Constellation Brands Inc (STZ) 2014 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Constellation Brands' third quarter fiscal year 2014 earnings conference call.

(Operator Instructions)

Thank you.

I will now turn the call over to Patty Yahn-Urlaub, Vice President of Investor Relations.

Please go ahead.

Thank you, Laurie.

Good morning, everyone, Happy New Year.

Welcome to Constellation's third quarter fiscal 2014 conference call.

I am 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.

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 impact Company's estimates, please refer to the news release and Constellation's SEC filings.

And now I would like to turn the call over to Rob.

Thanks, Patty, and good morning and Happy New Year, everyone.

Hopefully everybody enjoyed the holidays, and had an opportunity to drink some of our Constellation products this holiday season.

Welcome to our discussion of Constellation's third quarter fiscal 2014 sales and earnings results.

Before we get started with a review of the quarter, I believe it is worth noting that for a second consecutive year, Constellation's stock was the best performer in the S&P 500 Consumer Staples Universe, as well as one of the top performing stocks within the overall S&P 500 index, increasing almost 100% for calendar year 2013.

We believe that the realization of significant benefits from the beer business acquisition, along with excellent execution within Crown's US commercial business are the key driver of this stock price appreciation.

In addition, we have successfully completed the transition of our new brewery in Nava, Mexico.

Beer operations are running smoothly.

The supply chain is operating efficiently, and all key performance metrics are being achieved at the brewery.

As you know we are in the initial phase of the brewery expansion project which will include the build out of the brewhouse packaging, warehousing, and site infrastructure.

Although we are in the early stages of this process, I am pleased to report that all design work for the brewery and the packaging area has been completed, and we are currently finalizing warehouse expansion details.

In addition, stainless steel is being fabricated for the beer tanks, and we have begun grading of the site in preparation for the building construction.

From a commercial beer business perspective in the US, Crown had a phenomenal quarter generating sales growth of 21%, while continuing to gain market share.

All four Mexican brands posted notable depletion growth during the quarter, with their two most significant brands Modelo Especial increasing 18%, and Corona Extra growing almost 6%.

Depletions for the draft beer business increased more than 30%, and after repositioning Victoria in key markets and expanding into select new markets, this brand has regained momentum posting depletion growth of greater than 20%.

Overall, excellent sales and depletion results for Crown were driven by a number of factors, including continuing strong consumer demand for our outstanding portfolio of brands, an increase in third quarter shipments to replenish distributor inventory levels which were running below normal after this year's robust summer selling season, an easier comparison versus last year's third quarter due to the timing of shipments in the second quarter of fiscal 2013 in advance of price increases in select markets, and excellent execution by Crown wholesalers who now have the assurance that Constellation will be their long-term business partner since the closing of the beer deal.

The renewed momentum we experienced during the summer selling season particularly for the Corona brand continued throughout the fall and into the holiday selling season.

We believe this strong consumer demand was driven by the combined success of a number of marketing initiatives, including execution of the new TV advertising including the Some Beaches campaign, Jon Gruden TV ads featured during Monday Night football games, and new Spanish language creative which was aired on TV during Mexican national team soccer matches and other key programs on Spanish-language networks.

Corona also sponsored the Mayweather versus Canelo boxing fight supported by TV advertising and limited edition 18-pack wrapped bottles, which resulted in strong execution in Hispanic accounts.

Corona Extra has now become the fifth largest dollar share brand in IRI channels, and continues to grow and gain share.

The strong momentum of Modelo Especial also continued throughout the quarter.

New SKU and innovation including Modelo Especial Chelada are driving consumer trade-up within the overall portfolio, and bringing new customers into the franchise.

New Spanish-language TV advertising was recently introduced to support the newly-released Modelo Especial Chelada, which has significantly exceeded volume and distribution targets in its launch markets.

Modelo Especial draft, Crown's second-largest draft brand after Pacifico grew 30% -- 35% during the quarter.

Overall, the strong results that Crown has achieved this year are the primary driver of the upward revision to Constellation's overall EPS guidance for fiscal 2014.

As such, we are also revising our fiscal 2014 forecast for the Crown business, and now expect beer depletions to increase mid-single digits which will drive sales growth in the high single-digit range, with operating profits expected to increase in the low to mid-teens range.

And now I would like to focus on the operational results for our wine and spirits business.

As we noted earlier this year the performance of our wine and spirits business would be skewed towards the second half of the year to align with the peak seasonality of the business, as well as new product introductions.

I am very encouraged by the acceleration of depletion trends during the third quarter and the fact that on a year-to-date basis, we are outperforming the US wine market on a volume basis across all channels.

These results were driven by some of our key focus brands that continue to achieve noteworthy accomplishments, a few of which I will highlight.

The 2011 Robert Mondavi Oakville Fume Blanc was recently awarded a 95-point score and a top 100 wine for 2013 from Wine Enthusiast.

The 2010 Robert Mondavi Cabernet Reserve received 95 points from Robert Parker of the Wine Advocate, who also liked the Franciscan 2010 Magnificat, which was awarded a 91-point score.

Wine.com, the nation's number one online retailer recently released its top 100 list based entirely on consumer preferences.

Some of the great Constellation brands that made the list include Robert Mondavi Napa Cabernet, Ruffino Modus, Kim Crawford Sauvignon Blanc, and Franciscan Cabernet Sauvignon.

Impact recently presented blue-chip awards for Estancia, Robert Mondavi Private Selections, Svedka, Ruffino and Kim Crawford.

Constellation received 37 medals across all brands submitted to the 2013 World Value Wine Challenge, the nation's most comprehensive competition of wines priced at less than $20.

Gold medals, 90-plus point scores and Best Buy distinction were awarded to Robert Mondavi Private Selection, as well as Rex Goliath.

Overall, third quarter segment net sales for wine increased 3% driven by the US wine portfolio, with depletion trends for the entire portfolio growing more than 4%.

Third quarter spirit sales declined by 5%, and can be primarily attributed to an unfavorable comparison versus last year, when we had the benefit of some bulk bourbon sales.

However, we experienced improving spirits depletion trends in the third quarter as some of our investments took hold for this business.

As a matter of fact from a consumer takeaway perspective, across all channels during the third quarter.

Constellation's overall spirit growth of more than 5% exceeded the category growth of about 1.5%.

Svedka depletions grew in high single-digit range during the third quarter, while gaining almost 2 points of volume share of the imported vodka category in IRI channels.

We are currently preparing to introduce the next two new Svedka flavors, strawberry lemonade and mango pineapple, which are expected to launch during the first quarter.

The new Black Velvet Cinnamon Rush which launched early in the third quarter is performing well, and is one of our top performing new SKUs from a distribution perspective.

Since the closing of the beer deal, we have also begun to leverage our sales and marketing efforts across our beer, wine and spirits business.

For instance, Svedka and Corona joined forces for a national on-premise program showcasing the Svedka Coronation cocktail This delicious proprietary beer cocktail harnesses the popularity of these two key brands, and leverages the joint on-premise efforts of our organization.

Corona Extra and Woodbridge by Robert Mondavi recently partnered with Butterball, in a major cross portfolio program that leveraged the power of the two strongest brands in our portfolio.

This fully-integrated holiday promotion began in advance of Thanksgiving, reaching consumers to display, point-of-sale material, and a unique turkey top line where consumers received recipes and pairing tests.

Now, despite this quarter's improving depletion results for wine and spirits, we will be unable to obtain our original fiscal 2014 operating profit goal for this business due to the following factors.

The positive mix trends that we anticipated earlier this year have not reached the targeted levels, as our premium priced products are growing faster than our super and ultra premium priced products, and we have invested more than originally anticipated in promotional activity, as the key $5 to $15 price point at retail remains competitive.

While we are disappointed that the wine and spirits business will not achieve its expected profitability goals, the hard work and significant accomplishments we have made throughout the last few years have favorably positioned this business heading into next year.

Overall, our wine and spirits strategy has been the focus on brand building, and maintaining market share to ensure that our business remains strong and healthy.

Strong competition for some of our key brands has necessitated higher promotional spend to meet this objective.

We expect this strategy to reap rewards in the future, when market dynamics begin to enable lower levels of promotional activity or more favorable pricing environments, as our brands will be in a great position to capitalize on these trends.

Meanwhile, our focus on new product development and innovation, as well as channel development and execution to continue to contribute to our future growth while we remain committed to brand building in our core business.

We believe these initiatives will drive enhanced mix results, while we also expect to begin to realize benefits from abating grape costs.

Collectively, these actions are expected to drive EBIT growth of the wine and spirits business in the future.

In closing, as a true triple threat in beer, wine and spirits, we have ushered in an exciting new era of growth and opportunity.

We are progressing with the brewery expansion in Mexico while maintaining the strong momentum of Crown's US commercial business.

We have a great premium wine business, and plans in place to work through the current set of challenges we are facing.

I am especially gratified by the fact that Constellation was the best performing S&P 500 Consumer Staple stock in calendar 2013 for the consecutive year in a row.

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

Thanks, Rob.

Good morning, everyone.

Our comparable basis diluted EPS for Q3 came in at $1.10.

This represents a sizable increase versus Q3 last year, as we continue to realize the tremendous accretion attributable to the beer business acquisition which is significantly enhancing our sales, operating profit, operating margin, and free cash flow.

Our Q3 results also benefited from a lower than anticipated tax rate driven by higher than expected foreign tax credits.

The strong marketplace momentum we experienced over the summer for our beer business continued into the fall timeframe.

This has helped to drive year-to-date financial performance ahead of our expectations, and is the primary driver for the upward revision to our fiscal 2014 EPS guidance.

Favorability in our tax rate and interest expense expectations are also contributing to our improved EPS guidance.

The positive guidance factors that I just noted are being somewhat offset by our wine and spirits business, where fiscal 2014 financial performance is expected to come in below our original expectations as Rob just noted.

We will look closer at the guidance highlights just mentioned, as we review Q3 performance in more detail.

My comments will generally focus on comparable basis financial results.

As you can see from our news release, consolidated net sales in Q3 included $662 million of incremental net sales related to the beer business acquisition, as we consolidated 100% of beer sales for Q3.

For Q3, beer segment net sales increased 21%, primarily due to volume growth as highlighted by Rob.

These results are somewhat enhanced by an easier than normal sales comparison versus Q3 last year, when net sales increased 1%.

Depletions were strong at 10% growth for the quarter.

Wine and spirits net sales on an organic constant currency basis increased 3%.

This reflects a 4% increase in branded wine and spirits shipment volume, partially offset by higher promotion expense and lower bulk spirits sales.

For the quarter, consolidated gross profit increased $298 million.

As you know, under the Crown joint venture structure, we recognize our share of Crown's earnings on the equity earnings line.

Since the close of the beer transaction on June 7, 100% of Crown's results along with the Mexican beer production profit stream are consolidated by Constellation.

Incremental gross profit from the consolidation of beer was $301 million in Q3.

This produced a beer segment gross margin of 45% for the quarter, based on the incremental beer sales discussed earlier.

For the quarter, our consolidated gross margin was 42.4% versus 41% for the prior-year quarter.

The benefit from the consolidation of the beer business was partially offset by the lower gross margin in wine and spirits, which resulted from increased product costs and higher promotional spending.

SG&A for the quarter increased $96 million.

The incremental SG&A associated with consolidating the beer business was $88 million.

Essentially all of the SG&A for the beer business is related to Crown, as the brewery has very little costs classified as SG&A.

Based on what I just outlined, operating income generated by the beer business was $213 million for the quarter.

This produced a beer segment operating margin of approximately 32%.

Since the close of the acquisition on June 7, the consolidation of the beer business results has produced a beer operating margin of approximately 30%.

The inclusion of the beer business results was the primary driver behind the 350 basis point improvement in our consolidated operating margin for the quarter.

Due to the timing of the close of the beer acquisition, we did not recognize any equity earnings for Crown during the third quarter.

For the prior-year third quarter, equity earnings for Crown was $39 million.

Equity earnings for the wine and spirits segment increased $4 million in Q3 of this year due to strong results for Opus One.

Interest expense for the quarter was $90 million, up 46% versus last year.

The increase reflects higher average borrowings as a result of the acquisition, partially offset by lower average interest rates.

We now expect interest expense for the year to approximate $325 million, which puts us at the low end of our previous $325 million to $335 million guidance range.

Timing of our cash flow generation and benefit from our lower-cost securitization facilities helped drive this improvement.

That provides a good spot to discuss our debt position.

At the end of November, our total debt was $7.1 billion.

This represents a $3.8 billion increase from our debt level at the end of fiscal 2013.

The increase primarily reflects the financing of the beer business acquisition, partially offset by some of our cash build in advance of the transaction, and our free cash flow generation.

During the third quarter, our debt balance decreased by $166 million.

I would also like to note that the calculation of the post-closing purchase price adjustment payment for the beer transaction has been finalized, and we expect to make a payment of $558 million in the second quarter of fiscal 2015.

In connection with this, the calendar 2012 EBITDA related to the acquired manufacturing and brand owner profits came in a little above the $370 million we had originally estimated.

Our Q3 comparable basis effective tax rate came in at 28%, which reflected benefits from integrating the beer business, as well as higher than anticipated foreign tax credits.

Given the additional foreign tax credits, we now expect the comparable basis effective tax rate to approximate 31% for fiscal 2014, versus our previous 32% guidance.

Longer-term, we continue to target a 32% effective tax rate as the brewery gets built out over the next three years.

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

For the first nine months of fiscal 2014, we generated $543 million of free cash flow, versus $337 million for the same quarter last year -- the same period last year.

The increase was primarily due to benefits from the beer business acquisition, partially offset by higher interest payments.

We are pleased with the strong year-to-date free cash flow results, but we expect brewery capital expansion investments to significantly increase in the fourth quarter.

We have updated our free cash flow guidance to reflect the improvement in our projected beer business results, and now expect to generate free cash flow in the range of $525 million to $575 million.

This puts us at the higher end of our previous guidance range.

Now I would like to move to our full-year fiscal 2014 P&L outlook.

We are now forecasting comparable basis diluted EPS to be in the range of $3.10 to $3.20 a share, versus our previous guidance of $2.80 to $3.10 a share.

Strong beer business performance is driving the upward revision to our fiscal 2014 guidance.

For fiscal 2014, Crown is now targeting net sales growth in the high single-digits, generally in line with what Crown has experienced on a year-to-date basis.

We now expect underlying operating income for Crown, which is before any beer manufacturing and brand owner profit, to be in the low- to mid-teens range.

Our brewery and brand owner profits are also expected to exceed original expectations.

Higher production volumes, favorable peso to dollar exchange rates, and lower than anticipated SG&A build are driving this favorability.

As mentioned earlier, wine and spirits performance has tracked below our original targets.

We now expect wine and spirits organic revenue growth to be in the low to mid-single-digit range.

The decrease versus our original mid-single-digit target is being primarily driven by higher than planned promotional spending and lower-than-expected sales mix benefits.

These factors are also driving a reduction in our wine and spirits operating income expectations.

We now expect wine and spirits operating income to be flat to down slightly from the fiscal 2014 results.

This is versus our original low to mid-single digit growth projection.

The EPS guidance improvement also includes tax rate and interest rate favorability that I highlighted earlier.

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

Before we take your questions, I would like to emphasize how pleased we are with the transformational beer business acquisition.

Our results continue to demonstrate how this transaction enhances our financial profile, as it significantly increases sales, operating profit, operating margin and free cash flow.

Our beer supply chain has been operating efficiently, and Crown's execution and momentum in the marketplace has been outstanding, driving the upward revision in our EPS goal, and positioning us well as we head towards the completion of a phenomenal year for Constellation.

With that, we are happy to take your questions.

(Operator Instructions)

Your first question comes from the line of Tim Ramey of Davidson.

Good morning and congratulations.

What an amazing couple of years it has been.

Thanks, Tim.

I mean, actually 15 years as I think about it.

You are a 20 bagger over the 15 years that I have followed you, so isn't just the last couple of years.

Let's see, the wine business did underperform a bit, but you made some comments that sort of were in line with my bigger picture thinking, which is that promotional spending will go down and pricing will go up in relationship to the tighter overall supply.

The 2013 crop was big, but longer-term I think that that thesis is correct.

Can you comment at all on that?

Yes.

I would say that, we agree with that thesis.

It depends, of course, what segments that you are talking about historically, or at least in the last 12 months.

We have seen sort of the $5 to $15 segment be fairly competitive, which in our view necessitated some additional investment in promo this year.

Because our principal goal and strategy is really all about brand-building, and making sure that we keep our portfolio healthy, precisely so that we can take advantage of the kind of trends that you were talking about.

So we feel pretty good about that thesis, and layered onto our strategy, is pretty robust new product development process and initiatives, also designed to continue to enhance our mix and our margins and ROIC as well.

So we think that sort of the combination of -- the expectation of an improving environment combined with some NPD intended to, as I said drive mix and margins is a pretty good formula for success in the future.

And if I could just follow up.

One on the beer side, I think you said Corona's depletions were like 6%.

Would that be indicative of kind of the pre-innovation number in the beer business?

Should we kind of be thinking that baseline business was up 5% or 6%, and innovation drove it higher to the 10%-ish level?

Well, I wouldn't really call that baseline performance per se, even inclusive of the NPD.

I mean, that is very, very strong performance.

We would probably say that for the longer term, it is fair to count on, or to expect more like mid-single-digit growth in total over the longer run.

But clearly, we are significantly outperforming that due to very strong consumer takeaway.

So it is a little hard to predict right now.

Terrific.

Thank you.

Our next question comes from the line of Alice Longley of Buckingham Research.

Good morning, congratulations.

Thanks, Alice.

I have a little housekeeping question, and then another one.

In terms of your beer shipments, you had 4% price mix.

I am wondering if it is reasonable to think that the level of shipping to the retailers, there was also 4% price mix on top of the 10% volume growth for beer?

And then, can you take apart the 4%?

How much of it was price and how much mix?

Yes, Alice.

What I would say is that, there might have been some anomalies year over year in the quarter, but our price mix in beer is consistent with what we have been talking about all year.

And that is probably right around 2% is where we will kind of end up at the end of the year, similar to last year's.

Okay.

That's helpful.

And that was all price, right?

Because mix is maybe even a little negative?

It was mostly price, yes.

Yes.

And then my other question is a longer one.

Your -- the only guidance you have given for where beer margins ultimately can go is, I think you said the low to the mid-30%s by fiscal 2017.

That is starting to look a little conservative.

Can you comment on that, where you think beer margins ultimately can go for you, now that you know more about the business?

Yes.

So again, this quarter it was a fantastic quarter, so I would be careful to extrapolating that into the future.

But we right now have no reason to change that beer operating or gross profit margin guidance.

And remember, we are still new to the manufacturing of this, and as we build out the brewery and double the capacity, there is still some unknowns on what would happen.

We were fortunate this year also, that the peso/dollar exchange rate turned out to be much better than it was when we originally set guidance.

So we are still sticking with that beer operating profit margin guidance, and as we learn more -- because remember, a big piece of our finished goods is not produced by ourselves, and we have less than perfect visibility into the cost structures of those, when we take that over.

So there is still a bit of grayness in there, so we are sticking with that guidance.

Okay.

Appreciate it.

Thank you.

Our next question comes from Bill Chappell of SunTrust.

Good morning.

This is Sarah Miller on for Bill.

Hello, Sarah.

Hello.

One of my questions is on do you have any visibility into what your timing of marketing is going to be, I guess, from a -- over the balance of the next year for the beer business?

I could say -- well, I mean, this year I think we made a concerted effort to really take advantage of the peak summer sale season, and we kind of moved some of our marketing activities to that period of time.

I think we are very happy with that result.

So and actually at this time of year is, when we are really nailing down next year's plan, so it is not completely formulated yet, but I think we are pretty happy with this year's results.

So there could be good probability that we replicate this year's timing of marketing spend.

Okay.

And then a second question on, can you talk about the status of the draft opportunity at this point?

I know you mentioned that Modelo draft was up 35% in the quarter.

Where is Corona Light, and kind of where are you seeing that success there?

Yes.

So in total, we are very happy with our draft business.

And in addition, as we get into accounts with draft, we do see some evidence that it helps our case sales as well.

It is a very good marketing point to have those tap handles in front of the consumers as they are enjoying our products on-premise.

But this year total draft is growing about 30%, and actually our largest draft product is Pacifico.

But I think we are expecting great things from Corona Light draft, which we were in test market last year, and we are rolling that out nationally as we go forward so we probably expect Corona Light to be our biggest draft brand, followed by Pacifico, and then I think Modelo Especial is closely behind that.

But we see great things for our draft business.

And Corona Light starts to roll out now or next month or -- ?

It is rolling out as we speak.

Okay.

Thanks so much.

Sure.

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

Good morning.

Good morning, Mark.

Two questions, one on beer, and then over onto wine and spirits.

On the beer side kind of following on the last question, can you give us a little more color on what in your opinion is really driving this improvement in the Corona trend, the acceleration there, and similarly what is driving the accelerating trends for Especial?

I think there is a number of things going on here, at a number of different levels.

First of all, it is -- a little bit of success breeds more success, especially with our wholesale customers who now I would say, have the assurance that they are going to continue to retain these brands as they are going to be partnered with Constellation.

As you can well imagine, the rest of the beer business which constitutes very large portions of their business, is pretty lackluster and down.

So our wholesalers are really looking at our business as being the only material business that they have, which is really driving growth and profitability for them for the future.

So I would say that they have really gotten behind it in a big way, which from a push perspective is really driving the continued expansion of the brands at retail, and with the consumer I would say.

Number two, our marketing of these brands has been very strong.

Our investment behind these brands has been strong, and really we are seeing sort of better brand health for these brands than we have ever seen in their history.

And I think that that's translating to improved and better consumer takeaway.

Something that I have said in the past that I think differentiates us from a lot of the competition is beer, is that we have had a very consistent message to the consumer about what these products stand for year in and year out that has resonated with the consumer.

I think that -- as I have said, that is a differentiating factor versus the competition, which has kind of been all over the place trying to find some hook with the consumer in a market that has been down overall.

So, but the better beer market is the place to be, and we are the largest player in the better beer market.

The consumer is definitely also trading up in beer to more premium products, and we are reaping the rewards of all of these trends, as well as our own good marketing and sales execution, and as well as having a very strong distribution network behind our brands in a way like they have probably never gotten behind any brands in the past.

That's great.

If I could on that topic before I go over to wine and spirits, when you look at Especial specifically, can you speak to how the brand is doing when you factor out the ACV gains you are getting?

Well, we think that the -- look we don't have -- those numbers are very hard to really ascertain across the whole business.

But to put it very simply, I believe we have got two things going for us which is number one, gains in ACV which are driving growth in the brand, as well as gains in velocity per point of distribution.

So I will put it in simple terms, I think that we have got growing same-store sales as well as growing distribution.

So you are basically are hitting on all cylinders as far as that goes.

Got it.

Great.

And then over on wine and spirits, this promotional, need more money, has been going on for a number of years.

How are you thinking about the earnings algorithm for that business that you put out there back in June?

Do you still feel good about that?

Is it kind of a work in process?

Can you speak to how you are thinking about that algorithm?

I appreciate the comments on inputs coming down, but when you net it altogether, how are you thinking about that?

Yes, I would say that we feel very good about the algorithm, and we stick by it.

I would say that we are disappointed.

We don't feel good about the fact that we are probably a bit behind in achieving the algorithm.

But I think as a general proposition, we feel probably more confident than ever as we go into next year and the year after that we will be able to grow the profits in this business.

So look, we have been making some calculated decisions to invest behind this business and focus on brand-building and brand health, so that the business stays fundamentally healthy.

I think that as far as the wine business goes, we have got the best and healthiest wine business in the industry.

I think fundamentally the category is a great category, growing faster than almost any other consumer staple category, taking share from the other category.

We know that that is offset to some degree by some negatives around fragmentation and lack of brand loyalty, in the same sense that it exists in certain spirit segments and beer segments.

But nevertheless, it is an extremely strong consumer segment that has backing of the retailers.

We are the major player in premium wines, and I think that as Tim Ramey expressed, what we believe is going to be the trends for the future.

So I think we are going to be able to translate our strong position in wine, not only into sales and market share growth, but into profit growth as well.

So we feel good about it.

So the final thing here, and I appreciate -- I apologize I am taking so much time here.

But the -- a bit of a disconnect here with this year being flat to down slightly, next year you are basically saying, you get back in terms of profit growth in wine and spirits, and that is a function of inputs improve?

Like if you had to put something at the top of the list, why are we supposed to think that that business from a profit growth perspective is going to get better?

Yes.

So I will give you two simple answers to that, which is businesses continues to grow nicely, number one.

We probably don't see this need for increasing promotional activity in the future, and input costs which were significantly higher this year will not be significantly higher next year.

So the conditions are pretty good for profit growth.

Fair enough.

Great.

Thank you, Rob.

Your question comes from the line of Robert Ottenstein of ISI Group.

Great.

Thank you very much.

Congratulations on a phenomenal quarter.

Can you remind -- a couple questions, can you remind us what percentage of your beer sales are draft right now?

It is a very low 2% or 3%, whereas the industry overall is at 10%.

Yes.

So it is -- (Multiple Speakers).

Pretty small.

Right.

And what exactly -- I mean, there is a huge competition, right, for new taps, or for -- on the handles of with craft and everybody else.

What is actually your strategy in terms of -- what do you have to do to get people to change out?

Well, I think the great thing is that historically there is very pent-up demand for taps from our portfolio, because we have had no draft, and our on-premise retailers have been calling and begging and asking for drafts for many years.

We didn't have it historically, because it was the strategy of the owner of the brands, Modelo, prior to our acquisition of them to not have draft in the United States.

We didn't think that that was a great position and we disagreed with it, but fundamentally we didn't have any choice there.

So since we gained control of the brands, we have introduced drafts.

I think it has turned out to be a very good choice, and has been completely additive to the business, as opposed to cannibalistic, especially given the brands that we have focused on for drafts.

So we don't have any trouble getting draft handles in the on-premise.

So it doesn't take much of a strategy, given that it is a called-for item called for items in most cases, as opposed to a push item.

Think about the craft business, okay?

You re talking about tiny little brand that nobody has ever heard of outside of their city in most cases.

So, yes, that requires a strategy to get people to put taps in on brands that nobody has ever heard of in a crowded and fragmented category.

In our particular case, you are talking about the largest import brands that haven't had drafts and now have drafts, that have a lot of consumer acceptance.

Which in fact is actually building and growing, and therefore our retailers are calling and asking for the taps.

Yes, that makes a huge amount of sense.

Is there any reason to think that draft can't get the 10% of your business over time?

I would say there is no reason to think that draft can't get to 10% of our business over time.

Yes, the only pause for that is, the Corona Extra strategy, which is very unique in the beer marketplace, because it is so well developed, and the bottle is so much of the brand equity.

So we will go slowly on that.

But other than that, it is a go for everything we can get.

Terrific.

Moving to the wine business, is there -- can you give us a sense of how the innovations are being received in the marketplace?

And how -- and whether it is -- given the tremendous proliferation of SKUs in all of the categories, beer, wine and spirits, is it more difficult today to get new products out on the shelves than it was a few years ago?

Well, first of all, to the first part of your question, NPD is an interesting and tricky business of, and you don't expect to have 100% success in NPD.

It is sort of the nature of the animal.

You have to have a good pipeline of it, to get the occasional successes.

And I would say that, true to that, we have got some really good successes.

I think that if I was to cite what I think is our number one success rate now, it is our brand, the Dreaming Tree which is our joint venture with Dave Matthews, which we think is going to be a blockbuster brand in a very mixed accretive segment.

We have got other NPD, which I think is very solid like our brand, Simply Naked.

For instance, in the super premium category, we have introduced some new products of late, where we are seeing some very positive sides of product called Besieged, which is a Sonoma product from our Ravensworth winery which we actually saw a lot of success with.

We have got a new product called Saved, which we are very hopeful for.

We have got an on-premise product called Hidden Crush.

We introduced a new brand targeted towards millennials in the super premium category called Milestone, which we are seeing some early signs of success.

So it is a little early to call.

We have had some really good successes I think.

As I have said, like Dreaming Tree is our number one success, and then we have got a lot that we are in the process of developing at the current time.

And our -- I would say, have seen some early signs, and are hopeful that we will have some good successes in our pipeline.

And is it -- but is it more difficult now to get the shelf space than it was in the past?

I think it depends who you are.

So as a general proposition across the industry, I would say, yes, because of the amount.

Even though if you really kind of look at what percentage NPD constitutes of the business, it has been pretty stable in wine for quite a number of years now, running at around 6%.

So it seems like there is a lot of proliferation, but it has generally been the case for a long time.

Now I would say, it depends who you are.

I would say for the leaders in the industry that have strong distribution relationships, and even more importantly, strong key account relationships, the answer is that we can get distribution on our new products.

And across the total beverage alcohol business, wines, beer and spirits in the United States, there is really only a few leaders in what we call category management.

Only a couple, okay?

There is two or three companies, ourselves, and a couple of our other competitors are the only companies that have world-class category management.

Which really means that we are the leaders in having the relationship with the key accounts that are going to matter for the future.

And clearly, there is a shift going on in the business away from smaller liquor stores, mom-and-pop stores, consumers purchasing product at the large chains and mass merchandisers.

And I would say that, as a consequence of a large organization geared against that, and years and years of developing those relationships, we enjoy very strong relationships with those key accounts.

So we can get the distribution.

Great.

And that's great, and one follow-up on that.

I saw that your relationships with, I guess, Republic was just renewed recently I think a couple months ago.

Any change in terms of that we should be aware of, and in that relationship?

No, fundamentally the terms of the renewal are very similar to the previous agreement.

We think that it is a very favorable agreement, in fact for both parties, and we expect to see continued great performance from RNDC, as we have had over the previous contract.

So that is a relationship and an agreement that is working very, very well, from both a relationship and a mechanical perspective.

Terrific.

Thank you very much.

Your next question comes from the line of Caroline Levy of CLSA.

Good morning, and my congratulations too.

Just a question on distribution opportunity, with retailers seeing the kind of takeaway from your brands versus others, are you expecting some big shelf set changes in 2014 calendar?

Because again, that you are talking about the draft opportunity, but what is the takeaway opportunity as well?

Yes.

I think we are looking at good growth in 2014 across wine and beer and spirits.

Our retail customers are particularly pleased with our portfolio.

I think that one of the interesting things about Constellation which is an important differentiator, is that we are the largest multi-category player in beverage alcohol or TBA as we call it, total beverage alcohol.

Which means that two of the large accounts, we are either the number one or number two supplier to them in dollar terms.

And number one, is either us or [ABI].

And obviously, as it relates to our portfolio across wine, beer and spirits, we are providing the growth, being the number one TBA supplier to the retailer.

We are providing the growth, and TBA is probably the most important category in grocery and to the mass merchandisers today.

It is not their number one category, number one.

Number two, of the major categories, it is the only growing category from both a dollar topline and bottom-line perspective, and it is providing much, much more profitability than any of the other major categories basically in grocery.

And what are the other major categories, right, CSV, cigarettes and beer?

So, and TBA is number one, and we are either number one or number two with all the major players, right, Cosco, Supervalu, Kroger, Safeway, so on and so forth?

So, and then as I said, there is a shift that is just going on in general towards those kind of retailers for beverage alcohols so -- (Multiple Speakers).

The other thing -- I would say if -- very good place.

The other thing I would follow-up with -- I think you might have been hinting specifically at beer.

Because one of our compelling beer stories to retailers is the well-known national brands that we provide that, and retail shelves turn very fast.

So we all see all this stuff written about SKU and in craft beer, right?

And we are kind of used to this in wine, but there are a lot of SKUs, it does get a little confusing in the beer aisle these days.

But we believe -- when we go to retailers, we have a very good story that look, we have this distribution opportunity with our non-Corona Extra brands that we think will turn much better than almost all craft brands and deserve more shelf space.

Indeed, we think Corona Extra deserves a lot more shelf space than it gets, because it also turns much better than craft beers.

It also grows like craft beers, right?

Another reason to give it more space, and it has a higher ring and more profitability to the retailer like craft beers.

So we think, we are like -- to a retailer -- we provide a lot of the benefits of craft beers, but we have much more scale and obviously much more tenure in the industry to actually help them do some category management that maybe the smaller, newer craft beers aren't at expert at yet.

So I think that is really -- and we have fantastic sales execution and fantastic marketing plans behind those brands.

So it is really kind of synchronistic to get this volume growth- the consumers want, retailers want, the distributors want it, and of course, we want it.

That makes sense, thank you.

And just looking at the brewery, you have owned it very briefly.

But can you just fill us in on what you have discovered about running a brewery since you have owned it?

It's big.

(Laughter).

So I will start -- here is what I will say.

As we, and Rob said this earlier.

The employees we inherited at the brewery, we couldn't be happier with.

They fit right into Constellation's culture.

They are expert at their job and highly skilled, and really, it has been fantastically turnkey for us, and we have been able to focus more our attention on the buildout which they are also critical to.

And the other good thing we inherited is, the way Modelo ran the business was pretty decentralized, so we inherited a brewery with full functions.

Human resource, finance, they operate very well as a team, and every -- they fit in so well with us.

Because there is a lot of changes and a lot of complexity on assimilating this brewery, and I couldn't give a higher grade than the grade we give them on assimilation, and as Rob said, real expertise in their jobs.

We are thrilled.

Hopefully, they are happy with us.

And in terms of risks of delays and stuff which happens with any big project generally, how would you handicap the risks of things not going exactly on time, and on -- in terms of just not getting exactly where you thought you would be over the next two to three years?

Right now we anticipate completing the project on time, and we would handicap it as a low probability that we will not be able to finish the project on time.

Okay.

And the spending being a little lower than maybe expected in the current quarter, last quarter -- fully expect to catch up in the fourth quarter on that?

Yes.

Okay.

Spending will really ramp-up.

As Rob said, we are fabricating stainless steel.

We are breaking ground, and the beehive will start being built.

Because there is going to be a lot of activity around doubling the capacity of this brewery.

Okay.

And then just moving to wine -- and it has been a while since I looked at this in detail.

But apparently, there is a lot of supply and the vats are full in Nava in particular.

Does that not mean that there will be a lot of private-label competition and so on?

I mean, could margins be a little worse than you expect again, as you go forward?

I would say that the supply is balanced, is the way that I would describe it.

I would say it is actually, over the last couple of years, depending on where exactly you are looking at sort of tips to slate under-supply.

We have had a couple of decent harvests which have, I would say tipped it to what I would call pretty much balanced.

In the areas that matter to us, I would say that we are not expecting an oversupply that would drive lower pricing or higher promotions in the future.

I think that we see a pretty balanced situation, and in fact, it is as a general proposition, the way the wine business is growing overall, and sort of given the level of plantings, especially if we are talking about the United States, things will continue to tip more towards under supply.

Yes, I mean, as a point that the consumer demand for wind continues to be very robust, and the mix shift also continues to be positive, so we actually need more supply just to satiate demand.

Okay, great.

And the just finally, on the distributor renegotiations that are probably coming up with a number of wine and spirits distributors, do you largely expect similar terms to the ones you have, or is there room for some improvement for you there?

I would say that we are hopeful -- I think, first of all, I think we had great terms -- we have great terms to begin with, but I would be hopeful that there is room for improvement.

But really, that has got to be a win-win for both parties.

I mean, as we renegotiate with these parties these contracts, both parties look at the agreements, and say what is working, what is not working, and adjustments are made to enhance the relationship for both parties.

That is really the nature of it here especially with wholesalers.

It is not a one side can exact some kind of extreme favorable term out of the other side for no reason.

But, yes, we expect that there will be favorable enhancements to our agreements.

Thank you.

Thanks so much.

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

Hello, I have one quick balancing question.

Your account payable were a little higher than expected for me, and I am wondering if the terms are just different in the beer business than in the wine business, or is there a timing issue going on there?

Yes.

Terms are different in beer and wine, mostly due to regulations.

So the accounts receivable terms are lower in beer than they are in wine, which is good working capital outcome.

But accounts payable, there is just a lot of stuff going on with us assimilating the brewery.

There is a lot of timing stuff going on there.

Okay.

And then your cash flow, your strong guidance for the year, does that imply you should just take every 2014 million -- I'm sorry, just 2014 bond maturity with cash flow, or do you intend to refinance it?

Yes.

I mean, we are still looking at that, but we will, in this environment we are happy to see that go, because I think it is at 8 3/8% Right now, the thinking is we won't have to refinance that.

It will just be financed from our revolver and securitization facilities which, of course, are at much lower composite.

That should be very positive arbitrage for us.

Okay.

Great.

Thank you.

Your next question comes from Karen Eldritch of Mitsubishi.

Thank you.

We look at the year ahead, what are your thoughts with regards to priority of free cash flow?

And as you make your manufacturing expansions what kind of -- sorry, what kind of capacity increases are we -- can we expect?

Well, I mean our priorities in the medium-term on free cash flow is to pay down debt, which we have been doing.

As we said, our debt was about $165 million last -- in Q3.

We paid some debt down.

We want to get our leverage below 4 times EBITDA.

But as you referred to, we have got a lot of builds coming our way.

We have got, I will say the final tranche on the purchase price which we referred to, right?

That is just shy of $600 million which we talked about.

And then, we have got the brewery buildout which, of course, is pretty big money, over three years, and a decent amount of that is front-loaded.

So but we think we have all the financing we need to pay those bills.

And we still think we can get below 4 times EBITDA leverage by fiscal 2017.

Because you can see, beer this year is generating more cash than we originally anticipated.

So we will take it, and pay that debt down.

Great.

And in terms of what kind of capacity expansion are these builds going to produce for you?

Well, the brewery is doubling its capacity from 10 million hectoliters to 20 million hectoliters.

Great.

Thank you.

Sure.

At this time, there are no further questions.

I will now return the call to Rob Sands for any closing remarks.

Thanks for joining our call today, everyone.

Needless to say, we are very excited about the fact that our newly consolidated beer business is performing extremely well, and driving enhanced consolidated results for the year.

We certainly believe that we are well-positioned in both wine and spirits as we currently stand, and are confident that our accomplishments in these businesses will position us well for the future.

And overall, we feel very good about a solid final quarter for our fiscal year.

So thanks again, for your participation.

Thank you for participating in the Constellation Brands third quarter fiscal year 2014 earnings conference call.

You may now disconnect.