Operator: Ladies and gentlemen, thank you for standing by and welcome to the Constellation Brands’ Fiscal Year 2010 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions). Thank you.
I would now like to turn the conference over to Ms. Patty Yahn-Urlaub, Vice President of Investor Relations. You may begin your conference.
Patty Yahn-Urlaub - VP of IR: Thank you, Paula. Good morning, everyone, and welcome to Constellation’s fourth quarter and fiscal year end 2010 conference call. I’m here this morning with Rob Sands, our President and Chief Executive Officer and Bob Ryder, our Chief Financial Officer.
This call complements our news release, which has also been furnished to the SEC. During this call, we may discuss financial information on a GAAP, comparable, organic and constant currency basis. However, discussions will generally focus on comparable financial results.
Reconciliations between the most directly comparable GAAP measure and those and other non-GAAP financial measures are included in the news release or otherwise available on the Company’s website at www.cbrands.com under the Investors section. Please also be aware that we may make forward-looking statements during this call. While those statements represent our best estimates and expectations, actual results could differ materially from our estimates and expectations.
For a detailed list of risk factors that may impact the Company’s estimates, please refer to the news release and Constellation’s SEC filings.
And now, I would like to turn the call over to Rob.
Robert Sands - President and CEO: Thanks, Patty, and good morning, everyone and welcome to our call. We have several items to review this morning including our fiscal 2010 results and our guidance for fiscal 2011.
In February, we reached the conclusion of a very dynamic year, one in which we executed against our strategic goals despite lingering economic challenges around the world that affected our key markets. We accomplished a great deal through fiscal 2010, continuing the disciplined work of transforming our portfolio, our operations and our financial model. We continued our portfolio transformation efforts as we began the fiscal year with the sale of our value spirits business, which resulted in cash proceeds of $276 million, and then we successfully integrated the remaining spirits business into our North American wine business, and we ended the fiscal year with the sale of our U.K. cider business, the Gaymer Cider Company to C&C Group for approximately $70 million.
These transactions combined with strong free cash flow generation helped drive a $600 million decrease in our debt levels. We continued our efforts to improve our prospects for our U.K. and Australian businesses by tightening the portfolio of focus, increasing efficiencies, reducing costs and approving cash flow generation.
We significantly improved our cost structure, not only through our global cost reduction initiative, but through supply chain initiatives and tightened controls on SG&A spending. We improved productivity and created efficiencies through global SKU rationalization efforts and consolidation of our global footprint. We progressed in our efforts to create an integrated technology platform, which has been designed to improve the accessibility and visibility of global data. This initiative is already creating value by reducing costs and improving efficiencies and is designed to ultimately enhance performance in key areas such as supply chain, global procurement, customer service and information management and analysis.
We implemented our new go-to-market sales and marketing structure in the U.S., which was successfully integrated into a single organization. This resulted in synergy benefits and improved the efficiency and effectiveness with our trade partners. From a strategic perspective, we have undertaken one of our most important initiatives with the launch of our U.S. consolidation effort. Presently, this program gives five distributors the right to sell Constellation’s portfolio of wine and spirits exclusively in the respective markets in 22 states and currently represents approximately 60% of our total U.S. wine and spirits volume.
Since the initial transition in September 2009, these distributors have allocated more than 1000 dedicated distributor sales people to focus exclusively on selling Constellation’s product portfolio. As you know, the initial distributor transition commenced September 1, 2009, with the second quarter of fiscal 2010 benefiting from the implementation of this program. At that time, actions were taken to ensure maximum service levels between distributors and the retail customers during the transition period.
These actions had the planned effect of moving a portion of third quarter sales into the second quarter and resulted in some inventory build at distributors. During the third quarter, consumer takeaway was softer than expected at the beginning of the quarter, but improved as our new selling model and promotional efforts began to take effect. However, at the end of the third quarter, distributor inventories were higher than targeted level.
In the fourth quarter, we made a proactive tactical decision to work with our distributors in decreasing their higher than average inventories to more moderate levels, and how did we accomplish that? We did not require distributors to purchase product at contracted levels; in return, they agreed to invest in additional marketing and promotional programs behind our brands in the marketplace.
As expected, these actions unfavorably impacted our U.S. wine business during the fourth quarter by approximately $60 million to $70 million in net sales and about $0.07 to $0.09 in diluted EPS and created negative leverage on the remainder of the P&L. However, we believe it was an appropriate trade-off in order to better position the distributors for success in the future as they work with us to drive profitable organic growth.
Going forward, we are refocusing our energies from managing transition activities to improving depletions and consumer takeaway. Our ultimate goal is to grow our U.S. wine business in line with the total industry growth trends and we expect to achieve this goal in 2011. This translates to an estimated volume growth rate of approximately 1% for the U.S. wine industry inclusive of all channels, both on and off-premise.
As we’ve discussed, the on-premise channel is tempering the overall growth rate for the wine category while the grocery, mass merchant and club channels are growing at faster rates. For instance, current growth in the (indiscernible) IRI channel remains healthy at about 5% on a dollar basis according to recent 12-week IRI data that corresponds to the end of our fiscal year.
In particular, the premium segment where wine sells for greater than $5 a bottle at retail continues to grow in IRI channels at a rate of mid to high single-digits. And within these price segments many of our leading well known brands continue to perform well in the marketplace, including for instance, Rex Goliath, Robert Mondavi Private Selection, Clos du Bois, Estancia, Toasted Head, Simi, Franciscan and Kim Crawford.
Remember, about 40% of our U.S. wine volume is currently sold in several states but are not included in the transition process. It is in these states that our depletion trends are generally better than those undergoing transition.
From a marketing perspective, we are currently in the process of launching several new products or line extensions as part of our strategy to fill portfolio gaps and drive profitable organic growth. For instance, as we focus on gaining share in the rapidly growing Argentinean Malbec segment, we are preparing to roll out the new Black Box Malbec varietal. We will also be relaunching our Diseno brand with a new package and marketing positioning.
We will soon begin shipping our new Blue (Sub) Riesling wine. This action will establish a presence for us in the rapidly growing German Riesling segment. Constellation will begin its participation in the emerging organic wine nitch with the Mendocino Vineyards brand which is made using organic grapes. And we are in the process of a national rollout of a sparkling wine under the Woodbridge by Robert Mondavi umbrella.
I just returned from the Wine & Spirits Wholesaler Conference where Constellation was awarded 9 Impact 2009 Hot Brand awards for several of our well known brands, including SVEDKA, Black Box, Kim Crawford, Rex Goliath, Corona Light and the Modelo Especial, just to name a few.
Our Canadian wine business posted positive net sales results for the year, primarily driven by the premium wine portfolio including Jackson-Triggs, Naked Grape and the (indiscernible) import business. As you know, Vincor Canada was the official wine supplier for the 2010 Winter Olympic Games. This sponsorship provided unprecedented exposure for our Canadian brands and showcased the Canadian wine industry to the world. Although the full business impact of this sponsorship is yet to be realized, I am pleased to report at this time that an incremental 20,000 cases of our Canadian brands were sold at Olympic venues and surrounding areas during the games.
In addition, our participating Canadian brands were showcased through Canadian and international media, including The Today Show, A Taste of Canada with Kathie Lee Gifford, and Wine Spectator.
In the spirits segment, SVEDKA Vodka had another great year and generated phenomenal sales growth of almost 40% versus last year which translates to more than 3 million cases sold in fiscal 2010. SVEDKA is the fastest growing major U.S. spirits brand and now has become the fourth largest vodka brand in the entire United States. And we just launched SVEDKA’s first national TV advertising campaign, which began airing March 1st.
Black Velvet is the second largest Canadian whisky brand in the U.S. and grew to more than 2 million cases in fiscal year 2010. It also posted solid results for the year with sales increasing in the low to mid single-digit range.
From an international perspective, earlier this week we announced that we have ended our discussion with Australian Vintage Limited pertaining to a potential combination of our businesses. Despite our mutual best efforts, we were unable to accomplish our goals and we have decided to focus individually on our respective businesses.
As a result, we will continue to restructure our businesses in Australia and the U.K. in order to align them with the realities of the respective markets. We will be more aggressive in taking out costs, minimizing our net working capital investment, increasing efficiencies and selling assets. Our primary goal is to generate cash and improve gross profit.
Moving to the Crown Imports joint venture, during the Company’s fiscal year 2010, the Crown joint venture generated $2.3 billion in net sales and $444 million of operating income. Crown continues to have the leading market share in the import category in the U.S., with five of the Modelo brands represented in the top 20 import brands.
Corona remains the number one import beer and Modelo Especial is currently the third largest import brand in the United States today. Speaking of Modelo Especial, it is one of the few major super premium brands in calendar 2009 that experienced double-digit market growth. This is a major accomplishment considering that 2009 was particularly a challenging year for the U.S. beer industry in general, with growth trends softening as the year progressed. Many major domestic brands lost volume and share to craft beers and sub premiums.
As we previously indicated, volumes for Crown’s businesses have been impacted by the economy, particularly in the convenience and on-premise channels. However, the Crown portfolio outperformed the import category and grew share throughout the year. These results were driven in part in the grocery channel as Crown introduced new packaging, executed targeted promotions and supported the business with enhanced strategic media activity.
For fiscal 2011, Crown is focused on further enhancing the integration of sales and marketing efforts by optimizing promotional activity and media support during peak seasonal periods when consumers buy the most. Some of these activities will be visible on the marketplace including the following, and summer consumer sweepstakes program that will begin immediately following the Cinco de Mayo holiday and run through the 4th of July. This program will be supported with television advertising.
Crown will partner with Sports Illustrated during soccer’s upcoming World Cup event, which will begin in June in South Africa. World Cup magazine issues will be promoting Modelo Especial specifically for the convenience and on-premise channels. Corona will also be one of the three major beer sponsors of World Cup TV. Crown has extended the roll out of Modelo Especial with Negra Modelo draft to nearly 50% of the U.S. with positive results and will continue expanding distribution throughout the remainder of the year.
Crown is also seeing success with new SKUs recently introduced into the convenience channel including Corona, and Corona Light 24-ounce cans. And going into Cinco de Mayo holiday and the key summer season, we believe Crown is well positioned to maximize execution at retail.
Before I turn the call over to Bob, I wanted to discuss our guidance for fiscal 2011. As you can see, our comparable EPS estimate for fiscal 2011 is projected to be in the range of $1.53 to $1.68, and reflects our belief that challenges from persistent and uncertain economic conditions will continue to impact our results, especially with regard to the Crown Imports business.
However, we expect to begin to realize the benefits of our U.S. distribution – distributor consolidation efforts as the year progresses. Meanwhile, our strong free cash flow enables us to create value in the form of an accelerated share buyback, while continuing our debt reduction efforts.
And now, I’d like to turn the call over to Bob Ryder for a financial discussion of our business results.
Robert Ryder - EVP and CFO: Thanks, Rob. Good morning, everyone. Fiscal 2010 was a year of dramatic change, operationally, culturally and financially. From an operational perspective, we took positive steps during the year to strengthen our organic business model. We sold the value spirits business and moved our two scale spirits brands into our U.S. wine business and eliminated our spirits SG&A.
We then consolidated the majority of our U.S. distributor network, while also reducing the infrastructure of our U.S. wine business from three selling units down to one. This also resulted in reduced SG&A.
We now have a single scale U.S. business focused on a streamlined premium wine and spirits portfolio going through a consolidated focused and aligned distributor network.
Culturally, we are focused on profitable organic growth of our premium scale business brands, primarily wine. This means increased focus on brand building and sales execution, especially in North America.
This also represents our next logical business stage, as we move beyond a previously decentralized organization, which had been very focused on acquisitions toward a more centralized organization, more focused on profitable organic sales growth.
In our U.K./Australia business, we have a renewed focus on profits, driving synergies and generating cash flow.
Financially, we reduced cost to help offset the negative impact of the current economy and generated strong free cash flow to help drive another year of debt reduction and reduced interest expense. Our full year fiscal 2010 comparable basis diluted EPS came in at $1.69 versus $1.60 in the previous year. Our results included the impact of challenging economic conditions, especially on Crown's performance, U.S. wine sales force restructuring, U.S. distributor consolidation and continuing difficult operating environment for our U.K. Australia business.
On the more positive side, we reduced costs which helped to offset some unfavorable mix impacts driven by the challenging economy. We extended our revolving credit facility and the portion of our term debt. We generated strong free cash flow as we exceeded the upper end of our guidance range. We significantly reduced debt and interest expense and we realized tax benefits for the year.
Now, let's look at our fiscal 2010 P&L performance in more detail, where my comments will generally focus on comparable basis financial results.
Let's go to our net sales line. As you can see from our news release on page 15, our consolidated net sales decreased 8% for the year, primarily due to the divestiture of our value spirits business and the unfavorable impact of our year-over-year currency rate fluctuations.
On an organic constant currency basis, which excludes the impact of acquisitions, divestitures and ForEx rate changes, net sales increased 1%. My commentary for the following net sales comparisons will be on a constant currency basis.
Our worldwide branded wine organic net sales, which appear on page 14 of the release, decreased 1%. This included a 3% decrease for North America, partially offset by increases of 7% in Europe and 4% in Australia/New Zealand.
North American sales were impacted by continuing economic challenges in U.S. distributor and sales force transitions. In connection with our recently implemented distributor contracts, sales to newly contracted distributors for an initial period are based on a predetermined plan.
Our sales force and distributor transitions resulted in a fall-off of depletions and consumer takeaway during fiscal 2010. As a result, distributors have generally been taking in more inventory than they have been depleting. While we were proactive during the fourth quarter and working with distributors to help reduce their inventory levels as outlined by Rob, the distributors ended fiscal 2010 with higher inventory levels than they ended fiscal 2009.
For Europe, sales benefited from the growth of our value price product offerings in the U.K. Sales for Australia/New Zealand increased due to New Zealand product growth in the region. Spirits’ organic net sales increased by an impressive 19% for the year.
Now, let’s look at our profits on a comparable basis using information on page 17 of the release. For the year, our consolidated gross margin was 35% versus 37.1% for the prior year. This reflects the higher Australian COGS due to the flow-through of the more expensive calendar 2008 harvest and growth of the lower margin U.K./Australia businesses. Although they remain profitable, our U.K./Australia businesses experienced another year of reduced profits.
Our consolidated SG&A for the year decreased $136 million and came in at 18.3% of net sales compared to 20.6% a year ago. The margin reduction was primarily driven by our global cost reduction efforts, elimination of our spirits SG&A with the sale of the value spirits business and lower marketing expense.
Consolidated operating income decreased 7% to $560 million and operating margin remained essentially flat at 16.6%. From the margin perspective, our stewardship of SG&A spend effectively offset the reduction in our gross profit margin for the year.
I’d now like to turn to our segment operating income results on page 13 of the release to provide highlights of our full year operating income change. Wine segment operating income decreased $37 million to $655 million. The decrease is primarily due to the divestiture of the value spirits business, decrease in U.S. branded wine sales and a decrease in U.K./Australia gross margin due to the negative mix and higher grade costs for Australian wine, partially offset by savings from our global cost reduction initiatives.
For the year, corporate and other expenses totaled $95 million versus $87 million in the prior year. The increase was primarily driven by higher stock-based compensation expense and cost related to Project Fusion, a multi-year program designed to strengthen our global business systems and processes.
Consolidated equity investment earnings totaled $239 million versus $270 million last year. Equity earnings include $222 million from Crown. For the year, Crown generated net sales of $2.3 billion, a decrease of 6% and operating income of $444 million, a decrease of 12%.
Economic challenges have impacted the entire beer industry, driving lower volumes and consumer movement to lower-priced beer. Operating income for Crown was impacted by the lower volume, negative mix and the contractual cost increase.
Interest expense for the year was $265 million, down 18% versus last year. The decrease was primarily driven by our significant debt reduction actions during the past 12 months.
Now, let's take a look at our debt position. At the end of February, our debt totaled $3.8 billion, which represents $600 million decrease from our debt level at the end of fiscal 2009. The decrease primarily reflects proceeds received from the sale of value spirits and cider businesses combined with our strong free cash flow generation.
Our average interest rate for the year was a little bit above 6%. Our debt to comparable basis EBITDA ratio at the end of fiscal 2010 was 4.0 versus a 4.3 ratio at the end of '09. Our strong free cash flow, reduced leverage and improved credit profile, positioned us to take advantage of improved credit markets and complete certain refinancing activities during the fourth quarter.
Let me summarize these actions. These activities included the amendment of our senior credit facility to extend $650 million of our revolver from June 2011 to June 2013. In addition $192 million of preexisting revolver remains in place at historical pricing through June 2011.
We also extended the maturity of our $300 million of our $1.2 billion term loan in June 2013 to June 2050. The margin applicable to the extended revolver facility and term loan increased by 125 basis points. In addition, we redeemed our $250 million 8 1/8% sub notes that were due in January 2012, without any penalty.
I am quite pleased with the result. We were able to maintain a low cost of capital, extend the term of our facilities, maintain appropriate financial flexibility, improve our covenants and reduce overall interest expense.
Our comparable basis effective tax rate came in at 30%, which reflects the favorable outcome of tax items from various jurisdictions. Favorable tax outcomes during the fourth quarter helped drive a negative 11% tax rate for Q4.
Looking a little closer at Q4 results, the favorable tax rate helped to offset the financial impact of soft Q4 net sales performance. For the fourth quarter, organic constant currency net sales decreased 2%. Branded wine organic constant currency net sales decreased 6% versus the prior year quarter. This included a 12% decrease in North America, a 23% increase in Europe and flat performance in Australia/New Zealand.
The increase in Europe was primarily due to volume growth and favorable comparison versus the disappointing fourth quarter last year. The decrease in North America reflects the impact of working with U.S. distributors to lower their inventory levels in Q4 as discussed by Rob earlier.
Lower sales in North America drove a $22 million decrease in wine segment operating income. Lower sales in North America coupled with high growth in the U.K. drove negative mix and 140 basis points gross margin decrease and reduced operating leverage as SG&A as a percent of net sales increased 220 basis points.
During the fourth quarter and in conjunction with our annual impairment testing, the Company recorded $103 million non-cash impairment charges, primarily related to trademark assets for the Australian business.
Now, let's turn to cash flow on page 13 of the news release. For purposes of this discussion, free cash flow is defined as net cash provided by operating activities less CapEx. For fiscal 2010, we generated free cash flow of $295 million, exceeding the high end of our most recent guidance range, but less than the $378 million produced in the prior year.
Although various year-over-year fluctuations in the cash flow details, the lower FY ’10 cash generation was due in part to a $65 million tax payment related to the sale of the value spirits business. Working capital benefited from inventory reductions from lower grade harvest cost in Australia and New Zealand and CapEx came in at $108 million versus $129 million in the prior year.
As a reminder, free cash flow for fiscal 2009 reflected a benefit of approximately $55 million in after-tax proceeds related to the favorable settlement of certain foreign currency hedges.
For fiscal 2011, we're targeting free cash flow to be in the range of $350 million to $400 million. This includes CapEx in the range of $110 million to $130 million. The targeted improvement of free cash flow versus 2010 is expected to be driven in part by anticipated lower tax payments, lower interest and lower restructuring activities versus the prior year.
In March 2010, we received $60 million from Sazerac that they paid off but not receivable related to the purchase of our value spirits business. This cash benefit will be included in the investing section of the FY ’11 cash statement and therefore is not included in our free cash flow estimates.
Due to our continued strong free cash flow generation and successful deleveraging and refinancing efforts, we believe we can redeploy a portion of free cash flow to repurchase stock while we continue to reduce debt. In connection with this strategy, the Board of Directors has authorized a repurchase of up to $300 million of the Company’s stock. Our intent is to implement an accelerated share buyback transaction when appropriate.
Now, let’s move to our P&L outlook for the full year. Given the uncertain global economic conditions, we're forecasting comparable basis diluted EPS to be in the range of $1.53 to $1.68 for fiscal ‘11. Our reported sales will be unfavorably impacted by the divestiture of our U.K. cider business, which contributed about $100 million in net sales for fiscal 2010. On an organic constant currency basis, we are targeting flattish net sales for fiscal ’11. On a consolidated basis, we expect operating income to be down slightly due to the impact of divested businesses in continuing profit pressures for Australian and U.K. operations.
Crown volumes are expected to be flat to down low single-digits due to continued impacts from the economy. Negative mix and a planned small contractual cost increase are also expected to impact Crown profits. As a result, we are targeting equity earnings for Crown to be down mid single-digits from fiscal 2010.
Interest expense is expected to be in the range of $210 million to $220 million. The healthy improvement is being driven by our significant debt reduction, the prepayment of the 8 1/8% sub notes with the lower cost revolver fund and the roll off of unfavorable interest rate hedges at the end of fiscal 2010. The comparable basis tax rate is expected to increase to 35%, and we’re assuming weighted average diluted shares to increase to approximately 224 million. These items will essentially offset the benefit of lower interest expense.
Looking at Q1 fiscal 2011, we expect results to be impacted by higher marketing expense at Crown Imports versus the prior year first quarter, as it ramps up on the marketing activities that Rob highlighted in his comments.
Our comparable basis guidance excludes acquisition-related integration costs, restructuring charges and unusual items, which are detailed in our page 19 of the news release. It also excludes any impacts from the share repurchase program. We expect the share buyback to be accretive to EPS, and we will update our full year guidance when the transaction is completed.
For fiscal 2011, we expect to incur diluted EPS charges of about $0.17 for restructuring and other one-time charges related to the previously announced cost reduction initiatives and the continuing efforts to increase efficiencies and improve ROIC.
Before we take your questions, I’d like to reiterate that over the long term we’ll focus on working to leveraged benefits of our new U.S. business structure and distributor consolidation initiative in increasing operational and cost efficiencies to drive improvement in our organic business model and ROIC.
In addition, we plan to use free cash flow to further reduce debt and interest expense and at the same time return cash to shareholders in the form of a share repurchase.
With that, we’re happy to take your questions.