an outside party. The guidance will become effective for us beginning fiscal 2019 and is to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption.
In January 2017, the FASB issued updated guidance that eliminates the second step of the existing two-step quantitative test of goodwill for impairment. Under the new guidance, the quantitative test will consist of a single step in which the carrying amount of the reporting unit will be compared to its fair value. An impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the amount of the impairment would be limited to the total amount of goodwill allocated to the reporting unit. The guidance does not affect the existing option to perform the qualitative assessment for a reporting unit to determine whether the quantitative impairment test is necessary. Although adoption is not required until fiscal 2021, we currently expect to adopt the new standard, prospectively, beginning in fiscal 2019.
In March 2017, the FASB issued new guidance for the presentation of the net periodic cost (NPC) associated with pension and other postretirement benefit plans. The guidance requires the service cost component of the NPC to be reported in the income statement in the same line item(s) as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of the NPC are to be presented separately from the service cost and outside of income from operations. In addition, the guidance allows only the service cost component of NPC to be eligible for capitalization when applicable. The guidance will become effective for us beginning fiscal 2019. It is to be applied retrospectively for the presentation in the income statement and prospectively, on and after the effective date, for the capitalization of service cost.
In August 2017, the FASB issued updated guidance on hedge accounting. The guidance expands hedge accounting for financial and nonfinancial risk components, eliminates the requirement to separately measure and report hedge ineffectiveness, simplifies the way assessments of hedge effectiveness may be performed, and amends some presentation and disclosure requirements for hedges. The guidance will become effective for us beginning fiscal 2020. It is to be applied using a modified retrospective transition approach for cash flow and net investment hedges existing at the date of adoption. The amended presentation and disclosure guidance is required only prospectively. Although we have not yet determined our plans for adoption, we are considering the possibility of adopting this new guidance before the required adoption date.

Early adoption of any of the new accounting pronouncements described above is permitted. However, except as noted above, we do not currently expect to adopt the new pronouncements before their effective dates.

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 $272 million higher than reported as of April 30, 2017, and $285 million higher than reported as of October 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 or a change in judgment occurs. The effective tax rate of 25.5% for the six months ended October 31, 2017, is lower than the expected tax rate of 28.4% on ordinary income for the full fiscal year, primarily due to (a) a reduction in U.S. tax recorded in the first quarter of fiscal 2018 for certain prior years on foreign exchange gains in non-U.S. entities due to a change in method of accounting for U.S. tax purposes, and (b) the excess tax benefits related to stock-based compensation. Our expected tax rate includes current fiscal year additions for existing tax contingency items.

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
 
Six Months Ended
 
October 31,
 
October 31,
(Dollars in millions, except per share amounts)
2016
 
2017
 
2016
 
2017
Net income available to common stockholders
$
197

 
$
239

 
$
342

 
$
417

Share data (in thousands):
 
 
 
 
 
 
 
Basic average common shares outstanding
389,050

 
384,120

 
390,994

 
384,076

Dilutive effect of stock-based awards
2,798

 
2,507

 
2,895

 
2,428

Diluted average common shares outstanding
391,848

 
386,627

 
393,889

 
386,504

 
 
 
 
 
 
 
 
Basic earnings per share
$
0.51

 
$
0.62

 
$
0.87

 
$
1.08

Diluted earnings per share
$
0.50

 
$
0.62

 
$
0.87

 
$
1.08


We excluded common stock-based awards for approximately 1,937,000 shares and 1,201,000 shares from the calculation of diluted earnings per share for the three months ended October 31, 2016 and 2017, respectively. We excluded common stock-based awards for approximately 1,555,000 shares and 1,288,000 shares from the calculation of diluted earnings per share for the six months ended October 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 October 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 $11 million (subject to changes in foreign currency exchange rates). Both the fair value and carrying amount of the guaranty are insignificant.

As of October 31, 2017, our actual exposure under the guaranty of the importer’s obligation is approximately $9 million. We also have accounts receivable from that importer of approximately $10 million at October 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,
2017
 
October 31,
2017
1.00% senior notes, $250 principal amount, due January 15, 2018
$
249

 
$
250

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

 
248

1.20% senior notes, €300 principal amount, due July 7, 2026
324

 
346

2.60% senior notes, £300 principal amount, due July 7, 2028
383

 
391

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

 
248

4.50% senior notes, $500 principal amount, due July 15, 2045
486

 
486

 
1,938

 
1,969

Less current portion
249

 
250

 
$
1,689

 
$
1,719

As of April 30, 2017, our short-term borrowings of $211 million included $208 million of commercial paper, with an average interest rate of 1.04% and a remaining maturity of 22 days. As of October 31, 2017, our short-term borrowings of $235 million included $230 million of commercial paper, with an average interest rate of 1.28% and a remaining maturity of 20 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. Information about similar international plans is not presented due to immateriality.
 
Three Months Ended
 
Six Months Ended
 
October 31,
 
October 31,
(Dollars in millions)
2016
 
2017
 
2016
 
2017
Pension Benefits:
 
 
 
 
 
 
 
Service cost
$
6

 
$
6

 
$
13

 
$
12

Interest cost
9

 
7

 
18

 
15

Expected return on plan assets
(10
)
 
(10
)
 
(21
)
 
(21
)
Amortization of net actuarial loss
6

 
6

 
13

 
11

Net cost
$
11

 
$
9

 
$
23

 
$
17

 
 
 
 
 
 
 
 
Other Postretirement Benefits:
 
 
 
 
 
 
 
Service cost
$

 
$

 
$
1

 
$

Interest cost
1

 
1

 
1

 
1

Amortization of prior service cost (credit)
(1
)
 
(1
)
 
(1
)
 
(1
)
Net cost
$

 
$

 
$
1

 
$



10



8.    Fair Value Measurements
The following table summarizes the assets and liabilities measured or disclosed at fair value on a recurring basis:
 
April 30, 2017
 
October 31, 2017
 
Carrying
 
Fair
 
Carrying
 
Fair
(Dollars in millions)
Amount
 
Value
 
Amount
 
Value
Assets:
 
 
 
 
 
 
 
Cash and cash equivalents
$
182

 
$
182

 
$
212

 
$
212

Currency derivatives
25

 
25

 
3

 
3

Liabilities:
 
 
 
 
 
 
 
Currency derivatives
10

 
10

 
21

 
21

Short-term borrowings
211

 
211

 
235

 
235

Current portion of long-term debt
249

 
249

 
250

 
249

Long-term debt
1,689

 
1,752

 
1,719

 
1,791


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.

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 spot rates, forward rates, and discount rates. The discount rates are based on the historical U.S. Treasury rates. These fair value measurements are categorized as Level 2 within the valuation hierarchy.

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. These fair value measurements are categorized as Level 2 within the valuation hierarchy.

The fair value of cash, cash equivalents, and short-term borrowings approximate the carrying amounts due to the short maturities of these instruments.

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.    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

11



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 $1,188 million at April 30, 2017 and $1,149 million at October 31, 2017.

During fiscal 2017, we designated 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. During fiscal 2018, we have continued to designate some foreign currency-denominated debt for that purpose. 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 October 31, 2017, $607 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.

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 as derivative instruments.

12




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

 
 

Net gain (loss) recognized in AOCI
n/a
$
23

 
$
7

Net gain (loss) reclassified from AOCI into earnings
Sales
9

 
(5
)
Currency derivatives not designated as hedging instruments:
 
 

 
 

Net gain (loss) recognized in earnings
Sales
2

 
1

Net gain (loss) recognized in earnings
Other income
(3
)
 
(4
)
Non-Derivative Hedging Instruments
 
 
 
 
Foreign currency-denominated debt designated as net investment hedge:
 
 
 
 
Net gain (loss) recognized in AOCI
n/a
34

 
1

Foreign currency-denominated debt not designated as hedging instrument:
 
 
 
 
Net gain (loss) recognized in earnings
Other income
3

 
1

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

 
 

Net gain (loss) recognized in AOCI
n/a
$
52

 
$
(29
)
Net gain (loss) reclassified from AOCI into earnings
Sales
19

 
(3
)
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 earnings
Sales
3

 
(2
)
Net gain (loss) recognized in earnings
Other income
(8
)
 
5

Non-Derivative Hedging Instruments
 
 
 
 
Foreign currency-denominated debt designated as net investment hedge:
 
 
 
 
Net gain (loss) recognized in AOCI
n/a
24

 
(15
)
Foreign currency-denominated debt not designated as hedging instrument:
 
 
 
 
Net gain (loss) recognized in earnings
Other income
2

 
(15
)

We expect to reclassify $5 million of deferred net losses on cash flow hedges recorded in AOCI as of October 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 October 31, 2017, the maximum term of our outstanding derivative contracts was 36 months.


13



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, 2017:
 
 
 
 
 
Designated as cash flow hedges:
 
 
 
 
 
Currency derivatives
Other current assets
 
$
21

 
$
(2
)
Currency derivatives
Other assets
 
9

 
(4
)
Currency derivatives
Accrued expenses
 
2

 
(8
)
Currency derivatives
Other liabilities
 
1

 
(4
)
Not designated as hedges:
 
 
 
 
 
Currency derivatives
Other current assets
 
2

 
(1
)
Currency derivatives
Accrued expenses
 

 
(1
)
October 31, 2017:
 
 
 
 
 
Designated as cash flow hedges:
 
 
 
 
 
Currency derivatives
Other current assets
 
5

 
(3
)
Currency derivatives
Other assets
 
1

 

Currency derivatives
Accrued expenses
 
6

 
(15
)
Currency derivatives
Other liabilities
 
4

 
(15
)
Not designated as hedges:
 
 
 
 
 
Currency derivatives
Accrued expenses
 

 
(1
)

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 $9 million at April 30, 2017 and $21 million at October 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.


14



The following table summarizes the gross and net amounts of our derivative contracts:
(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, 2017:
 
 
 
 
 
 
 
 
 
Derivative assets
$
35

 
$
(10
)
 
$
25

 
$
(1
)
 
$
24

Derivative liabilities
(20
)
 
10

 
(10
)
 
1

 
(9
)
October 31, 2017:
 
 
 
 
 
 
 
 
 
Derivative assets
16

 
(13
)
 
3

 

 
3

Derivative liabilities
(34
)
 
13

 
(21
)
 

 
(21
)

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

10.    Goodwill and Other Intangible Assets
The following table summarizes the changes in goodwill and other intangible assets during the six months ended October 31, 2017:
(Dollars in millions)
Goodwill
 
Other Intangible Assets
Balance at April 30, 2017
$
753

 
$
641

Foreign currency translation adjustment
3

 
18

Balance at October 31, 2017
$
756

 
$
659


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

11.    Stockholders’ Equity
The following table summarizes the changes in stockholders’ equity during the six months ended October 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, 2017
$
25

 
$
43

 
$
65

 
$
4,470

 
$
(390
)
 
$
(2,843
)
 
$
1,370

Retirement of treasury stock
 
 
(10
)
 
(8
)
 
(2,684
)
 
 
 
2,702

 

Net income
 
 
 
 
 
 
417

 
 
 
 
 
417

Net other comprehensive income (loss)
 
 
 
 
 
 
 
 
(1
)
 
 
 
(1
)
Cash dividends
 
 
 
 
 
 
(140
)
 
 
 
 
 
(140
)
Acquisition of treasury stock
 
 
 
 
 
 
 
 
 
 
(1
)
 
(1
)
Stock-based compensation expense
 
 
 
 
9

 
 
 
 
 
 
 
9

Stock issued under compensation plans
 
 
 
 
 
 
 
 
 
 
10

 
10

Loss on issuance of treasury stock issued under compensation plans
 
 
 
 
(17
)
 

 
 
 
 
 
(17
)
Balance at October 31, 2017
$
25

 
$
33

 
$
49

 
$
2,063

 
$
(391
)
 
$
(132
)
 
$
1,647


Retirement of Treasury Stock. On May 24, 2017, we retired 67,000,000 shares of Class B common stock previously held as treasury shares. This retirement reduced the number of issued shares of Class B common stock by that same amount.


15



Dividends. The following table summarizes the cash dividends declared per share on our Class A and Class B common stock during the six months ended October 31, 2017:
Declaration Date
 
Record Date
 
Payable Date
 
Amount per Share
May 24, 2017
 
June 5, 2017
 
July 3, 2017
 
$0.1825
July 27, 2017
 
September 7, 2017
 
October 2, 2017
 
$0.1825
As announced on November 16, 2017, our Board of Directors increased the quarterly cash dividend on our Class A and Class B common stock from $0.1825 per share to $0.1975 per share. Stockholders of record on December 7, 2017, will receive the cash dividend on January 2, 2018.

Accumulated Other Comprehensive Income. The following table summarizes the changes in each component of AOCI, net of tax, during the six months ended October 31, 2017:
(Dollars in millions)
Currency Translation Adjustments
 
Cash Flow Hedge Adjustments
 
Postretirement Benefits Adjustments
 
Total AOCI
Balance at April 30, 2017
$
(204
)
 
$
11

 
$
(197
)
 
$
(390
)
Net other comprehensive income (loss)
9

 
(16
)
 
6

 
(1
)
Balance at October 31, 2017
$
(195
)
 
$
(5
)
 
$
(191
)
 
$
(391
)



16



12.    Other Comprehensive Income
The following tables present the components of net other comprehensive income (loss):
 
Three Months Ended
 
Three Months Ended
 
October 31, 2016
 
October 31, 2017
(Dollars in millions)
Pre-Tax
 
Tax
 
Net
 
Pre-Tax
 
Tax
 
Net
Currency translation adjustments:
 
 
 
 
 
 
 
 
 
 
 
Net gain (loss) on currency translation
$
(4
)
 
$
(14
)
 
$
(18
)
 
$
(25
)
 
$

 
$
(25
)
Reclassification to earnings

 

 

 

 

 

Other comprehensive income (loss), net
(4
)
 
(14
)
 
(18
)
 
(25
)
 

 
(25
)
Cash flow hedge adjustments:
 
 
 
 
 
 
 
 
 
 
 
Net gain (loss) on hedging instruments
23

 
(9
)
 
14

 
7

 
(3
)
 
4

Reclassification to earnings1
(9
)
 
4

 
(5
)
 
5

 
(2
)
 
3

Other comprehensive income (loss), net
14

 
(5
)
 
9

 
12

 
(5
)
 
7

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

 

 

 
(1
)
 

 
(1
)
Reclassification to earnings2
7

 
(3
)
 
4

 
6

 
(2
)
 
4

Other comprehensive income (loss), net
7

 
(3
)
 
4

 
5

 
(2
)
 
3

 
 
 
 
 
 
 
 
 
 
 
 
Total other comprehensive income (loss), net
$
17

 
$
(22
)
 
$
(5
)
 
$
(8
)
 
$
(7
)
 
$
(15
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended
 
Six Months Ended
 
October 31, 2016
 
October 31, 2017
(Dollars in millions)
Pre-Tax
 
Tax
 
Net
 
Pre-Tax
 
Tax
 
Net
Currency translation adjustments:
 
 
 
 
 
 
 
 
 
 
 
Net gain (loss) on currency translation
(72
)
 
(13
)
 
(85
)
 
3

 
6

 
9

Reclassification to earnings

 

 

 

 

 

Other comprehensive income (loss), net
(72
)
 
(13
)
 
(85
)
 
3

 
6

 
9

Cash flow hedge adjustments:
 
 
 
 
 
 
 
 
 
 
 
Net gain (loss) on hedging instruments
52

 
(20
)
 
32

 
(29
)
 
11

 
(18
)
Reclassification to earnings1
(19
)
 
8

 
(11
)
 
3

 
(1
)
 
2

Other comprehensive income (loss), net
33

 
(12
)
 
21

 
(26
)
 
10

 
(16
)
Postretirement benefits adjustments:
 
 
 
 
 
 
 
 
 
 
 
Net actuarial gain (loss) and prior service cost

 

 

 

 

 

Reclassification to earnings2
12

 
(5
)
 
7

 
10

 
(4
)
 
6

Other comprehensive income (loss), net
12

 
(5
)
 
7

 
10

 
(4
)
 
6

 
 
 
 
 
 
 
 
 
 
 
 
Total other comprehensive income (loss), net
$
(27
)
 
$
(30
)
 
$
(57
)
 
$
(13
)
 
$
12

 
$
(1
)
1Pre-tax amount is classified as 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).


17



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 2017 Form 10-K. Note that the results of operations for the six months ended October 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.

Presentation Basis
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, 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.
“Underlying change” in income statement measures. We present changes in certain income statement measures, or line items, that are adjusted to an “underlying” basis. We use “underlying change” for the following income statement measures: (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, (f) underlying other expense (income), (g) underlying operating expenses, and (h) underlying operating income. To calculate these measures, we adjust, as applicable, for (a) acquisitions and divestitures, (b) foreign exchange, and (c) estimated net changes in distributor inventories. We explain these adjustments below.
“Acquisitions and divestitures.” This adjustment removes (a) any non-recurring effects related to our acquisitions and divestitures (e.g., transaction gains or losses, transaction costs, and integration costs), and (b) the effects of operating activity related to acquired and divested brands for periods that are not comparable on a year-over-year basis (non-comparable periods). By excluding non-comparable periods, we therefore include the effects of acquired and divested brands only to the extent that results are comparable on a year-over-year basis.
In fiscal 2016, we sold our Southern Comfort and Tuaca brands and related assets to Sazerac Company, Inc. and entered into a related transition services agreement (TSA). During fiscal 2017, we completed our obligations under the TSA. This adjustment removes the net sales and operating expenses recognized in fiscal 2017 pursuant to the TSA related to (a) contract bottling services and (b) distribution services in certain markets. On June 1, 2016, we acquired The BenRiach Distillery Company Limited (BenRiach). This adjustment removes (a) transaction and integration costs related to the acquisition and (b) operating activity for the acquisition for the non-comparable period. For both fiscal 2017 and 2018, the non-comparable period is the month of May.
“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 year results at prior-year rates.
“Estimated net change in distributor inventories.” This adjustment refers to the estimated net effect of changes in distributor inventories on changes in our income statement line items. For each period compared, we use depletion information provided by our distributors to estimate the effect of distributor inventory changes on our income statement line items.
We use the non-GAAP measures “underlying change” for the following reasons: (a) to understand our performance from period to period on a consistent basis; (b) to compare our performance to that of our competitors; (c) in connection with management incentive compensation calculations; (d) in our planning and forecasting processes; and (e) in communications concerning our financial performance with the board of directors, stockholders, and investment analysts. We provide reconciliations of the “underlying changes in income statement measures” to their nearest GAAP measures in the tables below under “Results of Operations - Year-Over-Year Period Comparisons.” We have consistently applied the adjustments within our reconciliations in arriving at each non-GAAP measure.

18



Definitions
Geographic Aggregations.
From time to time, in order to explain our results of operations or to highlight trends and uncertainties affecting our business, we aggregate markets according to stage of economic development as defined by the International Monetary Fund.
“Developed” markets are “advanced economies” as defined by the International Monetary Fund, with the largest for Brown-Forman being the United States, the United Kingdom, and Australia. Developed international markets are developed markets excluding the United States.
“Emerging” markets are “emerging and developing economies” as defined by the International Monetary Fund, with the largest for Brown-Forman being Mexico and Poland.
In “Results of Operations - Fiscal 2018 Year-to-Date Highlights”, we provide supplemental information for our largest markets ranked by percentage of total fiscal 2017 Net Sales. In addition to markets that are listed by country name, we include the following aggregations:
“Rest of Europe” includes all markets in the continent of Europe and the Commonwealth of Independent States other than those specifically listed.
“Remaining geographies” All other markets (approximately 110), other than those specifically listed or included in “Rest of Europe”, with the largest being Brazil, South Africa, and China.
“Travel Retail” represents our sales to global duty free customers, travel retail customers, and the U.S. military.
“Other non-branded” includes used barrel, bulk whiskey and wine, and contract bottling sales.
Brand Aggregations.
From time to time, in order to explain our results of operations or to highlight trends and uncertainties affecting our business, we aggregate brands by spirits category.
“Premium bourbon” products include Woodford Reserve, Old Forester, and Coopers’ Craft.
“American whiskey” products include the Jack Daniel’s family of brands, premium bourbons, and Early Times.
“Tequila” products include el Jimador, Herradura, New Mix, Pepe Lopez, and Antiguo.
In “Results of Operations - Fiscal 2018 Year-to-Date Highlights”, we provide supplemental information for our largest brands ranked by percentage of total fiscal 2017 Net Sales. In addition to brands that are listed by name, we include the following aggregations:
“Jack Daniel’s family of brands” includes Jack Daniel’s Tennessee Whiskey (JDTW), Jack Daniel’s Tennessee Honey (JDTH), Jack Daniel’s RTD and RTP products (JD RTDs/RTP), Gentleman Jack, Jack Daniel’s Tennessee Fire (JDTF), Jack Daniel’s Single Barrel Collection, Jack Daniel’s Tennessee Rye Whiskey, Jack Daniel’s Sinatra Select, Jack Daniel’s No. 27 Gold Tennessee Whiskey, and Jack Daniel’s 1907 Tennessee Whiskey.
“Jack Daniel’s RTD and RTP” products include all RTD line extensions of Jack Daniel’s, such as Jack Daniel’s & Cola, Jack Daniel’s & Diet Cola, Jack & Ginger, Jack Daniel’s Country Cocktails, Gentleman Jack & Cola, Jack Daniel’s Double Jack, Jack Daniel’s American Serve, Jack Daniel’s Tennessee Honey RTD, Jack Daniel’s Cider (JD Cider), Jack Daniel’s Lynchburg Lemonade (JD Lynchburg Lemonade), and the seasonal Jack Daniel’s Winter Jack RTP.
Other Metrics.
“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.
“Drinks-equivalent.” 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-

19



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.

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 2017 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, 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

20



Overview
Fiscal 2018 Year-to-Date Highlights
Key highlights of our operating results for the six months ended October 31, 2017 include:
We delivered net sales of $1.6 billion, an increase of 10% compared to the same period last year. Excluding (a) the net effect of our Scotch acquisition and the loss of net sales related to our TSA for Southern Comfort and Tuaca, (b) the positive effect of foreign exchange, and (c) an estimated net increase in distributor inventories, we grew underlying net sales 7%.
We delivered operating income of $590 million, an increase of 17% compared to the same period last year. Excluding (a) the net effect of our Scotch acquisition and the loss of net sales related to our TSA for Southern Comfort and Tuaca, (b) the negative effect of foreign exchange, and (c) an estimated net increase in distributor inventories, we grew underlying operating income 14%.
We delivered diluted earnings per share of $1.08, an increase of 24% compared to the same period last year due to an increase in reported operating income, the benefit of a lower effective tax rate, and a reduction in shares outstanding.
Our underlying operating results were driven by the Jack Daniel's family of brands, our premium bourbon brands, and our tequila brands. Our used barrels sales also increased compared to the same period last year. From a geographic perspective, the United States and emerging markets led the growth, developed international markets contributed meaningfully, and Travel Retail growth accelerated. In addition, our underlying operating results benefited from a decline in underlying SG&A spend, as well as underlying advertising expense growth of 5% compared to underlying net sales growth of 7%.
While foreign exchange had a positive effect on net sales, our operating income was negatively affected, driven by the reduction of foreign exchange gains in other expense (income) compared to the same period last year. An estimated net increase in distributor inventories, primarily in the United States, positively affected our reported results.
Summary of Operating Performance
 
Three months ended October 31,
 
Six months ended October 31,
(Dollars in millions)
2016
 
2017
 
Reported Change
 
Underlying Change1
 
2016
 
2017
 
Reported Change
 
Underlying Change1
Net sales
$
830

 
$
914

 
10
%
 
8
%
 
$
1,491

 
$
1,637

 
10
%
 
7
%
Cost of sales
278

 
304

 
9
%
 
9
%
 
486

 
534

 
10
%
 
8
%
Gross profit
552

 
610

 
11
%
 
8
%
 
1,005

 
1,103

 
10
%
 
7
%
Advertising
107

 
111

 
4
%
 
3
%
 
190

 
200

 
5
%
 
5
%
SG&A
163

 
163

 
%
 
(1
%)
 
326

 
324

 
(1
%)
 
(1
%)
Other expense (income), net

(9
)
 
(10
)
 
3
%
 
(4
%)
 
(15
)
 
(11
)
 
(28
%)
 
(2
%)
Operating income
$
291

 
$
346

 
19
%
 
16
%
 
$
504

 
$
590

 
17
%
 
14
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As a percentage of net sales2
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit
66.5
%
 
66.8
%
 
0.3
 pp
 
 
 
67.4
%
 
67.4
%
 

 
 
Operating expenses3
31.4
%
 
28.9
%
 
(2.5
)pp
 
 
 
33.6
%
 
31.4
%
 
(2.2
)pp
 
 
Operating income
35.1
%
 
37.9
%
 
2.8
 pp
 
 
 
33.8
%
 
36.0
%
 
2.2
 pp
 
 
Interest expense, net
$
15

 
15

 
3
%
 
 
 
$
27

 
30

 
10
%
 
 
Effective tax rate
28.6
%
 
27.9
%
 
(0.7
)pp
 
 
 
28.4
%
 
25.5
%
 
(2.9
)pp
 
 
Diluted earnings per share
$
0.50

 
$
0.62

 
23
%
 
 
 
$
0.87

 
$
1.08

 
24
%
 
 
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.
2Year-over-year changes in percentages are reported in percentage points (pp).
3Operating expenses include advertising expense, SG&A expense, and other expense (income), net.

21



Fiscal 2018 Outlook
Below we discuss our outlook for the remainder of fiscal 2018, reflecting the trends, developments, and uncertainties that we expect to affect our business. Overall, we expect slower growth rates for both net sales and operating income in the remainder of fiscal 2018 compared to growth rates experienced in the six months ended October 31, 2017. This updated outlook revises certain aspects of the 2018 outlook included in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our 2017 Form 10-K.
Net sales. We expect net sales growth to be slower in the remainder of fiscal 2018 than the 10% growth in the six months ended October 31, 2017. We believe net sales growth in emerging markets will be slower in the remainder of the fiscal year compared to the growth rate experienced in the six months ended October 31, 2017. Our reported net sales benefited from an estimated net increase in distributor inventories during the six months ended October 31, 2017, and we do not expect that benefit to continue in the remainder of the fiscal year.
Cost of sales. We expect total cost of sales to grow at a higher rate than net sales in the remainder of fiscal 2018. We expect underlying cost of sales growth from cost/mix to grow at a higher rate in the remainder of the year compared to 2% cost/mix growth for the six months ended October 31, 2017.
Operating expenses. We expect total operating expenses to grow at a higher rate in the remainder of the fiscal year compared to the growth rate experienced in the six months ended October 31, 2017. For the remainder of fiscal 2018, we expect (a) advertising expenses to grow at a higher rate than net sales growth, and (b) underlying SG&A to grow compared to the decline for the six months ended October 31, 2017.
Foreign exchange. For the six months ended October 31, 2017, operating income was adversely affected by foreign exchange. For the remainder of fiscal 2018, we expect that foreign exchange will positively affect our results.
Effective tax rate. Absent any changes due to the enactment of proposed U.S. tax reform legislation, we expect our effective tax rate to increase in the remainder of fiscal 2018 compared to the 25.5% effective tax rate for the six months ended October 31, 2017. We expect our full year effective tax rate to be approximately 27.5% based on the tax rate of 28.4% on ordinary income for the full fiscal year adjusted for known discrete items.

22



Results of Operations – Fiscal 2018 Year-to-Date Highlights
Market Highlights
The following table provides supplemental information for our largest markets for the six months ended October 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 six months ended October 31, 2017, compared to the same period last year.
Top 10 Markets1 - Fiscal 2018 Net Sales Growth by Geographic Area
 
Percentage change versus prior year period
Six months ended October 31, 2017
Net Sales
Geographic area
Reported
Acquisitions & Divestitures
Foreign Exchange
Net Chg in Est. Distributor Inventories
 
Underlying2
United States
9
%
%
%
(3
%)

6
%
Europe
16
%
%
(4
%)
(2
%)

10
%
United Kingdom
15
%
%
(8
%)
%

7
%
Germany
13
%
(1
%)
(2
%)
%

11
%
France
8
%
%
(2
%)
%

6
%
Poland
24
%
%
(12
%)
%

12
%
Russia
NM

%
(18
%)
NM


43
%
Rest of Europe
6
%
%
(1
%)
3
%

8
%
Australia
7
%
2
%
%
%

10
%
Other geographies
5
%
%
%
1
%

6
%
Mexico
9
%
%
(1
%)
1
%

9
%
Japan
(18
%)
%
3
%
1
%

(15
%)
Canada
(3
%)
%
2
%
1
%

%
Remaining geographies3
11
%
(1
%)
%
1
%

11
%
Travel Retail3
18
%
%
2
%
(9
%)

11
%
Other non-branded3
(6
%)
21
%
%
%

14
%
Total
10
%
1
%
(1
%)
(2
%)

7
%
Note: Totals may differ due to rounding
 
 
 
 
 
 
 
 
1“Top 10 markets” are ranked based on percentage of total fiscal 2017 Net Sales. See 2017 Form 10-K “Results of Operations - Fiscal 2017 Market Highlights” and “Note 15. 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.
3See “Definitions” above for definitions of market aggregations presented here.

United States. Reported net sales grew 9%, while underlying net sales increased 6% after adjusting for an estimated net increase in distributor inventories. Underlying net sales gains were driven primarily by the growth of (a) the Jack Daniel’s family of brands, (b) our premium bourbons, led by Woodford Reserve and Old Forester, and (c) our tequila brands, led by Herradura and el Jimador.
Europe. Reported net sales increased 16%, while underlying net sales increased 10% after adjusting for the positive effect of foreign exchange driven by the broad weakening of the dollar compared to the same period last year and an estimated net increase in distributor inventories in Russia. Underlying net sales gains were led by Russia, Germany, the United Kingdom, Poland, Turkey, and France.
In the United Kingdom, underlying net sales growth was driven by higher volumes of JDTW and JD RTDs, the latter of which was fueled by the launch of JD Cider.
In Germany, underlying net sales growth was driven by solid growth of JD RTDs, including the launch of JD Lynchburg Lemonade, and volumetric growth and favorable price/mix of JDTW.

23



In France, underlying net sales growth was led by JDTW and JDTH, as both experienced higher consumer demand compared to the total whiskey category.
In Poland, underlying net sales growth was fueled by volume gains of JDTW, which has experienced strong consumer takeaway trends.
In Russia, underlying net sales growth was driven by higher price and volumetric growth of Finlandia. The higher prices are partly attributed to import duties resulting from a change in our route-to-consumer.
The increase in underlying net sales in the Rest of Europe was led by improved trends for JDTW in Turkey, where our results in the same period last year were negatively affected by geopolitical and economic instability.
Australia. Reported net sales increased 7%, while underlying net sales increased 10% after adjusting for the loss of net sales related to our TSA for Southern Comfort and Tuaca. Underlying net sales growth was driven by the Jack Daniel’s family of brands, led by favorable price/mix and higher volumes of JD RTDs and volumetric growth of JDTW.
Other geographies. Reported net sales for our other markets collectively increased 5%, while underlying net sales increased 6% after adjusting for an estimated net decrease in distributor inventories. Underlying net sales growth was led by Mexico as well as the return to growth of Southeast Asia, China, and Brazil, all of which declined in the same period last year. These gains were partially offset by declines in Japan, where volumes increased considerably in the same period last year due to buy-ins ahead of a price increase last September.
Travel Retail. Reported net sales increased 18%, while underlying net sales increased 11% after adjusting for the negative effect of foreign exchange and an estimated net increase in distributor inventories. Underlying net sales growth was led by higher volumes of JDTW, Woodford Reserve, Gentleman Jack, and Herradura, the last of which also benefited from favorable price/mix.
Other non-branded. Reported net sales decreased 6%, while underlying net sales increased 14% after adjusting for the net effect of our Scotch acquisition and the loss of net sales related to our TSA for Southern Comfort and Tuaca. The underlying net sales growth was driven by higher volumes of used barrel sales, which benefited from an easy comparison to a weak prior-year period, as well as timing of shipments in the current year.

24



Brand Highlights
The following table highlights the worldwide results of our largest brands for the six months ended October 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 six months ended October 31, 2017, compared to the same period last year.
Major Brands Worldwide Results
 
Percentage change versus prior year period
Six months ended October 31, 2017
Volumes
 
Net Sales
Brand family / brand
9L Depletions2
 
Reported
Foreign Exchange
Net Chg in Est. Distributor Inventories
 
Underlying1
Jack Daniel’s Family
9
%
 
10
%
(1
%)
(2
%)
 
7
%
Jack Daniel’s Tennessee Whiskey
7
%
 
9
%
(1
%)
(2
%)
 
6
%
Jack Daniel’s Tennessee Honey
9
%
 
10
%
(2
%)
%
 
8
%
Jack Daniel’s RTDs/RTP2
11
%
 
14
%
1
%
%
 
15
%
Gentleman Jack
9
%
 
11
%
%
(2
%)
 
9
%
Jack Daniel’s Tennessee Fire
15
%
 
22
%
(1
%)
(7
%)
 
14
%
Other Jack Daniel’s whiskey brands2
19
%
 
36
%
(1
%)
(22
%)
 
13
%
Woodford Reserve
20
%
 
23
%
%
(2
%)
 
21
%
Finlandia
5
%
 
18
%
(3
%)
(7
%)
 
8
%
el Jimador
8
%
 
15
%
(1
%)
(4
%)
 
10
%
Herradura
13
%
 
15
%
%
5
%
 
19
%
Note: 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.
2See “Definitions” above for definitions of brand aggregations and volume measures presented here.

Jack Daniel’s family of brands grew reported net sales 10% (underlying 7%), and was the most significant contributor to our overall underlying net sales growth. Reported net sales were helped by an estimated net increase in distributor inventories and foreign exchange due to the weakening of the dollar against the British pound, Polish zloty, and the euro. The following are details about the underlying performance of the Jack Daniel’s family of brands:
JDTW grew underlying net sales in the majority of its markets including the United States, the United Kingdom, Poland, Turkey, Southeast Asia, and Travel Retail.
JDTH grew underlying net sales in the United States, its largest market, Latin America, Russia, and France.
The increase in underlying net sales growth for Jack Daniel’s RTDs/RTP was driven by Australia, Germany, and the United States, with all markets benefiting from new RTD line extensions.
Gentleman Jack grew underlying net sales led by volumetric growth in the United States, its largest market, and Travel Retail.
Growth of JDTF was driven by higher volumes in the United States and the launch of the brand in Brazil and Chile.
The launch of Jack Daniel’s Tennessee Rye in September of this year in the United States was the primary driver of underlying net sales growth for Other Jack Daniel’s whiskey brands.
Woodford Reserve led the growth of our premium bourbons as reported net sales increased 23% (underlying 21%). This growth was driven by the United States, where the brand continued to grow volumetrically with strong consumer takeaway trends. Reported net sales were helped by an estimated net increase in distributor inventories in Travel Retail.
Reported net sales for Finlandia grew 18%, while underlying net sales increased 8% led by higher price and volumetric growth in Russia. The higher prices in Russia are partly attributed to import duties resulting from a change in our route-to-consumer. Reported net sales were helped by an estimated net increase in distributor inventories in Russia and foreign exchange.

25



Reported net sales for el Jimador increased 15%, while underlying net sales increased 10% driven by volume gains in the United States supported by strong takeaway trends. Reported net sales were helped by an estimated net increase in distributor inventories in the United States and foreign exchange.
Herradura grew reported net sales 15%, while underlying net sales increased 19% driven by higher volumes and favorable price/mix in the brand’s largest markets, the United States and Mexico, the latter of which benefited from volumetric growth of Herradura Ultra. Reported net sales were hurt by an estimated net decrease in distributor inventories in the United States.


26



Year-over-Year Period Comparisons
Net Sales
Percentage change versus the prior year period ended October 31
 
 
3 Months
 
 
6 Months
Change in reported net sales
 
 
10
%
 
 
10
%
Acquisitions and divestitures
 
 
1
%
 
 
1
%
Foreign exchange
 
 
(1
%)
 
 
(1
%)
Estimated net change in distributor inventories
 
 
(2
%)
 
 
(2
%)
Change in underlying net sales
 
 
8
%
 
 
7
%
 
 
 
 
 
 
 
Change in underlying net sales attributed to:
 
 
 
 
 
 
Volume
 
 
7
%
 
 
6
%
Net price/mix
 
 
2
%
 
 
2
%
Note: Totals may differ due to rounding
 
 
 
 
 
 
For the three months ended October 31, 2017, net sales were $914 million, an increase of $84 million, or 10%, compared to the same period last year. After adjusting reported results for (a) the net effect of our Scotch acquisition and the loss of net sales related to our TSA for Southern Comfort and Tuaca, (b) the positive effect of foreign exchange, and (c) an estimated net increase in distributor inventories, underlying net sales grew 8%. The change in underlying net sales was driven by 7% volume growth and 2% of price/mix.
The primary factors contributing to the growth in underlying net sales for the three months ended October 31, 2017 were:
volumetric growth of JDTW in several international markets, most notably, the United Kingdom, Germany, Southeast Asia, Turkey, Travel Retail, France, China, Poland, and Australia;
growth of our American whiskey portfolio in the United States, led by the Jack Daniel’s family, Woodford Reserve, and Old Forester;
volumetric growth and favorable price/mix of Herradura in the United States and Mexico and volume gains of el Jimador in the United States;
higher price and volume growth of Finlandia in Russia;
higher volume of JD RTDs led by Germany and the United Kingdom, both of which benefited from new RTD line extensions, and China;
increased volumes of JDTH in several international markets, most notably the United Kingdom and France;
higher volume of used barrel sales, which is partially due to the timing of orders; and
growth of Korbel Champagne in the United States.
These gains in underlying net sales were partially offset by declines in Japan, where JDTW and Early Times volumes increased considerably in the same period last year due to buy-ins ahead of a price increase last September.
For the six months ended October 31, 2017, net sales were $1,637 million, an increase of $146 million, or 10%, compared to the same period last year. After adjusting reported results for (a) the net effect of our Scotch acquisition and the loss of net sales related to our TSA for Southern Comfort and Tuaca, (b) the positive effect of foreign exchange, and (c) an estimated net increase in distributor inventories, underlying net sales grew 7%. The change in underlying net sales was driven by 6% volume growth and 2% of price/mix. Volume growth was led by the Jack Daniel's family, tequilas, premium bourbons, and Finlandia, partially offset by declines in Early Times. Price/mix was driven by (a) an increase in share of sales from higher priced brands, most notably the Jack Daniel's family and Woodford Reserve, and (b) higher average pricing on tequilas, partially offset by lower pricing on JDTW.
The primary factors contributing to the growth in underlying net sales for the six months ended October 31, 2017 were:
volumetric growth of JDTW in several international markets, most notably, the United Kingdom, Poland, Turkey, Southeast Asia, Travel Retail, Germany, Brazil, France, and Australia;
growth of our American whiskey portfolio in the United States, led by the Jack Daniel’s family, Woodford Reserve, and Old Forester;
our tequila brands, led by (a) higher volumes of Herradura in the United States and Mexico, and (b) volume gains of el Jimador in the United States, and (c) higher prices and volume gains of New Mix in Mexico;

27



higher volume of JD RTDs, led by Australia as well as Germany and the United Kingdom, which both benefited from new RTD line extensions;
higher price and volume growth of Finlandia in Russia;
higher volume of used barrel sales, which is partially due to the timing of orders; and
growth of Korbel Champagne in the United States.
These gains in underlying net sales were partially offset by declines in Japan, where Early Times and JDTW volumes increased considerably in the same period last year due to buy-ins ahead of a price increase last September.
Cost of Sales
Percentage change versus the prior year period ended October 31
 
 
3 Months
 
 
6 Months
Change in reported cost of sales
 
 
9
%
 
 
10
%
Acquisitions and divestitures
 
 
2
%
 
 
3
%
Foreign exchange
 
 
(2
%)
 
 
(3
%)
Estimated net change in distributor inventories
 
 
%
 
 
(1
%)
Change in underlying cost of sales
 
 
9
%
 
 
8
%
 
 
 
 
 
 
 
Change in underlying cost of sales attributed to:
 
 
 
 
 
 
Volume
 
 
7