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Brown-Forman Corporation (NYSE:BF.B)

F3Q09 (Qtr End 01/31/09) Earnings Call

March 10, 2009, 9:30 am ET

Executives

Ben Marmor - Director, IR

Don Berg - EVP and CFO

Paul Varga - President and CEO

Jane Morreau - SVP, Finance Management, Accounting, and Technology

Analysts

Kaumil Gajrawala - UBS

Lauren Torres - HSBC

Timothy Ramey - D.A. Davidson

Lindsay Mann - Goldman Sachs

Bill Leach - TIAA-CREF

Ann Gurkin - Davenport

Kevin Dreyer - Gabelli & Company

Ian Stapleton - Nomura

Operator

Good morning. My name is [Scathe] and I will be your conference operator today. At this time I would like to welcome everyone to the Third Quarter Fiscal 2009 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions).

Thank you, I would now like to turn the call over to Ben Marmor, Director of Investor Relations.

Ben Marmor

Good morning everyone and thank you for joining us for Brown-Forman’s third quarter earnings calls. This is Ben Marmor, the Director of Investor Relations of Brown-Forman. Joining me today are Paul Varga, our President and Chief Executive Officer; Don Berg, Executive Vice President and Chief Financial Officer; and Jane Morreau, Senior Vice President, Finance Management, Accounting and Technology. Don will begin our call this morning with a review of our third quarter results and Paul will follow with some strategic commentary.

As always, this morning's conference call contains forward-looking statements based on our current expectations. Numerous risks and uncertainties may cause actual results to differ materially from those anticipated or projected in these statements. Many of the factors that will determine the future results are beyond the company’s ability to control or predict. You should not place undue reliance on any forward-looking statements and the company undertakes no obligation to update any of these statements whether due to new information, future events or otherwise.

This morning we issued a press release containing our third quarter results for fiscal 2009. The release can be found in our website under the section titled Investor Relations. We have listed in the press release a number of risk factors that you should consider in conjunction with our forward-looking statements. Other significant risk factors are described in our Form 10-K, Form 8-K and Form 10-Q reports filed with the Securities and Exchange Commission.

During this call we will also be discussing certain non-GAAP financial measures. These measures and the reasons management believes they provide useful information to investors regarding the company's financial conditions and results of operations are contained in the press release.

And with that I will turn the call over to Don.

Don Berg

Thank you, Ben, good morning everyone. Well our second quarter certainly posted robust growth, like many of our competitors have announced recently, market conditions during our fiscal third quarter were far more challenging and tested our resiliency.

I am pleased to say, however, that despite these many challenges, we continued to grow our underlying business at both the net sales and operating income lines. For the quarter, underlying sales grew 1% and underlying operating income grew 8%. For the first nine-months of fiscal 2009, we grew underlying sales 4% and underlying operating income 5%.

As you are all aware, the global economy continues to slide throughout this period, affecting our business in a number of ways. First, significant strengthening of the US dollar negatively impacted our results in the quarter reducing net sales $84 million and operating income $30 million.

Second, and when we talked about a number of times before, the move consumers are making away from the on-premise to the off-premise.

Third, we also saw some acceleration of trading down in the United States, but we will talk more about in a bit.

And finally, this quarter we saw retailers, wholesalers and distributors around the world, significantly reduce their inventories in what we believe is our quest for cash and an expectation of lower future consumer demand.

On this last point, let me give you an example of what we are seeing and the magnitude of the different trends. If we take Jack Daniel's in the United States, consumer takeaway using NABCA data as a proxy, was down about 3% for the third quarter. This was approximately half of our depletion decline indicating that retailers did not fully replenish their inventory. Similarly, our shipments to distributors were down about double the depletion rate, suggesting that distributors did not fully restart their inventory levels as well. These four themes you will hear repeatedly in our comments this morning, we also believe that all of these trends are continuing in our fourth quarter which we will discuss more when we talk about our guidance in a few minutes.

While we believe we have adapted quickly in respond to the fast changing conditions around the world our overall philosophy for managing our business has not changed. We continue to focus on driving our current underlying net sales and operating income performance with a view to positioning ourselves for continued long-term success.

I will now highlight some of our specific brand and market performances. Globally, Jack Daniel's depletions declined in the high single digits in the third quarter. And grew in the low single digits for the nine months. For Jack Daniel's in the United States, Q3 proved difficult with depletions declining in the high single digits.

However, for the first nine months, the brand’s depletions were about equal to last year. As noted above, we believe these softer results can be attributed in large part to inventory reductions throughout the supply chain. While takeaway performance outpaced depletions, these trends were somewhat mixed during the quarter depending on the source of information.

For the period ending February 07, 2009, Nielsen which focuses on off-premise business reported solid trends for Jack Daniel's. With 12 month volume growth of 5% compared to 2% for total distilled spirits, three-month volume growth of 4% versus 1% for total distilled spirits, and one-month result plus 3% versus 1% for TDS. On the other hand, NABCA trends through January 31 which includes results for both off- and on-premise were not as strong for Jack Daniel's.

For the 12-month period, Jack Daniel's case sales grew 1.5% compared to twice that for total distilled spirits, but posted a three-month trend and a one-month trend of minus 3% compared to plus 1% for TDS. We believe these statistics reflect our focus at the off-premise level continues to work, while we continue to see the effects of the declines in the on-premise channel. While the 12-month NABCA growth trend of 1.5% is almost identical to a year ago. The more recent performance increases our caution in our rest of the year outlook. While the third quarter NABCA results for Jack Daniel's were disappointing, we are encouraged by the fact that Jack Daniel's outperformed most brands in its competitive set including Bacardi, Absolut, Crown Royal, Grey Goose and Jose Cuervo.

Having said that, the NABCA results also show the trend of trading down to lower price brands as brands such as Evan Williams, Old Crow and Ancient Age all posted some nice growth rates in this difficult economic environment.

In international markets, Jack Daniel's saw overall depletion gains increasing in the low single-digit when compared to third quarter last year. During Q3, Jack Daniel’s depletions expanded at double-digit rates in several markets, including the UK, France, Poland, Romania and Mexico while softness continued in Spain, Italy and Ireland. In the Eastern European region as a whole, Jack Daniel’s continued to post strong high single-digit depletion gains for the quarter. While we are pleased with this continued growth, the rate has slowed from the double-digit levels experienced earlier in the year.

Talking a bit more about the UK, the depletion gains were due in part to significant successful holiday promotion activity and from a retail buy and prior to a February price increase. We have talked in the past about the UK being one of our larger markets, seeing a shift from the on-premise to the off-premise. That shift continued during this period, however, for Jack Daniel’s, the momentum in the off trade began to offset on-trade declines.

Looking for a moment at France, this, our fourth largest Jack Daniel's market has continued to perform well in the third quarter and the year-to-date periods. France is a well developed spirit market and the largest whisky market in the world. In spite of the economic difficulties there, Nielsen data showed the whiskey category grew 3% for the 12-months ended January 2009. Jack Daniel's during the same period grew over 15%.

For the first time, Jack Daniel's now comprises slightly over a 2% share of the whiskey market in France. And we believe this is a perfect illustration of just continuing global potential and how there is a plenty of share left to gain. In Australia, according to data from the Liquor Merchants Association, Brown-Forman increased its market share. Through the first nine-months for fiscal year, our brand’s total share of full strength spirits in this market increased 1 point from 6% to 7%. Our total share of all ready-to-drink products increased almost 3 points from 6% to 9%, and our share of Bourbon based RTD’s increased more than 5 points from 11% to 16%.

Jack Daniels Whisky led our full strength sprits share gains in Australia as the full strength line continue to benefit from consumers switching from ready to drinks due to the dramatic tax increase on RTD products last April. While we believe Jack Daniels benefited from this shift, our Jack Daniel's & Cola ready-to-drink brand also improved its depletion trends in the quarter returning to double-digit growth following the declines experienced in the first half of our fiscal year. We believe this as a result of actions we have taken including a proof reduction to keep pricing affordable for our consumers.

The improved volume trends have not offset the gross profit impact of these changes, but we believe we are in a better position today when after the excise tax took effect last April.

Turning to Gentlemen Jack, this vibrant brand once again registered double-digit depletion gains for the third quarter. Although its overall growth rate moderated somewhat, Gentlemen Jack attain these double-digit gains both in the United States and Internationally.

Moving on to Finlandia, we are very proud that the brand crossed the 3 million case depletion milestone during the quarter. In only three short years, we have been able to add another million cases to the brand. Finlandia has continued to be a powerful Eastern European growth story as the region’s significant growth rates fueled the brand’s double-digit growth on a global basis.

In the third quarter, Finlandia became the number one imported Vodka and the number one imported spirit in the Czech Republic. This adds the Czech Republic to the growing list of markets where Finlandia is the number one imported Vodka, including Poland, Russia, Romania, Bulgaria, Hungary and few other markets that in total represent over 50% of Finlandia’s business.

Southern Comfort had a difficult quarter with global depletion trends down in the high single-digits. In the United States, a high single-digit depletion decline for the quarter was due in part to continued weakness in the on-premise and to what we believe were inventory reductions. This belief is supported by the fact that the brand’s overall depletion trends lag the Nielsen takeaway results which were up 1% for the rolling three months through February 7th compared to the high single-digit declines.

In the UK, Southern Comfort experienced similar issues as in the United States with depletions declining in the mid single-digits for the quarter. In Germany, the brand grew in the low single-digits as the brand benefited from increased promotional activity. Southern Comfort also performed well in Australia as consumers switched from ready-to-drink products to full strength spirits following the excise tax increase I mentioned before.

Casa Herradura Tequilas experienced overall depletion declines in the quarter, while the new mix ready-to-drink product continued its growth. Although our Tequila’s were down, Nielsen trends similar to several of our other brands indicated our Herradura and El Jimador are experiencing inventory reductions as takeaway trends exceeded depletion performance. While Jimador had a difficult quarter, the brand is outperforming as competitive set in each of its major markets. We believe the traders responded well to our 100% of Garvey reformulation and repackaging of El Jimador this past fall. And we are encouraged by the 12-month trends where the brand grew in the mid single-digits globally driven by growth in both of its major markets.

The Herradura brand, however, has been more affected by the current global economic downturn given its ultra premium price point and its heavy skew toward the on-premise. We are working to improve the brand’s tool kit and are taking actions to improve the brands trends such as pushing for further off-premise distribution gains and making packaging improvements.

We continue to be excited about Herradura's and El Jimador's long-term prospects in the US and in Mexico and we also believe these brands have potential well beyond these two markets. In fact, certain international markets such as Greece, Spain, the UK and the Chez Republic, although on a fairly small base, have already exceeded our expectations.

For developing brands, performance was mixed in the third quarter, lots of reserve grew depletions in the middle single-digits, Tuaca was flat and Chambord, Sonoma-Cutrer and Bonterra declined. We believe that the underlying performance of these brands are stronger than the depletion results indicated for the quarter, as similar other brands in our portfolio, depletions generally lag Nielsen takeaway trends indicating the occurrence of inventory reductions.

In addition, these brands at ultra premium price points and skew to be on-premise had continued to see some pressure in the current market environment. However, despite these difficulties in the marketplace, we believe our developing brands benefit from having built strong brand equities as demonstrated by various recognitions they continue to receive. For example, impact magazine awarded our Bonterra and Gentleman Jack, Hot Brand status in its annual Hot Brands list. Little Black Dress also received a Hot Brands prospect award.

Sonoma-Cutrer was once again recognized by the annual Wine & Spirits Restaurant Poll. The brand received the Best Overall [Restaurant] Award for the 18th time in the last 20 years. It was also recognized as the best overall brand which marks the seventh of the last 11 years it received that accolade.

Turning now to margins, operating margins have remained fairly consistent approximating 21% to 22% of net sales. For the quarter, operating margins increased 190 basis points due largely the timing of adjustments related to lower expected performance related costs including incentive compensation.

At the gross margin level, we experienced a 200 basis point decline for the third quarter. The biggest impact on gross margins during the quarter was the geographic mix shift from higher margin market such as the UK, US and Spain to lower margin markets in Eastern Europe, as well as the portfolio mix shift as Finlandia’s growth outpaced Jack Daniel’s. Higher input cost and the impact of the Australia RTD excise tax also affect the year-over-year and quarter-over-quarter gross margin comparisons. While the non-cash agave charge in the first quarter also affected the year-to-date margin.

As I said earlier, our management's primary focus was driving underlying net sales and operating income growth. We plan to continue to manage the business in a manner we believe is appropriate for this environment while also keeping a view to the long run.

We are looking to ensure the long term health of our brands by seeking the proper mix of brand building support whether it's through traditional advertising and promotions or incremental value added packs or targeted discounting.

At the same time we continue to be very focused on the tight management of discretionary operating expenses. Our goal is to maximize our shareholder returns in every economic environment, no matter how uncertain it may be.

Before we move on to discuss our guidance for the year, let me touch on our balance sheet for a moment. Traditionally, we have a very conservative philosophy with respect to our balance sheet. We believe this attitude has served us well, especially now in this extremely uncertain times. During the third quarter, our strong credit ratings allowed us to complete the sale of a total of $250 million of 5% notes due in 2014. We have also enjoyed continued access to the commercial paper markets and have not had a drop on our credit facility. Our solid balance sheet was supported through strong positive operating cash flows, which totaled $343 million for the first nine months of our fiscal year.

Our operating cash flow is less than last year, due in part the appreciation of the US dollar, the absence of a VAT tax refund received in fiscal 2008 related our Herradura acquisition and slightly higher inventory levels. Because of our strong cash flow, in January, our quarterly dividend to shareholders increased 6% over the prior period. This represents the 25th year in a row we have been able to increase our dividend payout.

Now, turning to our fiscal 2009 guidance, due to a significantly stronger US dollar, expectations of additional trade and distributor inventory reductions in the fourth quarter and some softening in consumer takeaway trends around the world, we are lowering our diluted earnings per share guidance to a range of $2.70 to $2.90, representing a reported decline of 5% to a growth of 2% when compared to our fiscal 2008 earnings per share.

This outlook assumes the decline in earnings per share in the fourth quarter when compared to the same prior year period as a result of the following factors. We expect currency to negatively affect our quarter-over-quarter comparisons in the range of $0.08 to $0.10 per share. Additionally, we had an unusually low tax rate in the fourth quarter last year which we do not expect to repeat itself this year.

Finally, as we have highlighted throughout our earnings release and discussed during our call today, we expect a further reduction of global inventory levels and some modestly lower volumes reflecting some softening in consumer takeaway.

However, we expect the impact of these declines to be partially offset by continued tight management of discretionary expenses including additional benefits from lower performance related cost.

With that, I will turn the call over Paul for his further commentary.

Paul Varga

Thank you, Don and good morning to everyone. As you likely picked up from Don's commentary, we have what I term a solid performance in the third quarter. But due in large part to foreign exchange, the expectation of the unfavorable fourth quarter tax rate relative to the last year, and the impact of the deteriorating global economy, we have more cautious outlook for our full year reported earnings.

As foreign exchange and inventory reductions affected our third quarter reported results negatively, a growth in underlying sales and tight management of expenses helped propel us to a nice underlying growth for the quarter.

During these challenging times, our employees have demonstrated great resiliency in the allocation of both their time and the company's resources. Additionally, our innovation around packaging, product, and line extensions has allowed us to officially enhance several of our valuable trademarks. This is an example of what we refer to as leverage existing assets.

We believe this is particularly important in a difficult environment and has made a real contribution to company's underlying performance. Because of our ability to leverage Brown-Forman's two greatest assets, our brands and our people, we have been able to post year-to-date underlying growth in net sales of 4% and operating income of 5%. I believe these are excellent results in an environment that is not yielding growth of any kind easily.

A worldwide business like ours where we sell globally, but typically produce our brands at a single location can at times be either helped or hurt the fluctuations in foreign exchange and inventory levels.

In recent months, we have been hurt more than helped by these two factors and looking ahead to the reminder of FY'09 we expect this to continue. Beneath the currency and inventory impact, we are still seeing some growth at a consumer level in many markets. But there has been some softening in consumer takeaway in a number of markets around the world in recent months, which does put pressure on underlying net sales growth.

As a result of these three specific factors and the general state of the global economy we are taking a more cautious view toward the fourth quarter of FY'09 and that is reflected in the downward adjustment to our full year range for reported earnings.

Importantly, we expect our underlying profit performance which we believe better represents the health of our brand and the manner of which we are running the company to significantly outpace reported profit performance during both the fourth quarter and for full year FY'09.

Some of you may recall that on the same day as our second quarter earnings release in early December, a number of our management team spoke with many of you in the analyst and investment community about the long term potential for our brands and our company.

We enjoyed that discussion very much as it is one of the topics that enthuses us most as we look at out into the future. The condition of the global economy today and the mood of people over the last 15 months particularly in the last six months are obvious causes for concern. And while these may tamper short-term growth rates for everyone including Brown-Forman, we do not believe they diminish the wonderful long-term opportunities to build our brands overtime for the immense benefit of our shareholders.

The creation of enduring shareholder value remains our highest priority in both good times and bad. And while different times dictate the need for different actions which does not vary our commitment to excellence in brand building, our strong financial discipline and our very long-term perspective on the business and the company.

Thank you for listening to our comments and I will be happy to answer any questions you might have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Kaumil Gajrawala from UBS.

Kaumil Gajrawala - UBS

Thank you, hey guys.

Paul Varga

Good morning.

Kaumil Gajrawala - UBS

As it relates to the distributor inventory levels, do you have any line of sight on how long it might take to get these levels to an appropriate run rate, and how much of this is the growth rates in some of the emerging markets coming down in the near term versus need to just free up some short-term cash?

Don Berg

It’s a good question, I mean, when you look the distributor tier, it really depends a lot on the market that you look at, if you look for example here in the United States, you will generally see on average anywhere between 40 and 50 days of inventory, when you look outside the United States, a lot of it depends upon the individual market and what our distribution model looks in that market. And those markets where we own our own distribution, of course you do not have any effect whatsoever, in those markets where we have third-party agencies, you tend to have far higher inventory levels generally they can range anywhere from 60 up to 120 days.

And so as we look out, hopefully, we will see whatever changes that they plan on making in their inventory levels come through the system by the end of our fiscal year, early next fiscal year. But at this stage, there is really no way to know for sure, what to expect on that.

Kaumil Gajrawala - UBS

I see. And if I could ask about the US, the distributors over the last few years have gotten a lot more sophisticated. If they did decide to try to go, let's just for example say, from 40 days to 20 days, is the supply chain efficient enough that they still wouldn't risk any or have any risk of out-of-stocks given the turns in the business?

Don Berg

That's a pretty significant (inaudible), both the things you are thinking about a reduction from 40 to 20 being extremely significant, I think for our US distribution system. I mean for years, I think people in this business have speculated that the capacity to operate particularly as they consolidated down and become more efficient with investments in their warehousing and their delivery that people could get below 40. But 20, I have just never looked at it to see it that dramatic.

And I think if you went across today, you would see variations by specific distributors, so there has been some probably some evidence that people operating at lower than 40. So when we give you an average number, it varies of course by market. But we would have to look into that a little further to see if we could go that far.

Kaumil Gajrawala - UBS

Got it, and then last question on advertising, looks like there was a fair decline in the absolute dollars of advertising. How much of that is just lower rates versus maybe a shift in spending from one place to another?

Paul Varga

Well, I think there is a bunch of factors in there. Some of that when you look at them on a global basis is foreign exchange influenced. When you strip that out, I think there is also the impact of where our investments are landing within our P&L. We have had a lot of shifting in this environment really over the last year or so, where we have been allocating more investments in things like value-added packaging, which would show up more in your cost-to-sale.

So unless you strip that out, it can actually distort the picture as well. But we are seeing some efficiency and investing in some places and we also are being more conservative with some of our investment postures as well around the world just because we feel like in many, many markets the receptivity of consumer is lower than it would have been a year or two ago. So I think those are the main factors driving, which you will see in year-on-year comparison in the A&P.

Kaumil Gajrawala - UBS

Okay, great. Thank you.

Paul Varga

Thank you.

Operator

Your next question comes from Lauren Torres at HSBC.

Lauren Torres - HSBC

Good morning.

Don Berg

Hey, Lauren.

Paul Varga

Good morning.

Lauren Torres - HSBC

Hey, first just a quick clarification on the quarter, the $0.81 that you reported that includes the gain from the wine asset sales?

Paul Varga

Yeah.

Don Berg

Yes.

Lauren Torres - HSBC

And where is that reflected in the P&L, or how much?

Jane Morreau

It's in other income and expense. It's roughly $20 million, Lauren.

Lauren Torres - HSBC

Okay, thanks. And also I was just curious as we are just about two months from closing out fiscal '09, or I don't know if you have any initial comments for fiscal '10, be it, just a few months away.

If you talk about adjusting your promotional mix, and also reallocating spend and selectively discounting, I was curious to find out as we think into fiscal '10, your ability to continue with these types of activities, how comfortable are you doing that and how should we think about those types of activities for next year?

Paul Varga

Yeah, we are not going to provide a status-specific guidance or anything for F'10, but I would say in the environment we are in today, I mean you almost have to go back 18 months ago, where we were actually beginning to change some of our advertising and promotional mix in the United States as far back as then.

And I would say that the international markets weren't experiencing some of the same conditions at that time, and so they were probably several months behind it. I think in the later half of this year, we have seen a more global application of people altering their mix to compete more effectively in this environment.

And I mentioned a handful of things. Things such as leveraging the trademarks through line extensions, or packaging, or product improvement and I think all of those are the types of technique and valuable additions to brand marketing tool kit that will service well not just in F'09, but probably in F'10 and beyond as well.

Lauren Torres - HSBC

And can you just comment, as you mentioned selective discount programs. I don't know if there is any detail you could give behind that of what you have been engaging in and plans are on that front.

Paul Varga

Yeah. I think one thing for sure on the United States was, I think we did a lot of effective changes in the, kind of protesting throughout the first half of the year, a number of changes that would influence both the frequency and debt of discounting.

And so as we have actually started to do the planning for next year, of course, as you would expect and we have been studying that data, and I think if we found some sweet spots for our brand, where they are really, because you never know with great specificity, where the right level of discounting is, and what the right frequency is.

But we do know that they vary by brand, also they will vary within a brand of that size. And so you have to get down to sort of that granular study. And of course they vary by market in order to understand the right sorts of practices.

And so, I feel like the good results we have been able to achieve that are really are evident, you will see them in the US Nielsen that Don referenced, are part of that on that ongoing work that we are doing on the discounting.

Southern Comfort has had similar good results. They have started little later than Jack Daniel's in the United States. But, I think, it shows up in their takeaway being better as well versus their depletion trend.

So, I think, the one thing that we are advising our employees who are working on this all the time that is to keep testing and practicing, staying on top of it and then adjust where you need to, to make it the most effective discounting program.

Lauren Torres - HSBC

Okay, great. Thanks.

Paul Varga

Sure.

Operator

Your next question comes from Tim Ramey of D.A. Davidson.

Timothy Ramey - D.A. Davidson

Good morning. Just trying to get a greater granularity on how the impact of currency hedging impacted the quarter and where those impacts would have been booked in the P&L?

Jane Morreau

Tim, this is Jane. Can you be a little bit more specific, I mean I can tell where our hedges is booked, but I'm not sure.

Timothy Ramey - D.A. Davidson

Well, yeah. I mean I wasn't sure whether the benefit of the hedges, is that showing up at the other income line as well, or does it show it up in the cost of goods?

Jane Morreau

The hedges themselves show up in net sales.

Timothy Ramey - D.A. Davidson

Okay. So, it is netted out through the sales alignment, okay.

Jane Morreau

We do have obviously P&L, up and down your P&L, there is FX impact however.

Timothy Ramey - D.A. Davidson

Okay.

Paul Varga

The number we gave you Tim, is the net number for the entire P&L.

Jane Morreau

That’s correct. As Paul said, that $30 million that Don referred to during his script includes the underlying losses, if you will, offset by hedges.

Timothy Ramey - D.A. Davidson

Okay. Is that expected to get a little worse in the fourth quarter, is that the comment that, going from your earlier?

Jane Morreau

Yes, I think the way I look at it Tim, what we were trying to specify is while we think our fourth quarter results are going to be softer this year versus last year. And looking at FX right this year versus last year, you got to understand what we had our fourth quarter effective rate last year at versus what we have our effective rate this year at.

The second example like the Polish Zloty. The Polish Zloty, I think if this stays, happens to be one of our more major currencies now. We see these Zloty up to in think 360, 361 somewhere on that range. Last years fourth quarter I think the average was about 280. So, you can see when we are talking about our fourth quarter comparison why we are pointing out that yes we do things that our results when you compare them this year versus last year will be impacted by the stronger US dollar.

Timothy Ramey - D.A. Davidson

Okay. I didn’t really hear you talk about some of your more popular price, by popular I guess long-term but mid premium price brands. But were you seeing benefits there from trade down?

Paul Varga

Actually one thing that I was looking at, as we were getting prepared for this was, almost every brand in our portfolio is you can tell from things that Don was commenting on, may have suffered depletion growth rate from inventory reductions. But one of the things we were seeing at the consumer takeaway level, and this, I just could cite to you some data from the NABCA is that just the 12-months run rate ending January of '08 is an example for early times was about minus 5%.

The 12-month run rate ending January of this year is about minus 2%. So we have seen a three point improvement in its run rate over the 12-months and I think some of that would be indicative of the benefits of trading down that's going on. When you tear apart these, Nielsen's and NABCA, you can really see the benefit that are occurring to some of the very low end brands, it's not in some cases, almost a new segment of brands that are at a very value level and brands in prior years we referred to as popular price may not even be benefiting as much as those that are priced below that.

Timothy Ramey - D.A. Davidson

Okay. And one quick last one. Paul, if you talk about your captive distribution outside the US, are you making any changes in inventory levels in captive distribution, or is that sort of steady state?

Paul Varga

I think that's pretty steady state. But we do have of course as Don referred to, still a number of agents around the world, whether it be in Western and Eastern Europe and other parts, for sure Latin America. And so you are susceptible to fluctuation in these inventories and of course the US you can see it as well. But place like the UK or place like Korea, for example, or a place like Poland where we have more captive distribution you don’t see the fluctuations.

Timothy Ramey - D.A. Davidson

Okay.

Don Berg

Just to be clear on that, those inventory levels show up on our balance sheet as opposed to where we have agency brands where we get the benefit of the sale at a point in time that we move the inventory over to them. And that's where we have been seeing that bigger impacts on the inventory levels.

Timothy Ramey - D.A. Davidson

Great. Thanks.

Paul Varga

Thanks Tim.

Operator

Your next question comes from Lindsay Mann of Goldman Sachs.

Lindsay Mann - Goldman Sachs

Hi everyone.

Paul Varga

Good morning.

Don Berg

Hello.

Lindsay Mann - Goldman Sachs

So, I just wanted to dig in on your implied fourth quarter guidance based on your full-year range. So if I take out that $0.08 to $0.09 of currency and then, if I actually use the inventory, the distributor inventory impact you reported in the third quarter as being a 6 point drag on your EBIT growth, if I actually strip away those two things, it seems like you are still implying a down 15% sort of currency neutral, distributor neutral sort of fourth quarter EBIT trend. So can you tell me if my math makes sense and what the drivers would be behind that?

Paul Varga

Partially I think your math does partially make sense, but we will try to get you there.

Jane Morreau

I think there is a couple of other things to consider and this is something that Don also alluded to during his calls. Our tax rate last year in the fourth quarter was extremely low, unusually low due to some expiration of statute limitations and some effects of the settlement that occurred in the quarter. We don’t expect that to repeat itself and that in and of itself is going to affect our year-over-year comparisons in a negative way.

So we are expecting some more in the nickel $0.06 somewhere in that range from tax rates to be affected, okay. In terms of what you are doing on distributor inventory levels, we are expecting to see even more reductions in the fourth quarter. Nothing bad combined with offset by some operating expenses that we continue to think will come in favorable, those are how you get to your numbers and all that help. But I don't think the number you are using on the year-to-date or for the quarter on reductions of inventory, we are expecting even more in the fourth quarter.

Lindsay Mann - Goldman Sachs

Could you quantify about how much more you are looking for and what the driver would be in the step-up versus sequentially?

Paul Varga

Well let me say it this way, because I was working through this recently, and a lot of it depends on where of course we land within the range that we have provided, but let me just for an example, pick a mid-point of it.

At a mid-point, you have more than accounted for the change versus last year with three items. Foreign exchange, the higher tax rate and then I call it broadly the term volumes, a good portion of which would have inventory reductions in it and then we are just from what we are saying you have heard it several times here this morning, we think there is some reason to be cautious about the underlying consumer demand in many markets around the world.

So the combination of underlying consumer demand and then system inventory reductions would account for the volumes, and all three of those would more than account for the difference between last year's reported growth and if you just pick the mid-point of the range.

Lindsay Mann - Goldman Sachs

Okay thanks, that's helpful. For the third quarter, could you talk about -- you talked about 1% underlying sales growth number -- what the split between volume, and pricing sort of was?

Paul Varga

Let me think about that. We might have to, somebody look at that and see if there is a what the different spread would be between depletions and I know we would have picked up benefit from underlying net sales price I think. And then it would have been offset some about yeah maybe slightly lower under depletion, so let us get in at a specific answer point. We will have it here by the end of the call. We can give it to you, okay?

Lindsay Mann - Goldman Sachs

Okay great, and then you mentioned the reduction in performance initiatives in the third quarter? Could you quantify that and then are there any other items, could you quantify what it was in the third quarter how you think it will be in the fourth quarter. And what are some of the other cost savings you are drawing from here?

Paul Varga

A lot of it I mean in the third quarter, I mean it really was, we call them bunch of different things, but I think the biggest driver was when we expensed our expectations of incentive compensation and it hitting the third quarter. We actually expect there to be probably additional savings associated with that in the fourth quarter.

The reality of it is that if the impact of the foreign exchange has a direct impact on that. And so that changed dramatically during Q3. So we would not have had the knowledge of foreign currency impact on incentive comp in the first half of the year, so we would not have expensed it.

So we expensed it during Q3 and we expect a little more of it here in Q4. I think beyond that, we are just really in this environment being conservative with our expenses and operating investments whether it’s everything from discretionary spending like travel and some of these other things that I think will flow through, and an offset to any inventory reductions or volumes in the fourth quarter. Does that help you?

Lindsay Mann - Goldman Sachs

Yeah, I mean, that is helpful, I was trying to get at, absent the timing of the expensing incentive comp which is one time, how much benefit, if you could quantify, if your underlying SG&A was down 15%, if you exclude that sort of incentive compensation, how much of your underlying SG&A you have been able to pull back?

Paul Varga

Let us to calculate that for you, I know its --

Lindsay Mann - Goldman Sachs

I think you do a lot of math here?

Paul Varga

In the aggregate I know it’s in the statement we provided in the earnings release, we just have to back out the incentive comp piece, so let us do that calculation and let you know.

Lindsay Mann - Goldman Sachs

Great. All right, thanks guys.

Paul Varga

Okay. Thank you.

Operator

Your next question comes Bill Leach of TIAA-CREF

Bill Leach - TIAA-CREF

Good morning. There seems to be some confusion as to what the operating EPS were in the quarter excluding the wine gain. Could you just go through that, little bit more detail for the quarter and the nine months.

Jane Morreau

The wine gain, is that what you are referring to?

Bill Leach - TIAA-CREF

Yes I mean JP Morgan for that note saying that you are in $0.69 rather than $0.81 for example.

Jane Morreau

Impact on the quarter from an EPS perspective was roughly $0.13.

Bill Leach - TIAA-CREF

$0.13 and that’s included in other income.

Jane Morreau

Yeah it is included in other income. You got some other things going on there. Again as I referred, I think, to Tim earlier. Sales tax is up and down the P&L and you will see some FX impacts going the other way with regard to cash revaluations etcetera in the other income line partially offsetting that gain.

Bill Leach - TIAA-CREF

It was $0.13 for the quarter and for the nine months.

Jane Morreau

$0.13 for the quarter and year-to-date.

Paul Varga

Well one thing that is, earlier in the year, I think Q1 we had agave write-offs and one of the things that, the two approximately offset each other. The gain on the sale of Bolla and the earlier write-offs associated with the agave. So, those two things we felt, when you look at your overall year-to-date in any single quarter, you will see a larger variance. But now as we look at nine months of data they largely offset each other.

Bill Leach - TIAA-CREF

Okay, and then what are you guiding to for the tax rate for the full year and the fourth quarter.

Jane Morreau

We are guiding to a slightly lower effective tax rate than where we are today. So you see our tax rate I think is around 31%, it’s going to be right at that approximately for the year, and may be $0.01 or $0.02 below.

Bill Leach - TIAA-CREF

So the fourth quarter, that would be 31 too.

Jane Morreau

The fourth quarter will be slightly lower than, yeah it will be approximately what it is there, yeah you are right.

Bill Leach - TIAA-CREF

Okay great. Thanks a lot.

Jane Morreau

Let me add it, go back to Lindsay's question with regard to stripping out the incentive compensation, the lower pay-for-performance adjustment that Paul was referring to in the quarter. If you strip that out, our underlying SG&A, it was still down 5%.

Bill Leach - TIAA-CREF

Okay.

Operator

Your next question comes from Ann Gurkin of Davenport.

Ann Gurkin - Davenport

Good morning.

Don Berg

Good morning, Ann.

Paul Varga

Hi, Ann.

Ann Gurkin - Davenport

Just want to follow-up on the discussion about reducing inventories with distributors. Do you have any situations where you are concerned about the financial health of these distributors and you are pulling back inventory either in the US or overseas?

Don Berg

No. We are not seeing anything of that at this juncture at all. We have seen a little bit in a couple of our markets where we own distribution, where we are exposed to the retail environment, where we have had a couple of very small credit issues. But at the distributor level, with any our major customers, they are all in pretty good financial health at this juncture.

Ann Gurkin - Davenport

Okay. And then may I just get an update on your alliance with the Bacardi and Remy in several states here in the US, how is that going?

Don Berg

We are still going through the RFP process, we are at a point we have pretty much concluded our decisions. And over the course of the next couple of weeks, we will be having conversations with the individual distributors in those markets and trying to share some of our plans that way forward.

Ann Gurkin - Davenport

Okay. That's all I have to ask, thank you.

Paul Varga

Thank you.

Operator

Your next question comes from Kevin Dreyer of Gabelli & Company.

Kevin Dreyer - Gabelli & Company

Hi, good morning.

Paul Varga

Good morning.

Don Berg

Good morning.

Kevin Dreyer - Gabelli & Company

Just on the range, what would you say is the biggest delta between the high and low-end? Is it how much more in terms of inventory reductions, is it consumer demand? Is it FX?

Paul Varga

Yeah, I think my view on it is, and the reason for such a large range at the end of the year is the general economic environment and uncertainty around, I would call, volumes which can be in two forms really here it can be inventories, both at wholesale and retail, but it also can be consumer takeaway.

So, I think we are just being cautious and I think rightfully conservative in thinking about what might actually unfold over the next few months here. And so I think I would write it up more to volume than I would. Because as we said, we have a pretty good feel for the tax rate and the foreign exchange is within a certain range. And so I think the biggest reason for variability is related to volumes.

Kevin Dreyer - Gabelli & Company

Okay. And in Eastern Europe, you pointed out that you have done very well in a lot of these markets especially with Finlandia. Are there any of these markets that you are particularly concerned about with them slowing down?

Don Berg

Well, sure. I am personally concerned about the whole global economy. And so, we are still seeing nice growth as Don talked about in a whole bunch of these markets for, both Jack Daniel's and Finlandia, primarily.

A lot it may depend on how far up the development curve, or lifecycle we are, I mean sometimes the macroeconomic changes where you may not be totally immune from them, they may not impact you in some places as much as others, because you are just kind of small.

And we do have some nice businesses, but there may be some small bases. As so maybe we will see maybe less of an impact there in few of those markets. The growth of Jack Daniel's in Finlandia and many of these markets is still a relatively recent phenomenon, it's not like their -- experience there goes back 30 or 40 years where they become part of the culture or something like that.

So I do feel like we have to just wait and see, and that would be very different than sort of the experience one might have with the Jack Daniel's in the United States where it's been around a long time and it's a prevalent brand and known to many people and so it's been along it's own development growth cycle for quite some time.

So, I think it will vary. But I think we are just concerned about everywhere, simply because of the deterioration that we have seen in the global economy, and we will cross our fingers and hope that it gets better, but we think it's smart to be, be concerned and be cautious about it.

Kevin Dreyer - Gabelli & Company

Okay. And have you acted yet at all on your share repurchase plan, and do you plan to, or has that changed because of the environment?

Paul Varga

We did implement and start repurchasing our shares back in December, looking for that. And we are authorized by our Board to go ahead and purchase for the remainder of the calendar year. But Don and I noticed company has been taking a very cautious look at it in this environment. Again, we are being conservative. We bought I think, Don you have the data here?

Donald Berg

Yeah. So far we bought 3.75 million shares and spent an average price of around $53.

Paul Varga

Don, I think one thing I would add. We have actually bought a little over 700,000 shares.

Kevin Dreyer - Gabelli & Company

700,000.

Paul Varga

Yes.

Kevin Dreyer - Gabelli & Company

Okay. But you do.

Don Berg

Yeah, you are right. As of March 9th, we were at 718,000 shares and the average price was $47.40.

Paul Varga

So, we bought a little over $30 million so far.

Kevin Dreyer - Gabelli & Company

Okay, but there is no change in plans to continue to execute on that $250 million plan?

Paul Varga

It’s a broad authorization, I mean we have our own board and internal requirements related to it, but we are going to play it by year and see how to implement it, I think the world and the markets unfold in front of us.

Kevin Dreyer - Gabelli & Company

Okay. And then final question, just on the tax rate maybe I am missing something. You said you were 31% for the quarter, seems like you are at 27%?

Jane Morreau

I think that, I said that was where we are approximately year-to-date.

Kevin Dreyer - Gabelli & Company

Year-to-date, okay. Thank you, that’s all I have.

Paul Varga

Thank you.

Operator

Your next question comes from Ian Shackleton of Nomura.

Ian Shackleton - Nomura

Good afternoon gentlemen. I know the way that I do rework the impact conference last week and I didn’t see anybody from Brown-Forman there. But there were two issues I guess that [global last space], and I was quite keen to get your views on them, first on the outlook for the US spirits market, there is some volume of price opportunity in 2009. And secondly, around the stocking issues you flagged, this is certainly impact the US de-stocking by the whole sellers, it’s sort of finished in Q4 calendar last year. When you are talking about further de-stocking issues, it's very much a comment on some of the agency situation you have around the world that you still to go for?

Paul Varga

Okay Ian, let me just address a couple of those, and just to be clear on it, ahead of our US, Mike Cheek was over to Impact last week, so you quite didn’t have a chance to meet him, but he was there. And the first question you had related to the pricing and volume environment, and I think, our expectations there flow directly as a result of the commentary Don was making. All we can really do is look at what we are seeing from a consumer takeaway standpoint and then try to make that flow back through to what we actually do from a shipment standpoint.

I would just say this for everybody’s benefit. I think you know this but when it gets into the business of inventory for a company that has multi-tiers of distribution, you end up in the forecasting business quite a bit which is very different than somebody’s stages of retail or somebody who isn’t very much in the direct sales business as we are in many markets.

Now, having said that, I will just reiterate what Don said. We have seen the spirits market in the United States continue to grow, but at slightly lower levels than we have been experiencing in years a two ago. And at the dollar level, we expect that the impacts may be a touch stronger because of some of the trading down we have referenced here.

As it relates to pricing, I still think there are possibilities for modest price increases, but I also feel like you will see accompanying that probably more activity related to competitive discounting. I don’t know if that necessarily means a lower overall net sales dollars, but I do think that people will be doing what we have been doing over the last couple of years, it's really looking at the frequency and depth of promotions and discounts.

And we are just going to look at it once in a quarter at a time to see what’s appropriate for that environment as it relates to a volume and price mix. But one thing I will say is, even if that market gets incredibly aggressive, we did not anticipate you know being some leader of heavily reduced prices and in fact we have not done that to-date. So, we can be effective with our leading brands, but really trying to study what the sweet spots are in terms of frequency and depth of discounting. As it relates to the inventory situation of the United States I think you are basically implying that maybe a lot of these deals with international agency, we do think that inventories in the United States have some room at any given time and they fluctuate all the time between quarters.

But as we look at the US, I think maybe in part response to some pressures that the US distributors are feeling as retailers pull down their inventories, maybe US distributors will react accordingly and they could pull theirs down.

Always the challenge on inventories are looking at it point in time are you looking forward and the hardest part for us is trying to ascertain which the fluctuations in the inventory are rebalancing versus some prior period, and those which are some ones forecast about future demand. And so we do not have clear visibility to everyone’s forecast, it’s harder for us to comment on that.

Ian Shackleton - Nomura

When you look out to next fiscal 2010, I mean do you get a sense you could still see some destocking in certain markets as the effect of these rates becomes more efficient?

Paul Varga

I think, I suspect particularly more on the international side, I think where we have higher days of inventory, I guess possible that we could but, what our plan here just so you can have a clear expectation of it is. We have got another couple of months here obviously to go in this fiscal year, we will look at our inventory situation at that point around the world, try to compare to our estimates for consumer takeaway and then we will give you a view on how we think inventories might check out during FY'10.

Ian Shackleton- Nomura

Great, thanks a lot.

Paul Varga

Okay.

Operator

You have no further questions at this time. Mr. Marmor, do you have any closing remarks.

Ben Marmor

Thank you, Scathe. We do not have any closing remarks today. And we would like to thank everyone for joining us. And have a great day.

Operator

This concludes today's conference call. You may now disconnect.

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Source: Brown-Forman Corporation, F3Q09 (Qtr End 01/31/09) Earnings Call Transcript

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