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Molson Coors Brewing Company (NYSE:TAP)

Q2 2008 Earnings Call

August 5, 2008 12:00 pm ET

Executives

Peter Swinburn - Chief Executive Officer

Stewart Glendinning - Global Chief Financial Officer

Mark Hunter - President and Chief Executive Officer - Coors Brewers Limited

Kevin T. Boyce - President and Chief Executive Officer, Molson Canada

Analysts

Mark Swartzberg - Stifel Nicolaus

Analyst for Kaumil Gajrawala - UBS

Bryan D. Spillane - Banc of America Securities

Carlos Laboy - Credit Suisse

Judy Hong - Goldman Sachs

Christine Farkas - Merrill Lynch

Operator

Good day, ladies and gentlemen, and welcome to the Molson Coors Brewing Company 2008 second quarter earnings conference call. (Operator Instructions) I would now like to introduce your host for today’s conference, Mr. Peter Swinburn, President and Chief Executive Officer of Molson Coors Brewing Company. Sir, you may begin.

Peter Swinburn

Thanks, Matt. Hello and welcome to everybody. Thanks for joining us today. With me on the call are: Kevin Boyce, CEO of Molson Canada; Mark Hunter, CEO of Coors Brewers Limited; Sam Walker, our global Chief Legal Officer; and Dave Dunnewald, Vice President of Investor Relations.

I also want to introduce two new leaders on our global finance team who are on the call with us today. First, Stewart Glendinning is our new Molson Coors' CFO. Stewart comes to the global team from his role as CFO of our U.K. business. Prior to that, Stewart held leadership roles in global audit and finance consulting firms.

Secondly, Bill Watters joined the global team as Controller in June, moving over from his role as CFO of our U.S. business. Bill has more than 15 years of finance and accounting experience with our company in the U.S. and overseas.

On the call today, Stewart and I will take you through some highlights of our second quarter 2008 results for Molson Coors Brewing Company, along with some perspective on the balance of the year. Then we will open it up for questions.

So let’s get started -- with the creation of Molson Coors, we accomplished the most significant business combination in the history of U.S. beer. This new venture fundamentally changes the game in the U.S. beer industry by creating a stronger and more competitive company with the talent, brands, and scale to win in this critical market.

Molson Coors is bringing new energy to the beer industry and will drive additional profitable growth for Molson Coors Brewing Company. This in turn provides important new financial resources for us to continue building our brands in our core markets and around the world.

Turning to financial performance in the second quarter, we benefited from another exceptional quarter by our U.S. business, which achieved gains in sales volume and pricing and double-digit underlying earnings growth. Maintaining this strong momentum is particularly exciting as we launch Molson Coors.

On a company-wide basis, our top brands continued to outperform the industry in the second quarter and we achieved net pricing gains and substantial cost savings in each of our core markets. At the same time, however, energy costs and commodity inflation have become bigger challenges for our company and for the global beer industry. This cost inflation, combined with a higher tax rate, drove lower underlying earnings for our total company in the second quarter.

In the face of these challenging economic conditions, we continue to implement value-added strategies that will allow us to build our brands, achieve positive pricing, reduce costs, and grow profits and cash for our shareholders.

Let’s review some total company performance highlights for the quarter. We grew Coors Light sales to retail nearly 4% globally. We achieved net sales growth of 4.8%, driven by brand strength, positive pricing, and the benefit of favorable foreign currency. We grew net pricing in all three of our major markets on the strength of our brand building efforts. We captured $18 million of cost redemptions as part of our resources for growth program in the quarter.

These cost reduction programs allowed us to offset nearly a third of our cost inflation in the quarter. Excluding special and one-time items, underlying income from continuing operations declined 2% to $172.6 million in the second quarter, due to a higher effective tax rate in the quarter, which Stewart will discuss in a few minutes. And I’m now going to pass it over to Stewart to review the second quarter financial results and trends, and then we’ll cover the outlook for the rest of 2008. Stewart, over to you.

Stewart Glendinning

Thanks, Peter and hello, everyone. I’ll start with the second quarter financial highlights. We grew total company volume 0.9% and net sales 4.8%. Meanwhile, our underlying pretax income grew 2.5% in a challenging cost environment.

On the bottom line, underlying after-tax earnings of $172.6 million, or $0.93 per diluted share in the second quarter were 2% lower than a year ago.

We will discuss our earnings performance today primarily in terms of underlying earnings, a common performance measure that excludes special and other one-time items from our U.S. GAAP results. Also, unless otherwise indicated, all financial results we share with you today will be in U.S. dollars.

It is important to note that our second quarter underlying earnings exclude $103.9 million of special items. Nearly half of this total was a $50.6 million non-cash charge to reduce the carrying value of the Molson brands sold in the U.S. The remaining items are virtually all cash charges that offer attractive returns on investment, including expenses associated with the formation of Molson Coors, restructuring costs in the U.K., and transition costs related to an outsourcing contract. These adjustments to our U.S. GAAP results are described in more detail in the earnings news release we distributed this morning.

Foreign exchange movements increased our total company pretax profit by approximately $6 million in the second quarter on an underlying basis, driven by an 8% year-over-year appreciation of the Canadian dollar versus the U.S. dollar.

In segment performance highlights, starting with Canada, underlying pretax income of $154.4 million in the second quarter was 5.6% higher than a year ago, driven by an $11 million benefit from favorable foreign currency. Positive net pricing was offset by fuel and commodity price inflation and lower comparable Canada market volume.

As we discussed last quarter, the new Modelo Molson import joint venture and the loss of Foster’s U.S. production contract affect the way that we report our Canada results this year in the following ways.

First, the loss of Foster’s contract has the effects through the end of the third quarter of reducing reported sales volume about four to six percentage points while increasing net sales per barrel about three to four percentage points and increasing cost of goods sold per barrel about two to three percentage points. The effects in the fourth quarter this year are not significant as we cycle the October 2007 contract termination. The negative impact on pretax profits in the first three quarters of 2008 is about $1 million per quarter. Finally, the loss of this contract has no impact on our STRs, since the Foster's U.S. production volume has never been included in our Canada STRs.

Second, the new Modelo Molson arrangement has the effect of reducing our reported sales volume, net sales per barrel, cost of goods per barrel and marketing expense because of the change to equity accounting. Our 50% share of the joint venture earnings are included in Canada cost of goods sold. In addition, sales to retail and market share results will now include our half of Modelo product sales for all of Canada.

As I discuss Canada results, I will provide year-over-year changes that exclude the reporting effects of Foster's and Modelo Molson in order to provide more-comparable results. So, let's review the highlights.

Our Canada sales to retail, or STRs, for the second calendar quarter ended June 30th decreased 0.8% on a comparable basis versus a year ago, driven by unusually wet weather in key major markets during the quarter. Molson's strategic brands, which represent more than 85% of our Canada STRs, continued to grow, including mid-single-digit growth by Coors Light and double-digit growth by Rickard's, Creemore, Carling, and our partner import brands. Molson Canadian experienced a mid-single-digit volume decrease compared to the prior year.

Total Canadian beer industry sales to retail declined an estimated 0.7% in the calendar second quarter. On a comparable basis, our second quarter estimated Canada market share was virtually even with a year ago.

Our Canada sales volume on a comparable basis decreased 1.1% versus prior year.

Comparable net sales per barrel increased approximately 3% in local currency, driven almost entirely by positive pricing, along with a small increase from partner-import brand growth.

Cost of goods sold per barrel in the second quarter increased 9% on a comparable basis in local currency when we exclude the impact of the Foster's and Modelo changes, as well as the benefit of cycling a $5.8 million unfavorable foreign currency adjustment last year. This underlying cost of goods increase was due to the net effect of three factors: an 8% increase driven by higher commodity and packaging material costs, along with increased energy and transportation costs; second, a 2.5% decrease from our Resources for Growth cost savings initiatives; and third, a 3.5% increase due to higher fixed overhead costs and the ongoing shift in sales mix to partner import brands.

Comparable marketing general & administrative expense in the quarter decreased 6.4% in local currency driven by results of our costs savings initiatives and lower amortization and administrative expenses.

Other income decreased $17.5 million in the second quarter primarily due to the cycling the $16.7 million gain on the sale of our interest in the House of Blues Canada business during the second quarter of 2007. This non-recurring gain was excluded from our underlying non-GAAP earnings for the second quarter of 2007.

In the U.S., second quarter underlying pretax income increased 14.8% to $112.7 million. This increase was driven by strong sales volume growth and positive net pricing, partially offset by higher transportation and packaging material costs.

Looking at highlights: U.S. sales to retail increased 5.1%, yielding solid market share growth in the quarter. Our U.S. STR growth would have been about two percentage points higher without the impact of a shift in the year-over-year timing of the July 4th holiday within our fiscal calendar. This strong sales performance was driven by mid-single-digit growth by Coors Light, high-single-digit growth by Coors Banquet, and double-digit growth by Blue Moon and Keystone Light. Each of our four largest brands achieved accelerated sales and market-share growth trends in the quarter.

For the second consecutive quarter, we grew sales-to-retail in all major channels and in 47 out of 50 states, a geographic base that represents over 96% of our total U.S. volume. We also continued to expand distribution, with more than 70,000 new SKU placements of Coors Light and Keystone Light in the quarter.

U.S. volume to wholesalers growth of 7.0% was not significantly affected by the timing of the July 4th holiday.

Net sales per barrel increased 3.8% in the second quarter, driven by three percentage points of higher net pricing, along with increased distributor fuel surcharges and new commercial sales from our U.S. can joint venture. Excluding the commercial can sales, net sales per barrel increased 3.3%.

Cost of goods per barrel increased 4.9% in the quarter, driven by higher fuel, transportation and packaging material costs, as well as commercial can sales. Excluding the impact of commercial can sales, cost of goods per barrel increased 4.1%.

Price increases and cost savings more than covered the significant cost of goods inflation we saw in the quarter. Cost savings initiatives alone offset more than one-third of our U.S. cost of goods inflation in the quarter.

U.S. marketing, general & administrative expense increased 6.6% in the second quarter, driven equally by increased sales and marketing spending and incentive compensation related to strong performance in the first half of the year.

All in, our U.S. business entered Miller Coors with strong volume and pricing momentum and with continued cost control, all of which allowed the business to again achieve double-digit profit growth, despite higher cost inflation.

Moving to our U.K. business, second quarter underlying pretax income was $21.5 million, a decrease of $19.0 million from a year ago, primarily due to higher levels of input inflation, increased pension costs and lower sales volume.

Our U.K. owned-brand volume outperformed the market in both the on- and the off-premise channels. However, volumes decreased 2.6% year-on-year due to the smoking bans, Easter falling in the first quarter, and customers buying in advance of the 9% increase in the beer excise tax in the first quarter.

Volumes in the off-premise channel grew by 6% as a result of selective but more-visible promotional features, but volumes in the on-premise declined 9%.

Net sales per barrel increased 3.4% in local currency, predominantly due to our acquisition of the Camerons on-premise distribution business in July last year. Comparable net sales per barrel of our own products increased 0.6%, driven by higher on-premise pricing. This represents our sixth consecutive quarter of year-over-year growth in owned-brand pricing.

Cost of goods sold per barrel in local currency increased 11.9% in the second quarter, due primarily to higher Camerons factored brand sales, energy and materials cost inflation, and higher pension expense. More than half of this increase was driven by higher input cost inflation and pension expense.

Marketing, general & administrative expense in the U.K. decreased 0.8% in local currency. General and administrative expense increased due to the addition of the Camerons business and higher pension costs. Excluding these year-over-year changes, our overhead costs declined in the quarter. Marketing expense in the quarter decreased as a result of reductions in spending to match the trading environment.

In global markets and corporate, excluding the reporting effect of changing our Mexico business to a license arrangement this year, global markets grew volume more than 13% and increased investments in our developing markets around the globe, including China and Europe. MG&A totaled $35.1 million in the second quarter, including corporate general and administrative expense of $25.9 million, which was $3.7 million lower than a year ago.

Corporate net interest expense declined $1.8 million from a year ago because of the benefit of debt restructurings we completed last year, along with lower debt balances this year. These reductions were partially offset by nearly $3 million of incremental interest expense due to year-over-year foreign exchange movements.

The underlying loss for global markets and corporate was $57.1 million pretax in the second quarter, a 3.4% decrease as a result of lower corporate G&A and interest expense this year.

Moving beyond operating business unit performance, our second quarter effective tax rate was 23% on a reported and underlying basis. This quarterly rate is higher than we expected earlier in the year, which I will discuss in a minute. Free cash flow for the second quarter reflected a net cash generation of $225 million, which was made up of positive operating cash of $287 million plus $5 million of proceeds from asset sales, minus capital spending of $67 million. This free cash flow result represents a $133 million improvement this year due to both lower capital spending and higher operating cash flow versus the second quarter of 2007.

Total owned debt at the end of the second quarter was $1.96 billion, excluding approximately $118 million of non-owned joint venture debt. Cash and cash equivalents totaled $284 million at the end of the quarter, resulting in owned net debt of $1.68 billion.

Now, I'll preface the outlook portion of this call as usual by paraphrasing our Safe Harbor language. Some of what we talk about now and in the Q&A may constitute forward-looking statements. Actual results could differ materially from what we project today, so please refer to our most recent 10-K, 10-Q and proxy filings for a more complete description of factors that could affect our projections.

We do not undertake to publicly update forward-looking statements, whether as a result of new information, future events, or otherwise.

Regarding any non-U.S. GAAP measures that we may discuss during the call, please visit our website, www.molsoncoors.com, for a reconciliation of these measures to the nearest U.S. GAAP results.

Looking forward, we continue to anticipate 2008 corporate net interest expense of approximately $100 million to $105 million on a reported basis. We expect full-year 2008 corporate general and administrative expense of approximately $110 million, plus or minus 5%, which is in line with last year and our previous guidance.

Turning to our effective tax rate, we now anticipate that our underlying tax rates for full-year 2008 and for the second half of the year will be in the range of 20% to 24%, assuming no further changes in tax laws. This 2008 guidance is higher than we provided on our last earnings call because we now expect the closing or settling of certain tax years to be delayed until 2009. As a result, we also expect our 2009 effective tax rate to be below our long-term range of 22% to 26%.

Note that we do not expect the completion of Miller Coors in the U.S. to significantly affect our outlook in the areas of interest expense, G&A and underlying effective tax rate.

Our new capital spending outlook for 2008 is approximately $245 million, excluding the U.S. in the second half of this year. As usual, this guidance excludes self-funded capital spending by our consolidated joint ventures, primarily The Beer Stores in Ontario.

Our annual CapEx outlook for the Canada and U.K. businesses, which is incorporated into this guidance, has not changed since our last earnings call.

At mid-year, we were on plan to achieve our 2008 free cash goal of $550 million, excluding any effects from Miller Coors. As we have shared previously, Miller Coors will have one-time cash outlays of approximately $450 million during the next couple of years to capture the $500 million of targeted cost synergies for this new company. This incremental cash will be divided about equally between one-time restructuring costs to reduce overhead expenses and net capital expenditures to reconfigure the Miller Coors supply chain.

Leo Kiely's team is in the process of finalizing these integration and capital investment programs and we plan to share more details next quarter.

Now, highlights of our cost-reduction initiatives: in the second quarter, we captured an incremental $18 million of cost savings as part of our three-year, $250 million resources for growth, or RFG, cost reduction initiative. We are on target to achieve our 2008 goal of $77 million of additional cost savings and we have already delivered more than 60% of this annual goal in the first half of the year.

Looking beyond 2008, we are assessing how the formation of Miller Coors affects our RFG program. As with cash flow, we plan to provide more specifics on our next earnings call.

At this point, I'll turn it back over to Peter for a look ahead to the balance of 2008. Peter.

Peter Swinburn

Thanks, Stewart. In 2008, we remain focused on building strong brands and reducing costs in each of our businesses. To keep our brand momentum going this year, in Canada, we continue to focus on building our strategic brands. In the second half of the year, we anticipate continued aggressive competitive pricing activity, primarily in Quebec and Ontario. In the face of this activity, we are committed to remaining competitive while growing our strategic brands over the long term, including the introduction of new innovative packaging, promotions and advertising creative.

Building on our Coors Light Cold Activated Can launch last year, we recently introduced Coors Light Cold Certified bottles across Canada, strengthening our Rocky Mountain Cold Refreshment with our consumers.

We will continue to focus on capturing growth from our super-premium owned and partner-import brands, including the addition of Corona in Western Canada, which has strengthened our national portfolio.

In the U.K., we anticipate a challenging trading environment in the second half of the year, due to the weakening U.K. economy. Nonetheless, we expect our U.K. business to benefit in the second half from cycling the U.K. smoking bans, and we will begin to accrue the benefits of the Heineken contract brewing arrangement, the Magners cider agreement, and recent supplier renegotiations. We will also cycle a one-time $9.5 million increase in pension expense in the third quarter last year.

In addition, we continue to roll out our new cold dispense technology for Carling, with 20,000 new installations year to date, as well as the "Cold You Can See" thermo-chromatic packaging and our compact draught system. Coors Light volume is also showing encouraging growth, driven by solid retail partnerships and increasing consumer demand for lighter, more-refreshing beers.

Based on the strength of our brands, and considering the challenging cost environment in each of our businesses, we are re-evaluating our pricing plans for the balance of this year. As always, we will make market-by-market pricing decisions that are consistent with our goals of building our brands and shareholder value.

Following are the most recent volume results for each of our businesses early in the third quarter.

In Canada, our comparable sales to retail in July, including 50% of Modelo brands for all of Canada in both years, increased at a low-double-digit rate.

In the first five weeks of the third quarter, our U.K. sales to retail have decreased at a mid-single-digit rate from a year ago.

In the U.S., with respect to the first few weeks of the third quarter for Miller Coors, we really like our execution over the Fourth of July weekend and our plans heading into Labor Day. Because it is very early days in the financial reporting of this shared venture between two parent companies, we are not in a position to discuss volume more specifically for this particular straddle quarter but we do look forward to having Leo Kiely and Tom Long on our next earnings call to discuss the performance of the U.S. business.

Regarding cost reductions, we are on track to meet or exceed our goals in 2008. Looking at the cost outlook by business, in Canada we now anticipate that our reported cost of goods per barrel in local currency will be virtually unchanged for full year 2008. We expect comparable cost of goods sold per barrel to increase at a mid-single-digit rate in local currency. This is up from the guidance of low-single-digits on our last earnings call.

Comparable 2008 cost of goods in Canada excludes the new Modelo Molson joint venture accounting, the loss of the Foster's contract, and an $8 million full-year benefit of cycling 2007 foreign currency adjustments.

This guidance implies improved Canada cost trends in the back half of this year, in particular in the fourth quarter, despite a challenging commodity cost environment. This outlook is primarily due to cycling higher materials costs and additional expenses related to closing our Edmonton brewery and starting up the Moncton brewery last year.

Our U.K. team will continue to attack costs and maximize the return on our production assets. We are targeting substantial savings as part of our resources for growth program, driven by headcount reductions, supplier negotiations and improvements in supply chain efficiencies. We are also reviewing opportunities to further reduce overhead costs. We currently expect full year 2008 U.K. cost of goods per barrel to increase at a mid-single-digit rate in local currency.

Since the new Miller Coors business in the U.S. will be critical to our future financial performance and shareholder value, I want to provide an update on the progress to date.

Leo Kiely and his team have filled virtually all the top positions in this new company. I believe that they are truly taking the best talent from both the Coors and Miller organizations and building one of the strongest teams globally.

Miller Coors has hit the ground running on integration and marketplace effectiveness, including their commitment to deliver $500 million of cost synergies. As an example, they are already making adjustments to their supply chain to improve service and lower costs. The extensive planning over the past 10 months is paying off, and as we move to peak season, these efforts will gain even more momentum.

From a financial reporting standpoint, Miller Coors results will flow through our P&L in a new equity income line above operating income. This will be pretax income, and corporate income taxes on these results will be paid at the parent level.

For greater visibility, we also plan to provide a full Miller Coors income statement each quarter in U.S. GAAP, along with selected balance sheet and cash flow information. These results will be released by the parent companies, Molson Coors and SABMiller, on the same day as the Molson Coors earnings release, starting with our third quarter release on Wednesday, November 5th.

We will have Miller Coors results to discuss in future quarters and Leo and others of his top team plan to participate in our earnings calls to provide perspective on the U.S. business. We will provide more details on Miller Coors’ strategies and plans on our next earnings call, along with the first quarter of results from this exciting new company.

To summarize our results and discussion today, in the second quarter we created the most significant business combination in the history of U.S. beer; a new company that will make us stronger and more competitive in the U.S. Miller Coors offers tremendous potential in resources and value for Molson Coors and our shareholders.

On a company-wide basis, our top brands continue to outperform the industry and we achieved net pricing gains and substantial cost savings in each of our core markets. At the same time, however, energy costs and commodity inflation have become bigger challenges. This cost inflation, combined with our higher tax rate, drove lower underlying earnings for our total company in the second quarter.

In the face of these challenging economic conditions, we continue to implement value-adding strategies that will allow us to build our brands, achieve positive pricing, reduce costs, and grow profits and cash for our shareholders. The fundamentals of our business remain strong and we are more excited than ever about the future for Molson Coors Brewing Company, as we strive to become a top-performing global brewer.

Now, before we start the Q&A portion of the call, a quick comment: our prepared remarks will be on our website for your reference within a couple of hours this afternoon. Also, at 3:00 p.m. Eastern Time today, our Investor Relations team, led by Dave Dunnewald, will host a follow-up conference call, essentially a working session for analysts and investors who have additional questions regarding our quarterly results. That call will also be available for you to hear via webcast and recorded replay on our website.

So at this point, Matt, we would like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Mark Swartzberg from Stifel Nicolaus.

Mark Swartzberg - Stifel Nicolaus

Thanks. Good morning, everyone. Peter, a couple of questions on Canada -- just a clarification, did you say it was up, volumes were up mid-single -- or I guess STR is up mid-single-digit in the month of July? And if so, can you tell us what’s happening local currency on net revenue per barrel?

And then, also on Canada, Molson Canadian, down mid-single-digits in the quarter. Can you give us an idea of how that played out by region, or at least by Quebec and Ontario on that brand?

Peter Swinburn

I’ll let Kevin jump in in a minute, as he can give you probably more detail on some of the questions but what I actually said on Canada for July is that the STRs were up low double-digit, and that basically represents a bounce-back in July from really what was unprecedented bad weather in the Canadian market in the quarter that we just experienced.

We won’t give guidance on where we are in terms of margins but Kevin, do you want to pick up on the Canadian question, the Molson Canadian question?

Kevin T. Boyce

Mark, the Molson Canadian is not sold actually in Quebec. It’s sold in the rest of Canada and if you look at it, it had a good period in the Atlantic and broadly speaking, the rest of the country was pretty consistent, about mid-single-digit decline in the quarter.

Mark Swartzberg - Stifel Nicolaus

And Kevin, on that low double-digit increase in July for all of your brands, do you put all of that on weather on or are there also -- is it getting more promotional?

Kevin T. Boyce

Well, to be honest, the weather wasn’t super in July either. I think that we had a couple of good weekends early in the month. We’ve got a couple of extra shipping days in Quebec but basically I think the country has decided, this is a little bit anecdotal, but the country has decided that it’s time to have summer, that there was enough rain in June, and we can see shipments from an industry perspective are quite strong in July and broadly speaking, it had to happen -- there’s no indications that the industry is in decline or anything like that. It was just some pretty bad weather for a prolonged period of time in May and June, which as I said has extended into July but a little bit of it would be promotional but most of it I think is simply returning to normal levels where the industry has historically grown year over year at about 1%.

Mark Swartzberg - Stifel Nicolaus

And when you say up low double-digits, are we talking the same number of selling days in each period or are you getting the benefit of the selling days in that number?

Kevin T. Boyce

Well, in Quebec, for example, you would get -- there’s a couple of extra shipping days and that’s -- in Quebec, our STRs are measured by shipping days, so there’s a little extra days in there but most of it would seem to be, or at least half plus would seem to be the industry strength and us participating or more than participating in that.

Mark Swartzberg - Stifel Nicolaus

Okay, great. Thank you.

Operator

Thank you. Our next question comes from Kaumil Gajrawala from UBS.

Analyst for Kaumil Gajrawala - UBS

This is actually Zack standing in for Kaumil. I have a quick question for you guys -- could you just comment on whether there were any cost-savings opportunities in the U.S. that you guys ended up delaying in the quarter, you know, waiting for the closing of the Miller Coors JV?

Peter Swinburn

I’ll take that -- the short answer is no. We ran the business as we would. We got the cost savings that we wanted out and the Miller Coors people are working very hard at the moment putting together their plans to make sure that they get their cost savings and synergies out as well, so what you would expect, really.

Analyst for Kaumil Gajrawala - UBS

Thanks.

Operator

Thank you. Our next question comes from Bryan Spillane from Banc of America.

Bryan D. Spillane - Banc of America Securities

Good morning. Peter, I guess one of the things that we’re sort of struggling with on this side today is visibility, and seeing that the cost inflation expectations have changed sequentially from the first quarter to the second quarter and now looking out into next year, and I think there’s about a 35%, 40% difference in the range of consensus estimates for next year between the high and the low end, can you talk a little bit about, as much as you can on some broader themes? First, where you stand today relative to past statements that management has made on share buy-backs. Also, is the language on your expectations for the phasing of the cost savings from the Miller Coors JV the same? Meaning is it still $50 million in year one, the first fiscal year after the JV closed?

And then also, if you could talk a little bit about your expectations for the continuing of cost savings programs in -- resources for growth, I guess, savings in the U.K. and in Canada beyond this year.

Peter Swinburn

Okay, Bryan, I’ll try my best to answer all of those for you and I’ll let Stewart jump in as well to help out as well.

First of all, can I just -- before I address the specifics, can I just say we appreciate that this particular quarter is slightly unique. Miller Coors as a business is less than five weeks old and so we simply are not in a position to provide you with the sort of information that we would like to provide you with and which we will provide you with on an ongoing basis. So our apologies for that but it’s just -- and I’m sure you’ll understand why that is the case.

In terms of your specifics, on share buy-backs, we really want the same visibility that you want on Miller Coors and what is likely to be our expenditure and their cash needs going forward. We’ll have that by the end of the next quarter and that will give us -- that will put us in a position where we can discuss that particular issue with our board clearly, so that’s where we are on that one.

In terms of the synergy savings then, yes, everything is still in line with the numbers that we’ve given you previously, $50 million in the first year and so on. And again, Leo and his team will be able to update you on that at our next quarter announcements.

And in terms of the cost savings, our resources for growth program is bang in line Canada, bang in line in the U.K. I think we said in the announcement that we are bang in line with hitting the numbers that we’ve already given you for this year and again, the Miller Coors people are working on their numbers and we’ll have greater visibility on that at the end of the third quarter. But at the moment, certainly we are very confident that we are in line with our cost saving-program.

Stewart Glendinning

The only thing I would add to that, Bryan, is that if you looked out for ROT this year, I mean, we’ve delivered 60% of the numbers already. We feel confident about this year. We are taking a look at next year in concert with Miller Coors and on that subject, we feel quite confident that to the extent that there are any detrimental effects from the Miller Coors joint venture, that that will be offset by additional savings they had realized on their side.

Bryan D. Spillane - Banc of America Securities

Okay, great. Thank you, guys.

Operator

Thank you. Our next question comes from Carlos Laboy from Credit Suisse.

Carlos Laboy - Credit Suisse

Good morning. Could you expand on the importance of the Corona brand in Canada? You mentioned it briefly, and for your growth, with Modello on the block, if Modello goes to InBev, how do you hang on to the brand? And if you lose it, how does it affect your Canada earnings?

Peter Swinburn

I’ll let Kevin again jump in on the detail of it but you are well aware we’re not going to speculate on anything that might happen in the future. We’ve got no more insight into that than you have, to be honest with you, but Kevin, do you want to talk about the Modello brand specifically in Canada?

Kevin T. Boyce

The Modello brand, it’s hard to give comparisons because we’ve added Modello to Western Canada this year, so it obviously distorts the numbers. But it is a sizable brand that continues to enjoy good growth, both in the east and western part of Canada, and we’ve had a long relationship with Corona and the creation of the joint venture for us and for them we think is a great opportunity to continue to grow in the country.

Carlos Laboy - Credit Suisse

How important is it to your portfolio and to your growth? It’s a pretty important brand in the portfolio, no?

Kevin T. Boyce

Yeah, it’s within our -- it’s one of our top 10 brands. It’s not our biggest but it’s certainly not our smallest. As I said, it’s -- I’m trying to give you a size without giving the actual share here but it is -- I think it’s fair to say it’s one of our more meaningful brands. It’s after obviously Coors Light and Molson Canadian but it’s a very substantial brand and it plays a very important role in our super premium portfolio.

Carlos Laboy - Credit Suisse

Thank you.

Peter Swinburn

Carlos, just to clarify because maybe we didn’t make it clear -- our agreement with Modello for the Corona brand in Canada is a long-term agreement, so there’s not question of us losing it, if that’s really what you are trying to get at.

Carlos Laboy - Credit Suisse

That’s the concern.

Peter Swinburn

No, if that answers your concern, hopefully we’ve done so.

Carlos Laboy - Credit Suisse

Thank you.

Operator

Thank you. Our next question comes from Judy Hong from Goldman Sachs.

Judy Hong - Goldman Sachs

Good morning. Kevin, a couple more questions on Canada, particularly focusing on the pricing environment there -- if I look at revenue per barrel in the second quarter, it looks like it was more moderate growth than the first quarter, while the fuel and commodity outlook has worsened. So I’m hoping to get a little bit more color in terms of the competitive promotional activity, as well as your promotional activity. And with commodity outlook getting worse, your confidence level in taking more pricing to offset the commodity inflation there.

Kevin T. Boyce

In the second quarter, we still got pretty good pricing in the marketplace. Our pricing grew, our MSR grew about 3% per barrel, which is pretty good growth. The first quarter was a little bit better because we had taken pricing a little bit earlier in the year than in previous years, so our comparables versus previous year were a little bit better. But if you look at it on an ongoing basis, obviously we are facing a challenging cost environment. There’s still a province or two where we have yet to take pricing this year and obviously we’ll be looking very seriously at those quite soon. But I think given all the cost pressures, we will be going back even to markets where we’ve already taken some price this year and look at those markets and say should we be re-looking at our price for this year and ongoing to try to offset some of these cost increases.

Judy Hong - Goldman Sachs

And what are you seeing from your competitors and their pricing?

Kevin T. Boyce

Well, I think they are right in there with us in terms of -- it’s a pretty aggressive marketplace right now. One of the things with the kind of weak industry in May and June, it’s caused people to chase volume a little bit and worry about what the summer was going to be like. So I think what you are seeing out there now in a couple of markets is some pretty aggressive discounting, probably more aggressive than a year ago right now, as people are chasing a little bit of volume.

This market has historically gone in some of those cycles and we would expect that things will work their way through. Everybody is facing the same challenge and cost environment but right now, it is pretty aggressive out there.

Judy Hong - Goldman Sachs

Okay, and then I think your MG&A in Canada was down 6% if you exclude some of the factors that affected the comparability. Is that more of a timing issue or cost savings help the MG&A line, or is your brand spending actually declined in the second quarter?

Kevin T. Boyce

Well, our marketing and sales, if you like, rather than MG&A on a comparable basis year over year is about flat.

Judy Hong - Goldman Sachs

Okay, and then a couple of questions in the U.K. market -- you talked about the second half potentially getting better as you cycle the smoking bans a year ago. Are you seeing any evidence that that is indeed happening? Sales to retailers were down mid-single-digits in July, so it doesn’t really look like it got a whole lot better.

And then secondly on pricing, it seems like you got a little bit more promotional in off-premise outlets and I’m wondering if this is something that we should look forward to going forward, and are you pleased with the returns that you are getting as you ramped up promotional spending in that part of the channel?

Mark Hunter

With regard to the industry, I mean, what we’ve seen is basically the industry volumes have accelerated from a decline perspective through the second quarter, so second quarter was down about 4.6%, the first quarter was down a couple of percent, so the total market at the half year is down just over 3, and we would expect the market for the full year to be down around about 3.5% in total volume terms. That still has a little bit of uncertainty associated with it because although we’ll be cycling the smoking ban from last year, clearly the U.K. economy is not in great shape so consumer spending and disposable income is clearly under a lot of pressure. But we’re currently forecasting total market volume to be down pretty much in line with where the market is at the half year, around about 3.5%.

With regard to pricing, we I think intimated at the start of this year that we wanted to be more selective in some of our promotional activity in the take-home market. We lost share as a business last year and as we’ve come through the first two quarters of this year, we’ve managed to achieve both pricing growth and market share growth, which is really the formula that we’re looking to repeat on an ongoing basis.

Our pricing growth was a little bit lower in the second quarter, principally because the take-home market, the off-premise market took up a larger proportion of the overall volume in margins and the take-home market are generally lower than they are in the on-premise market.

But we will continue to push for selective promotional activity through the balance of this year.

Judy Hong - Goldman Sachs

Okay, and then my last question, a clarification on the cash flow outlook from this year. That didn’t change even though the tax rate guidance went up -- is that correct?

Peter Swinburn

That’s correct, Judy. That tax change won’t affect us from a cash flow perspective.

Judy Hong - Goldman Sachs

Okay. Thank you.

Operator

(Operator Instructions) Thank you. Our next question comes from Christine Farkas from Merrill Lynch.

Christine Farkas - Merrill Lynch

Thank you very much. A couple of questions, if I could -- with respect to your Canadian market where your costs of goods or the raw material inflation was up eight points, and this was offset by 2.5 points of your cost savings, this ratio seems a little bit lower, of course, than what you reported in the past with your cost savings program offsetting a lot of the inflation. Can you talk a little bit about firstly, is that ratio correct going forward, given the inflation pressures that we are seeing?

And then with respect to North American raw material, specifically on your packaging inflation and your AG inputs, we can all see what fuel is doing, what is your hedging position and outlook on those two particular components? Thank you.

Kevin T. Boyce

I’ll take those. Let’s start with the inflation has been higher than in previous quarters, obviously. Peter mentioned or Stewart may have mentioned that for the rest of the year, we see more mid-single-digit increases. A lot of what you saw in this quarter has been driven by a combination of agriculture but obviously fuel is an important part of our business, as we have DSD delivery system in some provinces and we share a system through either BBL or TBS with some other brewers, so we’ve seen some pretty dramatic increases through there, and some of that going forward will depend on what’s happening. You know that right now, oil is moderating somewhat, which is good news for us, but we are forecasting that it’s not going to get a whole lot better. It’s certainly for the balance of the year, the agricultural products we’ve kind of built in today’s pricing, as well as oil.

So if there’s any upside in that, it would be in the sense of if there’s some substantive movements downward in oil.

Christine Farkas - Merrill Lynch

Do you hedge where you can on these inputs?

Peter Swinburn

Just to cover that point, we don’t as a rule sort of get into all of our specifics of hedges, but all of our hedging is taken into account in looking at our going forward COGS for the rest of the year, which we’ve outlined at a sort of mid-single-digit rate.

Christine Farkas - Merrill Lynch

Okay, great. And then just a follow-up question on the U.K., with respect to the higher pricing, you’ve talked about a buy-ahead ahead of the higher excise taxes. In the U.K., your pricing was up on core brands 0.6%. Can you talk about whether or not you can pass on more pricing there to offset potentially some of the volume decline?

Mark Hunter

We’re currently reviewing pricing options for the balance of this year. It’s going to be a combination of our SKU mix and driving more profitable packs and we are currently reviewing whether there is any room for a more blanket price increase, but that’s still work in progress.

Christine Farkas - Merrill Lynch

Okay, great. That’s all for me. Thanks.

Operator

Thank you. Our next question comes from Patricia O’Donnell from [Kingdom]. Ms. O’Donnell, your line is open. Our next question comes from Bryan Spillane from Banc of America.

Bryan D. Spillane - Banc of America Securities

Thanks for taking the follow-up. I just wanted to get a little perspective on the U.K. There’s been a pretty -- I guess an accelerated level of pub closures in the last year or so. I think I read one story where there’s maybe 1400 pubs closed last year and they are closing at a rate of two or three per day right now.

So two questions related to that -- one, are your volumes and sales being influenced or affected by sort of a reduction of inventory in the trade? If you’ve got fewer customers, there’s not only just less throughput but maybe less stock in the trade, so maybe like a de-stocking effect.

And then the second thing is does it still make sense to spend the capital on cold dispense equipment right now if the on trade is declining at the rate it is? And I think Carlsberg said this morning that 2Q on trade was down something in the neighborhood of 9% in the second quarter. So could you just talk a little bit about that and how that’s affecting your numbers and maybe affect your thinking going forward?

Mark Hunter

With regard to the pub closures, I mean, clearly that’s a concern for the long-term viability of the pub industry in the U.K. I think what we are seeing at this stage is that the pubs that are closing tend to be the smaller volume pubs, so pubs you would describe as kind of the tail end of the market, so their impact on our overall performance relative to the industry is pretty small at this stage. So I would rule that out as kind of a material issue in the short-term but clearly as we look longer term at pub closures generally and on-premise performance is a concern for us.

With regard to CapEx, we will continue to invest in those outlets that we think can generate a material return for us, so we are very selective with regard to where we are installing cold dispense. It’s all being driven on the back of our core brands and brands that we see having a long-term future, so it’s important that those brands represent themselves effectively. But this isn’t a ubiquitous approach across all customers. It’s a selective approach and we look to invest where we can maximize the returns. It tends to be with those customers who are investing in the retail proposition and where our brand positioning is reflected at the point of purchase.

Bryan D. Spillane - Banc of America Securities

Okay, great. And if I could just follow-up on the -- again in the U.K. on the pricing, were the excise tax increases passed through by retailers or did they not pass that, the excise tax increases through to consumers?

Mark Hunter

It would certainly appear that within the off-trade market, the excise increases were not passed through so we’ve seen very little movement in off-trade pricing. And the on-premise, most of the excise tax increases seemed to have been passed through.

Bryan D. Spillane - Banc of America Securities

And does that potentially raise the question or a flag that there could be some more aggressive regulatory action taken? I mean, part of the -- my impression has been part of the reason why excise taxes were increased were to raise revenue but part of it is a public policy action to try to curb consumption, and it seems both in beer and wine that the off-trade has sort of ignored the suggestion that shelf price ought to move up.

First of all, am I on target with that and if so, is there a chance that maybe there’s going to be potentially more aggressive regulation to try to ensure that you don’t get the same level of discounting in the off-trade?

Mark Hunter

It’s a good observation, Bryan. You have to connect that to two things; the first thing you need to connect is the commentary from the current U.K. government and other interested bodies about their concern relating to aggressive promotional pricing in take-home and the need for something to change. And then you have to connect that to the fact that there’s going to be an election in the U.K. probably in the next 18 months, so the likelihood of the current government putting through a material change that affects retail pricing, I would suggest -- and this is a pure personal perspective -- would be pretty limited.

There is a lot of discussion around this topic and we will wait to see whether there will be any movement from the government, but I would just set it in the context of a forthcoming general election.

Bryan D. Spillane - Banc of America Securities

Okay, great. Thank you very much.

Operator

(Operator Instructions) I am showing no further questions.

Peter Swinburn

Okay. Thanks very much, Matt. We’ll call that a wrap. Thank you, everybody, for joining us and thanks very much for your interest in Molson Coors. We look forward to speaking to you again next quarter.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. You may now disconnect. Everyone have a great day.

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Source: Molson Coors Q2 2008 Earnings Call Transcript
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