Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Introduction

This Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader better understand Brown-Forman, our operations, our financial results, and our current business environment. Please read this MD&A in conjunction with our Consolidated Financial Statements and the accompanying Notes contained in “Item 8. Financial Statements and Supplementary Data” (the Consolidated Financial Statements).

Our MD&A is organized as follows:

Table of Contents
	Page
Presentation basis. This MD&A reflects the basis of presentation described in Note 1 “Accounting Policies” to the Consolidated Financial Statements. In addition, we define statistical and non-GAAP financial measures that we believe help readers understand our results of operations and the trends affecting our business.	30
Reclassifications. We discuss retrospective adjustments to our prior year statements of operations during fiscal years 2018 and 2017. Please read this section in conjunction with Note 2 to the accompanying financial statements.	33
Significant developments. We discuss developments during the most recent three fiscal years. Please read this section in conjunction with “Item 1. Business,” which provides a general description of our business and strategy.	34
Executive summary. We discuss (a) fiscal 2019 highlights and (b) our outlook for fiscal 2020, including the trends, developments, and uncertainties that we expect to affect our business.	36
Results of operations. We discuss (a) fiscal 2019 results for our largest markets, (b) fiscal 2019 results for our largest brands, and (c) the causes of year-over-year changes in our statements of operations line items, including transactions and other items that affect the comparability of our results, for fiscal year 2019 and 2018.	39
Liquidity and capital resources. We discuss (a) the causes of year-over-year changes in cash flows from operating activities, investing activities, and financing activities; (b) recent and expected future capital expenditures; (c) dividends and share repurchases; and (d) our liquidity position, including capital resources available to us.	48
Off-balance sheet arrangements and long-term obligations.	50
Critical accounting policies and estimates. We discuss the critical accounting policies and estimates that require significant management judgment.	51

Presentation Basis

Non-GAAP Financial Measures

We use some financial measures in this report that are not measures of financial performance under U.S. generally accepted accounting principles (GAAP). These non-GAAP measures, defined below, should be viewed as supplements to (not substitutes for) our results of operations and other measures reported under GAAP. Other companies may not define or calculate these non-GAAP measures in the same way.

“Underlying change” in measures of statements of operations. We present changes in certain measures, or line items, of the statements of operations that are adjusted to an “underlying” basis. We use “underlying change” for the following measures of the statements of operations: (a) underlying net sales; (b) underlying cost of sales; (c) underlying gross profit; (d) underlying advertising expenses; (e) underlying selling, general, and administrative (SG&A) expenses; (f) underlying other expense (income) net; (g) underlying operating expenses1; and (h) underlying operating income. To calculate these measures, we adjust, as applicable, for (a) acquisitions and divestitures, (b) a new accounting standard, (c) foreign exchange, (d) estimated net changes in distributor inventories, and (e) the establishment of our charitable foundation. We explain these adjustments below.

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“Acquisitions and divestitures.” This adjustment removes (a) any non-recurring effects related to our acquisitions and divestitures (e.g., transaction gains or losses, transaction costs, and integration costs), and (b) the effects of operating activity related to acquired and divested brands for periods not comparable year over year (non-comparable periods). By excluding non-comparable periods, we therefore include the effects of acquired and divested brands only to the extent that results are comparable year over year.

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

In fiscal 2016, we sold our Southern Comfort and Tuaca brands and related assets to Sazerac Company, Inc. and entered into a related transition services agreement (TSA). During fiscal 2017, we completed our obligations under the TSA. This adjustment removes the net sales, cost of sales, and operating expenses recognized in fiscal 2017 pursuant to the TSA related to contract bottling services and distribution services in certain markets.

On June 1, 2016, we acquired The BenRiach Distillery Company Limited (BenRiach). This adjustment removes (a) transaction and integration costs related to the acquisition and (b) operating activity for the acquired business for the non-comparable period. With respect to comparisons of fiscal 2018 to fiscal 2017, the non-comparable period is the month of May.

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“New accounting standard.” Under Accounting Standards Codification (ASC) 606, “Revenue from Contracts with Customers,” we recognize the cost of certain customer incentives earlier than we did before adopting ASC 606. Although this change in timing did not have a significant impact on a full-year basis, there was some change in the timing of recognition across periods. Additionally, some payments to customers that we classified as expenses before adopting the new standard are classified as reductions of net sales under our new policy. See Note 2 to the accompanying financial statements for additional information. This adjustment allows us to look at underlying change on a comparable basis.

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“Foundation.” In fiscal 2018, we established the Brown-Forman Foundation (the Foundation) with an initial $70 million contribution to support the Company’s charitable giving program in the communities where our employees live and work. This adjustment removes the initial $70 million contribution to the Foundation from our underlying SG&A expenses and underlying operating income to present our underlying results on a comparable basis.

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“Foreign exchange.” We calculate the percentage change in certain line items of the statements of operations in accordance with GAAP and adjust to exclude the cost or benefit of currency fluctuations. Adjusting for foreign exchange allows us to understand our business on a constant-dollar basis, as fluctuations in exchange rates can distort the underlying trend both positively and negatively. (In this report, “dollar” always means the U.S. dollar unless stated otherwise.) To eliminate the effect of foreign exchange fluctuations when comparing across periods, we translate current-year results at prior-year rates and remove transactional and hedging foreign exchange gains and losses from current- and prior-year periods.

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“Estimated net change in distributor inventories.” This adjustment refers to the estimated net effect of changes in distributor inventories on changes in certain line items of the statements of operations. For each period compared, we use volume information from our distributors to estimate the effect of distributor inventory changes in certain line items of the statements of operations. We believe that this adjustment reduces the effect of varying levels of distributor inventories on changes in certain line items of the statements of operations and allows us to understand better our underlying results and trends.

We use the non-GAAP measures “underlying change” to: (a) understand our performance from period to period on a consistent basis; (b) compare our performance to that of our competitors; (c) calculate components of management incentive compensation; (d) plan and forecast; and (e) communicate our financial performance to the board of directors, stockholders, and investment analysts. We provide reconciliations of the “underlying change” in certain line items of the statements of operations to their nearest GAAP measures in the tables under “Results of Operations - Year-Over-Year Comparisons.” We have consistently applied the adjustments within our reconciliations in arriving at each non-GAAP measure.

“Return on average invested capital.” This measure refers to the sum of net income and after-tax interest expense, divided by average invested capital. Average invested capital equals assets less liabilities, excluding interest-bearing debt, and is calculated using the average of the most recent 13 month-end balances. After-tax interest expense equals interest expense multiplied by one minus our effective tax rate. We use this non-GAAP measure because we consider return on average invested capital to be a meaningful indicator of how effectively and efficiently we invest capital in our business.

Definitions

Aggregations.

From time to time, to explain our results of operations or to highlight trends and uncertainties affecting our business, we aggregate markets according to stage of economic development as defined by the International Monetary Fund (IMF), and we aggregate brands by spirits category. Below, we define the geographic and brand aggregations used in this report.

Geographic Aggregations.

In “Results of Operations - Fiscal 2019 Market Highlights,” we provide supplemental information for our largest markets ranked by percentage of total fiscal 2019 net sales. In addition to markets listed by country name, we include the following aggregations:

•	“Developed International” markets are “advanced economies” as defined by the IMF, excluding the United States. Our largest developed international markets are the United Kingdom, Australia, Germany, France, and Japan. This aggregation represents our net sales of branded products to these markets.

•	“Emerging” markets are “emerging and developing economies” as defined by the IMF. Our largest emerging markets are Mexico, Poland, Russia, and Brazil. This aggregation represents our net sales of branded products to these markets.

•	“Travel Retail” represents our net sales of branded products to global duty-free customers, other travel retail customers, and the U.S. military regardless of customer location.

•	“Non-branded and bulk” includes our net sales of used barrels, bulk whiskey and wine, and contract bottling regardless of customer location.

Brand Aggregations.

In “Results of Operations - Fiscal 2019 Brand Highlights,” we provide supplemental information for our largest brands ranked by percentage of total fiscal 2019 net sales. In addition to brands listed by name, we include the following aggregations:

•	“Whiskey” includes all whiskey spirits and whiskey-based flavored liqueurs, ready-to-drink (RTD), and ready-to-pour products (RTP). The brands included in this category are the Jack Daniel's family of brands, Woodford Reserve, Canadian Mist, GlenDronach, BenRiach, Glenglassaugh, Old Forester, Early Times, Slane Irish Whiskey, and Coopers’ Craft.

•	“American whiskey” includes the Jack Daniel’s family of brands, premium bourbons (defined below), and Early Times.

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“Jack Daniel’s family of brands” includes Jack Daniel’s Tennessee Whiskey (JDTW), Jack Daniel’s RTD and RTP products (JD RTD/RTP), Jack Daniel’s Tennessee Honey (JDTH), Gentleman Jack, Jack Daniel’s Tennessee Fire (JDTF), Jack Daniel’s Single Barrel Collection (JDSB), Jack Daniel’s Tennessee Rye Whiskey (JDTR), Jack Daniel’s Sinatra Select, Jack Daniel’s No. 27 Gold Tennessee Whiskey, and Jack Daniel’s Bottled-in-Bond.

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“Jack Daniel’s RTD and RTP” products include all RTD line extensions of Jack Daniel’s, such as Jack Daniel’s & Cola, Jack Daniel’s & Diet Cola, Jack & Ginger, Jack Daniel’s Country Cocktails, Gentleman Jack & Cola, Jack Daniel’s Double Jack, Jack Daniel’s American Serve, Jack Daniel’s Tennessee Honey RTD, Jack Daniel’s Cider (JD Cider), Jack Daniel’s Lynchburg Lemonade (JD Lynchburg Lemonade), and the seasonal Jack Daniel’s Winter Jack RTP.

•	“Premium bourbons” includes Woodford Reserve, Old Forester, and Coopers’ Craft.

•	“Tequila” includes el Jimador, Herradura, New Mix, Pepe Lopez, and Antiguo.

•	“Vodka” includes Finlandia.

•	“Wine” includes Korbel Champagne and Sonoma-Cutrer wines.

•	“Non-branded and bulk” includes our net sales of used barrels, bulk whiskey and wine, and contract bottling regardless of customer location.

Other Metrics.

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“Depletions.” We generally record revenues when we ship our products to our customers. Depletions is a term commonly used in the beverage alcohol industry to describe volume. Depending on the context, depletions means either (a) our shipments directly to retail or wholesale customers for owned distribution markets or (b) shipments from our distributor customers to retailers and wholesalers in other markets. We believe that depletions measure volume in a way that more closely reflects consumer demand than our shipments to distributor customers do. In this document, unless otherwise specified, we refer to depletions when discussing volume.

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“Consumer takeaway.” When discussing trends in the market, we refer to consumer takeaway, a term commonly used in the beverage alcohol industry. Consumer takeaway refers to the purchase of product by consumers from retail outlets as measured by volume or retail sales value. This information is provided by third parties, such as Nielsen and the National Alcohol Beverage Control Association (NABCA). Our estimates of market share or changes in market share are derived from consumer takeaway data using the retail sales value metric. We believe consumer takeaway is a leading indicator of how consumer demand is trending.

Reclassifications

As discussed in Note 2 to the accompanying financial statements, we retrospectively adjusted our prior year statements of operations in connection with the adoption of Accounting Standards Update (ASU) 2017-07, “Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.” We also reclassified some previously reported expense amounts related to certain marketing research and promotional agency costs. The impact of these changes, which had no effect on net income, was not material.

The following tables reconcile the previously reported amounts to the currently reported amounts in the statements of operations for fiscal years 2017 and 2018.

	Fiscal 2017
(Dollars in millions)	Previously Reported				Adoption of ASU 2017-07				Reclassifications				Currently Reported
Net sales	$	2,994			$	—			$	—			$	2,994
Cost of sales	973				—				—				973
Gross profit	2,021				—				—				2,021
Advertising expenses	383				—				(11		)		372
Selling, general, and administrative expenses	667				(21		)		11				657
Other expense (income), net	(18		)		—				—				(18		)
Operating income	989				21				—				1,010
Non-operating postretirement expense	—				21				—				21
Interest income	(3		)		—				—				(3		)
Interest expense	59				—				—				59
Income before income taxes	933				—				—				933
Income taxes	264				—				—				264
Net income	$	669			$	—			$	—			$	669

	Fiscal 2018
(Dollars in millions)	Previously Reported				Adoption of ASU 2017-07				Reclassifications				Currently Reported
Net sales	$	3,248			$	—			$	—			$	3,248
Cost of sales	1,046				—				—				1,046
Gross profit	2,202				—				—				2,202
Advertising expenses	414				—				(9		)		405
Selling, general, and administrative expenses	765				(9		)		9				765
Other expense (income), net	(16		)		—				—				(16		)
Operating income	1,039				9				—				1,048
Non-operating postretirement expense	—				9				—				9
Interest income	(6		)		—				—				(6		)
Interest expense	68				—				—				68
Income before income taxes	977				—				—				977
Income taxes	260				—				—				260
Net income	$	717			$	—			$	—			$	717

Significant Developments

Below we discuss the significant developments in our business during fiscal 2017, fiscal 2018, and fiscal 2019. These developments relate to (a) innovation, (b) acquisitions and divestitures, and (c) capital deployment.

Innovation

•	Jack Daniel’s family of brands. Innovation within the Jack Daniel’s family of brands has contributed to our growth over the last three years as described below. In addition, we recently announced the launch of Jack Daniel’s Tennessee Apple, which we expect to introduce in the United States in the fall of 2019.

◦	In fiscal 2018, we introduced several new JD RTD products, including Jack Daniel’s Southern Peach Country Cocktails in the United States and Jack Daniel’s Lynchburg Lemonade in Germany. These introductions contributed to our JD RTD growth in those markets.

◦	In fiscal 2018, we introduced Jack Daniel’s Tennessee Rye (JDTR), the first full-strength whiskey with a different grain recipe from the Jack Daniel’s family of brands in over two decades, in the United States and certain international markets. In fiscal 2019, we expanded JDTR to several additional markets including France, Travel Retail, Germany, and Poland.

◦	In fiscal 2019, we launched Jack Daniel’s Bottled-in-Bond exclusively in Travel Retail.

•	Other American whiskeys. We continue to capitalize on consumers’ interest in premium plus whiskey with our wide range of brands, including Woodford Reserve, Old Forester, and Coopers’ Craft.

◦	In fiscal 2017, we unveiled new packaging for Woodford Reserve Double Oaked, the most successful line extension from Woodford Reserve to date (first introduced in 2012). The Double Oaked variant of Woodford Reserve continued to contribute meaningfully to the brand’s growth and surpassed 50,000 nine-liter cases in fiscal 2018. We introduced a new in Woodford Reserve Straight Malt in fiscal 2019.

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Five years ago, we introduced the Whiskey Row Series as a platform for high-end, craft expressions from Old Forester. From fiscal 2017 through fiscal 2019, we expanded our Old Forester Whiskey Row Series by adding two new craft expressions. In fiscal 2018, we added another craft expression in Old Forester Statesman. In addition, we launched new packaging for our core Old Forester bourbons in February 2017. In fiscal 2019, we introduced the brand’s first new grain recipe with the launch of Old Forester Rye.

◦	In fiscal 2017, we introduced our first entirely new bourbon in 20 years, Coopers’ Craft, a super-premium brand now in limited distribution in the United States. In fiscal 2019, we unveiled new packaging for Coopers’ Craft and introduced Coopers’ Craft Barrel Reserve.

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Tequila brands. We experienced another record year for our tequila brands in fiscal 2019, as Herradura, el Jimador, and New Mix contributed significantly to our overall net sales growth. In fiscal 2015, we released Herradura Ultra to participate in the fast-growing market for ultra-premium “cristalino” tequilas in Mexico, and it has been a significant driver of our tequila growth during the last five fiscal years. In fiscal 2019, we added additional “cristalino” expressions for the Mexico market in el Jimador and Antiguo, with total “cristalino” volume surpassing 120,000 nine-liter cases.

•	Irish whiskey. In April 2017, we unveiled the first product from our Slane Irish Whiskey brand in Travel Retail in Ireland, and we introduced the brand selectively in the United States, the United Kingdom, and Australia in the summer of 2017. In fiscal 2019, we expanded Slane nationally in the United States and introduced the brand in France.

Acquisitions and Divestitures

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On June 1, 2016, we acquired The BenRiach Distillery Company Limited (BenRiach). The acquisition, which brought three single malt Scotch whisky brands to our portfolio, included brand trademarks, inventories, three visitors’ centers, three malt distilleries, a bottling plant, and BenRiach’s headquarters in Edinburgh, Scotland. In fiscal 2019, we continued to expand these brands globally, most notably in Travel Retail and several markets in Asia. See Note 13 to the Consolidated Financial Statements for additional information.

Capital Deployment

•	Beyond the acquisition described above, we have focused our capital deployment initiatives on (a) enabling the expected future growth of our existing businesses through investments in our production capacity, barrel whiskey inventory, and brand-building efforts; and (b) returning cash to our stockholders.

•	Investments. From fiscal 2017 through fiscal 2019, our capital expenditures totaled approximately $360 million and focused on enabling the growth of our premium whiskey brands:

◦	Jack Daniel’s. We expanded our shipping warehouse facility and built an additional warehouse.

◦	Woodford Reserve. We expanded our bottling facility and built two new warehouses.

◦	Old Forester. We opened the Old Forester Distillery and visitors’ center on Main Street in Louisville, Kentucky, in the summer of 2018.

◦	Slane Irish Whiskey. We opened a visitors’ center on the historic Slane Castle Estate in the fall of 2017. We also finished building a new distillery, which opened in the summer of 2018.

•	Cash returned to stockholders. From fiscal 2017 through fiscal 2019, we returned $2.1 billion to our stockholders through $0.9 billion in regular quarterly dividends, $0.5 billion in special dividends, and $0.8 billion in share repurchases. We financed our dividends and share repurchases with cash on hand and proceeds from the issuance of long-term debt totaling $1.3 billion.

Executive Summary

Tariffs

Tariffs negatively affected our results in fiscal 2019. In the highlights and outlook below, we discuss (a) certain facts about tariffs as they relate to our business, (b) the effect of this development on our fiscal 2019 results, and (c) the expected effect of tariffs in fiscal 2020.

In response to the U.S. tariffs on steel and aluminum, the European Union, Mexico, Canada, Turkey, and China imposed retaliatory tariffs on a number of U.S. goods, including American whiskey. The effective dates of the retaliatory tariffs and the import duty rates before and after the retaliation are summarized below.

Summary of Retaliatory Tariffs in Effect for Fiscal 2019
				Rate
Geographic Area		Effective Date		Before		After
European Union		June 22, 2018		—	%	25	%
Mexico1		June 5, 2018		—	%	25	%
Canada1		July 1, 2018		—	%	10	%
Turkey1		June 21, 2018		—	%	140	%
China		July 6, 2018		5	%	30	%

1Following April 30, 2019, the retaliatory tariffs in Mexico and Canada were rescinded and the tariff rate in Turkey was reduced to 70%. See “Fiscal 2020 Outlook” below for additional information.

Tariffs negatively affected our fiscal 2019 performance as described below. These costs will continue to negatively impact our results as long as tariffs are in place.

◦	Lower net sales. Certain customers paid the incremental costs of tariffs. We compensated these customers for these incremental costs by reducing our net prices.

◦	Higher cost of sales. In markets where we own the inventory, we paid the incremental cost of tariffs.

The combined effect of these tariff-related costs, whether arising as a reduction of net sales or as an increase in cost of sales, is hereafter referred to as “incremental costs associated with tariffs.”

Fiscal 2019 Highlights

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We delivered net sales of $3.3 billion, an increase of 2% compared to fiscal 2018. Excluding (a) the negative effect of foreign exchange (reflecting the strengthening of the dollar against the Turkish lira, British pound, euro, Australian dollar, and Mexican peso) and (b) the adoption of the revenue recognition accounting standard, we grew underlying net sales 5%. We estimate that incremental costs associated with tariffs reduced our underlying net sales growth by approximately one percentage point.

◦	From a brand perspective, our underlying net sales growth was driven by the Jack Daniel’s family of brands, our premium bourbon brands, and our tequila brands.

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From a geographic perspective, emerging markets led the Company’s growth in underlying net sales. The United States was our second largest contributor to underlying net sales gains, although the rate of growth slowed compared to fiscal 2018. Developed international markets continued to be a significant driver of our growth, although incremental costs associated with tariffs dampened the year-over-year gains.

•	We delivered operating income of $1.1 billion, an increase of 9% compared to fiscal 2018. Excluding the impact of (a) the $70 million contribution to establish the Foundation in fiscal 2018 and (b) the negative effect of foreign exchange, underlying operating income grew 5% driven by our underlying gross profit growth and a decrease in underlying SG&A expenses.

•	We incurred a pension settlement charge of $15 million in non-operating postretirement expense, which was reclassified from accumulated other comprehensive income in accordance with U.S. accounting standards. The settlement resulted from a significant increase in lump-sum pension payments.

•	We delivered diluted earnings per share of $1.73, an increase of 17% compared to fiscal 2018, due to (a) the absence of the $70 million contribution to establish the Foundation in fiscal 2018, (b) the benefit of a lower effective tax rate from the Tax

Cuts and Jobs Act (Tax Act), and (c) an increase in reported operating income. These benefits were partially offset by higher interest expense, which resulted from a new bond issuance in March 2018, and higher non-operating postretirement expense, which resulted from the pension settlement charge described above.

•	Our return on average invested capital increased to 22.0% in fiscal 2019, compared to 20.0% in fiscal 2018. This increase was driven by the absence of the Foundation contribution and the benefit of a lower effective tax rate from the Tax Act, partially offset by higher invested capital.

Summary of Operating Performance Fiscal 2017-2019
													Reported Change						Underlying Change1
Fiscal year ended April 30	2017				2018				2019				2017 vs. 2018			2018 vs. 2019			2017 vs. 2018			2018 vs. 2019
Net sales	$	2,994			$	3,248			$	3,324			8	%		2	%		6	%		5	%
Cost of sales	973				1,046				1,158				7	%		11	%		8	%		12	%
Gross profit	2,021				2,202				2,166				9	%		(2	%)		6	%		2	%
Advertising2	372				405				396				9	%		(2	%)		6	%		3	%
SG&A2	657				765				641				16	%		(16	%)		4	%		(5	%)
Operating income2	$	1,010			$	1,048			$	1,144			4	%		9	%		6	%		5	%
Total operating expenses3	$	1,011			$	1,154			$	1,022			14	%		(11	%)		5	%		(2	%)
As a percentage of net sales4
Gross profit	67.5		%		67.8		%		65.2		%		0.3	pp		(2.6	pp)
Operating income	33.8		%		32.3		%		34.4		%		(1.5	pp)		2.1	pp
Interest expense, net	$	56			$	62			$	80			9	%		31	%
Effective tax rate	28.3		%		26.6		%		19.8		%		(1.7	pp)		(6.8	pp)
Diluted earnings per share	$	1.37			$	1.48			$	1.73			8	%		17	%
Return on average invested capital5	19.8		%		20.0		%		22.0		%		0.2	pp		2.0	pp

1See “Non-GAAP Financial Measures” above for details on our use of “underlying changes,” including how we calculate these measures and why we think this information is useful to readers.

2We retrospectively adjusted our fiscal 2017 and fiscal 2018 advertising expense, SG&A expense, and operating income as described in Note 2 to the accompanying financial statements and “Reclassifications” above. Our previously disclosed growth rates from fiscal 2017 vs. fiscal 2018 were as follows (reported/underlying): advertising expense (8% / 6%), SG&A expense (15% / 3%), and operating income (5% / 8%).

3Operating expenses include advertising expense, SG&A expense, and other expense (income), net.

4Year-over-year changes in percentages are reported in percentage points (pp).

5See “Non-GAAP Financial Measures” above for details on our use of “return on average invested capital,” including how we calculate this measure and why we think this information is useful to readers.

Fiscal 2020 Outlook

We are optimistic about our prospects for growth of net sales, operating income, and diluted earnings per share in fiscal 2020. Below we discuss our current expectations for fiscal 2020, including trends, developments, and uncertainties that we expect may affect our business. When we provide guidance for underlying change for the following line items of the statements of operations, we do not provide guidance for the corresponding GAAP change because the GAAP measure will include items that are difficult to quantify or predict with reasonable certainty, including the estimated net change in distributor inventories and foreign exchange, each of which could have a significant impact to our GAAP line items of the statements of operations.

In response to the U.S. tariffs on steel and aluminum, the European Union, Mexico, Canada, Turkey, and China imposed retaliatory tariffs on a number of U.S. goods, including American whiskey, in the summer of 2018. Our American whiskeys are made in the United States and exported around the world. Our fiscal 2019 results were hurt by incremental costs associated with tariffs through lower net sales and higher cost of sales. Following April 30, 2019, the retaliatory tariffs in Mexico and Canada were rescinded and the tariff rate in Turkey was reduced from 140% to 70%. These favorable changes to tariffs will slightly reduce the incremental costs associated with tariffs in fiscal 2020. The outlook below assumes that the remaining tariffs in the European Union, Turkey, and China remain in place in fiscal 2020. If the tariffs in the European Union, Turkey, and China were rescinded,

we would benefit either through higher net sales or lower cost of sales. Conversely, if additional tariffs were imposed on our products, we would be negatively impacted either through lower net sales or higher cost of sales.

Outlook for key measures:

•	Underlying net sales. We expect the underlying net sales growth rate trend from fiscal 2019 to accelerate in fiscal 2020. We anticipate the Jack Daniel’s family of brands, our portfolio of premium bourbons, and our tequila brands to again drive growth. We expect that volume will be the most significant driver of underlying net sales growth in fiscal 2020.

•	Underlying cost of sales. We expect underlying cost of sales to grow at a significantly higher rate than net sales in fiscal 2020, reflecting incremental costs associated with tariffs as well as a significant increase in input cost compared to fiscal 2019, driven by the cost of agave and wood.

•	Underlying operating expenses. We expect total underlying operating expenses to grow more slowly than net sales.

Additional considerations related to our fiscal 2020 outlook:

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Foreign exchange. In fiscal 2019, our reported results were hurt by foreign exchange due to the strengthening of the U.S. dollar. We cannot predict the movement of foreign exchange rates with reasonable certainty; however, if April 30, 2019 spot rates were to hold for fiscal 2020, we would expect foreign exchange to negatively affect our fiscal 2020 results, but less so than in fiscal 2019. See “Item 7A. Quantitative and Qualitative Disclosures about Market Risk” for details about how we manage foreign exchange risk.

Results of Operations

Fiscal 2019 Market Highlights

The following table shows net sales results for our ten largest markets, summarized by geographic area, for fiscal 2019 compared to fiscal 2018. We discuss the most significant changes in net sales for each market.

Top 10 Markets - Percentage of Fiscal 2019 Total Net Sales and Fiscal 2019 Net Sales Growth by Geographic Area
					Net Sales % Change vs. 2018
Markets1		% of Fiscal 2019 Net Sales			Reported		New Accounting Standard		Foreign Exchange		Estimated Net Chg in Distributor Inventories			Underlying2
United States		47	%		2	%	1	%	—	%	—	%		3	%
Developed International		28	%		1	%	—	%	4	%	(2	%)		4	%
United Kingdom		6	%		(4	%)	—	%	6	%	—	%		3	%
Australia		5	%		—	%	—	%	6	%	—	%		6	%
Germany		5	%		8	%	—	%	2	%	—	%		10	%
France		4	%		(1	%)	—	%	3	%	—	%		2	%
Japan		1	%		15	%	1	%	(3	%)	(11	%)		2	%
Rest of Developed International		7	%		—	%	1	%	3	%	(4	%)		(1	%)
Emerging		18	%		4	%	1	%	6	%	—	%		11	%
Mexico		5	%		3	%	3	%	6	%	—	%		11	%
Poland		3	%		9	%	—	%	1	%	—	%		10	%
Russia		2	%		16	%	—	%	4	%	(3	%)		17	%
Brazil		1	%		(13	%)	2	%	13	%	23	%		25	%
Rest of Emerging		7	%		3	%	—	%	8	%	(4	%)		8	%
Travel Retail		4	%		1	%	1	%	—	%	4	%		6	%
Non-branded and bulk		3	%		10	%	—	%	—	%	—	%		10	%
Total		100	%		2	%	1	%	2	%	—	%		5	%
Note: Totals may differ due to rounding

1See “Definitions” above for definitions of market aggregations presented here.

2See “Non-GAAP Financial Measures” above for details on our use of “underlying change” in net sales, including how we calculate this measure and why we believe this information is useful to readers.

•

The United States, our most important market, accounted for 47% of our reported net sales in fiscal 2019. Reported net sales in the United States grew 2%, while underlying net sales increased 3%, after adjusting for the adoption of the revenue recognition accounting standard. Underlying net sales gains were led by (a) volume growth supported by strong takeaway trends of Woodford Reserve, (b) higher volumes and favorable price/mix of our tequila brands and Old Forester, and (c) increased volumes of JD RTDs and Gentleman Jack. This growth was partially offset by (a) slight declines of JDTW, partially related to a route-to-market change in one state, and (b) lower volumes of Canadian Mist.

•

Developed International markets accounted for 28% of our reported net sales in fiscal 2019. Reported net sales increased 1%, while underlying net sales grew 4%, after adjusting for (a) the negative effect of foreign exchange (reflecting the strengthening of the dollar against the British pound, euro, and Australian dollar), and (b) an estimated net increase in distributor inventories. Underlying net sales growth was driven by gains in Germany, Australia, Spain, and the United Kingdom, partially offset by the incremental costs associated with tariffs in certain markets in the rest of developed Europe. We estimate that incremental costs associated with tariffs reduced our underlying net sales growth in Developed International markets by approximately one percentage point.

◦	In the United Kingdom, underlying net sales growth was driven by higher volumes of JDTW, JDSB, Gentleman Jack, and JDTH, partially offset by declines of JD Cider and Chambord.

◦	In Australia, underlying net sales growth was driven by higher pricing of JD RTDs and increased volumes of Gentleman Jack.

◦	In Germany, underlying net sales growth was driven by volumetric growth of JDTW and JD RTDs.

◦	In France, underlying net sales growth was driven by higher volumes of JDTH and the launch of JDTR, partially offset by unfavorable price/mix and lower volumes of JDTW.

◦	In Japan, underlying net sales growth was led by increased distribution of our Scotch brands, while lower pricing offset volume growth of the Jack Daniel’s family of brands.

◦	Underlying net sales in the Rest of Developed International markets were down as incremental costs associated with tariffs in certain European markets more than offset the growth in Spain, Belgium, Czechia, and Korea. JDTW grew volumes in Spain, where our owned-distribution organization continued to lead to an acceleration in performance over the past fiscal year.

•

Emerging markets accounted for 18% of our reported net sales in fiscal 2019. Reported net sales increased 4%, while underlying net sales grew 11% after adjusting for (a) the negative effect of foreign exchange (reflecting the strengthening of the dollar against the Turkish lira, Mexican peso, and Brazilian real) and (b) the adoption of the revenue recognition accounting standard. Underlying net sales growth was led by Mexico, Brazil, Russia, Poland, and China.

◦	In Mexico, underlying net sales growth was driven by higher volumes and favorable price/mix of Herradura and el Jimador. The growth of Herradura benefited from strong consumer demand for Herradura Ultra, our cristalino tequila expression. The launch of New Mix mineral water line extensions also contributed to growth.

◦	In Poland, underlying net sales growth was led by higher volumes of JDTW and Gentleman Jack, partially offset by unfavorable price/mix of Finlandia.

◦	In Russia, underlying net sales growth was led by higher volumes and favorable price/mix of JDTW due in part to our fiscal 2018 distributor change. Volumetric gains of Finlandia also contributed to growth.

◦	In Brazil, underlying net sales growth continued to be led by increased volumes, higher pricing, and favorable channel mix of JDTW.

◦	Underlying net sales growth in the Rest of Emerging markets was led by China, Ukraine, and sub-Saharan Africa. All of these geographic areas benefited from higher volumes of JDTW. Ukraine also benefited from higher volumes and favorable price/mix of Finlandia.

•

Travel Retail accounted for 4% of our reported net sales in fiscal 2019. Reported net sales increased 1%, while underlying net sales increased 6% after adjusting for (a) an estimated net decrease in distributor inventories and (b) the adoption of the revenue recognition accounting standard. Underlying net sales growth was led by the launch of Jack Daniel’s Bottled-in-Bond and JDTR, higher volumes of Woodford Reserve, and the expansion of our Scotch whiskey brands.

•	Non-branded and bulk accounted for 3% of our reported net sales in fiscal 2019. Both reported and underlying net sales increased 10%. Growth came from increased bulk sales and higher volumes and prices for used barrel sales.

1International Wine & Spirit Research (IWSR), 2018 data.

Fiscal 2019 Brand Highlights

The following table highlights the worldwide results of our largest brands for fiscal 2019 compared to fiscal 2018. We discuss results of the brands most affecting our performance below the table.

Major Brands Worldwide Results for Fiscal 2019
	Volumes			Net Sales % Change vs. 2018
Product category/brand family/brand1	9L Depletions1			Reported		New Accounting Standard		Foreign Exchange		Estimated Net Chg in Distributor Inventories			Underlying2
Whiskey	4	%		3	%	1	%	2	%	—	%		5	%
Jack Daniel’s family of brands	4	%		1	%	1	%	2	%	—	%		4	%
JDTW	2	%		—	%	—	%	2	%	—	%		2	%
JD RTD/RTP	4	%		4	%	—	%	4	%	—	%		8	%
JDTH	6	%		5	%	1	%	2	%	(1	%)		7	%
Gentleman Jack	9	%		6	%	1	%	2	%	—	%		8	%
JDTF	5	%		3	%	1	%	1	%	(1	%)		4	%
Other Jack Daniel’s whiskey brands	25	%		9	%	1	%	2	%	4	%		16	%
Woodford Reserve	23	%		17	%	1	%	—	%	4	%		22	%
Tequila	3	%		6	%	2	%	3	%	—	%		12	%
el Jimador	9	%		8	%	2	%	2	%	—	%		13	%
Herradura	10	%		8	%	3	%	3	%	—	%		13	%
Vodka (Finlandia)	(1	%)		(4	%)	1	%	4	%	(2	%)		(1	%)
Wine	—	%		—	%	1	%	—	%	(1	%)		—	%
Rest of Portfolio	(8	%)		(16	%)	2	%	9	%	1	%		(3	%)
Non-branded and bulk	NA			10	%	—	%	—	%	—	%		10	%
Note: Totals may differ due to rounding

1See “Definitions” above for definitions of brand aggregations and volume measures presented here.

2See “Non-GAAP Financial Measures” above for details on our use of “underlying change” in net sales, including how we calculate this measure and why we believe this information is useful to readers.

•

Whiskey brands grew volumes 4% in fiscal 2019. Reported net sales grew 3%, while underlying net sales increased 5% after adjusting for (a) the negative effect of foreign exchange (reflecting the strengthening of the dollar against the British pound, Turkish lira, euro, Australian dollar, and Brazilian real) and (b) the adoption of the revenue recognition accounting standard. Growth was led by the Jack Daniel’s family of brands, Woodford Reserve, Old Forester, and our Scotch brands, partially offset by declines in Canadian Mist.

◦	The Jack Daniel’s family of brands grew underlying net sales led by (a) JDTW in markets outside of the United States, (b) broad-based geographic growth of JD RTDs, JDTH, and Gentleman Jack, and (c) further expansion of JDTR along with the launch of Jack Daniel’s Bottled-in-Bond in Travel Retail.

•

JDTW generates a significant percentage of our total net sales and is our top priority. The brand is the largest one in the world priced over $25 per 750 ml per bottle1 and the world’s fourth-largest premium spirits brand measured by both volume and retail value.2 During calendar 2018, JDTW grew volume for the 27th consecutive year1 and, among the top five premium spirits brands on the list, was the only one to grow volume in each of the past five years2 – an achievement that underscores our belief in the brand’s sustainable appeal and long-term growth potential. Underlying net sales growth of JDTW was broad based, led by increases in Brazil, Germany, Poland, Russia, Spain, and China. These increases were partially offset by the incremental costs associated with tariffs in certain markets in the rest of developed Europe, which reduced the underlying net sales growth of JDTW by approximately one percentage point. Slight declines in the United States, partially related to a route-to-market change in one state, also offset these gains.

1IWSR, 2018 data.
2Based on industry statistics published by Impact Databank, a well-known U.S. trade publication, in March 2019.

•	The Jack Daniel’s RTD/RTP brands grew underlying net sales driven by higher pricing in Australia along with consumer-led volumetric growth in Germany and the United States.

•	Since its introduction in late fiscal 2011, JDTH has contributed significantly to our net sales growth. JDTH remains one of the top 20 largest brands in the world priced over $25 per 750 ml bottle.1 Underlying net sales gains were driven by broad-based volume growth, particularly in France, the United States, Mexico, and the United Kingdom.

•	Gentleman Jack grew underlying net sales driven by higher volumes in the United States along with broad-based international volume gains, particularly in the United Kingdom, Poland, and Australia.

•	JDTF grew underlying net sales led by increased volumes and favorable price/mix in the United States along with higher volumes in the United Kingdom and Brazil. JDTF has grown volumes each year since its introduction in late fiscal 2015.

•	Our Other Jack Daniel’s whiskey brands increased underlying net sales driven by (a) higher volumes of JDSB in the United States and the United Kingdom, (b) the launch of Jack Daniel’s Bottled-in-Bond in Travel Retail, and (c) the launch of JDTR in Travel Retail and select European markets. JDTR is the third largest rye brand in the world in just its second year on the market.1

◦

Woodford Reserve was once again selected as an Impact “Hot Brand.”2 The United States is by far the brand’s most important market and was responsible for most of its growth during fiscal 2019. However, the brand continued its momentum outside the United States, growing volumes 17%, driven by Travel Retail. Woodford Reserve is the leading super-premium American whiskey globally1, and is poised for continued growth as interest in bourbon continues to increase around the world. We plan to continue devoting substantial resources to Woodford Reserve to support its growth potential with sustained advertising, including our Kentucky Derby sponsorship, and ongoing capital investments.

•	Tequila brands grew volumes 3% in fiscal 2019, while reported net sales increased 6% and underlying net sales grew 12% after adjusting for (a) the negative effect of foreign exchange (reflecting the strengthening of the dollar against the Mexican peso) and (b) the adoption of the revenue recognition accounting standard.

◦	el Jimador grew underlying net sales driven by consumer-led volumetric growth and favorable price/mix in the United States and Mexico. Mexico also benefited from the launch of el Jimador Cristalino.

◦

Herradura grew underlying net sales driven by increased volumes and higher prices in the brand’s largest markets, the United States and Mexico, as both markets benefited from consumer-led volumetric growth of the brand’s “cristalino” tequila expression, Herradura Ultra. We remain focused on developing Herradura in the United States, which has considerable potential for growth, strengthening our position in Mexico, and continuing to build our presence in higher-value tequila markets throughout the world.

•

Finlandia volumes fell 1% in fiscal 2019, while reported net sales decreased 4% and underlying net sales declined 1% after adjusting for (a) the negative effect of foreign exchange (reflecting the strengthening of the dollar against the Russian ruble, Turkish lira, and Ukrainian hryvnia), (b) an estimated net increase in distributor inventories, and (c) the adoption of the revenue recognition accounting standard. The decrease in underlying net sales was driven by unfavorable price/mix in Poland and lower volumes in the United States, partially offset by increased volumes and favorable price/mix in Russia and Ukraine.

•

Wine volumes were flat in fiscal 2019 and both reported and underlying net sales growth were also flat after adjusting underlying growth for an estimated net increase in distributor inventories and the adoption of the revenue recognition accounting standard. In the United States, higher volumes and favorable price/mix of Sonoma-Cutrer were offset by unfavorable price/mix and lower volumes of Korbel Champagne.

•

Rest of Portfolio volumes declined 8%, while reported net sales decreased 16% and underlying net sales dropped 3% after adjusting for (a) the negative effect of foreign exchange (reflecting the strengthening of the dollar against the Australian dollar, euro, and British pound), (b) the adoption of the revenue recognition accounting standard, and (c) an estimated net decrease in distributor inventories. The decrease in underlying net sales was due to discontinued agency brands in Turkey and unfavorable price/mix and lower volumes of Chambord in the United Kingdom.

•	Non-branded and bulk reported and underlying net sales grew 10% from increased bulk sales and higher volumes and prices for used barrels sales.

1IWSR, 2018 data.
2Impact Databank published the Impact’s “Hot Brands - Spirits” list in March 2019.

Year-Over-Year Comparisons

Net Sales
Percentage change versus the prior fiscal year ended April 30	2018			2019
Change in reported net sales	8	%		2	%
New accounting standard	—	%		1	%
Foreign exchange	(1	%)		2	%
Estimated net change in distributor inventories	(1	%)		—	%
Change in underlying net sales	6	%		5	%
Change in underlying net sales attributed to:
Volume	5	%		3	%
Net price/mix	2	%		2	%
Note: Totals may differ due to rounding

Fiscal 2019 compared to Fiscal 2018

Net sales of $3,324 million increased 2%, or $76 million, in fiscal 2019 compared to fiscal 2018. Underlying net sales grew 5% after adjusting reported results for (a) the negative effect of foreign exchange (reflecting the strengthening of the dollar against the Turkish lira, British pound, euro, Australian dollar, and Mexican peso) and (b) the adoption of the revenue recognition accounting standard. The change in underlying net sales comprised 3% volume growth and 2% price/mix. Volume growth was led by the Jack Daniel’s family of brands, our premium bourbons, and our tequilas brands. Price/mix was driven by (a) favorable portfolio mix reflecting faster growth from our higher-priced brands, most notably Woodford Reserve, the Jack Daniel’s family of brands, and our Scotch brands, (b) higher average pricing on our tequila brands and JD RTDs, and (c) favorable portfolio mix reflecting declines from our lower-priced brands, most notably Canadian Mist and Early Times. We estimate that lower pricing to certain customers related to tariffs reduced our underlying net sales growth by approximately one percentage point for fiscal 2019. See “Results of Operations - Fiscal 2019 Market Highlights and Fiscal 2019 Brand Highlights” above for further details on the factors contributing to the growth in underlying net sales for fiscal 2019.

Fiscal 2018 compared to Fiscal 2017

Net sales of $3,248 million increased 8%, or $254 million, in fiscal 2018 compared to fiscal 2017. Underlying net sales grew 6% after adjusting reported results for (a) the positive effect of foreign exchange (reflecting the weakening of the dollar against the euro, Polish zloty, and Mexican peso) and (b) an estimated net increase in distributor inventories. The change in underlying net sales comprised 5% volume growth and nearly 2% price/mix. Volume growth was led by the Jack Daniel's family of brands, our tequilas brands, and our premium bourbons. Price/mix was driven by (a) an increase in the share of sales of higher-margin brands, most notably the Jack Daniel’s family of brands and Woodford Reserve, and (b) higher average pricing on JD RTDs and tequilas.

Cost of Sales
Percentage change versus the prior fiscal year ended April 30	2018			2019
Change in reported cost of sales	7	%		11	%
Acquisitions and divestitures	1	%		—	%
New accounting standard	—	%		—	%
Foreign exchange	—	%		2	%
Estimated net change in distributor inventories	(1	%)		—	%
Change in underlying cost of sales	8	%		12	%
Change in underlying cost of sales attributed to:
Volume	5	%		3	%
Cost/mix	3	%		9	%
Note: Totals may differ due to rounding

Fiscal 2019 compared to Fiscal 2018

Cost of sales of $1,158 million increased $112 million, or 11%, in fiscal 2019 compared to fiscal 2018. Underlying cost of sales grew 12% after adjusting reported costs for the positive effect of foreign exchange driven by (a) higher input costs, including wood, agave, and depreciation expense related to capital expansion; (b) incremental costs associated with tariffs, primarily in Europe; and (c) higher volumes of the Jack Daniel’s family of brands, our premium bourbons, and our tequila brands. We estimate that incremental costs associated with tariffs increased our underlying cost of sales by approximately four percentage points.

Fiscal 2018 compared to Fiscal 2017

Cost of sales of $1,046 million increased $73 million, or 7%, in fiscal 2018 compared to fiscal 2017. Underlying cost of sales grew 8% after adjusting reported costs for (a) the net effect of our Scotch acquisition and the absence of sales related to our TSA for Southern Comfort and Tuaca and (b) an estimated net increase in distributor inventories. The increase in underlying costs of sales was driven by higher volumes and an increase in input costs, including wood and agave.

Gross Profit
Percentage change versus the prior fiscal year ended April 30	2018			2019
Change in reported gross profit	9	%		(2	%)
New accounting standard	—	%		1	%
Foreign exchange	(2	%)		2	%
Estimated net change in distributor inventories	(1	%)		—	%
Change in underlying gross profit	6	%		2	%
Note: Totals may differ due to rounding

Gross Margin
Fiscal year ended April 30	2018			2019
Prior year gross margin	67.5	%		67.8	%
Price/mix	0.3	%		0.4	%
Cost	(0.7	%)		(0.9	%)
Acquisitions and divestitures	0.3	%		—	%
Tariffs1	—	%		(1.6	%)
New accounting standard	—	%		(0.3	%)
Foreign exchange	0.4	%		(0.2	%)
Change in gross margin	0.3	%		(2.6	%)
Current year gross margin	67.8	%		65.2	%
Note: Totals may differ due to rounding

1“Tariffs” include the combined effect of tariff-related costs, whether arising as a reduction of net sales or as an increase in cost of sales. See “Executive Summary - Tariffs” for additional details of these costs.

Fiscal 2019 compared to Fiscal 2018

Gross profit of $2,166 million decreased $36 million, or 2%, in fiscal 2019 compared to fiscal 2018. Underlying gross profit improved 2% after adjusting reported results for the negative effect of foreign exchange and the adoption of the revenue recognition accounting standard. The increase in underlying gross profit resulted from the same factors that contributed to the increase in underlying net sales, partially offset by the same factors that drove higher underlying cost of sales.

Gross margin decreased to 65.2% in fiscal 2019, down 2.6 percentage points from 67.8% in fiscal 2018. The decrease in gross margin was driven by incremental costs associated with tariffs and higher input costs.

Fiscal 2018 compared to Fiscal 2017

Gross profit of $2,202 million increased $181 million, or 9%, in fiscal 2018 compared to fiscal 2017. Gross profit on an underlying basis improved 6% after adjusting reported gross profit for the positive effect of foreign exchange and an estimated net increase in distributor inventories. The increase in underlying gross profit resulted from the same factors that contributed to the increase in underlying net sales, partially offset by the same factors that drove higher underlying cost of sales.

Gross margin increased to 67.8% in fiscal 2018, up 0.3 percentage points from 67.5% in fiscal 2017. The increase in gross margin was primarily due to (a) favorable price/mix, (b) the positive effect of foreign exchange, and (c) the net effect of acquisitions and divestitures, partially offset by an increase in underlying cost of sales.

Operating Expenses
Percentage change versus the prior year period ended April 30
2018	Reported		New Accounting Standard		Foundation		Foreign Exchange			Underlying
Advertising1	9	%	—	%	—	%	(3	%)		6	%
SG&A1	16	%	—	%	(11	%)	(2	%)		4	%
Total operating expenses2	14	%	—	%	(7	%)	(2	%)		5	%
2019
Advertising	(2	%)	4	%	—	%	2	%		3	%
SG&A	(16	%)	1	%	8	%	2	%		(5	%)
Total operating expenses2	(11	%)	2	%	6	%	2	%		(2	%)
Note: Totals may differ due to rounding

1We retrospectively adjusted our fiscal 2017 and fiscal 2018 advertising expense and SG&A expense as described in Note 2 to the accompanying financial statements and “Reclassifications” above. Our previously disclosed growth rates from fiscal 2017 vs. fiscal 2018 were as follows (reported/underlying): advertising expense (8% / 6%) and SG&A expense (15% / 3%).

2Operating expenses include advertising expense, SG&A expense, and other expense (income), net.

Fiscal 2019 compared to Fiscal 2018

Operating expenses totaled $1,022 million and decreased $132 million, or 11%, in fiscal 2019 compared to fiscal 2018. Underlying operating expenses declined 2% after adjusting for (a) the absence of the $70 million contribution to establish the Foundation in fiscal 2018, (b) the adoption of the revenue recognition accounting standard, and (c) the positive effect of foreign exchange.

•

Reported advertising expenses declined 2% in fiscal 2019 compared to fiscal 2018, while underlying advertising expenses increased 3% after adjusting for reclassifications related to the adoption of the revenue recognition accounting standard and the positive effect of foreign exchange. The increase in underlying advertising expense was driven by higher spending on our American whiskey portfolio with investments in (a) JDTW, led by increased spending in emerging markets; (b) Woodford Reserve, partially due to our Kentucky Derby sponsorship; and (c) Old Forester, partially due to our new distillery and visitors’ center. Increased investments in our tequila brands in Mexico and the United States also contributed to our higher underlying advertising expense.

•

Reported SG&A expenses declined 16% in fiscal 2019 compared to fiscal 2018, while underlying SG&A declined 5% after adjusting for (a) the absence of the $70 million contribution to establish the Foundation in fiscal 2018, (b) the positive effect of foreign exchange, and (c) reclassifications related to the adoption of the revenue recognition accounting standard. The decrease in underlying SG&A was driven by lower personnel costs, primarily compensation-related costs.

Fiscal 2018 compared to Fiscal 2017

Operating expenses totaled $1,154 million and increased $143 million, or 14%, in fiscal 2018 compared to fiscal 2017. Underlying operating expenses grew 5% after adjusting for the establishment of the Foundation and the negative effect of foreign exchange.

•

Reported advertising expenses increased 9% in fiscal 2018 compared to fiscal 2017, while underlying advertising expenses increased 6% after adjusting for the negative effect of foreign exchange. The increase in underlying advertising expense was driven by higher spending on (a) our American whiskey portfolio in the United States, including JDTW, Woodford Reserve, Gentleman Jack, and the launch of JDTR; (b) the continued rollout of Slane Irish Whiskey in the United States; and (c) the expansion of our single-malt Scotch brands.

•

Reported SG&A expenses increased 16% in fiscal 2018 compared to fiscal 2017, while underlying SG&A increased 4% after adjusting reported results for the effect of our $70 million contribution to establish the Foundation and the negative effect of foreign exchange. The increase in underlying SG&A was driven by higher incentive compensation expenses and strategic investments, including our new Spain distribution operation, partially offset by continued tight management of discretionary spending.

Operating Income
Percentage change versus the prior fiscal year ended April 30	20181			2019
Change in reported operating income	4	%		9	%
Foundation	7	%		(7	%)
Foreign exchange	(2	%)		3	%
Estimated net change in distributor inventories	(2	%)		—	%
Change in underlying operating income	6	%		5	%
Note: Totals may differ due to rounding

1We retrospectively adjusted our fiscal 2017 and fiscal 2018 operating income as described in Note 2 to the accompanying financial statements and “Reclassifications” above. Our previously disclosed reported and underlying growth rates from fiscal 2017 vs. fiscal 2018 were as follows: 5% reported, 8% underlying.

Fiscal 2019 compared to Fiscal 2018

Operating income was $1,144 million in fiscal 2019, an increase of $96 million, or 9%, compared to fiscal 2018. Underlying operating income grew 5% after adjusting for (a) the absence of the $70 million contribution to establish the Foundation in fiscal 2018 and (b) the negative effect of foreign exchange. The same factors that contributed to the growth in underlying gross profit also contributed to the growth in underlying operating income in addition to operating expense leverage driven by a reduction in underlying SG&A.

Operating margin increased 2.1 percentage points to 34.4% in fiscal 2019 from 32.3% in fiscal 2018. The increase in our operating margin was due to the absence of the $70 million contribution to establish the Foundation in fiscal 2018 and lower SG&A spend in fiscal 2019. These factors were partially offset by the decrease in underlying gross margin, largely reflecting the incremental costs associated with tariffs and higher input costs.

Fiscal 2018 compared to Fiscal 2017

Operating income was $1,048 million in fiscal 2018, an increase of $38 million, or 4%, compared to fiscal 2017. Underlying operating income growth was 6% after adjusting for (a) the establishment of the Foundation, (b) the positive effect of foreign exchange, and (c) an estimated net increase in distributor inventories, driven by the United States. The same factors that contributed to the growth in underlying gross profit also contributed to the growth in underlying operating income, enhanced by meaningful operating expense leverage, as underlying SG&A spend grew 4% compared to underlying net sales growth of 6%.

Operating margin declined 1.5 percentage points to 32.3% in fiscal 2018 from 33.8% in fiscal 2017. The decrease in our operating margin was primarily due to the 2.2 percentage point effect of the establishment of the Foundation, partially offset by operating expense leverage.

Fiscal 2019 compared to Fiscal 2018

Interest expense (net) increased $18 million, or 31%, in fiscal 2019 compared to fiscal 2018, due to a higher average long-term debt balance and a higher interest rate on our short-term borrowings.

Our effective tax rate for fiscal 2019 was 19.8% compared to 26.6% in fiscal 2018. The decrease in our effective tax rate was driven by the reduction in the U.S. statutory federal tax rate and a beneficial change in the discrete transitional impacts of the Tax Act. These reductions were partially offset by (a) a decrease in the beneficial impact of foreign earnings at lower rates, (b) the absence of the amortization of deferred tax benefit that was reclassified to retained earnings as a result of the application of ASU 2016-16, and (c) the impact of other miscellaneous provisions of the Tax Act. Because our fiscal year ends on April 30, the lower U.S. corporate income tax rate prescribed by the Tax Act was phased in, resulting in a U.S. statutory federal rate of 30.4% for our fiscal year ended April 30, 2018, and 21% for our current and subsequent fiscal years. See Note 12 to the Consolidated Financial Statements for additional information.

Diluted earnings per share were $1.73 in fiscal 2019, up 17% from $1.48 in fiscal 2018. This increase resulted from (a) the absence of the $70 million contribution to establish the Foundation in fiscal 2018, (b) the benefit of a lower effective tax rate from the Tax Act, and (c) an increase in reported operating income. These benefits were partially offset by higher interest expense and non-operating postretirement expense.

Fiscal 2018 compared to Fiscal 2017

Interest expense (net) increased $6 million, or 9%, in fiscal 2018 compared to fiscal 2017, due to a higher average long-term debt balance and a higher interest rate on our short-term borrowings.

Our effective tax rate for fiscal 2018 was 26.6% compared to 28.3% in fiscal 2017. The decrease in our effective tax rate was driven by an increase in the beneficial impact of foreign earnings at lower rates and an increase in excess tax benefits related to stock-based compensation, partially offset by the net impact of the Tax Act. See Note 12 to the Consolidated Financial Statements for additional information.

Diluted earnings per share were $1.48 in fiscal 2018, up 8% from $1.37 in fiscal 2017. This increase resulted from (a) an increase in reported operating income (net of a $0.10 decrease from the establishment of the Foundation) and (b) the benefit of a lower effective tax rate.

Liquidity and Capital Resources

Our ability to generate cash from operations consistently is one of our most significant financial strengths. Our strong cash flows enable us to invest in our people, invest in our brands, invest in our assets, pay regular dividends, make strategic acquisitions that we believe will enhance shareholder value, repurchase shares of common stock, and, from time to time, pay special dividends. We believe cash flows from operations are sufficient to meet our expected operating and capital requirements for the foreseeable future.

Cash Flow Summary

(Dollars in millions)		2017				2018				2019
Operating activities		$	656			$	653			$	800
Investing activities:
Acquisition of business		(307		)		—				—
Additions to property, plant, and equipment		(112		)		(127		)		(119		)
Other		(20		)		(22		)		—
		(439		)		(149		)		(119		)
Financing activities:
Net change in short-term borrowings		(122		)		(3		)		(71		)
Net proceeds from long-term debt		717				345				—
Acquisition of treasury stock		(561		)		(1		)		(207		)
Dividends paid (regular)		(274		)		(292		)		(310		)
Special dividend payment		—				(481		)		—
Other		(45		)		(34		)		(11		)
		(285		)		(466		)		(599		)
Foreign exchange effect on cash and cash equivalents		(13		)		19				(14		)
Net increase (decrease) in cash and cash equivalents		$	(81	)		$	57			$	68

Fiscal 2019 compared to Fiscal 2018

Cash and cash equivalents increased $68 million in fiscal 2019, compared to an increase of $57 million in fiscal 2018. Cash provided by operations during fiscal 2019 was $800 million, up $147 million from fiscal 2018. The increase was largely attributable to certain capital deployment actions announced and implemented during fiscal 2018. Those actions included a special contribution of $120 million (in addition to other regular funding) for our U.S. pension plans and a $70 million contribution to create the Foundation. Excluding those items, cash provided by operations declined $43 million from fiscal 2018, due largely to the adverse effect of higher tariffs.

Cash used for investing activities was $119 million during fiscal 2019, compared to $149 million for the prior year. The $30 million decline primarily reflects an $19 million reduction in payments for corporate-owned life insurance and an $8 million decrease in capital spending.

Cash used for financing activities was $599 million during fiscal 2019, compared to $466 million for fiscal 2018. The $133 million increase largely reflects a $345 million decline in net proceeds from long-term debt, a $206 million increase in share repurchases, and a $68 million increase in net repayments of short-term debt, partially offset by a $463 million reduction in dividends (largely reflecting a special dividend payment of $481 million in fiscal 2018).

The impact on cash and cash equivalents as a result of exchange rate changes was a decrease of $14 million for fiscal 2019, compared to an increase of $19 million in the prior fiscal year.

Fiscal 2018 compared to Fiscal 2017

Cash and cash equivalents increased $57 million in fiscal 2018, compared to a decrease of $81 million in fiscal 2017. Cash provided by operations was down $3 million from fiscal 2017, as a $124 million increase in discretionary contributions to our pension plans was largely offset by higher earnings (net of a $70 million contribution to establish the Foundation) and a $66 million decline in income tax payments. The decline in income tax payments reflects the impact of the contributions to the pension plans and charitable foundation and the lower federal tax rates resulting from the enactment of the Tax Act.

Cash used for investing activities was $149 million during fiscal 2018, compared to $439 million for the prior year. The $290 million decrease largely reflects $307 million in cash paid to acquire BenRiach in June 2016, partially offset by a $15 million

increase in capital spending during the current year. The increase in capital spending is largely attributable to the construction of new distilleries and visitors’ centers for both Slane Irish Whiskey and Old Forester and to the modernization and automation of our Brown-Forman Cooperage operation.

Cash used for financing activities was $466 million during fiscal 2018, compared to $285 million for fiscal 2017. The $181 million increase largely reflects a special cash dividend payment of $481 million in April 2018, the repayment of $250 million of notes that matured in January 2018, and a $122 million decrease in proceeds from long-term debt, partially offset by a $560 million decline in share repurchases and a $119 million decrease in net repayments of short-term borrowings.

The impact on cash and cash equivalents as a result of exchange rate changes was an increase of $19 million for fiscal 2018, compared to a decline of $13 million in fiscal 2017.

Capital Expenditures

Over the past several fiscal years, we significantly increased the level of our capital spending in order to build the production platform for our current and expected future growth. Capital expenditures exceeded $100 million for each of the past six fiscal years from 2014 through 2019 compared to, on average, $60 million for the prior six fiscal years.

In fiscal 2019, we continued to modernize and automate the Brown-Forman Cooperage; we expect to complete that project in fiscal 2020. We also invested in expanding capacity, especially at Jack Daniel’s Distillery where we completed a multi-year project that (a) extended both the shipping warehouse and processing building, (b) renovated the bottling house, and (c) improved the shipping office.

In fiscal 2020, we expect capital expenditures to be approximately $130 million. We expect capital expenditures in fiscal 2021 and fiscal 2022 to remain at similar levels as we continue to evaluate both cost-saving initiatives and warehouse needs.

Share Repurchase Programs

Since the beginning of fiscal 2017, we have repurchased approximately 19 million shares of our common stock under two separate repurchase programs.

		Shares Purchased (Thousands)						Average Price Per Share, Including Brokerage Commissions								Total Cost of Shares
Period		Class A			Class B			Class A				Class B				(Millions)
May 1, 2016 – April 30, 2017		30			14,757			$	38.77			$	37.75			$	558
May 1, 2018 – April 30, 2019		43			4,187			$	47.49			$	47.30			$	200
		73			18,944											$	758

Dividends

From fiscal 2017 through fiscal 2019, we paid dividends totaling $1,357 million, including the $481 million special cash dividend in fiscal 2018. As announced on May 23, 2019, our Board of Directors declared a regular quarterly cash dividend of $0.166 per share on our Class A and Class B common stock. Stockholders of record on June 6, 2019, will receive the dividend on July 1, 2019.

Sources of Liquidity

We manage liquidity to meet current obligations, fund capital expenditures, sustain and grow our regular dividends, and return cash to our shareholders from time to time through share repurchases and special dividends while reserving adequate debt capacity for unforeseen events and acquisition opportunities. Investment-grade credit ratings (A1 by Moody’s and A- by Standard & Poor’s) provide us with financial flexibility when accessing global credit markets.

In addition to our cash and cash equivalent balances, we have access to several liquidity sources to supplement our cash flow from operations. One of those sources is our $800 million commercial paper program that we regularly use to fund our short-term credit needs. Commercial paper outstanding was $215 million at April 30, 2018, and $150 million at April 30, 2019; details of average commercial paper balances are presented below.

	Year Ended
	April 30,
(Amounts in millions)	2018				2019
Average daily commercial paper balance	$	485			$	421
Average interest rate	1.39		%		2.33		%
Average days to maturity	31				31

Our commercial paper program is supported by available commitments under our currently undrawn $800 million bank credit facility that expires on November 10, 2022. Although unlikely, under extreme market conditions, one or more participating banks may not be able to fund its commitments under our credit facility. We believe the debt capital markets are accessible sources of long-term financing that could meet any additional liquidity needs. We believe our current liquidity position is sufficient to meet all of our future financial commitments.

As of April 30, 2019, approximately 70% of our cash and cash equivalents were held by our foreign subsidiaries whose earnings we expect to reinvest indefinitely outside of the United States. During fiscal 2019, we changed our indefinite reinvestment assertion with respect to current year earnings and prior year undistributed earnings for one of those foreign subsidiaries and repatriated approximately $120 million of cash to the United States from this subsidiary. No incremental taxes were due on this distribution of cash beyond the repatriation tax recorded in fiscal 2018. In addition, we changed our indefinite reinvestment assertion with respect to current year earnings and prior year undistributed earnings for additional select foreign subsidiaries. The earnings for these select foreign subsidiaries are no longer indefinitely reinvested and may be distributed within our foreign entity structure; however, they remain indefinitely reinvested outside of the United States. We continue to evaluate our future cash deployment and may decide to repatriate additional cash held by other foreign subsidiaries to the United States. Future repatriations to the United States may require us to provide for and pay additional taxes.

Off-Balance Sheet Arrangements

As of April 30, 2019, we were not involved in any off-balance sheet arrangements that have or are reasonably likely to have a material effect on our financial condition, results of operations, or liquidity.

Long-Term Obligations

We have long-term obligations related to contracts, leases, borrowing arrangements, and employee benefit plans that we enter into in the normal course of business (see Notes 6, 7, and 10 to the Consolidated Financial Statements). The following table summarizes the amounts of those obligations as of April 30, 2019, and the years when they are expected to be paid.1 We expect to meet these obligations with internally generated funds.

(Dollars in millions)		Total				2020				2021-2022				2023-2024				After 2024
Long-term debt		$	2,323			$	—			$	—			$	250			$	2,073
Interest on long-term debt		1,244				74				148				141				881
Tax Act repatriation tax		67				—				8				20				39
Grape purchases		24				12				10				1				1
Operating leases		59				23				26				8				2
Postretirement benefits2		25				25				n/a				n/a				n/a
Agave purchases3		25				n/a				n/a				n/a				n/a
Total		$	3,767			$	134			$	192			$	420			$	2,996

1	Excludes liabilities for tax uncertainties, as we cannot reasonably predict their ultimate amount or timing of settlement.

2	As of April 30, 2019, we have unfunded pension and other postretirement benefit obligations of $204 million. Because we cannot determine the specific periods in which those obligations will be funded, the table above reflects no amounts related to those obligations other than the $25 million of expected contributions in fiscal 2020.

3

As discussed in Note 6 to the Consolidated Financial Statements, we have obligations to purchase agave, a plant whose sap forms the raw material for tequila. As of April 30, 2019, based on current market prices, obligations under these contracts totaled $25 million. Because we cannot determine the specific periods in which those obligations will be paid, the above table reflects only the total related to those obligations.

Critical Accounting Policies and Estimates

Our financial statements reflect some estimates involved in applying the following critical accounting policies that entail uncertainties and subjectivity. Using different estimates or policies could have a material effect on our operating results and financial condition.

Goodwill and Other Intangible Assets

We have obtained most of our brands by acquiring other companies. When we acquire another company, we first allocate the purchase price to identifiable assets and liabilities, including intangible brand names and trademarks (“brand names”), based on estimated fair value. We then record any remaining purchase price as goodwill. We do not amortize goodwill or other intangible assets with indefinite lives. We consider all of our brand names to have indefinite lives.

We assess our goodwill and other indefinite-lived intangible assets for impairment at least annually. Goodwill is impaired when the carrying amount of the related reporting unit exceeds its estimated fair value, in which case we write down the goodwill by the amount of the excess (limited to the carrying amount of the goodwill). We estimate the reporting unit’s fair value using discounted estimated future cash flows or market information. Similarly, a brand name is impaired when its carrying amount exceeds its estimated fair value, in which case we write down the brand name to its estimated fair value. We typically estimate the fair value of a brand name using either the “relief from royalty” or “excess earnings” method. We also consider market values for similar assets when available. Considerable management judgment is necessary to estimate fair value, including making assumptions about future cash flows, discount rates, and royalty rates.

We have the option, before quantifying the fair value of a reporting unit or brand name, to evaluate qualitative factors to assess whether it is more likely than not that our goodwill or brand names are impaired. If we determine that is not the case, then we are not required to quantify the fair value. That assessment also takes considerable management judgment.

Based on our assumptions, we believe none of our goodwill or other intangibles are impaired. Further, we estimate the fair values of goodwill and other intangible assets substantially exceed their carrying amounts, with the exception of two brand name intangible assets. As of April 30, 2019, the carrying amounts of these two brand names totaled $360 million. Net sales attributable to these two brand names currently represent approximately 5% of our consolidated net sales.

Reasonably possible changes in the assumptions used to estimate the fair value of either brand name could result in a future impairment charge. For example, we estimate that (a) a 10% decline in projected future cash flows for both brands would result in a total non-cash impairment charge of approximately $5 million and (b) a 1 percentage point change in the discount rate would result in a total non-cash impairment charge of approximately $8 million.

Pension and Other Postretirement Benefits

We sponsor various defined benefit pension plans and postretirement plans providing retiree health care and retiree life insurance benefits. Benefits are based on factors such as years of service and compensation level during employment. We expense the benefits expected to be paid over employees’ expected service. This requires us to make assumptions to determine the net benefit expense and obligations, such as interest rates, return on plan assets, the rate of salary increases, expected service, and health care cost trend rates.

The assets, obligations, and assumptions used to measure pension and retiree medical costs are determined at the beginning of the year (“measurement date”). Because obligations are measured on a discounted basis, the discount rate is a significant assumption. It is based on interest rates for high-quality, long-term corporate debt at each measurement date. The expected return on pension plan assets reflects expected capital market returns for each asset class that are based on historical returns, adjusted for the expected effects of diversification and active management (net of fees) of the assets. The other assumptions also reflect our historical experience and management’s best judgment regarding future expectations.

Beginning in fiscal 2018, we changed the method used to estimate the service cost and interest cost components of net periodic benefit cost for our U.S. pension and other postretirement benefit plans. The new estimation approach discounts the individual expected cash flows underlying the service cost and interest cost using the applicable spot rates derived from the yield curve used to discount the cash flows used to measure the benefit obligation at the beginning of the period. Previously, we estimated these service and interest cost components using a single weighted-average discount rate derived from the yield curve used to measure the benefit obligation at the beginning of the period. We believe the new approach provides a more precise measurement of service and interest costs by improving the correlation between projected benefit cash flows to the corresponding spot yield curve rates. We accounted for this change in estimate prospectively, beginning May 1, 2017. The new approach does not affect the measurement of our plan obligations, but generally results in lower service cost and interest cost in periods when the yield curve slopes upward.

The following table compares the assumed discount rates and expected return on assets used in determining net periodic benefit cost for fiscal 2019 to those to be used in determining that cost for fiscal 2020.

	Pension Benefits						Medical and Life Insurance Benefits
	2019			2020			2019			2020
Discount rate for service cost	4.30	%		4.17	%		4.34	%		4.24	%
Discount rate for interest cost	3.93	%		3.57	%		3.90	%		3.53	%
Expected return on plan assets	6.50	%		6.50	%		n/a			n/a

Using these assumptions, we estimate our pension and other postretirement benefit cost for fiscal 2020 will be approximately $29 million. The following table compares the actual cost for fiscal 2019 to the estimated cost for fiscal 2020.

(Dollars in millions)	2019 Actual				2020 Estimated
Service cost	$	25			$	24
Non-operating costs	22				5
Total	$	47			$	29

Decreasing/increasing the assumed discount rates by 50 basis points would increase/decrease the total fiscal 2020 cost by approximately $6 million (including $2 million of service cost and $4 million of non-operating costs). Decreasing/increasing the assumed return on plan assets by 50 basis points would increase/decrease the total fiscal 2020 cost by approximately $4 million (consisting only of non-operating costs).

Income Taxes

Significant judgment is required in evaluating our tax positions. We establish liabilities when some positions are likely to be challenged and may not succeed, despite our belief that our tax return positions are fully supportable. We adjust these liabilities in light of changing circumstances, such as the progress of a tax audit. We believe current liabilities are appropriate for all known contingencies, but this situation could change.

Years can elapse before we can resolve a particular matter for which we may have established a tax liability. Although predicting the final outcome or the timing of resolution of any particular tax matter can be difficult, we believe our liabilities reflect the likely outcome of known tax contingencies. Unfavorable settlement of any particular issue could require use of our cash. Conversely, a favorable resolution could result in reduced cash tax payments, the reversal of previously established liabilities, or some combination of these results, which could reduce our effective tax rate.

Updated Accounting Standards

See Note 2 to the Consolidated Financial Statements for information about updated accounting standards that we have recently adopted or will adopt in future periods.