Constellation Brands Inc (STZ) 2014 Q4 法說會逐字稿

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

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions)

Thank you.

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

Please go ahead.

Thank you, Laurie.

Good morning, everyone, and welcome to Constellation's fourth quarter and fiscal year-end 2014 conference call.

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

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

During this call, we may discuss financial information on a GAAP comparable organic and constant currency basis; however, discussions will generally focus on comparable financial results.

Reconciliations between the most directly comparable GAAP measure and these and other non-GAAP financial measures are included in the news release or otherwise available on the Company's website, at www.cbrands.com.

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

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

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

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

Thanks, Patty, and good morning and welcome to our year-end call.

Wow, it has certainly been another productive and very exciting year at Constellation.

It was just about one year ago at this time when we received regulatory approval to proceed with the completion of our most transformational acquisition in the history of our Company.

As you know, the beer deal has positioned Constellation as the largest multi-category supplier for beer, wine and spirits.

We are not only the third largest total beverage alcohol company in the United States, but the number 3 brewer and seller of beer for the US market, as well as the largest marketer of imported beer.

And to reinforce our position as a top tier player in this space, we posted the highest dollar sales growth in IRI channels for FY14 amongst our key competitors in the total beverage alcohol category.

Our FY14 results are a testament to the significant contribution that our beer business is making, as we had an exceptional year posting sales, profits and cash flow that were better than our expectations for both the Crown commercial business and our new brewery in Nava, Mexico.

The beer segment generated sales growth of 10% with corresponding depletion growth of nearly 8%, which represents a significant out performance of the import category and the overall US beer market.

As matter of fact, in FY14, our beer business accounted for 85% of total import category dollar sales growth and gained more than 50 basis points of market share of the US beer industry and IRI channels.

So what's driving this phenomenal level of growth?

It's a combination of robust consumer demand, strong sales execution, excellent support from our wholesalers, creative new marketing and advertising programs, as well as the outstanding efforts of our commercial team and our brewery team in Mexico.

I'd like to take a minute to share some of this past year's amazing accomplishments for our iconic beer brands.

As you know, Corona Extra is the best selling imported beer at more than 100 million cases and is now outselling the nearest import competitor by almost 50 million cases.

By executing well designed marketing campaigns and leveraging its brand equity, Corona Extra posted depletion growth of almost 4% and grew volumes by nearly 2.5 million cases in FY14, jumping to the fifth best selling beer overall, while posting positive volume trends for the third consecutive year.

As for Corona Light, it is the best selling imported light beer, at more than 13.5 million cases, and continues to strengthen its own identity with its creative advertising that is driving consumers to trade up from domestic lights.

Overall, Corona Light is outpacing the import light category and currently represents more than 50% of segment dollar share and IRI channels.

Modelo Especial is the fastest growing Constellation beer brand, with depletion growth of almost 20% in FY14.

It exceeded the 50 million case milestone during the year, with the most volume gains and largest volume trend of any top 15 beer brand.

Pacifico increased volumes 5%, which marks three consecutive years of volume growth and Negro Modelo posted its fourth consecutive year of annual volume growth, at 4%.

While draft currently represents a small part of our overall volume, depletions grew more than 35% for this format, increasing brand recognition for Corona Light, Negro Modelo and Pacifico brands throughout FY14.

The five core brands within the Constellation beer portfolio are ranked in the top 15 imports and collectively account for more than 175 million cases, representing greater than 50% of the volume of this category in 2013.

Overall as we begin FY15, we will be focused on the following strategies from our beer business perspective.

The continued expansion of our new brewery in Nava, Mexico, which I will discuss in more detail in a few moments; maintaining the marketplace momentum for the commercial side of the beer business with incremental investments in marketing and SG&A; and finally, driving the great organic growth opportunities within this product portfolio.

I am excited about the organic growth prospects for our beer business in FY15, as we are once again targeting sales and depletion trends to exceed US beer industry and import trends.

Some of the initiatives we have underway to drive these results include the following.

As we head into the Cinco de Mayo holiday, we will continue to build our Corona de Mayo equity to reinforce our positioning around summer's first fiesta to create momentum to keep Corona top of mind with consumers and our wholesalers as we kick off 120 days of Summer.

Our 120 Days of Summer campaign will highlight 18 different weekly themes with special activities, content, and prize drawings.

The goal is to own the summer by driving repeat consumer engagement and purchase throughout the key summer selling season.

New Corona national TV and digital video that launched recently to support these efforts will ramp up leading into Cinco de Mayo, with high profile media properties that include the NBA playoffs on national TV.

In addition, promotional, digital and radio advertising and digital video sponsorships will launch leading into key occasions, including the World Cup and the ESPN NFL draft.

To continue to reach new consumers and increase awareness of the brand, Corona Light recently expanded its draft offering to over 100 distributors and 35 markets.

This launch will be supported by 15-second advertising spots airing with high profile sports programs that position the brand as a light beer with taste.

Two new ads for Modelo Especial's Hispanic Real World campaign will launch in the first quarter, with strong support and targeted Spanish language TV and digital video programming.

In addition, Modelo Especial will feature a 2014 summer promotion that includes a sweepstake with three prize tiers, including a custom soccer tour to three global soccer destinations.

A national launch of Modelo Especial Chelada began April 1. This initiative is supported by Spanish language TV ads on national Spanish networks, consumer sampling at retail, PR in key markets, social media engagements and C-store print trade ads.

In its first six months since launch, Modelo Especial Chelada has significantly outpaced our distribution and volume forecast.

From a brewery and operational perspective, we began FY14 by successfully completing the initial transition of our new brewery in Nava, Mexico.

As you know, we are currently concentrating our effort on doubling the size of this brewery from 10 million to 20 million hectoliters, including the build of a new brew house, packaging area and warehouse, as well as completion of site infrastructure.

Overall, beer operations continue to run smoothly.

The beer expansion project remains on time and all major brewery key performance metrics and initiatives are on or better than target.

Establishing foundations for the brewing area are well underway, mass excavation for the packaging area is in progress, and the first shipment of brewery tanks is expected to arrive shortly.

There are more than 500 construction people on site each day, with that number growing significantly over the next few months.

As we progress with this major undertaking, we have determined that we need to increase the capital required to complete the brewery expansion from our original estimate of $500 million to $600 million.

The primary drivers of the increased investment to a range of $900 million to $1.1 billion include the following.

The most significant incremental cost relates to outsourcing and utilizing third party external engineering resources and consultants versus the initial brewery build by Modelo, which had the benefit of utilizing in-house resources.

In addition, the timeline for the current expansion is much shorter than that of Modelo's original build, resulting in additional costs for expediting much of this project.

Other incremental expenses include inflation on materials since the original brewery build and investments to improve brewery efficiency and flexibility to enhance overall capacity utilization in order to support the growth of the business.

In a few moments, Bob will provide additional details about how this incremental spend will impact free cash flow and our deleveraging efforts going forward.

Now turning to the wine and spirits business, before we begin our year-end review and discussion of our wine and spirits plans for FY15, I'd like to mention that I am very pleased we have reached a long-term strategic agreement with VATS Liquor, a Chinese producer and distributor of spirits and wine.

We plan to jointly develop and exclusively market and promote the iconic Robert Mondavi brand, which is the world's Number 1 selling table wine, in China.

China is currently the fifth largest wine consumption market globally, selling more than 200 million cases annually.

It's a market that has doubled in size in five years.

Category growth in China continues to be driven by imports, which are projected to comprise about 33% of total wine consumption within the next five years.

We are looking forward to working with VATS, who has a vast distribution network, professional brand building capabilities, and an established retail presence for consumers to buy fine wine and spirits.

And now I would like to focus our discussion on Constellation's year-end results for our wine and spirits business, as well as our strategic plans for the year ahead.

As we discussed, FY14 represented a year of focus on brand building activity for our US wine and spirits business in order to insure that our business remained healthy and was positioned to generate profit growth going forward.

These activities included incremental promotion and marketing investments that enabled us to maintain our marketplace momentum by achieving market share volume gains and above market depletion trends of 3.5% across our entire US wine and spirits portfolio, while our collection of Focus Brands grew at almost 6% for the year.

In addition, we were able to maintain dollar share in measured channels.

As a result of these efforts, we continue to garner awards and recognition from prominent industry publications, particularly for our new products and our Focus Brands.

They include the following.

We won 11 2013 Hot Brand awards from Impact Magazine, and several of our new brands landed on Beverage Information Group's list of 2014 Growth Brand awards.

Our Focus Brands that received these awards included Kim Crawford, Mark West, Black Box, SVEDKA Vodka, Ruffino, Rex Goliath and Woodbridge, just to name a few.

And our new product offerings included on the awards list were The Dreaming Tree and Thorny Roads.

The Dreaming Tree also received the distinction of Best New Wine Product from Market Watch.

From a spirits perspective, for FY14, SVEDKA posted double digit consumer take-away trends in IRI channels, in addition to gaining volume and dollar share of the vodka category.

SVEDKA is currently the number 2 imported vodka brand and a top 10 spirit brand in the US.

In FY15, we plan to capitalize on the continue growth of flavored vodkas by launching mango pineapple and strawberry lemonade as additions to SVEDKA's flavor line up.

For the year, Black Velvet grew volumes 11% in IRI channels, driven by the core Black Velvet brand, as well as new flavor introductions Toasted Caramel and Cinnamon Rush.

From a wine and spirits strategic perspective in FY15, we plan to leverage the hard work and significant accomplishments we've made throughout the last several years to grow profits for this business, while also growing revenue.

And we are committed to executing the following strategies in an effort to make this goal a reality.

Number 1, our marketing efforts will be focused on a subset of Focus Brands in order to drive key brands that have scale, higher margin and the greatest growth potential.

Number 2, we will continue to drive margin-accretive innovation and new product development.

Number 3, we plan to increase points of distribution and deliver more effective feature and display activity at retail, with added accountability and visibility for both Constellation and our distributors.

Number 4, for the first time in several years, we plan to execute price increases for select products in the value and luxury segments of the market where pricing is currently occurring.

And number 5, we will minimize COGS increase through continued global blend management initiatives and lower grape costs.

Overall, we plan to limit our marketing expense to grow in line with our net revenue, with the concentration of spend focused on key margin accretive focused brands.

One of the things that will impact FY15 financial results for our wine and spirits business, particularly in the first quarter, is that we are working with one of our exclusive distributors to reduce their inventory levels.

Because this action is outside the scope of their contractual arrangement with us, they have agreed to a make whole payment, as they begin to reduce their purchases of our products.

As I mentioned this is primarily a first quarter event and will have a minor impact on sales for the year.

In a few minutes, Bob will discuss the financial implications of this action from a P&L perspective.

Before I close, I would like to address the potential drought issue in California, as we have received several inquiries related to this topic.

Fortunately, grapevines are highly drought resistant and can actually produce better fruit in dry conditions.

At this stage, our California vines have begin to bud and the state, in general, is running approximately two weeks ahead of schedule.

While recent heavy rains have improved our overall position, California is still officially in drought status; and at this time we do not yet know the potential overall impact from this situation, because it is too early to call.

If drought conditions persist, we have the ability to source both wine from around the world in order to supplement what could potentially be a short harvest.

Keep in mind that an above average harvest last year created a situation where we currently have adequate supply.

In closing, we had a great year, driven by our beer business.

We also achieved above market depletion growth and market share gains across our beer and wine businesses.

The strong operating cash flow that we are generating will allow us to capitalize on value creating opportunities going forward, and the new Constellation is well positioned to drive value for the future.

I would now like to turn the call over to Bob for a financial discussion of our year-end business results and our outlook for FY15.

Thanks, Rob.

Good morning, everyone.

As we close out FY14 and move forward into FY15, it's a very exciting time at Constellation for employees, investors, lenders, vendors and consumers.

As Rob said, FY14 was a very strong year, where we closed our beer transaction, maintained or grew market share in our growing beverage alcohol categories, established some all-time highs with EBIT up nearly 60% and comparable basis EPS almost 50%, while generating sales approaching $5 billion and free cash flow that surpassed the $600 million mark; and we exceeded all consolidated guidance metrics provided at the beginning of the year.

We expect FY15 to be another exciting year.

We expect to maintain or grow market share and grow EBIT at or above our sales growth on an organic basis.

On an absolute comparable basis, performance will be much better as we enjoy a full year of consolidated beer economics; and we expect operating cash flow to cross the $1 billion mark.

Let's begin to look at FY14 results.

Our comparable basis diluted EPS for FY14 came in at $3.25.

This represents a sizeable increase versus 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.

The strong marketplace momentum and financial performance for the beer business continued in Q4.

This drove year-to-date financial results ahead of our expectations and capped off a phenomenal year for Constellation.

Given those brief highlights, let's look at full year FY14 performance in more detail, where my comments will generally focus on comparable basis financial results.

As you can see from our news release, consolidated net sales for the year included $2 billion of incremental net sales related to the beer business acquisition, as we consolidated 100% of beer sales as of the June 7, 2013 acquisition date.

For FY14, beer segment net sales increased nearly 10% on volume growth of 7%.

Depletions were equally strong, growing close to 8%.

Wine and spirits net sales on an organic constant currency basis increased 2%.

This reflects an organic branded wine and spirits shipment volume increase of almost 4%, partially offset by higher promotion expense, unfavorable mix and lower bulk spirit sales.

For the year, consolidated gross profit increased $892 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, 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 $891 million.

This produced a beer segment gross margin of 44%, based on the incremental beer sales discussed earlier.

For the year, our consolidated gross margin was 41.2% versus 39.9% for the prior year.

This increase primarily reflects the benefit from the consolidation of the beer business, partially offset by lower gross margin in wine and spirits, driven by the higher promotion expense.

SG&A for the year increased $280 million.

The incremental SG&A associated with consolidating the beer business was $260 million.

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

The remainder of the SG&A increase was primarily driven by higher selling and marketing investments in the wine and spirits business.

Based on what I just outlined, incremental operating income generated by the beer business was $630 million for the year.

This produced a beer segment operating margin of approximately 31% since the close of the acquisition.

The inclusion of the beer business results was the primary driver behind the 410 basis point improvement in our consolidated operating margin for the year.

Equity earnings from the Crown joint venture totaled $70 million, compared to $220 million in the prior year.

The decrease was due to the timing of the beer business acquisition.

Interest expense for the year was $323 million, up 42% versus last year.

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

That provides a good spot to discuss our debt position.

At the end of February, our total debt was $7 billion.

This represents a $3.7 billion increase from our debt level at the end of FY13.

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

I would also like to remind you that in June, we expect to make a $558 million post-closing purchase price adjustment payment for the beer transaction.

We also have $500 million of 8.375% senior notes that are coming due in December.

Our comparable basis effective tax rate came in at 31%, which reflected benefits from integrating the beer business and the benefit of foreign tax credits.

Now let's briefly discuss Q4 results.

Comparable basis diluted EPS for the quarter came in at $0.81.

The quarter reflected significant acquisition benefits and, as mentioned earlier, beer performance exceeded expectations.

For Q4, beer segment net sales increased 13% on volume growth of 10%.

This was somewhat offset -- this was somewhat of an easier comparison versus Q4 last year, when sales increased 1%.

Consumer demand remains strong, as depletions for the quarter were up nearly 12%.

Wine and spirits net sales on an organic constant currency basis increased 1%, as volume growth was mostly offset by unfavorable mix and higher promotional spend.

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

For FY14, we generated $603 million of free cash flow, versus $494 million in the previous year.

This result exceeded our expectation, primarily as a result of the strong beer business performance in Q4.

Operating cash flow for the year totaled $826 million, an increase of $270 million over last year.

The increase was primarily due to the profit growth for the beer business acquisition, partially offset by higher interest payments and lower contribution from wine and spirits, primarily due to some working capital timing.

CapEx for the year totaled $224 million, an increase of $161 million.

CapEx for the beer segment totaled $137 million.

Most of the beer spending occurred in the fourth quarter, as brewery expansion activities began to ramp up.

Now let's move to our full year FY15 P&L outlook.

We're forecasting comparable basis diluted EPS to be in the range of $3.95 to $4.15 a share.

For FY15, we're targeting mid- to high single digit net sales growth for the beer segment.

Shipment and depletion volumes are targeted to grow mid-single digits and continue to outpace the import category and the total beer industry.

For FY14, beer segment operating income totaled $773 million.

This amount is presented in our summarized segment information in our press release financial statements and includes 100% of Crown's operating income for all of FY14 and brewery profits since the June 7 acquisition date.

For FY15, we expect beer segment operating income to grow in the low to mid-20% range.

Excluding the estimated brewery acquisition benefit, underlying operating income growth for the beer segment is expected to be in the 10% to 12% range.

For wine and spirits, we're targeting net sales growth to be in the low to mid-single digit range.

Volume growth is expected to be in the low single digit range, and we expect to generate positive mix.

While we expect depletions to track in line or better than the US wine and spirits category for the year, shipment volumes are projected to be lower than depletions, as we expect some distributor inventory reduction to occur during the first quarter, as Rob highlighted earlier.

Operating income growth for wine and spirits is expected to align with net sales growth, in the low to mid-single digit range.

Headwinds from grape costs are expected to abate, as we continue to realize benefits from blend management initiatives and we begin to move into lower priced grape inventories.

We expect promotional and marketing spending to stabilize, and we are increasing prices on some products in the value and luxury categories, as Rob outlined earlier.

We also expect mix to be favorable in the FY15, as we focus more of our investment on higher margin products.

Interest expense is expected to be in the range of $345 million to $355 million.

The increase versus FY14 is primarily being driven by the beer acquisition funding impact that carries into Q1 of FY15.

The tax rate is expected to approximate 30%.

This represents a slight decrease versus the FY14 comparable basis tax rate, as we expect to realize some favorable outcomes on various tax items.

Free cash flow is expected to be in the range of $425 million to $500 million.

Operating cash flow is targeted to reach at least $1 billion, as we continue to realize earnings benefits from the beer business transaction.

CapEx is projected in the range of $575 million to $625 million, including $450 million to $500 million for the beer business, driven by the brewery expansion activities outlined by Rob.

We're still on track to complete the brewery in calendar 2016.

Although the brewery expansion CapEx is higher than our original estimate, beer volumes and profits are also higher.

Even with the higher CapEx spend, our goals of reaching $1 billion of free cash flow in FY17 and moving our debt to comparable basis EBITDA leverage ratio below 4 times in FY16 remain intact.

I would now like to mention a couple of items from a FY15 quarterly gating perspective.

As discussed earlier, for wine and spirits, we expect some distributor inventory de-stocking to mostly occur during Q1, which will impact our shipment volume.

As a result, we expect net sales to be down in the low to mid-single digit range for Q1; however, we don't expect this to negatively impact profits, as we will receive a make whole payment from the distributor related to this activity in the same time frame.

I would also like to note that our targeted wine and spirits EBIT growth for FY15 is weighted towards the second half of the year.

From a beer gating perspective, I would like to note that we will be facing some difficult comparisons in the second half of the year.

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

We currently estimate one-time costs at $60 million in FY15.

This includes about $25 million in professional services and transition costs associated with the beer business acquisition.

These costs were originally expected to occur in FY14, but shifted to FY15.

The remaining $35 million represents amortization expense related to the acquisition accounting asset established for the interim supply agreement for beer finished goods.

I would like to make a few brief comments on commodity risk management.

We've begun to hedge certain commodities in the energy and agricultural categories.

These commodity derivatives generally do not qualify for hedge accounting treatment.

As a result, mark-to-market unrealized gains and losses on open hedge contracts will flow through our GAAP income statement.

We will exclude these unrealized gains and losses from our comparable earnings.

At the time that a gain or loss is realized on a commodity hedge, it will be allocated to the appropriate business segment for reporting and will be included in our comparable earnings.

This approach is in line with other companies in the consumer space.

We began this reporting in the fourth quarter.

At the end of FY14, it was an immaterial unrealized gain related to this activity.

Before we take your questions, I'd like to highlight that the beer acquisition has been a game changer.

In addition to the positive financial impact of the acquisition, our commercial performance has accelerated dramatically.

Despite the increased cost to build out the brewery, our improved commercial results keep our free cash flow and deleveraging goals intact.

The improved commercial performance of the beer business improves our financial profile, and we currently anticipate exceeding our original IRR and shareholder value assumptions for the beer transaction, despite higher capital costs for the 20 million hectoliter build out.

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

(Operator Instructions)

Your first question comes from line of Nik Modi of RBC.

Yes, thanks.

Good morning, everyone.

Just two quick questions on my end.

If you can just kind of reiterate -- I'm sorry if I missed it -- how much CapEx has already been spent on the brewery expansion?

And then the second question is really trying to frame the opportunity that you might have in China.

Certainly long-term, it makes sense and probably big opportunity.

Just trying to get some texture on how much of a P&L implication it could have in the next 18 months or so.

Sure, Nik.

I'll handle the first one and Rob can handle the China question.

As far as how much capital was spent on the brewery in FY14, that was just shy of $140 million.

And that pretty much all occurred in the fourth quarter.

Want to do China?

Sure.

Hello, Nik.

China, I think you really have to look at that as a long-term investment.

Or I'll say a long-term project.

We're just really kind of getting up and running and developing our plans.

It hasn't been a material business there, historically.

So the idea is developing it into a material business in that market.

But it's going to take a number of years.

So I wouldn't expect it to have any real impact, from a financial perspective, in the short term.

Great.

And just one quick follow-up.

I know it's still early in the transaction, but the margins have been tracking ahead of I think what most people have been expecting.

And I know there's still a lot of spending to come in the beer business.

But have you thought about the 30% to 35% since you initially gave that guidance, and if you think there's where you might be in that range at the higher end, maybe even able to exceed that at some point in the next couple of years?

Yes, Nik.

We're not updating our guidance in that area.

We would be happy if it exceeded it.

But we've still got quite a few of steps involved in negotiating our commodity contracts as a stand-alone company going forward.

As you know, we've talked about we haven't settled anything on glass, which is a big piece of the cost inputs for our business.

So we're very happy with the progress of the project, certainly, the progress of the beer business.

But we're not changing our margin guidance.

What might be throwing people off a little bit is maybe in the fourth quarter, the beer business had increased margins.

And really what that is is in the fourth quarter, again, I think volumes exceeded our expectations, but we spend, accounting-wise, very little marketing in the fourth quarter.

So you had a pretty high level of sales, certainly growth to the prior year, with very little marketing expense against it.

For the full year, the margin from the date of acquisition through the end of the year was about 31%, which was a little bit higher than what we guided when the transaction just started, but very much in the ballpark.

So we're sticking to that mid-30% operating profit margin guidance.

Fair enough.

Thanks a lot.

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

Hello.

Good morning.

Hello, Brian.

Just two questions.

The first one just related to the capital spending, and I think this is the crux of why the stock has responded the way it has this morning.

But could you walk through first, now that you've got a better sort of perspective or deeper perspective on the project and the cost increase, is the brewery going to be more efficient?

So is there an enhancement in efficiencies, both in the existing capacity and maybe what you're going to be building versus what you originally thought?

And then the second question related to that is just, I think there's some concern you've got the run rate right now on volume growth in beer is very strong, and how do we think about the potential to have to add more capacity going forward?

Does the increase in spending at all make it less expensive to add capacity going forward?

So yes, Bryan, I'll answer that for you.

Number one, the fundamental answer to your question is yes.

We are designing the brewery in a manner to get more volume out of the capacity that we originally planned.

So we were expanding the brewery from 10 million hectoliters to 20 million hectoliters in theoretical capacity.

That still remains the case.

But in terms of the efficiency, i.e, how many cases we'll actually get out of that, we are expanding the brewery in a manner to get more cases out of that than we originally planned.

That's point number one.

So we are taking steps in that regard to plan for higher volumes than we originally anticipated.

And then with respect to your second question, the capacity that we're currently building we do expect to be sufficient for, I would say, the mid-term, meaning the next few years.

But if the business continues to grow at the rates that it's currently growing, we'll have to be thinking about additional capacity increases some time in the near future, in the next couple of years, and to begin that process.

So a good problem to have, in essence.

Yes.

And Bryan, just to follow up on Rob, we're currently assessing -- because volumes are doing so well -- when do you expand capacity and where do you expand capacity?

So related to that question, if we were to put the next tranche of capacity expansion at the existing brewery, I think we would get some efficiencies from the $1 billion we're spending on the first 20 million hectoliters.

If we decided to put the capacity somewhere else, meaning do you build another brewery or buy a brewery somewhere, then that wouldn't help us so much.

So we're currently in the thought process around that.

And then fair to characterize the higher price tag, especially for the outsourcing, in part helps to ensure that you meet the calendar 2016 deadline, meaning you're sort of paying to get to the front of the line?

Yes, there's definitely a premium that we are paying to complete the project within the three-year time frame.

There's no question about that.

It's pretty much half the time frame in which the original brewery is built, and it's a pretty compressed timetable.

And we've got to do everything in our power to ensure that the brewery is built in that time frame.

We're happy to see that even with that increased capital cost, as I mentioned earlier, because I know a lot of investors are keeping an eye on our deleveraging and keeping an eye on when we potentially reallocate capital.

So all those deleveraging targets and free cash flow targets, even though we've increased these capital spend, they all remain intact.

So frankly, after you get past the brewery, what that means -- and you guys know your math guys, right -- is the EBIT's higher, so that's going to drive much better returns after you get past this stage where the snake is eating a camel.

Got it.

Okay.

I'm going to get back into the queue.

Thanks, guys.

Your next question comes from the line of Bill Chappell of SunTrust.

Good morning.

Just want to follow-up one more time on Bryan's questions.

So I'm just trying to understand over the past maybe six to nine months, at what point did -- and it seems like the timeline for the new plant is still the same and the size is still the same.

Where did all of a sudden it change in terms of your budgeted cost?

What came about to change that versus what we saw six or nine months ago when we were first talking about this?

Well, six to nine months ago, we had obviously just closed the deal.

We had a very short time frame to actually decide and agree to purchase the brewery and purchase it.

We put together, at that time, a very rough estimate of what we thought the costs would be.

And we've spent the last basically nine months bidding out the project and translating it into definitive costs, which have resulted in the number that we disclosed.

So there was definitely changes in the scope of the project from what we also originally thought.

And it was along the lines that Bryan suggested in that although we are building the same 20 million of theoretical capacity, we expect to get more out of it and have scoped a project to get more out of it than originally planned.

So whereas you might only get 80% or 85% efficiency out of your theoretical capacity, we're building a brewery now to get more out of it than that, really as a result of the increased growth in the products that we're experiencing and that we expect to continue into the next fiscal year.

So that's basically why or how the brewery project cost increased from our original estimates, which were really, in many respects, just a swag, in that it had not been able, at that stage, and obviously so, to bid the project and to scope it fully.

Got it.

And then just a couple things, also on the beer.

Wasn't there at some point a change in the price you're paying for the 40% outsourced, and will that change?

Any update on that?

And then on the beer pricing in general, is your guidance assuming a price increase for the FY15?

Yes, there was a price reset for what we paid InBev for the finished goods that they're making for us based on the audited EBITDA of the acquired business.

But building the brewery out does not change any of that.

Those numbers are still intact.

Sure.

And then in terms of overall pricing for just to the consumer for the next year?

Yes, on pricing we will -- as we said before, beer is a very regional business.

So we look at what's going on with volumes and what's going on with competitors in our various different regions, and we talk to distributors, we talk to retailers to try to assume what will happen to volumes and what will consumers reactions be to the price increase, and then we determine what that price increase will be on a regional basis, and then it kind of rolls up.

So the only way you'll know what happens is to watch IRI.

Generally, beer pricing occurs right after the peak summer season.

So September, October, you'll be able to see what the big boys have done and what we've done.

And we take a guess, generally, what pricing would be when we give guidance.

So that's included in the volume in net sales guidance you would have seen in our beer segment.

Okay.

I'll get back in the queue.

Thank you.

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

Good morning, everyone.

Thank you so much.

One of my questions is, can you tell us what the difference was between beer volumes in California and in the rest of the country?

I'm trying to drive at what -- mainly what the drought impact was on demand.

But also, my understanding is that in areas where Corona is strongest, it's actually growing faster.

So if you can just disaggregate a little bit of what you understand about your beer business.

Yes, there's a couple things going on there, Caroline.

We actually did have a very strong year in California.

It's our highest share state.

It's kind of where Corona began.

I think we're around 20% share.

But as Rob mentioned in his statements, they're experiencing a drought in California.

So actually we experienced very good beer weather in California and we also have, like elsewhere in the country, very good consumer momentum from our great marketing and our great sales initiatives.

But we did have pretty favorable weather for beer in California, and we're very happy with our results out there in FY14.

But I'm just trying to understand what happened in the rest of the country.

Was the rest of the country up mid-single digit?

Yes, we had our strongest performance in FY14 in the West and the South.

We had strong performance, but not as strong, in the Midwest and the East.

That's kind of how it broke out regionally.

but we grew in every geography, we gained share in every geography, we grew in every channel, we gained share in every channel, but we did better in the West and the South.

Right.

Okay.

Thank you.

Now just moving to wine.

The issue with the distributor inventories, is this one distributor?

Is this something that's a one quarter phenomenon?

If you could just help us understand a little more about what's going on there and how long it will take to work through the system.

Sure.

Yes, the answer is it's one distributor.

And yes, we're anticipating that it will be a one quarter or first quarter phenomenon.

And as we mentioned, it will have no impact on our bottom line.

No impact on earnings whatsoever.

Okay.

And as we think through wine, it's always got challenges, but always for different reasons.

But as a long-term top line growth rate, is 3% to 4% a reasonable sort of assumption, given a blend of volume and pricing?

Do you think that still holds?

Yes, Caroline, definitely sort of the 3% to 4% range is sort of a good number.

That's sort of what the industry has been growing at.

We're pretty optimistic about our wine business going into this year, our FY15.

As I mentioned, we've got a lot of, I'm going to say, tailwind this year.

We've been focusing for the last few years on developing strong momentum behind our brands, making sure our brands are healthy.

And as we move into 2015, I think that our brands are healthier than they've ever been, and that positions ourself well to capitalize on that and take some actions to drive profit growth, as I said.

So I think that that business is going to be -- it's going to make a very good contribution to our bottom line growth this year.

Got it.

Thank you so much.

Your next question comes from the line of Rob Ottenstein of ISI.

Thank you, guys.

Can you give us your latest assessment in terms of when you may start paying a dividend?

Has that changed?

And also your thinking on M&A, is there any change there?

Sure.

I'll handle the first.

I'll let Rob handle the second.

The dividend, we haven't changed the way we're thinking about it, is we would start assessing redeploying capital to shareholders when we get close to being below four times EBITDA leverage.

And that goal has not changed.

It looks like that will happen, if everything happens the way we think, towards the end of FY16 is when we would get below that leverage ratio.

So we'd start to talk to investors and our Board, in inverse order, of course, around that time.

I'll let Rob handle the M&A questions.

So on M&A, the answer is our position, or our strategy, has not changed relative to M&A.

Our principal goal at the moment is debt pay down.

That's really what we're focused on.

But obviously, M&A is opportunistic, so we keep our ear to the ground for investments that we think will generate superior returns to our shareholders.

But generally, the focus is debt pay down versus M&A.

And Bob, given the tremendous success of the beer business that you're achieving and the transformation of the Company, as you look to do incremental investment, do you see yourself gearing more towards beer or more towards wine?

Has that changed at all-in terms of where you're looking to take the Company long-term?

Well, as I said, we're certainly focused on debt pay down at the current time.

But as it relates to investments, there's potentially good investments in all three categories.

We look at it very fundamentally.

We don't have a favored child, necessarily.

And so as opportunities arise, we're going to look at investment opportunities in all three categories and they'll be evaluated on what generates the highest return in the shortest amount of time.

That's basically the bottom line, IRR and payback.

So we'll see.

Are you taking a look at PBR?

(Laughter) Okay, Robert.

I think we have to move to the next question.

We can't comment on that, obviously, Robert.

All right.

Thanks guys.

Your next question comes from the line of Brett Cooper of Consumer Edge Research.

Good morning, guys.

Two questions, one on the beer side, one on the wine side.

On the beer side -- I'm not sure if I missed it in your commentary -- but what was marketing, or what are you planning marketing to be up in 2014?

In 2015 or in 2014?

I'm sorry, in FY15.

Yes, so in the beer business, we are investing commercially both sales and marketing, investing ahead of sales, because we want to keep our momentum up and because the sales and marketing guys have some good ideas that we think are worthy of investing in.

So marketing and sales will be going up faster than sales.

Marketing in the beer business is about 8%, 8.5% of sales, which has gone up over the last three to five years.

Perfect.

And then on the wine side, back to the distributor inventory reduction.

How did that come about?

Who drove it?

And as some of your other distributor contracts come to an end, if memory serves, would you expect to see more of these types of deals?

And then as an aside to that, when these things have happened in past, sometimes you've had your distributors spend more against the brands in the market.

This time you're getting a payment.

Can you just explain your thoughts on receiving a payment versus a greater investment in the marketplace from your distributor?

Sure.

Number one this is the particular circumstances of one distributor who desired to do something really outside of the parameters of our normal business relationship.

That's answer number one.

And answer number two is no, we don't have any expectation that it will occur in any other context or in any other cases.

And number three, since it's outside of our normal contractual relationship, we felt that a make whole kind of arrangement was most appropriate in this particular case.

And more importantly, as far as what we invest in the marketplace behind our business, we determine that completely on a commercial basis, meaning it's not based on any payments that we might receive or might not receive.

We'll spend what we think is appropriate to drive the business in any event.

So it just so happens that with the way this particular transaction is structured, we don't expect it to have any impact on the bottom line.

And it is an isolated matter with one wholesale customer.

So we bring it to your attention only in that it will affect the top line in the first quarter.

We don't really expect it to affect the top line materially even for the whole year.

And as we've said, it will have no impact on the bottom line.

So that's really it.

Perfect.

Thanks.

Your next question comes from the line of Brian Hunt of Wells Fargo Securities.

Thank you.

Two questions.

One, Ron, when you started to talk about pricing in the value and the luxury segment in the wine business, it sounded as though you were a follower and not a leader.

Can you discuss maybe the level of pricing and clarify whether Constellation is leading or following price increases in the wine segment?

Yes.

I would say we have about a 15% total market share in the wine segment.

As you know, it's a pretty fragmented category compared to the other two categories in the beverage alcohol business.

Therefore, I'm not even sure the talk of being a leader in this and that is even particularly relevant.

We take a look at our products, we take a look at the competition, we take a look at the categories, we see what's happening, and we decide what we're going to do.

Over the last few years, there hasn't been much pricing in the wine business, period.

We're seeing some opportunities for pricing as we move into FY15, and we're going to take those opportunities, and we think that they're in the high end and the lower end, so that's where we're going to focus in terms of that element of our strategy.

So it's really as simple as that.

I don't think leader/follower makes a lot of sense in terms of even the discussion in this particular context.

But yes, we look around, we see what's going on in the marketplace, and we make our judgments in that regard.

And with regards to magnitude, is there any comments around that you care to make?

No.

We're really developing our plans and our strategies for taking the pricing in the areas that we're going to take it, and they're not fully baked at this time.

So it's really kind of hard to discuss the absolute magnitude of it at this moment.

Okay.

And then my other question is, when you look at the supply contracts across your businesses with the new beer business and the scale it brings to the Company, you mentioned you haven't worked on the glass contract yet and that's an opportunity going forward.

Have you looked at any other supply contracts and has progress been made in garnering savings, given the new scale of the business?

Number one, we didn't say we haven't -- or if we did say it, we said it incorrectly.

We have been working on glass and we have been working on the other commodities.

We're not at a stage yet where we are prepared to say exactly what our strategy is on glass, but it is something that we are working on.

And yes, we're working on the other commodities, as well.

And I would say the most we're prepared to say at the current time is I think that where we end up on commodities is going to be favorable.

And should we expect to see those results this year --

So it's going to work out pretty well.

That's what we think.

Okay.

Should we expect to see those, from a timeline perspective, this year, or is --

I'm sure we'll have something to say on commodities as we go through the year, yes.

All right.

I appreciate your time.

Thank you.

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

Hello, Bryan.

Hello.

Thanks for taking the follow-up.

So I'm just going to give you a couple of quick questions, some housekeeping items, and then just one related to wine pricing.

First, just Bob, if you could talk about what the cash tax rate was for the year and what you expect it to be next year?

Yes, so the cash tax rate for the year is kind of anomalous.

So let me walk you through it.

What we've said -- and we haven't updated this guidance in a while -- but we would expect a cash tax rate in like the mid-20%, on an ongoing basis.

I'd say that the beer structure will probably improve on that over the medium to long-term.

And we'll update you on that when things settle down.

I would say that FY14, and actually FY15, as well, are going to be pretty anomalous because of the big increase in the stock price and some option exercises from options that were expiring, et cetera, or people that are just exercising some in the money, we get a tax deduction for that.

And that's actually a reasonably big number.

If you look at the cash flow statement, you can see the cash we brought in from option exercises.

So that will bring the cash tax rate down relatively dramatically, while this situation goes on.

We don't expect it to last big time past FY15.

So I would call that not really an operating cash tax environment.

It's just that the anomalous equity activity.

But it will be a little better -- it will be favorable in 2015 relative to what your normal run rate ought to be going forward?

Yes, I would agree with that.

Okay.

Foreign exchange, just the peso/dollar exchange rate.

How should we think about that from a transaction and translation impact for next year?

Or this year, I should say.

Sorry, go ahead.

Finish your question.

For 2015.

Yes.

So the way we handle this -- and actually, and we told you this on previous calls -- the peso/dollar rate was more favorable than we thought, because actually the rate physically has gotten favorable from when we closed the deal.

We do hedge transaction exposure to the peso.

There isn't actually as much peso exposure as you would think, because most of the commodities in the beer industry are dollar based.

So really, the core peso exposure is our on-site labor at the facility, which still is a sizeable number, but nowhere near what you would think.

And we do have hedge contracts.

We go out two or three years on those.

And we're actually relatively hedged for FY15.

And as I recall, I haven't looked at it in awhile, but I think the peso/dollar is around 13.

So we monitor closely and lay on hedges when they get more favorable.

But we're not expecting a ton of volatility there in FY15.

Okay.

And then gross margins for the beer business in the fourth quarter and the full year?

I think you disclosed that in the last couple of calls.

Are you going to -- do you have that figure?

I think I had it in my script.

I think it said it was 44%.

Okay, I must have missed it.

Sorry about that.

And then just the last one.

Jeez, Bryan.

I'm exhausted, man.

Come on.

It's the lightning round.

Exactly.

The last one is just the wine pricing.

Rob, could you just characterize, the decision to raise prices in wine, both low end and in your premium wines, is it a function of your assessment of the market, especially at the low end where there's been quite a bit of pricing the last couple years, and so you feel comfortable with the pricing dynamic or the competitive activity make you feel comfortable about taking prices up?

Or is it a question or a function of now that you've made some marketing investments, new products investments, you feel more comfortable raising prices behind that?

Or is it have some effect on what you think commodity costs or raw material costs might be in the future?

Just trying to understand the motivation to take prices.

So yes, yes, and no.

Okay.

(Laughter)

So yes, our assessment of the marketplace and so on and so forth.

It's the fact that we do feel pretty well positioned, given our previous investments and where we are relative to momentum and brand health, that the timing is right.

And no, it's really not related to commodity -- not related to commodity costs.

Although from a commodity cost perspective, it's kind of the opposite.

We aren't facing any particular headwinds this year in wine, so we're not expecting much inflation in cost of goods sold.

That will be helpful to us, from a bottom line perspective.

Okay.

All right.

Thank you very much and thanks for being so generous with your time.

Our pleasure.

Thank you.

That concludes the Q&A portion of today's call.

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

Okay.

Well, thanks for joining our call today.

As Bob mentioned, the beer deal has been a real game changer for us.

And the team plans to capitalize on the tremendous momentum that we have underway to continue to drive the growth and enhance financial performance of the business.

As Bob said, we now expect the beer business to exceed our original expectations from a return on invested capital point of view.

And I believe that our plans for FY15 prove that we have not wavered from our overarching strategic goal of generating profitable, organic growth across all of our businesses, including our wine and spirits businesses.

We have recently posted two videos on our website that provide some nice views of the Nava brewery.

I encourage you to take a look when you have a few moments.

Thank you, everybody for your participation today.

Thank you.

That does conclude the Constellation Brands fourth quarter and fiscal year earnings conference call.

You may now disconnect.