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Molson Coors Brewing Company (NYSE:TAP)

Q3 2009 Earnings Call

November 4, 2009 11:00 am ET

Executives

Peter Swinburn - President, Chief Executive Officer, Director

Stewart Glendinning - Chief Financial Officer

Dave Perkins - Chief Executive Officer, Molson Canada

Mark Hunter - Chief Executive Officer, Molson Coors U.K.

Dave Dunnewald - Vice President, Investor Relations

Analysts

Kaumil Gajrawala - UBS

Judy Hong - Goldman Sachs

Marc Greenberg - Deutsche Bank

John Faucher - J.P. Morgan

Mark Swartzberg - Stifel Nicolaus

Ross Turner - Pelham

Operator

Good day, ladies and gentlemen, and welcome to the Molson Coors Brewing Company 2009 third quarter earnings conference call. (Operator Instructions)

Before we get started, we want to paraphrase the company’s Safe Harbor language. Some of the discussion today may include forward-looking statements. Actual results could differ materially from what the company projects today, so please refer to its most recent 10-K, 10-Q and proxy filings for a more-complete description of factors that could affect these projections. The company does not undertake to publicly update forward-looking statements, whether as a result of new information, future events, or otherwise.

Regarding any non-U.S. GAAP measures that may be discussed during the call, please visit the company’s website -- www.molsoncoors.com -- for a reconciliation of these measures to the nearest U.S. GAAP results.

I would now like to turn the conference over to your host, Mr. Peter Swinburn, President and Chief Executive Officer of Molson Coors Brewing. Sir, you may begin.

Peter Swinburn

Thanks very much, Matthew. Hello and welcome, everybody and thanks for joining us today. With me on this call are: Stewart Glendinning, Molson Coors CFO; Leo Kiely, CEO of MillerCoors; Gavin Hattersley, CFO of MillerCoors; Dave Perkins, CEO of Molson Coors Canada; Mark Hunter, CEO of Molson Coors U.K.; Sam Walker, Molson Coors Chief Legal Officer; Bill Waters, Molson Coors Controller; and Dave Dunnewald, Molson Coors Vice President of Investor Relations.

On the call today, Stewart and I will take you through the highlights of our third quarter and year-to-date 2009 results and also will give you some perspective on the fourth quarter of 2009. As usual, we will include a review of financial results for MillerCoors. Then, we will open it up for questions.

Molson Coors had a successful third quarter, with underlying earnings growing more than 22% versus a year ago. This headline profit has some non-operating and unusual noise in the numbers due to the favorable resolution of tax positions, partially offset by unfavorable currency and one-off headwinds. Stewart will take you through the details but given the economic and industry challenges, we are pleased with the performance of our company in the third quarter.

Our results reflect a high level of brand investment, coupled with strong cost control and price management. They also show the effects of weak industry volume trends and continued cost inflation, along with more promotional pricing activity in Canada.

In terms of our portfolio performance, total-company volume in the third quarter declined, and worldwide Coors Light volumes were down slightly against a strong growth quarter a year ago.

Looking at the regional headlines, in Canada comparable revenue per hectoliter and gross margin grew as front-line price increases outpaced growth in promotional activity and cost of goods sold. Lower volume and increased brand investments, however, resulted in a 2% decline in local currency earnings.

Our U.K. team also reinvested higher revenue per hectoliter in its brands, while growing pretax profit in local currency more than 20% in the quarter. Also, the newly acquired Cobra brand got off to a good start in the quarter.

MillerCoors achieved its 5th consecutive quarter of strong double-digit profit growth in the U.S., driven by cost synergy delivery, solid pricing and lower marketing general and administrative spending. Equally important, the U.S. brand portfolio performed well in the peak summer selling season against its competitive set.

We remain focused on building a diverse portfolio of extraordinary brands, offering value-enhancing innovations for consumers and achieving positive pricing to grow our top-line and bottom-line as the economy improves. In a few minutes, I will give you a flavor for the investments we are making in brand building and innovation across our business as we close out 2009 and enter 2010.

We continue to achieve significant success in generating cash and leveraging our capital base to increase returns. At the end of the third quarter, we have already achieved more than 90% of our $575 million free cash flow goal for the full year.

In terms of leveraging our capital base, we recently announced the sale of our ownership interest in the Montreal Canadiens hockey club and our intent to buy Granville Island Brewing Company of British Columbia. The Granville Island acquisition, which we expect to close early in 2010, will represent a high-return addition to our super-premium portfolio. When combined with our Ontario-based Creemore Springs Brewery, the Granville Island brands will position us for additional growth in the Canada craft and specialty segment.

So with that as an overview, I'll turn it over to Stewart to review third quarter financial results and trends and then we’ll cover the outlook for the final quarter of 2009. Stewart.

Stewart Glendinning

Thanks, Peter, and hello, everyone. I’ll start with third quarter financial highlights. Worldwide beer volume for Molson Coors declined 2.9% from a year ago, driven by industry weakness in our major geographies, as well as our pricing strategy in the U.K. On the bottom line, underlying after-tax income of $212.9 million, or $1.14 per diluted share, was 22.7% higher than the third quarter a year ago.

As Peter mentioned, the headline profit result has some non-operating and unusual noise in the numbers, so it is helpful to look below the surface. Headwinds in the third quarter included unfavorable year-over-year currency movements, a mark-to-market hedge loss this year, and supplier negotiation benefits last year both in the U.K. These headwinds totaled more than $22 million pretax in the quarter, with foreign currency making up $13 million of this total. Meanwhile, our underlying results benefited from the favorable resolution of some unrecognized tax positions, which increased $36.4 million versus a year ago.

If we take these factors out of our underlying results to get a better view of the ongoing performance of the business, after-tax earnings increased approximately 13% in the quarter.

It is important to note that our third quarter underlying earnings do exclude some one-time gains and expenses, primarily related to our Foster’s cash-settled total-return swap and MillerCoors integration costs, as well as net special charges of $4.3 million. These adjustments to our U.S. GAAP results are described in detail in the earnings release we distributed this morning. Also, unless otherwise indicated, all financial results we share with you today will be in U.S. Dollars.

In segment performance highlights, starting with Canada, underlying pretax income in local currency declined 2% versus a year ago. Positive net pricing and the benefit of cost savings initiatives were offset by declines in volume and higher MG&A expenses, driven by increased brand investment and the deconsolidation of our interest in the beer stores in Ontario, known as Brewers Retail Inc., or BRI.

In U.S. dollars, Canada underlying earnings of $139.3 million in the third quarter declined 7.7% due to an approximate 6% year-over-year decline in the Canadian dollar versus the U.S. dollar. The weaker Canadian dollar this year reduced Canada segment underlying income by approximately $9 million in the quarter.

To provide more-comparable results in our Canada discussions today, as we have done on our previous calls, we will exclude the sales and costs relating to exporting beer to MillerCoors as well as the reporting effects of deconsolidating BRI.

So, let’s review some highlights -- our Canada sales to retail, or STRs, for the calendar quarter ended September 30th decreased 3.2% versus a year ago. Coors Light continued to show growth, while Molson Export and Molson Canadian declined versus prior year. Total Canadian beer industry sales to retail declined an estimated 0.7% in the calendar third quarter. Our estimated Canada market share decreased about one point in the third quarter versus a year ago. Our Canada sales volume was 2.5 million hectoliters in the third quarter, down 1.8% from a year ago. Comparable net sales per hectoliter increased 2% in local currency, driven by favorable net pricing, led by price increases across all major markets, partially offset by continued price discounting activity.

Cost of goods sold per hectoliter in the third quarter was flat on a comparable basis in local currency. This increase was due to the net effect of three key factors: first, commodity, packaging material, distribution and other input costs, including pension expense, increased about 1%; second, an increase of about 2% was driven by fixed cost deleverage related to lower export volume to the U.S. this year; and third, these increases were offset by savings from our Resources for Growth initiatives.

Comparable marketing general & administrative expense in the quarter increased 4.4% in local currency, driven by higher brand and innovation investments.

In the U.S., underlying U.S. segment pretax income grew 16.6% to $107.4 million in the third quarter, driven by continued strong underlying earnings growth by MillerCoors. Strong MillerCoors income growth was partially offset by cycling high equity income last year and one day of income for our legacy Coors business prior to the formation of MillerCoors on July 1, 2008. The equity income adjustments for our U.S. segment results are described in more detail in our earnings release distributed this morning.

Looking specifically at the total MillerCoors P&L, third quarter underlying net income increased 28.1% to $244.4 million from the prior year. MillerCoors is successfully delivering synergies, controlling costs, and managing revenue for sustainable profit growth, despite continuing commodity cost pressures.

In a weak U.S. beer market, MillerCoors domestic sales-to-retailers, STRs, were down 1.3% due to a decline in premium light volumes and continued softness in above premium and premium brands. Domestic sales-to-wholesalers, STWs, fell 0.7%, driven by lower retail sales. Despite the challenging environment, we're realizing the benefit of a well-balanced portfolio that offers consumers choice and variety in all segments. In the third quarter, during the key summer sales period, MillerCoors had four of the six largest dollar-growth brands in the scanner data. These brands are MGD 64, Coors Light, Miller High Life and Keystone Light.

MillerCoors total net sales revenue increased 3.1% to $2.01 billion versus a year ago, driven by domestic net pricing. Pricing remained strong in the third quarter, as domestic net revenue per hectoliter, excluding contract brewing and company-owned distributor sales, increased 3.7%, driven by sustained price increases taken in the fall of 2008 and reductions in discount activity.

Cost of goods sold per hectoliter increased 3.5% as benefits from synergies and other cost-reduction programs were more than offset by higher brewing and packaging material costs under procurement contracts largely arranged prior to more-recent commodity market price reductions. Marketing, general and administrative costs decreased 4.5%, driven primarily by synergies and other cost savings.

Moving to our U.K. business in the third quarter, underlying pretax earnings increased more than 20% in local currency from a year ago. This increase was driven by positive results from the strategic actions our U.K. team has taken in the past year, including leveraging our contract brewing arrangement and brand building efforts, allowing us to forgo low-margin volume. The benefit of these actions was partially offset by the one-time impact of a mark-to-market adjustment on natural gas hedges and cycling a one-time supplier negotiation benefit of $6 million in 2008, combined with lower volume and higher marketing, general and administrative expenses in the quarter.

In U.S. dollars terms, third quarter U.K. underlying pretax profit increased 6.5% to $32.7 million versus a year ago. These results include the impact of a 13% devaluation of the British Pound versus the U.S. dollar, which reduced U.K. earnings by $5 million in the quarter.

Looking at third quarter highlights, our U.K. owned-brand volume decreased 6.3% in the quarter due to declining industry volume and the company’s strategy to forgo low-margin volume. U.K. beer industry volume declined approximately 1% in the third quarter. Comparable net sales per hectoliter of our own products increased 21% in local currency, driven by two factors: first, 17% was due to higher pricing in all channels, as we benefited from our strategy to forgo low-margin volume; and second, four percentage points were due to positive sales mix, due to growth in draught Magners cider, Cobra, and favorable channel mix.

Comparable cost of goods sold per hectoliter of our own products increased 22% versus 2008 in local currency, driven by the following: 6% was due to cycling the one-time supplier negotiation benefit in 2008; 5% was due to input cost inflation; 4% was driven by growth in draught Magners cider, Cobra, and adverse channel mix; 3% was related to a mark-to-market adjustment on natural gas hedges, which is expected to partially reverse in the fourth quarter; and 2% was due to the deleveraging impact of lower owned-brand volumes.

Recall also that our contract brewing arrangements effectively take up spare capacity in the production network to deliver sales revenue which contributes positively to the bottom line company performance.

Marketing, general and administrative expenses in the U.K. increased 7.8% in local currency due to higher marketing, incentive compensation, and bad-debt expenses in the quarter, along with sales-related costs in our new Cobra business.

In the International Markets and Corporate segment, our International Markets team grew volume nearly 28% in the third quarter off a small base, driven by China and Europe. MG&A expense for International was $12.7 million in the quarter, an increase of $1.1 million versus a year ago. In addition, corporate general & administrative expense increased $7.7 million to $28.1 million, primarily due to higher incentive compensation, project spending, and labor-related costs this year.

Third quarter net interest expense declined $3.7 million from a year ago, with about 2.7 of this reduction attributable to the deconsolidation of BRI and the balance due to foreign currency movements. Note that interest expense for the third quarter of 2008 has been increased $4 million retroactively in accordance with the new accounting rules for convertible debt.

Corporate other income increased $49.1 million, driven by a $59.3 million non-cash mark-to-market gain related to the total return swap we arranged with respect to Foster’s common stock. As usual, these mark-to-market gains on the Foster’s swap are excluded from our underlying earnings.

The underlying loss for International markets and corporate combined was $57.5 million pretax in the third quarter, 7.1% higher than a year ago.

Now, highlights of our cost-reduction initiatives -- in the third quarter, we captured an incremental $18 million of cost savings as part of our three-year, $250 million Resources for Growth, or RFG, cost reduction initiative. Savings from the RFG program during the past 2.75 years now total $246 million.

In addition to RFG savings, MillerCoors delivered $73 million of incremental cost synergies in the third quarter, largely due to organizational savings. Our 42% share of these synergies is $31 million.

As we announced earlier in the year, we are wrapping up the RFG program and locking down our next generation cost-reduction program, called RFG2. This new program offers at least $100 million of permanent cost reductions over the next three years. The primary areas of savings for the new program will be in logistics, waste, utilities, maintenance, systems, and procurement. We plan to provide more details regarding RFG2 during our annual New York analyst meeting this March.

Moving beyond operating business unit performance, our third quarter effective tax rate was 9% on a reported basis and 4% on an underlying basis. These rates are well below our long-term rates due to the favorable resolution of unrecognized tax positions in the third quarter, which was one quarter earlier than we anticipated at the time of our previous earnings call.

Free cash flow for the first three quarters of 2009 reflected net cash generation of $490 million, which was made up of $667 million of operating cash flow, plus $4 million of proceeds from asset sales, minus capital spending of $72 million and $109 million of investing cash contributed to MillerCoors. If we exclude one-time cash uses by MillerCoors to capture synergies, along with the return of collateral cash related to MillerCoors commodity hedges, our underlying free cash flow totaled $534 million for the first three quarters of this year. As a result, we are more than 90% of the way toward our 2009 goal of generating $575 million of underlying free cash flow.

Total debt at the end of the third quarter was $1.68 billion. Cash and cash equivalents totaled $565 million at the end of the third quarter, resulting in net debt of $1.11 billion.

Looking forward, we continue to expect full-year 2009 MG&A expense in the Corporate and International Markets segment of approximately $160 million. We now anticipate full-year corporate interest expense in the range of $90 to $95 million at today’s foreign exchange rates, including the net effect of new accounting rules for convertible debt and the deconsolidation of BRI.

Turning to our effective tax rate, we now expect our full-year underlying tax rate for 2009 to be close to zero, assuming no further changes in tax laws. In the fourth quarter this year, we anticipate a significantly negative tax rate due to the resolution of additional tax years. With the substantial reduction in unrecognized tax positions this year, we anticipate that our effective tax rate after 2009 will be less volatile and more likely to be in our long-term range of 22% to 26% for underlying earnings.

Based on our year-to-date cash generation, we are confident that we will achieve our goal of generating $575 million of underlying free cash flow this year. As in the past, this goal excludes the one-time MillerCoors impacts on our cash flow. This goal also excludes the benefit of MillerCoors using less collateral cash for commodity hedges this year. Our total free cash generation for the year will depend significantly on working capital timing in the fourth quarter.

As we mentioned last quarter, another factor that could affect the company’s free cash flow this year is the potential to resolve some of the contingent liabilities related to our former Brazil business. During the second quarter, the Brazilian government enacted a tax amnesty that may accelerate the resolution of some of these liabilities, which could result in a use of cash.

Our 2009 capital spending outlook is now approximately $130 million for the full year. As usual, this guidance excludes MillerCoors.

At this point, I'll turn it back over to Peter for a look ahead to the balance of 2009. Peter.

Peter Swinburn

Thanks very much, Stewart. Throughout 2009, we have consistently said that we would focus on brand building, reducing costs across our company, and generating cash, and that goes on.

In Canada, for the balance of 2009, we expect a continued challenging environment due to overall weak economic conditions, soft beer industry volume, continued price discounting, and the cost of offering enhanced value propositions to consumers. Our commitment to improve the brand portfolio in Canada is now gaining traction. In the fourth quarter, we are launching Rickard’s Dark, Molson “M,” the first micro-carbonated lager, and Molson Canadian 67, the lowest calorie beer in Canada.

Also, with the 2010 Vancouver Olympics approaching, we will begin to accelerate our promotional activity as the Official Beer Supplier to the Vancouver 2010 Winter Olympic and Paralympic Games.

In the U.S., the first priority for MillerCoors is driving growth for our premium light portfolio. We believe we have the marketing platforms, tools and the beers to do that. First, we are supporting Miller Lite with great football and soon holiday programming. We’re driving its great taste message with the “Great Calls” campaign celebrating great sports moments, and we’re injecting humor into the message with “Love Your Beer” spots that have just started airing.

Secondly, we believe the cold refreshment message will continue to drive Coors Light’s success and we’ll continue to innovate and drive distribution and display just to make sure that happens.

Finally, we’re stepping up display, sampling and education behind MGD 64.

In the U.K., we expect performance comparisons with prior year will become more challenging in the fourth quarter as we cycle the ramp up of our strategic initiatives, an extraordinary price increase in the fall of 2008, a greater portion of our sales coming from the higher-cost off-premise channel, and a reduction in marketing spending in 2008. We also anticipate higher incentive compensation in the fourth quarter this year in the UK. This business is now on much firmer footing and has made substantial progress in improving profitability.

Our international business is increasing its investments in a number of new brand and market initiatives, particularly in developing markets. As a result, we expect MG&A expense to increase significantly in the fourth quarter from a year ago.

Following are the most recent volume trends for each of our businesses early in the fourth quarter: in Canada, our comparable sales to retail in the first four weeks of October decreased at a high-single-digit rate, driven by weak economic conditions and poor weather, especially around the Canadian Thanksgiving holiday, leading to a decline in industry volume.

In the first five weeks of the fourth quarter, our U.K. sales to retail have decreased at a low-double-digit rate.

In the U.S. for the first four weeks of the fourth quarter, MillerCoors sales to retail declined at a mid-single-digit rate due to overall industry softness.

As always, please keep in mind that these numbers represent only a very small portion of the fourth quarter, and trends could change in the weeks ahead.

In the area of cost outlook, by business: in Canada, on a comparable basis, excluding exports and BRI deconsolidation impacts, we now anticipate that cost of goods sold per hectoliter will decrease at a low-single-digit rate in the fourth quarter of 2009, due to benefits from our RFG cost savings program and lower overhead costs, which we expect to more than offset input inflation and ongoing product mix shifts.

On a reported basis, we expect our Canada cost of goods per hectoliter in the fourth quarter to decrease at a high-single-digit rate in local currency, due to lower exports to the U.S. and the effect of deconsolidating BRI this year.

Our U.K. team is targeting more reductions as part of the Resources for Growth program, driven by supplier negotiations and operational efficiencies. In a challenging industry volume environment, we expect our fourth quarter 2009 U.K. cost of goods per hectoliter to increase at a double-digit rate in local currency. Drivers include an increase in the high-cost off-premise channel as a percent of our mix, continued input cost inflation, product mix reflecting more Cobra and draught Magners volume, and fixed-cost de-leverage as a result of lower owned-brand volumes this year.

In the U.S., MillerCoors has delivered $183 million in synergies to date this year, bringing the total to $211 million since beginning operations on July 1, 2008. The U.S. team now expects to achieve $270 million of cumulative synergies by the end of 2009, surpassing its original commitment of $225 million.

As we’ve previously mentioned, MillerCoors plans to deliver incremental cost savings above its $500 million synergy target, and approximately $200 million of additional cost savings are now expected to be delivered by the end of 2012. These additional cost savings include efficiencies in production costs, procurement, and MG&A expenses.

So, to summarize our discussions today, our third quarter results included significant non-operating and unusual noise in the numbers. Regardless, Molson Coors grew earnings at a double-digit rate in the quarter.

Looking at year-to-date performance for Molson Coors Brewing Company, the first three quarters of 2009 have been positive in terms of both financial results and progress in our businesses. Highlights include: total company underlying earnings up more than 33% year to date; in Canada, the new members of the leadership team, led by CEO Dave Perkins, is improving our competitive position. They have begun to roll out several portfolio-building innovations, and announced their intention to purchase Granville Island Brewing in British Columbia; our U.K. business has posted strong financial results year to date, with underlying pretax income up more than 75% in local currency. The team is leveraging strategic initiatives to improve financial performance and now has finalized contracts with all its major on-premise chain customers, which offers a solid platform to drive both volume and margin in the years ahead; in the U.S., MillerCoors is delivering on its synergies commitments, controlling costs and managing revenue for sustainable profit growth. In a challenging economic environment, MillerCoors is also realizing the benefits of a well-balanced portfolio, as evidenced by our out-performance versus the category this summer.

Molson Coors achieved good performance year-to-date, and as we look forward to the fourth quarter, we anticipate that global beer markets will remain soft and consumers will continue to look for value in a weak economy.

To drive volume, price and profit, we will continue to offer value to consumers in many forms, including innovative brands and packaging, as well as category-leading advertising, retail promotions, and service to our customers. In the fourth quarter, there will be incremental investments related to these efforts, and these will be most significant in our Canada, U.S. and international businesses.

In Canada, we are introducing three innovative brands -- Molson M, Molson Canadian 67 and Rickard’s Dark, and accelerating our promotional activity as the official beer supplier to the Vancouver 2010 Winter Olympics. And in the fourth quarter, we are also rolling out new advertising creative for the Molson Canadian brand.

In the U.S., we are increasing our investment behind the fast-growing MGD64 and other brands, as well as expanding distribution of our innovative home draft package. Also, our latest Miller Lite advertising, which is hitting the air waves now, has received positive reviews from distributors and in consumer research.

International growth is a key part of our strategy going forward, and we are investing more behind our strategic brands in select markets in Asia and Europe.

These fourth quarter investments are consistent with our brand-led strategies, and we expect them to drive top-line and bottom-line growth as we move into 2010. Equally important, our innovation pipeline is full for 2010, with a wide range of opportunities to build brands and drive profitable growth in each of our businesses well into the future.

Now, before we start the Q&A portion of the call, a quick comment -- our prepared remarks will be on our website for your reference within a couple of hours this afternoon. Also, at 2:00 p.m. Eastern Time today, our Investor Relations team led by Dave Dunnewald will host a follow-up conference call, essentially a working session for analysts and investors who have additional questions regarding our quarterly results. That call will also be available for you to hear via webcast on our website.

So at this point, Matthew, we would like to open it for questions, please.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Kaumil Gajrawala.

Kaumil Gajrawala - UBS

Stewart, on the free cash flow, your 90% of the way but you still have a quarter left. Could you give us a read on what we should be thinking about or if there is any reason why you haven’t taken up the free cash flow target for the year?

Stewart Glendinning

Good question, Kaumil. We’re not going to give any guidance on where we are going to end up in the -- at the end of the year. That will come a little closer to the fourth quarter but I think really just step back and just say this is really a positive for us, given where we started the year and we set our targets, our earnings have come in stronger, and the business is performing better than we had expected. And that is showing through to our cash and that’s just got to be good news for the shareholders.

Kaumil Gajrawala - UBS

Okay but there is nothing incremental in terms of uses of cash, maybe the increment CapEx related to the new cost savings at MillerCoors -- is there anything like that in there?

Stewart Glendinning

No, I think we -- all of that we’ve shared with you. MillerCoors is at 84% of the one-time cash, the 450. They will be at 90 by the end of the year, so there is that piece.

The other piece we look at is our exposure in Brazil and as we updated you last quarter, we are still in some discussions with [DEMSA] to decide how that will be resolved but that is a potential use of cash and I’d use -- I’d go to our Q and you’ll see we’ve got about $160 million of liability on the books. That’s not all related to those specific -- to that specific item. I’d say probably in the sort of 85% to 90% is the number on our balance sheet related to that and that’s the best guide for that particular issue.

Kaumil Gajrawala - UBS

Okay, got it. And then last question, in every region, pricing was very -- or net revenue per hec was strong but volumes were weak. How comfortable do you feel in your ability to hold on to strong pricing?

Peter Swinburn

A couple of things I think we mentioned in the script -- first of all in the U.K., we’ve locked out negotiations with all the major pub-cos this year, so that gives us -- those deals are three-year deals at least, so the pricing is -- the price increase mechanisms are locked in for those and that would account roughly for about a third of our business in the U.K., so we feel comfortable in the U.K.

If you were listening to the MillerCoors call earlier this morning, I think that both Leo and Gavin talked about where the MillerCoors business was. They’ve got about 80% of their pricing through this year, cost of goods look a bit more reasonable going forward so again, I think we are relatively comfortable in the U.S.

And in Canada, it’s a slightly different perspective, to be honest with you. I think we’ve shared with you that we will be competitive in Canada. The team there is really getting its act together but we manage pricing by market, by SKU there and across the piece, to be honest with you, to ensure that we are competitive. So I think that’s the best summary I can give you, if that’s helpful.

Kaumil Gajrawala - UBS

Thank you.

Operator

Your next question comes from Judy Hong of Goldman Sachs.

Judy Hong - Goldman Sachs

I guess my question is really by looking at Canada more closely, you know, your share decline has gotten worse in the quarter. Maybe you can shed a little bit more light into sort of the competitive activity in terms of what is going on there. It sounded like in the beginning of the year, really the discounting was more limited to Quebec and I’m wondering if that is spreading out into other regions. What’s causing sort of the heightened competitive environment and at what point do you think that you may have to take more aggressive steps just beyond some of the innovation things that you are doing to really stem the market share losses in that market?

Peter Swinburn

I’ll pass the main body of the question on to Dave but I think that you hit one of the main points again, Judy, and that is that we see the market being managed in totality and we have been pretty open in the past saying that we weren’t happy with our overall portfolio in Canada and we believe we are making very good steps, great strides, in fact, to sorting that out with the innovations that we’ve got coming into the market place and the new creative with Canadian, which we are very excited about. But Dave, do you want to address the main body of the question?

Dave Perkins

Thanks, Peter, and thanks, Judy, for the question. Judy, as I look at Q3 and our year-to-date share results, obviously we are not where we need to be. I think it’s valuable to go a little bit below the surface in looking at our Q3 share results. We did actually make progress in our competitiveness and our share results in our major markets of Quebec and Ontario and I feel good about what I am seeing starting to happen there as we get to a better balance of price and volume. We are dealing with challenges and opportunities in the remainder of the country.

I think as we went through the quarter, we also saw some progress which felt good to me. But no question we saw smaller regional brewers in each market grow share at the expense of the two major brewers combined and that is something that we will continue to be focused on.

As we have heard, we are really taking action now to strengthen our market position and our brand portfolio in a variety of ways. We feel very good about the innovation that we have coming up with Molson Canadian 67, Molson M, and Rickard’s Dark. I think the announcement regarding Granville Island Brewing is another commitment to strengthening the portfolio, and particularly in the above premium segment there, so that’s a well-known, well-regarded brand in B.C. that we think has the ability to travel and we are excited by that.

We also have work underway to strengthen Molson Canadian, as Peter referenced, and we have the upcoming Olympic platform, and we will certainly leverage that fully.

And finally, as we noted, we continue to improve our competitive position and finding that right balance between price and volume.

So I would say as you go below the surface in the quarter, there are some encouraging signs. Certainly the entire team here is focused on the share challenge because we know we need to step into that and feel good about the activity in fact that we have in front of us there.

Judy Hong - Goldman Sachs

Just following up on your comment about the smaller regional brewers getting more competitive outside of Quebec and Ontario, can you maybe tell us what sort of are the factors that are driving that competitive behavior in those markets?

Dave Perkins

A lot of it is in fact price or value related. I would say though that during Q3 there was in fact some innovation activity, lime entries, that in fact did get fairly high trial. They have subsequently diminished but they did get high trial. But generally what we are seeing is small brewer pricing activity that we are needing to deal with.

Judy Hong - Goldman Sachs

Okay, and then just a clarification -- when you said the Canada SPR was down high single digits so far in the quarter, can you tell us what the industry volume has been during that time?

Dave Perkins

We believe what we are seeing in October is largely related to industry. There does appear to be during October a fairly significant drop-off in industry. Last year I would tell you that we had particularly favorable weather and so we believe that that’s a factor in it. Tough to know what all the factors are -- I mean, there’s even impact in Canada related to the flu going around, so you look at the various factors and there’s probably a combination of weather, economy, and other factors that are at play.

Judy Hong - Goldman Sachs

Okay, thanks. And then just my question for Stewart -- on the free cash flow side of the equation, I mean, clearly it sounds like you are pretty pleased with the cash flow generation performance and even if you are to use a portion of that to settle some of the tax liabilities in Brazil, it seems like you are going to be left with still a pretty ample cash flow. And so I’m just wondering why not again sort of commit to some of that going to shareholders at this point?

Stewart Glendinning

Great question, Judy. We are in a place I guess where if you looked at our cash holding, the cash balance at the end of this quarter, about $575 million, so we are in a place now where we feel good about our cash balance.

I will reiterate the point we made in previous quarters, which is that on a quarterly basis, we review this with our board and there’s a range of cash options that we could look to. If you looked at some of the places we have put cash this year, we’ve made two great purchases of smaller brands this year -- well, we haven’t completed the purchase of Granville Island but we’ve made effectively a down payment on that. We also have purchased Cobra, so we are trying to use cash first and foremost in ways that will grow shareholder value. We will also look then at ways to take liabilities off our balance sheet and tax would be an example of that. Last year you saw a use of funds for pensions, and then we will look at what our dividend policy is and consider buy-backs. And again, we have our board meeting next week so we will go through that with the board and if there is any change to any of that, we expect to update shareholders in the next quarter.

Judy Hong - Goldman Sachs

Okay. Thank you.

Operator

Your next question comes from Marc Greenberg of Deutsche Bank.

Marc Greenberg - Deutsche Bank

Just to dig a little deeper on Judy’s question around shareholder value, Peter, can you comment more broadly with regard to what kind of a dividend pay-out over the long-term you think is appropriate for a business like Molson Coors and if shareholders would be more significantly enhanced by a repurchase and as an adjunct to that, what kinds of net debt to EBITDA levels are gearing this kind of business should have over the longer term?

Peter Swinburn

Thanks, Marc -- I’m probably going to disappoint you by saying that no, I probably can’t give you all of that but I think you’ve got to look at our track record. We’ve increased our dividend by a pretty substantial rate last year and this year and so I think the important thing, or the way that we look at it is that we need to come to our shareholders and hold our heads up in terms of how we use their cash and I think as Stewart said, in the recent -- in the last 12 months, we put $100 million into the pension scheme in the U.K. We have got very, very good returns from that investment over this year. We have made a couple of really smart acquisitions I think with Cobra and Granville Island. Although you guys get quite excited about it, we are not sitting on a ton of cash. We are in a comfortable position and we will continue to look at the options out there that will give us the best possible return for shareholders and that will include dividends, obviously, it will include share backs, but it would include other options in terms of strengthening our balance sheets as well and that’s just an ongoing dialog that we have with our board, as Stewart said.

Marc Greenberg - Deutsche Bank

Great, and just a quick follow-up -- on the U.K. business, nice to see the operating profit trending up but it is still, at least based on your 2002 pro formas, below what CBL earned eight years ago, so I guess it’s been kind of a long road there and I’m wondering, as you look at that business today, what kind of sign posts you look at to gauge the success of that business, how might we properly characterize progress there sort of beyond the obvious metrics?

Peter Swinburn

I will let Mark take most of the question but I think my -- the initial response is that you have put a couple of sort of sign posts out there that we look at and most importantly, the sort of cost of -- return on capital we get on that business has got to be acceptable to shareholders. I think we have made good progress this year. We are not where we want to be. The percentage that we achieve in -- our net sales percentage we are achieving is still not where we want to be but again, I think the team is making really good strides in that direction and most importantly for this year and probably last year as well, it’s been about developing a platform that allows us to address those issues. And I think, Mark, you can probably speak to that more effectively than I can in terms of the strategic initiatives and your pricing strategy.

Mark Hunter

Yes, I certainly can. Thanks for the question, Mark. We’ve been very clear in our business that currently our return on invested capital is below our [WAC] rate and we have set out as part of our three-year plan an ambition to move that return on invested capital ahead of our [WAC] rate, so we start growing shareholder value. Our return on sales have improved significantly over the last 18 to 24 months and we have set a very clear ambition for the business to start to generate returns which get us back to where we were in the early part of the 2000s.

All of the activities that you are seeing taking place through the latter half of 2008 and through 2009 are very consistent with that ambition and job number one has been to reset our pricing and ensure that our net sales [have always starts to] support those ambitions. That job is almost complete as we go through 2009. We’ve continued to invest heavily behind our brands. We’ve been investing a growth rate which is a low double-digit on a per hectoliter basis as we’ve moved our pricing up. And as we move into 2010, we expect to see pricing continue to move forward and we expect to see our share performance start to rebound, having reset pricing -- all of that relative to an ambition that we’ve set for the organization on a 36-month timeline.

Marc Greenberg - Deutsche Bank

Mark, just briefly, how would you characterize the market environment heading into the important winter holidays?

Mark Hunter

The market environment remains challenging. If you look at where industry volume was as we left 2008, the market finished down about 5.5%. On a year-to-date basis, the market is still tracking down about 4.3%. On-trade has improved but it is still declining at kind of mid-single-digits. Off-trade has been extremely volatile -- up until Q3 of this year, we’ve seen four straight quarters of pretty substantial decline. That rebounded slightly in the third quarter, so still enormous volatility and certainly no tailwinds from an industry volume perspective and that is why our focus on not chasing any low margin volume, focusing on revenue growth at a time when we’ve got very high asset utilization because of our contract brewing deal -- all of that I think puts us in a pretty strong position as we move into Q4 and into 2010.

Marc Greenberg - Deutsche Bank

Thank you.

Operator

Your next question comes from the line of John Faucher from J.P. Morgan.

John Faucher - J.P. Morgan

I want to talk a little bit about the Canadian pricing again and you know, strong revenue per barrel growth -- can you talk about what the industry revenue per barrel growth was? So how did you guys compare?

And then also, looking at the quarter to date trends, you talked about your being down I think it was mid-single-digits in Canada and can you compare that -- you said it’s an industry issue, so I am assuming the industry is basically in line with your quarter to date trend, is that correct?

Dave Perkins

Yeah, the quarter to date would be largely industry related, so you are correct on that. With regard to the NSR for the industry, I wouldn’t have data on that. I only obviously have ours, so I am not able to give you the comparison.

John Faucher - J.P. Morgan

Can you give us a rough idea in terms whether you think the rest of the category is -- I’m not looking specifically, I’m looking sort of general trends in terms of whether you feel like the rest of the category is up a similar amount.

Dave Perkins

Well, we certainly are achieving the kind of balance we want on price and volume so I would say we are not dramatically out of line with what would be happening within the industry but it is really difficult obviously to get more precise than that.

John Faucher - J.P. Morgan

Okay, thanks.

Operator

Your next question comes from Mark Swartzberg of Stifel Nicolaus.

Mark Swartzberg - Stifel Nicolaus

Canada, on the cost side of things, Stewart or David, we heard from MillerCoors this morning, they described their costs per hectoliter view for the U.S. next year being essentially flat on ’09 levels. Can you share with us, given where your hedges are and where the commodities are and your mix, how you think your costs per hectoliter will shake out next year versus this year’s levels?

Stewart Glendinning

I’ll take that. I think MillerCoors did give some of that sense of 2010. For the Molson Coors business, normally we would give that kind of guidance early in the next year and I think that is what our plan is.

Mark Swartzberg - Stifel Nicolaus

Can you give us any directional feel at this juncture?

Stewart Glendinning

We can't give you any guidance on that. I can say though that I think that team has done a terrific job in terms of managing costs. If you looked at this past quarter, keeping costs flat on a year-over-year basis I think was a great result.

Mark Swartzberg - Stifel Nicolaus

And can you just remind us about your strategy in terms of hedging for commodities?

Stewart Glendinning

Well for us, like any hedging program, and you can certainly see some of those disclosures in our Q. We have a declining hedging balance so you will have more hedging in the early periods than the later periods and then so obviously in any kind of rising price market, you’d be slower to see some of that rising prices coming through. In a declining price market, you will obviously be a little bit slower to see some of that benefit coming through.

I should also point out, Mark, that we did at least give guidance for the fourth quarter, which shows Canada to be down low single digits in terms of their COGS, so combine that together with the performance in the third quarter and I think you probably get a good answer for next year.

Mark Swartzberg - Stifel Nicolaus

Great. Thank you, Stewart.

Operator

And our final question in queue comes from Ross Turner of [Pelham].

Ross Turner - Pelham Capital

It’s [inaudible] from Pelham Capital. Just looking at the Canadian business, you obviously reported 2% increase in revenue per hectoliter, but if you actually look at your revenue and divide it by your volume, it actually was a decline. I’m guessing that is due to the import side of the Canadian business. Can you give us some feel about how the mix effect that you have seen in the Canada business from your import and how much that should decline specifically?

Stewart Glendinning

Let me just pick up the first part of that -- you are better off looking at some of the comparable numbers that we have given you because there is a little bit of noise in there as we look at the impact obviously of FX -- that’s going to be one impact. I think the other impact you are going to see is the Molson -- sorry, the Blue Moon that we stopped producing in Canada has a negative impact on a reported basis on our NSR of about 3%. So we stopped producing Blue Moon last year in Canada. We have that year-over-year comparison issue, so best to really stick with the comparison --

Ross Turner - Pelham Capital

What I am looking at -- the way I’ve looked at it, to be honest, and also a [few other things in Canada], is actually look at your Q2 sales this year and your Q3 sales and divide that by your volume for Q2 and Q3. Now I know there’s seasonal effects, I’m sure, but even then just looking at those three months sequentially, it’s down sort of 3% or 4% in Canadian dollars per hectoliter.

Stewart Glendinning

I think one of the things you are going to see there is potentially the impact of exports and I think that was the second part of your question, which perhaps Dave can pick up.

Dave Perkins

I’m sorry, Stewart, we didn’t hear the original question.

Ross Turner - Pelham Capital

The question was basically that obviously you said that on a comparable basis, sales per hectoliter in Canada increased 2%. Looking at it sequentially from Q2 to Q3 09, if you look at revenue per hectoliter on the Canadian dollar, it actually declines sort of 3% or 4%. And I am guessing that’s to do with imports, because you exclude imports when you are looking at it on a comparable basis. I’m just trying to understand how much were your imports down and what sort of effect this is going to have going forward.

Dave Dunnewald

The answer to the question is essentially you had a flip of the impact that Stewart mentioned related to exports to MillerCoors. In the second quarter, the -- essentially the accounting for those exports increased revenue per hectoliter as well as cost of goods per hectoliter. In the third quarter again on a year over year basis, the exports to MillerCoors reduced the revenue per hectoliter and the cost of goods per hectoliter and that is why when we present comparable analysis of our Canadian results, we strip those out because it’s basically just noise in the numbers, change in the way we account for the beer that we sell to MillerCoors. Now, subsequent to the formation of MillerCoors and subsequent to the moving of Blue Moon product production from Canada to the U.S.

Ross Turner - Pelham Capital

Okay -- going forward, this should be -- this sort of noise won't -- is less likely to be there?

Dave Dunnewald

Actually in the fourth quarter, you should see a similar effect to what we saw in the third quarter and then more normal thereafter.

Ross Turner - Pelham Capital

Thank you very much.

Operator

Thank you. I have no other questions in queue. I would like to return the program to the presenters for any concluding remarks.

Peter Swinburn

Thank you very much, Matthew and thank you, everybody, for joining us this morning, this afternoon and for your interest in the business. We look forward to speaking to you again at the end of our next quarter. Bye now.

Operator

Ladies and gentlemen, thank you for your participation on today’s conference. This does conclude the program and you may now disconnect.

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Source: Molson Coors Q3 2009 Earnings Call Transcript
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