10-Q 1 form10q1003.txt United States Securities and Exchange Commission Washington, D.C. 20549 FORM 10-Q (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended OCTOBER 31, 2003 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to _______________ Commission File No. 1-123 BROWN-FORMAN CORPORATION (Exact name of Registrant as specified in its Charter) Delaware 61-0143150 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 850 Dixie Highway Louisville, Kentucky 40210 (Address of principal executive offices) (Zip Code) (502) 585-1100 (Registrant's telephone number, including area code) N/A (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_| Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: November 28, 2003 Class A Common Stock ($.15 par value, voting) 28,420,496 Class B Common Stock ($.15 par value, nonvoting) 32,258,226 BROWN-FORMAN CORPORATION Index to Quarterly Report Form 10-Q PART I - FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Page Condensed Consolidated Statement of Income Three months ended October 31, 2002 and 2003 3 Six months ended October 31, 2002 and 2003 3 Condensed Consolidated Balance Sheet April 30, 2003 and October 31, 2003 4 Condensed Consolidated Statement of Cash Flows Six months ended October 31, 2002 and 2003 5 Notes to the Condensed Consolidated Financial Statements 6 - 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 - 18 Item 3. Quantitative and Qualitative Disclosures about Market Risk 18 Item 4. Controls and Procedures 18 PART II - OTHER INFORMATION Item 1. Legal Proceedings 19 Item 6. Exhibits and Reports on Form 8-K 20 Signatures 21 2 PART I - FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) BROWN-FORMAN CORPORATION CONDENSED CONSOLIDATED STATEMENT OF INCOME (Unaudited) (Dollars in millions, except per share amounts) Three Months Ended Six Months Ended October 31, October 31, 2002 2003 2002 2003 ------- ------- -------- -------- Net sales $ 691.6 $ 725.2 $1,171.1 $1,257.8 Excise taxes 90.8 98.1 145.9 169.9 Cost of sales 262.0 262.3 439.0 450.8 ------- ------- -------- -------- Gross profit 338.8 364.8 586.2 637.1 Advertising expenses 86.4 95.0 164.7 172.5 Selling, general, and administrative expenses 123.4 132.4 237.6 262.5 Other expense (income), net 4.5 (1.4) 3.3 11.2 ------- ------- -------- -------- Operating income 124.5 138.8 180.6 190.9 Interest income 0.6 0.5 1.2 0.9 Interest expense 1.3 5.6 3.0 10.9 ------- ------- -------- -------- Income before income taxes 123.8 133.7 178.8 180.9 Taxes on income 42.7 45.5 61.7 61.5 ------- ------- -------- -------- Net income $ 81.1 $ 88.2 $ 117.1 $ 119.4 ======= ======= ======== ======== Earnings per share - Basic $ 1.18 $ 1.45 $ 1.71 $ 1.97 - Diluted $ 1.18 $ 1.45 $ 1.71 $ 1.96 Shares (in thousands) used in the calculation of earnings per share - Basic 68,406 60,658 68,391 60,633 - Diluted 68,592 60,921 68,592 60,887 Cash dividends per common share - Declared $ 0.000 $ 0.000 $ 0.700 $ 0.750 - Paid $ 0.350 $ 0.375 $ 0.700 $ 0.750 See notes to the condensed consolidated financial statements. 3 BROWN-FORMAN CORPORATION CONDENSED CONSOLIDATED BALANCE SHEET (Dollars in millions) April 30, October 31, 2003 2003 (Unaudited) -------- -------- Assets ------ Cash and cash equivalents $ 72.0 $ 74.5 Accounts receivable, net 324.6 431.2 Inventories: Barreled whiskey 221.6 220.0 Finished goods 203.4 231.1 Work in process 112.2 115.3 Raw materials and supplies 47.4 59.4 -------- -------- Total inventories 584.6 625.8 Current portion of deferred income taxes 56.0 56.0 Other current assets 29.9 29.5 -------- -------- Total current assets 1,067.1 1,217.0 Property, plant and equipment, net 506.1 511.1 Prepaid pension cost 39.2 43.0 Investment in affiliates 41.2 43.2 Trademarks and brand names 235.0 237.9 Goodwill 311.0 315.5 Other assets 64.0 62.0 -------- -------- Total assets $2,263.6 $2,429.7 ======== ======== Liabilities ----------- Commercial paper $ 167.1 $ 193.8 Accounts payable and accrued expenses 297.2 334.0 Accrued taxes on income 43.4 58.2 Current portion of long-term debt 40.1 35.7 -------- -------- Total current liabilities 547.8 621.7 Long-term debt 628.7 629.2 Deferred income taxes 77.8 73.7 Accrued pension and other postretirement benefits 142.7 147.7 Other liabilities 26.4 28.5 -------- -------- Total liabilities 1,423.4 1,500.8 Commitments and contingencies Stockholders' Equity -------------------- Common stock: Class A, voting (30,000,000 shares authorized; 28,988,091 shares issued) 4.3 4.3 Class B, nonvoting (60,000,000 shares authorized; 40,008,147 shares issued) 6.0 6.0 Retained earnings 1,506.1 1,579.3 Accumulated other comprehensive loss (83.4) (75.4) Treasury stock (8,429,000 and 8,318,000 shares at April 30 and October 31, respectively) (592.8) (585.3) -------- -------- Total stockholders' equity 840.2 928.9 -------- -------- Total liabilities and stockholders' equity $2,263.6 $2,429.7 ======== ======== Note: The balance sheet at April 30, 2003, has been taken from the audited financial statements at that date, and condensed. See notes to the condensed consolidated financial statements. 4 BROWN-FORMAN CORPORATION CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited) (In millions; amounts in parentheses are reductions of cash) Six Months Ended October 31, 2002 2003 ------- ------- Cash flows from operating activities: Net income $ 117.1 $ 119.4 Adjustments to reconcile net income to net cash provided by (used for) operations: Depreciation 27.7 27.4 Deferred income taxes (19.6) (3.9) Changes in assets and liabilities: Accounts receivable (122.8) (106.6) Inventories (41.5) (41.2) Other current assets 4.8 0.4 Accounts payable and accrued expenses 27.9 38.2 Accrued taxes on income 17.7 14.8 Noncurrent assets and liabilities 0.2 6.9 ------- ------- Cash provided by operating activities 11.5 55.4 Cash flows from investing activities: Additions to property, plant, and equipment (36.2) (29.1) Computer software expenditures (1.9) (2.1) Trademark and patent expenditures (0.3) (1.1) ------- ------- Cash used for investing activities (38.4) (32.3) Cash flows from financing activities: Net change in commercial paper 91.8 26.7 Reduction of long-term debt -- (7.4) Proceeds from exercise of stock options 3.8 5.6 Dividends paid (47.9) (45.5) ------- ------- Cash provided by (used for) financing activities 47.7 (20.6) ------- ------- Net increase in cash and cash equivalents 20.8 2.5 Cash and cash equivalents, beginning of period 115.6 72.0 ------- ------- Cash and cash equivalents, end of period $ 136.4 $ 74.5 ======= ======= See notes to the condensed consolidated financial statements. 5 BROWN-FORMAN CORPORATION NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) In these notes, "we," "us," and "our" refer to Brown-Forman Corporation. 1. Condensed Consolidated Financial Statements We prepared these unaudited condensed consolidated financial statements using our customary accounting practices as set out in our 2003 annual report on Form 10-K (the "2003 Annual Report"). We made all of the adjustments (which include only normal, recurring adjustments) needed for a fair statement of this data. We condensed or omitted some of the information found in financial statements prepared according to generally accepted accounting principles ("GAAP"). You should read these financial statements together with the 2003 Annual Report, which does conform to GAAP. 2. Inventories We use the last-in, first-out ("LIFO") method to determine the cost of most of our inventories. If the LIFO method had not been used, inventories would have been $130.4 million higher than reported as of April 30, 2003, and $137.8 million higher than reported as of October 31, 2003. Changes in the LIFO valuation reserve for interim periods are based on a proportionate allocation of the estimated change for the entire fiscal year. 3. Taxes on Income Our consolidated effective tax rate may differ from current statutory rates due to the recognition of amounts for events or transactions that do not have tax consequences. We use the estimated annual effective tax rate in determining our interim results. 4. Earnings Per Share Basic earnings per share is calculated as net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated in the same manner, except that the denominator also includes additional common shares that would have been issued if outstanding stock options had been exercised during the period. The dilutive effect of outstanding stock options is determined by application of the treasury stock method. 6 The following table presents information concerning basic and diluted earnings per share: Three Months Ended Six Months Ended October 31, October 31, 2002 2003 2002 2003 ------ ------ ------ ------ Basic and diluted net income (in millions) $ 81.1 $ 88.2 $117.1 $119.4 Share data (in thousands): Basic average common shares outstanding 68,406 60,658 68,391 60,633 Effect of dilutive stock options 186 263 201 254 ------ ------ ------ ------ Diluted average common shares outstanding 68,592 60,921 68,592 60,887 Basic net income per share $1.18 $1.45 $1.71 $1.97 Diluted net income per share $1.18 $1.45 $1.71 $1.96 5. Environmental We face environmental claims resulting from the cleanup of several manufacturing or waste disposal sites in the United States. We accrue for losses associated with environmental cleanup obligations when such losses are probable and reasonably estimable. At some sites, there are other potentially responsible parties who are expected to bear part of the costs, in which cases our accrual is based on our estimate of our share of the total costs. A portion of the cleanup costs with respect to certain sites is expected to be paid by insurance. The estimated recovery of cleanup costs from insurers is recorded as an asset when receipt is deemed probable. We do not believe that any additional environmental cleanup costs we incur will have a material adverse effect on our consolidated financial position, results of operations, or cash flows. 6. Contingencies We operate in a litigious environment, and we get sued in the normal course of business. Sometimes plaintiffs seek substantial damages. Significant judgment is required in predicting the outcome of these suits and claims, many of which take years to adjudicate. Brown-Forman Corporation and certain other beer, spirits and wine producers are defendants in a civil action entitled "Hakki v. Adolph Coors Company", et. al, in the Superior Court of the District of Columbia, No. 03-9183. The suit alleges that the defendants have engaged in deceptive advertising in violation of the District of Columbia Consumer Protection Procedures Act ("the Act,") by marketing their beverage alcohol products to purchasers under the legal drinking age. Plaintiff alleges that defendants violated the Act by unfair and deceptive trade practices, engaging in wrongful conduct resulting in unjust enrichment, negligently marketing their products, and fraudulently concealing their alleged misconduct. 7 The plaintiff seeks class action certification of the suit on behalf of: (a) a guardian class, consisting of all persons who are or were parents or guardians of children whose funds were used to purchase beverage alcohol marketed by the defendants which were consumed without their prior knowledge by their children under the age of 21 during the period 1982 to present; and (b) an injunctive class, consisting of the parents and guardians of all children under the age of 21. The plaintiff seeks (1) a declaration that the defendants violated the Act; (2) disgorgement of all proceeds resulting from such alleged underage sales; (3) rescission of all sales to underage consumers and refund of those revenues to the classes; (4) an injunction against the defendants from marketing beverage alcohol to underage persons; (5) an award of damages against all defendants jointly and severally for all actual damages sustained by the plaintiff classes, plus treble damages or $1500 per violation, whichever is greater, punitive damages and attorneys fees. Brown-Forman denies that its marketing violates the Act, denies that it intentionally markets its beverage alcohol products to minors, and will vigorously defend this case. We accrue estimated costs for a contingency when we believe that a loss is probable, and adjust the accrual as appropriate to reflect changes in facts and circumstances. In our opinion, based on advice from legal counsel, none of the suits or claims against us will have a material adverse effect on our consolidated financial position, results of operations, or cash flows. In August 2003, we entered into an agreement with Diageo Great Britain Limited to settle a lawsuit involving the distribution of Jack Daniel's Tennessee Whiskey in the United Kingdom. Under the settlement, Brown-Forman paid Diageo 8.9 million British pounds (approximately $14.3 million) to end the controversy between the parties. The cost of the settlement was accrued as of July 31, 2003, and reduced earnings for the three months then ended by $0.11 per share. 7. Stock Options Under our Omnibus Compensation Plan, we can grant stock options and other stock-based incentive awards for a total of 3,400,000 shares of common stock to eligible employees until April 30, 2005. We apply Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for stock options. Accordingly, no stock-based employee compensation cost is reflected in net income, as no options granted under those plans had an exercise price below the market value of the underlying stock on the grant date. The following table illustrates the effect on net income and earnings per share if we had instead recognized compensation expense for stock options based on their fair value at their grant dates consistent with the methodology prescribed under Financial Accounting Standards Board Statement No. 123, "Accounting for Stock-Based Compensation." 8 (Dollars in millions, except per share amounts) Three Months Ended Six Months Ended October 31, October 31, 2002 2003 2002 2003 ------ ------ ------ ------ Net income, as reported $ 81.1 $ 88.2 $117.1 $119.4 Stock-based employee compensation expense determined under fair value based method, net of tax (1.0) (1.0) (1.8) (1.7) ------ ------ ------ ------ Pro forma net income $ 80.1 $ 87.2 $115.3 $117.7 ====== ====== ====== ====== Earnings per share - pro forma: Basic $1.17 $1.44 $1.69 $1.94 Diluted $1.17 $1.43 $1.68 $1.93 Earnings per share - as reported: Basic $1.18 $1.45 $1.71 $1.97 Diluted $1.18 $1.45 $1.71 $1.96 The plan requires that we purchase shares to satisfy stock option requirements, thereby avoiding future dilution of earnings that would occur from issuing additional shares. We acquire treasury shares from time to time in anticipation of these requirements. We intend to hold enough treasury stock so that the number of diluted shares is always less than the original number of shares outstanding at inception of the stock option plan (as adjusted for any share repurchases or issuances unrelated to the plan). The extent to which diluted shares exceed the number of basic shares is determined by how much our stock price has appreciated since options were granted, irrespective of how many treasury shares we have acquired. 8. Business Segment Information (Dollars in millions) Three Months Ended Six Months Ended October 31, October 31, 2002 2003 2002 2003 ------ ------ -------- -------- Net sales: Beverages $517.9 $544.6 $ 878.0 $ 968.3 Consumer durables 173.7 180.6 293.1 289.5 ------ ------ -------- -------- Consolidated net sales $691.6 $725.2 $1,171.1 $1,257.8 ====== ====== ======== ======== Operating income: Beverages $105.5 $119.8 $ 167.2 $ 183.9 Consumer durables 19.0 19.0 13.4 7.0 ------ ------ -------- -------- 124.5 138.8 180.6 190.9 Interest expense, net 0.7 5.1 1.8 10.0 ------ ------ -------- -------- Income before income taxes $123.8 $133.7 $ 178.8 $ 180.9 ====== ====== ======== ======== Consumer Beverages Durables Total --------- -------- ------ Goodwill: Balance as of April 30, 2003 $180.7 $130.3 $311.0 Additions related to Distillerie Tuoni e Canepa: Purchase accounting adjustment 1.6 -- 1.6 Foreign currency translation adjustment 2.9 -- 2.9 ------ ------ ------ Balance as of October 31, 2003 $185.2 $130.3 $315.5 ====== ====== ====== 9 9. Comprehensive Income Comprehensive income is a broad measure of the effects of all transactions and events (other than investments by or distributions to shareholders) that are recognized in stockholders' equity, regardless of whether those transactions and events are included in net income. The following table adjusts the company's net income for the other items included in comprehensive income: (Dollars in millions) Three Months Ended Six Months Ended October 31, October 31, 2002 2003 2002 2003 ------ ------ ------ ------ Net income $ 81.1 $ 88.2 $117.1 $119.4 Other comprehensive income (loss): Net gain (loss) on cash flow hedges 2.7 (0.7) (1.2) 0.1 Net gain (loss) on securities (0.4) (0.1) (0.3) 0.2 Minimum pension liability adjustment -- -- (0.4) -- Foreign currency translation adjustment 0.3 4.9 5.6 7.7 ------ ------ ------ ------ Other comprehensive income 2.6 4.1 3.7 8.0 ------ ------ ------ ------ Comprehensive income $ 83.7 $ 92.3 $120.8 $127.4 ====== ====== ====== ====== Accumulated other comprehensive loss (income) consisted of the following: (Dollars in millions) April 30, October 31, 2003 2003 ------ ------ Pension liability adjustment $ 79.1 $ 79.1 Cumulative translation adjustment 2.8 (4.9) Unrealized gain on cash flow hedge contracts 1.6 1.5 Unrealized gain on securities (0.1) (0.3) ------ ------ $ 83.4 $ 75.4 ====== ====== 10. Reclassifications Certain prior year amounts have been reclassified to conform with the current year presentation. 10 11. Subsequent Events On November 20, 2003, Directors of Brown-Forman Corporation approved a 2-for-1 stock split for all shares of Class A and Class B common stock, to be paid in the form of a stock dividend. Assuming that the company's stockholders authorize the additional shares of both classes of stock, the distribution of additional shares would be made to stockholders of record on or about January 8, 2004. Simultaneously, the Board of Directors approved a 13% increase in the company's regular quarterly cash dividend, from $0.375 to $0.425 per share. If the stockholders approve the 2-for-1 stock split, subsequent quarterly cash dividend payments and earnings per share amounts will be divided in half to reflect the stock split. 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion and analysis along with our 2003 Annual Report. Note that the results of operations for the six months ended October 31, 2003 do not necessarily indicate what our operating results for the full fiscal year will be. In this Item, "we," "us," and "our" refer to Brown- Forman Corporation. Important Note on Forward-Looking Statements: This report contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Words like "believe," "expect," "anticipate," and "project" identify a forward-looking statement, which speaks only as of the date the statement is made. Except as required by law, we do not intend to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. These statements are subject to a number of important risks and uncertainties that could cause our actual results and experience to differ materially from the anticipated results or other expectations expressed. Such risks and uncertainties include changes in general economic conditions, political and social trends, and the uncertainties of litigation. Our projections for our domestic beverage business assume that U.S. economic activity will continue at about the same pace as currently, and our earnings will be hurt if the economy weakens. Federal or state excise tax increases on spirits and wine would also depress our domestic beverage business. Profits from our international beverage business may be adversely affected if the U.S. dollar strengthens against other currencies or if economic conditions deteriorate in our principal export markets. As a leading exporter of American spirits brands, our foreign sales could be hurt as a result of anti-Americanism in response to the Iraq war or other international developments. The long-term outlook for our beverage business is based in part on favorable demographic trends in the U.S. and many international markets for the sale of spirits and wine. We may not meet current expectations for our global beverage business if these demographic trends do not translate into corresponding sales increases. Profits could also be hurt by increases in the price of grain, grapes, or energy. Margins for our wine business are likely to stay low so long as the current oversupply of grapes continues. Attacks by anti-alcohol activists or legal or regulatory measures against beverage alcohol (including its advertising and promotion) could adversely affect sales. Earnings from our consumer durables segment depend heavily on the state of the U.S. economy, as purchases of fine china and luggage are discretionary. The performance of our fine china dinnerware business depends on the health of major department stores, the primary distribution channel for these products, as well as further department store consolidation, a soft retail environment at outlet malls, and consumer response to direct mail. The Hartmann luggage business continues to be adversely affected by reduced travel in the U.S. 12 Results of Operations: Second Quarter Fiscal 2004 Compared to Second Quarter Fiscal 2003 Here is a summary of our operating performance (expressed in millions, except percentage and per share amounts): Three Months Ended October 31, 2002 2003 Change ------ ------ ------ Net Sales: Beverages $517.9 $544.6 5% Consumer Durables 173.7 180.6 4% ------ ------ Total $691.6 $725.2 5% Gross Profit: Beverages $253.7 $279.7 10% Consumer Durables 85.1 85.1 0% ------ ------ Total $338.8 $364.8 8% Advertising Expenses: Beverages $ 62.2 $ 72.1 16% Consumer Durables 24.2 22.9 (5%) ------ ------ Total $ 86.4 $ 95.0 10% SG&A Expenses: Beverages $ 82.2 $ 90.8 10% Consumer Durables 41.2 41.6 1% ------ ------ Total $123.4 $132.4 7% Other Expense (Income): Beverages $ 3.8 $ (3.1) Consumer Durables 0.7 1.7 ------ ------ Total $ 4.5 $ (1.4) Operating Income: Beverages $105.5 $119.8 14% Consumer Durables 19.0 19.0 0% ------ ------ Total $124.5 $138.8 11% Net Income $ 81.1 $ 88.2 9% Earnings per Share - Basic $ 1.18 $ 1.45 23% Earnings per Share - Diluted $ 1.18 $ 1.45 23% Effective Tax Rate 34.5% 34.0% 13 The company's earnings for the quarter ended October 31, 2003 were $1.45 per share, up 23% or $0.27 per share compared to the same period last year. Higher quarterly earnings were driven by the company's March 2003 share repurchase, benefits from a weaker U.S. dollar, and solid profit growth for both Jack Daniel's and Southern Comfort. These increases were partially offset by lower profits from several of our wine brands, increased advertising investments for our spirits brands, and higher pension expenses. Operating income for the Consumer Durables segment was even with last year. The March 2003 share repurchase accounted for $0.12 of the quarter's increased earnings. Excluding this benefit, earnings increased $0.15 per share, or 13%. We believe that disclosure of the increase in earnings per share excluding the benefit from the share repurchase is informative because it reflects the underlying operations of the company. Beverages In the second quarter, Beverage revenue increased 5% and gross profit increased 10%. Gross margin improved from 49.0% to 51.4%, the first increase in 10 quarters, driven by favorable foreign exchange trends, organic price increases in both wine and spirits, and positive mix benefits resulting from higher sales in the United Kingdom and the discontinuation of some lower margin wine brands. Advertising expenses were up 16% in the quarter, as we substantially increased investments behind our spirits brands. SG&A expenses were also up significantly in the quarter, as the segment recognized $2 million more in pension expenses and consolidated the financial results from both Finlandia Vodka Worldwide and Distillerie Tuoni e Canepa following these acquisitions in the second half of last fiscal year. Quarterly results were boosted by the absence of an operating loss recorded in the prior year's second quarter related to upfront advertising on Jack Daniel's Original Hard Cola, but were negatively impacted by significant increases in advertising on Finlandia Vodka, primarily related to the brand's re-launch in the U.S. As a result of these factors and the benefits from foreign exchange, segment operating income was up 14% for the quarter. Global shipments for Jack Daniel's Tennessee Whiskey were down slightly for the quarter, but depletions were up in the mid-single digits, led by robust growth in both the United States and U.K. These gains were partially offset by weaker results in Japan and several countries in Continental Europe. (Depletions are shipments from wholesale distributors to retailers, and are commonly regarded in the wine and spirits industry as a better proxy for consumer demand.) Worldwide shipments for Southern Comfort were also very strong, reflecting solid underlying growth in the U.K. and U.S., and domestic wholesalers adjusting inventories in advance of the holiday season. In addition to higher shipments, price increases in the U.S. boosted the brand's gross profit and operating income significantly. Global depletions were up in the low single digits for the quarter. 14 Shipments and depletions for Finlandia Vodka were also up in the quarter, as the company expanded its geographic distribution of the brand following last year's acquisition of a majority interest in Finlandia Vodka Worldwide. The wine industry continues to face challenging times. Profitability for several of our wine brands declined for the quarter, reflecting lower volumes. These volume declines were somewhat offset by an improved gross profit margin and lower SG&A expenses. We expect modest improvement from our wine brands this fiscal year, driven by slight improvement in the gross margin and lower operating expenses. Consumer Durables Net sales for Consumer Durables were up 4% for the quarter, with improved sales to department stores and through the segment's retail outlet stores. However, sales through the direct-to-consumer channel were down. Quarterly operating profit was flat compared with last year, as reductions in advertising and selling expenses were largely offset by higher pension costs. Although Consumer Durables full year performance is generally dependent upon the results of the holiday season, we expect that overall segment earnings this fiscal year will be down due to continued softness in the direct-to-consumer channel. 15 Results of Operations: Six Months Fiscal 2004 Compared to Six Months Fiscal 2003 Here is a summary of our operating performance (expressed in millions, except percentage and per share amounts): Six Months Ended October 31, 2002 2003 Change -------- -------- ------ Net Sales: Beverages $ 878.0 $ 968.3 10% Consumer Durables 293.1 289.5 (1%) -------- -------- Total $1,171.1 $1,257.8 7% Gross Profit: Beverages $ 445.2 $ 501.9 13% Consumer Durables 141.0 135.2 (4%) -------- -------- Total $ 586.2 $ 637.1 9% Advertising Expenses: Beverages $ 119.9 $ 128.7 7% Consumer Durables 44.8 43.8 (2%) ------ ------ Total $ 164.7 $ 172.5 5% SG&A Expenses: Beverages $ 157.5 $ 181.0 15% Consumer Durables 80.1 81.5 2% ------ ------ Total $ 237.6 $ 262.5 10% Other Expense (Income): Beverages $ 0.6 $ 8.3 Consumer Durables 2.7 2.9 ------ ------ Total $ 3.3 $ 11.2 Operating Income: Beverages $ 167.2 $ 183.9 10% Consumer Durables 13.4 7.0 (47%) -------- -------- Total $ 180.6 $ 190.9 6% Net Income $ 117.1 $ 119.4 2% Earnings per Share - Basic $ 1.71 $ 1.97 15% Earnings per Share - Diluted $ 1.71 $ 1.96 15% Effective Tax Rate 34.5% 34.0% 16 The company's diluted earnings for the six months ended October 31, 2003 were $1.96 per share, up 15% from the $1.71 earned in the same period last year. Year-to-date results benefited from the share repurchase ($0.14 per share), favorable foreign exchange trends, solid growth for both Jack Daniel's and Southern Comfort, and increased profits from a new distribution arrangement in the U.K. These gains were partially offset by a charge of $0.11 per share to settle a lawsuit with Diageo Great Britain Limited involving the distribution of Jack Daniel's in the U. K., as well as lower profits from several of our wine brands and Consumer Durables. Beverages For the first six months of the fiscal year, beverage revenues and gross profit were up 10% and 13%, respectively. Growth was driven by a weakening of the U.S. dollar, which increased year-to-date revenues and operating income by $38 million and $17 million, respectively. The new distribution arrangement in the U.K also contributed to the growth in revenue. In the first quarter of fiscal 2003, we had a one-time reduction in trade inventories as we began selling our spirits brands directly to the trade in the U.K. through a cost sharing arrangement with Bacardi. As a result, revenues improved by $13 million during fiscal 2004 due to the resumption of a normal shipment pattern into the U.K., as well as the higher profit margin earned in that market via the new distribution agreement. Additionally, we now record excise taxes for our U.K. spirits sales in both sales and cost of sales, which increased segment revenue by $20 million. Solid growth in Jack Daniel's and Southern Comfort more than offset lower profits from wines. Advertising expenses were up $9 million during the period, as increased investments behind our spirits brands more than offset a reduction in advertising for our wine brands. SG&A expenses increased approximately $23 million, as we added sales and marketing people in the U.K. to support the new distribution arrangement and recognized higher pension costs. SG&A expenses were also higher in Continental Europe due to the consolidation of financial results from both Finlandia Vodka Worldwide and Distillerie Tuoni e Canepa. Consumer Durables Net sales for Consumer Durables were down 1% and gross profit decreased 4%. The segment reported year-to-date operating income of $7 million compared to $13 million during the same period last year. A significant decline in operating profits from the direct-to-consumer channel exceeded growth in sales registered through the segment's wholesale channel. Outlook The company's full year 2004 earnings guidance of $4.10 to $4.30 per share remains unchanged. This projection includes the $0.11 per share charge incurred in the first quarter for the litigation settlement with Diageo Great Britain Limited. We expect that higher earnings from our core spirits brands and the benefits from foreign exchange will continue to offset higher pension costs and weakness from Consumer Durables. 17 Liquidity and Financial Condition Cash and cash equivalents increased by $2.5 million during the six months ended October 31, 2003, compared to an increase of $20.8 million during the same period last year. Cash provided by operations improved by $43.9 million, largely reflecting a more favorable working capital position. Cash used for investments declined by $6.1 million, due primarily to lower capital expenditures related to vineyard properties. Cash provided by financing activities declined by $68.3 million, mainly reflecting a decrease in net debt proceeds. In November, we increased the quarterly cash dividend 13% from $0.375 to $0.425 per share on both Class A and Class B common stock. Item 3. Quantitative and Qualitative Disclosures about Market Risk We hold debt obligations, foreign currency forward and option contracts, and commodity futures contracts that are exposed to risk from changes in interest rates, foreign currency exchange rates, and commodity prices, respectively. Established procedures and internal processes govern the management of these market risks. As of October 31, 2003, we do not consider the exposure to these market risks to be material. Item 4. Controls and Procedures The company, under the supervision and with the participation of its management, including the Chief Executive Officer ("CEO") and the Chief Financial Officer ("CFO"), evaluated the effectiveness of the design and operation of the company's "disclosure controls and procedures" (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) as of the end of the period covered by this report. Based on that evaluation, the CEO and CFO concluded that the company's disclosure controls and procedures are effective in timely making known to them material information relating to the company and the company's consolidated subsidiaries required to be disclosed in the company's reports filed or submitted under the Exchange Act. There has been no change in the company's internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the company's internal control over financial reporting. 18 PART II - OTHER INFORMATION Item 1. Legal Proceedings Brown-Forman Corporation and certain other beer, spirits and wine producers are defendants in a civil action entitled "Hakki v. Adolph Coors Company," et. al, in the Superior Court of the District of Columbia, No. 03-9183. The suit alleges that the defendants have engaged in deceptive advertising in violation of the District of Columbia Consumer Protection Procedures Act ("the Act,") by marketing their beverage alcohol products to purchasers under the legal drinking age. Plaintiff alleges that defendants violated the Act by unfair and deceptive trade practices, engaging in wrongful conduct resulting in unjust enrichment, negligently marketing their products, and fraudulently concealing their alleged misconduct. The plaintiff seeks class action certification of the suit on behalf of: (a) a guardian class, consisting of all persons who are or were parents or guardians of children whose funds were used to purchase beverage alcohol marketed by the defendants which were consumed without their prior knowledge by their children under the age of 21 during the period 1982 to present; and (b) an injunctive class, consisting of the parents and guardians of all children under the age of 21. The plaintiff seeks (1) a declaration that the defendants violated the Act; (2) disgorgement of all proceeds resulting from such alleged underage sales; (3) rescission of all sales to underage consumers and refund of those revenues to the classes; (4) an injunction against the defendants from marketing beverage alcohol to underage persons; (5) an award of damages against all defendants jointly and severally for all actual damages sustained by the plaintiff classes, plus treble damages or $1500 per violation, whichever is greater, punitive damages and attorneys fees. Brown-Forman denies that its marketing violates the Act, denies that it intentionally markets its beverage alcohol products to minors, and will vigorously defend this case. 19 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: 31.1 CEO Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002 31.2 CFO Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002 32 CEO and CFO Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (not considered to be filed) (b) Reports on Form 8-K: On August 14, 2003, Brown-Forman Corporation filed a report on Form 8-K announcing the resolution of certain litigation between itself and Diageo Great Britain Limited relating to the distribution of Jack Daniel's Tennessee Whiskey in the United Kingdom. On August 27, 2003, Brown-Forman Corporation filed a report on Form 8-K announcing the results of its operations for the quarter ended July 31, 2003. On September 25, 2003, Brown-Forman Corporation filed a report on Form 8-K announcing the appointment of Paul C. Varga to its Board of Directors, effective October 1, 2003. On November 20, 2003, Brown-Forman Corporation filed a report on Form 8-K announcing (i) its regular quarterly cash dividend, (ii) a solicitation of shareholder consents to authorize additional shares and (iii) a 2-for-1 stock split. On November 25, 2003, Brown-Forman Corporation filed a report on Form 8-K announcing the results of its operations for the quarter October 31, 2003. On November 26, 2003, Brown-Forman Corporation filed a report on Form 8-K announcing a lawsuit filed against several beer, spirits, and wine companies, including Brown-Forman Corporation. 20 SIGNATURES As required by the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned authorized officer. BROWN-FORMAN CORPORATION (Registrant) Date: December 5, 2003 By: /s/ Phoebe A. Wood Phoebe A. Wood Executive Vice President and Chief Financial Officer (On behalf of the Registrant and as Principal Financial Officer) 21 Exhibit 31.1 CERTIFICATION PURSUANT TO SECTION 302 OF SARBANES-OXLEY ACT OF 2002 I, Owsley Brown II, certify that: 1. I have reviewed this Quarterly report on Form 10-Q of Brown-Forman Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report. 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: December 5, 2003 By: /s/ Owsley Brown II Owsley Brown II Chief Executive Officer 22 Exhibit 31.2 CERTIFICATION PURSUANT TO SECTION 302 OF SARBANES-OXLEY ACT OF 2002 I, Phoebe A. Wood, certify that: 1. I have reviewed this Quarterly report on Form 10-Q of Brown-Forman Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report. 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: December 5, 2003 By: /s/ Phoebe A. Wood Phoebe A. Wood Chief Financial Officer 23 Exhibit 32 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Brown-Forman Corporation ("the Company") on Form 10-Q for the period ended October 31, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), each of the undersigned hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, in the capacity as an officer of the Company, that: (1) The Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. This certificate is being furnished solely for purposes of Section 906 and is not being filed as part of the Report. Date: December 5, 2003 By: /s/ Owsley Brown II Owsley Brown II Chief Executive Officer and Chairman Date: December 5, 2003 By: /s/ Phoebe A. Wood Phoebe A. Wood Executive Vice President and Chief Financial Officer A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. 24