Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Brown-Forman Corporation (NYSE:BF.B)

F3Q08 (Qtr End 1/31/08) Earnings Call

February 29, 2008 10:00 am ET

Executives

T.J. Graven - VP, IR

Paul Varga - President, CEO

Phoebe Wood - CFO

Jane Morreau - SVP, Controller

Analysts

Kaumil Gajrawala - UBS

Lauren Torres - HSBC

Tim Ramey - DA Davidson

Ann Gurkin - Davenport and Company

Bryan Spillane - Banc of America Securities

Justin Maurer - Lord Abbett

Thomas Russo - Gardner Russo

Operator

Good morning. My name is Cathy and I will be your conference operator today. At this time, I'd like to welcome everyone to the third quarter fiscal 2008 conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question and answer session. (Operator Instructions) Thank you. Mr. Graven, you may begin your conference.

T.J. Graven

Thank you. Good morning, everyone. Thanks for joining us today. This is T.J. Graven, Vice President, Investor Relations at Brown-Forman. Joining me today on the conference call are Paul Varga, our President and Chief Executive Officer, Phoebe Wood, Chief Financial Officer, and Jane Morreau, Senior Vice President and Controller.

Before we get started this morning, a brief note on our press release. In our first version this morning, there was a wording error in the second sentence of the second paragraph. We issued a corrected version which is already on the wire. And that sentence should read net sales and gross profit gains benefited from the addition of Casa Herradura and a weaker US dollar, partially offset by changes in global trade inventories. We apologize for that wording error.

As usual our comments this morning will contain forward-looking statements based on management's current expectations. Numerous risks and uncertainties may cause our actual results to differ materially from those anticipated in these statements, and many other factors that will determine future results are beyond our ability to control or predict. You should not place undue reliance on any of our forward-looking statements, and we undertake no obligation to update them, whether due to new information, future events or otherwise.

A press release containing our results can be found on our website, under the section titled Investor Relations. And we have listed in that press release a number of the risk factors to consider in conjunction with our forward-looking statements. Other risk factors are described in Form 10-K or Form 8-K, and Form 10-Q reports.

During this call we'll also be discussing certain non-GAAP financial measures. These measures, and the reasons we believe they could be useful information to investors regarding the Company's financial results are contained in our press release.

Now, I'll turn the call over to Phoebe Wood.

Phoebe Wood

Good morning, everyone and thank you for joining us. This morning, Brown-Forman reported operating income for the third quarter ended January 31, 2008 of a $182 million, up $13 million or 8% compared to the same period last year. Performance in the quarter reflects improved US results, continued solid international growth, the addition of Casa Herradura and additional benefits from a weaker US dollar.

On an underlying or organic basis, operating income grew 7% in the third quarter. This represents an improvement over our second quarter growth rate of 6% and is equal to the organic growth rate in the first half. We believe this is a strong rate of growth particularly in the context of some challenging economic conditions in the US market.

Ten years ago, a US economic softening like we're experiencing would have resulted in a much lower rate of growth for our overall business. However, these results reflect the continued healthy international business, which now contribute more than half of our total net sales. We expect the growth in our international business to be significant to the overall growth of the company over the next several years.

During the third quarter, we improved our net sales growth rate over the second quarter for many of our brands in the US, reflecting a modest increase in volume and the benefit of higher prices.

Jack Daniel's volumes were up in the low single digit in the United States in the quarter and when combined with low single digit price increases, net sales for the brand were up at a mid single digit rate. The super-premium Jack Daniel's brand expression Gentleman Jack is the fastest growing brand in our portfolio, growing volumes and net sales more than 40% in the quarter in the US

Annual depletions now exceed 200,000 cases globally and the brands new and appealing package which has been in the market for roughly a year has received an exceptional consumer response. We'd also note that a fair amount of the growth for Gentleman Jack is coming at the expense of Jack Daniel's Tennessee Whiskey's volume metric growth, but at a higher price point and consequently higher margins.

Notably, the three super-premium bourbon brands in our portfolio including Gentleman Jack, Jack Daniels Single Barrel and Woodford Reserve represent over 400,000 nine-liter cases, and are growing at more than a 20% rate. In the US, these brands together have a market share of nearly 50% of the super-premium priced American Whiskey category that is brands priced above $25 a bottle at retail.

Southern Comfort experienced softness in volume trends for the quarter with low single digit decline globally. Over the past year, unlike many brands in its competitive set SoCo has taken aggressive price increases in the US, and more modest increases in many of the brand's key international market.

Economic softening in these key markets, weakness in the on-premise channel which is important to this brand and an ineffective promotion effort in the quarter contributed to the decline in volumes. As we finish off the fiscal year with efforts underway that will address some of these issues.

To finish our discussion of the US, net sales improved for several other brands including but not limited to Sonoma-Cutrer, Woodford Reserve, Tuaca and Bonterra reflecting higher volumes and higher pricing.

Outside of the United States, Jack Daniel's international depletions were up mid single digits in the quarter. Jack Daniel's & Cola, a ready-to-drink brand extension in Australia, continue to grow at a healthy double digit rate, well above the ready-to-drink category.

Finlandia vodka's net sales grew at a double digit rate, reflecting the benefit of both volume and price increases. These gains were driven by continued robust growth in consumer demand in Eastern Europe. Perhaps most impressive is the breadth of this brands growth in this entire region, was solid double digit gains in Poland, the Czech Republic, Hungary, Romania and Russia, where according to official import statistics, Finlandia is now the largest imported vodka.

I'm particularly pleased with our progress behind the development of Finlandia internationally. Since we took majority control of the business in 2003, we have added over 1 million cases to it base volumes. In fact, in the last 12 months the brand has grown by more than 400,000 cases, making it an increasingly important component of the company's overall growth.

Last fiscal year, we made two significant acquisitions both in the premium and of the spirits category, Chambord and Casa Herradura, using some leverage from our healthy balance sheet to add great brands of exceptional growth potential and excellent margins to our portfolio.

During the last few weeks of the quarter, we cycled the anniversary of our acquisition of Casa Herradura, and results for the business this year remain in line with our expectations. Our brand fared well in both Mexico and the US during our first important holiday season. As a result of new trade practices we implemented over the last year in Mexico and work to reduce abnormally high levels of trade inventories there, we believed our brand are in a much healthier positions compared to where they were 12 months ago.

I would also like to mention, we've had much stronger than expected performance for our el Jimador ready-to-drink brand extension called New Mix, which is the largest in the Mexican market and continues to outperform in that category.

The Herradura and el Jimador Tequila brands in the US are going well. We continue to focused our efforts in two areas; one, increasing points of distribution of the brands that more really available, and two, doing the basic marketing work, positioning, research, etcetera, that must be done, to build these brands effectively in this important market.

The integration of Casa Herradura into Brown-Forman is progressing as planned. Our efforts are on track, and we are scheduled to achieve a notable milestone tomorrow March 1st with merging of their processes and systems into Brown-Forman's established systems.

Earlier this month, members of the Casa Herradura team attended an award ceremony in New York hosted by one of the industry's noted trade publications at which Herradura was the first Tequila maker to win the prestigious award as 2007 Best Distillery of the Year. We salute, all of the employees at Casa Herradura for that fine accomplishment.

A brief note on our progress of the Chambord, net sales globally for the brand were up double digits in the quarter, and we're encouraged with the progress we've made improving our revenue and cash contribution for this brand versus our original expectations, and the consumer opportunities we continue to see in the US We're also pleased with the strong growth we're experiencing in high potential markets such as Australia and the UK Notably, we're now selling Chambord in more than 30 countries around the world.

Now turning to our cash flow, this is the first nine months of this year cash from operations is more than $397 million, compared to $278 million in the same prior year period. Solid earnings growth and working capital improvements including a one-time refund of VAT totaling more $30 million related to the acquisition of Casa Herradura contributed to the strong cash generation year-to-date.

This cash from operations and our healthy cash balances enabled the company to use nearly $443 million this fiscal year for the following; to pay dividends of $170 million, to distribute $204 million of proceeds from the sale of our consumer durable business to our shareholders, and a repurchase $122 million worth of shares in the quarter.

The shares repurchase were part of $200 million authorization by our Board of Directors. As of yesterday the program is nearly complete. Since the inception of the plan, we've repurchased 2,974,900 shares for $199.847 million; leaving only a couple of $100,000 remaining under the board's authorization. We believe this was an excellent investment at a time when interest rates and our stock price were both at attractive level.

We are narrowing the range of our full year earnings outlook for fiscal 2008 from $3.42 to $3.54 per diluted share to a range of $3.42 to $3.50 per share representing forecasted growth of 9% to 11% over a comparable prior year earnings of $3.14 pre share.

We expect in the fourth quarter to have continued global growth for the company's brands, a lower tax rate, and modest additional benefit from favorable foreign exchange. This outlook is tempered slightly by a challenging economic environment and our expectations of higher energy and grain cost.

With that I will turn it over to Paul Varga.

Paul Varga

Good morning, everyone. As you heard from Phoebe, our 7% underlying operating profit growth represents a slight improvement over the 6% underlying growth we reported in our last quarter and it equals our year-to-date growth. We continue to grow our net sales and gross profit at a mid single digit growth rate, while growing our operating profit at a higher rate due to lower growth rates in operating expenses, most notably SG&A, despite what we see as a somewhat challenging current environment compared to just a year ago.

As we look ahead, we will continue to aim for high single digit growth in operating income over the long-term. We have a strong track record of delivering this consistently, on naturally producing results that are, at times, both slightly above and slightly below this range.

Over the next year or so, we believe that our year-to-date profit growth rate can be improved upon, as we focused on the best top line and bottom line initiatives available to us and is noticeably more in competitive environment. Specifically, in the US, we continue to make appropriate shifts in our Jack Daniel's and Southern Comfort investment mix toward activities, which we expect to be more relevant in today's environment.

Examples of this include, spending more to expand our in-store presence, particularly display activity, as the consumer shifts some of their purchasing from on to off-premise, allocating more dollars to value-added packages where the consumer receives promotional material such as branded glassware that can strengthen their affinity toward our brand and ensuring our brands are promoted both on and off-premise with competitive frequency and competitive prices without compromising brand equity or operating margins.

While we still anticipate having strong investments behind longer term, awareness and image building vehicles like advertising and event marketing, we believe this environment calls for an investment bias toward brand-building program that have the potential to stimulate a more near term consumer response.

Looking at our most recent Nielsen data, ending in early February, we're encouraged that Jack Daniel's outperformed its largest two whiskey competitors, Crown Royal and Jim Beam and its second largest non-whisky competitor Cuervo on a dollars sales basis for the twelve, three and one month periods. Importantly we've seen some slight improvements in the most recent period.

In addition to these results, we're extremely encouraged by the potential for our Casa Herradura brand. We expect them to become a more important part of our growth story, initially in the US and Mexico and later in other countries around the world.

In the US, these premium and super-premium Tequila brands give us a meaningful position in the fastest growing segment of one of the industry's fastest growing category. Our historically small position in the fastest growing segments of the US business, namely vodka, rum and tequila has been a contributing factor at times to our corporate performance relative to competition. The Casa Herradura brand, therefore represent a great opportunity for Brown-Forman to improve our overall US performance and position.

Further important growth potential is signaled by our recent milestone of generating more than 50% of our company sales from outside the United States. This is the direct result of many, many years of consistent effort across our company and we believe this will continue to be our most significant long term growth opportunity.

Along side this potential in international markets, we believe our prospects for growth in the US remain substantial, as we have only a 5% share of the US market, and see much more room for growth here at home. The fact is that despite our wonderful success over the last two decades, we are still a relative newcomer in most markets and many categories and we believed our long term growth potential around the world remains enormous.

And with the US environment somewhat softer today than in prior years, we expect to place to more of our incremental investments in international markets to help spur the company's over all growth rates.

Additionally, we expect lower increases in SG&A to be a source of leverage and another contributor to our future growth rate. This is partially a reflection of the environment in which we are operating, but it's also due to the fact that we anticipate fewer incremental investments in the near term behind our worldwide infrastructure. After steadily and successful investing to strengthen our route-to-market over the last five to seven years, we now concede additional productivity from these earlier investments.

And finally, while we do expect the hard grain cost to persist. We do anticipate some lower wine cost over the next year or so to provide some offsetting release. Hope this additional commentary has given you some further perspectives on our business and we are now happy to answer any questions you might have.

Question-and-Answer Session

Operator

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

Kaumil Gajrawala - UBS

Thank you. Hi, Phoebe. Hi, Paul.

Phoebe Wood

Good morning.

Paul Varga

Good morning.

Kaumil Gajrawala - UBS

As you look at the economy and you talk about the economy, are you more concerned about potential trading down or is it that there just might be decreasing volume, but the consumer stays within the brands that they are in?

Paul Varga

I guess, a little of both. As you look at the numbers over the last couple of years, I think this is a comment about the US We've highlighted this in our last call some shifts from the on-premise to the off-premise which we think have the tendency to encourage some of the trade down that you are referencing there. Overall, I think our take on the performance in the US at the spirits level is that it may be down about 1.5 versus a year, may be a year or two ago and so it may be a combination of both factors.

Kaumil Gajrawala - UBS

All right. When you say down 1.5 point, you mean the growth rate is 1.5 points lower?

Paul Varga

Yeah.

Kaumil Gajrawala - UBS

But we are still growing.

Paul Varga

If we are running 4.5% growth, it's down about 3%.

Kaumil Gajrawala - UBS

Okay. That's all I have. Thank you.

Paul Varga

Thank you.

Phoebe Wood

Thank you.

Operator

Your next question comes from Lauren Torres with HSBC.

Lauren Torres - HSBC

Good morning.

Phoebe Wood

Hi, Lauren.

Paul Varga

Good morning.

Lauren Torres - HSBC

Hi, question on Jack Daniel's in the US We saw the sequential improvement in the quarter, if you put more framework around, what we're seeing there? Last quarter you talked about improving execution, you talked about competitive pricing activity in the market, if you kind of breakdown the changes you've seen in that respect and how that helped you actually see some improvement in depletion growth in the quarter?

Paul Varga

Well, I think you just referenced that, some of this stepped up execution and some of the promotional activities geared more towards the off-premise that I referenced in that comments. They were contributing factors as with some gift packs that we were out doing the holiday period contributing factors to some of the quarterly stronger sales. Looking at little longer term I think excited, I think in my comments there that we really are looking closely at the comparative performance relevant to other premium whiskies or other whisky brands, also to other non-whisky brands.

I'm reasonably encouraged that here in the last three months of Jack Daniel's volumes and dollars are growing at a higher rate than the three brands I referenced in my comments. Some of this is, it still early days, but the early work we did here over the last really 60 to 90 days seems to bare a little bit of fruit and we will just keep on with that activity.

Lauren Torres - HSBC

And then your comment you made, you said something about the pricing activity or changes, I'm thinking about pricing and also was referenced to the Jack Daniel's brand that what are your thoughts there as far as your pricing strategy? I know you've been relatively consistent. Do you expect any changes there?

Paul Varga

No, I'll tell you Lauren. We still think Jack Daniel's particularly, but across the number of our brands, we can take modest price increases and consistent ones like we've done. The references I was marketing to pricing there and what I did last quarter deal with sort of the promotional frequency where Jack Daniel's may get promotional pricing in the store particular sometimes on ad often accompanied by displays and often times this is an issue, we call blocking and tackling.

That was the executional comments I was taking about as well, making sure we're getting our fair share and being competitive with that. So, I think our frontline pricing has to continue as it has historically. We just making sure in this environment particularly with the broad consumer franchise that Jack Daniel's had, that we are getting our fair share of in-store promotion and where appropriate the right sort of pricing to the consumers that makes the brand attractive to them.

Lauren Torres - HSBC

And just lastly a clarification or just to checkup on you, your guidance still includes the same dilution related to Herradura and also same tax rate guidance?

Paul Varga

Yes.

Lauren Torres - HSBC

Okay, thank you.

Operator

Your next question comes from Tim Ramey with DA Davidson.

Tim Ramey - DA Davidson

Good morning.

Paul Varga

Hi Tim.

Tim Ramey - DA Davidson

Phoebe, just a little bit more clarification on the non-cash dilution piece, is that still running about $0.02 in the quarter?

Phoebe Wood

Yes it is.

Tim Ramey - DA Davidson

Okay. And if we think about the degradation and gross margin, some of that comes from mix with Herradura, some comes from cost pressure, have you done any work on trying to parse that those two factors out?

Phoebe Wood

Yes, we looked pretty closely and trying to segregate out, what was really happened in gross margin. And when you look at it the main reason is the effect of the Casa Herradura it just a mixed change in the lower margins from adding in the Casa Herradura brand, there are other changes we have some advantages from foreign exchange those offset the cost increases that we have. And so we have looked, yes, at many different components of that, if you're to summarize it and looking at the one thing that stands out, it's a mixed change because of the Casa Herradura brand.

Tim Ramey – DA Davidson

The base business gross margin is not really down?

Paul Varga

In the quarter, Tim, there was some shift in the geographic mix where it will make sense to you, brands like Finlandia are growing that this in the brand mix. The Finlandia is growing faster than say than Jack Daniel's which is it, or you are getting some of the, where we're really seeing strength right now in Jack Daniel's is in Eastern Europe and it's growing faster than say the United States, the United Kingdom. You will get some geographic mix, if you spread it out over the full fiscal year-to-date so far, it's less consequential, but on the quarter there was a little of that.

Phoebe Wood

Right.

Tim Ramey – DA Davidson

Okay. And Paul one more if I may, one of it bigger arguments a year ago was the change in the structure and how that might lever growth in brands throughout the world as you reorganized from, into a product function organization. Can you talk about, is that strategy working for you, or are you disappointed with results on that?

Paul Varga

I think I referenced it in the last quarter, the time it's taking us to acclimate, particularly the U.S. comment to the activities that we ended up focusing on, in a much better way during the third quarter was something I would say was disappointing not just to me, but all of us. It took us longer to get in the flow of new organization than we might have all hoped. But it's not just one single structural change that defends are approach us to distribution strategy of route-to-market.

I am seeing people more comfortable with roles and responsibilities and even so much. In this last quarter, we announced an expansion in the US of this partnership we got with Bacardi and Remy and working with some of our US distributors, which I think can be a nice addition as well to the US. I think it's not just the structural changes that we made a couple of years ago that the fans what we're trying to do in the US and outside the US, it's a really different story because of our portfolio is quite a bit smaller.

And we intend to focus on three to six brands whereas in the US you've got upwards of 25 and so it just a different exercise. But we've done a lot of work on this route to market and our approaches to distribution, we'll continue to do it those strategically and tactically. But I think we are in -- as I said in my comments, I think we are in a pretty settled to date right now that relates to that and it's a great time for us to make what we've got invested out there work real hard for us.

Tim Ramey – DA Davidson

Thank you.

Paul Varga

Sure.

Operator

Your next question comes from Ann Gurkin with Davenport and Company.

Ann Gurkin - Davenport and Company

Good morning.

Paul Varga

Good morning.

Phoebe Wood

Hi, Ann.

Ann Gurkin - Davenport and Company

Well, I ask you about the change in your inventory statement, as there inventory build somewhere. Can you comment on that?

Phoebe Wood

If you look carefully at the schedule A and you look at it, you can see that -- if you look at the year-to-date essentially we are -- there is no inventory affect. But, what we have been trying to be very clear about and to disclose if when there is an inventory build. So, we had a slight inventory build in the first half, third quarter there was de-stocking. And so, when you look at it again on the entire full year-to-date, there is essentially no impact from any inventory changes.

Ann Gurkin - Davenport and Company

[But] in your statement, offset by changes in global trade inventories? Sounds like a negative to me.

Phoebe Wood

Yes. There was some de-stocking in the international in the quarter.

Paul Varga

And we would have recorded at the end of the second quarter that we were slightly ahead on our shipments versus depletion and we kind of keep out a balance running for you all as we go through quarterly statements, so the adjustments that we announced today third quarter brings the full year-to-date, the nine months into about balance.

Ann Gurkin - Davenport and Company

Okay, that's great, thanks. And I was just little curious as to any comments regarding further industry consolidation whether among spirit companies globally or beer and sort of would curious, your current thoughts on that?

Paul Varga

That is always lots written out there, you probably tell from our comments we're highly focus these days on doing our business organically and that will stay alert to good possibilities for acquisitions that we did well at Brown-Forman.

Ann Gurkin - Davenport and Company

Are you in a position to take on more acquisitions at this time?

Paul Varga

Sure, I think from a investment and balance sheet standpoint, the things we tend to focus on its how well we can do with the brand, what potential prices you would end up paying and then also for us to, we're always looking at what we're working on that we has and what sort of, how to make room if you're focusing on a particular market on couple of brands how you actually get the sales and marketing and focus that you indeed in order to build anything you acquire, so there is a lot of considerations we look at but we'll remain open to all of them.

Ann Gurkin - Davenport and Company

Right, thank you.

Operator

Your next question comes from Bryan Spillane with Banc of America Securities.

Bryan Spillane - Banc of America Securities

Hey, good morning, Paul and Phoebe.

Paul Varga

Hey Bryan.

Phoebe Wood

Hi Bryan.

Bryan Spillane - Banc of America Securities

Couple of questions on first, in terms of the guidance, Phoebe does the guidance assume for the fourth quarter that there is any benefits from the share repurchase?

Phoebe Wood

It does.

Bryan Spillane - Banc of America Securities

Or put it in other way, will that be added at the EPS?

Phoebe Wood

It's certainly within the range of guidance that we have provided. We estimate that the fourth quarter effect of our earnings on our earnings is up about $0.01.

Bryan Spillane - Banc of America Securities

Okay. All right, great and then it will be it should be more -- it should contribute more as we look into fiscal '09.

Phoebe Wood

Indeed fiscal '09 may be $0.04 something like that.

Bryan Spillane - Banc of America Securities

Okay. All right.

Phoebe Wood

But that's something we can disclose and will talk F'09.

Bryan Spillane - Banc of America Securities

Okay, great and then also in terms of raw material cost, was there a change I guess will you contracted it all with there some change in the prices you were paying for raw materials in the third quarter and or what kind of volatility I guess should we expect there?

Phoebe Wood

I think it's going to be all over the board Bryan because some of our input cost, our raw material cost were under contract.

Bryan Spillane - Banc of America Securities

Okay.

Phoebe Wood

If we are under long-term contract with something those prices are going to stable whether their unusually high and usually low or perfectly normal, so we are and we do have pretty good hedging programs in place something like corns for example so you are going to have some effects but they are muted and in any particular quarter. Nonetheless is a clear march upward in terms of grain cost and we try to be very clear about what that effect is going to be and I think that if you look at those grain cost we see that they have been probably as much as $7 million year to-date and we think for the full fiscal year be about $10 million.

Bryan Spillane - Banc of America Securities

Well.

Phoebe Wood

So that's just the effect on us. Now but again there are all kinds of input cost that just happens to be one that international way to attract that because you can look up in the Wall Street Journal everyday with corn prices, (inaudible) and it's very it's on a march upward

Bryan Spillane - Banc of America Securities

Sure, okay. And then just while we are talking about a glass or packaging cost, have those moved up as well?

Phoebe Wood

Again these all depend upon contracts and in the case of glass we have a contract and so you don't see any short-term effects you are going to have more step function changes, but in this facility have immediate changes in the pace stock market, since we've got some those long-term contracts act on those where (inaudible) (16:27) was due in the traded commodities.

Bryan Spillane - Banc of America Securities

Sure, okay. And then in the quarter, just any commentary you have or color you can give on how you performed in the UK, given now little bit where I guess six months in the smoking bans and it seems like the on-premise channel has been somewhat weak for some of your other competitors, just any color you have terms of how you performed in the UK would be great?

Paul Varga

We had actually a pretty nice November, December and a softer January within the quarter in the UK and it was I would say it cause we were able to go for Jack Daniel's particularly, get some additional business out of the off-premise and as you mentioned the on-premise when it soft in the UK it really it can realty hit Jack Daniel's in Southern Comfort because we get such a larger percentage of our business out of that channel. But everything we are seeing from the brand health monitors and things like that they remain really healthy and I mean we hits our growth particularly in Jack Daniel's for the quarter in the UK, but it was needed some by softer January.

Bryan Spillane – Banc of America Securities

And then finally Paul, just when you think about promotions or in the US for Jack Daniel's, I guess it kind of strikes me that what may be different today versus previous economic downturns is that the spirits industry is probably merchandised more or like other consumer package goods than has been the case historically. So as you think about that are you looking for, and if you going to shift some of your spending sort of more push instead of pull, is it more frequency of promotion, is it bigger depth of promotion when Jack Daniel's is on deal, just how do you think that that's going to sort of manifest itself?

Paul Varga

I mean we're looking at both of those. I mean Jack Daniel's has a wonderful on normal base, it has a wonderful frequency of promotion, but in these environments we're always looking to get your fair share and more. And then on the debt I think I've mentioned this in the last call where Jack Daniel's had such a broad demographic and socioeconomic consumer franchise that we really want to work to get value in the consumer's hands and an environment where they will appreciate that particular type of value. And so an environment like this we attain and it's nice, it's a shuttle shift.

It's not like some wholesale alteration to your marketing mix that where you take on the margins sometimes 10% or 15% of your spending mix and you try to move it towards things that can stimulate, as I've said in the comments and more of a near term response. Where things like the advertising and other things like a wet market, even the on-premise promoting from time-to-time, they have a less of an impact on your near term consumption and purchasing, whereas the off-premise stuff it is, as you say, it's more like the environment of the packaged goods.

You will see I think it's not just stuff, I think all the companies are out there, playing a more competitive game in that off-premise. But I also would qualify by making sure you understand this, not the kind of activity, we still consider it to be added to brand building for Jack Daniel's in Southern Comfort and not coming at the expense of any long-term brand equity or even the operating margin.

Bryan Spillane – Banc of America Securities

Okay, thanks Paul.

Paul Varga

Sure

Operator

Your next question comes from Justin Maurer with Lord Abbett.

Justin Maurer - Lord Abbett

Good morning, guys.

Paul Varga

Good morning.

Phoebe Wood

Hello.

Justin Maurer – Lord Abbett

Just a few housekeeping things on similar question on the tax rate, to the earlier question on the share repurchase for the fourth quarter, just kind of order of magnitude what do you expecting there just to the benefit of EPS?

Phoebe Wood

Let me give you the some additional facts. The full year tax rate is expected to be between 32.5% and 33% that contrast with last fiscal year, which was 31.7%. If you take what we've done here today which is 34.1% that implies the 28% tax rate for the fourth quarter, what you're seeing here is a lot more volatility because of the adoption of FIN 48 and when you have changes in your tax rates that are event driven and we happen to have more fourth quarter event driven kinds of things. So, we're trying to provide a lot more detail here and I'll let you model to gear with the EPS perspectives, but again full year we're expecting between 32.5% and 33% tax rate.

Justin Maurer – Lord Abbett

I don't remember on that the notes in front of me, but was that kind of what you are thinking coming in to the year that would be at that level 32.5 to 33?

Phoebe Wood

Yes, indeed. If I did exactly what we've said last quarter that we saw here.

Justin Maurer – Lord Abbett

Okay, that's helpful. Secondly on the gross margin question and you guys answered that most of that related to Herradura, but does foreign exchange factor in to that at all meaning are you guys being hurt by that currently, just I presume most of the cost is in dollars, but sales are in foreign currencies or is there a hedge there?

Phoebe Wood

So, foreign currency is definitely included and of course it is favorable. And so if you think about it, we've already talked about the mix of business that has certainly changed. We think that it primarily, Casa Herradura, and favorable foreign exchange and price increases were, and we use the facts, I mean, the foreign exchange and how we've done our price increases to offset higher cost from grain and energy.

And so, we think again for full year, just to kind of give an idea, and it's probably about a point decline for the full year effect, about 66 is where we think its going to be. So we think we cover little bit from where we are year-to-date. But again, yes its foreign exchange, is in there and it is favorable to us and we use that to offset the higher cost.

Justin Maurer – Lord Abbett

Got it, okay. And on the grain cost, is there way for us in the outside to, kind of, calibrate. I appreciate the color on the $7 million year-to-date and $10 million, but just in terms of directional way to monitor that and in the sense that I presume the contemplation of some of the price increases by product, you kind of take that into account as opposed to just kind of the average 5% price increase per year what have here. So you've been able to offset that to your point through the gross margin, through additional price increase, if you will.

Phoebe Wood

No question that the cost pressure is a big piece of how we are thinking about it. But I don't, we don't, if just to answer your question. No, sorry, Paul. I think if you want to think about the future and cost prices, it is really to look at the cost of corn. And what is going to happen there and you won't have visibility to what the affect of any hedges that we put on until and we won't know what the effects of the hedges are until they actually occur. But it's best commodity business and can be certainly tracked. As a input, it's a large one but certainly, our spending, our other expenditures on brands, building and on our people far outweigh or cost certainly or any changes in say, grain.

Paul Varga

Something else I'd add to that is that the, if you go back to several years, just to be safe say three years ago or so, the types of price increases we would have been taking more of it for sure would be falling into our margin, into the bottom line than we're seeing here. So a portion of what we're doing with pricing these days is absolutely being absorbed by the entire cost.

As a result, and I could a couple of things we have been working on is with, you can imagine not just probably at our company, I imagine every company is really looking at their supply chain and their cost inputs in areas that they have far greater control over, try to find savings in other places and I've just said in my opening comments, that one area down the road here over the next year so, we see some offset to the higher grain costs is coming from some lower grade cost.

So that's one thing for us that could be a help down the road and we're going to continue to look at all kinds of cost projects that can be helpful and when you are in environment where this grain cost are going up so much.

Justin Maurer – Lord Abbett

Okay.

Phoebe Wood

Our production team is very active and what we call blocking and tackling, just trying to get those cost as efficient, as low as possible and get their processes as efficient as possible given the environment of higher input and higher raw material cost.

Justin Maurer – Lord Abbett

And have you guys, just philosophically on hedging, have guys thought more defensively about hedging as costs, say for corn continue to escalate, meaning you are more concerned with locking that in today than may be were a couple of years ago. Or conversely are you saying, well, we think our experts think corn prices are artificially too higher right now therefore we are not going to lock in as much for fear they were locking in high prices.

Phoebe Wood

Yeah. We look each year at some of those things that can really fluctuate, foreign exchange, grain cost, interest rates and we try to take a point of view, a steady point of view on what we think it actually would be appropriate and actively manage program such as corn and foreign exchange rates. Typically, what we have done in many cases is to lock in a floor and then allow yourself to be able to benefit from changes in foreign exchange rates to our favor if you have that particular point of view.

So that's very typical approach, it's an informed approach when it comes to grain. I think it is to, part of it is to make sure that you do not only ride the vagaries of the commodity market, so that you actually do lock in something you have some certainty about what your input cost are going to be in further coming years.

And I think that that's, we continue to look at managing those market fluctuating pieces of our cost all the time.

Justin Maurer – Lord Abbett

Got it. Okay. And my last question, sorry to be asking so many, but this was really the big one. Paul, you made the comment in your prepared remarks that the profit growth this year 7% as year to-date and historically it's been about 9% and you hope to get back to that next year. Whether it's the grain discussion we just had or your point about may be what was 4.5% growth as may be now 3% in the U.S and there has been issues that some have made about marginal share losses with some of the brands. How should we think about, how you get to that type of number not to try nail it down '09 right now, but the thought that profits in '09 can grow faster than what you guys have seen in 08?

Paul Varga

Yeah. I think, it's back to those opening remarks, it's some combination as we look ahead to the international growth of what we would consider to be a hopefully a better performance going forward, built off this last quarter here in the United States. As I said, I think that the Casa Herradura piece can be a more important part of our growth story in the year and next couple of years going ahead. And then really intentionally put in to see all could understand this focus we put placing on, one leveraging the infrastructure we built over the last several years and trying to make it more productive versus having those costs go up at a rate that would be higher in my view than we would be smart to invest in right now, and then the second piece would be some of these cost projects, some combination of that. We'll be updating you guys in next quarter on the full year, but already started to looking ahead, I think you have to be looking at that kind of stuff today. So that you can get a feel for what the environment might look like going ahead.

Justin Maurer – Lord Abbett

Got it, okay, I appreciate that

Operator

(Operator Instructions). Your next question comes from Tim Ramey for DA Davidson

Tim Ramey - DA Davidson

Thanks for the follow-up. Phoebe, are you using mark-to-market accounting for hedges?

Phoebe Wood

Yes.

Tim Ramey - DA Davidson

Were there any mark-to-market gains or losses in this quarter?

Phoebe Wood

Jane Morreau is here and is going to answer that question for us.

Jane Morreau

We do use mark-to-market Tim, and the amount of the gain, there was some small gain in the quarter, it was not material

Tim Ramey - DA Davidson

Thank you. And then also on the global de-stocking, is it safe to assume that most of that is Casa Herradura or is there some going on elsewhere in the world?

Phoebe Wood

No, it's Casa Herradura.

Tim Ramey - DA Davidson

Okay.

Phoebe Wood

Yeah it's our main brand.

Tim Ramey - DA Davidson

Great, okay. And then Paul, you've two or three times alluded to economic impact. Are you mainly seeing that in terms of weak on-premise consumption or would you perceive, it doesn't seem like your perceiving much trade down, particularly like the Gentleman Jack anecdotal evidence?

Paul Varga

Well, I mean that's yeah, you have to bring it a perspective of the small base of Gentleman Jack where you're still building everything from initial distribution and certain accounts to the ability to grow it within a more narrow consumer franchise. When I talk about the trade down effect, I was looking at some of the numbers that go back just thinking back two years, and when I look at the changes in the growth rates for many of the major brands in the United States, all of the changes in the growth rate, this is at a consumer takeaway level. It looks to be down more than the growth rate of the industry as a whole. What I mean by that is, you'll see most of the leading brands if they were growing at 8%, they're down more to like 3%, if they're growing at 12%, they're down to 7, a lot of one that were six are down in the ones and twos.

The industry as a whole may be down from say 4.5 to 3. So, what that tells me and a lot of the brands, I am talking about one of the most leading brands, or a lot of the premium and super-premium brands, it tells me that there has to be some trading down in order for that math to work. So I think it is and I think it's attributable to what I talked about last time in what you reference, which is some of it deals with lower discretionary income and shows up in different ways, the part of it is people drinking a little bit more, may be at home than in the on-premise.

Tim Ramey - DA Davidson

Thanks.

Paul Varga

Sure.

Operator

Your next question is a follow-up from Lauren Torres with HSBC.

Lauren Torres - HSBC

Thanks. Underlying advertising and SG&A growth seem to slow a bit in the third quarter, is this more the timing issue in the third quarter versus the first half or is there some slowdown there as far as how you're thinking about these expenses?

Paul Varga

We expected the SG&A to comedown in the second half and I think talked about that in the prior second quarter call. On the A&P I think it was one thing that to help with A&P piece. It was a higher going in to in the first half, but also a lot of people expect these growth rates to really peak sometimes during what we all call our holiday period and remember that in this international business of ours, a large piece of it still is on-premise, which is not particularly driven by holiday promoting and so you don't see as much of the incremental investments coming, like they used to our company during the holiday period. During the US, I would call it a more moderate increase in the investment, because of the environment we felt we were in.

Phoebe Wood

Lauren, if you just look at our quarterly advertising, if you just look for example, at last year's quarterly, we had one quarter at 4%, so again longer term trends are appropriate I think to look at here.

Paul Varga

And we tried on the A&P I've have making comments here about SG&A and A&P piece I do you think you wanted to approximate your growth in gross profits. We're going to need to be competitive both in advertising and promoting above the land, but also in some of these areas have been reference in below the line. So as it relates to leverage in the income statement, I see more opportunity to do that in SG&A right now than A&P.

Lauren Torres - HSBC

And then, just one question on Herradura. You talked about increasing distribution and penetration in the US, is there any feeling you gave us or kind of just an idea of how that's progressing versus what we've talked about, may be just a quarter ago, it sounds like you been pretty active on that front?

Paul Varga

Same-story. We are continuing to build points of distribution. There is not a lot of new news on it and I would categorize all of the work as early days, I mean it really is. But, we are pretty pleased with the work we're doing. I mean some of it was the natural cleanup that goes on post transaction. But these last few months, we are starting to see the brand have a just a better overall presence, particularly in the United States and while we are continuing to do some of this other work that is helping us, think about positioning and packaging and all the other stuffs that's basically the same story and more points of distribution. And I think, as I said, is we get it that boarder base of distribution and get some of the, I call it the sales and marketing toolkit filled up with our own ideas. I think, we'll see these brands add more to our profit story going forward.

Lauren Torres - HSBC

Great, thank you.

Paul Varga

Sure.

Operator

Your next question comes from Thomas Russo with Gardner Russo.

Thomas Russo - Gardner Russo

Hi Paul and Phoebe, how are you?

Paul Varga

Hey, Tom.

Phoebe Wood

Fine, Tom, how are you?

Thomas Russo - Gardner Russo

Good. I've heard a lot of questions about grain and about corn and about rising commodity cost. I wonder whether you've run the numbers, yet, to find out whether you might not do well by launching a Jack Daniel's branded line of ethanol. May be take Jack Daniel's to the pump, and may be that we're going to convert it to the higher margin selling ethanol than we do whisky these days in line of the commodity pressures that that's driving across your industry.

But, and honestly, the Herradura question just asked, that remind me of Phoebe's earlier comment that you're doing at the same time a rollout into distribution that you are, a review with the brands equity and possibly have it packaging and to market it. And I wonder to what extent if part of this brand story is going to be one of scarcity and hard to get and premium position, the rollout before establishing that brand attribute might end up working against you, if you want to have it be a more coveted and hard to get brand and to start early.

Paul Varga

It's a good question, I think just to qualify, in know way do we intend to over distribute this brand.

Thomas Russo - Gardner Russo

Yeah.

Paul Varga

One of the early stages of the brands development is catching up the distribution with what appears to me to be a natural interest, particularly in the US or both the El Jimador and the Herradura. So I still see about a years worth of distribution work to catch up to the brand equity that exists today and you want to do that in a measured way because if you over distribute any of these brands, not just the tequila ones, you can hurt yourself long term. So did that help?

Thomas Russo - Gardner Russo

Yeah. That's the story. And then Paul, one other question. When you talk about absorbing well spent inventory, as the infrastructure route-to-market investments made a broad historically and trying to get some leverage off of that? How do we make sure that it's not also a reduction in marketing and promotion overseas that drives the improved operating income that might result from what you said ought to take place naturally now that you have grown into some of those structures?

Paul Varga

I don't think it will, because that's exactly I was trying to refer to, I see us still trying to put the dollar resources behind A&P where the growth is and the example of it would be, I mean I just I love this example of what's going on in Poland these days, where it was initially almost exclusively a Finlandia story, then on the back end out that here on the last couple of years we've seen wonderful development story on Jack Daniel's and then starting to see it on some other brands in Brown-Forman's portfolio and that's a great example of the kind of ways you can use the structure you've built up on often times behind one brand and then extended over to another end. And you show me A&P portion to go into those markets to help feel the consumer interest and get the promotional effort behind it. But you can leverage the initial investments you made in the infrastructure through SG&A.

Thomas Russo - Gardner Russo

Thank you very much.

Paul Varga

Okay. Thank you, Tom.

Phoebe Wood

Thank you, Tom.

Thomas Russo - Gardner Russo

Yeah.

Operator

Your next question is a follow-up from Justin Moore of Lord Abbett.

Justin Moore - Lord Abbett

It is my last question. Just a philosophical thought on on-premise versus off-premise because again there is lot of gnashing of teeth, I guess it relates to fears of weakness on the on-premise sales but if you guys look at a fully loaded dollar profit of an on-premise sales versus an off-premise, is it meaningfully different than, I guess, intuitively I'd say yeah but at the same time I just wonder what the selling cost and distribution cost and everything that goes into the on-premise sale and matter of fact as it end up being not too far different if it's off-premise?

Paul Varga

I think it would depend on how you allocated your, and all of your investments because they are all intended. I hate to give you an it depends. I know if you were directly promoting within an individual and singular on-premise account you are going to see the cost per kg relatively higher, of course. Because you just sell more volume metrics out of the retail environment than the on-premise but we spread it across the entirety of the universe. It's a really difficult thing to pin down and would depend heavily how you are allocating your media cost and all kinds of things like that.

But one thing I do know, I think the on-premise environment, while it is, you've all seen the figures. There is some of the traffic is down, they are a little bit softer, but its still an incredibly important environment to our business and still particularly in the key target audience for a number of these brands, which should be sales for the LDA to 29 continued to be vibrant in the right places.

So part of it is not thinking about some total and fundamental shift away from on-premise to off-premise, as much of this doing the right sort of targeting to make sure you are in the right accounts even, in the right cities, at the right time to promote your brand. So I didn't want you all to misinterpret in any ways, the way we are turning up our efforts to be more competitive in the off-premise is meaning that we are not going to be really active in promoting in the on-premise as well.

Justin Moore - Lord Abbett

I guess everybody is fully aware of the traffic problems with the casual diners are seeing down mid single digits and even the food companies that supply food service are saying, they have seen a meaningful weakening in that business, hence, the fear for spillover in to your business and if you guys are somewhat agnostic as to whether you're selling a case to an off-premise channel versus to on-premise, doesn't really matter that much at the end of the day, that's what I was asking?

Paul Varga

They're both, as you would expect, they're incredibly important to us. I think It has obviously a less direct impact on us, as it might, some of these food suppliers. But for us, it just goes to show the power of how even an individual consumer who might have an individual drink one day a week, when you add all those up sometimes they can have a modest impact on the business as a whole. I think some of that not only is going on now, I think it has been going on for a while and we will stay alert to it and see what the environment shows, know when to get back in and you also have to be creative, it doesn't mean the business, there is going to be creative of about how you go get it.

Justin Moore - Lord Abbett

Got it, okay. Thanks a lot.

Paul Varga

Thank you.

Phoebe Wood

Thank you, Justin.

Operator

At this time there are no further questions. Do you have any closing remarks?

Paul Varga

We do not. Thank you everyone and have a great weekend. Thank you all.

Phoebe Wood

Thank you.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

This Transcript
All Transcripts