Brown-Forman Corp (BF.B) 2007 Q2 法說會逐字稿

Good morning.

My name is [Meredith] and I'll be your conference operator.

At this time I would like to welcome everyone to the Brown-Forman second quarter fiscal 2007 conference call.

[OPERATOR INSTRUCTIONS] Thank you.

I will now turn the conference over to T.J. Graven.

Please go ahead, sir.

Good morning, everyone.

Thank you for joining us today.

This is T.J.

Graven, the Director of Investor Relations at Brown-Forman.

With me here today are Paul Varga, our President and Chief Executive Officer, Phoebe Wood, Executive Vice President and Chief Financial Officer and [Jane Morrow], Vice President and Controller.

This morning's conference call contains forward-looking statements based on management's 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 undo reliance on any forward-looking statements and the Company undertakes no obligations to update any of these statement, whether it be due to new information, future events, or otherwise.

This morning we issued a press release containing our results for the second quarter.

The release can be found on our Web site at www.Brown-Forman.com under the section titled Investor Information.

We have listed in the press release 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 SEC.

During this call, we'll also be discussing certain non-GAAP financial measures.

These measures and the reasons management believe they provide useful information to investors regarding the company's financial conditions and results of operations are contained in the press release.

Now let me turn the call over to Paul Varga.

Good morning, everyone, and thanks for joining us.

Hopefully you've had a chance to read our press release this morning which details our second quarter and first half results.

Our plan is to discuss the results briefly leaving plenty of time for any questions.

Our business continued to grow at a healthy pace in the second quarter, contributing to a first half EPS growth rate of 9%, both on a reported and underlying basis.

As previously anticipated and reported, this 9% growth rate reflects a moderation of our exceptional underlying growth during fiscal 2006.

However, it continues to compare favorably with our estimate of the average industry underlying growth rate of 5 to 7%.

We are very pleased with our progress in the first half of the year and we remain optimistic about the opportunity for our brands in the second half of this year and beyond.

A few factors have contributed to our slight moderation, notably tougher conditions in a few key markets around the world, such as the United Kingdom, China, and Turkey.

All of these items are peripheral to fundamental brand health and a consumer's affinity to our brands remain strong heading into the second half of the year.

Jack Danie'ls, Southern Comfort, and Finlandia continue to lead our Company's brand-building progress, and brand health remains strong across the Brown-Forman portfolio.

Our second quarter depletion growth rates for Jack Daniel's and Finlandia improved versus their first quarter growth rates, while Southern Comfort continued to grow at a very healthy rate.

We see tremendous growth opportunities for our Company worldwide and accordingly we continue to invest behind an attractive array of brand building opportunities, which include new product, line extension, and portfolio additions, such as Chambord.

Our work continued in the quarter on the Casa Herradura, and we still expect to close that transaction by calendar year end.

We also continue to strengthen our route to market in key countries, such as the United Kingdom, Australia, Germany, markets in central and eastern Europe, and of course in the United States.

This investment is evident in our year-to-date and expected full-year growth in operating expenses and of course is reflected as well in our expectation of an $0.08 to $0.12 delusion from the Casa Herradura acquisition.

Despite our projected need to utilize some of our strong cash flows for acquisition-related debt reduction, two weeks ago, we announced an 8% increase in our dividend for calendar year 2007.

This solid increase builds on three consecutive years of double digit growth in the dividend and continues our desire to return cash to shareholders in a environment conducive to such actions.

Now I'll turn the call over to Phoebe for a review of our financial results.

Thank you, Paul.

And good morning, everyone.

There were three major themes to our financial results in the quarter that I would like to discuss this morning.

First, our business continued to grow at a healthy rate in the second quarter, driving first-half reported and underlying earnings per share growth of 9%, a nice start to the year.

Second, we made progress on our work to rationalize wine assets in an effort to reduce costs for our major brands, and third, we continued our trend of reinvesting at healthy rates behind our brand and brand-building infrastructure around the world.

Reported earnings per share from continuing operations for the second quarter of fiscal 2007 were $1, up 10% over the same period last year.

During the quarter, we reported an $0.08 per share gain on the sale of our [Pedimonte] winery in Italy.

The sale of this facility to GIV, Gruppo Italiano Vini, who will produce and supply us with wine for our Bolla brand was part of our previously-announced agreement and we expect this will enable us to both -- to increase both efficiency and flexibility in the sourcing of high-quality wines for the Bolla label, which we continue to own and market around the world.

Now if we take out this gain as well as last year's $0.04 per share benefit associated with the reduction of tax expense to get a good comparison, underlying earnings per share grew 7%.

This $0.04 reduction in tax expense arose in the second quarter last year as we were able to offset the capital gain recognized in the first quarter by utilizing some of the capital loss recorded in the sale of Lenox assets.

The gain was from consideration received relating to the termination of our marketing and distribution rights for the Glenmorangie brand.

Looking at the performance of our premium global brand portfolio, Jack Daniel's Tennessee whisky worldwide depletions grew in the mid-single digits if the quarter.

In the United States, consumer trends accelerated from low single digit growth in the first quarter to mid-single digit growth in the second.

Outside the U.S., Jack Daniel's depletion growth moderated to a mid-single digit rate in the quarter.

Consumer trends in the U.K., the brands' largest market outside the U.S., was soft, as on premise consumption trends for the entire industry declined according to Nielsen statistics.

Depletion trends were particularly strong in France, Australia, and Japan, with each market recording double digit depletion increases.

On a global basis, Southern Comfort depletions grew in the low single digits for the quarter.

In the U.S., depletion growth was in the mid-single digits, a few points below the six-month trend which is in the high single digits.

Finlandia depletion outside of the U.S. continue to grow at a double digit rate, with nearly half the growth in the quarter coming from continued, strong double digit gains in Poland.

Consumer trends in the U.S. were flat in the quarter, as trading conditions remain difficult in a highly competitive market for premium vodka.

Depletions for our midprice regional brands reflected moderate growth in the quarter as declines for Bolla and Canadian Mist were offset by solid growth for Fetzer, Korbel and Bonterra.

Depletions for our super-premium brands continued to grow at strong double digit rates in the quarter led by the addition of Chambord and healthy gains for Sonoma-Cutrer and Woodford Reserve.

These brands contribute a relatively small percentage of overall revenues but provide high margins and we continue to see strong possibilities and opportunities for their growth in many markets around the world.

In the second quarter, the growth margin for continuing operations improved from 64.9% to 65.3%.

This is calculated on a stripped net sales basis, that is excluding excess taxes, which are simply a pass-through from the calculation.

This gross margin improvement was due in part to favorable foreign exchange and incremental margins associated with the new distribution structures in Germany and Australia.

SG&A costs increased 12%, or $14 million in the quarter, with approximately $6 million of the increase due to changes in our global route to market infrastructure, including Australia and Germany.

Advertising expenses were up 6%, or $5 million in the quarter as a result of increased investments behind our premium global brands.

For the first half of this fiscal year, cash from operations was approximately $107 million versus $66 million in the same prior-year period.

Total cash balances declined by approximately $252 million, reflecting cash used for the acquisition of Chambord, a $30 million reduction in debt, and approximately $68 million paid in dividends.

Turning to our outlook for the remainder of the fiscal year, the Company is narrowing the range of its full-year earnings outlook to $3.14 to $3.30 per share, representing forecasted growth of 8 to 14% over adjusted prior year earnings of $2.90 per share.

This outlook includes the current quarter's $0.08 per share gain from the sale of the company's Italian winery, additional benefits from favorable foreign currency fluctuations, expected further reductions in global distributor inventory levels, and an expected higher tax rate in the second half of the fiscal year versus the prior year's second half.

Our outlook excludes the impact of the Company's pending acquisition of Casa Herradura, which was announced on August 28, 2006.

As previously communicated, the Company projects the acquisition will be dilutive to earnings through fiscal 2009.

In fiscal 2007, the company estimates the transaction will dilute earnings in the range of $0.08 to $0.12 per share.

Now we'll answer any questions you have.

[OPERATOR INSTRUCTIONS] Your first question is from Lauren Torrez with HSBC.

Your first question is from Lauren Torres with HSBC.

Good morning.

Good morning.

Phoebe,, I was hoping you could run through, maybe in a little more detail your revised guidance.

Now as we think about this guidance that includes the $0.08 benefit and a little more of an FX benefit, what are the offsets, what are the concerns.

I don't know if it's on the cost side, the SG&A side, the distribution, just kind of how we think about the rest of the year as we think about topline growth and also just cost management.

Okay, good.

If you think about the full year, we've grown 9% year-to-date both on an organic and reported basis and our forecast is 8 to 14% growth.

We think there are maybe four or five factor that is really we've taken into looking at the health of the brands, certainly, and I think how well they're doing, but there are four or five factors we'd like to mention specifically.

First of all, we think that inventories are really going to come down.

Distributor inventories are going to come through at the top line.

If you think about it that way, that's where we're going to see that.

We think this is a structural change.

We had a number of distributor changes last year and I think that they built inventory during that time of transition that were simply at a level higher than what the consumers were taking away.

And so I think as we move through those, we're going to see a reduction in that.

In addition, we've talked about the effect of a tax rate.

That tax rate is going to be about 33%, is what we're saying, whereas during last fiscal year, the rate was 29.3%.

So I think the changes in taxes paid generally.

In addition, we have a change in interest expense that we're looking at.

We had a large cash balance prior to the acquisition of Chambord and we're certainly now that we don't have that $250 million piece in there.

We've had an increase in the number of shares that diluted.

Shares have gone up by 1 million shares.

And in addition, we've had increased grain costs, which have been coming through and which we anticipate for the rest of the year.

So I think those factors are the things that we've really looked at and had to take those into consideration as well as the fact that our brands, while doing well, some are up compared to where they were in the first quarter.

Some are moderating a little bit.

I'd like to just keep us focused on the fact that we're growing very healthfully, but these other factors do influence us and has changed our guidance, as you can see.

Does that help you, Lauren?

It does, it does.

And also, if I could quickly ask about Jack Daniel's trends in the quarter.

Obviously improvement from the first quarter.

Do you think what occurred in the first quarter was somewhat quarter specific and we're getting past that, or is there still an overhang of what we saw from the first quarter?

I'll take that.

I think it depends by location.

I think in the United States, what we saw was very low single digit growth in the first quarter and sort of the 6 to 7% range in the second quarter and so I think the way we feel about it is that first quarter was influenced by a handful of factors.

The two that I bring to note the most are, that was probably the period of the highest gasoline prices in the U.S., so we think that the brand is broadly consumed as Jack Daniel's feels some of that.

The other thing, too is that was also the very height of our U.S. reorganization and the most direct impact any disruptive impact from that when people are focused on changing jobs or moving cities and that sort of stuff is going to happen then.

And as I say, as you move three months forward into the second quarter, we already see much improved performance in the 6 to 7% range.

That's the U.S.

Globally, we mentioned a few of the other things that are going on.

I would call them one of the things that's happened both at Jack Daniel's and Brown-Forman is that the comps we've got this year versus our FY '06 are pretty tough.

Last year, I consider it a year where virtually everywhere on every brand across the board everything went well and we've just got a couple of hiccups this year.

We mentioned them -- or at least headlined that the United Kingdom -- but I would also add to it China and we mentioned Turkey.

There's a few markets where Southern Comfort internationally as well, an area where we've been a little soft, where there's been more hiccups.

I think those also contribute to the moderation as well.

Lauren, you asked specifically about foreign exchange, which I did not specifically address.

We have had the benefit of foreign exchange $0.06 year-to-date as we look out into the future, it's down a couple cents.

We have a pretty active hedging program in place and even so, the dollar has weakened.

We think that it's just very modest increases and so it's not going to make -- it's not going to be a huge increase as we see it in the last half of the year.

Okay.

Great, thank you.

Sure.

Your next question is from Tim Ramey with D.A. Davidson.

Good morning.

Hi, Tim.

Just a follow-up on the FX question there.

As I recall, it was $0.05 in the first quarter, so I was surprised by the deceleration of the impact on that.

Was that just a hedging program that didn't really kick in much for the first quarter, but did in the second quarter?

What happened is that we had the FX in the first quarter and hedging program had a dampening affect in the second quarter.

So it was a hedging -- a hedging effect.

You're right, it is only a small amount in the second quarter.

Okay.

And on the Herradura acquisition, two questions there -- and I can't remember if you've addressed this, but the $0.08 to $0.12 dilution that's expected this year, how much of that would be considered the run rate of dilution and it's only over a four-month period, I guess, and how much would be considered one-time actions that will occur in those first 120 days or so?

We've not disclosed any specifics with regard to that dilution.

You have in there one-time costs.

Certainly, as those of us here can attest, the company is very hard at work at integrating that and they are real costs that will certainly be coming through.

In addition, we would anticipate that brand expense and the interest.

All of those are going to have very dilutive effects.

We have not really laid out in any specificity, Tim, yet, how we think that's going to be.

We just estimate it.

It depends on time of closing and a number of things we don't have the information on.

My confusion lies in the fact of when annualized that, it will be $0.30 annually, dilution, and I'm hoping that isn't the case.

It is not.

Do you have a guess on what '08 dilution might be?

The dilution -- Rich is trying to think if we -- we're trying -- we don't think we've disclosed what the dilution is going to be for the future years, but it is through 2009.

I don't think we've yet disclosed what that dilution is going to be, but I would think that taking $0.30 is the wrong assumption to make there.

One way to think about it, if you make an acquisition eight months into your fiscal year in those final four months, not only do you have the vast majority of one-time transaction and transition costs that go on, but you have a very limited amount of time to move and work on the top line that you've got all the costs associated with getting brands up to speed in your organization and getting it ready for the next year.

It's just heavily dilutive during those four months.

You should not extrapolate it.

Okay.

Have you made decisions about some of the structural issues with Herradura?

Will you distribute, or will you be the importer of record on those brands in the U.S.?

Will you think about having their agency business distribute your brands in Mexico?

We're working through all of those still.

We haven't made conclusions on all of them, but I think the one thing I can safely say is that your question on the United States, we think that is a relatively straightforward one where we would expect to be able to work through, I think any of the -- what we consider to be very workable issues on the United States and make those very much a part of our system and not operate them outside our existing U.S. route to market.

We're confident about that.

We've been working through all the other ones.

That's why these things take time to close.

We're making all the progress we expect to make.

As I said in my opening remarks, we still expect to close this thing by year end.

Go ahead, Tim.

Just a quick one on China.

You mentioned that was down.

Is there anything we need to know about that, or is that just the fits and starts of that business?

I don't know if it's fits and starts, it's just everybody loves China and so there's a lot of competition there right now.

And previous to the last 12 months or so, it really was concentrated on a very small number of very premium brands and it's very natural that you'd expect with as attractive a market as that is that the competition stepped up.

That's one thing that's going on.

And also the brands that have been there for quite some time and have done a nice job and we're one of them are all beginning to see an uptick in things like counterfeiting.

There are a few things that are going on, as I call them, peripheral to the fundamental brand health, but there's also heightened competition there.

Thanks very much.

Sure.

Thanks, Tim.

Your next question is from Bryan Spillane with Banc of America Securities.

Hey, good morning, everybody.

Hi, Bryan.

A couple of questions.

First, Phoebe, just inventory days look like they ticked up sequentially from the first quarter and they're up year on year.

Is there anything there -- is that Herradura, or is there something else there that's causing inventories to rise?

There's nothing from Herradura, we don't yet have that.

Okay.

We haven't closed yet on that.

We have -- for one thing, you've got some natural calendar and -- how do I want to say this --

Seasonal.

Seasonal changes, thank you, seasonal changes as distributors are building inventory for this very important holiday season.

So anything you would say from quarter to quarter is probably readily be explained by that.

We mentioned inventory, though, Bryan, because we see that we're unwinding in '07 some of the additional inventories that were built not primarily U.S. issue as much as it is a non-U.S. issue that were built as we had some new distributors and some new partners and this is just certainly natural structural correction that we see occurring, but it does have impact on the top line.

But getting back to your own inventory.

Because your inventory days are even up year-over-year on the quarter.

It depends on how -- number one, anytime you're calculating days, it depends heavily what your forecast is for the future.

Bryan, here's the way I would say it.

I'll give you one example.

We know for a fact that our shipments on our largest brands, for example, Jack Daniel's in the first half are below our depletions for the first half, which tells you that the inventories on -- particularly on a growing brand, are down on the first six months.

And as Phoebe was referencing, one of the things that has happened, when you go into new arrangements, but also take on new partners, and the new partners is an particularly importantly piece to it, oftentime you have two people in a market during that transition that have inventories.

And it builds artificially inventories in a market.

And so I think that is one of the explanations for why we just had a lot of that activity in FY '06 and it stayed at relatively high levels and has been, as Phoebe said, beginning to wind its way down through the course of '07.

We expect some more of that to happen in the second half.

And do you think this is the rate of differential between shipments and depletions will be similar in the second half than what you saw in the first half?

I think, actually, there's a possibility that could be about the same or a little more and part of it is because of the fact that last year we had, I think, a large percentage of the build in the inventories occurred during the last three quarters of the year.

Sort of from the -- I'd say from the Christmas period on through to the end of our fiscal year, a good part of inventory is built.

I think we'll get -- we'll have second half inventory build and I think it could be the same amount or more -- excuse me, inventory reductions.

Could be the same amount or more as you've seen in the first half.

And I think what you're seeing on the balance sheet is just seasonal.

So when we're looking at margins, they're actually going to be deflated a little bit unusually this year just because you're booking marketing expenses to a different revenue number than you'll actually ship.

Exactly right.

Okay.

I just want to try to get an understanding of how the revenues built in the quarter.

So you had 10% revenue growth.

How much of that is structural, how much of it is FX?

Did acquisitions contribute?

And if you could just give some comment on what the underlying growth was for the underlying business?

Bryan, it's Jane.

It's roughly three percentage points of the growth is due to those items you said, so underlying's about 7%.

About 7%.

And of the underlying, any sense for how much was volume and how much was mix, or price mix?

I don't have that readily available.

But, Bryan, we'd have to study it, because there's probably both a little of that in there contributing to that for sure.

Okay.

But rough proportion, you'd have maybe an equal split between volume and price mix?

If I were guessing, I don't have it from front of me, but if I were guessing, I would say so.

One of the markets of the U.K., which is a great market for us, and with that coming down, that's a very high-priced market for Jack Daniel's around the world, as an example, so that would influence mix.

My guess would be it's equal parts, but we should study it.

Thanks, guys.

Yep, thank you.

Your next question is from Michael Bleakley with Credit Suisse.

Hi, guys.

How you doing?

It's just a quick question on your European numbers coming through.

Obviously the U.K., you've been saying, is weak.

Are you seeing the same kind of, I guess, weakness in Spain and Germany as well as the U.K.?

Would you characterize this all as the same problem, or are there specific issues in each market?

I think they're very specific issues in each market.

There's -- I'll comment on a couple of things.

I think we've seen -- it's been pretty noted by the industry about some of the softness in the U.K. on premise environment.

We're certainly seeing it, but also when you have softness in the environment, you see an increase in competition.

We've seen an increase in the U.K. from new brands, new products, new ciders are doing particularly well in the U.K.

I think there's both not only on premise softness, but some competitive activity there.

As it relates to Spain, people have been talking about the on premise softness.

That also happens to be where we have a new partner.

So I think for our company, that's an additional influence and we're still working through methods of selling and brand building and all that and it's sometimes very typical when you take on a new partner.

That would be one of the influences for us in Spain.

As it relates to both markets over a long period of time, we're still very enthusiastic about the potential for Jack Daniel's that we're still relatively small in Spain, we feel, and the U.K., we continue to be just a really powerful brand.

We think there are some structural things going on there.

Germany and France, I'd mentioned , are doing very well, both last year and year-to-date this year.

I would not apply the comments from the U.K. or Spain over to those two countries, for example.

Does that help?

That helps a lot.

Thanks very much, indeed.

Your next question is from Dara Mohsenian with JPMorgan.

Good morning.

Just a couple detailed questions.

Why was the tax rate lower in Q2 than Q1.

And your expectations for the back half of the year?

Hi Dara, this is Jane.

What happened in the second quarter was we had a gain on the sale of our facility, an Italian winery over in Italy.

And that was taxed at a very favorable tax rate, about 3% tax rate.

What that had affect of, drawn down the taxes in the quarter.

Stripping that out, our effective tax rate for the quarter was essentially the same as it was in the first quarter, right at 33%.

Okay.

Does it makes sense?

That makes sense.

And the distributor changes that you guys have gone through in Germany and Australia, did that artificially impact revenue in the quarter and was that referenced in the 3% number that you gave earlier in the call, Jane.

Yes, sir, yes it was.

Dara, it also hit other P&L items like SG&A, because the model has a multiple line impact.

Okay.

Great.

And just in terms of the softness in the U.K. on premise, Paul, is that across your entire portfolio or is it more centered just in Jack Daniel's, which I know is your biggest brand there.

It hits Jack Daniel's, Southern Comfort is also a very good on premise brand there.

It impacts that as well.

Those are the two very large brands we've got in the United Kingdom.

Finlandia is doing okay there.

It impacts Finlandia less because it's less pervasive in the on premise, but I think it particularly hits Jack Daniel's and Southern Comfort.

Thank you.

Your next question is from Thomas Rousseau.

A quick question, I hope the reception is all right.

Jack Daniel's in the U.S., which recovered in the second quarter, you mentioned the factors might have been gas prices and relocation.

I seem to recall you also mentioned in the first quarter that you had retained competency up against an industry [technical difficulties].

To what extent has pricing played a role in the second quarter and an observation about the competitive landscape in the U.S. whiskey market in light of your improved second quarter results.

We still continue the see a lot of competitive activity out there from not just whiskey brands, but the wide variety of brands that Jack Daniel's competes with and it sometimes comes in the form of specific deep discounts and specific channels, is the way I'd say it.

I think that was particularly heavy in the summer and I haven't studied it closely enough to see if there was less or more activity, but certainly, it's out there.

These brands, even when discounted, I know the trade can still make good money on them, so there's always that tendency.

But I think a number of things could be contributing -- I really do think there was this thing more macroeconomic, the gas prices, which were really at a high level, and also, Tom, as we've been able to watch our reorganization unfold to see how much more settled people are today than they were back in June and July, when they were really learning what their new jobs were all about.

I think there really are the largest impacts that we think to that first quarter.

Macroenvironment improving, in other words is starting to help?

It does help.

The gas prices really are down from where they were.

The thing about Jack, it's just so broadly consumed, socioeconomically and demographically that macroeconomic changes do impact the brand somewhat.

Thank you very much.

Congratulations.

Thanks, Tom.

[OPERATOR INSTRUCTIONS] You have a follow-up question from Tim Ramey.

I wonder if you guys get off easy never making forecasts about Christmas, but I wondered if you'd make a forecast about just industry trends for the holiday season this year?

You're not going to let me get off easy?

No.

I'm giving you space.

It doesn't have to be a Brown-Forman forecast.

Here's the way I would -- if you look at this as I think about them and I'm assuming a good piece of this deals with the U.S., where you do have more data.

One thing I would say, I've been encouraged by what's been going on in the numbers associated with wines and spirits industry over the last, say, three to four months relative to 12 months ago.

If you just look at the underlying -- we don't have data reported up to the minute, but you can certainly get it through to September.

And if you look at those numbers, the spirits business is reported by the NABCA data, which shows that the spirits industry as a whole is up by as much as a point over the last three to four months in the U.S.

And that has to be a good sign of momentum as you head into the holidays for spirits.

And the wine Nielsen numbers look really nice.

Not only on volume but dollars versus a year ago.

So I would say for the wine and spirits industry in the United States, the momentum going into the holiday season is certainly a good sign versus a negative one.

We won't know any of our even early November results for yet another week.

So I just -- I can't even comment on that.

But I do know our brands have good investments behind them and we really are excited about the programs we've got behind the portfolio.

So if the consumer's there and we execute well, I think we'll have a good Christmas.

At least I hope we do.

Outside the United States, we're a little less impacted, to be quite honest with you, by the holiday season.

Because so much of our activity in many of the markets is still in the on premise, which is not a big gift giving, for example.

You really are into more fundamental day by day, drink by drink brand building.

It's a little less dependent on the holiday season.

Just a follow-up on Phoebe's strategic point number two I think it was, reduction in wine costs.

Were you speaking there, Phoebe, about the sales of the Italian winery, were you talking about structural issues in the U.S.?

Can you elaborate a little bit more on that?

And how close are we to getting the grape costs under control in the U.S.?

Is that next year?

I'll be happy to talk about that, Tim.

The transaction that we did in Italy has a -- certainly generated a gain, but that was just because we sold a winery.

Fundamentally what it does it's going to reduce SG&A because the infrastructures that have been built up around all of that winery has also been taken down in large part.

There is certainly still going to be oversight and important functions that our people do in Italy, but the large administrative overstructure is all going to come down.

That's sort of a couple million dollars.

That's going to start coming through in the margins.

You won't see any affect of costs -- that cost reduction in '07, really, as we work through all the severance, et cetera.

But you'll see it starting to come through a little bit next year in margins.

We continue to work on the reduction of wine costs.

Projects are underway.

But this is one of those activities that we have thought about, previously announced, and I think the financial results are just coming through and the way to think about it is, yes, it's trying to be good brand builders, and at the same time reduce those costs.

One of the structural things that's going to happen in the U.S., it's going to have a real big impact, again, that we've talked about had to do with terminations, by that the natural termination of the grape contracts.

Those were contracts that were signed, a lot of them in 1997.

They are just with harvest '07, they're going to start coming off eventually you'll see that coming through and we can see that coming through in the forecast.

That's just a natural reduction in wine costs.

What we would consider high price grape contracts are coming to an end.

We honor those contracts, we live with them.

We made great wine.

Consumers are enjoying them.

I hope people drink them responsibly all through this Christmas season, but fundamentally, over time, we're going to see that coming down and that will be very welcome.

And that's a fiscal '08 impact primarily?

Begins '08.

You'll really see it in fiscal '09.

Jim, it's phased.

As all of these things get, you structure them to end at different times.

You start to see it '08, but I think it goes into '09 and even '010, or '10.

Thank you again.

You have a follow-up question from Bryan Spillane.

Paul, just a question for you.

You've got some news in the press now.

The Swedish government potentially making a move on BNF.

You can interpret Remy's actions in pulling out a [Maxium] as that potentially for that being up for sale.

With the consolidation you've had and potentially some more, just your perspective on what impact you've seen in the industry so far.

Has it made pricing more rational?

And second, it seems to me at least that there's a large tail of not premium brands in this industry and what's the potential as the industry consolidates that you start to see that tail get shook out.

Some of those brands get shaken out over the next few years.

Let me answer that.

I'll answer the second one first, which is the large amount of volume associated with nonpremium brands.

I'll remind you that the largest majority of the industry still exists that the level.

They really do.

They fill -- those brands do fill a role for the consumption needs of people who honestly just don't want to pay or can't afford to pay the premium prices.

I expect that to go on for a very, very long time.

And also is one of the great opportunities.

As economies emerge and grow and you see more middle class development around the world and growing incomes that people can trade up.

That's been one of the wonderful things about this industry.

But I still think the largest amount of volume over -- just studying this thing now.

My reference is to worldwide volumes still is predominantly in the way that you asked the question, nonpremium.

So I think if you're looking for a dramatic shakeout, I think it would take a very long time because most of these brands -- this is a good business.

They produce great cash and they fill the consumer need.

So I think that it will continue.

Having said that, I still expect the trend toward premium and in some countries, super premium brands to grow much faster than that segment.

And as I said, that segment, that lower price segment tends to be the source for the growth in many cases.

I think that's just going to be an ongoing trend and I think economics will have as much to do with the pace of that as anything.

It's one of the reasons why we think there's so much growth potential for our company over a really long time, just the massive size of the distilled spirit and wine business worldwide and how relatively small a share we actually have of it.

It just makes us think there's a tremendous amount of opportunity out there to get business.

As it relates to consolidation, I think it will continue at virtually all levels of the industry.

It from time to time have an impact of the competitive dynamics of some of the markets for sure.

Just one observation I would make about the recently announced Remy's intent to leave Maxium is that in an odd sort sort of way, to me, it reinforced a lot of what we believe about distribution, route to market and the focus on brand building.

It appears to me that the folks at Remy are thinking they would like to have more focus on their brands out in Asia, which is at least the things that were sited and they've been taking note of how other companies have been building their brands with a high degree of focus and depending a little bit less on scale and real large portfolio efforts.

In a way, I felt like that sort of reinforced something we've always believed anyway.

And has consolidation so far -- how has it impacted your business in North America and Europe?

It seems in North America, there's been pricing discipline -- better pricing discipline in the industry.

In Europe, it's a little more unclear.

It seems like it's become more competitive?

Yeah, I think European dynamics are competitive simply because of things like the markets aren't growing as rapidly as say the U.S. market is and the demographics may not be as favorable.

The U.S. there's been just a tremendous amount of investment from not just the largest players, but even the mid- and small size and entrepreneurial players in the industry.

Everyone's getting excellent results, to be honest with you.

The market in the U.S. over the last few years has been excellent for spirits and wines, particularly at the premium end.

So I think that makes for a competitive environment.

But it's competitive going for organic growth and natural growth that's occurring in the market, which is a very different dynamic than some of the discounting you see from time to time in Europe going after more stagnant markets.

Okay.

All right.

Thanks.

I'll see you next week in New York.

We'll look forward to it.

Thanks, Bryan.

At this time, there are no further questions.

Mr. Graven, are there any closing remarks?

No, no closing remarks.

Thank everyone for joining us and we'll end the call now.

Happy holidays to everyone.

Thank you all.

This concludes today's conference.

You may now disconnect.