Constellation Brands Inc (STZ) 2003 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Robert Mondavi second-quarter fiscal 2003 earnings conference call.

At this time, all participants are in a listen-only mode.

Following today's presentation, instructions will be given for the question-and-answer session.

If anyone needs assistance at any time during the conference, please press star, followed by the zero.

As a reminder, this conference call is being recorded today, Thursday, January 23rd, 2003.

I would now like to turn the conference over to Mr. Mondavi, Chairman.

Please go ahead, sir.

Thank you.

Good morning.

It's Michael Mondavi speaking, and I want to welcome you to today's conference call discussing Robert Mondavi's second-quarter fiscal 2003 results.

Joining me today are Greg Evans, our president and CEO, Hank Salvo, our CFO, and Bob Philips, our VP of treasury and IR.

Before I get started, let me remind you that we'll make a number of forward-looking statements today, and these statements should be taken as estimates only.

Actual results may differ from our expectations, so please refer to the MD&A in our annual report for a discussion of the risks in the wine business.

All of the numbers are -- and comparisons reviewed today will be on an adjusted pro forma basis, excluding the inventory step-up charges associated with our Ornalia venture and with the Arrowood acquisition, and other one-time gains or losses, such as the charges that last fiscal year for the Disney restructuring.

In the current quarter, the step-up charges were $222,000 for Ornalia, which shows up in equity income and $1.2 million for Arrowood, which shows up in the cost of goods sold.

We also recognized a one-time write-down of $3.1 million for a vineyard that we have accepted an offer to sell at less than book value.

This particular transaction will not be completed until later in the fiscal year, when we expect other divestitures to provide offsetting gains.

During last year's quarter, we recorded step-up charges of $195,000 for Ornalia and $940,000 for Arrowood and $1 million operating expenses for the Disney restructuring charges.

We plan to cover two major topics during our 30 minutes of prepared remarks.

First, the review of the status of the premium wine market, and a detail of our performance during the quarter and our outlook for the remainder of fiscal 2003.

After that, we'll move to your questions.

Hopefully we can limit the conference call to no more than one hour.

Q2 was disappointing for Robert Mondavi, and probably for the entire wine industry.

Our strategy has been to protect brand equity in the market that reflects significant price discounting.

We started the year with a planning assumption that the U.S. wine market would grow between 5 to 7% in volume, with flat to slightly negative pricing.

During the first quarter, off-premise growth, measured by A.C.

Nielsen food, drug and liquor stores, tracked to that forecast.

Domestic and imported varietial wines grew at 6% in volume on slightly negative pricing.

The on-premise business channel appeared weak, but there is no data that's available to quantify industry performance in this channel.

During the 13 weeks ending December 21st, however, domestic and imported varietial wine growth slowed to 3.6% on 1.1% lower pricing, which may have partly been due to the holiday selling season that was one week shorter than last year.

During Q2, most of the growth in the scanning channels came from imported wines.

Imports sold in the U.S., led by wines from Italy and Australia, grew significantly faster, up 12% in volume on 2% lower prices.

Italian wines grew 10% in volume but declined 3% in price, while Australian wines grew 58% in volumes but declined 10% in price.

On the other hand, sales of domestic varietial wines grew only 1% in volume and declined 1% in price.

The numbers really only tell part of the story.

The retail market is even more competitive than the scanned data would suggest.

There are a number of new domestic and imported brands sourced from bulk wine which in today's oversupplied market gives them a short-term cost advantage that is being used to fund aggressive trade incentives and to capture retail floor space and shelf space.

Much of the action is below $8 a bottle and these brands are stealing share from well-known, higher-priced brands.

We do not expect significant near-term improvements in the U.S. economy, nor do we expect the oversupply of grapes to go away soon.

This means that the demand for luxury wines sold at the high-end hotels and restaurants will probably remain weak, while the demand for mass-market wines sold in off-premise retail accounts will grow, but growth will be slow and competition will be intense.

Turning to our business, the next two quarters will likely be difficult ones.

Our Q2 shipments were based on wholesale depletion forecasts of 6% growth, but the wholesale depletions grew at about 1%, causing a rise in wholesale inventories.

Therefore, we've lowered our second-half shipment expectations substantially in order to bring wholesale inventories back in line by June 30th.

Secondhand revenues will be about the same as last year, but the profits will decline about 20%.

Yielding EPS of between $2.30, $2.35 a share compared with $2.41 a share last year.

And our previous fiscal 2003 guidance of 2.55 to 2.60.

The decision to lower earnings guidance was not taken . lightly.

We've reduced the costs to offset some of the top-line shortfall but we have decided not to eliminate our new second-half advertising campaigns for Woodbridge and Robert Mondavi, which would have closed much of that EPS shortfall.

Our success has always come from doing the right thing for the long term, and we believe strongly that successful brand building will determine the winners and losers in our industry.

Maybe not over the next 12 months, but surely over the next three to five years.

Now, Greg and Hank will cover some of the other details of our Q2 performance and the plans for the upcoming quarters.

Greg?

Thanks, Michael.

The conditions Michael just outlined had a big impact on our growth during the quarter.

Back in the first quarter, wholesale depletions of Robert Mondavi brands grew 3 . 4% on 2.6% lower pricing.

While we underperformed versus the category, we also funded less marketing activity than the prior year.

Going into Q2, we expected growth to accelerate from heavier marketing support.

However, it looks as though the competition focused on much deeper discounting than we anticipated to drive volume growth.

During Q2, wholesale depletion growth of our wines slowed to 1.3% on flat pricing.

This curtailed shipment and revenue growth to below the expectations we outlined in October, and resulted in distributor inventories increasing to 51 days.

Despite the weaker top line, earnings were 77 cents per share.

Although about a million dollars -- or 4 cents per share -- was due to favorable timing of equity income, primarily from strong demand from Opus 1 that normally would have been fulfilled in the March quarter.

Note that Opus 1, despite having a retail price of well over a hundred dollars per bottle, is in short supply because we have invested the time and money up front to build the brand so that it could weather economic conditions like we're seeing today.

But Opus 1 is the exception.

We made good progress towards our balance sheet and cash flow objectives during the quarter.

We currently have two pending transactions that should be complete by the end of the fiscal year, including the one Michael mentioned.

And the growth of inventory from what could have been a very large 2002 grape harvest was tightly managed to the point where working capital declined when compared to the September quarter.

Disciplined capital spending controls led to free cash flow of $15.6 million.

Now let me talk about the brands.

Second quarter total company shipments grew 7% to 3,031,000 cases.

Wholesale inventories rose to 51 days compared to 44 days last year, and 45 days at the end of September as we shipped against an overly optimistic depletion forecast.

Average price per case was slightly above last year's quarter, at $46.55.

This positive mix of Robert Mondavi wines offset higher promotional spending on Robert Mondavi Private selection and Woodbridge brands.

Total company net revenues were 141.1 million, 8% above last year's $131.1 million.

In the food, drug, and liquor scanning channels as reported by A.C.

Neilson, , our volumes declined 4% and revenues declined 5%.

Now let's review the performance of Robert Mondavi Winery brand.

Wholesale depletions of Robert Mondavi winery decreased 5%.

Shipments grew 8% to 85,000 cases as the Napa Valley and reserve tiers posted modest growth, but the district tier grew in anticipation of strong channel-focused marketing programs in Q3, and a growing recognition that these wines represent excellent value.

Average price per case was about $170, 2% above last year, due to a richer mix of district wines.

Net revenues grew 10% to $14.4 million.

In scanning channels, Robert Mondavi Winery volumes declined 17%, and revenues declined 20% due to weaker demand for high-priced wines in these channels.

The average retail bottle price was $22.80, down 3% from last year, but level with the September quarter.

Sales of wine and merchandise sold at the winery's retail and tasting rooms were $1.6 million, 1% above last year, despite 2.5% fewer visitors.

Wholesale depletions for Robert Mondavi Private selection grew 6%, lower than the 8 to 10% growth plan we communicated last June.

Shipments grew 10% to 477,000 cases.

Net revenues grew 7% to $29 million on 3% lower pricing, due to heavy promotion spending and a mix shift towards lower-priced markets.

Private selection's U.S. scanning store volumes grew 5% on slightly positive pricing, which made it the only domestic wrapped in the top 10 that gained share.

The brand also made good progress in improving its price position compared to its competitive set ^ while still growing share.

Woodbridge had a difficult quarter.

Depletions grew 1%, which was much slower than we had targeted.

It looks as though two factors were at work.

Competitive price discounting was severe.

Woodbridge's price premium in the 1.5-liter category widened 12% compared to the average of its competitive set.

Second, Woodbridge clearly had a lot more competition now than at any time during its history, some of which is from bulk wines sourced opportunity brands that subsidize low bottle prices via short-term cost advantage.

Woodbridge shipments grew 9% to 2.3 million cases and net revenues grew 8% to $80.4 million.

Average price per case declined 1% to $34.96 due to heavier promotional spending in selected markets.

From a channel perspective, trends in U.S. scanning stores were weak, with volumes down 5% and revenues down 6%.

However, stronger performance in other channels helped offset these scanning channel losses.

Woodbridge print and cable television ads ran during the quarter.

November and December were supplemented by Internet ads and spot radio.

As Michael said, we are continuing with the advertising campaign in the second half since it is a critical part of our long-term strategy to build brand equity and consumer loyalty.

In the spring, we'll measure whether the fall campaign delivered meaningful improvements in brand awareness and purchase intent.

Wholesale depletions of our other California brands grew 37% over last year, led by Arrowood's grand Archer and hang time, a new on-premise brand that we've launched with high-quality surplus central coast fruit.

Shipments grew 34% to 40,000 cases, and net revenue grew 15% to $5.2 million, primarily to strong growth of brand Archer and hang time.

Since these two brands have a lower price than the rest of the group, average price per case declined 13% to $132.

It appears as though our new specialty wine sales force has been successful in bringing to bear focus and execution for these emerging brands.

Finally, import depletions, excluding inaudible Mediterranean declined 16% due to a steep decline in Caliterra sales amidst a weakening category.

Net revenues declined 8% primarily due to Caliterra.

In U.S. scanning stores, our imported wines declined 39% in volume, as our sales efforts continue to be more focused on non-scanning, independent and general market channels.

Prices in A.C.

Nielsen grew 6% as the mix shifted from Chilean wines to Italian wines.

Now Hank will cover the rest of the financials.

Thanks, Greg.

Since Greg covered the revenues, I'll move to the rest of the P&L.

Cost of goods sold per case grew 3% to $26.34.

Compared to last year's level of $25.50.

Two factors are at play here.

First, the beneficial effect of lower-cost 2001 harvest fruit is helping us compared to a year ago.

But it's offset by the effect of our inventory balancing efforts which shifts surplus high-cost grapes to lower-cost programs.

Note, however, that this program is delivering higher-quality wines with great consumer value.

We expect the inventory balancing efforts to continue for several more quarters, masking the benefits from the even lower-cost 2002 harvest grapes which will begin hitting the P&L in Q3 with the release of the Woodbridge whites.

Gross profit per case declined 4% to $20.20 from $20.95 last year, and gross margin was 43.4%, a decrease of 170 basis points from last year's 45.1%.

Operating expenses grew 5% to 36.7 million dollars, or 26% of net revenue, a decrease of 60 basis points from last year as a result of aggressive cost-cutting efforts and some volume leverage.

Operating income grew 1% to $24.5 million compared to $24.3 million last year.

Operating margin was 17.4%, 110 basis points below last year's level of 18.5%.

Other income and expense netted $992,000 of income, which, as Michael said earlier, was nearly entirely due to strong demand for Opus 1.

Since we saw a similar thing happen in the September quarter, when about $1.8 million, or 7 cents per share, was pulled forward, we expect a weak March quarter on the equity income line as the wine has already been sold.

EBIT grew 6% to $25.5 million versus $24 million last year, and EBIT margin was 18.1% of net revenue versus 18.3% last year.

Without the favorable equity income timing, EBIT would have grown 1% and EBIT margin would have been 17.4%.

Net interest expenses were $5.4 million, about level with last year (inaudible) and favorable interest rates but lower amounts of capitalized interest.

Capitalized interest expense for the quarter was $470,000 compared to $947,000 last year.

The effective tax rate for the quarter was 37%.

Net income increased 9% to $12.7 million, and EPS grew 8% to 77 cents compared to 71 cents last year.

Without the favorable equity timing, net income would have grown 4% to $12.1 million and EPS would have grown 3% to 73 cents.

The December 31, 2002 balance sheet was $910.4 million, 1% larger than last year.

Later shipments in December this year caused a 15% rise in receivables, but inventories grew only 1% due to a successful crop reduction program.

Capital spending for the quarter was $1.7 million, with most of the money being spent on completing vineyard development.

Fiscal year-to-date capital spending of $11.4 million puts us on track to spend about 25 million for the year at the low end of our guidance of 25 $30 million.

Operating cash flow for the quarter was $17.3 million compared to a negative $43.3 million last year.

The cash flow was 15.6 million, compared to a negative 47.5 million last year.

Now let's look at the balance of the year.

During the second half, we expect wholesale depletion growth of 5%, but the number of cases we ship will be less than the number of cases depleted by our wholesalers as we work down our inventories back to the 45-day level.

From an earnings standpoint, we face several difficult obstacles in the third quarter compared to last year.

First, 4 cents of equity income shifted from Q3 to Q2 as a result of strong joint venture wine demand.

Second, the timing of Easter, which is three weeks later in 2003 than 2002, shifts about $6.4 million in revenue and 4 cents in earnings per share from Q3 to Q4.

Third, there is some margin dilution as we roll out our new wines from Australia and Italy since we take an importer margin rather than a producer margin on these wines.

And finally, we need to reduce wholesale inventories.

So while Q3 EPS was 53 cents last year, Q3 EPS this year is likely to be in the range of 30 to 35 cents.

For the full year, we expect revenues of between 470 and $475 million, reported by 3% depletion growth and balanced wholesale inventories and earnings of between 230 and 235 per share compared to 241 last year.

Our previous balance sheet forecast of about $900 million is probably okay, since we've taken aggressive steps in managing inventories and this does not include the effect of asset divestitures expected to close before year end.

Now, Bob has some housekeeping items.

Thanks, Hank.

Today's call is copyrighted material of Robert Mondavi and cannot be rebroadcast without our express written consent.

Beginning at about 9:30 a.m.

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Today's prepared remarks can also be viewed, downloaded, or listened to on our website, www.RobertMondavi.com in about one hour.

Look under "about the company," "investor relations" followed by "news and events" and then "conference calls."

In terms of upcoming events, during the March quarter we're scheduled to present at the NAIC Atlanta annual investor fair this weekend, followed by the consumer analysts' group of New York annual conference in Scottsdale, Arizona on February 18th.

For more information on any of these events, visit our website.

Finally, our next conference call covering the third-quarter fiscal 2003 results is scheduled for April 24th, 2003, at 7:30 a.m.

Pacific time.

I want to thank you for your participation in today's call.

Operator, we'll now open up the line for questions.

Thank you, sir.

Ladies and gentlemen, at this time we will begin the question-and-answer session.

If you have a question, please press star, followed by the 1, on your push-button phone.

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Your questions will be pulled in the order they are received.

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One moment, please, for our first question.

Our first question comes from Marc Cohen.

Please state your company name followed by your question.

Hi.

It's Goldman Sachs.

Hi, guys.

Good morning.

Good morning.

You know, you just gave some indications of an acceleration in depletion growth for the second half of the year from the kind of 1 to 3% range in the first half to 5% for the second half.

Can you -- can you put more perspective around some of the -- some of the factors that are driving that, whether they're operational factors or just comparisons, and, you know, just help us understand a little bit better how you come to that point of view?

Right, Marc.

That forecast is developed on a trend basis, and if you took the first half trend of Q1 and Q2, we're running at about 2.2% above prior year if we exclude V Shon med.

On top of that, we've got a couple of bumps from new products that are coming in the back half.

I think Bob mentioned or Mike mentioned we've got a new Australian brand that's being released this month.

We are beginning to sell our partner, Marchese de Fresca de baldy wines also this month and in late fiscal year, probably May or June, we're putting out a Woodbridge line extension on a test basis that when you aggregate the depletions on the new items that you're looking at roughly another 2 to 2 and a quarter percent of growth on top of the 2.2.

The balance that gets you to 5% is made up of two factors that we are relating to promotional activity.

One is that we have a new spring advertising campaign for Woodbridge which is going against no ad campaign the prior year, and we also have some advertising in May and June that is beginning on Robert Mondavi -- principally Robert Mondavi Winery, but there will be a spillover effect to Robert Mondavi Private selection ^, so with those three elements, we think that 5% depletion rate, which then averages to 3.3 for the full year, is an achievable number.

Let me add that there are a couple of markets now, as we have sorted through the distributor transitions that took place in the first two quarters, where we are also, let's say, optimizing pricing relative to the competitive set, now that we've got the execution in place.

Okay.

Thank you.

Our next question comes from Skip Carpenter.

Please state your company name, followed by your question.

Thomas Weisel.

Good morning, guys.

Good morning.

Hi, skip.

A question with regards specifically to Woodbridge.

You just talked a little bit about the spring advertising campaign.

Could you talk a little bit specifically what other tactics you guys could, I guess, be using in the marketplace, given, as you've kind of outlined, the two issues, particularly from a competitive standpoint?

Clearly, given some of the trends in the market, I can't imagine that's going to go away anytime soon.

Are there other tactics that you guys can implement in the next couple quarters, in terms of that -- that may kind of improve Woodbridge's position in the marketplace?

We're doing a number of things.

As you mentioned, the advertising.

But the key is, get the wine on the floor, get the displays, and get broader or better shelf.

What we've found is that when that happens, even though there is price discounting, a lot of new brands that are coming out very low-priced, if we are on the floor, the wines move.

So we've focused individual markets.

The last couple months, it was very interesting because, for example, Arizona, where you thought it would be a strong market because of the weather, the fiesta bowl, et cetera, during December, it was a very disappointing market, not just for us but others in Arizona.

On the other hand, northern California did very well.

Southern California was weak.

New York and Connecticut were strong.

And so it was a very erratic market, very focused on what is happening on specific promotions regionally.

So we are very tactically looking at each of these markets, understanding what the different customers want, whether it's the independent stores, the different supermarkets, chains, et cetera.

We're working on a very specific local basis, rather than just a national campaign.

We think that execution is going to benefit and complement the advertising.

Have you gotten any feedback regarding your -- the first half of the year advertising on Woodbridge?

I know that there was some -- some different positioning with regards to the media placement this year versus a year ago.

Have you gotten any feedback in terms of whether it's from your wholesalers or in terms of analyzing some of the data that you've gotten in regards to was it appropriately placed versus last year's more, I guess -- I mean more pronounced -- I guess more visible media locations.

Skip, that's a great question because it's premature to have the research back yet, but it's something that we've been asking the whole time.

We know that the focus of the people who are seeing the advertising are more in the demographic and more in the lifestyle of people who drink wines more regularly.

The key was focusing the 60% of the target audience was women, because women buy the majority of the wine.

So we were really focusing on that area.

We hope, as I think Greg mentioned, to have detailed data that will analyze that.

What we're looking for is how it improves the purchase intent, and how it moves Woodbridge from being one of 10 items that people are interested in, to one of one or two.

Okay.

Thank you very much.

Our next question comes from Ann Gurkin.

Please state your company name followed by your question.

Davenport.

Hello?

Good morning.

Good morning.

Just wondering if you could review a little bit your thought process behind volume versus pricing mix.

I hear that -- about the new products and the advertising and positioning your wine on the shelf, et cetera, but it seems like the category is really moving on price.

And can you just walk me a little bit through that, your thought process?

The category on price, I can refer to some price data from the second quarter that will -- I mean perhaps give you a flavor for what we're seeing on the shelf, and put our wines in that context.

Maybe that will help out.

But before -- let me make a general comment that what we're seeing in general, particularly in the off-premise pricing environment, seems to be a fair amount of trading down in price by consumers to lower price segments, as well as producers taking prices down significantly during the second quarter.

So I'll give you a couple of reference points that I think is indicative of at least Q2.

During the second quarter, Robert Mondavi Private selection -- and this is from A.C.

Nielsen 13 weeks through December 21, food, drug and liquor.

Robert Mondavi Private selection's price actually was up 0.7% on volume growth of 6.8% during the prior period.

So private selection, despite the pricing behavior, achieved some growth.

Some of the key competitors for private selection -- I'll just name a few -- Beringer's founders estate during that period.

The percentage growth in price was minus 6%.

That generated 7.1% growth in revenue.

Meridian was minus 3.7%.

That generated growth of 0.8%.

ED coastal had flat pricing, but its revenue growth was minus 15.9%.

Let me give you a few Woodbridge benchmarks.

Woodbridge one five pricing was minus 0.7% during the period, and it had revenue growth of minus 2.7.

Some of the key competitors, Redwood creek, which is a Gallo product, had price growth of minus 8.4%, turning leaf had price growth of minus 2.0%, Fetzer one five minus 6.8%, Lindeman one five is minus 4.3.

Sutter home minus 4.9.

Et cetera, et cetera.

It looked like the competitive set is pricing down approximately 5% in that channel to try to achieve volume growth, and as we mentioned, our price behavior and strategy was to keep prices relatively flat.

Okay.

Thank you.

Our next question comes from Bud Leedom.

Please state your company name, followed by your company.

Wells Fargo Securities, and good morning.

Good morning, Bud.

Good morning.

Just I wanted to expound just upon one of the previous questions, in that, you know, we sort of talked about the -- the competitive pricing environment at the ultra-low end.

I just wanted to be a little bit more specific.

You know, and I guess primarily we saw KJ obviously coming down into the Woodbridge segment but, you know, all the way down to what we saw from bronco, was that having a direct effect on you guys?

And with that said, you know, obviously the this over-planting will, by best estimates, persist through the 2004 vintage.

Does this sort of make the same ingredients for this type of situation to continue through the 2004 vintage?

Well, first of all, you know, anytime you get real low prices out there, you're talking share of stomach.

People can only enjoy so much wine in a day.

And they're going to try certain things.

One of the things that we're confident of is the fact that our wines will have better quality, better consumer value, and consistency of quality.

As you know, when you try something at home, especially a wine or beverage, if you're not confident and sure that the quality is going to be consistent, you may buy it once or twice because of a great deal, but it will not become one of your longer-term brands.

If you look at the -- you were asking about through '04 on this.

If you look at the '02 vintage, there were not a lot of grapes harvested as custom crush as there were in 2001 or in 2000.

Most of the surplus grapes ended up being distilling material or left on the vine.

So there wasn't a Big Sur plus created from 2002.

2001's surplus wines are pretty well now being used up ^ in a lot of this low-priced special stuff that's going on. 2000 vintage, the cats and dogs that are left out there aren't very good, and probably a lot of it will just be burned into high-proof alcohol rather than blended into any -- any wine that's palatable.

So while there's still a surplus of grapes and wine, the ocean that people were talking about has shrunk considerably and the quality of the wines that people will be able to use there is shrinking.

So we are convinced that the quality/value relationship has already been spent, and these very low, fire-sale wines are going to be much more erratic in quality in the future.

Okay.

And also, could you just get into briefly the impact of your distributor shift on the east coast?

Has there been any material change there, or has it been pretty much a smooth transition?

Okay.

You're probably alluding to the New York distributor change that took place in the fall?

Right.

We moved from peerless, which received the inaudible I don't brands, to charmer, and they really hit stride during the holiday period.

New York was one of the real bright spots.

They did, in four months, what our previous wholesaler did in six.

So New York is really clicking and we are seeing that, you know, there's been some turmoil and change in the state of Illinois, and we feel that that will settle out by February and March and really hit its stride, come the end of March and April as well.

So there are some distributor disruptions that are taking place, and as you know, anytime those take place, it takes a little time to get it settled out and refocused.

Bud LeedomRight.

Okay.

And then just finally, what's your outlook on synthetic leases?

Has there been any material comment from your auditors on that?

Do you expect any near-term changes?

Or -- I guess I'm just trying to sense the environment for that.

Bud, it's Hank.

The rules are still not finalized yet on those.

We're waiting for them to be published by the regulatory agencies on this.

We're sorting through them, and we're waiting for the -- the final inaudible we'll comply.

The original assumption was that they would be on our balance sheet in the fourth quarter.

I think that still is the direction, but there's nothing final and as you know, the agencies are going through their own issues right now in trying to figure out who is running --

Right.

Thanks very much.

Our next question comes from David Roberts.

Please state your company name followed by your question.

J.B. Greer.

Good morning.

Good morning.

Just a quick point on the bulk wine opportunistic brands you talked about.

Can you just give us some flavor on those brands?

And also you mentioned I think (inaudible) for revenue growth of' 7% and meridian was down 7% in for (inaudible).

Meridian was down 3 minus 3.7% price for revenue growth 0.8%.

Okay.

Great.

This is A.C.

Nielsen food stores.

Thank you.

On the brands you were talking about, there are a whole slew of them out there.

It's kind of use your imagination, make up a name, paint a label, put a cheap price on it, and buy floor space.

I think that, you know, if you go back to previous supply shortage, then supply surplus cycles in the industry, this is normal.

The first things that flush out are the inventories that are held either by growers or wineries in the more precarious financial positions and they're flushing not because they want to but because the banks or whoever said, "Do it" and/or the banks took over and are doing it for them.

So there are a lot of opportunity brands being created.

Those generally will go away in 18 to 24 months.

And we've seen the cycle before, and that's why we believe that it's very important to communicate to the consumer, to have a very positive advertising campaign complemented by very active promotional programs in the individual specific market on a very tactical focused way.

So we're not here to be the low-cost producer or to come out with the low price spread.

We're here to protect our market and to build our brand image for the long and medium term.

That's great.

I think the point to think about is whether or not $2 wines that, you know, are acceptable to the consumer palate, is that a sustainable proposition from a cost structure standpoint, and thus far, in the industry cycle Mike is referring to, it doesn't appear that fundamentally that's a sustainable proposition.

You really can't grow the grapes and produce the wine on a long-term basis.

Now, having said that, this is a category that also appears to allow these products, because it's so fragmented, to appear on the shelf so that we do expect a fairly lengthy period of 18 to 24 months to continue to deal with this kind of expansion of SKUs at lower prices, and that's why we think that continuing to pound away at building brand equity is the way for the producers to really consolidate the categories.

David RobertsOkay.

Great.

Thanks very much.

Our next question comes from Caroline Levy.

Please state your company name followed by your question.

Good morning.

UBS Warburg in New York.

My question is a little more strategic, and I'm just wondering, as you see the Constellation brands, acquisition of (inaudible) and Gallo, obviously, of a big-scale operation, do you see a need for more scale in the business that may make you move towards looking at partnering with other people?

Just strategically to address that question.

And then I'm wondering if you could step a little deeper, and since California is such a developed wine market, talk a little bit about how retailers are behaving there right now.

You know, where most of your wine is sold in the retail trade, not the on-premise but the off-premise business.

And are they adding shelf space?

Are you seeing less shelf space than you did a while ago because of all the new brands?

Do they see wine as a lost leader?

Just a little conversation on the retailers.

I'll take the first part, Caroline, and ask Michael to comment on the retail part.

Fine.

You know, we mentioned Gallo's acquisition of (inaudible) -- some of (inaudible) assets and martini, I think in our previous call and we believe that's an interesting development, more from the standpoint of competitor behavior because Gallo has not historically been an acquirer.

They have grown or began organically.

In terms of adding significant scale, we don't think that at least those two transactions have much effect on Gallo or on the industry.

However, the Constellation party acquisition is one that obviously adds significant size to the new company.

I believe it puts the new company in the position of being the number one wine revenue company in the world.

But having said that, I think you have to look a little bit more closely on, at least relative to the U.S., where is that entity or how much more is that entity going to achieve true leverage and synergy that can be turned into some sort of economic advantage.

And we're not aware that there is anything significantly different than what already is in place.

Since Constellation, I think, has been dealing with some of the hearty brands thus far.

The other thing that we think about in terms of size is not only how -- how many bottles of wine are you selling, but really, how compelling and how strong are the brands in that portfolio.

Because to have a very large company with brands that don't have strong consumer pull -- and I'm not suggesting at all that that's Constellation, but pure size alone doesn't really achieve what you need to achieve with the distributor and the retailer.

But all things being equal, a large company with very strong brands, we think, is probably going to be able to achieve better margins in the future than a smaller company with strong brands, just because you're going to be able to create some synergy and pass that on through either economic advantages or reinvestment in your brands.

So size probably will become a factor in this environment, as consolidation will, looking forward.

On the retail shelf space, we are seeing that, first of all, independent retailers are doing an excellent job of representing good brand names and they're complementing it with some of the new value wines that are coming out there.

The supermarkets, depending on the market, will have -- have expanded their shelf space and display area of wines, and a few of the others keep shrinking it down.

And so there's no generic answer to the supermarket area.

They do realize that wines give them, as a category, a very high return compared to other grocery items, and so they are looking -- by "they" -- the Albertsons, the safe ways, the Puwlix, et cetera, HEB's in Texas -- they're looking to grow their wine business disproportionately and that's very healthy.

Can you comment at all on Wal-Mart, Costco, what role they play.

I think that the role that they play is very, very solid in the wine industry and it's growing.

You know, the scale of both of them probably far better than I. But they focus, as you know, on about 400 SKUs, and they give the consumer a nice selection there.

But they are not a full-line wine shop.

They don't intend to be a full-line wine shop.

But they're growing very, very well.

Particularly in this environment.

I'm sorry.

Just lastly, is Wal-Mart, would you say, your market share in Wal-Mart compared to all other retail would be the same, or better or worseworse?

In Wal-Mart, they're really just beginning in the wine area.

The lower-priced wines are mainly involved in Wal-Mart.

I'd say that in the next three to five years, you'll see growth in the premium wines in Wal-Mart that will be very interesting.

Great.

Thank you very much.

Our next question comes from Bryan Spillane.

Please state your company name followed by your question.

Hi, good morning.

It's Banc of America Securities.

Most of my questions, I guess, have already been answered but one, Michael, if you could answer for us, is, you know, as you've seen the pricing environment come down and it seems to me there's a lot more wine available right now at a lower price point, that that change consumption patterns at all.

Are there more people sort of coming into the wine category now and drinking wine today or are we just sort of looking at the same user base buying wine at a lower price point?

To answer your question, for today and what's going on in the environment, it's a little premature, but if you go back and study each of the previous cycles, what has happened when the price of wines got down, there were more sales, more promotion, more advertising.

The breadth of wine consumption increased.

It was not just the same old wine consumers drinking more wine.

So one of the silver linings to this is that in the next two to three years, I believe that we, the wine industry, are going to gain a lot more loyal consumers and we'll have a stronger base as we move forward.

And so this will be healthy to develop the longer-term wine business.

Okay.

Thank you.

Our next question comes from William Nobler.

Please state your company name followed by your question.

Hey.

It's Bill Nobler letter of (inaudible).

I had a couple questions about your earnings.

In the first quarter, I believe the consensus had been something like 51 or 2 or 3, and you reported 58 cents and you mentioned 7 cents was attributable to joint venture or partnership income that you thought would come into the second quarter.

In the second quarter, the consensus was something like 71 or 72 or 3, and you reported 77 cents and you mentioned that 4 cents, again, that you expected, I guess, in the third quarter came into the second quarter.

Now you're forecasting, I guess, 35 cents, I guess -- no.

You're forecasting -- yes. 35 cents.

30 to 35.

-- in the third quarter and you mentioned the timing of Easter and again another 4 cents on partnership income in the second quarter that you had thought would be in the third quarter.

It sounds as though some of your forecasts are either excessively conservative or it's very hard for you to make these kinds of forecasts so I'd love to have your comment on that.

And in your release, you talk about most of the, quote, shortfall from what you had previously been expecting is going to be in the third quarter.

Now, actually, when you do the numbers, I believe it looks like your fourth quarter will actually be the biggest year-to-year decline.

Bill, this is Bob.

Let me address your first question on the joint ventures.

You're right, those are difficult to predict from a profit forecasting standpoint, or financial standpoint, because many of the high-end wines are released based upon -- or sell based upon a winemaker's decision as to when the wine is ready to release, rather than, let's say, an ongoing business.

Opus 1 is an example.

It sells most of its wine -- releases most of its wine in September and then they told hold back a little bit of wine for release in generally March.

Now, if they released the wine -- they say -- the winemaker says the wine is ready to go in early September, we'll see a lot of the wine ship in our first quarter.

If they say the wine is ready to be released in mid to late September, we'll see a shift of those same wines and therefore equity income into the second or December quarter.

Those things are difficult to predict ahead of time for us because it -- really it's up to the winemaker.

Essentially what's happened -- and you're right, we have kind of timing and timing here -- is demand for Opus was so strong that we -- we shipped more than we would have expected in the September quarter, and again in the December quarter, and therefore, as we said in the call, there's essentially very, very little left for Opus to sell, because unlike some of our other brands, Opus doesn't sell wine every month of the year.

So that's kind of the -- the thing driving equity income.

Okay.

How about third quarter versus fourth quarter?

Bob PhilipsYeah.

No, the third quarter, if -- if -- we can probably do this off-line but if we work through the numbers, we would see the biggest decrease year over year in the third quarter for sure.

You got the effects of Easter moving actually to the fourth quarter.

There is some margin dilution as we roll out our new wines where we get just the importer margin.

Uh-huh.

It is the beginning of the launch of the Woodbridge wines and that includes a shift of some higher-end wines to the lower-end brand.

And finally, we've got the inventory issue which we need to address which means we're going to start curtailing shipments in the third and fourth quarter to get back down to the right number.

Yeah.

The guidance that we provided for the third quarter in terms of earnings per share would imply year over year our net income or earnings per share would be down between 35% and 40% from the prior year.

Uh-huh.

Also, it sounds like from your comments that one of the things that's negatively affecting year-to-year comparisons, fiscal year comparisons, is perhaps a fairly meaningful increase in media spending.

Is that true?

Very, very true.

Could you give us some idea of what you're going to spend this year, say, versus last year?

Bob Philips Yeah.

This year, we're spending about $14 million, I believe, between Woodbridge and Robert Mondavi, and I believe the number last year, Greg --

10-and-a-half, I believe.

We have a 35% increase this year in advertising spend, and I think the difference that you may be hitting on that we tried to make clear in the call is that we have 4 million of that, roughly, that's falling in the back half, in the spring.

Last year, we didn't have the spring advertising campaign.

So there -- there clearly is a bit more of a media spend element going forward.

What we've tried to do this year is be more targeted in the types of media that we have selected, so that we could achieve a longer duration for the advertising ^, so last year most of the advertising took place, as Greg said, in the -- in the Christmas or Thanksgiving holiday period.

This year, we have a second flight that will continue in our second half of the fiscal year.

You have to be a little careful.

We do case rate advertising along with volume, so there is an increase in the case rate which does affect the second half, but it's not a black and white, because we spend that 4 million in the second half, it hits all the second half.

But it has increased the advertising spend in the second half.

I want to clarify.

A comment was just made of a 35% increase.

You just said 14 versus 2-and-a-half.

What did I miss.

EUFRPLGS I'm sorry. 10-and-a-half to 14.

I'm sorry. 10-and-a-half to 14.

10.5 million to 14.0 million.

Okay.

Right.

And that's just measured media as compared to promotional or other costs?

That's a combination of media and the creative preparation is in that number, so there is probably a million-and-a-half of creative that's part of that number.

So it's -- it's --

And that includes television, radio, print.

Uh-huh

Internet.

Internet.

And over and above that is the actual promotion in the markets.

Sure.

Right.

So it sounds like with 16 million shares outstanding, a good part of the shortfall -- not all, but a good part of the shortfall is due to this 35% increase in media spending.

Well, I think that -- that would be one way to look at it, but I -- I think the shortfall, if we attribute it to any factor, is more related to the slowdown in our demand for the wines in the top line, and I guess you're referring to our choice not to cut the advertising, which -- which could cover some of that earnings gap.

Is that -- you're correct in that sense.

Right, right.

Okay.

Thank you.

Our next question comes from John Feeney.

Please state your company name followed by your question.

Hi, guys.

Thank you.

SunTrust Robinson Humphreys.

Good morning.

Just one question on import competition.

I understand with vested competitors selling (inaudible) is ultimately going to be lower prices but do you feel like -- versus import competitors, you know, you have unfavorable cost structure and that's -- and if so, what factors are going to, you know, take this aggressive import competition out of the picture or at least reduce it?

Well, the import -- the import category is broad, so I think we have to be a little more specific about who are the players at the moment that would be competitive concerns, and I think the two growers in the import category, Australia and Italy, they each have -- they each have very different cost structures.

So I would say from the standpoint of Italians, there is no particular advantage over the cost structures in California.

I think the Italians have other factors going for them.

They have varieties like Pina Grigio that have caught the attention of the consumer, so forth and so on.

Chile and Australia both have attractive cost structures but among those two participants, the Chilean category is actually on the down-slope, at least in the last couple of quarters.

They're negative.

So Australia has really been the competitor who has been growing and they have a cost basis that is probably on a structural basis lower than some of the California brands that compete in the same category.

I think what's happened with Australia, in part, has been the competitive leverage from currency as well that has allowed them to be even more competitive in the U.S. on the shelf.

Whether that will change or erode I think is really more of a financial question, but if -- if you look at markets like the U.K., which is changing fairly dramatically, you begin to see some of the other competitors for California -- from Californian Chile actually battling fairly effectively with Australia in the U.K. market.

So I -- I think the playing field is relatively level for those -- for those countries, if the currency environment is stabilized.

Also,.

Also, John, we have -- as I'm sure you recall -- joint ventures both in Italy and the Australian joint venture where we're in the process of introducing the wines come next month.

Uh-huh.

Good.

And just one other follow-up.

You know, given that you're, you know, holding the line somewhat on pricing and clearly taking this as an opportunity to, you know, expand your brand name, are there any competitors you would highlight out there that are having anything -- taking anything like this strategy or, you know, doing anything like the kind of marketing you guys are doing with the print, you know, TV, or otherwise?

I think one of the nice things is that you find out where everybody's going and the way we've built the business over the last 35 years is we do something different and we think better.

The vast majority of our competitors are investing essentially a hundred percent of their funds in price reduction.

We think that's very short-term, we think it's ill-advised from a brand building standpoint, and we are very pleased that we are the key person out there communicating directly with the consumer.

Excellent.

Thank you.

Our next question comes from Kristine Koerber.

Please state your company name followed by your question.

Hi.

W.R. Hambrecht.

A couple questions.

First of all, can you give us some idea of what the price range of these new product introductions, the new products that you expect to introduce over the next month or so, where the prices will be?

And then, also, can you give us some idea how much you expect gross margin to be down in Q3 and Q4?

The price range of the Australian product that we're releasing this month is, on a retail basis, in the range of 12 to $15 per bottle.

The Fresca balledy portfolio, which has a fairly broad range of wines ^ would have a an average price for the portfolio that's probably in the range of, let's say, 15 to $20 a bottle.

Some of those wines sell for 75 and a few -- a few of them sell for 10.

The Woodbridge line extension that we're talking about later in the fiscal year is priced more in the super-premium range, so that would be somewhere below private selection and above the Woodbridge 750 brand, so that's probably in the range of, on average, 8 to $10.

And I think Bob mentioned hang time, which is the new entry that we have in the on-premise.

Although it's an on-premise item, if I give you the off-premise equivalent, that would be in the range of, let's say, 15 to $18 per bottle.

Most of these entries, as you can see, are in the category $12 and over where, from a portfolio standpoint, we don't have as much market share as we think we ought to.

Kristine, the gross margin, we think, will be about -- will be down about 70 basis points in the second half.

Thank you.

Gentlemen, at this time, there are no additional questions.

Please continue.

Michael Mondavi If there are no questions, we will terminate the conference call.

Thank you.

Ladies and gentlemen, this concludes today's Robert Mondavi second-quarter fiscal 2003 earnings conference call.

If you would like to listen to a replay of today's conference, please dial 1-800-405-2236 or 303-590-3000 followed by access number 502408.

Once again, if you would like to listen to a replay of today's conference, please dial 1-800-405-2236 or 303-590-3000, followed by access number 51 -- pardon me, 502408.

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You may now disconnect.