BF.B Q1 2018 Earnings Call
Operator: Good morning. My name is Dorothy and I will be your conference operator today. At this time, I would like to welcome everyone to the Brown-Forman First Quarter Fiscal 2018 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn the call over to Jay Koval, Director of Investor Relations. Sir you may begin.
Jay Koval: Thanks, Dorothy, and good morning, everyone. I want to thank you for joining us for Brown-Forman's first quarter 2018 earnings call. Joining me today are Paul Varga, our Chairman and Chief Executive Officer; Jane Morreau, Executive Vice President and Chief Financial Officer; and Brian Fitzgerald, Chief Accounting Officer. This morning's conference call contains forward-looking statements based on our current expectations. Numerous risks and uncertainties may cause actual results to differ materially from those anticipated or projected in these statements. Many of the factors that will determine future results are beyond the company's ability to control or predict. You should not place undue reliance on any forward-looking statements and the company undertakes no obligation to update any of these statements, whether due to new information, future events or otherwise. This morning, we issued a press release containing our results for the first quarter of fiscal 2018 in addition to posting presentation materials that Jane will walk though momentarily. Both the release and the presentation can be found on our Web site under the section titled Investors, Events & Presentations. In the press release, we have listed a number of the risk factors that you should consider in conjunction with our forward-looking statements. Other significant risk factors are described in our Form 10-K, Form 8-K and Form 10-Q reports filed with the Securities and Exchange Commission. During the call, we will be discussing certain non-GAAP financial measures. These measures and the reasons management believes they provide useful information to investors regarding the company's financial conditions and results of operations are contained in the press release. And with that, I'll turn the call over to Jane for her prepared remarks.
Jane Morreau: Thanks Jay. And thanks everyone for joining us this morning for our first quarter earnings call. During my comments today, I will reference the slides we posted on our Web site this morning to help you walk through our two main areas of focus which are first, our first quarter results and second, our outlook for fiscal 2018. So, after I complete my prepared remarks, I will turn the call over to Paul for a few quick comments and then we will open it up to Q&A. So, let me start with our overall highlight shown on Slide 3, first, we experienced our fourth sequential quarterly improvement and underlying net sales with our first quarter up 6%. Second, our reported results were even stronger helped by distributor inventory and a lower tax rate and not to mention diminishing foreign exchange headwinds. Third, we invested significantly in our brands with an underlying A&P increase of over 6%, while we continue to deliver a meaningful operating leverage, the reductions in SG&A. And finally, we reaffirmed our full year outlook for underlying net sales growth of 4% to 5% and underlying operating income growth of 6% to 8%. We would note that we increased our EPS range for fiscal 2018 by 5% due to an improved outlook for our tax rate and foreign exchange. I will come back to our outlook in a few minutes. So, now, let's turn to Slide 4, to review our first quarter growth. Underlying net sales grew 6% in the quarter. This represented a continued acceleration from fiscal 2017 growth which improved throughout the year from last year's first quarter growth of 2%. This 6% growth was essentially inline with our expectations and keep this on track for our full year outlook of 4% to 5% growth in underlying net sales. As highlighted on Slide 5, reported net sales increased 9% in the quarter and was helped by 3 points due to the expected year-over-year change and distributor inventories in the United States as well as Russia. Slide 6 and 7 highlight our net sales growth by geographies. So beginning with the United Sates, underlying net sales grew 5% in the quarter. The growth was driven by our American Whisky portfolio led by the Jack Daniels Family of Brands, Woodford Reserve and Old Forester as well as sustained double-digit growth from el Jimador and Herradura. However, we are encouraged to see solid growth in the United States, our results were slightly ahead of takeaway on a value basis and as a result, we anticipate some get back in the second quarter. Turning to our developed market outside the United States, underlying net sales were flat impacted heavily by timing and test comparisons to last year's first quarter. While Australia delivered 17% underlying net sales growth reflecting buys-in on RTDs in advance of an August 1, price increase. Japan's underlying net sales declined 14% against last year's price driven buys-in. And combined sales for the United Kingdom and Germany were down 3% against the very strong 11% growth registered during last year's first quarter. We expect to see a nice rebound in the second quarter for these two markets as comparisons ease and takeaway trends remain solid. We experienced a strong improvement in underlying net sales growth in the emerging markets in the first quarter up 19%. Slide 8, highlights the improvement in our emerging markets trend over the last 12 months. While economic conditions in many of these markets remain volatile, we are optimistic that the recent declines have passed and we could be entering the most stable period of growth for these geographic areas with large population bases where our market shares remain well below what we believe are their full potential. That being said, we expect comparisons will get more challenging in the emerging markets as we move through the fiscal year. Our travel retail channel continued to grow nicely in the quarter with underlying net sales up 12% up against Woodford Reserve and Finlandia in the account. Additionally, passenger volumes are growing again in important markets such as Turkey, Russia and Brazil. Slide 9 breaks out our key brands underlying net sales growth. Jack Daniels Family of Brands grew underlying net sales by 6%, an acceleration from the 3% net sales growth for the family in fiscal 2017, growth was broad-based including solid gains projecting Tennessee Whiskey, Tennessee Honey, Tennessee Fire and Gentleman Jack. Jack Daniels RTDs had a particularly strong start to the year reflecting the combined effects of the Australia buy-in, new line extensions including Southern Peach Country Cocktails in the United States, Jack Daniels Tennessee Cider in the U.K. and Lynchburg Lemonade in Germany and expanding consumer demand in Mexico and Western Europe. Our premium and super premium bourbons such as Woodford Reserve and Old Forester continue to grow underlying net sales well into the double-digit as did our Tequila brands of el Jimador, Herradura and New Mix RTD. Following a modest decline in fiscal 2017, Finlandia grew underlying net sales to 6% in the first quarter fueled by Russia in travel retail. Now, before I move down the P&L, I wanted to share a quick update on our used barrel sales, which were stronger in the first quarter and contributed nearly a 0.5 point to our underlying net sales growth. And while this is a positive span as we enter the negotiating season for calendar 2018, we still anticipate that our used barrel sales will be down this fiscal year. We believe that the growth we experienced over the last three months was largely due to the timing of orders against a very easy comparison a year ago allowing volume gains to offset price decline. Moving down the P&L, and as shown on Slide 10, reported gross margin declined 40 basis points, while our underlying gross margins were flat. This decline was driven by 100 basis points of adverse foreign exchange partially offset by the absence of the prior year's A&D related activity of 60 basis points. So Slide 11 summarizes our operating performance on both the reported and underlying basis for the first quarter. You'll note our underlying A&P increased 6% as we found ample opportunities to invest in the Jack Daniels Family of Brands and the continued growth of our bourbon portfolio while also seeing our new brands including Slane, BenRiach and Glendronach. On the SG&A front, we remain committed through a discipline approach to controlling our cost including reducing discretionary spending as we look to continue to reallocate resources to our bands and consumer facing activities. First quarter SG&A was consistent with our expectations with underlying and reported SG&A down 1%. It should be noted that we delivered this decline at the same time we launched our own distribution in Spain on July 1. In the aggregate, we delivered 12% growth in underlying operating income during the first quarter. Reported operating income to improve even faster up 14% helped by year-over-year change in distributor inventories and operating margins expanded by 150 basis points to 33.7%. We delivered reported earnings per share of $0.46 in the first quarter, up 27% over the same period last year. Earnings per share growth was propelled by the large growth in operating income and helped by $0.03 due to a lower tax rate in the quarter. The reduction in the tax rate in the quarter was due to discrete items which are expected to help drive down full year tax rate to about 28% compared to our prior expectations for 29% to 30%. So, let me move on to my second and final topic for this call, a brief update on our fiscal 2018 outlook highlighted on Slide 12. As I previously mentioned, our first quarter results on an underlying basis were essentially inline with our expectations, keeping this on track we delivered an anticipated 4% to 5% growth in underlying net sales for the full year. This will represent 1 to 2 point acceleration in our top-line growth compared to fiscal 2017 results. We expect the top-line in our second quarter to be a bit lower than the first quarter strong start to the year on both the reported and underlying basis. This incorporates our expectations for some get back in the United States after our strong first quarter offset somewhat by a better Q2 results expected for our non-U.S. developed markets. This also considers the launch of Jack Daniels Tennessee Rye which is expected to benefit our underlying results mainly in the second half of fiscal 2018. Investing in our business with improved effectiveness, efficiency, cost consciousness and prioritization will remain a focus throughout fiscal 2018 and over the coming years. We are only three months into the fiscal 2018 and our plans for resource reallocation; we are already seeing these efforts pay-off as we increase investments in our brand, while simultaneously realizing cost savings and leverage to the bottom-line. We will use our year-end call to update you on our progress. Come back to our current year outlook, we still anticipated A&P growth will grow at or above our underlying net sales growth. In addition, we anticipate that SG&A will be roughly flat for the year as we continue to seek efficiencies, while also making strategic investment such as the same route-to-consumer change and start-up expenses associated with our new distillery in own places were Slane Irish Whiskey and Old Forester. We believe this cost discipline will drive a nice expansion of our operating margin in fiscal 2018. So, putting in altogether, we still expect full year underlying operating income growth of 6% to 8%. Given our revised expectations for our full year tax rate for about 28% and a slight benefit from foreign exchange due to the dollars recent slide, we [affirm] [ph] our EPS outlook by a nickel to a range of $1.85 to $1.95 equating to growth of 8% to 14%. As the sensitivity, our foreign currency cash [disclosures] [ph] collectively move 10% in either direction; we would expect EPS over the balance of the year would be impacted by about $0.04. While distributor inventories were likely fluctuate on a quarterly basis, this full year EPS range incorporates a little additional change in inventory. Though in summary, our brands performed well in the first quarter and we are encouraged to see continued top-line momentum and increasingly efficient use of resources delivering profitable sales growth. The global economic backdrop has improved over the last year and foreign exchange headwind have diminished. Our employees are executing with a great sense of near-term urgency and commitment to our long-term aspiration. And we remain focused on delivering superior long-term return for our shareholders. So, with that, let me turn over to Paul for his comments.
Paul Varga: Thank you, Jane, and good morning, everyone. To start, I was pleased with the very strong start to our fiscal year and I was really encouraged to see the acceleration in the quarter's underlying growth rate particularly the underlying growth in net sales alongside the favorable developments on our tax rate and FX that Jane referenced we chose to revise our full year forecast up slightly which is quite unusual for us with only one quarter of the year complete. But, it is worth emphasizing that quarter one is only one quarter's result. But, it was a very good quarter nonetheless and it provides us with a nice momentum as we prepare for the launch of Jack Daniels Tennessee Rye, the brand has been many years in the making and for which we have very high hopes. So, why did the first quarter's underlying results accelerate versus what we experienced in FY 2017? There was some influence from a few timing-related items such as soft comps from last year or the pre-price increased buy-in Australia that Jane referenced and [these really] [ph] will be offset are not repeated as the year unfolds. A more significant factor, however, is the way we are executing our plan at Brown-Forman in FY 2018 and that is with an even greater sense of competitiveness, prioritization, effectiveness and efficiency. In Jane's discussion of our results, she highlighted that A&P investment is solid up, at the same time, we are striving to manage SG&A at a level that is at or below two fiscal years ago all the while absorbing important SG&A investments this fiscal year related to our Spanish, route-to-consumer and a start-up cost associated with our distilleries and hospitality efforts at both Old Forester and Slane. This cannot happen without conscious prioritization and resource reallocation. Or said in another way, the more active pursuit of efficiency and some parts of Brown-Forman to help fund in incremental investments in other parts of Brown-Forman that we believe are necessary to ensure or improve our competitiveness, effectiveness and ultimately our ongoing results. And I believe this is particularly well-timed given the increasingly competitive context for our industry. Let me give you just two illustrative examples to this resource reallocation and action this year at Brown-Forman. First relates to our used barrel sales which have been very soft over the last several quarters after years of favorable supply/demand circumstances. After those circumstances shifted against this last year, we asked our team, if we could be doing anything differently to positively affect our results. They responded by better resourcing our direct selling effort while reaching out to a more expansive used barrel customer base. While the largest portion of the Q1 improvement we experienced in this area was timing related, we do believe that this improvement in our outreach is playing and will continue to play a role in help the guys in our efforts to arrest the significant decline we experienced last year. The second example relates to Gentleman Jack, a brand which received stronger media investment in the first quarter by new creative which we anticipated would really hit the mark with consumers. The early results would suggest that it did. Globally, the brand grew underlying sales to 8% in the first quarter after growing roughly 4% in the full 12 months of FY 2017. Additionally, the U.S. Nielsen's are indicating an approximate doubling of the Gentlemen of Jack volume and sales growth rate in the latest three months relative to their 12 month run rate. The incremental sales efforts behind our used barrels and the increased media investment behind Gentleman Jack were in part funded by conscious cost containment and sacrifices on the SG&A front this year. These came in the form of less travel, pure meeting and reduce training, lower consulting expense and a partial merit increase is freeze to name a few example. They can sometime be difficult to know what management means when we sight improved competitiveness, prioritization, effectiveness and efficiency. So, I hope these few examples give you an improved understanding of what we mean -- when we refer to them both today and in future communications. Let me conclude by saying that these types of trade-offs as thoughtful as we believe them to be are not easy for any organization and Brown-Forman is no exception. So, I want to thank my Brown-Forman colleagues not only for such nice quarter one results, but also for the spirit of understanding and cooperation that they have exhibited as we made these trade-offs and carried out these initiatives. As all of you undoubtedly know an organization with a positive pre-disposition and attitude is a huge enabler of ongoing success and we feel fortunate to have such an organization here at Brown-Forman. That concludes our prepared remarks and now we are happy to take any other questions you might have.
Operator: [Operator Instructions] Your first question comes from the line of Tim Ramey with Pivotal Research Group.
Tim Ramey: Good morning and thanks. I was stuck by the strong growth in Finlandia which was a nice departure, I know you mentioned Russia, but perhaps you would have a little bit more color on that?
Jane Morreau: On Finlandia?
Tim Ramey: Yes. I think you mentioned it, travel retail Russia and Poland to some extent, I think there is -- the brand is so concentrated in Eastern Europe any improvements we see out in that part of the world directly help Finlandia and that it was in fact the case particularly driven by Russia in Q1.
Jane Morreau: Yes. And we are overall -- Tim, we saw improvements in Russia for Jack Daniels as well. So, I think some of that just due to some stabilization that happen in that economy. Something that bodes well, we think as we look forward over the next few months perhaps through the year.
Tim Ramey: Terrific. And then, just on el Jimador and Herradura, you had a multiyear trend of raising price in moderating volume, it was -- can you elaborate on whether this was back to organic growth and volume or is it still sort of continuing that price shift?
Jane Morreau: Mexico.
Paul Varga: Yes. Just to clarify Tim, a lot of which you referred to there was very concentrated on the el Jimador Mexico business where we are consciously trading pricing for volume in that marketplace. But otherwise, it's been a more volume led growth trajectory in the United States for both brands and for even Herradura and Herradura Ultra and New Mix down in Mexico. So, I would say the continuation here continues to be volume-led on our tequila brand particularly when you look at the U.S. market.
Tim Ramey: Thanks so much.
Paul Varga: Welcome.
Operator: Your next question comes from the line of Nik Modi with RBC Capital Markets.
Nik Modi: Yes. Thanks everyone. Good morning. Just two quick questions. Emerging markets you guys commented obviously things have looked like they have improved, just wanted to understand what you are seeing to come to that conclusion because it still looks like it's pretty weak for most other consumer companies, just wanted to get some thoughts there. And then maybe just an update on what you are seeing on the Craft competition, are you seeing more supply coming to the market, any update there would be great. Thank you.
Paul Varga: Yes. I think two very different questions there.
Jane Morreau: I can take the emerging market question. Some of the -- we may have talked about this at year end. We were expecting our emerging markets to improve. They actually started to improve in the back half of last year. We saw a continuation of that happen in the first quarter some of it just to frankly to some easier comps versus last year where we had some disruption rather was geopolitical [indiscernible] example our own, are out to consumers changes that we did in China. But, we are actually are seeing some stabilization, you actually are seeing some foreign exchange improvement so we really actually see that these markets are seeing some stabilizing trends out there and our brands are seeing the growth and benefiting from the…
Paul Varga: I think the other factor that -- because you are referenced our competition just always worth remembering that, when you even look within our emerging markets, our concentration in the brick portion of the emerging markets relative to many of our larger competitors is smaller. So, our emerging market business will really benefit when -- for example, in this quarter was very prominent where Mexico and Poland were doing very, very well. And they are larger percentage of our emerging market business than they are for some of our competitors. I think that could explain us relative to some competitors you maybe referencing. The other part was on Craft, and yes, I mean I think the way you asked the question, I think you could have just made a statement. There is in fact continuing to be increasing competition across the board. Most notably in the United States but also in other key develop markets around the world where we are seeing just a rise in entrepreneurism, new distilleries coming online both in white goods and in brown goods. And so, I just would chock that up as increased competition for all of us, you are the most established players that has been around for a while. But it is a reality and it's interesting it’s not -- using the United States as an example, I'm trying to think through how significant some of the more recent news around Craft has been. One thing is so interesting, when you go back and study the performance of the United States, which, of course, has had such a nice and steady growing distill spirits market for a very long time. For many years now, the largest players, whether you segment them by the largest five or the largest 10 or 12, been losing share to the smaller players. It’s not some new phenomenon. This is only going to create even more competition as you have competition for shelf-space, back bar space et cetera from all the new Craft competition. But, one thing I was encouraged about by the first quarters and really the last 12 months, U.S. performance for Brown-Forman, I will just give you statistics which were fresh from the most recent data was that, of the top-12 largest companies in the U.S., only four outperformed the rate of growth of distilled spirits, which means and by and large the group as a whole would have continued as I said that trend of losing share. But, one of the four companies over both the 12 months and the last three months period in Nielsen that would have outperformed total of the distilled spirits is Brown-Forman. So, even though we paid great attention to every single individual category and every brand that we have represented in those categories, but I was encouraged by that continuing trend of Brown-Forman performing at the rate of total distilled spirits. Now, what does catch our attention now is competition is that that rate of growth for distilled spirits in the Unite States has been slowing, sort of modestly but steadily over the course of this fiscal year. And what would have first happened, there is usually a response to that comes in usually a more competitive effort particularly from the large and established players and so which you will see them as quite typical, you can see it come in the form of increased investments. But, what can really can create some competitive noise in the marketplace are the tried and -- increase in line extension activity, so you will see people particularly in the category that have flavored extension and then the other one is when people get particularly aggressive with lower pricing. And in the first quarter, we did absorb, I think the rate of innovation seem to be about the same, I don't have the data to prove that. But, I definitely have been paying attention to the lower prices that some competitors seem to be pursuing as they deal with this more competitive environment in the U.S. So, I know it’s a long answer to your Craft question, but those are some of the dynamics we see for us, particularly using the U.S. as an example. But, we continue to be holding up pretty well as a company.
Nik Modi: Great. Thanks for the perspective.
Paul Varga: You are welcome.
Operator: Your next question comes from the line of Judy Hong with Goldman Sachs.
Frida Leibowitz: Hi. This is actually Frida on for Judy.
Paul Varga: Hello.
Frida Leibowitz: Just a follow-up question, hi, on pricing in particular and the price mix this quarter was a little bit better than what you have seen in fiscal 2017 up 2%. And the geographic mix, it sounds like was much more heavily tilted to emerging market. So, could you talk about the drivers, the price mix being stronger than this particular quarter, was it better tequila growth, was it more mix in certain regions, any kind of color on that? And then, I have a follow-up.
Jane Morreau: I will start with this. When you have Jack Daniels in this Family of Brands growing itself 6%, you are going to get some nice price and mix benefit from both. And that's what actually happened in the quarter. We had a bit more price -- mix benefit than we did -- price if you actually broke the two numbers down apart. And so that coupled with a continued double digit growth in our bourbon, super premium bourbon brands such as Woodford Reserve and then Herradura going strongly. And there were some pricing in Mexico on that. So, all combined that contributed to our factor or more contribution coming from price mix than we did last year, but it's mainly mix.
Paul Varga: Yes.
Frida Leibowitz: Okay, great. And then, just thinking more holistically about the pricing strategy throughout your portfolio in the U.S. I mean it seems as though again the Jack Daniels pricing may been a little bit more rationale, and then, at least sequentially we have seen a little bit of declines in annual pricing in Gentleman Jack. And so, can you talk about how you are thinking in terms of pricing amongst the different brands in your portfolio especially as you are seeing some of these, Craft's competitors pricing at the lower end?
Paul Varga: Yes. I mean I think because of the large degree of -- increased number of brands is the best way to say it, and it's really very heavy in the 20 plus per bottle price segments. First, that will go up well above $50 a bottle. I mean, last year, I will give you the example, last year, I think consciously and implementing this very well market by market taking price on both Old Forester and Woodford Reserve. And in both instances, against the backdrop that's out there, there were some volume hit as those prices made their way. And so, with each brand, we will continue to look at what the opportunities are to raise price. I would say it is more difficult today than it would have been two years ago. And from time to time, we will continue to raise prices on brands for reasons other than volume which are about premium price position et cetera. And that is, it can be a significant and influence as selling the product through to the consumer. And that for sure has been the case in the Old Forester price repositioning over several years there. So, there will be a variety of influences, also think it will depend on the economy not just the degree of competition it's in there. And for example, if you have -- right now we feel like we have a -- between category momentum for bourbon which should be benefiting us in a nice economy there will be opportunities for targeted price increases. So, and our people are very well trained to find those. The other form of portfolio management is the one that, it sort of goes back to your first question, and the way that Jane answered it. You can imagine how we will benefit from introducing line extensions and new brands at higher price points. And you don't want to just go flood the market for that reason. But, the example that I would provide -- for that slide it is being something we are very excited about this forthcoming introduction of Jack Daniels Rye, which is going to be priced above the Jack Daniels price point. And it will be a form of portfolio mix that provides benefit, it's not technically a price increase but being positioned above Jack Daniels or the more rapid growth of Gentleman Jack that I referenced. Both of those are examples of being able to get portfolio mix benefit to replace some of the pricing that we are not seeing.
Frida Leibowitz: Thanks.
Operator: Your next question comes from the line of Will Chappell with SunTrust.
Will Chappell: Thanks. Good morning.
Paul Varga: Good morning.
Will Chappell: Hey, Paul. Just want to follow-up on the Rye launch and just make sure I understand, I mean. If you look over the past couple of years, Rye is going to almost become a market by itself with fast growth and really going to niche in smaller brands making most of that growth. I mean, does it make sense or kind of as you look at your optimism on the back half in this launch to have a separate brand kind of similar what you've done with Woodford Reserve or what you have done on the Irish side or do you feel like you can still capture your fair share with just -- not just, but with the Jack Daniels brand?
Paul Varga: Yes. I'm glad you mentioned Woodford because that was a great example of brand that's been in the market for what 18 years before we introduced it's Rye version at nearly -- I think at approximate almost $40 price point now and it's growing at astronomical rate. It's getting incredible product critical acclaim. So, that is one of the things this early experience on Woodford Reserve Rye is one thing just giving some excitement. Actually, see the categories momentum and remember this category has largely been built by the bar tenders and any entrée associated with resurgence of the classic cocktail and this particular sort of category that's spice and bold and flavored is resonating very well. I mean it's an extremely mix of all category. I mean the product raise. It's very interesting to taste the various expressions because that was a great range from the 51% raise to the 100% raise. And they all made cocktails differently and one of the things it had just excited is the excellent balance in this Jack Daniels Tennessee Rye product, I really do think it lends itself very well to the cocktail boon that's going on. It's an extremely well-balanced product. We have very good -- some encourage, you can never go to the bank on these things but the preparatory consumer research we did was really encouraging about Jack Daniels potential in this arena. And actually think at the low of $30 price point, while still super premium in price, this will, I think be a value. And we just have had so much experience over so many years and just introducing brands to other consume public from Jack Daniels in doing that we hope the right way. And I just would note that this is the first Jack Daniels distillery whiskey brand with a different grain recipe. I mean that in and of itself will encourage all kinds of interest in this legion of Jack Daniels brand devotees will undoubtedly want to try it. Actually think the Jack Daniels Tennessee Rye has the ability to expand the category beyond what people might experience because there is -- I'm sure a lot of Jack Daniels Tennessee whiskey drinkers who have not ventured into the rye category yet and experience cocktail made with rye. And so, there is all number of reasons for us to be excited about it. And I would not under estimate the ability of Jack Daniels Tennessee Rye to play a role in the globalization of the rye category. It’s not our primary focus to start. But, as we learned with Jack Daniels Black Label Tennessee whiskey, and then, later with even the flavored expression that we can play a very prominent role in taking the flavors of American whiskey around the world. And so, I just know from some of the outreach, we've already had from our colleagues around Brown-Forman who are interested in this because the world is already learning about its introduction in the United States. So, we got our fingers crossed that it will be a big success for us and I'm personally just very excited about it. I think it’s a really exciting introduction from the distillery.
Will Chappell: Okay. And then, just a follow-up with that, I think Jane you said the majority of the benefit comes in the back half, is that pipeline, I think we are seeing the launch is pretty imminent, were is that just you won't get to full distribution until the third or fourth quarter and that's why we wouldn’t expect it as a big of a benefit until then?
Jane Morreau: Yes. So, getting ready to ship it September first of all. Well, first of all, we have laid this found five years ago. And so, we lay down a certain amount of -- some of it's limited by the amount of quantity that we laid down. So, shipping in September for us means it will start hitting the shelves in October timeframe. We have more coming obviously as the year goes on. That’s why we are saying it was more at the back -- but, we are limited by the amount of -- thought that we laid down five years ago not withstanding the profit. But, we are very optimistic about the brand that we will get into full distribution, it’s our plan.
Paul Varga: Yes. We would have available in ensuing years, more quantities available. But, I personally, if you go down the list of the leading brand in the U.S. rye category, one of the selling attributes I believe that is very compelling for Jack Daniels Tennessee Rye is the fact that it's actually made the Jack Daniels distillery. And, there are a number of these competitors out there that really haven't been making their own rye and it doesn't mean they are bad products per se, but I do think there are some real positive selling attributes associated with our particular entry because they have been crafted by the distillers themselves at the distillery and not source from a third party.
Will Chappell: Done. Thanks so much.
Paul Varga: You are welcome.
Operator: Your next question comes from the line of Brett Copper with Consumer Edge Research.
JayKoval: Hey, Brett. I think you might be on mute.
Brett Copper: Sorry. Can you hear me now?
Jane Morreau: Yes.
Paul Varga: Yes. We can. Thanks.
Brett Copper: Sorry. I just want to circle back on the message of competition; others outside of the company haven't really heard you speak up about that until your annual meeting and then again today. So, I guess, is this something new for the company or is it a new message for kind of for us [indiscernible]? And then, as we think about it, is it competition sort of really focused or is there, I guess increased competition within Brown-Forman whether would be cost brands in countries? And then, if I can slip one final in is, is this idea of increased competitiveness, is that going to spill over to advertising, you spoke just about it a second ago, but where you can compare yourself your sourcing versus what else is out there given the new competition? Thanks.
Paul Varga: Those are good questions. Let me clarify. We have always been in tune with competition, I mean I would tell you that for example years ago the introduction of Jack Daniels Tennessee Honey was the direct response to competitive activity in the marketplace, new innovation from competitors that we would first solve directly related to the short businesses on both, Southern Comfort when we owned it and Jack Daniels. So, I mean, I feel like we regularly talk about what's the changing competitive dynamics. I think a lot of it is, while we emphasizing it, just try to sharpen our own perspective and to give you some transparency to how we are thinking about mostly all these new entrants that are forthcoming particularly the time when 10 years ago, you would have heard the phrase barrier to entry described around many of the categories notably the age categories like whiskey. And today, you just see so because of an available third party markets you can make products, but also the willingness of entrepreneurs to open their own distilleries and get into the business. And so, I think here we are what's about 10 years later and so, it's just normal to talk about what's going on with competition. And also to not -- to not let misinterpretation of how the competition is unfolding, either the way you will interpret our business or the way we run it. And I think we have to be very conscious, I mean, like the one example in one of the earlier question was, is it now a great time to be taking more aggressive price increases while some of our motivated competitors are reducing prices is making their brands more affordable through promotion or one-off. And there is a lot of new entrants in the market. It just is a little more difficult today than it might have been three or four years ago. It doesn't mean it's not possible, but it does mean it's a little more difficult. So, we go ahead and emphasize that point with you. I think it also is one of the things that compels us and to look at ways that we can be innovative. Look at ways that we can participate in some of where the category momentum is or there is countless examples of it. And sometimes we are followers and other times we can lead some of that. I mean and that's why I tried to -- it's even much for our own internal conversations here to try to shed light on what is really happening in the marketplace. There are more SKUs. There are more brands competing for -- I actually do think this space is increasing, but it's not increasing at the rate that the number of brands are. But, so it just makes it inherently fight for shelf space and market share. Thankfully the categories themselves are growing. That does enable some of the headspace or new competition et cetera. But, I personally think that should sharpen the company, it should make us the very attentive to things such as, are your resources working as hard as they should be for, do you have them in the right places. And that's why we emphasize in our prepared comments. Some of the ways are suddenly running Brown-Forman a little differently against changing competitive context. As to whether there is internal competition, of course. All of our people are regularly lobbying for more resources and that takes some both art and skill to make sure that we keep everybody focused on the outset and not inset. But, as I said in my comments, I'm really been pleased by the way that people have adopted such a good attitude about wanting to compete and win. I mean we are a very competitive company. Sometimes we are prone because we are so long-term earning and we make decisions based on the long-term were owned back and controlled back family that has the long-term interest of the company very much at the core of everything. If you listen to that too much you can forget to go out and get the weekly market share figures or you can forget to go out and compete in a way that we try to turn that up just a notch with our employees but keep it in balance this year. It's all total. Look at the very competitive but also exciting arena out there and I mean having emphasized a little more than I have in the past is, introduction of Jack Daniels Tennessee Rye, mostly because it's upon us. But, all because we waited many years, you have to remember just a small sea of us sat around five or six years ago. And so, let's start making some of this, so it will be ready. And so, for us it's been many years in the making, we are excited about it.
Brett Copper: Thanks.
Operator: Your next question comes from the line of Robert Ottenstein with Evercore.
Eric Serotta: Hi. It's Eric Serotta in for Robert. I was hoping you could give some --
Paul Varga: Hey, Eric.
Eric Serotta: Hey. Hope you could give some color in terms of your gross margin outlook, it's a very good operating leverage at the operating income line this quarter, but the gross margin was kind of flattish on an underlying basis and down reported. As we are looking out of the next few quarters, should that FX headwinds start to moderate, how should the other moving pieces play out in terms of your gross margin progression for the year.
Jane Morreau: Sure. I'll take that. Yes. You are right. Our reporting gross margin was down as we mentioned little bit due to FX, Middle East, quarter offset a little bit by now, A&D activity from last year. So, as we look throughout the year, we expect that Middle East on a reported basis subside and actually reported gross margin probably because it's flat, flattish. And when we look at it on underlying basis, we were flattish for the quarter and we would expect our underlying as we get to the end of year -- close to flattish down, just a tad potentially depending on mix just because we have been talking about the competitive pricing environment. And we were not table to [strike excellent pricing] [ph] we have done in the past. But, not marginally down even on an underlying basis. And as it related to the operating margin we talk about -- I just saw in our results, I remember we had 150 basis points of improvement and that was driven largely by the decrease in SG&A in the quarter. And so, when we look ahead, we are not forecasting SG&A to be down for the year but instead flattish. So, when we look at the operating margin for the year, we are looking for somewhere around of 100 basis points improvement.
Eric Serotta: Okay. And then, Paul, I don't think you guys mentioned Slane much on this call, just wondering any additional early read on how that launch is going and I know it's fairly limited thus far, but any initial color would be helpful?
Paul Varga: Thank you. It's off to a good start. It's the way I say it, obviously very, very small, it's literally I think 18 U.S. days and introducing into Ireland and the U.K. in travel retail some. It's a good reception. I mean some of the things that have been written about the product and what we heard from trade reactions a lot of that's anecdotal, it's all been good. We just I think opened last week, so the public-- so for distillery business as we complete our construction and doubling, we are actually going to have our Board [indiscernible] next month in September. So, it would be exciting for a number of our Board members to see that as well. So, also very good, we are always very encouraged, but again, it's a very staged unlike the amount of product for example that we are -- we have available to go with Jack Daniels Rye for example, I mean Slane is not at that level of immediate expectation if the new trademark et cetera. And it's one of the things that is -- that base that it's in, which is -- as a lot of excitement around it. But, we will be dabbling with very different selling and marketing techniques in different parts around the world just to learn the best way to introduce it to consumers. But, so far what we have seen in terms of the product, I mean I really like the package, I think the package and product make a great presentation, I think for the initial reactions that has been very good. And then, it's up to the good old fashion day today grand building that we have to do. But, I know our system is very excited about it.
Eric Serotta: Great. Thanks I will pass it on.
Paul Varga: Welcome.
Operator: Your next question comes from the line of Laurent Grandet with Credit Suisse.
Laurent Grandet: Good morning, Paul and Jane. I had two questions. The first one Jane, I mean you mentioned bounce sales, can you provide about half of the points of supply game, what was the contribution in term of margin expansion. And the second one is, I was a bit conscious I joined the quarter for the U.S. market, as of course, [indiscernible] last fiscal year from 5% in the first half to 2% in second half, I mean really 1% in the last quarter. So, now, with the first quarter in the U.S. being in plus five, it's a strong inflection, so, it's a pressure from Craft's flavored whiskey is reducing, while you just executing better, so like to have more colors on that on this from you?
Paul Varga: Okay. I will take that second question here first. I don't think it impacted Craft, so I don't think it is at the same sort of intent level as it's been in my view. I do think there are some execution aspects of it. As I described in my prepared remarks, our teams are increasingly more competitive and efficient and then, also just the efforts in sales around it. I mean it's hard to always pinpoint whether it might be a partnership -- new partnership with the NBA and the media that's related to that or other elements that can contribute to a slight lift in a particular brand sales. But, I think we are putting forth better effort right now against the brand and this year I also say for it's the case of Woodford Reserve and to some external Forrester, they don’t have the pressure of higher pricing that we are placing on them a year ago. So, that can be a contributor. We continue to see for us a very good trends they presented earlier on the call related to Herradura and el Jimador. So, I think these are number that contributing factors, so why we might see slight acceleration. But having said that, I continue to think it's going to be particularly as we get into the fall and holiday season continue to be very competitive. So, we look like you remain conscious about the marketplace because of that level of competition. But, that's just part of the game.
Laurent Grandet: Thank you. And then, Jane, the margin?
Paul Varga: Then the margin. Yes, Jane will address the margin side.
Jane Morreau: Yes. Now, I have got all the information in front of me and so, I would happy to follow up with you after the call, that would be okay?
Laurent Grandet: That's fine with me.
Jane Morreau: Okay. Can we do that? Yes. Thanks.
Laurent Grandet: Thanks.
Paul Varga: Thank you.
Operator: We will take our final question from the line of Bryan Spillane with Bank of America.
Bryan Spillane: Hey, good morning, everyone.
Paul Varga: Hey, Bryan.
Bryan Spillane: Hey, Jane. Just a couple of questions on cash flow. I guess first in this quarter, it look like working capital, it might have been a little bit more of a drag at least versus kind of the way we have modeled it. So, is it just simply the timing of the shipments, or is there anything that we should think about in terms of working capital in the first quarter or for the year?
Jane Morreau: Actually working capital is a funny calculation as you know. And if you look at this year, don't think there is anything, I think it's relative to last year, the question maybe arising it's because last year's first quarter and really all of last year, we had the absence of Southern Comfort. So that impacted our AR, so think about that. We had AR in the previous year, it may weigh last year, still that was a source of cash if you will last year came through -- what we actually [sold it] [ph]. This year it's impacting -- I'm not worried about anything, our sales are up this year. So we see it is being use of cash this year, if you will. So, it's really due to the Southern Comfort.
Bryan Spillane: All right. Yes. That makes sense. And then, just in terms of uses of cash, can you just remind us what the expectations are for capital spending for the year. And then, I guess you should have a pretty good sort of free cash flow year, there hasn't been any share repurchases the last couple of quarters. So, just -- how you are thinking about using free cash flow for the balance of the year?
Jane Morreau: Yes, sure. So, specifically to your first question as it related to our capital spending forecast for the year. We are projecting up to about $140 million of capital spending. We have a couple of big projects that we are completing when Paul just mentioned a moment ago, which was this completion of the Slane [Complex] [ph] and Distillery, which just open to the public [indiscernible] went to the public this weekend. And then, our Old Forester distillery which is set to open in the spring, but those are couple of our big investments behind up to $140 million of spending. When you look at our free cash flow for the year, first of all, think it's probably worthwhile to take a step back and look at our approach to capital allocation, which we have not changed that approach to capital allocation. At least want to look for ways to deploy cash to create shareholder value and we will always will do that. But, this particular year beyond the -- up to $140 million of fully investing behind our business and of course, we look to increase continually deliver ordinary dividends to our shareholders in increase. We do have $250 million of debt coming through in January which we plan to pay the cash. So that will take some of our or most of free cash flow it's left from there. Beyond that we have ample. Debt capacity should acquisitions become available that makes sense and fit into our [indiscernible] and into what we are doing.
Bryan Spillane: That's great. Very helpful. Enjoy Labor Day.
Jane Morreau: You too in [releasing] [ph] of our product.
Bryan Spillane: I definitely will. Thanks guys.
Jay Koval: Thank you, Paul and Jane. And thanks to all of you for joining us today for Brown-Forman's first quarter earnings call. We hope you all enjoyed your Labor Day and our thoughts are with all of the people that have been impacted by the floods. Take care.
Operator: Thank you, ladies and gentlemen. That does conclude today's conference call. You may now disconnect.