Good morning. My name is Dorothy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Brown-Forman third quarter fiscal 2019 conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. I would now like to turn the call over to Jay Koval, Vice President of Investor Relations. Sir, you may begin.
Thanks, Dorothy, and good morning, everyone. I want to thank you for joining us for Brown-Forman's third quarter 2019 earnings call. Joining me today are Lawson Whiting, President and Chief Executive Officer, and Jane Morreau, 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 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 third quarter of fiscal 2019, in addition to posting presentation materials that Lawson and Jane 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, Form 8-K, and Form 10-Q reports filed with the Securities and Exchange Commission. During this call, we'll 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 conditions and results of operations, are contained in the press release and investor presentation.
With that, I'll pass the call over to Lawson.
All right. Well, thanks, Jay, and good morning, everyone. Overall, I'm pleased with the third quarter and the year-to-date results that we released this morning. In particular, we're focused on maintaining our top-line momentum around the world. Underlying net sales are largely where we expected them to be at the beginning of the fiscal year, growing about 6% after adjusting for the impact of tariffs. As a reminder, we chose to absorb the majority of the tariffs this fiscal year in order to maintain that solid business momentum, and Jane's going to talk a lot more about that in just a few minutes. As a result, though, we are on track for another year of strong, sustained top-line growth.
Given recent trends and our expectations for a relatively strong fourth quarter, we reaffirmed our fiscal 2019 outlook of 6%-7% underlying net sales growth and 4%-6% operating income growth. Importantly, these estimates have been unchanged since Q1. As I said, Jane will run through the financials in more detail. Before she does, I'd like to take a few minutes this morning to talk about the ongoing evolution of both our geographic and our brand growth drivers, and really how they've changed over the past decade or two. For many years, Brown-Forman's growth was powered by Jack Daniel's Tennessee Whiskey in the U.S. Over the last decade, we've invested significantly in the international expansion of the company, as all of you are very well aware. We've broadened the portfolio within the Jack Daniel's family of brands.
We've reshaped the rest of the portfolio to get out of weaker businesses and invested in faster-growing premium spirits categories. We've put significantly more resources to organically accelerate the growth behind two of the fastest-growing spirits categories, bourbon and tequila. This increasingly balanced approach has been an integral driver of the company's ability to deliver consistently high rates of growth with limited volatility. Let me use the U.S. as an example, where we've really been focused on portfolio diversification. We're seeing an increasing share of growth coming from other brands in our portfolio beyond just Jack Daniel's Tennessee Whiskey. For example, Gentleman Jack Daniel's Single Barrel, and Jack Daniel's Tennessee Rye continue to grow nicely and provide margin benefits to the trademark. Jack Daniel's Tennessee Honey is now about 750,000 cases in the U.S., and Jack Daniel's Tennessee Fire is roughly 400,000 cases, and both continue to grow.
Additionally, we've been investing in what is now a leading portfolio of bourbon and tequila brands. The Woodford Reserve and the Old Forester trademarks have been registering impressive gains in the bourbon category over the last several years, approaching 1 million cases between the two brands. Woodford is on track to be the single largest contributor to growth in the U.S. market this fiscal year. The brand is simply on fire and has a long runway ahead of it. Old Forester continues to present itself as a leader in American whiskey. The brand has really gained a reputation for quality and innovation with a balance of its core 86 and 100 proof expressions, the popularity of the Whiskey Row Series, and the annual release of the acclaimed Birthday Bourbon.
The opening of the Old Forester Homeplace on Louisville's Main Street and the recent release of the Old Forester Rye contributed to its position as a real leader in the renaissance of American whiskey. We're also seeing very nice growth in our tequila portfolio in the U.S., with Herradura over 200,000 cases now at a $40 price point. el Jimador was a 160,000-case brand when we purchased the company 12 years ago, and today it's over 600,000 cases in the United States. These brands are the most material drivers of our U.S. growth, but we're also hard at work on developing the growth drivers for the next decade. Last summer, we created an emerging brands team in the U.S. to focus on some of our high-end super premium brands, including Benriach, GlenDronach Single Malt Scotches, and Slane Irish Whiskey. We also put Herradura and Old Forester into this group.
I'm pleased to say that we've accelerated the growth rate on every one of these brands over the past year. The team has really done a fantastic job in making and growing these brands a bit faster and making them into brands where we will see a meaningful impact in the future. We believe we've positioned these burgeoning brands to really become the future growth drivers in the highly profitable yet competitive U.S. spirits market. In terms of our increasing geographic breadth, 30 years ago, roughly 20% of Jack Daniel's Tennessee Whiskey volumes were from outside the U.S. It was an 80% U.S., 20% international. Today it's flipped, where over 60% of the volumes are international and only 40% inside the United States.
Over the last decade, 80% of its incremental growth has come from markets outside of the U.S., split evenly between developed international and emerging markets. Our developed international markets are performing well, growing comfortably in the mid-single-digit range, in line with our historic rates of growth. Europe and Australia remain solid contributors as we have been steadily investing in our routes-to-consumer capabilities in markets that many peers view as mature, including most recently, Spain. We're also putting more focused resources on building our super premium portfolio in Europe. Although much smaller than the emerging brands team in the U.S., the idea is the same: invest additional resources to focus on super premium brands that will fuel the next generation of growth. For Europe, that is primarily about American whiskey leadership, led by Gentleman Jack and Woodford Reserve.
While tariffs complicate our near-term American whiskey strategy, we'll continue to invest in momentum against our medium to long-term goals in the developed world. Emerging markets and travel retail have been delivering even higher rates of growth as we are in the early stages of building our brands in these major population centers of the world, including outstanding results over the last few years in both Mexico and Brazil. At approximately 20% of total company revenues, we believe these markets are rich with opportunity for our brand portfolio, and over time, additional route-to-market investments. This is also an area where we under-index relative to our big competitors, we also really believe that we've got a long runway ahead.
The key takeaway is that we've been expanding the geographic and portfolio drivers of our growth and diversifying our revenue base in categories that we believe have the best long-term global growth potential. At our Investor Day this past December, we shared with you our strategic framework. If you'll recall, the framework covered four focus areas, including portfolio, geography, investment, and people. We believe that through executing against this framework, we'll extend our leadership of premium American whiskey around the world and continue our track record of consistently delivering profitable growth. While tariffs remain a near-term challenge on American whiskey exports, we'll weather the storm as we have so many other challenges over the last 150 years, as we look to create value for our shareholders. I'm going to turn the call over to Jane for a review of the financials.
Okay. Thanks, Lawson. Good morning, everyone. I plan on covering three main areas today during my prepared remarks. First, I will review our year-to-date results through the third quarter. Second, I'm going to discuss our full-year fiscal 2019 outlook, which we affirmed this morning. Third, I will cover our approach to capital allocation. After I complete my prepared remarks, we'll open the call up to Q&A. As Lawson said, we delivered solid results during the first nine months of the year, despite the substantial burden that tariffs had on our business. Our underlying net sales grew over five percent in the first three quarters of the fiscal year. The noise around buy-ins and give backs associated with tariff inventories at the retail level that we discussed on our Q1 and Q2 earnings call is behind us.
However, we began to see the cost of tariffs hit not just our cost of sales and gross margins, but also our underlying net sales growth in the quarter and year to date. In markets where we own inventory and sell direct, tariff costs go through our P&L as higher cost of sales. This treatment represents the majority of our tariff costs. However, in certain markets where we sell through a distributor, the effect shows up in our net sales as we lower net prices to compensate for the incremental tariff costs that our partners are incurring. We estimate that these price adjustments reduce our year-to-date underlying net sales growth by approximately one percentage point. Thus, our underlying net sales growth of six percent, after adjusting for tariff, is largely in line with what we expected at the beginning of the year.
A very solid performance against last year's seven percent growth in the first nine months, which were not affected by tariff. While I'm on the topic of tariffs, we continue to work with our government affairs partners and industry associations such as DISCUS to resolve the tariff situation. If the tariffs remain in place, they will have an estimated annualized cost to our company before taking into account any mitigation actions of roughly $125 million. As we have discussed previously, we have taken actions to mitigate roughly half of the tariff impact we expect in fiscal 2019. As a reminder, incremental tariff costs began to impact our operating results beginning in October 2018. We anticipate that we will have about seven months of tariff drag on our results this fiscal year.
Switching to our third quarter, underlying net sales grew 4% and were negatively impacted by that one percentage point due to tariff-related pricing actions. Excluding this effect, our underlying net sales grew over 5% for the quarter. Foreign exchange continued to weigh heavily on the top and bottom line results through the first nine months of the fiscal year, as the U.S. dollar has appreciated against most major currencies over the last year. This impact has pushed both our reported net sales and operating income growth by roughly three percentage points. When combined with a slight year-to-date increase in distributor inventory levels, our reported net sales grew 3% and reported operating income increased 10%. Revenue growth was well-balanced across our portfolio. Performance was led by the strength of underlying net sales growth across the Jack Daniel's family of brands.
Tariff-related pricing actions reduced the family of brands' underlying net sales growth by one percentage point from over five. Our premium bourbons, including Old Forester and Woodford Reserve, grew underlying net sales 24%, and our tequilas, including Herradura, el Jimador, and new RTDs, grew underlying net sales in aggregate of 13%. Moving down the P&L to our gross margins. Year-to-date gross margins declined 190 basis points year-over-year. The impact of absorbing the majority of the tariff cost accounted for roughly two-thirds of this decline, while higher input costs for both wood and agave drove the remainder of the decrease. Gross margin compression was partially offset by the continued tight management of SG&A spend. Underlying SG&A declined 2%, due in part to lower personnel costs, including compensation-related expenses.
I want to take a moment and point out that we expect fiscal 2019 will mark the fifth straight year of SG&A leverage we've delivered via our efficiency and productivity initiatives. It's important to note that while we've leveraged prior investments such as in route- to- consumer, we've also increased our SG&A in markets such as France and Spain, as well as established the emerging brands group in the U.S. Over the same period, we've heightened our focus behind building our brands and consistently reallocated from SG&A to increase investments behind the consumer, growing our underlying A&P roughly in line with our sales. Our underlying A&P investment grew 3% year-to-date as we invested in our American whiskey brands, including the first year of our Woodford Reserve Kentucky Derby sponsorship, Jack Daniel's Tennessee Whiskey, and the new Old Forester Homeplace and Distillery.
Pulling it all together, we grew underlying operating income 4%. Higher operating income, coupled with a significant reduction in our effective tax rate resulting from last year's Tax Act, more than offset higher interest expense and a pension settlement charge, and helped power the 12% EPS growth to $1.40 per share through the first nine months of this year. Let me move on to my second topic, and I'll share a little bit more color on our reaffirmed outlook for fiscal 2019. Given our year-to-date results, our improving recent takeaway trends, and easing comparisons in our fourth quarter, we remain on track to deliver another year of strong underlying net sales growth in the range of 6%-7%. Our trends outside the U.S. remain healthy.
In the U.S., we are seeing encouraging trends in the recent takeaway data that points to further acceleration in our business from the year-to-date underlying net sales growth of 4%. As we discussed on our second quarter call, our brand activation and promotional periods were back-half weighted. Combined with the strong execution by our sales team and distributor partners, we have seen a meaningful acceleration in our U.S. business over the first nine months. From 2% underlying net sales growth in Q1, 3% in Q2, and 5% in the most recent quarter. We expect that this momentum will continue as we move into fiscal 2020. Looking at our U.S. business over a longer period, our recent mid-single-digit rates of value growth are in line with our average growth rate over the last five years.
We're very pleased with the consistency and sustained solid growth in this important market, which is also in line with TDS growth over that same period. As a reminder, top-line comparisons for the company softened from 7% underlying net sales growth delivered through the first nine months of fiscal 2018 to 4.5% in the fourth quarter. Comparisons are even more dramatic on the bottom line, where year-to-date underlying operating income grew 11% during the first nine months of fiscal 2018 and then declined 4% in the fourth quarter. Also recall, our reported SG&A in the fourth quarter of last year included a $70 million contribution to create a charitable foundation. We anticipate gross profit will remain under pressure in Q4, primarily due to tariffs and cost of sales inflation on wood and agave.
As a result, we anticipate our full-year gross margins will decline more than 200 basis points versus 2019. Given expectations for modest Adjusted Net declines for the full fiscal year and the sell of investment in A&P, we continue to expect our underlying operating income will grow in the 4%-6% range and earnings per share to increase 11%-18%, to $1.65-$1.75. This outlook assumes the tariffs remain in effect throughout the remainder of fiscal 2019. Let me move on to my third and final topic today, a quick discussion on our capital allocation. As you know, the consistency of our revenue growth and efficiency of our business model allows us to generate strong and growing free cash flow. Over many years, we have followed a systematic approach to allocating this cash.
First on our list is appropriate reinvestment back into the business to meet future anticipated demand. Second is growing our cash dividends, and third, in the absence of meaningful M&A opportunities, we look to return excess cash through special dividends and share buybacks. Over our past 12 months, we've returned an aggregate of $1 billion to our shareholders. At the same time, we've continued to invest behind our business, expanded our production capabilities, leveraged technology for cost savings and revenue growth initiatives, increased whiskey inventories to meet future growth expectations, fully funded our employee pension program, and established a charitable foundation for the communities where our employees live and work. This disciplined approach to capital allocation, combined with our track record of delivering sustained top-line growth in the 6% range, have been key drivers of our value creation equation for our shareholders.
The consistency of our revenue delivery over the last 10 years can be attributed to Brown-Forman's brand-building model and the company's early success at developing our trademarks in new markets around the world. While we have been successfully navigating our near-term results through the challenging world of tariffs, we manage our business for the long term. Strong support from our shareholders, including the Brown family, enable these time horizons, which is essential for a company that derives the majority of its revenue from aged spirits. We believe our portfolio of premium American whiskey brands is second to none and positions us well to continue creating value for our shareholders. With that wraps up my prepared remarks. Dorothy, go ahead and open up the call for questions.
To ask a question, press star, followed by the number 1 on your touch-tone phone. To remove yourself from the queue, press the pound key. In the interest of time, we ask that you please limit yourself to 1 question. If you have more than 1 question, press star 1 to get back into the queue, and we will address additional questions as time permits. Please hold while we compile the Q&A roster. The first question comes from the line of Robert Ottenstein with Evercore.
Morning. It's Eric Serotta on the line for Robert. My main question was on travel retail. Looks like there was a fairly dramatic slowdown in the third quarter, with bringing your year-to-date up 6% or so. Just wondering if you could give some color behind what drove that, and if you could remind us how your global travel retail business splits up by major regions and what the trends have been there. Thank you.
Sure. You're exactly right. We did see some slowdown in our third quarter. As we've been communicating all year about our travel retail business, it started off quite strong in our first quarter, over 20% I've ever seen, and has been steadily coming down. That just simply represents some noise in the business. What I would say noise is buying patterns with a handful of customers and some actions actually we've taken related to a customer that are disrupting the results. I suspect that noise might continue a bit more into Q4. Pulling back out of all the noise that's happened this year, the business remains fundamentally healthy. Travel trends continue. The business is strong there for us. We've got very solid growing business with our Woodford Reserve and Herradura business. Nice innovation going in with Jack Daniel's Bottled-in-Bond and Rye in our single malt.
Fundamentally, what I think you're seeing in this year's numbers is nothing but some timing of buying patterns and so forth that I think will continue for the balance of the year. Not to be overread, I think our business in travel retail remains solid, probably in the mid-single digit type growth area.
Great. Just as a reminder, how does your business split out geographically within travel retail?
It's about one-third in Americas, one-third in Europe, and one-third in Asia.
Great. Thanks. I'll pass it on.
Your next question comes from the line of Tim Ramey with Pivotal Research.
Good morning. I was struck by the OND numbers that you gave on the impact of the tariffs and then the mitigation effects, and I wasn't quite sure how to interpret it since I think you said tariffs only impacted seven months of the year. I assume that major number was an annualized basis rather than just seven months. Would you argue that you have mitigated roughly 50% on a go-forward basis?
Yes. Tim, the number that I noted in my prepared remarks of $127 million was an annualized cost of tariff alone, just themselves. That was before any mitigation. For this year, the number somewhere within $70 million-$75 million, of which we've mitigated half of that this fiscal year. We're in the process of our planning for next fiscal year, assuming tariffs remain. Another $45 million-$50 million before any mitigation. We're working on mitigations as it relates to that now.
Yeah.
Does that clarify your numbers?
It does. Thanks, Jane.
Yes.
Your next question comes from the line of Judy Hong with Goldman Sachs.
Thank you. Good morning. Jane, just one quick clarification. The 1% impact on net sales in the quarter related to the lower pricing to the distributors, I presume that's going to stay in place until the tariff impact has left. Is that the right way to think about that impact?
Well, we expect about a 1% impact for our year as it relates to that. If tariffs stay in place forever, let's hope not, but if they stay in place next year, we've taken the vast majority of the impact to our sales line this year already. Meaning that when you start cycling against next year, you're not going to see as large of impact on the sales line.
Okay. Got it. I guess my follow-up question is just in terms of your advertising spending. Number one is as it relates to your guidance, when you say it will grow in line with your sales growth this year, I just wanted to confirm that's in line with your underlying net sales growth, not your reported net sales growth. I think the line has changed a bit over the course of the year, so I just wanted to confirm that that's the case. I guess more broadly, it seems like many of your competitors are actually raising your advertising spending as a % of sales, particularly in the U.S. market. I guess I just wanted to get a sense of your spend level versus your competitors. When you look at your market share performance in the U.S., I think the total sales growth is better.
The category also improved. Just in thinking about your spending level with the market share losses, particularly around the Jack brand, we could see some softness there. Thank you.
Judy, let me take a stab at it. I think if you look at the 5-year A&P numbers and our underlying net sales are about the same. That's a pattern we expect to continue for the foreseeable future. That's something we're pretty comfortable with. As Jane has referred to it, some of that is being funded as we continue to hold SG&A much tighter so that we can reallocate some of what would have been the SG&A costs into more consumer-facing programs. Year-to-date underlying is up 3. We said we'd be roughly in line with sales for the full year, which would mean the fourth quarter is going to be healthy. As far as relative to the competitive spend, things like that's obviously been a factor for a long time.
A lot of that's driven by the efficiency, and I think you know this, the efficiency of the Jack Daniel's brand itself. When you've got one that is such a big % of a company and it's such a big brand in and of itself, you get efficiencies from that. We still feel pretty comfortable that that's a sustainable business model, where sales, when you get enough leverage. Now tariffs aside in that conversation. That we can get some leverage out of SG&A and continue to grow operating income at a rate higher than sales. Obviously, in the middle of this stub period we're in here with tariffs, that's not going to happen.
Judy, if I might just build on a little bit to what Lawson was referring to, your question on the competitive set. We clearly think of A&P and SG&A together. Think about some of the things we've done as it relates to route-to-consumer that clearly show up in SG&A. We think that's building our portfolio overseas. Think about the emerging brand group that we invested in this year. Of course, that's really feet on the street there, building brands on-premise location. We look many times at the two combined, if you will. The new Old Forester home place in distillery, as an example, would show up in our SG&A, not in our A&P spend. There's probably differences there, too, when you compare ourselves to competitors. We want to look at it holistically when we think about how we invest behind our business.
That is the answer.
Awesome. Thank you.
You're welcome. Thanks for calling.
Your next question comes from the line of Vivien Azer with Cowen.
Hi, this is Gerald Pascarelli on for Vivien. Thanks very much for taking the question.
Hi. My question's on inventory and pricing outlook, given where we are in the bourbon cycle. There's been craft bourbon coming online. It's been laid down and aged for 4+ years now, which should be hitting the market. Can you speak to your view of current industry inventory levels, and whether there's a risk of oversupply that would pressure on U.S. pricing going forward? Thanks.
I'll take it. At least I'll start it. First of all, as far as industry supply numbers, I think we would look at the big Kentucky bourbon producers as pretty significant increases in supply. I'm actually much less worried about the other 49 states or 48 states and those craft suppliers, because in aggregate, it's really not all that significant. Although, I must say, the most recent volume numbers that you would see in Nielsen for the bourbon market, sort of in that 8%-9% range.
US
US.
That's U.S. Globally, it's more like six or seven.
We feel those kind of numbers are awfully strong and shouldn't be outstripping supply. The situation seems to be in pretty good shape, I think. We're looking at it, obviously, too. I do think another part of it is, we, along with some of the other larger competitors, have a very obvious and large global distribution network that many of the craft players obviously don't have, but many other smaller bourbon producers here, even in Kentucky, don't have. We do have that advantage too, that we can continue to grow. When we talk about leadership in American whiskey, we're going to continue to grow and expand our bourbon and our Tennessee whiskey franchise outside the U.S.
That's very helpful. Thanks very much.
Your next question comes from the line of Amit Sharma with BMO Capital.
Good morning, everyone.
Good morning.
Jane, a couple questions for you. One, it was a very helpful conversation on G&A and how you see it together. It makes sense. If you really just look at the G&A part of it, we did see some flexing this quarter and this year. Can you talk about where is that flex coming from? As you look to next year, is there opportunity to continue to do more? Second, on the gross margin line, obviously, we are doing basis point contraction this year, but the raw material prices are still high. I know it's a little bit early for 2020, but as you look through, do you expect that pressure to continue next year as well?
Okay, sure. Let me see if I can take this. You're right. There was a bit more flex in the quarter as it related to SG&A. Let me just take a minute to talk about that. Of course, the reported results were impacted by favorable variances , but even stripping that away, our SG&A expenses were down a couple percentage points in the quarter. There was a piece of it that was one-time in nature, that won't be repeating itself again. That's related to a change in our benefits for a segment of our employee population base. The other piece of it is, this is probably important, is something that we customarily do at this time of the year. Once we understand our performance through the OND period is we adjust for performance-based compensation, that occurred in the quarter.
That happens every quarter, every third quarter, thereabout, we'll go up or down with that. Those were the two main things as it relates to the quarter. As it relates to the ongoing ability to look at SG&A, again, we shared a slide this morning that shows the number of years that we've been leveraging SG&A. I think what we have been doing is part of the G&A here now. Almost to look at the productivity initiatives, we ask ourselves, are these dollars being spent in the right places? We're leveraging technology. We'll continue to do that. I think there's still more opportunity to see leverage through SG&A as we look ahead.
Gross margin? For agave.
Sorry, the agave. You're exactly right. The agave prices, from what we can tell from the information that we have available to us, the agave prices will remain under pressure probably through the next 18 months to even two years as we look out there. They will continue to have pressure on our margins next year. What we've seen in a market like Mexico, is the pricing environment fairly robust, and most competitors have taken pricing. We have not seen that so much in the U.S. at the super premium and ultra premium levels. We have seen it below that level. There is going to be continued increase just because agave's doing so well. It's on fire in the U.S. It's doing well in Mexico, too.
Supply/demand, just what was planted several years ago, is going to have upward pricing pressures that we would expect over the next couple of years that will impact our margins.
Got it. Thank you so much.
Your next question comes from the line of Kevin Grundy with Jefferies.
Thanks. Good morning, everyone. I had a question on the organic sales guidance and your decision to maintain it for the year. The 6%-7% that you're still expecting for fiscal 2019 implies a pretty sharp acceleration in 4Q. Jane, I know you talked about some of the easing year-over-year comparisons, and I think some encouragement with what you're seeing from a retail takeaway perspective. I was hoping you could drill down a little bit on that, number 1. Number 2, I guess, where you kind of expect to land within the range. The high end would certainly seem to be an extremely strong result in the current environment.
Just more broadly, is there anything that you see that makes you either more encouraged or a bit discouraged in terms of that type of number looking out to next year, something in that 6%-7% kind of range? Thank you for all that.
I think you answered a lot of the question yourself. That was a great recap. As we said, we are growing over 5% for our results year to date. As I mentioned, this is against last year's tough path, over 7% growth. We talked about how we were adjusting for tariffs that are really more in the 6% range. I think maybe it's helpful to look at a two-year stack. If you look at our two-year stack after adjusting for tariffs and so forth, we've been clearly, on a two-year stack basis, in the 12% range. Implying that as we look ahead, we're expecting a strong quarter. As you said, high single digits. We feel good about that when we see the momentum in the business that is happening in the U.S. You pointed that out. We saw recent takeaway trends that support that.
Our emerging market business remains very strong. We can expect that to continue in our fourth quarter. We know we had some timing-related items that are going to help us in this year's fourth quarter as well. When I look at what we're expecting, you're exactly right, we are expecting a high single-digit growth in Q4. It still sits squarely in our range of 6%-7%, but I'd say would we be at the high end of 7%? Probably not. We're squarely within the range, including with or without tariffs.
Let me add another point on there, too. The pricing environment in the U.S. has actually improved a bit over, I'll say, this fiscal year. 12 months ago, you were seeing price declines. Let's just talk TDS for a second. Of a point, 100 basis points, 150 basis points down, and that is essentially flat now. There's been a nice improvement in the pricing environment. As we said last call, too, the promotional activity for Brown-Forman is going to be weighted to the back half of the year. That's helping accelerate our business right now. We also talked about in Q2 the material increase in media spend, which is just rolling out or has been rolling out over the last month or so. That's starting to help things, too.
The timing of the year of our spend this year was a little unusual and off, but it's heavy right now. You're seeing some of that, and I hope that should be stimulating some volume, and you're also seeing some innovation. We've got a legacy product out there on Jack Daniel's and Tennessee Travelers. There's others, not huge, but incrementally positive for our sales growth. Another comment I think that's just interesting about the industry these days, when you talk about TDS sales growth, and it's sort of in that 6% range itself right now, the mix to get to 6 has evolved a little bit over the last year. Half is volume and half is mix. The mix piece of it is what I think is interesting because it's gotten to be so material. That's the premiumization of the U.S. spirits market.
To have volume growth of three, little to no pricing on any individual brand, a 3% mix is a really strong indicator, I think, in the health of the business. When you break down TDS into the sort of standard mid-premium and ultra-premium buckets, the really, really strong growth that you're seeing in that ultra and super premium buckets, well into teens or low teens, is quite impressive, and that's where a lot of our portfolio is playing these days. I just think it's interesting to see the premiumization of the U.S. market continues and if anything, it's accelerating.
Okay. That's helpful. Thank you. Good luck.
The next question comes from the line of Bill Chappell with SunTrust.
Hi, this is actually Grant on for Bill. Thanks for taking the question. Just wondering on the EU market, even though you guys didn't pass through the pricing, we're wondering if you guys have seen any changes in your ordering pattern there, whether that be maybe pick up as some smaller craft players are not entering the market or a slowdown as kind of the market shifts away from brown spirits at all?
Our growth has, I think Lawson may have mentioned this definitely in our earnings release this morning. Our business in Europe has been pretty steady. It's been in the mid-single digit, 5% range for a number of periods of time. We really haven't seen a big change there because of the tariffs, whether it's impacting craft players or ourselves. It's been fairly consistent and pretty healthy, steady business that we're seeing in that part of the world.
I'm not sure if I got the point right. You had said people moving away from brown spirits. I mean, that's true in the U.K., clearly, with gin doing what it is doing, but that's not true for many other markets in Europe where vodka, bourbon, and tequila, American whiskey continue to take share from a lot of the white spirits categories. It's a different country by country, obviously, but I wouldn't want you to walk away thinking that white spirits are growing faster than brown spirits and at least American whiskey in many of those countries.
Got it. Thank you.
Your next question comes from the line of Bryan Spillane with Bank of America.
Hey, good morning, everyone.
Good morning, Bryan.
Jane, just wanted to follow up on some earlier question related to gross margins. Just wanted to clear a couple of things up if you could. Just the $125 million, I guess, gross sort of hit gross profits. That all sits in cost of goods sold, right? Also the mitigation, the $70 million-$75 million mitigation. That's all captured above the gross profit line?
Yes, let me just take it back again. The $125 million is an annualized number.
Right.
We only have about $70 million to $75 million of that happening this year.
Right.
Roughly, a little more than two-thirds is hitting the cost of sales line this year, and one-third hitting ourselves this year. It's all hitting above gross profit.
All above gross profit. Okay.
All above gross profit. The split I just mentioned, one-third, two-thirds roughly.
Okay. If nothing changes.
Yeah
You're really just one more quarter of that next year, right? You're just trying to kind of think about how gross margins could evolve. It just would seem like fourth quarter and first quarter, nothing changes. You'd still have it, and then it should begin to sort of moderate after that. Is that the way to think about it?
It will moderate. We still have a little bit more coming through because spillovers, right? Roughly seven months we've protected ourselves largely this year because of some of the mitigations we did, as we talked about earlier, we shipped in or we built inventories in advance this year. That protected us to roughly September, October time period. Until you anniversary that, we'll still have some impact in Q2.
Okay. All right. Beyond tariffs, the other pieces, agave, wood, and the other things that have sort of been pressuring on cost of goods sold haven't really changed much, meaning they're not, if we're thinking about it 2019 to 2020, it's not as if they've inflated more, right? You're sort of absorbing that rate of inflation now.
Yeah. The FY 2019 numbers that we discussed to you, what I had talked back in June in terms of the margin impact because of those, that has not changed. We're in the early planning stages of our FY 2020 process, we'll be able to share more color with you in June as it relates to cost. Clearly, the cost of agave continues to increase, though. I will say that much.
Okay. All right. Thanks, Jane.
Your next question comes from the line of Brett Cooper with Consumer Edge Research.
Good morning. A question on innovation. It's been a small driver of your growth recently, certainly less than your peers. I was wondering if you could offer your view on how innovation will come into the business going forward, I guess, relative to the past, and if the focus on seeding smaller brands for the future impacts innovation efforts. I guess a sub-question of that is certainly seeing more efforts on ready-to-drink cocktails in the U.S. wondering what your view is on the opportunity that's offering given your brands. Thanks.
I mean, your comment that our innovation is not as robust as our competitors, I'm surprised to hear that because I don't normally think about it quite that way. I guess it's certainly true that we haven't rolled out a large Jack Daniel's one in a number of years. That's largely because the current line extensions that we have, primarily Honey, and including Fire too, continue to grow. We feel pretty good that those have, I mean, very large brands now and driving some very nice profitable growth. A lot of line extensions in the bourbon brands that we have primarily, but it would also include some tequila too, are very strong and meaningful actually. Woodford has got a bunch. Old Forester has a bunch. And even Herradura with its Ultra line extension has been very successful.
We feel pretty good about that. I get that you're commenting about should the Slane and GlenDronach and those small brands cause you to pause? I think, is that what you were trying to imply? I think it's fair to say those brands got off to a slower start immediately after we bought them, we did put a lot of focus and attention to say, look, we want to get these things going. We may have hit the pause button on some of our smaller brands so that we didn't get too much clutter in the innovation pipeline. Now those brands are growing really nicely. You'll gradually see Brown-Forman turn up the innovation dial again and continue to make that an important part going forward.
Was there a third? Sorry.
RTDs. RTDs in the U.S., well, Jack Daniel's Country Cocktails play squarely in the middle of that. It has been a dramatic turnaround in that business over the last few years and how successful it has been. That is our large play right now. In that business, we continue to look at other potential things to do in that RTD world in the United States. Obviously, it's a huge business for us in many countries around the world, both on New Mix and on Jack Daniel's & Coca-Cola and the different variants there. I think, as you know, it's tougher to put a spirit-based, put real spirits into a U.S. RTD and make much money at it, and really nobody's making material money at that side of things. You got to do it a different way. We continue to look at that.
I would say we believe in the RTD business on a global basis. I mean, it's something that we've developed into, as I said, a very large piece of business for us, and we want to make sure that we can play it in the United States.
As a reminder, if you would like to ask a question, please press star, then the number 1 on your telephone keypad. Your next question comes from the line of Robert Ottenstein with Evercore.
Hi, thanks for the follow-up. It's Eric again. When the tariffs first started going in, I think October last year, you were pretty vocal about taking a deliberate and balanced approach of absorbing some of the tariffs in some of your largest markets. I'm wondering now that we're a good six months into it, as you start to plan for next year, how are you thinking about that balance in some of your key markets in the EU? Have you taken any mitigation actions in any of those markets to date?
Well, you want me to take it?
Go ahead.
Yes, we have been a bit surgical, I think, to use the word, in the way that we've approached the pricing and a lot of the pricing decisions that we've had to make. If we're really talking mostly about Europe, it's obviously been a tough pricing environment for a long time over there. We continue to push it in some third-party markets. We've pushed it in some relatively smaller markets. We've been less aggressive in some of the very large grocery-dominated markets over there for reasons that are pretty obvious, I think. They're very difficult places to take pricing right now, and we've made a conscious decision to what we've been calling an investing in momentum. It's something, once you lose momentum, it's very hard to get back.
When it came to really getting country by country, trying to decide what the right decision might be, in a lot of cases in those big ones, we decided the right decision was to wait. It's not wait forever, but it is wait for now until these things hopefully get resolved.
I think we'll continue to do some of the surgical approach that Lawson was mentioning. We're continuing to balance, be very balanced in where we are taking it. We're looking for as many opportunities as we can. Still hoping that the situation will resolve itself. As he mentioned, we are in a unique position with the export of American whiskey, and we're competing against other players that don't have the same issues. We want to continue to make it affordable for our consumers as well, balancing the margins that we can and how long we think this might last. We're in the early stages of our planning process for next year, so we'll talk in more detail in June to you about pricing as it relates to that for next year.
Okay. Thanks for the color.
Your next question comes from the line of Sean King with UBS.
Hi, thanks for the question. Yeah, tariffs aside, and knowing that tequila and international are becoming an increasingly important part of the long-term growth algorithm, are there any sort of long-term margin implications that we should be thinking about, as sort of the mix shifts away from the core?
Look, historically, our margins internationally were pretty close to what they are in the United States. Some of the more recent FX moves over the last year have made the U.S. sort of on a per case basis or whatever, a bit more profitable, but they're not hugely different in some markets. For the most part, our international business has pretty high margins too. Yeah, no, you shouldn't expect that will change the overall company mix all that much.
think about some of the brands we're also selling at the higher end.
Yeah.
I think what Lawson was referring to, if you were thinking of we were only a one-trick pony, Jack Daniel's, and we're not anymore. We've got Woodford Reserve and it's much higher priced than Jack. We're looking to expand that around the world, and so its margins will be more. We've got the Herradura, which is also higher than the Jack, which is growing quite nicely in the U.S. and really in Mexico and starting to gain footing around the world. We have our Scotch brand, which are very nice margins, and we've got high hopes for those. If you think about the mix of our portfolio too, that's going to help our business quite a bit too.
If everything stayed the same as it was 20 years ago in Lawson's conversation, that might have it, but it's not in our look ahead given the mix of our business and how we're progressing in that regard.
There are no further questions at this time. We'll now turn the call back over to you, Mr. Koval.
Thank you, Dorothy, and thank you, Lawson and Jane, and to all of you for joining us today for our third quarter earnings call. Please feel free to reach out to us if you have any additional questions. Take care.
Thank you, ladies and gentlemen. That does conclude today's conference call. You may now disconnect.