Constellation Brands Inc (STZ) 2009 Q3 法說會逐字稿

Good morning.

At this time, I would like to welcome everyone to the FY 09, Q3 Constellation Brands 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 session.

(Operator Instructions).

Thank you.

I would now like to turn the conference over to Ms.

Patty Yahn-Urlaub, Vice President of investor relations.

Please go ahead.

Thank you, Julianne.

Good morning, everyone, and welcome to Constellation's third quarter fiscal 2009 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 compliment 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 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 details of (inaudible) sectors that may impact the Company's estimates please refer to the news release and Constellation's SEC filings.

Thank you, and now I'd like to turn the call over to Rob.

Thanks, Patty, and good morning and happy new year to everybody.

I hope everybody had a great holiday season, and perhaps the opportunity to enjoy some of our fine products.

Well welcome to our discussion of Constellation's third quarter fiscal 2009 sales and earnings results.

I'm pleased to report that our third quarter marks a continuation of the momentum we gained in the first half of our fiscal year towards achieving our goals.

For the first three quarters of fiscal 2009 we generated strong free cash flow, reduced our debt, significantly improved margin and enhanced our ROIC, and we are tightening our EPS guidance range now that we have only one quarter remaining in our fiscal year.

Although we continue to meet our earnings expectations, the economic environment remains extremely challenging and unpredictable.

I'd like to take a minute to discuss how are we managing the Company in this environment.

The following are some of the key strategies and actions we are taking to preserve the long-term health of the business.

First, we have taken a leadership role in taking pricing, which is key to managing cash, including taking all opportunities to optimize operating cash flow through working capital initiatives that focus on inventories, accounts receivable, and accounts payable.

Second, we are improving our capital structure through rapidly deleveraging as we [use] the combination of strong operating cash flow generation and proceeds from the divestiture of noncore assets to pay down debt and optimize our portfolio.

And I am especially pleased that we have been able to prepay a portion of our debt obligation for the next year, the details of which Bob will review in a few minutes.

This continued deleveraging of our debt portfolio is our first priority for free cash flow and is a prudent strategy given this challenging economic environment.

Third, we are streamlining our organization through efforts, such as the right sizing of our Australian footprint, to bring overhead in line with buying expectations.

We have also started to reduce our European overhead structure to better reflect the realities of that market.

Last, in addition to optimizing pricing, we are reducing COGS through supply chain initiatives and tightening controls on SG&A spending to continue to leverage sales growth into higher EPS growth.

Collectively these actions are being taken during a time of increasing financial market volatility and on-going competitive challenges in our key geographies, a situation where (inaudible) monitoring closely to insure that we continue taking appropriate and timely actions in response to marketplace changes.

Now I would like to focus on our operational business results for the third quarter.

Excluding the impact of foreign currency, our consolidated net sales in the quarter were a bit below our expectations, primarily as a result of the adverse economic conditions we are facing around the world.

Despite these challenges we continue to execute our strategy by pruning our portfolio via SKU reductions and and taking selective pricing actions to offset duty and cost increases.

These efforts help us to protect profit margins, free cash flow, and ROIC, which is the appropriate trade off in this environment.

The good news is the consumers tend to purchase well-known, trusted brands that represent good value during these challenging economic times.

As you know we offer an extensive selection of these kind of well-established brands at varying price points to appeal to customers.

Looking at our US wine business, overall we continue to improve the EBIT of the US wine business as a result of the favorable profit mix generated from the acquisition of higher-profit premium brands, the divestiture of lower-margin value brands, and the resulting synergies generated by this on-going strategic portfolio transformation.

However, as I indicated earlier, our sales are a bit below our expectations for a number of reasons.

We continue to experience a slight slowing of the US wine category market growth and category traded activity has slowed a bit.

As you know we've increased pricing across the majority of our wine portfolio in the US in order to enhance financial returns for the business.

However, these pricing actions have unfavorably impacted volumes in the short term.

Despite the slowing market growth I just mentioned, according to recent 12-week IRI data the overall US wine market, including the premium segment, remains healthy at mid single-digit growth rates.

And many of our premium brands are exceeding this market growth rate, including Woodbridge, Nobilo, Estancia, Toasted Head, Simi, Kim Crawford and Wild Horse, just to name a few, all of which posted strong dollar growth during the latest 12-week IRI reporting period.

As a reminder, the sales growth trajectory of our US wine portfolio has also been impacted by the on going brand and SKU rationalization currently underway for our value wine portfolio, which is expected to negatively impact the growth rate of the portfolio by more than 2% in the fiscal year 2009, as it represents more than 25% of our US wine SKUs.

This vast majority of this initiative will be completed as we head into fiscal 2010.

However, we may proactively discontinue additional selective SKUs as we continue our efforts to focus on growing those products that generate ROIC, enhancing growth and are incremental to our returns.

Overall we've been able to achieve significant operating leverage from EBIT growth despite a reduction in volume.

We expect our sales growth for the US wine business to return to levels that are more consistent with market growth as we lap price increases which we expect to occur in the next few months.

From an international perspective our Canadian wine business posted strong results for the third quarter, primarily reflecting sales growth from our premium portfolio led by brands such as Jackson Triggs, Sawmill Creek, Inniskillin and the Naked Grape Our European sales are less than our expectations, driven by extreme market conditions, including the worsening economic climate in the UK and mainland Europe, price wars amongst UK off-premise retailers and planned SKU reductions.

In addition, unanticipated duty increases were recently implemented by the UK government in order to compliment their economic stimulus package.

We immediately implemented additional price actions to cover this duty increase.

We are managing this situation in the UK by working to align our costs with our sales expectations, including the recently-announced elimination of 50 positions.

We intend to continue reducing our investment in the UK in the form of capital and operational costs as appropriate.

In the short term we are reviewing our strategy and assessing the alternatives for dealing with the challenging situation that continues to impact this business.

We plan to stay the course in the growing UK marketplace and will continue to focus on increasing operating efficiencies and improving product and channel mix.

We are currently in the process of bringing our new state-of-the-art distribution and bottling facility on line in the United Kingdom.

We expect to fully leverage the benefits of this investment, which will reduce the costs of production and distribution and significantly increase capacity and efficiencies and result in improved environmental footprint.

In Australia we've already taken actions to align the business with marketplace reality.

This marketplace remains healthy and we are continuing our efforts to further premiumize our product portfolio.

I'd like to reiterate that our UK and Australian markets combined represent less than 10% of our total Company EBIT and should therefore not cause a significant amount of operational volatility.

During the third quarter the spirit segment posted a 5% organic sales increase, driven primarily by strong double-digit, top-line and market growth for SVEDKA Vodka, which continues to gain momentum in the form of increased distribution, national accounts penetration and flavor SKU expansion within the product portfolio.

In addition, Ridgemont Reserve 1792 Bourbon, Black Velvet Reserve, Caravella, the [De Amardi] family of products also delivered solid sales performance.

Moving to the Crown Imports joint venture, the Crown portfolio generated 1% net sales growth in the third quarter.

Improved sales for Corona Light, Modelo Especial, Negro Modelo and Pacifico products were offset by meager results for Corona Extra, which continues to be impacted by the adverse economic conditions in larger-volume Corona markets and unfavorable trends in the on-premise segment, where Corona are more heavily weighted versus the industry.

We are beginning to benefit from narrowing price gaps versus competitors as they increase their prices to cover rising input costs.

Crown continues to explore new product introductions and packaging options across the portfolio.

Modelo Especial and Negro Modelo Draft continue to be successful in test markets.

During the third quarter operating income from the Crown joint venture remained unchanged versus last year's third quarter, as they have closely managed marketing and SG&A expense during these challenging economic times.

In closing, we are working diligently to manage through an increasingly tough economic environment worldwide.

Despite these challenges beverage alcohol remains a growing, healthy, consumer category and I am pleased with our ability to continue to deliver solid results and execute our strategy.

And now I'd like to turn the call over to Bob Ryder for a financial discussion of our third quarter business results.

Bob?

Thanks, Rob.

Good morning, everyone.

I think the third quarter reflects good performance in relatively challenging times.

Despite some softness in our branded wine net sales performance we were able to expand our profit margins and grow our comparable basis EBIT, EPS and free cash flow.

The higher margins generated by the pricing actions and portfolio transition in our US wine business are evident in our income statement and help offset the challenging environment we face outside North America.

Our comparable basis diluted EPS for the quarter came in at $0.60 versus $0.50 a share last year and we will refine our targeted former EPS goal to $1.68 to $1.72.

We generated $235 million of free cash flow through Q3 and we remain on track to reach our $360 million to $390 million free cash flow goal for fiscal 2009.

The combination of free cash flow generation and asset sales has helped us decrease our total debt level by more than $475 million at the end of fiscal '08 and increase our cash position more than $160 million.

This attributed significant reduction to our leverage and provides us with ample liquidity as we enter Q4 and fiscal 2010.

Now let's look at our Q3 fiscal 2009 P&L performance, where my comments will focus on comparable basis financial results.

Let's look at net sales.

As you can see from our news release on page 13 our consolidated reported net sales decreased 6%, primarily due to the impact of the year-over-year currency exchange rate fluctuation.

The benefit of adding the Clos du Bois and Wild Horse sales was essentially offset by the divestiture of the Almaden, Inglenook and certain Pacific Northwest wine brands and in certain spirits contract production services.

On an organic constant currency basis, which excludes the impact of acquisition, divestitures and foreign exchange rate changes, net sales increased 1%.

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

Our worldwide branded wine organic net sales decreased 2%.

Organic branded wine net sales for North America, which appears on page 12 of the release, increased 2%.

Branded wine organic net sales for Europe and Australia/New Zealand decreased 11% and 2% respectively.

As Rob mentioned, our growth has been impacted by a challenging worldwide economic environment, our price increases and planned SKU reductions.

We believe the price increases and SKU reductions were the appropriate actions to take, as they are contributing to some pretty dramatic worldwide wine margin and ROIC enhancements.

Our North American business remains very healthy and we are a leader in a profitable and growing category which holds up relatively well through most economic conditions.

The international business, primarily in the UK, continues to be very challenging.

We're undergoing the various initiatives in the UK and Australia to increase our return in these markets.

Turning our attention to spirits, organic net sales increased 5%, led by a 60% growth in SVEDKA Vodka.

Now let's look at our profits on a comparable basis using information on page 14 of the release.

For the quarter our consolidated gross margin was 40%, up an impressive 3.7 percentage points.

This reflects the benefits of implementing price increases across our markets and favorable product mix shift from adding higher margin brands, like Clos du Bois and Wild Horse, and divesting the lower-margin Almaden and Inglenook brands.

These actions reflect the benefits of our on-going premiumization strategy and should drive long-term improvements to Constellation's profit profile.

Our consolidated SG&A for the quarter was 18.8% of net sales compared to 18% a year ago.

Although actual SG&A expense decreased versus last year, due to the translation of foreign expenses, this [ForEx] impact was somewhat offset by higher marketing and stock compensation costs.

These changes, combined with the negative impact of ForEx rates on sales, drove the increase in SG&A as a percent of sales.

Consolidated operating income increased 9% to $219 million and our operating margin increased a healthy 2.9 percentage points to 21.2%.

I'd now like to turn to our segment operating income results on page 11 of the release, which will provide highlights of this page.

Wine segment operating increased $20 million to $222 million.

Profits benefited from pricing and targeted mix shift in the US organic brand and the addition of Clos du Bois and Wild Horse, somewhat offset by the US wine divestitures and UK performance.

For the spirits segment operating income decreased $2 million, primarily due to higher G&A costs.

For the quarter corporate number expenses totaled $22 million compared to $23 million for the prior year.

Equity investment earnings of Crown Imports totaled $62 million, which was even with the prior year.

For the third quarter Crown generated net sales of $555 million, an increase of 1%, and operating income of $124 million, or flat with last year.

Consolidated equity investment on these totaled $76 million versus $75 million last year.

Equity earnings for the quarter are comprised of $62 million from Crown, with the remainder generated primarily from our Opus One joint venture.

Interest expense for the quarter was $78 million, down 5% versus last year.

The decrease in interest primarily reflects a decrease in our average interest rate during Q3 versus the prior year quarter, as LIBOR decreased for our variable rate debt.

Now let's take a look at our debt and cash position.

At the end of November our debt totaled $4.8 billion, which represents a $476 million decrease from our debt level at the end of '08.

During the same period our cash position increased $161 million to $181 million.

The changes in the debt and cash were primarily driven by strong free cash flow generation and proceeds from asset disposition.

At the end of the quarter we had approximately $2.2 billion in bank debt under our senior credit facility and $2.6 billion of fixed term and other debt.

Our average interest rate in the third quarter was around 6.5%.

We had $868 million of revolving credit available under our senior facility at the end of November.

In December we prepaid $195 million in term loans due in calendar 2009 under our senior credit facility.

This represented our tranche A term loan payments that would have come due in March, June, and September of 2009.

Factoring in this activity we have only $79 million of tranche loans due in December 2009.

In addition, $155 million of -- I'm sorry -- $155 million of sterling notes are due in November 2009.

We currently expect that both of these debt requirements will be met through next year's free cash flow generation.

As you can see, we are deleveraging at a rapid pace, as our debt to comparable EBITDA basis ratio at the end of November was 4.5 times versus the 5.3 times level at the end of February.

This reflects our earnings improvement and debt reduction.

If you factor in the $195 million in debt prepayments I just mentioned the ratio would decrease to 4.3 times and get us to our low four times target for the year.

Our comparable basis tax rate came in at 39% compared to 37% last year, as a higher percentage of our earnings are coming from North America.

The higher rate is expected and already factored into our full-year tax rate estimate, as we continue to project our full-year comparable basis tax rate to approximately 37%.

Our weighted average diluted shares for the quarter totaled 220 million compared to 219 million last year.

Due to the many factors just mentioned, diluted EPS was $0.60 a share versus $0.55 last year.

Now let's turn to our cash flow on page ten of the news release.

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 '09 we generated free cash flow of $235 million versus $173 million in the prior year.

The improvement in net cash from operating activities reflects the benefit of approximately $85 million in pretax proceeds related to the favorable settlement of certain foreign currency hedges.

which we announced in early December.

As we continue to refine certain international businesses we have been reducing our foreign exchange exposure by adjusting corporate parent loans through our operating companies around the world.

We accelerated these activities primarily to take advantage of the in-the-money hedges driven by the sudden strength in the US dollar.

The tax payments associated with these transactions are expected to occur in Q4 and we expect to realize approximately $50 million in after-tax proceeds from this activity this fiscal year.

Operating cash flow has also been impacted by higher inventory, reflecting an increase in our southern hemisphere harvest intake.

Additionally, CapEx for the first three quarters of fiscal '09 totaled $96 million compared to $80 million for the same period last year.

As mentioned earlier, for fiscal '09 we are targeting free cash flow to be in the range of $360 million to $390 million.

This includes CapEx in the range of $150 million to $170 million.

Moving to our P&L outlook for fiscal year 2009, given the challenging economic environment impacting our key markets we are adjusting our sales expectations for fiscal '09.

We expect to continue mitigating this impact by taking actions to reduce operating and borrowing costs.

As a result we're tightening our comparable basis (inaudible) EPS range to $1.68 to $1.72 from our previous estimate of $1.68 to $1.76.

As reflected in the outlook section of the press release we now expect the quarterly net sales to increase from the low to mid single-digits versus our previous mid single-digit estimate.

For organic net sales we expect a increase of mid single-digits versus our previous mid to high single-digit estimate.

These estimates include the benefit of lapping the distributer inventory reduction initiative completed in the first half of fiscal '08.

[Given this] anticipated favorability in average debt balances, interest expense is now expected to be in the range of $315 million to $320 million versus our previous guidance of $325 million to $335 million.

This improvement, combined with cost containment efforts, helps offset the impact of lower net sales growth.

We're now assuming a weighted average diluted shares of approximately 220 million.

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

While favorable certain foreign currency hedges that I discussed earlier did not have an impact on income before taxes, in the quarter we recognized $0.15 of diluted EPS impact associated with income tax expense related to these transactions.

This amount has been excludes from comparable earnings.

We anticipate an additional $0.03 diluted EPS impact for income tax expense related to this activity to be recognized during Q4.

The remaining charges reported in the third quarter were primarily related to previously-announced restructuring and business realignment activities.

Before we take your questions I would like to note that given the challenging environment I'm pleased with our results and I believe our actions and results continue to demonstrate our overall focus on improving our sales mix, increasing operating efficiency, and implementing pricing to enhance overall margins and profitability.

Our Q3 year-to-date operating margin has increased 2.9 percentage points.

Generating strong free cash flow, as we target $360 million to $390 million for fiscal 2009 and paying down debt, we're rapidly deleveraging and have already reduced our debt to comparable basis EBITDA ratio 0.8 points to 4.5 times, and we are -- we (inaudible) four times when you take into account our prepayment.

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

Thank you.

(Operator Instructions).

Your first question is from the line of Kaumil Gajrawala with UBS.

Thanks, everybody.

First, on the SKU rationalization do you feel that you've identified all of the SKUs you'll be discontinuing or are there continuing -- are there more studies ahead of us and potentially a further cut in your brands and packages?

Yes, I think as we've discussed before we are looking at pretty detailed gross margins and ROI (inaudible) by SKU.

That process continues and actually we will continue to do that, so I would think we're going to continue to scale back on SKUs which -- that can't cover their inventory investment or just don't make money for us.

We want our sales guys focused on our most profitable products.

Okay.

And as you think about your portfolio long term is there an overall margin goal you're aiming for after you're complete with this process, specific to just in the wine business?

No, I don't think we're that far along in the process to say where do we want our overall profit margins to be.

I'd say that's an on going effort.

Okay, that's all.

Thank you.

Your next question is from the line of Judy Hong with Goldman Sachs.

Thanks.

Good morning, everyone.

Rob, if you can just give us a little bit more color in terms of consumer behavior across different price segments for all of your portfolio?

If you're really talking about market conditions, Judy, I think that starting many the United States market conditions remain pretty healthy as measured by consumer take away.

Mid single-digit value growth for the wine business.

The spirits business has probably been impacted to the greatest extent with growth getting near flattish, but that hasn't affected us particularly because we get some very hot brands and they're just on fire.

The beer business has actually accelerated in general during the economic downturn, as you are probably aware, but driven, I would say, by the domestic premiums and the next tier up which is in that marketplace.

If you look around the world you're seeing somewhat similar trends.

The UK has slowed down, I'd say to the greatest extent in terms of consumer take away on wine, which is really all we track in the UK, and has gotten much closer to flattish in that marketplace.

There's not a lot of data, Judy, that's been published on -- just in the last day or so on the holiday season.

It's probably on top of everybody's mind, how was the holiday season.

I would characterize it as foll -- as is follows, okay?

In the US, in particular, for beer it wasn't necessarily a stellar holiday season, but a lot of the IRI data that's being quoted is through 12/28 and whereas last year it was through 12/30.

It did not include the last few days of selling prior to New Year's and one of the things that characterized this holiday season is consumers definitely waited until the last minute to do their shopping.

So, on beer I think that in the end it'll probably wrap up to not be a fantastic holiday season, but on the other hand I don't think that it's going to wrap up to be as bad as the currently published IRI data suggests.

On wine the anecdote right now -- and I say anecdote because, again, we've got some IRI data through 12/28, it still lacks the last few days which are critical to understanding the holiday season -- but anecdotally from our wholesalers and so on and so forth it appears that the wine consumer take away was pretty good over the holiday season.

So when everything is reconciled we're hopeful that it's going to look pretty good.

So that's pretty much where things stand as it relates to our principal product categories and markets, Judy.

Okay.

And then if we look at your branded wine organic growth in North America in the third quarter of 2%, the way we should think about that number is if you adjust for the SKU rationalization you get to about 4% and that compares to about a mid single-digit growth for the category, and the difference may be that you're taking more pricing so that's hurting your brands a little bit in the near term.

Is that a fair assessment?

Yes, I would say that that is a fair assessment, Judy.

I wouldn't say that our sales results were optimal, but clearly at the lower end of our range of expectations or slightly below.

I don't think that they're bad given the marketplace and the economic conditions, and more importantly as you pointed out, given our pricing, we have led in pricing in every market that we're in in the world.

And in this economic environment I'd be the first to say that our pricing actions have probably impacted volume to a slightly greater degree than we anticipated, and that's why we said that our sales were being affected by the economic environment.

That being said, we're 100% confident that the pricing actions that we're taking are the right thing to be doing.

Worrying about a point of, of volume growth or two points of volume growth in this environment in certainly our opinion is not where our focus should be.

Our focus is on improving margin, generating free cash flow, paying down debt and improving ROIC, and we think that that is the key and proving course of action in managing the business in difficult economic times.

So, yes, our sales results are being affected by our pricing by a greater degree than we anticipated.

We're at the lower end just slightly below, actually, our previous range expectations on sales growth and we've modified that to low single-digits.

We're taking into account our adding back the distributor inventory reduction last year, but we don't see this as being a material issue for the Company given the economic environment.

Okay.

Thank you.

Thank you.

Your next question is from the line of Reza Vahabzadeh with Barkleys Capital.

Hi, Reza.

Good morning.

You talked, Robert, to talk about the price mix improvement driving your earnings.

What was the blended average price mix that you may have realized that there's a good data point you could come up with?

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

I'd say a shift in sales and profits from Europe where the fundamental margins are lower to the US helps increase the total portfolio gross profit margin.

but also if you focus on -- within North America, okay, if you say that our margins went up close to 400 basis points probably 60% of that is price mix and the other 40% is the Almaden, Inglenook, Clos du Bois impact.

and the other 40% is the -- impact.

That's helpful.

Thank you.

And then you've been paying down debt and obviously reducing leverage creating more financial flexibility the last, I'd say, six to 18 months.

Is there more to do on that front post the next quarter, or are you kind of close to where you want to be from a leverage standpoint?

No, we anticipate continuing paying down debt.

The fourth quarter is generally our largest cash flow quarter and we anticipate using that free cash flow to pay down additional debt.

We also -- as we've done this year we will continue to look at our portfolio to see if there's other assets that we should be monetizing because they -- just like from a shareholder value perspective if they can't cover their -- our weighted average cost of capital we should be liquidating and paying down debt.

It's an on-going strategy, so I'd say overall we'd be much happier with our EBITDA leverage ratio around the three to 3.5 on an on-going basis so if a great acquisition opportunity popped up -- of which there are none right now -- we want to have powder dry in order to drive after those.

Sure.

And speaking of that do you see any potential M&A activity occurring in the alcoholic beverage space that would be of interest to you in the foreseeable future?

Yes, it's hard to -- this is Rob.

It is hard to comment on that because these things come in spurts.

Clearly, as I have said in the past, right now our focus is on the things that I said that we're focusing on; i.e., cash flow generation, debt pay down.

We consistently said that we're not categorically saying that we won't do acquisition, but the environment hasn't been particularly conducive to that at the current time and we've got to -- we've made some great acquisitions.

We've got a lot to do and continue to do with the Company and our portfolio, so we don't feel compelled to have to go out and do anything if we're talking acquisitions.

And as Bob said, relative to this position we're going to continue to look at the portfolio and keep working on making adjustments to favor our higher growth, higher ROI businesses, and to eliminate businesses, that don't cover their cost of capital, and our drag on our ROIC growth.

Hence you are seeing very good progress in ROIC growth in the Company , and we believe that what -- on a fundamental basis drives shareholder value is driving ROIC in excess of the weighted average cost of capital.

So that's what we're going to strive to achieve as a corporation.

That is the key in the end and is the most fundamental thing to improve shareholder

Got it.

Thank you.

Your next question is from the line of Lauren Torres with HSBC Bank.

Good morning.

Rob or Bob, in the quarter there was a notable decline in your cost of sales as a percentage -- or your cost of goods as a percentage of sales and I assume much of this is attributable to SKU reductions and your mix changes, but you also talked about supply chain improvement.

I was just hoping you can give us a sense of how much of this came from some of these just changes in your portfolio versus your ability to manage cost going forward?

Yes, I would say one is the wide majority of (inaudible) is coming through pricing and eliminating unprofitable, lower gross profit margin SKUs, okay, and the mix shift, both the organic mix shift that's happening generally in the wine category as people trade up to higher-price wines.

The higher-priced wines generally have a higher gross profit margin, okay, and the relatively big shift from taking Clos du Bois, which is at the higher rate of wine gross profit margin, and selling Almaden/Inglenook, which is on the lower end of the wine gross profit margins.

So what we saw in this quarter as a percentage of sales that's kind of low because of the change and that should get higher or something back to where we were before, or stay at that level?

I think you have seen -- I think if you look at the year to date, gross profit margin is also much improved.

I think what we're seeing -- certainly the Almaden/Inglenook and Clos du Bois transaction, that's a permanent increase to our gross profit margin as a Company and that was a (inaudible).

Number one, the category Clos du Bois and Wild Horse participate in, that category of wine is moving up (inaudible) faster than the category of price points of Almaden and Inglenook, so it helped our sales profile and it helped our gross profit profile because the Clos du Bois is much higher gross profit margin than Almaden/Inglenook, but that is a permanent improvement in US gross profit.

Okay.

And also if I can ask, Rob, I think on the last call you talked about grape supply coming in and prices going up.

I was curious if there was any update there with respect to grape prices going forward?

No.

Obviously we're way away from the next US harvest although we're getting closer to the Australian harvest, which is a big piece of our grape costs, right, the Australian harvest, which will start occurring early spring, and we expect grape prices in the Australian harvest to go down dramatically in point of fact.

So we'd be looking at double-digit declines in grape pricing in the Australian harvest.

Again, it hasn't happened yet.

Harvests are very unpredictable.

No one can tell you what any harvest is actually going to be much before the harvest has actually happened, but the pudent and the believe is that the Australian grape harvest will be -- result in much significantly reduced grape costs.

Now that being said, remember that the grapes go in to make the wine, the wine goes into inventory and therefore it doesn't -- the lower grape costs are delayed in terms of when they flow through the P&L.

You get a small benefit in the current year and then you start seeing the benefits in the subsequent years.

So, Australian harvest lower costs.

California harvest, again no one knows what the California harvest is going to look like in next August, September, October.

But I would say most people believe that the California harvest is going to remain in a fairly balanced state to slightly favoring under supply, which might suggest that there should be some price cost inflation on grapes out of California, especially on certain varieties that tend to be -- that are tending to be in shorter supply.

So, if I was going to predict anything on the California harvest, as I said, a balanced to slight under supply this quarter, some cost increases and, of course, that's what we're planning on so we don't see it as a problem.

On the other hand the pricing environment for wine, we're certainly leading price increases, others are taking price increases, so moving to slight under supply is not a bad thing.

Okay, that helps.

Thanks.

Your next question is from the line of Christine Farkas with Banc of America Securities.

Hello.

Thanks so much for taking the call.

A couple of follow-up questions, if I could.

Bob, back to costs but moving to the operating expense line, you talked about higher marketing spend on a dollar per dollar basis yet you talked about lower investments in the UK and I imagine Australia, so where is the spend going, in what form?

Is it largely Spirit?

Is it feet-on-the-street?

How should we look at that higher marketing spend by segment?

Well, the higher marketing spend -- actually the UK year over year did have a higher marketing spend this quarter.

The statement that I made that we're looking to reduce costs in the UK is more around -- so we recently took 350 heads out of the business, so it's more relooking at that.

But the marketing -- a big piece of the marketing piece for the quarter was in the UK; basically in the UK and the US and a little bit in the Spirit business.

Okay.

And then in terms of marketing spend going forward or allocating that because your pricing is up so we're not talking about promotion, how should we look at that marketing spend?

Again, is it feet-on-the-street or direct sales?

Is it increase in advertising on particular brands?

How should we look at that generally?

This is Robert.

It's marketing, therefore it's not sales and therefore it's nonprice related, so it is various forms of marketing activity on-premise mostly.

Okay.

And then just moving to Corona, you've certainly talked about the trends there, perhaps, Rob, you can talk about geographic movement.

Is there any surprises in terms of what markets may have recovered and may not have recovered by now?

Recovered in terms of what?

Just with price gaps potentially narrowing, lapping price increases in prior years, there could have been some recovery in the Corona brand in some geographic pockets.

I'm just curious if you have any commentary as to what's lower than expected or what's better than expected?

Yes, the -- first of all, the data that's flowing in up until, I'd say, the very most recent period which I told you is somewhat problematic because there's some comparison issues has shown in general, I'd say, some constant improvement in the Crown business.

You're talking beer; right?

That's right.

So has shown some constant improvement in the business, whereas -- again, on a general basis our competitors are all taking pricing.

We took our pricing going on a couple of years ago and we really don't have any need to, any further pricing at the current time.

We are seeing the price gap pretty much all over the country declining and narrowing.

We have new -- I would say a fairly aggressive promotional program that we're putting in place in the beer business around the country and therefore I would say that as we move into 2009 -- because the competitive environment for the Crown portfolio is going to improve very significantly -- so we're optimistic in terms of seeing some rebound and regain momentum in that portfolio in 2009.

And as I said, the economic conditions aside the competitive conditions should be very favorable for that.

Now the economy that's another story, and it's not something that's in our control, so we're focusing on what is in our control and that's monitoring the markets very closely, monitoring those price gaps, execution in the marketplace and executing, as I said, new and aggressive promotional programs that should drive results.

So, hopefully that answered your question.

That's terrific.

Thanks a lot.

Your next question is from the line of Karla Casella with JPMorgan.

Hi.

I missed one comment you made on the revolver availability and did you also give the outstanding amount on the revolver?

Yes, there's no outstanding on the revolver, because we had a net cash position at the end of the quarter, so we had paid the entire revolver down.

Okay.

And availability then is the full $900 million less how much in LCs?

Yes, it was like $870 million --

Okay.

-- available.

Great.

And then I'm wondering if you could comment on any potential acquisition opportunities.

Are you -- is it completely off the table for now, or is there anything in the spirit side that you would look at given Fortune's comments made that they may divest some more brands?

Yes, what I said was our focus is definitely not on acquisitions but we're not categorically rejecting it.

On the other hand, acquisitions come up on an opportunistic basis so there's really nothing to comment on relative to acquisitions unless in itself something develops to a stage where we would be -- where we normally comment on it.

So, not a focus for the Company at the current time.

On the other hand we're not categorically rejecting the idea but the environment -- current environment hasn't been one that necessarily favors M&A and any of that.

And we've been in the past very aggressive in M&A so we're focused on integrating our -- the acquisitions that we made year-plus ago and bringing home the bacon on those deals.

So Clos du Bois, Wild Horse, SVEDKA, those are the things that right now we're focused on.

Okay, great.

And then, if you look across your different geographies can you just give us a sense for what percentage of the business is on-premise versus off-premise and how much that varies market by market?

Yes.

It depends on the category and this and that.

US, talking wine, it's probably about 70/30, off-premise, on-premise.

In other words, 30% on-premise.

Beer is a higher percentage than the 30%.

If you go to the UK I'd say it's still around that 70/30 off on, maybe a little less on.

Again talking wine, which is all that matters really.

Beyond what -- beyond that you're starting to talk about pretty small markets so there's not much to talk about.

Okay.

And our spirits business is a very small percentage of our business overall, so the spirits business in general is -- while we're in the more popular -- the more -- being in the more -- the mid premium to value end of the businesswe'd be SKU'd more off-premise than the normal spirits business would be, so the majority would be off-premise for us.

Okay, great, and then one last question on interest rates.

Have you locked in on your term loans any of your LIBOR rates?

We have interest rates locked in place.

About $800 million of our bank debt is floating and we can lock that in on a 30, 60, 90 day LIBOR basis.

So, we should be benefiting from that as we go forward, but again it's pretty small piece of our total debt portfolio.

That's floating.

Right.

Correct.

Okay, great.

Thanks.

Your next question is from the line of Tim Ramey with D.A.

Davidson & Co.

Hi, Tim.

You made a big push in Wal-Mart and the clubs and just those categories or those channels have been hot.

Can you give us any kind of update on how that's working out for you?

Yes.

The -- we're definitely seeing those categories perform and grow for our business, as well as in the marketplace in general at a higher rate.

For our business it is a significantly higher rate.

Those channels are much -- to a much greater extent out-performing pretty much other channels in general.

But it's no surprise.

Those channels are growing in the US in general.

One of the aspects of the economic downturn is not only [venueship] from on-premise to off-premise, but then within the off-premise from the more traditional retail channels, the chains, to the mass merchandisers.

So from an alcoholic beverage standpoint they're benefiting and our business is benefiting there and we're a leader and we're one of the leaders in that category.

We're one of the key one or two players in those categor -- in those channels that are -- we're either category captains or we're validating or -- it's an important channel for us and we're doing well in it.

Good.

Rob.

you've talked a few times about how Europe's getting small enough -- or the UK is getting small enough so that it doesn't really wag the dog too much but is there a risk you could lose money there on a sustainable basis or are you pretty on top of that to make sure we don't have losses?

The latter.

We're on top of that to make sure that we don't have losses.

Okay, good to hear.

And just in spirits you mentioned the great performance in SVEDKA, which I've got to take my hat off to you since I criticized that acquisition.

But Barton and Black Velvet, any specific (inaudible) performance there?

I understand Black Velvet's been fairly strong, as well.

Black Velvet is out performing the marketplace and really -- I think it's up about 6% right now, which for a mature brand, is huge and tremendous great margins on that product.

You look at SVEDKA and you look at Black Velvet, okay, that's 50% of our spirits business, certainly from a pro -- at least from a profit -- from a profitability basis.

And second I have to tell you, before we used to say it's one of a couple of major premium spirits brands that are growing at these very high rates, 50%, 60%.

Today it is the only major premium spirits brand that continues to grow at that rate.

The Patron's of the world, the Gray Goose's of the -- they've all slowed down tremendously.

Still growing, still healthy, but it's slowed down to more normalized growth levels.

SVEDKA,, if anything, is accelerating as we sit here and speak.

It is -- as we said it's looking at 60% growth rate and a multimillion case brand, so -- and Black Velvet is -- as a mid-premium spirits brand is also clearly benefiting from this economy, as well as, I think, superlative execution by our people.

And we're looking at opportunities for that brand, for new packaging, and ways to continue to make that brand relevant to the consumer and actually take advantage of the current trend for its mid-premium spirits brand.

So we're pretty excited about especially those two brands, Black Velvet and SVEDKA.

Thanks a lot, Rob.

Your final question is from the line of Mark Swartzberg with Stifel Nicolaus.

Hi, Mark.

Good morning, everyone.

Hey, Rob.

A couple of questions, first on North American wine.

Sounds like you're happy with how that pricing has worked out, and what that's meant on the volume side.

It's kind of a good trade.

Can you talk a little bit about what you saw over the holidays from the competition in terms of promotional activity in the wine business?

And as I ask that it seems like there's a bit of an analogy here between where beer was a year or a year-and-a-half ago with having taken price.

Thought it was the right thing to do for the brand but, of course, in time it proved to create some volume problems that were not as -- that were greater than what you anticipated.

So, just trying to get my arms around the risk, if you will, that these price, which has been good for you guys in the wine business, has to come off to an extent, simply because of what's going on with the consumer and because it creates some opportunity for competitors.

Yes.

So I'll answer that in a couple of different ways.

First of all, commercial activity is fairly intensive in the wine business during the holiday season and it certainly has benefited at some of the lower-end brands, the lowe-end companies, like the Sutter Home wine group, Gallo, but not anything that we're particularly concerned in and often in price categories and price segments that we're not that interested in, low margin, low return kind of stuff, okay?

Now relative to your analogy to the beer business, number one, what you said about the domestic beer business I would say is true.

There's one notable and very important exception to that, okay?

I think that the beer business -- the domestic beer business started to rely upon pricing to the exclusion of invasion and the pricing was probably the right thing to do in the beer business, but it should have been coupled with continuous innovation.

Then they woke up one day, okay, and said, oh, we forgot part two, and they started going very heavy on part two and you've seen a lot of the benefit of that actually in the beer business over the last year or two, as they've kind of gotten back on track, so that then rendered the pricing initiative that they had taken historically.

The wrong decision to make.

It's just that they took the foot off the innovation pedal and then they put it back on.

In the wine business, okay, we're taking the pricing, but we are continuously also refining the portfolio with new products, new innovative brands, that are taking advantage of consumer trends; whether it's the single variety kind of brands that are taking advantage of trends toward consumers wanting to drink new varieties like [Argentinian Malbec] so we have a new Argentinian Malbec brand.

Consumers finding -- discovering a [Spanish Tempranillo] brand.

We've got a new -- relatively new Spanish Tempranillo brand, which is focused purely on that brand -- that variety (inaudible).

So, without belaboring the point, pricing without innovation, yes, you'll -- eventually, if you don't do anything you'll start seeing consumers -- consumer resistance and volumes hurt, so you have to couple that with new products extensions, new packaging, much as -- I'm not here to tout any competitors, but as a Coors as done or others, these are -- this type of action is when -- pricing coupled with innovation I think is what really works, so that's what we're focused on.

Black box.

And another example, yes, it's something like our black box, which has turned into a multimillion case brand.

Premium three-liter bag in the box has really taken off in this particular marketplace.

Great.

And then --

Packaging, new packaging,.

Packaging, great.

That's very helpful.

And then as it relates to beer you commented -- I think it was Christine's question about new and aggressive promotions planned for the various Modelo brands, can you give us a little bit more -- a better understanding of what you mean by that and within that, to what extent?

Is it shifting money around from using it more at the consumer level to moving it more to the trade level?

To what extent it's really an absolute increase in the amount of dollars per case that you're putting behind your brands?

Yes, there will be some increases in that regard, which we expect to drive additional volume, so more funds.

It's not so much a shift because we're going to maintain our strong consumer marketing programs, but there'll be additional promotional activity in the marketplace, which we found to be very effective in terms of driving volume and from a profitability perspective as we've tested certain configurations of promotional activity and marketing.

Clearly when we talk about promotional activity what we're talking about is our efforts to really drive merchandising activity; feature ads and displays coupled with strong consumer offers at retail.

Okay.

This is the key to driving basically volume growth in beer and in the beverage alcohol business, in general, okay?

Strong merchandising, which means getting feature displays coupled with ads, coupled with strong consumer promotional activity.

So this is what we are focusing on and when we talk about strong execution in the marketplace what we mean by that is the degree to which we are able to achieve that, I'll say, three-pronged type of activity at retail which drives consumer take away.

Great.

And then last one -- that's very helpful.

Last one on restructuring, looking at the whole scope of the organization -- BCG's been helping you in some regards -- you talked a little bit about SKU rationalization, but as you think about opportunities from where you are right now to take out further structural costs, whether it's here in the US or in another part of your business, I know there are constraints on what you can say here, but can you give us some idea about what opportunity remains and any incremental color about what you see going forward there?

Yes.

As you said -- first of all, when it comes to restructuring activities and lastly, until we have a restructuring activity to comment on we're not going to comment in advance on restructurings that haven't happened, so we don't have any at the current moment in time.

But that being said, we're looking at the business and we're looking at ways to optimize the business.

Our preference is to do it outside the context, actually, of restructuring, if we can.

It's not that we don't look for restructuring, as least from a financial perspective per se.

We'd rather be able to optimize the business through organic activity, but if restructuring opportunities come down the line, which represents good investments -- and I've told you this before, Mark.

We look at restructuring opportunities strictly as investments.

We look at it strictly from a return on investment point of view.

If a restructuring opportunity comes down the road that represents a very high return project -- and we don't do those things if they're moderate return or low return.

We look for double -- high double-digit returns when we execute restructuring activities, okay?

And if those kind of opportunities come down the road, just like any other investment, if you get the opportunity to make an investments that has a high probability of generating double-digit return we will take advantage of that.

But nothing planned at the current time that we can talk about.

Great.

Thanks, Rob.

There are no further questions at this time.

I would like to turn the call back over to Mr.

Rob Sands for any closing remarks.

Well, thank you, everybody, for joining our call today and needless to say I'm pretty pleased, especially in this economic environment, with our results for the quarter and I'd summarize the highlights as follows: Number ones, we've led the market in pricing; number two, we've significantly improved gross margins and operating margins; generated strong free cash flow; delivered improved profitability of our North American wine business; improved ROIC to targeted levels for the year; and in addition we've increased our free cash flow guidance for the year and prepaid a significant portion of next year's debt obligation.

Our plan is to continue this strong execution throughout the final quarter of the year, and finally we will be providing guidance for our fiscal year 2010 during our next quarterly conference call scheduled for early April.

So again, thank you, everybody, for joining our conference call.

Thank you for participating in today's conference call.

You may now disconnect.