Constellation Brands F2Q08 (Qtr End 8/31/07) Earnings Call Transcript

Oct. 4.07 | About: Constellation Brands, (STZ)

Constellation Brands, Inc. (NYSE:STZ)

F2Q08 Earnings Call

October 4, 2007 10:00 am ET

Executives

Patty Yahn-Urlaub - Vice President of Investor Relations

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

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

Analysts

Bonnie Herzog - Citigroup

Lauren Torres - HSBC

Timothy Ramey - D. A. Davidson & Co.

Judy Hong - Goldman Sachs

Bill Leach - Neuberger Berman

Brian Scodari - Wachovia Securities

Christine Farkas - Merrill Lynch

Qamil Varawalla - UBS

Mark Swartzberg - Stifel Nicolaus

Bryan Spillane - Banc of America

Operator

My name is Elsa and I will be your conference operator today. At this time, I would like to welcome everyone to the Constellation Brands second quarter 2008 earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Patty Yahn-Urlaub, Vice President of Investor Relations. Madam, you may begin your conference.

Patty Yahn-Urlaub

Thank you, Elsa. Good morning, everyone and welcome to Constellation’s second quarter fiscal year 2008 conference call. I am here this morning with Rob Sands, our President and Chief Executive Officer; and Rob Ryder, our Chief Financial Officer.

By now, you should have had an opportunity to read our news release, which has also been furnished to the SEC. This conference call is intended to complement the release.

During the call, we will discuss financial information on a GAAP comparable organic and constant currency basis. Reconciliations between the most directly comparable GAAP measure and these and other non-GAAP financial measures are included in the news release or otherwise available on the company’s website at www.cbrands.com, under the investor section. These reconciliations include explanations as to why management uses the non-GAAP financial measures and why management believes they are useful to investors.

Discussions will generally focus on comparable financial results, excluding acquisition-related costs, restructuring and related charges on unusual items. We will also discuss organic and sales information, which is defined in the news release and constant currency net sales information, which excludes the impact of year-over-year currency exchange rate fluctuations.

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

Thank you, and now I would like to turn the call over to Rob.

Robert S. Sands

Thanks, Patty and good morning, everybody. Welcome to our discussion of Constellation’s second quarter. Before we get started, I want to officially welcome Mark [Zupan] to Constellation’s Board of Directors. Mark is currently Dean of the Simon Graduate School of Business at the University of Rochester. His previous teaching assignments included Harvard, Dartmouth, USC and the University of Arizona. Mark has a Bachelor’s Degree from Harvard and a PHD in Economics from MIT, and I am really looking forward to working with Mark.

Now I would like to discuss our financial performance for the second quarter of fiscal 2008. We are currently at the halfway mark for the year and are pleased with our progress to date, which I believe provides the momentum required to achieve our full year goals. As anticipated, results for the quarter were impacted by a continuing competitive marketplace in the U.K. and Australia and our initiative to reduce distributor wine inventories in the U.S.

As of the end of the second quarter, we estimate that the total sales impact for the distributor inventory reduction program was approximately $110 million, which was less than our initial estimate.

Despite the lower sales impact, the EPS impact was $0.15, which was at the low-end of our targeted range of 15% to 20% as the mix of reduced distributor inventories was of higher margin premium products than we originally anticipated. This program is now substantially complete as we are within the range of our goal in terms of targeted average number of days in distributor inventories.

From a market perspective, the momentum continues around our wine premiumization efforts with solid marketplace sales growth contributed during the quarter by brands such as Woodbridge, Nobello, and Estancia, as reported in recent U.S. IRI data.

I also want to take this opportunity to provide an update relating to the U.S. grape harvest, which is underway as we speak and is expected to continue through the end of October. While we expect this year’s harvest to produce high-quality output due to a mild, dry-growing season, we are estimating that the 2007 U.S. industry harvest may potentially decline in the mid-single digit range from last year’s harvest. And it appears that overall pricing for grapes is moving up a bit, reflecting a decrease in yields and tightening supply for key varietals such as Pinot Noir, Pinot Grigio, and Chardonnay, with fairly stable prices for generic wine varietals.

Overall the U.S. wine market is very healthy and indications are that overall supply and demand should generally remain in balance.

Our Canadian wine business posted an excellent quarter. Jackson Triggs, the number one brand in Canada, posted double-digit volume and sales growth, partially as a result of strong sales across Canada of the Jackson Triggs Esprit wine, which is our Olympic co-branded product launched in June. We also released a 2006 vintage for our Inniskillin and Ice Wine, which we believe ranks as one of the best ice wine vintages we’ve ever seen.

Turning to the U.K., the market conditions in the U.K. have not change significantly during the quarter.

As you know, the 2007 Australia grape harvest came in approximately 30% lower than the 2006 grape crush. Severe drought conditions continue to affect the area, with the key wine producing regions of Australia currently experiencing rainfall levels that have been less than 50% of normal.

As I mentioned in the first quarter, these conditions are expected to reduce the output of the 2008 harvest, although we can’t be specific on the magnitude of the reduction at this time, as the rainy season in Australia will continue through late October.

Due to the lower harvest in 2007, the Australian bulk wine market has begun to dry up. There is currently limited availability of bulk wine for production of low cost, private label Australian wines selling in the U.K. However, U.K. market pricing has not changed significantly as the wine market overall remains quite competitive.

Despite challenging market conditions in the U.K., we continue to increase marketing support behind our premium wine brands. We are focused on improving our go-to-market model and are working to improve our operating efficiencies.

Although we remain cautious, we believe the tightening Australian wine supply had some indication of trading up activity in the U.K. marketplace are positive trends. The Matthew Clark joint venture with Punch Taverns, which provides wholesale services to the U.K. on premise channel, continues to progress and perform within expectations, despite the U.K.’s rainiest summer weather conditions in recent memory and the implementation of a smoking ban during the quarter.

In the spirit segment, the strong marketplace momentum from SVEDKA vodka continues with the posting of strong double-digit growth year-to-date. From an operational transition perspective, the SVEDKA integration is essentially complete. We are beginning to build on the strength of the brand with enhanced distribution capabilities through national accounts and the export channel, and we are capitalizing on and channeling our strength with retailers in the wine channel to benefit our spirits business.

The spirits business is continuing to benefit from premiumization trend occurring in the market and our focus on building our premium investment and priority growth brands, including 1792 Ridgemont Reserve Bourbon, the ’99 Schnapps family, Meukow cognac and recently launched new products.

Moving to the Crown imports joint venture, during the quarter, we were able to bring distributor inventories more into balance after working through challenges resulting from marketplace conditions prior to the formation of Crown.

From a market perspective, Crown implemented a price increase for its Modelo beer portfolio earlier this year and, as is typical with a price increase, we continue to experience a short-term retraction in imported beer volumes in the IRI channel, one that correlates very closely with the volume trends we experienced when we implemented a similar price increase in 2004. At that time, the negative volume trends reversed gradually over a number of months and we expect that trend to repeat itself going forward.

Crown maintains that this strategic pricing initiative is the right long-term decision for the Modelo portfolio of brands, despite a competitive market in the short-term.

Lastly, some of you may be aware that there is an ongoing tight supply of blast bottles on an industry-wide basis due to various glass industry factors, as well as continued strong wine and spirits industry growth resulting in decreased capacity worldwide. Although we are experiencing some impact from this situation, it has been fully contemplated in our full-year EPS guidance.

In closing, we continued to execute on our strategy despite headwinds from marketplace dynamics and business initiatives. We are entering our strongest seasonal period and are well-positioned to achieve our goals for next year.

Now I would like to turn the call over to Bob Ryder for a financial review of the quarter. Bob.

Robert P. Ryder

Thanks, Rob. Good morning, everyone, and thanks for joining us. Similar to our first quarter, in the second quarter we had several items which impacted the comparability of results, including the SVEDKA acquisition, the Crown and Matthew Clark wholesale joint ventures, and our initiative to reduce distributor inventories in the U.S.

In general, I am pleased with our results for the quarter as we substantially completed our distributor inventory reduction initiative, continued efforts to better position our U.K. and Australian businesses for improved performance, and delivered solid cash flow, which helped us reduce our debt by more than $200 million from first quarter levels.

I would like to start with the review of our P&L for the quarter, where my comments will focus on comparable basis financial results. The commentary for net sales comparisons will be on a constant currency basis. Let’s take a look at our net sales line.

As you can see from our news release on page 13, our consolidated net sales decreased 39%, reflecting a 1% benefit from the SVEDKA acquisition, which was more than offset by the move of the U.S. imported beers to the Crown imports joint venture and the U.K. wholesale business to the Matthew Clark joint venture.

As previously discussed, these joint ventures follow equity accounting and are not reflected on the consolidated net sales line.

We experienced a 1% decrease in consolidated organic net sales for the quarter, which was primarily driven by our efforts to reduce distributor wine inventories in the U.S., which is now substantially complete.

After excluding an estimated $110 million of net sales impact for this initiative for the first half of the year, we estimate that we organic net sales growth would have been in line with our long-term target of mid-single digits.

We estimate that the EPS impact for this program during the first half of the year was approximately $0.15. Despite the lower-than-anticipated sales impact, the estimated EPS impact came in at the low end of our previous guided range. As Rob said, this was mostly due to greater de-stocking of higher margin premium products.

Spirits net sales increased 25%, due to the acquisition of SVEDKA and an 11% increase in organic net sales driven by higher average selling prices and volume gains. We are quite happy with SVEDKA as it continued to perform within our expectations and generated strong growth over the first half of the year.

Worldwide branded wine net sales decreased 1%. This reflects the benefit of reporting sales of our wines through the Matthew Clark joint venture, which were previously sold through our U.K. wholesale business, offset by a 3% decrease in organic net sales.

In our presentation of branded wine organic sales growth, we have added back $15 million of U.K. branded wine net sales in Q2 fiscal 2007, previously sold through the 100% owned U.K. wholesale business. We feel this approach provides a better reflection of organic sales performance. The add back for Q1 fiscal 2007 totaled $7 million and is included in the year-to-date data presented.

Turning our attention to branded wine geographic net sales on page 12 of the release, you will see branded wine net sales for North America decrease 4% as strong growth in Canada was more than offset by the impact of our efforts to reduce U.S. distributor wine inventories.

For Europe, branded wine organic net sales increased 4%, reflecting increased sales of popular priced wine in Mainland Europe, and a slight increase in sales in the U.K. Our Australian/New Zealand branded wine organic net sales decreased 7%. Our New Zealand portfolio continues to perform well but the markets in the U.K. and Australia remain highly competitive, with ongoing pricing pressures.

Now, we will look at our profits for the quarter on a comparable basis using information presented on page 14 of the news release. For the quarter, our consolidated gross margin was 35.2%, up 5.4 percentage points. This primarily reflects the benefits of shifting the lower margin U.K. wholesale and imported beer businesses to joint venture structures subject to equity accounting, somewhat offset by a temporary mix shift in the U.S. due to the distributor wine inventory reduction and lower margins for U.K. branded wine.

Our consolidated SG&A for the quarter was 21.2% of net sales, compared with 13.1% a year ago. This increase was primarily due to moving the imported beer and U.K. wholesale businesses to joint venture structures, the deleveraging impact of the distributor inventory reductions in the U.S., higher brand marketing support for branded wine in the U.K. and U.S., and increased stock compensation expense.

Consolidated operating income decreased to $125 million from $237 million for the prior year quarter. This change was primarily driven by the factors already mentioned, combined with reporting $79 million of equity earnings for the Crown JV, compared to the second quarter of last year when $74 million of earnings for imported beer business was included in operating income.

This year-over-year increase in beer business profitability reflects increased pricing and the economic benefits of having a national platform for the Modelo portfolio.

Now I would like to turn to our segment operating income results, which are reflected on page 11 of the release.

Wine segment operating income decreased $39 million to $125 million. This was primarily due to the lower net sales associated with efforts to reduce U.S. distributor inventories and U.K. and Australia business performance, partially offset by an increase in profits from our Canadian business.

For the spirits segment, operating income increased $3 million, primarily due to the contribution from SVEDKA and higher sales for the base business, offset somewhat by higher material costs.

For the quarter, corporate and other expenses totaled $21 million, compared with $18 million for the prior year. The increase includes additional stock compensation expense and costs to support the growth of the company.

Moving back to page 14, interest expense for the quarter was $87 million, up 20% over last year. The increase primarily reflects the incremental interest from funding the SVEDKA acquisition and $500 million of share repurchases.

At the end of August, our debt totaled $4.7 billion, a decrease of more than $200 million from the Q1 level. At the end of the second quarter, we had approximately $2.4 billion of bank debt and $2.3 billion of fixed term and other debt. With interest rate swaps that are in place through the end of fiscal 2010, approximately 70% of our debt is effectively fixed rate.

We had approximately $850 million of revolving credit available under our senior facility at the end of Q2. This, combined with our strong capital base and free cash flow generation ability, provides flexibility to fund further growth.

Our comparable basis tax rate for the quarter came in at 34.7%, versus 36.9% last year. This rate was somewhat lower than our previously anticipated rate for the quarter, primarily due to favorable legislative changes in various state and foreign tax jurisdictions.

As a result, we now expect our comparable basis tax rate for fiscal 2008 to approximate 37% versus our previous guidance of 38%.

Our weighted average diluted shares outstanding totaled $219 million compared to $240 million last year, reflecting the benefit from our share repurchase during this year.

During the second quarter, the company received an additional 933,000 shares under the accelerated share repurchase transaction announced in May. We were not required to make any additional cash payment in connection with receipt of these shares which completed this transaction.

For the first half of ’08, the company purchased 21.3 million shares of its class A common stock through a combination of open market repurchases and an accelerated share repurchase program at an aggregate cost of $500 million, for an average of $23.44 per share.

Due to the many factors just mentioned, diluted EPS decreased to $0.35 versus $0.43 last year.

Now let’s turn to cash flow on page 10. For purposes of this discussion, free cash flow is defined as net cash flow provided by operating activities less CapEx. For the first six months of fiscal ’08, we generated $131 million of free cash flow versus a $22 million usage in the prior year.

The year-over-year increase reflects a lower cash use for networking capital during the first half of fiscal ’08 due in part from lower net sales and accounts receivable associated with the U.S. distributor inventory reduction.

In addition, CapEx totaled $47 million for the first six months versus $103 million last year, which included expenditures for our New Zealand vineyard expansion.

Our free cash flow guidance for the year remains unchanged at $160 million to $180 million.

As in previous years, in Q3 we fund the North American harvest activities and build working capital to meet seasonal business demands. Q4 is expected to provide strong cash flow generation, which has been the case historically.

Now, let’s summarize Q2 and discuss our full year guidance. From an earnings perspective, we are pleased with our results. Excluding the expected positive and negative impacts on our results from our various strategic initiatives, we believe that net sales growth through the first half of the year is in line with our long-term stated goals. We will continue to closely monitor the Australian harvest dynamics and the potential marketplace impacts. The U.K. market remains a difficult environment but we believe we are making progress with the initiatives we have in place designed to improve future performance.

Moving to our P&L expectations for the full year 2008, we’re revising our comparable basis diluted EPS outlook to $1.34 to $1.42. This is from our previous range of $1.30 to $1.40. The increase reflects the benefit of the anticipated lower tax rate I mentioned earlier. This guidance excludes acquisition related integration costs, restructuring related charges, and unusual items which are detailed on page 16 of the news release.

Additional assumptions for our full year fiscal 2008 guidelines are outlined on page four of the release.

Before we take your questions, I wanted to make you aware that we have recently filed a preliminary proxy statement relating to a special stockholders meeting and I would like to briefly frame in this activity for you.

The meeting has been called in response to a situation created by recent changes in U.S. tax laws. Under these new rules, the dividend rights of our class A common stock could potentially create additional income tax expense and accelerate the timing of tax expense for stock option recipients in the U.S. These changes would significantly reduce the benefit that option recipients receive without reducing costs associated with the option program.

In response to this situation, we have proposed to create a new class of common stock and amend our long-term stock incentive plan to permit granting of rewards with respect to the new class of stock to preserve the tax treatment of stock options that was applicable prior to the new rules. These actions require shareholder approval.

Finally, I want to emphasize that these proposed actions will not affect the underlying economic of the company’s stock option program and will not increase the aggregate number of shares available for granting awards under the stock incentive plan.

With that, we are happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is coming from Bonnie Herzog of Citigroup. Please go ahead.

Bonnie Herzog - Citigroup

Good morning, everyone. I just had a few quick questions. I guess first of all, given the Australian grape supply issue that we are all very well aware of and you discussed, I would be curious to hear how much of your supply is grown by company-owned vineyards versus how much you actually purchase on the open market. Hello?

Robert S. Sands

Good question, Bonnie. The vast majority of what we -- of our grape supply in Australia is purchased on the open market.

Bonnie Herzog - Citigroup

It is open. That’s what I -- okay, I just wanted to verify that.

Robert S. Sands

Open but under contract.

Bonnie Herzog - Citigroup

Okay, and how long are the contracts?

Robert S. Sands

They vary but it’s just -- they are relatively long-term.

Bonnie Herzog - Citigroup

Long-term meaning three years, five years --

Robert S. Sands

Multiple years.

Bonnie Herzog - Citigroup

All right. And then just turning over to your beer business, I was curious if you could just provide a little bit more color on how you think it performed overall this quarter and I am curious if the disruptions to the East Coast business have been resolved in your view, and also trying to understand the performance in the East Coast versus the West Coast, whichever metric you’d like to share with us, whether it be volume pricing, income, that’d be helpful.

Robert S. Sands

I think that in general, Bonnie, the beer business has performed in accordance with our expectations. As you know, we took a price increase at the beginning of the year. What we’ve seen as a result of that is very much in line with exactly what we’ve seen when we taken price increases, so there’s really nothing different there than what we would have expected to occur, and as I said in my talk, we expect to see that to start to rebound.

As we also have mentioned previously, there were some high inventories when we took over the east and therefore, during the first half, we have now brought those inventories back into line.

And then, with respect to your question about east versus west, I think we are seeing some very positive trends in the short-term, the last reporting periods for IRI and things to that affect, in the east in particular. So we are optimistic about how we are performing in that regard.

Bonnie Herzog - Citigroup

Okay, good, and then just a quick final question, just in terms of the currency, the translation helping your earnings this quarter. Can you quantify that in terms of the impact to your EPS?

Robert P. Ryder

It’s not significant, Bonnie. We actually hedge most of that away.

Bonnie Herzog - Citigroup

All right, but I was under the impression, I’m sorry, that it impacted your top line by several percentage points.

Robert P. Ryder

It’s about two percentage points. I think if you go through some of the footnotes in the press release --

Bonnie Herzog - Citigroup

Thank you. All right. I appreciate your time.

Operator

Thank you. Our next question is coming from Lauren Torres of HSBC. Please go ahead.

Lauren Torres - HSBC

Good morning. Just a quick clarification first, Rob. You mentioned that you substantially completed the reduction, the inventory reduction in the quarter. By the word substantially, I guess it does assume or allow us to assume there’s some more to come? And if you could give us a sense if there is, how much is more to come?

Robert S. Sands

The reason we used the word substantially is because there always can be some fluctuations in the short-term in distributor inventory. For your purposes, I think you should consider it complete and any changes in distributor inventory, which as I said really shouldn’t be anything significant, are fully taken into account in the guidance that we’ve given you.

Lauren Torres - HSBC

And that’s why you are giving us that $0.15 number, kind of stick with that and that’s what --

Robert S. Sands

The $0.15 is where we’ve added up with the distributor inventor reduction. That’s what you should stick with, exactly.

Lauren Torres - HSBC

Okay, and I guess too a question for Bob; in the quarter, it does look like you had some good free cash flow growth. I’m just wondering why maybe you’re not getting a bit more optimistic on guidance for the full year?

Robert P. Ryder

That’s a good question and basically, we are pretty happy with our free cash generation in the first half but from a cash flow perspective, we’re so early in the year -- I mean, last year we were negative at this point. And as we enter the back half of the year, especially the third quarter, the inventory distribution program is behind us and we expect to build up some decent working capital in the back half of the year.

I would say we are cautiously optimistic on cash flow but not optimistic enough to change the guidance right now.

Operator

Thank you. Our next question is coming from Timothy Ramey of D. A. Davidson. Please go ahead.

Timothy Ramey - D. A. Davidson & Co.

Good morning, a couple of follow-ups, one on the hedging expense. Where exactly are you booking that? Is that pushed down to the segment operating income?

Robert P. Ryder

Yes, all the hedging I think is booked down, is pushed down to the operating income, so it is sort of invisible to you guys. If you look at the statements, I might have misstated the number a little bit but I think in the line segment, for-ex helped us about 4% on net sales. That’s all in our net sales breakouts in the background, so when we hedge translation, we are hedging the EBIT of it, not the net sales impact of it.

Timothy Ramey - D. A. Davidson & Co.

Got it. And on the inventory reduction program, why did it end up being less -- it ended up being smaller than originally forecast. Was that due to strong consumer movement or did you just kind of back away from the program a bit? What changed?

Robert S. Sands

Tim, it was really a mix impact. The mix of the reduced inventory was skewed towards higher margin products and therefore the sales impact was lower than expected, but the earnings impact was within the range that we specified and we accomplished in general the goal that we were trying to accomplish in terms of what we took out. So it was really the sales and the sales was a function of the mix being towards lower volume, higher margin items.

Timothy Ramey - D. A. Davidson & Co.

Okay, and I think you mentioned that SVEDKA was running at double digits. Do you have a current case sales run rate that you could share, or what it has actually done in case sales year over year in terms of percent change?

Robert S. Sands

The first half of the year, it’s been running very much in accordance with our expectations, very high, double digits in the 50-percentage type growth rate, and it’s a great brand and it’s performing exactly as we’d like it to be. We are extremely happy with it.

Timothy Ramey - D. A. Davidson & Co.

Okay, and any other wine brands that you would highlight in terms of scanner data that are either particularly bad or particularly good?

Robert S. Sands

Well, there’s nothing particularly bad but our premium portfolio continues to perform well. We continue to see very strong -- I should say strong growth in major brands, like Robert Mondavi Private Selection, Toasted Head, Rex Goliath. We are very pleased with our growth.

We have to remember that our premium wine portfolio is a very large portfolio. We are the largest and we look for strong growth in that portfolio and we are getting it.

Timothy Ramey - D. A. Davidson & Co.

Sounds good. Thanks so much.

Operator

Thank you. Our next question is coming from Judy Hong of Goldman Sachs. Please go ahead.

Judy Hong - Goldman Sachs

First, just in terms of the depletion numbers, are you willing to give us the depletion numbers for U.S. wine and the Crown imports?

Robert S. Sands

No, we don’t normally talk depletions. With Crown, we said that we did reduce some distributor inventories throughout the first half. We’ve brought those down. That’s really the only relevant news, relative to depletions.

In general, our depletions and shipments are basically equal, so it’s really not important to talk about depletions independently unless there is something to highlight. That’s how we’ve discussed this in the past.

Judy Hong - Goldman Sachs

So if we go back to your comment about the organic net sales in the first half being up in line with your long-term guidance excluding the impact of distributor inventory situation in the U.S., we’d take that and think that the depletions are up in that range as well?

Robert S. Sands

Yep.

Judy Hong - Goldman Sachs

And then secondly, I just wanted to sort of broadly look at the global wine supply situation. Obviously we are hearing that the Australian is likely to come in much below last year’s harvest. It looks like the U.S. is going to be down this year as well. If you sort of look out, kind of looking at the global wine situation, do you think we are entering a point where the supply is becoming tighter and that really creates a more conducive pricing environment for your wines? What’s the implication from a pricing standpoint in the U.S. wine market and the U.K. wine market?

Robert S. Sands

I think that in answer to your question, we certainly see supplies around the world beginning to tighten and there has been quite a bit of press about precisely what you are suggesting, that we might be turning from global oversupply to global undersupply.

I will say that having been in this industry for many, many years, those exact turning points are extremely difficult to predict, but certainly some of those indications are there.

To your second point in that regard, if in fact we are at one of those inflection points or moving into one of those inflection points, that should be a positive trend that should be positive as it relates to pricing trends.

Again, we are not predicting anything at this stage relative to our business specifically, but the kinds of things that you are talking about could very well be the case on a macro basis, so if anything, as I said, it would be a positive trend.

Judy Hong - Goldman Sachs

At what point would you be willing to sort of think that we are at that inflection point? Is it when the Australian harvest does indeed come in significantly below last year’s number, then the U.S. is also short? Do you have to see a more balanced situation coming out of Chile and other markets around the world? What are the milestones that we should be looking at?

Robert S. Sands

I think that as you’ve said, the southern hemisphere harvest coming up and then the next northern hemisphere at the end of next summer. That should give us some better indications of exactly where we are at.

Remember, as I said, this is a very big macro trend. It’s not measured in any particular instant in time. You can’t make gross overstatements about it based on one harvest or another harvest. It’s going to take a few harvests and it should become more evident, as I said, after the next two northern and southern hemisphere harvest.

Judy Hong - Goldman Sachs

Okay. Thank you.

Operator

Thank you. Our next question is coming from Bill Leach of Neuberger Berman. Please go ahead.

Bill Leach - Neuberger Berman

Good morning. Maybe you said it, but can you tell us exactly how much the beer volume was down at Crown and how much you raised prices?

Robert S. Sands

No, I don’t think that we did say that.

Robert P. Ryder

I think you can get that off IRI if you look, but remember that’s just sort of a microcosm of the total. You will see sales growth ahead of volume growth.

Bill Leach - Neuberger Berman

Can’t you just tell us the number?

Robert P. Ryder

I don’t remember it off the top of my head.

Bill Leach - Neuberger Berman

Was it like mid single digits?

Robert P. Ryder

I think that’s close to right, around a mid single digit price increase.

Bill Leach - Neuberger Berman

And the volume was down mid single digits too?

Robert P. Ryder

I don’t remember the volume, frankly. I think it was lower. It wasn’t down that low.

Bill Leach - Neuberger Berman

So their revenues were actually up?

Robert P. Ryder

It was probably down low single digits.

Bill Leach - Neuberger Berman

Okay.

Robert S. Sands

There is a pattern to this, at least in the beer business, as to how the volume growth wanes after you take a price increase and how it gradually comes back over time as the retailers and consumers adjust to it.

Bill Leach - Neuberger Berman

Okay, but we can say the volume was down low single digits in the quarter?

Robert P. Ryder

Again, as you know, we don’t consolidate Crown so that doesn’t flow through our financials.

Bill Leach - Neuberger Berman

Right but it obviously impacts your equity income, so we need to know how the health of the business is.

Robert P. Ryder

Yes, I just don’t remember the volume thing. If you look at the -- and again, it’s year over year because last year we were just west coast. We don’t have complete visibility into what the east coast volumes did last year, east coast sales did last year, so unfortunately it’s not a real clear road map.

Bill Leach - Neuberger Berman

It looks like the stock compensation expense was about $0.03 a share; is that right?

Robert P. Ryder

That seems high to me, but as you know what we did is we changed the option program and this will be filtering into our P&L over four years. This is the second of four years that you will see increased stock compensation expense, and I think it was closer to a penny.

Bill Leach - Neuberger Berman

But you show it as of six months, it’s almost $17 million pretax, versus $7.8 million last year. It’s a big increase.

Robert P. Ryder

That’s year-to-date numbers. Are you talking the quarter or --

Bill Leach - Neuberger Berman

Yes, well, I would like to know the quarter.

Robert P. Ryder

The quarter was about a penny.

Bill Leach - Neuberger Berman

A penny. Okay, thanks a lot.

Operator

Thank you. Our next question is coming from Jonathan Feeney of Wachovia Securities. Please go ahead.

Brian Scodari - Wachovia Securities

Good morning. This is actually Brian [Scodari] on behalf of John Feeney. In regard to distributor inventory reduction, I was wondering if you could give us any color on what types of safeguards and/or consumer data that you’ve put in place to prevent this problem from reoccurring in the future?

Robert S. Sands

There’s really not the need for any safeguards. The key is over a longer range period that shipments and depletions should be somewhat equal, and that’s largely in our control. We monitor that and we don’t expect to take, as I said in the medium term or long term, distributor inventories up. Now there are fluctuations from time to time, as we have said in the past. You might see, for instance, in the quarter leading up to the holiday season, it’s necessary to build some inventories because we have sales growth during those periods and then in periods that are not as fast, you might see some inventories going down. But generally depletions and shipments are equal.

Brian Scodari - Wachovia Securities

And just one more on the joint venture front --

Robert S. Sands

Sorry, what was that?

Brian Scodari - Wachovia Securities

Just one more on the joint venture front, particularly with Matthew Clark wholesale business. How is that working out? I mean, essentially you have partnered with a customer, so does that close the door to others? Or does that particular JV change the go-to-market in any way that limits you?

Robert S. Sands

Number one, they were not a big customer and the direct answer to your question is no, it really doesn’t limit us. That marketplace is -- well, let me just put it a little differently. We sell to thousands and thousands, tens of thousands of different outlets. What they buy is largely a function of price and service and they are not particularly concerned with corporate ownership structures. They are concerned, as I said, with the price and the service they are getting for the products that they are purchasing. So it is really not a factor in dealing with our tens of thousands of customers around the country.

Brian Scodari - Wachovia Securities

Great, thanks.

Operator

Thank you. Our next question is coming from Christine Farkas of Merrill Lynch. Please go ahead.

Christine Farkas - Merrill Lynch

Thank you very much. I would like to start with spirits’ trends, if I could. We’ve heard some anecdotal evidence that perhaps the low end of the market is getting hurt but the high end, of course, is trading up. Your organic growth is pretty strong. Could you just give me a little bit of a sense of mix and what is growing and what isn’t?

Robert P. Ryder

I would say for the quarter, we experienced some positive mix shifts, so what you are saying is pretty correct, that the low end of the market is not growing as fast as the upper end of the market and our higher price per bottle brands, which also carry higher profits with them, are growing faster than the lower price per bottle brands. Similar to the wine business.

Christine Farkas - Merrill Lynch

But on that, given your organic growth up 11%, how much of your portfolio would you consider low end versus high end now?

Robert P. Ryder

It’s probably about 50-50.

Christine Farkas - Merrill Lynch

Okay, so that means pretty strong growth at the high end, I guess, with some of the innovation that you’ve put out there.

Robert S. Sands

It’s actually a little bit less than that. It’s somewhat less than that but we do have very strong growth in the high end and that is causing the mix shift.

Christine Farkas - Merrill Lynch

Okay, great. Moving to Canada, good growth in that market. I’m just wondering, and perhaps this might be looking a little bit over-analytical at the market, but with the strong dollar, are there fewer imports going into Canada that might perhaps allow your domestic brands to thrive even more? Is there any of that going on in Canada?

Robert S. Sands

Actually, the import business in Canada is very strong, as well as the domestic business, and remember imports into Canada are coming from a lot of different places, like Australia, like Chile, and like the U.S.

I don’t think that we’ve really seen the -- well, in general, the import business has been strong and it has not been hurting the domestic business, which has also remained strong. In particular, the premium end of the market, what we call DQA, which are the entirely produced in Canada products, they also remain very strong. So really both ends of the market are good.

Christine Farkas - Merrill Lynch

Okay, so that’s good. It’s not hurting your business. Your exports from California to Canada, has that gone up?

Robert S. Sands

Our exports -- I’m sorry, what did you say?

Christine Farkas - Merrill Lynch

Your exports from California, for example, into Canada, does your business benefit just based on your strong base and distribution in Canada?

Robert S. Sands

Our exports have been fine, but remember we export to Canada from a number our different wine producing regions, like Australia. And I would also point out that Vincorp has a strong import business, as well as a strong domestic business, so we are really positioned to take advantage of all the positive trends, both imports and domestic.

Christine Farkas - Merrill Lynch

Okay, that’s helpful, and just on Australia, again similarly with Australian supplies potentially drying up here and the Australian segment really dominating that $5 to $9 price point, I’m wondering if either your forecasts or even existing trends so far, would your own brands in the $5 to $9 segment, like a Woodbridge, for example, be in a better position should those supplies just really slow into North America?

Robert S. Sands

Yes, I would say the answer to that is yes, even though I would also say that Woodbridge is performing exceptionally well, given that it’s a huge brand and the biggest brand in the category and segment. We are seeing some good growth for a brand that size, so even without imports being hurt or Australian imports being particularly hurt, we are seeing strong Woodbridge growth as we sit here. But clearly what you’ve suggested could be the case as well.

Christine Farkas - Merrill Lynch

Okay, that’s helpful, and sorry, last quick point on SG&A; you mentioned stock compensation up and marketing up in terms of some brand spend, but also SG&A higher based on I guess the transition or destocking. Can you quantify how much of that SG&A increase is considered more one-time in nature in the quarter?

Robert S. Sands

I think that the SG&A increase is due to the change in equity accounting of our major segments, of Crown and Matthew Clark, so I think that that’s what you are really seeing there. That’s why SG&A has become a larger percentage of net sales as we eliminated from the net sales line the businesses that we are now accounting for in the equity method.

Robert P. Ryder

I would say that there’s not any big one-time absolute dollar cost in there. It’s just that as a percentage of sales, as Rob said, that the geography has changed because we took so many sales out because of the JV accounting.

Christine Farkas - Merrill Lynch

Okay, great. Thanks so much.

Operator

Thank you. Our next question is coming from [Qamil Varawalla] of UBS. Please go ahead.

Qamil Varawalla - UBS

Thank you. A couple of things. First thing, on the distributor inventory issue, now that you’ve gone through it, could you talk a little bit about distributor support and investment behind the brands? I remember when you first announced the program one of the intentions were to free up some working capital at the distributor levels so that they can support your brands more and I just want to see if you can give us an update on that.

Robert S. Sands

I think that it’s having the intended result. We are working well with our distributors. We are a very large supplier. The distributor inventory reduction has benefited them and they are very willing to partner with us to continue to build our brands and our portfolios and that was really the whole idea behind the whole thing. So I think we are very positive in that regard and our partnership remains very strong in that regard.

Qamil Varawalla - UBS

So incrementally, is the support higher than it was?

Robert S. Sands

It is a huge -- you know, we have thousands and thousands of distributors and it’s hard to make that kind of a judgment because it is something that is constantly in flux and there is all sorts of mix and so on and so forth, but we, as I said, are getting good distributor support against our growth initiatives, so I think it’s working.

Qamil Varawalla - UBS

Okay, thanks and then on the Crown side, how much are you reliant or do you expect the domestic brewers to begin to take some pricing this fall in order to get volumes to start to pick up again in the Modelo portfolio?

Robert S. Sands

We are not relying on anything. We are not privy to what the domestic brewers are going to do and when they are going to do it. There is already anecdotal evidence that there’s pricing being taken in the marketplace, reading all the typical trade press and so on and so forth, so we think that that’s happening, which is fairly consistent with the patterns of the past. When the high end takes the pricing, usually the lower end bows after a certain period of time. So the anecdotal evidence is that that’s the case.

Qamil Varawalla - UBS

Okay, got it, and then the last thing, you talked about no changes in the business in the U.K., yet your organic number in Europe for branded wine seemed to be fairly strong when you adjust for the wholesale. Could you talk a little bit where the growth is there and where it’s coming from?

Robert S. Sands

In the first half, particularly in the first quarter we had some very strong growth, a little less on the second quarter and it’s been coming from mainland Europe. We are really not overemphasizing that because a lot of it has come from, some of the growth has come from lower margin product that we’ve sold in mainland Europe, so it’s not necessarily flowing through to the bottom line in a big way. I think that’s basically the answer to your question. Volumes in general and in our U.K. and Europe business are not -- this is a double negative -- are not unhealthy. In other words, they are healthy but we do -- it is a competitive market. There continues to be pricing and margining issues. We continue to work through that and we are at best cautiously optimistic about our recovery plans there.

Qamil Varawalla - UBS

Thank you.

Operator

Thank you. Our next question is coming from Mark Swartzberg of Stifel Nicolaus.

Mark Swartzberg - Stifel Nicolaus

Thanks, Operator. Good morning, guys. Rob, on this destocking and then a couple of financial questions for you, Bob. I want to make sure I’m piecing the pieces together properly here. It sounds like you are basically saying that at the distributor level, you are simply leaving inventories at a higher level than you originally anticipated because you are not in fact seeing a material pick-up in depletion rates out of those distributors, which might be a very sound business decision but I’m just trying to understand ultimately what drove this 110 versus 160 or higher.

Robert S. Sands

No, that’s not right, Mark. We met our goals at the distributor level. The reason that the dollar sales number is lower than the range that we gave is because of the mix impact towards lower volume, higher margin products. What we had said originally was that we were targeting about a 25% to 30% reduction in days, and as we look sort of market by market, distributor by distributor, product by product, we have accomplished those goals, so we have accomplished the goal that we have set forth.

Mark Swartzberg - Stifel Nicolaus

Okay, but higher -- I guess we can move on, but higher margin

Robert S. Sands

Based on lower volume, higher margin products, right.

Mark Swartzberg - Stifel Nicolaus

Right, so that means even less absolute volume was taken out of your distributors, but it is what it is. Just in terms of financial items, Bob, I might have missed it, but as it relates to fiscal -- looking beyond fiscal ’08, in the past you guys have said that using fiscal ’07 as an earnings base, you expect to return over the medium to long-term to high single-digit to low double-digit EPS growth. I might have missed it in your prepared remarks but is that still your view?

Robert P. Ryder

Yes, I think that’s still -- why do you think our remarks are prepared? This is all unscripted. Yes, we are not -- obviously we are not talking about next year yet but nothing we see this year would be changing what we said historically about long-term trends in the business. It’s still an extremely healthy category.

Mark Swartzberg - Stifel Nicolaus

Okay, great, and then lastly, just on fiscal ’08, as you look at your share count assumptions, you are saying 225 million for the year. You are at 219.3 in the quarter, so that 225 implies a fairly meaningful pick-up in the second half.

Robert P. Ryder

I think it’s a weighted average thing, the way the EPS is calculated. I think it is done on a year-to-date basis, so you had a higher share count sort of in the front-end of the year.

Mark Swartzberg - Stifel Nicolaus

Right, but I’m saying if you take the 219 and the higher number for the first quarter, and then if you just take 219 and hold it constant for the balance of the year, you are at more like 223 I think for the full year. So it basically implies you are expecting it to go up a good bit again in the second half.

Robert P. Ryder

It would be mostly just how the option dilution kicks in to the calculation. Obviously we are not -- we don’t plan to issue or buy back any more shares.

Mark Swartzberg - Stifel Nicolaus

Excellent. Okay, that’s what I thought. Thanks very much.

Operator

Thank you. Our final question is coming from Bryan Spillane of Banc of America Securities. Please go ahead.

Bryan Spillane - Banc of America

Good morning, everybody. Just two points; one a point of clarification. Are the distributor inventory correction or draw-down for Crown is all -- is completed, right? You are not -- Crown is not in a position where they are still destocking wholesaler inventories, is that correct?

Robert S. Sands

Correct.

Bryan Spillane - Banc of America

Okay, and then second --

Robert S. Sands

Again, not taking into account short-term fluctuations, but in general that’s correct.

Bryan Spillane - Banc of America

Okay, and then the second point is Rob, if you could talk a bit about looking into the holidays in the U.K., is your participation in promotions with retailers, sort of what’s on your holiday merchandising calendar this year any different than last year? I guess what I’m trying to drive at is do you expect that your shelf space, your display space, and the number of promotion activities this year to be on par with, greater than, or less than last year?

Robert S. Sands

We don’t know that until after the holiday, unfortunately, but a lot of the processes going into the holidays is all about working out our promotional programs with the major retailers. Based on what I’m hearing, we’re being very successful in getting our holiday promotions locked away and I’m hoping for a better holiday season in that regard than we had last year, which was not necessarily particularly negative or otherwise, but our portfolio is a good portfolio. The market is fairly strong and what I’m hearing is that retailers are favorable towards what we are doing and so I’m looking forward to a good holiday season in terms of promotional activities. So I don’t see anything negative in any respect on the horizon in that regard, Bryan.

Bryan Spillane - Banc of America

Okay, great. Thanks, guys.

Robert S. Sands

Sure. Okay. Well, thanks for joining our call today and I would characterize this quarter as one of continued execution toward our goals. We delivered solid cash performance and paid down debt. We substantially completed our U.S. wine distributor inventory reduction program. We are driving marketplace initiatives around the world, which will help us drive growth from our portfolio of products, and from a financial perspective, we believe that we are well-positioned to achieve our revised full year EPS goal and free cash flow targets.

Thanks again, everybody, for your participation. Our next call is scheduled after the New Year, so I am sure everybody will responsibly enjoy some of our excellent products during the upcoming holiday season. I will talk to you all after that. Thanks.

Operator

Thank you. That does conclude today’s teleconference. You may disconnect your lines at this time and have a wonderful day.

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