Constellation Brands Inc (STZ) 2013 Q2 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 second-quarter 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)

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 second-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 basis 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.

Please also 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 affect 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.

Thank you, Patty, and good morning everybody, and welcome to our second-quarter call.

We've reached the halfway point in the year, and I am very pleased with our progress to date, as we continue to solidly execute our profitable organic growth strategy throughout our wine, beer, and spirits businesses.

We are currently experiencing great marketplace momentum for our outstanding wine and spirits portfolio.

This includes excellent performance for our collection of focus brands, as well as great consumer response to our new product introductions.

On the beer side, the second quarter marks the tenth consecutive quarter that the Crown business has outperformed the US beer industry and the import category.

We remain excited about the prospect of owning 100% of Crown Imports, as it will enhance our participation in the US beer market, which is one of the most attractive sectors in the beverage alcohol industry.

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 solidify our place in the US beer market for the long term.

It will also make Constellation the largest multi-category supplier for beer, wine, and spirits, and the third-largest total beverage alcohol Company in the United States on a volume basis.

The deal is progressing as planned, and is still expected to close during the first quarter of calendar 2013.

And now, I would like to focus our discussion on the Company's operational results for the second quarter.

As you know, within our wine and spirits business, we have been refocusing our resources behind brand building and innovation and new product development.

This area represents one of our primary growth drivers going forward, as it is also one of the key contributors to overall US market growth.

As such, we continue to strengthen our focus brands while developing, launching, and promoting new products in the marketplace.

Throughout the second quarter, many of these brands were performing very well in the market, as a result of the promotional and marketing efforts we currently have underway.

Remember, we have more evenly distributed our promotional spend this year versus last year, when most of our programming was executed in the second half of the year, primarily during the holiday selling season.

This year, we capitalized on the strong momentum we had generated coming out of last year, and more evenly distributed that promo spend throughout this year.

Our current levels of promotional spend are expected to continue throughout the second half of this year.

Overall, these brand building efforts are yielding results, as we are experiencing strong depletion trends, and growing market share for our US wine and spirits business.

We also succeeded by increasing points of distribution at retail, and implementing more effective merchandising.

Throughout the remainder of the year, we plan to continue to build on this momentum, especially as we head into the critical holiday selling season.

I'd like to take a moment to highlight some of the key brand-building initiatives that were executed during the second quarter.

The new TV advertising campaign for Woodbridge by Robert Mondavi was a hit with consumers, driving double-digit consumer takeaway trends in SymphonyIRI channels for the quarter.

Recent Woodbridge line extensions have also attracted new consumer interest with the addition of Malbec Sweet Red and Sweet White.

Black Box currently boasts strong double-digit sales and depletion growth driven by its attention-grabbing national TV advertising campaign which was launched Memorial Day weekend and showcases this family of wines, delivering the quality of premium wine in a bottle with the value of a box.

The relaunch of Robert Mondavi Private Selection is creating buzz in the trade, as its new packaging is currently rolling out along with the new Coastal Crush Red, with its revitalized label design and new print advertising.

Rex Goliath posted strong double-digit sales and depletion growth during the second quarter, driven in part by the introduction of the Pink Moscato, Free Range White, White Zinfandel, and Malbec line extensions.

During the second quarter, we launched five varietals for our new Thorny Rose brand, which is specifically targeted to Millennials who contributed to the development of this brand.

Imports have also outperformed the market with Nobilo experiencing phenomenal quarterly depletion growth of more than 40%, making it the number one New Zealand Sauvignon Blanc in the US, and Kim Crawford has become the number one luxury New Zealand wine in the US, with sales growing more than 30% in the quarter.

The Kim Crawford Undo Ordinary print advertising campaign was launched in July in the US, conveying the innovative spirit of the brand, with a luxury look and feel.

Last but not certainly least, on the wine side, the Mark West Pinot Noir brand has been a fabulous addition to our portfolio, posting quarterly double-digit SymphonyIRI growth, which exceeds that of the market category where it participates.

We have successfully integrated Mark West into our existing product portfolio, and we are currently increasing distribution and a display activity to drive off-premise growth.

Collectively, our focus brands grew depletions 11.5% during the second quarter, with several of these products recently receiving 90 plus point scores from some well-known publications.

These brands include Robert Mondavi, Franciscan, Ruffino, Nobilo, Ravenswood, Wild Horse, and Inniskillin.

From a spirits perspective, SVEDKA remains one of the fastest-growing major vodka brands in the US.

New must-have formats like the recently-launched Stars and Stripes and the new Colada flavor continued to draw consumers to this iconic brand.

For the quarter, SVEDKA posted SymphonyIRI growth of more than 20%, in addition to gaining volume share of the vodka category.

Black Velvet has capitalized on the hot growth trend of flavored whiskeys by launching the new Toasted Caramel flavor which offers a distinctive taste that is being well received by consumers.

As is typical at this point in the year, I would like to provide an update relating to the US grape harvest, which is just more than 60% complete in California, but finished on the East Coast.

Although there are divergent estimates from varying sources relative to the expected size of this year's harvest, we are currently estimating that the 2012 US industry harvest will experience high single-digit growth versus last year's short harvest.

Overall, grape pricing is expected to increase in the mid-single digit range, depending on variety, location, and demand.

Last year, at this time, we had experienced the first significantly short harvest in several years.

So how does this all play out from a pricing perspective?

Although we are currently seeing some moderate price moves in the US wine space, at the less than $5 retail price point, and less promotional activity at the greater than $15 price point, there is little or no pricing movement within the $5 to $15 price range, which represents the majority of our market participation.

Now let's move to the Crown Imports joint venture.

As I mentioned earlier, the second quarter marks the tenth consecutive quarter that Crown has outperformed the total US beer industry and the import category, across both on- and off-premise channels with year-to-date depletions increasing in the mid-single digits.

Crown experienced favorable consumer demand during the key summer selling season, resulting from the combined success of a number of initiatives including the Win Your Beach sweepstakes program, the Corona Extra Find Your Beach campaign, and Corona Light's new Refreshing Change of Beer ads.

The strong sales generated during the second quarter benefited from distributor buy-in of product prior to some planned price adjustments this Fall.

These price adjustments are expected to occur in select key markets where Crown has identified pricing opportunities.

However, this is no different from the pricing strategy that Crown has employed in the past.

As a result of Crown's favorable year-to-date performance, we are now projecting that both depletions and operating income will grow in the mid-single digit range for fiscal 2013 versus a previous guidance range of low single digits.

Throughout the remainder of fiscal 2013, we expect Crown to be focused on strong market execution, supported by new product introductions, packaging expansions, and solid promotional and media activity, which are planned for the balance of our fiscal year.

I would like to take a minute to highlight some examples.

Corona Extra has once again teamed up with Super Bowl winning coach and ESPN commentator Jon Gruden to showcase the Top 30 football beach destinations around the country with the launch of Corona's Find Your Beach For the Game Facebook promotion.

Crown will continue to leverage the momentum from the new Corona Light creative, which is focused on driving consumers to trade up from domestic lights.

Pacifico recently rolled out its new State of Pacifico national marketing campaign, honoring the brand's free spirit lifestyle.

The campaign is designed to drive Pacifico's rapid growth, which is fueled by the expansion of Pacifico on draft, now available in 37 states.

Crown is leveraging the growing popularity of the cider business to launch Somersby Hard Apple Cider in key test markets across the US.

Somersby is a leading global hard cider within the Carlsberg portfolio, that will be exclusively imported into the US market via Crown.

And Modelo Especial, which has been an important growth driver within the Crown portfolio, recently received Market Watch Magazine's Leaders Choice "Beer Brand of the Year" Award.

Modelo Especial also recently achieved a major milestone, becoming the number two import beer in the US convenience store channel on a volume basis.

In closing, to reiterate, I am pleased with our progress so far this year.

We are experiencing very strong marketplace momentum across our product portfolio.

We are encouraged by our innovation initiatives, and we will continue to fill the new product pipeline for the remainder of the year.

We are entering one of our strongest seasonal periods and we plan to effectively leverage the positive marketplace momentum we already have underway for our US wine, spirits, and beer businesses, which positions us well to achieve our goals for the year.

I'd now like to turn our call over to Bob for a financial discussion of our second-quarter business results.

Thanks, Rob.

Good morning, everyone.

Our comparable basis diluted EPS for Q2 came in at $0.71.

This result reflects our effective tax rate coming in better than expected, due to some favorable tax benefits.

EBIT was down 1%, which was a little better than the mid-single digit decrease we previously anticipated and discussed on our last earnings call.

This favorability was primarily driven by Crown, as highlighted by Rob earlier.

Given those brief highlights, let's look at our second-quarter 2013 P&L performance in more detail.

My comments will generally focus on comparable basis financial results.

As you can see from the news release, Q2 wine and spirits net sales on an organic constant currency basis were even with Q2 last year, as higher volumes were essentially offset by higher promotional costs.

For the quarter, our consolidated gross margin was 41%, which was level with the prior year.

This reflects volume growth and the benefits of the consolidation of Ruffino and Mark West, offset by the increase in promotional spending.

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 $6 million to $161 million, primarily due to an increase in SG&A expense.

This was driven primarily by the consolidation of Ruffino and some unfavorable expense overlaps.

Corporate costs increased $2 million, primarily due to higher depreciation expense related to Project Fusion, our ERP system upgrade, which is now complete.

Consolidated equity earnings totaled $71 million versus $64 million last year, almost all of these earnings are related to the Crown joint venture.

For the quarter, Crown generated net sales of $788 million, an increase of 8%, and operating income of $143 million, an increase of 14%.

The net sales increase was primarily driven by volume growth of Modelo Especial and Corona Extra, including a benefit from wholesaler buy-in ahead of the upcoming price increases in select markets.

This effectively pulled ahead some sales from Q3 into Q2.

Crown also recognized income from an early termination payment related to the St.

Pauli Girl distribution agreement.

This benefit effectively reverses in the second half of the year as Crown loses the St.

Pauli Girl volume going forward.

Interest expense for the quarter was $55 million, up 28% versus last 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 interest expense increase, let's discuss our debt position.

At the end of August, our debt totaled just under $4 billion.

This represents an $858 million increase from our debt level at the end of fiscal 2012.

We also finished August with $179 million available in cash on our balance sheet.

This extra debt and the higher than normal cash balance primarily relates to the pending Crown acquisition funding.

During Q2, we effectively secured the permanent financing for the $1.85 billion Crown transaction.

As part of this activity, we took advantage of our improved credit profile and the attractive interest rate environment to issue $650 million, 4.6% senior notes due in 2023.

The cash proceeds from the notes issuance were placed in escrow, and will be released when the Crown transaction closes.

As a result, this cash has been recorded as restricted cash on our balance sheet.

During Q2, we also amended our senior credit facility to establish a $575 million delayed draw term loan.

As previously discussed, we plan to use our revolving credit facility and available cash for the remaining funding requirements of the Crown transaction.

Overall, we're quite pleased with the collective financing we have put in place for the deal, as it currently represents a blended interest rate in the 3% to 3.5% range.

Given the early Crown deal funding related to the notes issuance, we now expect interest expense for fiscal 2013 to be in the range of $225 million to $235 million or $15 million higher than our previous guidance range.

We feel this was a good investment to secure financing and lock in favorable rates for the 10-year period.

As a reminder, during the first quarter, we refinanced our senior credit facility and issued $600 million of 6% 10-year notes.

Proceeds from this note issuance, along with our free cash flow generation and proceeds from stock option exercises have been effectively used to reduce borrowings under our revolving credit facility, and to fund the Q1 share repurchase and the Mark West acquisition.

Our comparable basis effective tax rate came in at 16%, compared to a 3% rate for Q2 last year.

Both periods reflect favorable benefits from various tax items.

During Q2 fiscal year 2013, we recorded higher foreign tax benefits, which drove the favorable rate.

As a result, we now anticipate the full year fiscal 2013 effective tax rate to approximate 30%.

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

For the first half of fiscal 2013, we generated free cash flow of $333 million versus $478 million for the same period last year.

The decrease was primarily due to the receipt of tax refunds in the prior-year period that were primarily driven by the sale of our UK business.

Given our strong free cash flow results in the first half of the year, we're increasing our fiscal 2013 free cash flow expectation by $25 million to a range of $450 million to $500 million.

This increase is primarily being driven by additional tax related cash benefits and factors in the higher interest cost mentioned earlier.

Now let's move to our full-year fiscal 2013 P&L outlook.

We now expect comparable basis diluted EPS guidance to be in the range of $2 to $2.10, versus the previous guidance of $1.93 to $2.03.

This increase primarily reflects the benefits of the lower anticipated tax rate that I noted earlier, along with the increase in Crown operating income guidance highlighted by Rob, partially offset by the incremental interest expense for the August senior notes issuance that I previously discussed.

In addition, we're now estimating weighted average shares to approximate 190 million, which is at the high end of our previous range of 185 million to 190 million shares.

The increase reflects the impact of recent employee option exercise activity, and the appreciation in our stock price on our diluted share calculation.

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

It also excludes any impact from the closing of the purchase of the remaining 50% interest in Crown.

Let me make a few comments to help frame in the second half of fiscal 2013.

During the first half of the year, we saw improved wine volume, but muted wine sales and profits, due primarily to our increased promotional and marketing investments.

In the back half of 2013, we should see sales and earnings grow nicely, as we overlap last year's promotional and marketing investments and our volumes continued to show crisp growth.

For the beer business, the first half of fiscal 2013 witnessed very strong sales and earnings growth.

We expect this will abate in the back half of the year, due primarily to marketing timing and SG&A timing, the St.

Pauli Girl transition and sales calendarization.

We expect most of this unfavorability for beer to occur in the third quarter.

Before we take your questions, I would like to note that we are seeing solid consumer takeaway and depletion trends for our US wine and spirits business, with good results around our innovation efforts 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 Crown transaction is transformational, as it will solidify our participation in the US beer market over the long term, and strengthen our US market position in beverage alcohol.

The incorporation of Crown's strong business and financial model will significantly enhance our overall financial profile.

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

(Operator Instructions)

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

Congratulations.

Looks like some good numbers.

If I could ask on wine and on promo activity, looks like there's a balance between marketing and promotional spend.

To what degree do you feel like the current rate of promo spend is necessary, and what do you expect happens to depletions if you were to pull that back a bit?

Yes, Kaumil, this is Rob.

We think that the current level of promotional spend is just about right.

Obviously, it's driving the kind of growth that we want to achieve to meet our goals, relative to growth and market share, and I would say that in general, our view is that we're going to sustain the current level of promotional activity and to your question, the market, the wine market in particular is pretty sensitive to pricing, and is therefore fairly elastic, so pulling back on promo would definitely have an impact on volume and growth, so our intention is to maintain our promotional levels and maintain our growth rates.

Okay, got it.

And you gave us some context on the tighter harvest and grape pricing.

As of now we haven't seen any pricing, particularly in the $5 to $15 range but do you feel from a competitive standpoint, that's something we might see down the road?

As I said relative to the harvest, the harvest was actually significantly larger this year than last year.

Last year was the short harvest.

This year, it's a larger harvest, and at least an average harvest relative to previous years.

I think that grape prices are definitely up from the shorter harvest and the fact that the industry is experiencing grape growth.

I would say that yes, we might see some pricing in the $5 to $15 range, but we really haven't seen any yet.

Got it.

Last question, same topic, would you, given your size would you ever consider being the price leader?

Really if you look at what our strategic imperatives are at the current moment, Kaumil, it's really about NPD, driving growth.

A lot of our NPD is in higher price, higher margin categories so this is one of the ways that we're working on improving mix and margins but in the wine category, we don't really see much of an upside in being a price leader because there are a lot of brands, and we really take sort of a market basket approach to looking at when pricing is appropriate.

You really have to look at a bunch of brands, large and small players to make that judgment.

So the direct answer to your question is no, being a price leader is not consistent with our strategic imperatives.

Got it, thank you.

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

So first, just following up on the earlier question.

On the wine and spirits business, so this is the year where obviously you're seeing improvement on the depletion side, profitability has been impacted by higher spending and promos.

So as you look out fiscal 2014, what are sort of, kind of bigger puts and takes that you see that would cause you to grow profit, at that point now in line with the sales growth or are there any other risks to not achieving that profit growth next year?

Well, Judy, if you look at what our primary strategy is for growing profits, it's really about growing the business and growing our volumes and growing market share.

That's what should, in essence, generate profit growth as we go into 2014.

So right now, we've got strong momentum, we're growing well, and I think that should translate into profit growth in 2014.

We don't see any big puts and takes.

Like everybody, there will be some cost pressures going into 2014 that will need to be offset, but we're looking at that at the current time, and the basic premise is pretty simple.

Grow the business, grow the profits.

Okay, and then on the Crown business, so the 8% sales growth, can you just give us a sense of the breakdown between volume and then price mix?

And then just quantification of how much select pricing that you're taking right now, and then broadly speaking, just longer-term, how do you balance volume and pricing as you think about owning 100% of that business?

Judy, I'd say for the second quarter, the great preponderance of sales increase is due to volumes, because really, the only pricing that would be reflected in the second quarter would be that pricing that we took last year in the Fall when the beer category generally goes up, which was not a big pricing level.

So I'd say in the second quarter, again, most of the increase was volume.

Now, as you know, the beer category generally prices in like the October time frame after the peak Summer season and we did take some pricing.

It differs by region.

It differs by SKU, because as you know, the beer category is very local.

We have different competitors, different price points in the different geographies.

And generally, like wine, Crown has really never considered itself a price leader, because the domestic guys are so much larger.

So we just, like wine, react to the competitive landscape, and we're doing nothing different in beer pricing, as far as we approach the market than we have in historic years.

Bob, just on the free cash flow generation, clearly you've done really well on generating a lot of cash.

Pro forma for Crown, I think we're looking at maybe north of $600 million, $650 million of cash flow.

Can you talk about opportunities to maybe even accelerate cash generation once the deal closes?

And then I know it's early but just think about what you might be doing with the cash.

Sure.

So as far as and thank you on the compliment for free cash flow generation and, as you know, what we've done with it we've paid down a lot of debt, and we've actually bought back I think almost 25% of our outstanding shares at a price way below where we're currently traded, so Rob and I are pretty happy about that, the shareholders would be as well.

I think you're right, generally speaking, and as we know the Crown deal hasn't closed, but pro forma free cash flow full run rate with 100% of beer and wine as it currently exists, that number should start with a six, so it should be $600 million, a little bit more than that.

As far as how that could accelerate, I think we've done -- our wine guys, both the finance guys and the operations guys, have really done a great job of reducing our net working capital investments.

There is some of that going forward, but I'd say the wide majority of that is behind us, so I would say probably the biggest driver for improved free cash flow going forward will be earnings growth.

That's where most of it will come from.

And of course as you know, cash taxes have been very low as well.

Our tax guys have done a fantastic job there and that's helped ramp up free cash flow growth, so that's always a big driver.

And again going forward, we would assume a more normal cash tax rates, but we still think with all that being said, the number should start with a six and most of the growth from that I think should come from earnings growth.

Then as far as what we're going to do with the cash, I think as we said, right now, the focus will be mostly pay down debt.

When the Crown deal closes, and we're very confident that it will, we'll probably be at an EBITDA leverage ratio of around 4.5%.

That's higher than we would like.

Generally speaking, it would take us about 12 months to get that under 4%, so I think the primary focus that we will have will be debt pay down.

But should M&A tuck-in acquisitions come up, we might look at them, and we haven't ruled out additional share buybacks, because we still have $700 million remaining on our $1 billion Board authorization, and I think as we look out to medium term, I think there could be a dividend on the radar screen, because as you know, we've never paid a dividend.

We're the only player in beverage alcohol that did not pay a dividend, and I think when the Crown deal closes, we're a very different Company, more mature, more diversified, much better free cash flow, and that cash flow actually right now is even pro forma with Crown is generating about a 10% free cash flow yield on the stock, so we feel we have ample opportunity to do very good things with that cash, to help enhance shareholder returns.

Great, thank you.

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

Just on the input costs for higher grape cost, with the lag that usually flows through your inventory, when would you anticipate actually experiencing the higher grape costs in your P&L, and when do you anticipate taking any incremental pricing to offset that?

Okay so there's two questions.

I'd say the input costs as everyone knows wine, the great wine that we make ages for awhile with some tender loving care.

So generally speaking, the whites come out maybe 12 to 16 months after the harvest, the reds maybe six months after that, so we will start seeing some of the impact from last year's more expensive harvest start coming through in the back half of this year but most of that will happen next year, and then the more expensive harvest this year will be yet another 12 months out.

And regarding how you look at margins in the face of those increased costs per ton, Rob touched on that.

Pricing in the wine category is very competitive, so we've said we won't be a price leader, we'll keep a close eye on what the industry is doing pricing-wise and we'll try to react, again to try to balance between volume and market share and EBIT.

And we'll also look at other areas.

Fortunate for us, two or three years ago, our operations guys really started on a really vibrant plan to reduce costs throughout our wineries, and we've consolidated bottling wines, we've closed wineries, we've taken a hard look at oak barreling, we've taken a hard look at wine blends, a hard look at how long we age the wines, always with wine quality as the number one priority.

But we have found some opportunities to reduce costs, and I think those strategies which were a lot of work, and impacts the wine in the tank, will help us offset some of the inflation that we've seen in the cost per ton for grapes.

Can you comment on glass costs as well, and the outlook for the next 12 months?

Sure, what we do in our geographies is we have relatively medium to long-term glass contracts.

The glass industry is very consolidated on a global basis, and generally speaking, our glass contracts are bifurcated.

You have a cost, and that goes up --- one piece of the cost goes up with a CPI index, and then we call out the impact of natural gas on the glass price, and then we can decide whether to hedge or not hedge.

So I'd say probably there's been inflation on the core glass, but as you know natural gas prices have come down so that's helping offset some of that other inflation.

Got it, and then as far as uses of cash, you threw out the idea of a dividend, potentially tuck-in acquisitions.

Is there a leverage level at which point in time you would be comfortable entertaining those options?

Yes, I mean generally speaking, right now and this is guidance that we gave out before the Crown deal came up, our guidance now is to have our optimal leverage ratio between 3 and 4 times, which is pretty much where we've been running.

I think for the last few years or so we've been right in the middle there.

I think when the Crown deal closes, we may reassess that, because we've got a lot more free cash flow and a very consistent cash flow stream from Crown but I don't think it will be far off.

We'll probably narrow that range because 3 to 4 times is pretty broad.

That's why we've said right now we're at about 3.5.

When Crown closes we'll be at about 4.5 times and within 12 months, we can get that number down closer in between 3.5 and 4 times, so because we'll have all that beer cash flow coming in, we continue a good job on generating cash flow in wine.

Got it, thank you.

Your next question comes from the line of Vivian Azer with Citigroup.

First question has to do with the second quarter puts and takes that you saw in the beer business.

One, can you quantify the volume pull-forward and number two, can you quantify the income benefit from the St.

Pauli Girl?

Sorry could you repeat the first half of that?

It was choppy.

Sorry.

Yes absolutely.

I was hoping you could quantify the volume pull-forward that you felt in the beer business in the second quarter, and then can you quantify the income benefit that you saw?

Yes, the income benefit from the volume pull-forward or from St.

Pauli Girl?

St.

Pauli Girl.

The volume pull-forward, it's a shift from Q3 to Q2, and it was probably worth just slightly less than half the volume growth that we experienced in the quarter, and it's a tough thing because it's very subjective calculation, let's put it that way, because you're comparing to something that really didn't exist.

How much did people pre-order, it's a judgmental call, but we would say I think beer grew 8% in the quarter.

It was probably 2% to 4% of that growth, was probably the volume pull-forward, and as I said that will modify the growth that we would have experienced in Q3, so it's moved from Q3 to Q4.

St.

Pauli Girl from an absolute volume perspective, annually was probably 1.5 million to 2 million cases, right?

So you'd say, gee, that's not a big number to 170 million cases, but from a growth perspective, right, it went to zero this quarter, and so it probably held back our growth by about 1% for the quarter.

Great, but you mentioned that because St.

Pauli went away there was some kind of one-time income benefit?

Correct, and that was part of my first-half, back-half story so there was one-time income in the second quarter, roughly speaking, because if you saw for the second quarter, EBIT grew a lot faster than sales for the Crown business.

If you strip out that St.

Pauli anomaly I'd probably say income probably grew pretty much in line with net sales.

And in the back half, of course, we don't have the St.

Pauli Girl volume which we had in the back half of last year, and of course, we won't replicate that one-time payment so that's why the second half for beer won't be as strong, one of the reasons second half won't be as strong as the first half.

Understood.

That's perfect.

That's exactly what I was looking for.

The second question has to do with the portfolio composition in wine, and where you're seeing your outsize growth.

Rob you ran through a number of different brands that really hit a bunch of the different price points in your portfolio that are all growing very nicely, but I'm curious if we thought about your portfolio from a value, mid-tier and premium, where is the majority of your growth coming from, from a price point perspective?

First of all the vast majority of our portfolio, Vivien, is premium-plus, so value is not, we don't really play in the value category at all, which is the under $5.

Right now, we're experiencing market share growth across pretty much the entire premium-plus category.

Our strongest growth right now, and this is merely what I'm saying is really factual, our strongest growth right now is in the premium category which is the $5 to $8 range and we're seeing really, really strong growth in pretty much three brands that are driving that big time, which is Black Box, Rex Goliath and Woodbridge by Robert Mondavi, Woodbridge being one of the largest brands in the entire wine business, so that's very positive.

A really good thing is that we're seeing market share gains in the super premium category as well, which is really one of the key sweet spots of the entire business, so call it $8 to $12 and we have made some really, really good progress there with reintroductions of our brands like Robert Mondavi Private Selection, with new packaging and new products.

A lot of our NPD is in that super premium category with things like, Simply Naked is a good example of that, so we're really seeing strong growth there as well and that's important, because we have the largest market share of that particular category.

We're also seeing good market share growth in the next category up, okay $12 to $15 which is the ultra premium category where some of our brands like Clos du Bois play and some of our new products like Dreaming Tree, Thorny Rose.

So we're really in the main part of the business, $5 to $15 we're taking share across all of the categories, and we're growing well in all of those particular price points.

Luxury may continues to grow as well, and there it's a really small part of the business, constitutes something like 3% of the total business, it's important to us.

We've got great brands.

In some cases, we're a bit volume-constrained in that segment, especially in the $20 and above which is not untypical, but again, we're getting good growth out of that as well.

Understood, but fair to say that your $5 to $8 is growing faster than $8 to $12?

Yes.

Okay, thank you.

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

A couple of questions, transaction-related and one back on Crown underlying business question.

Regarding the transaction, if we imagine day of close, can you give us a sense, is 4.7 or so a good number for net debt, trying to project out a borrowing cost there, what's a good number for net debt assumption and weighted average borrowing cost?

Is around 5% a good number knowing what we know today about interest rates?

So Mark, is your question what the interest rate would be just on the incremental Crown debt, or like the all-in rate at that point in time?

The all-in.

Yes, my guess is it will probably be around 5%.

I can't do the math in my head, but you're adding the incremental debt at 3% to 3.5% and right now we're just under 6%, so you just have to do the weighted average on that.

Okay, great.

And then same kind of question.

Long term effective tax rate, you're saying 30% for this fiscal year.

Is that a good representation from a GAAP perspective of what your effective tax rate with Crown wholly-owned would be or are you getting some special benefits again from a GAAP perspective in this Fiscal Year.

Simple question, long-term effective tax rate from a GAAP perspective post-transaction?

Yes, I'd say, look as I said, our tax guys have done a great job over the last four or five years, and generally speaking a 30% effective tax rate is kind of where we've been around.

We're primarily a US business, and actually we have a lot of presence in high tax states.

A lot of the tax benefits that you've seen over the last few years were due to our international business, our international footprint of course is much diminished versus prior years, so I'd say medium long-term going forward, our tax rate would get up closer to a US statutory tax rate, which is more in the, say, 37%, 38% range.

Longer term?

Yes.

Great and then talking a little bit more about what's going on with the brands within Crown, I'm not sure I followed the St.

Pauli Girl.

Are you saying ex-St.

Pauli Girl low-to-mid single digit underlying depletion growth for the whole Crown business in the quarter?

Well so -- sorry for this complexity.

I'll try to make this answer not too long.

St.

Pauli Girl wasn't a big piece for us but when something goes from something to zero, it hurts growth.

But the other thing to remember, so Crown had just over 2% depletion growth for the second quarter, but the other thing to remember, if everyone remembers in Q1 and this was a total beer industry thing, Q1, the beer industry saw really high growth.

I think the beer category in IRI was something like 8% or 9%.

I think Crown in the first quarter was something like 12% or 13%.

I think some of that was timing, Q1 versus Q2 so I think for the full year what we're saying is Crown should grow its top line around 3% to 4%.

St.

Pauli Girl, Crown has just under 170 million cases and St.

Pauli Girl was between 1.5 million and 2 million cases and St.

Pauli Girl did exist in the first quarter but not in the last three, so that's how the numbers pan out.

So I'd like to travel a little there.

So depletions in the quarter, including the benefit of St.

Pauli Girl, were plus 2% is that what you said?

Mark, it's pretty simple, okay?

About 2% depletion growth in the second quarter would have been 3% growth, around 3% or another 1% of St.

Pauli Girl was there.

It's no more complicated than that.

That's what I'm trying to understand.

Excluding St.

Pauli Girl, depletions for your Crown business were what?

Up about 2% to 3%.

Got it, okay, great.

Can you just talk a little bit about --?

Just add 1% if St.

Pauli Girl had been included, which it is not.

Got it.

So core business, plus 2% to 3%.

And can you talk a little bit about the dynamic where you've got this big brand Corona that is back to growth, low growth, but growth nonetheless and then the smaller brand Especial, can you talk a little bit more about how you think that dynamic is playing out today, and the outlook there?

Yes, I think the dynamic is playing out very well.

I mean, Corona is a big brand.

It's the leading import brand in the United States.

Corona Extra is back into growth, which is a testament to how strong the brand is.

Modelo Especial is the third-largest import brand in the United States, and probably the hottest, significant beer brand, the hottest significant beer brand in the country today.

Continuing to grow at strong double digit rates, taking advantage of almost every positive trend that you can imagine, interest in Hispanic or Latin American products, the growth in the Hispanic population, which is going to be particularly strong, it's skewed almost entirely Hispanic, it's now growing in the general market.

I fully expect Modelo Especial basically to become the next Corona.

It's number two in the C-store channel which is the largest channel for beer at the current moment in time.

At its current growth rate versus the competition, I fully expect in the next relatively short period of time a couple of years it will become the number-two import in the United States, and it's an exciting part of our portfolio, so that's how we think that's going to play out.

We also have very good growth in some of our other brands like Pacifico, which is really seeing some positive results on the West Coast in particular, and Corona Light is the number-one imported light beer in the country, in the United States, so a lot of really good things.

We've introduced draft into a number of our product lines, which is going really well.

The Corona Familiar line extension, which is the 32-ounce bottle, is, I've got to say, a huge hit, okay, bigger than we expected, which is helping to drive the Corona Extra growth, great addition to that portfolio.

And then we have some new products that we're introducing.

Cider is hot right now.

We've got a great new cider brand that we're introducing, Somersby.

We expect that will be very favorable, the Victoria introduction over the last year, couple years has gone well, so the portfolio is working well on all fronts.

That's great detail.

Thank you Rob, thanks Bob.

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

Just two questions.

One, a follow-up on Mark's question on the tax rate.

Just the tax rate going to 37% to 38%, is that for next year or is that medium term?

I missed a little bit of that.

Yes, Mark we aren't giving guidance for next year yet so I'm just giving a medium to longer-term number.

Okay, and then the benefit you got this quarter on the tax rate, I'm just going back to where we were on the fourth quarter, when we were looking forward to this year and the tax rate was going up.

Were the benefits that you received this year a bit of a surprise to you, versus what you were looking at going into the year?

Well yes, I mean because we gave 34% guidance, and now we're going with 30% guidance.

Surprise probably isn't the right word.

Our tax guys are always working on a lot of different things and they all have different probabilities, and they all have different timing aspects.

So I'd say certain of the planning opportunities moved up in timing, and got better on probabilities.

Okay, and then just one question on wine, if you look at the industry now, where there's pricing at the $5 and below level and pricing in the industry above $15, do you think that's driving demand into the $5 to $15 price point or price segment in general?

Yes, I think that it potentially has that impact.

I think you see the overall growth rate in wine slowing down a little bit right now.

I think that's definitely as a consequence of the below $5 but if you start looking at the growth rates of premium-plus it's growing well, and yes I think that there could be a little bit of a shift there from plain varietals and below into premium plus.

Okay, great.

Thank you.

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

My question goes back to some comments on Crown and your raised guidance for mid single-digit operating income growth.

I think you well explained depletions in the buy in, but I was just curious as we look at the second half relative to the first half, how should we think about marketing spend, promo spend if there's a big difference as far as how that's weighted, and also too, it seems like you downplayed a bit the ability to take pricing.

I'm not sure if you're willing to give what pricing you're doing, but it seems like the industry is firming up a bit and there are more opportunities for pricing.

So I was just curious how you think about taking that either this year or maybe even any preliminary comments on next year on pricing?

Yes, so there is some marketing timing expense for Crown front half versus back half.

Remember first quarter we actually had some negative marketing impact.

We took more marketing expense this year than last year.

Second quarter, that was kind of the opposite, and in the back half I think we will see an increase in marketing spend, mostly in the third quarter.

We also have some selling days differences.

The back half of this year has more selling days than the front half, as compared to last year, so actually, sorry, it's the other way around.

So the front half of the year had more selling days than the back half so that will hurt the back half, and we also have some SG&A timing front half versus back half, so net-net, a reasonable amount of noise through quarter movements but net-net, the beer business is doing better than we originally anticipated, which is why we have increased the full-year guidance from low-single digit growth to mid-single digit growth.

And on pricing?

Yes, pricing I've already answered that.

I think Rob has already answered that.

We aren't doing anything differently than we've done historically.

We look at it regionally, depending on what the competition does, and we run our elasticity calculations and decide what should we do versus the competition.

I guess I'm just trying to get a sense if you see things firming up generally in the US, and you were very slow to take pricing for awhile, if the opportunities are greater.

Yes, I'd say that you got to remember we're a distant third volumetrically in the beer business.

We're definitely not a price leader, and much like the wine business, our primary interests and strategic imperatives are brand health and growth, so our pricing is pretty modest.

Okay and if I could just lastly ask, your comparable EPS guidance went up, but your reported EPS guidance went down.

Why was that?

That would just be the difference that's in the back of the press release for comparable items.

Okay.

Thanks.

It's year over year comparable items, right, so it gets a little complex.

Okay.

That's fine, thank you.

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

Just a quick question on the distribution side.

The full distribution strategy, are you -- is that pretty much finished at this time?

Are you near completion of that project?

Yes.

It's pretty much finished so in the first phase of that, we did about 60% of the business.

In the second phase, which we've completed that's another call it 8%, 9% of the business, 8% of the business, so we're up to about 7%.

And the rest of it is not really, there's not much we could do.

There's a few states that we'll work on, but there's really not much we can do, because it's either control states where we have brokers and not distributors or it's franchise law states where we can't make any move, so it's pretty much done.

Okay, great.

That's all I had.

Thank you.

That was our final question.

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

Thanks everybody for joining our call today.

As I mentioned, we are very, very excited about the prospect of owning 100% of Crown Imports, the number one beer importer in the United States.

And I'm also very pleased with our operational execution so far this year.

We're growing our market share for our respective wine, beer, and spirits businesses, and as we are experiencing strong marketplace momentum across our entire product portfolio, and our new products and innovation initiatives continue to gain traction in the marketplace.

Overall, we believe we are well-positioned for market execution during the upcoming holiday, selling season and throughout the second half of the year.

Our next quarterly conference call is scheduled after the New Year, so please be sure to enjoy some of our great products during the upcoming holiday season.

Thanks again, everybody, for your participation.

Thank you.

This concludes today's conference call.

You may now disconnect.