Constellation Brands Inc (STZ) 2004 Q2 法說會逐字稿

Good morning.

Welcome to the Robert Mondavi fiscal year 2004 conference call.

I would now like to turn the conference over to Mr. Bob Phillips.

I want to welcome you to today's conference discussion our fiscal second quarter 2004 results.

Joining me are Greg Evans, Dennis Joyce, and Hank Salvo, our CFO.

Before we get started, let me remind you we will 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 risks of the wine business.

To help you follow this call, we have already posted a copy of our prepared remarks on our website, www.robertmondavi.com.

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

On occasion we will talk about inventory step-up charges, write-downs of inventory or fixed assets, severance costs or gains and losses on the sale of fixed assets.

A complete list can be find under financial information on our website, followed by financial history.

This morning, we plan to discuss three main topics during our 30 minutes of prepared remarks, first provide an overview of key industry performance measures and review some of the recent developments at Robert Mondavi.

Second, we'll detail our company's financial performance for the quarter, and third we'll review our outlook for the Q3, and the full year fiscal 2004.

After that, we'll move to your questions, and hopefully we can limit the call to no more than one hour.

Greg will now get us started.

Thanks, Bob.

Good morning, everyone.

It appears as though the growth we saw in scanning channels during the September quarter cooled a bit in the September quarter.

Food drug and liquor store data ended December 20, 2003, sales of wine in scanning channels slowed dramatically compared to the growth rate during the September quarter and during the last 52 weeks.

Domestically produced varietal wine volumes were flat compared to 4% growth in the September quarter and 2% growth during the last 52 weeks.

Imports grew 11% in the December quarter, compared to 14% in the September quarter, and 13% during last 52 weeks.

In the blended-volume growth rate, it was 3%, compared to 7% in the September quarter and 5% during the last 52 weeks.

So, in essence, a slower quarter.

Part of the reason for the slowdown in national growth trends undoubtedly reflects the effects of the grocery strikes.

In southern California, food stores domestic wine volumes declined 24% during the period and import wine volumes declined 12%.

The effect on total California was substantial.

Statewide domestic food store wine volumes declined 15% while imported wines declined 9%.

Some of this volume appears to have shifted to the drug mass merchandiser and convenience channels.

For example, sales in non-striking food stores grew 15.

Finally, pricing in food, drug and liquor stores continued to weaken.

Domestic wines declined 3% in price and imports declined 1%.

Now, let's move from the industry to Robert Mondavi.

Before we get into the details of our performance, I want to remind you of the three-part plan we've been aggressively implementing since last March.

First, increasing top-line growth by investing in our core brands, and placing greater emphasis on developing new products.

Second, streamlining operations by improving asset utilization, increasing efficiency and delevering the balance sheet, and third reshaping the organizational structure to develop a clean line of sight to the consumer and sharpen our execution in market.

As Hank Salvo has focused on goal number two, I've asked Dennis Joyce to begin participating in these calls, since he is focused on achieves goal number one and number three marketplace communications and execution.

Relative to the results from the December 2003 quarter, Dennis and Hank will share with you the details of our progress in a moment.

On balance, the quarter's results reflected the progress we're making in executing these strategies.

First, sales of Robert Mondavi wine imports are fueling op-line growth.

Second, new brands are exceeding expectations to this point.

The success of wines like Woodbridge Select vineyard series, the 17 milliliter, tap I don't, and others demonstrates or ability to meet demands in a timely fashion.

Operating expenses as a percent of net revenues were below last year, consistent with our emphasis on improving efficiency.

Finally, we continue to make progress on reducing our balance sheet with the most recent transaction, including the sale of our 50% interest of Caliterra.

From a corporate governance and marketplace execution standpoint the assumption of Michael Mondavi and Ted Hall's appointment as Chairman should bring us benefits, freeing up Michael to spend more time in the marketplace gives us a competitive weapon that no other wine company can match.

Naming Ted as chairman reflects best practices, because it separates the chairman's role from management and family, and puts an independent director in a position to help shape the board's agenda and priorities.

Now, specifics, during our last conference call on October 23rd, we want we expected second quarter EPS to range from 75 cents to 80 cents on mid-digit increases in revenue, stable pricing, and flat EBIT margins.

However, we qualified the remarks given the potential impact of two grocery strikes, one in Ohio, West Virginia, and Kentucky, and the other one I previously mentioned, in southern California and Arizona.

The strike in the Midwest was settled in December.

The strike in southern California and Arizona.

Then last week we 'announced the sale of our 50% interest in the Caliterra brand and assets which were primary winemaking vineyards to our partner in Chile, Vina Errazuriz.

The sales price was $9 million, and we recognized a pretax asset impairment charge in the quarter of $6.1 million.

This enables us to balance our investment in Chile with expected future profits and remove about $7.8 million from our balance sheet.

We'll keep our 50% ownership of Sena and Arboleda, and continue to import Sena, Arboleda, Caliterra, and Vina Errazuriz to the U.S. and represent the brands in some key marks around the world.

For those of you interested in more detail on this transaction, we've included a full reconciliation in the prepared remarks on our website.

Due to the Caliterra charge, we lowered earnings guidance for the quarter by 23 cents per share, the amount of the charge, to a range of 52 to 57 cents.

The results we reported for the quarter show that revenues grew slightly lower than our guidance but pricing is firm, and EPS was at the high end of the range.

Revenues grew 4% on a 1% improvement in average price per case, and GAAP earnings were 57 cents compared to 2k3w57 earnings of 59 cents last year.

Since we also reported an asset impairment charge in Q2 of fiscal 2003, on a vineyard that was subsequently sold, let's look at earnings without the two one-time charges.

Last year's charge was 3.1 million pretax or 12 cents per share.

So excluding last year's and this year's charges, EPS grew 13% from 71 cents last year to 80 cents this year.

We also made more progress reducing the balance sheet.

The Caliterra sale reduced investments and joint ventures by $7.8 million, and reduced inventories despite modest sales growth.

With that, I'll turn it over to Dennis.

Thank you, Greg.

Good morning.

I'd like to begin by reviewing the top-line performance from a company perspective and gets into the brands themselves specifically.

Total company wholesale depletions for the quarter ended December 31st, 2003, grew 1% over last year.

On-premise depletions were particularly strong, growing 7%, offset by declines in the A.C.

Nielsen channels.

Total company shipments grew to.1 million cases, which lets wholesale inventory at 49 days, compared to 51 days last year, and 49 days at the end of September.

We estimate there was about one extra day of inventory due to new products that were shipped into the trade at a greater rate than they were depleted.

Average price per case grew to approximately $47, as a result of strong sales of Robert Mondavi winery, Private Selection, and our imports.

As a result, total company net revenue grew 4% to $147.million.

Let's turn to the brand specifically, in this case Robert Mondavi winery brand.

We were pleased with the third quarter in a row of strong depletion growth.

Needless to say, we were pleased to note the positive response to many of our Robert Mondavi wineries 2000 Cabernets, including that from Robert Parker with scores ranging from 9 to 94 points on the reserve.

The wholesale depletions grew 16%, shipments grew 16% as well to 99,000 cases.

Average price per case was $158, 7% below last year, and net revenues grew 9% to $15.6 million.

Concomitant with this strong performance, with the resurgence of visitor revenues, sales of wine and merchandise sold at the winery's retail and tasting rooms grew 9% to 1.7 million.

On 6% higher visitor traffic.

Robert Mondavi Private Selection also had another good quarter, wholesale depletions up 2% above last year, in a very competitive segment that exhibited some of the lowest prices in years, and included a very soft California number.

Shipments on this brand grew 7% to 512,000 cases, and net revenues grew 5% to 35.5 million on 2% lower average price per case, which reflected the competitive nature of the category.

Private Selection's U.S. scanning store volumes declined 2% and revenues declined 5.5%.

However, we're pleased to see that our focus during this quarter in the on-premise channels paid off with 4% growth there.

Now, let's move to Woodbridge, which like most established brands, did not have a good quarter.

In fact, ten of the top 11 major brands in the country experienced some share erosion in this quarter as measured by A.C. Nielsen.

Woodbridge depletions declined 3%.

California continued to be a challenging market with depletions there down 20%.

However, some of the declines were offset by new products.

A.C.

Nielsen data indicates that Woodbridge select vineyard series has been the number one new wine entrant in the past few weeks, and we expect select vineyard series to continue to grow.

In addition, consumer and trade feedback to the Woodbridge 187 milliliter bottles has been very encouraging due to their superior closure design and of course high wine quality.

Woodbridge shipments declined 2% to 2.3 million cases, and net revenues declined 4% to $77.3 millions U.S. scanning score volumes declined 2.2% and price per case declined 3.9%.

Wholesale depletions of our other California brands grew 61% led by strong demand across the portfolio.

Shipments doubled to 1343,000 cases, and net revenues grew 32% to 7.7 million.

One of our newest brands is off to an excellent start.

Average price per case declined to about $58, with the mix shifted toward lower-priced wines.

Finally, import depletions grew 37% over last year and net revenues grew 41% led by strong sales from the Italian and Chilean brands.

Shipments grew 37% from last year to 139,000 cases, while revenues grew 41% to $9.3 million.

In U.S. scanning scores, the imports grew 34% in volume on flat pricing.

In closing, the quarter showed our ability to post results despite a difficult quarter for Woodbridge, reflecting the strides we have made in our strategic plan alluded to by Greg, focusing on top-line growth, streamlining our operations, and sharpening or strategy with respect to new wines and our execution in market.

With that, I'll turn to Hank who will cover the financials.

Thanks, Dennis.

Again, as Bob said earlier, I'll talk to GAAP numbers and to restated historical financial numbers in compliance with 46.

This quarter's balance sheet included 11.1 million of these leases, while last year's second quarter was restate to do including $110.3 million.

After the adoption of 46, last year's second quarter GAAP earnings were restated to 59 cents per share versus 60 cents previously recorded, due to interest expense recorded on the consolidated balance sheet.

The specifics are listed on our website where we've restated of the four quarters.

As Dennis said, Q2 net revenue were 47.3 million, 4% above last year.

Cost of goods per case grew 4% to $28 during the quarter from last year's level of $26.97.

This year's number includes 1.1 million pretax in Arrowood step up inventory charges.

Gross profit per case declined 3% to $18.99, from $19.58 last year, and gross margin declined 170 basis points to 40.4% from last year's 42.1%.

Operating expenses declined 10% to $35.9 million, or 24.4% of net revenue, a decrease of 380 basis points from last year.

Last year's number included a 3.1 million write-down on a vineyard that was subsequently sold, and excluding last year's write-down, operating expenses declined 2% and operating expenses as a percent of net revenues declined 160 basis points.

Operation income grew 21% to $23.6 million, compared to $19.5 million last year, and operating margin was 16%, 220 basis points above last year's 13.8%.

Including last year's written down, operating income grew 4.5%.

Equity income was a.5 million loss, compared to a 1.1 million gain in income last year.

Last year's equity income included 222,000 in Ornellaia step up charges.

Excluding the charge from the Caliterra sale,, there had be about $750,000 or three cents earnings per share timing benefit from Q3 to Q2 this year because of later Opus One sales, if you're reading the script, it's a typo, it should say Q3 to Q2.

EBIT declined to $20.5 million, versus the 21 million last year.

The margin was 13.9 versus 14.9 last year, while EBIT is not a GAAP measure, we think it's an important indicator of our performance, which are not fully reflected in reported gross and operating margins.

Excluding this year's Caliterra charge, EBIT grew 90 basis points from 17.1% of net revenue to 18%.

Net interest expense was $5.7 million, up 2% from last year.

As a result of lower capitalized interest this year, offsetting lower interest rates and borrowing levels.

Capitalized interest expenses were $68,000, compared to $470,000 last year.

Effective tax rate for the quarter remained at 36.5%.

Income declined 3% to 9.4 million, compared to 9.7 million last year, and EPS declined 4% to 57 cents, compared to 59 cents last year.

However, adjusting for the inventory step-up charges in both years, last year's vineyard write down and the Loff of Caliterra, it grew to 14 million and EPS grew 10% to 85 cents.

December 31, 2003 was $996 million, $25 million smaller than last year due primary to continued progress in reducing inventories and divesting non-strategic assets. 50 million dollars due to a rise of receivable due to timing of sales and lower short-term buying..

Operation cash flow to the quarter of $15.6 million, less capital spending of 3.4 million and 12.2 million in free cash flow.

Greg will offer our outlook for the remainder of the year.

Thank you, Hank.

With the benefit of 20/20 hindsight, it looks like the September quarter was a very strong quarter, not only for Robert Mondavi, but for the wine industry and many other industries as well.

The December quarter, on the other hand was a more difficult quarter for many reasons.

While consumer confidence has risen, companies have been reluctant to increase capital spending or hire new workers.

In the premium wine sector, we're still seeing aggressive promotions, which suggest some producers are long in supply, and we think this will continue for at least the next six to 12 months.

Through the first two quarters of our fiscal year, total shipments were up 3.3%, slightly below our guidance, but the growth has been more skewed towards new products than the 50-50 mix we planned.

On the other hand, operating margins have improved, and resulting GAAP EPS growth of 8% and excluding inventory step-up charges and asset impairment charges, pro forma EPS growth of 5%.

As we look ahead, we think these trends will continue.

For the second half of our fiscal year, we expect 4 to 6 percent total growth due to accelerating momentum of new products and imports as well as more new product introductions.

Because of the greater reliance on new products and imports, we expect average price per case for the second half to be 50 to 100 basis points higher than the prior-year period.

Now, to talk to the full year, we expect GAAP operating margins to be between 12.5 and 13%, compared to 8.8% last year, and earnings to be in the change of $1.63 to $1.78 per share, consistent with our prior guidance after deducting the 23 cent Caliterra charge announced last week.

Note that this guidance also includes Arrowood's inventory step-up charges of about 11% for the year or 5 cents remaining in the second half, which shows cost of goods sold.

We expect second-half earnings to be skewed towards of fourth quarter.

Third quarter earnings per share are expected to be in the range of a penny to a nickel.

This includes 7 cents per share in incremental operating expenses for compensation for the company's new non-executive chairman of the board, restricted stock units to be granted in the quarter, and outside services related to Sarbanes-Oxley section 404 compliance of the 7 cents per share, 4 cents will be nonrecurring expenses.

Let me add one more point here that's not in the script.

Historically, we have released our new vintage of our flagship wine, the Cabernet Sauvignon March.

This year, both because the wine will benefit from more aging, but also because it is a better time to release they great wines just prior to the holidays, the 2001 vintage Cabernet will shift to Q1 2005.

If you compare this to previous third quarters, this would be a timing difference.

Now, Bob has some housekeeping items.

Thanks, Greg.

Robert Mondavi, our founder is continuing to sell shares through a plan in order to satisfy charitable obligations of his.

In addition, Michael Mondavi has a program to begin converting about 12% of his class B shares to class A, and then monetizing the shares to use the proceedings to repay loans on a new home he constructed last year in Napa.

I mention this now so that none of you are surprised when you see Michael listed as a seller, and more importantly that none of you misinterpret his intentions in selling stock, since this sale will represent a very small portion of his overall holdings.

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

Today's prepared remarks can also be viewed downloaded or licensed to on our website, www.robertmondavi.com looks under "about the company," Investor Relations, followed by news & events, followed by conference calls.

Our next call is scheduled for April 22nd, 2004 at 7:30 a.m.

Pacific time.

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

We'll now open up the line for your questions.

Operator?

Thank you.

The first question is from Tim Ramey.

Congratulations.

The $7.8 million reduction in the balance sheet, just a clarification there, since the debt assets associated with that would have been I assume off balance sheet, that's an asset size reduction?

Yeah.

The liabilities would not have been on our balance sheet, Tim, this is the investment and joint ventures.

The debt would have been on the Caliterra entity in Chile, the purchaser assumed those liabilities.

Fair enough.

Just a follow-on to your statement on the full-year guidance, you mentioned that because of your greater reliance on new products and imports, you're expecting average selling prices to be up in the second half.

I'm just trying to envision what that would be.

PAPPIO, I would think, would be negative to mix, SVS is positive to mix, and Caliterra would be out of the mix?

Is that right, Greg?

No, we're continuing to import Caliterra.

But will you count it as dollars per case since you're a distributor there?

Import activity is counted as part of our top-line, so that has a neutral impact.

But I think the piece that you're probably missing would be the incremental addition to the import portfolio of both Kirralla brand, which is our Australian joint venture, and the Marchesi de'Frescobaldi which are skewed toward the high end.

You're going to see that higher revenue per se.

And I'm glad you mentioned Australia.

You know, the rationalization of.

JV and Chile begs the question, do you have enough skin in Australia to make it worth your while?

It's obviously accounted for more than 100% of the growth in the wine business for the last year or so.

What's your plan there?

Well, we'd like to see the Australian joint venture become more important to both the partners, but I would distinguish in a fundamental sense that the asset we sold with the Chilean joint venture was an under-$6 wine, and the Australian venture really begins at there 12.

So we're already playing in a higher segment.

You typically won't see the kind of volume out of that segment that you would see under $10.

We would expect that joint venture to become more important to our business over time.

Understood.

Thanks.

Thank you.

Our nest comes from Marc Cohen.

Can you give a color on the quarter, what it looked like, and in December was it pretty steady?

Let me repeat the question to see if we got the question right.

We made comments that the industry's wine sales for the quarter ending December were weaker than for the quarter ending September.

And we believe that was an industry phenomenon, and it also was true of the Robert Mondavi wine performance.

Is that your question?

No, my question more is, in the December quarter, what did it look like month to month?

Was it really bad December?

Was it getting worse or better through the quarter?

Yeah.

I'll have to look at the Nielsen data for that period --

Well, from your perspective, really is what I'm looking for.

This goes back to a comment I think we made in the last call, where it's very difficult, given the fragmentation of this category, to look at this business on a month-to-month basis.

So the variance from month-to-month I think is less relevant than to look at the full picture in the quarter, given that any given company, and even within a company, promotion periods are really managed down to the local level.

So you can see a spike in volume or drop in volume, depending on that promotional activity.

So we're looking at it from a quarterly perspective to give us a broader view of what the broader trends are over time.

The month-to-month variance happens in every quarter and I think will continue to happen.

Thank you.

If your question is, did the trail-off period continue to weaken through the end of December, I think our answer would be no.

Yeah.

Thank you very much.

Our next question comes from Skip Carpenter with Thomas Weisel partners.

Good morning, everything.

Just to make sure I have the numbers collect, with regards to the pretax charge in terms of the asset impairment, was it 6.1 and that was recorded in the equity joint venture line of the income statement?

Yes, that is correct, Skip.

Second, on Arrowood, again, 1.1 million, in terms of a step-up charge for this quarter.

So what was that in terms of an EPS?

Five cents a share.

For the quarter?

Yes.

For the December quarter.

And then you said in the back half, third quarter, fourth quarter will be a combined total of five cents?

Correct, Skip.

Any kind of gauge, was that fairly equal in terms of the step-up charges for that quarter?

It's hard to project, because it's based on a forecast of very specific items at Arrowood, but for working purposes, wee assuming three cents, two cents, but it could shift easily a penny one way or another.

It depends on the sales of the brand.

Fair enough.

This goes to what Greg was talking about, you seem to indicate in the second half, I think you were talking about 4% to 6% growth kind of top-line performance, the press release obviously indicating that would be more skewed in the fourth quarter.

Given depletion trends and the shipment trends in Q2, will we look for more tempered growth in terms of is it more realistic like a 2%-3% growth expectation in Q3 and see some acceleration in the fourth quarter?

Let me talk to that with the notion of base business and new business here.

If we look at the December-to-date six months -- and I'm going to characterize the business in three buckets here.

The base business, which would be the existing sizes and products of our existing brand grew at .5% in depletions.

The new products and sizes that would relate to the base business, so 178-milliliter Woodbridge, SVS, in other words, extensions of brands during that period, actually added 1.5 to growth.

So if you look at the existing brands, they grew 2% in the first six months on depletion basis and the completely new products we added 1.3% to growth.

We had 3.3% depletion growth brown down during that period of time.

If we look at the back half, again focusing on the same three buckets, we're anticipating our base business to be about flat.

That would be the base business of existing sizes.

However, the product extensions and new sizes within that base business we think will bring the growth rate to about 2.7% for the existing brands, and then the new brands, which I mentioned before, particularly driven by POPPIO, should contribute about three points of growth in the back half.

That will get between you 5% and 6% on a depletion basis, which will flow through basically to a revenue basis.

Skip, was your question trying to get a better understanding of how that would break out between Q3 and Q4?

A little bit, and also you keep on referring to the op-line growth and again that skew will be even more pronounced when you have that contribution in the fourth quarter.

Is that correct as well?

We have a very easy comp in the third.

On a shipment basis a year ago, our shipments were off 14%.

That may help us a bit when you look at the growth rates in fiscal 04.

Okay.

Then I guess my last question, specifically with regards to Woodbridge, it's the bulk of your business from at least from a case standpoint, and this year it just seems to kind of be struggling a bit more than I had anticipated.

What do you see, I guess, going forward for the remainder of this year?

More importantly, as we're going into next year, that will get this brand, you know, growing again?

It's core business, I know you talked about line extensions and things like that, but in this environment, is it possible to get what I guess is defined as base business Woodbridge growing again.

Skip, I'm going to have Dennis answer this question.

He's been focusing on this brand for the last few weeks.

To answer your question specifically, sure it is, it's absolutely possible to get the brand on a growth trajectory again.

I think it's important to bring in a historical perspective, as we think about Woodbridge, we think about it over a longer time horizon than you're permitted to.

As we look back over the past 25 years of its life span and consider the various attacks and challenges that have faced the brand over that time, we've learned that there are plenty of storms we have weathered and will continue to weather into the future.

I think that's a function of a number of things, or able to execute in market with our very strong sales and distribution network and the quality of the wine relative to its competitive set.

But more specifically. as we go forward, where we will be focused on is making sure that we continue to extend the product line, and in particular, with the current line extensions that are in front of us, both Woodbridge select series and 187s, there are significant upside on distribution of those two items.

So we will be focused in this back half on those two areas, and then going forward, a sustained investment enhancing activities that will produce insulation against competitive activity, as well as afford us the ability to continue to bring new items under the Woodbridge brand umbrella.

Okay.

So just based on some of these comment tears, it seems that you're saying in order for Woodbridge brand equity to continue to grow in this arena, obviously there are investment issues you'll have to continue to throw at the brand, it sounds to me like diversifying is critical for the aggregate of this brand to know?

I think innovation is critical to our entire company.

Obviously, but when you look at this specific brand, you're down 2% in Q1, down 2% in Q2, the way to get that brand turned around is through, you know, innovation in terms of I guess Greg alluded to --

I would also add we don't look at brand extension or dedicated solely to product, but also towards our marketing communications programs, our focus on the consumer, our promotions, so we think we can apply innovation and leverage across the entire marketing mix.

Okay.

Thank you.

Thank you.

Our next question comes from Jon Finey.

Good morning.

Congratulations.

I want to may coincidentally pick up where Skip left off with Private Selection.

You guys have some impressive growth numbers there, and are taking commented in your prepared remarks about the aggressive competition.

My two questions would be, is there anyone in particular or any segment in particular, like imports from a particular place that make that category tough from a pricing perspective?

Secondly you're with impressive volume numbers you're putting up, anyway, what's the rationale behind your thinking of keeping you will with these price decreases, when you have perhaps a December 3 or 4% increase.

Well, interestingly enough, Jon, we've been able to pull that off.

I think it speaks to the strength of the equity of Robert Mondavi Private Selection and the loyalty it has among its consumer base.

You begin with a great brand name, a fabulous package and fantastic wines, and so when you hit on all slinders in that regard, it leads to the success we have seen with this brand in particular.

It is interesting to know that as you look at the A.C.

Nielsen numbers, boy, we're one of the few, if not the only brand, in the close-in competitive set, the usual suspects, to have posted growth over the course of the past 52 weeks, with minimal price declines.

I think we stated in our prepared remarks, the 2% price decrease, which relative to our competitive set is, on average, about half of what our competitors have been doing without realizing growth.

So I think it comes back to the ideas that I just mentioned, which are fantastic brand, fantastic package, and fantastic wine, which adds up to a proposition for the consumer that can't be beat.

I think your other question around imports is one that generally I think we are beginning to see some impact of the dollar weakness at this stage, and that is going to begin to influence pricing or promotions by some of the competitors in the segment.

In a positive sense, right?

In a positive sense, from the standpoint of selling California wines.

Right.

But in terms of the most recent quarter, was it imports that make Private Selection difficult?

Or any particular competitors?

I think actually what we saw beginning in September, I believe continued through December, which is that the domestic competitors increased their pricing and promotion at a more aggressive clip than the import competitors, and we think that that shift may continue for the period that we outlined of six to 12 months during the grape surplus period.

So I think the domestic players are driving pricing at this point more fundamentally than the importers.

Interesting.

Thank you.

Our next question comes from Bryan Spillane with Banc of America Securities.

Good morning, guys.

Couple questions, Greg, if you could just give us a little bit of your outlook on where you think, you know, total supply, industry supply is now, as you've gotten more information I guess on the harvest, and kind of the outlook in terms of at least what you guys are seeing in terms of the number of acreage or amount of acreage that's been ripped up over the last 12 months or so, and where you see that going.

Then also, if you and maybe Hank would just remind us, you're making progress on reducing the size of the balance sheet.

If you could just remind us of what your goals are, what you have done so far, and importantly where you see the opportunities to reduce it going forward here.

The supply picture is improving slowly, and the paradigm in the industry has shifted to more of a global supply picture, as you know, Brian, where we can no longer look simply at the California production of Grapes, but you also have to take into account the Australian production, the Chilean production and now the Italian and French production.

So in a sense, if you step back and look at how you manage supply, the cycle of ups and downs, shortages and surpluses we think over the long term will even out, because access to supply will be available in places other than California.

So having said that, we think the picture from California is improving slowly, the harvest was down anywhere from 1210 to 12 percent in forecast, in specific varieties, particularly per lo and to some extent Chardonnay, in the case of Merlot, they may actually be short.

So we're seeing some pricing increases on the bulk line side.

That's not so say there aren't surpluses of Cabernet and Shiraz and others, so you have that inequality at the supply level.

That's why we speak to the overhang, we're thinking six to 12 months before the pressure might come off from the marketplace, particularly for lifestyle wines that would be sold, say under $12 in commercial channels.

The good news on the Robert Mondavi side is that we have been able to manage supply more effectively, and if you look at our inventory at 12/31 of this year, they're down about $25 million from a year ago, so we've made a good deal of progress in terms of our own supply picture.

As we go forward, I think Hank can talk about our long-term goals, but we see this industry beginning to balance itself out, and as the demand will pick up, we believe, in the next 12 to 18 months as the economy improves, this will also start to balance the supply picture out a little more quickly.

Bryan, just a quick reminder we're looking for $30 million of cost savings, and that should flow because of the timing of the inventory about four or five million next fiscal year, about 12 in 06, and then the 30 in 07.

Our goals also include 22% EBIT margin at that point in time.

Backing off into our assets, we currently have sold about $27 million worth of assets with another 40 or so to go.

We're actively doing that.

Obviously the market is not totally helping us, and we have to be careful, but the assets are held for sale, and while we're still operating them, we are active moving them.

The bottom line is we basically sold at about a break-Devin including Caliterra.

As I said before, we think we can ultimately sell them for about book value.

Finally, if you look at capital expenditures in general, this year we projected by $30 million 8 of that is about vineyard development, to finish the vineyard we had planted in the late '90s, short of that we think about 22 million of CAPEX, and we're actually running slightly below that so far.

So in this market, this is despite our performance a tough market, we're trying to keep the screws down on all spending that's unnecessary, while obviously spending money in those areas where it makes shall sense.

Okay.

That's great.

Thank you.

Our next question is a follow-up from Tim Ramey.

Hank you were mentioning the four to five million of cost benefit next year and I was curious about the dollar per case average cost increase in the quarter.

Part of that's the FIFO impact, part of it would be mitigated by cost saves next year.

How much of that dollar would have been just kind of the financial impact of FIFO, you know, continuing to flow through relatively high cost versus sort every current cost product?

I can't give you specific answer, Tim, but what I can tell you is, remember, what's going through cost of goods sold is two years old, and I can't do anything about that.

So we're also two years ago we're sitting at about -- my guess is about 12% internally sourced, and today we're approaches in the 25% level.

On top of all that, we've also shifted our mix to more R and W, which has raised our cost of goods per case.

So, I'll add one more thing to the mix.

We're selling some bulk wines, which obviously affects our gross margin, because we're not selling it for any kind of profit.

We're moving it as we said we were going to move through the system.

So I guess it's a long-winded way of saying I can't give you a specific answer, but if you take all those things into account, it bodes well for moving forward when you think we're moving more towards a internally sourced fruit, more towards the newer vintages which should help over the next few years, and, you know, we should get through some of those bulk wine sales as the year progresses.

Just on the timing shift on the reserve Cabernet, as I recall, that product is not like an Opus wine in that it sells out on the day it's released, it's a timing shift over a period of quarters?

Am I right on that?

We're actually moving towards a format that is more like Opus One or some of the other great Cabernets released, where we do offer the wine with usually some tastings and introductions with the trade and the press in a fairly significant crunch.

So generally speaking, there would be a significant sale as there has been in the past in March and April.

We now see that significant sale probably occurring in September and October.

It's not to say there won't be some sold subsequently through the fiscal year 05, but those kinds of wines don't behave like ordinary products, and they're not available all year.

So that the opportunity to buy into that reserve Cabernet program would probably be showing up mostly in September and October.

And if I'm doing the math right, am I thinking that's about a $6 to $8 million revenue shift?

At this point we haven't picked a number, Tim, but you know, in the past we've certainly seen something on the order of 5,000 cases of that wine being sold in the March-April time frame in a normal year, and because that wine has a high revenue and a high margin, you know, you could be looking at something on the order of ten cents in that kind of timing shift.

Thanks very much.

Our next question comes from Jeff Kanter with the prudential equity group.

Good morning.

Hank, what did California cost you in the first quarter, if you could put a number on it?

About a penny.

I'm sorry.

About 30,000 cases of -- you know, it's hard to measure totally, because some of that's moved between stores, but we think that southern California cost us about 10,000 cases a month, or about 30,000 cases of overall wine.

Obviously, that would be skewed towards the Woodbridge brand, so you know, probably one to two cents.

That's actually less than I think you were forecasting during your last conference call.

I think to the point our guys sales guys did a hell of a job to move it to other outlets.

It could have been worse.

I think that showed up on some of the other premise wines.

Some of your competitors were saying that the holiday-selling period was brutal as far as competitive and promotional and what have you.

Has that eased as we started new year?

Dennis, you may have looked at the recent Nielsens.

We saw some positive results.

I guess the way we look at it, Jeff, is we expect the competition to continue ad infinitum.

So that's our perspective on it.

They've seen pretty decent growth rate, I haven't seen the Woodbridge numbers yet, I'm sure they're sitting on my desk right now.

I would suspect the competitive nature of the category is going to continue.

I think we would characterize our outlook around that supply comment that, you know, no relief in site for six to 12 months from a promotional activity standpoint.

You know, the except to that would be the high-end wines that we talk about earlier.

But the goal, I guess, is try to work that mix pretty hard see Woodbridge whose pricing may still be a little under pressure.

That's right.

If you look at what's happened mix Weis during the quarter, we think number one it makes sense, it probably reverb rates with what's happening in other consumer products.

I think it speaks to both the diversification in the portfolio and our ability to sell a range of wines at the higher-end wine level, Robert Mondavi, some of the luxury wines are doing quite well.

We're seeing as you move down in price, where the grape supply affects the promotional behavior of competitors, particularly at the Woodbridge level, things are much more difficult, but the performance we have seen is the import portfolio, robbed Mondavi winery, our smaller luxury wines has helped to offset some of the promotional activity we're seeing in the more commercial side.

That said, though, were you surprised to see a domestic varietal wines basically flat given how the promotional, you know, the environment is right now?

Did that surprise you?

I don't think it did, Jeff.

This is Dennis talking, because weave seeing that for some period now.

So now so much a surprise there.

I would add a couple points to that, Jeff.

There's probably, you know, a 1% growth we would attribute -- if the southern California strike affected total wine sales to the degree it affected us, there's a point of growth that's accounted for there.

There's also channel-shifting going on as we pointed out in the comments, and we tend to refer to A.C.

Nielsen because the data is comprehensive, but there's clearly channel shifting that's not being included in the numbers we're looking at, and some of the other value-oriented channel it is to purchase wine that we think are showing growth.

Okay.

Thank you very much.

Thank you.

Our next question is a follow-up question from Skip Carpenter.

Thanks.

Just with regard to the guidance I want to make sure I'm reading it right.

On a reported basis, a penny to five cents in the upcoming fiscal third quarter.

That will be compared to the lost of 11 cents a year ago on a reported basis?

That's correct.

So we have the incremental expenses of roughly seven cents per share.

Was that that incremental expenses, have you factored that into your guidance of the $1.63 to $1.78?

Yes, we have.

Okay.

Therefore, I guess what I'm still trying to get a sense of is, why is there still such a significant range with regard to the fourth quarter on earnings per share outlook, given what you guys are talking about with the top-line outlook.

What is the, quote/unquote, area of uncertainly that could skew such a big range on the fourth quarter?

The area of uncertainly for us is twofold.

One is the wine market continues to be wild and woolly in terms of competitive behavior, as we've just talked to, Skip.

Number two, the components of growth we're looking at include a fairly significant reliance on new products that we feel quite confident about, but it's not the same thing as having an existing brand being put into the marketplace.

Because of those two factors, we think that range is still appropriate for the back half.

But then again -- fair enough.

I guess with regards to that seven cents that was incremental that was, quote/unquote, was new I would look at it as you guys bumping up guidance if that's not incorporated.

Is that a fair way to look at that?

What we have done internally to manage the business would be find other areas to cover those expenses that are showing up in the seven cents that are obviously high priorities.

So there are other things we have chosen not to spend on to offset that.

But, Greg, if I'm looking at it -- correct me if I'm wrong -- going into this year you were giving us a range, and then obviously you have these other charges, but then you didn't anticipate this seven cents of incremental expenses several months ago, so these are not baked into guidance you haven't changed.

I look at that in a sense that you are effectively bumping up the guidance a bit if you're keeping the same guidance yet taking on the additional seven cents of expenses.

You're right, we're absorbing this seven-cent number within our range, and we've been able to do that by changing other discretionary spending items so offset what we see as important areas to cover.

So, in essence, you're correct.

I know there's a lot of moving numbers here, so I wanted to make sure I was thinking about it correctly.

Thank you.

We have no further questions fit.

I'd like to turn the conference back over for any additional comments.

I think we're all done.

So thank you all for participating.

Ladies and gentlemen, thank you for participating in the Robert Mondavi second quarter fiscal year 2004 conference call.

You may now disconnect.