Constellation Brands Inc (STZ) 2006 Q2 法說會逐字稿

Good afternoon ladies and gentlemen.

My name is Jason and I will be your conference facilitator today.

At this time I would like to welcome everyone to the Constellation Brands second quarter 2006 earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question-and-answer period.

If you would like to ask a question during this time, please press star, then the number one on your telephone's key pad.

If you would like to withdraw your question, please press the pound key.

It is now my pleasure to turn the floor over to your host, Lisa Schnorr, Vice President of Investor Relations.

Ma'am, you may begin.

Thank you, Jason.

Good afternoon, everyone, and welcome to Constellation's second quarter fiscal year 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 today 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 compliment 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 and/or pro forma basis measures are available on the company's website at 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're useful to investors.

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

They will also discuss certain pro forma net sales information after giving effects to Robert Mondavi and Ruffino 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, on May 13, 2005, we affected two for one stock split 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 split.

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 Constellation's SEC filings.

Following the call, if you should have any following-up question, please call me or Bob Czudak, Director of Investor Relations.

And now I'm pleased to turn the call over to Richard Sands.

Thank you, Lisa.

And good afternoon, everyone.

Thanks for joining us for our review of Constellation's second quarter fiscal 2006 results.

I'm going to deviate somewhat from my usual detailed review of our quarterly results because I'd like to start with the discussion of some of the macro issues affecting our industry.

With that as a back drop, I'll then talk a little bit about Constellation's strategic advantages and why we've been able to grow profitably despite a variety of external factors affecting businesses today.

After I'm finished, Tom Summer will review our second quarter results in detail.

I don't need to tell you that these are dynamic and challenging times.

Rising energy costs and interest rates have combined to create a climate of uncertainty for businesses and consumers.

Recent events, including terrorist attacks and two devastating hurricanes in the Gulf of Mexico, have only exacerbated this situation.

To some degree all of these factors impact businesses, including Constellation's.

Yet, we overcome these challenges better than most companies because our diverse product lines and geographic markets along with our scale, help enable us to manage through these challenges and mitigate the impact on our results.

This was clearly demonstrated by our second quarter results which were in line with expectations.

Looking ahead, we're confidant in our ability to remain focussed on our business and deliver full year results within our original range of guidance.

As you look at our second quarter, you'll see some results on either side of expectations.

On the plus side, both our imported beer business and our U.S. wine business experienced robust growth.

Imported beer grew 9% while our U.S. wine business, pro formed for Robert Mondavi and Ruffino a year ago, grew 10%.

This led to our world wide branded wine growth of 7%, again pro formed, with less than 1% for currency.

This is a tremendously positive result.

To produce these types of growth involved a major turn-around for Woodbridge by Robert Mondavi, many new product initiatives and a continuation of the growth of many of our major brands, as we'll discuss a little later.

But what is most important, again on the positive side of expectations, we levered this growth and increased our margins, increased our net income percentage, and showed dynamic EPS growth in the quarter.

Realize that this performance was adversely impacted by an increasingly competitive retail environment in the UK.

And I know the UK market is a concern for many of you.

It is a well-known fact that the UK market is challenging and is becoming increasingly challenging recently.

We all know that the top five UK retailers account for more than three-quarters of the total retail market.

These very important customers have considerable clout, which means it is even more important for us to be their top supplier for wines.

The other known issue in the UK is that suppliers of Australian wine, other than Constellation, have large inventory imbalances with premium red varietals in particular.

They're aggressively promoting their wines to work down their inventories.

Again, it's good that our inventories are more balanced and it is good for our brands that we can be selective about when and where to invest behind our leading market share.

Nevertheless, these factors are creating margin pressure on wine suppliers in the UK market.

Our broad product portfolio and scale and breadth of positions in distribution channels in the UK market have enabled us to mitigate the impact on our business.

As an example of this, Constellation Europe is emphasizing its product offerings in the California wine category, which is growing at more than twice the rate of the Australian wine category, albeit off of a smaller base.

We're well represented in this category with great brands like Echo Falls, Paul Masson, Turner Road or Ravenswood, not to mention our most recent introduction, Robert Mondavi Woodbridge.

Even in the face of challenging market conditions, Constellation's breadth and scale allowed us to deliver another quarter of overall sales growth in the high single-digits and bottom-line results in line with expectations.

Companies smaller than Constellation often lack scale and have much greater exposure to these risks, making them more susceptible to volatile swings in their profitability.

I'd like to make one final point here before moving on.

As I mentioned earlier the UK retail environment has changed dramatically over the past several years as a result of ongoing retailer consolidation.

As they grow, retailers want to simplify their businesses by dealing with the fewest number of suppliers possible.

Suppliers with the most comprehensive and best product portfolios will clearly have a competitive advantage.

So Constellation's great stable of brands consumers want across the fastest growing new world wine categories, position us for continued long-term success in the UK and many other new world wine markets.

Now, I've probably spent too much time on the UK and I'd like to turn to our strategy and our competitive advantage.

There are three primary elements at the core of Constellation's success.

Our portfolio has the right high quality brands consumer want.

We have the distribution network and scale to get these products to the market.

And, we have the financial discipline to invest in the right opportunities.

We will not overspend and under deliver as many acquirers or investors in brands have done in the past.

Our second quarter results clearly demonstrate the importance of having the right brands.

Take our beer business, which is on fire, driven by the strength of our Mexican portfolio and particularly Corona.

As I said, net sales for beer grew 9% during the second quarter, defying the trends in the overall beer category, which was flat to down 1% according to IRI data for the latest 52-week period.

This stellar performance clearly demonstrates the strength of the Corona brand and its positioning for connection with consumers, with brand equity that has been built for more than 25 years.

Our branded wine business, as I mentioned, in the U.S. also experienced extremely strong growth in the second quarter.

On a reported basis, U.S. branded wine net sales grew 59%, including 122 million of net sales from Robert Mondavi and Ruffino brands.

And excluding the Robert Mondavi and Ruffino brands, the U.S. branded wine net sales grew 7%.

Existing brands such as Blackstone, Ravenswood, Estancia and Franciscan Oakville Estates continued to perform well and gained distribution and market share during the second quarter.

Successful new product introductions, including Twin Fin, a full range of super premium California wines and Monkey Bay, a New Zealand Sauvignon Blanc, also contributed to our second quarter growth.

These brands have quickly become consumer favorites and continue to rapidly gain momentum in the market place.

Distribution scale is clearly a competitive advantage when introducing new products.

The retail rollout for Twin Fin and Monkey Bay began earlier this year in a January/February time frame.

According to IRI data through September 4th, Twin Fin and Monkey Bay have already achieved 38% and 42% ACV, respectively, in less than nine months.

And according to IRI data Twin Fin has generated higher retail dollar sales than any other label introduced in the U.S. since January.

Additionally, Monkey Bay is already the single best selling New Zealand brand in the U.S.

By the way, we also have the second best selling New Zealand brand, Nobilo.

To capitalize on the momentum of the Monkey Bay brand with consumers, we're in the process of rolling out a Monkey Bay no oak New Zealand Chardonnay.

We're very excited about this product, which will hit the retail shelves soon and will be available for the holidays.

In addition to new products, we've had some good news on building relationships in the fine wine business.

A couple of weeks ago we announced jointly with Baron Philippe de Rothschild to remain 50-50 joint venture partners in Opus 1.

This is icing on the cake of the Robert Mondavi acquisition.

In fact, we're expanding our relationship with Baron Philippe de Rothschild.

As we recently announced, North Lake Wines has become the exclusive U.S. importer of Mouton today and several other of the Baron Philippe de Rothschild wines.

We're also very excited about another pending acquisition, Rex Goliath.

As we announced a couple of weeks ago, we're in the process of acquiring the Rex Goliath brand from Hahn Estates.

Introduced in 2002, Rex Goliath is a premium California line with six varietals, Merlot, Cabernet Sauvignon, Chardonnay, Pinot Noir, Shiraz and Pinot Grigio, in the 7 to 8.99 price segment.

It has been on a terrific growth trajectory and is rapidly approaching a run rate of 400,000 cases per year with a current ACV of approximately 22%.

As part of Constellation's portfolio, Rex Goliath will have the opportunity to flourish and gain additional distribution to reach its full potential in the marketplace.

Some analysts have drawn an analogy to Blackstone, which was approximately the same size, 400,000 cases annually, when we acquired it in 2001.

Today Blackstone, with an annual volume of approximately 1.5 million cases, is the number three super-premium wine brand by value in the 9 to 12 category in the United States.

Of course, Blackstone is in good company.

We're the clear leader in this category with number one, Robert Mondavi Private Selection and number seven, Ravenswood.

According to the latest IRI data, Blackstone has an ACV of 70%.

The stellar growth of Blackstone demonstrates that Constellation has the distribution scale and the marketing expertise to take good brands and make them great.

Because I know some of you were curious about how the Robert Mondavi integration went, I'd like to provide an update on the acquisition and how we're maximizing the value of our investment.

First and foremost, we've stabilized the Robert Mondavi business by integrating the acquisition quickly.

That is clearly demonstrated in the marketplace by the performance of the Robert Mondavi brands.

According to the latest IRI results, Woodbridge grew slightly in the second quarter after several quarters of decline and Robert Mondavi Private Selection grew 21%, which was slightly ahead of the growth rate for the super-premium category as a whole.

Also, as you know, we had identified a number of non-strategic assets when we acquired Robert Mondavi.

I'm pleased to say that the sale of these non-strategic assets are essentially complete.

Now with the integration and other acquisition related activities substantially behind us, we're moving forward with initiatives to leverage the Robert Mondavi acquisition and our operational infrastructure to create more true growth.

Earlier this week we initiated a plan to consolidate certain Constellation Wine's U.S. west coast production processes to reduce ongoing operating costs and increase asset utilization.

Specifically, we're increasing the crush capacity of our Gonzales facility and we're consolidating Constellation Wine's U.S. bottling sites from four facilities to two.

This is a very short payback period on the up-front investment in fixed assets and one-time costs.

And we believe there are more opportunities to create value by leveraging our global operating infrastructure.

I realize I've covered a lot of material, so let me briefly summarize the key points.

We reported a second quarter with great top-line revenue growth and results in line with expectations.

We had strong performance in beer and U.S. branded wine driven by the addition of Robert Mondavi and Ruffino, as well as growth of existing products and new product introductions.

We also had strong margin expansion.

These results clearly demonstrate the benefits of scale and distribution strength.

And our guidance, which is within our original range, demonstrates confidence in our ability to continue to offset the many factors affecting businesses globally.

There are always going to be external factors, economic cycles, grape cycles and unforeseen events.

Those factors are part of the business environment.

No company and no industry is immune.

However, Constellation's strategy of product line and geographic diversity positions us well to mitigate the impact of everyday business challenges.

Add to that our entrepreneurial flexible close to the market decision-making and we demonstrate our ability to manage through business cycles and unforeseen events to create true growth and continued long-term shareholder value.

We remain confident in our ability to deliver fiscal 2006 EPS within our range, within our original range of expectations, and to continue to create dynamic long-term shareholder value growth.

Now, I know you're all interested in an update on Vincor International.

As you know, last week we announced our interest in acquiring Vincor for a negotiated transaction of $31 per share Canadian in cash.

Vincor has since indicated that it was commencing a process to auction the company and we look forward to participating in that process.

We and our advisors are ready, willing and able to begin sharing information with Vincor at any time.

As you know, the purpose of this conference call is to discuss our second-quarter results and that's what we intend to focus on.

Therefore, we will not respond to any questions related to a possible Vincor transaction on this conference call.

We're available to discuss this topic offline.

However, before I turn the call over to our CFO, Tom Summer, I'd like to leave you with a few important points as they relate to our proposal to acquire Vincor in a negotiated transaction.

First, $31 per share in cash is a full and fair price. $31 represents 12.3 times Vincor's last 12 months EBITDA.

Vincor is a good company, but I want to stress that it does not have the margins or the assets, including scale, land holdings or brand equity, that have attracted higher multiples paid for premium brands in our industry.

Second, for Constellation this transaction is about growth.

We believe Vincor's purported synergies--shouldn't say believe--we know Vincor's purported synergies of $100 million-plus would result in significant layoffs and severely impact the underlying value we see in Vincor, again, severely impact our ability and their ability to grow.

Finally, Vincor management and Canadian analysts would like you to believe this is a must-have acquisition for us.

It is not.

One, Canada is not a must-have geography.

It is one of eight second-tier markets that we have been interested in.

Two, Vincor does not have must-have brands like Robert Mondavi or Hardy's.

Three, our results stand on their own.

We do not need to make an acquisition to cover weakness in our business.

We have a very strong business and in fact, the strongest business in the beverage alcohol industry.

There is no one comparable to Constellation today.

And we do not need to make acquisitions to further strengthen our business, no less cover these, quote, weaknesses, end quote, that we seem to be not showing.

So, with that, I'm going to turn the call over to Tom Summer for a more detailed review of our second quarter results and our full year expectations.

Thanks, Richard, and good afternoon, everyone.

As Richard mentioned, I'm going to begin with a detailed review of our second quarter income statement and then I'll spend a bit of time discussing our debt positions and our de-leveraging efforts before closing with our third quarter and full year fiscal 2006 guidance.

My comments on the income statement will focus on comparable basis financial results.

Our consolidated net sales for the quarter grew 15% driven by growth in the U.S. branded wine and imported beers.

The Robert Mondavi and Ruffino brands contributed $110 million and $12 million of net sales for the quarter respectively.

Excluding those brands, our base business net sales were up 3%.

Branded wine net sales increased 35%, driven by the addition of sales from Mondavi and Ruffino brands and 5% growth in the base business.

Currency contributed less than 1% of the growth.

Wholesale and other declined by 6%, including a 2% negative impact from currency.

On a constant currency basis, wholesale and other declined 4%.

Slight growth in our UK wholesale business was more than offset here by a reduction in net sales of cider and water as well as the divested commodity concentrate business.

Our imported beers business grew by 9%, with all the brands in our imported beers portfolio posting gains for the quarter.

Spirits grew 2% over the prior year due primarily to an increase in our contract production services.

Branded spirits net sales were in line with the prior year.

However, IRI data does indicate that our spirits portfolio grew 2% in the retail food and drug channel for the last 12-week period.

Our pro forma net sales for the quarter, which include $104 million of net sales from Robert Mondavi for the prior-year's second quarter, increased 4% and pro forma branded wine net sales for the quarter increased 8%, including a 1% benefit from currency.

Net sales of the Robert Mondavi brands continued to be in line with our plan and we're very pleased with the performance through the first six months of the year.

Gross margins for the quarter were 29.9% up 190 basis points from the prior year.

This increase reflects improved sales mix due in part to the addition of Mondavi premium products to our portfolio and improved pricing in our U.S. popular wine portfolio.

In addition, in the United States we are still seeing the trend of consumers trading up to higher margin premium wine.

SG&A, on a percentage basis our SG&A expense for the quarter was 13.4% of net sales compared with 12.8% a year ago.

The increase was expected and was due in part to the addition of Robert Mondavi.

As you will recall, Mondavi's historical SG&A run rate was much higher than Constellation's, yet the synergies we have achieved allowed us to bring that SG&A rate much closer in line with Constellation's historical run rate.

For the quarter, general corporate expenses increased $1 million to $14.3 million, reflecting increases incurred to support growth, we're targeting corporate expenses to be in the range of $55 to $57 million for the full fiscal year.

Our operating income increased 24% for the quarter and operating margins were 16.5%, an increase of 120 basis points from the prior year due primarily to the favorable product mix I discussed earlier.

Interest expense was $47 million, up $16 million over last year, reflecting the increase in borrowings primarily related to the Robert Mondavi acquisition and our investment in Ruffino.

At the end of August, we had about 2 billion of debt outstanding under our credit facility, 1.2 billion of which is fixed with swaps and fix-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% for the quarter.

As I said before, due to the facts and circumstances of each discrete quarter, our effective tax rate will be somewhat variable on a quarter to quarter basis.

We anticipate the tax rate for the full year to approximate 36%, which is consistent with the prior year and consistent with our guidance to date, but that also implies a higher tax rate in the second half of physical 2006 compared to the actual tax rate for the first half of the fiscal year.

As a result of the factors I've just mentioned, net income increased 20% for the quarter.

Our weighted average diluted shares outstanding were 239 million compared with 232 million a year ago.

And our diluted EPS grew 17% to $0.41 for the quarter and was in line with expectations.

Now, if I can quickly move to our debt position and de-leveraging.

We finished the quarter with $3 billion of debt, down $300 million from the $3.3 billion balance at the end of fiscal 2005.

During the second quarter we received $19 million of proceeds attributed to the Robert Mondavi vineyard assets.

And for the first six months of this fiscal year we generated $164 million from Mondavi asset sales.

These proceeds contributed to our debt paydown during the quarter.

Since the end of the second quarter we've received an additional $7 million of proceeds.

These disposition efforts are now essentially complete and came in at the high end of our expectations effectively reducing our original investment in Mondavi.

At the end of the second quarter our debt to trailing 12 month adjusted EBITDA was 3.7 times, compared with 4.5 times at the end of fiscal 2005.

This improvement reflects the benefits of the company's growth and our debt paydown as our de-leveraging efforts continue subsequent to the Mondavi acquisition.

Now, let me move to our full year expectations.

We're tightening the range of our guidance to reflect the fact that we're half-way through the year and are now projecting comparable basis diluted EPS in the range of $1.56 to $1.60, which is within the range we provided at the outset of the year.

For the third quarter of this fiscal year 2006, we expect comparable basis diluted EPS in the range of $0.48 to $0.51.

The comparable basis EPS guidance excludes acquisition related integration costs, restructuring and related charges and unusual items which are all detailed in the press release.

Our full-year guidance assumes consolidated net sales growth in the mid-teens, including the benefit of 10 additional months of Robert Mondavi, and assumes for the full year high single-digit growth rate for beer, mid single-digit growth rate for spirits, mid to high single-digit growth rate for base branded wine, meaning branded wine without the incremental sales from Mondavi and Ruffino and low single-digit growth for full sale and other.

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

We're guiding to interest expense for the year in the range of $190 to $195 million and, as I mentioned earlier, we expect our effective tax rate for the full year to approximate 36% on a comparable basis.

And we're assuming weighted average diluted shares of about $240 million.

And our guidance for fiscal 2006 excludes the impact of FAS 123R, which the company will adopt at the beginning of fiscal 2007.

In addition, we expect to exit the year with about $2.9 billion of debt.

This implies approximately $400 million of debt paydown during the year from a combination of free cash flow and asset sales and demonstrates our ability to de-leverage after we complete acquisitions.

And we continue to target CapEx of approximately $140 million.

So I will summarize briefly.

We delivered strong bottom-line performance reflecting strong margin expansion.

These results demonstrate the underlying strength of our business and the benefits of our diversified portfolio and our operational scale.

The Mondavi acquisition and our investment in Ruffino accelerated our net sales growth and our strong balance sheet positions us with plenty of flexibility to grow and further strengthen our portfolio.

Overall we are very pleased with the second quarter results and we continue to be enthusiastic about the prospects for the remainder of fiscal 2006 and beyond.

That concludes my remarks and now we'll be happy to take your questions regarding our second quarter results and our full year expectations.

Thank you.

Ladies and gentlemen, the floor is now open for questions.

If you do have a question at this time, we ask that you press star, one on your touch-tone phones.

Once again, to ask a question, it is star, then one on your touchtone telephone's keypad.

We do ask that if you are using a speakerphone, please lift the handset to provide optimum sound quality.

We will now be taking our first question from Caroline Levy of UBS.

Hi, everybody.

Hello, Caroline.

Starting with Mondavi and the brand growth there, could you give us a sense of how much of that improvement was driven by increased distribution versus more kind of same-store growth?

It's very, very little increased distribution, both Private Selection and Robert Mondavi Woodbridge are for all intents and purposes fully distributed.

So it is all same-store growth.

Okay.

And then also could you give a sense of whether you think Mondavi's brand will be fully -- Woodbridge will be fully distributed in the UK during the current quarter and that we would see a substantial benefit from that?

How big do you expect the business to be relative to the scale of the total UK business you have now?

It is relatively small versus the scale of the total UK business.

There is really two prongs to the introduction.

One is Woodbridge -- Robert Mondavi Woodbridge, which is going to the multiples.

On the on-premise we're going with Robert Mondavi--what is it?

It's Twin Oaks.

And that is cork finished whereas the Woodbridge is finished with a screw cap.

The reason that it will be relatively small to our total business is that the price point of the brand is not in the popular premium under 3 -- under 4 pounds.

It is a premium price point.

So we don't expect the same type of volume.

Eventually we think that's where the market is moving to and the brand will be well positioned to take advantage of that.

Would it be at all accretive to earnings in its first year, do you think, this brand launch?

Well, yes, I would say it's accretive to earnings but not of any significance and it is already in our forecasts and our guidance.

Okay.

That's fine.

And then if I might just ask on the spirits side, I think, Tom, that you said you expected mid single-digit growth in spirits or slight growth in spirits for the year.

That would be reversing a trend, I think, in the second quarter.

If you could just talk a little bit about what you see happening for spirits in the back half of your fiscal year.

Caroline, I take a look at the first quarter, which was on the stronger side of the trend and look at the first half of the year as an indicator of the full year performance.

I guess that is basically another way of saying that there is a little bit of timing difference going on.

But if you look at the performance for the full first half, I think that is really a good indicator for the full year.

All right.

Thank you.

Thank you.

We have our next question coming from Jonathan Feeney of Wachovia.

One question I had to follow up on Caroline was if it is not so much just distribution gains, what specifically do you think you've done?

Is it more marketing spending that halted this pretty long and disappointing declines for Woodbridge?

You’ve certainly done a good job.

What do you think are the most important things you've done to turn it around and how sustainable are they?

Well, it's not more marketing spent, because that is not our approach to throw more dollars at things.

It is clear and direct leadership, a marketing strategy that is focussed and a sales execution strategy that's focussed.

The distributors and retailers respond very well to clear direction.

That's what Mondavi was having difficulties given their -- difficulties giving, given the various conflicts of point of view that existed within the company.

Interesting.

And just also on Mondavi.

Hitting the shelves now, or in August in the UK, is that more or less on schedule with what you would hoped to head behind.

It seems like you were excited about that and maybe that's a little bit behind the initial schedule.

Nope, it's right on schedule.

We were just giving updates early on as to the acceptance.

When you intro a product, you go to the multiples, two, three months in advance and sell the product in.

Not physically, but conceptually, for delivery two to three months out.

So early in the summer we said that we had great success.

Retail was excited.

We may not have been clear that that was success in our sales pitch delivery of the product would be on the shelves three months later.

And on the subject of the UK market, when you look at the factors behind what's making the UK market, they seem like pretty durable things.

If I could just roll two question into one.

You've left the high single-digit option for base branded wine kind of open here.

That would be an acceleration versus what you've done thus far.

Do you expect any turn-around in the UK, or is it just acceleration base branded wine, where could the high-end come from, why not just mid single-digit on the guidance?

The high single-digit growth was for our worldwide branded wine business.

Okay?

Which is in line with what we have accomplished.

And, is in spite of a weak UK market we do tend to believe that we'll see a little more growth out of the UK market than we did in the second quarter.

So, I just wanted to make it clear we're not saying that we're looking for high--high single-digit growth out of the UK right now.

Sure.

But you mentioned you do expect better results.

I guess, why is that?

What is changing at the margin for the better?

In the UK specifically.

Yes, where are you getting that we expect better results?

I'm sorry, I must have just misheard you.

I said -- you said we do expect something better in the UK, I thought that is what you said?

No, no.

We expect pretty much the same out of the UK as we've seen.

Okay.

That's an answer.

Thank you very much.

Thank you.

We have our next question coming from Tim Ramey of DA Davidson.

Richard, the wine crush in California is turning out to be a big harvest, unexpectedly big, and I think you did have some excess capacity out there in terms of crush and tank capacity.

Are you able to be opportunistic at all in perhaps picking up some of the incremental production that is looking for a home?

To a small degree, yes.

But what's really happened is, first of all, the harvest is bigger than expected because it's been a very nice cool and long growing season.

But everything's coming to maturity right at the same time.

So while there has been some excess capacity in California, the capacity is constrained by the length of time that we're going to have to harvest all of the grapes.

By the way, this long, cool, growing season is ideal for quality and fruit development.

So, in addition to it being somewhat plentiful, it should be an extremely high-quality vintage across the board.

There will be -- California prices had started to move up a little.

This long crop will mitigate pressure on grape costs and keep grape costs pretty much the same as they were.

And there is actually very little capacity in the industry, given the shortness of the harvest for anybody to be extremely opportunistic.

Even among your Gonzales facility and the Woodbridge facility?

For us or other industry members.

Again, because the harvest is short.

Okay.

And I know you're not going to answer questions on Vincor but maybe I could just make a statement that I was glad that you said that this is not a must-have deal.

I thank you for being disciplined as a buyer turning your back on, I think, two other deals in the last 12 months.

Thank you for your comments.

Thank you.

We have our next question coming from Marc Greenberg of Deutsche Bank.

One of the concerns investors have is the sustainability of growth without new acquisitions.

I'm wondering if some of the challenges that you're seeing right now, UK in particular, have changed any of your thinking about your long term targets, both in terms of sales, profit and earnings?

I think investors would like to feel better -- have a better comfort level with your ability to hit the numbers as is with this portfolio.

This is Tom, Mark.

I'm glad you asked the question and I'm happy to answer it.

As you know, there is hardly a quarter that goes by when we're not asked this question and not -- partly because of that and partly because it is our job, we analyze this question constantly and I would tell you that our view on our top-line growth hasn't changed.

We believe that our -- we can continue to deliver strong top-line growth over an extended period of time, and what always happens is is one quarter one part of the business will be under the trend and a couple will be over.

And everybody will focus on the one part of the business and say, gees, doesn't this mean your long-term trend has changed?

And the answer is no.

That part comes around and maybe some other part is a little bit soft the next quarter.

The fact is, is that this is a great industry and this is a great business with a broad portfolio with strong brands and we believe in our ability to continue to deliver strong top-line growth.

Thanks, Tom.

Just a follow-up on your earlier cash flow comments.

You've come in nicely relative to expectations in terms of debt paydown.

There has been some asset sales.

Wondering if you might comment with regards to how we should think about remainder of year.

Are there other assets that could generate unexpected cash flows or is it going to be largely a function of the operating cash in the business?

I think the comments I made in my -- in my prepared remarks were that we continue to target a debt balance at the end of the year of $2.9 billion.

Now, if you kind of work backwards from that, our -- we have completed our asset sales.

That was at the high-end of our range.

We continued to target the same number for free cash flow.

But there's still a lot of moving parts.

The harvest isn't totally complete, yet.

We may have some small investments relative to acquired businesses.

And so because there is still moving parts we're keeping our end of year guidance at a debt balance of $2.9 billion.

Great.

Thanks.

Last question for Richard.

I wonder if you might give us some perspective on your view of the US wine pricing environment at present.

You've seen good mix lately.

What about absolute price increases and how should we think about this season?

Yes, especially in wine we have seen a strong pricing environment on an absolute basis or certainly an absence of weakness.

You are correct that there have been good mix effects.

I think as we go into the holiday season, we will see a strong market, distributors, everybody is suffering with higher fuel costs.

That will keep people from getting overactive on promotions and discounting, and may even lead to some price increases across the board.

The fact that inventories are relatively in balance and the dollar is weak supports a stronger pricing environment than a weaker one.

So we're optimistic that the pricing environment will remain strong.

Thank you.

Thank you.

Our next question is coming from Bill Leach of Neuberger Berman.

Good afternoon.

For perspective, I was wondering can you give us some guidance on how large your UK business is?

On how large are UK business is?

Yes.

It is about 30% of our total sales, Bill.

In terms of profits, would it be less?

Yes.

And another question I have, this morning Cadbury reduced their margin guidance, citing higher glass costs.

I guess one of their big glass suppliers has gone bankrupt and it's raising prices.

Do you foresee that being any problem for your wine business, higher glass prices?

No, not in the near-term.

Okay.

Tom, last question, can you update us on your expectations for options expensing next year?

I think the last estimate was it was about $0.08 a share.

Is that still a good working number?

We actually didn't give guidance and nor will we.

Options aren't -- options aren't granted until they're granted and I think we would be ill advised to be giving guidance.

I think what I suggested at that time when we met, Bill, was that if people want to look at our footnote disclosures and use the past as some kind of barometer of the future, you can get yourself into a ballpark.

So I would say the same thing now.

Okay.

Thanks.

Okay.

Thank you.

We have our next question coming from Mark Swartzberg of Legg Mason.

Thanks, good afternoon, Richard, good afternoon, Tom.

On the beer side here in the U.S., Richard, trying to get a better sense of how you feel the trade is situated presently in terms of Corona and total Modelo inventories.

Perhaps you can tell us how your year-to-date shipments, fiscal year to date, latest six months compares to your fiscal year-to-date depletion rate.

Anything to give us a better sense of how you’re positioned going into a second half which obviously has some seemingly friendly shipment compares?

Inventories in general are actually contracting and that is on purpose as Modelo and ourselves want to really keep inventories, I'm going to say, as low as possible to keep the beer fresher and better.

So I don't want you to take that, that this is big numbers, but we're constantly reducing inventory levels, a day or two a year.

So that process continues.

So is it misreading things to see these -- this dramatic slow-down in growth you had in the second half of fiscal '05 and think that apples to apples, if your total shipment levels, putting aside growth, just remain at current levels in terms of the barrelage you're shipping, you're going to have some benefit in terms of year-on-year growth in the second half.

The growth, the lack of growth, the slow-down of growth in fiscal '05 was because of the January '05 price increase.

Fiscal '05 ends in February.

It was because of the January price increase -- the January '04 price increase a year ago which had this gigantic increase.

So it was an anomalous comparison.

That's all.

And that's completely past us.

It's way in the history of the anomalies no longer carried forward on shipment trends.

Fair enough.

Thank you.

Mark, you look good on Canadian TV, by the way.

Thank you.

We have time for one more question.

Thank you.

We do have our final question coming from Bryan Spillane of Banc of America.

Hi, good afternoon, guys, and thanks for taking the question.

I'm going to slip two in here, if I can.

The first is I just wanted to make sure it was clear, your guidance for mid to high single-digits on branded wine, does that number compare to the branded wine sales that were up 5% on a comparable basis?

Yes, it is, Bryan.

So branded wine sales this quarter were up 5 and there is 1% benefit from currency, so that is what, let's just call it plus 4.

It was up, I think, eight in the first quarter with three points of currency.

So it was up five in the first quarter.

Correct.

So what we're saying in the guidance is that it's mid single -- mid to high single-digits which would suggest that maybe it accelerates a little bit in the second half.

Is that fair?

Your math is correct, Bryan.

Okay.

I guess to get back to Feeney's question on that.

Are your expectations that the UK stays the same and the U.S. continues to get better?

Or are you expecting some improvement out of the UK?

I would say we're expecting some improvement across the board.

I mean, I don't think we should get too granular on the UK.

It is a tough market.

We do have a lot of initiatives going on over there.

But, I guess I would say our expectations are really across all of our geographies.

Okay.

And then just one last thing.

Could you just -- I don't know if you gave this or not, but what impact did the -- did your popular priced wines have on your overall sales, branded wine sales in the quarter?

The Almadens, Inglenooks.

We didn't give the number, but they always tend to be lower than the average.

In other words, they tend to be flat.

And, Bryan, I think we discussed when we saw each other recently, we had a SKU which was of Almaden White Zinfandel that was discontinued.

So that part of the portfolio which is normally flat, was actually down in the first half of the year.

So on an apples to apples basis, we really did a little bit better.

The margin expansion has been, I think, certainly better than I was modeling.

Is the margin expansion here better than you were expecting at the beginning of the year?

And, if so, why?

You know, I don't--I don't think it's that much better.

I mean, I think we're very happy with the margin expansion.

Again, the impact of Mondavi and Ruffino was well understood by us at the beginning of the year.

I think that we're very happy with the mix of products that we're selling.

Obviously I'm talking primarily about the branded wine business and the mix in our wine's division is better.

Part of that is, branded wine versus non-branded business and part of it is consumers trading up to premium wines, which is benefiting us, as well.

So there is a positive benefit in the wine business for our mix.

Okay.

Great.

Thank you very much.

Okay.

Thank you.

Well, thank you, everybody.

I hope that everybody is pleased with our quarter.

I know that we're very pleased.

We're looking forward to two great quarters coming up to finish off the year and then a continuation into our fiscal 2007 of a similar level of performance.

So stay tuned and we'll keep performing.

Thank you.

Thank you.

This concludes today's conference.

You may disconnect all lines at this time, and have a great day.