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United States
Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JANUARY 31, 2005
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission File No. 002-26821
BROWN-FORMAN CORPORATION
(Exact name of Registrant as specified in its Charter)
Delaware 61-0143150
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
850 Dixie Highway
Louisville, Kentucky 40210
(Address of principal executive offices) (Zip Code)
(502) 585-1100
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: February 28, 2005
Class A Common Stock ($.15 par value, voting) 56,782,037
Class B Common Stock ($.15 par value, nonvoting) 65,022,149
BROWN-FORMAN CORPORATION
Index to Quarterly Report Form 10-Q
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited) Page
Condensed Consolidated Statement of Income
Three months ended January 31, 2004 and 2005 3
Nine months ended January 31, 2004 and 2005 3
Condensed Consolidated Balance Sheet
April 30, 2004 and January 31, 2005 4
Condensed Consolidated Statement of Cash Flows
Nine months ended January 31, 2004 and 2005 5
Notes to the Condensed Consolidated Financial Statements 6 - 11
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12 - 18
Item 3. Quantitative and Qualitative Disclosures about Market Risk 19
Item 4. Controls and Procedures 19
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 20 - 21
Item 6. Exhibits 21
Signatures 22
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
BROWN-FORMAN CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(Unaudited)
(Dollars in millions, except per share amounts)
Three Months Ended Nine Months Ended
January 31, January 31,
2004 2005 2004 2005
------- ------- -------- --------
Net sales $ 695.7 $ 758.3 $1,951.8 $2,116.0
Excise taxes 103.1 127.8 272.9 319.4
Cost of sales 249.0 255.2 699.8 722.8
------- ------- -------- --------
Gross profit 343.6 375.3 979.1 1,073.8
Advertising expenses 87.5 96.9 260.0 278.9
Selling, general, and
administrative expenses 131.7 146.2 392.5 418.9
Goodwill impairment -- 37.0 -- 37.0
Other expense (income), net (2.5) 0.5 8.8 1.2
------- ------- -------- --------
Operating income 126.9 94.7 317.8 337.8
Gain on sale of investment
in affiliate -- 73.5 -- 72.3
Interest income 0.4 3.1 1.3 3.8
Interest expense 5.3 5.1 16.3 15.4
------- ------- -------- --------
Income before income taxes 122.0 166.2 302.8 398.5
Taxes on income 41.5 70.1 102.9 147.9
------- ------- -------- --------
Net income $ 80.5 $ 96.1 $ 199.9 $ 250.6
======= ======= ======== ========
Earnings per share
- Basic $ 0.66 $ 0.79 $ 1.65 $ 2.06
- Diluted $ 0.66 $ 0.78 $ 1.64 $ 2.05
Shares (in thousands) used in the
calculation of earnings per share
- Basic 121,385 121,755 121,305 121,723
- Diluted 122,114 122,482 121,886 122,432
Cash dividends per common share
- Declared $0.4250 $0.4900 $ 0.8000 $ 0.9150
- Paid $0.2125 $0.2450 $ 0.5875 $ 0.6700
See notes to the condensed consolidated financial statements.
3
BROWN-FORMAN CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(Dollars in millions)
April 30, January 31,
2004 2005
(Unaudited)
-------- --------
Assets
- ------
Cash and cash equivalents $ 67.7 $ 289.5
Accounts receivable, net 348.6 357.1
Inventories:
Barreled whiskey 217.9 237.7
Finished goods 185.4 196.5
Work in process 111.0 102.2
Raw materials and supplies 42.9 37.3
-------- --------
Total inventories 557.2 573.7
Current portion of deferred income taxes 66.9 66.9
Other current assets 43.1 23.7
-------- --------
Total current assets 1,083.5 1,310.9
Property, plant and equipment, net 515.2 500.5
Prepaid pension cost 118.2 129.9
Investment in affiliates 44.6 18.2
Trademarks and brand names 246.6 334.4
Goodwill 314.6 282.8
Other assets 53.3 45.5
-------- --------
Total assets $2,376.0 $2,622.2
======== ========
Liabilities
- -----------
Accounts payable and accrued expenses $ 271.5 $ 314.3
Dividends payable -- 29.8
Short-term borrowings 49.5 32.5
Accrued taxes on income 48.0 112.6
-------- --------
Total current liabilities 369.0 489.2
Long-term debt 630.0 600.8
Deferred income taxes 122.2 113.2
Accrued pension and other
postretirement benefits 136.7 143.6
Other liabilities 33.0 34.2
-------- --------
Total liabilities 1,290.9 1,381.0
Commitments and contingencies
Stockholders' Equity
- --------------------
Common stock:
Class A, voting (57,000,000 shares
authorized; 56,841,000 shares issued) 8.5 8.5
Class B, nonvoting (100,000,000 shares
authorized; 69,188,000 shares issued) 10.4 10.4
Retained earnings 1,236.2 1,376.1
Accumulated other comprehensive loss (14.3) (3.4)
Treasury stock, at cost (4,441,000 and 4,266,000
shares at April 30 and January 31, respectively) (155.7) (150.4)
-------- --------
Total stockholders' equity 1,085.1 1,241.2
-------- --------
Total liabilities and stockholders' equity $2,376.0 $2,622.2
======== ========
Note: The balance sheet at April 30, 2004, has been taken from the audited
financial statements at that date, and condensed.
See notes to the condensed consolidated financial statements.
4
BROWN-FORMAN CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(In millions; amounts in parentheses are reductions of cash)
Nine Months Ended
January 31,
2004 2005
------- -------
Cash flows from operating activities:
Net income $ 199.9 $ 250.6
Adjustments to reconcile net income to net
cash provided by (used for) operations:
Gain on sale of investment in affiliate -- (72.3)
Goodwill impairment -- 37.0
Depreciation 41.7 43.8
Deferred income taxes (10.2) (34.2)
Changes in assets and liabilities:
Accounts receivable 11.1 (8.5)
Inventories (5.7) (16.5)
Other current assets (8.1) 19.4
Accounts payable and accrued expenses (10.9) 43.2
Accrued taxes on income 19.1 64.6
Noncurrent assets and liabilities 11.3 16.2
------- -------
Cash provided by operating activities 248.2 343.3
Cash flows from investing activities:
Proceeds from sale of investment in affiliate,
net of disposal costs -- 92.7
Acquisition of minority interest in subsidiary -- (63.6)
Additions to property, plant, and equipment (42.8) (32.2)
Proceeds from sale of property, plant,
and equipment -- 8.7
Computer software expenditures (2.8) (1.6)
Trademark and patent expenditures (1.1) (0.5)
------- -------
Cash provided by (used for)
investing activities (46.7) 3.5
Cash flows from financing activities:
Net repayment of short-term borrowings (92.6) (47.0)
Reduction of long-term debt (7.4) --
Proceeds from exercise of stock options 7.9 6.5
Acquisition of treasury stock -- (2.9)
Dividends paid (71.3) (81.6)
------- -------
Cash used for financing activities (163.4) (125.0)
------- -------
Net increase in cash and cash equivalents 38.1 221.8
Cash and cash equivalents, beginning of period 72.0 67.7
------- -------
Cash and cash equivalents, end of period $ 110.1 $ 289.5
======= =======
See notes to the condensed consolidated financial statements.
5
BROWN-FORMAN CORPORATION
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
In these notes, "we," "us," and "our" refer to Brown-Forman Corporation.
1. Condensed Consolidated Financial Statements
We prepared these unaudited condensed consolidated financial statements using
our customary accounting practices as set out in our 2004 annual report on Form
10-K (the "2004 Annual Report"). We made all of the adjustments (which include
only normal, recurring adjustments) needed for a fair statement of this data.
We condensed or omitted some of the information found in financial statements
prepared according to generally accepted accounting principles ("GAAP"). You
should read these financial statements together with the 2004 Annual Report,
which does conform to GAAP.
2. Inventories
We use the last-in, first-out ("LIFO") method to determine the cost of most of
our inventories. If the LIFO method had not been used, inventories at current
cost would have been $145.6 million higher than reported as of April 30, 2004,
and $148.9 million higher than reported as of January 31, 2005. Changes in the
LIFO valuation reserve for interim periods are based on a proportionate
allocation of the estimated change for the entire fiscal year.
3. Taxes on Income
Our consolidated effective income tax rate may differ from current statutory
rates due to the recognition of amounts for events or transactions that do not
have income tax consequences. We use the estimated annual effective income tax
rate in determining our interim results.
The company's effective income tax rate increased during the quarter ended
January 31, 2005 due primarily to the nondeductibility for income tax purposes
of a $37.0 million goodwill impairment charge recorded during the quarter.
4. Earnings Per Share
Basic earnings per share is calculated as net income divided by the weighted
average number of common shares outstanding during the period. Diluted earnings
per share is calculated in the same manner, except that the denominator also
includes additional common shares that would have been issued if outstanding
stock options had been exercised during the period. The dilutive effect of
outstanding stock options is determined by application of the treasury stock
method. Stock options for approximately 1.1 million common shares have been
excluded from the calculation of diluted earnings per share because the exercise
price of the options was greater than the average market price of the shares.
6
The following table presents information concerning basic and diluted earnings
per share:
Three Months Ended Nine Months Ended
January 31, January 31,
2004 2005 2004 2005
------ ------ ------ ------
Basic and diluted
net income (in millions) $ 80.5 $ 96.1 $199.9 $250.6
Share data (in thousands):
Basic average common
shares outstanding 121,385 121,755 121,305 121,723
Effect of dilutive
stock options 729 727 581 709
------- ------- ------- -------
Diluted average common
shares outstanding 122,114 122,482 121,886 122,432
Basic earnings per share $0.66 $0.79 $1.65 $2.06
Diluted earnings per share $0.66 $0.78 $1.64 $2.05
5. Stock Options
We apply Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations in accounting for stock
options. Accordingly, no stock-based employee compensation cost is reflected in
net income, as no options granted under those plans had an exercise price below
the market value of the underlying stock on the grant date. The following table
illustrates the effect on net income and earnings per share if we had instead
recognized compensation expense for stock options based on their fair value at
their grant dates consistent with the methodology prescribed under Financial
Accounting Standards Board ("FASB") Statement No. 123, "Accounting for
Stock-Based Compensation" ("FAS 123").
(Dollars in millions, except per share amounts)
Three Months Ended Nine Months Ended
January 31, January 31,
2004 2005 2004 2005
------ ------ ------ ------
Net income, as reported $ 80.5 $ 96.1 $199.9 $250.6
Stock-based employee compensation
expense determined under fair
value based method, net of tax (1.0) (1.1) (2.8) (3.0)
------ ------ ------ ------
Pro forma net income $ 79.5 $ 95.0 $197.1 $247.6
====== ====== ====== ======
Earnings per share - pro forma:
Basic $0.65 $0.78 $1.63 $2.03
Diluted $0.65 $0.78 $1.62 $2.02
Earnings per share - as reported:
Basic $0.66 $0.79 $1.65 $2.06
Diluted $0.66 $0.78 $1.64 $2.05
7
The plan requires that we purchase shares to satisfy stock option requirements,
thereby avoiding future dilution of earnings that would occur from issuing
additional shares. We acquire treasury shares from time to time in anticipation
of these requirements. We intend to hold enough treasury stock so that the
number of diluted shares is never more than the original number of shares
outstanding at inception of the stock option plan (as adjusted for any share
issuances unrelated to the plan). The extent to which the number of diluted
shares exceeds the number of basic shares is determined by how much our stock
price has appreciated since options were granted, irrespective of how many
treasury shares we have acquired.
In December 2004, the FASB issued Statement No. 123(R), "Share-Based Payment"
("FAS 123(R)"). FAS 123(R) revises FAS 123 and requires companies to expense the
fair value of stock options and other forms of stock-based compensation. The
company intends to adopt FAS 123(R) during the fourth quarter of fiscal 2005 by
retroactively adjusting its financial statements for all periods since fiscal
1997, when it first began granting stock options. The adoption of FAS 123(R) is
expected to reduce fiscal 2005 earnings by approximately $0.033 per share.
6. Environmental
We face environmental claims resulting from the cleanup of several manufacturing
or waste disposal sites in the United States. We accrue for losses associated
with environmental cleanup obligations when such losses are probable and
reasonably estimable. At some sites, there are other potentially responsible
parties who are expected to bear part of the costs, in which cases our accrual
is based on our estimate of our share of the total costs. A portion of the
cleanup costs with respect to certain sites is expected to be paid by insurance.
The estimated recovery of cleanup costs from insurers is recorded as an asset
when receipt is deemed probable.
We do not believe that any additional environmental cleanup costs we incur will
have a material adverse effect on our consolidated financial position, results
of operations, or cash flows.
7. Contingencies
We operate in a litigious environment, and we get sued in the normal course of
business. Sometimes plaintiffs seek substantial damages. Significant judgment is
required in predicting the outcome of these suits and claims, many of which take
years to adjudicate. We accrue estimated costs for a contingency when we believe
that a loss is probable, and adjust the accrual as appropriate to reflect
changes in facts and circumstances.
Brown-Forman and many other manufacturers of spirits, wine and beer are
defendants in a series of similar class action lawsuits seeking damages and
injunctive relief over alleged marketing of beverage alcohol to underage
consumers. The suits allege that the defendants have engaged in deceptive
marketing practices and schemes targeted at underage consumers, negligently
marketed their products to the underage, and fraudulently concealed their
alleged misconduct. Brown-Forman denies that we intentionally market beverage
alcohol products to minors and denies that our advertising is illegal. We will
vigorously defend this position and it is not possible at this time to estimate
a possible loss or range of loss, if any, in these lawsuits. However, an adverse
result in these lawsuits or similar class action lawsuits could have a material
adverse effect on our business.
8
8. Pension and Other Postretirement Benefits
The following table shows the components of the pension and other postretirement
benefit expense recognized during the periods covered by this report:
(Dollars in millions) Three Months Ended Nine Months Ended
January 31, January 31,
2004 2005 2004 2005
----- ----- ----- -----
Pension Benefits:
Service cost $ 3.6 $ 4.2 $10.7 $12.5
Interest cost 7.1 7.5 21.4 22.5
Expected return on plan assets (11.0) (10.8) (33.0) (32.4)
Amortization of:
Unrecognized prior service cost 0.3 0.2 1.0 0.7
Unrecognized net loss 0.2 1.1 0.6 3.3
Unrecognized transition asset (0.4) -- (1.1) --
----- ----- ----- -----
Net expense (income) $(0.2) $ 2.2 $(0.4) $ 6.6
===== ===== ===== =====
Other Postretirement Benefits:
Service cost $ 0.5 $ 0.4 $ 1.5 $ 1.3
Interest cost 1.2 1.0 3.7 3.0
Amortization of:
Unrecognized prior service cost 0.1 0.1 0.2 0.2
Unrecognized net loss 0.3 -- 0.8 --
----- ----- ----- -----
Net expense $ 2.1 $ 1.5 $ 6.2 $ 4.5
===== ===== ===== =====
In January 2005, we made a discretionary contribution of $11 million to our
pension plan assets. Including that amount, we expect to make total
contributions of $12 million for our pension plans during fiscal 2005.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 ("the
Act") was enacted in December 2003. The Act provides a federal subsidy to plan
sponsors for certain qualifying prescription drug benefits covered under the
sponsor's postretirement medical benefit plans. We estimate that the subsidy has
reduced our postretirement medical benefit obligation by $16 million. The
postretirement medical expense recognized during the three months ended January
31, 2005 includes a subsidy-related reduction of $0.6 million ($0.1 million of
service cost, $0.3 million of interest cost, and $0.2 million of amortization of
unrecognized net loss). The postretirement medical expense recognized during the
nine months ended January 31, 2005 includes a subsidy-related reduction of $1.8
million ($0.4 million of service cost, $0.8 million of interest cost, and $0.6
million of amortization of unrecognized net loss).
9
9. Business Segment Information
(Dollars in millions) Three Months Ended Nine Months Ended
January 31, January 31,
2004 2005 2004 2005
------ ------ -------- --------
Net sales:
Beverages $529.7 $598.3 $1,496.3 $1,692.3
Consumer Durables 166.0 160.0 455.5 423.7
------ ------ -------- --------
Consolidated net sales $695.7 $758.3 $1,951.8 $2,116.0
====== ====== ======== ========
Operating income (loss):
Beverages $117.4 $118.6 $ 301.3 $ 363.2
Consumer Durables 9.5 (23.9) 16.5 (25.4)
------ ------ -------- --------
126.9 94.7 317.8 337.8
Gain on sale of investment
in affiliate -- 73.5 -- 72.3
Interest expense, net 4.9 2.0 15.0 11.6
------ ------ -------- --------
Income before income taxes $122.0 $166.2 $ 302.8 $ 398.5
====== ====== ======== ========
Consumer
Beverages Durables Total
--------- -------- ------
Goodwill:
Balance as of April 30, 2004 $184.3 $130.3 $314.6
Impairment charge (Note 13) -- (37.0) (37.0)
Foreign currency translation
adjustment 5.2 -- 5.2
------ ------ ------
Balance as of January 31, 2005 $189.5 $ 93.3 $282.8
====== ====== ======
10. Comprehensive Income
Comprehensive income is a broad measure of the effects of all transactions and
events (other than investments by or distributions to shareholders) that are
recognized in stockholders' equity, regardless of whether those transactions and
events are included in net income. The following table adjusts the company's net
income for the other items included in comprehensive income:
(Dollars in millions) Three Months Ended Nine Months Ended
January 31, January 31,
2004 2005 2004 2005
------ ------ ------ ------
Net income $ 80.5 $ 96.1 $199.9 $250.6
Other comprehensive income (loss):
Net gain (loss) on cash flow hedges 0.2 0.1 0.3 (2.9)
Net gain (loss) on securities 0.1 0.1 0.3 (0.1)
Foreign currency translation
adjustment 12.9 1.1 20.6 13.9
------ ------ ------ ------
Other comprehensive income 13.2 1.3 21.2 10.9
------ ------ ------ ------
Comprehensive income $ 93.7 $ 97.4 $221.1 $261.5
====== ====== ====== ======
10
Accumulated other comprehensive loss (income) consisted of the following:
(Dollars in millions) April 30, January 31,
2004 2005
------ ------
Pension liability adjustment $ 31.8 $ 31.8
Cumulative translation adjustment (15.5) (29.4)
Unrealized (gain) loss on
cash flow hedge contracts (1.6) 1.3
Unrealized gain on securities (0.4) (0.3)
------ ------
$ 14.3 $ 3.4
====== ======
11. Acquisition of Minority Interest in Subsidiary
In December 2004, we acquired the remaining capital stock of Finlandia Vodka
Worldwide Ltd. ("FVW") from the Altia Corporation of Finland ("Altia") for $63.6
million. The value of FVW consists primarily of the Finlandia brand name, which
has an indefinite useful life. As a result of this transaction, we have
preliminarily allocated $83.9 million to the Finlandia brand name, which is
partially offset by a deferred income tax liability of $25.2 million, and $4.9
million to various other net assets.
As previously disclosed, we acquired 45% of FVW in 2000 and an additional 35% in
2002. The 2002 acquisition agreement granted Altia an option to require
Brown-Forman to buy its remaining interest in FVW during a two-year window
beginning December 31, 2004. This transaction reflects Altia's exercise of that
option.
12. Sale of Investment in Affiliate
In January 2005, we consummated the sale of our equity stake in Glenmorangie plc
for proceeds of $92.7 million (net of disposal costs). As a result of this
transaction, we recognized a pre-tax gain of $73.5 million during the three
months ended January 31, 2005.
Under pre-existing contracts, Brown-Forman continues to have distribution and
marketing rights for Glenmorangie brands in the U.S. and other select markets
and marketing and representation rights for the brands in several European
markets.
13. Goodwill Impairment
The accompanying financial statements reflect a charge of $37.0 million during
the quarter ended January 31, 2005 for impairment of goodwill associated with
the company's Lenox retail business. The impairment charge reflects lowered
expectations for the future prospects of the Lenox retail outlet business in
light of changing consumer buying patterns. The $37.0 million represents the
excess of the book value of the goodwill over the fair value, as estimated using
discounted projected future cash flows based on the revised long-term outlook
for the business. Due to the nondeductibility of the charge for income tax
purposes, no income tax benefit related to this amount has been recorded.
14. Reclassifications
Certain prior year amounts have been reclassified to conform with the current
year presentation.
11
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
You should read the following discussion and analysis along with our 2004 Annual
Report. Note that the results of operations for the nine months ended January
31, 2005 do not necessarily indicate what our operating results for the full
fiscal year will be. In this Item, "we," "us," "our," and "the company" refer to
Brown- Forman Corporation.
Important Note on Forward-Looking Statements:
This report contains statements, estimates, or projections that constitute
"forward-looking statements" as defined under U.S. federal securities laws.
Generally, the words "expect," "believe," "intend," "estimate," "will,"
"anticipate," and "project," and similar expressions identify a forward-looking
statement, which speaks only as of the date the statement is made. Except as
required by law, we do not intend to update or revise any forward-looking
statements, whether as a result of new information, future events, or otherwise.
We believe that the expectations and assumptions with respect to our
forward-looking statements are reasonable. But by their nature, forward-looking
statements involve known and unknown risks, uncertainties and other factors that
in some cases are out of our control. These factors could cause our actual
results to differ materially from Brown-Forman's historical experience or our
present expectations or projections. Here is a non-exclusive list of such risks
and uncertainties:
- changes in general economic conditions, particularly in the United States
where we earn the majority of our profits;
- a strengthening U.S. dollar against foreign currencies, especially the
British Pound;
- reduced bar, restaurant, hotel and travel business in wake of other terrorist
attacks, such as occurred on 9/11;
- developments in the class action lawsuits filed against Brown-Forman and
other spirits, beer and wine manufacturers alleging that our advertising
causes illegal consumption of alcohol by those under the legal drinking age,
or other attempts to limit alcohol marketing, through either litigation or
regulation;
- a dramatic change in consumer preferences, social trends or cultural trends
that results in the reduced consumption of our premium spirits brands;
- tax increases, whether at the federal or state level;
- increases in the price of grain and grapes;
- continued depressed retail prices and margins in our wine business because of
our excess wine inventories, existing grape contract obligations, and a
world-wide oversupply of grapes; and
- the effects on our Consumer Durables business of the general economy,
department store business, response rates in our direct marketing business,
and profitability of mall outlet operations.
12
Results of Operations:
Third Quarter Fiscal 2005 Compared to Third Quarter Fiscal 2004
Here is a summary of our operating performance (expressed in millions,
except percentage and per share amounts):
Three Months Ended
January 31,
2004 2005 Change
------ ------ ------
Net Sales:
Beverages $529.7 $598.3 13%
Consumer Durables 166.0 160.0 (4%)
------ ------
Total $695.7 $758.3 9%
Gross Profit:
Beverages $264.9 $301.3 14%
Consumer Durables 78.7 74.0 (6%)
------ ------
Total $343.6 $375.3 9%
Advertising Expenses:
Beverages $ 63.6 $ 76.3 20%
Consumer Durables 23.9 20.6 (14%)
------ ------
Total $ 87.5 $ 96.9 11%
SG&A Expenses:
Beverages $ 88.2 $104.8 19%
Consumer Durables 43.5 41.4 (5%)
------ ------
Total $131.7 $146.2 11%
Goodwill Impairment:
Consumer Durables -- $ 37.0
Other Expense (Income):
Beverages $ (4.3) $ 1.6
Consumer Durables 1.8 (1.1)
------ ------
Total $ (2.5) $ 0.5
Operating Income:
Beverages $117.4 $118.6 1%
Consumer Durables 9.5 (23.9) N/M
------ ------
Total $126.9 $ 94.7 (25%)
Gain on Sale of Investment in Affiliate -- $ 73.5
Net Income $ 80.5 $ 96.1 19%
Earnings per Share - Basic $ 0.66 $ 0.79 19%
Earnings per Share - Diluted $ 0.66 $ 0.78 19%
Effective Tax Rate 34.0% 42.2%
13
Diluted earnings per share for the third quarter ended January 31, 2005 were
$0.78, up 19% over the same period last year. Results for the quarter include a
gain of approximately $0.39 per share from the sale of the company's investment
in Glenmorangie plc and a $0.32 per share charge for asset impairments
associated with Lenox, Inc.'s retail business ($0.30 per share) and a minority
interest in a small Mexican tequila company ($0.02 per share). Excluding these
items, earnings growth in the quarter was driven by solid growth for Jack
Daniel's Tennessee Whiskey, Southern Comfort, and Finlandia Vodka, and benefits
from stronger foreign currencies. These gains were partially offset by higher
advertising and SG&A expenses in the company's Beverages segment.
Excluding the Glenmorangie gain, the impairment charges, and favorable foreign
exchange, the company's quarterly earnings per share grew 8%, as follows:
Reported Diluted EPS growth 19%
Adjustments:
Glenmorangie gain (59%)
Asset impairments 49%
Foreign currency benefit (6%)
All other, net 5%*
-----
Adjusted Diluted EPS growth 8%
=====
*Includes net earnings impact associated with incremental pension and
incentive compensation expense; partially offset by restructuring
expenses in the prior year.
We believe that disclosing the adjusted diluted EPS growth of 8% is useful
because it is a more accurate reflection of the ongoing operating performance of
the company.
Beverages
In the third quarter, revenues and gross profit for the Beverages segment were
up 13% and 14%, respectively. This growth was driven by stronger foreign
currencies and continued volume growth and price increases for the company's
global spirits brands. Advertising expenses were up 20%, reflecting both the
company's desire to invest aggressively in the current robust global spirits
environment and the impact of a weaker U.S. dollar on the company's costs. SG&A
expenses increased 19% in the quarter, reflecting higher compensation and
pension expense and the negative impact of foreign exchange.
Global depletions for Jack Daniel's Tennessee Whiskey continued to grow
impressively in the quarter, with high single-digit gains in the United States
and double-digit increases in international markets. (Depletions are shipments
from wholesale distributors to retailers, and are commonly used in the wine and
spirits industry as an approximation of consumer demand.) Southern Comfort
continued its strong performance in the quarter as global depletions were up in
the high single-digits. Global depletions and shipments also grew at
double-digit rates for Finlandia Vodka, driven by continued strength in Eastern
Europe and the return to growth in the U.S. which is partially attributable to
the introduction of a new flavor.
14
Consumer Durables
Net sales for Consumer Durables declined 4% in the quarter, as the benefit from
liquidation sales related to the previously-announced closing of Dansk retail
outlets was insufficient to fully offset continued softness in the
direct-to-consumer channel. Although segment gross profit declined $4.7 million
during the quarter, operating income (excluding the impairment charge) improved
$3.6 million due to reductions in operating expenses, the absence of
restructuring charges incurred in the prior year, improved profits at Hartmann,
and a gain on the sale of a closed distribution facility.
The $37.0 million goodwill impairment charge recorded in the quarter is a result
of the continued disappointing performance of Lenox's retail stores through this
holiday season and management's conclusion that the retail chain should not be
operated in its current configuration in the future. As a result, management has
revised the long-term outlook for its retail business.
On February 22, 2005, Brown-Forman announced that it is exploring strategic
alternatives for Lenox, Inc., including a possible sale. Goldman Sachs & Co. has
been retained to assist in these efforts, and Cavendish Corporate Finance, Ltd.
in the U.K. will provide advice regarding Lenox's British operations.
15
Results of Operations:
Nine Months Fiscal 2005 Compared to Nine Months Fiscal 2004
Here is a summary of our operating performance (expressed in millions,
except percentage and per share amounts):
Nine Months Ended
January 31,
2004 2005 Change
-------- -------- ------
Net Sales:
Beverages $1,496.3 $1,692.3 13%
Consumer Durables 455.5 423.7 (7%)
-------- --------
Total $1,951.8 $2,116.0 8%
Gross Profit:
Beverages $ 765.2 $ 878.6 15%
Consumer Durables 213.9 195.2 (9%)
-------- --------
Total $ 979.1 $1,073.8 10%
Advertising Expenses:
Beverages $ 192.4 $ 218.4 14%
Consumer Durables 67.6 60.5 (11%)
-------- --------
Total $ 260.0 $ 278.9 7%
SG&A Expenses:
Beverages $ 267.4 $ 297.8 11%
Consumer Durables 125.1 121.1 (3%)
-------- --------
Total $ 392.5 $ 418.9 7%
Goodwill Impairment:
Consumer Durables -- $ 37.0
Other Expense (Income):
Beverages $ 4.1 $ (0.8)
Consumer Durables 4.7 2.0
-------- --------
Total $ 8.8 $ 1.2
Operating Income:
Beverages $ 301.3 $ 363.2 21%
Consumer Durables 16.5 (25.4) N/M
-------- --------
Total $ 317.8 $ 337.8 6%
Gain on Sale of Investment in Affiliate -- $ 72.3
Net Income $ 199.9 $ 250.6 25%
Earnings per Share - Basic $ 1.65 $ 2.06 25%
Earnings per Share - Diluted $ 1.64 $ 2.05 25%
Effective Tax Rate 34.0% 37.1%
16
For the first nine months of the fiscal year, diluted earnings per share were
$2.05, up 25% over the same period last year. Year-to-date growth was driven in
part by the Glenmorangie gain, favorable foreign exchange trends, strong
earnings growth for our global spirits brands, and the absence of litigation
expenses incurred in the prior year. These increases were partially offset by
the asset impairment charges, higher compensation and pension expense, and lower
operating profits from Consumer Durables. Adjusting for the Glenmorangie gain,
the asset impairment charges, favorable foreign exchange, and the prior year
litigation expenses, diluted earnings per share for the nine months grew 8%, as
follows:
Reported Diluted EPS growth 25%
Adjustments:
Glenmorangie gain (24%)
Asset impairments 20%
Foreign currency benefit (9%)
Absence of prior year litigation expense (4%)
-----
Adjusted Diluted EPS growth 8%
=====
We believe that disclosing the adjusted diluted EPS growth of 8% is useful
because it is a more accurate reflection of the ongoing operating performance of
the company.
Beverages
For the first nine months, Beverages revenue and gross profit increased by 13%
and 15%, respectively, compared to the same period last year. Growth was driven
primarily by accelerating consumer demand and margin improvement (pricing and
foreign exchange related) for Jack Daniel's, Southern Comfort, and Finlandia,
and the impact of the company's new low-carbohydrate wine brands. These gains
were partially offset by top-line declines for Fetzer Premium Varietals and Jack
Daniel's Country Cocktails.
Beverages advertising investments increased 14% through January, reflecting
higher brand-building efforts behind several brands, most notably Jack Daniel's,
Southern Comfort, and Finlandia, the impact of a weaker U.S. dollar, and
promotional investments supporting the launch of the new low-carbohydrate wines.
SG&A expenses increased by 11%, due largely to higher employee compensation and
pension expense and the negative impact of foreign exchange. In addition to
solid top-line growth, the absence of litigation and restructuring expenses
boosted the segment's year-to-date operating income growth to 21%.
17
Consumer Durables
Revenues and gross profit declined 7% and 9%, respectively, during the period.
The segment's disappointing results for the first nine months reflect the
overall softness experienced in the U.S. for tabletop and giftware products.
Profit gains from "kate spade" co-branded patterns and Hartmann luggage combined
with aggressive reductions in advertising (down 11%) and other operating
expenses were insufficient to offset the overall decline in consumer demand
across all three channels of distribution - wholesale, retail, and
direct-to-consumer. As a result, the segment's operating income through January
of $11.6 million (excluding the impairment charge) lagged prior year performance
by $4.9 million.
As discussed above, the $37.0 million goodwill impairment charge reflects the
continued disappointing performance of Lenox's retail stores through this
holiday season and management's conclusion that the retail chain should not be
operated in its current configuration in the future. As a result, management has
revised the long-term outlook for its retail business.
Liquidity and Financial Condition
Cash and cash equivalents increased by $221.8 million during the nine months
ended January 31, 2005, compared to an increase of $38.1 million during the same
period last year. Cash provided by operations grew by $95.1 million, primarily
reflecting a $57.0 million increase in operating income, excluding a $37.0
million non-cash goodwill impairment charge, and a more favorable working
capital position. Cash provided by investments increased by $50.2 million, due
largely to the receipt of $92.7 million on the sale of our equity stake in
Glenmorangie plc and a $19.3 million reduction in net fixed asset additions,
partially offset by $63.6 million used to acquire the outstanding minority
interest in Finlandia Vodka Worldwide Ltd. Cash used for financing activities
declined by $38.4 million, mainly reflecting lower net debt repayments.
Outlook
Following strong growth in earnings through January, only moderate growth is
expected for the remainder of the fiscal year. Continued solid consumer demand
for several of the company's beverage brands is projected to be partially offset
by increases in advertising investments and reductions in global trade inventory
levels related to both supply chain efficiency initiatives and potential
distribution changes in continental Europe. Additionally, the company intends to
adopt FAS 123(R) related to the expensing of stock options during the fourth
quarter of this fiscal year which will reduce full year diluted earnings by
approximately $0.033 per share. We are increasing our full year outlook to a
range of $2.47 to $2.51 per share. Excluding the Glenmorangie gain and the asset
impairment charges, diluted earnings per share are expected to be in a range of
$2.41 to $2.45, reflecting growth of 16-18% for the full fiscal year.
On October 22, 2004, the American Jobs Creation Act ("the Act") was signed into
law. The Act contains provisions that might affect Brown-Forman's future
effective tax rate, including a special one-time 85% dividends received
deduction for certain repatriated foreign earnings. The company may make this
one-time election with respect to funds repatriated during either fiscal 2005 or
2006. The deduction is subject to a number of limitations and requirements,
including adoption of a specific domestic reinvestment plan for the repatriated
funds. At this time, we do not plan to repatriate any dividends during fiscal
year 2005, and are investigating whether to do so in fiscal 2006. We do not
expect to complete this evaluation until fiscal 2006.
The Act also creates a deduction for income from qualified domestic production
activities which will be phased in from 2005 through 2010, effective for our
fiscal years 2006 through 2011. In return, the Act also provides for a two-year
phase-out of the existing extra-territorial income exclusion ("the ETI
exclusion") for foreign sales that was viewed to be inconsistent with
international trade protocols by the European Union. The new deduction for
domestic production activities is subject to certain limitations and
interpretations and, as such, we are not yet in a position to determine with
reasonable certainty the potential impact on the effective tax rate of future
years. However, we anticipate the combined net effect of the phase-out of the
ETI exclusion and the phase-in of the new deduction for domestic production
activities to result in an immaterial increase in the effective tax rate for
fiscal years 2005 and 2006.
18
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We hold debt obligations, foreign currency forward and option contracts, and
commodity futures contracts that are exposed to risk from changes in interest
rates, foreign currency exchange rates, and commodity prices, respectively.
Established procedures and internal processes govern the management of these
market risks. As of January 31, 2005, we do not consider the exposure to these
market risks to be material.
Item 4. Controls and Procedures
The Chief Executive Officer ("CEO") and the Chief Financial Officer ("CFO") of
Brown-Forman (its principal executive and principal financial officers) have
evaluated the effectiveness of the company's "disclosure controls and
procedures" (as defined in Rule 13a-15(e) under the Securities Exchange Act of
1934 (the "Exchange Act")) as of the end of the period covered by this report.
Based on that evaluation, the CEO and CFO concluded that the company's
disclosure controls and procedures: are effective to ensure that information
required to be disclosed by the company in the reports filed or submitted by it
under the Exchange Act is recorded, processed, summarized, and reported within
the time periods specified in the SEC's rules and forms; and include controls
and procedures designed to ensure that information required to be disclosed by
the company in such reports is accumulated and communicated to the company's
management, including the CEO and the CFO, as appropriate, to allow timely
decisions regarding required disclosure. There has been no change in the
company's internal control over financial reporting during the most recent
fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the company's internal control over financial reporting.
19
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Beverages
Brown-Forman Corporation and many other manufacturers of spirits, wine and beer
are defendants in a series of essentially similar class action lawsuits seeking
damages and injunctive relief over alleged marketing of beverage alcohol to
underage consumers. Six lawsuits have been filed to date, the first three
against eight defendants, including Brown-Forman: Hakki v. Adolph Coors Company,
et.al., District of Columbia Superior Court No. CD 03-9183 (November 2003);
Kreft v. Zima Beverage Co., et.al., District Court, Jefferson County, Colorado,
No. 04cv1827 (December 2003); and Wilson v. Zima Company, et.al., U.S. District
Court for the Western District of North Carolina, Charlotte Division, No.
3:04cv141 ( January 2004.) Two virtually identical suits with allegations
similar to those in the first three lawsuits were filed in Cleveland, Ohio, in
April and June, 2004, respectively, against the original eight defendants as
well as an additional nine manufacturers of spirits and beer, and are now
consolidated as Eisenberg v. Anheuser-Busch, U.S. District Court for the
District of Northern Ohio, No. 1:04cv1081. A similar suit was filed in Madison,
Wisconsin on February 23, 2005, styled Jacquelin Tomberlin v. Adolph Coors, Dane
County (Wisconsin) Circuit Court, 05CV0545, In addition, Brown-Forman received
in February, 2004, a pre-lawsuit notice under the California Consumer Protection
Act indicating that the same lawyers intend to file a lawsuit there against many
industry defendants, including Brown-Forman, presumably on the same facts and
legal theories.
The suits allege that the defendants have engaged in deceptive marketing
practices and schemes targeted at underage consumers, negligently marketed their
products to the underage, and fraudulently concealed their alleged misconduct.
Plaintiffs seek class action certification on behalf of: (a) a guardian class
consisting of all persons who were or are parents of children whose funds were
used to purchase beverage alcohol marketed by the defendants which were consumed
without their prior knowledge by their children under the age of 21 during the
period 1982 to present; and (b) an injunctive class consisting of the parents
and guardians of all children currently under the age of 21.
The lawsuits seek: (1) a finding that defendants engaged in a deceptive scheme
to market alcoholic beverages to underage persons and an injunction against such
alleged practices; (2) disgorgement and refund to the guardian class of all
proceeds resulting from sales to the underage since 1982; and (3) judgment to
each guardian class member for a trebled award of actual damages, punitive
damages, and attorneys fees. The lawsuits, either collectively or individually,
if ultimately successful, represent significant financial exposure.
Brown-Forman denies that it intentionally markets its beverage alcohol products
to minors and denies that its advertising is illegal. It will defend these cases
vigorously.
20
Consumer Durables
On August 23 and 26, 2004, plaintiffs purporting to represent a class of
consumers who purchased tableware sold in the United States from May 1, 2001,
through the present filed suit against Federated Department Stores, the May
Department Stores Company, Waterford Wedgwood U.S.A., and Brown-Forman's Lenox,
Inc. subsidiary. In November 2004, plaintiffs filed a consolidated complaint
alleging that the defendants violated Section 1 of the Sherman Act by conspiring
to fix prices and to boycott sales to Bed Bath & Beyond. The cases are
consolidated in the U.S. District Court for the Northern District of California,
Nos. C-04-3514VRW and C-04-3622VRW. Plaintiffs seek to recover an undisclosed
amount of damages, trebled in accord with the anti-trust laws, as well as costs,
attorney fees and injunctive relief. Lenox, Inc. denies the allegations of the
complaint and intends to defend the cases vigorously.
Item 6. Exhibits
31.1 CEO Certification pursuant to Section 302 of Sarbanes-Oxley Act
of 2002
31.2 CFO Certification pursuant to Section 302 of Sarbanes-Oxley Act
of 2002
32 CEO and CFO Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(not considered to be filed)
21
SIGNATURES
As required by the Securities Exchange Act of 1934, the Registrant has caused
this report to be signed on its behalf by the undersigned authorized officer.
BROWN-FORMAN CORPORATION
(Registrant)
Date: March 1, 2005 By: /s/ Phoebe A. Wood
Phoebe A. Wood
Executive Vice President and
Chief Financial Officer
(On behalf of the Registrant and
as Principal Financial Officer)
22
Exhibit 31.1
CERTIFICATION PURSUANT TO SECTION 302 OF SARBANES-OXLEY ACT OF 2002
I, Owsley Brown II, certify that:
1. I have reviewed this Quarterly report on Form 10-Q of Brown-Forman
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects
the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report.
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision,
to ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which this
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the
case of an annual report) that has materially affected, or is reasonably
likely to materially affect, the registrant's internal control over
financial reporting.
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent function):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: March 1, 2005 By: /s/ Owsley Brown II
Owsley Brown II
Chief Executive Officer
23
Exhibit 31.2
CERTIFICATION PURSUANT TO SECTION 302 OF SARBANES-OXLEY ACT OF 2002
I, Phoebe A. Wood, certify that:
1. I have reviewed this Quarterly report on Form 10-Q of Brown-Forman
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects
the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report.
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision,
to ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which this
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the
case of an annual report) that has materially affected, or is reasonably
likely to materially affect, the registrant's internal control over
financial reporting.
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent function):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: March 1, 2005 By: /s/ Phoebe A. Wood
Phoebe A. Wood
Chief Financial Officer
24
Exhibit 32
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Brown-Forman Corporation ("the
Company") on Form 10-Q for the period ended January 31, 2005, as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), each of
the undersigned hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, in the capacity as an
officer of the Company, that:
(1) The Report fully complies with the requirements of Section 13(a) of the
Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Date: March 1, 2005
By: /s/ Owsley Brown II
Owsley Brown II
Chief Executive Officer and
Chairman
By: /s/ Phoebe A. Wood
Phoebe A. Wood
Executive Vice President and
Chief Financial Officer
A signed original of this written statement required by Section 906 has been
provided to the Company and will be retained by the Company and furnished to the
Securities and Exchange Commission or its staff upon request.
This certificate is being furnished solely for purposes of Section 906 and is
not being filed as part of the Report.
25