Earnings Call Transcript
BROWN FORMAN CORP (BF-A)
Earnings Call Transcript - BF-A Q1 2025
Sue Perram, Vice President, Director of Investor Relations
Thank you, and good morning, everyone. I would like to thank each of you for joining us today for Brown-Forman's First Quarter Fiscal Year 2025 Earnings Call. Joining me today are Lawson Whiting, President and Chief Executive Officer; and Leanne Cunningham, Executive Vice President and Chief Financial 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 except as required by law, 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 fiscal year 2025, in addition to posting presentation materials that Lawson and Leanne will walk through momentarily. Both the release and the presentation can be found on our website under the section titled Investors, Events and Presentations. In the press release, we have listed a number of the risk factors you should consider in conjunction with our forward-looking statements. Other significant risk factors are described in our Form 10-K and Form 10-Q reports filed with the Securities and Exchange Commission. During this call, we will be discussing certain non-GAAP financial measures. These measures, a reconciliation to the most directly comparable GAAP financial measures and the reasons management believes they provide useful information to investors regarding the company's financial condition and results of operations, are contained in the press release and investor presentation. With that, I would like to turn the call over to Lawson.
Lawson Whiting, President and CEO
Thank you, Sue, and good morning, everyone. It's a pleasure to speak to you today about Brown-Forman's first quarter fiscal 2025 results. In June, we shared our outlook for fiscal '25, with the expectation that it would be a year of two halves. As you'll recall, we anticipated the second half of our fiscal year would be stronger than our first half on a year-over-year basis as in the first half, we are comparing against strong shipments in a few emerging international markets related to the replenishment of inventory and also lapping stronger shipments that occurred prior to planned price increases. The first quarter results we're sharing with you today are in line with our expectations, and we're confident in reaffirming our full year growth outlook for fiscal '25. As we move into the details of the quarter, I'll provide an overview of the top line from a brand perspective and share a few insights on gross profit and margin. Then I'll turn it over to Leanne, who will share additional insights on our geographic performance as well as other financial highlights. Our fiscal 2025 reported net sales declined 8%, with organic net sales decreasing 4% after adjusting for the divestitures of Finlandia and Sonoma-Cutrer in the prior fiscal year. The negative effect of foreign exchange and a change in how we manage our Jack Daniel's Country Cocktail business with Pabst Brewing Company. We haven't talked about Jack Daniel's Country Cocktails for a while, so let me take a few moments to explain that last point. As you may recall, in fiscal '21, we entered into a partnership with the Pabst Brewing Company for the supply, sales and distribution of Jack Daniel's Country Cocktails in the United States. At that time, Brown-Forman continued to produce certain formats of this refreshing ready-to-drink beverage. But during fiscal '24, we transferred production of all Jack Daniel's Country Cocktails products to Pabst Brewing Company, and as a result, our sales related to Brown-Forman produced Jack Daniel's Country Cocktail products are significantly lower compared to the prior year period. In the quarter, Diplomático Rum, Old Forester and Woodford Reserve, along with Jack Daniel's Tennessee Honey and Jack Daniel's Tennessee Apple were the largest positive contributors to organic net sales. This growth was more than offset by a decline for Jack Daniel's Tennessee Whiskey. First, to our most recent acquisitions. Diplomático Rum delivered very strong results in the first three months of the year, largely related to the timing of ordering patterns in the prior year period, which created an easier comparison. Gin Mare was also impacted by the timing of ordering patterns in the prior year period, but this created a tougher comparison and led to a slight decrease in organic net sales. Naturally, there is a higher level of volatility in the trends as the trend only reflects three months of data. Importantly, in the first quarter of fiscal '25, shipments are largely in line with depletions, and we continue to believe that we'll benefit from having a full year of growth from these outstanding super premium brands in our portfolio. Old Forester, our founding brand, delivered strong double-digit organic net sales growth as the brand benefited from increased volume and our pricing strategy. The brand continues to be incredibly popular with whiskey consumers, as evidenced by the over 100,000 entries that were received on the first day of the Old Forester Birthday Bourbon Sweepstakes, which gives participants a chance to purchase one bottle at $199.99 at the Old Forester distillery in Louisville, Kentucky. The demand is so high for this special release, we were fortunate to be able to increase the number of bottles available, which is probably welcome news to anyone that has been trying to add a bottle of birthday bourbon to their home bar. For more than 150 years, we have aspired to uphold George Garvin Brown's founding promise that there's nothing better in the market. I want to wish good luck to everyone who entered the sweepstakes, as I think they will announce winners in downtown Louisville today. I'm also pleased to report that organic net sales growth continued for Woodford Reserve, the #1 super-premium American whiskey globally. This performance was driven by higher volume in the United States, even when total distilled spirits trends remained well below historical levels. Of the top 20 total distilled spirits brands in the United States, only two are growing in the past 13-week takeaway results, and Woodford Reserve is one of them. This speaks to the strength of the brand and also the challenges many in our industry are facing in the current environment. Both Jack Daniel's Tennessee Honey and Jack Daniel's Tennessee Apple delivered mid-single-digit organic net sales growth, led by Brazil as well as Türkiye, even as Tennessee Apple was lapping its prior year launch in Korea. In Brazil, we continued our strategic geographic expansion efforts, investing more efficiently with bolder and bigger activities and high engagement content for the consumer. Turning now to Jack Daniel's Tennessee Whiskey. Organic net sales declined 6%, driven by lower volumes led by the United States, the United Arab Emirates and the United Kingdom, partially offset by an increase in volume in Japan following the transition to own distribution and higher prices in Türkiye. As I mentioned in my opening comment, this decline was expected. In the year-ago period, the United States and the United Kingdom experienced a shift in ordering patterns as inventory was purchased ahead of a price increase in the U.S. and an excise tax increase in the U.K. In addition, in the United Arab Emirates, we faced a tough comparison against the strong shipments in the year-ago period due to the replenishment of inventory. As you'll recall, with the supply chain disruptions we experienced, the emerging markets were among the last of the markets to be replenished. We continue to believe that Jack Daniel's has a significant runway for long-term growth despite the recent short-term headwinds. We continue to invest behind the brand and have strategies and plans in place to engage a new generation of legal drinking age consumers, while retaining our core consumers, including the Make it Count global campaign, the McLaren Formula 1 sponsorship and the Jack Daniel's and Coca-Cola RTD. We're also investing more in short-term activations within the on and off-premise channels and events such as music festivals and McLaren races globally. Music has been an important part of the Jack Daniel's relevance in pop culture, and was recently featured in the mega hit, A Bar Song, also known as Tipsy by singer, Shaboozey. The song was released in April and reached #1 on the Billboard Hot 100 in the United States and other countries such as Australia, Canada, Ireland, Norway and Sweden. Our global sponsorship with McLaren Racing is also on display, with a top 3 finish for McLaren in 12 of the 15 races held in calendar 2024 with the cars, race suits and the team garage featuring increased branding for Jack Daniel's. There are two upcoming races in the United States, one in Austin in October and then Las Vegas in November. We'll be cheering on Team McLaren to victory. In addition, we're continuing the geographic expansion of the Jack Daniel's family of brands and are well positioned to capture the global growth of American Whiskey as evidenced by our share growth in markets such as the United Kingdom, Australia, Poland, Mexico and Brazil. Before moving on, I'll provide a brief update on the continued expansion of the Jack Daniel's and Coca-Cola RTD. While growth from the Jack Daniel's and Coca-Cola launch continues to be offset by the planned declines in Jack and Cola, which makes it difficult to evaluate the brand from an external perspective, but we are very pleased as we enter our second year. We continue to add new markets, expanding further throughout Europe as well as launching in South Africa and additional Latin American markets. We plan to launch in India in September and expect to be in more than 30 markets by the end of calendar '24. In addition to geographic growth, we're also innovating. In the U.S., the first displays of Jack & Coke Cherry are beginning to appear. Jack & Coke Cherry will be a limited time offering intended to generate interest and intention for the family of Jack Daniel's RTDs as well as the full strength family of brands. We'll also be introducing a variety pack as package formats and flavors are vital to the ready-to-drink category and further address the consumer trends of convenience and flavor. The Jack Daniel's and Coca-Cola RTD has been a great addition to our portfolio, which is, as you know, we have been very strategically reshaping over the past couple of decades to focus on premium and super premium brands. Before turning the call over to Leanne, I'd also like to provide some additional perspective on our gross profit and margin. In the first quarter of fiscal '25, our reported gross profit decreased 13% and organic decreased 8%, resulting in a gross margin of 59.4%. This gross margin contraction is largely due to timing. As we have shared previously, following the divestitures of Finlandia and Sonoma-Cutrer, we entered into a transition service agreement with the buyers to ensure a smooth and orderly transition. These agreements had a negative effect on our overall reported gross margin, as the gross margin for these services agreements was significantly lower than the sale of finished goods. This was the main driver of the 140 basis point negative impact from A&D. Overall costs negatively impacted reported gross margin by 440 basis points, largely influenced by inventory levels and the timing of input cost fluctuations. In the first quarter of fiscal '25, we continued to reduce our finished goods inventories on a year-over-year basis. The finished goods that supported our first quarter sales were at a higher cost compared to the year-ago period due to the timing of input cost fluctuations, particularly for our tequila brands, as we work through the higher cost inventory. Leanne will share more details regarding our outlook, but I'll share now that we do anticipate the headwinds in the first half will become tailwinds in the second half of the year. Favorable product mix with price/mix contributed 200 basis points in the first quarter. There was also a positive impact to reported gross margin of 70 basis points from the recent business model change for Jack Daniel's Country Cocktails. This is an example of how we continually look for efficiencies and opportunities to improve our production and supply chain. These tailwinds though, were more than offset by the headwinds from A&D and the timing of costs. In summary, the start to our fiscal '25 was as we expected, and we believe we're positioned to achieve our full year guidance. We're still operating in a highly dynamic environment, yet our portfolio remains well positioned. Our geographic reach is broad and our team members are immensely talented and highly dedicated to growing our business. This has enabled us to navigate short-term volatility and uncertainty as we focus on the long-term growth of our business. With that, I'll turn the call over to Leanne, and she'll provide more details on our first quarter results.
Leanne Cunningham, Executive Vice President and CFO
Thank you, Lawson, and good morning, everyone. As Lawson mentioned, I will provide additional details on our geographic performance, other financial highlights as well as our fiscal 2025 outlook. From a geographic perspective, organic net sales for our developed international markets collectively declined 6% in the first quarter, as growth in Japan was more than offset by declines in the United Kingdom and Germany. As expected, Japan returned to growth following our route-to-consumer change to own distribution on April 1, 2024. We are now recognizing the benefits of owning our distribution, including the execution of our pricing strategy. We are very pleased with the transition, and I want to thank all of our dedicated team members for their contribution to this success. For the U.K. and Germany, lower volumes of Jack Daniel's Tennessee Whiskey had the largest impact on performance. In the U.K., the results of this quarter compared against higher volumes in the year ago period related to purchases ahead of the excise tax increase. And in Germany, annual pricing negotiations lasted longer than is typical, but have now been completed as of the end of June. In the United States, organic net sales decreased 4%, as lower volumes of Jack Daniel's Tennessee Whiskey were partly offset by growth of Woodford Reserve and Old Forester, with both of these brands having takeaway trends that are outperforming the American Whiskey category. As Lawson has already highlighted, the drivers of these brands in his remarks, I will provide a few additional comments on the inventory and consumer environment. Just a quick reminder, from our June call, distributor inventory levels were largely at normal levels throughout fiscal 2024 with movement to the low end or just below the normal range in our fourth quarter. Consistent with our expectations, distributors are continuing to target the low end of their normal range as higher inflation and interest rates are impacting the consumer and trade. From a takeaway perspective, trends for total distilled spirits as well as Brown-Forman remain below the long-term historical rates of growth. While rates of growth are moderating, the premiumization trend continues to persist, with higher price tiers continuing to grow value and maintain share as value-priced brands are losing share to RTDs. The growth in the $40 and above price tiers are driven largely by the U.S. whiskey and tequila categories. Collectively, organic net sales for our emerging international markets, which lapped a 32% increase in the year ago period declined by 5%, driven by a decline in Mexico, led by New Mix and our tequila portfolio as the economic environment is decelerating and consumers are trading down. Despite the decelerating conditions, we continue to outperform and gained market share across the channels, driven by strong takeaway in RTDs and whiskey. We also had lower volumes of Jack Daniel's Tennessee Whiskey in the United Arab Emirates, as we lap the strong shipments from the replenishment of inventory in the year ago period. These declines were partially offset by growth in Türkiye, driven by higher prices as well as Brazil, where Jack Daniel's Tennessee Whiskey, Jack Daniel's Tennessee Apple and Jack Daniel's Tennessee Honey are benefiting from the growth of the premium-plus whiskey category, geographic expansion and the launch of an additional package size for Jack Daniel's Tennessee Whiskey. And lastly, organic net sales in the Travel Retail channel decreased 8% as the channel compared against the strong growth from our super premium brands, particularly Woodford Reserve and Jack Daniel's Single Barrel in the year ago period. Growth of Diplomático along with our Single Malt Scotches partially offset the decline. Importantly, consumer takeaway remains strong in global Travel Retail accounts. Lawson has shared the details of our gross profit and margin for the quarter, so I will now turn to our operating expenses and operating income. In the first quarter, organic advertising expenses decreased 1% as we lapped a 14% increase in the year ago period. As a reminder, the increased spend in the first quarter of fiscal 2024 was largely due to the timing of our spend to support the launch of the Jack Daniel's and Coca-Cola RTD, which was skewed to the first few months of the fiscal year. And our organic SG&A investment decreased 5% as we compared against a 12% increase in the year ago period, which reflected higher compensation-related expenses related to organizational changes including our route-to-consumer expansions. In total, reported and organic operating income decreased 14% and 13%, respectively in the first quarter of fiscal 2025. These results led to a 14% diluted earnings per share decrease to $0.41 per share. And finally, to our fiscal 2025 outlook, which we are reaffirming. We anticipate a return to growth for organic net sales and organic operating income in fiscal 2025, driven by gains in international markets and the benefit of normalizing inventory trends on a year-over-year basis. This outlook is tempered by our belief that the operating environment ahead will remain challenging and volatile with global macroeconomic and geopolitical uncertainties. In this environment, we are not forecasting significant changes in the level of trade inventories, as the impacts from inflation and higher interest rates on the consumer and trade are expected to continue. We also continue to forecast that fiscal 2025 will be a year of two halves. In our first quarter, on a year-over-year basis, we compared against the strong shipments in a few emerging international markets as well as lapping stronger shipments associated with the execution of our pricing strategy. In the second quarter, with the majority of the movements in inventory across the distributor, retailer and consumer supply chain behind us, we believe our results will more closely reflect total distilled spirits trends. We expect the second half of the year to be stronger, as we anticipate that we will benefit from having a full year of growth from our outstanding new brands of Gin Mare and Diplomático, and we will begin to compare against the softening of total distilled spirits trends in the year-ago period. We remain confident in the strength of our portfolio, along with our pricing strategy and the further globalization of our entire portfolio across vast geographies. Therefore, we continue to expect organic net sales growth in the 2% to 4% range, driven by our emerging and developed international markets. We also continue to expect reported gross margin expansion in fiscal 2025 with sequential improvement as we believe we will benefit from price/mix through the evolution of our portfolio, which includes the addition of two super premium brands, Gin Mare and Diplomático and the divestiture of lower-margin brands, Finlandia and Sonoma-Cutrer. Price/mix should also continue to benefit from our revenue growth management activities. In addition, transition services agreements typically last approximately 12 months, so they should come to an end in our second half, which will remove the A&D headwind that Lawson highlighted in his remarks. And while costs were higher in the first quarter of fiscal 2025, compared to the year ago period, this is largely due to the timing of input cost fluctuations, particularly for our tequila brands. For these brands, we still expect to benefit from lower agave prices for the full year as we work through our higher cost inventory. As we previously shared, we continue to expect that the benefit will be more than offset by the impact of inflation on our input costs and lower production volumes. Our outlook for organic operating expenses reflects continued investment behind our brands and our team to unlock future growth, leading to growth generally in line with our top line growth. Based on the above, we continue to forecast organic operating income growth in the 2% to 4% range. We also expect our effective tax rate to be in the range of approximately 21% to 23%, and that our estimated capital expenditures will be in the range of $195 million to $205 million for the full year, as we continue to fully invest behind our business to meet what we believe will be the future consumer demand for our brands over the long term. And lastly, as a reminder, in the second quarter of fiscal 2025, we will begin to reflect our equity shares of The Duckhorn Portfolio's earnings or losses as a line item below the operating income line of our P&L based on the equity method one quarter in arrears. In summary, our fiscal 2025 started off as we expected. The first quarter results reflect the current consumer demand environment, along with a few remaining unusual comparisons against the very strong shipments in the year ago period. While our short-term organic results in the quarter were below our historical trends, we believe our brands and our business are healthy. Lawson and I would again like to thank all of our team members for their continued dedication and contributions in navigating the dynamic operating environment that continues to normalize from the historic manner in which we started this decade. As we look ahead to our fiscal year, we remain confident in our ability to deliver our near-term goals as we continue to focus on executing our long-term strategy and building Brown-Forman for generations to come. This concludes our prepared remarks. Please open the line for questions.
Operator, Operator
Our first question comes from Peter Grom of UBS.
Peter Grom, Analyst
You both mentioned in the release that the first quarter met your expectations. Given the tough start to the year with organic sales down 4%, can you share your confidence or visibility in reaching the full-year target? I understand that comparisons will get easier and that you always expected stronger growth in the second half. I would like your thoughts on the key building blocks from a category perspective. Leanne, you mentioned that second quarter growth will align more closely with category trends, but the data we have indicates they still appear quite challenging. Should we expect organic sales to remain down in the second quarter with a return to growth in the second half, or might we anticipate better performance in the second half than what I outlined?
Leanne Cunningham, Executive Vice President and CFO
Thank you, Peter. I'll start by reiterating a few points. We expect this year to unfold in two halves, with sequential improvement throughout the remainder of the fiscal year. Our first quarter results met our expectations. For the second quarter, we believe the results will more accurately reflect the overall trends in the distilled spirits market in the U.S. In the second half, we anticipate benefiting from the full-year impact of Gin Mare and Diplomático. Additionally, we will begin to compare against the decline in total distilled spirits from the same period last year, which was significant in our second half. Regarding costs, we will continue to work through higher cost inventory early in the year, particularly related to our tequila business, as our agave costs are decreasing more rapidly than we can deplete our inventory. It's worth noting that we'll also be free of some unusual one-time items that impacted fiscal year 2024, such as the transition of Jack & Cola into the Coca-Cola system in the U.K. and the transition of Jack Daniel's Country Cocktails production. In fiscal year 2025, we expect to see our organic growth return in Japan with our own distribution and improvements in other international markets, like the UAE, where inventories have returned to normal levels. As we consider our innovation pipeline for the year ahead, it's important to recognize that we believe our growth will primarily come from international markets. However, we must acknowledge that all these markets are currently performing below what we would consider our long-term growth expectations.
Operator, Operator
Our next question comes from the line of Andrea Teixeira of JPMorgan.
Andrea Teixeira, Analyst
I just want to follow up in terms of like the cadence and how the inventory levels have been flowing through. I guess you mentioned on the press release and now also the fact that some of your wholesalers have been more cautious in keeping inventory levels low. What are you seeing on the trade? And also what are you seeing from an on-premise and off-premise perspective, right? So part of the inventory buildup is also on the pantry. So can you talk about how you felt the quarter evolved as you get into the fiscal second quarter and the balance of the year, how we should be thinking of those dynamics from a consumer takeaway standpoint?
Leanne Cunningham, Executive Vice President and CFO
Yes, I'll address the first part of your question, Andrea. We believe that overall, our distributors are continuing to target the lower end of their usual range, and retailers have adjusted their inventory levels due to consumer demand being below historical averages, especially in the current high interest rate environment. Our depletions are aligned with our shipments, which you can see on our Schedule B. Ultimately, it boils down to consumer demand as inventory moves from suppliers to distributors to retailers. In the U.S., we are working closely with our distributor partners, and we do not anticipate any significant changes in trade inventory levels as we expect the consumer and trade impacts to persist as they have been. Regarding inventory, we primarily own our distribution in Europe, so our stock levels there are normal, and we are also satisfied with our position in Latin America. Year-over-year, we have made progress in reducing our finished goods, work-in-progress, and raw material inventory levels.
Lawson Whiting, President and CEO
Yes, let me elaborate a bit because inventory levels, especially at the consumer level, have been fluctuating, and we discussed this extensively last quarter. Many of you have commented on it. Currently, in the U.S., total distilled spirits data from Nielsen and NABCA is essentially flat. At this time last year, Nielsen reported a plus 5.7, but it quickly dropped to 0 last fall, contributing to a disappointing Christmas for both the industry and Brown-Forman last year. It’s noteworthy how abruptly it declined. During our last call, we discussed why this happened, focusing on the significant factors of cannabis, GLP-1s, and Gen Z, and how we believe these are not structural changes but are mainly influenced by consumer spending and inventory levels. We continue to think these two factors are the primary influences on the past year. Regarding Brown-Forman in the U.S., there are several unusual elements this quarter. Nielsen and NABCA report the industry as flat. Brown-Forman appears to be flat to down 1 in NABCA, but Nielsen shows a decline closer to mid-single digits. The main reason for this discrepancy is the launch of Jack & Coke last year in Q1. The launch was significant, particularly in control states reflected in NABCA, which was slower. The initial push at the start of Q1 with Jack & Coke accounts for about half of the 5-point difference between Nielsen and NABCA. The other half, which is more encouraging, is driven by Woodford and Old Forester in the on-premise sector. Surprisingly, both brands are performing well above the overall weak trend in total distilled spirits on-premise, which is down between 1 and 2. We are defying that trend, with two of our strongest brands making a significant impact.
Operator, Operator
Our next question comes from the line of Eric Serotta of Morgan Stanley.
Eric Serotta, Analyst
Leanne and Lawson, could you provide more details on the progress you've made year-over-year in reducing your finished goods and raw material inventories? Does this indicate that further reductions are anticipated in the second half? Additionally, how do you expect this to impact gross margins? On a related note regarding inventories, Lawson, do you have any updates on your thoughts about the level of inventories and aging stocks in the industry? There are over 12 million barrels aging in Kentucky and likely many in Tennessee. How do you envision the market absorbing these as they reach maturity over the next few years?
Leanne Cunningham, Executive Vice President and CFO
Yes. So Eric, I'll start with the first part of your question. So from barrel whiskey, like we always talk about, that's about our future growth expectation of our aged product. So as we look out, we continue to see demand in the future, we should always expect that to grow. But to my comment on finished goods WIP and raw material on a year-over-year basis, with the volatility that was created by the COVID cycle and strong demand and the supply chain constraints, we've been working intentional and we shared that on our last call to reduce our finished goods WIP and raw material inventory levels on a year-over-year basis, we have accomplished that. There is one piece that, if you look at from April 30, our year-end, our finished goods is up a bit, and that is all about us proactively preparing for a variety of tariff-related scenarios. And then to your point on how it related to gross margin, again, we talked about that as we think about our cost for the full year and where we kind of expect it to be, what's happening in the first couple of quarters of the year is more related to timing as we move through some inventory. But that we were specific to say that we would still have, and that would be offset by the impact of inflation on our input costs and our lower production volumes as we are continuing to focus on returning to more normal levels of our working capital. So I hope that is all factored into our gross margin guidance for the year.
Lawson Whiting, President and CEO
Yes. The discussion about industry supplies and Brown-Forman's supplies is quite interesting. A year ago, we were focused on whether we had enough supply. Now, the conversation has completely shifted. I tend to avoid overreacting to these changes because they are very sensitive to demand, and even a slight shift can significantly affect industry supply. In terms of American Whiskey, we feel optimistic at the moment. The major suppliers still dominate most of the American Whiskey sales, and although everyone is building their inventories, they are doing so in line with reasonable sales growth expectations, which we believe will balance out. Additionally, we have strategies we can implement when supply fluctuates, and after 154 years of managing supply, we've become quite adept at navigating these challenges. Therefore, I don't see whiskey supply as a significant risk, and we're not experiencing pricing issues or promotional pressures in the United States. Overall, we're quite confident about the supply situation.
Eric Serotta, Analyst
Great. Just one more short follow-up. One of my favorite quotes from you last year, Lawson, was that Christmas stunk. It seems a bit silly to ask about the holiday season with Labor Day weekend coming up, but the holiday sell-in will be here soon. How are you planning for demand this holiday season, considering various comparisons and inventory movements?
Lawson Whiting, President and CEO
That's a tough question. The usual answer regarding comparisons seems to apply here, as the comparisons this Christmas are expected to be much easier than they were last year. Last year was quite unexpected, not just for us but for the entire industry, as demand dropped off more quickly than anticipated. We've mentioned that the second half of the year should be stronger, and even the second quarter is expected to perform better than the first. This suggests we could have a better Christmas than last year, though I’m hesitant to predict just how positive it will be.
Leanne Cunningham, Executive Vice President and CFO
And I think one thing we can build on that is one thing that we know is while we do continue to see a stretched consumer that is seeking to stretch their discretionary income, premiumization trends are continuing. And we feel like our portfolio is incredibly well positioned for that premiumization trend to continue, which I think you can see about the strong performance of Woodford Reserve and Old Forester during the first quarter.
Operator, Operator
Our next question comes from the line of Nadine Sarwat of Bernstein.
Nadine Sarwat, Analyst
Lawson, maybe if I ask my first question, putting the lumpiness of the distributor inventories to one side that we've had over many quarters now. And I look at what the implied underlying net sales growth was, I think it's the weakest now that we've seen in probably about 4 years. So well below that medium-term growth algo, I fully appreciate your comment on sort of this being a year of two halves. But could you help us understand what you believe are the underlying drivers of that weakness? And how you expect that to develop over the remainder of the fiscal year, again, focusing on that underlying number rather than inventory? And then second question related to that, what are you assuming in terms of the health of the American consumer in your guidance versus perhaps what are you observing today in terms of the health of that consumer?
Lawson Whiting, President and CEO
If we concentrate on the factors affecting Q1, and excluding inventory from our discussion, it’s important to note the price increases from last year that took effect on August 1. There was significant buying in June and July prior to that. This is not insignificant. The same timeline applies to the U.K. with tax increases causing similar pre-buying behaviors. Consequently, this timing influence has an effect on depletions and related metrics. Now, focusing on the U.S. consumer, it's clear that the consumer market is currently weaker. With TDS at zero, according to NABCA and Nielsen, we’re seeing a considerable decline. However, I believe improvements are on the horizon. Historically, this business experiences cycles of decline followed by relatively quick recoveries. While our guidance doesn’t assume a rapid turnaround, we do anticipate sequential improvement each quarter moving forward.
Leanne Cunningham, Executive Vice President and CFO
As we look ahead to the first quarter, we recognize that France and Germany were affected by prolonged price negotiations, which have now concluded. In the short term, we experienced a decline in market share there. However, we believe we will be more competitive moving forward now that these negotiations are settled. In the U.K., we are striving to increase our market share compared to last year, despite consumers being more value-conscious, waiting for brand promotions, and searching for deals online. In contrast, markets like Brazil are showing growth where we are gaining share with strong double-digit increases, particularly with Jack Daniel's Tennessee Whiskey and our products Apple and Honey and Fire, supported by our geographic expansion and the shift in strategy from grocery to cash and carry to meet consumer needs. We have also introduced a new pack size that appeals to consumers. In Mexico, while the market is slowing down, we are acquiring value share in whiskeys and ready-to-drink beverages, even amidst lower consumer confidence. Additionally, in Australia, we continue to gain market share with Jack Daniel's Tennessee Whiskey. Overall, in many international markets, we continue to find opportunities for growth despite the changing market dynamics, which is why we are optimistic about growth prospects in these areas throughout the year.
Lawson Whiting, President and CEO
Yes. Let me add on to, Leanne just said about France and Germany, too, because those are two very large markets for Brown-Forman. We haven't been in that proverbial penalty box in a while. But it's a sign that we continue to be persistent in our goal of getting low and slow price increases, and Europe's always been the challenge, with the big retailers in pricing. But through different revenue growth management techniques and different negotiations, you stick it out, it hurt the quarter. But the nice thing is that stuff should come back in Q2 and beyond. And so that's just one more reason to believe that we can accelerate from this point forward.
Nadine Sarwat, Analyst
Got it. And just on what you're assuming in terms of the health of the American consumer in your guidance? Are you expecting that to pick up in the second half of the year? Or is your guidance assuming the status quo from here?
Leanne Cunningham, Executive Vice President and CFO
Yes. Overall, for the U.S. consumer specifically, we are not expecting a significant change in consumer trends or behavior.
Operator, Operator
Our next question comes from the line of Filippo Falorni of Citi.
Filippo Falorni, Analyst
I wanted to follow up on the gross margin. Can you break down the impact of 4.4 points on gross margin from commodities versus the effect of inventory revaluation, particularly with the higher cost inventory? Looking ahead, should we anticipate that inventory impact to persist in Q2, with margin expansion more pronounced in the second half of the year? Or do you expect to see some improvement in the second quarter?
Leanne Cunningham, Executive Vice President and CFO
Yes. So specifically on the 440 basis points of cost, again, it's like we said, it's largely timing hitting largely in the first quarter. If you remember last year, our gross margin started higher and we kept trying to guide others down to where we inevitably landed at 60.5%. This year is going to kind of be the inverse, as we have higher cost in this period due to those inventory cost fluctuations, again, related largely to our tequila brands. As we kind of work through that higher cost inventory, we do think that was largely in the first quarter, we'll get some of that in the second quarter as well. So it's really the second half which will see the absence of that impact or will be to the benefit of our lower cost inventory. Impact from inflation on our input costs and our lower production volumes will, for the full year, still when we're thinking about cost in total, and we're kind of in that low single-digit range, low to low mid-single-digit range for our full year.
Filippo Falorni, Analyst
Just a quick follow-up on the transition service agreement. Should we expect a headwind in Q2 from these agreements, and then see that fade away or potentially turn into a tailwind in the second half?
Leanne Cunningham, Executive Vice President and CFO
Correct. They are planned to end as we go into our second half. So again, that's part of our tail of two halves from a gross margin perspective. We expect those to be absent as we go into the second half.
Operator, Operator
Our next question comes from the line of Robert Moskow of TD Cowen.
Robert Moskow, Analyst
I wanted to ask about just the marketing efforts on Jack Daniel's in general. You talked at your Investor Day about a lot of plans to improve trends, boost the image of the brand. How do you think it's going? Because you look at the tracking data and it indicates continued declines. Do you feel like these efforts are strong enough to reacquaint the brand or strengthen the brand in a mainstream manner and offset what I think is happening, which is more shifts to premium offerings?
Lawson Whiting, President and CEO
The Jack Daniel's brand remains one of the largest and strongest in the world. We believe we are being creative with our McLaren racing partnership and our ongoing efforts in pop culture, which are crucial for attracting new consumers every year. We’ve seen solid performance over the past five years, with sales growth for the Jack trademark ranging from 4% to 5%. If we can maintain that growth over the next 5 to 10 years, we are well positioned for the medium- and long-term. The overall strength of our portfolio supports this growth trend, especially as many segments were experiencing double-digit growth prior to COVID and the recent challenges. We are committed to continuing the growth of the Jack Daniel's brand, and last quarter we mentioned the super premium Jack Daniel's extensions, which contributed significantly to our sales growth last year. These unique offerings help strengthen the overall trademark and support our growth strategy. While we recognize the last 12 months have been challenging, we believe improvements are on the horizon. In fact, U.S. sales for Jack show signs of recovery, albeit slowly, but we are starting to see positive changes.
Robert Moskow, Analyst
Can I ask a follow-up, Lawson? You mentioned that the key is to engage younger consumers with the Jack Daniel's brand and attract new customers. What metrics do you use to determine if younger consumers are responding to these ads, if the message is resonating with them, and if their perception of the brand is changing?
Lawson Whiting, President and CEO
We have a comprehensive set of consumer insights and data that we track monthly. We can analyze this data by age, and we frequently discuss the importance of recruitment versus retention, which is a common challenge for major brands. Our new campaign, internally referred to as Back in Black, features a well-known song that we believe is more relevant to consumers. We're seeing positive signs in our progress, which is reflected in our statistics. It's noteworthy that among the 20 largest brands in the U.S., only two are experiencing growth, one of which is Woodford. The largest brands are currently showing the weakest performance in Nielsen trends. This highlights our previous point that these brands were popular during the COVID period and its aftermath, which has led to inventory challenges. This situation adds to the evidence explaining the slowdown in trends for the largest brands.
Operator, Operator
Our next question comes from the line of Nik Modi of RBC.
Nik Modi, Analyst
Lawson, I was hoping you can just share your perspective. I mean, feedback from the trade in August would suggest a pretty steep drop off at the industry level. And just curious kind of what you guys are observing just broadly why there could have been such a precipitous drop from July to August? And then just kind of piggybacking on that. I mean, the more we hear about the delta-9 on cannabis beverages and how fast they're selling out when they're on display. And I know you kind of dismissed it last quarter, but I'm just curious, like have you seen some traction for some of those products and maybe infringing on some of the beverage alcohol occasions?
Lawson Whiting, President and CEO
Well, regarding the drop from July to August, I honestly don't have any insights on that. I haven't heard anything from our teams either, so I'm unsure of the source or what to say about it. Concerning cannabis, particularly cannabis beverages, I've mentioned this several times in past calls. Cannabis has been present for a long time, and just because it’s moving from illegal to legal doesn’t significantly affect current trends. While products like gummies are certainly seeing growth compared to the past, I don’t believe there's a significant overlap between cannabis beverages and spirit brands. Studies indicate that beer is more likely to face competition from cannabis beverages rather than spirits, which makes logical sense to me. Looking ahead, I still have difficulty seeing cannabis beverages as a major business opportunity. There are numerous alternatives available, and people won't typically consume these beverages in large quantities. Therefore, I think the growth potential in this area is fairly limited.
Leanne Cunningham, Executive Vice President and CFO
From our consumer research, we found that spirits are the preferred type of alcoholic beverage among individuals who have used cannabis in the past month. This is based on feedback from our consumers.
Operator, Operator
Our next question comes from the line of Steve Powers of Deutsche Bank.
Stephen Robert Powers, Analyst
So in the quarter, we saw distributor inventories tick up 3 points in the U.S. and 4 points in developed international. And just relative to your comments that you're not really expecting much improvement in the consumption run rate, especially in the U.S., I mean, is there a risk there, that, that kind of one quarter build unwinds as we go into 2Q or the remainder of the year? How are you thinking about that?
Leanne Cunningham, Executive Vice President and CFO
Our comments really is about a year-over-year perspective, and it's about lapping the softening of the total distilled spirits trends that we saw in the year ago period. So when we think about our year to go, and again, we'll have the largest benefit of that lapping in our second half. That was really a year-over-year comment. Because, again, with distributors and our outlook of their inventory levels, it continues to be that we are not forecasting an outlook that has significant change. We're continuing to believe that the trade and consumer behavior will be similar to what it is now.
Stephen Robert Powers, Analyst
Consumption is down compared to last year's inventory levels, which have decreased to reflect worsening consumption. Currently, consumption is not improving, and inventory levels are rising. This situation presents some risks, but I can follow up later. Regarding your second question, you mentioned that France and Germany faced headwinds during the quarter, but those are expected to normalize as we proceed, especially after completing retailer negotiations, which will benefit the remainder of the year. You also noted that Gin Mare and Diplomático are expected to make notable contributions to growth, particularly in the second half of the year. Is there a way to quantify the impact of these factors as we transition from the first quarter to the second quarter and then into the second half?
Leanne Cunningham, Executive Vice President and CFO
I mean I think what we can say that they are all implied in our guidance and what we've said first half, second half. From an organic perspective, again, with the shipment base for Gin Mare and Diplomático compared to where we were last year, we believe we're going to have a benefit in this year. We are not quantifying that specifically or quantifying the benefit that we believe that's in our year-to-go period now that we have concluded our pricing negotiations in Germany and France. But again, we believe that we had the biggest impact from those negotiations, specifically with Germany and France in the first quarter that now will not be present as we go forward.
Operator, Operator
Our next question comes from the line of Stephen Robert Powers of Deutsche Bank.
Stephen Robert Powers, Analyst
We wanted to inquire about the tequila performance, which has been disappointing this quarter and was also weak last quarter. Can you share more about the reasons behind this trend? Previously, we discussed the goal of significantly increasing tequila sales in the future, which I assume remains the objective. I'm looking to understand why we've seen such a noticeable decline in these recent quarters and how to view this as we move ahead.
Lawson Whiting, President and CEO
Yes, I'll address that. First, I find it interesting that tequila is projected to surpass vodka as the largest value category in the United States in 2024. For those of us in the industry for a while, this rapid growth is remarkable. Additionally, it's surprising that 22 to 24-year-olds are now just as likely to drink tequila as beer. A significant portion of our tequila decline can be attributed to challenges in Mexico, where we are aggressively pushing prices. We are also adjusting prices in the U.S. as part of a competitive strategy. While total distilled spirits pricing in the U.S. remains stable, tequila pricing has dipped slightly, by about one point. Despite this, we're seeing a three-point increase in our pricing strategy. While we are cautious about current tequila trends, it's important to note that they haven't hindered the company's overall growth; in fact, they've been beneficial. The tequila category is highly competitive with many brands, and we believe we have one of the best. el Jimador, a key brand in our portfolio, is well-positioned internationally, making it a significant growth opportunity in markets like the U.K., Australia, and Brazil, which many may not be aware of.
Operator, Operator
This concludes the question-and-answer session. I would now like to turn it back to Sue Perram for closing remarks.
Sue Perram, Vice President, Director of Investor Relations
Thank you, Marvin, and thank you, Lawson and Leanne, and thank you to everyone for joining us today for Brown-Forman's First Quarter Fiscal Year 2025 Earnings Call. If you have any additional questions, please contact us. We look forward to participating in the Barclays Global Consumer Staples Conference next week, and hope to see many of you. For those of you unable to attend, our fireside chat will be made available as a webcast accessible via the Brown-Forman corporate website under the section titled Investors, Events and Presentations. We wish everyone an enjoyable weekend, particularly those in the United States that are celebrating the Labor Day holiday. And on Monday, September 2, we hope you will join us in raising a glass as we say happy birthday to our founder, George Garvin Brown, and good luck, again, to those of you who entered into the Birthday Bourbon Sweepstakes. With that, this concludes our call.
Operator, Operator
Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.