United States Securities and Exchange Commission Washington, D.C. 20549 FORM 10-Q (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended OCTOBER 31, 2005 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to _______________ Commission File No. 002-26821 BROWN-FORMAN CORPORATION (Exact name of Registrant as specified in its Charter) Delaware 61-0143150 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 850 Dixie Highway Louisville, Kentucky 40210 (Address of principal executive offices) (Zip Code) (502) 585-1100 (Registrant's telephone number, including area code) N/A (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_| Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes | | No |X| Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: November 30, 2005 Class A Common Stock ($.15 par value, voting) 56,829,081 Class B Common Stock ($.15 par value, nonvoting) 65,335,661
BROWN-FORMAN CORPORATION Index to Quarterly Report Form 10-Q PART I - FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Page Condensed Consolidated Statement of Operations Three months ended October 31, 2004 and 2005 3 Six months ended October 31, 2004 and 2005 Condensed Consolidated Balance Sheet April 30, 2005 and October 31, 2005 4 Condensed Consolidated Statement of Cash Flows Six months ended October 31, 2004 and 2005 5 Notes to the Condensed Consolidated Financial Statements 6 - 12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 - 19 Item 3. Quantitative and Qualitative Disclosures about Market Risk 20 Item 4. Controls and Procedures 20 PART II - OTHER INFORMATION Item 1. Legal Proceedings 20 - 21 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 22 Item 6. Exhibits 22 Signatures 23 2
PART I - FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) BROWN-FORMAN CORPORATION CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited) (Dollars in millions, except per share amounts) Three Months Ended Six Months Ended October 31, October 31, 2004 2005 2004 2005 ------- ------- -------- -------- Net sales $ 627.2 $ 665.8 $1,108.5 $1,213.2 Excise taxes 109.6 115.4 191.6 213.0 Cost of sales 187.1 193.0 333.0 339.8 ------- ------- -------- -------- Gross profit 330.5 357.4 583.9 660.4 Advertising expenses 81.5 87.4 143.1 159.7 Selling, general, and administrative expenses 105.5 110.2 201.8 220.5 Other expense (income), net (0.4) (0.4) (0.8) (14.2) ------- ------- -------- -------- Operating income 143.9 160.2 239.8 294.4 Interest income 0.4 3.2 0.7 5.1 Interest expense 5.1 4.5 10.3 9.1 ------- ------- -------- -------- Income from continuing operations before income taxes 139.2 158.9 230.2 290.4 Income taxes 45.8 46.8 77.0 90.4 ------- ------- -------- -------- Income from continuing operations 93.4 112.1 153.2 200.0 Income (loss) from discontinued operations, net of income taxes 8.0 (3.3) (0.6) (78.4) ------- ------- -------- -------- Net income $ 101.4 $ 108.8 $ 152.6 $ 121.6 ======= ======= ======== ======== Basic earnings (loss) per share: Continuing operations $ 0.76 $ 0.92 $ 1.25 $ 1.64 Discontinued operations 0.07 (0.03) -- (0.64) ------- ------- -------- -------- Total $ 0.83 $ 0.89 $ 1.25 $ 1.00 ======= ======= ======== ======== Diluted earnings (loss) per share: Continuing operations $ 0.76 $ 0.91 $ 1.25 $ 1.62 Discontinued operations 0.07 (0.03) -- (0.63) ------- ------- -------- -------- Total $ 0.83 $ 0.88 $ 1.25 $ 0.99 ======= ======= ======== ======== Shares (in thousands) used in the calculation of earnings (loss) per share: Basic 121,737 122,016 121,708 121,978 Diluted 122,417 123,242 122,409 123,199 Cash dividends per common share: Declared $ 0.000 $ 0.000 $ 0.425 $ 0.490 Paid $ 0.213 $ 0.245 $ 0.425 $ 0.490 See notes to the condensed consolidated financial statements. 3
BROWN-FORMAN CORPORATION CONDENSED CONSOLIDATED BALANCE SHEET (Unaudited) (Dollars in millions) April 30, October 31, 2005 2005 -------- ---------- Assets - ------ Cash and cash equivalents $ 294.9 $ 451.9 Accounts receivable, net 295.9 405.0 Inventories: Barreled whiskey 248.7 260.4 Finished goods 102.3 114.1 Work in process 80.5 97.0 Raw materials and supplies 38.4 51.0 -------- -------- Total inventories 469.9 522.5 Current portion of deferred income taxes 69.9 69.9 Current assets held for sale 157.6 9.8 Other current assets 27.0 24.6 -------- -------- Total current assets 1,315.2 1,483.7 Property, plant and equipment, net 417.9 417.3 Prepaid pension cost 130.2 126.8 Trademarks and brand names 334.2 331.3 Goodwill 192.7 188.1 Noncurrent assets held for sale 217.9 7.4 Other assets 41.0 37.2 -------- -------- Total assets $2,649.1 $2,591.8 ======== ======== Liabilities - ----------- Accounts payable and accrued expenses $ 264.2 $ 299.7 Accrued income taxes 41.9 37.3 Current portion of long-term debt 279.3 249.7 Current liabilities held for sale 52.7 3.8 -------- -------- Total current liabilities 638.1 590.5 Long-term debt 351.5 351.8 Deferred income taxes 157.8 146.3 Accrued pension and other postretirement benefits 77.6 80.5 Noncurrent liabilities held for sale 82.9 -- Other liabilities 31.2 22.7 -------- -------- Total liabilities 1,339.1 1,191.8 Stockholders' Equity - -------------------- Common stock: Class A, voting (57,000,000 shares authorized; 56,841,000 shares issued) 8.5 8.5 Class B, nonvoting (100,000,000 shares authorized; 69,188,000 shares issued) 10.4 10.4 Additional paid-in capital 33.9 37.9 Retained earnings 1,415.5 1,478.3 Accumulated other comprehensive income (loss) (11.4) 4.9 Treasury stock (4,141,000 and 3,904,000 shares at April 30 and October 31, respectively) (146.9) (140.0) -------- -------- Total stockholders' equity 1,310.0 1,400.0 -------- -------- Total liabilities and stockholders' equity $2,649.1 $2,591.8 ======== ======== See notes to the condensed consolidated financial statements. 4
BROWN-FORMAN CORPORATION CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited) (In millions; amounts in parentheses are reductions of cash) Six Months Ended October 31, 2004 2005 ------- ------- Cash flows from operating activities: Net income $ 152.6 $ 121.6 Adjustments to reconcile net income to net cash provided by (used for) operations: Impairment charge -- 59.5 Depreciation 28.9 26.0 Stock-based compensation expense 3.3 4.4 Deferred income taxes (22.3) (10.8) Changes in assets and liabilities: Accounts receivable (140.1) (107.3) Inventories (44.5) (77.1) Other current assets 10.2 7.4 Accounts payable and accrued expenses 73.4 51.6 Accrued income taxes 34.7 (8.5) Noncurrent assets and liabilities 15.2 (0.9) ------- ------- Cash provided by operating activities 111.4 65.9 Cash flows from investing activities: Proceeds from sale of discontinued operations -- 196.5 Additions to property, plant, and equipment (21.5) (22.4) Computer software expenditures (1.4) (0.7) Trademark and patent expenditures (0.3) -- ------- ------- Cash (used for) provided by investing activities (23.2) 173.4 Cash flows from financing activities: Net change in commercial paper (22.7) -- Proceeds from long-term debt 0.5 -- Reduction of long-term debt -- (30.0) Proceeds from exercise of stock options 5.7 8.4 Excess tax benefits from stock options 1.0 2.3 Acquisition of treasury stock (2.9) (3.2) Dividends paid (51.7) (59.8) ------- ------- Cash used for financing activities (70.1) (82.3) ------- ------- Net increase in cash and cash equivalents 18.1 157.0 Cash and cash equivalents, beginning of period 67.7 294.9 ------- ------- Cash and cash equivalents, end of period $ 85.8 $ 451.9 ======= ======= See notes to the condensed consolidated financial statements. 5
BROWN-FORMAN CORPORATION NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) In these notes, "we," "us," and "our" refer to Brown-Forman Corporation. 1. Condensed Consolidated Financial Statements We prepared these unaudited condensed consolidated statements using our customary accounting practices as set out in our 2005 annual report on Form 10-K (the "2005 Annual Report"). We made all of the adjustments (which include only normal, recurring adjustments) needed for a fair statement of this data. We condensed or omitted some of the information found in financial statements prepared according to generally accepted accounting principles ("GAAP"). You should read these financial statements together with the 2005 Annual Report, which does conform to GAAP. 2. Inventories We use the last-in, first-out ("LIFO") method to determine the cost of most of our inventories. If the LIFO method had not been used, inventories at current cost would have been $144.8 million higher than reported as of April 30, 2005, and $138.6 million higher than reported as of October 31, 2005. Changes in the LIFO valuation reserve for interim periods are based on a proportionate allocation of the estimated change for the entire fiscal year. 3. Income Taxes Our consolidated effective tax rate may differ from current statutory rates due to the recognition of amounts for events or transactions that do not have tax consequences. We use the estimated annual effective tax rate in determining our interim results. The effective tax rate of 31.1% for the six months ended October 31, 2005, is based on an expected effective tax rate of 32.5% on ordinary income for the full fiscal year, less the tax benefit achieved by offsetting the capital gain associated with the early termination of Glenmorangie marketing and distribution rights against the capital loss resulting from the sale of Lenox. 4. Discontinued Operations During July 2005, we entered into a definitive agreement to sell our wholly-owned subsidiary Lenox, Incorporated ("Lenox") for $190 million in cash (subject to a post-closing working capital adjustment). The agreement followed the February 2005 announcement that we were exploring strategic alternatives for Lenox, including a possible sale. On September 1, 2005, we consummated the sale of substantially all of Lenox to Department 56, Inc. ("Department 56") for $196 million. This total was $6 million higher than previously announced due to a working capital adjustment provision included in the sale agreement. After consummation of the sale to Department 56, we retained ownership of the Lenox headquarters building and property in Lawrenceville, New Jersey and Lenox's Brooks & Bentley, a former subsidiary of Lenox, located in the United Kingdom. We intend to sell these assets, which are classified as held for sale in the accompanying consolidated balance sheet. 6
In connection with the agreement, we recognized a non-cash impairment charge during July 2005 of $59.5 million, representing the excess of the carrying value of the net assets being sold over the expected sales proceeds. We have also recorded transaction costs of $9.6 million, including investment banking fees, transaction success payments, and legal, tax and actuarial expenses. Due to the sale of Lenox, its results of operations through August 2005, the impairment charge, and other transaction costs have been classified as discontinued operations, net of income taxes, in the accompanying consolidated statement of operations, and its assets and liabilities have been classified as held for sale in the accompanying consolidated balance sheet. In reports issued prior to July 2005, Lenox's operating results and assets were presented in the Consumer Durables segment, of which it comprised the major part. The Consumer Durables segment no longer constitutes a separate reportable segment. A summary of discontinued operations follows: (Dollars in millions) Three Months Ended Six Months Ended October 31, October 31, 2004 2005 2004 2005 ------- ------- ------- ------- Net sales $ 152.5 $ 39.6 $ 249.2 $ 119.0 Operating expenses (139.3) (41.5) (250.2) (134.2) Impairment charge -- -- -- (59.5) Transaction costs -- (2.1) -- (9.6) ------- ------- ------- ------- Income (loss) before income taxes 13.2 (4.0) (1.0) (84.3) Income tax (expense) benefit (5.2) 0.7 0.4 5.9 ------- ------- ------- ------- Net income (loss) from discontinued operations $ 8.0 $ (3.3) $ (0.6) $ (78.4) ======= ======= ======= ======= The net assets held for sale consist of the following: (Dollars in millions) April 30, October 31, 2005 2005 ------ ------ Current assets: Accounts receivable, net $ 48.4 $ 5.7 Inventories 103.6 3.1 Other 5.6 1.0 ------ ------ 157.6 9.8 ------ ------ Noncurrent assets: Property, plant and equipment, net 82.8 6.6 Goodwill 89.7 -- Other 45.4 0.8 ------ ------ 217.9 7.4 ------ ------ Current liabilities: Accounts payable and accrued expenses 47.2 3.8 Accrued income taxes 5.5 -- ------ ------ 52.7 3.8 ------ ------ Noncurrent liabilities: Accrued postretirement benefits 78.3 -- Other 4.6 -- ------ ------ 82.9 -- ------ ------ Net assets held for sale $239.9 $ 13.4 ====== ====== 7
5. Earnings Per Share Basic earnings per share is based upon the weighted average number of common shares outstanding during the period. Diluted earnings per share includes the dilutive effect of stock-based compensation awards, including stock options, stock-settled stock appreciation rights ("SSARs"), and non-vested restricted stock. Stock-based awards for approximately 1.7 million common shares were excluded from the calculation of diluted earnings per share for the periods ended October 31, 2004, because the exercise price of the options was greater than the average market price of the shares. No stock-based awards were excluded from the calculation of diluted earnings per share for the periods ended October 31, 2005. <TABLE> Three Months Ended Six Months Ended October 31, October 31, (Dollars in millions, except per share amounts) 2004 2005 2004 2005 ------- ------- ------- ------- <S> <C> <C> <C> <C> Basic and diluted net income (loss): Continuing operations $ 93.4 $112.1 $153.2 $200.0 Discontinued operations 8.0 (3.3) (0.6) (78.4) ------- ------- ------- ------- Total $101.4 $108.8 $152.6 $121.6 ======= ======= ======= ======= Share data (in thousands): Basic average common shares outstanding 121,737 122,016 121,708 121,978 Dilutive effect of non-vested restricted stock 10 28 8 25 Dilutive effect of stock options and SSARs 670 1,198 693 1,196 ------- ------- ------- ------- Diluted average common shares outstanding 122,417 123,242 122,409 123,199 ======= ======= ======= ======= Basic earnings (loss) per share: Continuing operations $0.76 $0.92 $1.25 $1.64 Discontinued operations 0.07 (0.03) -- (0.64) ------- ------- ------- ------- Total $0.83 $0.89 $1.25 $1.00 ======= ======= ======= ======= Diluted earnings (loss) per share: Continuing operations $0.76 $0.91 $1.25 $1.62 Discontinued operations 0.07 (0.03) -- (0.63) ------- ------- ------- ------- Total $0.83 $0.88 $1.25 $0.99 ======= ======= ======= ======= </TABLE> 8
6. Goodwill and Other Intangible Assets The following table shows the changes in the amounts recorded as goodwill during the six months ended October 31, 2005: (Dollars in millions) Balance as of April 30, 2005 $192.7 Foreign currency translation adjustment (4.6) ------ Balance as of October 31, 2005 $188.1 ====== Our other intangible assets consist of trademarks and brand names. As of October 31, 2005, we consider all of our trademarks and brand names to have indefinite useful lives. 7. Environmental Matters We face environmental claims resulting from the cleanup of several manufacturing or waste disposal sites in the United States. We accrue for losses associated with environmental cleanup obligations when such losses are probable and reasonably estimable. At some sites, there are other potentially responsible parties who are expected to bear part of the costs, in which cases our accrual is based on our estimate of our share of the total costs. A portion of the cleanup costs with respect to certain sites is expected to be paid by insurance. The estimated recovery of cleanup costs from insurers is recorded as an asset when receipt is deemed probable. We do not believe that any additional environmental cleanup costs we incur will have a material adverse effect on our consolidated financial position, results of operations, or cash flows. 8. Contingencies We operate in a litigious environment, and we get sued in the normal course of business. Sometimes plaintiffs seek substantial damages. Significant judgment is required in predicting the outcome of these suits and claims, many of which take years to adjudicate. We accrue estimated costs for a contingency when we believe that a loss is probable and a reasonable estimate of the loss can be made, and adjust the accrual as appropriate to reflect changes in facts and circumstances. A law firm has sued Brown-Forman and many other manufacturers and marketers of spirits, wines, and beer in a series of nine very similar class action lawsuits seeking damages and injunctive relief from alleged marketing of beverage alcohol to underage consumers. The suits allege that the defendants engage in deceptive and negligent marketing practices targeting underage consumers. They seek to recover on behalf of parents those funds that their children spent on the illegal purchase of alcohol as well as disgorgement of all profits from the alleged illegal sales. Brown-Forman is vigorously defending these cases. One suit has been dismissed by a trial court, from which the plaintiff has appealed, and another voluntarily dismissed by the plaintiff. Four others are pending on motions to dismiss. It is not possible at this time to predict the outcome of these claims but an unfavorable result in these or similar class action lawsuits could have a material adverse impact on our business. 9
9. Pension and Other Postretirement Benefits The following table shows the components of the pension and other postretirement benefit expense recognized during the periods covered by this report: (Dollars in millions) Three Months Ended Six Months Ended October 31, October 31, 2004 2005 2004 2005 ------ ------ ------ ------ Pension Benefits: Continuing operations: Service cost $2.8 $3.2 $5.6 $6.3 Interest cost 5.1 5.5 10.2 11.0 Expected return on plan assets (8.0) (7.8) (16.0) (15.7) Amortization of: Unrecognized prior service cost 0.2 0.1 0.3 0.3 Unrecognized net loss 0.7 2.1 1.5 4.3 ------ ------ ------ ------ Net expense 0.8 3.1 1.6 6.2 ------ ------ ------ ------ Discontinued operations: Service cost 1.4 0.5 2.8 1.8 Interest cost 2.4 0.8 4.8 3.3 Expected return on plan assets (2.8) (0.9) (5.6) (3.5) Amortization of: Unrecognized prior service cost 0.1 -- 0.2 0.1 Unrecognized net loss 0.3 0.2 0.6 0.9 ------ ------ ------ ------ Net expense 1.4 0.6 2.8 2.6 ------ ------ ------ ------ Total net benefit expense $2.2 $3.7 $4.4 $8.8 ====== ====== ====== ====== Other Postretirement Benefits: Continuing operations: Service cost $0.3 $0.3 $0.5 $0.6 Interest cost 0.6 0.6 1.2 1.3 Amortization of unrecognized net loss -- 0.1 -- 0.1 ------ ------ ------ ------ Net expense 0.9 1.0 1.7 2.0 ------ ------ ------ ------ Discontinued operations: Service cost 0.2 0.1 0.4 0.4 Interest cost 0.4 0.2 0.8 0.6 ------ ------ ------ ------ Net expense 0.6 0.3 1.2 1.0 ------ ------ ------ ------ Total net benefit expense $1.5 $1.3 $2.9 $3.0 ====== ====== ====== ====== The sale of Lenox, which included its pension and other postretirement benefit plans, has reduced the amount that we expect to be required to contribute for pension and other postretirement benefits during fiscal 2006 to approximately $5.0 million. However, we may decide to contribute more than that amount. 10
10. Comprehensive Income Comprehensive income is a broad measure of the effects of all transactions and events (other than investments by or distributions to shareholders) that are recognized in stockholders' equity, regardless of whether those transactions and events are included in net income. The following table adjusts the Company's net income for the other items included in comprehensive income: <TABLE> (Dollars in millions) Three Months Ended Six Months Ended October 31, October 31, 2004 2005 2004 2005 ------ ------ ------ ------ <S> <C> <C> <C> <C> Continuing operations: Net income $ 93.4 $112.1 $153.2 $200.0 Other comprehensive income (loss): Net gain (loss) on cash flow hedges (1.9) (1.3) (3.0) 2.3 Net gain (loss) on securities (0.3) -- (0.2) 0.1 Foreign currency translation adjustment 9.8 (0.8) 12.5 (12.8) ------ ------ ------ ------ 7.6 (2.1) 9.3 (10.4) ------ ------ ------ ------ Comprehensive income 101.0 110.0 162.5 189.6 ====== ====== ====== ====== Discontinued operations: Net income (loss) 8.0 (3.3) (0.6) (78.4) Other comprehensive income (loss): Pension liability adjustment -- 27.6 -- 27.6 Foreign currency translation adjustment 0.1 0.1 0.3 (0.9) ------ ------ ------ ------ 0.1 27.7 0.3 26.7 ------ ------ ------ ------ Comprehensive income (loss) 8.1 24.4 (0.3) (51.7) ------ ------ ------ ------ Total comprehensive income $109.1 $134.4 $162.2 $137.9 ====== ====== ====== ====== </TABLE> Accumulated other comprehensive income (loss) consisted of the following: (Dollars in millions) April 30, October 31, 2005 2005 ------ ------ Pension liability adjustment $(38.1) $(10.5) Cumulative translation adjustment 27.2 13.5 Unrealized gain (loss) on cash flow hedge contracts (0.7) 1.6 Unrealized gain on securities 0.2 0.3 ------ ------ $(11.4) $ 4.9 ====== ====== 11
11. Termination of Glenmorangie Distribution Agreement During July 2005, we entered into an agreement with LVMH Moet Hennessey Louis Vuitton for the early termination of our long-term importing and marketing agreements for Glenmorangie products in the United States, Canada, and certain countries in Europe and Asia, effective July 29, 2005. We received approximately $13.5 million for the early termination, which is included in "other income" for the six months ended October 31, 2005, in the accompanying consolidated statement of operations. 12. Stock Options Prior year amounts have been restated to reflect the retroactive adoption of FASB Statement No. 123(R), "Share-Based Payment," during the fourth quarter of fiscal 2005. 12
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion and analysis along with our 2005 Annual Report. Note that the results of operations for the six months ended October 31, 2005, do not necessarily indicate what our operating results for the full fiscal year will be. In this Item, "we," "us," and "our" refer to Brown-Forman Corporation. Important Note on Forward-Looking Statements: This report contains statements, estimates, or projections that constitute "forward-looking statements" as defined under U.S. federal securities laws. Generally, the words "expect," "believe," "intend," "estimate," "will," "anticipate," and "project," and similar expressions identify a forward-looking statement, which speaks only as of the date the statement is made. Except as required by law, we do not intend to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. We believe that the expectations and assumptions with respect to our forward-looking statements are reasonable. But by their nature, forward-looking statements involve known and unknown risks, uncertainties and other factors that in some cases are out of our control. These factors could cause our actual results to differ materially from Brown-Forman's historical experience or our present expectations or projections. Here is a non-exclusive list of such risks and uncertainties: - changes in general economic conditions, particularly in the United States where we earn the majority of our profits; - lower consumer confidence or purchasing in the United States associated with the aftermath of hurricanes Katrina, Rita and Wilma, all of which occurred this year; - tax increases, whether at the federal or state level or in major international markets and/or tariff barriers or other restrictions affecting beverage alcohol; - restrictions on alcohol marketing, including advertising and promotion, as a result of stricter governmental policies adopted either in the United States or globally; - adverse developments in the class action lawsuits filed against Brown-Forman and other spirits, beer and wine manufacturers alleging that our advertising causes illegal consumption of alcohol by those under the legal drinking age; - a strengthening U.S. dollar against foreign currencies, especially the British Pound; - reduced bar, restaurant, hotel and travel business in wake of terrorist attacks or threats, such as occurred in September, 2001 in the U.S. and in July, 2005 in London; - lower consumer confidence or purchasing associated with rising energy prices; - a decline in U.S. spirits consumption as might be indicated by recent published trends suggesting a slight reduction in the growth rate of distilled spirits consumption; - longer-term, a change in consumer preferences, social trends or cultural trends that results in the reduced consumption of our premium spirits brands; - changes in distribution arrangements in major markets that limit our ability to market our products; - increases in the price of energy or raw materials, including grapes, grain, wood, glass, and plastic; - excess wine inventories or a further world-wide oversupply of grapes; - adverse developments as a result of state investigations of beverage alcohol industry trade practices of suppliers, distributors and retailers. 13
Results of Operations: Second Quarter Fiscal 2006 Compared to Second Quarter Fiscal 2005 A summary of our operating performance (expressed in millions, except percentage and per share amounts) is presented below. Continuing Operations consist of our beverage business and Hartmann luggage business. Discontinued Operations consist of Lenox and Brooks & Bentley. Three Months Ended October 31, CONTINUING OPERATIONS 2004 2005 Change ------ ------ ------ Net sales $627.2 $665.8 6% Gross profit 330.5 357.4 8% Advertising expenses 81.5 87.4 7% Selling, general, and administrative expenses 105.5 110.2 4% Other expense (income), net (0.4) (0.4) Operating income 143.9 160.2 11% Interest expense, net 4.7 1.3 Income before income taxes 139.2 158.9 14% Income taxes 45.8 46.8 Net income 93.4 112.1 20% Gross margin 52.7% 53.7% Effective tax rate 32.9% 29.5% Earnings per share: Basic $0.76 $0.92 20% Diluted 0.76 0.91 19% Revenues and gross profit for the quarter increased 6% and 8%, respectively, driven by volume growth and margin improvement for Jack Daniel's, higher profits for several of our super-premium developing brands, and continued growth for Finlandia and Southern Comfort. The impact of lower global trade inventories reduced revenue growth by about $19 million. Adjusting for this, and for approximately $6 million of revenue associated with the Glenmorangie family of brands that we no longer represent, underlying revenues grew 10%. Reported revenue growth 6% Net reduction in global trade inventories 3% Glenmorangie family of brands 1% ----- Adjusted revenue growth 10% ===== 14
Leading our premium global brand portfolio, Jack Daniel's worldwide depletion growth rate was in the high-single digits for the quarter, with mid-single digit growth in the U.S. and the United Kingdom, and double-digit gains in Germany, Spain, France, South Africa, China, and Japan. (Depletions are shipments from wholesale distributors to retailers, and are commonly regarded in the wine and spirits industry as an approximate measure of consumer demand.) Shipment growth for the brand was several percentage points below the quarter's depletion growth rate as a result of distributors and importers reducing their inventory positions following relatively high levels of trade inventory at the end of the first quarter of fiscal 2006. Depletions for Southern Comfort grew in the mid-single digits globally for the quarter, driven by the brand's continued gains in the U.S. Finlandia experienced double-digit depletion growth for the quarter, with particular strength in Poland and Russia. Improving trends were registered in the second quarter for several of our mid-priced regional brands. Fetzer recorded mid-single digit depletion growth in the quarter, and consumer measures for the brand continue to strengthen heading into the important holiday season. Korbel depletion growth improved to the mid-single digits, while depletions for Canadian Mist, Early Times and Bolla declined over the prior year period. Super-premium developing brands Sonoma-Cutrer, Appleton, Tuaca, and Woodford Reserve each posted double-digit depletion growth for the quarter. Advertising expenses were up 7% in the quarter. This increase in spending represents significant incremental investments behind our premium global brand portfolio, partially offset by the absence of expenses associated with the introduction of low-carbohydrate wines, and the expenses associated with the Glenmorangie family of brands, which we no longer represent. SG&A spending increased 4% for the quarter, which was less than the growth we have experienced over the past five quarters. The underlying rate of growth was actually about 6% after adjusting reported growth for the higher compensation expense recorded last year that was directly related to better-than-expected performance from our premium spirits portfolio. This increase represents inflationary growth and expenses associated with the development and implementation of our global distribution strategy. Second quarter operating income grew 11%, driven by the same factors described above. Adjusting for the impact of lower global trade inventories and expenses associated with last year's low-carbohydrate wine introduction, underlying operating income grew 18% for the quarter. Reported operating income growth 11% Net reduction in global trade inventories 9% Absence of low-carbohydrate wines (2%) ----- Adjusted operating income growth 18% ===== 15
The effective tax rate of 29.5% for the quarter was unusually low due to the tax benefit achieved by offsetting the capital gain associated with the early termination of Glenmorangie marketing and distribution rights in the first quarter against the capital loss resulting from the sale of Lenox during the second quarter. Diluted earnings per share for the quarter were $0.91, up 19% from the same period last year. Strong underlying performance from our premium global brands portfolio, which includes Jack Daniel's, Southern Comfort and Finlandia, and improved profits from several of our mid-priced regional wine brands drove earnings growth in the quarter. Quarterly earnings per share growth also benefited from a lower effective tax rate, lower net interest expense (attributable to higher cash balances), and the absence of prior year expenses associated with the introduction of low-carbohydrate wine brands and advisory fees associated with the sale of our Glenmorangie shareholding. An anticipated reduction in global trade inventories tempered earnings growth in the quarter. Adjusting for these factors, underlying earnings per share growth for the quarter was 16%, as follows: Reported diluted EPS growth 19% Net reduction in global trade inventories 9% Lower net interest and lower effective tax rate (5%) Capital gain treatment (termination of Glenmorangie distribution rights) (5%) Absence of low-carbohydrate wines / Glenmorangie fees (2%) ----- Adjusted diluted EPS growth 16% ===== We believe that disclosing this measure of earnings per share is important because it more accurately reflects the underlying operations of the Company. DISCONTINUED OPERATIONS As discussed earlier, we consummated the sale of substantially all of Lenox on September 1, 2005, and we intend to sell Brooks & Bentley. As a result, we have reported the operations of Lenox and Brooks & Bentley as discontinued operations in the accompanying financial statements. The net loss from discontinued operations during the three months ended October 31, 2005, consists primarily of fees and other costs associated with the Lenox transaction, as well as the results of operations for Brooks & Bentley. Three Months Ended October 31, 2004 2005 ------ ------ Net income (loss) $ 8.0 $ (3.3) Earnings (loss) per share: Basic 0.07 (0.03) Diluted 0.07 (0.03) 16
Results of Operations: Six Months Fiscal 2006 Compared to Six Months Fiscal 2005 A summary of our operating performance (expressed in millions, except percentage and per share amounts) is presented below. Continuing Operations consist of our beverage business and Hartmann luggage business. Discontinued Operations consist of Lenox and Brooks & Bentley. Six Months Ended October 31, CONTINUING OPERATIONS 2004 2005 Change ------ ------ ------ Net sales $1,108.5 $1,213.2 9% Gross profit 583.9 660.4 13% Advertising expenses 143.1 159.7 12% Selling, general, and administrative expenses 201.8 220.5 9% Other expense (income), net (0.8) (14.2) Operating income 239.8 294.4 23% Interest expense, net 9.6 4.0 Income before income taxes 230.2 290.4 26% Income taxes 77.0 90.4 Net income 153.2 200.0 30% Gross margin 52.7% 54.4% Effective tax rate 33.4% 31.1% Earnings per share: Basic $1.25 $1.64 30% Diluted 1.25 1.62 30% Revenues and gross profit increased 9% and 13%, respectively, reflecting solid growth for Jack Daniel's, Southern Comfort, and Finlandia, and improved profits from Fetzer and the Jack Daniel's & Cola ready-to-drink product that is sold primarily in Australia. Adjusting revenue for the absence of low-carbohydrate wines and the effect of the termination of the Glenmorangie distribution rights in the prior year, and the impact of higher net trade inventory levels, underlying revenues were up 11% in the first half of this fiscal year. Reported revenue growth 9% Absence of low-carbohydrate wines/ Glenmorangie family of brands 3% Net increase in global trade inventories (1%) ----- Adjusted revenue growth 11% ===== Advertising expenses were up 12% for the first half of the fiscal year, reflecting significant incremental investments behind our premium global brands, partially offset by the absence of expenses associated with the introduction of low-carbohydrate wines and the termination of the Glenmorangie distribution arrangement. 17
SG&A expenses were up 9% on a year-to-date basis. This increase represents inflationary growth as well as expenses associated with the development and implementation of our global distribution strategy, advisory fees directly related to our effort to partner with Constellation Brands in the acquisition of Allied Domecq's spirits and wine business, and incremental pension costs. Operating income grew 23% on a year-to-date basis. Adjusting operating income for the absence of profits associated with low-carbohydrate wines last year, the impact of higher net trade inventory levels, and consideration received for the termination of Glenmorangie distribution rights, underlying operating income was up about 17% in the first half of this fiscal year. Reported operating income growth 23% Absence of low-carbohydrate wines 2% Net increase in global trade inventories (2%) Consideration from termination of Glenmorangie distribution rights (6%) ----- Adjusted operating income growth 17% ===== The effective tax rate of 31.1% for the first half of the fiscal year is based on an expected effective tax rate of 32.5% on ordinary income for the full fiscal year, less the tax benefit achieved by offsetting the capital gain associated with the early termination of Glenmorangie marketing and distribution rights against the capital loss resulting from the sale of Lenox. For the first six months of the fiscal year, diluted earnings per share were $1.62, up 30% from the $1.25 earned in the same period last year. Adjusting year-to-date results for profits associated with the early termination of Glenmorangie marketing and distribution rights, the net increase in global trade inventory levels, the absence of income associated with the introduction of low-carbohydrate wine brands in the prior year period, advisory fees related to the prior year sale of our Glenmorangie shareholding, lower net interest, and a lower effective tax rate, earnings per share for the first half of fiscal 2006 increased approximately 16%, as follows: Reported diluted EPS growth 30% Glenmorangie consideration (includes capital gain treatment) (9%) Net increase in global trade inventories (3%) Lower net interest and lower effective tax rate (3%) Absence of low-carbohydrate wines / Glenmorangie fees 1% ----- Adjusted diluted EPS growth 16% ===== We believe that disclosing this measure of earnings per share is important because it more accurately reflects the underlying operations of the Company. 18
DISCONTINUED OPERATIONS As discussed earlier, we consummated the sale of substantially all of Lenox on September 1, 2005, and we are pursuing the sale of Brooks & Bentley. As a result, we have reported the operations of Lenox and Brooks & Bentley as discontinued operations in the accompanying financial statements. Six Months Ended October 31, 2004 2005 ------ ------ Net loss $(0.6) $(78.4) Loss per share: Basic -- (0.64) Diluted -- (0.63) For the first half of the fiscal year, we reported a net loss from discontinued operations of $78.4 million, or $0.63 per diluted share, versus a net loss of $0.6 million for the same prior year period. The loss recorded during fiscal 2006 includes a non-cash impairment charge and fees related to the transaction of approximately $0.56 per share. OUTLOOK FOR CONTINUING OPERATIONS Based on continued strong consumer demand for our premium global brands, we are increasing our earnings estimate for the fiscal year that ends April 30, 2006. Our previous estimate for earnings per share from continuing operations was in the range of $2.70 to $2.80, which included a net $0.05 per share benefit related to the early termination of distribution rights for the Glenmorangie family of brands. Excluding this $0.05 benefit, the previously-communicated range was $2.65 to $2.75 per share. We now expect fiscal 2006 earnings per share from continuing operations in the range of $2.73 to $2.79, which represents full year growth of 13% to 15% over comparable prior year earnings. This earnings estimate excludes both the net benefit of the Glenmorangie termination and an anticipated net favorable impact from restructuring the Company's Australian distributor, which is expected to occur in the second half of this fiscal year. We expect a much more moderate growth rate in earnings per share for the second half of the fiscal year, reflecting further reductions in global trade inventory levels, additional transition expenses associated with changes in global distribution, incremental brand investments designed to sustain long term business momentum, and the anticipated unfavorable impact of the strengthening U.S. dollar. LIQUIDITY AND FINANCIAL CONDITION Cash and cash equivalents increased by $157.0 million during the six months ended October 31, 2005, compared to an increase of $18.1 million during the same period last year. The increase primarily reflects the receipt of $196.5 million in cash from the sale of Lenox. The amount of cash used for other investing activities was essentially the same as the amount used during the same period last year. Cash provided by operations declined by $45.5 million, largely reflecting a planned increase in inventory to meet expected future consumer demand. Cash used for financing activities increased by $12.2 million, due primarily to an increase in dividend payments and debt repayments. 19
Item 3. Quantitative and Qualitative Disclosures about Market Risk We hold debt obligations, foreign currency forward and option contracts, and commodity futures contracts that are exposed to risk from changes in interest rates, foreign currency exchange rates, and commodity prices, respectively. Established procedures and internal processes govern the management of these market risks. As of October 31, 2005, we do not consider the exposure to these market risks to be material. Item 4. Controls and Procedures The Chief Executive Officer ("CEO") and the Chief Financial Officer ("CFO") of Brown-Forman (its principal executive and principal financial officers) have evaluated the effectiveness of the company's "disclosure controls and procedures" (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")) as of the end of the period covered by this report. Based on that evaluation, the CEO and CFO concluded that the company's disclosure controls and procedures: are effective to ensure that information required to be disclosed by the company in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC's rules and forms; and include controls and procedures designed to ensure that information required to be disclosed by the company in such reports is accumulated and communicated to the company's management, including the CEO and the CFO, as appropriate, to allow timely decisions regarding required disclosure. There has been no change in the company's internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the company's internal control over financial reporting. PART II - OTHER INFORMATION Item 1. Legal Proceedings Brown-Forman Corporation and many other manufacturers of spirits, wine, and beer are defendants in a series of essentially similar class action lawsuits seeking damages and injunctive relief for alleged marketing of beverage alcohol to underage consumers. Nine lawsuits have been filed to date, the first three against eight defendants, including Brown-Forman: "Hakki v. Adolph Coors Company, et.al.," District of Columbia Superior Court No. CD 03-9183 (November 2003); "Kreft v. Zima Beverage Co., et.al.," District Court, Jefferson County, Colorado, No. 04cv1827 (December 2003); and "Wilson v. Zima Company, et.al.," U.S. District Court for the Western District of North Carolina, Charlotte Division, No. 3:04cv141 ( January 2004). Two virtually identical suits with allegations similar to those in the first three lawsuits were filed in Cleveland, Ohio, in April and June, 2004, respectively, against the original eight defendants as well as an additional nine manufacturers of spirits and beer, and are now consolidated as "Eisenberg v. Anheuser-Busch," U.S. District Court for the District of Northern Ohio, No. 1:04cv1081. Five similar suits were filed in 2005: "Elizabeth H. Sciocchette v. Advanced Brands," Albany County, New York Supreme Court No. 102205 (February 16, 2005); "Roger and Kathy Bertovich v. Advanced Brands," Hancock County, West Virginia, Circuit Court No. 05-C-42M (February 17, 2005); "Jacquelin Tomberlin v. Adolph Coors," Dane County (Madison, Wisconsin) Circuit Court, (February 23, 2005); "Viola Alston v. Advanced Brands," Wayne County, Michigan, Circuit Court No. 05-509294, (March, 30, 2005), and "Craig Konhauzer v. Adolph Coors Company," Broward County Florida Circuit Court, No. 05004875 (March 30, 2005). In addition, Brown-Forman received in February, 2004, a pre-lawsuit notice under the California Consumer Protection Act indicating that the same lawyers intend to file a lawsuit there against many industry defendants, including Brown-Forman, presumably on the same facts and legal theories. 20
The suits allege that the defendants have engaged in deceptive marketing practices and schemes targeted at underage consumers, negligently marketed their products to the underage, and fraudulently concealed their alleged misconduct. Plaintiffs seek class action certification on behalf of: (a) a guardian class consisting of all persons who were or are parents of children whose funds were used to purchase beverage alcohol marketed by the defendants which were consumed without their prior knowledge by their children under the age of 21 during the period 1982 to present; and (b) an injunctive class consisting of the parents and guardians of all children currently under the age of 21. The lawsuits seek: (1) a finding that defendants engaged in a deceptive scheme to market alcoholic beverages to underage persons and an injunction against such alleged practices; (2) disgorgement and refund to the guardian class of all proceeds resulting from sales to the underage since 1982; and (3) judgment to each guardian class member for a trebled award of actual damages, punitive damages, and attorneys fees. The lawsuits, either collectively or individually, if ultimately successful, represent significant financial exposure. Brown-Forman, in coordination with other defendants, is vigorously defending itself in these cases. The Defendants' motion to dismiss the Kreft complaint was sustained by the trial court on September 16, 2005; Plaintiffs have appealed the dismissal. The Konhauzer complaint was voluntarily dismissed by the plaintiff on October 19, 2005. Four of the remaining cases are pending on motions to dismiss. 21
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds During the quarter ended October 31, 2005, the Company acquired 90,733 shares of Class B Common Stock for $35.25 per share. These shares had been tendered at that price (adjusted to reflect the 2-for-1 stock split in January 2004) during our March 2003 "Dutch Auction" share repurchase, but were not delivered until August and September 2005. No additional shares will be acquired pursuant to that March 2003 share repurchase. <TABLE> Total Number of Maximum Number Total Shares Purchased of Shares that May Number of Average as Part of Yet Be Purchased Shares Price Paid Publicly Announced Under the Plans or Period Purchased per Share Plans or Programs Programs <S> <C> <C> <C> <C> August 1, 2005 - August 31, 2005 16,000 $35.25 16,000 -- September 1, 2005 - September 30, 2005 74,733 35.25 74,733 -- October 1, 2005 - October 31, 2005 -- -- -- -- Total 90,733 $35.25 90,733 -- </TABLE> Item 6. Exhibits 31.1 CEO Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002. 31.2 CFO Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002. 32 CEO and CFO Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (not considered to be filed). 22
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. BROWN-FORMAN CORPORATION (Registrant) Date: December 1, 2005 By: /s/ Phoebe A. Wood Phoebe A. Wood Executive Vice President and Chief Financial Officer (On behalf of the Registrant and as Principal Financial Officer) 23
Exhibit 31.1 CERTIFICATION PURSUANT TO SECTION 302 OF SARBANES-OXLEY ACT OF 2002 I, Paul C. Varga, certify that: 1. I have reviewed this Quarterly report on Form 10-Q of Brown-Forman Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: December 1, 2005 By: /s/ Paul C. Varga Paul C. Varga Chief Executive Officer
Exhibit 31.2 CERTIFICATION PURSUANT TO SECTION 302 OF SARBANES-OXLEY ACT OF 2002 I, Phoebe A. Wood, certify that: 1. I have reviewed this Quarterly report on Form 10-Q of Brown-Forman Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: December 1, 2005 By: /s/ Phoebe A. Wood Phoebe A. Wood Chief Financial Officer
Exhibit 32 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Brown-Forman Corporation ("the Company") on Form 10-Q for the period ended October 31, 2005, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), each of the undersigned hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, in the capacity as an officer of the Company, that: (1) The Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: December 1, 2005 By: /s/ Paul C. Varga Paul C. Varga Chief Executive Officer By: /s/ Phoebe A. Wood Phoebe A. Wood Executive Vice President and Chief Financial Officer A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. This certificate is being furnished solely for purposes of Section 906 and is not being filed as part of the Periodic Report.