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Brown-Forman Corporation (NYSE:BF.B)

F2Q10 Earnings Call

December 08, 2009; 10:00 am ET

Executives

Paul Varga - Chairman, Chief Executive Officer

Donald Berg - Chief Financial Officer

Jane Morreau - Senior Vice President, Finance Management, Accounting, and Technology

Ben Marmor - Director, Investor Relations

Analysts

Lauren Torres - HSBC

Timothy Ramey - D. A. Davidson & Co.

Lindsay Mann - Goldman Sachs

Ann Gurkin - Davenport & Company

Thomas Russo - Gardner Russo & Gardner

Operator

Good morning. My name is Vernel, and I will be your conference operator today. At this time, I would like to welcome everyone to the Brown-Forman second quarter fiscal year 2010 conference call. (Operator Instructions).

I would now like to turn the call over to Ben Marmor, Director of Investor Relations. Mr. Marmor, you may begin your conference.

Ben Marmor

Thank you Vernel. Good morning everyone and thank you for joining us for Brown-Forman’s fiscal 2010 second 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 remarks about our performance and Don will provide additional commentary on the quarter and our guidance.

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 the fiscal 2010 second quarter. The release can be found in our website under the section titled Investor Relations. We have listed in the press release a number of the 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 reason management believes they provide useful information to the 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 Paul.

Paul Varga

Thanks Ben, and good morning and happy holidays to everyone. This morning we were very pleased to report first half results that we believe are excellent given the world’s economic challenges. Our people and our partners deserve great credit for producing a 15% growth and reported and underlying operating income at any time but they merit extra recognition for producing such strong results in the difficult environment of today. Let me say thanks to each and everyone of these professionals.

During the 12 months which ended October 31, we all witnessed a staggering and for most of us, unprecedented decline in global economic conditions, since our second quarter’s end marked roughly one year since the onset of the global economic crisis, I thought we should review our 12 months results ending October to see how we performed during such challenging times.

Of course, this is an unusual time in the modern era of business and accordingly the manner in which Brown-Forman derived its results was somewhat unusual, as we rely more heavily on operating leverage to produce our strong results. What was not unusual or unprecedented was the Brown Forman’s results, namely our performance on key metrics, such as underlying net sales, underlying operating income, and return on invested capital continued at or near the top of our industry competitive set.

For the 12 months ended October 2009, our performance reflected flat underlying sales, a 10% reduction in underlying operating expenses and a 10% growth in underlying operating income. When paired with tight management of both capital spending and working capital. This underlying growth help drive an excellent 17% return on invested capital for the same period. We believe this RSOC stands at the very top of our industry competitive set.

Our results were enhanced further by the quality of the balance sheet behind them. At a time when financial stability could not be taken for granted, our conservative balance sheet and strong cash flows enabled us to increase the dividend by roughly 6% over the 12 month period ending October. And during the same time frame we also repurchased $177 million of our shares at an average price of $45.71 per share.

Our consistent track record of providing liquidity to shareholders was acknowledged just yesterday when Standard & Poor’s announced that Brown-Forman would be added to the S&P 500 Dividend Aristocrats Index, an index which recognizes S&P 500 Company which have increased their dividend for at least 25 consecutive years.

The external conditions over the last year required our company to be more adaptive. And I believe that our people responded well to this challenge. Our performance over the last year benefited significantly, from a heightened level of innovation and productivity, and I believe we realized early the need to seek our greater efficiency from our operations while at the same time, pursuing new sources of sales growth, particularly in the off-premise channel.

By more fully recognizing the potential of our assets, most notably our brands, our distribution networks, our production capabilities, and of course our people. I believe our company had its most resilient 12-month effort in a very long time. Two of the most noteworthy examples of this are the performances of the Jack Daniel’s and el Jimador trademarks during the last year.

Over the last 12 months, the underlying net sales of the Jack Daniel’s trademark grew by 4%. In addition to the modest growth of our flagship Jack Daniel’s Tennessee Whisky, the growth of Jack Daniel’s RTDs and the super-premium Gentleman Jack both played an important role in the trademarks underlying sales growth.

Given all that transpired this past year, we are proud of the progress we made around the world on our company’s most important brand trademark. While quite a bit smaller than Jack Daniels, the el Jimador trademark is becoming increasingly more important to Brown-Forman’s growth story.

Acquired as part of the Casa Herradura purchase back in the early 2007, the el Jimador trademark encompasses both el Jimador tequila and the New Mix ready-to-drink brand. In the last 12 months, the advance in underlying net sales of this trademark was attributable to the rapid growth of the el Jimador tequila in the United States, a stabilization of the very large el Jimador business in Mexico. The expansion of el Jimador beyond the U.S. and Mexico and a solid growth of the important New Mix business in Mexico.

Since we have reformulated the el Jimador product to be 100% agave and improve the quality and global consistency of the el Jimador packaging, the brand has responded strongly, particularly in the United States where we believe it as one of the hardest premium to distill spirits in the country, while continuing to have considerable upside.

I believe the Jack Daniel’s and el Jimador successes are great examples of how Brown-Forman is utilizing our valuable assets to improve sales performance and marketing efficiency. Through their ready-to-drink line extensions. We believe both brands improved sales of the trademark while also sending important marketing messages about brand mixability and convenience at a time when consumers have been shifting more of their consumption to the off-premise.

Additionally, we feel the presence of these branded drinks in store and in home provide a broader overall brand name presence in the marketplace that is available to the full strengths Spirit Brands alone.

In addition to their ready-to-drink brand extensions both Jack Daniel’s and el Jimador benefited from Brown-Forman’s growing distribution assets around the world. Several of the headline performances for the Jack Daniel’s trademark over the last 12 months came from markets where our company has improved our end market presence and influence in recent years, such as Australia, Poland, Germany and Mexico.

Similarly, el Jimador leveraged our distribution strength in the U.S., the U.K., Australia, Germany and Poland to help drive its sales growth over the same period. The primary purpose of providing these trademark and distribution examples is to better illustrate for you how our company has achieved greater efficiency and effectiveness from assets that already existed and from investments that had previously been made, because of this, at a time when it was more difficult to incrementally invest we found more resourceful ways to spur our sales beyond a simple increase in advertisings or reduction in price.

Before I turn it over to Don, let me conclude by expanding the horizon a bit beyond the last 12 months. Since we will complete this century’s first decade in a few weeks, we recently took the opportunity to review our ten year performance metrics.

While this is subject to change as the last few weeks unfold. Brown-Forman’s ten year compound growth and total shareholder return at the end of business last Friday was right at 10% and is compared quite favorably to the S&P 500’ decline of approximately 1% over the same time period. We consider this a stellar long term performance, and it would not have been possible without the commitments of our long term shareholders over the last decade. We are manfully appreciative of their ongoing support.

Thank you for listening, and now let me turn things over to Don.

Don Berg

Thanks Paul. Good morning everyone and happy holidays. As Paul mentioned, we believe that Brown-Forman has continued to perform at or near the top of the industry for both the last six and twelve months for both underlying net sales and underlying operating income growth.

Our growth and underlying operating income has come from reduced operating expenses as a result of cost reductions, cost efficiencies and productivity improvements. Operating expenses also appear lower due to reallocation of some investments from advertising and promotions to packaging innovations and value added packs that is recorded as cost of sales, and additional promotional discounting which is a reduction from gross sales.

Given that, I’m going to focus most of my comments on what we’ve seen more recently in terms of our top line results. Thinking about our top tier underlying net sales performance, at times it seems as some who follow our business have a hard time understanding how we outperform the industry’s growth when we are not the biggest player.

So let me delve a little more deep into the quarter’s results, because I think they speak to the resiliency of our brands and geographies, and the benefits that we get through the portfolio and geographic diversification that we have achieved.

It’s easy to try and oversimplify Brown-Forman. I believe that in the past, we have mentioned that roughly half of our sales are from Jack Daniel’s Tennessee whiskey, and that roughly half of our sales are in the United States. Using those figures, it seems that many people will just watch Jack Daniel’s sales in the U.S. and think they have the Brown-Forman story. We are far more diversified in that, so let’s look at it a different way.

Looking at net sales over the last 12 months, Jack Daniel’s Tennessee whiskey in the U.S. only represented about 20% of the story. This past year roughly 80% of our sales came from a combination of the rest of our portfolio globally and through our sales of Jack Daniel’s internationally.

So, let me start with what represents this 80% of our business. Looking first, our international sales of Jack Daniel’s Tennessee whiskey, we continue to benefit from our broad international diversification, while the brand showed slight depletion growth in the quarter.

For the quarter, very strong depletion growth continued in France and Australia. Germany, Russia and Mexico also showed double-digit growth as had Poland which we anticipate will break through the 100,000 case milestone in the third quarter.

Additionally, Japan showed nice mid single-digit growth and Spain and Italy showed some modest depletion growth for the first time in quarter while, although it appears that they benefited from some retail restocking as consumer trends there remained a concern.

The import in U.K. market was also up, although we believe this quarter benefited by some shifts in retail buying patterns. Not surprisingly, we also had some countries that showed depletion declines in the quarter, for example, South Africa which continued to struggle. But overall, with a broad geographic reach of Jack Daniel’s Tennessee Whiskey the brand grew outside of the United States.

Moving to the international sales of the rest of our portfolio. Depletions grew mid single-digits led by strong performances of our pre-mixed products as well as our tequila portfolio. On the Pre-Mix front we continue to benefit significantly from our investments and ready-to-drink products.

In Australia, Jack & Cola continued to grow in mid double-digits. Germany toward the end we saw almost 300,000 cases of Jack Daniel’s ready-to-drink products also continued to grow at solid double-digit rates. In Mexico, where Brown-Forman leads the ready-to-drink market with over 4.5 million cases of New Mix, that brand grew in the mid single-digits during the quarter.

This New Mix growth led the mid single-digit growth in our overall tequila performance outside of the United States, along with significant growth of el Jimador in a number of international markets including the U.K., Spain, Poland, Canada and Australia. These strong results were tempered by Southern Comfort in Finlandia, which continued to struggle with mid single-digit depletion declines.

Turning to United States, and our broad portfolio beyond Jack Daniel’s Tennessee Whiskey, results were somewhat mixed. A number of our brands did well in the second quarter. Finlandia Vodka, Early Times, Old Forester, Pepe Lopez, Little Black Dress, Gentleman Jack, Jack Daniel’s Single Barrel, Woodford Reserve and especially el Jimador all showed depletion growth in the quarter.

Although, there’s no doubt that there is continued concern about the level of trading down that we’re seeing generally throughout the U.S., we remain encouraged about the future of premium and Super Premium brands as depletions for Gentleman Jack, Single Barrel and Woodford Reserve all grew in the mid single to low double-digits in the quarter.

In addition, a number of other premium and super premium brands in our U.S. portfolio Sonoma-Cutrer, Bonterra, Herradura and Chambord are all still declining somewhat showed improving depletion trends compared to the first quarter. One milestone particularly worth mentioning, el Jimador in the U.S. which sells for about $20 for a 750, during the quarter surpassed 200,000 cases on a twelve month basis.

We’re particularly pleased with the performances of this brand as it continues to grow at significant double digit rates. On the other hand, a number of brands continued to struggle in this period, particularly brands that are more depended on strong on-premise environment which has especially affected Southern Comfort.

Finally, let’s talk about that roughly 20% of our business that is Jack Daniel’s Tennessee Whiskey in the United States. Second quarter depletions showed a small decline and a slight improvement over the first quarter. Encouragingly, roughly half of the 50 States showed improvement in their depletion trends, which included our four largest markets of California, Texas, New York and Florida. The last three, Texas, New York and Florida all growth in the low to mid single-digits, while California showed a slight decline.

A couple of reasons why this is particularly encouraging, both Florida and California were early markets to suffer in the economic downturn and suffered disproportionately. In addition, all four of these markets are where we had implemented our distributional lines with Bacardi. Nielsen and NABCA consumer takeaway data also confirmed these improving trends.

If you look at the broader Nielsen data that includes liquor stores and management club stores and beyond just food and drug, and you combine that with NABCA sales data which brings in both on-premise and off-premise performance in the control states, all of this information together represents about 55% of the total U.S. spirits business.

Here for the last three months, Jack Daniel’s Tennessee Whiskey shows value growth as increased pricing more than offset slight depletion declines and some negative size mix. Besides the benefits that accrued at Brown-Forman as a result of its brand and geographical diversification, a number of innovative brand extensions and a host of other creative activities contributed to our top tier industry performance and underlying net sales growth.

Throughout the first half of this fiscal year, our sales volume benefited from the new distribution of Southern Comfort ready-to-pour offerings in the U.S. and New ready-to-drink in the U.K. Flavor extensions on Finlandia, new flavors of new mix in Mexico, the launch of Jack Daniel’s & Cola ready-to-drink in Mexico and in the U.K. and the recent launch of Antiguo tequila in the United States. All these introductions have contributed to our top-line growth, but it is still quite early to assess our ability to contribute it to ongoing future growth.

Having said that, particularly with the ready-to-drink and the ready-to-pour products, we are pleased with the additional benefit from the increased consumer impressions, all of this activity is bringing to the parent brands. Besides the innovation around line extensions, as the businesses move more to the off-premise, where the consumer directly interacts with the package. We have also been investing significantly in new packaging.

Besides the package upgrade on Gentleman Jack where we have been seeing the benefits for almost two years now, we had recently introduced package and label changes on Jack Daniel’s Single Barrel, el Jimador, Herradura and New Mix. We also have a number of packaging projects underway for several others brands in our portfolio that we anticipate to have in the market by the end of this fiscal year or early next fiscal year. We believe these activities in particular can be very effective in creating added awareness especially in off-premise channel.

Finally, as we think about Brown-Forman’s top tier performance within the industry, it’s important to focus a bit on our ability to compete in today’s environment. During the past several months, we have seen dramatic shifts in consumer behavior. Particularly as it relates to the move from on-premise to the off-premise, this coupled with the increase sensitivity, consumers appeared to be adding to pricing and the related trading down we have been seeing, we believe we have moved quickly to adapt to the trends.

We’ve already discussed some of the innovative moves we’ve made as it relates to line extensions and package changes. While we have also made a number of other competitive moves as well, this includes shifting appropriate advertising and promotion activities from the on promise to the off-premise and focusing these activities more towards encouraging consumer purchase behavior.

We have also considered consumer behavior changes, and targeting the timing of our nil investments, to try to talk to consumers when they are most receptive while at the same time taking advantage of recent opportunities to gain media buying efficiencies. For example, comparing our second quarter media impressions for Jack Daniel’s to the same period last year, impressions increased by double-digit rates in markets such as the U.S., Germany, China and Australia.

While the overall media spend in these markets was down. We have also invested more in value-added packs as a way to provide the consumer more rather than just reducing price. And as we mentioned before, we continue to be price competitive and very targeted strategic ways on a market by market basis all with an eye towards increasing sales value rather than sales volume.

We believe all of this flexibility have served us well and expect to continue to change our mix in investment levels if the conditions worn. At Brown-Forman we tend to take a longer term view and rarely obsess on any one quarter’s results. That has not had changed even during these difficult times, while with the rapid pace of consumer behavioral change our industry have seen from more than one year, we look to these shorter term results to help inform us on how to think about the future and what the longer term trends maybe.

We do believe that the on-premise business will eventually stabilize and growth of the return. Although that certainly is not in sight yet. We also believe that the consumer is interested in flavor full drinks and multiple drink choices will continue, and that this trend towards mixability will continue to be an advantage for spirits. And we believe that the long-term trend towards premiumisation will also continue and we are encouraged by the trends we see on some of other high-end brands.

But in the meantime, we continue to be watchful about some of the other trends we are seeing, particularly in the United States. Where the on-premise continues to weaken, consumer seem to be trading down at a faster rate, and the marketplace seems to have become more competitive with more price discounting. No doubt there continues to be a lot of uncertainty about consumer behavior, particularly as it relates to this holiday season.

But even with the shorter term concerns, our results show that not only does the broad diversification of brands and geography bring a lot of resiliency, but we believe our results also show that we are well equipped to meet these challenges just as we consistently met the challenges at the past, and while we have no clear crystal ball on how consumers will respond over the next few months, we continue to have confidence in our belief that we have wherewithal to continue to perform overall in the top tier of the industry.

So, with those comments in our business generally, and on the quarter specifically, let me turn the attention to our outlook and how we are thinking about the rest of the fiscal year. This has probably been one of the more complicated years in a long time in which to compare results. Stepping back for a moment, last year’s first half had relatively strong and we believe top tier performance and underlying operating income growth for fiscal year 2009.

So coming into this year, for the first half we had more difficult top line comps and easier operating expense comps. For the last half we anticipate the reverse, easier top line comps but much more difficult operating expense comps. Add to that the fairly dramatic swings we have seen in currency exchange rates which further complicate the comps on a reported basis.

With that said, we increased our fiscal 2010 earnings guidance today to a range of $2.95 to $3.15 per share. This updated guidance reflects our better than expected sales performance in the first half of the year, our excellent management of operating expenses and our confidence about our ability to operate effectively in what remains a competitive and uncertain environment.

As mentioned before, we expect to continue to perform in the top tier of our industry this year. This guidance reflects the modest improvement and second half underlying net sales trends with full year underlying net sales performance that are expected to represent flat to modest growth, that also assumes that underlying operating income will be down in the second half of the fiscal year, as we cycle against the adjustment and performance based expenses last year, as well as the significant operating expense reductions recognized in the last half of last fiscal year.

Net-net we expect a slight improvement in underlying operating income growth when compared to the company’s original guidance in early June. Our current expectations for underlying operating income to grow in a low to mid single digits to fiscal 2010.

We called that the original guidance of $2.60 to $3, included a $0.12 unfavorable exchange rate variance. Based on recent exchange rates, the current guidance assumes the results will have a slight year-over-year benefit from foreign currency. In terms of our tax rate, we expect an effective rate for the full fiscal year will be in a range of 32.5% to 33%.

Our guidance also assumes approximately $0.04 per share of benefit from the share repurchase program authorized last year which expired last week on December 3. A quick summary of that program over the past 12 months, we repurchased approximately a 196 million worth of Class A and Class B shares. The average price for the shares was $46.06, more than $5 less than the most recent closing prices.

Finally, there are a number of distribution contracts primarily in Europe that expired at the end of our fiscal year. We continue to evaluate alternatives during the midst of various discussions and considerations, and so do not yet know what if any, potential onetime impact any changes might have. So, at this juncture, we have not included any estimate in this guidance.

In summary, for those of you who like to reconcile things, this guidance has been updated for foreign exchange and recent spot rates, and narrowed to reflect less than certainly for the years as a result of completing the first half. It reflects top-line results above our initial expectations, but still have knowledge of the uncertainty that continues, especially related to the important holiday selling period and finally this guidance recognizes our expectation to continue to perform the top tier of the industry.

At this point we will welcome any questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question is from the line of Lauren Torres - HSBC.

Lauren Torres - HSBC

Don just to clarify as far as the guidance you mentioned the FX impact now is a slight benefit, is that what you set for the year?

Don Berg

That’s correct.

Lauren Torres - HSBC

Okay, and that’s actually better I think last quarter you said that was six to eight correct, so you went from 12 to six to eight to now slightly a positive?

Don Berg

Yes that’s correct.

Lauren Torres - HSBC

Okay just a clarification and secondly, I guess broadly speaking on your expense outlook for the second half of the year, obviously that’s been the benefit for you in the first half and you are aggressive also on the second half of last year.

Any guidance how we think about what you will be doing both on the advertising line and the SG&A line in the second half, how aggressive do you expect to be more with respect to advertising and also on the SG&A line, is there room here for reductions or just tells that we shouldn’t expect to see any improvement on that line?

Don Berg

Yes, on the advertising expenses, and I think we mentioned this a little bit in the first quarter as well, there has been some timing shifts on all of that, and we are expecting that, we will be seeing more A&P activity towards the last half of the year in particularly during the course of this holiday period.

On the SG&A front, we were probably be seeing something in the array of increases in SG&A over the last half of the year because those comps are so difficult, and so when you think about when we look at the total operating expense line, that’s what’s kind of bringing us to the conclusions that I talked about in terms of low to mid single digits in operating income growth for the whole fiscal year.

Lauren Torres - HSBC

And if I guess just one more question trend wise, I guess I’m a bit surprised to hear about further trading down and further sensitivity to pricing, I guess within the consumer world we are hearing about maybe modest improvements in sentiment, is it something that you think that’s more reflective of the categories that you are in or the channels that are you skewed to because I guess, I am just trying to get a sense of how much worse these trends over the last couple months has gone or what you have seen over the last several months?

Don Berg

Yes I think, I mean I think part of it is the time that we are in right now, the holiday period is always a very competitive period, and so you hear a lot about different additional discount programs that might be out there, and so that gives us a little bit of pause for concern although, it’s early yet, we will have to see how the holidays end up when all of a sudden done.

I think on the trading down front, it is particularly being seen in the U.S., although we see it in a couple of other countries outside the U.S. as well, and within the U.S. I mean when you follow kind of the NABCA and Nielsen data, I mean it continues to show stronger growth at the lower price points in our business; you are starting to see a little bit improvement at the higher end as well. It’s kind of in the middle where there seems to be a little bit of pressure.

So hopefully, we will be through that soon, but that’s pretty much the data that we are looking at is giving us some cause for concern.

Paul Varga

Yes, the way I might add to that Lauren is, versus those folks who you might be referencing that are seeing a reversal of prior trends, I mean we are seeing more stabilization, I would say of the trading down phenomenon and but it hasn’t yet turned the corner and started to go back toward better trends for the most premium price brands versus the value on top of their price.

Operator

Your next question is from the line of Tim Ramey - D. A. Davidson & Company.

Timothy Ramey - D. A. Davidson & Company

Just thinking back you mentioned el Jimador just passed the 200,000 case level I think you said in the U.S., can you remind us what that was at the time of the acquisition, that must have doubled I think is that right or close to double?

Paul Varga

Well I will tell you, it depends there was a lot of transition that was going on with the brands and all of its in the two primary countries, that even outside the U.S. and Mexico, but we would estimate sort of at the consumer level that the brand was somewhere in the 125,000 case range back a couple of years ago.

Timothy Ramey - D. A. Davidson & Company

And just you’ve done a great job growing the ready-to-drink business, but yes, there is something that just continues to concern me that, that business isn’t as good a business as your high end spirits business, do you view that as a defensive adaptation for the times or is the shape of the spirits business to come?

Paul Varga

That goes so far as your last statement that the shape of the spirits business to come, actually if you have had that expectation then I could see what you might be concerned, because I think by bringing a balance view to it would help.

I actually think there is a perception that because these brands are in a single serve format that they therefore are trendy, and our experience if we just peg the primary markets where we have ready-to-drink entrance, we have been in existence successfully in those markets for probably on average in excess of a decade, the Australia business goes back now and it’s roughly around 15 years I think Don.

The U.S. business where we’ve got a decent presence is a 20-year old business, the Germany business now, it’s probably more or like a six to seven year old business, Mexico the ready-to-drink brand down there, New Mix has been around for quite sometime.

So, I know because we have seen the lot of volatility and in the trends that you see from especially those that break out and get to very high levels and they drop it gets that perception, but we tend to think of them more, if you market them more as extensions of your parent brand versus free standing trendy drinks, I think they have a better chance of endurance.

On the profitability side of it, you have to remember that we tend to convert these to their how useful they are in the assets that we have such as whisky or vodka or tequila whatever it happens to be the expression, and you do, when you convert the overall business, I mean you can use conversion rates depending on the project from anywhere from eight to ten to one, and when you do that and multiply that also times the growth profit per case, they become very attractive alternative and hold up very well versus spirits brands.

So in addition, there is not typically as much aged inventory in warehouses behind them. So, I think there is a lot of benefits to them, it have to managed carefully and thoughtfully like almost any business, but I think on some levels because of the fluctuation in trends for some of the leading brands at various times they have gotten a bad reputation for being too trendy.

Don Berg

I would just add a little bit to that Tim in just in terms of how to think about it, in most of the markets where we are actively involved in this, the offerings that we are giving tend to be the way that the brand gets consumed generally.

So for example, in Australia, most of that business, predominantly Jack & Cola which is very, very prevalent throughout there, and so what happens is it’s a convenient form of drinking the beverage in the way a consumer likes to drink it, and it gets us into new drinking occasions, and particularly more beer drinking occasions that we don’t necessarily get into otherwise, and so while some have gone after this market more in the trendy way that Paul is talking about or is it really been more concentrated in taking the parent brand the uses it has today, and giving it to consumers in a convenient way.

Operator

Your next question is from the line of Lindsay Mann - Goldman Sachs

Lindsay Mann - Goldman Sachs

I guess so, you guys mentioned some of the strategic shifts that you have taken on in order to help both through the bottom-line during the recession, during the downturn and clearly you have had some nice benefits in terms of your underlying profit growth, but whereas so much of the very, very robust growth that you saw in the early part of the decade came from things like premiumisation, the badge of the brand, on-premise and all that sort of stuff.

Can you talk about how things like investing in promotional activity, value packaging and even RTD expansion whether that dampens your ability to recover when we come off the bottom, whether the growth outlook, with the equation from the growth would be the same as it was when we started that very robust period.

Paul Varga

Well might be Lindsay, that will depend more on how the environment recovers more so than what we’ve been doing in the interim, actually things what we’ve been doing will prepare us even better for any recovery, because of the fact we’ve kept our brands relevant during the time when in the absence of things like ready-to-drink and special packages that our brand trademarks could have become less relevant. It’s really just a shift in course that I think we’ve made to try to be where the consumer is, and in this case the large sort of within the industry term we referred to as the shift from on-premise to off-premise.

As Don mentioned, with the media spending particularly here in the last several months is well down the impressions are up, so I feel like from a total marketing program in trying to meet the needs of our consumers today, we are doing the right job for today, but also positioning the business for any kind of recovery and depending upon how that recovery unfolds we will make that what we hope for the right adjustments to continue to stay with the consumer.

So, I don’t have even a minute concern that we are doing something today that would hurt our chances in the future or would hurt our ability to participate in the future recovery.

Lindsay Mann - Goldman Sachs

Okay great, and you mentioned some of the promotional activity and we see it in the measure channel data really heating up into holiday. Could you give us just a bit more color on whether the geography or segments or parts of the market and the way in which that’s playing out?

Paul Varga

Do you want to take that Don or do you want me to?

Don Berg

Sure, I mean there is no doubt that we have been seeing more and more pressure coming in from, particularly on the pricing side. We just looked at some of Nielsen data that came in as of November the 14th, and it’s interesting.

If you look at the top five suppliers and clearly, the largest have really taken down their price mix, anywhere around 2% and whereas the other three have us, Fortune and Bacardi have continued to try to find ways to create additional value through the pricing mechanism, and so I don’t think there is any doubt that coming into those holiday season, pricing was going to be more of an issue particularly here in the United States.

By having said that, I also think we will able to find the right ways to compete, I mean everyone is kind of out there with their coupons, we are out there with our FSIs, it’s a typically competitive period anyway, I think will end up finding ways that everybody will all get through it, but there is no doubt that we are starting to see some pricing pressure out there.

Lindsay Mann - Goldman Sachs

And then you know last year there was some issues with inventory around third and fourth quarter, inventory destocking hurt you, and as we approach lapping that, is there a chance that your shipments will actually get a boost as we lap that sort of destocking that happened or have people permanently taking inventories down to even below those levels.

Don Berg

Well I mean there is potential there for us to see a boost coming into the early part of next calendar year as we relap against those, getting against that same period last year, there is no doubt.

Paul Varga

And that was both through that period that we saw from really, from last year’s end of Q2, all the way through the end of the year, we saw examples and they were in our numbers in the last half of not only distributable, we will call distributor inventory reductions, so it is also the most prominent period for retail inventory reductions as people dealt with the financial crisis, so I think there is the potential on both end that we could a beneficiary against those soft comps.

Operator

Your next question is form the line of Ann Gurkin - Davenport & Company.

Ann Gurkin - Davenport & Company

In your comments if I heard it correctly you believe we will see a return premiumisation in the category, do you think will reach levels we saw before the economic downturn or do you think it will be change kind of in the mix or the level reached

Don Berg

Well hopefully overtime we will get back to that point, I think it will probably be pretty gradual, I think part of what’s boosting our confidence when we looked at some of the data that we have seen recently, two of the categories that seems to be doing particularly well at the higher end are whisky and tequila, and so it serves us particularly well if those trends to continue, but I do think in terms of some of the premiumisation that we saw in the past to get back to those levels it’s going to take some time.

Paul Varga

And I would add to that, I think the Don comments I think are right on the money as it relates to most of the developing world. I actually think that in the emerging world, often whether people used the brick acronym or whatever, that the degree of premiumisation may be even stronger than what we would have experienced in places such as the United States or Europe over the prior 10 or 20 years, as those economies grow and the middle classes emerge, and they have more access to disposable income.

I actually think premiumisation as you refer to the trading up should become a stronger phenomenon in those countries, and in terms of where the demographics are, and population growth, those should be very attractive markets as the global economy continues to recover, and they could come back faster in some cases to say the references we often make to the U.S. market or maybe a western Europe.

Ann Gurkin - Davenport & Company

Okay, and do you have the competency you can raise prices on your portfolio in the U.S. over the next 12 to 18 months?

Paul Varga

Sure, on various brands and various prices, I mean as we always say, I think in the aggregate which sure are going to look today’s opportunities, it will depend somewhat on the degree of competitiveness in each market from price discounting and things like that, but I think the last 12 months as Don referenced, we have been able in one of the more difficult environments that I can ever recall to be able to take frontline prices up and then hold on to most of the increase. So, on our key brands where we do have real pricing potential. So if things improve we would hope to be able to do that or do better.

Ann Gurkin - Davenport & Company

That positive price mix incorporated in your 2010’s outlook.

Paul Varga

For the remainder of the year it should be yes, just a continuation of it.

Ann Gurkin - Davenport & Company

And then you mentioned you have distributor contracts coming up for renewal in Europe, are you looking at changing your strategy on how you go to market in those countries or can you give us any other detail on that?

Paul Varga

It’s just too early we are still in really evaluation and consideration stage, but wanted the people to be aware that it could have the potential that third quarter or fiscal year end, they have an influence on our reported earnings, but it’s just too early right now to know what impact that might have.

Ann Gurkin - Davenport & Company

So you may make some changes?

Paul Varga

We don’t know, we truly are in the evaluation and given consideration of what we are going to do over there and it goes a little bit beyond Europe, but it’s mostly Europe.

Paul Varga

And then Don, can you give us any update or what should you expect the tax rate and capital spending for fiscal 2011?

Jane Morreau

For 2011, let me take that, for 2011 I would have used a similar rate of 2010, so $32.5 to $33 is fine there and capital spending I don’t see increasing significantly from this year’s levels, so I think it bleeds us $40 to $50 million is appropriate for next year as well.

Operator

(Operator Instructions). Your next question comes from the line of Thomas Russo - Gardner Russo & Gardner

Thomas Russo - Gardner Russo & Gardner

First just a quick question on the ready-to-drink for you, is any of that still malt based or are you going back to original spirits in these offerings.

Paul Varga

The majority of it spirits around the world, the one exception have been in the United States where the country cocktails brands which is actually one of our first if not our first ready-to-drink expression, changed several years back to malt, but vast majority of its spirit based.

Thomas Russo - Gardner Russo & Gardner

Okay, good, the Don referred to a price point on el Jimador I think it was something like $25 and the race of the question in general, in North America how are you positioning Jimador and Herradura and what’s your sense of how the brand DNAs evolving, what’s the message that consumers to either on-premise or off when they reflect across the tequila category as to why to buy both of those, either of those brands anything particular you are succeeding at?

Paul Varga

Well I might talk a little bit Don you might fill in here, I think that I mean, we genuinely have a tiered pricing portfolio strategy for our entrance in the United states, and it goes everywhere from one of our products actually below the el Jimador price has been with us for a long time, which we think has a little bit better price fighting capability which is Pepe Lopez.

Then el Jimador hit the sweet spot for us, at around that $20 price point and so being very premium priced, and at a 100% agave meeting one of the needs of the U.S. market place but also capturing, what we think is a wonderful opportunity for the U.S. Hispanic audience to consume el Jimador in America whereas, previously it was less available as Mexican American sorted out.

Of course you mentioned Herradura which is the most premium priced, but even in between there is a brand that we are beginning to test in the United States, which is Antigua, which is a pretty large sized brand down in Mexico which is between the el Jimador and Herradura price points.

You got quite a bit of excitement about it for filling the same role that el Jimador is right now, in terms of meeting the needs of Mexicans in America who are seeking that brand out, and of course Herradura has been in the country for a long time, it’s been under distributed in our view, and right now it’s got the same conditions, and issues that are confronting a lot of brands up above $40 a bottle that are skewed to the on–premise.

But we are doing a pretty good job I would say with the new label launch which went out in the United States in September of getting added points to distribution and we are starting to see a little bit of pickup in the brand, which is really good despite the fact that the conditions are great. So we sort of run the gamut from $10 to $15 at the low end all the way up to above $40 and it was part of a tequila strategy we have when we purchased the company.

Thomas Russo - Gardner Russo & Gardner

Thank you very much, and Herradura of course has sort of three or four price lines under its own label?

Paul Varga

It actually does, depending on the expression. Actually they all will have slightly different prices based on the expression.

Thomas Russo - Gardner Russo & Gardner

Yes good. And then the incentive comp comparison, that in fact the second half of last year, how will they express this second half, is it that you are going to invest more internal comps this year because of year to date?

Paul Varga

Tom can you clarify that we’ve went out on just a minute there.

Thomas Russo - Gardner Russo & Gardner

Just a reference to the incentive comp comparisons in the second half last year I gathered, they were lower and hence provided you with operating income lift, this year will they be higher is that what we should expect.

Paul Varga

This year you would expect them to be back closer to normal.

Jane Morreau

Let me just reiterate or explain just a little bit Tom reminded me, last year through the first half our performance, it was very good as Don alluded to in his script. In the last half, particularly after the holiday season when the economy began to go down, and our business began to suffer to, and we adjusted our incentive comp in that quarter, and we recall that our incentive comp is based upon performance, how we are performing and what our expectations were for the year.

So that adjustment we made last year was to take that in consideration how we are performing this year and Don alluded to is we pay it up based upon again our performance and that’s reflective in our guidance that will be a higher number than it was a year ago.

Don Berg

Tom one of the reasons it was so strong last year is, I mean, the third quarter into a lesser extend the fourth had to bear the entire brunt of the seasonalization of that expensing because, in the first half we wouldn’t have envisioned it in the first half, and then whereas this year we’ve been able to plan for it a little more through each quarter, so the delta is going to look pretty significant as we get into the third quarter.

Thomas Russo - Gardner Russo & Gardner

Thank you last call, it sounded like Finlandia did well in North America, we’ve heard about other vodka brands are really competitively priced have done extremely well, so how were you able to get Finlandia to grow perform well again some very sharp price discounting?

Paul Varga

Yes, Tom we are actually in the process of repositioning Finlandia in the United States right now. And so we have taken the price down on a permanent basis, while we have taken it to a spot that we think is probably represents kind of where the consumers sees a greatest price value relationship, and as a result of that that’s where we are seeing some of this nice growth coming through the United Sates right now.

Operator

Thank you and I’m showing there are no further questions at this time. I would now like to turn the call back over to Mr. Marmor.

Ben Marmor

Thank you Vernel. We don’t have any closing remarks today, but as you complete your holiday shopping remember your loved ones would be thrilled to receive a gift of Herradura or Jack Daniel’s Single Barrel or any of other fine products. So, thank you everyone for joining us and happy holidays.

Don Berg

Thank you all.

Paul Varga

Thank you.

Operator

Thank you participating in today’s conference call, you may now disconnect.

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Source: Brown-Forman Corporation F2Q10 (Qtr End 31/10/2009) Earnings Call Transcript.
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