Constellation Brands F3Q08 (Qtr End 11/30/07) Earnings Call Transcript

Jan. 8.08 | About: Constellation Brands, (STZ)

ConstellationBrands, Inc. (NYSE:STZ)

F3Q08Earnings Call

January8, 2008, 10:00 a.m., ET

Executives

RobertSands – President, Chief Executive Officer

RobertRyder – Executive Vice President, Chief Financial Officer

PattyYahn-Urlaub – Vice President of Investor Relations

Analysts

BryanSpillane – Banc of America

TimothyRamey – D. A. Davidson & Co.

ChristineFarkas – Merrill Lynch

MarkSwartzberg – Stifel Nicolaus

LaurenTorres – HSBC

WilliamLeach – Neuberger Berman

RisaVahasetta (sic) – Lehman Brothers

BrianScudieri – Wachovia Securities

AlecPatterson – RCM

Operator

Good morning. Myname is Elsa and I’ll beyour conference operator today. Atthis time I would like to welcome everyone to Constellation Brands’ thirdquarter 2008 earnings conference call. Alllines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be aquestion and answer period. If you would like to pose a question during this time please press‘star’ then thenumber one on your telephone keypad. If you would like to withdraw yourquestion press thepound key. Thank you.

It is now mypleasure to turn thefloor over to your host, Patty Yahn-Urlaub, Vice-President of InvestorRelations. Ma’am, you may begin your conference.

Patty Yahn-Urlaub

Thank you, Elsa.Good morning, everyone, and welcome to Constellations’ third quarter fiscalyear 2008 conference call. I’m here this morning with Rob Sands, our Presidentand Chief Executive Officer, and Bob Ryder, our Chief Financial Officer.

By now youshould have had anopportunity to read our newsrelease, which hasalso been furnished to theSEC. This conference call is intended to compliment the release.

During the call we will discuss financialinformation on aGAAP comparable organic and constant currency basis. Reconciliations between the most directly comparable GAAPmeasure and these and other non-GAAP financial measures are included in thenews releaseor otherwise available atthecompany’s website atwww.cbrands.com under the investor section. Thesereconciliations include explanations as to why management uses the non-GAAP financial measures and whymanagement believes they areuseful to investors.

Discussions willgenerally focus on comparable financial results, excluding acquisition-relatedcosts, restructuring and related charges, and unusual items. We will alsodiscuss organic net sales information, which is defined in thenewsrelease, and constant currency net sales, which excludes the impact of year-over-year currency exchange rate fluctuations.

Please be aware that we may makeforward-looking statements during this call. While those statements representour best estimates and expectations, actual results could differ materiallyfrom our estimates and expectations. For adetailed list of risk factors that may impact the company’s estimates please refer to the newsrelease and Constellations SEC filings.

Now I’d like toturn thecall over to Rob.

Robert Sands

Thanks, Patty,and good morning. I hope everybody had agreat holiday and welcome to our discussion of Constellations third quarter2008 results.

Before we get started I want to mention howpleased I amthat we recently finalized theacquisition of Fortune Brands US wine portfolio. This acquisition marks anothermilestone inthe growthand development of our business as itfurther strengthens our leadership position inthe US wineindustry, improving our overall scale and our premium position.

The total portfolioof products we acquired is well positioned among the fastest growing super premium-pluswines, solidifying our position as anundisputed leader inthe US winebusiness. These super premium and above categories are growing at double-digit growth rates of 14% andrepresent approximately 40% of theentire US wine business inIRI channels on avalue basis.

The acquired Closdu Bois brand is theleading super premium wine brand inthe US.According to themost recent IRI data, ithas beengrowing at a rateof 18% on avolume basis during thelast 52-week period. Clos du Bois hasa range ofproduct offerings, including theleading presence insuper premium chardonnay and strong growth across all keyvarietals. This brand is now thebest selling Sonoma County wine and will join other major wine assets we have in that area, including Simi andRavenswood.

ConstellationsUS market share of thesuper premium and above categories is expected to increase by approximatelyfive percentage points on both avolume and value basis with theaddition of theacquired wine brands.

As we mentionedpreviously, we will betaking arestructuring charge associated with theintegration of this acquisition sothat we may fully realize thesynergies that will result inthe combinedwine operations of both entities. Bob will outline the details of the restructuring plan in just a few minutes.

As we integratethis newly-acquired wine business we arealso taking theopportunity to evaluate and rationalize our US wine product portfolio,primarily within thevalue segment. This includes smaller, low-margin, regional brands at price points generally less than $5and includes brands such as Vinicasada (sic), Capri, Vintner’s Choice, just toname a few.

From the sales and marketing perspective ourgoal is to focus on specific consumer segment opportunities to include finewines, premium wines, and specialty value wines. Overall, we are taking the appropriate actions to further strengthenthe growthand profitability of our wine business and will continue to take advantage of the favourable consumer trade-up trendsoccurring inthemarketplace.

Now I’d like todiscuss our performance for thethird quarter of fiscal 2008. We continue to execute on our strategy andachieve our financial goals which positions us well for the year. As you can see from our press release, one of the financial highlights of the current quarter is that we achievedexcellent free cash flowperformance. As aresult, we aresignificantly increasing our free cash flowguides for theyear. Bob will have more to sayabout this ina fewmoments.

Our US winebusiness returned to targeted sales growth levels during the quarter as theUS distributor inventory reduction initiative was essentially completed in thesecond quarter. Thepositive momentum continues around our wine premiumization efforts with USsales growth during thequarter contributed to by premium wines, including Robert Mondovi brands,Estancia, Blackstone, KimCrawford, Simi, just to name afew.

Moving to the United Kingdom and Australia. Asexpected, theyear-over-year results for thethird quarter were impacted by continuing competitive market conditions in theUK and Australia.

In the UK there is diminishing availabilityof both wines for production of low-cost private label Australian wines due to the lower Australian harvest in 2007 and the projected short harvest in 2008. However, UK market pricing has not changed significantly as the wine market overall remains quitecompetitive, primarily driven by thelarge grocery chains.

I’m generallypleased with theprogress of theMatthew Clark joint venture with Punch Taverns, which provides wholesaleservice to theUK on-premise channel.

From a marketplace perspective, according to the most recent Nielsen UK-wide trans-data,Constellation is outperforming themarket in the price points where we have the most significant market share. In addition, we continue to makeprogress inoffsetting challenging UK market conditions by focusing on increasing marketshare for our premium wine offerings, including the recently acquired super premiumbrands; improving our go-to-market model increasing our penetration in non-grocery channels such ason-premise convenience and specialty retailers; and working to improve ouroperating efficiencies to include initiatives such as streamlining our supply chain. We believe these efforts willdrive improvements inour future financial performance inthe UKmarket.

In Australia, the continuing drought conditions are expected to impact the output of the 2008 harvest, although at this time we cannot fully predict the magnitude of this impact. Ourpreviously announced restructuring actions inAustralia areprogressing as planned and should position us well for the future.

Our Canadianwine business delivered positive revenue growth primarily driven byJackson-Triggs naked grape and our Inniskillin ice wine products.

In the spirit segment the strong marketplace momentum ofSVEDKA vodka continues with theposting of 50% shipment growth inthe thirdquarter. Thebase spirits business also contributed strong sales growth in thequarter driven by premium brands, including Black Velvet, Ridgemont Reservebourbon, and the99 Schnapps family, and recently launched new product as we continue to benefitfrom thepremiumization trend occurring inthe market.

Additionally, weclosed on thepurchase of theremaining 50% of thePlanet 10 joint venture for Effen vodka. Effen vodka continues to benefit from a strong marketplace performance withvolumes increasing 55% inIRI channels during thelast 52-week period.

Moving to the Crown Imports joint venture. During the quarter, Crowns’ performance wasprimarily impacted by price increase, by theprice increase which Corona implemented earlier this year for the entire Modello beer portfolio. It continues to impact volumes, althoughthe trendshave been improving as anticipated and aretracking very closely to thetrends experienced with prior price increases.

Year over year,Crown trends for thesecond half of this year areexpected to beimpacted by challenging comparisons as we prepared for the joint venture transition during the same time last year. However, Crownis continuing to focus on approved execution and generating ad features andpromotions that arecommensurate with its leading US market share in theimported beer category. Inaddition, consumer trade-up trends arecontinuing to support thegrowth of theCrown brands.

Now, before Iturn thecall over to Bob I want to address theimpact of theeconomic downturn on our business as ithas recentlybeen top of mindfor many of our shareholders. Although thebeverage alcohol industry is somewhat immune to unfavourable economic trends, the category has experienced varying segment growth rate atretail in the US during calendar year 2007. Forinstance, recent industry retail data shows thegrowth transfer beer and thespirits category have remained relatively constant while the wine segment continues to exhibithealthy growth, albeit ata slowingrate.

For instance, the dollar growth rate of super premium wines and above ismore than twice thedollar growth rateof beer or spirits. Moreover, thesuper premium plus wine segment where Constellation has leading market share is experiencingdouble-digit volume and dollar growth, also exceeding the trends of the US wine segment. And we continue to see afavourable consumer trade up to premium products across all beverage alcohol categories thatshould drive positive mixed impact on our margins going forward.

The diversificationof our total portfolio also helps to insulate us from consumption shiftsbetween beverage alcohol categories. While we’re well aware of the economic challenges impacting manyindustries, beverage alcohol products arenot expected to beas significantly impacted as other consumer discretionary goods.

In closing,overall I feel good about what we’ve accomplished so far this year. I’m pleased with ourrecent premium wine acquisition and I’m confident in our ability to achieve our goals for the year.

Now I’d like toturn thecall over to Bob Ryder for afinancial review of thequarter. Bob?

Robert Ryder

Thanks, Rob.Good morning, everyone. Ingeneral I’m pleased with our results for thequarter as we generated 6% organic net sales growth on a constant currency basis. Comparablebasis diluted EPS was $0.55 versus $0.58 last year as our results continue to be negatively impacted by the UK and Australian businesses. We’vecontinued our efforts to better position these business for improvedperformance as evidenced by our recent Australian winery rationalizationannouncement. I’m especially pleased that for the year to date we have generatedexcellent free cash flowand we expect free cash flowfor fiscal 2008 to besignificantly above last year and our previous estimate.

I’d like tostart with areview of our P&L for thequarter where my comments will focus on comparable basis financial results. Forthe thirdquarter theSVEDKA acquisition and theCrown and Matthew Clark wholesale joint ventures impacted the comparability of results.

Let’s look at our net sales line. As you can see from our news release on page 14, ourconsolidated net sales decreased 27% reflecting the moveof our US imported beers to theCrown Imports joint venture and theUK wholesale business to theMatthew Clark joint venture. As previously discussed, these joint venturesfollow equity accounting and, therefore, areno longer reflected on theconsolidated net sales line. This impact was partially offset by a 1% benefit from the SVEDKA acquisition, 3% benefit fromcurrency, and branded wine growth.

Commentary for the following net sales comparisons willbe on a constant currency basis. Weexperienced a6% increase inthe consolidatedorganic net sales for thequarter. Spirits net sales increased 31% due to the acquisition of SVEDKA and a 12% inorganic net sales driven by higher average selling prices and volume gains forbranded spirits portfolio, as well as anincrease inour production services business. We continue to be very pleased with SVEDKA and itsmarketplace momentum as itcontinues to generate high double-digit sales growth. World-wide branded wineorganic net sales increase 4%.

Turning ourattention to branded wine geographic net sales on page 13 of the release you will see branded wine net sales for NorthAmerica increased 5% reflecting solid growth inthe US and a slight increase in Canada. For Europe, branded wineorganic net sales increased 4% reflecting increased sales of popular pricedwines inmainland Europe and aslight increase insales in the UK. Our Australian/New Zealandbranded wine net sales were level with last year. The markets in theUK and Australia remain highly competitive with ongoing pricing pressures.

Now we’ll look at our profit for the quarter on a comparable basis using informationpresented on page 15 of thenewsrelease. For thequarter our consolidated gross margin was 36.3%, up 5.3 percentage points. Thisprimarily reflected thebenefits of shifting thelower margin UK wholesale and imported beer businesses to joint venturestructures subject to equity accounting somewhat offset by lower margins for the branded wine businesses in theUK and Australia.

Our consolidatedSG&A for thequarter was 18% of net sales compared with 12.5% a year ago. This increase was primarilydue to moving theimported beer and UK wholesale businesses to joint venture structures. In addition we saw increased managementincentive expense due to alow bonusaccrual in the prior year.

As noted in previous quarters, we have alsorecognized higher stock compensation expense for the transition effects of the new option accounting rules. The quarter also includes highermarketing support for branded wine inthe UK.

Consolidatedoperating income decreased to $200 million from $279 million for the prior year’s quarter. This change was primarily driven by the factors already mentioned, combinedwith reporting $62 million of equity earnings for the Crown joint venture compared to the third quarter of last year when $60million of earnings for imported beer business was included in operating income.

The year-over-yearincrease inbeer business profitability reflects increased pricing and the economics of having a national platform for the Modella portfolio. We did see lower profit growth for the beer business versus the first half of the year. This was primarilyattributable to thehigh level of sales and theprior year third quarter as thebusiness was preparing for theCrown transition.

Now I’d like toturn to our segment operating income results which are reflected on page 12 of the release. Wine segment operatingincome decreased $12 million to $202 million. This was primarily due to the UK and Australia businessperformance, partially offset by anincrease inprofits from our North American business.

For the spirits segment operating incomeincreased $4 million, primarily due to thecontributions from SVEDKA and higher sales for the base business, offset somewhat byhigher material costs.

For the quarter, corporate and otherexpenses totalled $23 million compared with $13 million for the prior year. The increase includes additionalmanagement incentive and stock compensation expenses for the reasons I mentioned earlier and higheroutside service and professional fees.

Moving back topage 15, equity investment earnings totalled $75 million versus $12 millionlast year. Equity earnings for thequarter arecomprised of $62 million from Crown and theremainder related substantially to our Opus One joint venture.

Interest expensefor thequarter was $82 million, up 13% over last year. The increase primarily reflects the incremental interests from funding the SVEDKA acquisition in the$500 million share repurchase, net of theproceeds received from theMatthew Clark transaction, allof which occurred inthe firstquarter.

Now let’s take a look at our debt. At theend of November our debt totalled $4.7 million, a decrease of nearly $300 million fromour Q1 debt level, reflecting our strong free cash flow generation during the second and third quarters. At theend of thethird quarter we had approximately $2.4 billion of bank debt and $2.3 billionof fixed-term and other debt with approximately $850 million of revolvingcredit available under our senior facility.

In mid-December weclosed theacquisition of Fortune Brands US wine business for a purchase price of $885 million. Wefinanced theacquisition using net proceeds from thesale of $500 million of 8.38% senior notes due in 2014, together, with borrowings undertherevolving portion of our senior credit facility. The average interest rate on our revolving borrowings isabout 6.2%.

We’re verypleased to have executed anefficient bond offering ina verychallenging market. This reflects our ability to access capital markets, even in adifficult financing environment, and itshows our experience inexecuting acquisition and financing transactions.

As previouslydiscussed, theacquisitions expected to bring our debt to comparable basis EBIDTA ratio to the five to 5.5 times range. Although onthe highside of our historical range, we’re quite comfortable with this level. As wehave done historically, we believe we can reduce this ratio to around the mid four times range over the next 12 months by paying down debtwith free cash flowgenerated by our growing phase and thecash flowfrom our acquired business.

Our comparablebasis tax ratefor thequarter came inat 37.1%versus 36.1% last year, and our weighted average diluted shares outstandingtotalled 219 million compared to 239 million last year reflecting the benefit of the share repurchase. Due to the many factors just mentioned, dilutedEPS was $0.55 versus $0.58 inthe thirdquarter last year.

Now let’s turnto our cash flowon page 11. For thepurposes of this discussion, free cash flowis defined as net cash provided by operating activities less capex. For the first nine months of fiscal ’08 we generated$173 million of free cash flowversus a $22million usage inthe prioryear. Theyear-over-year increase reflects improved working capital, lower taxes paid,and reduced capital spending.

Beginning in 2008, cash flow is now part of management’sincentive and as acorporation we’re much more focused on generating free cash flow. As a result of the strong performance to date we are increasing our free cash flow guidance for the year to a range of $280 million to $300 million.This is $160 million to $180 million above prior year’s free cash flow. Thisimprovement is primarily attributable to lower taxes paid, reduced capitalspending, and lower working capital investment.

Now let’ssummarize Q3 and discussion our full-year P&L guidance. From an earnings perspective we’re pleasedwith our results. Net sales growth for thequarter and on ayear-to-date basis, excluding theimpact of thereduction of US distributor inventory, hastracked inline with our long-term stated goals.

We continue toclosely monitor theAustralian harvest dynamics and thepotential marketplace impacts. TheUK and Australian markets remain difficult, but we believe we’re makingprogress with theinitiatives we have inplace that aredesigned to improve thefuture performance.

Moving to ourP&L expectations for thefull year 2008, we’re revising our comparable basis EPS outlook to $1.33 to$1.38 range from our previous range of $1.34 to $1.42. This includes an anticipated $0.04 dilution impactfrom theacquisition of Fortune Brands’ US wine business and tightening the bottom end of the range.

As previouslydiscussed, thedilution is being primarily driven by thehigh levels of product inventory currently inthedistributor channel, which is expected to result in net sales for the acquired business that will be well below normal levels for Januaryand February. As areminder, we substantially completed our initiative to reduce distributor wineinventories inthe US by the end of the second quarter. The goal of this initiative was toassure distributors have sufficient inventory to meet consumer demand, but toreduce any permanent bumper stock innon-peak periods.

As previouslydiscussed, thecompletion of this program is driving atiming changein our USwine sales pattern. Our new shipment patterns, we expect a lower growth rate inQ4 as we return to thelower distributor inventory level established at theend of thesecond quarter.

The Q4 comparisonfor the beerbusiness will also bedifficult as thefourth quarter last year benefitted from anassimilation of theeast coast Modello brands business into theCrown JV. Our comparable basis guidance excludes acquisition-relatedintegration costs, restructuring, and related charges, and unusual items which are detailed on page 17 of the release.

On pages fourand five of therelease we outline plans for theintegration of Clos du Bois and theother acquired brands. Realignment of thesales and marketing organizations supporting our US wine business and the rationalization of certainlow-margin, low-growth brands. Collectively we believe these actions willfurther strengthen our US wine business and produce enough synergies of about$30 million annually by theend of 2010, with approximately $20 million insynergies being achieved infiscal 2009. We arestill targeting about apenny to two-penny accretion infiscal 2009 for theacquired wine business. This includes thesynergy benefits just outlined.

The majority ofsynergies will begenerated inthe salesand marketing area where we expect to add thenewly acquired brand and maintain essentially the same level of sales and marketingcosts as we had prior to theacquisition. To better assure thecommercial focus on our new (inaudible) consumer segments we’re rationalizingcertain low-margin brands from our current portfolio.

We expect toincur $45 million on one-time charges related to these restructuring andintegration activities, themajority of which arerelated to SG&A and brand exit costs. We expect approximately half of thisamount to come inas cash charges for employee termination and acquisition-related integration costsand theother half as non-cash charges for asset write-offs and accelerateddepreciation. Thecash impacts from this activity is contemplated in our fiscal 2008 free cash flow guidance.

In addition, weexpect to incur one-time cash costs of $28 million for employee and contractterminations that will bereported in the allocation of purchase price for the acquired wine business, with most ofthese payments expected to occur infiscal 2009.

Additionalassumptions for our full fiscal 2008 guidance are outlined on page five and six of the release.

As you canimagine, we’ve been very busy assimilating our recent acquisition anddeveloping our new US wine organization. We arealso beginning theprocess of developing our 2009 annual plan. This planning process will be finished in March when we intend to provide fullfiscal 2009 guidance as part of our fourth quarter fiscal 2008 reportingactivities, which aretentatively scheduled for April 3rd.

With that, we’rehappy to take your questions.

Question-and-Answer Session

Operator

Thank you. The floor is now open for questions.(Operator Instructions). Our first question is coming from Bryan Spillane ofBanc of America. Please go ahead.

Bryan Spillane – Banc of America

Hi. Goodmorning.

Robert Sands

Good morning,Bryan.

Bryan Spillane – Banc of America

Just twoquestions related to thewine business. One, just interms of restructuring activity and cost-savings measures for 2009, I knowyou’ve outlined $20 million of incremental savings related to assimilating orintegrating theFortune Brands business. Should we expect that there will be incremental savings above and beyondthat relative to what you’re doing to therest of your business?

And then the second question with regards to freecash flow. Very nice to seethe increasein free cashflowguidance for 2008, especially given that there’s some cash costs related tosome of therestructuring activity. Is that amore normal run ratefor free cash flowas we begin to model out 2009 and 2010? Should we start to think about this asbeing a morenormal run ratefor free cash flow? Thanks.

Robert Ryder

Hi, Bryan. It’sBob. I guess on thefirst question I’d saythe numberswe put in the press release regarding the costs and benefits of the restructuring activities, they’reour best estimates right now. And as you know, these are estimates. We hope to do better, but these are our best estimates right now. Ithink you’ll also look at, thegood thing about therestructuring is we areacting quite fastso we are getting a lot of the restructuring costs behind usquickly. And also, we’re getting savings quite quickly. And if you just look at thecash payback on these activities, it’s inbetween about ayear and two years. Soit’s apretty quick payback on therestructuring activities.

On the cash flow, we’re very happy with the cash flow for this year. We’re not reallygiving guidance for future years cash flow, but as a corporation, as I mentioned, we are much more focused on bringing moreof our EBIDTA down to thefree cash flowline. So Ihope we continue to seebetter cash flowperformance as we go forward. We’re not giving any specifics right now.

Bryan Spillane – Banc of America

Would it befair to saythat thefactors that drove theincrease in yourfree cash flowguidance aresort of more sustainable-type things, like better working capital management asopposed to one-time things like asset sales or one-time, like, cash taxrefunds?

Robert Ryder

Yeah, I’d say they’re probably more along the more permanent cycle. However, youknow, on working capital we dohave a lotof exposure to agro industry, sowe aresomewhat subject to thetiming of harvests and things like that. And one of the bigdrivers this year for theimproved working capital is we dohave reduced inventories inthe US and in Australia. We think that’s healthyfor thebusiness.

We are focused on keeping our cash tax rate down; we’ve been pretty successfulwith that and hope we can keep replicating that. And the other drivers to improve cash flow is reduced capital spending. We are very focused on capital spending,however, we aregoing to spend what we need to keep thebusiness quite healthy. But I think as we make part of management’scompensation attributable to cash flowit is havingthe desiredimpact. Sonow we have alltheassociates inthe businessreally focused on how we can drive better cash flow from the business.

Bryan Spillane – Banc of America

Okay. Great.Thank you, guys.

Robert Sands

Thanks, Bryan.

Operator

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

Lauren Torres – HSBC

Good morning.

Robert Sands

Hi, Lauren.

Lauren Torres – HSBC

Hi. I was hopingyou could just bea littlebit, if you can, more specific on performance at Crown Imports in thequarter. You know, obviously we’re still talking about the impact of the price increases on your volumes, butif you could give us any sense of either shipment or consumption data thatwould behelpful.

Robert Sands

Yeah, you know,as we continue to say, Crown is really performing right in accordance with expectations and istracking very closely to what occurred when we previously increased pricing. The business is fundamentally veryhealthy. If you look at, take for instance depletion growth rates, the Crown business, even with the price increase, continues to grow inthe low single-digits, which is, as I said,pretty consistent with what typically occurs during a price increase year. So ingeneral, Crown is meeting our expectations and we’re pleased with its performance.

Lauren Torres – HSBC

And you saidthat you’ve seen some improvement, I guess, over the last couple months beyond November?

Robert Sands

Yes. As we startgetting into theyear following theprice increase in’08 we’re seeing some improvement.

Lauren Torres – HSBC

Okay. And if Icould also just ask aquick question on spirits, organic sales inthe quarterwas up 12%. Can you just give us anidea, you know, obviously that’s not SVEDKA’s, so what’s really driving the growth right now behind your spiritsdivision? I guess we saw that last quarter, also. If you could give us a sense of how sustainable these growthrates are.

Robert Sands

Yeah, well, youknow, it isattributable inpart to our premium businesses, thetrend towards premiumization trading off those businesses continue to do very well. So ingeneral we’re pleased with our spirits’ performance and our strategy offocusing on themore premium categories and developing internally premium brands is paying off.These arehigh levels of growth. I don’t know that they’re sustainable at those levels on an organic basis forever, but we’re verypleased with thespirits performance and continued good spirits performance.

Lauren Torres – HSBC

But is thisgrowth more volume or price related? I’d assume price related.

Robert Sands

It’s a mix of prices and volume. Volumes are strong on our premium portfolios.And pricing is, there’s some pricing inthere as well. Sopricing, mix and volume. Allthree factors.

Lauren Torres – HSBC

Okay. Thank you.

Operator

Thank you. Ournext question is coming from Christine Farkas of Merrill Lynch. Please goahead.

Christine Farkas – Merrill Lynch

Thank you verymuch. Good morning, Rob.

Robert Sands

Hello,Christine.

Christine Farkas – Merrill Lynch

A question onyour volumes, if I could, your rationalized volumes on the value wine portfolio. Can you giveus a senseof how much of your volume you’re considering rationalizing here, either in percentage of below $5 or percentageof total portfolio? Just to geta sense ofwhat kind of size we’re talking about.

Robert Sands

Yeah, well,we’re really working on that atthe currenttime so wedon’t have any specific numbers to give you on that other than to say that, you know, as a result of how we will go about doingthis and taking advantage of things like greater focus on our premiumportfolio, theability to substitute either listings or skews, and this kind of thing, wereally don’t expect itfrom anEBIDT perspective to have material impact on us at all. We think it’s a good thing for the business and it’s not somethingthat, you know, as I said, from anearnings perspective we’re particularly concerned about.

Christine Farkas – Merrill Lynch

Okay. What aboutfrom amarket share perspective again? Would that besomething meaningful?

Robert Sands

Well, we’ll see when it allgets done, but atthe moment Idon’t think we really anticipated to have ameaningful impact. But as I said, we’ll seewhen all the plans are complete and the rationalization is finished.

Christine Farkas – Merrill Lynch

Okay. Great. A couple of classifications, if I could.Back to your capex. You did talk about lower capital spending. Were there anyspecific projects that you pushed out into fiscal ’09 or anything that couldreverse interms of your capital spending plans that would be considered not, I guess, ongoing in your new free cash flow step up?

Robert Ryder

This is Bob. No,we don’t, we did reduce our capital budget for this year and we don’t expect tospend that infuture years.

Christine Farkas – Merrill Lynch

Okay. So that’s real. And then finally onspirits, again, back to thestep up inorganic growth, we saw second and third quarter organic growth of 11%, 12%. Youdid mention, Rob, about anincrease inproduction services. Could that have something to do with the fact that the pace of growth in organic spirits really stepped up in thesecond and third quarter and can you comment on the margins of those businesses?

Robert Ryder

Yeah, this isBob. Theproduction services, you know, was areasonably large piece of thegrowth involume. We don’t make much money on it. It’s more of a way to leverage our productionfacility.

Christine Farkas – Merrill Lynch

And is thatsomething that was picked up earlier this year, for example in thesecond quarter? Or hasthis been ongoing for some time?

Robert Sands

It’s sort ofchoppy, depending on when our suppliers want theproduct. But itcertainly was pretty bigin the third quarter and it was in thesecond quarter as well.

Christine Farkas – Merrill Lynch

Okay. And thenjust finally, could you comment on thegrowth of high-end spirits versus low-end spirits? Are you seeing a continuation of what you saw in earlier quarters?

Robert Sands

Yeah, I thinkthat trend continues. Generally thetrend continues over allbeverage alcohol. There is awhole trading up mentality through allthecategories and we’re trying to take advantage of that in thespirits business through our higher-end spirits product offerings likeRidgemont Reserve, Effen, and SVEDKA. Those products are allperforming quite well intheir categories. We’re very happy with them.

Christine Farkas – Merrill Lynch

Okay. Thank youvery much.

Operator

Thank you. Ournext question is coming from Bill Leach with Neuberger Berman. Please go ahead.

William Leach – Neuberger Berman

Good morning,everyone.

Robert Sands

Good morning,Bill.

William Leach – Neuberger Berman

I was justwondering if you could elaborate abit more on your implied fourth quarter guidance. If you look at your new full-year guidance you’reimplying afourth quarter EPS of about $0.25 versus $0.35 and if you add that $0.04 for the Fortune wine dilution it’s still$0.29 versus $0.35, soit’s down 17%, you have about 8% to your share. That’s not a real cheery forecast, I don’t think.Could you just, you mentioned afew things inpassing, but why would thequarter bethat weak?

Robert Sands

Yeah, there’s a couple things going on. We’ve got the UK and Australia margins are bringing down the estimates versus prior year. Ofcourse thenew dilution we just announced is bringing itdown. And we still have some SVEDKA dilution, okay? Quarter over quarter isalso contributing to it.

William Leach – Neuberger Berman

In terms of the Fortune dilution, do you expect that all being in theFebruary fourth quarter or was itlikely to dribble into thefirst quarter of next fiscal year?

Robert Ryder

No, it’s fourthquarter. Theother thing inthe fourthquarter, as Rob and I mentioned, we were overlapping some pretty favourablebeer (inaudible) from last year as we rolled out the Crown joint venture. So you should not expect to see good beer sales or profit numbers in thefourth quarter.

Also, the timing, as I mentioned in my script on wine sales, as we bringour distributor inventories down to thelevels we established inthe secondquarter, you shouldn’t expect to seevery good wine sales growth inthe fourthquarter either.

Those two are mostly overlapped timing things. The underlying businesses are still very healthy.

William Leach – Neuberger Berman

And in terms of the UK, is there some point where wejust getaround to comparing against such terrible results that ceases to be ayear-to-year negative? I mean, it’s not ahuge part of your business and itseems like it’s been dragging down your results for two years now.

Robert Sands

Yeah, that’sfair enough. I think we have taken abig downcheck because of theduty increase and some (inaudible) rates, soI think theyear-over-year erosion, this was abig erosion,we’re not talking about next year, but I don’t think we’d expect it to bethe kind oferosion we’ve seen this year. Sohopefully, you know, that’s why we’re keeping our eye on the Australian harvest, because that has abig impacton both theAustralian business and theUK business. We think we’re doing theright thing to make that business as profitable as it can be.

William Leach – Neuberger Berman

Could it possibly be ayear-to-year positive infiscal ’09?

Robert Sands

We’re not reallytalking about ’09 yet, but we’ll let you know on the fourth quarter call for sure.

William Leach – Neuberger Berman

Okay. Thanks.

Operator

Thank you. Ournext question is coming from Tim Ramey with D. A. Davidson. Please go ahead.

Timothy Ramey – D. A. Davidson & Co.

Good morning.First on theSVEDKA business. I think you said itwas up 50% inshipments. Was that sequential or was that year over year?

Robert Sands

Year over year,Tim.

Timothy Ramey – D. A. Davidson & Co.

Okay. It looked like there’s quite a strong sequential as well, but Iassume there’s aseasonal pattern to this as theholidays.

Robert Sands

Yeah, I would say that that’s probably true. But the brand’s been growing, you know, in that range in general for us. So I don’t think it, if it varies sequentially is really notindicative of anything. Ingeneral it’s been growing inthat sort of high double-digit, you know, 50% range.

Timothy Ramey – D. A. Davidson & Co.

And we had thisdiscussion when you bought it, but if itcontinues inhigh double-digit growth that’s probably above the range that you modelled for yourdilution assumptions. Is thedilution from SVEDKA less onerous that you thought it would be or likely to be less than you thought it would be?

Robert Ryder

Tim, this isBob. We had pretty high expectations for SVEDKA, as we had to. So it’s pretty much performing in line with our acquisition modelassumptions. SoI think thedilution assumptions arestill pretty valid.

Timothy Ramey – D. A. Davidson & Co.

Okay. And thenI, grape purchases, we didn’t talk about that, but your model in thelast couple years hasbeen sort of theglobal backstop, backstopping any potential short falls with the global supply chain. With Australia sort of drying upis anything changingthere? Areyou extending your contracts with US growers? What’s the status there?

Robert Sands

I’d say that we continue to be pretty much in balance. When you take a look at Australia it’s the same story. Oversupply turning intobalance, potentially turning into undersupply. But those are not trends that we expect to be unfavourable to us. So ingeneral I would sayin terms ofour global position and theway that our portfolios arepositioned to beable to use wines from different appellations I would say that we continue to be inpretty good balance.

Timothy Ramey – D. A. Davidson & Co.

Okay. And justone on thewine restructuring. Doyou have anumber of SKUs that you’re eliminating there that you can share?

Robert Sands

On the wine restructuring? Well, Imentioned, you’re talking about therationalization I mentioned?

Timothy Ramey – D. A. Davidson & Co.

Yeah, that’sright. Is itthree brands or 20?

Robert Sands

Oh, it’s morethan three brands. I gave you some examples. As I said, brands that you’dactually never heard of, would never have heard of and most people would haveheard of. Small regional brands that arelegacy businesses and relatively lowmargin. You know, there’s awhole slew of brands like that, but again itwouldn’t beanything that you’d be, you’d inalllikelihood would have heard of.

Timothy Ramey – D. A. Davidson & Co.

Thank you.

Robert Sands

I know you drinkbetter wine than that, Tim.

Timothy Ramey – D. A. Davidson & Co.

---Laughter

Thanks, Rob.

Operator

Thank you. Ournext question is coming from Risa Vahasetta (sic) with Lehman Brothers. Pleasego ahead.

Risa Vahasetta (sic) – Lehman Brothers

Good morning.

Robert Sands

Hi, Risa.

Risa Vahasetta (sic) – Lehman Brothers

On the wine business EBIDT decline the dynamic of UK, you know, EBIDT in thewine business weakening and US kind of strengthening, is that likely tocontinue in the next quarter or two or are we going to level out at some point?

Robert Sands

We have a number of initiatives ongoing in both Australia and the UK. Australia we just put out a month or so agoon we’re doing some wine re-rationalization down there. In theUK we’re doing apretty significant supply chaininvestment to reduce our costs over there. Sowe’re doing alot to improve thelong-term profitability of this business. I’d say ingeneral, you know, look, you can’t keep seeing these kind of declines or eventuallyyou sort of go out of business. SoI would saythat yes, inthe mediumterm these things are, they gotta turn around. There’s no choice.

Risa Vahasetta (sic) – Lehman Brothers

And when didthis import duty that you mentioned inthe UK startto impact theresults? I can’t recall off hand.

Robert Sands

It comes in around the March time period.

Risa Vahasetta (sic) – Lehman Brothers

Okay. Now onceyou cycle after March doyou still think UK EBIDT will still beunder dollar pressure or can you start to level out?

Robert Sands

We’reanticipating what theUK duty increase will be, which happens inMarch, and we think we have thebusiness plans to improve profitability inthe UK as wego forward, but we donot know what thegovernment’s going to do. Sowe have anumber of alternatives depending on what theduty increase will be. But we think we’re as prepared as we can be for what’s going to happen in March.

Risa Vahasetta (sic) – Lehman Brothers

Got it. And thenlastly on theMNA environment thepotential consolidation inthe industrywith theSwedish spirits business, I mean, how can that potentially impact you positiveor otherwise if any?

Robert Sands

Well, that’s onetransaction that you’re talking about. TheVNS deal. Theindustry does continue to consolidate, but there also continues to be opportunities across the beverage alcohol segment that I’msure we’ll beable to take advantage of. SoI don’t seeany dramatic changein the environment in that regard at this point in time.

Risa Vahasetta (sic) – Lehman Brothers

But do you think that potential sale willactually offer you more opportunities or more of the same?

Robert Sands

You know, as Isaid, it’s just one sale. It’s hard to, areyou asking if there’s any specific opportunities coming out of that sale? Ifthat’s thecase, I mean, I think we’ve said that we’re not really going to play in theVNS deal for absolute, you know, we’re not anticipating necessarily, withoutcommenting on any specific transactions, you know, it impacting us from an opportunities standpoint one way oranother.

Risa Vahasetta (sic) – Lehman Brothers

But will there be repercussions from that sale thatother people may have to sell stuff that might be of interest to you?

Robert Sands

You know, that’salways possible. It’s hard to speculate on those kind of things because wedon’t know who’s going to buy it. Yeah, that’s possible.

Risa Vahasetta (sic) – Lehman Brothers

Okay.

Robert Sands

If that’s whatyou were getting at, yes, that’s possible.

Risa Vahasetta (sic) – Lehman Brothers

I appreciate it.I had to ask thequestion. Thank you.

Operator

Thank you. Ournext question is coming from Mark Swartzberg with Stifel Nicolaus. Please goahead.

Mark Swartzberg – Stifel Nicolaus

Thanks. Goodmorning, everyone.

Robert Sands

Good morning,Mark.

Mark Swartzberg – Stifel Nicolaus

I guess onecorporate question and then acouple business questions. On thecorporate side, just interms of theshares outstanding, when you take your full-year guidance it seems like you’re implying about 224million, 225 million shares on average inthe fourthquarter. Is that right?

Robert Sands

Yeah, that’sabout right.

Mark Swartzberg – Stifel Nicolaus

And is thatbecause of restricted, like, inthe latestquarter it’s more like a219, 220 level. Is that restricted stock options? Why would we see such a material pick up?

Robert Sands

It should be for the fourth quarter, you should assumeabout 220 million shares.

Mark Swartzberg – Stifel Nicolaus

Oh. So it’s not really a 225 full-year number?

Robert Sands

A little bitlower than that.

Mark Swartzberg – Stifel Nicolaus

Okay. All right. All right. Then that’s helpful. Okay.And then moving on to thebusiness. Starting inNorth America, ina sense. Ifyou look atyour North American wine business, it’s been therelative outperformer, if you will, inthe quarterversus theUK and Australia. Not only ina salessense, but as best we can tell ina marginsense. But we really don’t know what absolutely is happening with the margins here in North America. Can you give us a sense, are your contributions margins in North America up year on year versusthird quarter of fiscal ’07 and also how does the operating margin – and I’m talkingNorth America wine, obviously excluding spirits – but how does the operating margin for North Americanwine look versus last year, as well?

Robert Sands

It’s relativelyeven with last year for thequarter.

Mark Swartzberg – Stifel Nicolaus

Even. Okay. Andyou’re talking atwhich level? Contribution, operating?

Robert Sands

Operating marginkind of level.

Mark Swartzberg – Stifel Nicolaus

Okay. Perfect.And then going to themore challenged business, theUK and Australia wine business, obviously we’ve been talking about thiscollectively for anumber of quarters here, but when you look atthe input cost pressure, if you will, rising and so far not getting the release you’d like at theretail level interms of selling price, them accepting selling price increases, can you talk a little bit more than you have alreadyabout theenvironment for getting theselling price increases accepted by your retail partners, both in theUK and Australia?

Robert Sands

Yeah. Mark, thisis Rob. I would saythat our view is that pricing is going to have to be taken. It’s pretty much as simple asthat if you read any of thetrade press, both inour industry and inother industries for that matter, suppliers areindicating pretty much across, you know, allconsumer goods durable that they’re going to take pricing. I would say that as a consequence of that we’re hopeful thattheenvironment is going to bepositive inthat regard. Is that to saythat theretailers aregoing to like it? No. Theretailers aresaying that they don’t like itin the UK. The retailers I think will, you know,try to dowhatever they can to either avoid itor offset it, but I think it’s going to bea fact oflife across theboard. Sowe’re optimistic.

Mark Swartzberg – Stifel Nicolaus

Okay. And, yeah,you always getpushed back. But atthe end of the day you either you get itor you don’t and you getsome degree of realization. When you think about that, I mean, what gives youoptimism that you’ll getthe level ofincreases you’re thinking about and what sort of timing are you thinking about?

Robert Sands

Well, what givesus the optimismis I truly believe it’s going to beacross theboard, not only inbeverage alcohol but ina lot ofother sectors, and therefore it’s sort of, if everybody’s doing it I think it’s going to happen. Andthen, yeah, you getpushed back, but we control our pricing to theretailers, soit’s fundamentally our decision and we’ll dowhat we have to doin thatregard.

In the meantime we’re working with ourretailers very closely. We continue to support our brands very well. If youlook at UK, Nielsen’s,as I mentioned inmy talk, we’re outperforming themarket. Themarket actually is very healthy from avolume perspective and consumer demand inthe end isgoing to drive thereaction to thenecessity to increase prices, which, as I said, is pretty much an across the board thing at this point.

Mark Swartzberg – Stifel Nicolaus

Okay. And thenlast, I know it’s tough, but I think there’s aduty increase coming inMarch in the UK. I don’t believe we know the magnitude. But can you talk a little bit about how you factor thatinto your thinking and what you’re hearing from retailers on that or is it just too soon to say?

Robert Sands

Yeah. Bob talkedabout that alittle bit, but basically repeating what Bob said, first of all, there will be aduty increase inMarch. We donot know exactly what themagnitude of that duty increase will be. We believe that we’ve put in place plans to cover just about anyscenario that can occur inthat regard. And we expect without commenting on the specifics related to ’09 that we’ll be able to act accordingly with the duty increase so that it doesn’t hurt us further.

Mark Swartzberg – Stifel Nicolaus

Great. Thankyou, Rob. Thanks, Bob.

Operator

Thank you. Ournext question is coming from Jonathan Feeney with Wachovia. Please go ahead.

Brian Scudieri – Wachovia Securities

This is actuallyBrian Scudieri infor John Feeney. Good morning.

Robert Sands

Hi, Brian.

Brian Scudieri – Wachovia Securities

How are you? I guess my first question isaddressed to Bob. What was thesingle biggest surprise infree cash flowthis quarter and, I guess, why did theanticipated working capital growth not really materialize?

Robert Ryder

Well, I don’tknow if I’d put theword ‘surprise’ around free cash flow. We wanted to really wait until the third quarter ended to really get areal hard look atwhat’s been happening for thefull year, but we’ve been doing better than prior year in cash flow pretty much all year long. But you know, there wasno negative anything inworking capital. Itwas allpositive. And I mean, mostly if you just dial down the cash flow statement year to date, accountsreceivable was positive mostly due to sales timing and inventory was positive,and this will carry through for thefull year. Theinventory positive is mostly because of theharvest inUK and inAustralia. You had some sort of negative timing on accounts payable, but that’s– Australia and theUS. Sorry. Thenegative timing inaccounts payable for thequarter, that will reverse as we getto the fullyear. I think our cash tax ratetiming, that will bepermanent for thefull year. As will our favourable capital spending versus prior years.

Brian Scudieri – Wachovia Securities

Okay. Great. AndI guess amore broad question for Rob maybe. Have you seen any signs of bottoming in theUK and Australia on acategory level?

Robert Sands

You know, as I’dsaid, when you saybottoming, especially as we talked about theUK, bottoms arevery healthy. Theissues have been more of amarkets issue and I think that as we’ve discussed, although it is somewhat unpredictable, and againwe’re not giving guidance, but you know, I guess it would, I would say that it appears to be bottoming.

Brian Scudieri – Wachovia Securities

And I knowlastly this might bea toughnumber to getto, but maybe could you estimate across thecountry your on premise, off premise and consumption mix? Is that possible?

Robert Sands

No. Not really.Across thewhole company on aworld-wide basis?

Brian Scudieri – Wachovia Securities

M-hm.

Robert Sands

No. But I would say on the higher side of 50% for off premiseand under 50% for on premise. You know, I don’t know, 60/40, 70/30. We reallydon’t track those numbers very specifically. Itfluctuates market by market and brand by brand. It’s not really a relevant number. But more off premisethan on premise.

Brian Scudieri – Wachovia Securities

Okay. Great.Thanks for your time.

Operator

Thank you. Ourfinal question is coming from Alec Patterson with RCM. Please go ahead.

Alec Patterson – RCM

Yeah, justquickly anupdate on thematerial costs outlook here. Glass inparticular. And then I just wanted to geta read on the ACB on Clos du Bois. Where does it stand? Is it nearly fully distributed or do you guys have a lot of opportunity there still?

Robert Sands

To your firstquestion, you know, glass as we’ve indicated previously, glass costs continueto escalate ingeneral. But that’s been completely taken into account in everything that we’ve told you so it’s just something that we, likeeverybody else, hasto deal with.

As to Clos duBois distribution, Clos du Bois is ahighly distributed brand. Meaning, it’s got very good and high levels ofdistribution. Soyeah, I wouldn’t saythat theopportunity is inthe US, let me put it this way, is in gaining distribution. It is growing, as I said, in the18% range inIRI channels, sotheopportunity is to continue to grow, continue to take advantage and to drivethat growth inthemarketplace. Now, distribution internationally is an opportunity, they would have hadlittle to no distribution outside theUnited States, for allintents and purposes. With our roots to markets around the world we should be able to take advantage of that todrive distribution outside its coremarket of theUnited States.

Alec Patterson – RCM

Okay. That’sclear. And just lastly, Rob. Thepricing trend on theown label product lines inthe UKretailers, what areyou seeing there? Any sort of sense that their starting to reflect what grapecosts may look like down theroad?

Robert Sands

As I said,pricing continues to remain competitive atthe retaillevel driven by themultiple, thechains. We’renot seeing atthis stage significant price movement, but there is no doubt that as it relates to Australian bulk wine that the market has moved dramatically. The retailers are going to have cost of goods sold if not supply issueson Australian bulk. Theretailers aregoing to suffer thesame duty increase inMarch as everybody else. Sothey’re going to have theissue of whether to absorb that or not and typically retailers don’t absorbthose kind of things. Sowe’ll see. Stay tuned.

Alec Patterson – RCM

Okay. All right. Thank you.

Operator

Thank you. At this time I’d like to turn the floor over to Rob Sands for anyfinal remarks.

Robert Sands

Well, thank you,everyone, for joining our call today. I’m very pleased about the way the year is shaping up and our progress in implementing our strategy. Just tosummarize, during thethird quarter we completed theacquisition of Fortune Brands’ premium wine business. We are executing the integration plan for our US winebusiness. We’re rationalizing our portfolio of value wines and focusing more onour premium and super premium plus portfolios. We’ve delivered very strong cashflowperformance year to date and increased our free cash flow guidance as a result and we are driving marketplace initiativeswhich will help us generate growth from our portfolio of products.

Thanks again foryour participation and during our next quarterly conference call we willprovide guidance for thefiscal year 2009. In addition,we’re planning aninvestor day inNew York for late May, early June, sokeep that inmind asyou’re planning your calendars and of course we’ll give you a specific time frame on that shortly, so stay tuned for those details.

Again, thank youvery much, everybody, and have agood rest of your day.

Operator

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

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