BF.A (BF.A) Q3 2015 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Brown-Forman Third Quarter Fiscal 2015 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn today’s conference over to Mr. Jay Koval, Vice President of Investor Relations. You may begin.

Thanks, Victoria, and good morning, everyone. I want to thank you for joining us today for Brown-Forman's third quarter 2015 earnings call. Joining me today are Paul Varga, our President and Chief Executive Officer; Jane Morreau, Executive Vice President and Chief Financial Officer; and Brian Fitzgerald, Chief Accounting Officer. This morning's conference call contains forward-looking statements based on our current expectations. Numerous risks and uncertainties may cause actual results to differ materially from those anticipated or projected in these statements. Many of the factors that will determine future results are beyond the company's ability to control or predict. You should not place undue reliance on any forward-looking statements and the company undertakes no obligation to update any of these statements, whether due to new information, future events or otherwise. This morning, we issued a press release containing our results for the third quarter of fiscal 2015. The release can be found on our website under the section titled Investor Relations. In the press release, we have listed a number of the risk factors that you should consider in conjunction with our forward-looking statements. Other significant risk factors are described in our Form 10-K, Form 8-K and Form 10-Q reports filed with the Securities and Exchange Commission. During this call, we will be discussing certain non-GAAP financial measures. These measures and the reasons management believes they provide useful information to investors regarding the company's financial conditions and results of operations are contained in the press release. And with that, I will turn the call over to Jane for her prepared remarks.

Thanks Jay, and thanks everyone for joining us for our third quarter earnings call. I’ll cover two three topics today which should leave plenty of time for our questions after our prepared remarks. First, I’ll review our year-to-date results including trends in the third quarter and second I’ll discuss our updated outlook for 2015. So, let me start by reviewing our recent results. Third quarter underlying net sales growth of over 5% is particulary impressive in light of the strong 8% underlying growth we delivered in the third quarter of last year and against the competitive threat that is showing little to no growth. Year-to-date underlying sales are also up 5% with price mix contributing 3 points of sales growth. Topline results in the United States continued to accelerate in the quarter, up 7% year-to-date compared to 5% for the first half. Market share gains in the U.S. are being driven by the great work our teams and partners are doing to capitalize on the renewed consumer interest and authentic American Whiskey including the Jack Daniel’s family Woodford Reserve Double and Old Forester. Premiumization trend and innovation have played key roles in driving our out performance over the last few years and we look to introduce new expressions overtime that we believe can help us deliver sustainable long term growth. Developed markets outside the United States grew underlying net sales 4% during the first nine months. France, the United Kingdom and Canada are also growing quite well, while Germany and Italy grew up slightly. These markets help offset sluggish results in Australia and Japan and in Spain where the results were then [ph] double-digits. And in the emerging markets Jack Daniel’s Tennessee Whiskey continued to grow mid-teens, driven by strength in Turkey, Russia, Ukraine, Brazil, Indonesia, the Philippines and Sub Sahara Africa. Mexico results were flat as the main stream Tequila category remains quite competitive and we are actively repositioning our El Jimador brand at a higher price point. Additionally, large declines in Poland driven by some Finlandia poured down our total emerging market growth to 6% in the first nine months. Remember Poland had large buyings [ph] in advance of last year’s January 1st excess tax increase. The comparisons were challenging in calendar 2014. Excluding Poland, our emerging markets sales growth would have been seven points higher. Furthermore we estimate that year-to-date underlying net sales growth for the entire company excluding Poland would have been a point higher at 6.5%. Lets now move to the reconciliation of reported to underlying results. In appreciating U.S. dollars continued to weigh heavily on our reported results. Last quarter, I used euro as an example, stating that it had declined 7% since our first quarter call. These declines continued in our third quarter as the euro dropped another 9%. In total, we experienced additional FX headwinds of approximately $0.04 in the third quarter beyond our expectations at the time of our second quarter call. So while our topline grew 5% on an underlying basis during the first nine months of fiscal 2015, foreign exchange negatively impacted our reported results approximately 3 percentage points. An increase in estimated net distributable inventories helped reported results by one percentage point due to our uptick [ph] and similar change in France. As a reminder, our former distributor fully depleted inventories of our brands during November and December of last fiscal year leading to a simply no shipments in the third quarter of 2014 in France, which negatively impacted our reported results last year. The absence of these reductions this year resulted in a favorable one time comparison. This benefit combined with the negative effect of foreign exchange resulted in reported net sales growth of 3% over the nine month period. Underlying AMP spend increased 4% while underlying SG&A grew 9%. Both line items were a few points lower on our reported basis as foreign exchange helped our non-U.S. dollar denominated cost. Year-to-date SG&A increases have been driven in part by our – to market investments in France, but we expect lower, full year SG&A growth. Putting this all together we delivered 7% year-to-date growth in underlying operating income. Foreign exchange headwinds hurt [ph] our reported operating income growth by seven points. This was due to transactional impact on net exposures and the revaluation of net current assets denominated in foreign currencies. The revaluations are captured in the $22 million negative swing in the other income and expense line items on the P&L. For the first nine months of the year, earnings per share came in at $2.54 up 4% year-over-year. Foreign exchange was an $0.18 drag on reported EPS so year-over-year growth in EPS would have been approximately $0.11 excluding this impact. Moving now to my second and final topic an update on our outlook for fiscal 2015. Today, we are reaffirming the ranges we shared with you for our full year outlook for underlying net sales growth of 6% to 8%. Our year-to-date topline results are running slightly below the low end of this range due largely to comparison issues with the prior year. Our business momentum remains robust and we will be comping against last year’s soft fourth quarter underlying sales growth of 3% which was negatively impacted by give [ph] back in Poland. So with two new aspects [ph] sales growth running 14% in the third quarter and the expectation of easier comparison we anticipate strong fourth quarter top line growth to pull off full year sales growth pact in the 6% to 8% range. Regarding the national launch of the Jack Daniel’s Tennessee Fire, our teams have been hard at work and we recently began shipping our first cases to the other 42 states. Our initial read-through from our eight test states have been very encouraging with Fire continuing to index [ph] quite favorably to Honey’s introduction four years ago and we believe that the limited roll out has helped fuel consumer interest in the brand. Equally important, we believe that Fire is not only complimenting Jack Daniel’s Tennessee Whiskey but is showing little sign of slowing the rate of growth for Jack Daniel’s Tennessee Honey in the initial test markets. From an earnings perspective we expect a few cents of benefit to fiscal’s 2015 reported result reflecting pipeline build. Year-to-date gross margin expansion of 70 basis points has been stronger than what we expect for the full year given our expectations for higher cost in the fourth quarter related to wood for our barrel making operations caused by growing an increased interest for bourbon. Underlying SG&A growth moderated to 6% in the third quarter as we began to lack [ph] the process market change in France on January 1st. We anticipate additional moderation in the fourth quarter as we lapped last year’s 14% growth rate. In the aggregate we expect underlying operating income growth in the fourth quarter in the teens which should result in full year underlying operating income growth of 9% to 11%. And that’s surprisingly FX remains ahead a headwind. But given today’s spot rate which for reference was -- 13% weaker than 35 year average versus the dollar, we expect foreign exchange to pull down our reported EPS in the fourth quarter. We anticipate FX will herd our full year operating income by over $60 million and EPS over $0.20 assuming today’s spot rate. This year full year FX impact is a nickel worse than we expected at the time of our second quarter call and a driver for our revised EPS range of $3.15 to $3.25. As a sensitivity assuming our foreign exchange cash flow exposures collectively move 10% in either direction our EPS over the balance of the year would be impacted by approximately $0.04. And while it’s too early in our planning process, this year specific guidance on fiscal 2010 till ’16 we remain optimistic about our prospects for continued growth giving the health of our existing business continued category momentum and our discipline innovation strategy. We’ll of course share more specifics with you on our fourth quarter call. So in closing, we continued to deliver strong, underlying growth. We attribute this out performance to our leading portfolio of American Whiskey brands led by the Jack Daniel’s trademark. Strong and growing geographic diversification and premiumization opportunities for our portfolio of brands. Our business model has been built around premium brands and the efficiencies inherent in single point production leading to high gross margins and strong free cash flow. We approach our capital deployment with a very long term view supported by the health and strength of our balance sheet. This allows us to simultaneously invest in future growth as we are actively doing today behind Jack Daniel’s and our other American Whiskey brand, evaluate potential acquisitions and return cash to our shareholders as we have done to the tune of almost $0.5 billion so far this fiscal year through ongoing dividend and share buyback programs. So let me turn the call over now to Paul for his comments. Paul?

Thank you, Jane and good morning everyone. First, let me say that I continue to be pleased with the company’s results and I want to publicly thank my Brown-Forman colleagues worldwide for again producing them. I think we had another very good quarter of underlying performance and I would highlight that our 5% sales growth and 8% operating income growth on an underlying basis came on top of a very strong Q3 last year. So with the expectation that we will finish the year along the lines of what we have guided today, I believe we will have recorded another excellent year of underlying growth and business progress with the company. One of the things that makes our underlying results stand out in my view is that they compare quite favorably to those we observe across our industry. And this has been a consistent reality over the last many years. One of the reasons for our differential underlying performance I believe is that Brown-Forman is uniquely well positioned through our American Whiskey leadership and our ownership of the Jack Daniel’s brand, which itself is a superb geographic breadth diversification in continuing opportunity. In our communications with you over the years we’ve discussed an aspect of American Whiskey that I believe is particularly unique. It is simultaneously enjoying the desirable attributes of both mixed ability and premiumization. Most often in these categories these two dimensions are observed as mutually exclusive. If you consider the two largest multi country categories in the spirits industry by volume and that’s scotch and vodka, this point is made rather clearly. Within Scotch we frequently see leading trademarks positioned very successfully at many price points spanning from standard to luxury in each case utilizing the same trademark name at each of the price points. Within Vodka, the leading trade marks have not exhibited the same vertical agility. The leading brands at each successive price tranche in vodka typically carry a different brand name. A contrast however vodka has shown tremendous horizontal agility if you will through flavored vodkas and premixed RTDs, which provide consumers with a broad range of flavor options for the consuming occasions. Scotch on the other hand has had little success extending their trademarks along their same flavor for mixability dimension. But uniquely with American Whiskey and best evidenced by our own Jack Daniels, the categories brands have shown the ability to be successful or in both of these attractive dimensions within the same trademark. I am going to give you an example of this. On the mixability and flavor front, Jack Daniel’s is enjoyed today in a more varied fashion than its Scotch Whiskey competition through everyday mixed drinks like Jack and Coke, premium convenience offerings like Jack Daniel’s RTDs, and proprietary flavor whiskey expressions like Jack Daniel's Tennessee Honey and our new Jack Daniel’s Tennessee Fire which is currently rolling out in the United States. At the same time that Jack Daniel enjoys in its consumption variety through its inherent mixability, the brands reputation for crafting the finest American Whiskey is evidenced through the success of brand like Gentlemen Jack and Jack Daniel's Single Barrel, two trademark expressions that have become sizeable brands in the ultra premium American Whiskey segment. In fact, these two brands figure prominently in a milestone Brown-Forman celebrated during our most recent quarter. For the first time, the combined 12 month volumes of Gentlemen Jack, Jack Daniel Single barrel and Woodford Reserve eclipsed one million cases. Beyond being our company’s standing illustration of premiumization within American whiskey, these brands also represent a very valuable ultra premium whiskey business for Brown-Forman today given their attractive of profitability, returns and growth rate. Now as nice as this 1 million case milestone is to recognize, just as exciting is the fact that the ultra premium plus price segment of American whiskey is still at a very early stage of development. Contrasting this price segment of American whiskey to the equivalent one in scotch whiskey, we observed that this highest end represents only 2% to 3% of total American whiskey retail dollars, whereas the same price segment accounts for over 30% of total scotch. So on a share of category basis alone, there is a 10 to 15 fold opportunity for the highest end of American whiskey if it can develop as ultra-premium scotch has. And to reinforce the point in a different way in pure retail dollar terms because scotch is so much larger than American whiskey, a highest end of scotch today represents a segment that is more than 35 times the size of the American whiskey equivalent. Any view we view the data we see this as an enormous long term opportunity for Brown-Forman within the category that is most important to us and that we know best. So the brand building capabilities our people have demonstrated in achieving this first one million case milestone will be the enabling factor as we strive for the next one million cases. And while my focus today has been on this one particular ultra premium whiskey achievement, we also intend to apply these same capabilities with a significant opportunities we envision for other premium plus brands such as Herradura, Sonoma-Cutrer and Old Forester, to name just a few. The highest priority for our time and capabilities however, will remain the responsible globalization and development of the Jack Daniel’s Black Label brand as we continue to build its mixabiliy and premium. Jack Daniel’s Black Label is the foundation of the Jack Daniel’s trade mark overall as well as Brown-Forman’s most meaningful growth opportunity for the foreseeable future. This concludes our prepared commentary this morning and we’re now happy to take any questions you might have.

[Operator Instructions] The first question comes from the line of Vivien Azer from Cowen.

Hi, Vivien.

Hi, Vivien.

And my first question has to do with the depletion trends in the quarter, it looks like they slowed it little bit but I see that that’s on a tough comp, so could you dive in a little bit more in terms of the depletion trend specifically for 3Q, please?

Yes Vivien, I think the way I would look at that – if you looked at our first quarter I think they were a little bit softer, you are right. Q2 was a little bit stronger and Q3 is a little bit down versus Q2. But I think it’s all relative to last year, so really if you look at where we worked through the first half we are at 2%, we’re still at 2% so I don’t really see it slowdown, I think it’s’ really, can’t really look at one quarter in isolation, if you will in fact that’s the improving trend particularly in the U.S. and we experienced some acceleration there. So I think a lot of what you are seeing is simply a difficult comp and that I was referring to my script and then we alluded to in our earnings release as it related to buy-ins last year, and so we don’t – we are not seen – I don’t view it as a slowdown you are going to see these one-off things happening when you look at quarter to quarter.

That’s very helpful. Thank you very much. Jane, you mentioned in your prepared remarks that Fire continues to track well relative to Tennessee Honey. At your Investor Day you indicated it was about 1.35 times, can you give us a little bit more detail on how the trajectory has evolved as you have kind of included 5 more states and those comparisons?

Yes so and just to reiterate how encouraged we are about what we are seeing and how excited our people are, the trade is, and the consumer wanting and excited about seeing a super premium sentiment brand expression from Jack Daniel. So you are right. We did talk about the early test market stock at our investor conference. We are not seeing a slowing. We have continued to see somewhere in the 130% to 140% indexing so we’re not seen it slowdown. If you will, it’s maintained and we’re very encouraged by that. But that being said, these are – orders first a bit given that it is a higher price offering versus what the category price point that already exists. But nonetheless we are very excited, we just started shipping our first cases out a couple of weeks ago to the remaining 42 states as I said earlier, so time will tell but I think we’re positioned well.

Yes, I mean the trade reaction so far is I mean if anything because there was pent up demand, and I would say the national rollout has been received with as many or even more enthusiasm as the original sort of test market were and the thing that’s so interesting when you go national is you know your ability to use things like media, the ability for social media to help you, I mean this brand. I would give you one sort of, I thought that was an interesting thing I heard in the last month that the Jack Daniel’s Tennessee by her Twitter followers have already eclipsed the Jack Tennessee Honey followers. And so, while it’s too early to know you know how their actual consumer acceptance in terms of real purchases in the market place will unfold. But we’ve seen so far both at trade and consumer on this is really encouraging.

That is very good news. My last question just in terms of the acceleration that you are seeing in the United States, can you talk about the balance between on and off premise, I think you guys pointed to some improving trends in on-premise last quarter, so I’m curious if that’s continued?

Yes, I could talk a little bit and then Paul can chime in. I think the latest NAFTA information through January indicated that the on-premise trends are continued to accelerate. Both overall spirits is up and Brown-Forman we're beating overall spirit. So Jack Daniel’s itself continues to improve as well. I think we’re up about 2% in the on-premise. It’s up a point, about half a point over the prior month so we continuously since about last March or April have seen continued improvement and overall trends in the on-premise and its impacted favorably all brands. I would say when I look at our brands Old Forester is our fastest growing on-premise brand by a long shot. But we’ve got a lot of other brands that are growing quite nicely in the on-premise too Woodford Reserve, El Jimador, they're growing very, very strongly. Gentlemen Jack is doing well, so the trends are improving. We’ll see what kind of weather you guys are predicting there today, but we’re predicting more snow here today. So I remember last year the winter was quite bad and I know in the month of February has been dicey around the states, United States. But we think we got a couple of more months of soft comps depending again how the weather goes over the next couple of months.

Sure. You know the question you asked comment, I mean we don’t have as great a visibility and timeliness on International on premise, but it's been its been our experience here as with the places where these economies t have been difficult with the on premise along with some of the off premise has continued to show some weakness. But I would say that even though the on-premise is improving, the strength of particularly this U.S. off premise environment as spirit brands and I'll say premiums brands are very much affordable luxury still. And so if you just compare a drink outlaid by the consumer for either a bottle of Jack Daniels or Woodford Reserve, compared to many other entertainment alternatives that stacks up quite nice. I think the off premise continues to really drive in the U.S. market and its not to diminish the impact of a recovering on premise, but I mean at least our read of the last 12 months the U.S. distilled sales driven in great parts of our core category Bourbon and American whiskey has obtained a little bit.

Terrific. Thanks very much.

Welcome.

The next question comes from the line of John Faucher with JPMorgan.

Yes, good morning. I apologize; I got a little confused in terms of the impact in France vis-a-vis the impact in Poland. Were they similar impacts and with all of that in the most recent quarter is that where we should look at that and so that’s more of a housekeeping question. And then I think sort of a longer term question, you know Paul you talked about sort of being single sourced and that’s been a huge advantage for you, as it allows you guys to build scale, what have you. But U.S. based manufacturing cost could provide a little bit of pressure over the next several years if we continue to see strength in the dollar. So can you talk a little bit about how you guys are looking at that if we do have a stronger dollar longer term, what you can do in place to offset some of the transactional FX impact that you guys….

I’ll tackle that one. Jane considers your first question here. These are always tradeoffs, the single point producer in the United States at the time of the strengthening dollar, yes I mean all this trips, I will tell you it’s better to be positioned at the very high of a market versus low end when that’s happening, because you know fortunately the FX impact is less though on your profits. And so as I feel like net when you balanced it all out, the efficiencies and we’ve been well served over these years by the single point production and efficiency and frankly also the importance of that home place. And the important status that's conferred to Jack Daniel's as an important American whiskey when it leaves the shores of the United States that all have been very important to the brand, development over the years. So I think there is both efficiency reasons that you asked questions but also some marketing ones. I do think there are things that you know implied that in the same way even more indirectly than directly as the dollar strengthens and I think the most significant is at least the – who I think about it and there might be a big rationalization here. But if you think about why the U.S. dollar has been strengthening, one of the contributing factors is the strength of the U.S. economy. And you know relative to other countries. And in the way I look at it, we happen to have the good portion of having that’s our largest country, it’s the most valuable distilled spirits market in the world. It’s our home country which we know very well. And it also happens within our industry to be one of the most exciting times for our core category. So, I know this might be a very simplistic way of thinking. But the way I think about it is as it relates to things, everything from resource allocation or inbation or the way that we think about developing our business at a time when the U.S. dollar is strong is make sure you are maximizing the opportunities available to you in the United States market, that’s one thing. And so that’s one of the ways in this past year we certainly have upped our investment behind Jack Daniels where you first talk about the introduction here of Tennessee fire which is an innovative effort you – I mean I like to emphasized very strongly here the ultra whiskey’s which have the predominant presence for them in the largest market in each one of those cases is the United States. So I think it’s a remand, its’ all of us you know at Brown-Forman’s managers to really make sure you are doing the best possible job you can in the market attractive it is in some ways causing the dollar to strengthen. So – and that’s difference than, I mean, it’s certainly U.S. based companies has a wonderful time to either be making acquisitions in Europe or to be borrowing European denominations, those kind of things. But those alone aren’t reason to go do it. They just increase I think the benefits of timing as you think about it. But I think the biggest takeaway is for us is to make sure we’re doing the best possible job in the United States.

Okay. I’ll follow-up on your housekeeping questions. I see France and Poland as two different things. The reason why we illustrated France for you was because it impacted our third quarter only reported results. So when we’re providing the reconciliation understanding between reported and underlying, so it’s a reported aspect, Poland on the other hand has been something that has hurt us all 2014, following the excessive or huge significant tax increase taken last Jan 1. And as a result of that it’s been a market that has impacted our comparisons all year long and we do expect easier comps as we go into the fourth quarter. That has impact on our underlying results and that’s why I isolated Poland as is related to our discussion.

That does. But does that mean that the impact – was the impact in Q3 the same, did they offset each other generally and understanding the differences between the situations, was there a rough offset between the two countries in the third quarter specifically?

No, no. And again, one was on a reported and one is an underlying. France did not impact my underlying results is my reported. Poland…

Yes. And the impact in France that we’ve highlighted, I think I’ve got it right, it would be larger than the direct impact that you were citing for the underlying in Poland. Don’t you think? I think as it relates to one’s in underlying one’s in the reported that there was a significant – in terms of estimated net change industry in terms of six point quarterly impact on France. I don’t know, Poland impact of six points at the underlying.

It impacted might emerging markets.

Emerging markets, yes, but not the corporation.

Okay, great. Thank you very much.

Thank you.

Your next question comes from the line of Judy Hong with Goldman Sachs.

Thank you. Hi, everyone. Just following up on Poland, I guess I’m curious to hear more about the underlying trends. I think Jane you talked about last quarter where obviously the shipment number that you’ve been reporting has been impacted by the inventory movement, but the underlying trends were starting to improve. So, just wanted to understand if that’s continuing in the back half of the year? And then, as it relates to the fourth quarter sales guidance, obviously, you’re expecting pretty sizeable acceleration, the comps are easier, but just in terms of thinking about some of the underlying trends. Are you expecting any sizeable improvement in some of the markets? It sounds like maybe Tennessee Fire is adding about couple of points to sales in terms of pipe sales, so can you just verify that number? And is there any inventory movement that we should be thinking about as relates to the fourth quarter?

A lot there, Judy. Let me talk about Poland.

Yes. You ready on Poland? I could answer the last one if you want.

Yes. I can start on Poland. And what we are seeing there and continue to see as it relates to the premium whiskey, in the Polish markets as well as Jack Daniel’s from an underlying takeaway trend perspective, we see accelerating results. So, another – I’ll just give you one example. The premium whiskey are growing 33% in Poland market on a three-month basis, up from 25% on a 12 months. So, similarly Black Label is growing 13%, on a three-month, up 9% on 12 months, so you can see the acceleration there. And again, the excise tax as a comparisons impacted the difficult comps that we’ve been talking about all long impacted both Jack Daniel’s Black Label and Finlandia. So neither brand has been growing at the takeaway trends, rates that I’m showing here. The takeaway trends for Finlandia are much better than what we’re seeing in our current results as well. So 12 months trends are running 3% and were down right now year-over-year again. So, that gives you a little bit of flavor that the takeaway trends of consumer is taking is working its way throughout all the inventory and the adjustments from the excess tax a year ago. So, does that help on Poland?

Yes. And are we done with all the inventory destocking that needed to get cleaned out?

On Poland? Yes. That’s behind us.

For purpose of the comparison, we hope there is no more excise tax increase there. You’ll always have the trading pace but as it relates to what we’re guiding today. Yes, so and then Judy I think the other question you had there was what are the components that give us the confidence? And you cited that all of them and I’ll just comment in the general way. The biggest thing are these soft comps that relate to, for example, Poland and in Europe, we feel that are we’re in Q4 last year, that we do expect and would as part of our guidance at the United States that continue to accelerate along the lines of what we’ve been saying. So the industry in the category, but also our business has been accelerating. So it’s with that expectation that will continue through the fourth quarter. And we think we’ve got the right sort of I think investments in programming and system effort around that to comps what we want. And then you mentioned the other one, which is Tennessee Fire and that Tennessee Fire in addition, which is – this is U.S. comment, its introduction to the United States on the national level is the other contributing factor that we would be incorporating into that acceleration. So, those are the main three components that we soft comp U.S. acceleration with some Tennessee Fire on top of it. Now, we also ask would that create any inventory things. And the only inventory things that I think Jane might highlighted little bit would on Tennessee Fire pipeline, because you shift some of course at the national launch in advance of the depletions and so there might be a little there. But otherwise we’re expecting inventories to largely be at balance at the end of the year.

No different really from what we are.

Okay. So just to clarify on Fire, because you had called out few sense of EPS benefit related to pipe fill in the fourth quarter, so I guess that implies roughly 1.5 to 2 points of sales impact, that potentially would come down on a reported basis. But that’s not included in your underlying sales growth guidance?

The impact on our underlying full year impact is less than a half point as I recall.

Okay. Got it.

We’re investing back behind the fire launch.

Okay. And then, Jane just lastly on FX, I know we’ll get obviously full year guidance for next year when you report next quarter and FX continues to be a moving target. But if I just sort of take where those spot prices are today. I get to another r$0.15 or so of negative FX. I just wanted to understand if there’s anything missing in terms of hedging exposure or transactions that are missing as I calculate the impact as of today?

The only thing that I would say is as I’ve been trying to explain as we’ve talked the last two quarters about transaction and transitional FX, so the transactional being attributable to our translating our foreign denominated net earned asset, back to the U.S. dollars. Assuming the spot rates they were they are today, we have the pretty significant impact I talked about, I think its $22 million, $23 million is shown up in our other income and expense line item. I would consider that one-time in nature if you will the spot rates they where they are, so that would not repeat itself next year, if you thinking about hits of FX from this year. So that would come – be a favorable comparison if you will next year. That’s the only thing right now I would say.

Yes. Understand. Okay. Got it.

In terms of how we hedge and I think we’ve discussed that before our hedging philosophy and how we rolling our hedging actually over time.

Right. Okay. Got it. Thank you very much.

Your next question comes from the line of Bryan Spillane with Bank of America.

Hey, good morning everyone.

Good morning.

Just -- Jane, just two quick questions relative to the quarter. One, I think you’ve said that underlying SG&A was up 6% in the quarter, did you give us what underlying advertising was up or down in the quarter?

4% in this quarter I believe. Okay, let me double check that, I’m sorry.

Yes.

It is a 4% in the quarter.

Up 4%.

Judy, I’m sorry, 3% and 4% year to-date. Yes.

Okay. And then second question just I seem to recall from the last – from the Q2 earnings call that underlying sales growth was 7% and the expectation was that it had accelerated to 7% and it wouldn’t move from that. So I’m just trying to understand was the third quarter a little bit like relative to what you’re expecting or was that comment about you don’t expected to get – you expect there’s a hold that a bit better or more of a comment on what you would think over the second half instead of specifically the third quarter?

Yes. Actually Bryan, that’s a great question and what we were referring, what we said was with the back half, not – we won’t given any quarterly guidance, so we were saying, that we were expecting the back half to go down if you will or to change, so I think the third quarter was largely in line with what we expected we knew we would have difficult topline comparisons to last year where we had really strong third quarter, growing topline 8%. So, our comment was more as it related to the back half.

Yes. Overall I think it met our expectations, I mean, you I mean, you can always find places around the world we would hope to more, but actually I think the U.S. actually surprises on the upside a little bit, my point of view. So, but think we’re sticking to what we basically said back in I think Q2 calls it relates to the back half.

Great. Thank you.

You’re welcome.

Your next question comes from the line of Tim Ramey with Pivotal Research.

Thanks so much. Just dipping from kind of the macro negative of FX to what seemed to me to be a couple of meaningful macro positive gas prices in travel retail. Can you talk about, I mean, I do recall hearing those as negative on the way up. Are you starting to see benefits in perhaps on-premise or travel retail segment?

Yes. So, we have discuss little bit earlier, mainly it was all around the U.S. but we continue to see on-premise trends for our brands continuing, growing in the low single-digit, so overall, we do think there has been if you look back and when this acceleration began there seems to be a correlation between when gas prices started going down, so, perhaps having a few extra pennies in their pocket to buy this affordable luxury if you will. As it related to travel retail business, we’ve actually have mix results there, I think, parts of the world doing very well, but places over in Europe largely around Russia, our European operations, because of the disruption going on in that part of the world and the number consumers from Russia actually is a large percentage that actually purchase in the European market has been a little bit lighter than we would have and hoped for. And so, we have seen some good certain parts – at certain travel retail markets around the world and I hope that due to gas prices and more affordable, but it’s hard to say, I tell you with FX and where people are coming from, and how that maybe way more than offsetting gas prices other than consumers in the U.S. I think is probably a larger trends to pay attention to.

Yes. As relates to the U.S. market I don’t have any specific data on this, but I do know anecdotally that we might even have stronger on-premise U.S. numbers particularly European tourism one being hit that by the strong dollar. We heard restaurants. We know from hotels and places like that, there are not as buoyant as they were six or eight months ago. So, all these things have offsets to each others, you go around world for Brown-Forman, it’s one of the benefits that we’ve accrue from having such a nice geographic diversity. But I think net-net for our business around the world, low gas prices are held net-net and of course there should be a help – they particularly if they stay down for quite some time there would be a help to you expect like fuel cost and energy and things like that as they will make their way in. But on the flip side, what ends up happening is for a company like us having negative foreign exchange impact with it. So, these offset each other in some ways partially or not, but I will say this, we do spend some time looking at what foreign exchange rate indices look like. I wouldn’t note, but I think the last time we look at it. The current index is the dollar stronger than it sort of 20 year average and it always fluctuate above and below that average of course. But this would be a particular time of strength, so for those who are thinking about how much more will this run or how long, if you believe history at all, the US dollar is at a stronger point than its historical index would indicate.

Terrific. Thanks.

Welcome.

Your next question comes from the line of Ian Shackleton with Nomura.

Yes, good morning. Two questions. Firstly, within the emerging markets the commentary on Russia actually it is more positive and I remember how you had specific issues in Russia. Are they all now resolved now? And the second question was around the Investor Day in December you did talk quite a bit about Scotch and Irish whiskeys being attractive categories to go into. Is there any update you can provide us on that at this stage?

I can talk about Russia real quick. We are pleased with Russia in terms of doing pretty well there. We had a net sales growth of around 6% I think year-to-date through 9 month, of course being heard by the devaluation of the ruble. But specifically as it relates to our ability to sell our products and reach the consumers and have things been put up there if you will. We're very encouraged by what we've seen. And feel like we're able to sell our product in the marketplace at this point in time.

Yes. Ian, I think you are correct in your recall of our interest, particularly I'd say in the – at the ultra-premium, super premium plus segments of those particular categories. And no real news to update you on other than to say we remain as excited about that as we study those marketplaces and continuing development of them. And it's only been a couple months since we saw you in December. So – and I would say this. The only thing that might have changed if for US-based company if you can find attractive properties in either one of those, even more attractive because of the currency as I mentioned, and you could tell probably from that initial comments that we really think, I highlighted American whiskey, but we really think the premium end of whiskey is a very attractive place to play. I mean, amongst the most you can really find it. To be quite honest with you, not within our industry, I just think it's enormously attractive and valuable business when you contrast it to many other industry. So you want to find the most attractive and advisable investments you can make their, so we are scanning that as you would expect us to.

So going back on Russia because there was some threat of a boycott there. Has it's all gone away if I recall correctly?

A boycott on our products? Is that what you're saying?

Yes.

We had some administrative labeling things in a particular region of Russia that temporary disrupted our sales and accounts they are on Jack Daniel's Tennessee Honey, and it was a sort of a very small part of Brown-Forman's total Russia business. And there's been I think some generally positive administrative to develop on that front. So I would say things as it relates to quite a larger question on Russia for us is the impact of all of this on their economy, more so than what we would declare as any kind of administrative problems or trade restrictions, those kinds of things. Really right now more the impact on the economy.

Very good. Thanks for clarifying that. Thank you.

Your next question comes from the line of Bill Chappell with SunTrust.

Hi, this is Stephanie in for Bill. My question has to do with advertising and if you can provide either on a reported or underlying perspective more details on what you expect next quarter, particularly with the launch of Tennessee Fire? And then going off of that what you expect in terms of or what you're seeing in with your competitors in terms of what they're doing for advertising?

Okay. So we are spending – we're as you know we're at 4% year-to-date underlying increase in net sales. We are going to expand to launch the brand quite nicely in the fourth quarter, so I would expect that number to pick up a little bit from where we are on a year-to-date basis. So by the end of the year, the number will be more than 4%. I hope that answers that question. And then your – the question around competitors, and I can't really answer all the questions there in terms of what they're doing. They definitely – it varies by market, it varies by brand.

I looked at a weighted average of our competition, we sometimes do, try to study the difference between maybe their sales growth rate and their operating income growth rate as they guide. It looks to me like they – because most of the industry when you look at is growing at very low organic growth rate and then when you translate at least the way they are guiding as an operating income or EBITDA growth rate, it might be just a little bit higher. So it would appear to me that somewhere I can't be specific advertising, but somewhere between advertising and SG&A investment they might be getting a point or maybe 0.2 of leverage from whatever their reported – or whatever they are guiding on sales. So a little bit of leverage, but I can't imagine that people are in very strong investment mode or else it would be showing up with a diminishment to operating income versus an increase in it. So if you think about us, our fiscal year-to-date results, we've got a 5% underlying growth rate, and to date a 7% operating income growth rate. So about two points of leverage between sales and operating income, which is a little less than in some years in the past because we've been investing particularly in this brand rollout of the company over the last year. But in the way we're sort of guiding for the end of the fiscal year, that relationship sort of stays the same as you – even though we've got the soft comps and we expect strong Q4, the relationship stays the same. So we're – it would be my guess that we are investing today at the operating investment line ahead of most of the competition based on what I see from their numbers versus ours.

That's really helpful. Thank you so much.

Your next question comes from the line of Eric Serotta with Evercore ISI.

Hi. Thanks, for taking the question. I'll try and keep this quick. Two questions. First, last quarter you highlighted some distributor inventory overhang that was still left from I guess, going back in the first quarter in the US and Germany. What was the impact of that reduction in the third quarter, and is that all behind us? And then the second question is in terms of how we should think about US pricing going forward. Clearly this year was one of much more constrained pricing in the US following several years of robust pricing. I know you're not giving fiscal 2016 guidance yet, but conceptually should we think about next year looking more like this year or more like previous years, somewhere in between, any help would be greatly appreciated?

Okay. I'll talk to you distributor inventory for Germany, as well as the US. It is behind us. It largely came through in the third quarter. I think we had isolated about a point of impact when we talked about it in the second quarter in terms of what it was impacting our overall results. The time you get to a third quarter you've got another quarter underway it was less than that on the quarter in terms of the overall impact to our growth. Okay?

I mean, just on pricing, I mean, we'll guide more specifically what our expectations are when the time we get out to our Q4 release, and set the expectations for 2016. But I mean, I think one thing that would certainly be running through all of our minds is where our core concentration is, which is more at the premium end of a category that has outstanding volumetric momentum right now. And I just really believe that you can be less aggressive with pricing when you're getting the sort of consumer interest and acceptance in bourbon and American whiskey like we're seeing and the high end of this category is growing I mean, strong double-digits. Overall category is growing in the high single digits in the United States. And so I mean, I think of course all these will vary back by region and country around the world as we go along. But I think it was the right move for the company with the momentum and sort of enthusiasm we were seeing around the category volumetrically to you know, sort of as you say constrained the pricing progress in the way that we did in the last year and I think we're benefiting from it. So we'll be looking at that here over the next eight weeks or so as we set our plan and give you more information on it specifically when we get into sort of fiscal 2016 guidance.

Great. Thanks a lot.

You're welcome.

Your next question comes from the line of Bill Schmitz with Deutsche Bank.

Hey, good morning. I'll also try to be quick here. Can we just talk about pricing on two fronts? The first is emerging markets. When we have to take pricing in places like Russia, and some of the other markets they were currency has been such a big impact and do you expect any big pre-buying ahead of those price increases and maybe directionally how high they are? And then just I have a follow-up on how you priced Tennessee Fire relative to Fireball?

So talking about emerging markets. First off I think, I'd step back for a moment. Because FX is hurting us it doesn't necessarily mean that we're going to take the price up to the consumer in the market. So it's something that we look at on a market-by-market basis. So I wanted to make sure that that was clear, we aren't going to jerk up prices up and down as FX goes up and down.

You're not going to offset like even in Russia where you had like a 50%...

No. Russia is an unusual one because it has been so significant, for sure. Again, that we look at these on a case-by-case basis and we have already been through a price increase there. I talk about buy-in and stuff to move our needle. There wasn't – there hasn't been anything to move the needle that would warrant you to put something in your model in place of that…

Yes, remember we look not only at the – at what the currency is doing in those instances, but you really are also looking at what your competition in the marketplace is.

They got to…

So as you can imagine that's a pretty dynamic consideration, but it's rare for us. I mean, it’s sort of rare for the currency to move like this as rapidly as it has in Russia. But it's unusual for us as Jane was exciting for us to start to make pricing moves based particularly on more moderate fluctuations in currency. And then your second question related to Tennessee Fire pricing?

Yes, like relative to Fireball. I probably should know this, but I don't think Fireball advertises at all. So I mean, when you guys go out would you have roughly 100% share of voice when you launch this thing and kind of what kind advertising are you going to do and how are you going to build trial?

It depends on how you define advertising. I would say that they have enormous presence in social media. And I today consider that very much advertising. So I mean, if you're talking about television advertising on cable networks or whatever, I haven't observed any. But to the just of your question, I think first and foremost we price Jack Daniel's Tennessee Fire off of Jack Daniel's Tennessee whiskey. That is with the foremost consideration in our price positioning for that. For a variety of what I consider to be very good reasons. Now, we're not ignorant of where the marketplace falls out in terms of pricing and volumetric and all that. But we really wanted to enter this category as the premium, in this case super premium entrant in the cinnamon flavor segment. And I consider that to be a pretty important part of our marketing program and something that I know our people consider very important that they'll stick to. And so far what we've seen in our experience on Tennessee Honey with this where there are today lower price competitors and have been is that those prices have held up very well. And just to let you know, we have no internal designs or ambitions to do anything volumetrically that would compromise that price. We're not setting some internal ambition to be the number one brand by volume or anything else. It's really to build a responsible business that super premium and of this particular opportunity, and along the way to be really responsible in the way we manage the Jack Daniel's trademark. So – and actually I just think our people have demonstrated a capacity to do that so well that we really don't worry about it that much. The better thing for us to focus on is these early stages of distribution and creating the awareness. And I would tell you that, I don't know we were still sort of refining how we'll communicate on behalf of Jack Daniel's Tennessee Fire over this first year of its national launch. But I would expect social media just because of the importance of it to, the brand's target audience, but also just Jack Daniel's prominence as a trademark, and social media being very important to Tennessee Fire as well.

Great. That's very helpful. Thank you.

You're welcome.

Your final question comes from the line of Mark Swartzberg with Stifel Financial.

Yes, thanks. Good morning, everyone. Quick technical one on the quarter. I see on the revenue outlook, on the quarter, did I hear you Jane say, I don't think I heard you right, you're saying FX that means EPS will actually be down in the fourth quarter? And then like I said, I had a few revenue questions.

Just to clarify, the FX will hurt us in the fourth quarter. It will result in our reported numbers from underlying because I said we would be up on an underlying basis in the teens, and I'm saying we won't be up as strongly on a reported basis is what I was implying because of FX.

Right. That could be in safe reported down, okay. Great. Just needed to clarify that. And on the revenue outlook, I guess a few things. Firstly, Paul, with add spend it's lagging sales a bit year-to-date. Can you just update us on how that relationship you think looks for the full year and from a longer-term perspective? And then with the quarter itself, you're looking for pretty healthy acceleration, Fire's going to contribute to that, I think nine is the minimum number that hit before your rate of growth. Can you just talk about how you think about trade inventories in the US specifically, what you routed to for then potentially increasing, putting aside the effect of Fire? I guess those are my two revenue related questions.

Okay. I guess, I'll answer the second question first. As we said early on the call, we expect our inventories particularly if you exclude Fire at retail, to be very much in line with our historical date of inventory around the globe, so no excessive building or diminishment either way. So I think it’s sort of normal course there. I would say on that point, I mean, it's always a swing factor as to how well received in the first sort of 60 days here. So Tennessee Fire's national launch, how much just not only distribution we expect that to be pretty rapid because of trade enthusiasm's, so high, but also then it always comes down to how much display activity and promotional activity you get around that. So you hope for a nice piece of that and you would expect that the enthusiasm to convert to that, but that's a harder one for us to predict as it relates to what the April 30 retail inventories will be on a really new brand. So I hope that helps you understand how we're approaching it. Otherwise beyond the Tennessee Fire we expect it to be pretty normal course as it relates to days of inventory at retail. And your first question, related to – I'm just going to repeat it and make sure I got it right. Had a little bit of a broken communication here, you just wanted to see if there's a relationship between the way we think either historically or philosophically on A&P investment as a percentage of sales? Is that – am I reading that right?

Yes, basically. Like last fiscal year it grew faster than sales. This fiscal year it's lagging sales slightly, which is how you're thinking about it going forward?

Going forward, I mean, look I think, here's the way we've been and we've talked about this over the last couple years. I mean, I really feel like we've been at a significant level of reinvestment in the business over the last 36 months and it's come in three forms really. It's been A&P what I would consider to be because our results have wanted it and they A&P impact has supported, it’s been a cat of our competition and in some instances you always have pockets where you have an opportunity to invest more one example being the Jack Daniel's Black Label this past year in the United States, we have our investment there. So there's always pockets, but and we were also at the same time, I would have liked this last 18 months or so as it relates to brands and the investment and route to market and before that we were investing in Germany and Turkey and all kinds of places we were adding at the SG&A line. And the third area which isn't showing up in the P&L as much right now is the capital investments we've been making to get the company ready for the growth we foresee out many, many years into the future. So those have been investments at Woodford, Jack Daniel's, [indiscernible] I mean, so we've had a string of capital investments we've seen continuing most significantly, cooperage as well, as we're one of the only barrel operator, manufacturers and operators. So there's not a wave here of investment and still with that we've been able to get nice leverage across the many years. And so I continue to expect, I really do feel like we're at a point where particularly some of the SG&A that we can start to leverage some of the investments we've made in particularly the route to market around the world. I mean, over long periods of time like to see generally A&P, that it doesn’t – I'm not worried about it in one particular quarter or year per se to track along with sales. I just think its nice thing. It all depends on the brand building model and I do think social media will make it more efficient, not less efficient to actually invest over time. But I would expect after many, many years of very systematic and continuous investment that the company should still be able from sales to operating income to be able to get a little leverage. I mean, there were times in our history, I mean, I know way back where there was very little leverage that was up and down the P&L the same number and in terms of growth rate. But I really do feel like this will vary by what time you're operating into and the economies are and everything else. But as we stand right now, I think we cited we are a 5% growth right now converted to 7% and investing nicely behind the business. And we see that elevating by year end because the soft comp, and things we cited. But as you go out, I feel like we would be gaining share of voice with mid-single-digit, even growth rates in A&P compared to our condition right now, I mean, that’s mandate.

Okay. That’s a great comparison too. If I could just one last one, your comments on US pricing it sounds very interesting because you enjoyed premium positioning in your various brands versus your nearest competition and you also enjoy volume momentum. So that seems to favor being more – seeking more rates of price growth to not only to strength the long term position of your brands, but to kind of be – it’s a time to do it if you will when volumes are doing well. Yet you're saying you want to have a competitively higher focused on maintaining volume momentum. So could you just talk a little bit about why does it have to do with the inventory you've already got sort of ready to come on stream? Can you just talk a little bit about why do you have that attitude, because it seems you could make the opposite argument to be more disciplined on price?

You absolutely could make the opposite argument depending upon how you approach it. But I'll use the example here and we do know look, with aged products, a dollar of pricing is more valuable mathematically if you look at it than perhaps a dollar of volume. But in expanding category where people are fighting for consumption occasions and consumers, you don't want to lose some of these consumers because we have found people who adopt and fall in love with the brand will actually continue some of that consumption. And so it can be more costly later try to get it, but I'd give you the example of here we've got a Woodford Reserve, take that as an example and let's say the brand's growing 25% or 30%. I guess, we could consider just taking your example to a specific thing to consider here is I guess we could take our prices up on Woodford Reserve 10% or 12% and deliver the same dollars through a lower growth rate. I mean, you could do the math on that. But I feel like for brands at an early stage of development introducing the brand because you're still at relatively low levels of awareness and adoption, to introduce the brand to consumers and at lower prices, not that we're lowering price, I mean, even at 25% or 30% growth rates we might be taking 2% or 3% price increases. So it's not like we're not taking pricing. It's just that you're delivering the volumetrics are a reflection of the adoption of consumerism around the brand. And if you've already started in this case with Woodford and ultra-premium price position, I mean, if you had a significant shortage in your stocks or something sure, you could do a supply demand trade off there and you might find yourself in those circumstances if you're forecasts weren’t particularly accurate. But that's not the case with us. And so I mean, I think introducing 30% more occasions or consumers to the base of Woodford Reserve is today on balance better than asking the current base to pay 15% higher prices and only attracting 10% or 15% people. I mean, that's just the trade off. You can definitely make the other argument, but at this stage of development with its base of awareness and distribution, on a brand like that, I would favor the way we're doing it.

That's very helpful. Great. Thank you. Thanks, Jane.

You're welcome.

Thanks for that question, Mark. And thanks, Paul and Jane. Thanks to all of you for joining us today for Brown-Forman's third quarter earnings call and we hope you all have a great week. Thanks, everyone.

Thanks.

Again, thank you for your participation. This concludes today's call. You may now disconnect.