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

FORM 10-Q
(Mark One)
 
  þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 20172018
OR
  o
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)
Delaware61-0143150
(State or other jurisdiction of(IRS Employer
incorporation or organization)Identification No.)
  
850 Dixie Highway 
Louisville, Kentucky40210
(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 þ   No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post 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, 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 filerþ Accelerated filer¨
Non-accelerated filer¨(Do not check if a smaller reporting company)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 o     No  þ
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  July 31, 20172018
Class A Common Stock ($.15 par value, voting)169,061,063169,055,397
Class B Common Stock ($.15 par value, nonvoting)215,209,950312,104,114


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.
   
   




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 EndedThree Months Ended
July 31,July 31,
2016 20172017 2018
Sales$856
 $929
$929
 $987
Excise taxes195
 206
206
 221
Net sales661
 723
723
 766
Cost of sales208
 230
230
 243
Gross profit453
 493
493
 523
Advertising expenses82
 89
87
 98
Selling, general, and administrative expenses163
 161
161
 168
Other expense (income), net(5) (1)(1) (7)
Operating income213
 244
246
 264
Non-operating postretirement expense2
 2
Interest income1
 1
(1) (2)
Interest expense13
 16
16
 22
Income before income taxes201
 229
229
 242
Income taxes57
 51
51
 42
Net income$144
 $178
$178
 $200
Earnings per share:      
Basic$0.37
 $0.46
$0.37
 $0.42
Diluted$0.36
 $0.46
$0.37
 $0.41
Cash dividends per common share:      
Declared$0.3400
 $0.3650
$0.292
 $0.316
Paid$0.1700
 $0.1825
$0.146
 $0.158
See notes to the condensed consolidated financial statements.


BROWN-FORMAN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Dollars in millions)
 
Three Months EndedThree Months Ended
July 31,July 31,
2016 20172017 2018
Net income$144
 $178
$178
 $200
Other comprehensive income (loss), net of tax:      
Currency translation adjustments(67) 34
34
 (12)
Cash flow hedge adjustments12
 (23)(23) 23
Postretirement benefits adjustments3
 3
3
 3
Net other comprehensive income (loss)(52) 14
14
 14
Comprehensive income$92
 $192
$192
 $214
See notes to the condensed consolidated financial statements.


BROWN-FORMAN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in millions)
April 30,
2017
 July 31,
2017
April 30,
2018
 July 31,
2018
Assets      
Cash and cash equivalents$182
 $238
$239
 $211
Accounts receivable, less allowance for doubtful accounts of $7 at April 30 and July 31557
 576
639
 658
Inventories:      
Barreled whiskey873
 895
947
 945
Finished goods186
 217
225
 270
Work in process119
 117
117
 137
Raw materials and supplies92
 108
90
 97
Total inventories1,270
 1,337
1,379
 1,449
Other current assets342
 352
298
 305
Total current assets2,351
 2,503
2,555
 2,623
Property, plant and equipment, net713
 719
780
 778
Goodwill753
 755
763
 755
Other intangible assets641
 661
670
 658
Deferred tax assets16
 17
16
 16
Other assets151
 147
192
 195
Total assets$4,625
 $4,802
$4,976
 $5,025
Liabilities      
Accounts payable and accrued expenses$501
 $454
$581
 $564
Dividends payable
 70

 76
Accrued income taxes9
 57
25
 52
Short-term borrowings211
 258
215
 176
Current portion of long-term debt249
 250
Total current liabilities970
 1,089
821
 868
Long-term debt1,689
 1,720
2,341
 2,310
Deferred tax liabilities152
 135
85
 119
Accrued pension and other postretirement benefits314
 298
191
 192
Other liabilities130
 140
222
 168
Total liabilities3,255
 3,382
3,660
 3,657
Commitments and contingencies
 

 
Stockholders’ Equity      
Common stock:      
Class A, voting, $0.15 par value (170,000,000 shares authorized; 170,000,000 shares issued at April 30 and July 31)25
 25
Class B, nonvoting, $0.15 par value (400,000,000 shares authorized; 284,627,000 shares and 217,627,000 shares issued at April 30 and July 31, respectively)43
 33
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 capital65
 47
4
 2
Retained earnings4,470
 1,824
1,730
 1,767
Accumulated other comprehensive income (loss), net of tax(390) (376)(378) (364)
Treasury stock, at cost (70,540,000 and 3,356,000 shares at April 30 and July 31, respectively)(2,843) (133)
Treasury stock, at cost (3,531,000 and 3,372,000 shares at April 30 and July 31, respectively)(112) (109)
Total stockholders’ equity1,370
 1,420
1,316
 1,368
Total liabilities and stockholders’ equity$4,625
 $4,802
$4,976
 $5,025
 See notes to the condensed consolidated financial statements.


BROWN-FORMAN CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in millions)
Three Months EndedThree Months Ended
July 31,July 31,
2016 20172017 2018
Cash flows from operating activities:      
Net income$144
 $178
$178
 $200
Adjustments to reconcile net income to net cash provided by operations:      
Depreciation and amortization15
 15
15
 18
Stock-based compensation expense4
 4
4
 5
Deferred income taxes(11) (3)(3) 20
Changes in assets and liabilities, excluding the effects of acquisition of business(24) (92)
Changes in assets and liabilities(89) (117)
Cash provided by operating activities128
 102
105
 126
Cash flows from investing activities:      
Acquisition of business, net of cash acquired(307) 
Additions to property, plant, and equipment(16) (28)(28) (23)
Computer software expenditures(1) 
Payments for corporate-owned life insurance(3) (2)
Cash used for investing activities(324) (28)(31) (25)
Cash flows from financing activities:      
Net change in short-term borrowings(43) 45
45
 (41)
Proceeds from long-term debt717
 
Debt issuance costs(5) 
Net payments related to exercise of stock-based awards(3) (5)(5) (4)
Acquisition of treasury stock(201) (1)(1) (1)
Dividends paid(67) (70)(70) (76)
Cash provided by (used for) financing activities398
 (31)
Cash used for financing activities(31) (122)
Effect of exchange rate changes on cash and cash equivalents(6) 13
13
 (7)
Net increase in cash and cash equivalents196
 56
Net increase (decrease) in cash and cash equivalents56
 (28)
Cash and cash equivalents, beginning of period263
 182
182
 239
Cash and cash equivalents, end of period$459
 $238
$238
 $211
See notes to the condensed consolidated financial statements.


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

In these notes, “we,” “us,” “our,” “Brown-Forman,” and “our”the “Company” refer to Brown-Forman Corporation.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). 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, 2017 (2017 Form 10-K). We prepared the accompanying financial statements on a basis that is substantially consistent with the accounting principles applied in our 2017 Form 10-K.

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 covered by this report. The results for interim periods are not necessarily indicative of future or annual results.

The BenRiach acquisition occurred duringWe suggest that you read these condensed financial statements together with the firstfinancial statements and footnotes included in our Annual Report on Form 10-K for the fiscal quarter of 2017 andyear ended April 30, 2018 (2018 Annual Report). Except for adopting the purchase price allocation was finalized as of June 1, 2017. There have been no material changes tonew accounting standards discussed below, we prepared the purchase price allocation.accompanying financial statements on a basis that is substantially consistent with the accounting principles applied in our 2018 Annual Report.

NewRecently adopted accounting pronouncements to be adopted.standards. InAs of May 2014,1, 2018, we adopted the following Accounting Standards Updates (ASUs) issued by the Financial Accounting Standards Board (FASB) issued a new revenue recognition standard that,:
ASU 2014-09: Revenue from Contracts with Customers. This update, codified along with various amendments issued in 2015 and 2016, will replace substantially all existingas Accounting Standards Codification Topic 606 (ASC 606), replaces previous revenue recognition guidance in U.S. GAAP.guidance. The core principle of the standardASC 606 requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration that it expects to be entitled to in exchange for those goods or services. The new standardASC 606 also requires significantly more financial statement disclosures than existingwere required by previous revenue standards do.

Therecognition standards. We applied this new standard can be adopted using either of two transition options: a full retrospective transition method orguidance on a modified retrospective method. Under the full retrospective method, the guidance would be applied to each prior reporting period presented. Under the modified retrospective method, the cumulative effect of initially applying the new guidance would be recorded as anbasis through a cumulative-effect adjustment to the opening balance ofthat reduced retained earnings for the annual reporting period that includes the dateas of initial application.

We are continuing to assess the potential impactMay 1, 2018, by $25 million (net of the new guidance on our financial statements. Based on our assessment to date, we currently expect our accountingtax). See Note 2 for certain customer incentives to be the area most likely affected by the new recognition requirements. We also expect to disclose additional information about our revenues underand the new standard. As we progress in our assessment, we are also identifyingimpact of adopting ASC 606.
ASU 2016-15: Classification of Certain Cash Receipts and preparing to make any changes to our accounting policies and practices, systems, processes, and controls that may be required to implement the new standard. We currently expect to choose the modified retrospective method in transitioning to the new standard, which we will adopt effective May 1, 2018.

We are also currently evaluating the potential impact on our financial statements of the additional new accounting pronouncements described below:
In February 2016, the FASB issued a new standard on accounting for leases. Under the new standard, 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. The standard 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. The standard, which also requires additional quantitative and qualitative disclosures about leasing arrangements, will become effective for us beginning fiscal 2020. It is to be applied using a modified retrospective transition approach for leases existing at the beginning of the earliest comparative period presented in the adoption-period financial statements.
In August 2016, the FASB issuedCash Payments. This new guidance onaddresses eight specific issues related to the classification of certain cash receipts and cash payments on the statement of cash flows. The impact of adopting the new guidance was limited to a change in our classification of cash payments for premiums on corporate-owned life insurance policies, which addresses eight specificwe previously reflected in operating activities. Under the new guidance, we classify those payments as investing activities. We retrospectively adjusted prior period cash flow classification issues, is intendedstatements to reduce diversity in practice. It will become effectiveconform to the new classification. As a result, we reclassified payments of $3 million from operating activities to investing activities for us beginning fiscal 2019 and is to be applied retrospectively.the three months ended July 31, 2017.
In October 2016, the FASB issued
ASU 2016-16: Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory. This revised guidance that requires the recognition of the income tax consequences (expense or benefit) of an intercompany transfer of assets other than inventory when the transfer occurs. It maintains


the existing requirement to defer the recognition of the income tax consequences of an intercompany transfer of inventory until the inventory is sold to an outside party. TheWe applied the guidance will become effective for us beginning fiscal 2019 and is to be applied on a modified retrospective basis through a cumulative-effect adjustment directly tothat increased retained earnings as of May 1, 2018, by $20 million.
ASU 2017-04: Simplifying the beginning of the period of adoption.
In January 2017, the FASB issuedTest for Goodwill Impairment. This updated guidance that eliminates the second step of the existingprevious two-step quantitative test of goodwill for impairment. Under the new guidance, the quantitative test will consistconsists of a single step in which the carrying amount of the reporting unit will beis compared to its fair value. An impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the amount of the impairment would be limited to the total amount of goodwill allocated to the reporting unit. The guidance does not affect the existing option to perform the qualitative assessment for a reporting unit to determine whether the quantitative impairment test is necessary. It will become effective for us beginning fiscal 2021The prospective adoption of the new standard had no impact on our consolidated financial statements.
ASU 2017-07: Improving the Presentation of Net Periodic Pension Cost and is to be applied prospectively.
In March 2017, the FASB issuedNet Periodic Postretirement Benefit Cost. This new guidance foraddresses the presentation of the net periodic cost (NPC) associated with pension and other postretirement benefit plans. The guidance requires the service cost component of the NPC to be reported in the


income statement in the same line item(s) as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of the NPC are to be presented separately from the service cost and outside of income from operations. In addition, the guidance allows only the service cost component of NPC to be eligible for capitalization when applicable. TheWe applied the guidance will become effective for us beginning fiscal 2019. It is to be applied retrospectively for the presentation in the income statement and prospectively on and after the effective date, for the capitalization of service cost. The retrospective application increased previously-reported operating income by $2 million for the three months ended July 31, 2017. As the retrospective application merely reclassified amounts from operating income to non-operating expense, there was no effect on previously-reported net income or earnings per share.

Early applicationNew accounting standards to be adopted. The FASB has issued the ASUs described below that we are not required to adopt until May 1, 2019 (although early adoption is permitted). We are currently evaluating their potential impact on our financial statements.
ASU 2016-02: Leases. This update, codified along with various amendments as Accounting Standards Codification Topic 842 (ASC 842), replaces existing 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 any12 months or less. It also requires additional quantitative and qualitative disclosures about leasing arrangements. We will adopt ASC 842 as of May 1, 2019, using a modified retrospective transition approach for leases existing at that date.
ASU 2017-12: Targeted Improvements to Accounting for Hedging Activities. This new guidance is intended to better align hedge accounting with an entity’s risk management activities and improve disclosures about hedges. The guidance expands hedge accounting for financial and nonfinancial risk components, eliminates the new accounting pronouncements described aboverequirement to separately measure and report hedge ineffectiveness, simplifies the way assessments of hedge effectiveness may be performed, and amends some presentation and disclosure requirements for hedges. It is permitted. Although weto be applied using a modified retrospective transition approach for cash flow and net investment hedges existing at the date of adoption. The amended presentation and disclosure guidance is required only prospectively. We have not yet determined our plans for adoption, we do not currently expect to apply anybut are considering the possibility of theadopting this new guidance before their effective dates.the required adoption date.
ASU 2018-02: Reclassification of Certain Effects from Accumulated Other Comprehensive Income. This new guidance would allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act enacted by the U.S. government in December 2017. It is to be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. We have not yet determined our plans for adoption, but are considering the possibility of adopting this new guidance before the required adoption date.

There are no other new accounting standards to be adopted that we currently believe might have a significant impact on our consolidated financial statements.

Reclassifications. We have reclassified some previously reported expense amounts related to certain marketing research and promotional agency costs to conform to the current year classification. These immaterial reclassifications between advertising expenses and selling, general, and administrative expenses had no impact on net income.

2.    InventoriesNet Sales 
Effective May 1, 2018, we updated our policy for recognizing revenue (“net sales”) to reflect the adoption of ASC 606. We describe the updated policy below. Also, we show how the adoption impacted our financial statements and we present disaggregated net sales information in accordance with the new standard.

InventoriesRevenue recognition policy. Our net sales predominantly reflect global sales of beverage alcohol consumer products. We sell these products under contracts with different types of customers, depending on the market. The customer is most often a distributor, wholesaler, or retailer.
Each contract typically includes a single performance obligation to transfer control of the products to the customer. Depending on the contract, control is transferred when the products are valuedeither shipped or delivered to the customer, at which point we recognize the lowertransaction price for those products as net sales. The transaction price recognized at that point reflects our estimate of the consideration to be received in exchange for the products. The actual amount may ultimately differ due to the effect of various customer incentives and trade promotion activities. In making our estimates, we consider our historical


experience and current expectations, as applicable. Adjustments recognized during the three months ended July 31, 2018, for changes in estimated transaction prices of products sold in prior periods were not material.
Net sales exclude taxes we collect from customers that are imposed by the government on our sales, and are reduced by payments to customers unless made in exchange for distinct goods or services with fair values approximating the payments.
Net sales include any amounts we bill customers for shipping and handling activities related to the products. We recognize the cost of those activities in cost of sales during the same period in which we recognize the related net sales.
Sales returns, which are permitted only in limited situations, are not material.
Customer payment terms generally range from 30 to 90 days. There are no significant amounts of contract assets or market. Someliabilities.

Impact of adoption. We adopted ASC 606 using the modified retrospective method. As a result, we recorded an adjustment that decreased retained earnings as of May 1, 2018, by $25 million (net of tax). The adjustment reflects the cumulative effect on that date of applying our updated revenue recognition policy, under which we recognize the cost of certain customer incentives earlier than we did before adopting ASC 606. Although we do not expect this change in timing to have a significant impact on a full-year basis, we do anticipate some change in the pattern of recognition among fiscal quarters. Additionally, some payments to customers that we classified as expenses before adopting the new standard are classified as reductions of net sales under our new policy.
The following table shows how the adoption of ASC 606 impacted our consolidated inventories are valued using the last-in, first-out (LIFO) method, which we usestatement of operations for the majoritythree months ended July 31, 2018:
 Three Months Ended July 31, 2018
 Under Prior As Reported Under Effect of
(Dollars in millions, except per share amounts)Guidance ASC 606 Adoption
Sales$997
 $987
 $(10)
Excise taxes221
 221
 
Net sales776
 766
 (10)
Cost of sales243
 243
 
Gross profit533
 523
 (10)
Advertising expenses101
 98
 (3)
Selling, general, and administrative expenses169
 168
 (1)
Other expense (income), net(7) (7) 
Operating income270
 264
 (6)
Non-operating postretirement expense2
 2
 
Interest income(2) (2) 
Interest expense22
 22
 
Income before income taxes248
 242
 (6)
Income taxes44
 42
 (2)
Net income$204
 $200
 $(4)
Earnings per share:     
Basic$0.43
 $0.42
 $(0.01)
Diluted$0.42
 $0.41
 $(0.01)


The following table shows how the adoption of ASC 606 impacted our U.S. inventories. If the LIFO method had not been used, inventories at current cost would have been $272 million higher than reportedconsolidated balance sheet as of April 30, 2017, and $278 million higher than reported as of July 31, 20172018:
 As of July 31, 2018
 Under Prior As Reported Under Effect of
(Dollars in millions)Guidance ASC 606 Adoption
Assets    

Other current assets$307
 $305
 $(2)
Deferred tax assets15
 16
 1
Total assets5,026
 5,025
 (1)
      
Liabilities    

Accounts payable and accrued expenses$527
 $564
 $37
Accrued income taxes53
 52
 (1)
Deferred tax liabilities127
 119
 (8)
Total liabilities3,629
 3,657
 28
     

Stockholders’ Equity    

Retained earnings$1,796
 $1,767
 $(29)
Total stockholders’ equity1,397
 1,368
 (29)

Disaggregated revenues.
The following table shows our net sales by geography:
 Three Months Ended
 July 31,
(Dollars in millions, except per share amounts)2017 2018
United States$355
 $357
Developed International1
193
 215
Emerging2
123
 131
Travel Retail3
30
 38
Non-branded and bulk4
22
 25
Total$723
 $766
1. ChangesRepresents 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, and Germany.
2Represents sales of branded products to “emerging and developing economies” as defined by the IMF. Our largest emerging markets are Mexico and Poland.
3Represents sales of branded products to global duty-free customers, travel retail customers, and the U.S. military regardless of customer location.
4Includes 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, except per share amounts)2017 2018
Whiskey1
$557
 $602
Tequila2
58
 62
Vodka3
31
 26
Wine4
42
 40
Rest of portfolio13
 11
Non-branded and bulk5
22
 25
Total$723
 $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 LIFO valuation reserve for interim periods are based on a proportionate allocationJack Daniel's family of the estimated change for the entire fiscal year.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 sales of used barrels, bulk whiskey and wine, and contract bottling regardless of customer location.

3.    Income Taxes
Our consolidated interim effective tax rate is based upon our expected annual operating income, statutory tax rates, and income tax laws in the various jurisdictions in which we operate. Significant or unusual items, including adjustments to accruals for tax uncertainties, are recognized in the quarter in which the related event or a change in judgment occurs. The effective tax rate of 22.1%17.4% for the three months ended July 31, 2017,2018, is lower than the expected tax rate of 29.0%21.1% on ordinary income for the full fiscal year, primarily due to (a) a reduction inthe impact of the current year adjustment to the provisional repatriation U.S. tax for certain prior years on foreign exchange gains in non-U.S. entities due to a change in method of accounting for U.S. tax purposes,charge that was made during fiscal 2018 (discussed below) and (b) the excess tax benefits related to stock-based compensation. Our expected tax rate includes current fiscal year additions for existing tax contingency items.

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (Tax Act). The Tax Act significantly revised the future ongoing U.S. corporate income tax by, among other things, lowering U.S. corporate income tax rates and implementing a territorial tax system. As we have an April 30 fiscal year-end, the lower corporate income tax rate was phased in, resulting in a U.S. statutory federal rate of 30.4% for our fiscal year ended April 30, 2018, and 21% for our current and subsequent fiscal years. For the quarter ended July 31, 2018, the impact of the lower tax rate resulted in a tax benefit of approximately $27 million. With the enactment of the Tax Act, we continue to evaluate our global working capital requirements and may change our current permanent reinvestment assertion in future periods.

There are also certain transitional impacts of the Tax Act. As part of the transition to the new territorial tax system, the Tax Act imposed a one-time repatriation tax on deemed repatriation of historical earnings of foreign subsidiaries. In addition, the reduction of the U.S. corporate tax rate caused us to adjust our U.S. deferred tax assets and liabilities to the lower federal base rate of 21%. These transitional impacts resulted in a provisional net charge of $43 million for the year ended April 30, 2018, comprised of a provisional repatriation U.S. tax charge of $91 million and a provisional net deferred tax benefit of $48 million. In the quarter ended July 31, 2018, we recorded a provisional benefit of $6 million as an adjustment to the provisional repatriation charge.

The Tax Act also established new tax laws that impact our financial statements beginning in the current fiscal year. These new laws include, but are not limited to (a) Global Intangible Low-Tax Income (GILTI), a new provision for tax on low-tax foreign earnings; (b) Base Erosion Anti-abuse Tax (BEAT), a new minimum tax; (c) Foreign-Derived Intangible Income (FDII), a new provision for deductions related to foreign-derived intangibles; (d) repeal of the domestic production activity deduction; and (e) limitations on certain executive compensation. For the quarter ended July 31, 2018, the net impact of these provisions was approximately $2 million of additional tax.



As noted, certain income earned by foreign subsidiaries must be included in U.S. taxable income under the GILTI provisions. The FASB allows an accounting policy election of either recognizing deferred taxes for temporary differences expected to reverse as GILTI in future years or recognizing such taxes as a current period expense when incurred. We have elected to recognize these taxes as a current period expense when incurred.
The changes included in the Tax Act are broad and complex. The final transition impacts of the Tax Act may differ from the current estimates, due to, among other things, changes in interpretations of the Tax Act, any legislative action to address questions that arise because of the Tax Act, any changes in accounting standards for income taxes or related interpretations in response to the Tax Act, or any updates or changes to estimates we have used to calculate the transition impacts, including impacts from changes to current year earnings estimates and foreign currency exchange rates. The SEC has issued rules that allow for a measurement period of up to one year after the enactment date of the Tax Act to finalize the recording of the related tax impacts. As of July 31, 2018, the amounts recorded for the Tax Act remain provisional for the one-time repatriation tax and the adjustment to our U.S. deferred tax assets and liabilities. We will finalize and record any additional adjustments within the allowed measurement period.

4.    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).



The following table presents information concerning basic and diluted earnings per share:
Three Months EndedThree Months Ended
July 31,July 31,
(Dollars in millions, except per share amounts)2016 20172017 2018
Net income available to common stockholders$144
 $178
$178
 $200
   
Share data (in thousands):      
Basic average common shares outstanding393,018
 384,038
480,048
 480,964
Dilutive effect of stock-based awards2,991
 2,349
2,936
 3,477
Diluted average common shares outstanding396,009
 386,387
482,984
 484,441
      
Basic earnings per share$0.37
 $0.46
$0.37
 $0.42
Diluted earnings per share$0.36
 $0.46
$0.37
 $0.41

We excluded common stock-based awards for approximately 1,173,0001,719,000 shares and 1,375,000100,000 shares from the calculation of diluted earnings per share for the three months ended July 31, 20162017 and 2017,2018, respectively. We excluded those awards because they were not dilutive for those periods under the treasury stock method.

5.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 $290 million higher than reported as of April 30, 2018, and $295 million higher than reported as of July 31, 2018. Changes in the LIFO valuation reserve for interim periods are based on a proportionate allocation of the estimated change for the entire fiscal year.



6.    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, 2018:
(Dollars in millions)Goodwill 
Other Intangible Assets
Balance at April 30, 2018$763
 $670
Foreign currency translation adjustment(8) (12)
Balance at July 31, 2018$755
 $658

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

7.    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 are recorded as of July 31, 2017.2018.

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 $11$10 million (subject to changes in foreign currency exchange rates). Both the fair value and carrying amount of the guaranty are insignificant.

As of July 31, 2017,2018, our actual exposure under the guaranty of the importer’s obligation is approximately $5$4 million. We also have accounts receivable from that importer of approximately $4$6 million at July 31, 2017,2018, 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.

6.8.    Debt
Our long-term debt (net of unamortized discount and issuance costs) consists of:
(Principal and carrying amounts in millions)April 30,
2017
 July 31,
2017
1.00% notes, $250 principal amount, due January 15, 2018$249
 $250
2.25% notes, $250 principal amount, due January 15, 2023248
 248
1.20% notes, €300 principal amount, due July 7, 2026324
 350
2.60% notes, £300 principal amount, due July 7, 2028383
 388
3.75% notes, $250 principal amount, due January 15, 2043248
 248
4.50% notes, $500 principal amount, due July 15, 2045486
 486
 1,938
 1,970
Less current portion249
 250
 $1,689
 $1,720


(Principal and carrying amounts in millions)April 30,
2018
 July 31,
2018
2.25% senior notes, $250 principal amount, due January 15, 2023$248
 $248
3.50% senior notes, $300 principal amount, due April 15, 2025296
 296
1.20% senior notes, €300 principal amount, due July 7, 2026361
 349
2.60% senior notes, £300 principal amount, due July 7, 2028408
 389
4.00% senior notes, $300 principal amount, due April 15, 2038293
 293
3.75% senior notes, $250 principal amount, due January 15, 2043248
 248
4.50% senior notes, $500 principal amount, due July 15, 2045487
 487
 $2,341
 $2,310
As of April 30, 2017,2018, our short-term borrowings consisted of $211 million included $208$215 million of commercial paper, with an average interest rate of 1.04%2.04%, and aan average remaining maturity of 2223 days. As of July 31, 2017,2018, our short-term borrowings of $258$176 million included $253$161 million of commercial paper, with an average interest rate of 1.29%2.17%, and aan average remaining maturity of 1720 days.


7.9.    Pension and Other Postretirement BenefitsFair Value Measurements
The following table showssummarizes the components of the pensionassets and other postretirement benefit cost recognized for our U.S. benefit plans. Information about similar international plans is not presented due to immateriality.liabilities measured or disclosed at fair value on a recurring basis:
 Three Months Ended
 July 31,
(Dollars in millions)2016 2017
Pension Benefits:
   
Service cost$6
 $6
Interest cost9
 8
Expected return on plan assets(10) (10)
Amortization of net actuarial loss6
 5
Net cost$11
 $9
    
Other Postretirement Benefits:
   
Interest cost$1
 $1
Amortization of prior service cost (credit)(1) (1)
Net cost$
 $
 April 30, 2018 July 31, 2018
 Carrying Fair Carrying Fair
(Dollars in millions)Amount Value Amount Value
Assets       
Cash and cash equivalents$239
 $239
 $211
 $211
Currency derivatives1
 1
 5
 5
Liabilities       
Currency derivatives39
 39
 7
 7
Short-term borrowings215
 215
 176
 176
Long-term debt2,341
 2,386
 2,310
 2,347

8.    Fair Value Measurements
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 that are supported by little or no market activity.


The following table summarizes the assets and liabilities measured or disclosed at fair value on a recurring basis:
(Dollars in millions) Level 1
 Level 2
 Level 3
 Total
April 30, 2017:        
Assets:        
Currency derivatives $
 $25
 $
 $25
Liabilities:        
Currency derivatives 
 10
 
 10
Short-term borrowings 
 211
 
 211
Current portion of long-term debt 
 249
 
 249
Long-term debt 
 1,752
 
 1,752
July 31, 2017:        
Assets:        
Currency derivatives 
 9
 
 9
Liabilities:        
Currency derivatives 
 28
 
 28
Short-term borrowings 
 258
 
 258
Current portion of long-term debt 
 250
 
 250
Long-term debt 
 1,792
 
 1,792

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 rates, forward rates, and discount rates. The discount rates are based on the historical U.S. Treasury rates. These fair value measurements are categorized as Level 2 within the valuation hierarchy.

The fair value of short-term borrowings approximates their carrying amount. We determine the fair value of long-term debt primarily based on the prices at which 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.

9.    Fair Value of Financial Instruments
The fair value of cash, cash equivalents, and short-term borrowings approximate the carrying amounts due to the short maturities of these instruments. We determine the fair value of currency derivatives and long-term debt as discussed in Note 8. 

Below is a comparison of the fair values and carrying amounts of these instruments:
 April 30, 2017 July 31, 2017
 Carrying Fair Carrying Fair
(Dollars in millions)Amount Value Amount Value
Assets:       
Cash and cash equivalents$182
 $182
 $238
 $238
Currency derivatives25
 25
 9
 9
Liabilities:       
Currency derivatives10
 10
 28
 28
Short-term borrowings211
 211
 258
 258
Current portion of long-term debt249
 249
 250
 250
Long-term debt1,689
 1,752
 1,720
 1,792


10.    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 (except any ineffective portion) in accumulated other comprehensive income (AOCI) until the underlying hedged transaction occurs, at which time we reclassify that amount into earnings. We assess the effectiveness of these hedges based on changes in forward exchange rates. The ineffective portion


of the changes in fair value of our hedges (recognized immediately in earnings) during the periods presented in this report was not material.

We had outstanding currency derivatives, related primarily to our euro, British pound, and Australian dollar exposures, with notional amounts totaling $1,188$1,098 million at April 30, 20172018 and $1,225$1,203 million at July 31, 2017.2018.

During fiscal 2017, we used some currency derivative forward contracts andWe also use foreign currency-denominated long-term debt to help manage our currency exchange risk. As of July 31, 2018, $606 million of our foreign currency-denominated debt instruments were designated as after-taxnet investment hedges. These net investment hedges of ourare 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. As of July 31, 2017, $526 million of our foreign currency-denominated debt was designated as a net investment hedge. Our net investment hedges are intended to mitigate foreign exchange exposure related to non-U.S. dollar net investments in certain foreign subsidiaries against changes in foreign exchange rates. There was no ineffectiveness related to our net investment hedges.hedges in any of the periods presented.

We do not designate some of our currency derivatives and foreign currency-denominated debt 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 instruments in earnings.

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.

The following tables present 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 Three Months Ended
 July 31, July 31,
(Dollars in millions)Classification2016 2017Classification2017 2018
Derivative Instruments        
Currency derivatives designated as cash flow hedges:  
  
  
  
Net gain (loss) recognized in AOCIn/a$29
 $(36)n/a$(36) $27
Net gain (loss) reclassified from AOCI into earningsNet sales10
 2
Sales2
 (2)
Currency derivatives designated as net investment hedge:    
Net gain (loss) recognized in AOCIn/a8
 
Currency derivatives not designated as hedging instruments:  
  
  
  
Net gain (loss) recognized in earningsNet sales1
 (3)Sales(3) 3
Net gain (loss) recognized in earningsOther income(5) 9
Other income9
 3
Non-Derivative Hedging Instruments        
Foreign currency-denominated debt designated as net investment hedge:        
Net gain (loss) recognized in AOCIn/a(10) (16)n/a(16) 28
Foreign currency-denominated debt not designated as hedging instrument:        
Net gain (loss) recognized in earningsOther income(1) (16)Other income(16) 4

We expect to reclassify $10$2 million of deferred net losses on cash flow hedges recorded in AOCI as of July 31, 2017,2018, 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, 2017,2018, the maximum term of our outstanding derivative contracts was 36 months.



The following table presents the fair values of our derivative instruments:

(Dollars in millions)


Classification
 
Fair value of derivatives in a gain position
 
Fair value of derivatives in a
loss position


Classification
 
Fair value of derivatives in a gain position
 
Fair value of derivatives in a
loss position
April 30, 2017:    
April 30, 2018    
Designated as cash flow hedges:        
Currency derivativesOther current assets $21
 $(2)Other current assets $2
 $(2)
Currency derivativesOther assets 9
 (4)Other assets 1
 
Currency derivativesAccrued expenses 2
 (8)Accrued expenses 4
 (23)
Currency derivativesOther liabilities 1
 (4)Other liabilities 2
 (18)
Not designated as hedges:        
Currency derivativesOther current assets 2
 (1)Other current assets 
 
Currency derivativesAccrued expenses 
 (1)Accrued expenses 1
 (5)
July 31, 2017:    
July 31, 2018    
Designated as cash flow hedges:        
Currency derivativesOther current assets 8
 (7)Other current assets 5
 (3)
Currency derivativesOther assets 2
 (1)Other assets 7
 (5)
Currency derivativesAccrued expenses 5
 (17)Accrued expenses 4
 (9)
Currency derivativesOther liabilities 3
 (22)Other liabilities 1
 (2)
Not designated as hedges:        
Currency derivativesOther current assets 7
 
Other current assets 1
 
Currency derivativesAccrued expenses 4
 (1)Accrued expenses 
 (1)

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 that are subject to net settlement agreements are presented on a net basis in our balance sheets on a net basis.sheets.

In our statement 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 are regularly monitored, 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 creditworthiness requirements that were in a net liability position was $9$38 million at April 30, 20172018 and $26$6 million at July 31, 20172018.

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 the balance sheet. Similarly, we present the


fair values of noncurrent derivatives with the same counterparty on a net basis. Current derivatives are not netted with noncurrent derivatives in the balance sheet.



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
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, 2017:         
April 30, 2018         
Derivative assets$35
 $(10) $25
 $(1) $24
$10
 $(9) $1
 $(1) $
Derivative liabilities(20) 10
 (10) 1
 (9)(48) 9
 (39) 1
 (38)
July 31, 2017:         
July 31, 2018         
Derivative assets29
 (20) 9
 (2) 7
18
 (13) 5
 (1) 4
Derivative liabilities(48) 20
 (28) 2
 (26)(20) 13
 (7) 1
 (6)

No cash collateral was received or pledged related to our derivative contracts as of April 30, 20172018 or July 31, 20172018.

11.    GoodwillPension and Other Intangible AssetsPostretirement Benefits
The following table summarizesshows the changes in goodwillcomponents of the net cost of pension and other intangible assets during the three months ended July 31, 2017:postretirement benefits recognized for our U.S. benefit plans. Information about similar international plans is not presented due to immateriality.
(Dollars in millions)Goodwill 
Other Intangible Assets
Balance at April 30, 2017$753
 $641
Foreign currency translation adjustment2
 20
Balance at July 31, 2017$755
 $661
 Three Months Ended
 July 31,
(Dollars in millions)2017 2018
Pension Benefits:
   
Service cost$6
 $6
Interest cost7
 9
Expected return on plan assets(10) (12)
Amortization of net actuarial loss5
 5
Net cost$8
 $8
    
Other Postretirement Benefits:
   
Interest cost$1
 $1
Amortization of prior service cost (credit)(1) (1)
Net cost$
 $

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

12.    Stockholders’ Equity
The following table summarizesshows the changes in stockholders’ equity during the three months ended July 31, 2017:2018:
(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, 2017$25
 $43
 $65
 $4,470
 $(390) $(2,843) $1,370
Retirement of treasury stock  (10) (8) (2,684)   2,702
 
Net income      178
     178
Net other comprehensive income (loss)        14
   14
Cash dividends      (140)     (140)
Acquisition of treasury stock          (1) (1)
Stock-based compensation expense    4
       4
Stock issued under compensation plans          9
 9
Loss on issuance of treasury stock issued under compensation plans    (14) 
     (14)
Balance at July 31, 2017$25
 $33
 $47
 $1,824
 $(376) $(133) $1,420

Retirement of Treasury Stock. On May 24, 2017, we retired 67,000,000 shares of Class B common stock previously held as treasury shares. This retirement reduced the number of issued shares of Class B common stock by that same amount.


(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 (Note 1)      (5)     (5)
Net income      200
     200
Net other comprehensive income (loss)        14
   14
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

Dividends. The following table summarizesshows the cash dividends declared per share on our Class A and Class B common stock during the three months ended July 31, 2017:2018:
Declaration Date Record Date Payable Date Amount per Share
May 24, 20172018 June 5, 20176, 2018 July 3, 20172018 $0.18250.158
July 27, 201726, 2018 September 7, 20176, 2018 October 2, 20171, 2018 $0.18250.158

Accumulated Other Comprehensive Income.other comprehensive income. The following table summarizesshows the changeschange in each component of AOCI, net of tax, during the three months ended July 31, 2017:2018:
(Dollars in millions)
Currency Translation Adjustments
 
Cash Flow Hedge Adjustments
 
Postretirement Benefits Adjustments
 Total AOCI
Currency Translation Adjustments
 
Cash Flow Hedge Adjustments
 
Postretirement Benefits Adjustments
 Total AOCI
Balance at April 30, 2017$(204) $11
 $(197) $(390)
Balance at April 30, 2018$(180) $(17) $(181) $(378)
Net other comprehensive income (loss)34
 (23) 3
 14
(12) 23
 3
 14
Balance at July 31, 2017$(170) $(12) $(194) $(376)
Balance at July 31, 2018$(192) $6
 $(178) $(364)



13.    Other Comprehensive Income
The following tables presenttable shows the components of net other comprehensive income (loss):
Three Months Ended Three Months EndedThree Months Ended Three Months Ended
July 31, 2016 July 31, 2017July 31, 2017 July 31, 2018
(Dollars in millions)Pre-Tax Tax Net Pre-Tax Tax NetPre-Tax Tax Net Pre-Tax Tax Net
Currency translation adjustments:                      
Net gain (loss) on currency translation$(68) $1
 $(67) $28
 $6
 $34
$28
 $6
 $34
 $(5) $(7) $(12)
Reclassification to earnings
 
 
 
 
 

 
 
 
 
 
Other comprehensive income (loss), net(68) 1
 (67) 28
 6
 34
28
 6
 34
 (5) (7) (12)
Cash flow hedge adjustments:                      
Net gain (loss) on hedging instruments29
 (11) 18
 (36) 14
 (22)(36) 14
 (22) 27
 (6) 21
Reclassification to earnings1
(10) 4
 (6) (2) 1
 (1)(2) 1
 (1) 2
 
 2
Other comprehensive income (loss), net19
 (7) 12
 (38) 15
 (23)(38) 15
 (23) 29
 (6) 23
Postretirement benefits adjustments:                      
Net actuarial gain (loss) and prior service cost
 
 
 1
 
 1
1
 
 1
 
 
 
Reclassification to earnings2
5
 (2) 3
 4
 (2) 2
4
 (2) 2
 4
 (1) 3
Other comprehensive income (loss), net5
 (2) 3
 5
 (2) 3
5
 (2) 3
 4
 (1) 3
                      
Total other comprehensive income (loss), net$(44) $(8) $(52) $(5) $19
 $14
$(5) $19
 $14
 $28
 $(14) $14
1Pre-tax amount is classified as net sales in the accompanying condensed consolidated statements of operations.
2Pre-tax amount is a componentclassified as non-operating postretirement expense in the accompanying condensed consolidated statements of pension and other postretirement benefit expense (as shown in Note 7, except for amounts related to non-U.S. benefit plans, about which no information is presented in Note 7 due to immateriality).operations.



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 20172018 Form 10-K. Note that the results of operations for the three months ended July 31, 20172018 do not necessarily indicate what our operating results for the full fiscal year will be. In this Item, “we,” “us,” “our,” “Brown-Forman,” and “our”the “Company” refer to Brown-Forman Corporation.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 income statement measures.We present changes in certain income statement measures, or line items, that are adjusted to an “underlying” basis. We use “underlying change” for the following income statement measures: (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), (g) underlying operating expenses1, and (h) underlying operating income. To calculate these measures, we adjust, as applicable, for (a) new accounting standard, (b) foreign exchange, and (c) estimated net changes in distributor inventories. We explain these adjustments below.
“New accounting standard.” Under ASC 606 (Revenue from Contracts with Customers), we recognize the cost of certain customer incentives earlier than we did before adopting ASC 606. Although we do not expect this change in timing to have a significant impact on a full-year basis, we do anticipate some change in the pattern of recognition among fiscal quarters. Additionally, some payments to customers that we classified as expenses before adopting the new standard are classified as reductions of net sales under our new policy. See Note 2 to the accompanying financial statements for additional information. This adjustment allows us to look at underlying change on a comparable basis.
“Foreign exchange.” We calculate the percentage change in our income statement line items 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 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 our income statement line items. For each period compared, we use volume information from our distributors to estimate the effect of distributor inventory changes on our income statement line items. We believe that this adjustment reduces the effect of varying levels of distributor inventories on changes in our measures and allows us to understand better our underlying results and trends.
We use the non-GAAP measures “underlying change” for the following reasons: (a) to understand our performance from period to period on a consistent basis; (b) to compare our performance to that of our competitors; (c) in connection with management incentive compensation calculations; (d) in our planning and forecasting processes; and (e) in communications concerning our financial performance with the board of directors, stockholders, and investment analysts. We provide reconciliations of the “underlying changes in income statement measures” to their nearest GAAP measures in the tables below under “Results of Operations - Year-Over-Year Period Comparisons.” We have consistently applied the adjustments within our reconciliations in arriving at each non-GAAP measure.

Volume


1Operating expenses include advertising expense, SG&A expense, and Depletionsother expense (income), net.
When discussing volume, unless otherwise specified,

Definitions
Aggregations.
From time to time, to explain our results of operations or to highlight trends and uncertainties affecting our business, we referaggregate markets according to “depletions,stage of economic development as defined by the International Monetary Fund (IMF) and we aggregate brands by spirits category. Below, we define aggregations used in this report.
Geographic Aggregations.
In “Results of Operations - Fiscal 2019 Year-to-Date Highlights”, we provide supplemental information for our largest markets ranked by percentage of total fiscal 2018 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, and Germany. This aggregation represents our 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 and Poland. This aggregation represents our sales of branded products to these markets.
“Travel Retail” represents our sales of branded products to global duty-free customers, travel retail customers, and the U.S. military regardless of customer location.
“Non-branded and bulk” includes our sales of used barrels, bulk whiskey and wine, and contract bottling regardless of customer location.
Brand Aggregations.
In “Results of Operations - Fiscal 2019 Year-to-Date Highlights”, we provide supplemental information for our largest brands ranked by percentage of total fiscal 2018 net sales. In addition to brands that are listed by name, we include the following aggregations:
“Whiskey” products include 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.
“American whiskey” products include the Jack Daniel’s family of brands, premium bourbons, and Early Times.
“Jack Daniel’s family of brands” includes Jack Daniel’s Tennessee Whiskey (JDTW), Jack Daniel’s RTD and RTP products (JD RTDs/RTP), Jack Daniel’s Tennessee Honey (JDTH), Gentleman Jack, Jack Daniel’s Tennessee Fire (JDTF), Jack Daniel’s Single Barrel Collection, 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 bourbon” products include Woodford Reserve, Old Forester, and Coopers’ Craft.
“Tequila” products include el Jimador, Herradura, New Mix, Pepe Lopez, and Antiguo.
“Vodka” products include Finlandia.
“Wine” products include Korbel Champagne and Sonoma-Cutrer wines.
“Non-branded and bulk” includes our sales of used barrels, bulk whiskey and wine, and contract bottling regardless of customer location.



Other Metrics.
“Depletions.We generally record revenues when we ship our products to our customers. Depending on our route-to-consumer (RTC), we ship products to either (a) retail or wholesale customers in owned distribution markets or (b) our distributor customers in other markets. “Depletions” is a term commonly used in the beverage alcohol industry.industry to describe volume. Depending on the context, “depletions” means either (a) our shipments directly to retailersretail or wholesalers,wholesale customers for owned distribution markets or (b) shipments from our distributor customers to retailers and wholesalers. We generally record revenues when we ship our products to our customers, so our reported sales for a period do not necessarily reflect actual consumer purchases during that period.wholesalers in other markets. We believe that our 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.
“Drinks-equivalent.”Volume is discussed on a nine-liter equivalent unit basis (nine-liter cases) unless otherwise specified. At times, we use a “drinks-equivalent” measure for volume when comparing single-serve ready-to-drink (RTD) or ready-to-pour (RTP) brands to a parent spirits brand. “Drinks-equivalent” depletions are RTD and RTP nine-liter cases converted to nine-liter cases of a parent brand on the basis of the number of drinks in one nine-liter case of the parent brand. To convert RTD volumes from a nine-liter case basis to a drinks-equivalent nine-liter case basis, RTD nine-liter case volumes are divided by 10, while RTP nine-liter case volumes are divided by 5.
Non-GAAP Financial Measures
We use certain financial measures in this report that are not measures of financial performance under 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. The non-GAAP measures we use in this report may not be defined and calculated by other companies in the same manner.
“Underlying change” in income statement measures.We present changes in certain income statement measures, or line items, that are adjusted to an “underlying” basis. We use “underlying change” for the following income statement measures: (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), (g) underlying operating expenses, and (h) underlying operating income. To calculate these measures, we adjust, as applicable, for (a) acquisitions and divestitures, (b) foreign exchange, and (c) estimated net changes in distributor inventories. We explain these adjustments below.
“Acquisitions and divestitures.” In fiscal 2016, we sold our Southern Comfort and Tuaca brands and related assets to Sazerac Company, Inc. and entered into a related transition services agreement (TSA). During fiscal 2017, we completed our obligations under the TSA. This adjustment removes the net sales and operating expenses recognized in fiscal 2017 pursuant to the TSA related to (a) contract bottling services and (b) distribution services in certain markets. On June 1, 2017, we acquired The BenRiach Distillery Company Limited (BenRiach). This adjustment removes (a) transaction and integration costs related to the acquisition and (b) operating activity for the acquisition for the non-comparable period. For both fiscal 2017 and 2018, the non-comparable period is the month of May.
Foreign exchange.Consumer takeaway. We calculateWhen discussing trends in the percentage changemarket, we refer to “consumer takeaway,” a term commonly used in our income statement line items 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.
“Estimated net change in distributor inventories.” This adjustmentbeverage alcohol industry. “Consumer takeaway” refers to the estimated net effectpurchase of product by the consumer from a retail outlet 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 distributor inventories on changes in our income statement line items. For each period compared, we use depletion information provided by our distributors to estimatemarket share are derived from consumer takeaway data using the effect of distributor inventory changes on our income statement line items.retail sales value metric.
We use the non-GAAP measures “underlying change” for the following reasons: (a) to understand
Reclassifications
As discussed in Note 1, we retrospectively adjusted our performance from period to period on a consistent basis and to compare our performance to that of our competitors; (b)prior year income statements in connection with management incentive compensation calculations; (c) in our planningthe adoption of ASU 2017-07 and forecasting processes;the reclassification of some previously reported expense amounts related to certain marketing research and (d) in communications concerning ourpromotional agency costs. The impact of these reclassifications, which had no effect on net income, was not material.
The following table reconciles the previously reported income statement amounts to the currently reported amounts for the three months ended July 31, 2017.
 Three Months Ended July 31, 2017
 Previously Adoption of   Currently
(Dollars in millions)Reported ASU 2017-07 Reclassifications Reported
Net sales$723
     $723
Cost of sales230
     230
Gross profit493
 
 
 493
Advertising expenses89
   (2) 87
Selling, general, and administrative expenses161
 (2) 2
 161
Other expense (income), net(1)     (1)
Operating income244
 2
 
 246
Non-operating postretirement expense
 2
   2
Interest income(1)     (1)
Interest expense16
     16
Income before income taxes229
 
 
 229
Income taxes51
     51
Net income$178
 $
 $
 $178


financial performance with the board of directors, stockholders, and investment analysts. We provide reconciliations of the “underlying changes in income statement measures” to their nearest GAAP measures in the tables below under “Results of Operations - Year-Over-Year Period Comparisons.” We have consistently applied the adjustments within our reconciliations in arriving at each non-GAAP measure.
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 identifyindicate 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 20172018 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;sanctions, including potential retaliatory tariffs on American spirits and the effectiveness of our actions to mitigate the potential negative impact on our 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 (for example, LIFO, foreign income deferral, U.S. manufacturing, and other deductions) or accounting standards, and the unpredictability and suddenness with which they can occur
The impact of the recently enacted U.S. tax reform legislation, including as a result of future regulations 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 smallersmall 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 products 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
Route-to-consumer changes that affect the timing of our sales, temporarily disrupt the marketing or sale of our products, or result in higher implementation-related or 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, or termination difficulties or costs, or impairment in recorded value
Inadequate protection of our intellectual property rights
Product recalls or other product liability claims;claims, product counterfeiting, tampering, contamination, or product quality issues
Significant legal disputes and proceedings;proceedings, or government investigations (particularly of industry or company business, trade or marketing practices)
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


Overview
Tariffs
In response to new U.S. tariffs on certain foreign goods, the European Union, Mexico, Canada, Turkey, and China imposed retaliatory tariffs on a number of U.S. goods, including American whiskey. The effective dates of the retaliatory tariffs and the import duty rates before and after the retaliation are summarized below.
Summary of Retaliatory Tariffs
    Rate 
Geographic Area Effective Date Before
After
 
European Union June 22, 2018 %25% 
Mexico June 5, 2018 %25% 
Canada July 1, 2018 %10% 
Turkey June 21, 2018 %140%
1 
China July 6, 2018 5%30% 
1 Initially announced as 70%; subsequently revised to 140% on August 15, 2018.
In the first quarter of fiscal 2019, our net sales in major European Union countries 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 “tariff-related buy-ins”). We discuss the estimated effect of the tariffs on our results and outlook where relevant below.
Fiscal 20182019 Year-to-Date Highlights
Key highlights of our operating results for the three months ended July 31, 20172018 include:
We delivered net sales of $723$766 million,, an increase of 9%6% compared to the same period last year. Excluding (a) the impact of acquisitions and divestitures, the positivenegative effect of foreign exchange driven by the weakening of the Turkish lira, British pound, euro, and Mexican peso, (b) the adoption of the revenue recognition accounting standard, and (c) an estimated net increase in distributor inventories, we grew underlying net sales 6%9%. We estimate that the tariff-related buy-ins contributed approximately two to three percentage points to our underlying net sales growth.
From a brand perspective, our underlying net sales growth was driven by the Jack Daniel's family of brands and our premium bourbon brands.
From a geographic perspective, developed international markets led the growth in underlying net sales, partially due to tariff-related buy-ins. Emerging markets and the United States both contributed meaningfully. Travel Retail accelerated the rate of underlying net sales growth compared to the same period last year partially due to favorable timing of customer orders in the current year.
We delivered operating income of $244$264 million, an increase of 14%7% compared to the same period last year. Excluding (a) the impactadoption of acquisitions and divestitures,the revenue recognition accounting standard, (b) the negative effect of foreign exchange, and the(c) an estimated net increase in distributor inventories, we grew underlying operating income 12%10%.
We delivered diluted earnings per share of $0.46,$0.41, an increase of 27%12% compared to the same period last year due to anthe increase in reported operating income and the benefit of a lower effective tax rate, and a reduction in shares outstanding.
partially offset by higher interest expense.
Our underlying operating results were driven by the Jack Daniel's family of brands, our tequila brands, and Woodford Reserve. From a geographic perspective, emerging markets and the United States led the growth, Travel Retail net sales accelerated compared to the same period last year, while developed markets grew less than 1%. In addition, our underlying operating results benefited from a reduction in underlying SG&A expenses.
While foreign exchange had a positive effect on net sales, our operating income was negatively affected, driven by the absence of prior year foreign exchange gains in other expense (income). An estimated net increase in distributor inventories due primarily to the United States and Russia positively affected our reported results.
Summary of Operating Performance
Three months ended July 31,Three months ended July 31,
(Dollars in millions)2016 2017 Reported Change 
Underlying Change1
2017 2018 Reported Change 
Underlying Change1
Net sales$661
 $723
 9% 6%$723
 $766
 6% 9%
Cost of sales208
 230
 11% 6%230
 243
 6% 8%
Gross profit453
 493
 9% 6%493
 523
 6% 9%
Advertising82
 89
 8% 6%87
 98
 14% 17%
SG&A163
 161
 (1%) (1%)161
 168
 4% 5%
Other expense (income), net

(5) (1) (85%) 1%
Operating income$213
 $244
 14% 12%$246
 $264
 7% 10%
              
As a percentage of net sales       
Total operating expenses2
$247
 $259
 5% 9%
       
As a percentage of net sales3
       
Gross profit68.5% 68.1% (0.4)pp  68.1% 68.2% 0.1 pp  
Operating expenses2
36.2% 34.5% (1.7)pp  
Operating income32.2% 33.7% 1.5 pp  34.0% 34.5% 0.5 pp  
Interest expense, net$12
 15
 19%  $15
 20
 36%  
Effective tax rate28.2% 22.1% (6.1)pp  22.1% 17.4% (4.7)pp  
Diluted earnings per share$0.36
 $0.46
 27%  $0.37
 $0.41
 12%  
Note: Totals may differ due to rounding

Note: Totals may differ due to rounding

             
  
1See “Non-GAAP Financial Measures” above for details on our use of “underlying changes,” including how these measures are calculated and the reasons why we thinkbelieve this information is useful to readers.
2OperatingSee “Non-GAAP Financial Measures” above for definitions of operating expenses include advertising expense, SG&A expense, and other expense (income), net.presented here.
3Year-over-year changes in percentages are reported in percentage points (pp).
Fiscal 2019 Outlook
Below we discuss our outlook for the remainder of fiscal 2019, reflecting the trends, developments, and uncertainties that we expect to affect our business. This updated outlook revises certain aspects of the 2019 outlook included in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our 2018 Form 10-K. When we provide guidance for underlying change for the following income statement measures we do not provide guidance for the corresponding GAAP change because the GAAP measure will include items that are difficult to quantify or predict with reasonable certainty, including the estimated net change in distributor inventories and foreign exchange, each of which could have a significant impact to our GAAP income statement measures.
Tariffs. In response to the U.S. tariffs on certain foreign goods, the European Union, Mexico, Canada, Turkey, and China have imposed retaliatory tariffs on a number of U.S. goods, including American whiskey. Our American whiskeys are made in the United States and exported around the world. Our first quarter results benefited from tariff-related buy-ins. Our full year outlook, which is discussed below, has been adjusted to reflect the anticipated negative effect of tariffs, net of mitigation plans, over the remainder of our fiscal year. The effect of tariffs will largely result in higher cost of sales.
Net sales. We expect underlying net sales growth in the remainder of fiscal 2019 to be lower than the growth in the three months ended July 31, 2018, which benefited from tariff-related buy-ins. However, we continue to expect the fiscal 2019 underlying net sales growth rate to be similar to our fiscal 2018 growth rate.
Cost of sales. We expect total cost of sales to grow at a significantly higher rate than net sales in the remainder of fiscal 2019, as we expect to absorb costs related to tariffs as well as input cost increases in the mid-single digits. These costs are expected to result in lower gross margins for the remainder of the fiscal year compared to the three months ended July 31, 2018.
Operating expenses. We expect total operating expenses to grow at a lower rate in the remainder of the fiscal year compared to the growth rate experienced in the three months ended July 31, 2018.
Operating income. We expect slower growth rates for operating income in the remainder of fiscal 2019 compared to growth rates experienced in the three months ended July 31, 2018.


Foreign exchange. For the three months ended July 31, 2018, net sales and operating income were negatively affected by foreign exchange, and we expect that negative trend to continue for the remainder of the fiscal year.
New accounting standard. Our reported net sales and operating income were negatively affected by timing differences related to the implementation of the revenue recognition accounting standard during the three months ended July 31, 2018. We expect that negative trend to moderate in the remainder of the fiscal year.
Estimated net change in distributor inventories. Our reported net sales and operating income benefited from an estimated net increase in distributor inventories during the three months ended July 31, 2018. We expect that benefit to moderate in the remainder of the fiscal year.
Effective tax rate. We expect our full year tax rate on ordinary income to be 21.1%.


Results of Operations – Fiscal 20182019 Year-to-Date Highlights
Market Highlights
The following table provides supplemental information for our largest markets for the three months ended July 31, 2017,2018, compared to the same period last year. We discuss results for the markets most affecting our performance below the table. Unless otherwise indicated, all related commentary is for the three months ended July 31, 2017,2018, compared to the same period last year.
Top 10 Markets1 - Fiscal 2018 Net Sales Growth by Geographic Area
Top 10 Markets1 - Fiscal 2019 Net Sales Growth by Geographic Area
Top 10 Markets1 - Fiscal 2019 Net Sales Growth by Geographic Area
Percentage change versus prior year periodPercentage change versus prior year period
Three months ended July 31, 2017Net Sales
Geographic areaReportedAcquisitions & DivestituresForeign ExchangeNet Chg in Est. Distributor Inventories 
Underlying2
Three months ended July 31, 2018Net Sales
Geographic area2
ReportedNew Accounting StandardForeign ExchangeNet Chg in Est. Distributor Inventories 
Underlying3
United States10%%%(5%) 5%%1%%1% 2%
Europe13%%(5%)(3%) 4%
Developed International12%2%6%(3%) 16%
United Kingdom6%(1%)(11%)% (6%)19%%14%% 33%
Australia2%%4%% 6%
Germany6%(1%)(5%)% (1%)28%%10%% 38%
France8%%(4%)% 4%(1%)%5%% 3%
Canada(2%)4%2%(4%) %
Rest of Developed International13%7%1%(12%) 9%
Emerging7%3%7%(4%) 11%
Mexico(6%)2%9%% 5%
Poland29%%(9%)% 20%8%%(4%)% 4%
RussiaNM
%28%NM
 38%57%%(14%)(55%) (12%)
Rest of Europe3%%(2%)3% 4%
Australia12%5%(1%)% 17%
Other geographies5%(1%)1%4% 10%
Mexico11%%1%1% 13%
Japan(25%)%2%9% (14%)
Canada%%6%(3%) 2%
Remaining geographies3
11%(1%)(1%)6% 15%
Travel Retail4
4%%3%5% 12%
Other non-branded5
(8%)23%1%% 16%
Brazil20%2%20%(11%) 30%
Rest of Emerging7%4%9%1% 20%
Travel Retail24%%(2%)% 22%
Non-branded and bulk19%%(1%)% 18%
Total9%1%(1%)(3%) 6%6%1%2%(1%) 9%
Note: Totals may differ due to rounding      
  
1“Top 10 markets” are ranked based on percentage of total Fiscal 2017 Net Sales.fiscal 2018 net sales. See 20172018 Form 10-K “Results of Operations - Fiscal 20172018 Market Highlights” and “Note 15.14. Supplemental Information.”
2See “Definitions” above for definitions of market aggregations presented here.
3See “Non-GAAP Financial Measures” above for details on our use of “underlying change” in net sales, including how this measure is calculated and the reasons why we thinkbelieve this information is useful to readers.
3“Remaining geographies” represents over 110 countries, with the largest being Brazil, China, and Argentina.
4“Travel Retail” represents our sales to global duty free customers, travel retail customers, and the U.S. military.
5“Other non-branded” includes used barrel, bulk whiskey and wine, and contract bottling sales.
United States. Reported net sales grew 10%were flat, while underlying net sales increased 2% after adjusting for the adoption of the revenue recognition accounting standard and an estimated net decrease in distributor inventories. Underlying net sales gains were driven by the growth of Woodford Reserve, el Jimador, JD RTDs, Herradura, Old Forester, and JDTR. These gains were partially offset by declines of JDTW and Korbel Champagne, the former of which was largely due to timing and comparisons against a strong start to last fiscal year, although takeaway trends remain stable.
Developed International. Reported net sales increased 12%, while underlying net sales increased 5%grew 16% after adjusting for (a) the adoption of the revenue recognition accounting standard, (b) the negative effect of foreign exchange reflecting the strengthening of the dollar against the British pound and euro, and (c) an estimated net increase in distributor inventories. Underlying net sales gains were driven primarily by the growth of our American whiskey portfolio, led by the Jack Daniel’s family of brands and Woodford Reserve, and our tequila brands, led by el Jimador and Herradura. This growth was partially offset by declines in Canadian Mist.
Europe. Reported net sales increased 13%, while underlying net sales increased 4% after adjusting for the positive effect of foreign exchange driven by the broad weakening of the dollar and an estimated net increase in distributor inventories in Russia. Underlying net sales gains in Poland, Russia, Turkey, and France were partially offset by declinesmarkets in the United Kingdom.European Union reflecting tariff-related buy-ins.
In Poland,the United Kingdom, underlying net sales growth was leddriven by volume gainshigher volumes and favorable channel mix of Jack Daniel’s Tennessee Whiskey (JDTW), which has experienced strong consumer takeaway trends.JDTW along with higher volumes of JDTH, with both brands benefiting significantly from tariff-related buy-ins.


In Russia,Australia, underlying net sales growth was driven by favorable price/mixhigher volumes and higher pricing of JDTW partly due to a buy-in ahead of August 1, 2018 price increase. This growth was partially offset by lower volume of JD RTDs compared to the same period last year when there was a buy-in ahead of price increases.
In Germany, underlying net sales growth was driven by volumetric growth of JDTW and Finlandia. The market remained stable through the first quarter of fiscal 2018, building on growth in the second half of fiscal 2017.JD RTDs partly due to customer buying patterns, with both brands benefiting significantly from tariff-related buy-ins.
In France, underlying net sales growth was fueledled by Jack Daniel’s Tennessee Fire (JDTF)higher volumes of JDTH and JDTW, driventhe latter of which was partially offset by increasing consumer demand despite recent declines in the total whiskey category.timing of current year promotional activity.
In the United Kingdom,Canada, underlying net sales were flat as volume declines were driven by lower volumes ofin the Jack Daniel’s Tennessee Honey (JDTH) and JDTF and unfavorable price/mix on JDTW, partiallyfamily of brands were essentially offset by the launch of JD Cider.
In Germany, underlying net sales declines were primarily due to volume declines of JDTW, reflecting the timing of customer purchases. This reduction was nearly offset by solid growth of JD RTDs, including the launch of JD Lynchburg Lemonade.Woodford Reserve.
The increase in underlying net sales in the Rest of EuropeDeveloped International was primarily led by improved trendsSpain and Czechia. In Spain, JDTW grew volumes along with favorable price/mix, where our new owned-distribution organization has led to an acceleration in Turkey, whereperformance over the past 12 months. In Czechia, growth was drivenled by the Jack Daniel's family. Our results in the same period last year were affected by political and economic instability.Daniels family of brands.
Australia.Emerging. Reported net sales increased 12%7%, while underlying net sales grew 11% after adjusting for (a) the adoption of the revenue recognition accounting accounting standard, (b) the negative effect of foreign exchange reflecting the strengthening of the dollar primarily against the Turkish lira and Mexican peso, and (c) an estimated net increase in distributor inventories. Underlying net sales growth was led by Brazil, Turkey, Mexico, Commonwealth of Independent States (CIS), and China, partially offset by declines in Russia.
In Mexico, underlying net sales growth was led by higher pricing of New Mix along with higher pricing and volume growth of JD RTDs.
In Poland, underlying net sales growth was led by increased volumes of JDTW partly due to tariff-related buy-ins. Lower pricing and volume declines of Finlandia mostly offset the growth due to customer buying patterns and disruption related to packaging changes.
In Russia, the underlying net sales decline was driven by Finlandia and JDTW, which was mostly due to changes in distributor and related buying patterns.
In Brazil, underlying net sales growth was fueled by volumetric growth and higher pricing of JDTW.
The increase in underlying net sales in the Rest of Emerging was led by Turkey, CIS, China, and Romania. All of these geographic areas benefited from higher volumes of JDTW including Turkey, which was partly due to a buy-in ahead of price increases.
Travel Retail. Reported net sales increased 24%, while underlying net sales increased 17%22% after adjusting for the netpositive effect of acquisitions and the loss offoreign exchange. Underlying net sales relatedgrowth was led by higher volumes of the Jack Daniel’s family of brands, including the launch of JDTR and Jack Daniel’s Bottled-in-Bond, along with higher volumes of Woodford Reserve. Growth was due to our transition servicesfavorable timing of customer orders in the current year, strong consumer demand, and increased travel.
Non-branded and bulk. Reported net sales increased 19%, while underlying net sales increased 18% after adjusting for divested brands and the positive effect of foreign exchange. Underlying net sales growth was driven by the Jack Daniel’s family of brands, led by (a) Jack Daniel’s & Cola, which benefited from a buy-in ahead of August 1, 2017 price increase, (b) recently launched JD RTD line extensions, and (c) JDTW volume growth.
Other geographies. Reported net sales for our other markets increased 5%, while underlying net sales collectively increased 10% after adjusting for (a) the positive effect of acquisitions and divestitures, (b) the negative effect of foreign exchange, and (c) the estimated net decrease in distributor inventories. Underlying net sales growth was led by Mexico, Brazil (which benefited from a buy-in ahead of August 1, 2017 price increase), China, and Latin America. These gains were partially offset by volume declines in Japan due to buy-in ahead of price increases in the same period last year.
Travel Retail. Reported net sales increased 4% and underlying net sales increased 12% after adjusting reported results for the negative effect of foreign exchange and an estimated net decrease in distributor inventories. Underlying net sales growth was led by higher volumes of JDTW, Finlandia, and JDTH.
Other non-branded. Reported net sales decreased 8%, while underlying net sales increased 16% after adjusting for the net effect of acquisitions and the loss of net sales related to our transition services for divested brands. The underlying net sales growth was driven by higher net salespricing of used barrels reflecting an easy comparison to very weak net salesalong with growth in prior-year period, as well as timing of shipments in the current year.contract bottling.


Brand Highlights
The following table highlights the worldwide results ofprovides supplemental information for our largest brands for the three months ended July 31, 2017,2018, compared to the same period last year. We discuss results of the brands most affecting our performance below the table. Unless otherwise indicated, all related commentary is for the three months ended July 31, 2017,2018, compared to the same period last year.
Major Brands Worldwide Results
 Percentage change versus prior year period
Three months ended July 31, 2017Volumes Net Sales
Brand family / brand9L Depletions ReportedForeign ExchangeNet Chg in Est. Distributor Inventories 
Underlying1
Jack Daniel’s Family10% 10%(1%)(3%) 6%
Jack Daniel’s Tennessee Whiskey4% 9%(1%)(4%) 4%
Jack Daniel’s Tennessee Honey5% 3%(1%)1% 3%
Jack Daniel’s RTDs/RTP2
17% 24%%(2%) 22%
Gentleman Jack8% 7%%1% 8%
Jack Daniel’s Tennessee Fire19% 21%(1%)(6%) 14%
Other Jack Daniel’s whiskey brands3
(6%) (3%)(1%)2% (2%)
Woodford Reserve16% 10%%6% 16%
Finlandia6% 17%%(10%) 6%
el Jimador11% 19%1%(7%) 13%
Herradura13% 11%%7% 18%
Note: Totals may differ due to rounding       
Major Brands Worldwide Results
 Percentage change versus prior year period
Three months ended July 31, 2018Volumes Net Sales
Product category / brand family / brand1
9L Depletions1
 ReportedNew Accounting StandardForeign ExchangeNet Chg in Est. Distributor Inventories 
Underlying2
Whiskey7% 8%1%2%(1%) 11%
Jack Daniel's Family8% 7%1%3%(2%) 10%
JDTW9% 5%2%2%(1%) 8%
Jack Daniel's RTD/RTP5% 6%%5%% 10%
JD Tennessee Honey10% 21%2%2%(12%) 12%
Gentleman Jack6% 4%1%1%% 7%
JD Tennessee Fire11% 10%1%1%1% 13%
Other Jack Daniel's whiskey brands77% 43%1%2%1% 47%
Woodford Reserve26% 30%2%1%(4%) 29%
Tequila% 7%3%4%(5%) 9%
el Jimador4% 10%5%3%(6%) 11%
Herradura6% 11%4%3%(8%) 10%
Vodka (Finlandia)(6%) (18%)1%6%% (10%)
Wine(3%) (6%)1%%2% (3%)
Rest of Portfolio(3%) (11%)%5%1% (4%)
Non-brandedNM
 19%%(1%)% 18%
Note: Totals may differ due to rounding        
  
1See “Definitions” above for definitions of brand aggregations and volume measures presented here.
2See “Non-GAAP Financial Measures” above for details on our use of “underlying change” in net sales, including how this measure is calculated and the reasons why we thinkbelieve this information is useful to readers; see “Volumereaders.

Whiskey brands grew reported net sales 8%, while underlying net sales grew 11% after adjusting for (a) the adoption of the revenue recognition accounting standard, (b) the negative effect of foreign exchange reflecting the strengthening of the dollar against the Turkish lira, British pound, and Depletions” above for definitions of volume measures presented here.
2Jack Daniel’s RTDeuro, 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, Jack Daniel’s Lynchburg Lemonade, and the seasonal Jack Daniel’s Winter Jack RTP.
3In addition to the brands separately listed here,(c) an estimated net increase in distributor inventories. Growth was led by the Jack Daniel’s family of brands includes Jack Daniel’s Single Barrel Collection, Jack Daniel’s Sinatra Select, Jack Daniel’s No. 27 Gold Tennessee Whiskey, and Jack Daniel’s 1907 Tennessee Whiskey.

Jack Daniel’s family of brands grew reported net sales 10% (underlying 6%),premium bourbons, including Woodford Reserve and was the most significant contributor to our overall underlying net sales growth. Reported net sales were helped by the estimated net increase in distributor inventories, and foreign exchange due to the weakening of the dollar against the euro, Polish zloty, Mexican peso, Turkish lira, and the Australian dollar. The following are details about the underlying performance of the Jack Daniel’s family of brands:Old Forester.
Jack Daniel’s family of brands underlying net sales growth was led by JDTW in markets outside of the United States along with broad-based geographic growth of JD RTDs and JDTH.
JDTW grew underlying net sales in severalthe majority of its markets including the United States, Brazil, Poland,Kingdom, Germany, Travel Retail, Turkey, China,Brazil, Spain, Poland, and Russia. These increases wereAustralia, partially offset by volume declines in various markets, including Germany and the United Kingdom.States, which is considered timing related. Growth in many European markets was aided by tariff-related buy-ins.
JDTH grew underlying net sales in the United States, its largest market, Latin America, Brazil, Travel Retail, and Russia. These gains were partially offset by declines in the United Kingdom.
The increase in underlying net sales growth for Jack Daniel’s RTDs/RTP was driven by buy-ins ahead of price increasescontinued momentum in Germany and the United States.
JDTH grew underlying net sales led by volume gains in the United Kingdom and its largest market, the United States.
Gentleman Jack grew underlying net sales with broad-based international growth led by Australia and growththe United Kingdom.
Growth of underlying net sales of JDTF was driven by higher volumes in Germany, the United States and the United Kingdom, with all markets also benefiting from new RTD line extensions.Kingdom.


Underlying net sales growth for Other Jack Daniel’s whiskey brands was led by JDTR, which launched in September 2017, and the return to growth of Jack Daniel’s Single Barrel in the United States.
Gentleman JackWoodford Reserve grew underlyingled the growth of our premium bourbons. Underlying net sales through volumetric growth inwas driven by the United States, its largest market.
JDTF grew underlying net sales duewhere strong consumer takeaway trends led to volume growthvolumetric gains, and higher volumes in the United States and France and the launch of the brand in Brazil. These increases were partially offset by volume declines in the United Kingdom.
Our Other Jack Daniel’s whiskey brands’ decreased underlying net sales were due primarily to Jack Daniel’s Single Barrel Collection declines in the United Kingdom and the United States.Travel Retail.


Woodford ReserveTequila led the growth of our super- and ultra-premium American whiskeys withbrands grew reported net sales increasing 10% and underlying net sales growing 16%. This growth was driven by the United States, where the brand continued to grow volumetrically with strong consumer takeaway trends. Reported net sales were hurt by an estimated net decrease in distributor inventories.
Reported net sales for Finlandia7% grew 17% and underlying net sales increased 6% led by favorable price/mix and higher volumes in Russia and volumetric growth in Travel Retail. Reported net sales were helped by an estimated net increase in distributor inventories, primarily in Russia.
Reported net sales for el Jimador increased 19%, while underlying net sales increased 13% driven by volume gains ingrew 9% after adjusting for (a) the United States due to accelerating consumer takeaway trends. Reported net sales were helped byadoption of the revenue recognition accounting standard, (b) the negative effect of foreign exchange reflecting the strengthening of the dollar against the Mexican peso, and (c) an estimated net increase in distributor inventories in the United States.
el Jimador grew underlying net sales driven by higher pricing and volume gains due to a buy-in ahead of price increases in the United States.
Herradura grew underlying net sales driven by volumetric growth and higher pricing in the United States.
Reported net sales for Finlandia declined 18%, while underlying net sales decreased 10% after adjusting for the adoption of the revenue recognition accounting standard and the negative effect of foreign exchange reflecting the strengthening of the dollar against the Russian ruble. Volume declines in Poland (due to customer buying patterns and disruption related to packaging changes), Travel Retail, and Russia drove the decrease in underlying net sales.
Wine brands reported net sales 11% anddeclined 6%, while underlying net sales increased 18% driven primarily by increased volumes indecreased 3% after adjusting for the brand’s largest markets,adoption of the United Statesrevenue recognition accounting standard and Mexico, the latter of which also benefited from favorable price/mix due to consumer-led volumetric growth of Herradura Ultra. Reported net sales were hurt by an estimated net decrease in distributor inventories in the United States. Volume declines of Korbel Champagne were partially offset by modest growth of Sonoma-Cutrer.
Rest of portfolio reported net sales declined 11%, while underlying net sales decreased 4% after adjusting for the negative effect of foreign exchange and an estimated net decrease in distributor inventories. The decline was due to discontinued agency brands, partially offset by growth of Chambord.
Non-branded and bulk. Reported net sales increased 19%, while underlying net sales increased 18% after adjusting for the positive effect of foreign exchange. Underlying net sales growth was driven by higher pricing of used barrels along with growth in contract bottling.



Year-over-Year Period Comparisons
Net Sales
Percentage change versus the prior year period ended July 313 Months
Change in reported net sales96%
Acquisitions and divestituresNew accounting standard1%
Foreign exchange(12%)
Estimated net change in distributor inventories(31%)
Change in underlying net sales69%
  
Change in underlying net sales attributed to: 
Volume45%
Net price/mix24%
Note: Totals may differ due to rounding 
For the three months ended July 31, 2017,2018, net sales were $723$766 million, an increase of $62$43 million, or 9%6%, compared to the same period last year. AfterUnderlying net sales grew 9% after adjusting reported results for (a) the net effectadoption of acquisitions and loss of net sales related to our transition services for divested brands,the revenue recognition accounting standard, (b) the positivenegative effect of foreign exchange reflecting the strengthening of the dollar against the Turkish lira, British pound, euro, and Mexican peso, and (c) thean estimated net increase in distributor inventories, underlying net sales grew 6%.inventories. The change in underlying net sales was driven by 4%5% volume growth and 2%4% of price/mix. Volume growth was led by the Jack Daniel's family of brands, premium bourbons, and the tequilas. Improved price/tequilas, partially offset by declines in Finlandia. Price/mix was driven by a shift in sales to higher priced(a) favorable portfolio mix of fast growing higher-priced brands, most notably, the Jack Daniel's familyWoodford Reserve, and (b) higher average pricing on the Jack Daniel’s family of brands and tequilas.
The primary factors contributing to the growth in underlying net sales for the three months ended July 31, 20172018 were:
volumetric growth of JDTW in markets outside of the United States, most notably, the United Kingdom, Germany, Travel Retail, Turkey, Brazil, Spain, Poland, and Australia, with many of the European markets aided by tariff-related buy-ins;
growth of our American whiskey portfoliopremium bourbons in the United States and Travel Retail, led by Woodford Reserve and Old Forester;
higher volume of JD RTDs, led by continued momentum in Germany and the United States;
broad-based growth of JDTH and JDTF, most notably, the United Kingdom and the United States;
volumetric growth and higher pricing of our tequila brands in the United States, led by the Jack Daniel’s family, Woodford Reserve,Herradura and Old Forester;
JDTW in several international markets, most notably, Brazil, Poland, Travel Retail, Turkey, China, and Russia;
volume of JD RTDs, driven byel Jimador, which benefited from a buy-in ahead of price increases in Australiaincreases;
higher pricing of used barrel and growth in Germany, the United States,of contract bottling; and the United Kingdom, with all markets benefiting from new RTD line extensions;
our tequila brands, led by (a) volume gains and higher prices of New Mix in Mexico; (b) volume gains of el JimadorJDTR in the United States, and (c) higher volume and price of Herradurawhich launched in the United States and Mexico; and
volume of used barrels, which is partially due to the timing of orders.September 2017.
These gains in underlying net sales were partially offset byby:
volume declines in volume of JDTW and Korbel Champagne in Germany,the United States, the former of which is considered timing related;
declines of Finlandia in Poland due to be timing related.customer buying patterns and disruption related to packaging changes; and
discontinued agency brand sales in Turkey.


Cost of Sales
Percentage change versus the prior year period ended July 313 Months
Change in reported cost of sales116%
Acquisitions and divestituresNew accounting standard3%
Foreign exchange(53%)
Estimated net change in distributor inventories(31%)
Change in underlying cost of sales68%
  
Change in underlying cost of sales attributed to: 
Volume45%
Cost/mix23%
Note: Totals may differ due to rounding

 
Cost of sales for the three months ended July 31, 20172018 increased $22$13 million, or 11%6%, to $230$243 million when compared to the same period last year. Underlying cost of sales increased 6%8% after adjusting reported costs for (a) the net effect of acquisitions and divestitures, (b) the negativepositive effect of foreign exchange and (c) thean estimated net increase in distributor inventories. The increase in underlying cost of sales for the three months ended July 31, 2018 was driven by higher volumes, a shift in product mix to higher-cost brands, incremental


value-added packaging,higher bulk whiskey and contract bottling sales, and higher wood costs.input costs including wood. Looking ahead to the remainder of fiscal 2019, we expect that(a) input costs will continue to increase in the low single digits.mid-single digits largely due to higher cost of agave and wood, and (b) higher costs related to tariffs.
Gross Profit
Percentage change versus the prior year period ended July 313 Months
Change in reported gross profit96%
Acquisitions and divestituresNew accounting standard2%
Foreign exchange12%
Estimated net change in distributor inventories(31%)
Change in underlying gross profit69%
Note: Totals may differ due to rounding
 
Gross Margin
For the period ended July 313 months
Prior year gross margin68.568.1%
Price/mix0.1%
Volume0.5%
Cost(0.1%)
Acquisitions and divestituresNew accounting standard0.6(0.4%)
Foreign exchange(1.00.1%)
Change in gross margin(0.40.1%)
Current year gross margin68.168.2%
Note: Totals may differ due to rounding
 
Gross profit of $493$523 million increased $40$30 million, or 9%6%, for the three months ended July 31, 2017.2018. Underlying gross profit grew 6%9% after adjusting reported results for (a) the adoption of the revenue recognition accounting standard, (b) the negative effect of foreign exchange, and the(c) an estimated net increase in distributor inventories. The increase in underlying gross profit resulted from the same factors that contributed to the increase in underlying net sales and the increase in underlying cost of sales.
For the three months ended July 31, 2017,2018, gross margin decreasedincreased approximately 40 basis0.1 percentage points to 68.1%,68.2% from 68.5%68.1% in the same period last year driven primarily by the negative effect of foreign exchange, partiallyfavorable price/mix, mostly offset by the net effectadoption of acquisitions and divestitures.the revenue recognition accounting standard.



Operating Expenses
Three months ended July 31, 2017Percentage change versus prior year period
ReportedAcquisitions & DivestituresForeign Exchange Underlying
Percentage change versus the prior year period ended July 31Percentage change versus the prior year period ended July 31
3 MonthsReportedNew Accounting StandardForeign Exchange Underlying
Advertising8%%(1%) 6%14%4%% 17%
SG&A(1%)%% (1%)4%%% 5%
Other expense (income), net(85%)(3%)90% 1%
Total4%%(3%) 1%
Total operating expenses5%2%2% 9%
Note: Totals may differ due to rounding      
1Operating expenses include advertising expense, SG&A expense, and other expense (income), net.

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

Operating expenses totaled $249$259 million and increased $9$12 million, or 4%5%, for the three months ended July 31, 20172018 compared to the same period last year. Underlying operating expenses grew 1%9% after adjusting for reclassifications related to the netadoption of the revenue recognition accounting standard and the positive effect of foreign exchange driven by the absence of prior year foreign exchange gains in other expense (income).exchange.
Reported advertising expenses grew 8%, while underlying advertising expenses grew 6% after adjusting14% for the negative effect of foreign exchange, as we continued to invest in our American whiskey portfolio, including the Jack Daniel's family and Woodford Reserve.
Reported and underlying SG&A expenses dropped 1% due to lower pension expense and continued tight management of discretionary spending, partially offset by personnel costs driven by investments in our new Spain distribution operation.


For the three months ended July 31, 2017, operating2018, while underlying advertising expenses grew 17% after adjusting for reclassifications related to the adoption of the revenue recognition accounting standard. Underlying advertising expense increased as a percentage of net sales declined 170 basis points to 34.5%, from 36.2% in the same period last year. The declinewe invested in our operatingAmerican whiskey brands, including the first year of our Woodford Reserve Kentucky Derby sponsorship.
Reported SG&A expenses as a percentage increased 4% for the three months ended July 31, 2018, while underlying SG&A expenses grew 5% after adjusting for reclassifications related to the adoption of net salesthe revenue recognition accounting standard. The increase in underlying SG&A expenses was driven by the reduction in underlying SG&A spend, partially offset by the negative effect of foreign exchange.higher personnel costs.
Operating Income
Percentage change versus the prior year period ended July 313 Months
Change in reported operating income147%
Acquisitions and divestituresNew accounting standard(12%)
Foreign exchange52%
Estimated net change in distributor inventories(62%)
Change in underlying operating income1210%
Note: Totals may differ due to rounding
 
Operating income of $244$264 million increased $31$18 million, or 14%7%, for the three months ended July 31, 20172018 compared to the same period last year. Underlying operating income grew 12%10% after adjusting for (a) the net effectadoption of acquisitions and divestitures,the revenue recognition accounting standard, (b) the negative effect of foreign exchange, and (c) thean estimated net increase in distributor inventories. The same factors that contributed to the growth in underlying gross profit also contributed to the growth in underlying operating income, partially offset bywhile an increase in total underlying operating expenses.expenses partially offset these gains.
ForOperating margin increased 0.5 percentage points to 34.5% for the three months ended July 31, 2017, operating margin increased 150 basis points to 33.7%,2018 from 32.2%34.0% in the same period last year. The increase in our operating margin was driven by the reductiona slight increase in gross margin and operating expense leverage as underlying SG&A spend grew at a slower rate than underlying net sales, partially offset by the negative effect of foreign exchange.underlying advertising expenses, which grew at a faster rate than underlying net sales.
The effective tax rate in the three months ended July 31, 20172018 was 22.1%17.4% compared to 28.2%22.1% for the same period last year. The decrease in our effective tax rate was primarily driven by (a) athe net impact of the Tax Cuts and Jobs Act (including the current year reduction into the provisional repatriation U.S. tax for current and certain prior years on foreign exchange gainscharge made in non-U.S. entities due to a change in method of accounting for U.S. tax purposes, and (b)fiscal 2018), partially offset by an increase in the beneficial impact of the excess tax benefits from stock-based awards. We expect our full year effective tax rateexpense related to be approximately 28% based on the tax rate of 29.0% on ordinary income for the full fiscal year as adjusted for known discrete items.
Diluted earnings per share of $0.46$0.41 in the three months ended July 31, 20172018 increased 27%12% from the $0.36$0.37 reported for the same period last year. The increase in diluted earnings per share for the three months ended July 31, 2018 resulted from an increase in reported operating income and the benefit of a lower effective tax rate, andpartially offset by higher interest expense reflecting a reductionnew bond issuance in shares outstanding.April 2018.


Liquidity and Financial Condition
Cash flows. Cash and cash equivalents increased $56decreased $28 million during the three months ended July 31, 2017,2018, compared to an increase of $196$56 million during the same period last year. Cash provided by operations of $102$126 million was down $26up $21 million from
the same period last year, largely reflecting an $18 million reduction in discretionary contributions to our qualified pension plans (which became fully funded as a higher seasonal increase in working capital offset partially by higher earnings. result of contributions made during the fourth quarter of last year).
Cash used for investing activities was $28$25 million during the three months ended July 31, 2017,2018, compared to $324$31 million for the same prior-year period.period last year. The $296$6 million decreasedecline was largely reflects $307 million in cash paidattributable to acquire BenRiach in June 2016, partially offset by a $12 million increase inthe timing of payments related to ongoing capital spending during the current period.projects.
Cash used for financing activities was $31$122 million during the three months ended July 31, 2017,2018, compared to $398$31 million in cash provided by financing activities duringfor the same prior-year period.period last year. The $429$91 million changeincrease largely reflects a $717 million decrease in proceeds from long-term debt, partially offset by a $200 million decline in share repurchases and an $88$86 million increase in net proceeds fromrepayments of short-term borrowings.

borrowings and a $6 million increase in dividend payments.
The impact on cash and cash equivalents as a result of exchange rate changes was an increasea decrease of $13$7 million for the three months ended July 31, 2017,2018, compared to a declinean increase of $6$13 million for the same period last year.
Liquidity. We continue to manage liquidity conservatively to meet current obligations, fund capital expenditures, maintainsustain and grow our regular dividends, and repurchase sharesreturn cash to our shareholders from time to time through share repurchases and special dividends while reserving adequate debt capacity for acquisition opportunities.
In addition to our cash and cash equivalent balances, we have access to several liquidity sources to supplement our cash flow from operations. One of those sources is our $800 million commercial paper program that we regularly use to fund our short-term credit needs and to maintain our access to the capital markets.needs. During the three months ended July 31, 2017,2018, our


commercial paper borrowings averaged $486$463 million, with an average maturity of 2931 days and an average interest rate of 1.15%2.09%. Commercial paper outstanding was $208$215 million at April 30, 2017,2018, and $253$161 million at July 31, 2017.2018.
Our commercial paper program is supported by available commitments under our currently undrawn $800 million bank credit facility that maturesexpires on November 20, 2018. Further, we believe that the markets for investment-grade bonds and private placements are accessible sources of long-term financing that could meet any additional liquidity needs.10, 2022. Although unlikely, under extreme market conditions, one or more participating banks may not be able to fully fund its commitments under our credit facility.
We believe the debt capital markets for bonds and private placements are accessible sources of long-term financing that could meet any additional liquidity needs. We believe our current liquidity position is sufficient to meet all of our future financial commitments. We have high credit standards when initiating transactions with counterparties, and we closely monitor our counterparty risks with respect to our cash balances and derivative contracts. If a counterparty’s credit quality were to deteriorate below our credit standards, we would expect either to liquidate exposures or require the counterparty to post appropriate collateral.
As of July 31, 2017, we had total2018, approximately 87% of our cash and cash equivalents of $238 million. Of this amount, $180 million waswere held by our foreign subsidiaries whose earnings we expect to reinvest indefinitely outside of the United States. We do not expect to needWith the cash generated by those foreign subsidiaries to fundenactment of the Tax Act, we are evaluating our domestic operations. In the unforeseen event that we were to repatriate cash from those foreign subsidiaries, we would be required to provide forglobal working capital requirements and pay U.S. taxes on permanently repatriated earnings.may change our current permanent reinvestment assertion in future periods.
As announced on July 27, 2017,13, 2018, our Board of Directors authorized the repurchase of up to $200 million of our outstanding shares of Class A and Class B common stock from July 13, 2018, through July 12, 2019, subject to market and other conditions. Under this program, we may repurchase shares from time to time for cash in open market purchases, block transactions, and privately negotiated transactions in accordance with applicable federal securities laws. We can modify, suspend, or terminate this repurchase program at any time without prior notice. No shares were repurchased in the period from July 13, 2018 to July 31, 2018.
As announced on July 26, 2018, our Board of Directors declared a regular quarterly cash dividend of $0.1825$0.158 per share on our Class A and Class B common stock. Stockholders of record on September 7, 2017,6, 2018 will receive the quarterly cash dividend on October 2, 2017.
We believe our current liquidity position is strong and sufficient to meet all of our future financial commitments. A quantitative covenant of our $800 million bank credit facility requires the ratio of consolidated EBITDA (as defined in the agreement) to consolidated interest expense to be at least 3 to 1. As of July 31, 2017, with a ratio of 17 to 1, we were well within the covenant’s parameters.2018.
Item 3.  Quantitative and Qualitative Disclosures about Market Risk
We are exposed to market risks arising from adverse changes in (a) foreign exchange rates, (b) commodity prices affecting the cost of our raw materials and energy, and (c) interest rates. We try to manage risk through a variety of strategies, including production initiatives and hedging strategies. Our foreign currency hedging contracts are subject to changes inforeign exchange rates,rate changes, our commodity forward purchase contracts are subject to changes in commodity prices,price changes, and some of our debt obligations are subject to changes in interest rates.rate changes. Established procedures and internal processes govern the management of these market risks. Since April 30, 2017,2018, there have been no material changes to the disclosure on this matter made in our 20172018 Form 10-K.



Item 4.  Controls and Procedures
Evaluation of Disclosure Controls and Procedures. Our management, with the participation of our Chief Executive Officer (CEO) and Chief Financial Officer (CFO) (our principal executive and principal financial officers), has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)) as of the end of the period covered by this report. Based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures: (a) are effective to ensure that information required to be disclosed by the company in the reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms; and (b) 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.

Changes in Internal Control over Financial Reporting. There has been no change in our internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.




PART II - OTHER INFORMATION

Item 1. Legal Proceedings
We operate in a litigious environment and we are sued in the normal course of business. We do not anticipate that any currently pending suits will have, individually or in the aggregate, a material adverse effect on our financial position, results of operations, or liquidity.

Item 1A. Risk Factors
In addition to the other information set forth in this Quarterly Report, you should carefully consider the risks and uncertainties discussed in Part I, Item 1A. Risk Factors in our 20172018 Form 10-K, which could materially adversely affect our business, financial condition, or future results. There have been no material changes to the risk factors disclosed in our 20172018 Form 10-K.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds 
The following table provides information about shares of our common stock that we acquired during the quarter ended July 31, 2017:2018:
PeriodTotal Number of Shares PurchasedAverage Price Paid per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or ProgramsApproximate Dollar Value of Shares that May Yet Be Purchased under the Plans or Programs
May 1, 2017 – May 31, 201723,904
$48.06

$
June 1, 2017 – June 30, 2017
$

$
July 1, 2017 – July 31, 20171,054
$49.38

$
Total24,958
$48.12

 
PeriodTotal Number of Shares PurchasedAverage Price Paid per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or ProgramsApproximate Dollar Value of Shares that May Yet Be Purchased under the Plans or Programs
May 1, 2018 – May 31, 201817,116
$53.90

$
June 1, 2018 – June 30, 201892,658
$53.63

$
July 1, 2018 – July 31, 2018
$

$200,000,000
Total109,774
$53.67

 
The shares presented in the above table were acquired from employees to satisfy income tax withholdings triggered by the vesting of restricted shares.

As announced on July 13, 2018, our Board of Directors has authorized the repurchase of up to $200 million of our outstanding shares of Class A and Class B common stock from July 13, 2018, through July 12, 2019, subject to market and other conditions.

Item 3. Defaults Upon Senior Securities
None.

Item 4. Mine Safety Disclosures
Not applicable.

Item 5. Other Information
None.



Item 6. Exhibits
The following documents are filed with this Report:
31.1 
31.2 
32 
101 The following materials from Brown-Forman Corporation's Quarterly Report on Form 10-Q for the quarter ended July 31, 2017,2018, formatted in XBRL (eXtensible Business Reporting Language): (a) Condensed Consolidated Statements of Operations, (b) Condensed Consolidated Statements of Comprehensive Income, (c) Condensed Consolidated Balance Sheets, (d) Condensed Consolidated Statements of Cash Flows, and (e) Notes to the Condensed Consolidated Financial Statements.





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:August 30, 201729, 2018By:/s/ Jane C. Morreau
   Jane C. Morreau
   
Executive Vice President
and Chief Financial Officer
   
(On behalf of the Registrant and
as Principal Financial Officer)

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