Constellation Brands Inc (STZ) 2013 Q1 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the Constellation Brands first-quarter and fiscal year 2013 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 Patty Yahn-Urlaub, Vice President of Investor Relations.

Please go ahead.

Thank you, Jackie.

Good morning, everyone, and welcome to Constellation's first-quarter fiscal 2013 conference call.

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

This call complements our news release, which has also been furnished to the SEC.

During this call, we may discuss financial information on a GAAP, comparable organic and constant currency basis.

However, discussions will generally focus on comparable financial results.

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 and financial history.

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

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

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

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

Thanks, Patty, and good morning, and welcome to our call.

This has certainly been an exciting week for us.

First and foremost, by announcing earlier today that we intend to purchase the remaining 50% of Crown from ABI, we are enhancing our participation in the US beer market, which is one of the most attractive sectors of the beverage alcohol industry.

The structure of this transaction will solidify our place in this market for the long term, and most importantly, will remove the uncertainty that we believe has created a significant overhang related to the valuation of our stock.

Crown is the number one beer importer in the US, where it has the exclusive right to import, market, and sell the Modelo brands, which include Corona Extra, Corona Light, Modelo Especial, Pacifico, Negra Modelo, and Victoria.

This transaction represents a significant milestone in the history of the Company, and the next transformational step in the evolution of our business, as it will give constellation 100% ownership of the import, sales and marketing business for the Modelo brands currently being sold in the US.

This will also solidify Constellation's position as the largest multi-category supplier for beer, wine and spirits, and the third-largest total beverage alcohol Company in the US on a volume basis.

Crown will have complete independent control as a brand owner, with respect to distribution, marketing, promotion, and pricing.

ABI will be responsible for insuring the continuity of supply and quality of products, as well as providing the ability to introduce innovation, although they will have no visibility or future influence on marketing, distribution, or pricing.

Bill Hackett and the Crown team have built an absolutely phenomenal business, driven by their strength in brand building, and the strong relationships they have established with distributors and retailers in the marketplace.

This is a perpetual agreement that has an initial term of 10 years and renews automatically for subsequent 10-year terms.

In addition, ABI has the right, but not the obligation, to exercise a call option at a multiple of 13 times EBIT for the Grupo Modelo brands, approximately one year prior to the expiration of any 10-year term, subject to regulatory approval.

This arrangement will dramatically enhance Constellation's financial profile, as it will result in the full consolidation of Crown's financial results within Constellation's existing business model upon closing.

Bob will have specifics related to the funding of the deal, and the high-level financial implications for Constellation in just a few moments.

In the wine business, we are also pleased to announced today that we are purchasing the Mark West brand, which represents a synergistic high-growth complementary tuck-in to our existing portfolio of wine brands.

Mark West is primarily a California Pinot Noir, that is priced in the $10 to $12 price range at retail.

In 2011, Mark West sold nearly 600,000 cases in the US marketplace.

It is currently the top-selling Pinot Noir brand, experiencing nearly 35% volume growth in the SymphonyIRI channel.

As you know, we have a successful track record of integrating high growth, strong momentum brands and I am excited by the prospect of adding Mark West to our brand family.

And now I'd like to focus our discussion of our first-quarter operational results.

We are off to a good start for the year with results that were generally in line with our expectations.

Highlights for the first quarter include the purchase of almost 70% of our targeted share buybacks for the year, great momentum for the Crown beer business, strong consumer take away trends for our US wine and spirits business, the completion of the next phase of our US distribution consolidation effort, with the signing of exclusive multi-year agreements with additional US distributors, covering almost 10% of our US wine and spirits volume.

Collectively we now have almost 70% of our US wine and spirits business covered by exclusive distributor arrangements.

We continue to focus on developing, launching, and promoting our new products and existing focus brands in the marketplace, which to date, have received great reception by consumers.

Some examples include the recently-launched four varietals for our new Thorny Rose brand, which is specifically targeted to Millenials, who contributed to the development of this brand.

This generation is craving a brand that is tailored to their life stage as they enter the wine category.

A new Summer TV campaign kicks off as we speak for Woodbridge by Robert Mondavi.

This innovating advertising positions Woodbridge as the catalyst for creating moments for sharing.

The TV advertising is well supported by new line extensions, in-store retail support, and online engagement with our rapidly growing Facebook community, and is expected to drive trial during the busy Summer selling season.

The Black Box national TV advertising campaign was launched Memorial Day weekend, which showcases this family of wines delivering the quality of premium wine in a bottle, with the value of a box.

We launched nationally Arbor Mist frozen wine cocktails in three favors, BlackBerry Merlot, White Pear Pinot Grigio, and Strawberry White Zinfandel.

Arbor Mist is a top-20 wine brand by volume in the US, commanding more than 80% market share of the wine with fruit category.

Ready to drink pouches is one of the fastest-growing segments in the US, experiencing more than 180% volume growth in the past year in SymphonyIRI channels.

The new Svedka advertising campaign debuted this quarter, appearing on the top national cable TV stations and popular websites.

In addition we recently announced the expansion of Svedka's flavor portfolio with Colada, a unique and refreshing blend of coconut-flavored vodka, pineapple and mango.

For the quarter, Svedka posted market growth of almost 20% in addition to gaining volume share of the vodka category.

We also recently launched a new flavor for our Black Velvet Canadian Whiskey.

Toasted Caramel is a unique, versatile delicious addition to our spirits portfolio.

Flavored whiskeys are currently on fire in the marketplace, growing at a rate of more than 120% in calendar 2011.

These are just a few examples of the brand investments that we are making this year.

Although we had a slow start to the year from a depletion perspective, our overall depletion trends improved as we progressed through the quarter, as our marketing and promotional efforts gained traction in the marketplace.

And in May, our depletion trends exceeded industry trends.

We expect positive depletion momentum to continue into the second quarter.

Now these trends followed a strong close to our fiscal year last February, when we launched several new products at year-end.

You may remember that some of that strong fourth quarter depletion performance was driven by sell out of new products to distributor and retail channels, which we indicated would unfavorably impact our sales and depletion performance in the first quarter.

While this has taken some time to work through the system, the great programming we put in place during first quarter helped pull through volume to consumers which you are seeing and are very strong SymphonyIRI trends.

Overall, we are growing in line with the total US wine and spirits industry across all channels at a first quarter growth rate of about 4%.

Remember, we remain committed to growing in line with the US wine and spirits industry growth for fiscal 2013 and beyond.

Moving to the Crown Imports joint venture.

The first quarter marks the ninth consecutive quarter that Crown has outperformed the total US beer industry and the import category, both on and off premise channels.

Crown continues to build on the exceptional momentum generated last year, posting depletions in the high single digit range in the first quarter.

This is the result of several key initiatives, including the Corona Win Your Beach retail promotion, which was very successful during last year's Summer season.

It is bigger and better this year, offering consumers more ways to enter, and more chances to win prizes of their choice, to fit their preferred beach experience.

This promotion is accompanied by a new Win Your Beach TV spot.

The new Corona Light campaign debuted in April, and is centered on being the beer that breaks consumers free from their boring routine, offering a refreshing change of pace.

Corona Extra has extended the Find Your Beach advertising campaign with new creative, supplemented by a combined TV, digital and social media campaign.

I'd like to bring your attention to the fact that Corona Extra posted depletion trends of more than 5% during the first quarter, which is quite a turnaround story for the first brand.

It is the result of Crown's relentless focus on the brand, especially in on-premise channels where Crown has done an excellent job of expanding distribution.

Crown also benefited from unusually warm weather in March, and favorable timing of the Cinco De Mayo and Memorial Day holidays.

In closing, today's exciting announcements coupled with solid execution of first quarter results demonstrate that we continued to deliver on our key strategic imperatives, which I believe will drive the achievement of our one common goal, profitable organic growth.

I would now like to turn the call over to Bob for a financial discussion of our first quarter business results.

Thanks, Rob.

Good morning, everyone.

There's a lot of exciting news to speak about today.

In addition to Q1 results, we also have two acquisitions to discuss, for which I'm sure you have many questions.

So let me briefly provide some details on our first quarter P&L performance, where my comments will generally focus on comparable basis financial results, so I can then provide some financial details around the transactions outlined by Rob, and then we'll discuss our full-year outlook.

Our comparable basis diluted EPS for Q1 came in at $0.40.

At a high level, this result was generally in line with our expectations, and puts us on track to meet our EPS goal for the year.

EBIT was down 4%, which was slightly better than the range we discussed on our last earnings call.

Our weighted average shares came in better than planned, while our effective tax rate came in a little higher than expected, just due to timing.

As you can see from our news release, wine and spirits net sales on an organic constant currency basis decreased 1%, as higher promotional costs and a decrease in volume were mostly offset by positive mix.

As Rob mentioned, we had some timing items holding back shipment and depletion growth for the quarter.

Now let's look at our profits on a comparable basis.

For the quarter, our consolidated gross margin was 39.6%, which was essentially level with the prior year.

This primarily reflects the increase in promotion cost offset by the favorable product mix.

I'd now like to discuss the segment operating income results to provide highlights of our operating income change.

Wine and spirits segment operating income decreased $4 million to $133 million, primarily due to the higher promotional spending, along with marketing investments.

Corporate costs increased $2 million, primarily due to our technology investments.

Consolidated equity earnings totaled $61 million versus $62 million last year.

This includes a reduction for consolidating Ruffino in Q1, versus equity accounting treatment in Q1 last year.

For the quarter, Crown generated sales of $724 million, an increase of 7%, and operating income of $123 million, an increase of 3%.

The net sales increase was primarily driven by volume growth of Modelo Especial, and Corona Extra.

A timing-related increase in Marketing and a contractual cost of goods increase drove operating income growth below sales growth.

Interest expense for the quarter was $51 million, up 14% versus the prior year.

The increase was primarily due to higher average debt balances and an increase in average interest rates.

To better help frame in the drivers of the interest increase, let me discuss our debt position, share repurchases and recent refinancing activity.

At the end of May, our debt totaled $3.4 billion.

This represents a $292 million increase from our debt level at the end of fiscal 2012.

The increase was driven by our share repurchases, net of the free cash flow generation during the quarter.

During Q1, we repurchased 18 million shares, at a cost of $383 million.

That's an average cost of $21.28 a share.

Versus prior year, we've reduced our Q1 weighted average share count by 25 million shares, or 11%.

This represents a significant return to shareholders for our improved cash flow generation.

During the first quarter, we took advantage of our improved credit profile and the attractive interest rate environment to refinance our senior credit facility and issue $600 million of 6% 10-year senior notes.

Proceeds from the note issuance were effectively used to reduce borrowings on our senior credit facility and to fund the share repurchases.

The new senior credit facility includes an $850 million revolving credit facility, an $800 million term loan, which effectively replaced our previous term loans.

The revolver and term loans are generally tied to LIBOR plus the margin.

The margin is a grid, based on the grid centering on margins in the 1.75 to 2 range.

At the end of the quarter, borrowings under our revolver were approximately $26 million.

Our average interest rate for Q1 was approximately 6%, which was about 0.5% higher than Q1 last year.

The rate increase reflects the senior note issuance I just outlined.

Our comparable basis effective tax rate came in at 36%, compared to a 37% rate for Q1 last year.

We are still targeting an effective tax rate of 34% for the full year.

Now, let's discuss free cash flow, which we define as net cash provided by operating activities, less CapEx.

For Q1, we generated free cash flow of $77 million versus $220 million for the same period last year.

The decrease was primarily due to the receipt of tax refunds in the prior year's first quarter, that were primarily driven by the sale of our UK business.

We are continuing to target free cash flow for fiscal 2013 in the range of $425 million to $475 million.

This includes CapEx in the $70 million to $80 million range.

Before reviewing our fiscal 2013 P&L outlook, let me provide financial highlights related to the Mark West and Crown transactions.

For Mark West, we expect to finance the $160 million purchase price with borrowings under our revolver.

On an annual basis, this brand has been selling nearly 600,000 cases in the $10 to $12 price range at retail and generating net sales of about $35 million, at a margin profile higher than the average of our current US wine business.

We expect the transaction to close in July, and estimate the acquisition to be slightly accretive to diluted EPS for fiscal 2013.

We are only buying the brand, inventory and some grape supply contracts, so we do not expect any meaningful integration costs.

The acquisition of the remaining 50% interest in Crown Imports is truly transformational, and represents a significant milestone in our history and participation in the beer business.

The incorporation of Crown's strong business and financial model will dramatically enhance the financial profile of Constellation.

During fiscal 2012, Crown sold 164 million cases and generated $2.47 billion of net sales and $431 million of EBIT.

We currently account for our 50% interest in Crown under the equity method, and recognize $215 million of equity earnings from Crown in fiscal 2012.

Upon completion of the transaction, which is expected some time during the first quarter of calendar 2013, we will begin consolidating the full financial results of Crown.

As a result, we'll be layering in 100% of Crown sales and earnings throughout our income statement.

The Crown business is very complementary to our wine and spirits business.

It has strong financial profile with similar absolute sales dollars and EBIT margins.

It diversifies our consumer base and allows us to fully participate as a major competitor in the US beer industry.

With low working capital and fixed asset needs, it has an even higher operating return on invested capital profile than wine and spirits, and is a very strong cash flow generator.

It has a strong and proven management team, with whom we've worked closely for a very long time, and the business is currently experiencing very positive momentum.

We do not expect to incur any meaningful integration costs related to the transaction.

Our cost of debt for this specific transaction will be in the 4% to 4.5% interest rate range, with a tax rate in the 35% to 37% range for this transaction.

The transaction is expected to be significantly accretive to annual diluted EPS and free cash flow.

From a financing perspective, we have fully-committed bridge financing in place to complete the acquisition.

Permanent financing of the $1.8 billion purchase price is expected to consist of a combination of revolver borrowings, a new term loan under our existing senior credit facility, and the issuance of senior notes.

Depending on market conditions, some of the permanent financing may be put in place and drawn prior to transaction close.

As a result, we could see some incremental interest expense and banking fees before the deal closes.

At the end of May, our debt to comparable basis EBITDA ratio was 3.9 times.

Exclusive of the Crown transaction, we expect this measure to be around the mid-3 times range at fiscal year end.

The Crown transaction is expected to increase this ratio to the mid-4 times range when factoring in a full year of additional Crown EBITDA.

With our strong free cash flow generation, leverage should decrease back into our targeted ratio of 3 to 4 times EBITDA within the first 12 months after the close of the transaction.

Given the funding requirements just outlined, we plan to suspend our share repurchase program.

The $1 billion share repurchase authorization approved by the Board of Directors this past April continues to be in effect, with approximately $700 million of repurchase availability remaining.

As outlined earlier, we purchased $383 million of stock during Q1.

This represents nearly 70% of our original Fiscal 2013 share repurchase target of $550 million to $600 million.

Since we are able to buy such a significant amount of stock so early in the year, we are maintaining our fiscal 2013 weighted average share estimate of 185 million to190 million shares, even though we do not expect to repurchase any additional shares in fiscal 2013.

Now, for a full year 2013 P&L outlook, we are continuing to forecast comparable basis diluted EPS guidance to be in the range of $1.93 to $2.03 per share.

This includes the acquisition of the Mark West brand but excludes any impact from the anticipated purchase of the remaining 50% interest in Crown.

For now, we are also continuing to target interest expense in the range of $210 million to $220 million a year.

I would like to note that from a gating perspective, we expect fiscal 2013 Q2 EBIT performance to come in below Q2 of fiscal 2012 by a mid single digit percentage.

The reasons for the expected reduction are similar to what we experienced in Q1, and are due to an increase in promotional spending.

As a reminder, we're making promotional spending investments in the first half of the year to support new products and provide a more even distribution of promotional expense throughout fiscal 2013 versus fiscal 2012, which was heavily weighted to the second half of the year.

This should drive continued portfolio momentum going into the key October, November, December holiday selling season.

In addition, we expect Q2 to be impacted by the timing of US marketing expense, as we support new products and launch a new national advertising campaign for Woodbridge, Black Box, and Kim Crawford during the Summer.

Our comparable basis guidance excludes restructuring charges and unusual items, which are detailed on the last page of the release.

Before we take your questions, I would like to summarize by saying Q1 represents a very good start to the year, and we're on track to achieving our financial goals.

We're seeing solid consumer take away trends for our US wine and spirits business, with good energy around new products, and initiatives supporting our focus brands.

On the beer side, strong marketing programs and execution at retail continue to drive excellent marketplace performance, and improved earnings.

The Mark West brand has a good growth profile, and will be a nice addition to our wine portfolio, and finally, by purchasing the remaining 50% interest in the Crown beer business, we will significantly strengthen our US market position in beverage alcohol and our overall financial profile.

We also feel that pending the close of this transaction, the perpetuity of the beer business has become quite clear.

We are much happier participating in the beer category on a perpetual basis than receiving an 8 times multiple buyout at the end of calendar 2016.

We feel our shareholders should also be pleased.

We have 100% of the powerful consumer franchise and 100% of the excellent financial model that currently exists at Crown.

We financed the acquisition in favorable market conditions, and delever to pre-Crown acquisition levels within the first 12 months, and we eliminate the speculation around the perpetuity of our exclusive importer agreement.

We hope this provides the opportunity for Constellation's valuation to be more in line with our beverage alcohol peers.

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

(Operator Instructions)

Your first question comes from the line of Judy Hong with Goldman Sachs.

So first on the Crown, the new agreement, so just in terms of the terms of the contract, I know ABI said the spirits of the new contracts are pretty similar, in terms of the existing one that you have with Modelo, but can you just walk us through any changes in terms of the terms of the new contract versus the old one?

Yes, Judy.

Basically, the new contract was generally designed to preserve the economics of the old contract, so in terms of how Crown will operate or the economics, there's really no significant or material changes to that.

Do you still have the COGS increase every year that you'll be facing?

There are specific contractual provisions in the new contract with regards to Crown but with regard to COGS increases, but again, the contract was designed to preserve the economics of the current agreement.

Okay, and then I guess we can kind of walk through the financial accretion based on some of the details that you've given us, Bob, but I guess in terms of strategic perspective, and as you think about the Crown business longer term, can you give us some perspective on how you think about sales growth, EBIT growth, potential going forward for the business, and then do you envision also adding more brands into this portfolio, and whether that includes maybe other imports or craft brands to really expand the beer business within Constellation?

Yes, I'll answer the first half of that, and then I'll let Rob answer the second half.

So from an economic perspective, we're very happy with Crown's market share performance and its actually core depletion performance.

We would expect, going forward now, that we control 100% of the business.

And its future from our perspective is perpetual, I think that we would hope to get EBIT growth doing better than it has historically, and we will be focused on that and I think the current momentum that the Crown business has established will certainly help EBIT growth as we move into fiscal 2014 and beyond.

Let me let Rob answer the second half.

Yes, so you talked about your question was on new brands and innovation and things to that effect.

I think the number one, under the new agreement with ABI, we've secured a good innovation pipeline from Mexico.

And then secondly, there is no restrictions on what we're able to do with non-Mexican beer brands.

So in other words, we can add either through organic development or otherwise any new non-Mexican beer brands that we wish, so we don't have any restrictions in that regard.

So clearly with 100% ownership of the Crown business and the ability to entirely control that business just like our wine and spirits business, we'll be looking at the beer business very similarly to how we look at the wine business, as it relates to our innovation in new product plans.

Okay, and then Bob, just clarification on the leverage.

So the mid-4 times with Crown, the 100% of Crown, that assumes that you suspend the buyback as of today, or pretty recent, and then so you get the cash flow contribution for the year, but basically adding the $1.85 billion of debt?

So you're assuming that the buyback stops in that mid-4's?

Yes, that's correct, and Judy that assumes a full year of Crown EBITDA, so we think when the deal closes, if you assume the full year Crown EBITDA will be around 4.5 and within 12 months, we'll be well below 4 times EBITDA.

And it assumes that all our calculations assume including any accretion that you guys do that the incremental financing.

And when leverage comes back down to kind of your targeted level is it your intention to resume buyback at that point?

Yes, we still have the authorization, so I think at that point, we're happy because we've got a lot of financial flexibility to do pretty much anything we want around the capital structure.

So I think all that should bode well for our shareholders.

Because again, Crown is a very strong cash flow generator and a very consistent cash flow generator, so I think it really complements quite nicely the wine and spirits business.

We're lucky to be in a category that's very consistent in pretty much all economic scenarios and right now, beer in IRI is doing quite well.

Spirits is doing quite well and wine is doing quite well, so it's pretty good times for beverage alcohol.

Okay.

Great, thanks.

I'll get back in the queue.

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

Congratulations on the deals.

The first thing is, over the last couple years, there have been some public disagreements on how to run the Crown business between yourselves and Modelo so it's now fully in your control.

What are some of the things that you want to see change over the next couple of years?

Yes, we don't really see that a lot of change is necessary.

Obviously, the business is performing very well at the current time.

Specifically, we have no intention of changing management, the current management team under Bill Hackett has done a great job, and we certainly intend to leave that in place, and we see no change in distribution and the distribution network, which has also performed very well for us.

So obviously, we don't have the issue hanging over us of the 2016 date, and so we'll be thinking about the beer business very much as we think about the wine and spirits business, in terms of what investments make sense to drive the business for the future, and to achieve our strategic imperative of driving profitable organic growth.

Just to follow that up, some of the disagreements between Modelo and Constellation were probably kind of natural, given how the contract was set up and how both parties were looking at duration.

I think part of the reason that you saw a different buyout multiple for us, meaning like 8.5 times, and a different exit multiple, say 13 times, is I think InBev really wants us to think like a long-term brand owner of the Corona brand in the US and a 13 times exit multiple is kind of like a perpetuity multiple, right?

So they really want us to have that kind of mind set so I think going forward, we'll have a very similar mind set.

We'll be thinking very long term.

If I could also, considering long term, I think two things.

One is the idea of potentially importing other brands from around the world and putting it into Crown.

But also want to add, is there all opportunity to pick up better our sales resources to picking up domestic brands?

So there's no limitation on our ability to add brands whether imported or domestic with the exception of Mexican brands.

Modelo will continue to be our exclusive supplier of Mexican brands, but other than that, there's no limitation on what we can add in the Crown business, as part of the Crown portfolio.

So is it possible to think about that business, that maybe we can justify a step up of investment, because the opportunities are broader than they were prior?

Yes, well it's premature for us really to address that, but as I said we'll be looking at that business almost in the exact same way that we looked at our wine and spirits business, and in making decisions as to where we want to invest to get the best return from our investment dollars.

And we're a very disciplined Company in that regard, and we're very focused on ROIC, so it's basically no different than any other part of our business.

And it's a great business, more importantly, the imported beer business is very strong.

We've got the best brands in that business and we've got a fantastic platform with the Crown Management team.

And our distribution network for Crown is we think the strongest in the business, so we're very positive about the future opportunities there.

Let me be clear, so when Rob and I are saying long term, right, we're not going to be sacrificing short-term profitability.

We are focused as Rob said earlier, on profitable organic growth.

The guidance for this year is for Crown to grow EBIT.

We don't expect to come off that, and we expect to grow EBIT every year.

And we're just going to be prudent businessmen.

So you mentioned a comment where we pick up distribution of domestic brands.

Well maybe, but one of the decisions we make is the Crown business has quite a strong profit margin so we will be careful of diluting our salesmen's attention perhaps on other products that don't have the same kind of margins.

So they will be the kind of balancing acts that any Company with a long term view thinks about.

Got it.

Thank you.

Congratulations again.

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

Wow, what a stunning week.

Congratulations.

This is just transformative.

Just on the cost of debt, I was a little surprised by the 4%/4.5%, particularly since you were recently issuing bonds at over 6%.

Is that just the mix of revolver plus term loans that you'll be using?

Yes, so good question, Tim.

So if you think about it, our revolver, which we have $800 million or so of capacity against, is say 2% right now.

Things can change if LIBOR changes, so that's a pretty low cost funding.

The senior notes we issued before, you're correct.

We issued them at 6%.

They're currently trading below 5%, so if that would be, if we were to fund today, that might be reflective of thereabouts the funding we would get on that paper.

And then also bank debt which is LIBOR plus 200-ish so it would be the mix of those three.

And obviously the shorter term paper has a much lower yield, much lower interest rate, but we want to get some duration as we look at the maturities of our credits in total.

So as we balance all those things out, that's where we come out, about 4% to 4.5%, but of course, that's subject to when we fund and what the market rates are when we do fund.

Would it be wrong to think of your credit profile actually probably being better today than it was yesterday, just given that the debt markets would have had the same concerns about the sustainability of the JV income stream, now those questions are put to bed, your funding rate probably went down today.

Yes, so actually that's another great question, Tim, and it's not only an excellent question, it's a correct statement.

So if you look at the rating agencies will be coming out.

I think Moody's already came out this morning and we don't expect any negative ramifications from that.

There will be some wording I think in the press releases around the dependable beer cash flows.

And if you look at how our bonds are traded since the rumors of this transaction just started, the yields came way down, and as I said those 6% senior notes, the yield on those are now below 5%, so I think what you said is exactly right, from a credit perspective, we are now in better position than we were before this transaction, even though, as we said, our leverage will go up a little bit in the short-term but we will pay that off frequently.

Congrats.

What a home run.

Your next question comes from the line of Bryan Spillane with Bank of America.

Just a couple of questions.

First, to follow-up on the Crown transaction, is there any goodwill amortization or any kind of step up in goodwill that we will have to think about when we model, when we plug into our models?

Yes, so another good question.

So the way this will work, the way this will probably work, because the transaction hasn't closed, and we haven't completely formulated all the absolutes, is the $1.8 million, that will have, that will almost be all intangibles, because as you know, 100% of the Crown business has about $200 million of net assets, so heavy intangible acquisition there.

The fortunate piece of that is those intangibles are tax deductible, right?

So it should help the tax rate on this deal.

Now, the other kind of DT GAAP thing that's going to happen here is most likely, we're going to have to mark our existing interest in Crown to market, so what that means is we will record quite a significant gain, which will again increase the asset base of the Crown business.

So in essence, although cash going out the door will essentially be the $1.8 billion and most of that will be goodwill.

We will also have a gain and also record more intangibles for the first half we own, so the intangible asset will go up just shy of $4 billion, more likely than not, when this thing closes.

Okay, and so then as we're just, if we're taking a baseline EBITDA for Crown of, I don't know, just to use a round number, $450 million, we still have to, we will have to make some adjustment for that for the increase or I'm sorry, EBIT of about let's say $430 million.

We'll have to make some adjustment for a higher amortization.

No, the amortization won't occur on the GAAP financials.

We will be able to amortize it for tax purposes, and again, we haven't finished this but my guess is a lot of the intangibles from a book perspective won't be amortizing.

Okay, and then the tax benefit that would be created is included in what you've described, I said like a 36% tax rate or so to use for--

Yes, so that's a good point too, because as we said before, the Crown business by its nature has a pretty high tax rate, because the majority of its sales are in high tax rate districts, and it has nexus in a lot of states because of the distribution centers, so it's relatively high State tax rate.

But the amortization of the purchase price helps bring that tax rate down, so your statutory rate would be, I don't know, say 38% to 39%.

You're back down to say the 35% to 36% effective tax rate including the amortization of the purchase price.

Okay, and then are there any synergies?

Looking forward once you've got full control of Crown, are there any like overhead, leverage in overhead things like systems, any kind of cost synergies that are material that we should think about?

No, really not, Bryan, and because as we said, one of the glories of this acquisition is it's kind of like buying yourself, right?

We've known this business for so long.

We know the people.

We know how good they are.

We know the work they've done, even before the JV was formed, and there's actually a lot of symbiosis already between the two as we put in our ERP system, Crown put in the same system, the same instance, so those synergies pretty much already exist.

The other great thing about the Crown business, not only is it not capital intensive, because I said, the total net asset base is around $200 million for business, as you said, that has like $2.5 billion of sales and $450 million of EBIT thereabouts.

It's not very people intensive.

They don't have a lot of -- I think the total headcount in Crown is like 300 people.

Okay, and then just one last one.

If I could ask, just about the wine market.

We've begun to see, you can see it in the scanner data, you can see it in some of the other third-party sources, that you're beginning to see some general price increases in the industry.

And so I guess, just so far from your perspective, has that surprised you?

Is the way that the market is reacting to the supply shortages and the higher cost for both bulk wine and grapes has the industry responded in a way that you would have expected?

Just sort of your outlook on how that's evolving, your perspective on how its evolving now, and what you think may be happening as we go through the balance of the year would be helpful.

Yes, I think that the industry is reacting in a fairly rational manner.

As you said, grape supplies are a little tight.

It's probably been exaggerated to some degree, but they are a bit tight and grape prices are up and therefore, with raw material costs being up, as well as supply being somewhat limited.

In certain categories, price categories, you are seeing some pricing, so where have we seen that?

We've seen a little bit of it in the value segment or the every day segment below $5, which is relatively irrelevant to us, and we're also seeing it in the top end, call it sort of above $20, which is also from a business perspective, not particularly relevant because it represents less than 3% of the total industry.

So you're seeing a little bit of it here and there and you are seeing, as what I'd said, some rational behavior in the marketplace and I would expect to continue to see that as the harvest comes in and throughout the year.

We're not expecting to see any like major changes in those trends.

Okay, thank you.

Your next question comes from the line of Vivien Azer with Citi.

My first question is a follow-up to Judy's, when you guys talked about the opportunity to improve the EBIT growth.

Is there an opportunity to expand margins, or is it just a matter of kind of closing the gap between the top line and the EBIT from a growth perspective?

You're talking about the beer business?

Yes, I am sorry, excuse me, yes for Crown.

Just like all of our businesses in terms of driving EBIT growth, margin expansion is certainly one of those levers and margin expansion can occur in a variety of ways, but driving the mix of the products is certainly one of those levers.

But we'll be wanting to, just like any other part of the business, continue to focus on growing that business from a top line and bottom line perspective.

Fair enough and my second question also has to do with Crown.

I'm curious if you could offer a little bit more detail on how innovation is going to work, given that ABI is going to be your biggest competitor in the US, and now they are going to be in charge of producing your product but also handling the innovation?

Yes, well they're very interested and have provided for innovation because this is an important part of the business for them.

So in our agreements so to speak, we've provided for a strong innovation pipeline as it relates to new products and new packages from Mexico, and therefore, from Modelo.

And then as I stated previously, there isn't any prohibition on our part from introducing new products that are not Mexican in origin, in essence.

So we're also not limited there and can look at domestic and imports from other countries, as well, with respect to our innovation plans, so basically, we will run this business like any other business.

We have fundamentally no limitations on what we can do.

In terms of driving the innovation, and presumably it's coming from you guys and you're asking ABI, I want this new package or this new kind of formulation, is that right?

That's what we're talking about on innovation.

Yes, new packages, new products or formulations, right.

And then lastly, is there something in the contract that precludes ABI from replicating whatever clever idea that you have that you'll execute against Corona from taking that and applying it to Stella or something like that?

Well I think the basic answer to your question is yes.

We are the inclusive importer in the United States of their Mexican products, okay?

And basically they can't do knock offs and we can't do knock offs.

So the answer to your question is fundamentally yes, there are provisions that actually protect both parties from that.

Fair enough.

Thank you very much.

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

Congratulations.

On Crown, seems to be a popular topic.

A couple questions.

Firstly, I didn't catch it, but did you say Crown will continue to operate, even though it's going to be consolidated as a separate entity?

Yes, so Crown will operate as the beer division of Constellation, and it will continue to operate pretty much the same as it operates right now, with very little difference, same Management team, same distribution network, same sales force, so yes, separate.

Got it, great and then the incentive structure there at Crown, any intent?

I assume it's a different incentive structure than that for the presently wholly-owned businesses.

Is any intent to have it be aligned with the incentive structure for the wine and spirits business, or leave it as is?

Well right now, Crown is a private Company, so they don't have some of the benefits of being a wholly owned subsidiary of a public Company, so we'll be looking at ways to enhance the incentives that the Crown employees have, and I think that clearly, that it will involve looking at sort of the incentives on both sides and making sure that, meaning wine and spirits and beer and making sure that they're equivalent as well as consistent with the goals that we've set for the Crown business, so that's what incentives are all about, is making sure that the incentives align with the goals that you're trying to drive, so that was a long way of saying sort of yes.

Okay, and is it, can you just speak to generally how they are incentivized?

It seems like it's more of a volume-based incentive structure than a process waiting in the equation?

Can you just speak generally to that?

No, it's a pretty balanced system that relates to volume, profit and market share.

That's how they're currently incentivized, and they will be incentivized in the future in that regard.

And then there's the typical sort of split between short-term incentives and long-term incentives but both of those are based on pretty much the three things that I just talked about.

Market share, profit and volume, depletions.

Mark, it's a lot like the wine business, we basically set an annual plan and those three components get rolled up, and if they beat those numbers in the plan, they get better than a 100% bonus, and if they don't hit market share depletions in EBIT they get less than a 100% target bonus.

But very balanced in that regard.

Got it.

That's great, and then finally on Crown and I'll get back in the queue with a couple wine questions, but finally on Crown, it sounds like if you were to come up with the $1.85 billion today, it would be roughly in the neighborhood of 4.5%, 5% borrowing cost.

Is that a fair sense of what the market for this transaction is?

Yes, that's what we said earlier.

We said 4% to 4.5%.

Incremental.

Okay.

Fair enough.

That was just on the $1.8 billion.

Oh, okay, I thought that was financing related to refinancing your existing borrowings but fair enough.

Thank you.

Your next question comes from the line of Dara Mohsenian with Morgan Stanley.

I just want to get some more clarity on the long-term pricing algorithm you'd expect with the Crown business.

There hasn't been much pricing over the last few years here, despite some aggressive increases from the domestic brewed brands.

So given the pricing gap on Corona has closed significantly, I'm wondering if it's reasonable to assume perhaps you'd take more robust pricing going forward, now that you've taken full control of the business, and in the context of improved volume trends also in general for the brand.

We're generally not going to comment on pricing, suffice it to say that Crown management team is going to do what makes commercial sense for the business.

That's pretty much as we can say or are going to say at this point in time.

And on the on-premise side we've seen recently in the alcohol industry in general, over the last few months here, I was just looking for more clarity on what you're seeing post the quarter here.

Do you think that rebound is sustainable, or was it more transient and related to some of the favorable weather we saw earlier this year?

No, we think the rebound in on-premise is sustainable.

I think that we're seeing the on-premise return to growth and probably it's just about getting back to the pre-recession levels, after taking a pretty good hit.

So it's still, I would say, no one knows for sure, but in terms of the on-premise in general for beverage alcohol, I would say that we're probably now looking at low, very low single digit growth on the on-premise but that's a positive development from probably flat looking 6 to 12 months ago, to significantly down immediately post-recession 2008.

Okay.

And then on the Mark West acquisition--

And Crown's business is doing very well on the on-premise so we're happy.

Okay, and on the Mark West acquisition, obviously a high growth brand, I'm wondering if you can give us a bit more detail on what attracted you to the brand strategically, and also just implications going forward in terms of maybe consummating additional acquisitions in the same type of vein.

Sure.

First of all, Pinot Noir is one of the hottest major categories/varietals in wine and has been for some time and secondly, Mark West is now the number-one brand in the Pinot Noir category, so that makes it a extremely dynamic brand to be in a major hot varietal category, and to be the number one player, growing in IRI for the last 12 weeks at 35%.

So a lot of momentum behind the brand, we think that its got tremendous opportunity for the future.

And I think in terms of why it makes itself a very attractive acquisition candidate, when you think about the fact that it doesn't come with many physical assets, obviously there's a lot of synergy there in putting the brand into our production infrastructure.

Furthermore, it comes with a very good supply of grapes to ensure we maintain the supply and quality of the product, in again a varietal category where supplies are tight.

So we have assured supply, we have assured quality, we don't have the physical assets, we could pop it into our production infrastructure, there's a lot of synergies there, it's the number one brand in Pinot Noir, so it's a very logical fit for us.

Also, just in terms of its price positioning, it fills a nice niche in that it fits between two of our major brands, which are Robert Mondavi Private Selection and Estancia, so it's a good fit in terms of laddering from a price perspective as well so it's kind of a perfect tuck-in as we say.

Great, thanks.

Your next question comes from the line of Reza Vahabzadeh with Barclays.

Hi, this is actually Jamie Robbins on for Reza.

Can you bring us up-to-date on your outlook for grape costs in fiscal 2013 for the business?

Yes, we're looking for normal inflationary increases in grape costs for did you say 2014 or what did you say?

2013, sorry.

This coming year.

Yes, I think we've talked about mid single digit increases in just that component, but in terms of how that affects our overall cost of goods sold, it's only -- it's less than, it's only relatively small percentage of our total cost of goods sold, grapes per se, and therefore, again, we're looking sort of mid single digit increases there but on overall COGS, it's just sort of normal inflationary increases.

Okay, great.

Thank you.

Your next question comes from the line of Kevin Dreyer with Gabelli Asset Management.

Congratulations on the deal.

Curious again, a couple questions around taxes and the tax basis.

So will that be stepped up as well for the tax basis of the joint venture?

Yes, I mean the tax basis of the joint venture will be stepped up by our purchase price, by the $1.8 billion.

Okay.

It sounds like partially, there's that affect by the partial amortization of those intangibles or it will just stay there?

No, so the way it will work is we pay the 1.8 billion.

That will be tax deductible over say 15 to 20 years, so we'll get a tax deduction on that, you won't see the amortization on the GAAP income statements, you'll just see that's going to sit in goodwill, which most of it, which doesn't get amortized.

So but the effective tax rate for the beer business will be helped by the tax deductibility of our $1.8 billion purchase price.

Right, okay.

So the tax basis would basically be roughly speaking $3.7 billion then?

Nope.

The tax basis will be about $1.8 billion.

Oh, the $1.8 billion.

Okay, just by--

It's pretty confusing, what I said earlier was we'll have to mark-to-market the 50% interest that we currently have and that does not impact the tax basis, because there's no cash associated with that.

It's just like a book entry.

Got you.

The thing that impacts the tax basis is the check we cut for the $1.8 billion.

Got it, thank you.

And then just in terms of with all the buyback and what not, what are the current shares outstanding?

The current shares outstanding?

Yes.

About 190.

190 million.

Okay.

Thank you, that's all I had.

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

I had a couple questions.

One is, when you look at the Crown EBITDA margin or EBIT margin, its been coming down a little bit.

Is that all of a result of the step up in your purchasing terms for Modelo, that's built into the contract?

I'm sorry, the question was about the Crown EBIT margins?

Yes, the margins that you've been reporting on Crown have been coming down slightly every year and I'm wondering--

Yes, that's the relation, the big drivers there are cost of goods going up, advertising costs going up, and not offsetting that with price increases.

That's the big reason why margins have come down.

Okay, when is the next step up in the purchasing cost or is it something where it's tied to their production cost or is it tied to some kind of index?

Yes, the way the purchasing costs will be reassessed every year as we enter our fiscal year, so they get reset based on inflationary trends each year.

Okay, and did you give the depreciation for Crown?

To figure out an EBITDA?

Why don't you call maybe IR.

Okay, and then one debt question.

I show, it looks to me like you can add about $750 million of additional in term loans.

Am I reading that right or do you think you have additional availability?

Well availability under the revolver of almost $800 million.

Term loans, you have to go out, we have an accordion feature, so we can issue more term loans but it's not really like a revolver where it's like that available.

You can get it on a daily basis.

But when we go to finance the Crown acquisition, we do plan to use our revolver, which we think is on good terms to utilize the accordion feature that we put into our recent May refinancing, and to access the senior note markets, which as we said earlier, our credit worthiness has gotten a little better, so the rates on our senior notes have come down since issuance, almost 100 basis points.

Right, okay great.

And one I forgot to follow-up on the purchasing of products from Modelo, is there some type of a stipulation in the contract, if Modelo fails to deliver quantity or quality of beer?

Yes, it's a normal commercial contract where we order and they have to deliver to us within X number of days, and they have to deliver the SKUs as we ordered and the product quality has to be what we expect, so kind of normal commercial terms that you would expect that also existed under the joint venture agreement.

Okay, great.

Thank you very much.

Sure.

Thank you.

I'd now like to turn the floor back over to Mr. Sands for any closing remarks.

Yes, well thanks everybody for joining our call today.

We're extremely pleased about the prospect of owning 100% of Crown Imports, the number one beer importer in the United States, and I'm also very excited that we will be adding the Mark West brand, the top-selling Pinot Noir brand in the US to our award-winning portfolio of wines.

From an operational perspective, we're off to a good start for the year with strong marketplace momentum for our Crown beer business, as well as our US wine and spirits business, which positions us well for Fiscal 2013.

Our new products are being very well received in the marketplace, and we are planning several new initiatives in this area throughout the coming year, and of course, I hope you all have the opportunity to enjoy some of these fine products during the upcoming Fourth of July holiday.

So thanks again for your participation, everybody.

Thank you.

This concludes today's conference call.

You may now disconnect.