Constellation Brands Inc (STZ) 2010 Q1 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the Constellation Brands first quarter 2010 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 call over to Patty Yahn-Urlaub, Vice President of Investor Relations.

Please go ahead.

Thank you, Brandy.

Good morning, everyone and welcome to Constellation's first quarter 2010 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 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 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 fluctuations.

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

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

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

And now I'd like to turn the call over to Rob.

Thanks, Patty and good morning everybody and welcome to our discussion of Constellation's first quarter sales and earnings results.

We are generally pleased with our quarterly results which were in line with our expectations and demonstrate that we are on track to achieve our goals for fiscal 2010.

Despite the ongoing challenges of a difficult operating environment worldwide, we continued to reduce our debt and improve our operating margins.

We completed the sale of our value spirits business which is consistent with our strategic focus on premium, high growth, higher margin brands, and utilized the transaction proceeds to reduce debt.

In addition, we began to reap the benefits of our cost reduction initiative which was implemented with the goal of mitigating the negative impact from the turbulent global economy and creating efficiencies that will drive performance benefits over the long-term.

This cost focus helped us to offset the unfavorable product mix created by ongoing shifts in consumer buying patterns.

However, a continuation of our planned SKU reduction activities worldwide has tempered our topline growth.

Our focus on driving operational efficiencies as well as portfolio pruning through divestitures and SKU reductions is absolutely the right strategy to pursue as one of our top priorities is to manage for improved profitability in this challenging environment.

This helps to ensure the long-term health of our business.

And now I'd like to discuss the operational aspects of the quarter, beginning with the North American wine business.

During the quarter, we completed the integration of our remaining spirits business into our North American wine organization.

And begin refining the structure of our US wine business into a single, integrated organization, especially in the areas of sales and marketing.

These actions will simplify our organizational structure, provide synergy benefits, and are intended to improve efficiency and effectiveness with our trade partners.

We are also progressing with our efforts to consolidate our US distributor network in key markets and implement a new go to market strategy.

This has been made possible through the dramatic transformation of our portfolio, which has occurred throughout the last 18 months and has resulted in a much more focused set of premium, consumer-preferred brands that also have a desirable margin profile for distributors.

We are currently in the process of negotiating with our distributors.

The initial transition will encompass up to 17 states representing approximately 50% of our total US volume for wine and spirits.

The goal of our new US organizational structure and distributor consolidation initiative is to gain better alignment of dedicated selling resources working on a focused set of priorities and processes, aimed at driving execution and accountability.

We will implement an enhanced distributor incentive structure with the objective of driving organic growth.

We expect to begin transitioning by the end of this summer and will provide additional details when we're ready to officially launch the program.

This new level of increased importance to our key distributor partners is designed to position us for future growth in a consolidating market.

From a marketplace perspective, growth in the US wine market remains healthy, at about 5% on a dollar basis according to recent 12-week IRI data.

The premium plus segment of the market where wine sells for greater than $5 a bottle at retail continues to grow in line with the total category.

As you know, we have a strong portfolio of US wine brands throughout all price segments, and we continue to see consumers turning to trusted brands that represent quality for good value.

Many of our well-known premium wine brands performed well in the marketplace during the quarter, including Woodbridge and Rex Goliath, Blackstone, Nobilo, Clos du Bois, Simi, Wild Horse and Kim Crawford, just to name a few.

SVEDKA vodka posted another great quarter and generated sales growth of more than 30% versus last year.

According to market data it has become the fifth largest vodka brand overall in the US and now ranks as the third largest import.

Black Velvet also posted solid sales results for the quarter.

Our Canadian wine business posted positive results for the quarter, primarily driven by the premium wine portfolio, including Jackson-Triggs, Sawmill Creek and Naked Grape which all contributed to solid sales growth.

Recently, Canada's Le Clos Jordanne chardonnay captured the top spot for chardonnay in the judgment of Montreal experts blind tasting, surpassing wines from France, and other parts of the world.

And now moving to our international business.

As you know, Australia and the UK continue to be challenged by a myriad of issues that have negatively impacted our business in these locations.

These challenges do not relate to Constellation alone, but to all suppliers who do business in these geographies.

We also discuss these markets in the same vein as we ship approximately 70% of our Australian exports to the UK marketplace.

Although the UK and Australia combined represent a small percent of our total profits, our goal is to minimize operational variability for these businesses and our overall results going forward.

Therefore, we are now running the UK and Australian business with a focus on cash.

We will continue to take out costs, decrease our networking capital investment and increase efficiencies by consolidating as much production as possible.

Our goal is to generate cash, improve gross profit and variablize the business model.

As you know, we recently announced changes in our international management structure aimed at better aligning our businesses in the UK and Australia to provide opportunities for cost savings and increased efficiencies.

We are working on developing the appropriate long-term strategy for these businesses and will move rapidly to implement these plans once finalized.

In the UK, positive year-over-year sales trends in the first quarter were primarily the result of a year-over-year pre-buy in timing related to the duty increase.

The 2009 grape harvest in Australia is now complete, although final data is not yet available it appears that the current harvest estimate is approximately 1.7 million tons versus a harvest of about 1.8 million tons last year.

However, overall supply continues to outstrip demand.

The cost of Australian grapes has decreased significantly for the calendar 2009 harvest due to the fact that last year many growers paid for water supply during the growing season, due to the drought conditions in the region at the time.

Moving to the Crown Imports joint venture, Crown experienced positive momentum during the Cinco De Mayo holiday, driving year-over-year improvement in case sales through excellent execution at retail.

However, this positive momentum was offset by the economic driven trends particularly in the on-premise and convenience channels and an overall mix shift away from imports.

In addition, competitive price discounting has become prevalent in the form of mail-in rebates offered at retail as Crown enters the busy summer selling season.

More recently, however, Crown is beginning to see some improving trends in the grocery channel from national chain stores as a result of targeted marketing efforts and programming against this key channel.

These efforts include the reprisal of Corona Extra's iconic television ads from the 1990s, following considerable analysis and consumer research.

This is a very cost effective approach to media investment.

Overall, Crown is focusing on optimizing promotional activity and media support into and through the peak seasonal periods when consumers buy the most.

Crown is also seeing some success with a number of new SKU and packaging introductions, expanding distribution to additional states with Modelo Especial, Corona and Corona Light 18-pack, Corona Light 12-pack cans and Modelo Especial 24-packs.

And the next phase roll-out for Modelo draft will begin in late July.

Modelo Especial continues to be one of the few major super premium brands that is experiencing double-digit market growth.

Now in closing, we've been impacted by the global slowdown but are taking the necessary actions to fortify the Company short-term.

The culmination of everything we are doing positions us well to drive sales growth, margin expansion, and improved ROIC once we clear the headwinds from this challenging external environment.

Overall, our business strategy remains intact.

We are executing and taking the appropriate actions designed to further position our business for success in the future.

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

Thanks, Rob.

Good morning, everyone.

Given the continuing difficult global economic and market conditions, I'm generally pleased with our results which were in line with our expectations.

Our comparable basis diluted EPS for the quarter came in at $0.33 a share versus $0.34 last year.

The quarter saw quite a bit of change due to foreign exchange rates as the dollar strengthened dramatically versus our key currencies when compared to the prior year.

In dollar terms this reduced our international sales and SG&A expenses.

The state of the global economy also impacted our sales mix as consumers across the beverage alcohol category gravitated towards lower priced products.

For us, this generally means a lower gross profit margin.

The profit margin for our international business also continues to be disappointing.

We began to see the sales mix trend at the end of last year and we took some dramatic offsetting actions.

We sold our value spirits and other businesses and eliminated the associated standalone SG&A.

We began our global cost reduction initiative, tightened down our marketing and general expense and continued to focus on debt paydown and interest expense reduction.

These tactics were generally successful in Q1, as our SG&A and interest savings offset gross profit reductions resulting in slightly higher pretax income versus the prior year.

We also continued to pay down debt and are well on our way to achieving a comparable basis debt to EBITDA ratio by the end of fiscal 2010 in the high three times range.

Now, let's look at our Q1 P&L performance where my comments will generally focus on comparable basis financial results.

First, the net sales line.

As you can see from our news release on page 13, our consolidated reported net sales decreased 15%, primarily due to the impact of year-over-year currency exchange rate fluctuations and the divestiture of our value spirits business, spirits contract production services and certain Pacific Northwest wine brands.

On an organic constant currency basis which excludes the impact of acquisitions, divestiture and ForEx 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 increased 1%.

Organic branded wine net sales for North America which appears on page 12 of the release, decreased 1%, while Europe and Australia and New Zealand increased 6% and 7% respectively.

Our global branded wine business continues to be impacted by ongoing SKU reductions and a challenging economic environment, which is driving unfavorable sales mix.

However, the SG&A reduction efforts are having the expected benefit of offsetting much of the reduced gross profit margins from the negative mix.

We estimate that SKU reduction actions negatively impact the North American sales growth by approximately 2 percentage points.

Sales for Europe benefited from year-over-year timing related to customer buy-in prior to the UK duty increases.

Australia New Zealand saw some improvement, albeit on a small base, driven by sales in the Asia-Pacific region.

Spirits organic net sales increased 13% led by 33% growth from 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 34.9%, down 1.5 percentage points.

This reflects the unfavorable sales mix I discussed earlier, partially offset by the sale of the lower margin value spirits business.

Our consolidated SG&A for the quarter was 19.3% of net sales, compared to 22.3% a year ago.

The 3 percentage point decrease was primarily driven by previously mentioned cost reduction actions, lower advertising and marketing expense, and gains on foreign currency hedges.

Consolidated operating income decreased 6% to $123 million, but our operating margin increased 1.5 percentage points to 15.6%.

I would you now like to turn to our segment operating income results on page 11 of the release to provide highlights of these changes.

With the sale of the value spirits business, and the integration of the remaining spirits business into our North American wine organization, our segment reporting has changed accordingly and the spirits business is now included in the wine segment.

Prior periods have been classified in our press release and our segment history schedule on our website to reflect this change.

Wine segment operating income decreased $8 million to $148 million.

The decrease is primarily due to the divestiture of the value spirits business and certain Pacific Northwest brands negative mix and a decrease in international profitability, partially offset by our SG&A reduction initiatives and foreign currency gains.

For the quarter, corporate and other expenses totaled $24 million, which was level with the prior year.

Higher stock compensation was offset by cost savings.

On page 14 you can see consolidated equity investment earnings totaled $63 million, versus $72 million last year.

Equity earnings for Crown totaled $63 million versus $70 million.

For the first quarter, Crown generated net sales of $636 million, a decrease of 5%, and operating income of $126 million, a decrease of 9%.

Similar to the wine category, we have seen consumers gravitate towards lower priced beers.

Sales were impacted by soft performance in the convenience and on-premise channels which have seen a more dramatic impact from the economy.

In addition to the sales decrease, operating income was primarily impacted by a contractual cost increase and negative sales mix.

Interest expense for the quarter was $67 million, down 23% versus last year.

This decrease was driven by our significant debt reduction over the past 15 months and a decrease in our average interest rate for the quarter versus the prior year, as LIBOR decreased for our variable rate debt.

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

At the end of May, our debt totaled $4.3 billion, which represents a $112 million decrease from our debt level at the end of fiscal 2009.

The decrease reflects proceeds received from the sale of the value spirits business, partially offset by the use of free cash flow in the quarter.

I'll talk about free cash flow in a few moments.

Our average interest rate for the quarter was down to about 6%.

Our debt to comparable basis EBITDA ratio at the end of May was 4.3 times, consistent with the ratio at the end of fiscal '09.

The benefit of the debt reduction was essentially offset by lower EBITDA reflecting our softer financial performance over the last two quarters.

Our comparable basis tax rate came in at 39%, compared to 37% last year.

We are still targeting a full year tax rate of 38%.

Due to the many factors just mentioned, diluted EPS was $0.33, versus $0.34 last year.

Now let's turn to cash flow on page 10 of the news release.

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

Due to seasonal factors, we're normally a first quarter user of cash and for the first quarter of 2010, we used free cash flow of $102 million, versus a use in the prior year of about $55 million.

The higher use of cash is due in part to higher CapEx spending for the quarter due to timing.

In the working capital area, inventory benefited from lower grape harvest in Australia and New Zealand versus the prior year.

The majority of the higher cost fiscal year 2009 harvest is rolling through cost of goods sold in this fiscal year, contributing to our reduced international profits.

Receivables were higher due to the timing of sales in the quarter.

For fiscal 2010, we're still targeting free cash flow to be in the range of $230 million to $270 million.

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

As a reminder, free cash flow for 2010 is expected to be negatively impacted by higher taxes paid, primarily due to the $65 million tax payment related to the sale of the value spirits business which we expect to make in Q2.

We expect to continue to utilize free cash flow to reduce borrowings.

Moving to our P&L outlook for full year 2010, as reflected in the outlook section of the press release, we continue to forecast comparable basis diluted EPS in the range of $1.60 to $1.70 a share.

Interest expense is expected to be in the range of $265 million to $285 million, and we're assuming weighted average diluted shares to be about 222 million.

Our comparable basis guidance excludes acquisition related integration costs, restructuring charges, and unusual items which are detailed on page 16 of the news release.

During Q1 we recorded approximately $0.12 in charges from restructuring and related activities including our global cost reduction initiative announced in April.

We also recorded a $0.17 charge associated with the sale of the value spirits business.

Before we take your questions, I would like to note that in these uncertain times, with difficult economic and market conditions, we remain focused on margins and ROIC, reducing debt, and keeping leverage at manageable levels.

I believe the strength of our portfolio combined with our SG&A reduction efforts positions us well to work through the current environment and take advantage of opportunities when conditions improve.

With that we'll open up the line for questions.

(OPERATOR INSTRUCTIONS) We will pause for just a moment to compile the Q&A roster.

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

Hi, guys.

Good morning, this is Zach Poelma standing in for Kaumil.

Regarding the distributor transition that you mentioned would be taking place this summer, should we concerned about any disruption in 2Q or 3Q because of that?

Yes, this is Rob.

We don't expect any disruption at this time as a consequence of our distributor activities.

We've put a lot of things in place to ensure that things remain intact during the transition period, so right now we feel pretty good about that.

Thank you.

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

Davidson.

Good morning, congratulations guys.

As you get into the latter half of the year, have you -- I know you don't give quarterly guidance, but have you given thoughts to how the currency impacts shake out and what that might mean for you, particularly with regard to your new strategy in Australia and the UK?

Yes Tim, this is Bob and we do look at that stuff but if we were real good at anticipating ForEx rates, we would be working down on Wall Street.

But what we try to do with all our -- with our hedge activities, is we try to offset the volatility.

So for instance, in this quarter, we actually saw some positive impact from our hedges, whereas in last year's first quarter we saw some negative impact from hedges specifically, now they're offsetting things up in the other line items.

But we don't -- it's not really a big number.

We expect ForEx volatility to be maybe a positive, negative of about a penny in any quarter.

Okay.

And then just on some of the mid-tier brands, can you more fully flush out a little bit on what you're seeing in terms of tradedown and, I mean, you've described a couple of results as solid but I would rather have numbers than letters.

Yes, Tim, this is Rob.

In terms of our mid-tier brands, we are seeing some positive results.

We see brands like Woodbridge continuing to grow in the high single digit range.

We see brands like Clos du Bois, for instance, we're seeing about 8% volume growth on that particular brand.

So there's ups and downs in the portfolio.

We do see a trend towards what we would describe as better known and trusted brands that represent good value for money.

I think some of our brands are benefiting from that in general.

We do see a volume basis so trading up continuing in the industry with total wine in the lower single digit range, premium plus and super premium in the mid and moving up into the higher single digit range on a volume basis.

On a dollar basis, interestingly enough, in the value business, we continue to see a lot of pricing being taken in the marketplace.

So while we see value wine growing at a lower percentage on a volume basis than premium and super premium plus wines, on a dollar basis they're actually growing faster because I think the major players in that industry, in that segment, of which we're not one, are taking the opportunity to take pricing in the value segment.

Thanks.

Your next question comes from the line of Carla Casella with JPMorgan.

Hi.

One clarification question.

You mentioned a gain on FX hedges, that was in SG&A.

Did you give the amount that was in this year and last year?

No, but I'd say you can figure it out.

It was about a penny positive this year and about a penny negative last year.

So again, in any quarter, it's about a penny but this quarter when you look year-over-year, the delta's a positive to a negative so it makes it look bigger than it is.

Okay.

And then in the other segment of sales, I guess it's wholesale and other, it looks like some of the businesses you sold might have been included in that.

Could you just say-- the run rate at about $43 million this quarter, is that a good run rate to use or was that seasonally low or somewhat otherwise affected?

I think the biggest product in that category is our cider business in the UK and the cider business in the UK is very much a summer product.

So you might see like a higher number in, say, the second quarter.

You also have a lot of translation going on because most of those sales are overseas.

Okay.

That's helpful.

And then one question on gross margin.

Can you clarify any more how much of the gross margin change was affected by mix versus any promotional activity versus packaging or other cost increases?

Yes, we -- well, I mean, we look at it all as one big bucket, but obviously as we said negative mix shift had a pretty big impact on us in the quarter, because -- this is a general statement.

As you move down the price ladder, the gross profit margin tends to be less.

The thing we're really happy about is we saw this coming and we took some pretty dramatic cost out actions and those cost out actions are offsetting most of the negative mix shift up in gross profit.

You can see the SG&A coming down.

Okay.

So it sounds like it's more a mix than any promotional activity?

It's more mix than promotional activities, yes.

Okay.

And then just one last question.

June weather we know has been pretty bad and a lot of retailers have been hit.

Have you seen -- has that affected any certain segments of your business that are dependent on outdoor summer activities, et cetera?

Yes, this is Rob.

I think it's a little early to tell how June weather will affect the business.

Obviously the beer business is heavily skewed towards the summer selling season.

This is the big time and we are going to have to see how our brands, in particular, fare over the summer selling season.

We've got a lot in place relative to that.

Other than beer, obviously in the US and Canada, in particular, actually worldwide wine sales, don't tend to be affected by weather.

It's not a weather related --

it's not a thirst quencher beverage.

It's really the beer business and it's too early to tell how we're going to do during the summer selling season.

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

Thank you very much.

Good morning, Rob and Bob.

I think, Bob, you might have answered this a little bit.

I want to get a little bit more color on your North American or your overall wine margins, I should say.

In the fourth quarter we saw margin contraction of about 180 basis points on the operating profit line.

Sounds to me that cost controls are coming in maybe even stronger.

Can you tell us if your margin contraction was better or worse than what we saw in wine in the fourth quarter?

The fourth quarter generally has some anomalies that cause the margins to be lower year-over-year.

But I'd say in Q1, we saw slightly better margins than in Q4.

So it's getting a little bit better and I think you got the point, Christina, the cost savings initiatives that we began at the end of last year are really starting to kick in in Q1.

In Q1, we had to take out quite a few Constellation associates and that will continue through the balance of year and we're also taking some facility actions, and we're being really cautious on our marketing spend.

On spending that we can hold back on, we are holding back on.

(multiple speakers)

Can you clarify?

Sorry, I was going to ask if you can quantify what your targets were for SG&A or I would say overall cost reductions and how much you have achieved so far?

Sure.

So what we said, this is just for the global cost initiative that we announced I think in the fourth quarter call last year, we will be taking out savings this year, $25 million, full year run rate is $50 million.

Because we'll only have about a half year of savings this year.

So again, you will see our savings as you go through the year pick up.

Again, unfortunately, just last week we announced 100 people would be leaving the US wine business and that will be happening in Q2 and forward quarters.

So it continues to --

These are all part of your already-announced global initiative program as we see these headlines?

That is correct.

And a final question, if I could, on your international wine business.

Certainly your comments are clear about a challenging environment and SKU reduction, yet we saw positive sales growth in both Australia and Europe.

Can you give us just a little bit of color and I know that mix is hurting the profit but can you give us a little bit of color on the strength of the topline?

Yes, what I'd say, if you compare it to prior quarters, both Europe and Asia-Pacific sales were up a lot.

I wouldn't get too excited about that, I guess.

In the UK, or in Europe, the big thing driving that is in the previous year in the fourth quarter, when the governments announced the duty increase, which as you recall was pretty sizable, they gave a decent amount of time between the announcement and the implementation of the duty increase.

So it gave everybody quite a while to buy in a lot of product ahead of the duty increase and what that ended up doing was it kept our first quarter sales lower as that inventory sold through.

This year, when the duty increase was announced, there was no time between announcement and execution so that that duty buy-in didn't happen.

So it's a technical year-over-year selling activity which should even out over time.

Really, what happened, inventory got built up.

So that's Europe.

And in Asia-Pacific, it's more related again, to some timing of sales into mostly the Japanese market which I think will also even out over time.

The other thing to keep into account is unfortunately, sales in these two regions have a much lower margin than sales in North America, so as sales growth accelerates versus North America in any quarter, that tends to be a negative geographic mix shift for us.

Got it.

Thanks a lot.

Sure.

Your next question comes from the line of Mark Swartzberg with Stifel Nicolaus.

Thanks, good morning everyone.

Rob, I was surprised to hear you comment that you didn't expect disruption this summer with the plans to consolidate wine and spirit sales into fewer distributors.

I may have missed it, but can you tell us when that was announced to the trade?

Is that happening today?

And then talk a little bit about why you don't expect much disruption and I take it if you don't, that you don't have disruption in your guidance of $1.60 to $1.70.

Yes, Mark.

I think you asked when we're announcing to the trade.

Is that what you asked?

Yes.

Yes.

We expect that we should be announcing to the trade, actually fairly shortly, within the next 30, 60 days, something to that effect, and it might not be all at once, so it's not necessarily a big bang kind of a thing.

And then to your second question, in planning for how we would handle the changes that we're going to be making related to the consolidation, operationally, we obviously put in place some mitigation plans and there's some natural things that occur when you make these movements that tend to offset each other.

Such as when you're moving the brands you've got inventory moving around, shipments to new distributors, et cetera, so when you balance everything out, we really don't think that it will have a huge impact on retail sales.

We think that depletion should be somewhat stable.

There might be some loss from distributors who are losing brands, some pick-up from distributors who are gaining brands and actually the same kind of thing on the shipment side.

So we expect it at this time to balance out.

If there are any timing issues, which is probably the worst case scenario we -- let me put it this way.

At the current time we don't expect any significant timing issues related to the distributor transition between second quarter and third quarter and then we move into third quarter, it should be largely complete.

I think the thing should be stabilized.

Which is part of the idea, which was to get this done before OND, October, November and December, which is one of the key selling seasons.

So a lot of operational planning has gone into this, Mark, to ensure that we mitigate any possible disruption.

Okay.

Great.

And am I right that today's comments on this call are the first the trade's actually hearing of these intentions?

No, no, the trade is well aware of our intention and is well aware of what we're both doing internally with the sales organization, meaning the consolidation of the operating companies in the sales organization and we've been involved in an intensive RFC request for -- we call it a request for commitment, as opposed to a request for proposal.

We've been involved in a heavy RFC process with the distributors now for several months and are in the process of final negotiations as we sit here right now.

So there is --

Great.

Everybody knows what's going on, basically.

Great.

Great.

Thank you, Rob, that's helpful.

You're welcome, Mark.

Your next question comes from the line of John Faucher with JPMorgan.

Yes, good morning.

I apologize.

I seem to be getting confused about something.

You started off the conference call by saying I believe that the category was up about 5% and high end was growing at the same pace and then you talked about a shift into some of the higher priced wines, at least from a volume standpoint and it sounded like the category mix was coming down at the very low end.

So I apologize.

I'm trying to figure out why the mix is such an issue when what continues to come up, it seems, is the high end stuff seems to be holding up and growing at roughly the same pace as the category.

And if you could talk about that sort of on a total category basis as well as just for your portfolio?

Thanks.

Yes.

What is the case, if you look at the total industry, you'd see the total industry growing at lower, about 3%, when we said 5%, I was talking dollars, not volume, so 3% on a volume basis, 5% on a dollar basis, which in and of itself, this is total wine, would be indicative of the continuation of the general trade-up trend.

Okay?

So you see super premium plus which starts at $8 growing at about 6%, both in volume and dollars versus the total industry at 3% volume and 5% dollars and quoting IRI figures.

Now, within our -- that doesn't mean, however, that within the respective category that there might not be -- and in fact, I think that there is to some degree some trading down.

So take the super premium category, okay, which might range -- which ranges from $8 to $12, okay.

The highest end of that category is being more negatively affected or being negatively affected versus the lower end.

People are looking for bargains, even within their respective categories.

So when we talk about trading up in general, it does continue to be a phenomenon in the marketplace, as measured by either the difference of the total business in volume and dollar sales or by looking at, say, the whole super premium plus category versus the value category.

Now, there's also some trading down going on from the high end of the segment of the wine business, so wines over $15, over $20, there's clearly some trading down that's going on in those categories as well-- and our high end portfolio, which is our highest gross margin portfolio, sold by, Icon which is what we used to call Icon, well, it still is Icon, actually, it won't be much longer-- but the white table cloth, on-premise oriented brands are definitely being hurt in the economy.

You could call it trading down.

You could say that it's also an impact that the economic downturn is having on the on-premise, in particular.

So the highest margin brands in our portfolio, which are more on-premise oriented, are being negatively affected by the economic impact, especially on the restaurant business.

So it's hard not to confuse sort of general trends with what is very specifically going on.

In our case, as I said, the highest end of our portfolio is being negatively affected and some of the -- even within premium, some of the lower premium products, everyday products like Woodbridge, which is premium by definition, are growing at a fairly rapid rate.

So this is what's causing the negative mix shift.

So John, just to -- just a little bit of background math.

This is Bob speaking.

When we're talking negative mix, we're talking to previous year, okay?

So what we're seeing, it's what Rob just said, okay?

The total wine category is growing pretty consistently with prior year, say 4% to 5%.

The brands below $5 are growing a lot faster than they were last year, okay?

The brands above $5 a bottle at retail are growing slower than last year, but the brands above $5 a bottle are still growing in line with the total category, right.

They used to grow faster than the total category.

So when we say mix shift we're talking year-over-year.

And you can see if you look at IRI or Nielsen data that the lower price brands, this is across beverage alcohol, right, we see the same thing in our beer portfolio, the lower priced brands are now growing much faster than they were last year.

The higher priced brands are not growing as fast as they did last year.

They're all still in growth.

So to be technical, what's really going on is it's actually a lack of a mix shift.

You've been getting a more positive mix shift in the past.

If everything's going at the same pace, I realize that is a generalization, then you're not getting the positive mix shift that you're used to.

If the low end and the high end are both growing at 5%, then it's the lack of a positive mix shift as opposed to a mix shift?

That is correct.

That's correct.

We're getting less of a positive mix shift.

That's a fine way to put it.

I got it.

Great.

Thanks so much.

Your next question comes from the line of Kevin Dreyer with Gabelli & Company.

I just have a question on your margin changes.

What's driving -- you're saying that you've got these efficiency initiatives, offsetting the negative mix shift.

Should that accelerate, then, as the year goes on since you said you've got this $25 million coming in this year, going to $50 million next year?

Yes, I think that's true, because we will have -- of the $25 million savings we'll see much more of that in Q2, Q3, Q4.

We would also hope that the gross margin might improve a bit if the economy starts to improve a bit, but we're not really relying on that.

What drove the increase in the EBIT margin for the wine and spirits division this quarter?

What were the costs you took out or did you pull back on marketing or-- what were the specific items that helped it this quarter?

Yes, most of it was around SG&A.

The two big things were the -- the first was our global cost initiative which we started last year.

We saw a reasonable amount of savings of that in Q1.

The other -- people?

Yes, primarily people.

I'm sorry, yes.

And the other thing, the other big ticket item which, again, was primarily people, when we sold our value spirits business, which used to be an entire segment with a lot of very capable people in mostly Chicago running the business, we took the two largest, highest gross profit margin brands and we plugged them into our North American wine business to leverage that SG&A.

And unfortunately, again, we had to eliminate the spirits SG&A which resided in the X Spirit segments.

That actually for this quarter provided quite a bit of SG&A savings for us.

That's a permanent savings that the people are no longer within the Company.

Okay.

And then in terms of the distributor transition, I guess I'd have to agree with the previous comment, not totally clear to me why there wouldn't be some disruption but I guess all that being said, what's the reason for it?

Why -- what are you seeing in your business that makes you decide you need to go with fewer distributors now and what's changed versus how you did things previously?

Yes, this is Rob.

It's really very related to the dramatic change in our portfolio.

When we had a significant value wine and spirits portfolio, with many brands that competed with each other and that were fairly generic and low margin in nature, the only model that really worked for selling that was to put brands that competed against each other in different -- with different distributors.

Okay?

We had a huge number of brands as well, so it made sense to split the portfolio in a given market between different distributors, to get better prioritization against each set of brands that each distributor had and then to also get more effort against competing brands.

So you have two vodkas selling at the same price that are basically what we call well products, meaning they don't go on the back bar, nobody knows what brand it is.

Okay?

You were better off having two distributors sell the two different brands than one because you would get more exposure to different outlets.

With the elimination of our value spirits portfolio and our value wine business and really the narrowing down of our portfolio to a relatively small number of brands that are fairly well differentiated, I mean, really just about 10, 12 brands that are the key Constellation Brands; we are able then to focus -- one distributor can, number one, prioritize those brands and we don't have the issue of selling largely generic intercompetitive products.

At the same time, if we consolidate our portfolio with a single distributor in a market, Constellation today is in the top three largest operating profit providers to the US distribution network in general.

And in the top two largest gross profit providers to the US distribution network.

Now, if you've got your portfolio split in half, half of it with one distributor in a market and half of it with another distributor in a market, you don't get the full benefit of your size and strength and the contribution that you're making for the distributor, because they only have 50% of the business and, thus, 50% of the margin.

Whereas today many of the major spirits producers are consolidated in the marketplace.

It was really two-fold, as I said.

The change in our portfolio facilitated the change with a narrower portfolio of much more highly differentiated brands and then number do, it gives us -- it increases dramatically our level of importance to each individual distributor that we're consolidated with.

The change in our portfolio facilitated the change with a narrower portfolio of much more highly differentiated brands and then number two, it gives us -- it increases dramatically our level of importance to each individual distributor that we're consolidated with.

Great, thank you.

And then maybe just one final one, on SVEDKA, a big brand, continues to grow at a very healthy clip.

How much of that is new distribution versus just increased consumption where you're already selling it, share gains versus other brands?

And also, how much of that do you think is just benefiting from some tradedown within premium vodkas from the luxury vodkas down to a price point like SVEDKA?

This is Bob.

I'd say yes, yes and yes.

SVEDKA's really hitting on all cylinders.

So even in places like New York City where it has heavy penetration, okay, we still see per capita consumption increases.

We're also focusing on increasing penetration on the West Coast, where it's under represented in the vodka category.

And the marketing sales guys are spending a lot of time on that and we're seeing some success there.

And also the economy is certainly helping SVEDKA because it is at a price point for a 750-milliliter, say about $10 a bottle so my guess is it's getting some sales from products like say Ketel One and Grey Goose which are say, 20 to $30, so two to three times that price point because SVEDKA offers the premium positioning, it has all the marketing glitz.

It's a great tasting product like those others, it's just more affordable.

So I'd say it's a very good product in general and it's an even better product in these economic times and we're seeing the results of that.

It will be above 2 million cases at the end of this fiscal year.

That is a sizable spirits brand and it's still growing in the high double digits.

It's pretty amazing.

The team there, the commercial team is really doing a fantastic job with that product.

Great.

Thank you.

Your next question comes from the line of James Watson with HSBC.

Good morning everyone.

Good morning.

Had a question about the cost environment in the quarter.

You mentioned -- we saw the gross margin come down but you also mentioned that value wines in the US, the prices were being taken up.

I mean, is that -- are they both caused by the same thing, by the underlying increase in grape costs or are they just separate phenomenon?

So within cost of goods, we did see some increase in grape costs and we did see some increase in glass costs.

Okay?

Across the portfolio.

But we also saw generally a mix shift to -- even if those were the same, we saw a mix shift towards lower gross profit margin products.

Those three things were the big movers in the gross profit mix shift.

But again, we offset most of those with our SG&A reduction initiatives.

Okay.

And this increase in value pricing was in the US.

Have you seen any anywhere else, I mean, especially the UK or was the environment in the first quarter in the UK just as competitive as it was in the fourth quarter?

Yeah, when we say the pricing, really we can see this in the spirits, the beer and the wine category in the value segments.

You actually see pricing and I guess positive mix shift in the value segments.

We see that in North America, across all the beverage alcohol categories.

The UK is a very different market in that it's -- there's kind of a price ceiling there that's put in mostly by the retailers who use beverage alcohol to sort of just get people in stores.

So although we do see a general -- a mix shift positive in the UK, in our category, in wine, we're still seeing a pretty much in total a stabilization of that price point.

There's a ceiling there which impacts everybody's margin in beverage alcohol in the UK.

Great.

Thank you guys.

Your final question comes from the line of Bryan Hunt with Wachovia.

of Bryan Hunt with Wachovia.

Thank you.

I'm glad that I got under the wire.

I was wondering if you could just talk about the potential cost associated with your distribution transition.

It sounds like there's a lot of moving parts.

And also if you could clarify whether or not, again, this will be something where you flip a switch and all these states are at one time or are you going to do it by a state by state basis and execute this plan?

In terms of -- there's a lot of puts and takes and obviously that's all built into our guidance for the year.

Patty here can talk to you more about that, if you would like, but nothing that you should be particularly concerned about.

And relative to flipping a switch as I said, it will all be put in place over the next, say, 60 days-ish, not everything will happen simultaneously but it will be in place prior to the beginning of the key selling season, beginning with October.

So 60, 90 days.

Okay.

And my last question would be looking at your organic net sales growth on North American wine relative to the IRI data you were quoting, it appears that you all lost some share during the period.

Could you maybe clarify those statements that you made and where do you feel like if you did lose share, where were you losing share?

In what segment?

And maybe why?

Yes, well our growth is a bit behind the general growth but in general, we don't really operate the business on the basis of maintaining share, especially in the short term, in a largely fragmented category.

It's not the same kind of thing as if you're selling potato chips.

Now, we've also taken pricing during the period so if you look at our average pricing versus the same period a year ago, it's up.

And that always has an impact on share.

And also that if you just look in general at our volume growth versus our dollar growth, our dollar growth is ahead of our volume growth.

Again, related to pricing which will have some impact on share.

We're growing generally in line with our respective categories.

We could be off a bit here and there but, again, we're much more concerned about striking the right balance between profit and volume as opposed to just worrying about share, per se.

Also, we have had -- there's probably a couple hundred basis points of impact of SKU rationalization that we know that that's flowing through at least from -- on the shipment side, flowing through the depletion.

Retail sales lag a little bit but there is an impact of SKU rationalization on the retail numbers as well.

So we have large brands, large brands aren't going to grow as fast as small, new brands.

So in general, we're happy, and tend to look at our growth rates for our brands on an absolute basis, meaning are they growing at the rate we think is important.

Like a brand like Woodbridge, as opposed to -- is it taking share versus all the little brands that are coming and going in the marketplace.

The other--I'll just add another math comment in that we are underrepresented share-wise in the below $5 a bottle and as we said earlier, that is growing much faster than the above $5 a bottle.

So if you look at total wine category and our share of wine category, a lot of our share loss will be the fact that we've chosen not to participate heavily in the under $5 a bottle at retail and we've made that decision because the profit margins at that level are less than we would want.

So that's one of the math reasons why we're losing share in total.

In the premium plus categories so $5 a bottle and more, we're pretty close to growing with that category.

It's much less demonstrative.

When Bob talks about the value category growing faster, it's on a dollar basis, not a volume basis.

It's growing slower on a volume basis and faster on a dollar basis.

I was talking all dollars, sorry.

Thank you for clarifying that and thanks for taking my questions.

Sure.

At this time, I will turn the call back to Rob Sands for closing remarks.

Well, thank you everybody for joining our call today.

I would say that we're off to a solid start in fiscal 2010, despite the ongoing challenges from a top macro environment that everybody's facing.

Now, during the quarter, we did decrease debt.

We realized the benefit from our cost reduction efforts and in doing so, we improved our operating margins.

I believe we are well positioned to achieve our free cash flow and EPS goals for the year.

I'm especially excited about the implementation of our new distributor initiative and go to market strategy.

We'll certainly have more to say about this in the next coming weeks and next quarter when we talk to you again.

Now, in addition, we are planning on an Investor Day in New York for the early to mid-November time frame, so stay tuned for the details on that.

And thank you again for your participation and we hope you're able to enjoy some of our great products during the upcoming 4th of July weekend.

This concludes today's Constellation Brands first quarter 2010 earnings conference call.

You may now disconnect.