Constellation Brands Inc (STZ) 2008 Q2 法說會逐字稿

Good morning.

My name is Elsa and I'll be your conference operator today.

At this time, I would like to welcome everyone to the Constellation Brands second quarter 2008 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 floor over to your host, Patty Yahn-Urlaub, Vice President of Investor Relations.

Ma'am, you may begin your conference.

Thank you, Elsa.

Good morning, everyone, and welcome to Constellation's second quarter fiscal year 2008 conference call.

I'm here this morning with Rob Sands, our President and Chief Executive Officer, and Bob Ryder, our Chief Financial Officer.

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-comparable organic and constant currency basis.

Reconciliations between the most directly comparable GAAP measure and these and other non-GAAP financial measures are included in the news release or are otherwise available on the company's Web site at www.CBrands.com under the investor section.

These reconciliations include explanations as to why management uses the non-GAAP financial measures and why management believes they are useful to investors.

Discussions will generally focus on comparable financial results, excluding acquisition-related costs, restructuring, and related charges and unusual items.

We will also discuss organic net sales information, which is defined in the news release, and constant currency net sales information, which excludes the impact of year-over-year currency exchange rate fluctuation.

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

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

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

Thank you.

Now I would like to turn the call over to Rob.

Thanks, Patty, and good morning, everyone.

Welcome to our discussion of Constellation's second quarter.

I want to officially welcome Mark Zupan to Constellation's Board of Directors.

Mark is currently dean of the Simon Graduate School of Business at the University of Rochester.

His previous teaching assignments have included Harvard, Dartmouth, USC, and the University of Arizona.

Mark has a Bachelor's degree from Harvard, and has a Ph.D.

in economics from M.I.T.

and I'm really looking forward to working with Mark.

Now I'd like to discuss our financial performance for the second quarter of fiscal 2008.

We're currently at the halfway mark for the year and are pleased with our progress to date, which I believe provides the momentum required to achieve our full-year goals.

As anticipated, results for the quarter were impacted by a continuing competitive marketplace in the U.K.

and Australia and our initiative to reduce distributor wine inventories in the U.S.

As of the end of the second quarter, we estimate that the total sales impact for the distributor inventory reduction program was approximately $110 million, which was less than our initial estimate.

Despite the lower sales impact, the EPS impact was $0.15, which was at the low end of our targeted range of 15 to 20%, as the mix of reduced distributor inventories was of higher margin premium products than we originally anticipated.

This program is now substantially complete, as we are within the range of our goal in terms of targeted, average number of days in distributor inventories.

From a market perspective, the momentum continues around our wine premiumization efforts with solid marketplace sales growth contributed during the quarter by brands such as Woodbridge, Nobilo, and Estancia as reported in recent U.S.

IRI data.

I also want to take this opportunity to provide an update relating to the U.S.

grape harvest which is underway as we speak, and is expected to continue through the end of October.

While we expect this year's harvest to produce high-quality output due to a mild, dry growing season, we are estimating that the 2007 U.S.

industry harvest may potentially decline in the mid-single range from last year's harvest.

And it appears that overall pricing for grapes is moving up a bit, reflecting a decrease in yields and tightening supply for key varietals such as pinot noir, pinot grigio, and chardonnay, with fairly stable prices for generic wine varietals.

.

Overall, the U.S.

wine market is very healthy and indications are that overall, supply and demand should generally remain in balance.

Our Canadian wine business posted a an excellent quarter.

Jackson-Triggs, the number one brand in Canada, posted double digit volume and sales growth, partially as a result of strong sales across Canada of the Jackson-Triggs Esprit wine, which is our Olympic co-branded product launched in June.

We also released a 2006 vintage for our Inniskillin ice wine, which we believe ranks as one of the best ice wine vintages we've ever seen.

Turning to the U.K., the market conditions in the U.K.

have not changed significantly during the quarter.

As you know, the 2007 Australia grape harvest came in approximately 30% lower than the 2006 grape crush.

Severe drought conditions continued to affect the area with the key wine producing areas of Australia currently experiencing rainfall levels that have been less than 50% of normal.

As I mentioned in the first quarter, these conditions are expected to reduce the output of the 2008 harvest, although we can't be specific on the magnitude of the reduction at this time, as the rainy season in Australia will continue through late October.

Due to the lower harvest in 2007, the Australian bulk wine market has begun to dry up.

There is currently limited availability of bulk wine for production of low-cost, private label Australian wines selling in the U.K.

However, U.K.

market pricing has not changed significantly, as the wine market overall remains quite competitive.

Despite challenging market conditions in the U.K., we continue to increase marketing support behind our premium wine brands.

We are focused on improving our go-to-market model, and are working to improve our operating efficiencies.

Although we remain cautious, we believe the tightening Australian wine supply and some indication of trading up activity in the U.K.

marketplace are positive trends.

The Matthew Clark joint venture with Punch taverns, which provides wholesale services to the U.K.

on premise channel, continues to progress and perform within expectations, despite the U.K.'s rainiest summer weather conditions in recent memory, and the implementation of a smoking ban during the quarter.

In the spirit segment, the strong marketplace momentum from SVEDKA Vodka continues with the posting of strong double digit growth year-to-date.

From an operational transition perspective, this SVEDKA integration is essentially complete.

We are beginning to build on the strength of the brand with enhanced distribution capabilities through national accounts and the export channel and we are capitalizing on, and channeling our strengths with retailers in the wine channel to benefit our spirits business.

The base spirit's business is continuing to benefit from the premiumization trend occurring in the market, and our focus on building our premium investment in priority growth brands, including 1792 Ridgemont Reserve bourbon, the '99 Schnapps family, Meukow Cognac and recently launched new products.

Moving to the Crown Imports joint venture, during the quarter, we were able to bring distributor inventories more into balance after working through challenges resulting from marketplace conditions prior to the formation of Crown.

From a market perspective, Crown implemented a price increase for its Modelo beer portfolio earlier this year, and as is typical with a price increase, we continue to experience a short-term retraction in imported beer volumes in the IRI channel, one that correlates very closely with the volume trends we experienced when we implemented a similar price increase in 2004.

At that time, the negative volume trends reversed gradually over a number of months, and we expect that trend to repeat itself going forward.

Crown maintains that this strategic pricing initiative is the right long-term decision for the Modelo portfolio of brands, despite a competitive market in the short-term.

Lastly, some of you may be aware that there is an ongoing tight supply of glass bottles on an industry-wide basis due to various glass industry factors, as well as continued strong wine and spirits industry growth, resulting in decreased capacity worldwide.

Although we are experiencing some impact from this situation, it has been fully contemplated in our full-year EPS guidance.

In closing we continue to execute on our strategy despite headwinds from marketplace dynamics and business initiatives.

We are entering our strongest seasonal period and are well positioned to achieve our goals for next year.

Now I would like to turn the call over to Bob Ryder for a financial review of the quarter.

Thanks, Rob.

Good morning, everyone, and thanks for joining us.

Similar to our first quarter, in the second quarter, we have several items which impacted the comparability of our results, including the SVEDKA acquisition, the Crown and Matthew Clark wholesale joint ventures, and our new shift to reduce distributor inventories in the U.S.

In general, I'm pleased with our results for the quarter, as we substantially completed our distributor inventory reduction initiative, continued efforts to better position our U.K.

and Australian businesses for improved performance, and delivered solid cash flow, which helped us reduce our debt by more than $200 million from first quarter levels.

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

Commentary for net sales comparisons will be on a constant currency basis.

Let's take a look at our net sales line.

As you can see from our news release on page 13, our consolidated net sales decreased 39%, reflecting a 1% benefit from the SVEDKA acquisition, which was more than offset by the move of the U.S.

imported beers to the Crown Imports joint venture and the U.K.

wholesale business to the Matthew Clark joint venture.

As previously discussed, these joint ventures follow equity accounting and are not reflected on the consolidated net sales line.

We experienced a 1% decrease in consolidated organic net sales for the quarter, which was primarily driven by our efforts to reduce distributor wine inventories in the U.S., which is now substantially complete.

After excluding an estimated $110 million of net sales impact for this initiative for the first half of the year, we estimate that organic net sales growth would have been in-line with our long-term target of mid-single digits.

We estimate that the EPS impact for this program during the first half of the year was approximately $0.15.

Despite the lower-than-anticipated sales impact, the estimated EPS impact came in at the low end of our previous guided range.

As Rob said, this was mostly due to greater destocking of higher margin premium products.

Spirit's net sales increased 25% due to the acquisition of SVEDKA and an 11% increase in organic net sales driven by higher average selling prices and volume gains.

We're quite happy with SVEDKA, as it continued to perform within our expectations and generated strong growth over the first half of the year.

Worldwide branded wine net sales decreased 1%.

This reflects the benefit of reporting sales of our wines to the Matthew Clark joint venture, which were previously sold to our U.K.

wholesale business, offset by a 3% decrease in organic net sales.

In our presentation of branded wine organic sales growth, we have added back $15 million of U.K.

branded wine net sales in Q2 fiscal 2007, previously sold through the 100% owned U.K.

wholesale business.

We feel this approach provides a better reflection of organic sales performance.

The addback for Q1 fiscal 2007 totaled $7 million and is included in the year-to-date data presented.

Turning our attention to branded wine geographic net sales on page 12 of the release, you will see branded wine net sales for North America decrease 4% as strong growth in Canada was more than offset by the impact of our efforts to reduce U.S.

distributor wine inventories.

For Europe, branded wine organic net sales increased 4%, reflecting increased sales of popular-priced wine in mainland Europe and a slight increase in sales in the U.K.

Our Australian/New Zealand branded wine organic net sales decreased 7%.

Our New Zealand portfolio continues to perform well, but the markets in the U.K.

and Australia remain highly competitive with ongoing pricing pressures.

Now we'll look at our profits for the quarter on a comparable basis using information presented on page 14 of the news release.

For the quarter, our consolidated gross margin was 35.2%, up 5.4 percentage points.

This primarily reflects the benefits of shifting the lower margin U.K.

wholesale and imported beer businesses to joint venture structures subject to equity accounting, somewhat offset by a temporary mix shift in the U.S.

due to the distributor wine inventory reduction and lower margins for U.K.-branded wine.

Our consolidated SG&A for the quarter was 21.2% of net sales compared with 13.1% a year ago.

This increase was primarily due to moving the imported beer and U.K.

wholesale businesses to joint venture structures, the deleveraging impact of the distributor inventory reductions in the U.S., higher brand marketing support for branded wine in the U.K.

and the U.S., and increased stock compensation expense.

Consolidated operating income decreased to $125 million from $237 million from the prior-year quarter.

This change was primarily driven by the factors already mentioned, combined with reporting $79 million of equity earnings for the Crown JV compared to the second quarter of last year, when $74 million of earnings for our imported beer business were included in operating income.

This year-over-year increase in beer business profitability reflects increased pricing and the economic benefits of having a national platform for the Modelo portfolio.

Now I would like to turn to our segment operating income results, which are reflected on page 11 of the release.

Wine segment operating income decreased $39 million to $125 million.

This was primarily due to the lower net sales associated with efforts to reduce U.S.

distributor inventories and U.K.

and Australia business performance, partially offset by an increase in profits from our Canadian business.

For the spirits segment, operating income decreased increased $3 million, primarily due to the contribution from SVEDKA and higher sales from the base business, offset somewhat by higher material costs.

For the quarter, corporate and other expenses totalled $21 million, compared with $18 million for the prior year.

The increase includes additional sock compensation expense and cost to support the growth of the company.

Moving back to page 14, interest expense for the quarter was $87 million, up 20% over last year.

The increase primarily reflects the incremental interest from funding the SVEDKA acquisition, and $500 million of share repurchases.

At the end of August, our debt totaled $4.7 billion, a decrease of more than $200 million from the Q1 level.

At the end of the second quarter, we had approximately $2.4 billion of bank debt and $2.3 billion of fixed term and other debt.

With interest rate swaps that are in place through the end of fiscal 2010, approximately 70% of our debt is effectively fixed rate.

We had approximately $850 million of revolving credit available under our senior facility at the end of Q2.

This, combined with our strong capital base and free cash flow generation ability provides flexibility to fund further growth.

Our comparable basis tax rate for the quarter came in at 34.7%, versus 36.9% last year.

This rate was somewhat lower than our previously anticipated rate for the quarter, primarily due to favorable legislative changes in various state and foreign tax jurisdictions.

As a result, we now expect our comparable basis tax rate for fiscal 2008 to approximate 37%, versus our previous guidance of 38%.

Our weighted average diluted shares outstanding totaled $219 million compared to $240 million last year, reflecting the benefit from our share repurchase during this year.

During the second quarter, the company received an additional 933,000 shares under the accelerated share repurchase transaction announced in May.

We were not required to make any additional cash payment in connection with receipt of these shares, which completed this transaction.

For the first half of '08, the company purchased 21.3 million shares of its Class A common stock through a combination of open market repurchases and an accelerated share repurchase program at an aggregate cost of $500 million or an average of $23.44 per share.

Due to the many factors just mentioned, diluted EPS decreased to $0.35 versus $0.43 last year.

Now let's turn to cash flow on page 10.

For purposes of this discussion, free cash flow is defined as net cash flow provided by operating activities, less CapEx.

for the first six months of fiscal '08, we generated $131 million of free cash flow versus a $22 million usage in the prior year.

The year-over-year increase reflects a lower cash use for net working capital during the first half of fiscal '08, due in part from lower net sales in accounts receivable associated with the U.S.

distributor inventory reduction.

In addition, CapEx totaled $47 million for the first six months, versus $103 million last year, which included expenditures for our New Zealand vineyard expansion.

Our free cash flow guidance for the year remains unchanged at $160 million to $180 million.

As in previous years, in Q3, we fund the North American harvest activities, and build working capital to meet seasonal business demands.

Q4 is expected to provide strong cash flow generation, which has been the case historically.

Now, let's summarize Q2 and discuss our full-year guidance.

From an earnings perspective, we are pleased with our results, excluding the expected positive negative impacts on our results results from our various strategic initiatives, we believe that net sales growth through the first half of the year is in-line with our long-term stated goals.

We will continue to closely monitor the Australian harvest dynamics and the potential marketplace impacts.

The U.K.

market remains a difficult environment, but we believe we are making progress with the initiatives we have in place designed to improve future performance.

Moving to our P&L expectations for the full-year 2008, we're revising our comparable basis diluted EPS outlook to $1.34 to $1.42.

This is from our previous range of $1.30 to $1.40.

The increase reflects the benefit of the anticipated lower tax rate I mentioned earlier.

This guidance excludes acquisition-related integration costs for structuring and related charges and unusual items, which are detailed on page 16 of the news release.

Additional assumptions for our full-year fiscal 2008 guidelines are outlined on page 4 of the release.

Before we take your questions, I want to make you aware that we have recently filed a preliminary proxy statement, relating to a special stockholder's meeting and I would like to briefly frame in this activity for you.

The meeting has been called in response to a situation created by recent changes in U.S.

tax laws.

Under these new rules, the dividend rights of our Class A common stock could potentially create additional income tax expense and accelerate the timing of tax expense for stock option recipients in the U.S.

These changes would significantly reduce the benefit that option recipients receive, without reducing costs associated with the option program.

In response to this situation, we have proposed to create a new class of common stock and amend our long-term stock incentive plan to permit granting of rewards with respect to the new class of stock to preserve the tax treatment of stock options that was applicable prior to the new rules.

These actions require shareholder approval.

Finally, I want to emphasize that these proposed actions will not affect the underlying economic of the company's stock option program, and will not increase the aggregate number of shares available for granting awards under the stock incentive plan.

With that, we're happy to take your questions.

(OPERATOR INSTRUCTIONS) Our first question is coming from Bonnie Herzog of Citi Investments.

Please go ahead.

Good morning, everyone.

I just had a few, quick questions.

I guess, first of all given the Australian grape supply issue that we are all very well aware of, and you discussed, I'd be curious to hear how much of your supply has grown by company-owned vineyards versus how much you actually purchased on the open market?

Hello?

Good question, Bonnie.

Oh!

Bonnie, the vast majority of our grape supply in Australia is purchased on the open market.

It is open, that's what I -- okay.

I just wanted to verify that.

Open but under contract.

Okay, and how long are the contracts?

They vary.

Vary, okay?

But it's safe to say are relatively long-term.

Okay.

Long-term meaning three years, five --?

Multiple years.

All right.

And then just turning over to your beer business.

I was curious if you could just provide a little bit more color on how you think it performed overall this quarter, and I'm curious if the disruptions to the east coast business have been resolved, in your view?

And also, trying to understand the performance in the east coast versus the west coast, whichever metric you would like to share with us, whether it be volume pricing, income, that would be helpful?

I think in general, Bonnie, the beer business has performed in accordance with our expectations.

As you know, we took a price increase at the beginning of the year.

What we've seen as a result of that is very much in-line with exactly what we've seen when we've taken price increases.

So there's really nothing different there than what we would have expected to occur.

As I said in my talk, we expect to see that start to rebound.

As we also have mentioned previously, there were some high inventories when we took over the east and therefore during the first half, we have now brought those inventories back into line.

Then with respect to your question about east versus west, I think we're seeing some very positive trends in the short-term, the last reporting periods for IRI and things to that affect in the east in particular.

So we're optimistic about how we're performing in that regard.

Okay, good.

Then just a quick final question, just in terms of the currency, the translation, helping your earnings this quarter.

Can you quantify that in terms of the impact to your EPS?

Yeah.

We -- it's not significant, Bonnie.

We actually hedge most of that away.

All right.

But I was under the impression, I'm sorry, that it impacted your topline by several percentage points.

It's about 2 percentage points.

Okay.

I think if you go through some of the footnotes in the press release, that works out.

Thank you.

I appreciate your time.

Thanks.

Thank you.

Our next question is coming from Lauren Torres of HSBC.

Please go ahead.

Good morning.

Just a quick clarification, first, Rob.

You mentioned that you substantially completed the reduction, the inventory reduction in the quarter.

By the word substantially, I guess it does assume or allow to us assume there's some more to come and if you could give us a sense if there is, how much is more to come?

Yeah.

The reason we used the word substantially is because there's always going to be some fluctuations in the short-term and distributor inventory.

For your purposes, I think you should consider it complete and any changes in distributor inventory, which as I said, really shouldn't be anything significant, are fully taken into account and the guidance that we've given you.

And that's why you're giving us that $0.15 number, kind of stick with that and that's --

The $0.15 is where we've ended up with the distributor inventory reduction, that's what you should stick with, exactly.

Okay.

I guess, too, a question for Bob.

In the quarter, it does look like you had some good cash flow growth.

Just wondering why you're not getting a bit more optimistic with guidance for the full year?

That's a good question.

Basically, we're pretty happy with our free cash generation in the first half, but from a cash flow perspective, we're so early in the year -- I mean, last year we were negative at this point.

As we somewhere the back half of the year, especially the third quarter, the inventory distribution program is behind us and we expect to build up some decent working capital in the back half of the year.

So I would say we're cautiously optimistic on cash flow, but not optimistic enough to change the guidance right now.

Okay, thanks.

Thank you.

Our next question is coming from Tim Ramey of D.A.

Davidson.

Please go ahead.

Good morning.

A couple of follow-ups.

One on the hedging expense.

Where exactly are you booking that?

Is that pushed down to the segment operating income?

All the hedging, I think, is booked down -- is pushed down to the operating income.

It's sort of invisible to you guys.

If you look at the statements, I might have misstated the number a little bit, but I think on the wine segment, ForEx helped us about 4% on net sales.

That's all in our net sales breakout in the background.

So when we hedge translation, we're hedging the EBIT impact of it, not the net sales impact of it.

Got it.

And on the inventory reduction program, why did it end up being less -- end up being smaller than originally forecast?

Was that due to strong consumer movement or did you just kind of back away from the program a bit?

What changed?

Tim, it was really a mix impact.

The mix of the reduced inventory was skewed towards higher margin products and therefore the sales impact was lower than expected, but the earnings impact was within the range that we specified and we accomplished in general the goal that we were trying to accomplish in terms of what we took out.

So it was really the sales and the sales was a function of the mix being towards lower volume, higher margin items.

Okay.

And I think you mentioned that SVEDKA was running at double digits.

Do you have a current case sales run rate that you could share, or what it's actually done in case sales year over year in terms of percent change?

First half of the year has been running very much in accordance with our expectations, very high, double digits in the 50 percentage type growth rate and it's a great brand and it's performing exactly as we'd like it to be.

We're extremely happy with it.

Any other wine brands that you would highlight in terms of scanner data that are particularly bad or particularly good?

Well, there's nothing particularly bad, but our premium portfolio continues to perform well.

We continue to see very strong -- I should say strong growth in major brands like Robert Mandavi Private Selection, Toasted Head, Rex Goliath, we're very pleased with our growth.

We have to remember that our wine portfolio is very large portfolio, we are the largest, and we look for strong growth in that portfolio and we're getting it.

Sounds good.

Thanks so much.

Thank you.

Our next question is coming from Judy Hong of Goldman Sachs.

Please go ahead.

Hi, everyone.

First, just in terms of the depletion numbers, are you willing to give us the depletion numbers for U.S.

wine and the Crown Imports?

No, we don't normally talk depletions.

With Crown, we said that we did reduce some distributor inventories throughout the first half.

We brought those down.

That's really the only relevant news relative to depletions.

In general, our depletions and shipments are basically equal, so it's really not important to talk about depletions independently, unless there's something to highlight.

That's how we've discussed this in the past.

So if we go back to your comment about the organic net sales in the first half being up in-line with your long-term guidance, excluding the impact of the distributor inventory situation in the U.S., we'd take that and think that depletions are up in that range as well?

Yes.

Okay.

Secondly, I just wanted to sort of broadly look at the global wine supply situation.

Obviously, we're hearing that the Australian harvest is likely to come in much below last year's harvest.

It looks like the U.S.

is going to be down this year as well.

So if you sort of look out, looking at the global wine situation, are we -- do you think we're entering a point where the supply is becoming tighter and that really creates a more conducive pricing environment for your wines and sort of what's the implication from a pricing standpoint as you look on the U.S.

wine market and the U.K.

wine market?

Yes.

I think that in answer to your question, we certainly see supplies around the world beginning to tighten.

There has been quite a bit of press about precisely what you are suggesting, that we might be turning from global oversupply to global undersupply.

I will say that having been in this industry for many, many years, those exact turning points are extremely difficult to predict, but certainly some of those indications are there and to sort of second point in that regard, if in fact we are at one of those inflection points are moving into one of those inflection points, that should be a positive trend -- that should be positive as it relates to pricing trends.

Again, we're not predicting anything at this stage relative to our business specifically, but the kind of things that you're talking about could very well be the case on a macro basis.

So as I said, it would be a positive trend.

At what point would you be willing to sort of think that we're at that inflection point?

Is it when the Australian harvest does indeed come in significantly below last year's numbers and the U.S.

is also short?

Do you have to see a more balanced situation come out of Chile and other markets around the world, or sort of what are kind of the milestones we should be looking at?

I think that as you said, the southern hemisphere harvest coming up and then the next northern hemisphere harvest at the end of next summer.

That should give us some better indications of exactly where we're at.

Remember, as I said, this is a very big macro trend.

It's not measured in any particular instant in time.

You can't make gross overstatements about it based on one harvest or another harvest.

It's going to take a few harvests and it should become more evident, as I said, after the next two northern and southern hemisphere harvests.

Okay.

Thank you.

Thanks.

Thank you.

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

Good morning.

Maybe you said it, but can you tell us exactly how much the beer volume was down at Crown and how much you raised prices?

No, I don't think that we did say that.

You could get that off our IRI if you look, but remember, that's just certain microcosms in total.

But you'll see sales growth ahead of volume growth.

Can't you just tell us the number?

I don't remember it off the top of my head.

I mean, was it like mid-single digits?

I think that's close to right.

It was mid-- around a mid-single digit price increase.

And the volume was down around mid-single digit too?

I don't remember the volume, frankly, I think it was lower -- it wasn't down that low.

So their revenues were actually up?

It was probably down low single digits.

Okay.

As Rob said, there is a pattern in this, at least in the beer business, as to how the volume growth wanes after you take a price increase and how it gradually comes back over time.

Okay.

But we can say the volume was down low single digits in the quarter?

As you know, we don't consolidate Crown.

Right, but it obviously impacts your equity income, so we need to know how the health of the business is.

Yes.

I just don't remember the volume thing.

If you look at -- again, it's year over year, because because last year, we were just west coast.

We don't have complete visibility into what the east coast volumes did last year, east coast sales did last year.

So unfortunately it's not a real clear road map.

And it looks like the stock compensation expense was about $0.03 a share, is that about right?

That seems high to me.

What we did is we changed the option program and this will be filtering into our P&L over four years, and this is the second of four years that you'll see increased stock compensation expense, and I think it was closer to $0.01.

Well, you show it at six months at almost $17 million pretax versus $7.8 million last year, it's a big increase.

That's a year-to-date number.

Are you talking the quarter or --

Well, yeah, I would like to know the quarter.

The quarter was about a $0.01.

Okay.

Thanks a lot.

Thank you.

Our next question is coming from Jonathan Feeney of Wachovia Securities.

This is actually [Brian Skadary] on behalf of Jon Feeney.

In regards to distributor inventory reduction, I was wondering if you could give us any color on what types of safeguards and/or consumer data you have put in place to prevent this problem from reoccurring in the future?

Well, there's really not the need for any safeguards.

The key is over longer range periods that shipments and depletions should be somewhat equal and that's largely in our control, so we monitor that and we don't expect to take the -- as I said, in the medium term or long-term, inventory distributors are up.

There are disruptions from time to time, as we have said in the past.

You might see, for instance, in the quarter leading up to the holiday season that'snecessary to build some inventories because we have sales growth during those periods and in periods that are not as fast, you might see some inventories going down, but generally, depletions and shipments are equal.

Just one more.

(multiple speakers).

I'm sorry?

Just one more on the joint venture front.

Particularly with Matthew Clark wholesale business, how's that working out?

Essentially you have partnered with a customer, so does that close the door to others, does that particular JV change the go-to-market in any way that limits you?

Number one, they were not a big customer and the direct answer to your question is, no, it really doesn't limit us.

That marketplace is -- well, let me just put it a little differently.

We sell to tens of thousands of different outlets.

What they buy is largely a function of price and service and they're not particularly concerned with corporate ownership structures.

They're concerned, as I said, with the price and the service they're getting for the products that they're purchasing.

So it's really not a factor in dealing with our tens and tens of thousands of customers around the country.

Well, great.

Thanks.

Thank you.

Our next question is comes from Christine Farkas of Merrill Lynch.

Please go ahead.

Thanks very much.

I would like to start with spirits trends, if I could.

We've heard some anecdotal evidence that perhaps the low end of the market is getting hurt, but the high end, of course, is trading up.

Your organic growth was pretty strong.

Could you give me a little bit of sense of mix and what's growing and what isn't?

This is Bob.

I would say for the quarter, we experienced some positive mix shifts.

So what you're seeing is pretty correct, that the low end of the market is not growing as fast as the upper end of the market, and our higher price per bottle brands, which also carry higher profits with them, are growing faster than the lower price per bottle brands, similar to the wine business.

On that, given your organic growth up 11%, how much of your portfolio would you consider low end versus high end now?

It's probably about 50/50.

Okay.

That means pretty strong growth at the high end with some of the innovation that you've put out there?

This is Rob.

It's actually a little bit less than that, it's somewhat less than that, but we do have very strong growth in the high end and that is causing the mix shift.

Okay, great.

Moving to Canada, good growth in that market, I'm just wondering, and perhaps this might be looking a little bit overanalytical at the market, but with the strong dollar, is there -- are there fewer imports going into Canada that might perhaps allow your domestic brands to thrive even more?

Is there any of that going on in Canada?

Actually, the imports business in Canada is very strong as well as the domestic business.

Remember, imports into Canada are coming from a lot of different places, like Australia, like Chile, and like the U.S.

I don't think that we've really seen the -- well, in general, the import business has been strong and it has not been hurting the domestic -- it hasn't been hurting the domestic business, which also remains strong.

In particular, the premium end of the market, which we call VQA, which are the entirely produced in Canada products, they also remain very strong.

So really both ends of the market are good.

Okay, well, that's good, it's not hurting your business.

Your exports from California to Canada, has that gone up?

Our exports -- I'm sorry, what did you say in

Your exports from California, for example, into Canada, does your business benefit based on your strong base in distribution in Canada?

Our exports have been fine, but remember we export to Canada from a number of our wine-producing regions, like Australia, and I'll also point out that Vincor has a strong import business as well as a strong domestic business.

So we're really positioned to take advantage of all the positive trends, both imports and domestic.

Okay.

That's helpful.

Then just on Australia.

Similarly, with Australian supplies potentially drying up here, and the Australian segment really dominating that $5 to $9 price point, I'm wondering if either your forecast or even existing trends so far, would your own brands in the 5 to $9 segment, like a Woodbridge, for example, be in a better position should those supplies just really slow into North America?

Yes, I would say the answer to that is yes, even though I would also say that Woodbridge is performing exceptionally well, given that it's a huge brand, and the biggest brand in the category and segment, we're seeing some good growth for a brand that size, so even without imports being hurt, or Australian imports being particularly hurt, we're seeing strong Woodbridge growth as we sit here.

But clearly what you suggested could be the case as well.

Okay.

That's helpful.

Sorry, last quick one on SG&A.

You mentioned stock compensation up and marketing up in terms of some brand spends, but also SG&A higher based on the transition or destocking.

Can you quantify how much of that SG&A increase is considered more one-time in nature in the quarter?

I think that the SG&A increase is due to change of equity accounting of our major segments of Crown and Matthew Clark, so I think that's what you're really seeing there.

That's why SG&A has become a larger percentage of net sales as we eliminate it from the net sales line, the businesses that we're now accounting for in the equity method.

So I would say that there's not any big one-time absent dollar costs in there.

It's just that as a percentage of sales, as Rob said, the geography has changed because we've took so many sales out because of the JV accounting.

Great.

Thanks so much.

Thank you.

Our next question is coming from Kaumil Gajrawala of UBS.

Please go ahead.

Thank you.

A couple things.

First thing, on the distributor inventory issue, now that you've gone through it, can you talk a little bit about distributor support and investment behind the brands?

I remember when you first announced the program, one of the intentions were to free up some working capital at the distributor level so that they can support your brands more and I wanted to see if you could give us an update on that?

I think that it's having the intended result.

We're working well with our distributors, we're a very large supplier, the distributor inventory reduction has benefits them and they're very willing to partner with us to continue to build our brands and our portfolios.

And that was really the whole idea behind the whole thing.

So I think we're very positive in that regard and our partnership remains very strong in that regard.

And so incrementally is the support higher than it was?

It's a huge -- we have thousands and thousands of distributors and it's hard to make that kind of a judgment, because it's something that's constantly in flux and there's all sorts of mix and so on and so forth, but anecdotally, we, as I said, are getting good customer support against our growth initiatives, so I think it's working.

Okay.

On the Crown side, how much do you expect the domestic brewers begin to take some pricing this fall in order to get volumes to start to pick up again in the Modelo portfolio?

We're not relying on anything.

We're not privy to what the domestic brewers are going to do and when they're going to do it.

There's already anecdotal evidence that there's pricing being taken in the marketplace, reading all the typical trade press and so on and so forth.

So we think that that's happening, which is fairly consistent with the patterns of the past.

When the high end takes some pricing, usually the lower end follows after a certain period of time.

So the anecdotal evidence is that that's the case.

Okay, got it.

The last thing, you talked about no changes in the business in the U.K., yet your organic number in Europe branded wine seemed to be fairly strong when you adjust for the wholesale.

Can you talk a little bit about where the growth is there and where it's coming from?

Well, in the first half, particularly in the first quarter, we had some very strong growth, a little less on the second quarter, and it's been coming from mainland Europe.

We've been -- we're really not overemphasizing that, because a lot of it has come from -- some of the growth has come from, I'll say lower margin product that we've sold in mainland Europe, so it's not necessarily flowing through the to the bottom line in a big way.

So I think that's basically the answer to your question.

Volumes in general in our U.K.

and Europe business are not -- this is a double negative, are not unhealthy.

In other words, they are healthy, but we do -- it is a competitive market.

There continues to be pricing and margin issues.

We continue to work through that and we're at best cautiously optimistic about the -- our recovery plans there.

Okay.

Thank you.

Thank you.

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

Please go ahead.

Thanks, operator.

Good morning, guys.

Rob, on this destocking and then a couple financial questions for you, Bob, I want to make sure I'm piecing the pieces together properly here.

It sounds like you're basically saying that at the distributor level, you're simply leaving inventories at a higher level than you originally anticipated, because you're not in fact seeing a material pickup in depletion rates out of those distributors, which might be a very sound business decision, but I'm trying to understand ultimately what drove this 110 versus 160 or higher?

No, that's not right, Mark.

We've met our goals at the distributor level.

The reason that the dollar sales number is lower than the range that we gave is because of the mix impact towards lower volume -- lower volume, higher-margin products.

What we said originally that we were targeting a 25 to 30% reduction in days, and as we look market by market, distributor by distributor, product by product, we have accomplished those goals.

So we have accomplished the goal that we have set forth.

Okay.

But higher -- I guess we can move on, but higher margins --

Based on lower volume, higher margin products, right.

Right.

So that means even less absolute volume was taken out of your distributors, but it is what it is.

Just in terms of financial items, Bob, I might have missed it, but as it relates to fiscal -- looking beyond fiscal '08, in the past, you guys have said that using fiscal '07 as an earnings base, you expect to return over the medium to long-term to high single digit to low double digit EPS growth and I might have missed it in your prepared remarks, but is that still your view?

Yes.

I think that's still our -- why do you think our remarks are prepared?

This is all unscripted.

Obviously we're not talking about next year yet, but nothing we said this year would not be changing long-term trends in the business.

It's still an extremely healthy category.

Lastly, just on fiscal '08, as you look at your share count assumptions, you're saying $225 million for the year, you did $219.3 million in the quarter.

That 225 implies a fairly meaningful pickup in the second half.

I think it's a weighted average thing, the way the EPS is calculated.

I think it's done on a year-to-date basis, so you had a higher share count in the front end of the year.

Right.

But I'm saying the you take the 219 and the higher number for the first quarter, and if you take 219 and hold it constant for the balance of the year, you're at more like 223 for the full year.

So it basically implies you're expecting it to go up a good bit again in the second half?

It would be mostly just how the option dilution kicks into the calculation.

Obviously, we're not -- we don't plan to issue or buy back anymore shares.

Excellent.

That's what I thought.

Thanks very much.

Thank you.

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

Please go ahead.

Good morning, everybody.

Hi, Bryan.

Just two points.

One, a point of clarification.

Are the distributor inventory correction or draw down for Crown is all -- is completed, right -- you're not -- Crown is not in a position where they're still destocking wholesaler inventory, is that correct?

Correct.

Okay.

And secondly --

Not taking into short-term fluctuations, but in general, that's correct.

Okay.

The second point is, Rob, if you could talk a bit about looking into the holidays in the U.K., are your -- are your participations in promotion with retailers sort of what's on your holiday merchandising calendar this year any different than last year?

I guess what I'm trying to drive at is, do you expect that your shelf space, display space, and the number of promotion activities this year to be on par with, greater than, or less than last year?

Yes, well, we don't know that until after the holiday, unfortunately, but a lot of the process of going into the holidays is all about working out our promotional programs with the major retailers.

And based on what I'm hearing, we're being very successful in getting our holiday promotions locked away.

I'm hoping for a better holiday season in that regard than we had last year, which was not necessarily particularly negative or otherwise, but our portfolio is a good portfolio.

The market is not -- is fairly strong and what I'm hearing is that retailers are favorable towards what we're doing and so I'm looking forward to a good holiday season in terms of promotional activity.

So I don't see anything negative in any respect on the horizon in that regard, Bryan.

Okay, great.

Thanks, guys.

Sure.

Okay!

Well, thanks for joining our call today, and I would characterize this quarter as one of continued execution toward our goals.

We delivered solid cash performance and paid down debt, we substantially completed our U.S.

wine distributor inventory reduction program, we're driving marketplace initiatives around the world which will help us drive growth from our portfolio of products, and from a financial perspective, we believe that we're well positioned to achieve our revised full-year EPS goal and free cash flow targets.

So thanks, again, everybody, for your participation.

Our next call is scheduled after the New Year, so I'm sure everybody will responsibly enjoy some of our excellent products during the upcoming holiday season, and I'll talk to you all after that.

Thanks!

Thank you.

That does conclude today's teleconference.

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