Constellation Brands Inc (STZ) 2005 Q3 法說會逐字稿

Hello, and welcome to Constellation Brands' third-quarter earnings release conference call.

For your information, all participants will be in a listen-only mode.

There will be an opportunity for you to ask questions at the end of today's presentation. (OPERATOR INSTRUCTIONS).

This conference is being recorded.

If you have any objections, please let us know now (OPERATOR INSTRUCTIONS).

Hearing no objections, I would like to turn the conference over to Phillipa Dworkin.

Ms. Dworkin?

Thank you, Brock.

Good afternoon, everyone, and welcome to Constellation's third-quarter conference call for fiscal year 2005.

This is Phillipa Dworkin, Senior Vice President of Corporate Communications and Investor Relations.

Richard Sands, our Chairman and Chief Executive Officer, is here with me in Rochester this evening; and Tom Summer, our Executive Vice President and Chief Financial Officer, is joining us via teleconference from our European headquarters in the UK.

By now, you should have had an opportunity to read our media release, which has also been furnished to the SEC.

This conference call is intended to complement the release.

During the call, we will discuss financial and fiscal information on a GAAP and comparable basis.

Reconciliations between GAAP and comparable basis measures are available on the Company's web site at www.cbrands.com under the Investors section.

These reconciliations include explanations as to why Management uses comparable basis measures and why Management believes that they are useful to investors.

Richard and Tom's discussions will generally focus on comparable financial results, excluding restructuring and related charges and unusual costs or gains.

Please also be aware that we may make forward-looking statements during this call.

While those statements represent our best estimates, actual results could differ materially from our estimates.

For a detailed list of the risk factors that may impact the Company's estimates, please refer to the media release and Constellation's SEC filings.

If you have further questions after the call, please contact our Investor Relations department.

At this point, I'll turn the call over to Richard.

Well, thank you, and good afternoon, everyone.

I hope all had a restful time over the holiday break and took the opportunity to sample some of our new brands in the Robert Mondavi and Ruffino portfolios, or perhaps our new vodka, Effen.

Since we last spoke, many strategic initiatives have come to fruition.

I am very pleased to be here today to discuss these as well as to talk about the solid performance of our business.

I'd like to begin with an overview of where I think we are right now as a Company.

I believe that we have put together the building blocks to return to our historic 15 to 20 percent EPS growth for the next few years.

We are firing on all cylinders, and anyone involved in the business can feel the momentum building.

Contemplating the reason for our momentum, I came to the conclusion that the engine for all of this activity and what Constellation is really all about, as well as everything we aspire to be, is true growth.

True growth, as we define it, is growth from any source that creates an economic profit, whether it comes from our existing product portfolio, new products, or from acquisitions.

All too often, companies overinvest and then underperform.

You see this time and time again when companies make acquisitions, overpaying and underdelivering.

You see the same scenario with companies and existing brands overinvesting in existing brands without the performance to generate an economic profit.

Or how about companies who, year after year, invest in new products that make them look as if they are on top of trends and growing dynamically, but none really perform?

This all looks like growth, but it isn't true growth, because there isn't an economic profit.

Being a bit immodest, that's what I believe sets us apart from most other companies.

We are achieving true growth from all categories in our product portfolio -- beer, wine, and spirits -- and all geographies of our business -- the U.S., Australia, UK, the rest of the world.

We are also reaping true growth from our acquisitions and high level of new product development.

I believe that generating true growth on a sustained basis will become even more important in the future as the industry undergoes continued intense consolidation over the next 10 years.

There will be consolidation at all levels -- brand (technical difficulty) distributors and retailers.

It is critically important that we extend our leadership position in this type of environment.

We are well situated to be able to read the trends and identify opportunities long before they become obvious, be they acquisitions, joint ventures, or new products.

We are able to seize the opportunities because we have a stable business that generates scale and the cash flow required for true growth.

Remember -- you need the milk to create the cream.

Our ability to generate true growth is what I believe distinguishes Constellation from other companies, and I believe our third-quarter growth and our recent acquisitions demonstrate this.

I'll start with the review of our dynamic growth during the third quarter by first looking at our imported beer portfolio, which continues to be strong, led by our Mexican imports and Corona extra.

Depletions, or sales to retailers, were up a few percent, despite the price increase at the beginning of the fiscal year and despite a soft beer market.

The strength of this business after the price increase represents true growth as we continue to get performance as we invest more SG&A in our Mexican portfolio and Corona.

Now, I want to give all a cautionary note.

Remember that distributors bought in against the price increase in the third and fourth quarters a year ago.

That's why net sales are down this third quarter.

But retailers bought in against the price increase in the fourth and the first quarters, with buy-ins and attractive deals to retailers.

So depletions and IRI comparisons will be poor through our upcoming fourth quarter of 2005 and our first quarter of 2006.

This does not reflect weakness in the brand, just timing differences in the flow of sales through the distribution channels related to the timing of the price increase.

I want to emphasize this for 2 reasons -- first, so that investors are not surprise, and second, so that all realize this is not a sign of weakness.

And therefore, it is not a cause for us to consider rolling back our price increase.

Corona outsells its nearest imported competitor 3 to 1 in our territory -- 3 to 1.

It should, and it has, taken a price leadership position.

And as we expected, slowly, market by market, competitors are moving up to Corona pricing.

So we are happy with our leadership position and explainable poor comparisons in the next 6 months will not concern us.

So don't let it concern you.

Moving to spirits -- our branded portfolio grew 4 percent in the quarter.

You will note higher net sales growth in total as production services grew more rapidly.

This spirits portfolio continues to benefit from innovation and overall category growth.

New products -- for example, like 99 Oranges -- continue to outperform our expectations.

And core products contributed to strong branded spirits performance during the quarter.

Our initiatives in spirits are focused on moving our portfolio toward more premium-priced brands.

Therefore, we are very pleased with the results for our Black Velvet Canadian Reserve whiskey and the recent reintroduction of 1792 Ridgemount Reserve bourbon.

And I will elaborate more on our premium spirits initiative shortly.

Our wine segment this quarter was the most significant contributor to our growth.

Our wholesale business on an FX-adjusted basis grew in the midteens.

And branded wines returned to the high single-digit growth rate we anticipated.

Our branded wine growth in the UK at approximately 10 percent continues to outpace the healthy category growth rates as we continue to benefit from strong consumer demand for Australian and premium California wines.

In our expansion markets, the story is much the same.

Net sales more than doubled in mainland Europe -- again, benefiting from the growing demand for Australian and California wines, which was certainly aided by the strength of the euro.

We continue to gain traction in the rest of the world, the non-European expansion markets, which include Canada, Japan, and Korea, and see substantial growth opportunities -- although on a relatively small base.

In the U.S., our overall branded wine growth of 8 percent is almost double category growth rates, and our growth rate reflects the favorable mix shift toward our higher-priced, higher-margin products.

What is driving this growth, and is it true growth?

Well, the incremental investments we have made to support focused brands such as Alice White, Hardys, Blackstone, or Ravenswood have gained as much as 20 percent more distribution for these brands.

And volume for these brands has grown in the range of 30 to 100 percent from a year ago.

Additionally, our fine wine portfolio -- Franciscan, Simi, Mount Veeder, Columbia, Estancia and new brands like Drylands from New Zealand are growing in excess of 20 percent.

Net-net, we deliver true growth, profitable growth, and growth in our target range of 6 to 8 percent across our business.

Now let's move to another source of true growth for the future -- acquisitions.

In December, we finalized 3 acquisitions that will generate true growth.

I'll go smallest to largest, beginning with our spirits investments.

We have made no secret of our desire to strengthen our position in the premium spirits market, and in late December, we became a 50 percent owner in a joint venture with jstar brands.

The objective of this joint venture, called Planet 10 Spirits, is to create and market premium spirit brands in the U.S.

The joint venture's first product is Effen vodka, a luxury brand imported from northern Holland.

This includes straight vodka and flavored vodkas.

First introduced to the market in 2003, Effen has already made inroads into key metro markets, including New York, Chicago, Los Angeles, and Las Vegas.

Our sales organization and distribution network will allow us to expand this product beyond its initial markets and significantly grow this brand in the U.S.

In addition to Effen, the joint venture will focus its efforts on developing new high-end spirit products for our strong distribution and sales network.

Moving onto the Ruffino transaction -- in early December, we became a 40 percent owner in the Italian fine wine Company Ruffino.

And effective shortly, we will become the U.S. importer of record for the Ruffino portfolio of products.

Ruffino's focus is premium Tuscan wines.

And Tuscany is the pre-eminent wine region in Italy, which makes Ruffino a great addition to our fine wine portfolio.

With nearly 600,000 cases of superpremium wines ranging from $10 to $40 per bottle, Ruffino adds to our U.S. scale and strengthens our position as the number 1, superpremium wine company in the U.S., a category that is growing in the midteens.

Finally, I'd like to talk about our acquisition of the Robert Mondavi Corporation, which we finalized on December 22.

I'd like to start with a few facts about our wine business as it stands today after that acquisition.

Constellation is the largest wine company in the world, with annual case sales of approximately 87 million cases.

This includes the 10 million cases from the Robert Mondavi acquisition and clearly strengthens our position as the largest wine company in the world.

The addition of the Robert Mondavi brands to our portfolio also makes us the number 1 wine company in the U.S. on a retail dollar basis -- and the number 1 premium wine company in the U.S. on a volume basis.

The definition for us of premium wines are wines greater than 5 50 (ph) per 750 milliliter equivalent.

But acquisitions are not about rankings.

They are about creating shareholder value above and beyond purchase price.

The Mondavi acquisition will do this in spades because it will generate true growth.

Strategically, the portfolios lineup very nicely.

Woodbridge fills a gap in our portfolio in the 5 to $8 price point, where it is the number 1 brand.

Robert Mondavi private selection adds to our arsenal of wines that sell for around $10, which includes top-selling brands like Blackstone and Ravenswood.

This is a hot price point for us.

And the addition of Robert Mondavi winery, Napa's premier wine brand, to our Franciscan portfolio creates the most sought-after portfolio of fine wines in the world.

In the U.S., the Robert Mondavi brands will benefit from our marketing expertise and distribution scale, which has enabled us to grow brands like Blackstone or Ravenswood at 20 percent plus.

Outside the U.S., the Robert Mondavi brands are underdeveloped.

Our distribution strength, particularly in the UK, should allow us to remedy this situation quickly and create substantial incremental growth.

In addition to revenue opportunities, this acquisition also creates cost synergies that will add incrementally to shareholder value.

A significant portion of these synergies is related to production costs, but that does not mean we intend to close facilities.

In fact, we need the production facilities in Lodi and Napa in order to keep up with the growing demand for our premium California wines.

We have tremendous opportunities to reduce our grape costs by selling unnecessary vineyards and better balancing the Mondavi grape supply across our much larger portfolio.

Our purchasing power will allow us to more efficiently source materials like packaging, barrels, and other wine making supplies.

And finally, I'll talk briefly about selling, general, and administrative cost synergies.

As we integrate Mondavi into our existing infrastructure, there will be significant opportunities to reduce the SG&A of the combined organizations.

Details will be discussed at a later date, once our plans have been finalized and announced internally.

Now in just a few minutes, Tom will share our forecasts for fiscal year 2006, which take into account the expected impact of these 3 transactions.

By leveraging our breadth and scale, we are creating true growth and the potential for 15 to 20 percent EPS growth over the next few years.

In summary, we had very good performance in the third quarter.

And we have laid the foundation for true growth that leads to sustained profit improvement and increased shareholder value now and for the future.

The portfolio power we have and our insight to read the market and seize an opportunity before it becomes a reality are core competencies of this company.

Our (technical difficulty) shareholders should and can expect more of the same.

Now I'd like to ask Tom Summer, who is joining us from the UK, to take us through the third-quarter results in detail.

Thanks, Richard, and good evening, everyone.

As Richard and Philippa mentioned, I'm joining you from Constellation Europe's headquarters here in the UK.

And it is getting late here, so I will get right to the business at hand.

As is customary, my comments will focus on comparable basis results.

Our net sales exceeded the $1 billion mark for the second quarter in a row, and were up 10 percent from a year ago.

Net sales benefited 4 percent from currency.

And on a currency-adjusted basis, net sales grew 6 percent from a year ago, in line with our target range of 6 to 8 percent.

Branded wines, spirits, and the UK wholesale business were the primary drivers of growth for this quarter.

For the first time in 9 quarters, our beer business was down.

As Richard already mentioned, the price increase on our Mexican portfolio drove significant volume increases in the third and fourth quarters of the prior fiscal year, as distributors bought product ahead of the price increase.

This has resulted in unrepresentative year-over-year shipment comparisons.

However, as Richard also mentioned, our beer depletions were ahead of last year, a very strong indication that our beer business remains healthy.

And once again, the breadth of our business enabled us to deliver strong growth on other fronts.

In our beers and spirits segment, the 2 percent decline in beers was more than offset by an 11 percent increase in spirits, driven by growth in branded spirits and production services.

And our spirits depletions were also up over last year.

In our wine segment, our branded wine business grew 11 percent, including a 4 percent benefit from currency.

Wholesale and other grew 20 percent, including a 10 percent benefit from currency, driven again by strong growth in our UK wholesale business.

Our gross profit grew 11 percent year over year, and gross margins were 29.1 percent, up 20 basis points from the prior year.

Sales, general, and administrative expenses increased by $19 million, or 17 percent, from last year.

As you know, we have made some incremental investments this year behind key growth brands in our wine business and also including additional support behind Corona and the remainder of the Mexican beer portfolio.

And last year, SG&A benefited from a one-time currency gain.

On a percentage basis SG&A was 12 percent of net sales compared with 11.2 percent of net sales a year ago.

Our general corporate expenses increased 3.2 million year over year.

Most of this increase was due to Sarbanes-Oxley 404 costs incurred in the quarter.

Like many companies, the cost of Sarbanes-Oxley 404 implementation has unfortunately exceeded our expectations.

Operating income increased 6 percent year over year.

Interest expense was down $1.2 million from last year's third quarter due to debt paydowns.

Our average borrowing rate for the quarter was just over 6 percent, which is in line with a year ago.

Our tax rate remained at 36 percent.

And as a result, our net income increased 9 percent in the quarter.

We had 116.7 million shares outstanding on a diluted basis compared with 114.2 million a year ago.

And comparable basis, diluted EPS grew 6 percent to 85 cents per share for the quarter.

Now I'd like to spend just a few minutes on our cash flow and balance sheet before wrapping up with our outlook for the remainder of the year.

Our year-to-date CapEx has been $78 million, and depreciation and amortization was $74 million.

Year to date, we have generated $3 million of free cash flow, which we define as cash flow from operations minus capital expenditures.

As you know, the fourth quarter is our largest quarter in terms of cash collections and free cash flow, and we do expect to generate a record fourth-quarter free cash flow this year.

At November 30, our total debt stood at just over $2 billion, and our debt to trailing 12 months adjusted EBITDA stood at 2.9 times.

In connection with the Mondavi transaction, we replaced our bank facility with a new $2.9 billion facility which we funded on December 22.

Currently, our total outstanding debt stands at $3.4 billion, including 2.4 outstanding under the new credit facility.

The new credit facility is composed of 2 tranches -- a $600 million term loan A and a $1.8 billion term loan B with a $500 million revolver.

Interest rates on the new credit facility are floating-rate, with initial spreads ranging from 150 to 175 basis points over LIBOR.

I would like to note here that S&P and Moody's reaffirmed our ratings as this financing was coming to market.

The combination of our market timing and our strong track record of generating free cash flow allowed us to get the new bank facility at very favorable rates.

However, we felt the resultant level of floating-rate debt was higher than prudent in a rising interest rate environment.

To mitigate our interest rate exposure, on December 22, we entered into a series of interest rate swaps with a term of 5 years, during which our LIBOR rates are fixed at an average of 4.0 percent on 1.2 billion of our floating-rate debt.

After giving effect to the swaps, our average fixed rate to floating-rate debt over the swap term is about two-thirds fixed to one-third floating.

Now, as Richard already mentioned, besides closing on Mondavi, we also closed on Ruffino in early December and closed on our high-end spirits joint venture later in the month.

So overall, December was a very busy month for us.

So before I wrap up, let me make a few comments about our expectations for Q4 and for our coming fiscal year, 2006, which includes the expected impact of these acquisitions.

We are reiterating our full year guidance of $2.62 to $2.67 per diluted share, which means we are targeting 54 cents to 59 cents per diluted share in the fourth quarter of this fiscal year 2005.

With respect to fiscal year 2006, we believe with the acquisitions we closed this year, our EPS growth rate will accelerate to the 15 to 20 percent range.

As a result, we are targeting fiscal year 2006 comparable-basis diluted earnings per share in the range of $3.05 to $3.20.

And just one additional comment on this fiscal year 2006 guidance -- this does not include the impact of FASB 123R on share-based payments which the Company will be required to adopt during our fiscal year 2006.

To briefly summarize, we are very pleased with our third-quarter results.

Net sales growth was in line with our long-term target range of 6 to 8 percent, as growth in our wine and spirits businesses drove another strong quarter.

Our third quarter results clearly demonstrate the underlying strength of our business and the benefits of our diversified portfolio.

That concludes my prepared remarks.

And now we will open up the call for questions.

(OPERATOR INSTRUCTIONS).

Marc Cohen, Goldman Sachs.

I guess I would like to understand a little bit more about the beer comps, Richard.

I am comforted by your comments, but I would really like to understand the patterns a little more.

In particular, I was a little confused about why you would think that the load-in last year would be showing up in retail trend data.

I can understand how it shows up in sales to distributors and sales from distributors, but not retail.

So could you talk about how that impacted the business last year in a little bit more granularity and maybe with (multiple speakers) some numbers around it?

Yes.

The way it works is that when the retailers bought in from the distributors against the price increase, they also gave very good deals to the consumers.

So they took in a lot of goods and were far more aggressive in their pricing to consumers in advance of the price increase going up to them and them ultimately going up to the consumers.

This was also exaggerated by the chains coming off strike in California, where, even after the price increase, the chains for quite awhile didn't go up to the consumer in their price because they were trying to attract consumers.

So we're going to have very difficult comparisons on IRI as -- if you look at the type of IRI increases that occurred during that period, you will find they are very high, abnormally high.

So if the brand was tracking at up 6, 7 percent -- you go back and look at those periods, there was double-digit growth during those periods at the IRI level.

So if I understand it right, we have one more quarter, in the fourth quarter where shipping (ph) comparisons are tough, then 2 more quarters where depletion comparisons are tough and retail comparisons are tough?

Yes.

I'll call them IRI comparisons, because that's the only real measure we have of retail movement to the consumer.

Okay.

I know you don't want to go into specifics on the synergies with the Mondavi transaction, and I don't know if there's any with the Ruffino transaction.

But Tom, could you give us at least some sense of what you are building in in a gross sense when you look at this 3.05 to 3.20 number for next year?

Yes.

I think that -- first of all, Marc, as I've commented before, it isn't just -- it's synergies on all levels of the P&L.

But I think if you think about it, we are probably -- out of the 15 to 20 percent -- and we are still, obviously, finalizing our plans.

And so we don't have this buttoned up to the last dollar.

But probably something in the range of 3 percent to 5 percent of that is coming from accretion.

So you can take the math from there.

Nick Booth (ph), Wellington Management.

Good quarter.

A couple questions.

UK -- could you talk about the margin?

It looks like margins were off a little bit in the distribution side.

Is there some kind of a currency explanation there?

And then, secondly, could you just talk about Woodbridge?

What can you do that Mondavi wasn't able to do on getting Woodbridge growing again as a brand?

Yes.

First of all, on the distribution side or the wholesale side, I don't know where you would get the sense that margins are off.

I'll take a look again.

I thought they were off, but --

-- because we are reporting margins for wine and wholesale together.

Sales are reported separately. (multiple speakers) So there isn't any material margin compression in wholesale.

But what, obviously, you always have is -- there is increasing margin in the branded business as a result of this mix shift that we talked about.

And as wholesale grows faster, and it's a lower margin, it offsets the benefits.

And so in our wine business, we basically had roughly even margins, quarter to quarter.

Okay?

So hopefully that clarifies (multiple speakers) the first question.

Second question?

Woodbridge -- what can you do that Mondavi was not able to do with Woodbridge?

Do you see as a growth brand again, or is it a brand where there can be better execution and maybe some higher margins, but the volume really doesn't ever get back to where it had been a few years ago?

Do you mean in the United States?

Yes.

Okay.

It's a good question, Nick.

First of all, we feel that actually Woodbridge by Robert Mondavi over the last 3 or 4 years has actually performed very well, given that it has been attacked from 2 sides -- one being the super-value wines and the other being the Australian imports.

And so it's marginal declines.

These are not big declines, it's marginal declines.

And of late, its stability we consider to be a demonstration of its brand strength.

Now, first, there is less and less pressure from the super-value wines.

As marginal grape costs have gone up, you just can't produce wine and sell it for $1.99.

Too, I think we're seeing that the consumer and the retailer are moving away from that proposition.

So the growth that had been present there is now turned into declines.

That's going to benefit Woodbridge.

2, our strength with the distributors will give Woodbridge an advantage.

So we translate those 2 components into -- we're not going to see dynamic growth, but we should see stable to slight -- single digit, low single digit growth.

So for Woodbridge, what's most important is actually getting the cost structure in line as it should be for a brand of that size in that position at that price point.

Where the growth is going to come from will be Robert Mondavi Private Selection, which has been growing and we think can do very well in our portfolio, and certainly Robert Mondavi Winery -- Napa, which actually for a number of years has been in a state of decline.

Recently, it started growing again.

But with our focus, and it being a flagship brand, we think we can bring that back up to the levels of the past.

Then, the international markets are just an open playing field for us versus what Mondavi was able to accomplish.

Bryan Spillane, Banc of America Securities.

Just 2 questions. 1, Richard, if you could talk a little bit about the pricing environment for wine in the U.S. right now, both at the low-end and at the premium -- kind of what we have seen as we've moved through the holidays.

And then second, Tom, could you talk a little bit about free cash flow goals, I guess, for the new company for '06 and beyond?

I'll give you the first answer, as you requested.

The pricing environment actually through the end of November, which is really all that we have hard data on, has actually been pretty good for wine pretty much across categories.

You see a little upward movement in pricing, maybe 0.5 percent to 1 percent.

This reflects the fact that the grape market is tightening.

You actually see, as I've suggested, the most price increase in the value segment -- less than $3 a bottle -- reflecting what is going on in the 2-buck chucks (ph) and what is going on in the generic category, where grapes were again more expensive.

And so products like Almaden Chablis, Inglenook Burgundy -- prices are being moved up -- actually started to be moved up towards the end of that 12-week reporting period ending 11/28/04.

So the pricing environment is looking firm and good.

So the reason that I don't -- and we didn't make a big deal of it is 1 quarter doesn't really necessarily mean that you are absolutely guaranteed that the market will stay that way.

Through the holiday season, we didn't see or hear of anything that I would call unusual or that I would suggest is a sign of deterioration.

And we don't have the data to tell you if in fact the market firmed 0.5 percent or so.

Shall I take over with free cash flow, Richard?

Yes, please, Tom.

Okay.

I think, first of all, it is a little bit early in our planning process to get incredibly definitive, but I'd say a few things.

First of all, our base business -- prior to Mondavi, we certainly would expect continued growth in our free cash flow, up higher into the 200's next year.

Mondavi certainly -- before we acquired them, had disclosed an EBITDA approaching $100 million.

We are obviously going to affect that positively with synergies.

There shouldn't be a huge amount of working capital increases.

And we have already stated that the target for their CapEx would be about $25 million.

So I think that the sense I would want you to have from that is that, on an operating basis, the addition to our own base free cash flow from Mondavi should be significant, although we haven't firmed up any numbers.

And I would also add to that we are continuing to pursue some dispositions of marginal assets, which will also contribute significantly to our ability to pay down debt.

So those are both very positive things for us.

Okay.

And, Tom, just to be clear also, that your free cash flow or use of free cash flow here in the near-term is going to be just strictly just to pay down debt?

Yes, no change in strategy there.

Marc Greenberg, Deutsche Bank.

Tom, first, just a quick follow-up on the cash flow question.

In fiscal 2006 as we look forward, is it realistic to see the current $3.4 billion in debt work off to the tune of 500 million in year 1?

Are we talking about asset sales of that magnitude plus existing cash flows and Mondavi synergies?

Well, again, I think we're not prepared to give specific guidance, but that number certainly isn't out of the realm of possibility.

Okay, great.

And then maybe you could talk more broadly about how you think about debt coverage ratios, where this puts you right now with the 3.4 billion as of, and what kind of level you think you would like to work toward in the intermediate-term.

I think as we get to the end of our fiscal year, we would look for a debt to EBITDA number to be in the low 4's.

And probably we said that with our rate of debt pay down, we can reduce that by 0.6x or 0.7x per year.

So you are probably talking the end of our fiscal '06 being in the mid 3's.

Richard, if I could ask a follow-up question on trends in revenue per case, can you talk more specifically about wine trends in the quarter?

I know you said prices are firming.

Earlier, in prior calls, you talk about mix improvement as a key catalyst in the portfolio.

I wonder if you could just update us on how mix contributed in the quarter, and if you believe that that $10 wine price point in particular has got firm prices right now.

Yes.

First of all, mix continued to contribute very healthfully to the quarter, in that our fine wine portfolio -- bottles selling for $10 and above -- is growing the fastest.

The next fastest growth category is what I would call that 8 to $10 price point, and then your basic premium wines followed by your value wines.

So right up the ladder, you see higher growth rates as you move up in price point.

And it's a very difficult exercise to really say how much that contributes.

But of our 8 percent growth on an FX-adjusted basis, I would say 1.5 percent to 2 percent is coming from mix, which, again, we think is good.

It's actually better to have that than just everything being volume and volume alone.

The pricing per case -- our pricing per case without mix actually has not that much of an impact at this point in time.

There are some areas, as I mentioned, where we and the industry are taking price increases -- again, your generic value wines both in glass and in box.

But as a part of our total business, it's not having a material impact.

Just as a follow-up to that -- again, I know it's early.

But are you seeing signs from your key major competitors where they have the dominant brand in a particular category, that they are also looking more constructively toward price, and in some cases, taking price up?

Well, the answer is it's hard to look at it that way, because our key competitors, especially in the popular-priced -- yes, in the popular-priced area, it's definitely happening.

Okay?

You can see it.

But we all tend to be very market-by-market pricers, so there's nothing, no data to look at.

It's far more by field.

As you move up into the premium, superpremium, ultrapremium category, it isn't like being able to look at Budweiser or to look at Gallo.

There isn't what I would call a real, true key competitor.

There are many brands.

And we are the leader, because we have the most brands with the greatest momentum.

But taken as a whole, all of these brands are gradually increasing their prices very, very slowly (multiple speakers) is what the data shows.

So just to clarify, then, you're feeling as though Gallo as a key competitor is looking more toward price improvement on the popular side?

Definitely on the value glass, the generic business, especially where grape costs went up significantly.

Bill Leach, Neuberger Berman.

Tom, I was just wondering if you could give us your approximate interest expense forecast for 2006 that you are using to predicate the EPS forecast?

Yes.

Again, it's still a little bit rough, Bill.

But I would do something in the range of 200 to $210 million.

And just to be clear on the swap, you fixed the LIBOR portion of the borrowing rate?

Yes; we swapped.

We are paying a fixed rate and receiving LIBOR.

And then we are obviously paying LIBOR against the bank deal.

So on the swap, you have the 4 percent fixed, and then you have the fees on top of that, the 1.5 or whatever it is?

I'm sorry.

What fees?

Well, in your press release you talk about LIBOR plus --

Oh, okay, right.

So the 4 percent -- you would add the spread on top of the LIBOR.

So it would be -- at our current spread, it would be a 5.5 to 5.75 percent fixed rate.

So that's basically fixed, then; right?

Yes.

Kate McShane, Smith Barney.

Going back to the cost synergies with the Mondavi transaction, I know, again, you're not getting too specific.

But just to be clear, the synergies that you are referring to is more than just the cost synergies that you will realize.

Does it include the expansion of the Mondavi brands abroad in your 2006 assumption?

Do the synergies include those?

We would call those revenue synergies.

Right.

You know, I'm just trying to be clear.

Are the synergies that you're talking just cost savings, or is it the additional revenue that you will be getting (multiple speakers) --?

Well, we actually talk about both.

We talk about revenue synergies or our ability to generate incremental revenue.

And then we talk about cost synergies.

So we believe there will be both revenue synergies and cost synergies.

And then, secondly, now that you have closed these 3 acquisitions, what is your acquisition strategy going forward?

Is it going to be focusing on digesting these companies and expanding their businesses and paying down their debt?

Or, if the right opportunity comes along, you'll make a bid for that company and then focus on the rest later?

Or is there a timing with that?

Yes.

I would say it's really always as it has been.

Especially with our decentralized organization, where our business units are very close to their customers and their markets, we're very capable of making acquisitions while, at the same time, a couple of business units are integrating an acquisition, even one of the size of Robert Mondavi.

So we will continue to explore acquisition opportunities.

And certainly, if acquisition opportunities present themselves that meet our strategic objectives and our financial discipline, we will seize the opportunity.

If you look at strategically what we would like to accomplish, we still would like to broaden our spirits portfolio and, in particular, further develop our premium or midpremium spirits business.

And we would continue to look to strengthen our international routes to market, especially in our expansion markets that we talked about.

So those would be our strategic priorities, which do nicely complement what we're doing with our current integration of our acquisitions.

Jonathan Feeney, Wachovia Securities.

Just 1 for Richard and 1 for Tom, if I could.

Richard, you had some terrific performance here in some of these new spirits innovations -- any competitive response?

And I guess as you start growing off a bigger and bigger base here, do you see competitive pushback in the areas where you have been successful recently?

And the second question, for Tom, is -- could you refresh my memory and all our memories a little bit about this 21-cent inventory step-up?

Is this the last -- is this kind of a first crack at what you guys are going to do with all this new inventory, or is this kind of a finalized thing?

I will answer first.

First of all, for our branded spirits portfolio to grow 4 percent, a lot of that is coming from our base popular-priced business and basic category growth.

The inroads that we are making into premium spirits are still relatively small, and not what I would say would be of the magnitude that would result in a competitive response.

So, to date, we are growing our business very nicely in its base component and adding to it very nicely and improving the mix without a lot of obstacles.

And on the question about the inventory appraisal, as you know, the process is a fairly detailed one.

We engaged an outside appraiser for an independent assessment of our inventories.

A lot of that work has taken place, but there is still more work to take place before the process is complete.

So this is a preliminary estimate.

That said, we do have a lot of experience.

We were comfortable enough with this preliminary estimate to share it with our investors.

So we are comfortable with it, but it is subject to change when the final appraisal does come in.

Tom, I just think it may be worth adding to that the fact that we actually don't use a range and we just put 21 cents shouldn't (ph) mean that this is a fine estimate at the stage.

Jeff Kanter, Prudential.

Tom, question for you.

How much did it cost to establish the joint venture with Effen, and how much will it cost going forward?

How does that work?

When you say how much did it cost -- it was about $9 million for our share of the joint venture.

And I would say that in terms of the cost going forward, it really is a startup.

We think it has a lot of potential.

But we would expect it to be approximately neutral in our next fiscal year.

Fair enough.

And cash flows have been pretty poor.

They are going to turnaround, I would imagine.

Did you say that in 2006, your base business free cash flow is going to be around $200 million?

Is that correct?

No, I said it should be moving up into the 200s.

Into the 200s?

Yes.

Okay.

And why have cash flows in the quarter -- why were cash flows poor?

Well, I think that if you look at our year-to-date cash flow -- you know, there is always timing differences with cash flows.

In our prior fiscal year, we were -- in the early part of the year, had a much lighter Australian harvest and were burning down a lot of inventories in Australia versus where we were this year.

And there were also timing differences in our tax payments and other miscellaneous timing differences between last year and this year.

So it is going to be a big fourth quarter.

We expect to have a fairly large improvement -- a very large improvement in working capital that really drives every fourth quarter improvement.

But it's going to be particularly strong in this fourth quarter.

Yes, and 2006 should be good as you liquidate Mondavi's inventory, I would imagine?

Well, even before we do that, it will be good.

But it will be even better because we do that.

Which makes sense.

Now, just so I'm clear, and not to beat a dead horse -- the guidance includes all the synergies -- topline, SG&A savings, the whole thing, right, from Mondavi?

Yes, that's correct.

Okay.

And I know that you don't disclose currency impact to the bottom-line.

But assuming it was somewhat similar to the topline, is the lack of leverage just due to the mix, UK wholesale and the spirits business, production services business?

Yes.

I think that, first of all, this kind of growth is partly a factor of the investment we made behind our brands.

And the other piece is just the slightly higher cost of Sarbanes-Oxley and things like that.

So we had some 1-time things this year.

It's not as much mix as it is our investment behind the business.

And how much was that investment?

(multiple speakers) but that was planned.

That's right.

And now that its kind of done and 1-time, how much was in?

Well, first of all, its many, many different components.

It's the focused brand investment that we talked about.

It's the increased SG&A in beer, combined with the fact that we are in a quarter of low -- sales are actually negative comparisons.

So you really can't put it in terms of -- it was a x million dollar investment. (multiple speakers) That's what caused the lack of leverage from the topline growth to the operating income growth, or what resulted in our margins staying constant.

(multiple speakers) We talked about this from the beginning of the year and that actually, as we go into 2006, you'll see that situation right itself.

But there's no quantification of the 1-time investment that Tom was talking about?

No, because it's not 1-time investment.

The investment level may stay the same in dollar amounts.

But the sales levels will be higher.

So as a percent, the investment level will be lower.

(multiple speakers) The other thing I just want to clarify is you made a comment at the beginning of the question about currency.

And while the currency benefited our topline by 4 percent, I think you're aware -- we have a hedging program so that the currency impact on our operating income is minimal.

So the effect of -- the currency isn't what impacted this equation.

You really need to look at 6 percent core topline growth and how that translated down through the P&L.

Mark Swartzberg, Legg Mason.

Thank you, Tom, for that detailed response to Jeff's question.

I have 2 questions.

First, wrapping up free cash flow and then moving into the improving wine topline outlook -- on the free cash flow, what level of free cash flow are you looking for for fiscal '05?

You had last said you'd like to get something on the order of 235 million.

It doesn't sound like that will happen.

And then my follow-on -- you appear to be, obviously, readying for some incremental rates of growth, which would explain that.

But could you give us a number for starters?

And then I had a follow-up.

Well, you know, Mark, we haven't thrown in the towel yet.

And it's still our goal to replicate last year's number.

We do -- there are a number of timing issues.

We certainly think we're going to be over 200.

But we are pushing to replicate last year.

And it's still our target.

And it's just too soon to call right now.

And then -- I don't know if it's Tom, Richard, both.

But obviously your topline for wine is not only improving, but your outlook is improving.

It seems like it's well founded.

And while the market gives you some basis for that, you guys seem to have regrouped pretty effectively on a pre-Mondavi basis.

As you kind of try to rank order how you're looking at the world differently and approaching your business differently, what do you think is most important?

Is it simply some of the organizational changes you undertook several months back?

Is it the incremental focus on innovation?

Is it distribution?

I know it's a combination.

But if you had to rank order, what really ranks here in terms of what you have done?

What we have done that distinguishes us from our competition, or what we have done differently in the past?

Differently from the past.

The wine business is still tough.

It's improving, but it's still tough.

But your own outlook is upgrading considerably.

So in my opinion, that's a function of you guys getting even more on top of your game.

So my question is what are you doing differently?

I wouldn't say that.

I would say we're doing what we have been doing in the past and staying very focused on the markets, the categories, and investing behind those pieces of business, whether you call them brands or geographies, that have the most potential to give true growth, a return on your investment, an economic profit on your investment; and that after we made the Hardys acquisition, we tried to explain to all that it would take time to see the fundamental growth potential of what we had acquired and what we're putting together.

And we are just beginning to see that.

Now, I do think the environment is improving slightly.

But even when the environment was at its toughest, and the naysayers were talking about grape gluts and the deteriorating margins and this and that, we did very well.

We had growth in our wine business.

And we were investing where we thought we could get the most bang for the buck.

So it's just a continuation of sticking to it, and most importantly, having an operating style and an organization that is very responsive to the markets and the categories.

And that's what you get when you, yes, have a worldwide organization, but where people are accountable and people have a closeness to their customers and their markets.

So I just see it as a continuation of the same.

We now have time just for 1 more question.

Operator?

Timothy Ramey, D.A.

Davidson and Company.

Bringing up the rear here.

Richard, congratulations, number 1.

And, number 2, I think Tom mentioned in his remarks that there would be some minimal or small dispositions.

Can you talk a little bit about the status and the ability to retain Opus and Ornellaia in particular?

I know Byron and Arrowwood were previously announced as still likely to be sold.

Well, from a strategic perspective, the Robert Mondavi brands are what is important in this transaction.

And we are evaluating basically how interested we are in maintaining these relationships versus the benefits of liquidation.

So certainly, as you mentioned, Byron, Arrowwood -- that determination has already been made.

But the important part of this acquisition is the Robert Mondavi brands, which consist of those 3 brands.

So I know that's not a direct answer.

But it lets you understand how we approach it and where we'll be going.

And just on these liquidations, there's also asset liquidations -- in particular, vineyards that can generate a good deal of free cash flow.

So it sounds like there could be more than just a small amount of cash flow generated from dispositions?

Again, it depends on your definition.

But yes;

I think is a nice chunk of change out there.

And just to reiterate what I think you said earlier -- your plan for the Robert Mondavi winery is not to cut the size of the brand in half and lay off a third of the workforce and eliminate the sales force?

Yes.

It's more in line with growth.

Yes, absolutely not.

The brand is approximately 300,000 cases today.

It was 500,000 cases at its prime.

And as you recounted, the plan had been to cut it in half, and actually focus on cabernet.

We're exactly the opposite.

Our plans are to bring the heritage back and bring it to that past level of predominance that it had as an acre (ph) brand.

Okay.

Well, thank you, everybody, for your time.

We wish you all the best for the new year.

And I think for those of you who are very involved with us, followed us for a long time, I hope that you feel the momentum building the same way that we who work every day in the business feel it.

It's really a very exciting period of time for us.

And I think it's going to be exciting for the next few years.

And, by the way, I hope it's going to be exciting beyond that, but that's as far as I can see right now.

So thanks, everybody.

The conference has now ended.

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