Constellation Brands Inc (STZ) 2008 Q3 法說會逐字稿

Good morning.

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

At this time I'd like to welcome everyone to the Constellation Brands third quarter 2008 earnings conference call.

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 Investor Relations.

M'aam, you may begin your conference.

Thank you Elsa.

Good morning, everyone and welcome to Constellation's third quarter fiscal 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 FCC.

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 otherwise available on the company's website 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 cost, 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 fluctuations.

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 SEC filings.

Now I'd like to turn the call over to Rob.

Thanks, Patty and good morning.

I hope everybody had a great holiday and welcome to our discussion of Constellation's third quarter 2008 results.

Before we get started, I want to mention how pleased I am that we recently finalized the acquisition of Fortune Brands U.S.

wine portfolio.

This acquisition marks another milestone in the growth and development of our business, as it further strengthens our leadership position in the U.S.

wine industry, improving our overall scale in our premium position.

The total portfolio of products we acquired is well positioned among the fastest growing super premium plus wines, solidifying our position as an undisputed leader in the U.S.

wine business.

These super premium and above categories are growing at double-digit growth rates of 14%, and represent approximately 40% of the entire U.S.

wine business in IRI channels on a value basis.

The acquired [Kwodova] brand is the leading super-premium wine brand in the U.S.

According to the most recent IRI data, it has been growing at a rate of 18% on a volume basis during the last 52-week period.

[Kwodova] has a range of product offerings including a leading presence in super premium chardonney and strong growth across all key varietals.

This brand is now the best selling Sonoma County wine and will join other major wine assets we have in that area, including Simi and Ravenswood.

Constellation's U.S.

market share of the super-premium and above categories is expected to increase by approximately 5 percentage points on both a volume and value basis with the addition of the acquired wine brands.

As we mentioned previously, we will be taking a restructuring charge associated with the integration of this acquisition so that we may fully realize the synergies that will result on the combined wine operations of both entities.

Bob will outline the details of the restructuring plan in just a few minutes.

As we integrate this newly acquired wine business, we are also taking the opportunity to evaluate and rationalize our U.S.

wine product portfolio, primarily within the value segment.

This includes smaller low-margin regional brands at price points generally less than $5 and includes brands such as Vina [Cassada], Capri, Vendor's Choice, just to name a few.

From the sales and marketing perspective, our goal is to focus on specific consumer segment opportunities to include fine wine, premium wine and specialty value wines.

Overall, we are taking the appropriate actions to further strengthen the growth and profitability of our wine business, and will continue to take advantage of the favorable consumer trade-up trends occurring in the marketplace.

And now I'd like to discuss our performance for the third quarter of fiscal 2008.

We continue to execute on our strategy and achieve on our financial goals which positions us well for the year.

As you can see from our press release, one of our financial highlights of the current quarter is that we achieved excellent pre-cash flow performance.

As a result we are significantly increasing our pre-cash flow guidance for the year.

Bob will have more to say about this in a few moments.

Our U.S.

wine business returned to targeted sales growth levels during the quarter as the U.S.

distributor inventory reduction initiative was essentially completed in the second quarter.

The positive momentum continues around our wine premiumization efforts with U.S.

sales growth during the quarter contributed to by premium wines, including Robert Mondavi brands, Estansia, Blackstone, Kim Crawford, Simi, just to name a few.

Moving to the United Kingdom and Australia, as expected, the year-over-year results for the third quarter were impacted by continuing competitive market conditions in the UK and Australia.

In the UK, there is diminishing availability of both wine for production of low-cost private-label Australian wines due to the lower Australian harvest in 2007 and the projected short harvest in 2008.

However, UK market pricing has not changed significantly, as the wine market overall remains quite competitive, primarily driven by the large grocery chains.

I'm generally pleased with the progress of the Matthew Clark joint venture with PunchTaverns,which provides wholesale service to the UK on-premise channel.

From a marketplace perspective, according to the most recent Nielsen UK wine trans data, Constellation is outperforming the market in the price points where we have the most significant market share.

In addition, we continue to make progress in offsetting challenging UK market conditions by focusing on increasing market share for our premium wine offerings, including the recently acquired super premium brands, improving our go to market model, increasing our penetration in non-grocery channels, such as on premise, convenience and specialty retailers, and working to improve our operating efficiencies to include initiatives such as streamlining our supply chain.

We believe these efforts will drive improvements in our future financial performance in the UK market.

In Australia, the continuing drought conditions are expected to impact the output of the 2008 harvest, although at this time we cannot fully predict the magnitude of this impact.

Our previously announced restructuring actions in Australia are progressing as planned and should position us well for the future.

Our Canadian wine business delivered positive revenue growth primarily driven by Jackson-Triggs Naked Grape and our own Inniskillan ice wine products.

In the spirit segment, the strong marketplace momentum from Svedka vodka continue with the posting of 50% shipment growth in the third quarter.

The spirits business also contributed strong sales growth in the quarter driven by premium brands including Black Velvet, Ridgemont Reserve bourbon and the 99 Schnapps family and recently launched new product as we continue to benefit from the premiumization trend occurring in the market.

Additionally, we closed on the purchase of the remaining 50% of the Planet 10 joint venture for Effen vodka.

Effen vodka continues to benefit from a strong marketplace performance with volumes increasing 55% in IRI channels during the last 52-week period.

Moving to the Crown Imports joint venture.

During the quarter, Crown's performance was primarily impacted by price increase -- by the price increase which Corona implemented earlier this year for the entire Modelo beer portfolio.

It continues to impact volumes, although the trends have been improving as anticipated and are tracking very closely to the trends experienced with prior price increases.

Year-over-year, Crown trends for the second half of this year are expected to be impacted by challenging comparisons, as we prepared for the joint venture transition during the same time last year.

However, Crown is continuing to focus on improved execution and generating ad features and promotions that are commensurate with its leading U.S.

market share in the imported beer category.

In addition, consumer trade-up trends are continuing to support the growth of the Crown brands.

Now, before I turn the call over to Bob, I want to address the impact of the economic down-turn on our business, as it has recently been top of mind for many of our shareholders.

Although the beverage alcohol industry is what somewhat immune to unfavorable economic trends, the category has experienced varying segment growth rates at retail in the U.S.

during calendar year 2007.

For instance, recent industry retail data shows the growth trends for beer and the spirits category have remained relatively constant, while the wine segment continues to exhibit healthy growth, albeit at a slowing rate.

For instance, the dollar growth rate of super-premium wines and above is more than twice the dollar growth rate of beer and spirits.

Moreover, the super-premium plus wine segment where Constellation has leading market share is experiencing double-digit volume and dollar growth, also exceeding the trends of the U.S.

wine segment.

And we continue to see a favorable consumer trade-up to premium products across all beverage alcohol categories that should drive positive mix impacts on our margins going forward.

The diversification of our total portfolio also helps to insulate us of consumption shifts between alcohol beverage categories.

While we're well aware of the economic challenges impacting many industries, beverage alcohol products are not expected to be as significantly impacted as other consumer discretionary goods.

In closing, overall, I feel good about what we've accomplished so far this year.

I'm pleased with our recent premium wine acquisition, and I'm confident the our ability to achieve our goals for the year.

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

Bob?

Thanks Rob.

In general, I'm pleased with our results for the quarter, as we generated 6% organic net sales growth on a constant currency basis.

Comparable basis diluted EPS was $0.55 versus $0.58 last year.

As our results continue to be negatively impacted by the UK and Australian businesses.

We've continued our efforts to better position these businesses for improved performance, as evidenced by our recently Australian winery rationalization announcement.

I'm especially pleased that for the year to date, we have generated excellent free cash flow, and we expect free cash flow for fiscal 2008 to be significantly above last year and our previous estimate.

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

For the third quarter, the SEK acquisition and the Crown and Matthew Clark wholesale joint ventures impacted the comparability of results.

Let's look at our net sales line.

As you can see from our news release on page 14, our consolidated net sales decreased 27%, reflecting the move of our U.S.

imported beers to the Crown Imports joint venture and the UK wholesale business to the Matthew Clark joint venture.

As previously discussed, these joint ventures follow equity accounting and therefore are no longer reflected on the consolidated net sales line.

This impact was partially offset by a 1% benefit from is SEK acquisition, 3% benefit from currency and branded wine growth.

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

We experienced a 6% increase in the consolidated organic net sales for the quarter.

Spirit's net sales increased 31% due to the acquisition of Svedka and a 12% increase in organic net sales driven by higher average selling prices and volume gains for our branded spirits portfolio as well as an increase in our production services business.

We continue to be very pleased with Svedka and its marketplace momentum as it continues to generate high double-digit sales growth.

Worldwide branded wine organic net sales increased 4%.

Turning our attention to branded wine geographic net sales on page 13 of the release, you will see branded wine net sales for North America increased 5%, reflecting solid growth in the U.S.

and a slight increase in Canada.

For Europe, branded wine organic net sales increased 4%, reflecting increased sales of popular priced wines in mainland Europe, and a slight increase in sales for the UK.

Our Australian New Zealand branded wine net sales were level with last year.

The markets in the UK and Australia remain highly competitive with ongoing pricing pressures.

Now we'll look at our profit for the quarter on a comparable basis using information presented on page 15 of the news release.

This reflects benefits of shifting the UK wholesale and imported beer businesses to structures subsequent to accounting.

For the quarter, our consolidated gross margin was 36.3%, up 5.3 percentage points.

This primarily reflects the benefits of shifting the lower margin UK wholesale and imported beer businesses to joint venture structures subject to equity counting.

Somewhat offset by lower margins for the branded wine businesses in the UK and Australia.

Our consolidated SG&A for the quarter was 18% of net sales, compared with 12.5% a year ago.

This increase was primarily due to moving the imported beer and UK wholesale businesses to joint venture structures.

In addition, we saw increased management incentive expense due to a low bonus accrual in the prior year.

As noted in previous quarters, we have also recognized higher stock compensation expense for the transition effects of the new option accounting rules.

The quarter also includes higher marketing support for branded wine in the UK.

Consolidated operating income decreased to $200 million from $279 million from the prior-year quarter.

This change was primarily driven by the factors already mentioned combined with reporting $62 million of equity earnings for the Crown joint venture compared to the third quarter of last year with $60 million of earnings for our imported beer business was included in operating income.

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

We did see lower profit growth for the beer business versus the first half of the year.

This was primarily attributable to the high level of sales in the prior-year third quarter, as the business was preparing for the Crown transition.

Now I'd like to turn to our segment operating income results, which are reflected on page 12 of the release.

Wine segment operating income decreased $12 million to $202 million.

This was primarily due to the UK and Australia business performance, partially offset by an increase in profits from our North American business.

For the spirit segment, operating income increased $4 million primarily due to the contributions from SEDKA and higher sales for the base business, offset somewhat by higher material costs.

For the quarter, corporate and other expenses totaled $23 million compared with $13 million for the prior year.

The increase includes additional management incentive and stock compensation expenses for the reasons I mentioned earlier, and higher outside service and professional fees.

Moving back to page 15, equity investment earnings totaled $75 million versus 12 million last year.

Equity earnings for the quarter are comprised of $62 million from Crown and the remainder related substantially to our Opus One joint venture.

Interest expense for the quarter was $82 million, up 13% over last year.

The increase primarily reflects the incremental interest from funding the fed acquisition in the $500 million share repurchase.

Net of the proceeds received from the Matthew Clark transaction, all of which occurred in the first quarter.

Now let's take a look at our debt.

At the end of November, our debt totaled $4.7 million, a decrease of nearly $300 million from our Q1 debt level, reflecting our strong free cash flow generation during the second and third quarters.

At the end of the third quarter, we had approximately $2.4 billion of bank debt and $2.3 billion of fixed term and other debt, with approximately $850 million dollars of revolving credit available under our senior facility.

In mid-December, we closed the acquisition of Fortune Brands U.S.

wine business for a purchase price of $885 million dollars.

We financed the acquisition using net proceeds from the sale of $500 million of 8 3/8% senior notes due in 2014.

Together with borrowings under the revolving portion of our senior credit facility, the average interest rate on our revolving borrowings is about 6.2%.

We're very pleased to have executed a sufficient bond offering in a very challenging market.

This reflects our ability to access capital markets, even in a difficult financing environment and it shows our experience in executing acquisition and financing transactions.

As previous discussed, the acquisitions expected to bring our debt to comparable basis EBITDA ratio to the 5 to 5 1/2 times range.

Although on the high side of our historical range we're quite comfortable with this level.

As we have done historically, we believe we can reduce this ratio to around the mid times 4 times range over the next 12 months by paying down debt with free cash flow generated by our growing base and the cash flow from our acquired business.

Our comparable basis tax rate for the quarter came in at 37.1% versus 36.1% last year and our weighted average diluted shares outstanding total 219 million compared to 239 million last year, reflecting the benefit of the share repurchase.

Due to the many factors just mentioned diluted EPS was $0.55 versus $0.58 in third quarter last year.

Now let's turn to our cash flow on page 11.

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

For the first nine months of fiscal '08, we generated $173 million dollars of free cash flow, versus a $22 million usage in the prior year.

The year-over-year increase reflects improved working capital, lower taxes paid and reduced capital spending.

Beginning in 2008, cash flow is now part of management's incentive and as a corporation, we're much more focused on generating free cash flow.

As a result of the strong performance to date, we are increasing our free cash flow guidance for the year to a range of $280 million to $300 million.

This is a $160 to $180 million above prior year's free cash flow.

This improvement is primarily attributable to lower taxes paid, reduced capital spending and lower working capital investment.

Now let's summarize Q3 and discuss our full-year P&L guidance.

From an earnings perspective, we're pleased with our results.

Net sales growth for the quarter and on a year to date basis, excluding the impact of the reduction of U.S.

distributor inventory has tracked in line with our long-term stated goals.

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

The UK and Australian markets remain difficult, but we believe we're making progress with the initiatives we have in place that are designed to improve the future performance.

Moving to our P&L expectations for the full year 2008 we are revising our comparable basis EPS outlook to $1.33 to $1.38 range from our previous range of $1.34 to $1.42.

This includes an anticipated $0.04 delusion impact from the acquisition of Fortune brands U.S.

wine business and tightening the bottom end of the range.

As previously discussed, the delusion is being primarily driven by the high levels of product inventory currently in the distributor channel which is expected to result in net sales for the acquired business that will be well below normal levels for January and February.

As a reminder we substantially completed our initiative to reduce distributor wine inventories in the U.S.

by the end of the second quarter.

The goal of the initiative was to assure distributors have sufficient inventory to meet consumer demand or to reduce any permanent buffer stock in non-peak periods.

As previously discussed the completion of this program is driving a timing change in our U.S.

wine sales pattern.

Our new shipment patterns, we expect a lower growth rate in Q4 as we return to the lower distributor inventory levels established at the end of the second quarter.

The Q4 comparison for the beer business will also be difficult as the fourth quarter last year benefited from an assimilation of the east coast Modelo brands business into the Crown JV.

Our comparable basis guidance excludes acquisition-related integration costs, restructuring and related charges and unusual items which are detailed on page 17 of the release.

On pages 4 and 5 of the release, the outline plans for the integration of KODIWA and the other acquired brands, realignment of the sales and marketing organizations, supporting our U.S.

wine business and the rationalization of certain low margin, low-growth brands.

Collectively, we believe these actions will further strengthen our U.S.

wine business and produce net synergies of about $30 million annually by the end of 2010 with approximately $20 million in synergies being achieved in fiscal 2009.

We are still targeting about a penny to two penny accretion in fiscal 2009 for the acquired wine business.

This includes the synergy benefits just outlined.

The majority of synergies will be generated in the sales and marketing area, where we expect to add the newly acquired brands and maintain essentially the same level of sales and marketing costs as we had prior to the acquisition.

To better assure the commercial focus on our newly defined consumer segments, we're rationalizing certain low margin brands from our current portfolio.

We expect to incur $45 million in one time charges related to the restructuring and integration activities, the majority of which are related to SG&A and brand exit costs.

We expect approximately half of this amount to come in as cash charges for employee termination and acquisition-related integration costs, and the other half as non-cash charges for asset write-offs and accelerated depreciation.

The cash impact from this activity is contemplated in our fiscal 2008 free cash flow guidance.

In addition, we expect to incur one time cash costs of $28 million for employee and contract terminations that will be recorded in the allocation of purchase price for the acquired wine business with most of these payments expected to occur in fiscal 2009.

Additional assumptions for our full fiscal 2008 guidance are outlined on page 5 and 6 of the release.

As you can imagine, we've been very busy assimilating our recent acquisition and developing our new U.S.

wine organization.

We are also beginning the process of developing our 2009 annual plan.

This planning process will be finished in March, and we intend to provide full fiscal 2009 guidance as part of our fourth quarter fiscal 2008 reporting activities which are tentatively scheduled for April 3.

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

The floor is now open for questions.

(OPERATOR INSTRUCTIONS) Our first question is coming from Bryan Spillane from Bank of America.

Please go ahead.

Hi.

Good morning.

Good morning, Bryan.

Just two questions related to the wine business.

One, just in terms of restructuring activity and cost savings measures for 2009, I know you've outlined $20 million of incremental savings related to assimilating or integrating the Fortune brands business.

Should we expect that there will be incremental savings above and beyond that relative to what you're doing for the rest of your business?

And the second question is, with regards to free cash flow, very nice to see the increase in free cash flow guidance for 2008, especially given that there's some cash costs related to some of the restructuring activity.

Is that a more normal run rate for free cash flow as we begin to model out 2009 and 2010?

Should we start to think about this as being a more normal free run rate for cash flow?

Thanks.

Hi Bryan, this is Bob.

I guess on the first question, I would say the numbers we put in the press release regarding the cost and benefits of the restructuring activities, they're our best estimates right now.

As you know, these are estimates.

We hope to do better, but these are our best estimates right now.

I think you'll also look at -- the good thing about the restructuring is we are acting quite fast.

So we are getting a lot of the restructuring costs behind us quickly, and also we're getting the savings quite quickly; and if you just look at the cash payback on these activities, it's in between about a year and two years.

So it's a pretty quick pay-back on the restructuring activities.

On the cash-flow, we're very happy with the cash flow for this year.

We're not really giving guidance for future year's cash flow; but as a corporation, as I mentioned, we are much more focused on bringing more of our EBITDA down to the free cash flow line.

So I hope we continue to see better cash flow performance as we go forward.

We're not giving any specifics right now.

Would it be fair to say that the factors that drove the increase in your free cash flow guidance are sort of more sustainable type things, like better working capital management as opposed to onetime things like asset sales or onetime, like, tax refund?

Yes, I'd say they're probably more along the more permanent cycle.

However, on working capital, we do have a lot of exposure to AGRO industries.

So we are somewhat subject to the timing of harvest and things like that.

And one of the big drivers this year for the improved working capital is we do have reduced inventories in the U.S.

and in Australia.

We think that's healthy for the business.

We are focused on keeping our cash tax rate down, we've been pretty successful with that.

We hope we can keep replicating that.

And one of the other drivers to reduce cash flow is reduce capital spending, and we are very focused on capital spending.

However, we are going spend what we need to keep the business quite healthy.

But I think, as we make part of management's compensation attributable to cash flow, it is having the desired impact.

So now we have all the associates in the business really focused on how we can drive better cash flow from the business.

Okay.

Great.

Thank you, guys.

Thanks, Bryan.

Thank you.

Our next question is coming from Lauren Torres from HSBC.

Please go ahead.

Good morning.

Hi Lauren.

I was just hoping if you can, be a little bit, if you can, more specific on performance at Crown Imports for the quarter.

Obviously we're still talking about the impact of the price increases on your volumes, but if you could give us any sense of either shipment or consumption data, that would be helpful.

Yes, As we continue to say, Crown is really performing right in accordance with expectations and is tracking very closely to what's occurred when we've previously increased pricing.

The business is fundamentally very healthy.

If you look at -- take, for instance, depletion growth rates, the Crown business, even with the price increase continues to grow in the low single digits, which is, as I said, pretty consistent with what typically occurs during a price increase year.

So in general, Crown is meeting our expectations, and we're pleased with its performance.

And you said that you've seen some improvement, I guess, over the last couple of months beyond November?

Yes.

As we start getting into the year following the price increase in '08, we're seeing some improvement.

Okay.

And if I could also just ask a quick question on spirits, organic sales in the quarter was up 12%.

Could you just give us an idea -- obviously that's not Svedka, so what's really driving the growth right now behind your spirits division?

I guess we saw that last quarter also.

If you could give us a sense of how sustainable these growth rates are.

Yes, it is attributable in part to our premium businesses, the trends toward premiumization, trading off.

Those businesses continue to do very well.

So, you know, in general, we're pleased with our spirits performance and our strategy of focusing on the more premium categories and developing internally premium brands, is paying off.

These are high levels of growth.

I don't -- I don't know that they're sustainable at those levels on an organic basis forever, but we're very pleased with the spirits performance and the continued good spirits performance.

But is this growth more volume or price-related?

I would assume price-related?

It's a mix of price and volumes.

Volumes are strong in our premium portfolios, and, you know, pricing is -- there's some pricing in there as well.

So pricing, mix and volume.

All three factors.

Okay.

Thank you.

Thank you.

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

Please go ahead.

Thank you very much.

Good morning, Rob.

A question on your volumes, if I could, your rationalized volumes on the value wine portfolio.

Could you give us a sense of how much of your volume you're considering rationalizing here either in percentages -- percentage of below $5 or percentage of total portfolio?

Just to the get a sense of what kind of size we're talking about?

Yes, well, we're really working on that at the current time.

So we don't have any specific numbers to give you on that, other than to say that, as a result of how we will go about doing this and taking advantage of things like greater focus on our premium portfolio, the ability to substitute either listings or skews and this kind of thing, we really don't expect it from an EBIT perspective to have material impact on us at all.

So we think it's a good thing for the business, and it's not something that, as I said from an earnings perspective we're particularly concerned about.

Okay.

What about from a market share perspective?

Again, would that be something meaningful?

Well, we'll see when it all gets done; but at the moment, I don't think we really anticipate it to have a meaningful impact.

But as I said, we'll see when all of the plans are complete, and the rationalization is finished.

So --

Okay.

Great.

A couple of clarifications, if I could.

Back to your CapEx, you did talk about lower capital spending.

Were there any specific projects that you pushed out into fiscal '09 or anything that could reverse in terms of your capital spending plans that would be considered not, I guess, on going in your new cash flow step-up?

This is Bob.

No.

We don't -- we did reduce our capital budget for this year, and we don't expect to spend that in future years.

Okay.

So that's real -- and finally, on spirits, back to the step-up in organic growth, we saw second and third quarter organic growth of 11, 12%.

You did mention, Rob, about an increase in production services.

Could that have something to do with the fact that the pace of growth in organic spirits really stepped up in the second and third quarter, and can you comment on the margins of those businesses?

Yes, this is Bob.

The production services was a reasonably large piece of the growth in volume.

We don't make much money on it.

It's more of a way to leverage our production facilities.

And is that something that was picked up earlier this year, for example, in the second quarter, or has this been on going for some time?

It's sort of choppy depending on when our suppliers want the product.

But it certainly was pretty big in the third quarter and it was in the second quarter as well.

Okay.

And just finally can you comment on the growth of high end spirits versus low end spirits?

Are you seeing a continuation of what you saw in earlier quarters?

Yes, I think that that trend continues, and generally the trend continues over all beverage alcohol.

There is a whole trading up mentality through all the categories and we're trying to take advantage of that in our spirits business to our higher-end spirits product offerings like Ridgemont Reserve, Effen and Svedka and those products are all performing quite well in their categories, and we're very happy with them.

Okay.

Thank you very much.

Thank you.

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

Please go ahead.

Good morning, everyone.

Morning, Bill.

I was hoping you could elaborate a little bit a bit more on your implied fourth quarter guidance.

If you look at your new full-year guidance you're implying fourth quarter EPS of about $0.25 versus $0.35 and if you add that $0.04 to Fortune wine dilusion it's still $0.29 versus $0.35 so it's down 17%, you have about 8% fewer shares.

So it's not a real cheery forecast, I don't think.

You just -- you mentioned a few things in passing, but why would the quarter be that weak?

Yes, there's a couple of things going on.

We've got the UK and Australia margins are bringing down the estimate versus prior year.

Of course, the new dilution we just announced is bringing it down and we still have some Svedka dilutions, okay, quarter-over-quarter that's also contributing to it.

In terms of the Fortune dilusion, do you anticipate that all being in the February fourth quarter or is that likely to dribble into the first quarter of next fiscal year?

No.

It's fourth quarter.

The other thing in the fourth quarter, as Rob and I mentioned, we're overlapping some pretty favorable beer numbers from last year, as we rolled out the Crown joint venture.

So, you know, you should not expect to see good beer sales or profit numbers in the fourth quarter.

Also, the timing, as I mentioned in my script on wine sales, as we bring our distributor inventories down to the levels we established in the second quarter, you shouldn't expect to see very good wine sales growth in the fourth quarter either.

Those two are mostly overlapped timing things.

The underlying businesses are still very healthy.

And in terms of the UK, is there some point where we just get around to comparing against such terrible results, it ceases to be a year to year negative?

It's not a huge part of your business and seems like it's been dragging down your results for two years now.

Yes, that's fair enough.

I think we have taken a big down tick because of the duty increase and some poor X rates.

So I think the year-over-year erosion, this was a big erosion.

We're not talking about next year, but I don't think we'd expect it to be the kind of erosion we've seen this year.

So hopefully, that's why we're keeping our eye on the Australian harvest, because that has a big impact on the Australian business and UK business.

We think we're doing the right things to make that business as profitable as it can be.

Or could it possibly be a year-over-year positive in fiscal '09?

We're not really talking about '09 yet but we'll let you know in the fourth quarter call for sure.

Okay.

Thanks.

Thank you.

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

Davidson.

Please go ahead.

Good morning.

First on the Svedka business, I think you said it was up 50% in shipments.

Was that sequential or was that year-over-year?

Year-over-year, Tim.

Okay.

Looks like there's quite a strong sequential as well.

But I assume there's a seasonal pattern to this at the holidays?

Yes, I would say that's probably true, but the brand has been growing in that range in general for us.

So, I don't think it's -- if it varies sequentially it's really not indicative of anything.

In general, it's been growing in that sort of high double-digit, you know, 50% range.

And we had this discussion when you bought it; but if it continues in high double-digit growth that's probably above the range that you modeled for your dilution assumptions.

Is the dilution from Svedka less onerous than you thought it would be or likely less than you thought it would be?

Tim, this is Bob.

We had pre-high expectations for Svedka as we had to.

So it's pretty much performing in line with our acquisition model assumptions.

So I think the dilution assumptions are still pretty valid.

Okay.

And then on grape purchases, we didn't talk about that, but your model in the last couple of years have been sort of the global backstop, back stopping any potential shortfalls with the global supply chain.

With Australia sort of drying up, is anything changing there?

Are you extending your contracts with U.S.

growers?

What's the status there?

No.

I'd say that we continue to be pretty much in balance.

When you take a look at Australia, it's the same story.

Oversupply turning into balance, potentially turning into undersupply.

But those are not trends that we expect to be unfavorable to us.

So, you know, in general, I would say, in terms of our global position and the way that we -- our portfolios are positioned to be able to use wines from different Appalachians, I would say that we continue to be in pretty good balance.

Okay.

And just one on the wine restructuring.

Is there -- do you have a number of SKUs that you're eliminating there that you can share?

On the wine restructuring?

Well, I mentioned -- you're talking about the rationalization I mentioned?

Yeah, that's right.

Is it three brands, or 20?

Oh, it's more than three brands.

I gave you some examples, as I say, of brands that you'd actually never heard of, would never heard of and most people wouldn't have heard of, small regional brands that are legacy businesses and relatively low-margin.

You know, there's a whole slew of brands like that; but again, it wouldn't be anything that you'd be -- you, in all likelihood, have heard of.

Thank you.

I know you drink better wine than that, Tim.

(Laughs)Thanks Rob.

Thank you.

Our next question is coming from Reza Vahabzadeh from Lehman Brothers.

Please go ahead.

Good morning.

Hi Reza.

On the wine business EBIT decline, the dynamic of UK EBIT wine business weakening and U.S.

kind of strengthening, is that likely to continue in the next quarter or two, or are we going to level out at some point?

We have a number of initiatives on going in both Australia and the UK.

Australia, we just put out a month or so ago, and we're doing some winery rationalization down there in the UK.

We're doing a pretty significant supply chain investment to reduce our costs over there.

So we're doing a lot to improve the long-term profitability of this business.

So I'd say in general, look, you can't keep seeing these kind of declines or eventually you sort of go out of business.

So, I would say that, yes, in the medium term, these things have got to turn around there's no choice.

And when did this import duty that you mentioned in the UK start to impact the results?

I can't recall offhand.

It comes in around the March time period.

Okay.

Now, once you cycle in, after March, do you still think UK EBIT will still be under downward pressure, or can you start to level out?

We're anticipating what the UK duty increase will be, which happens in March, and we think we have the business plans to improvement profitability in the UK as we go forward, but we do not know what the government is going to do.

So we have a number of alternatives depending on what the duty increase will be, but we think we're as prepared as we can be for what will happen in March.

Got it, and lastly in the environment, the potential consolidation in the industry with the Swedish spirits business, I mean, how can that potentially impact you positive or otherwise, if any?

Well, that's one transaction that you're talking about, the V and S deal.

The industry does continue to consolidate, but there also continue to be opportunities across the beverage alcohol segments that I'm sure we'll be able to take advantage of.

So I don't see any dramatic change in the environment in that regard at this point in time.

But do you think that that potential sale will actually offer you more opportunities or more of the same?

As I said, it's just one sale.

It's just hard to -- are you asking if there's any specific opportunities coming out of that sale?

If that's the case, I think we've said that we're not really going to play in the V and S deal for absolute -- you know, we're not anticipating necessarily without commenting on any specific transactions, you know, it impacting from an opportunity standpoint one way or the other.

Well, will there be repercussions from that sale that other people may have to sell stuff that might be of interest to you?

You know, that's always possible.

It's hard to speculate on those kind of things, because we don't know who's going to buy it, and, yes, that's possible.

Okay.

If that's what you were getting at yes, that's possible.

I appreciate it.

I have to ask the question.

Thank you.

Thank you.

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

Please go ahead.

Thanks.

Good morning, everyone.

Good morning, Mark.

I guess one corporate question and then two -- a couple of business questions.

On the corporate side, just in terms of the shares outstanding, when you take your full-year guidance, it seems like you're implying about 224, 225 million shares on average in the fourth quarter.

Is that right?

Yeah, that's about right.

And is that because of restricted stock -- like in the latest quarter, it's more like a 219, 220 level.

Is that restricted stock options?

Why would we see such a material pick-up?

It should be -- for the fourth quarter, you should assume about 220 million shares.

So it's not really a 225 full-year number?

It's a little bit lower than that.

All right.

Then that's helpful.

Okay.

And then, moving on to the business, starting in North America, in a sense, if you look at your North American wine business, it's been the relative out performer, if you will, in the quarter versus the UK and Australia, not only in a sales sense; but as best we can tell, in a margin sense, but we really don't know what absolutely is happening with the margins here in North America.

Can you give us a sense -- are your contribution margins in North America up year-on-year versus third quarter of fiscal '07, and also, how does the operating margin -- and I'm talking North American wine obviously, excluding spirits, but how do the operating margin for North American wine look versus last year as well?

It's relatively even with last year for the quarter.

Even.

Okay and you're talking at which level?

Contribution?

Operating?

Operating margin kind of level.

Perfect.

And then going to the more challenged business, the UK and Australia wine business, you know, obviously we've been talking about this collectively for a number of quarters here; but when you look at the input cost pressure, if you will, rising and so far not getting the relief you'd like at the retail level in terms of selling price, them accepting selling price increases, can you talk a little bit more than you have already about the environment for getting the selling price increases accepted by your retail partners both in the UK and Australia?

Yes, Mark, this is Rob.

You know, I would say that, you know, our view is that pricing is going to have to be taken.

Yes.

It's pretty much as simple as that.

If you read any of the trade press, both in our industry and in other industries for that matter, suppliers are indicating pretty much across all consumer goods durable that they're going to take pricing, and I would say that as a consequence of that, we're hopeful that the environment is going to be positive in that regard.

Is that to say that the retailers are going to like it?

No.

The retailers are saying that they don't like it in the UK.

The retailers, I think, will try to do whatever they can to either avoid it or to offset it, but I think it's going to be a fact of life across the board.

So we're optimistic.

Okay.

And, you know, you always get pushed back; but at the end of the day, either you get it or you don't, or you get some degree of realization.

When you think about that, I mean, that what gives you optimism that you'll get the level of increases you're thinking about, and what sort of timing are you thinking about?

What gives us the optimism is I truly believe it's going to be across the board not only in beverage alcohol, but in a lot of other sectors; and therefore it's sort of -- if everybody's doing it, I think it's going to happen.

And then, yes, you get pushed back, but we control our pricing to the retailers.

So it's fundamentally our decision, and we'll do what we have to do in that regard.

Okay.

And what was --

In the meantime, we're working with our retailers very closely.

We continue to support our brands very well.

If you look at UK, Nielson's as I mentioned in my talk, the -- we're out performing the market.

The market, actually, is very healthy from a volume perspective, and consumer demand, in the end, is going to -- is going to drive the reaction to the necessity to increase prices, which, as I said, is pretty much an across the board thing at this point.

Okay.

And then last, I know it's tough, but I think there's a duty increase coming in March in the UK, and I don't believe we know the magnitude, but can you talk a little bit about how you factor that into your thinking and what you're hearing from retailers on that, or is it just too soon to say?

Yes, Bob talked about that a little bit; but basically, repeating what Bob said, first of all, we -- there will be a duty increase in March.

We do not know exactly what the magnitude of that duty increase will be.

We believe that we've put in place plans to cover, you know, just about any scenario that can occur in that regard, and we expect, you know, without commenting on the specifics related to '09, that we'll be able to act accordingly with the duty increase so it doesn't -- doesn't hurt us further.

Great.

Thank you, Rob, thanks, Bob.

Thank you.

Our next question is coming from Jonathan Feeney with Wachovia.

Please go ahead.

This is actually Brian [Scudieri] in for Jon Feeney.

Good morning.

Hi Brian.

How are you?

I guess my first question is addressed to Bob.

What was the single biggest surprise in free cash flow this quarter and why did the anticipated working capital growth not really materialize?

Well, I don't know if I'd put the word "surprise" around free cash flow.

You know, we really wanted to really wait until the third quarter ended to really get a real hard look at what's been happening for the full year, but, we've been doing better than prior year in cash flow pretty much all year long, but, you know, there was no negative anything in working capital.

It was all positive, and, I mean, mostly if you just dial down the cash-flow statement year to date, accounts receivable was positive mostly due to sales timing, and inventory was positive, and this will carry through for the full year, the inventory positiveness, mostly because of the harvest in the UK and in Australia.

You had some sort of negative timing on accounts payable, but that's -- Australia and the U.S., sorry.

You had negative timing in accounts payable for the quarter.

That will reverse as we get to the full year.

I think our cash tax rate, timing, that will be permanent for the full year, as will our favorable capital spending versus prior years.

Okay.

Great.

And I guess, a more broad question for Rob maybe.

Have you seen any signs of bottoming in the UK and Australia on a category level?

You know, as I said, when you say "bottoming," especially as we talk about the UK, volumes are very healthy, and the issues have been more of a market issue, and I think that as we've discussed, although it is somewhat unpredictable -- and again, we're not giving guidance, but I guess it would -- I would say that it appears to be bottoming.

And I know lastly, this might be a tough number to get to, but maybe could you estimate across the company, your on-premise, off-premise and consumption mix?

Is that possible, or --

No, not really.

Cross the whole company on a worldwide basis?

Uh-huh.

No, but I would say, on the higher side of 50% for off-premise and under 50% for on-premise.

You know, I don't know, 60, 40; 70, 30.

We really don't track those numbers very specifically, and so it's -- it fluctuates market by market and brand by brand.

Right.

It's not really a relevant number, but much more off premise than on premise.

All right.

Great.

Thanks for your time.

Thank you.

Our final question is coming from Alec Patterson with RCM.

Please go ahead.

Yes.

Just quickly, an update on the material costs outlook here, glass in particular, and then just wanted to get a read on the ACB on [Kwodova].

Where does it stand?

Is it nearly fully distributed, or do you guys have a lot of opportunity there still?

Your first question, you know, Glass as we've indicated previously, glass costs continue to escalate in general, but that's been completely taken into account in everything that we've told you.

So it's just something that we, like everybody else, have had to deal with.

As to [Kwodova] distribution, [Kwodova] a highly distributed brand, meaning it's got very good and high levels of distribution.

So, I wouldn't -- I wouldn't say that the opportunity is -- in the U.S., let me put it this way, is in gaining distribution.

It is growing, as I said, in the 18% range in IRI channels.

So the opportunity is to continue to grow -- to continue to take advantage of and to drive that growth in the marketplace.

Now, distribution internationally is an opportunity they would have had little to no distribution outside the United States for all intents and purposes, and with our groups to market around the world we should be able to take advantage of that to drive distribution outside of its core market of the United States.

Okay.

That's clear.

And then just lastly, Rob, the sort of pricing trend on the own label product lines in the UK retailers, what are you seeing there?

Any sort of sense that they're starting to reflect what grape costs might look like down the road?

As I said, pricing continues to remain competitive at the retail level, driven by the multiples, the chains.

We're not -- we're not seeing, at this stage, significant price movement, but there is no doubt that as it relates to Australian bulk wine, that the market has moved dramatically, and he retailers are going to have cost of goods sold, if not supply issues, on Australian bulk, and the retailers are going to suffer the same duty increase in margins as everybody else.

So they're going to have the issue of whether to absorb that or not, and, you know, typically, retailers don't absorb those kind of things.

So we'll see.

Stay tuned.

Okay.

All right.

Thank you.

Thank you.

At this time, I'd like to turn the floor over to Rob Sands for any final remarks.

Well, thank you, everyone for joining our call today, and I'm very pleased about the way the year is shaping up and our progress in implementing our strategy.

Just to summarize, during the third quarter, we completed the acquisition of Fortune brands premium wine business.

We are executing the integration plan for our U.S.

wine business.

We're rationalizing our portfolio of value wines and focusing more on our premium and super premium plus portfolios.

We delivered very strong cash-flow performance year-to-date and increased our free cash flow guidance as a result, and we are driving marketplace initiatives which will help us generate growth from our portfolio of products.

Thanks again for your participation; and during our next quarterly conference call, we will provide guidance for the fiscal year 2009.

In addition, we're planning an investor day in New York for late May, early June.

So keep that in mind as you're planning your calendars; and of course, we'll give you the specific time frame on that shortly, so stay tuned for those details.

Again, thank you very much, everybody, and have a good rest of your day.

Thank you.

That does conclude today's teleconference.

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