Constellation Brands, Inc. F4Q10 (Qtr End 02/28/2010) Earnings Call Transcript

Apr. 9.10 | About: Constellation Brands, (STZ)

Constellation Brands, Inc. (NYSE:STZ)

F4Q10 Earnings Call

April 9, 2010 10:30 am ET

Executives

Patty Yahn-Urlaub - Vice President of Investor Relations

Robert S. Sands - President, Chief Executive Officer, Director

Robert P. Ryder - Chief Financial Officer, Executive Vice President

Analysts

Lauren Torres - HSBC

Timothy Ramey - D.A. Davidson & Co.

Reza Vahabzadeh – Barclays Capital

Lindsey Druckerman – Goldman Sachs

Carla Casella – JP Morgan

Mark Swartzberg - Stifel Nicolaus

Kevin Dryer[ph] - Cavelli & Company[ph]

Operator

Welcome to the Constellation Brands fiscal year 2010 earnings call. (Operator Instructions) I would now like to turn the conference over to Ms. Patty Yahn-Urlaub, Vice President of Investor Relations. You may begin your conference.

Patty Yahn-Urlaub

Thank you. Good morning everyone and welcome to Constellation’s fourth quarter and fiscal year-end 2010 conference call. I am here this morning with Rob Sands, our President and Chief Executive Officer and Bob Ryder, our Chief Financial Officer. This call complements our news release which has also been furnished to the SEC.

During the 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 comparable GAAP measure and these and other non-GAAP financial measures are included in the news release or otherwise available on the company’s website at www.cbrands.com under the Investors section.

Please also be aware that we may make forward-looking statements during this call. Although statements represent our best estimates and expectations, actual results could differ materially from our estimates and expectations. For a detailed list of risk factors that may impact the company’s estimates, please refer to the news release and Constellation’s SEC filings.

Now I would like to turn the call over to Rob.

Robert Sands

Thanks Patty. Good morning everyone and welcome to our call. We have several items to review this morning including our fiscal 2010 results and our guidance for fiscal 2011.

In February, we reached the conclusion of a very dynamic year, one in which we executed against our strategic goals despite lingering economic challenges around the world that affected our key markets. We accomplished a great deal through fiscal 2010, continuing the disciplined work of transforming our portfolio, our operations and our financial model. We continued our portfolio transformation efforts as we began the fiscal year with the sale of our value spirits business which resulted in cash proceeds of $276 million and then we successfully integrated the remaining spirits business into our North American wine business and we ended the fiscal year with the sale of our U.K. cider business, the Gaymer Cider Company, to C&C Group for approximately $70 million.

These transactions combined with strong free cash flow generation helped drive a $600 million decrease in our debt levels. We continued our efforts to improve our prospects for our U.K. and Australian businesses by tightening the portfolio focus, increasing efficiencies, reducing costs and improving cash flow generation. We significantly improved our cost structure not only through our global cost reduction initiatives but through supply chain initiatives and tightened control on SG&A spending.

We improved productivity and created efficiencies through global SKU rationalization efforts and consolidation of our global footprint. We progressed in our efforts to create an integrated technology platform which has been designed to improve the accessibility and visibility of global data. This initiative is already creating value by reducing COGS and improving efficiencies and is designed to ultimately enhance performance in key areas such as supply chain, global procurement, customer service and information management and analysis.

We implemented our new go-to-market sales and marketing structure in the U.S. which was successfully integrated into a single organization. This resulted in synergy benefits and improved efficiency and effectives with our trade partners. From a strategic perspective we have undertaken one of our most important initiatives with the launch of our U.S. consolidation efforts.

Presently, this program gives five distributors the right to sell Constellation’s portfolio of wine and spirits exclusively in their respective markets in 22 states and currently represents approximately 60% of our total U.S. wine and spirits volume. Since the initial transition in September 2009, these distributors have allocated more than 1,000 dedicated distributor sales people to focus exclusively on selling Constellation’s product portfolio.

As you know, the initial distributor transition commenced September 1, 2009 with the second quarter of fiscal 2010 benefiting from the implementation of this program. At that time actions were taken to ensure maximum service levels between distributors and their retail customers during the transition period. These actions had the planned effect of moving a portion of third quarter sales into the second quarter and resulted in some inventory build at distributors. During the third quarter, consumer takeaway was softer than expected at the beginning of the quarter but improved as our new selling model and promotional efforts began to take effect. However, at the end of the third quarter, distributor inventories were higher than targeted levels.

In the fourth quarter, we made a proactive, tactical decision to work with our distributors in decreasing their higher than average inventory to more moderate levels. How did we accomplish that? We did not require distributors to purchase products at contracted levels and in return they agreed to invest in additional marketing and promotional programs behind our brand in the marketplace.

As expected, these actions unfavorably impacted our U.S. wine business during the fourth quarter by approximately $60-70 million in net sales and about $0.07 to $0.09 in diluted EPS and created negative leverage on the remainder of the P&L. However, we believe it was an appropriate tradeoff in order to better position the distributors for success in the future as they work with us to drive profitable organic growth.

Going forward, we are refocusing our energies from managing transition activities to improving depletions and consumer takeaway. Our ultimate goal is to grow our U.S. wine business in line with the total industry growth trends and we expect to achieve this goal in 2011. This translates to an estimated volume growth rate of approximately 1% for the U.S. wine industry inclusive of all channels both on and off-premise. As we have discussed the on-premise channel is tempering the overall growth rate for the wine category while the grocery, mass merchant and club channels are growing at faster rates.

For instance, current growth in the Symphony [ph] IRI channel remains healthy at about 5% on a dollar basis according to recent 12-week IRI data that corresponds to the end of our fiscal year. In particular, the premium segment where wine sells for greater than $5 per bottle at retail continues to grow in IRI channels at a rate of mid to high single digits. Within these trade segments, many of our leading well known brands continue to perform well in the marketplace, including for instance, Rex Goliath, Robert Mondavi’s Private Selection, Clos du Bois, Estancia, Toasted Head, Simi, Franciscan and Kim Crawford.

Remember about 40% of our U.S. wine volume is currently sold in several states that are not included in the transition process. It is in these states that our depletion trends are generally better than those undergoing transition. From a marketing perspective, we are currently in the process of launching several new products or line extensions as part of our strategy to fill portfolio gaps and drive profitable organic growth.

For instance, as we focus on gaining share in the rapidly growing Argentinean Malbec segment, we are preparing to rollout the new Black Box Malbec varietal. We will also be re-launching our Diseno brand with a new package and marketing positioning. We will soon begin shipping our new Blue [ph] Riesling Wine. This action will establish a presence for us in the rapidly growing German Riesling segment. Constellation will begin its participation in the emerging organic wine niche with the Mendocino Vineyards brand which is made using organic grapes. And we are in the process of a national rollout of the sparkling wine under the Woodbridge by Robert Mondavi umbrella.

I just returned from the wine spirits wholesaler conference where Constellation was awarded nine Impact 2009 Hot Brand awards for several of our well known brands including SVEDKA, Black Box, Kim Crawford, Rex Goliath, Corona Light and Modelo Especial just to name a few.

Our Canadian wine business posted positive net sales results for the year, primarily driven by the premium wine portfolio including Jackson-Triggs Naked Grape and the Quebec import business. As you know Vincor Canada was the official wine supplier for the 2010 Winter Olympic Games. This sponsorship provided unprecedented exposure for our Canadian brands and showcased the Canadian wine industry to the world. Although the full business impact of this sponsorship has yet to be realized I am pleased to report at this time that an incremental 20,000 cases of our Canadian brands were sold at Olympic venues and surrounding areas during the games.

In addition, our participating Canadian brands were showcased through Canadian and International Media including the Today Show, A Taste of Canada with Kathy Lee Gifford and Wine Spectator.

In the spirits segment, SVEDKA Vodka had another great year and generated phenomenal sales growth of almost 40% versus last year which translates to more than 3 million cases sold in fiscal 2010. SVEDKA is the fastest growing major U.S. spirits brand and now has become the fourth largest vodka brand in the entire United States. We just launched SVEDKA’s first national TV advertising campaign which began airing March 1.

Black Velvet is the second largest Canadian whiskey brand in the U.S. and grew to more than 2 million cases in fiscal year 2010. It also posted solid results for the year with sales increasing in the low to mid single digit range.

From an international perspective, earlier this week we announced that we have ended our discussions with Australia Vintage, Ltd. pertaining to a potential combination of our businesses. Despite our mutual best efforts we were unable to accomplish our goals and we have decided to focus individually on our respective businesses. As a result, we will continue to restructure our businesses in Australia and the U.K. in order to align them with the reality of their respective markets. We will be more aggressive in taking out costs, minimizing our networking capital investments, increasing efficiencies and selling assets. Our primary goal is to generate cash and improve gross profit.

Moving to the Crown Imports joint venture. During the company’s fiscal year 2010, the Crown Joint Venture generated $2.3 billion in net sales and $444 million of operating income. Crown continues to have the leading market share in the import category in the U.S. with five of the Modelo brands represented in the top 20 import brands. Corona remains the number one import beer and Modelo Especial is currently the third largest import brand in the United States today. Speaking of Modelo Especial, it is one of the few major super premium brands in calendar 2009 that experienced double digit market growth. This is a major accomplishment considering that 2009 was a particularly challenging year for the U.S. beer industry in general with growth trends softening as the year progressed.

Many major domestic brands lost volume and share to craft beers and sub-premiums. As we have previously indicated, volumes for Crown’s businesses have been impacted by the economy, particularly in the convenience and on-premise channels. However, the Crown portfolio outperformed the import category and grew share throughout the year. These results were driven in part in the grocery channel as Crown introduced new packaging, executed targeted promotions and supported the business with enhanced strategic media activity.

For fiscal 2011, Crown is focused on further enhancing integration of sales and marketing efforts by optimizing promotional activity and media support during peak seasonal periods when consumers buy the most. Some of these activities will be visible in the marketplace including the following; a summer consumer sweepstakes program that will begin immediately following the Cinco de Mayo holiday and will run through the 4th of July. This program will be supported with television advertising.

Crown will partner with Sports Illustrated during soccer’s upcoming World Cup event which will begin in June in South Africa. World Cup Magazine issues will be promoting Modelo Especial specifically for the convenience and on-premise channels. Corona will also be one of the three major beer sponsors of World Cup TV. Crown has expanded the rollout of the Modelo Especial with Negro Modelo draft in nearly 50% of the U.S. with positive results and will continue expanding distribution throughout the remainder of the year.

Crown is also seeing success with new SKUs recently introduced into the convenience channel including Corona and Corona Light 24-ounce cans. Going into Cinco de Mayo holiday and the key summer season, we believe that Crown is well positioned to maximize execution at retail.

Before I turn the call over to Bob I want to discuss our guidance for fiscal 2011. As you can see our comparable EPS estimate for fiscal 2011 is projected to be in a range of $1.53 to $1.68 and reflects our belief that challenges from persistent and uncertain economic conditions will continue to impact our results especially with regard to the Crown Imports business.

However, we expect to begin to realize benefits of our U.S. distribution distributor consolidation efforts as the year progresses. Meanwhile our strong free cash flow enables us to create value in the form of an accelerated share buyback while continuing our debt reduction efforts. Now I would like to turn the call over to Bob Ryder for a financial discussion of our business results.

Robert Ryder

Thanks Rob. Good morning everyone. Fiscal 2010 was a year of dramatic change, operationally, culturally and financially. From an operational perspective, we took positive steps during the year to strengthen our organic business model.

We sold the bottled spirits business and moved our two scale spirits brand into our U.S. wine business and eliminated our spirits SG&A. We then consolidated the majority of our U.S. distributor network while also reducing the infrastructure of our U.S. wine business from three selling units down to one. This also resulted in reduced SG&A.

We now have a single scale U.S. business focused on a streamlined premium wine and spirits portfolio going to a consolidated, focused and aligned distributor network. Culturally we are focused on profitable organic growth of our premium scale brands; primarily wine. This means increased focus on brand building and sales execution especially in North America. This also represents our next logical business phase as we move beyond a previously decentralized organization which had been very focused on acquisitions toward a more centralized organization more focused on profitable, organic sales growth.

In our U.K. and Australia business we have a renewed focus on profits, driving synergies and generating cash flow. Financially, we reduced costs to help offset the negative impact of the current economy and generated strong free cash flow to help drive another year of debt reduction and reduced interest expense. Our full-year fiscal 2010 comparable basis diluted EPS came in at $1.69 versus $1.60 in the previous year.

Our results included the impact of challenging economic conditions especially on Crown’s performance, U.S. wine sales force restructuring, U.S. distributor consolidation and continuing difficult operating environment for our U.K./Australia business. On the more positive side, we reduced costs which helped offset some unfavorable mix impacts driven by the challenging economy, we extended our revolving credit facility and a portion of our term debt, we generated strong free cash flow as we exceeded the upper end of our guidance range. We significantly reduced debt and interest expense and we realized tax benefits for the year.

Now let’s look at our fiscal 2010 P&L performance in more detail where my comments will generally focus on comparable basis financial results. Let’s go to our net sales line. As you can see from our news release on page 15, our consolidated net sales decreased 8% for the year primarily due to the divestiture of our Value spirits business and the unfavorable impact of our year-over-year currency rate fluctuations. On an organic constant currency basis, which excludes the impact of acquisitions, divestitures and FOREX changes, net sales increased 1%.

My commentary for the following net sales comparisons will be on a constant currency basis. Our worldwide branded wine organic net sales which appear on page 14 of the release decreased 1%. This included a 3% decrease for North America, partially offset by increases of 7% in Europe and 4% in Australia/New Zealand. North American sales were impacted by continuing economic challenges and U.S. distributor and sales force transitions. In connection with our recently implemented distributor contracts sales to newly contracted distributors for an initial period are based on a predetermined plan.

Our sales force and distributor transitions resulted in a fall off of depletions and consumer takeaway during fiscal 2010. As a result, distributors have generally been taking in more inventory than they have been depleting. While we were proactive during the fourth quarter in working with distributors to help reduce their inventory levels as outlined by Rob, the distributors ended fiscal 2010 with higher inventory levels than they ended fiscal 2009.

For Europe sales benefited from the growth of our value priced product offerings in the U.K. Sales for Australia/New Zealand increased due to New Zealand product growth in the region. Spirits organic net sales increased by an impressive 19% for the year.

Now let’s look at our profit on a comparable basis using information on page 17 of the release. For the year, our consolidated gross margin was 35% versus 37.1% for the prior year. This reflects the higher Australian costs due to the flow through of the more expensive calendar 2008 harvest and growth of the lower margin U.K./Australia business. Although they remain profitable our U.K./Australia business has experienced another year of reduced profits.

Our consolidated SG&A for the year decreased $136 million and came in at 18.3% of net sales compared to 20.6% a year ago. The margin reduction was primarily driven by our global cost reduction efforts, elimination of our spirits SG&A with the sale of the Value spirits business and lower marketing expense. Consolidated operating income decreased 7% to $560 million and operating margin remained essentially flat at 16.6%. From a margin perspective, our storage shift of SG&A spend effectively offset the reduction in our gross profit margin for the year.

I would now like to turn to our segment operating income results on page 13 of the release to provide highlights of our full-year operating income change. Wine segment operating income decreased $37 million to $655 million. The decrease was primarily due to the divestiture of the value spirit business, decreases in U.S. branded wine sales and a decrease in U.K./Australia gross margin due to negative mix and higher grade costs for Australian wine, partially offset by savings from our global cost reduction initiatives.

For the year, corporate and other expenses totaled $95 million versus $87 million in the prior year. The increase was primarily driven by higher stock based compensation expense and costs related to Project Fusion, our multi-year program designed to strengthen our global business systems and processes.

Consolidated equity investment earnings totaled $239 million versus $270 million last year. Equity earnings include $222 million from Crown. For the year, Crown generated net sales of $2.3 billion, a decrease of 6% and operating income of $444 million, a decrease of 12%. Economic challenges have impacted the entire beer industry driving lower volumes and consumer movement to lower priced beer. Operating income for Crown was impacted by the lower volume, negative mix and a contractual cost increase.

Interest expense for the year was $265 million, down 18% versus last year. The decrease was primarily driven by our significant debt reduction actions during the past 12 months. Now let’s take a look at our debt position. At the end of February our debt totaled $3.8 billion which represented a $600 million decrease from our debt level at the end of fiscal 2009. The decrease primarily reflects proceeds received from the sale of Value Spirits and Cider businesses combined with our strong free cash flow generation.

Our average interest rate for the year was a little bit above 6%. Our debt to comparable basis EBITDA ratio at the end of fiscal 2010 was 4.0 versus a 4.3 ratio at the end of 2009. Our strong free cash flow, reduced leverage and improved credit profile positioned us to take advantage of improved credit markets and complete certain refinancing activity during the fourth quarter.

Let me summarize these actions. These activities included the amendment of our senior credit facility to extend $650 million of our revolver from June 2011 to June 2013. In addition, $192 million of pre-existing revolver remains in place at historical pricing through June 2011. We also extended the maturity of $300 million of our $1.2 billion term loan from June 2013 to June 2015.

The margin applicable to the extended revolver facility and term loan increased by 125 basis points. In addition, we redeemed our $250 million 8.125% subnotes that were due in January 2012 without any penalty. I am quite pleased with the results. We were able to maintain a low cost of capital, extend the term of our facilities, maintain appropriate financial flexibility, improve our covenants and reduce overall interest expense.

Our comparable basis effective tax rate came in at 30% which reflects the favorable outcome of tax items from various jurisdictions. Favorable tax outcomes during the fourth quarter helped drive a negative 11% tax rate for Q4.

Looking a little closer at Q4 results, favorable tax rate helped offset the financial impact of soft Q4 net sales performance. For the fourth quarter organic constant currency net sales decreased 2%. Branded wine organic constant currency net sales decreased 6% versus the prior year quarter. This included a 12% decrease in North America, a 23% increase in Europe and flat performance in Australia/New Zealand. The increase in Europe was primarily due to volume growth and favorable comparisons versus the disappointing fourth quarter last year. The decrease in North America reflects the impact of working with U.S. distributors to lower their inventory levels in Q4 as discussed by Rob earlier.

Lower sales in North America drove a $22 million decrease in wine segment operating income. The lower sales in North America coupled with high growth in the U.K. drove negative mix and a 140 basis point gross margin decrease and reduced operating leverage as SG&A as a percent of net sales increased 220 basis points. During the fourth quarter and in conjunction with our annual impairment testing the company reported $103 million non-cash impairment charges primarily related to trademark assets for the Australian business.

Now let’s turn to cash flow on page 13 of the news release. For purposes of this discussion free cash flow is defined as net cash provided by operating activities less CapEx. For fiscal 2010 we generated free cash flow of $295 million, exceeding the high end of our most recent guidance range but less than the $378 million produced in the prior year. While there are various year-over-year fluctuations in the cash flow details, the lower FY10 cash generation is due in part to a $65 million tax payment related to the sale of the Value Spirits business.

Working capital benefited from inventory reductions from lower grape harvest costs in Australia and New Zealand and CapEx came in at $108 million versus $129 million in the prior year. As a reminder, free cash flow for fiscal 2009 reflected a benefit of approximately $55 million in after-tax proceeds related to the favorable settlement of certain foreign currency hedges.

For fiscal 2011, we are targeting free cash flow to be in a range of $350-400 million. This includes CapEx in a range of $110-130 million. The targeted improvement in free cash flow versus 2010 is expected to be driven in part by anticipated lower tax payments, lower interest and lower restructuring activity versus the prior year.

In March 2010 we received $60 million from Sazerac as they paid off a note receivable related to the purchase of our Value Spirits business. This cash benefit will be included in the “Investing” section of the FY11 cash statement and therefore it is not included in our free cash flow estimates.

Due to our continued strong free cash flow generation and successful de-leveraging and refinancing efforts, we believe we can redeploy a portion of free cash flow to repurchase stock while we continue to reduce debt. In connection with this strategy, the board of directors has authorized the repurchase of up to $300 million of the company’s stock. Our intent is to implement an accelerated share buyback transaction when appropriate.

Now let’s move to our P&L outlook for the full-year. Given the uncertain global economic conditions, we are forecasting comparable basis diluted EPS to be in a range of $1.53 to $1.68 for fiscal 2011. Our reported sales will be unfavorably impacted by the divestiture of our U.K. Cider business which contributed about $100 million in net sales for fiscal 2010. On an organic constant currency basis, we are targeting flattish net sales for fiscal 2011. On a consolidated basis, we expect operating income to be down slightly due to the impact of divested businesses and continuing profit pressures for Australian and U.K. operations.

Crown volumes are expected to be flat to down low single digits due to continued impacts from the economy. Negative mix and a planned small contractual cost increase are also expected to impact Crown costs. As a result, we are targeting equity earnings for Crown to be down mid single digits from fiscal 2010.

Interest expense is expected to be in the range of $210-220 million. The healthy improvement is being driven by our significant debt reduction, the prepayment of the 8.125% subnotes with the lower cost revolver fund and the roll off of unfavorable interest rate hedges at the end of fiscal 2010. The comparable basis tax rate is expected to increase to 35%. We are assuming weighted average diluted shares to increase to approximately 224 million. These items will essentially offset the benefit of lower interest expense.

Looking at Q1 fiscal 2011 we expect results to be impacted by higher marketing expense at Crown Imports versus the prior year first quarter as it ramps up on the marketing activities that Rob highlighted in his comments. Our comparable basis guidance excludes acquisition related integration costs, restructuring charges and unusual items which are detailed on page 19 of the news release. It also excludes any impacts from the share repurchase program.

We expect the share buyback to be accretive to EPS and we will update our full-year guidance when the transaction is completed. For fiscal 2011 we expect to incur diluted EPS charges of about $0.17 for restructuring and other one-time charges related to the previously announced cost reduction initiatives and our continued efforts to increase efficiencies and increase ROIC.

Before we take your questions I would like to reiterate that over the long-term we are focused on working the leverage to benefit of our new U.S. business structure and distributor consolidation initiatives in increasing operational and cost efficiencies to drive improvement in our organic business model and ROIC. In addition, we plan to use free cash flow to further reduce debt and interest expense and at the same time return cash to shareholders in the form of a share repurchase.

With that, we are happy to take your questions.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Lauren Torres – HSBC.

Lauren Torres - HSBC

A question on the branded wine performance in the quarter and expectations as we think about this year in North America. With respect to the U.S. distributor inventory level reductions, you said this in your comments but what phase are we? How much more is there to go on that? With trends it seems you are rather optimistic about how the U.S. consumer is behaving and I guess I am referring here to wine once again. I don’t know if other data you have with respect to different price points how things have changed since the last quarter and really how do you see this category developing as we start to think about the year?

Robert Sands

As to your first question, the inventory reduction that occurred in the fourth quarter is complete. That was not something we expected to carry over so it was pretty much a one-time activity that we finished up as I said, both started and finished it in the fourth quarter.

As to your second question on the wine industry in the United States, I would say calendar year 2010 we are actually looking for about similar growth rates overall in all channels to calendar year 2009. In 2009 the wine business was probably flat to up slightly and in 2010 we are not projecting anything much different than that. Again, probably flat to maybe up 1% and I would like to emphasize that is in all channels meaning on-premise and off-premise and within off-premise the grocery channel, the mass merchandise channel and the club channel.

In general, as I said, pretty similar trends this year versus last year.

Lauren Torres - HSBC

I think we are hearing from companies with respect to the consumer getting a bit stronger and certain channels improving be it in beer or wine. You are really not kind of getting there yet with those types of growth rates again?

Robert Sands

I would say we are actually fairly cautious on projecting big improvements in calendar year 2010. I would just say until we really start seeing some significant improvement in unemployment we really don’t expect trends to change significantly. I would say the industry is fundamentally healthy given the economic trends I think being flat to up slightly is pretty good. But we do see a continuation of the negative trends in the on-premise channel in particular which is offsetting gains in the off-premise. We see pretty good and healthy trends in the IRI channel of grocery and we probably see the strongest trends in the mass merchandise and club channel which are not reflected in IRI.

Operator

The next question comes from the line of Timothy Ramey - D.A. Davidson & Co.

Timothy Ramey - D.A. Davidson & Co.

Kind of continuing on the outlook for the categories, a number of restaurants have made comments about sort of return traffic and you just pretty clearly reasserted a negative trend in on –premise. Do you think that is the price points you are occupying on-premise? How would we think about that if in fact there is some reacceleration in traffic?

Robert Sands

First of all I was talking about the industry in general, not our on-premise business. Some restaurant chains have been reporting some improved traffic but I think overall we don’t really see huge improvements from an industry perspective in on-premise at the current time. I think to the extent that some restaurant chains are reporting more positive trends it may be they are going to be down a little bit less but there is still a lot of restaurant closures occurring that are offsetting any positive trends.

There is definitely if you look at who is projecting anything that you could call positive it is really sort of the value end of the restaurant chain business. Obviously some restaurant chains may be reporting they are more optimistic going into this year but overall we don’t see a big change in the on-premise as we move into 2010. If the economy improves and unemployment abates that may change but at the moment I would say there are pretty significant trends of people staying at home, eating at home and not going out as much. We don’t see that consumer behavior changing dramatically right now.

Timothy Ramey - D.A. Davidson & Co.

Taking it from a macro perspective you are talking about mirroring a flat to slightly up wine industry. You are talking about cost reductions that have come through. We are not factoring in share repurchase, lower interest expense, why are you actually looking at a down EPS forecast for your guidance if in fact those other three factors are true?

Robert Ryder

If you just do the rough math I think what we said is we expect Crown to be down mid single digits. We expect some pressures to continue on our international business so we probably expect EBIT to be down there. Although interest expense is coming down pretty dramatically it is pretty much offset by an increase in tax rate and an increase in share count. So kind of rough math, if you looked at the numbers we gave you, EBIT is down a little bit and everything else kind of offsets. That is why we are down $0.09 if you use the midpoint for FY11 of $1.60 versus the $1.69 this year in FY10.

Operator

The next question comes from the line of Reza Vahabzadeh – Barclays Capital.

Reza Vahabzadeh – Barclays Capital

How do you anticipate being able to complete the share buyback on an accelerated basis and still reduce debt or leverage for that matter?

Robert Sands

I will answer that one. The board authorized $300 million of share buyback and I think if you look at the midpoint of the free cash flow guidance we gave which was $350-400 million, that midpoint is above the $300 million. So we have used the cash flow above the approved share buyback to pay down debt.

Reza Vahabzadeh – Barclays Capital

Would you anticipate actual leverage to stay the same or improve as well for FY11?

Robert Sands

If you are talking about EBITDA leverage ratio it will essentially be flat. Remember also we received $60 million for our Sazerac note which although it doesn’t hit free cash flow it does reduce debt in FY11 because we received it in our first month of the new fiscal year. Our leverage ratio will essentially be flattish.

Reza Vahabzadeh – Barclays Capital

So you anticipate basically completing the share buyback in FY11?

Robert Sands

Yes.

Operator

The next question comes from the line of Lindsey Druckerman – Goldman Sachs.

Lindsey Druckerman – Goldman Sachs

I was hoping to dig down a little bit on the inventory reduction issue. If I take the sales impact you disclosed it looks like 10% plus of a drag on your North America branded wine sales and considering it was only in 60% of your territories it looks like a pretty sizeable missed forecast I guess in those markets of distributors buying too much in the third quarter. I guess maybe could you talk to first of all is that rationale the right way to think about it and where was the forecasting misstep? What fell short of your expectations to drive that?

Robert Sands

First of all, I wouldn’t characterize it quite that way. It is pretty much as we have said all throughout the year. We put inventory in the second quarter in anticipation of our consolidation efforts where we normally put it into the third quarter. Third quarter I would say due to economic conditions consumer takeaway was a bit less than we anticipated and therefore inventory levels ended up a bit higher than we anticipated. Then of course in the fourth quarter we felt that we had the room to adjust and we did take advantage of that and we reduced significantly distributor inventories during that period in a number of markets but primarily in that 60% as you indicated.

I wouldn’t call it a forecasting issue as you suggested. In fact, we decided that as long as we were going to get some benefit out of taking inventory levels down in the fourth quarter then it was in our best interest and we did get some benefit in that we negotiated some additional investment from the distributors behind our brands in exchange for the inventory reduction. In general, I would also point out our inventories at distributors are not particularly high from an industry perspective. They run somewhere even currently in the 60-90 day range which I would say is consistent with distributor inventories as a general proposition across the United States and significantly below many suppliers.

It was really all about the fact that we thought in the fourth quarter we thought there was an opportunity to do something that we thought was best for our distributors in exchange for more investment behind our brands to drive results in the future. That is really what went on.

Lindsey Druckerman – Goldman Sachs

Could you comment on the large California grape harvest in 2009 and what the implications might be for your business as we go through the year?

Robert Sands

Sure. Number one it was a large harvest in 2009. I think it was the second largest harvest in history. That said, the supply situation in California is pretty well balanced at the current time. As we went into this harvest from the previous harvest I would say the industry was tipped on the side of under supply. As we went into this harvest although it was a big harvest it was primarily large in what we call the North Central Valley and that is where most of the… let me put it this way, other than the North Central Valley the crop was pretty average in size and in some cases even smaller.

That said, bulk wine supplies even in North Central Valley type products were pretty low as we went into this harvest. Therefore when all is said and done and given the fact we are probably tipping towards under supply and therefore shortages especially in some of the key varieties like Chardonnay which continues to grow pretty heavily I would say that even though the crop was big we still end up in a fairly balanced state as we go forward. I definitely wouldn’t characterize it as over supply. If anything it was under supply and moved more towards balance.

Lindsey Druckerman – Goldman Sachs

Lastly, if you could help us out given all the lumpiness and noise in the wine business quarter-to-quarter last year just understanding the timing of your quarterly results as you lap the distributor transition?

Robert Ryder

FY10 or FY11?

Lindsey Druckerman – Goldman Sachs

This year, as we forecast 2011.

Robert Ryder

We don’t really talk about quarterly guidance. The one thing we did say as some of you may have noticed as you were watching Major League Baseball you will see some new Corona commercials. The way the accounting works on that you will see some front-loaded expense because the commercial flights happened. So we wanted to give you a bit of a heads up so there wouldn’t be a surprise for Q1 and it is just marketing expense timing. Beyond that we really don’t get involved in giving quarterly guidance.

Lindsey Druckerman – Goldman Sachs

But just to clarify from the shipment timing, Q2 is a tough comp for wine. Q3 is an easy comp and then Q4 is an easy comp?

Robert Ryder

From a shipment perspective, this year we were kind of combined Q2 and Q3 because it was kind of a movement from Q3 to Q2 as you said and Q4 because we kind of hold back a little bit on shipments which we spoke of there should be lower sales than next year. You have it pretty right.

Operator

The next question comes from the line of Carla Casella – JP Morgan.

Carla Casella – JP Morgan

I wonder if you could comment on the spirits. Are you seeing any pickup in competition with Diageo’s launch of the comparably priced vodka (inaudible)?

Robert Sands

They are apparently, it hasn’t occurred yet and it remains to be seen whether they do in fact launch it, but they claim they are launching a comparably priced product called (inaudible) and I think that is really sort of indicative of the fact that our product is extremely successful. It is growing very rapidly. There is actually a lot of imitators out there in the market and a lot of vodkas that are priced in that category. One more I would say really doesn’t matter much. It doesn’t really particularly concern us. We have always got our eye on competition and that is why we have initiated the new advertising campaign with regard to SVEDKA. It is on TV this year and we are doing a lot of things to continue to build the strength of what already is a very, very strong brand.

I would say imitation is the strongest form of flattery. That is about as much as I would say about it. One more vodka priced at that price point as I said doesn’t particularly concern us. We see great momentum behind SVEDKA as we have ended our fiscal 2010 and we see great momentum behind it as we enter 2011. We really are seeing no slow down at all in the momentum behind the brand. The consumer is deciding what they want and SVEDKA is clearly meeting all consumer needs in that particular category at the time.

I am sure not only will Diageo have a product but I think there will be other products and if anything it will grow that drink segment in the category overall as people pour more money into this mid priced vodka category. So it could actually be very favorable to us to have more entrants into the category. As I said, there is already a lot and there always has been a lot of vodka priced in that price range. It is not something that concerns us.

Carla Casella – JP Morgan

On the inventory at the distributors, you mentioned there was a $60 million to $70 million hit on the fourth quarter sales but the inventory at the distributor level remained somewhat high. Could we see a similar hit to first quarter?

Robert Sands

No. We anticipate no inventory reduction in the first quarter. In fact we are not anticipating any further actions of this nature at this time. It was exclusively related to the fourth quarter.

Carla Casella – JP Morgan

So then how long do you think it will take for the excess inventory that is in the trade now to work its way back down to normal levels?

Robert Sands

Inventory levels in the trade now are at normalized levels as a general proposition so we don’t anticipate it impacting us at all.

Operator

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

Mark Swartzberg - Stifel Nicolaus

I may have missed this. If you could give us a CapEx number for this fiscal year?

Robert Ryder

110-130.

Mark Swartzberg - Stifel Nicolaus

On the share repo, as much as $300 million accelerated, what is a good estimate on borrowing costs on that?

Robert Ryder

That is kind of a theoretical question and you have all the data. What we said was our average cost of borrowing last year was around 6%. But our revolver is in two pieces, it’s LIBOR plus 1.25 or LIBOR plus 2.50. As we have said, we are not using all free cash flow to buy back stock. We are also de-leveraging. If you want to use the incremental revolver rate, the overall average interest rate, if you want to take your own shot at the forward curve the cost of debt, so between 3-7%.

Mark Swartzberg - Stifel Nicolaus

Sounds like it is closer to the 3.

Robert Ryder

On an incremental basis, you are calculating a free share dilution in the short-term. I think you can assume the average revolver rate.

Mark Swartzberg - Stifel Nicolaus

There was something you just said not following why distributor inventories being higher than fiscal 2009 levels at the end of fiscal 2010 why that is not something you would expect to go down in fiscal 2011. Can you also give us some idea of just how significant that delta is versus end of fiscal 2009?

Robert Sands

We don’t expect it to go down simply because we don’t expect to deplete more than we shipped. So we expect inventory levels to be fairly stable in 2010 and to remain in this 60-90 days on an average basis amongst our distributors which as I also said, I would say is equivalent to distributor’s inventory in general for all suppliers. So it isn’t particularly high.

What was the second part of your question?

Mark Swartzberg - Stifel Nicolaus

How much higher end of fiscal 2010 are they versus end of fiscal 2009?

Robert Sands

Maybe 5-10 days.

Mark Swartzberg - Stifel Nicolaus

Continuing on the line of discussion trends by channel we have heard about, can you give us some more color on price point for your North America wine business? Give us more color on how different levels of price point are performing at the depletion level?

Robert Sands

Sure. I think looking at the industry I think we will continue to see continued trading up in the industry with the higher price points growing at a faster rate than the lower price points. Right now we do see some acceleration in the everyday wine up to $5. I would expect that to continue as well. Last year they went from being in decline to some pretty significant growth.

That said, there was also some pretty big pricing taken in the under $5 category and I would expect perhaps that to slow down that growth a bit as we go into this year. Now despite the fact we also see sort of continued positive mix shift and higher priced categories growing at a faster rate, in general the lower price categories are still within category I would say seems to be some tendency to go to the lower end of categories and there is still quite a bit of discounting going on, which is driving the fact that some of the categories like the luxury categories $15-20, why that category is growing and continues to grow nicely. Because you have some of the above $20 discounting into that category which is driving the category growth.

It is kind of a good news/bad news kind of a thing. Good news is consumers are continuing to trade up as a general proposition in wine. The bad news is that is being fueled by some fairly heavy discounting of more expensive wines. So that negatively impacts margin at the higher price points. As I said, it is kind of a good news/bad news kind of story. Overall things are pretty healthy. Overall there will be some growth we anticipate in the industry overall. Overall we do expect some positive mix shift for the industry and then on the negative side is that mix shift could be offset by some continued heavy discounting in the marketplace.

That is kind of where things shake out.

Mark Swartzberg - Stifel Nicolaus

That price increase on the $5 and under it sounds like that actually could benefit a large portion of your portfolio making your $6-10 wines, narrowing that gap. Is that in fact proving to be beneficial or do you expect it to be of significant benefit to some of your wines in that price area?

Robert Sands

Maybe. That is a theory. We will see what happens this year. As far as our wines in that price point right about $5 we actually are seeing some pretty good results. We see with Woodbridge some positive trends. That is good. Rex Goliath which is a brand that we have positioned and put some effort behind we are seeing gigantic growth in it. Very high double digits. In general I would say just above the $5 price point range is pretty healthy for us.

Operator

The next question comes from the line of Kevin Dryer [ph] - Cavelli & Company. [ph]

Kevin Dryer - Cavelli & Company

I just wanted to ask similar to previous questions but it seems like there is a little bit of a disconnect. Basically you did $1.69 for the year but the tax benefit if you normalize the tax rate at 35% I get that $1.57. But that’s including $0.07 to $0.09 hit from the reduction in distributor inventories which you say won’t be recurring, so granted I know you said the Modelo or the Crown business would be down a little bit but given modest growth in the wine business and reduction of interest expense why would you be down from that $1.57 with a normalized tax rate?

Robert Ryder

You are right. We are kind of double counting some things and not others. So you are correct. If you equalize the tax rate for this year you are at $1.57. But then you wouldn’t touch next year’s tax rate because we are using 35% in both years. So the way I look at it is EBIT is going to be down slightly because we sold [ph] our Crown international line and you remember we sold the Cider business which although it didn’t have very high margins it did have positive EBIT. Then we said year-over-year if you have already done it, if you take taxes, interest and shares into account they all sort of kind of offset each other.

So you can think about EBIT year-over-year is losing about $0.09 per share and that is the $1.69 to the $1.60.

Kevin Dryer - Cavelli & Company

Then in terms of the accelerated share repurchase, what would be the trigger for you potentially actually implementing that? You said whenever conditions are right or something like that.

Robert Ryder

We have chosen a banker to help us execute this transaction. Between the two of us, we will decide when we want to go into the market. We want to make sure we are not hurting ourselves. Plus the window isn’t open until this call is over. So I would expect it to be towards the early half of the year versus the latter half of the year.

Kevin Dryer - Cavelli & Company

What is the reason for not including that, that is going to be incremental in the guidance right?

Robert Ryder

What we wanted to do was kind of keep, because as you guys tell me often, we are a bit of a difficult stock to cover because we kind of have a lot of things that we report and talk about. We want to keep it as true and as organic as possible. We didn’t want to seem disingenuous, kind of taking credit for the stock buyback in next year’s guidance because I kind of look at it differently. What we decided to do was do as much apples-to-apples as possible, give you the data on the stock buyback and when we complete the program it will all be very visible to you. So then we will come out and update our guidance.

Kevin Dryer - Cavelli & Company

In terms of the share creep that is just from old options or new issuances around the end of the year or something like that?

Robert Ryder

The shares goes up. If the stock prices goes up it drives additional dilution and as we ramp new options in the New Year that also drives additional dilution.

Kevin Dryer - Cavelli & Company

To be clear, so the $60 million from Sazerac that is in the 350-400 number for free cash flow?

Robert Ryder

That is correct. It is below free cash flow. It is a financing activity. I tried to make that clear in the script (inaudible) 350 to 400.

Kevin Dryer - Cavelli & Company

Any update on the lawsuit with Modelo regarding Crown?

Robert Sands

Not really. No update. That is proceeding as one would expect. These things tend to move slow. I would reiterate it is really a generally immaterial thing. We did file a motion to dismiss the lawsuit. We are ultimately awaiting the results of that motion to dismiss. Clearly we would be hopeful on that but these things are somewhat unpredictable.

Kevin Dryer - Cavelli & Company

Okay, thanks.

Operator

Please carry on with your closing remarks.

Robert Sands

Thank you everyone for joining our call today. As I indicated I am pleased with the progress that we have made throughout the past year particularly with our strong free cash flow generation, our significant debt reduction and our operational improvements. I certainly believe we are well positioned for success in the future and have initiatives underway in fiscal 2011 that will help us to achieve our longer term strategic objectives.

We will be participating in investor conferences and road shows throughout most of May so we will look forward to seeing many of you while we are on the road. Again, thank you for your participation.

Operator

This concludes today’s Constellation Brands fiscal year 2010 earnings conference call. You may now disconnect.

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