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Brown-Forman Corporation (NYSE:BF.A)

F1Q10 Earnings Call

September 2, 2009 10:00 am ET

Executives

Ben Marmor – Director of Investor Relations

Paul C. Varga – Chairman and Chief Executive Officer

Donald C. Berg – Executive Vice President and Chief Financial Officer

Jane C. Morreau – Senior Vice President and Director of Finance

Analysts

Lauren Torres - HSBC

Timothy Ramey - D. A. Davidson & Co.

Lindsay Drucker Mann - Goldman Sachs

Ann Gurkin - Davenport & Company LLC

[Kevin Droyer] – Gabelli and Company

Thomas Russo - Gardner, Russo & Gardner

Operator

Good morning. My name is [Tasha] and I will be your conference operator today. At this time I would like to welcome everyone to the first quarter fiscal year 2010 conference call. (Operator Instructions) Thank you.

Mr. Marmor, you may begin your conference.

Ben Marmor

Thank you. Good morning everyone, and thank you for joining us for Brown-Forman’s fiscal 2010 first quarter earnings call. This is Ben Marmor, the Director of Investor Relations at 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.

Paul will begin our call this morning with a few brief remarks and Don will provide additional commentary on the quarter.

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 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 results for fiscal 2010 first quarter. The results can be found on our website under the section entitled 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 also will discuss 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’ll turn the call over to Paul.

Paul C. Varga

Thanks, Ben. Good morning everyone. Since we’re only three months into our fiscal year, and given that we discussed our business at our annual shareholders meeting just a few weeks ago, we intend to be relatively brief in our opening commentary.

In general, I’m pleased with the first quarter results we announced this morning. It’s a good start to our year in what remains a tough environment. We believe that the quarter’s underlying net sales growth of 2% is near if not at the top of our industry, and as you saw in the results that sales growth paired up with significant operating expense leverage to produce very strong underlying operating income growth for the quarter.

The quarter’s underlying sales progress benefited from our efforts to promote our brands more actively in the off-premise environment, most notably through the expansion and/or introduction of ready-to-drink expressions from two of our most important brands, Jack Daniel’s and Southern Comfort. Let me comment on this briefly. We believe that RTDs can play an important role on two fronts in this challenging environment. First, with the consumer shift from on-premise to off-premise, RTDs make it more convenient for the consumer to drink spirits cocktails at home, allowing our spirit brands to be more competitive with both beer and wine.

Second, we’ve learned over the years that the sheer presence of branded, single-serve RTDs at retail, at home and importantly in the hands of consumers at the actual point of consumption, creates a large number of incremental, highly efficient branded impressions. They also serve to educate consumers on new ways to consume our brands and in doing so, they promote brand mix ability. In short, we believe RTDs can be both a volume and sales generating vehicle for our brands, and importantly we believe they can serve as an efficient marketing tool for our trademarks as well. And as we’ve emphasized before, building sales and marketing efficiently are particularly high priorities for us in this challenging and competitive environment.

One additional point before I turn it over to Don. In highlighting the RTDs I don’t want you to misinterpret that we’ve totally shifted our focus from the full strength spirit brands to the RTDs. This isn’t the case. I wanted to discuss them because it is one example of how we are trying to be both adaptive and thoughtful with our sales and marketing activities in light of the changes in business conditions. I hope you find it a useful example.

Now I’ll turn things over to Don for some additional commentary.

Donald C. Berg

Thanks, Paul. Good morning everyone. As headlined in our earnings release this morning, we had an exceptional first quarter. Exceptional in that we had a strong double-digit earnings increase over the prior year, but also a bit of an exception in terms of how we see our performance potentially unfolding over the rest of the fiscal year.

First and foremost, we believe we are continuing to see the benefits of the evolution of our diversification, both in terms of brands and geographies. There are a number of areas of our business that continued to perform extremely well in the first quarter. Jack Daniel’s as a family of brands, including all of its ready-to-drink products, had an excellent quarter showing growth of 8% in net sales on a constant currency basis. Jack and Cola in Australia performed particularly well, partially due to easier comparatives versus last year but also as a result of continued strong performance on the brand there. Jack Daniel’s Black Label also had a strong quarter in Australia as it did in France, Germany and Mexico, as well as in many eastern and central European markets such as Poland, Russia, Hungary and Bulgaria.

Other areas that continued to do well include Finlandia in Russia and Hungary as well as some of our premium developing brands such as Gentleman Jack and Woodford Reserve. El Jimador posted strong double-digit growth across the board, and is one of the hottest premium brands today in the important U.S. market. In addition, we benefited during the quarter from the launch of some of our new innovative line extensions, especially Southern Comfort’s ready-to-pour line in the U.S. and its ready-to-drink extension in the UK.

On the other hand, the benefits from these favorable performances were partially offset by double-digit declines in our travel retail sales. We also experienced some softness surrounding our brands in the U.S. and UK markets, where volume growth generally slowed during the summer months for premium distilled spirits.

In eastern and central Europe, Finlandia’s depletions declined in the low double-digits as the strong performances I noted for Russia and Hungary were more than offset by declines elsewhere in the regions. In Poland, the brand’s most important market, depletions declined in the low double-digits as we believe it suffered from retail inventory reductions given that consumer takeaway according to Nielsen remained strong.

Before talking about our specific financial performance in the quarter, let me address some of the key trends that we’ve been talking about for some time now. I already mentioned the decline in travel retail, so I’ll concentrate on what we saw in the first quarter related to retail inventory reductions, on-premise weakness and trading down. In terms of retail inventory reductions, pressures seemed to have eased in the U.S. during the quarter. It also appears that retail inventory reductions have subsided in southern Europe as well. On the other hand, we have seen some acceleration of this trend in central and Eastern Europe.

Looking at the on-premise, we believe the industry experienced continued weakness in this channel throughout the world. We saw accelerating declines in the UK and Spain, declines in many markets throughout eastern and central Europe, as well as some softness in some important markets in Asia such as China. In the U.S., the decline in the on-premise also accelerated. According to NABCA data through July, on-premise volumes for total distilled spirits worsened as the three month decline of 6.5% outpaced the 12 month decline of 4.6%.

Finally, trading down and trading out continued to be a trend during the first quarter. First in the U.S., trading down to lower priced brands appeared to have accelerated. Trading down trends were also apparent in eastern and central Europe including switching to smaller sizes, switching from more expensive flavor extensions to classic vodka expressions, as well as trading down to less expensive brands.

For Brown-Forman, retail and distributor inventory reductions continue to be a potential concern but we are happy to have seen the overall impact stabilize this last quarter. On the on-premise front, we have talked a lot over the last number of quarters about how we have been working hard at shifting our focus to the off-premise, where the consumer has moved. For example, our off-premise brand building activities have increased, particularly in the U.S. and the UK. In addition, as Paul just mentioned, we’re introducing a number of innovative line extensions around ready-to-drink and ready-to-pour products as a means to move with these consumer trends.

In terms of trading down, during the quarter we did see some competitors try to counteract these trends by intensifying their discount activities in some markets. Our discounting activity also increased somewhat to keep our brands attractive to both the trade and to consumers. Having said that, we still benefited from increased pricing globally. In fact, our underlying net sales growth of 2% for the quarter was driven by price and mix as underlying volumes were flat.

Looking forward beyond targeted consumer pricing activities, we are continuing to look for ways to add value to our packs as a means to keep price high and our brand equity strong. Having said that, we anticipate that some of the aggressive deep discount programs we saw from competitors in the first quarter may return or even accelerate through this holiday period. And we plan to be somewhat flexible in this competitive landscape.

Before closing and taking questions, let me add some color to the significant reductions in our underlying operating expenses for the quarter and then make a few comments on our full year guidance.

Our underlying operating income benefited not only from underlying top line growth but also from lower advertising promotion and selling, general and administrative costs during the period. Specifically on advertising and promotion expenses, we believe the reductions were primarily a result of three factors. First, the quarter benefited from seasonal shifts of advertising and promotion investments. This year we plan to allocate a higher proportion of our brand spending to the September, October, November and December periods. Secondly, as I mentioned before we continue to reallocate expenses among activities within advertising. For example, savings from lower spend on media, on-premise promotions, PR and special events such as NASCAR were partially reallocated to lower cost, off-premise activities to drive top line growth.

Finally, we continue to shift our mix of spending to other areas of the P&L such as consumer price promotions, which is captured in net sales. We are also continuing to work on improving our primary packaging, which is accounted for within cost of sales. We believe these improvements can have a strong and effective impact with the consumer, as we’ve seen recently with our el Jimador and Gentleman Jack package upgrades. We are also planning to continue to reallocate more spending towards value-added packs, which also shows up in cost of sales.

Looking at our selling, general and administrative expenses, they were lower due in part to the timing of spending and to the early retirement planned workforce reduction we implemented in the first quarter of fiscal 2009. Additionally we benefited from further discretionary cost management such as reduced travel and entertainment, lower consulting expense and fewer charitable contributions. While we anticipate that year-over-year comparisons will continue to be positive, we expect a portion of the reduction in spending may be offset by such things as filling certain open positions as the year progresses. With all of these changes, we believe we have a strong organization in place to build our business in these tough and challenging times.

In summary, as Paul commented in the earnings release, we will continue to strive for an appropriate balance of supporting our brands growth and equity, while also delivering operating expense efficiencies in this challenging economic environment. Additionally, we believe we have retained flexibility to continue to be able to change our mix and investment levels as conditions warrant.

Moving to our fiscal 2010 full year guidance, we are leaving our full year guidance unchanged at $2.60 to $3 per share. Although we saw improvement in our underlying trends versus the third and fourth quarter of fiscal 2009, we remain concerned about the economic, consumer and competitive environments including the consumer channel shift, trading down, overall softening consumption trends, potential distributor and retail inventory level fluctuations and depletion trends for our three largest brands. As we enter what we expect to be an extremely competitive holiday period, and lap tough comparables last year, we continue to believe that we will be able to deliver on our previously guided expectation for modest underlying operating income growth for fiscal 2010.

Thank you. With that I will be happy to take any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Lauren Torres – HSBC.

Lauren Torres – HSBC

It seems you are quite more negative or gave instances where you are seeing on-premise trends yet tougher and trading down continuing, so I guess I was just hoping to hear maybe some more specific numbers either by brand or by channel, comparing this quarter to the last quarter or two. You know if you are seeing any hints of improvement? Is everything just getting progressively worse? I don’t know if there’s anything you could give number wise to support what you’re seeing but I was just curious on a you know quarter over quarter basis how much tougher things are actually getting out there.

Paul C. Varga

Don? Maybe both of us can answer this, Lauren. I think one thing that I thought was better versus when we last spoke was some of the stabilization in the inventory reduction was something that we noted in Don’s comments. So that would have been something versus what we were experiencing in particularly the last half of fiscal year ’09 that we saw some stabilization or slowing. We noted where there were differences. We saw some acceleration actually over in Eastern Europe. And then I think in addition to that you know you start to make your way through the supply chains, the more you get out towards the channels we do think that there’s still a lot of pressure on the on-premise. I mean it’s hard to provide a number that would capture sort of that globally, but a combination of the data we’ve looked at, and there’s always some lag, would tell us that that shift between on and off-premise is continuing and it continues to be I think not just in the United States. I think in countries all over the world.

But you know remember what that is, because you were expressing that as you know really negative. It is for the on-premise but then of course you get you know more of the traffic in the off-premise which we feel is, you know, so it’s an offsetting mechanism. But I don’t think we would have any news that would tell you we’ve seen an acceleration in any way in the on-premise. It seems to be pretty tough out there for the on-premise environment, so that’s why we’re trying to adjust some of our programs and activities accordingly to capture some of that business that is naturally shifting over to the off-premise.

Don, did you want to comment further on that?

Donald C. Berg

All right. I mean most of the data that we’ve got, particularly in the U.S., comes from the NABCA information. I mentioned that on the three month basis it accelerated to 6.5%. From a 12 month it had been 4.6. You know in the off-premise you’re seeing some of the opposite trends. The three month was up 2.3 and the 12 month was up 3.8. And so you know we do continue to see the shift. In the UK, which is a really important market for us, we’re pretty heavily skewed to the on-premise. And when you look at the seasonality there, historically the on-premise has had greater seasonality you know during the summer months and you see it skewing more to the off-premise during the holiday period. And so as we’ve seen this thing kind of moving again over the course of the first quarter, it has moved some of our results. And so we’re just keeping an eye on it.

Paul C. Varga

And Lauren you’d also asked about trading down. We think at least anecdotally what we’ve heard and some of the numbers we’ve seen outside the United States we’d say we’re starting to see more of that. In the U.S. in the quarter we definitely observed the numbers we have through the two syndicated sources of Nielsen and NABCA would indicate some trading down between categories. And a lot of it depends on where you segregate the price points. But I think in general we’re seeing better trends down at the popular and value price levels in spirits versus up at the very high levels where we would have been experiencing a lot of the growth two or three years ago.

Lauren Torres – HSBC

And if I could also just clarify, it seems like your advertising expense, you’re just reallocating. I’m just trying to get hold of the fact that you’re not really pulling back on that front, it’s just how we think about timing through the year. Is that correct?

Paul C. Varga

Let me comment on that. We do expect that and you know a lot will depend on how the year unfolds, that we may not spend in the A&P just as we didn’t at an organic level I think. In the first quarter we would have seen three major factors. One is timing, so we do think the large percentage change in the first quarter on an underlying basis in part is due to spending we’ll do in quarters two, three and four. So there is that shift within the seasonality. I think there also, Don was very explicit about this as well, that we are trying to shift from what I’ll call investments within A&P that maybe have longer term impact. You know things like media. And on-premise is clearly one of those areas, event marketing, lifestyle marketing we sometimes call it.

Shifts from there to things that can generate more media sales impact which is today, a lot of the primary medium today truly is the off-premise retail environment. Not just for Brown-Forman. We expect that area to be very competitive and there are a lot more effort going into the retail environment. And when we do that, we actually consider that to be less costly outlays as well, so that does bring down your A&P overall. The third is something that’s been highlighted throughout the course of the last year and is continuing through this year which is some reallocations out of A&P and into other areas of the P&L such as, Don mentioned too, which would be some into price promotions which would be captured in net sales and then offsets in net sales. And then the other one would actually be in cost of sales associated with things such as packaging improvements or special packs.

So we’re trying to give you enough information so you can understand why it shifts around, but I think year on year we would expect A&P overall to be down slightly.

Operator

Your next question comes from Timothy Ramey - D. A. Davidson & Co.

Timothy Ramey - D. A. Davidson & Co.

I just did a quick scan back for a few years. If I did the numbers right, 26.2% operating margin was the best I’ve ever seen for the company and if I try and you know take that apart a little bit, I see about 280 basis points coming from advertising, maybe 90 or so coming from gross margin. Was there anything else in there, Don? Was there a, you know, currency hedging benefit? You didn’t mention that but you guys use options, so was there a gain on that?

Donald C. Berg

Yes. Well, one of the things that you didn’t mention that was in there was you know within the SG&A we are starting to see some of the benefits coming through of the reduction in force that we did before. On the foreign exchange front, I think if you went back to last quarter when we were talking about our guidance for this year, we had indicated that we expected a full year impact at the EPS line on foreign exchange at that point of around $0.12. And there have been some improvement there and now as we look towards the full year we’re expecting there to be kind of the full year impact of somewhere around $0.06 to $0.08 at this juncture.

Timothy Ramey - D. A. Davidson & Co.

So $0.06 to $0.08 negative?

Donald C. Berg

Right.

Timothy Ramey - D. A. Davidson & Co.

I assume then that $0.04 to $0.06 was in the 1Q.

Donald C. Berg

That would be about right, yes.

Timothy Ramey - D. A. Davidson & Co.

You know I thought it was really interesting that you cited price mix improving with more emphasis on pack and price promotion and so on. Thinking about those things, I would normally think about them being at odds but is it possible that price mix improved and you also did more consumer promotion?

Donald C. Berg

On the value-added pack side of it, there was not a lot of value-added pack activity in the first quarter but we’re anticipating that there will be more value-added activity coming through the holiday period than what we saw last year.

Timothy Ramey - D. A. Davidson & Co.

So more shot glasses or?

Donald C. Berg

Yes, or you know a number of T-shirts. I mean there’s a number of different ways that you can do it. We tend to do more in the way at least here in the U.S. and a number of places outside the U.S. we tend to do it more in terms of not giving away additional product, but doing something in the way of some type of POS materials.

Timothy Ramey - D. A. Davidson & Co.

And as we think about, you know your opening comments were ready-to-drink which you know makes a strong statement. Should we be thinking about that as a gross margin degradation over the period of the year if that accelerates? Or how should we think about the emphasis on RTD?

Donald C. Berg

You have to look at it in two different ways. I mean there’s a way to look at it from the P&L but then there’s also a way to look at it in terms of from the consumer standpoint. And from the consumer standpoint what I mean by that is if you look at the gross margin per drink, a number of these ready-to-drink products actually have more attractive margins to them. When you look at what the overall impact is on the P&L, you know you will see some margin degradation there.

Timothy Ramey - D. A. Davidson & Co.

Terrific. Thanks, guys.

Paul C. Varga

It often depends on the size of the business and but one of the reasons.

Donald C. Berg

It depends on the product and depends on the market.

Paul C. Varga

Yes, and one of the reasons we highlighted that was more as an example of some of the techniques and activities we’re pursuing so that we can prepare our brands to have their best chances at retail. And RTD, particularly for spirit brands, are so important because often times the consumption that occurs in the on-premise isn’t as easily replicated in the off-premise. So the RTDs can really play a role there. So I wanted to use that as more of an example and of course it was a little more prominent than it has been in the first quarter results, so I think it helped to provide that example.

Operator

Your next question comes from Lindsay Drucker Mann - Goldman Sachs.

Lindsay Drucker Mann - Goldman Sachs

Okay, so I guess I was hoping for just a little clarification on some of the promotional activity we’ve seen in the whiskey segment premium and super premium in the Nielsen data for grocery stores. So first just a few points. Is that degree of price promotions broadly reflective of what you’re seeing in other channels? Or is that you know worse, better, sort of in the middle? When you say that you expect as we move into the holiday for the promotional activity to perhaps get more intense, you know is that from you know the current degree of promotions we saw in the sort of June, July period? And when you talk about being more flexible, you know we broadly have not seen the same depth of promotion as we’ve seen from Diageo and [Pruno] on your brands so do you expect to be participating more deeply?

Paul C. Varga

Well I think I’ll answer your first question or observation, I actually think that when you look at the syndicated data that it tends to highlight some of the most I think aggressive programming, particularly price programming often times, you know contrasting say Nielsen versus NABCA data or independent channel which doesn’t get picked up through some of these. So I think you’re probably out in the you know I think it’s probably emblematic of the most aggressive stuff is the way I’d say it. As it relates to us, we are obviously going to pay attention to what all our competition is doing out there. It’s not just really I think the larger players, say a Diageo but it’s also for every brand. And we have brands that compete with you know a multitude of companies.

And so we’ll be observant of that activity, but we always also try to look at what’s right for our business and for our brands at that time. And it’s always, I mean one of the great challenges is how do you balance out the need for competitiveness and relevance in the environment you’re in and do it in a way that is thoughtful enough that it actually builds equity or helps you with your long-term pursuit of, you know, building loyalty within a consumer franchise? I actually think that we work harder at that than many. I really do. I think we, and that’s why we go to the lengths of explaining some of the techniques or tools or activities we’re pursuing. So we don’t just blindly follow any single competitor on price. Frankly I just can’t recall a time when we have.

But that does not give us absolution on being competitive. We have to find ways for our products to be really competitive in that retail environment. And it really is a brand-by-brand exercise. We don’t just say okay, at Brown-Forman just everybody reduce prices and go follow the competition. So I mean we’re in and I mean it’s an ongoing process, and things we were thinking a year ago or even six months ago or even six weeks ago change. And our brand leaders and our regional leaders, not just in the United States but around the world, go through that balancing act and we look at it, market-by-market and size-by-size. I actually think it shows up over time in quality results I think if you work really, really hard at it. And so I feel pretty good about the results we posted here this morning because of some of the work we’ve been doing on that, but I also wouldn’t go so far as to tell you every idea or plan that we have for the next six or 12 months because it could get in the hands or become apparent to the competition and we wouldn’t want that to happen.

Lindsay Drucker Mann - Goldman Sachs

And Paul, maybe you can just comment on how you anticipate the tactical shift from investing in A&P that’s built sort of this longer term brand equity, you know, in media and sponsorships towards some of the nearer term defensive strategy of investing off-premise and some of the increased promotions, as we you know come off of this cyclical bottom how you anticipate your sustainable sales growth for the portfolio will be impacted, based on that.

Paul C. Varga

I mean that still remains to be seen, so it’s hard for me to forecast how it will unfold. But let me give you one example that I think certainly helps me. I’ll give you an example on Southern Comfort and this is the United States geography example. If you think about here’s a brand, a very good on-premise brand. And with occasions don’t necessarily move as easily between the on-premise and the off-premise. And we’ve known that. We’ve been working on programs and ideas to try to help Southern Comfort consumers remember Southern Comfort when they move from you know a bar or a restaurant to consumption in their home.

And let me just give you the alternative of two possibilities we might put forward. One would be to put up a major media campaign to promote the mix ability of Southern Comfort in the off-premise, and so think billboards or media newspapers, just something that would be very informative, create top of mind awareness. But then also let them know about how to drink Southern Comfort in their homes. That would be one alternative. A second alternative would be to pre-package Southern Comfort in a prepared cocktail or a mixed format, place it in the retail environment, try to get it merchandised and promoted in a prominent way and really try to build that awareness at the point of purchase. In the one hand you have an upfront media investment with the hope that it stimulates the awareness and trial and then the consumer responds and then they go into the store. And the other one you’re actually generating sales dollars, creating the mix ability and drink awareness and competing directly in the environment where the consumer tends to be the most.

So I give you that example as a conscious shift, for example, that one could make between media and off-premise promoting or RTDs. And in fact that is exactly what we’ve done in the United States here in the first quarter with the introduction of the RTT line. And so I’d give you that example as maybe a helpful way to think that a shift from media to something else isn’t necessarily low quality. Actually we consider it to be higher quality, more efficient and more impactful.

Does that help?

Lindsay Drucker Mann - Goldman Sachs

Yes. That’s very helpful.

Paul C. Varga

There’s many other such examples, but that one is one we’ve particularly worked hard on in the last six to nine months. And keep in mind the other thing that comes with it is the efficiency as usually when you have a media campaign behind it or typically up front production costs of the media, ad agency fees, sometimes research behind the media. And you get tons of efficiency if you’re acting in a more direct way. So what that example is showing you is not only a shift toward impact but also ways that you can be more efficient with your investment.

Lindsay Drucker Mann - Goldman Sachs

I guess my question related more towards the just pure you know price promotional increases.

Paul C. Varga

Well there’s some of that as well. That would be in the example that I just gave, that wouldn’t apply as much to that. That would apply more to finding the right channels and the right frequency and the right depth to make sure that in Southern Comfort is promoted by the retail. And frankly I feel like on Southern Comfort, because it’s a liqueur brand, and has no what I’ll call direct replacement which many category brands do have, often times its issues relate to a lack of trade support. That it’s not getting the kind of support and we haven’t provided the sort of you know merchandising or incentive to one of our trade partners to promote it on an end cap or to give it a secondary display. And so like I said each one of these brands are very different.

When I move over to Jack Daniel’s it has a lot of competition and does get promoted quite frequently by the off-premise channel, but we also need to make sure that those more price conscious consumers in the Jack Daniel’s franchise periodically have an opportunity to buy the brand with what they consider to be an affordable price. I mean I’ll end with just saying we’re not going to drop Jack Daniel’s, Southern Comfort or any of our brands prices so deep as to you know want to go just arbitrarily build volume metric market share. We’re just going to be a lot more thoughtful than that.

Lindsay Drucker Mann - Goldman Sachs

And then lastly it’s encouraging to hear that U.S. inventory behavior has stabilized on the distributor and the retail levels, so as we get closer to lapping you know the big declines in inventory towards year end, should we expect for your shipments to grow faster than consumer sell through?

Paul C. Varga

Well I think it’ll all depend on what the underlying consumer takeaway trends, because they all ultimately relate to that or particularly right on April 30 I guess they will deal somewhat not only with what the current trends are but what the forecasted trends are. So I think that remains an unknown. I mean clearly when you start to cycle it, if they remain stable, you won’t have the reduction. The degree to which they rebuild I think is an uncertain to us.

Donald C. Berg

And I would say there, too, there’s two different questions there. I think the distributors act differently than the retailers. I think as we get into the holiday season it won’t be surprising to see you know both of them stock their inventories along more normal levels. And the question becomes what happens after the holiday season? And do they go back to more rigorous financial discipline or not? And that just still remains to be seen.

Operator

Your next question comes from Ann Gurkin - Davenport & Company LLC.

Ann Gurkin - Davenport & Company LLC

As we look out to the second half of your fiscal year, I have a couple questions. One, what are you looking for on-premise performance in the second half of fiscal 2010? And then secondly, again on this timing of promotion and advertising spending, the shift in that spending to the September, December timeframe, how do you look at that increase in spending versus top line growth? Are you going to be able to accelerate growth enough to offset the step up in spending? Can you help me with that a little bit?

Donald C. Berg

Yes. You know as we have you know looked forward and provided information as it relates to guidance, we have pretty much stayed right at the operating income line, the underlying operating income line. And one of the reasons for that obviously is because of a lot of the uncertainty that we’re seeing but more importantly we really do want to keep the flexibility so that we can continue to react as we see things unfold. And part of it is to be able to react to competitive activities but also part of it is to continue to watch what the consumer is doing and where he’s going. So that you know if he becomes more responsive going forward, you know we can stay right there with him. And so you know in terms of the on-premise, you know it’s hard to say where that’s going to go. We would like to see it solidify. There is obviously a lot more brand building opportunities and activities that you can do in the on-premise than you can the off-premise, but it’s just hard to say at this point.

Ann Gurkin - Davenport & Company LLC

So at this point you look for it to remain relatively challenging in the second half?

Donald C. Berg

No, we don’t see anything that would suggest that the trends that we’re seeing are going to change much.

Ann Gurkin - Davenport & Company LLC

Then the step up in spending versus top line growth in the back half?

Donald C. Berg

I’m sorry, the what?

Ann Gurkin - Davenport & Company LLC

Higher advertising informational spending, the shift in that spending in the second half, how does that compare to top line growth? How are you going to manage the two perimeters?

Paul C. Varga

Well I think just trying to do a little bit of the math from the first quarter and then thinking about the second. I mean we certainly hope that what we invest behind, whether it’s in the A&P line or SG&A or in cost of sales or in promotional pricing has the impact. A lot of it, Ann, will depend on how competitive you know it is in terms of the activities or actions of our competition and how the environment goes. I think though the bottom line on it, if you’re trying to forecast out, is that we would expect you know a lot less operating leverage in Q2 through Q4, if you’re trying to you know mathematically reconcile you know our guidance with the first quarter. I just think we will expect to have less operating leverage so I don’t know if from an efficiency standpoint declares something that in the force-out. I was trying to read through your question a little bit. But we don’t expect to have near the degree of operating leverage in Q2 through Q4 that we had in Q1.

Ann Gurkin - Davenport & Company LLC

And then just the overall U.S. spirits market, what is your outlook for volume for 2010, calendar 2010?

Paul C. Varga

Well I mean we went in, I mean the first quarter showed some moderation of the growth that had been consistent for many years now, so it has us you know at least cautious about what might happen in the holiday season and for us from Q2 all the way through to our fourth quarter. I mean I actually feel like because of the profitability of the spirits segment and particularly the attractiveness of the premium segments, I continue to be a believer that there’s too many constituents whether they’re suppliers, the distributors, retailers in the industry who are going to want to promote premiumisation and should benefit from that promotion. Now the consumer has to be there. I will say that the consumer has to be there for it. And you know we’ll just have to see as the consumers you know perspective on what they do with their discretionary dollar changes as they get out into the fall and calendar year ’10. But I’m still a believer that premiumisation in time, in the right environment, will be motivating not only to consumers but particularly also all the participants in the industry have good reason to promote more premium items.

Ann Gurkin - Davenport & Company LLC

Do you still think modest growth is a fair assumption, modest volume growth?

Paul C. Varga

Yes. I think so. We were low single-digit anyway I mean and there’s varying sources, but a lot of it will depend I think more importantly even if you’ve got 1 to 2 to 3% global growth, a lot of the devil is in the details as to where is that growth coming from and are people trading down, staying where they are, trading up. And so I think that will play a larger role than whether spirits globally grow at 1.5% or 2%.

Ann Gurkin - Davenport & Company LLC

And then for your 2010 outlook, do you have any price increases in that outlook? Are you using that lever at all?

Paul C. Varga

I mean consistently. Number one, you always get the benefit from price increases you may have taken in a prior period as you lap the months where you didn’t have it. We have consistently looked for opportunities all over the world, brand by brand to take pricing. What we’re finding is and it was evident in the results is at various times on particular brands at particular times you’ll also have to make sure that you may price promote some of it back, but net net I think you saw in our results for the first quarter that pricing was a contributor to net sales above volume. So we’re encouraged by that and we’re going to try to keep that trend going. But we’re also going to have to be responsive out in the marketplace depending upon what else is going on from our competition.

Operator

Your next question comes from [Kevin Droyer] – Gabelli and Company.

[Kevin Droyer] – Gabelli and Company

I just want to ask a little bit about el Jimador. It looks like the numbers were very good for that brand. What was the source of that? Was it pipeline fill, share gains, just reaction to the new packaging?

Donald C. Berg

Yes, you know we’ve been talking about el Jimador for a little while now just in terms of some of the changes that we made going to 100% agaves, from the package changes that we made there. And it is getting traction. It has started out very strong. We’ve been seeing it improving you know over the course of the last several months. We’re also seeing some nice improvement on it in Mexico as well, which is a very challenging market right now generally, and particularly for tequila. And we do think you know we’ve got a nice tool kit in place. We’ve got a lot of activities going on behind it and our belief is that it’s resonating with the consumer.

Paul C. Varga

I mean it really is on fire in the U.S. It’s doing very, very well. I think it is associated in part with the product and package change and it’s also one of those things when a brand gets momentum, I think the system all the way through from Brown-Forman’s salespeople all the way through to retailers like that and they’ll support it. So we’re very happy to see it. And like I think Don mentioned, we believe it to be one of the best performing, sort of premium spirit brands of size in the U.S. right now.

Donald C. Berg

It’s also while it’s a very premium product, it’s one of the best values out there in terms of 100% agave.

[Kevin Droyer] – Gabelli and Company

And maybe you could talk a little bit more about how Herradura is going and also just overall how do you view these brands since the acquisition? Have they performed as expected, below, above?

Donald C. Berg

Yes, I mean Herradura is about and this is actually really an important stage for Herradura, it’s launching some new packaging in the United States sort of as we speak. And we think that’s a really important attribute. Our lessons over the years have taught us that packaging can have a, you know, major impact on trajectory. Now having said that, for Herradura it being one of the you know leading sort of super-premium brands and a brand that very much has an on-premise following, the environment I wouldn’t say is as conducive for growing that brand right now as say el Jimador. And so I think that Herradura has some of its challenges associated with these business conditions that have unfolded in front of it over the last 18 months or two years. We do have a number of initiatives that we think could you know help it. And all of them have a very consistent theme of trying to make sure the brand can travel between the on-premise and the off-premise, a number of packaging type initiatives, some special packs. So we’re working it hard but you know relative to what we would have expected, we did not anticipate the environment that has unfolded in front of Herradura.

But on the flip side, we didn’t anticipate the kind of performance that is going on with el Jimador. Similarly one of our RTDs down in Mexico has done very well which is the new mix RTD over the last couple of years. So as with these acquisitions, I mean the environment changes on you and you get some both positives and negative surprises and this acquisition is no different.

[Kevin Droyer] – Gabelli and Company

And just in terms of use of cash flow for the company, I mean that continues to come down. I see you’re still repurchasing shares. Any thoughts on future uses of that? Would you expect to continue to buy back shares, maybe increase that? And in the current environment how would acquisitions play?

Donald C. Berg

I think the best way to think about that is we’ve been very, very consistent about how we think about our cash flow and the uses for the cash flow. We tend to be you know very kind of shareholder first and foremost, whether as we think about acquisitions you know finding ways where brands in our hands can create value for the shareholder versus when we look at the opportunity for either buying back stock or looking at our dividend or other ways of getting value to the shareholder. And that really hasn’t changed. So you know as we continue to look forward we’ll continue to look for those opportunities and where we don’t see those things immediately, we’ll just continue to use the cash to continue to pay down our debt.

Operator

Your next question comes from Thomas Russo - Gardner, Russo & Gardner.

Thomas Russo - Gardner, Russo & Gardner

Two questions for Paul. The first one, Paul, how do you protect against with the passage of time the consumer price promotion that’s being used tactically? Flipping an unintended net lower price sort of permanently for brands whose equities you’ve built up over such a long period of time is the broad question. The second one, Paul, involves Australia where it seems like you moved in on the aftermath of the excise tax and seems to have invested well and taken some share in the RTDs there to put off the competitive dynamics in Australia. And I guess that’s it.

Paul C. Varga

Yes, I mean I think the answer to your first question, Tom, is trying to avoid the pitfalls of the traps which are well known about price promoting. I mean I think the basic answer is don’t do it too deep and don’t do it too frequently. Do it in a way by making sure you’re continuing also to promote the [premiumness] of the brand in ways beyond pricing. And so I mean I think we have our hands very much on this. And I recall at times, particularly in Jack Daniel’s history where you go through major price points. It’s really interesting. That’s a very different circumstance in the kind of competitive environment or the consumer environment we’re in today. But it’s not all that different in terms of the techniques.

You’re going through the price points to raise the perceived and actual value of the brand, but from time to time you need to be able to give price promotion so that people can buy it at what they would consider to be an attractive price point. And it’s particularly true for I think Jack Daniel’s, this balancing act, because of the broad franchise that is very loyal to Jack Daniel’s. But some of that loyalty gets questioned when discretionary income is lower. And so we don’t think people really leave Jack Daniel’s for good. They just have fewer occasions where they can afford to buy Jack Daniel’s. So you simultaneously build value in other ways beyond pricing. You make sure your front line pricing continues to go up and then you find very effective ways to create the value, whether it’s through periodic price promotions, value added packaging and other vehicles in the marketing tool kit to create value. So I think those are the responses to it.

Regarding Australia, I would say part of why we’re doing very well down there goes back two years and I actually think [inaudible] had a huge impact on our ability to react and respond to last year’s tax increase. I mean our knowledge of the RTD business, our knowledge of that marketplace helped us to make the right decisions we believe a year ago and position Jack Daniel’s and Cola down there to have the kind of year it did last year, which was a tough year on the profit side but we think we minimized the impact in the way that we maneuvered in that market. And I think as we start to cycle some of that we should have some benefit. And a lot of that came through with these particularly soft comps. We were going against some pretty soft comps in the first quarter, but the demand down there is very healthy for Jack Daniel’s. I think a large part of it is the fact that we have our own distribution down there and are alert to the marketplace and know what’s going on and make some good calls.

Operator

There are no further questions at this time. Are there any closing remarks?

Ben Marmor

Thank you, [Natasha]. Well for those of you planning your Labor Day weekend barbeques, be sure to pick up our new ready-to-pour Southern Comfort Hurricanes or Southern Comfort Sweet Tea to give them a try. But we thank everyone for joining us and have a great weekend.

Paul C. Varga

Thank you all.

Operator

Thank you. This concludes today’s conference call. You may now disconnect your line.

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Source: Brown-Forman Corporation F1Q10 (Qtr End 07/31/09) Earnings Call Transcript
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