Constellation Brands Inc (STZ) 2006 Q1 法說會逐字稿

Hello, and welcome to the Constellation Brands fiscal year 2006 quarter one earnings release conference call.

As a reminder, 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.

An Operator will give you instructions on how to ask your questions at that time. [OPERATOR INSTRUCTIONS] This conference is being recorded.

I would like to turn the call over to Lisa Schnorr, Vice President of Investor Relations.

Ms. Schnorr, you may begin.

Welcome to Constellation's first quarter 2006 conference call.

Richard Sands, our Chairman and Chief Executive Officer, and Tom Summer, our Executive Vice President and Chief Financial Officer, are here with me this morning in Rochester.

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 statistical information on a GAAP basis, comparable basis, and pro forma basis.

Reconciliations between GAAP and comparable basis, and GAAP and pro forma measures are available on the Company's website, www.cbrands.com under the Investor section.

These reconciliations include explanations as to why management uses comparable basis and pro forma basis measures, and why management believes they are useful to investors.

Richard's and Tom's discussions will generally focus on comparable financial results excluding acquisition-related costs, restructuring and related items, and unusual items.

They will also discuss certain pro forma net sales information after giving effect to Robert Mondavi brands, as if the brands had been in the Company's portfolio in the same period a year ago.

As noted in our press release, we recently affected 2-for-1 stock splits of Class A and Class B common stock, distributed in the form of stock dividends.

All share and per share amounts referenced during this call will reflect the impact of the splits.

And 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 our SEC filings, and if you have any follow-up questions after the call, please feel free to call Bob Czudak or me.

And now after going through that litany of legal language, I'd like to turn the call over to Richard Sands.

Good morning, everyone.

I'm really pleased to be here with you today to discuss our first quarter fiscal 2006 results, and that's because we had a great quarter in which we delivered top-line growth and earnings-per-share at the high-end of our range.

Also as you know earlier this week Standard & Poors announced that they will be adding Constellation to the S&P 500 index.

We're proud of this milestone accomplishment, and clearly we have a lot to celebrate.

But we're here this morning to review our first-quarter results, so let me get started.

Our reported net sales which include acquisitions grew a healthy 18%.

Our base business which excludes the net sales from Robert Mondavi and Ruffino brands contributed 7%.

Currency contributed 2% to the first quarter net sales growth.

Continued growth in existing products, introduction of new products, and strategic acquisitions, contributed to growth across all product categories in the first quarter.

Branded wines and imported beers registered the most impressive gains with 36% and 10% growth respectively.

Our imported beer business continues to be very healthy, performing extremely well in the first quarter despite a very competitive domestic beer environment in the U.S.

According to IRI food and drug data for the 13 weeks ended June 12, 2005, volume for our Mexican beers portfolio was up 7.3% versus a year ago.

While total domestic volume declined 2.3% during the same period.

Corona Extra, and Corona Light grew 4.7% on a combined basis demonstrating the strength of the brand and its positioning with consumers.

We believe imported light beer is a significant growth opportunity, as demonstrated by the growth of Corona Light.

Last year, we introduced several new Corona Light specific advertisements designed to support the brand's stand-alone identity.

This campaign is a variation on the long-running and very successful kick-back-and-relax lifestyle positioning of Corona Extra.

Keep an eye out for more of these Corona Light advertisements which recently began airing on television this season.

The remainder of our imported beers portfolio Pacifico, Negro Modelo, Modelo Especial, St. Pauli Girl, and Tsingtao all registered gains in the first quarter.

Based on the strength of our beer business in the first quarter, we're optimistic we can meet our full year expectations of mid-single digit growth.

Now moving on to spirits.

Our spirits business grew 8% overall, due to significant growth in production services off a small base, partially offset by a 3% decline in branded spirits.

The year-over-year decline in branded spirits was due primarily to the timing of new product introductions, including 99 Oranges and Chi-Chi's blue raspberry lemonade a year ago, and reduced shipments of tequila.

Consumer demand for our branded spirits products continues to be strong.

Based on IRI data in the food and drug channel our branded spirits volume was up approximately 5% versus last year on a calendar year-to-date basis.

We continue to focus on new products to support our strategy of moving our portfolio mix towards premium spirits products.

Ridgemont Reserve 1792 Kentucky small batch bourbon, which was induced to the market last year, is now available in 32 states, and will be available in 40 by the end of the calendar year.

We are also beginning the rollout of two additional premium products, Balblair Single Malt scotch and Danfield's Canadian whiskey.

Effen, our new luxury vodka through our plan of 10 joint venture, is being rolled out nationally and is receiving great marketplace acceptance.

We're truly excited about the opportunities for our spirits business and will continue to look for opportunities through new product development, acquisitions and partnerships to expand our presence in premium spirits, and leverage our position as the third largest spirits supplier in the United States.

Now moving on to our wine segment.

Starting with our wholesale and other business, wholesale and other grew 3%, and was down slightly on a currency adjusted basis.

Growth in the U.K. wholesale business was offset by a reduction in our other business, including cider and our commodity concentrate business, which we divested last year.

Our Matthew Clark wholesale business posted mid-single digit growth on a currency adjusted basis as expected.

Matthew Clark is the largest independent wholesaler in the U.K. with access to approximately 20,000 on-premise accounts.

This will be an important route to market in the upcoming international expansion of the Robert Mondavi brands.

Now moving to branded wine which benefited from acquisitions, new product introductions, and growth of existing products during the first quarter.

Overall, our branded wine business grew 36%, excluding sales of Robert Mondavi and Ruffino products branded wine net sales grew 8% including a 3% currency benefit.

Looking across our geographic markets, Australia Asia was up 16% including a 7% benefit from currency.

Our European branded wine business grew 13% in the first quarter including a 5% benefit from currency, and a small contribution from sales of the Robert Mondavi brands.

Competition in Australia and Europe, particularly the U.K., remains fairly intense due largely to an abundant supply of Australian wine and ongoing retail consolidation.

We continued to grow our revenue and market share in these markets despite this competition, by leveraging our position as a market leader by offering our large retail customers value-added services, such as category management that helped grow their business, and by continuing to introduce a steady stream of new products that consumers want, like Turner Road or Hardys Voyage in the U.K.

As new products go, we're particularly excited about the upcoming international launch this summer of Robert Mondavi.

The new products, Robert Mondavi Woodbridge and Robert Mondavi Private Selection, were developed specifically to address the taste profile of the European consumers.

The lineup of new Robert Mondavi products was unveiled at the London Wine Trade Fair last month, and should be on the retailers's shelves in the U.K. later this summer.

The initial response has been very positive, in fact, we've already secured listings in nearly all of the major retail chains.

We're very enthusiastic about the prospects from this new product launch, and the international potential for the world renowned wine brand.

Now moving to the U.S. wine market, branded wines in the U.S. grew 54% including contributions of Robert Mondavi, Ruffino brands, and new products.

Our ability to understand and respond to consumer taste is evident in the introductions of our Twin Fin line of California wines, and Monkey Bay sauvignon blanc from New Zealand.

These products contributed nicely to our first quarter growth and seem to be very popular with consumers.

Monkey Bay which was introduced in February, has quickly become the single best-selling New Zealand sauvignon blanc in the United States.

New products will continue to be an important growth driver for us, and we have a steady stream of new products that will be introduced in the U.S. market this year, including The Jibe from New Zealand.

We also continued to benefit from growth in our existing brands, driven by incremental investments and increased distribution.

Blackstone, Ravenswood and Alice White were up 17%, 48% and 22% respectively according to IRI data for the 12-week period ending June 12, 2005.

Clearly our success with new and existing products, is proof that we're in touch with our consumers.

In an effort to further improve our insights into the minds of premium wine consumers, we've undertaken ground-breaking consumer research, and the results will be shared with distributors and retailers this fall.

The insights we gain by understanding our consumers better will provide value to our operating companies and business partners.

A Review of our U.S. wine business would not be complete without an update on the Robert Mondavi integration.

Quite simply, the integration of Robert Mondavi into the Constellation family is moving along just as we expected.

As we mentioned back in April, the integration of sales, marketing and production was completed before the end of our last fiscal year.

Since then, we have been primarily focused on the back office integration which is essentially complete.

The international expansion of the Robert Mondavi portfolio into Europe is in process, and sales of nonstrategic assets have also progressed as planned.

Tom will provide a brief update on that in a few minutes.

With the Robert Mondavi brands now fully integrated into our portfolio, we're moving forward with our plans to reinvigorate those brands and unleash their full growth potential.

Based on recent IRI data Woodbridge volumes have stabilized over the past several months following a 12 month stretch of slight volume declines, Robert Mondavi Private Selection, which is the largest brand in its price segment, has continued to grow year-over-year, however, the rate of growth has slowed a bit.

As the marketing programs kick into higher gear later this year, we expect these brands to capture their fair share of growth in their respective price segments.

To summarize the Robert Mondavi acquisition, this has been a great addition to our organization.

We have strengthened our portfolio of premium and fine wines, our European distribution infrastructure provides a great platform for international expansion, and our infrastructure has enabled us to immediately extract SG&A synergies and contribute to the bottom line.

Now, moving to a different topic, there has been some media coverage about the excess Australian wine supply, so let me take a few minutes to give you my perspective on the situation.

Exports which represent approximately 60% of the global sales of Australian wines are continuing to grow in the mid-teens.

It is very important that the supply grow to keep pace with this demand.

Most categories of Australian grapes are in balance.

Some grape varieties like Chardonnay had been relatively short in supply and, therefore, actually benefited from the strong 2005 harvest.

However, there is currently an excess supply of Australian wine primarily in premium-priced cool climate red varietals.

As a point of reference, cool climate varietals accounted for 39% of the 2005 total tonnage intake, but only account for approximately 15 to 20% of sales volumes.

Now, Constellation's intake of cool climate varietals is at 13% of our total 2005 harvest.

This is much more in-line with our sales forecasts for cool climate varietal wines, than the industry as a whole.

We believe it is always better to be in an oversupply situation, than it is to be in an undersupply situation, as long as you're properly managing inventories and forward contracts.

We have demonstrated our able to manage our inventories and grape contracts, and believe that this is a particular strength of our Company.

Now before I wrap up, I'd like to make a few comments about our recent decision not to make an offer for Allied Domecq.

As you know premium and mid-premium spirits are high on our priority list for acquisitions and have been for several years.

Allied Domecq Spirits brands were very attractive and met our strategic priorities, and we knew we needed to take a very serious look at these assets.

Together with our consortium partners, we evaluated every option, however, we concluded the economics simply didn't support our true growth strategy, which as you know is growth that delivers returns above our cost of capital.

We are financially disciplined buyers, and are committed to delivering true growth that will create long-term shareholder value.

While we work through our analysis of this opportunity, our business leaders and 8,000 colleagues remained focus on managing our day-to-day basis and integrating the Robert Mondavi acquisition and, as a result, we delivered strong first-quarter results at the high end of our range and in line with consensus estimates.

Those of you who attended our investor conference in Napa last April, heard us talk about our decentralized management structure and how it supports our true growth strategy.

I think our first-quarter results clearly speak to the benefits of this decentralized structure, and our ability to deliver true growth in our business while pursuing complimentary acquisition opportunities.

We will continue to focus on activities that will generate true growth, that is investing behind our existing portfolio of brands, keeping our portfolio fresh with a steady stream of new products, investing in strategic acquisitions that complement and strengthen our portfolio, and that create new true growth opportunities and shareholder value.

Thank you for your time today.

I hope you're able to take some time off over the 4th of July holiday.

And as you're kicking back over the summer months, don't forget to pick up your favorite Constellation products.

Monkey Bay Sauvignon blanc is a nice light wine that is great at a summer picnic, or if you prefer, Corona Extra and Corona Light are always great choices.

I would also recommend Effen black cherry vanilla vodka over a little ice.

Now I'd like to turn the call over to Tom Summer who will review our first quarter 2006 results in more detail, and give you an update of our expectations for the remainder of fiscal 2006.

Thank you, Richard and good morning everyone.

Before I get started with my review of the quarter, I just want to briefly amplify Richard's comments regarding Allied.

The facts of the Allied situation, confirm that we do what we say we are going to do, and that is we evaluate a lot of opportunities, and in our analysis and decision-making we are thoroughly and financially disciplined.

We will continue to look at opportunities to compliment our growth, but we will only move forward with a transaction, if it creates shareholder value.

Now moving to the quarter, I'll begin with a review of our cash flow and balance sheet.

Then I'll review our income statement before closing with our guidance.

Free cash flow, which we define as net cash provided by [inaudible] activites minus CapEx, came in at $28 million for the quarter, reflecting net cash provided by operating activities of $60 million, and CapEx of $32 million.

This is almost $100 million more free cash flow than was generated in the same period last year.

As we've stated in the past, exclusive of acquisitions are priority for free cash flow is to pay down debt, and I'll talk about our debt activity in a moment.

For the quarter, depreciation and amortization totaled $29 million.

Now, in addition to the $28 million of free cash flow during the quarter, we received $145 million of proceeds attributed to Mondavi asset sales, including several Vineyards in some of the smaller brands.

We made great progress on this effort during the first quarter.

We're continuing our work in this area, and still expect to generate 150 to 175 million in total asset sales for the full fiscal year 2006.

These proceeds are not included in our definition of free cash flow, but they do contribute to our debt paydown, and did during the quarter.

These asset sales will effectively reduce our invested capital in Mondavi.

We finished the quarter with $31 billion of debt, down $200 million from the $3.3 billion balance at the end of our fiscal 2005.

At the end of our first quarter, our debt to trailing 12 month adjusted EBITDA was 4.0 times, compared with 4.5 at the end of fiscal 2005.

This improvement reflects the benefits of our growth and the results of our debt paydown.

Shifting now to the income statement, as is customary and as Lisa already mentioned, my comments will focus on comparable basis financial results.

Recapping what Richard said, consolidated net sales for the quarter grew 18%, driven by growth in branded wine and imported beers.

So Mondavi and Ruffino brands contributed $90 million and $13 million of net sales for the quarter respectively.

Excluding Mondavi and Ruffino brands, our base business net sales were up 7%, with currency contributing 2% to the increases.

Branded wine net sales increased 36% driven by the incremental sales from Mondavi and Ruffino brands, and 8% growth in the base business, including 3% in currency.

Pro forma net sales for the quarter which include $116 million of net sales from Mondavi for the prior year first quarter increased 5%, while pro forma branded wine net sales for the quarter increased 4%.

The prior year first quarter net sales for Mondavi reflect a significantly higher level of promotional activity throughout the period, as Mondavi historically ran heavy promotional activity over the Easter season and in the April/May period, which were in Mondavi's fourth fiscal quarter.

Net sales of the Mondavi brands were in-line with our plan, and we're pleased with the performance during the quarter.

Our press release includes a lot of detail on our net sales growth, and Richard already talked a lot about the dynamics of our revenue, so for the sake of our time, I won't go through those details again.

Moving down the P&L, for the first quarter our gross margin was 28.8%, up 170 basis points from the prior year.

This increase reflects improved sales mix driven by the addition of Mondavi premium products to our portfolio.

SG&A on a percentage basis SG&A expense for the quarter was 14.4% of net sales compared with 13.8 in the prior period, this increase was expected and was due in part to the addition of Mondavi, as you'll recall, Mondavi's historical SG&A run rate was significantly higher than Constellation's, but the synergies we've achieved has allowed us to bring that SG&A rate much closer in line with Constellation's.

General corporate expenses also contributed to the increase in the SG&A percentage for the quarter, those expenses increased $2.4 million to $14.3 million, reflecting increases incurred to support the Company's growth, and higher professional fees including Sarbanes-Oxley and audit-related fees.

Those corporate expenses were in-line with the average run rate for the last three quarters, and as such growth comparisons should begin to moderate, and we're targeting corporate expenses of 56 to $58 million for the fiscal year 2006.

Operating income increased 28% for the quarter.

Operating margins for the quarter were 14.4%, an increase of 110 basis points from the prior year, due primarily to favorable product mix as discussed before.

Interest expense for the quarter was $47 million, up $17 million over last year, reflecting the increase in borrowings primarily related to the Mondavi acquisition, and the investment in Ruffino.

At the of May we had approximately $2.1 billion of floating rate debt outstanding under our credit facility, and fixed rate debt of $1 billion.

Our average interest rate for the quarter on all of our debt was about 6%.

Our effective tax rate came in at 35.6% for the quarter.

During the first quarter, the Company recorded a nonrecurring income tax benefit of $0.07 per share, for the reversal of income tax accruals related to the completion of various income tax examinations.

As noted in our press release the impact of this item has been excluded from comparable basis results, and the effective tax rate for the quarter of 35.6% that I just talked about, is on a comparable basis.

Now due to the facts and circumstances of each discreet quarter, our effective tax rate will be somewhat variable on a quarter-to-quarter basis, but we continue to expect the tax rate for the full year to approximate 36%, and that's consistent with the tax rate for the prior year.

Net income increased 19% for the quarter, our weighted average diluted shares outstanding were 238 million, compared to 230 million a year ago and as a result, diluted EPS grew 15% to $0.30 for the quarter, which was at the high end of our guidance range.

Now moving to our expectations for the full year fiscal 2006, our comparable basis diluted EPS guidance is $1.55 to $1.61, that's on a post-split basis, and that's unchanged from the guidance we provided last quarter.

For the second quarter fiscal 2006 we expect comparable basis diluted EPS in the range of $0.40 to $0.42.

Our comparable basis EPS guidance excludes acquisition-related integration costs, restructuring and related charges and unusual items, all of which are detailed in our press release.

The full year guidance includes the following assumptions.

Consolidated net sales growth in the mid to high teens, including the benefit of 10 additional months of Mondavi.

Sales growth rate assumes mid-single digit growth rate for beer for the year.

Mid to high-single digit growth for spirits, high-single digit growth for base branded wines, that is without the incremental sales from Mondavi and Ruffino, and mid-single digit growth for wholesale and other.

Our operating margin expansion should continue to come primarily from our wine segment, due to mix savings and cost savings, while our operating margins in our beers and spirits segments should remain fairly stable.

Interest expense targeted to the range of 200 to $210 million, which includes anticipated additional increases in LIBOR for the balance of the year.

As discussed earlier, we expect our effective tax rate for the full year to approximate 36%, and we are assuming weighted average diluted shares to approximate 240 million.

Our guidance for fiscal 2006 excludes the impact of FASB-123(R) share based payment, for which the adoption date has been delayed to the beginning of our fiscal 2007.

In terms of of our cash flow and balance sheet metrics we expect the following.

For the full fiscal year we're currently estimating net cash operated, provided by operating activities, in the range of 380 to $400 million, less CapEx of approximately $140 million, resulting in free cash flow in the range of 240 to $260 million.

Our free cash flow target takes into account the outlay of cash required to fund Mondavi restructuring and integration plans, most of which has occurred during the first half of the fiscal year.

Our fiscal 2005 year end debt balance stood at $3.3 billion, as I stated earlier, our first priority for free cash flow continues to be paying down debt.

Based on our free cash flow projection of 240 to $260 million, combined with asset sales in the range of 150 to $175 million, we would expect to exit fiscal 2006 with approximately $2.9 billion of debt.

This demonstrates our ability to deleverage after completing acquisitions.

So to briefly summarize, we delivered 7% net sales growth on our base business accompanied by strong margin expansion in this quarter, these results demonstrate the underlying strength of our business, and the benefits of our diversified portfolio.

The Mondavi acquisition and our investment in Ruffino accelerated our sales growth, and our strong balance sheet and our ability to generate free cash flow, position us for plenty of flexibility to grow and further strengthen our portfolio.

We're pleased with these first-quarter results and we continue to be excited about the prospects for the remainder of fiscal 2006 and beyond.

That concludes my prepared remarks, and now we'll open the floor to questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question is coming from Mark Swartzberg with Legg Mason.

Please go ahead.

Thanks, operator.

Good morning, everyone, and Richard, do you recommend an Effen Martini shaken or stirred?

I like it shaken.

Moving on to beer, it sounds like you're talking about a slowdown for the balance of the year, if beer was up 10% for the quarter.

You're saying mid-single digit for the full year.

Are you being conservative or are you seeing things in the business that are causing to you expect a slowdown in strength?

And then relatedly, as you look at the month of June, and trade inventories out there, how's your business performing, or performed in June, and how do you feel about the trade situation?

Yeah.

Basically on the beer side, while we had shipment increases of 10% over a year ago, the underlying movement as indicated by our IRI was more in the 6% range.

June IRI data is I think 6, 7%, so we're just basically forecasting that you should see shipments equal consumer movement ultimately.

Obviously there's some noise between shipments in consumer movement on a constant basis.

So I wouldn't say that we're being conservative, and I wouldn't say that we're really looking for the business to weaken.

I would say it's just taking into account all of the anomalies that exists between shipping and movement to consumers.

In terms of inventory in the trade, our inventory levels across the businesses are fairly stable versus last quarter versus a year ago.

We're not, you know, taking down inventories.

We're not increasing inventories.

So I'd say that at the moment, we're happy with the trade inventory levels.

Great and that comment about trade inventory, sounds like you're not only talking about beer but your broader business profile.

Yeah, beer, wine and spirits.

Okay.

Great.

Thanks, Richard.

Thank you.

Our next question is coming from Caroline Levy with UBS.

Please go ahead.

Good morning, everybody.

Hi, Caroline.

I was just wondering if there was continued investment behind some of your featured brands in wine and beer.

I know you had stepped up the pace substantially last fiscal year.

Did you moderate the rate of increase in spending this year to more normal increased levels, or have you continued to invest very heavily behind certain key brands?

Well, think it's very much like we described last year, which is if you get the increases in business as we did, you can then maintain the investment level, and actually your investment as a percent of sales goes down a bit.

So the way we look at it, is we upped our investment as a percent of sales last year.

We got the sales increase, and we, therefore, are in a position to spend approximately the same money, which results in lowering the investment as a percent of sales.

Okay.

That is one of the things that contributed to wines nicely expanding margin, where you saw a 1.8% increase in our wine operating profit margin.

Yes.

Because --

Quarter-over-quarter.

One of my concerns was that the press release said the margins largely expanded because of Mondavi.

That was basically the only reason cited, and I was wondering to what extent your base business store margins moved?

It's almost impossible to extract today Mondavi from the base business because it's fully integrated.

So when we make that statement, the acquisition of Mondavi and the integration of the SG&A, especially the selling and G&A activities, as opposed to the marketing activities, basically has allowed us leverage across both businesses I would say.

And you're still getting the positive mix shift within your total portfolio, aside from just Mondavi?

Yes, absolutely.

Okay and if I might just change --

By the way, Caroline, the whole industry is getting a positive mix shift.

Right.

We may be getting more positive mix shift than the rest of the industry because of our, you know, #1 position in the premium wine business, versus our #3 position potentially in the value-value business.

Right and Richard, if I might, given that Allied is where it is, are we to assume that there really are no major spirits assets left at this point?

It seemed that that might have been the last great available cache of brands, and I'm just wondering if you could comment on that a little bit?

It depends on what you mean by major.

I would agree there's no $20 billion U.S. portfolios left.

But there's plenty of potential opportunities out there more in the 1,2, $3 billion range.

And they may not be as broad or as extensive, but they're more focused.

It doesn't mean that they're going to come and be available tomorrow.

But there's still a good deal of opportunity.

Thanks very much.

Thank you.

Our next question is coming from Jeff Kanter with Prudential Equity Group.

Please go ahead.

Good morning, everybody, thank you for moving the call up to the morning.

That's appreciated.

Question for you, Richard.

The currency neutral flat wine sales were 2% pro forma, or currency neutral branded wine sales, that was a surprise to me.

Was it a surprise to you?

No.

And out of curiosity, why?

Well, you, you know, when we look at pro forma, we have a big chunk of Mondavi in there last year, and Mondavi basically ran very, very heavy promotions for their April, May, June period which was their last quarter of their fiscal year, and actually it's pretty interesting.

They didn't wait till June, they actually loaded heavily in April from a shipment perspective, and then tried to move the goods through in May and June.

So I would say we were up against known anomalous conditions, that as Mondavi is integrated over time will go away, because we're not going to promote to their old fiscal year.

And this --

So --

And the same thing I think happened in the last quarter, or something similar.

When do we get into more normalized promotional activity for Mondavi, or do we have to wait for the acquisition to be last?

No, the same thing didn't happen last quarter.

Oh.

In fact, Mondavi, if anything, Mondavi on a shipment basis was up very, very significantly, versus a year ago last quarter.

So --

For your second quarter the comparisons should get a little bit easier and pro forma basis, is that correct?

That's correct, Jeff.

And Tom, your free cash flow guidance, does that include or exclude the $30 million benefit that you had in the first quarter here for the swap?

It does include it because it was known to us when we gave the guidance.

Got you.

Is that one-time or is that over?

Yes.

We an as I'm sure you know, interest rates ran up in February, and then into the middle of March.

And we took the opportunity to restructure the swaps that we had done to hedge some of the debt associated with the Mondavi acquisition.

Basically the net interest rate isn't affected, but we were just taking some of our cash earlier so it was a one-time event.

We took some of our cash in March, and we knew about it at the time we gave the guidance.

Fair enough.

And last question, Tom.

Many companies on a -- talk about, you know, inventory levels at the wholesale level.

I was hopeful that you could kind of give us a snapshot on where we are on the wine side this year relative to last year, if you can.

If you can, because I know things are kind of -- comparisons are difficult.

Yeah, you know, Jeff, we haven't, we haven't and we're not planning to give specific data on a quarter-by-quarter basis.

I think broadly speaking I'll reiterate what we've said in the past which is that, you know, we do manage our overall -- we wholesale our inventories to within a range, and we watch it very carefully, and we're within the range, and, you know, very comfortable that they're well managed and, you know, really don't creep into the equation.

So I think, you know, looking at consumer trends is what we like to do and that should, you know, in the intermediate term if not in the short term get you to where our shipments are going to be.

Perfect, thank you.

Thank you.

Our next question is coming from Tim Ramey with DA Davidson, go ahead.

It is Tim Ramey.

I was intrigued on some of the comments on your ramp-up in shipments into Europe.

I had maybe mistakenly been you know, under the impression that some of that huge Mondavi shipment in the fourth quarter, your fourth quarter was, you know, pipeline filling into Europe.

Are you telling us that that is still sort of ahead of us, or what can we really think about in terms of this shape of sales in Europe for the Mondavi brands?

Yeah, that definitely is ahead of us.

It had nothing to do with the fourth quarter Mondavi shipment increase.

And there really was a minimal shipment increase, if any this quarter, and you should see the pipeline start in the second quarter.

So -- that's still ahead of us and one would hope that the real benefit isn't the pipeline, but the continuing sales, and increasing momentum after the introduction, which would occur in the third and the fourth quarter.

Right.

The revenue synergies can probably be more impressive than the cost synergies that you already achieved?

Yeah, well I was specifically referring to the sales of Mondavi in U.K. Europe.

You know, the pipeline in U.K. and Europe isn't like the pipeline in the United States, because there aren't distributor inventories that get filled.

So there isn't a big bulge in shipments filling the pipeline.

What you hope is you fill the pipeline, you fill the shelves, and the consumer picks the product up and you have accelerating consumer movement and, therefore, you would want to see an acceleration in your shipments in the third and the fourth quarter.

Got it.

And relative to the brand, you seem to be indicating that you had made some changes or tweaks to the brand for its European distribution.

Did you increase the Robert Mondavi, you know, tie-in or label component and also did you reformulate the wine in some way?

Yeah.

We definitely reformulated the wine, and on the label there are some slight label changes and, in fact, basically, you know, we are trying to emphasize Robert Mondavi.

We also went to a screw cap for the European trade on the Woodbridge side, was that on Private Selection too?

On Private Selection also.

Yeah.

Are you considering that closure for the U.S. market as well?

We're looking at it.

Terrific, thank you.

Thank you.

Our next question is coming from Bill Leach with Neuberger Berman, please go ahead.

Morning.

Tom, half of your EPS growth came from the add-back of adverse grape cost again.

Can you just discuss what that is, and why we should add that back?

Sure.

To embellish a little bit, it's obviously discussed in the press release in the supporting detail, but what we've done there really is taken, you know, our goal is always to give you a view of what our ongoing operating earnings performance is going to be.

And so what we've done is taken Mondavi inventories, and Mondavi had some contracts which were in excess of market, and we've basically restated those grape values as if they had acquired the grapes, let's say, you know, slightly above market, so that it's more a reflection of what our ongoing performance should be.

For Constellation, we're obviously a very large buyer of grapes in California, and we're pretty much buying at market.

And so, you know, we want to give a picture of what we would expect the ongoing margin performance of these brands to be.

By the same token, couldn't you take a lot of the pro forma cost that you're removing from Mondavi and add them back?

I mean, why is this any different than severance cost, or other things?

I'm sorry, I'm not understanding the question.

You're going to realize synergies with Mondavi.

Yes.

But I mean --

It actually is a lot.

That's why we're excluding it.

We've already renegotiated these contracts, so much like the synergies that we're realizing on the SG&A side, it is out of our cost structure as of today.

How many more quarters will we have add-backs like this?

Generally on an acquisition like this, most of the activity is in the first year, but some of it will continue through next fiscal year, and then we'll be moving on.

So they had multi-year contracts?

It's not just the multi-year contracts.

It also reflects the fact that red wine, which Mondavi has pretty significant red wine sales, is an aged product, and therefore, you will see this -- you could see this three years out in smaller and smaller quantities, reflecting let's say the 2004 harvest, okay.

Which they paid adverse prices and that 2004, let's take Cabernet Sauvignon Robert Mondavi Reserve even, or Private Selection, that's released two to three years out, so that carries the adverse grape cost.

Okay.

Thanks a lot.

Thank you.

Our next question is coming from Alec Patterson with RCM.

Please go ahead.

Just to follow up on Bill's question because this is a sticking point, if I understand you correctly, you're basically trying to restate your grape cost in inventory for what your new contracts would reflect the value of those grapes to be today.

Is that right?

Correct.

It's as if we had acquired the grapes.

Right, okay.

So we just need to work through the inventory.

If you were running on a LIFO basis, this might be happening faster?

That is correct.

Okay.

All right.

So on a cash basis, we're effectively neutral then?

That's right, Alec.

Okay.

All right.

Different question.

On the rollout into the retail trade, et cetera, in the U.K. and all that, is it going to undergo the same similar kind of experience with the Hardy products, et cetera, that we had in the U.S?

Where you kind of have an upfront spending to get shelf place, get marketplace, media and, et cetera and then hope for some leverage a year out, or is there a different game plan?

It's really a bit different because what you're talking about in the United States, you build distribution off-premise slower in the United States, because there's many, many, many more retailers.

In the U.K., off-premise you're dealing with really four or five major accounts today.

And you can and we have got the product listed in those accounts.

So you build distribution, or you can build distribution much faster in the chains in the U.K.

So it's a pretty different cycle, and then there's a significant cash-and-carry business, which has a very different formula I'll say, and then there's the on-premise business which we have a good deal of control and strategic direction over through Matthew Clark wholesale.

So it's got very different dynamics than the U.S.

So in a nutshell, are you just saying, that the margin impact will be minimus compared to what you went through last year in the U.S.?

Last year we were increasing distribution for brands that had been in the market and may have had 30 to 60% distribution.

It's an entirely different animal in the U.K..

So you're saying the margin impact doesn't exist like it did in the U.S.?

Yes, that is correct.

Okay.

And lastly, more esoteric, the experience you had with Allied, and have experienced in trying to build up the premium side of your portfolio, and the costs involved as you pointed out, the economic model didn't quite work with Allied.

How does that experience compare to what you've got with something like Effen with what you're trying to do I think it was a planet 10, and building in-house, you know, how long that might take building it in-house and comparing the two, are you leaning one way versus another, in terms of finding a benefit of developing in-house versus acquiring?

They're really not comparable.

I mean, Effen is a small brand, has certainly potential to grow, but you're talking about, you know, a brand that does a couple million, 3, $4 million of business at this point in time, versus buying a portfolio that does billions of dollars of business.

It's just not comparable.

Acquisitions serve a very different role than new products or joint ventures.

So I wouldn't say we're leaning one way or another.

We're going to continue with our new products.

We're going to continue with our joint ventures, and we will make acquisitions, major acquisitions.

I guess I'm sorry to belabor this.

The notion that Effen seems to be doing well, you're rolling it out, increasing points of distribution, going nationwide, the thought is if it succeeds, the cost of having done that it may have been less than acquiring a brand from the get-go that was already there in today's market.

I mean, the cost of acquisition having gone up, so I'm just wondering whether Effen has changed the economic analysis of an acquisition, but -- ?

I mean, I guess I comment that the strategy which we've been very open about, is for us to grow our premium spirits business, and we believe that we can look at acquisition opportunities and at the same time, generate internally as much as we possibly can, to affect that strategy and those two paths are not mutually exclusive.

In fact, I think we all believe that they work very well together at the same time, and that therefore, we're doing them both at the same time, because growing in premium spirits is very important to us as a company.

Yes, okay.

Great, thank you very much.

I think we have time for one more question.

Thank you.

Our last question is coming from Bryan Spillane with Banc of America Securities.

Please go ahead.

Good morning, everybody.

Just two quick questions for Tom.

First, interest expense is a little bit lighter in the quarter than I thought.

Can you just walk through, you know, the full year guidance on interest, and why maybe that shouldn't come down, especially since it looked like you're paying debt down a little faster than expectations.

And the second, you've had a pretty big move in the dollar relative to the pound, and can you just walk through again for us, you know, how we should think about that in terms of currency, the impact on operating margins and on EPS?

Sure.

On the interest expense question, I will partially defer to Lisa and Bob, because I know that they've got lots of details prepared to share with anyone who wants to talk to them on this subject.

But the general concept is, you know, fairly stable debt levels until we get to our fourth quarter and rising LIBOR rates.

I mean, that's the high level picture.

On foreign exchange, I guess I'd say to you, you know, as you know, we do hedge both transaction and translation exposures, therefore, our net position is very much in-line with our expectations, while there's been a move, it really isn't that huge a move, I mean, I would say that the dollar is still relatively weak on a historic basis, not that I expect it to move in huge amounts any time in the near future.

So again from a high level, I would say FX, not that great of a move.

Pretty much as expected and not looking for a huge amount of movement in the near future.

And so it hasn't had a huge impact on our expectations, on our performance, or on our business.

Okay.

Thank you.

I think that wraps it up, Richard.

Thank you, everybody, for participating.

Have a great 4th of July, and as I said, relax and please, you know, make sure you drink Constellation products.

So enjoy yourselves.

Thank you.

This does conclude today's teleconference.

You may disconnect your lines at this time, and have a wonderful day.