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Section 1: 10-Q (10-Q)

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United States
Securities and Exchange Commission
Washington, D.C.  20549

FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2019
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________

Commission File No. 001-00123

Brown-Forman Corporation
(Exact name of Registrant as specified in its Charter)
Delaware
61-0143150
(State or other jurisdiction of
(IRS Employer
incorporation or organization)
Identification No.)
 
 
 
850 Dixie Highway
 
Louisville,
Kentucky
40210
(Address of principal executive offices)
(Zip Code)
(502) 585-1100
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Class A Common Stock (voting), $0.15 par value
BFA
New York Stock Exchange
Class B Common Stock (nonvoting), $0.15 par value
BFB
New York Stock Exchange
1.200% Notes due 2026
BF26
New York Stock Exchange
2.600% Notes due 2028
BF28
New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ   No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes þ   No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
Accelerated filer
Non-accelerated filer
 
Smaller reporting company
 
 
 
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes     No  
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  July 31, 2019
Class A Common Stock (voting), $0.15 par value
169,038,689

Class B Common Stock (nonvoting), $0.15 par value
308,500,493





BROWN-FORMAN CORPORATION
Index to Quarterly Report Form 10-Q
 
 
 
 
 
Page
 
 
 
Item 1.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 
 
 



2



PART I - FINANCIAL INFORMATION
 
Item 1.  Financial Statements (Unaudited)


BROWN-FORMAN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in millions, except per share amounts)

 
Three Months Ended
 
July 31,
 
2018
 
2019
Sales
$
987

 
$
978

Excise taxes
221

 
212

Net sales
766

 
766

Cost of sales
243

 
268

Gross profit
523

 
498

Advertising expenses
98

 
92

Selling, general, and administrative expenses
168

 
164

Other expense (income), net
(7
)
 
(6
)
Operating income
264

 
248

Non-operating postretirement expense
2

 
1

Interest income
(2
)
 
(2
)
Interest expense
22

 
21

Income before income taxes
242

 
228

Income taxes
42

 
42

Net income
$
200

 
$
186

Earnings per share:
 
 
 
Basic
$
0.42

 
$
0.39

Diluted
$
0.41

 
$
0.39

See notes to the condensed consolidated financial statements.

3



BROWN-FORMAN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Dollars in millions)
 
 
Three Months Ended
 
July 31,
 
2018
 
2019
Net income
$
200

 
$
186

Other comprehensive income (loss), net of tax:
 
 
 
Currency translation adjustments
(12
)
 
(13
)
Cash flow hedge adjustments
23

 
9

Postretirement benefits adjustments
3

 
3

Net other comprehensive income (loss)
14

 
(1
)
Comprehensive income
$
214

 
$
185

See notes to the condensed consolidated financial statements.

4



BROWN-FORMAN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in millions)
 
April 30,
2019
 
July 31,
2019
Assets
 
 
 
Cash and cash equivalents
$
307

 
$
307

Accounts receivable, less allowance for doubtful accounts of $7 at April 30 and July 31
609

 
626

Inventories:
 
 
 
Barreled whiskey
1,004

 
1,016

Finished goods
279

 
325

Work in process
152

 
163

Raw materials and supplies
85

 
105

Total inventories
1,520

 
1,609

Other current assets
283

 
295

Total current assets
2,719

 
2,837

Property, plant and equipment, net
816

 
815

Goodwill
753

 
754

Other intangible assets
645

 
654

Deferred tax assets
16

 
16

Other assets
190

 
246

Total assets
$
5,139

 
$
5,322

Liabilities
 
 
 
Accounts payable and accrued expenses
$
544

 
$
524

Dividends payable

 
79

Accrued income taxes
9

 
44

Short-term borrowings
150

 
220

Total current liabilities
703

 
867

Long-term debt
2,290

 
2,267

Deferred tax liabilities
145

 
148

Accrued pension and other postretirement benefits
197

 
197

Other liabilities
157

 
180

Total liabilities
3,492

 
3,659

Commitments and contingencies

 

Stockholders’ Equity
 
 
 
Common stock:
 
 
 
Class A, voting, $0.15 par value (170,000,000 shares authorized; 170,000,000 shares issued)
25

 
25

Class B, nonvoting, $0.15 par value (400,000,000 shares authorized; 314,532,000 shares issued)
47

 
47

Additional paid-in capital

 
1

Retained earnings
2,238

 
2,282

Accumulated other comprehensive income (loss), net of tax
(363
)
 
(407
)
Treasury stock, at cost (7,360,000 and 6,993,000 shares at April 30 and July 31, respectively)
(300
)
 
(285
)
Total stockholders’ equity
1,647

 
1,663

Total liabilities and stockholders’ equity
$
5,139

 
$
5,322

 See notes to the condensed consolidated financial statements.

5



BROWN-FORMAN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in millions)
 
Three Months Ended
 
July 31,
 
2018
 
2019
Cash flows from operating activities:
 
 
 
Net income
$
200

 
$
186

Adjustments to reconcile net income to net cash provided by operations:
 
 
 
Depreciation and amortization
18

 
18

Stock-based compensation expense
5

 
3

Deferred income tax provision (benefit)
20

 
(9
)
U.S Tax Act repatriation tax provision (benefit)
(6
)
 

Other, net
4

 
1

Changes in assets and liabilities, excluding the effects of acquisition of business:
 
 
 
Accounts receivable
(22
)
 
(20
)
Inventories
(83
)
 
(100
)
Other current assets
(5
)
 
(4
)
Accounts payable and accrued expenses
(33
)
 
(34
)
Accrued income taxes
27

 
35

Other operating assets and liabilities
1

 
(4
)
Cash provided by operating activities
126

 
72

Cash flows from investing activities:
 
 
 
Acquisition of business, net of cash acquired

 
(22
)
Additions to property, plant, and equipment
(23
)
 
(21
)
Payments for corporate-owned life insurance
(2
)
 

Cash used for investing activities
(25
)
 
(43
)
Cash flows from financing activities:
 
 
 
Net change in short-term borrowings
(41
)
 
67

Net payments related to exercise of stock-based awards
(4
)
 
(13
)
Acquisition of treasury stock
(1
)
 
(1
)
Dividends paid
(76
)
 
(79
)
Cash used for financing activities
(122
)
 
(26
)
Effect of exchange rate changes on cash and cash equivalents
(7
)
 
(3
)
Net decrease in cash and cash equivalents
(28
)
 

Cash and cash equivalents, beginning of period
239

 
307

Cash and cash equivalents, end of period
$
211

 
$
307

See notes to the condensed consolidated financial statements.

6



BROWN-FORMAN CORPORATION AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

In these notes, “we,” “us,” “our,” “Brown-Forman,” and the “Company” refer to Brown-Forman Corporation and its consolidated subsidiaries, collectively.

1.    Condensed Consolidated Financial Statements 
We prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (SEC) for interim financial information. In accordance with those rules and regulations, we condensed or omitted certain information and disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP). In our opinion, the accompanying financial statements include all adjustments, consisting only of normal recurring adjustments (unless otherwise indicated), necessary for a fair statement of our financial results for the periods presented in these financial statements. The results for interim periods are not necessarily indicative of future or annual results.

We suggest that you read these condensed financial statements together with the financial statements and footnotes included in our Annual Report on Form 10-K for the fiscal year ended April 30, 2019 (2019 Form 10-K). Except for adopting the new accounting standards discussed below, we prepared the accompanying financial statements on a basis that is substantially consistent with the accounting principles applied in our 2019 Form 10-K.

As of May 1, 2019, we adopted the following Accounting Standards Updates (ASUs) issued by the Financial Accounting Standards Board:
ASU 2016-02: Leases. This update, codified along with various amendments as Accounting Standards Codification Topic 842 (ASC 842), replaces previous lease accounting guidance. Under ASC 842, a lessee should recognize on its balance sheet a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. ASC 842 permits an entity to make an accounting policy election not to recognize lease assets and liabilities for leases with a term of 12 months or less. It also requires additional quantitative and qualitative disclosures about leasing arrangements.
We adopted ASC 842 using a modified retrospective transition approach for leases existing at the date of adoption. For the transition, we elected to use the package of practical expedients to not reassess (a) whether existing contracts are or contain leases, (b) the classification of existing leases, and (c) initial direct costs for existing leases. Upon adoption, we recorded lease liabilities and right-of-use assets of $54 million. The adoption did not have a material impact on our results of operations, stockholders’ equity, or cash flows. See Note 13 for additional information about our leases.
ASU 2018-02: Reclassification of Certain Effects from Accumulated Other Comprehensive Income (AOCI). This new guidance allows a reclassification from AOCI to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act enacted by the U.S. government in December 2017. We elected to make the reclassification, which increased retained earnings and decreased AOCI as of May 1, 2019, by $43 million.

2.    Earnings Per Share 
We calculate basic earnings per share by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share further includes the dilutive effect of stock-based compensation awards. We calculate that dilutive effect using the “treasury stock method” (as defined by GAAP).


7



The following table presents information concerning basic and diluted earnings per share:
 
Three Months Ended
 
July 31,
(Dollars in millions, except per share amounts)
2018
 
2019
Net income available to common stockholders
$
200

 
$
186

 
 
 
 
Share data (in thousands):
 
 
 
Basic average common shares outstanding
480,964

 
477,369

Dilutive effect of stock-based awards
3,477

 
2,719

Diluted average common shares outstanding
484,441

 
480,088

 
 
 
 
Basic earnings per share
$
0.42

 
$
0.39

Diluted earnings per share
$
0.41

 
$
0.39



We excluded common stock-based awards for approximately 100,000 shares and 362,000 shares from the calculation of diluted earnings per share for the three months ended July 31, 2018 and 2019, respectively. We excluded those awards because they were not dilutive for those periods under the treasury stock method.

3.    Inventories 
Inventories are valued at the lower of cost or market. Some of our consolidated inventories are valued using the last-in, first-out (LIFO) method, which we use for the majority of our U.S. inventories. If the LIFO method had not been used, inventories at current cost would have been $303 million higher than reported as of April 30, 2019, and $306 million higher than reported as of July 31, 2019. Changes in the LIFO valuation reserve for interim periods are based on a proportionate allocation of the estimated change for the entire fiscal year.

4.    Goodwill and Other Intangible Assets
The following table shows the changes in goodwill (which includes no accumulated impairment losses) and other intangible assets during the three months ended July 31, 2019:
(Dollars in millions)
Goodwill
 
Other Intangible Assets
Balance at April 30, 2019
$
753

 
$
645

Acquisition (Note 15)
11

 
12

Foreign currency translation adjustment
(10
)
 
(3
)
Balance at July 31, 2019
$
754

 
$
654



Our other intangible assets consist of trademarks and brand names, all with indefinite useful lives.

5.    Commitments and Contingencies
We operate in a litigious environment, and we are sued in the normal course of business. Sometimes plaintiffs seek substantial damages. Significant judgment is required in predicting the outcome of these suits and claims, many of which take years to adjudicate. We accrue estimated costs for a contingency when we believe that a loss is probable and we can make a reasonable estimate of the loss, and then adjust the accrual as appropriate to reflect changes in facts and circumstances. We do not believe it is reasonably possible that these existing loss contingencies, individually or in the aggregate, would have a material adverse effect on our financial position, results of operations, or liquidity. No material accrued loss contingencies were recorded as of July 31, 2019.

We have guaranteed the repayment by a third-party importer of its obligation under a bank credit facility that it uses in connection with its importation of our products in Russia. If the importer were to default on that obligation, which we believe is unlikely, our maximum possible exposure under the existing terms of the guaranty would be approximately $10 million (subject to changes in foreign currency exchange rates). Both the fair value and carrying amount of the guaranty are insignificant.

8




As of July 31, 2019, our actual exposure under the guaranty of the importer’s obligation was approximately $5 million. We also have accounts receivable from that importer of approximately $8 million at July 31, 2019, which we expect to collect in full.

Based on the financial support we provide to the importer, we believe it meets the definition of a variable interest entity. However, because we do not control this entity, it is not included in our consolidated financial statements.

6.    Debt
Our long-term debt (net of unamortized discount and issuance costs) consists of:
(Principal and carrying amounts in millions)
April 30,
2019
 
July 31,
2019
2.25% senior notes, $250 principal amount, due January 15, 2023
$
249

 
$
249

3.50% senior notes, $300 principal amount, due April 15, 2025
297

 
297

1.20% senior notes, €300 principal amount, due July 7, 2026
333

 
332

2.60% senior notes, £300 principal amount, due July 7, 2028
383

 
361

4.00% senior notes, $300 principal amount, due April 15, 2038
293

 
293

3.75% senior notes, $250 principal amount, due January 15, 2043
248

 
248

4.50% senior notes, $500 principal amount, due July 15, 2045
487

 
487

 
$
2,290

 
$
2,267


Our short-term borrowings consist of:
(Dollars in millions)
April 30,
2019
 
July 31,
2019
Commercial paper
$150
 
$220
Average interest rate
2.60%
 
2.45%
Average remaining days to maturity
18
 
27


7.    Stockholders’ Equity
The following table shows the changes in stockholders’ equity during the three months ended July 31, 2018:
(Dollars in millions)
Class A Common Stock
 
Class B Common Stock
 
Additional Paid-in Capital
 
Retained Earnings
 
AOCI
 
Treasury Stock
 
Total
Balance at April 30, 2018
$
25

 
$
47

 
$
4

 
$
1,730

 
$
(378
)
 
$
(112
)
 
$
1,316

Cumulative effect of changes in accounting standards
 
 
 
 
 
 
(5
)
 
 
 
 
 
(5
)
Net income
 
 
 
 
 
 
200

 
 
 
 
 
200

Net other comprehensive income (loss)
 
 
 
 
 
 
 
 
14

 
 
 
14

Declaration of cash dividends
 
 
 
 
 
 
(152
)
 
 
 
 
 
(152
)
Acquisition of treasury stock
 
 
 
 
 
 
 
 
 
 
(6
)
 
(6
)
Stock-based compensation expense
 
 
 
 
5

 
 
 
 
 
 
 
5

Stock issued under compensation plans
 
 
 
 
 
 
 
 
 
 
9

 
9

Loss on issuance of treasury stock issued under compensation plans
 
 
 
 
(7
)
 
(6
)
 
 
 
 
 
(13
)
Balance at July 31, 2018
$
25

 
$
47

 
$
2

 
$
1,767

 
$
(364
)
 
$
(109
)
 
$
1,368




9



The following table shows the changes in stockholders’ equity during the three months ended July 31, 2019:
(Dollars in millions)
Class A Common Stock
 
Class B Common Stock
 
Additional Paid-in Capital
 
Retained Earnings
 
AOCI
 
Treasury Stock
 
Total
Balance at April 30, 2019
$
25

 
$
47

 
$

 
$
2,238

 
$
(363
)
 
$
(300
)
 
$
1,647

Adoption of ASU 2018-02 (Note 1)
 
 
 
 
 
 
43

 
(43
)
 
 
 

Net income
 
 
 
 
 
 
186

 
 
 
 
 
186

Net other comprehensive income (loss)
 
 
 
 
 
 
 
 
(1
)
 
 
 
(1
)
Declaration of cash dividends
 
 
 
 
 
 
(158
)
 
 
 
 
 
(158
)
Acquisition of treasury stock
 
 
 
 
 
 
 
 
 
 
(1
)
 
(1
)
Stock-based compensation expense
 
 
 
 
3

 
 
 
 
 
 
 
3

Stock issued under compensation plans
 
 
 
 
 
 
 
 
 
 
16

 
16

Loss on issuance of treasury stock issued under compensation plans
 
 
 
 
(2
)
 
(27
)
 
 
 
 
 
(29
)
Balance at July 31, 2019
$
25

 
$
47

 
$
1

 
$
2,282

 
$
(407
)
 
$
(285
)
 
$
1,663



The following table shows the change in each component of AOCI, net of tax, during the three months ended July 31, 2019:
(Dollars in millions)
Currency Translation Adjustments
 
Cash Flow Hedge Adjustments
 
Postretirement Benefits Adjustments
 
Total AOCI
Balance at April 30, 2019
$
(207
)
 
$
31

 
$
(187
)
 
$
(363
)
Adoption of ASU 2018-02 (Note 1)
(1
)
 
(1
)
 
(41
)
 
(43
)
Net other comprehensive income (loss)
(13
)
 
9

 
3

 
(1
)
Balance at July 31, 2019
$
(221
)
 
$
39

 
$
(225
)
 
$
(407
)


The following table shows the cash dividends declared per share on our Class A and Class B common stock during the three months ended July 31, 2019:
Declaration Date
 
Record Date
 
Payable Date
 
Amount per Share
May 23, 2019
 
June 6, 2019
 
July 1, 2019
 
$0.166
July 25, 2019
 
September 6, 2019
 
October 1, 2019
 
$0.166



10



8.    Net Sales 
The following table shows our net sales by geography:
 
Three Months Ended
 
July 31,
(Dollars in millions)
2018
 
2019
United States
$
354

 
$
374

Developed International1
215

 
205

Emerging2
131

 
133

Travel Retail3
38

 
32

Non-branded and bulk4
28

 
22

Total
$
766

 
$
766


 
 
1Represents net sales of branded products to “advanced economies” as defined by the International Monetary Fund (IMF), excluding the United States. Our largest developed international markets are the United Kingdom, Australia, Germany, France, and Japan.
2Represents net sales of branded products to “emerging and developing economies” as defined by the IMF. Our largest emerging markets are Mexico, Poland, Russia, and Brazil.
3Represents net sales of branded products to global duty-free customers, other travel retail customers, and the U.S. military regardless of customer location.
4Includes net sales of used barrels, bulk whiskey and wine, and contract bottling regardless of customer location.

The following table shows our net sales by product category:
 
Three Months Ended
 
July 31,
(Dollars in millions)
2018
 
2019
Whiskey1
$
597

 
$
600

Tequila2
62

 
68

Vodka3
28

 
26

Wine4
40

 
39

Rest of portfolio
11

 
11

Non-branded and bulk5
28

 
22

Total
$
766

 
$
766


 
 
1Includes all whiskey spirits and whiskey-based flavored liqueurs, ready-to-drink, and ready-to-pour products. The brands included in this category are the Jack Daniel's family of brands, Woodford Reserve, Canadian Mist, GlenDronach, BenRiach, Glenglassaugh, Old Forester, Early Times, Slane Irish Whiskey, and Coopers’ Craft.
2Includes el Jimador, Herradura, New Mix, Pepe Lopez, and Antiguo.
3Includes Finlandia.
4Includes Korbel Champagne and Sonoma-Cutrer wines.
5Includes net sales of used barrels, bulk whiskey and wine, and contract bottling regardless of customer location.

11



9.    Pension and Other Postretirement Benefits
The following table shows the components of the net cost of pension and other postretirement benefits recognized for our U.S. benefit plans. Information about similar international plans is not presented due to immateriality.
 
Three Months Ended
 
July 31,
(Dollars in millions)
2018
 
2019
Pension Benefits:
 
 
 
Service cost
$
6

 
$
6

Interest cost
9

 
8

Expected return on plan assets
(12
)
 
(12
)
Amortization of net actuarial loss
5

 
5

Net cost
$
8

 
$
7

 
 
 
 
Other Postretirement Benefits:
 
 
 
Interest cost
$
1

 
$
1

Amortization of prior service cost (credit)
(1
)
 
(1
)
Net cost
$

 
$



10.    Income Taxes
Our consolidated interim effective tax rate is based on our expected annual operating income, statutory tax rates, and income tax laws in the various jurisdictions where we operate. Significant or unusual items, including adjustments to accruals for tax uncertainties, are recognized in the fiscal quarter in which the related event or a change in judgment occurs. The effective tax rate of 18.2% for the three months ended July 31, 2019, is lower than the expected tax rate of 21.0% on ordinary income for the full fiscal year primarily due to (a) excess tax benefits related to stock-based compensation and (b) the impact of other discrete items. Our expected tax rate includes current fiscal year additions for existing tax contingency items.

Historically, we have asserted that the undistributed earnings of our foreign subsidiaries are reinvested indefinitely outside the United States. Therefore, no income taxes have been provided for any outside basis differences inherent in these subsidiaries other than those subject to the one-time repatriation tax. During fiscal 2019, we changed our indefinite reinvestment assertion with respect to current year earnings and prior year undistributed earnings for select foreign subsidiaries (but not for their other outside basis differences). Although these earnings are no longer indefinitely reinvested and may now be distributed within our foreign entity structure, they remain indefinitely reinvested outside the United States. No deferred taxes have been recorded as no withholding taxes would be due on their distribution. No further changes have been made to our indefinite reinvestment assertion.

11.    Derivative Financial Instruments and Hedging Activities
Our multinational business exposes us to global market risks, including the effect of fluctuations in currency exchange rates, commodity prices, and interest rates. We use derivatives to help manage financial exposures that occur in the normal course of business. We formally document the purpose of each derivative contract, which includes linking the contract to the financial exposure it is designed to mitigate. We do not hold or issue derivatives for trading or speculative purposes.

We use currency derivative contracts to limit our exposure to the currency exchange risk that we cannot mitigate internally by using netting strategies. We designate most of these contracts as cash flow hedges of forecasted transactions (expected to occur within three years). We record all changes in the fair value of cash flow hedges in AOCI until the underlying hedged transaction occurs, at which time we reclassify that amount into earnings.

We do not designate some of our currency derivatives as hedges because we use them to at least partially offset the immediate earnings impact of changes in foreign exchange rates on existing assets or liabilities. We immediately recognize the change in fair value of these contracts in earnings.

We had outstanding currency derivatives, related primarily to our euro, British pound, and Australian dollar exposures, with notional amounts for all hedged currencies totaling $1,241 million at April 30, 2019 and $1,215 million at July 31, 2019.

We also use foreign currency-denominated debt to help manage our currency exchange risk. As of July 31, 2019, $609 million of our foreign currency-denominated debt instruments were designated as net investment hedges. These net investment hedges are intended to mitigate foreign exchange exposure related to non-U.S. dollar net investments in certain foreign subsidiaries. Any change in value of the designated portion of the hedging instruments is recorded in AOCI, offsetting the foreign currency translation adjustment of the related net investments that is also recorded in AOCI.

At inception, we expect each financial instrument designated as a hedge to be highly effective in offsetting the financial exposure it is designed to mitigate. We also assess the effectiveness on an ongoing basis. If determined to no longer be highly effective, designation and accounting for the instrument as a hedge would be discontinued.

We use forward purchase contracts with suppliers to protect against corn price volatility. We expect to physically take delivery of the corn underlying each contract and use it for production over a reasonable period of time. Accordingly, we account for these contracts as normal purchases rather than as derivative instruments.


12



The following table presents the pre-tax impact that changes in the fair value of our derivative instruments and non-derivative hedging instruments had on AOCI and earnings:
 
 
Three Months Ended
 
 
July 31,
(Dollars in millions)
Classification
2018
 
2019
Currency derivatives designated as cash flow hedges:
 
 

 
 

Net gain (loss) recognized in AOCI
n/a
$
27

 
$
15

Net gain (loss) reclassified from AOCI into earnings
Sales
(2
)
 
4

Currency derivatives not designated as hedging instruments:
 
 

 
 

Net gain (loss) recognized in earnings
Sales
$
3

 
$

Net gain (loss) recognized in earnings
Other income (expense), net
3

 
1

Foreign currency-denominated debt designated as net investment hedge:
 
 
 
 
Net gain (loss) recognized in AOCI
n/a
$
28

 
$
23

 
 
 
 
 
Total amounts presented in the accompanying consolidated statements of operations for line items affected by the net gains (losses) shown above:
 
 
 
 
Sales
 
$
987

 
$
978

Other income (expense), net
 
7

 
6



We expect to reclassify $23 million of deferred net gains on cash flow hedges recorded in AOCI as of July 31, 2019, to earnings during the next 12 months. This reclassification would offset the anticipated earnings impact of the underlying hedged exposures. The actual amounts that we ultimately reclassify to earnings will depend on the exchange rates in effect when the underlying hedged transactions occur. As of July 31, 2019, the maximum term of our outstanding derivative contracts was 36 months.

The following table presents the fair values of our derivative instruments:
 
 
 
April 30, 2019
 
July 31, 2019
(Dollars in millions)

Classification
 
Derivative Assets
 
Derivative Liabilities
 
Derivative Assets
 
Derivative Liabilities
Designated as cash flow hedges:
 
 
 
 
 
 
 
 
 
Currency derivatives
Other current assets
 
$
21

 
$
(2
)
 
$
30

 
$
(2
)
Currency derivatives
Other assets
 
22

 
(1
)
 
27

 

Currency derivatives
Accrued expenses
 

 
(5
)
 

 
(6
)
Currency derivatives
Other liabilities
 

 
(1
)
 

 
(2
)


The fair values reflected in the above table are presented on a gross basis. However, as discussed further below, the fair values of those instruments subject to net settlement agreements are presented on a net basis in our balance sheets.

In our statements of cash flows, we classify cash flows related to cash flow hedges in the same category as the cash flows from the hedged items.

Credit risk. We are exposed to credit-related losses if the counterparties to our derivative contracts default. This credit risk is limited to the fair value of the contracts. To manage this risk, we contract only with major financial institutions that have earned investment-grade credit ratings and with whom we have standard International Swaps and Derivatives Association (ISDA) agreements that allow for net settlement of the derivative contracts. Also, we have established counterparty credit guidelines that we monitor regularly, and we monetize contracts when we believe it is warranted. Because of these safeguards, we believe we have no derivative positions that warrant credit valuation adjustments.

Some of our derivative instruments require us to maintain a specific level of creditworthiness, which we have maintained. If our creditworthiness were to fall below that level, then the counterparties to our derivative instruments could request immediate payment or collateralization for derivative instruments in net liability positions. The aggregate fair value of all derivatives with

13



creditworthiness requirements that were in a net liability position was $6 million at April 30, 2019 and $8 million at July 31, 2019.

Offsetting. As noted above, our derivative contracts are governed by ISDA agreements that allow for net settlement of derivative contracts with the same counterparty. It is our policy to present the fair values of current derivatives (i.e., those with a remaining term of 12 months or less) with the same counterparty on a net basis in our balance sheets. Similarly, we present the fair values of noncurrent derivatives with the same counterparty on a net basis. We do not net current derivatives with noncurrent derivatives in our balance sheets.

The following table summarizes the gross and net amounts of our derivative contracts:
(Dollars in millions)
Gross Amounts of Recognized Assets (Liabilities)
 
Gross Amounts Offset in Balance Sheet
 
Net Amounts Presented in Balance Sheet
 
Gross Amounts Not Offset in Balance Sheet
 
Net Amounts
April 30, 2019
 
 
 
 
 
 
 
 
 
Derivative assets
$
43

 
$
(3
)
 
$
40

 
$

 
$
40

Derivative liabilities
(9
)
 
3

 
(6
)
 

 
(6
)
July 31, 2019
 
 
 
 
 
 
 
 
 
Derivative assets
57

 
(2
)
 
55

 

 
55

Derivative liabilities
(10
)
 
2

 
(8
)
 

 
(8
)


No cash collateral was received or pledged related to our derivative contracts as of April 30, 2019 or July 31, 2019.

12.    Fair Value Measurements
The following table summarizes the assets and liabilities measured or disclosed at fair value on a recurring basis:
 
April 30, 2019
 
July 31, 2019
 
Carrying
 
Fair
 
Carrying
 
Fair
(Dollars in millions)
Amount
 
Value
 
Amount
 
Value
Assets
 
 
 
 
 
 
 
Cash and cash equivalents
$
307

 
$
307

 
$
307

 
$
307

Currency derivatives
40

 
40

 
55

 
55

Liabilities
 
 
 
 
 
 
 
Currency derivatives
6

 
6

 
8

 
8

Short-term borrowings
150

 
150

 
220

 
220

Long-term debt
2,290

 
2,399

 
2,267

 
2,501



Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. We categorize the fair values of assets and liabilities into three levels based upon the assumptions (inputs) used to determine those values. Level 1 provides the most reliable measure of fair value, while Level 3 generally requires significant management judgment. The three levels are:
Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2 – Observable inputs other than those included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in inactive markets; or other inputs that are observable or can be derived from or corroborated by observable market data.
Level 3 – Unobservable inputs supported by little or no market activity.

We determine the fair values of our currency derivatives (forward contracts) using standard valuation models. The significant inputs used in these models, which are readily available in public markets or can be derived from observable market transactions, include the applicable spot exchange rates, forward exchange rates, and interest rates. These fair value measurements are categorized as Level 2 within the valuation hierarchy.


14



We determine the fair value of long-term debt primarily based on the prices at which identical or similar debt has recently traded in the market and also considering the overall market conditions on the date of valuation. These fair value measurements are categorized as Level 2 within the valuation hierarchy.

The fair values of cash, cash equivalents, and short-term borrowings approximate the carrying amounts due to the short maturities of these instruments.

We measure some assets and liabilities at fair value on a nonrecurring basis. That is, we do not measure them at fair value on an ongoing basis, but we do adjust them to fair value in some circumstances (for example, when we determine that an asset is impaired). No material nonrecurring fair value measurements were required during the periods presented in these financial statements.

13.    Leases
We enter into lease arrangements, which we use primarily for office space, vehicles, and land. Substantially all of our leases are operating leases. Our finance leases are not material.

Effective May 1, 2019, we updated our accounting policy for leases to reflect the adoption of ASC 842. Under ASC 842, we record lease liabilities and right-of-use (ROU) assets on our balance sheet for leases with terms exceeding 12 months. We do not record lease liabilities or ROU assets for short-term leases.

The amounts recorded for lease liabilities and ROU assets are based on the estimated present value, as of the lease commencement date, of the future payments to be made over the lease term. We calculate the present value using our incremental borrowing rate that corresponds to the term of the lease. We include the effect of an option to renew or terminate a lease in the lease term when it is reasonably certain that we will exercise the option.

Some of our leases contain non-lease components (e.g., maintenance or other services) in addition to lease components. For our land leases, we have elected the practical expedient not to separate the non-lease components from the lease components.

The following table shows the amounts and classification of ROU assets and lease liabilities on our balance sheet as of July 31, 2019:
 
 
July 31,
(Dollars in millions)
Classification
2019
Right-of-use assets
Other assets
$
50

 
 
 
Lease liabilities:
 
 
Current
Accounts payable and accrued expenses
$
17

Non-current
Other liabilities
33

Total
 
$
50



15




The following table shows information about the effects of leases during the three months ended July 31, 2019:
 
Three Months
 
Ended
(Dollars in millions)
July 31, 2019
Total lease cost1
$
5

Cash paid for amounts included in the measurement of lease liabilities2
5

Right-of-use assets obtained in exchange for new lease liabilities
3

1Consists primarily of operating lease cost. Other components of lease cost were not material.
2Classified within operating activities in the accompanying consolidated statement of cash flows.

The following table includes a maturity analysis of future (undiscounted) operating lease payments and a reconciliation of those payments to the lease liabilities recorded on our balance sheet as of July 31, 2019:
 
July 31,
(Dollars in millions)
2019
Fiscal 2020 (nine months remaining)
$
14

Fiscal 2021
15

Fiscal 2022
10

Fiscal 2023
5

Fiscal 2024
4

Thereafter
5

Total lease payments
53

Less: Present value discount
(3
)
Lease liabilities
$
50

 
 
Weighted-average discount rate
2.9%
Weighted-average remaining term
4.0 years


Future operating lease payments, as disclosed in our 2019 Form 10-K under the prior accounting standard (ASC Topic 840), were as follows as of April 30, 2019:
 
April 30,
(Dollars in millions)
2019
Fiscal 2020
$
23

Fiscal 2021
16

Fiscal 2022
10

Fiscal 2023
5

Fiscal 2024
3

Thereafter
2

Total lease payments
$
59



14.    Other Comprehensive Income
The following table shows the components of net other comprehensive income (loss):
 
Three Months Ended
 
Three Months Ended
 
July 31, 2018
 
July 31, 2019
(Dollars in millions)
Pre-Tax
 
Tax
 
Net
 
Pre-Tax
 
Tax
 
Net
Currency translation adjustments:
 
 
 
 
 
 
 
 
 
 
 
Net gain (loss) on currency translation
$
(5
)
 
$
(7
)
 
$
(12
)
 
$
(8
)
 
$
(5
)
 
$
(13
)
Reclassification to earnings

 

 

 

 

 

Other comprehensive income (loss), net
(5
)
 
(7
)
 
(12
)
 
(8
)
 
(5
)
 
(13
)
Cash flow hedge adjustments:
 
 
 
 
 
 
 
 
 
 
 
Net gain (loss) on hedging instruments
27

 
(6
)
 
21

 
15

 
(3
)
 
12

Reclassification to earnings1
2

 

 
2

 
(4
)
 
1

 
(3
)
Other comprehensive income (loss), net
29

 
(6
)
 
23

 
11

 
(2
)
 
9

Postretirement benefits adjustments:
 
 
 
 
 
 
 
 
 
 
 
Net actuarial gain (loss) and prior service cost

 

 

 

 

 

Reclassification to earnings2
4

 
(1
)
 
3

 
4

 
(1
)
 
3

Other comprehensive income (loss), net
4

 
(1
)
 
3

 
4

 
(1
)
 
3

 
 
 
 
 
 
 
 
 
 
 
 
Total other comprehensive income (loss), net
$
28

 
$
(14
)
 
$
14

 
$
7

 
$
(8
)
 
$
(1
)
1Pre-tax amount is classified as sales in the accompanying condensed consolidated statements of operations.
2Pre-tax amount is classified as non-operating postretirement expense in the accompanying condensed consolidated statements of operations.

15.    Acquisition of Business
On July 3, 2019, we acquired 100% of the voting interests in The 86 Company, which owns Fords Gin, for $22 million in cash. The purchase price has been preliminarily allocated largely to the intangible assets that were acquired, including goodwill of $11 million and other indefinite-lived intangibles of $12 million, net of deferred tax liabilities of $1 million. The goodwill is primarily attributable to the value of leveraging our distribution network and brand-building expertise to grow global sales of the Fords Gin brand and to the knowledge and expertise of the organized workforce employed by the acquired business. We do not expect the goodwill to be deductible for tax purposes. The initial allocation of the purchase price was based on preliminary estimates and may be revised as the intangible asset valuations are finalized. The 86 Company has been included in our consolidated financial statements since the acquisition date. Actual and pro forma results are not presented due to immateriality.
 
 


16



Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis in conjunction with both our unaudited condensed consolidated financial statements and related notes included in Part I, Item 1 of this Quarterly Report and our 2019 Form 10-K. Note that the results of operations for the three months ended July 31, 2019 do not necessarily indicate what our operating results for the full fiscal year will be. In this Item, “we,” “us,” “our,” “Brown-Forman,” and the “Company” refer to Brown-Forman Corporation and its consolidated subsidiaries, collectively.

Presentation Basis
Non-GAAP Financial Measures
We use certain financial measures in this report that are not measures of financial performance under U.S. generally accepted accounting principles (GAAP). These non-GAAP measures, defined below, should be viewed as supplements to (not substitutes for) our results of operations and other measures reported under GAAP. Other companies may not define or calculate these non-GAAP measures in the same way.
“Underlying change” in measures of statements of operations. We present changes in certain measures, or line items, of the statements of operations that are adjusted to an “underlying” basis. We use “underlying change” for the following measures of the statements of operations: (a) underlying net sales; (b) underlying cost of sales; (c) underlying gross profit; (d) underlying advertising expenses; (e) underlying selling, general, and administrative (SG&A) expenses; (f) underlying other expense (income) net; (g) underlying operating expenses1; and (h) underlying operating income. To calculate these measures, we adjust, as applicable, for foreign exchange and estimated net change in distributor inventories. We explain these adjustments below.
“Foreign exchange.” We calculate the percentage change in certain line items of the statements of operations in accordance with GAAP and adjust to exclude the cost or benefit of currency fluctuations. Adjusting for foreign exchange allows us to understand our business on a constant-dollar basis, as fluctuations in exchange rates can distort the underlying trend both positively and negatively. (In this report, “dollar” always means the U.S. dollar unless stated otherwise.) To eliminate the effect of foreign exchange fluctuations when comparing across periods, we translate current-year results at prior-year rates and remove transactional and hedging foreign exchange gains and losses from current- and prior-year periods.
“Estimated net change in distributor inventories.” This adjustment refers to the estimated net effect of changes in distributor inventories on changes in certain line items of the statements of operations. For each period compared, we use volume information from our distributors to estimate the effect of distributor inventory changes in certain line items of the statements of operations. We believe that this adjustment reduces the effect of varying levels of distributor inventories on changes in certain line items of the statements of operations and allows us to understand better our underlying results and trends.
We use the non-GAAP measures “underlying change” to: (a) understand our performance from period to period on a consistent basis; (b) compare our performance to that of our competitors; (c) calculate components of management incentive compensation; (d) plan and forecast; and (e) communicate our financial performance to the board of directors, stockholders, and investment analysts. We provide reconciliations of the “underlying change” in certain line items of the statements of operations to their nearest GAAP measures in the tables under “Results of Operations - Year-Over-Year Comparisons.” We have consistently applied the adjustments within our reconciliations in arriving at each non-GAAP measure.








 
 
1Operating expenses include advertising expense, SG&A expense, and other expense (income), net.

17



Definitions
Aggregations.
From time to time, to explain our results of operations or to highlight trends and uncertainties affecting our business, we aggregate markets according to stage of economic development as defined by the International Monetary Fund (IMF), and we aggregate brands by spirits category. Below, we define the geographic and brand aggregations used in this report.
Geographic Aggregations.
In “Results of Operations - Fiscal 2020 Year-to-Date Highlights,” we provide supplemental information for our largest markets ranked by percentage of total fiscal 2019 net sales. In addition to markets that are listed by country name, we include the following aggregations:
“Developed International” markets are “advanced economies” as defined by the IMF, excluding the United States. Our largest developed international markets are the United Kingdom, Australia, Germany, France, and Japan. This aggregation represents our net sales of branded products to these markets.
“Emerging” markets are “emerging and developing economies” as defined by the IMF. Our largest emerging markets are Mexico, Poland, Russia, and Brazil. This aggregation represents our net sales of branded products to these markets.
“Travel Retail” represents our net sales of branded products to global duty-free customers, other travel retail customers, and the U.S. military regardless of customer location.
“Non-branded and bulk” includes our net sales of used barrels, bulk whiskey and wine, and contract bottling regardless of customer location.
Brand Aggregations.
In “Results of Operations - Fiscal 2020 Year-to-Date Highlights,” we provide supplemental information for our largest brands ranked by percentage of total fiscal 2019 net sales. In addition to brands that are listed by name, we include the following aggregations:
“Whiskey” includes all whiskey spirits and whiskey-based flavored liqueurs, ready-to-drink (RTD), and ready-to-pour products (RTP). The brands included in this category are the Jack Daniel’s family of brands, Woodford Reserve, Canadian Mist, GlenDronach, BenRiach, Glenglassaugh, Old Forester, Early Times, Slane Irish Whiskey, and Coopers’ Craft.
“American whiskey” includes the Jack Daniel’s family of brands, premium bourbons (defined below), and Early Times.
“Jack Daniel’s family of brands” includes Jack Daniel’s Tennessee Whiskey (JDTW), Jack Daniel’s RTD and RTP products (JD RTD/RTP), Jack Daniel’s Tennessee Honey (JDTH), Gentleman Jack, Jack Daniel’s Tennessee Fire (JDTF), Jack Daniel’s Single Barrel Collection (JDSB), Jack Daniel’s Tennessee Rye Whiskey (JDTR), Jack Daniel’s Sinatra Select, Jack Daniel’s No. 27 Gold Tennessee Whiskey, and Jack Daniel’s Bottled-in-Bond.
“Jack Daniel’s RTD and RTP” products include all RTD line extensions of Jack Daniel’s, such as Jack Daniel’s & Cola, Jack Daniel’s & Diet Cola, Jack & Ginger, Jack Daniel’s Country Cocktails, Gentleman Jack & Cola, Jack Daniel’s Double Jack, Jack Daniel’s American Serve, Jack Daniel’s Tennessee Honey RTD, Jack Daniel’s Cider (JD Cider), Jack Daniel’s Lynchburg Lemonade (JD Lynchburg Lemonade), and the seasonal Jack Daniel’s Winter Jack RTP.
“Premium bourbons” includes Woodford Reserve, Old Forester, and Coopers’ Craft.
“Tequila” includes el Jimador, Herradura, New Mix, Pepe Lopez, and Antiguo.
“Vodka” includes Finlandia.
“Wine” includes Korbel Champagne and Sonoma-Cutrer wines.
“Non-branded and bulk” includes our net sales of used barrels, bulk whiskey and wine, and contract bottling regardless of customer location.


18



Other Metrics.
“Depletions.” We generally record revenues when we ship our products to our customers. Depletions is a term commonly used in the beverage alcohol industry to describe volume. Depending on the context, depletions means either (a) our shipments directly to retail or wholesale customers for owned distribution markets or (b) shipments from our distributor customers to retailers and wholesalers in other markets. We believe that depletions measure volume in a way that more closely reflects consumer demand than our shipments to distributor customers do. In this document, unless otherwise specified, we refer to depletions when discussing volume.
“Consumer takeaway.” When discussing trends in the market, we refer to consumer takeaway, a term commonly used in the beverage alcohol industry. Consumer takeaway refers to the purchase of product by consumers from retail outlets as measured by volume or retail sales value. This information is provided by third parties, such as Nielsen and the National Alcohol Beverage Control Association (NABCA). Our estimates of market share or changes in market share are derived from consumer takeaway data using the retail sales value metric. We believe consumer takeaway is a leading indicator of how consumer demand is trending.

Important Information on Forward-Looking Statements:
This report contains statements, estimates, and projections that are “forward-looking statements” as defined under U.S. federal securities laws. Words such as “aim,” “anticipate,” “aspire,” “believe,” “can,” “continue,” “could,” “envision,” “estimate,” “expect,” “expectation,” “intend,” “may,” “might,” “plan,” “potential,” “project,” “pursue,” “see,” “seek,” “should,” “will,” “would,” and similar words indicate forward-looking statements, which speak only as of the date we make them. Except as required by law, we do not intend to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. By their nature, forward-looking statements involve risks, uncertainties, and other factors (many beyond our control) that could cause our actual results to differ materially from our historical experience or from our current expectations or projections. These risks and uncertainties include, but are not limited to, those described in Part I, Item 1A. Risk Factors of our 2019 Form 10-K and those described from time to time in our future reports filed with the Securities and Exchange Commission, including:
Unfavorable global or regional economic conditions and related low consumer confidence, high unemployment, weak credit or capital markets, budget deficits, burdensome government debt, austerity measures, higher interest rates, higher taxes, political instability, higher inflation, deflation, lower returns on pension assets, or lower discount rates for pension obligations
Risks associated with being a U.S.-based company with global operations, including commercial, political, and financial risks; local labor policies and conditions; protectionist trade policies, or economic or trade sanctions, including additional retaliatory tariffs on American spirits and the effectiveness of our actions to mitigate the negative impact on our margins, sales, and distributors; compliance with local trade practices and other regulations, including anti-corruption laws; terrorism; and health pandemics
Fluctuations in foreign currency exchange rates, particularly a stronger U.S. dollar
Changes in laws, regulations, or policies – especially those that affect the production, importation, marketing, labeling, pricing, distribution, sale, or consumption of our beverage alcohol products
Tax rate changes (including excise, sales, VAT, tariffs, duties, corporate, individual income, dividends, or capital gains) or changes in related reserves, changes in tax rules or accounting standards, and the unpredictability and suddenness with which they can occur
The impact of U.S. tax reform legislation, including as a result of future clarifications and guidance interpreting the statute
Dependence upon the continued growth of the Jack Daniel’s family of brands
Changes in consumer preferences, consumption, or purchase patterns – particularly away from larger producers in favor of small distilleries or local producers, or away from brown spirits, our premium products, or spirits generally, and our ability to anticipate or react to them; legalization of marijuana use on a more widespread basis; shifts in consumer purchase practices from traditional to e-commerce retailers; bar, restaurant, travel, or other on-premise declines; shifts in demographic or health and wellness trends; or unfavorable consumer reaction to new products, line extensions, package changes, product reformulations, or other product innovation
Decline in the social acceptability of beverage alcohol in significant markets
Production facility, aging warehouse, or supply chain disruption
Imprecision in supply/demand forecasting
Higher costs, lower quality, or unavailability of energy, water, raw materials, product ingredients, labor, or finished goods

19



Route-to-consumer changes that affect the timing of our sales, temporarily disrupt the marketing or sale of our products, or result in higher fixed costs
Inventory fluctuations in our products by distributors, wholesalers, or retailers
Competitors’ and retailers’ consolidation or other competitive activities, such as pricing actions (including price reductions, promotions, discounting, couponing, or free goods), marketing, category expansion, product introductions, or entry or expansion in our geographic markets or distribution networks
Risks associated with acquisitions, dispositions, business partnerships, or investments – such as acquisition integration, termination difficulties or costs, or impairment in recorded value
Inadequate protection of our intellectual property rights
Product recalls or other product liability claims, product counterfeiting, tampering, contamination, or quality issues
Significant legal disputes and proceedings, or government investigations
Failure or breach of key information technology systems
Negative publicity related to our company, brands, marketing, personnel, operations, business performance, or prospects
Failure to attract or retain key executive or employee talent
Our status as a family “controlled company” under New York Stock Exchange rules, and our dual-class share structure

20



Overview
Tariffs
Tariffs negatively affected our results beginning in the second quarter of fiscal 2019, and are expected to continue to have a negative impact on our results as long as tariffs are in place. Our results for the three months ended July 31, 2019 were negatively affected by tariffs as described below.
Lower net sales. Certain customers paid the incremental costs of tariffs, and we compensated these customers for these incremental costs by reducing our net prices, which lowered our net sales.
Higher cost of sales. In markets where we own inventory, we paid the incremental cost of tariffs, which increased our cost of sales.
The combined effect of these tariff-related costs, whether arising as a reduction of net sales or as an increase in cost of sales, is hereafter referred to as “tariff-related costs.”
Our results for the three months ended July 31, 2019 were also affected by the timing-related impact of tariffs in the same period last year. In the first quarter of fiscal 2019, our net sales in a number of European markets were higher than normal as many retail and wholesale customers increased purchases to build inventory ahead of anticipated price increases related to tariffs (hereafter referred to as “prior-year tariff-related buy-ins”).
We discuss the estimated effect of the tariffs on our results where relevant below.
Fiscal 2020 Year-to-Date Highlights
We delivered reported net sales of $766 million, flat on both a reported and underlying basis compared to the same period last year. We estimate that prior-year tariff-related buy-ins and tariff-related costs reduced our underlying net sales growth by approximately three percentage points.
From a brand perspective, the Jack Daniel’s family of brands (excluding JDTW); our premium bourbon brands, fueled by Woodford Reserve; and our tequila brands all positively contributed to underlying net sales. Declines of JDTW, resulting from prior-year tariff-related buy-ins and tariff-related costs, offset this growth.
From a geographic perspective, growth in the United States and emerging markets was offset by declines in developed international markets and Travel Retail. Declines in developed international markets were driven by prior-year tariff-related buy-ins and tariff-related costs. Travel Retail’s underlying net sales were down primarily related to timing of customer orders in the same period last year.
We delivered reported operating income of $248 million, a decrease of 6% compared to the same period last year. Excluding (a) the positive effect of foreign exchange and (b) an estimated net change in distributor inventories, underlying operating income declined 8% driven by prior-year tariff-related buy-ins, tariff-related costs, and higher input costs.
We delivered diluted earnings per share of $0.39, a decrease of 6% compared to the same period last year due to the decline in our reported operating income.

21



Summary of Operating Performance
 
Three Months Ended July 31,
 
 
 
 
(Dollars in millions)
2018
 
2019
 
Reported Change
 
Underlying Change1
Net sales
$
766

 
$
766

 
%
 
%
Cost of sales
243

 
268

 
10
%
 
11
%
Gross profit
523

 
498

 
(5
%)
 
(5
%)
Advertising
98

 
92

 
(6
%)
 
(4
%)
SG&A
168

 
164

 
(2
%)
 
(1
%)
Operating income
264

 
248

 
(6
%)
 
(8
%)
 
 
 
 
 
 
 
 
Total operating expenses2
$
259

 
$
250

 
(3
%)
 
(2
%)
 
 
 
 
 
 
 
 
As a percentage of net sales3
 
 
 
 
 
 
 
Gross profit
68.2
%
 
64.9
%
 
(3.3
)pp
 
 
Operating income
34.5
%
 
32.4
%
 
(2.1
)pp
 
 
Non-operating postretirement expense
$
2

 
$
1