Constellation Brands Inc (STZ) 2007 Q2 法說會逐字稿

Good morning, ladies and gentlemen.

My name is Tierra and I will be your conference operator today.

At this time I would like to welcome everyone to the Constellation Brands second quarter 2007 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. [OPERATOR INSTRUCTIONS] Thank you.

It is now my pleasure to turn the call over to your host, Mr. Bob Czudak, Director of Investor Relations.

Sir, you may begin your conference.

Thank you, Tierra.

Good morning everyone and welcome to Constellation's second quarter fiscal year 2007 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.

By now you should have had an opportunity to read our news 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 information on a GAAP basis, comparable basis, organic basis and constant currency basis.

Reconciliations between the most directly comparable GAAP measures and these and other nonGAAP financial 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 the nonGAAP financial measures and why management believes they are useful to investors.

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

They will also discuss organic net sales information which excludes the impact of acquisitions and constant currency net sales information which excludes the impact of year over year currency exchange rate fluctuation.

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 statements.

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

Thank you.

And now I would like to turn the call over to Richard Sands.

Good morning everyone and thank you for joining us today.

The second quarter was active and exciting for Constellation Brands.

Highlights include completing the Vincor acquisition and beginning integration activities which was followed by the mid July announcement of our beer joint venture with Grupo Modelo.

Before getting into the details of these and other items, I want to first talk about the strong organic brand business growth generated for the second quarter.

All sales commentary is on a constant currency basis.

Our organic branded businesses increased 7%, driven by all three categories, imported beers, branded wine, and spirits.

Branded wine organic net sales increased 6%, driven by very strong sales for North America and a solid performance in Australia, New Zealand, which more than offset below trend results for the UK.

Our imported beer business grew 9% driven by continued strong consumer demand throughout the summer season.

And for our spirits business, investments behind our premium brands resulted in an 8% increase.

On a year to date basis, organic net sales for our branded businesses have met or exceeded expectations growing 8% overall.

We are very pleased with the solid growth trends in each category of our branded businesses.

Now turning to some topical areas.

First I'll provide a quick update on Australian wine supply and its impact on the UK wine market.

While not much has changed in regard to fundamental supply and demand since our discussion at the end of the first quarter, there continues to be increasing economic impacts on Australian wine companies and certain markets like the UK.

We continue to believe that it will probably take the industry two to three years before the supply comes into balance with demand.

This is not your common grape cycle.

In a normal grape cycle the change in pricing of various varieties results in a longer term increase or decrease in demand for that varietal.

In a situation like we see in Australia there are significant imbalances resulting from over planting in the cool climate areas.

In our opinion, a further change will be required to curtail industry supply, one which includes the removal of marginal vineyards instead of waiting for changes in demand, which is how a normal grape cycle would resolve itself.

With this as a backdrop, Constellation continues to evaluate proactive steps, managing inventory, grape contracts and our own vineyards.

Efforts to manage intake resulted in our total grape purchases for 2006 coming in about 10% lower than the prior year, and we are working on plans to try and achieve a similar reduction for 2007.

Similarly, we announced a restructuring of some of our cool climate supply during the middle of the quarter that will improve our efficiencies and ROIC.

And we will continue to look for additional opportunities of this nature.

Now I would like to turn to the UK market which has seen the most significant impact from the Australian supply situation.

Market conditions have not changed materially since the first quarter as some suppliers continue to discount product in an effort to reduce inventory levels, creating price pressure for all Australian wine suppliers with the multiple grocers.

Combine that with the duty increase and slowing of the overall market growth and you have a challenging environment that will likely remain in place for some time.

As such, in the near term we will continue to leverage our leadership position to maintain share and focus on increasing operating efficiencies as we manage our business in this extremely competitive market.

Longer term, we will focus on opportunities to create growth and value as we strive to increase our business at higher price points.

These efforts will include continuing to feature strong brands from new world countries of origin including the U.S., South Africa and New Zealand, while working to increase our presence in the on trade and impulse channels.

Shifting to the U.S. grape supply I think it's important to emphasize the following points.

The U.S. wine market is very healthy.

And the large 2005 crush, which followed two years of light harvest did not create a surplus.

Instead, the large harvest helped keep supply and demand in balance and grape prices in check.

For 2006 the industry harvest projections indicate a potential decline of about 20% from last year; a slightly smaller than average crop size.

We expect overall pricing to be flat with grapes for popular priced wines like Chablis, Burgandy or White Zinfandel coming down a bit and those for high-end varietals like Cabernet Sauvignon and Chardonnay moving up slightly.

All indications are that overall supply should generally remain in balance with demand.

One last comment on grape supply.

The additional of Vincor adds to our scale and geographic diversity and provides even more opportunity to efficiently manage grape supply across our international operating platform.

Speaking of Vincor, we completed the transaction on June the 5th, and it delivered solid results in line with our plans for the first three months under Constellation.

Vincors premium brands in the U.S. and Canada continue to demonstrate strong marketplace performance.

In the UK, Kumala has experienced a decline in the off trade marketplace which was fully anticipated because Vincor had implement a price increase to improve brand profitability.

This action occurred prior to the acquisition but is consistent with efforts to increase our UK branded business at higher price points over the long-term.

The Vincor transition has been smooth and the integration is progressing as-planned.

Most of the integration activities are focused on redundancies in the U.S., the UK and Australia where Constellation's operations are significantly larger in scale than Vincors.

While Vincor Canada remains as an independent operation under the direction of Jay Wright.

Market data shows the Canadian market and our business continue to grow in the mid single digits and we are seeing trading up trends driving positive mix across our portfolio.

I'd like to conclude my remarks this morning by updating you on our imported beer business and joint venture activities.

Our imported beer business delivered strong growth while managing lower than normal inventory levels for Corona and Corona Light due to a tight bottle supply.

We've been working very closely with the brewery and had optimized our supply chain efforts to work through this situation.

The bottle supply is expected to improve during the second half of our fiscal year.

Additionally, start up efforts for our beer joint venture with Grupo Modelo are under way.

The joint venture has been named Crown Imports and is on track to commence operations January 2, 2007.

This will provide the Grupo Modelo portfolio a single national importation and marketing approach for the first time.

Ching Tou(ph) has agreed to transfer importing and marketing of brands to Crown Imports and discussions with St. Pauli Girl are underway.

Bill Hackett and his team are working to ensure a seamless transition for the wholesalers in the eastern U.S.

Activities include recruiting, hiring and training new personnel together with back office preparation for supply chains and distribution.

Bill and members of his team have also been meeting with wholesalers to review how Crown Imports will operate as go to market strategy and alignment of responsibilities.

These visits have been well-received by the wholesalers and are integral to ensuring a smooth transition.

As many of you know, the current eastern U.S. importer announce a mid September price increase to wholesalers.

In relation to this action I would like to point out that Grupo Modelo has not imposed any corresponding increase to its current importers.

Also Crown Imports has communicated to the eastern wholesalers that it expects to initiate January 2007 pricing to wholesalers at levels that were in place prior to the mid-September price increase.

To ensure that price levels for the Grupo Modelo portfolio remain competitive, are in best interest of the brands and distributors for the long-term we believe many distributors will hold their pricing to the trade.

In closing I want you to know that we are pleased with our second quarter results.

Our branded categories are generating strong organic growth, and we are on track to deliver solid comparable earnings growth for the year while managing some difficult market conditions in our business.

And after taking into account the year over year impact of items like stock compensation expense and higher interest and tax rates, our performance is tremendous.

I'm enthusiastic about our ability to create value by continuing to harvest opportunities in our markets and from the operating platforms that we have built organically and through acquisitions.

Now I would like to turn the call over to Tom Summer for a financial review of our second quarter.

Thanks, Richard, and good morning everyone.

I would like to start with a review of the P&L for the quarter where my comments will focus on comparable basis financial results.

Commentary for net sales comparisons is on a constant currency basis.

Our net sales grew 18% driven by the acquisition of Vincor and 7% increase in organic net sales.

Net sales for our branded businesses, wine imported beer and spirits, increased 20%, reflecting the benefit of Vincor and 7% growth in branded business organic net sales.

This included imported beers up a strong 9%, spirits growing at 8%, and branded wine organic net sales up a solid 6%.

Our base business branded wine net sales for North America and Australia, New Zealand increased 9% and 8% respectively, while Europe decreased 4% as competitive conditions in the UK remain challenging.

Now moving to margins, for the quarter our gross margin was 29.8%, down 10 basis points as a sales mix benefit from Vincor was offset by the impact of higher UK duty, spirits material and beer product costs.

As I mentioned last quarter, around midway through fiscal 2006 the elimination of an advertising expense charge for the Company's Mexican beer portfolio was offset by a product cost increase.

This resulted in a classification shift between cost of goods and SG&A with no overall impact to operating margin.

Without this beer product cost reclassification gross margin would have been 30% even.

Operating margin for the quarter was 16.7%, an increase of 20 basis points.

Operating income included $4.1 million of stock compensation expense related to the adoption of FAS 123 R. In addition, we recognized $1.5 million of expenses which were primarily corporate transaction related costs associated with the formation of Crown Imports.

Wine operating margin for the quarter increased 100 basis points to 16.5%.

This primarily reflects a strong increase in operating margin in the U.S. base business from operating efficiencies.

The marginal list from Vincor synergies and sales mix were mostly offset by the impact of UK duty cost where competitive conditions have not allowed us to pass on the duty increase as well as stock compensation expense.

In beers and spirits, operating margin declined 90 basis points due to increased material costs for spirits, higher spending behind premium spirits and stock compensation expense.

Our SG&A for the quarter was 13.1% of net sales compared to 13.4% a year ago.

We're getting scale improvement on our SG&A reflecting the benefits of our restructuring program and other cost reduction efforts including the Vincor integration.

SG&A also benefited from reclassification shift between beer advertising expense and cost of goods that I discussed earlier.

For the quarter corporate and other expenses totaled $18 million compared with $14 million for the prior year.

This increase was primarily due to transaction related costs for Crown Imports and stock compensation expense.

We are targeting corporate expenses to be in the range of 63 to $66 million for this fiscal year 2007.

Overall our operating income increased 21% to $237 million for the quarter due to the addition of Vincor and base business growth.

The $4.1 million of stock compensation expense effectively reduced our operating income growth by two percentage points.

Interest expense for the quarter was $73 million, up 55% over last year, reflecting the impact of financing the Vincor acquisition and higher average interest rates on our floating rate debt.

Our average interest rate for the quarter on all of our debt was 6.9% compared with 6.1% for the second quarter of the previous year.

In connection with the Vincor acquisition, we closed on a new $3.5 billion credit facility which replaced our previous $2.9 billion credit facility.

In mid-August we completed an offering for $700 million, 7.25% senior note due 2016.

We used the net proceeds of the offering to reduce borrowing under our bank credit facility.

At the end of August we had approximately $2.6 billion of bank debt and $1.7 billion of fixed term and other debt.

Our bank debt is primarily LIBOR base debt with current margins ranging from 125 to 150 basis points. 1.2 billion of that bank debt is fixed with interest rate swaps that are in place through the ends of fiscal 2010.

As a result about two-thirds of our debt is effectively fixed rate.

Our effective tax rate on a comparable basis came in at 36.9% for the second quarter versus 35% for the previous year.

And as a result of all of those factors our net income increased 7% for the quarter.

Our weighted-average diluted shares outstanding were 240 million compared to 239 a year ago.

And diluted EPS grew 5% to $0.43 for the quarter which was in line with our expectations.

During the second quarter we repurchased 3.24 million shares of our Class A Common Stock at an average cost of $25.28 per share for a total of $82 million under our $100 million share repurchase program which was authorized by our board in February.

The primary purpose of this program is to mitigate the dilutive effect of stock option exercises.

Now if I can shift to free cash flow.

For the first six months of fiscal 2007, we used $9 million of free cash flow.

This included capital expenditures of $103 million.

Our CapEx guidance for fiscal 2007 is $180 million, and our free cash flow guidance for fiscal 2007 is 155 to $175 million.

We still intend to use the remaining $18 million available under our stock repurchase program.

But the balance of our free cash flow for the year will be used to pay down debt.

At the end of the second quarter our debt to trailing twelve-month comparable basis EBITDA was 4.5 times compared to 3.1 times at the end of fiscal 2006, this primarily reflects the increase in our debt balance related to the financing of the Vincor acquisition.

Our return on invested capital was 9.5% versus 9.7% at the end of last quarter.

The near term dilution in ROIC was expected and driven by the Vincor acquisition which should continue until we fully integrate Vincor and capture the full benefit of synergies from the acquisition, but even with the dilution from Vincor, ROIC was at a higher level than it was a year ago as a result of our base ROIC increasing.

In August we announced plans to invest in new distribution and bottling facilities in the UK and three line certain Australian wine operations.

These initiatives are just one example of our ongoing efforts to maximize asset utilization, further reduce costs and continue to improve ROIC throughout our operations.

Moving now to our expectations for fiscal, 2007.

Last quarter we indicated that we were evaluating whether to continue our practice of providing quarterly EPS guidance. based on that review we have decided that going forward we will only provide annual EPS guidance as this approach is more consistent with the way we manage and analyze the business for long-term growth.

Now looking at full year fiscal 2007 we've revived our comparable basis diluted EPS outlook and tightened the range to $1.72 to $1.76 from our previous range of $1.72 to $1.80.

This reflects the ongoing impact of the intensely competitive market conditions in the UK and our intentions to leverage our leadership position to maintain market share in this challenging environment.

These conditions have impacted our outlook for the second half of fiscal 2007 particularly in the third quarter which faces a difficult comparison versus the same period last year.

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

Our full year diluted EPS guidance assumes the following: reported net sales growth in the low teens.

This includes approximately 9 to 10% in benefits from the nine months of Vincor sales, and an approximate 3 to 4% reduction in growth rate for the move of beer sales to Crown Imports for the last two months of the fiscal year.

Breaking it down by category we see branded wine base business growth of mid to high single digits, imported beers growing high single-digit, before sales moved to Crown Imports in January of 2007, spirits growth at mid single-digit, and wholesale and other, low to mid single-digit growth.

The guidance includes an expectation of interest expense to be in the range of 255 to $265 million for the year.

Stock compensation expense of $15 million.

And we anticipate the comparable basis tax rate to approximate 36.9%.

And assuming a weighted-average diluted shares of about 241 million which implies a relatively stable share count for the year.

I want to remind you our comparable EBIT margin will expand in the fourth quarter as sales for the beer business move to Crown Imports and we report our share of equity earnings from the joint venture for January and February.

Now let me briefly summarize some of the key points from our second quarter results.

It was solid top line performance with strong organic growth in our base branded businesses.

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

And we generated operating margin expansion as a strong margin increase in the U.S. wine business and mix and synergy benefits from Vincor more than offset the negative impact from the challenges in the UK and the result of stock option expense.

Our earnings, which were also impacted by higher interest and tax rates, were in line with our expectations for the quarter and even after the Vincor acquisition our strong balance sheet and ability to pay down debt following an acquisition, position us with plenty of flexibility two grow, further strengthen our portfolio including sufficient capacity to fund other opportunities as they arise.

We continue to be very optimistic about our prospects for fiscal 2007 and beyond.

And with that I would be happy to open the call to questions.

[Caller Instructions].

Your first question comes from Kaumil Gajrawala of UBS.

Hi, guys.

Can you talk about what was behind the spirits numbers and how much of that was your newer premium products versus some of your existing brands?

And what kind of longer term growth we should be looking at for that business as well?

Yes, this is Richard and I would be glad to talk about that.

First of all, the 8% growth is, we would say, way above trend lines.

Any way you could look at it is compensatory for the below trend lines of the first quarter.

We are looking overall in the spirits category at 2 to 3% growth, low single digits, and that growth is being to a large extent being driven by our premium brands.

From an operating margin perspective you basically see that with the investment that we are making in the premium brands, and particularly advertising and promotion expenses, that it will drag down our operating margins in spirits a slight bit.

So our basic brands are doing very well, brands like a Black Velvet, some of our vodka brands, so on and so forth.

Thank you.

Your next question is coming from Bonnie Herzog of Citigroup.

Good morning.

I actually had just a couple quick questions.

I guess in listening to you speak and reviewing your results, it does appear that Vincor may not have met your expectations despite, I guess, your comments.

I just want to make sure I'm looking at this correctly, because when I look at the comparable EPS growth that you are going to be achieving in '07 it's going to be under 10% or basically high single digits.

But I'm just really trying to understand what value did Vincor provide for you?

And then, am I correct in that to believe that Vincor has under performed and what's really been the largest disappointment for you?

Or if I'm wrong tell me what's been the biggest surprise.

This is Tom, Bonnie, I think you are wrong.

First of all, the strategic value of Vincor to our business, we don't need to repeat what a great presence in Canada that's given us in the brands, but just talking about the numbers for a second.

We guided to $0.02 to $0.03 of accretion.

Most of that is in the second half of the year and primarily around the holidays.

So there really wasn't a whole lot of impact relative to this quarters financial results.

I can tell you that the integration spot on plan.

The sales trends in North America and in Australia Asia have gone actually I would say on or better than plan.

The one tweak that we are all aware of is the performance of Kumala.

Actually, when you look at the profitability of our UK business, it is also performing on plan.

The strategy of pricing that was taken by Vincor with Kumala prior to the acquisition is a good strategy and the earnings of that UK business again are tracking on plan.

So I would say right now we are at least on plan if not better than plan.

These are great brands we've added to our portfolio and a great platform in Canada and I'd say we couldn't be more pleased, frankly.

I would add just one thing, which is as Tom said, we were looking for $0.02 to $0.03 accretion, relatively small in the first year, and if you look at our earnings per share versus a year ago you will find that they are in the low teens or double digits, when you take into account things like stock option expenses, so on and so forth, things that are, we view as clearly noncomparable but we may do not account for them that way.

So going forward we should expect you to grow low double digits in terms of EPS?

That's still your goal?

Yes.

Okay.

And then finally, quick question on the spirits portfolio and the possibility of you expanding that portfolio.

I know you talked about it for a while, the interest is there.

And obviously there's been a lot of talk that Absolute vodka could be in place.

I'm curious if this is something you feel would fit within your portfolio?

And if so, do you have the current financial means to make this type of large acquisition?

Can you talk to that?

Yes, we definitely have the financial means.

But I am not going to comment on whether or not we would be interested.

And I will note it's way premature that potential transactions we believe won't take place for a couple of years.

So it's way premature to be talking about how it fits for us.

We can be a very different company by the time that happens.

But it's fair to say that you are still interested in white spirits?

We are interested in premium spirits, white or brown.

Okay.

Thank you.

Your next question is coming from Lauren Torres with HSBC.

Good morning.

Tom, you mentioned a number of items which limited margin expansion in the quarter but just speaking about 7% organic sales growth in the second quarter and some restructuring fades, were you surprised at all that you didn't get some or at least more margin expansion despite this?

No.

I think we were happy with the level of margin expansion.

Richard already talked about the stock option expense.

There is nothing you can do about that accounting, and if you kind of take that out of the equation, I think we're actually tracking, our guidance for this year will be tracking with kind of high single-digit operating margin expansion.

I think we're very happy, that's consistent with how we think about our business.

Yes, costs are up in some parts of our business, but we are gaining operating efficiencies and driving mix improvements in other a part of our business.

That's actually kind of typical for us.

We always have challenges somewhere and more than offset them in other places.

I'd say that we're tracking in line with our expectations which is healthy growth coupled with margin expansion.

And also Richard maybe could you talk a little bit too more about the UK market, what you are seeing there, if these issues are longer term in nature and how long it can take to correct or will take to correct?

Yes.

I think that they are -- I wouldn't use the word longer term but they are certainly not short term because of the Australian grape situation, which as we said, we see resolving itself at the next couple of years.

The situation I would say therefore is I think we will see the UK market remain competitive in the medium term.

But at a certain point there will be a significant change in the marketplace that will allow us to really change our margins as we move forward.

That will probably be precipitated by a more balanced supply in Australia.

So in the meantime we are very patient.

We can wait a year or so and focus on market share and protecting our market share and our leadership position because we have such a good business throughout the world.

It will never be the case that every market in the world is operating at its best.

So, we're not concerned.

Give it a couple of years and I think will you see dramatic changes.

Can you just remind us what percent of sales is the UK for you?

Or about?

Of our total sales?

Yes.

Of our total branded business, because you have to exclude wholesale because it really doesn't count here, I believe the number is about 8%.

Okay.

Thank you.

It's in that high single digits, of our total branded business.

That helps, that's great, thanks.

Branded.

Yes.

Your next question is coming from Christine Farkas of Merrill Lynch.

Thanks very much.

Good morning Richard and Tom.

A couple of questions on wine.

Firstly in the domestic market, can you talk a little bit about the recent momentum in Woodbridge, is that line extension, is that new channels or new outlets, what's driving that momentum?

And also in the same light, what kind of impact are you seeing from the excesses out of Australia or imports in general on the California wine market?

Yes, we are seeing very little impact out of Australia from the Australia surplus.

If you look at Australian imports in the United States, you will find that pricing is down a little bit in like the 1% range.

So we don't consider that an impact.

We actually think that's just more of a mix effect.

Actually, leading brands have increased their prices so that's, as I said, much more of a mix.

Would you repeat the question on Woodbridge?

Because I didn't hear the exact question.

Sure.

My question is if you could speak a little bit to the recent momentum in the brand?

Is it due to some line extension?

Is it due to maybe increased channels or distribution?

What's driving that Woodbridge growth in the U.S.?

I first of all will say that Woodbridge has been a very well distributed brand so it's not an increase in distribution.

We do have high activity level of adding varietials like Pinot Noir or Riesling, and that is part of the story.

I just think we're having much better sales execution, much more focus and attention to the brand, now that it's in our sales force and that basically it's in a sales force that's accustom to selling premium, popular premium priced wines as opposed to a sales force that is torn between ultra premium, super premium, popular premium priced wines.

Okay, great, and moving on to the UK, in looking at the Taylor Nelson data of off trade wine sales, it looks like wine sales were actually up in the UK, and again, this is just part of the channel, given your decline, I am just wondering, was there a share loss and is that what's leading you to pick up spending from your lowered guidance, it looks like about $15 million of expected pick in promotion or hit to your profits, is that what's going on here?

Well, first of all, what you are basically seeing is a real slow down in Australian growth and being the leader with a commanding share, we are -- I would say suffering some minor share losses while we try to maintain reasonable profitability.

We don't consider it a major share loss and with our commanding share lead we have adequate share to maintain that lead.

I am going to have Tom answer this question on the $15 million of spending but I don't think it exists.

I don't think so, either.

Why don't we follow up off-line but I'm not sure where that's coming from.

I was looking in terms of tightening up your range a little bit for your full year guidance, $0.04 is about 15 million in pretax, so, something in your outlook for the second half of the year is suggesting that kind of a shortfall versus your earlier guidance.

That again --

The tightening up of the guidance is taking all factors into account, which includes sales trends and margins and a lot of other things so it's not all in one bucket.

Okay.

Got it.

Just a final question, Tom, on beer.

There was 1.5 million cost related to the joint venture set up.

What's your outlook for the rest of the year in terms of set up cost?

We haven't given any precise numbers.

I wouldn't expect to see anything much larger in the third quarter, and as I think we said, we expect whatever costs we incur during the second and third quarter to be approximately offset but of course the joint venture hasn't finalized its plans yet so we are still, this is still all a little bit directional but that should give you an idea.

That's terrific.

Thanks a lot.

Your next question is coming from Mark Swartzberg of Stifel Nicolaus.

Thanks, operator, good morning guys.

Tom, two cash flow related questions, one I think a small one, and it looks like inventory step up expense went from $0.01 to $0.06, in terms of your full year expectation, is that right?

Why that?

And should we expect some small cash flow benefit there in terms of an incremental tax deduction?

And then the larger question is, what's, in your best judgment, what do you think the core free cash flow of the business is, obviously this year it's below 200 because of charges and some extraordinary CapEx, last year had you more than 300, but in your best judgment what do you think the core free cash flow of the business is?

Yes, that's a good question, Mark.

First of all, the inventory step up, the guidance that we were using before excluded our purchase accounting adjustments and were subject to pending appraisals.

So we've gotten more appraisal work done and more information and that's really what's driving that variance, if you will.

And so, your question is, should that be reflected in cash flow, favorably, the answer is that it should.

Relative to the core cash flow, as you know we started the year in the mid to high 200s, and basically, the two steps that got us to our current cash flow guidance, which hasn't changed since our last restructuring charge was announced, the range of 155 to 175, those, that was the cost of Vincor integration and the cost of our cool climate and UK operational platform restructuring charge which we would not expect to repeat.

So as a starting point, I would look at where we started the year, and then I would say that my normal expectation would be that free cash flow should at least track with EBIT growth.

So, if we can generate high single-digit EBIT growth going forward, that would kind of being my starting point, start in the mid to high 200s and tack on high single-digit growth and hopefully we can do even better than that.

You forgot to add any cash flow from Vincor, because the mid to high 200s was --

Correct.

-- was without Vincor when we started the year.

You're correct, that is right, thank you, Richard.

You should have Vincor on top of that.

That's very helpful.

Thank you, guys.

Thank you.

Your next question is coming from Bryan Spillane of Banc Of America.

Good morning.

Just a couple of questions.

First I just want to make sure I understand the SG&A piece correctly, Tom.

With your marketing spend on an apples-to-apples basis up or down for the quarter?

In total, is your question in total or relative to spirits?

In total.

In total I don't have an exact number, so I think it would be up a little bit.

Okay.

And then underneath that --

That's on an apples-to-apples basis, obviously including Vincor it's going to be up.

Right.

But on a like-for-like basis your marketing spend in the quarter was up slightly?

Correct.

Okay.

And then, Tom, if you could just talk a bit about the restructuring or, Richard as well, you are now a few months into this and it's really the first that I can remember major restructuring action you've done that's not related to an acquisition, as you've looked into this do you see opportunities potentially for other areas of cost savings beyond what you are doing now and what you see beyond this year?

Yes, let me, I think there's two parts to answering that question.

I think that first of all there is a relationship to the restructurings that we've announced and to our acquisitions.

I think that and I'm not talking about obviously the Vincor integration was very directly related but the latter announcement which was relating to the UK and Australia, did in fact relate to not just Hardy's and not just Mondavi but really taking our whole global platform as a whole, including what we've added with Vincor, and then saying, hey, and example of that for the UK platform is, hey, we're now a major marketer of South African wines in the United Kingdom, can we be doing something with that more cost-effectively and how our whole global platform operates.

Okay?

Well, we didn't have the South African wine to market before we did Vincor.

So there is very much a relationship between the latter operational changes, and really analyzing the global platform and that takes me to part two which is, I think Richard and I had both alluded to it quite a bit.

We really are intent as we operate this business on continuing to drive improvement and return on invested capital and this larger platform whether you want to attribute it to Vincor, Mondavi, Hardy's or just the fact that we've grown our base business and added a lot of really great brands around the world, we believe that there continues to be opportunity, and our management team in the business is very focused on looking at, can we do more with what we've got?

Can we drive further efficiencies?

Can we continue to generate healthy improvements in return on invested capital?

And so, because we are very actively working on these things as a management team we continue to communicate that to the investment.

So specifically towards the work you've done so far, are you seeing potentially more opportunities to do more beyond what you've identified already?

I have no doubt that there will be opportunities.

Will they be similar to things that we've already done or will they take a different form?

I'm not really sure, but, yes, we think that there's more that we can do to drive more efficiencies out of the business.

Just finally, and I think Mark had alluded to the increase in the inventory step up charges and you guys are both aware that one of the sore spots with investors has been the gap between reported and comparable earnings.

So being conscious of that and should we begin to expect that the level of charges will begin to drop as you move into fiscal '08?

If nothing else changes, yes but of course things continue to change in our business and we continue to grow both organically and through acquisitions.

So I can't make any absolute promises in that regard.

Okay.

Great.

Also, Tom, when you explain the increase in the charges, you didn't say that was related to the Vincor appraisal, Tom.

The $6 million was related to the Vincor appraisal -- and by the way, I would not on that the change in the appraisal had no impact on our comparable earnings, and I guess I would also note that our reported earnings came in above our guidance range.

So we shouldn't just cherry pick when we are talking about reported earnings.

I think we acknowledge when we give reported earnings that we are using the best estimates available to management and that everybody understands, I hope, that when detailed appraisal work is done on an acquisition that the results can vary from managements best estimates that existed before the appraisal took place.

And I would argue that from a fundamental perspective the appraisal, the increase in value that is attributed to the finished case goods and the bulk wine in the tank is entirely artificial.

The cost, especially in a Vincor acquisition, are what the costs were.

So the appraisal methodology which is required under GAAP is to allocate a certain amount of profit to the case goods and the bulk, but it's an artificial allocation from a fundamental perspective.

So to say that it's not going to increase is very hard.

Because, if you make an acquisition there is going to be another chunk.

But assuming no more acquisitions, we should expect that the level of charges would begin to come down?

I would expect without acquisitions that you would not see as many, as big of a gap between reported and comparable earnings, that is correct.

Okay.

Great.

Thanks.

Thank you.

Your next question is coming from Tim Ramey from D.A. Davidson.

Good morning, a couple of things on -- first the share repurchase, congratulations on doing that.

I can't remember you doing one of those for a long time and you've sort of used up most of your authorization in one quarter.

Any thoughts on a reload on that, Richard?

I am going to turn that over to Tom?

Well, look, I think first of all 1998 was the last time we had done it.

I think we were a different company then.

I think we are a much bigger company with a much stronger balance sheet today, and that is why our board approved and agreed with a strategy of offsetting the impact of option exercises.

I think it's a good strategy.

Obviously, it's something we are going to revisit every year as a part of our financing strategy that we review with the board.

Nothing will be approved until that happens, but I would say I think it's a good strategy and it's served us well.

And on Vincor, thinking back to the Mondavi acquisitions you were able to take some of the mid-size brands there and kind of ramp them quickly through the greater ACV gains, is that still ahead of us or is that ongoing right now or will we see the same types of distribution gains with Vincor?

On brands like Toasted Head, RH Phillips, Kim Crawford, the brand that have, I am going to call it, an established base, albeit low ACV in the United States there is no question we will ramp up the distribution.

That is more in the future than it is in the last three months, even though we have improved distribution somewhat in the last three months but that has not been the major focus.

Basic integration activities have been.

Okay.

Terrific.

Thank you.

There are no further questions at this time.

I would now like to turn the floor over to Richard Sands for any additional or closing remarks.

Great.

We are very happy with our second quarter results, and as many of you who followed the Company know we believe that success in this business, the alcoholic beverage business, is a joint function of scale and growth.

And one of my favorite things to talk about is how we are doing in the grocery and drug channels as measured by IRI in the United States, because, I think people have a tendency not to realize that within the United States we are the second largest provider of alcoholic beverages in wholesale dollar terms and clearly the largest provider of growth.

And this trend continues to be very strong.

We provided last year 7.4% growth in retail dollar sales to the channels that are measured by IRI.

Clearly, clearly way ahead of the largest purveyor of beverage alcohol products which is Anheiser Bush, and the third largest purveyor is Miller Brewing, and the fourth largest purveyor is Diageo, and none of those have the growth levels that we have.

And it's not just the size of your portfolio and the dollars, it's the growth.

That's what the wholesalers and the retailers are looking for today is growth.

And we provide both scale and growth and that is why, over the course of time, we are becoming an ever more important partner to our wholesalers and retailers throughout the United States.

So with that we are very happy.

We are looking forward to a great third quarter and fourth quarter.

And of continuation of our great success and track record.

So thank you, everybody, and have a good day.

Thank you.

This concludes today's Constellation Brands conference call.

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