Hello. Thank you for standing by. Welcome to the Brown-Forman Corporation Second Quarter and First Half of Fiscal Year 2023 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference may be recorded. I would now like to hand the conference over to your speaker today, Sue Perram, Vice President Investor Relations. Please go ahead.

Thank you, and good morning, everyone. I would like to thank each of you for joining us today for Brown-Forman’s second quarter and first half of fiscal 2023 earnings call. Joining me today are Lawson Whiting, President and Chief Executive Officer; and Leanne Cunningham, Senior Vice President and Chief Financial 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 except as required by law, 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 second quarter and first half of fiscal 2023, in addition to posting presentation materials that Lawson and Leanne will walk through momentarily. Both the release and the presentation can be found on our website under the section titled Investors, Events & Presentations. In the press release, we have listed a number of the risk factors you should consider in conjunction with our forward-looking statements. Other significant risk factors are described in our Form 10-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 are reconciliation to the most directly comparable GAAP financial 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 investor presentation. With that, I would like to turn the call over to Lawson.

Well, thank you, Sue, and good morning, everyone. I’m pleased to share our results with you today as we had a strong first half for fiscal ‘23. We delivered double-digit top line growth on both the reported and organic basis. This performance was led by the strength of our portfolio brands, which continued to benefit from strong consumer demand. We also benefited from the rebuilding of distributor inventories, which continued to recover as supply chain disruptions and constraints eased, particularly for glass. The recovery though has added additional costs as overall supply chain logistics and transportation continue to be constrained, and we proactively took actions to satisfy the demand from our distributors and retailers ahead of the important holiday season. These costs, along with inflationary increases and the negative effect of foreign exchange more than offset the positive impact gained from favorable price mix and the removal of the EU and UK tariffs on American whiskey. The result was gross margin contraction though during the first half. Now, let me provide a few additional details on the first half. Our reported top line growth increased 11% with organic growth increasing 17% after adjusting for foreign exchange headwinds. Organic net sales growth in the first half was driven by continued strong growth for Jack Daniel’s Tennessee Whiskey across all geographic clusters in the travel retail channel, Woodford Reserve in the U.S., Jack Daniel’s RTDs in Australia and Germany, along with New Mix in Mexico, and Jack Daniel’s Tennessee Honey and Jack Daniel’s Tennessee Fire in the United States. Jack Daniel’s Tennessee Whiskey was the largest driver of our top line performance, delivering double-digit growth with an organic net sales increase of 18%. The growth was driven by strong consumer demand, higher pricing and favorable channel mix. Our super-premium American whiskey portfolio…

Thank you, Lawson, and good morning, everyone. As Lawson reviewed our headlines for the first half of fiscal 2023, I will provide additional details on our business results and our outlook for the full year. First, I will share our top line results by geography for the first six months of fiscal 2023. The strong results were broad-based with each geographic cluster achieving double-digit organic net sales growth compared to the same period a year ago. The U.S. business accelerated through the first half, delivering organic net sales growth of 11%. This performance was driven by an estimated net increase in distributor inventories, price increases across the portfolio of brands, continued premiumization along with positive size and channel mix, as well as innovation. Woodford Reserve was the largest contributor to organic net sales growth in the first half, with the positive impact from higher pricing and higher volumes as glass supply and capacity constraints eased, supporting our ability to better meet the strong consumer demand. The Jack Daniel’s family of brands also contributed to the increase, led by volume growth from Jack Daniel’s Tennessee Whiskey. In addition, Jack Daniel’s Tennessee Fire, Jack Daniel’s Tennessee Honey and Gentleman Jack experienced volumetric gains as they benefited from an improved supply chain environment. The newest members of the Jack Daniel’s family, Jack Daniel’s Bonded Tennessee Whiskey and Jack Daniel’s Triple Mash Whiskey are the first two permanent super-premium expressions in almost a quarter of a century. These brands are off to a strong start as they continue to gain distribution and have been awarded multiple gold medals for taste in global spirits competition. Korbel California Champagne partially offset the growth of the rest of the portfolio. The sparkling wine category experienced significant growth during the pandemic and the trends are beginning to normalize.…

Thank you. [Operator Instructions] Our first question comes from Lauren Lieberman with Barclays.

I hate to get granular, but it’s a thing I’m getting kind of questions on most this morning is just around the guidance and trying to understand how the pieces fit together because we don’t have visibility into currency. So, I guess, first, gross margin outlook is worse, but raised the operating profit guidance. So, can you just help us bridge those two dynamics? How we should be thinking about operating expenses and how we should think about FX and the impact on those metrics?

Good morning, Lauren. So, I’ll start at kind of the highest level and walk all the way through our kind of our gross margin component for the full-year. And we still expect favorable tailwinds from stronger price positioning, the innovation, which we’ve launched with the Jack series and Herradura Legend at that higher margin products, and of course, the removal of the EU and UK tariffs. Now, the headwinds that we have been talking about remain the same, but they – some of them have strengthened. Firstly, I’ll start with inflation on our input cost. For F ‘23, we did plan for our inflation on our input cost to be above historic norms. But the current levels on our commodities are beyond what we had expected. And the theme really is the key drivers of energy and fuel, it’s everything it takes to make and move both, our inputs and our finished goods. So, just to give you a little bit of detail around that because I’m sure it’s on everybody’s mind. As it relates to our key components, our glass pricing continues to increase because of the commodities that it takes to produce it, which would be natural gas, diesel and fuel and labor. Freight, it’s really the cost of fuel that continues to be very volatile and the diesel prices are at all-time highs. We do see the continued imbalance of the equipment from the global freight and transportation system, and we expect that to continue throughout the full year. Natural gas, the prices are – they remain elevated even though they did moderate as we got towards the end of our second quarter. And as it relates to grain, again, similar, elevated above what our expectation was and the freight cost to transport our grains to our…

Yes. Lauren, was the question – about pricing?

The stronger top line growth.

Stronger top line growth. So, I mean that’s what – I think, look, the top line organic numbers are very, very strong, and they have remained very strong. A lot of that is I do think the consumer is still pretty healthy. I mean, for all indications of our own business, we are not seeing any kind of trade down. In fact, we’ve actually seen stronger performance even at the higher end of our portfolio. So, even – and I think to everyone – I know it’s always interested in the U.S. If you look at the TDS figures in the U.S., you’re still seeing premiumization as strong – I don’t know as strong as ever because – but it’s certainly continuing where the product, the $20, $30 and $40 and above are performing better than the lower value. So, you’re not seeing the trade down that so many people have suspected would be coming through. I would say that’s – I don’t know if it’s global, but it’s certainly more than just the U.S. We’re just not seeing the weakened consumer yet.

And the last thing I would add is we just continue to be really fortunate in an environment with the inflation on our commodities that we’re seeing is that we have a very strong portfolio of premium and super premium brands that are better able to handle these pressures that we’re seeing from the macro world.

Our next question comes from Robert Ottenstein with Evercore.

Great. Thank you very much. Wondering if you could talk a little bit more about tequila. I think we all understand some of the supply issues. But it’s had extraordinary growth. Is it moderating at all just in terms of what you think underlying demand is? And in your view, is rum potentially kind of the next tequila a few years out? Thank you.

Let’s hope so on that last one. So look, tequila, and now predominantly talking about the United States here. I mean, we have had some comparisons that have been really, really difficult. And I think that’s true across the category and some of the other brands that have had these extraordinary growth rates over the last few years. So, that has something to do with it. But, we have – Herradura, probably more than any other brand so far year-to-date has been constrained by glass. It’s gotten better over the last months, but it was really rough in the first quarter. And so, we are expecting to see improvement as we move throughout the year. The demand for the brand itself has been so strong in the last few years that I don’t really think it’s so much a weakening in the category or a weakening of consumer demand. I do think it’s mostly comps and then in our case, at least glass. So, I still believe it’s going to be one of the fastest-growing categories over the next several years, and it’s still – we still feel like we have some of the best brands in the business, so. And then, rum, we’ll see. Super premium rum is growing very nicely now. It is growing really quickly in Europe. So, this is one of those acquisitions that really is much bigger in Europe than it is in the United States, which is kind of different than most of the acquisitions we’ve done over the last, say, 10 years. There’s a lot of rum, particularly in Southern Europe, but really across Europe. So, it’s a big category. We’ve got one of the best brands, if not the best brands, at these higher price points. And it will be interesting to see what happens in the U.S. business. And does that become a tequila-like growth rate? It’s hard to predict those things, but we’re making a bet that we can grow and grow that brand into something pretty sizable in the U.S.

Our next question comes from Bryan Spillane with Bank of America.

So just – Leanne, maybe a clarification, just a follow-up on Lauren’s question, one clarification and then had another kind of question around just the FX piece. Just – if we’re looking at the – you gave the impact where you said in the back half of the year, the impact of foreign exchange I guess, for the full year will be equal to what it’s been for the first half on gross profits. Is that same – does that flow through the P&L as well? So, will the FX impact on operating income for the full year be similar to what it’s been in the first half?

Yes, it will flow down through the P&L.

Okay. And then just the gap, the fact that it’s a much bigger impact on gross – on operating income. Can you just kind of give us a little bit – just why that gap is so much – why the FX impact is so much greater on OI versus gross profit?

So I’ll start at the top where our strip net sales, as we’ve reported, is negatively impacted by 6%. That’s largely a translational impact, as we said, driven by the appreciation of the dollar against the ones – the currencies that are specific to us, which are the euro, the Turkish lira and the pound sterling. Gross margin we’ve already talked about was 140 basis points. That’s a bit different than our top line impact because the majority of our products are produced inside of the United States. And then just flowing down through the rest of the P&L, it has an outsized – a magnified impact as you move down just because it’s on a smaller base. But there continues to be, as we have said before, no meaningful remeasurement or translational impacts. And we just – it continues to be – it hasn’t been a factor for Brown-Forman for a period of time, a key driver. And hopefully, it’s one that reverses, and we were not talking about that at some point in the future.

Yes. Bryan, let me add on to it a little bit, too. The – if you guys – I would encourage everyone to look at page 7 in our – on the accompanying slide deck. I think it – I mean, it lays it out pretty clearly. You can see in there that our price mix and tariffs offset the input costs. As bad as they were, we were calling away with price actions around the world, and then we knew about the tariff money. The killer on the gross margin has been the foreign exchange. So, how that plays out the rest of the year, I mean, we will see. But – yes. I mean this is an impact that obviously we didn’t see coming.

Yes. Lawson, thanks for that. Because that was – I’ve got that. I was looking at the slide and trying to figure out what that looks like for the back half of the year. And I guess, you’ve kind of maybe answered this question. But just the fact that so much of this is FX is why you wouldn’t contemplate maybe raising prices or taking other actions to try to offset the margin pressure because it’s really something you can’t control. Is that the right way to think of it?

That is a fair way to look at it. I mean, I think on the pricing question, because that’s a good one. I mean, as we’ve been talking about, I think, for the last 5 or 6 quarters, we’ve been trying to change the Company’s execution of pricing around the world. We – I know you’ve been around long enough. I mean from 2000, the financial crisis was a really nice blend or balanced view, I guess, between volume and price. And then the financial crisis hit, and we went through 10 years in this industry with virtually no pricing. We’re trying to change that dynamic inside the Company right now, which involves – we’ve said low single digit, that 2% to 3% range, but doing it pretty much everywhere and for a year. And so that – and we’re executing against that and successfully executing against it. And it’s been something I think the groups are quite happy with. But that also means you don’t turn around on a dime because of foreign exchange movement and try to do something significantly bigger or an input cost movement either. So, we’re going to continue that steady climb. And hopefully, over the long run, that’s what delivers the most value. At this point, as we’ve said, we’ve not chased away consumers through these price increases, which is obviously very good news. And we think we’ve kind of found the right level of what it takes to maximize, sort of consumer demand.

Our next question comes from Peter Grom with UBS.

So, I guess I just wanted to make sure I’m understanding your response to both Bryan and Lauren’s question. So just to be quite specific, I think in the schedule, foreign exchange was a 14-point headwind to operating income in the first half of the year. So, if that’s the same, does that more or less imply – like is our math right that reported operating income is going to be down kind of in this mid-single-digit range? A, is that right? And then, I guess just maybe – I would love to ask about the implied organic sales guidance for the back half of the year. Can you maybe just remind us what your expectation is for distributor inventories? I know it was 500 basis points tailwind in the first half, but just any color on what you expect for the second half or full year would be helpful. And just because, I guess, in that context, the implied organic revenue growth to go from high single digits up to 17% in the first half is a pretty meaningful slowdown. So, just any color on that would be really helpful. Thanks.

Thank you, Peter. And then, I’ll start with kind of the reminder of the seasonality of our growth, which is for – our seasonality for fiscal ‘23 on the top line, it is going to be impacted by the abnormal seasonality of our 2022 shipments. And we all lived through that, which – the first half of 2022 with glass supply constraints, we didn’t build our inventory ahead of the holiday season the way we typically do. And then when glass supply challenges began to ease in the second half of our fiscal year, we were able to increase the level of shipments out to the market. So, then as we lap that in fiscal ‘23, we’re continuing to work to rebuild our distributor inventories, as you noted. And you can see on Schedule D, our growth rate in the first half had a 5-point benefit on a year-over-year basis. And again, that second half of this year has to lap the very strong comparisons that we had last year related to our inventory rebuild. So, then going specifically to the rebuild efforts. Since we’ve been working on this, and we’ve said this last quarter, as we’ve been rebuilding inventory, we have continued to experience a very strong consumer demand, and we’ve launched new innovations. So, while our inventory position is improving, there is still some brands and sizes that have to be replenished. So, we do believe that inventory – distributor and retailer inventories are below – remain below pre-pandemic levels. We’re making progress on that. And at this point, to the extent that we can look out, we believe our target as far as a return to normal levels would be in the early part of F ‘24, and we’ll talk more about that as we get closer to that fiscal year. But we expect it to remain through this fiscal year. And then, to your other part of FX impact on OI, and we talked about how it flows down the outside. We continue to – for the second half, we only guide on an organic basis, which wouldn’t have that FX impact in there. We are sharing that – in this report that our estimate would be is like – our assumption would be that the second half impact of foreign exchange would be similar to the impact of the first quarter – first half. Sorry.

Our next question comes from Nadine Sarwat with Bernstein.

So, given your earlier commentary on gross margin headwinds for this year, I think that was very clear. I’d like to step back and actually focus on the long-term story. So, how should we think about your gross margin development, given today’s news, over the next 1, 2, 3 years? Is there a way that you can quantify what you think you can achieve in terms of expansion in that time period? And then, one question on the top line guidance. To what extent is there a downside risk on this stronger guidance from perhaps weaker volumes or mix if a recession were to come and the consumer were to weaken? Thank you.

Nadine, as we’ve talked about before, on gross margin expansion, we have the entire company actively working on all elements of revenue growth management from pricing to effective promotions to all of the elements of pack size, distributor margins, and we are working significantly on our costs. As we look out, we continue to hope that the imbalance of the freight equipment will subside in this next kind of 1- to 3-year period so we can return to normal shipping lanes, which will have significantly less cost associated with that. We’ve been two years now with that higher air freight to get our products to market to continue to support consumer momentum. FX, again, when we look back over our recent past, it hasn’t been a key driver. We can’t predict what’s going to happen in that space, but we would say as we look over history, it generally isn’t a key driver. And then, inflation, that – we’re working to do everything we can to mitigate those costs. But if – they’re being driven by the macroeconomic environment in which we’re operating. And then, I think you were...

Let me add a little bit of color to the freight and logistics line, just so sort of every understands it. I mean, if you – if we back up six months, we were in the throes of some serious glass shortages. We still have some problems now, but it’s certainly better. But back in the summertime, we were looking out at really European and international holiday season, we could see that we were not going to be able to get our product to market in the normal way that we do it. And so, we were kind of stuck in a corner and said, all right, we’re either going to take on these literally tens of millions of dollars in freight expenses so that we can actually get our products on the shelf or just not sell it. And we chose the former, which I still think ultimately is the right long-term decision. But, back to your gross margin expectations going forward, we will not have – I mean, gosh, I would hope we don’t have those coming over the next – really – once we get through this holiday season, we hope to return to normal. It does feel like conditions are moving back towards a normal state again, and then – so that will be a boost to the margin.

And then...

Was there anything else?

Top line and recession?

Oh. Was the question, Nadine, that the sort of concern around...

The question was on the top line guidance that you guys have taken up today. To what extent is there downside risk to that if the consumer were to weaken in a recessionary environment? Or did you guys build that into your assumptions when putting out this new guidance?

To the extent that we could build in all of the assumptions that we were aware of with the trends and the information we have, it would have been built into the raising of our guidance.

I mean, I think I’d still argue, we still feel pretty good about the consumer takeaway. While normalizing, if you look at any of the – I mean, this is a U.S. comment, but the Nielsen’s and NABCA trends. But we – as we’ve been saying all along here, we haven’t seen the trade down. We haven’t seen a weakness in consumer demand yet. I just don’t – I tend to believe that not only Brown-Forman, but this category of super premium spirits is an affordable luxury that is, one people don’t like to give up. And I think the combination of that with strong – wages remain strong and employment, all the other macro things that are working well. I think it’s a relatively low risk.

Our next question comes from Kevin Grundy with Jefferies.

Lawson, I wanted to take a step back and ask about your ready-to-drink strategy. Just strategically, you’ve had a lot of success so far. And it seems like it’s going to increasingly become a bigger part of your portfolio as well as your peers. How do you think about it within the portfolio? How do you think about margin implications relative to the base portfolio? It certainly would be negative from a mix perspective. But – just broader thoughts on how this is going to evolve within the portfolio? How do attempt to limit cannibalization and maybe some updated thoughts on the Jack & Coke RTD?

Yes. So, I mean that’s obviously the – the story right now is the Jack and Cola RTD, which just launched in Mexico a few weeks ago, so obviously, only in the first few days of launch, but moving. Yes, we remain very excited and very optimistic on what we can do in this category. RTDs, obviously, if you look at the U.S. trends, RTD – spirit-based RTDs are flying, driven by a few very big brands. And we hope to join those ranks over the next year. We’ll be launching in the first half of 2023 in the U.S., in the UK, and then a handful of different European and Asian markets. Now just to make sure everyone – I don’t know how much of this we’ve given out. In the U.S., in Germany and Australia, Brown-Forman will be doing the sales, and that is a bit margin dilutive if RTDs were to get massive. Now Germany and Australia are already really big businesses. And so, moving forward, we don’t expect a lot of dilution from those markets. But, when you get to the rest of the world, it’s different. Coca-Cola is doing the sales, and we’re selling bulk. And so that is not a dilutive margin. So it’s mixed as to how that’s going to look going forward. But at the end of the day, these are brands that we really believe are the – Jack and Cola brand is something that we very much believe in as a long-term play with really nice – with a really nice growth look at it.

And then, what I would add to that is – and I know you’re aware of this, but I mean, we’ve had – we’ve been in business for 30-plus years. We have had over 20 million cases of that volume in our sales mix. And it’s going to depend on market-by-market basis, but we don’t see a significant impact to our long-term company margin over a period of time because, again, in a way, we’ll be transitioning some of this business from the Jack and Cola business we have, which again, we do – this is an attractive opportunity for us to continue to increase our geographic reach and to gain share and to potentially even premiumize the product. And again, we believe it has a halo effect on our full strength brand. And that halo effect will now be extended into geographies where we haven’t had the opportunity to kind of get our product there before.

Yes. That’s a reference a lot of it is to the emerging markets around the world where we’re just small. So, take on Africa, just to pick one big continent that has a hard time affording a full bottle of Jack Daniel’s. Well, this is a totally different offering and something that think can be scaled up and be a pretty big opportunity, but then, as Leanne said, becomes a sort of a halo effect on the rest of the brand. It just – it develops a lot more awareness because you’ve got that can in a hand in a market that we think can be very, very big.

Our next question comes from Nik Modi with RBC.

Lawson, I was hoping maybe you could just provide an update on where the glass situation stands? Because it seems like not just spirits companies, but companies outside of spirits, like the fragrance companies are having a big challenge right now with glass availability and supply. And I’m just curious kind of do you think it might get worse? Will it impinge your ability to rebuild inventories the way you’re expecting? And if not, how are you securing this glass when I know a lot of your competitors are still struggling?

So, I’ll start with that one from a glass supply perspective. I think you heard us say multiple times throughout our prepared remarks is that sour glass supply constraints are easing. So maybe we were just early in the cycle of constraints, but we have done and had the opportunity to really actively work with our current suppliers, and we’ve increased our capacity. They’ve improved their yields. And we’ve also worked closely with them for prioritization of our products on their lines. We’ve also taken the opportunity, like you’ve heard us say, is to broaden our supplier base. We’ve been able to do that both inside of the United States as well as internationally. And that – so largely for us, it’s easing. We do have some spaces where we are still facing constraints, and as Lawson talked about that that would be Herradura in Mexico. And we have plan in action for increased supply that we’re bringing on line in this fiscal year. So, all-in-all, for us, we believe we are kind of moving beyond – we’re still living with and moving beyond glass supply constraints. And you can see in the growth of Woodford Reserve and Gentleman Jack, how they have responded to that easing of that constraint and returning back to very strong growth, and then now moving more into the global logistic challenges of the world.

Thank you. Our time for questions has ended. I would now like to turn the call back over to Sue Perram for any closing remarks.

Well, thank you. And thank you, Lawson and Leanne. And thank you to everyone for joining us today for Brown-Forman’s second quarter and first half of fiscal 2023 earnings call. If you have any additional questions, please contact us. To wrap up today’s call, we would like to offer you a toast. To the spirit of the season and a vibrant New Year, cheers to everyone. With that, this concludes our call.

Thank you. This concludes today’s conference call. Thank you for participating. You may now disconnect.