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

Oct. 5.07 | About: Constellation Brands, (STZ)

Constellation Brands, Inc. (NYSE:STZ)

F2Q08 Earnings Call

October 4, 2007, 10:00 AM ET

Executives

Patty Yahn-Urlaub - VP of IR

Robert Sands - President and CEO

Robert Ryder - EVP and CFO

Analysts

Bonnie Herzog - Citigroup Smith Barney

Lauren Torres - HSBC

Timothy Ramey - D. A. Davidson & Co.

Judy Hong - Goldman Sachs

William Leach - Neuberger Berman

Christine Farkas - Merrill Lynch

Mark Swartzberg - Stifel Nicolaus

Bryan Spillane - Banc of America

Operator

Good morning. My name is Alfa 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. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. [Operator Instructions]. Thank you.

It is now my pleasure to turn the floor over to your host, Patty Yahn-Urlaub, Vice President of Investor Relations. Ma'am, you may begin your conference.

Patty Yahn-Urlaub - Vice President of Investor Relations

Thank you, Alfa. 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 Bob 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 Investors 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, and unusual items. We will also discuss organic net 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 fluctuation.

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 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 turn the call over to Rob.

Robert Sands - President and Chief Executive Officer

: 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 Ph. D. in Economics from MIT and I am really looking forward to working with Mark.

And now I would like to discuss our financial performance for the second quarter of fiscal 2008. We're 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, Nobilo 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. As 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 the 2006 vintage for our Inniskillin Icewine which we believe ranks as one of the best ice wine vintages we've have ever seen.

Turning to the U. K., the market conditions in the U. K. have not changed 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 market model and are working to improve our operating efficiencies. Although we remain cautious, we believe the tightening Australian wine supply and 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 Spirits 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, 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 channels to benefit our spirits business.

The base spirits business is continuing to benefit from the premiumization trend occurring in the market and are focused on building our premium investment in 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. As is typical with the 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 glass 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 continue 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 Ryder - Executive Vice President and Chief Financial Officer

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 new shift 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 initiatives, continued efforts to better position our U. K. and Australian businesses, 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 start with a review of our P&L for the quarter where my comments will focus on comparable basis financial results. 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 new 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, 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 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 destocking of higher margin premium products.

Sprits 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, 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 provided 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 decreased 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 de-leveraging 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 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 the efforts to reduce U. S. distributor inventories and U. K. and Australian 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 from 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 repurchase.

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 to 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 or an average of $23.44 per share. Due to the main 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 provide by operating activities less CapEx. For the first six months of fiscal '08, we generated $130 million... $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 net working 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 demand. 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 what we believe we're 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 the 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 guideline are outlined on page 4 of the release.

Before we take your questions, I want to make you aware that we have recently filed a preliminary proxy statement relating to 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 actual 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 awards with respect the new class of stock to preserve the tax treatment of stock option 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

Operator

Thank you. [Operator Instructions]. Our first question is coming from Bonnie Herzog of Citi Investments. Please go ahead.

Bonnie Herzog - Citigroup Smith Barney

Good morning everyone.

Robert Ryder - Executive Vice President and Chief Financial Officer

Hey Bonnie.

Bonnie Herzog - Citigroup Smith Barney

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'd be curious to hear how much of your supply has grown by company-owned vineyards versus how much do you actually purchase on the open markets? Hello.

Robert Ryder - Executive Vice President and Chief Financial Officer

Good question, Bonnie.

Robert Sands - President and Chief Executive Officer

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

Bonnie Herzog - Citigroup Smith Barney

It is open. That's what I... okay. Just wanted to verify that.

Robert Sands - President and Chief Executive Officer

Open but under contract.

Bonnie Herzog - Citigroup Smith Barney

Okay, and how long are the contracts?

Robert Sands - President and Chief Executive Officer

They vary...

Bonnie Herzog - Citigroup Smith Barney

Vary...

Robert Sands - President and Chief Executive Officer

In some cases, they are relatively long term.

Bonnie Herzog - Citigroup Smith Barney

Okay. Long term meaning 3 years 5?

Robert Sands - President and Chief Executive Officer

Multiple years.

Bonnie Herzog - Citigroup Smith Barney

All right. And then just turning over to your beer business. I was just 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 would like to share with us, let it be volume pricing, income, that will be helpful.

Robert Sands - President and Chief Executive Officer

Yes, I think that in general, while 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 take in 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...

Bonnie Herzog - Citigroup Smith Barney

Right.

Robert Sands - President and Chief Executive Officer

I think we are seeing some very positive trends in the short term, the last reporting periods for IRI and things to that effect... in the East in particular. So we are optimistic about how we're performing in that regard.

Bonnie Herzog - Citigroup Smith Barney

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 Sands - President and Chief Executive Officer

Yes we... it's not significant Bonnie.

Bonnie Herzog - Citigroup Smith Barney

Okay.

Robert Sands - President and Chief Executive Officer

We actually hedge most of that away.

Bonnie Herzog - Citigroup Smith Barney

All right. But I was under the impression, I am sorry, that impacted your top line by several percentage points?

Robert Sands - President and Chief Executive Officer

It's about two percentage points.

Bonnie Herzog - Citigroup Smith Barney

Okay.

Robert Sands - President and Chief Executive Officer

I think if you know... if you go through some of the footnotes in the press release...

Bonnie Herzog - Citigroup Smith Barney

Thank you.

Robert Sands - President and Chief Executive Officer

I think that works out.

Bonnie Herzog - Citigroup Smith Barney

All right, I appreciate your time.

Robert Sands - President and Chief Executive Officer

Thanks.

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 is still more to come. And if you could give us a sense... if there is how much, is more to come?

Robert Sands - President and Chief Executive Officer

Yes, 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 there... 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 Sands - President and Chief Executive Officer

The $0.15 is where we've ended up with the distributor inventory reduction, that's what you should stick with, exactly.

Lauren Torres - HSBC

Okay and I guess to a question for Bob. In the quarter, it does look like you had some good free cash flow growth. I am just wondering why maybe... I maybe, you are not getting a bit more optimistic on guidance for the full year?

Robert Sands - President and Chief Executive Officer

Yes it's a good question and basically, we are pretty happy with our free cash generation in the first half. But from the cash flow perspective, we are so early in the year. I mean last year we were negative at this point. And as we entered the back half for 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 for the year. So I would say we are cautiously optimistic on cash flow but not optimistic enough to change the guidance right now.

Lauren Torres - HSBC

Okay. Thanks.

Operator

Thank you. Our next question is coming from Tim 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... has that pushed down to segment operating income?

Robert Sands - President and Chief Executive Officer

Yes. All the hedging, I think is booked down. It is pushed down to the operating income. So it's sort of invisible to you guys. I mean, if you look at the statements, I might have misstated the number a little bit but I think in the wine segments ForEx helped us about 4% on net sales. Right because that's all in the... in our net sales breakout in the background. So when we hedge translation, we are hedging the EBIT impact of it, not in that net sales impact of.

Timothy Ramey - D. A. Davidson & Co.

Got it. And on the inventory reduction program, why did it end up being less, end 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 Sands - President and Chief Executive Officer

Tim, it was really a mix impact. The mix of the reduced inventory was skewed towards the 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's actually done in case sales year-over-year in terms of percent change?

Robert Sands - President and Chief Executive Officer

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're extremely happy with it.

Timothy Ramey - D. A. Davidson & Co.

Okay. And any other wine brands that you would highlight in terms of scan [ph] the data that are either particularly bad or particularly good?

Robert Ryder - Executive Vice President and Chief Financial Officer

Well there is nothing particularly bad, but...

Robert Sands - President and Chief Executive Officer

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

Hi everyone. At first just in terms of the depletion numbers are you wiling to give us the depletion numbers for U. S. wine and the Crown Imports?

Robert Sands - President and Chief Executive Officer

We don't normally talk depletions. With Crown, we said that we did reduce some distributor inventories throughout the first half. We 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's something to highlight. That's how we have 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 take that and thank that its depletions are up in that range as well.

Robert Sands - President and Chief Executive Officer

Yes.

Judy Hong - Goldman Sachs

Okay. And then secondly, I just wanted to sort of broadly look at the global wine supply situation. Obviously we are hearing that the Australian harvest 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, are we... 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 and sort of what's the implication from a pricing standpoint as you look in the U. S. wine market and the U. K. wine market?

Robert Sands - President and Chief Executive Officer

Yes 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 over supply to global under supply. 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.

And then to your sort of second point in that regard, if in fact, we're 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 kind of things that you are talking about could very well be the case on a macro basis. So, everything as I said 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 and the U. S. is also short? Do you have to see more balanced situation coming out of Chile and other markets around the world, sort of what are kind of the milestones that we should be looking out?

Robert Sands - President and Chief Executive Officer

I think that as you said that the Southern Hemisphere harvest coming up and then the next Northern Hemisphere harvest 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 and 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 harvests.

Judy Hong - Goldman Sachs

Okay, thank you.

Robert Ryder - Executive Vice President and Chief Financial Officer

Thanks.

Operator

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

William Leach - Neuberger Berman

Hi 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 Sands - President and Chief Executive Officer

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

Robert Ryder - Executive Vice President and Chief Financial Officer

Yes I think if you... you can get that off it right if you look but remember that's just sort of microcosmic in total. You will see sales growth ahead of volume growth.

William Leach - Neuberger Berman

Okay. Can you just tell us the number?

Robert Ryder - Executive Vice President and Chief Financial Officer

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

William Leach - Neuberger Berman

I mean was it like mid single digits, I mean?

Robert Ryder - Executive Vice President and Chief Financial Officer

I think that's close to right, it was around mid-single digit price increase.

William Leach - Neuberger Berman

And the volume was down mid single digit too?

Robert Ryder - Executive Vice President and Chief Financial Officer

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

William Leach - Neuberger Berman

So their revenues were actually up?

Robert Ryder - Executive Vice President and Chief Financial Officer

It's probably down low single digits.

William Leach - Neuberger Berman

Okay.

Robert Ryder - Executive Vice President and Chief Financial Officer

And asRob said 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 retailers and consumers suggest to it.

William Leach - Neuberger Berman

But we can say that volume was down low single digits in the quarter?

Robert Ryder - Executive Vice President and Chief Financial Officer

And again, as you know we don't consolidate Crown. So that doesn't flow through our financials.

William Leach - Neuberger Berman

Right. But that obviously impacts your equity income. So, we need to know how it helps the businesses.

Robert Ryder - Executive Vice President and Chief Financial Officer

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 didn'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 roadmap.

William Leach - Neuberger Berman

Okay. And looks like the stock compensation expenses are about $0.03 a share. Is that right?

Robert Ryder - Executive Vice President and Chief Financial Officer

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

William Leach - Neuberger Berman

Are you sure that, from 6 months it's almost $17 million pre-tax versus $7.8 million last year, it's a big increase?

Robert Ryder - Executive Vice President and Chief Financial Officer

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

William Leach - Neuberger Berman

Yes, well. I like to know the quarter.

Robert Ryder - Executive Vice President and Chief Financial Officer

The quarter is about a penny.

William 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.

Unidentified Analyst

Hi, good morning. This is actually, Brian Skedery [ph] on behalf of Jon Feeney. In regards to distributor inventory reduction, I was wondering if you could give us any color on what types of safeguards and/or kind of consumer data that you have put in place to prevent this problem from like recurring in the future.

Robert Sands - President and Chief Executive Officer

Well, you know there is really not a need for any safeguards. The key is over a longer range period that shipments and depletion should be somewhat equal and that's largely in our control. So we monitor that, and we don't expect to take... as I said the medium term or long term distributor inventory is 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 a 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.

Unidentified Analyst

Great. And just one more on the joint venture front.

Robert Sands - President and Chief Executive Officer

Sorry. Sorry I am sorry, what was that?

Unidentified Analyst

That's all right. Just one more on the joint venture front particularly Matthew Clark wholesale sale business you know. How is that working out? I mean essentially you have partnered with a customer. So does that close the door to others or like does that particularly... does that particular JV like change the go to market any way that limits you?

Robert Sands - President and Chief Executive Officer

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... 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's really not a factor in dealing with our tens and tens of thousands of customers around the country.

Unidentified Analyst

Okay, 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. Can you just give me a little bit of sense of mix and what's growing and what isn't?

Robert Ryder - Executive Vice President and Chief Financial Officer

Yes this is Bob. I would say for the quarter, we experienced some positive mix shift. So what you are saying is pretty correct that the low-end of the market is not going 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, in the wine business.

Christine Farkas - Merrill Lynch

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

Robert Ryder - Executive Vice President and Chief Financial Officer

It's probably about 50:50.

Christine Farkas - Merrill Lynch

Okay. That means pretty strong growth at the high end, I guess with some of the innovation that you've out there?

Robert Sands - President and Chief Executive Officer

Yes this is Rob. 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 am 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 Sands - President and Chief Executive Officer

Actually the imports 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.

Christine Farkas - Merrill Lynch

Sure.

Robert Sands - President and Chief Executive Officer

And like the U. S. I don't think that we have really seen the... well in general the import business has been strong, and it has not been hurting the domestic. It hasn't been hurting the domestic business, which has also remained strong.

Christine Farkas - Merrill Lynch

Okay.

Robert Sands - President and Chief Executive Officer

In particular the premium end of the market what we call VQA, which are entirely produced in Canada products. They also remain very strong. So really both the ends of the market are good.

Christine Farkas - Merrill Lynch

Okay. So well that's good, it's not hurting your business. Well your exports from California to Canada, has that gone up?

Robert Sands - President and Chief Executive Officer

Our exports. I am sorry what did you say?

Christine Farkas - Merrill Lynch

Your exports from California for example into Canada. Does your business benefit based on your strong base in distribution in Canada?

Robert Sands - President and Chief Executive Officer

Our exports have been. Fine but remember we export to Canada from a number of our different wine producing regions, like Australia and I'll also point out that Vincor has a strong import business as well as a strong domestic business. So we're really positioned to take advantage of all the positive trends.

Christine Farkas - Merrill Lynch

Okay.

Robert Sands - President and Chief Executive Officer

Both imports and the domestic.

Christine Farkas - Merrill Lynch

Okay, that's helpful. And then 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 am wondering if either your forecast or even existing trend 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 flow into North America?

Robert Sands - President and Chief Executive Officer

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

Christine Farkas - Merrill Lynch

Okay, that's helpful. And sorry last quick one 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 Sands - President and Chief Executive Officer

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's what you are really seeing there. It's why SG&A has become a larger percentage of net sales as we eliminated it from the net sales line, the businesses that we are now accounting for in the equity method.

Robert Ryder - Executive Vice President and Chief Financial Officer

So I would say that there is not any 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 Kaumil Gajrawala [ph] of UBS. Please go ahead.

Unidentified Analyst

Thank you. A couple of things. First thing on the distributor inventory issue. Now that you have gone through it, can 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 create some working capital for the distributor levels that they can support your brands more. And I just wonder if you can give us an update on that.

Robert Sands - President and Chief Executive Officer

I think that having the intended result, we're 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.

Unidentified Analyst

And so I think incrementally is the support higher than it was?

Robert Sands - President and Chief Executive Officer

No, it's a huge, we have thousands and thousands of distributors and it's hard to make that kind of a judgment because it's something that's constantly in flux. And there's all sorts of mix and so on and so forth. But we had... as I said are getting good distributor support against our growth initiatives. So, I think it's working.

Unidentified Analyst

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

Robert Sands - President and Chief Executive Officer

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 trend price 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 a pricing, usually the lower end falls after a certain period of time. So, the anecdotal evidence is that's the case.

Unidentified Analyst

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

Robert Sands - President and Chief Executive Officer

Yes, well as of in the first half, particularly in the first quarter we had some very strong growth. Little less on the second quarter and it's been coming from mainland Europe. We've been... we're really not over-emphasizing that because a lot of it has come from... some of the growth has come from... I will say 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. So I think that's basically the answer to your question. Volumes in general and 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 margin issues. We continue to work through that, and we are at best cautiously optimistic about the... our recovery plans there.

Unidentified Analyst

Okay, thank you.

Operator

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

Mark Swartzberg - Stifel Nicolaus

Thanks operator. Good morning guys. Rob, on this destocking and then couple of financial questions for you Bob. I want to make sure I am piecing the pieces together properly here. It sounds like you are basically saying that at the distributor level you're simply leaving inventory that are higher level than you originally anticipated because you are not in fact seeing a material pickup in depletion rates out of those distributors which might be a very sound business decision. But I am just trying to understand ultimately what drove this $1.10 versus $1.60 or higher.

Robert Sands - President and Chief Executive Officer

No that is 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, lower volume higher margin products what we had said originally that we were targeting about a 25% to 30% reduction in days. And as we've looked sort of a 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 Sands - President and Chief Executive Officer

Based on lower volume, higher margin products, right.

Mark Swartzberg - Stifel Nicolaus

But lower 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 it's... as it relates to fiscal... looking beyond fiscal '08 in the past, you guys have said that you think fiscal '07 has an earnings base you expect to return over the medium to long term to high single digit to low double digit EPS growth. And I might have missed it in your prepared remarks but is that still your view?

Robert Ryder - Executive Vice President and Chief Financial Officer

Yes, I think that's true. But why you think our remarks are prepared, this is all... 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 is 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 had about... you did 219.3 in the quarter. So that seems to... that 225 implies fairly meaningful pickup in the second half.

Robert Ryder - Executive Vice President and Chief Financial Officer

I think it's a weighted average thing, the way the EPS is calculated. So I think it's 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 am 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 more like 223 I think for the full year. So that basically implies, you are expecting to go up then again in the second half.

Robert Ryder - Executive Vice President and Chief Financial Officer

I thinkit will be mostly just how the option dilution kicks in to the calculation. Because I mean 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

Hey good morning everybody.

Robert Sands - President and Chief Executive Officer

Hi Bryan.

Bryan Spillane - Banc of America

Just a few points. One, a point of clarification. Are the... that the distributor inventory correction or drawdown for Crown is all... is completed, right? You are not... the Crown is not in a position where they are still de-stocking wholesaler inventories, is that correct?

Robert Ryder - Executive Vice President and Chief Financial Officer

Correct.

Bryan Spillane - Banc of America

Okay, and then second

Robert Ryder - Executive Vice President and Chief Financial Officer

And I am 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., are your... is your participation in promotions with retailers, so sort of what's on your holiday merchandising calendar this year. Any different than last year and I guess what I am trying to drive at is, 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 Sands - President and Chief Executive Officer

Yes. Well we don't know that until after the holiday unfortunately but a lot of the process of going into the holidays, and it's all about working out our promotional programs with the major retailers. And based on what I am hearing, we are being very successful in getting our holiday promotions locked away, and I am 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 not... it's fairly strong, and what I am hearing is that the retailers are favorable towards what we are doing. And so I am looking forward to a good holiday season in terms of promotional activity. 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 Sands - President and Chief Executive Officer

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.

So thanks again everybody for your participation. Our next call is scheduled after the new years. So I am sure everybody will responsibly enjoy some of our excellent products during the upcoming holiday season. And 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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