Jan 6, 2011
Executives
Patty Yahn-Urlaub – VP, IR Rob Sands – President and CEO Bob Ryder – EVP and CFO
Analysts
Kaumil Gajrawala - UBS Judy Hong – Goldman Sachs Vivien Azer – Citigroup Lauren Torres – HSBC Dara Mohsenian - Morgan Stanley Mark Swartzberg – Stifel Nicolaus Tim Ramey – D.A. Davidson Christine Farkas – Bank of America Merrill Lynch Carlos Laboy - Credit Suisse
Operator
At this time, I would like to welcome everyone to the Constellation Brands third quarter 2011 earnings conference call. [Operator Instructions.]
I would now turn the call over to Patty Yahn-Urlaub, Vice President of Investor Relations. Please go ahead.
Patty Yahn-Urlaub
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 these and other non-GAAP financial measures are included in the news release or otherwise available on the company's website at www.cbrands.com under the Investor section. Please also be aware that we may make forward-looking statements during this call.
Although 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'd like to turn the call over to Rob.
Rob Sands
Thanks Patty, and good morning and happy New Year everyone. I hope you all had a great holiday and certainly had the opportunity to enjoy some of our fine products during the festive season.
Now before we get started with a review of our third quarter results, I'd like to spend a few moments discussing the strategic intent behind the recent announcement of our plans to sell our U.K. and Australian business to CHAMP Private Equity.
Since the time that we acquired Hardys in Australia and Matthew Clark, we have adopted a new business strategy which has been focused on premiumizing our portfolio, generating strong free cash flow, and improving return on invested capital, all in an effort to drive profitable organic growth. And the sale of the U.K.
and Australia is the next transformational step in the execution of this strategy, as the business is no longer aligned with our strategic imperatives. These international markets have been consistently challenged by foreign exchange volatility, grape oversupply, retail pricing pressures, and ongoing duty assessments which have collectively eroded profitability.
And the majority of our sales volume in Australia has been dedicated to value-priced bag in the box products. However, we will continue to maintain a 20% interest in the business.
As a private equity firm, CHAMP will be operating the business very differently, and our remaining interest will enable us to participate in the potential upside. All employees currently dedicated to this business will transfer to the new entity.
Despite the sale of our two largest international businesses, Constellation remains the world's number one premium wine company, and we remain committed to growing an international operation that is consistent with our overall strategy. Remember we currently sell and distribute our portfolio of brands in about 150 countries worldwide through Constellation Wines International, which will continue to invest resources in new, emerging, and established markets around the world.
Constellation Wines International represents growth potential for the company going forward, and will continue to drive our premium portfolio around the world. And now I would like to focus our discussion on our financial and operational results for the third quarter.
This quarter marks the continuation of the strong momentum we've experienced this year in a number of areas which include the generation of record free cash flow levels that has been driven in part by our diligent focus, particularly in the area of working capital. The great news about this new level of free cash flow is that we believe it is sustainable longer term.
And, it was during last year's third quarter that we began the official transition for our new U.S. distributor network, giving select distributors the right to sell Constellation's portfolio of wine and spirits exclusively in their respective U.S.
markets. There seems to be some confusion related to the intricacies of the distributor contracts and their impact on our financial results since the inception of this initiative, which commenced September 1, 2009, so I will take a minute to describe how you should be thinking about the nuances of these contracts.
We initially negotiated long-term contracts with five U.S. distributors currently representing about 60% of our wine and spirits volume in the U.S.
These contracts included shipment commitments that required distributors to purchase specified levels of product in fiscal 2010 and during this fiscal year, 2011. Last year, depletions or distributor sales to retail lagged our shipments to distributors due to the challenging economic environment and the disruption caused by the distributor transition activity and our sales force reorganization.
In fiscal 2011, while depletion trends for our products are healthy, they have not caught up to the contractual shipment levels. As a result, our sales volumes to distributors are exceeding distributor sales to retail and on-premise channels.
This has benefitted sales and profits for our U.S. wine business and will create an EBIT comparison challenge for fiscal 2012.
After the shipment commitments roll off at the end of fiscal 2011, under the distributor contract we expect shipments to essentially equal depletions for the remainder of the contract term on an annual basis. This was absolutely the best way to execute the distributor contracts as it ensured more stable sales, earnings, and cash flow, as well as complete distributor focus on the Constellation portfolio of products during the transition period.
So, to put things into perspective relative to how Constellation is performing, it's best to consider the following. For the three months ending November, which coincides with the end of our fiscal third quarter, estimated depletions or distributor sales to retail for Constellation's total U.S.
wine and spirits business across all channels increased 3%. Interestingly, this includes the on-premise channel, which has been slowly improving throughout the year and posted positive growth trends in the low single-digit range during the third quarter for Constellation and for the industry as well.
More importantly, our focused brand group, which represents the majority of our U.S. wine profitability, posted depletion trends of almost 10% in the third quarter.
We are managing for cash and margin our other, more mature U.S. wine brands, many of which are in declining categories.
Overall, consumer takeaway trends for our U.S. wine portfolio are generally aligned with industry trends across all channels in the mid-single-digit range.
It is a combination of these and depletion trends that are indicative of the underlying health of our business. Additionally, although promotional spending on an industry wide basis appears to be abating slightly, it is a bit higher than last year and what we originally anticipated.
During the third quarter Constellation Wines U.S. also progressed in efforts to improve cost, cash, and operational effectiveness with activities that included completion of the east coast winery consolidation effort, further consolidation of the California warehouse system, continued expansion of the solar energy initiative at several of our California facilities, and in addition to these accomplishments, we've recently received several accolades for our well-known portfolio of brands, the following of which are particularly noteworthy.
Robert Mondavi's director of wine making, Genevieve Janssens, has received one of the industry's highest honors and was named 2010 Wine Star Winemaker of the Year by Wine Enthusiast magazine. Constellation also won eight Impact Blue Chip Brand Awards, more than any wine company has ever won in a single year.
Our winning U.S. brands include Estancia, Blackstone, Clos du Bois, Robert Mondavi Private Selection, Woodbridge, Corona Light, Modelo Especial, and SVEDKA.
Wine and Spirits Magazine named Ravenswood as one of the top 100 wineries of the year and Joe Peterson, founder of Ravenswood, is being inducted into the Culinary Institute of America's Vintner's Hall of Fame in February. The accolades also continue for our Canadian business.
At the International Wine and Spirits competition in London, Vincor achieved Gold and Best in Class wins for Inniskillin Wines' Niagara, the 2007 Cabernet Franc Icewine, and 2007 Sparkling Vidal Icewine. Jackson-Triggs Okanagan Estate 2007 Proprietors Grand Reserve Riesling Icewine, and 2007 Sunrock Vineyards Shiraz.
And Jackson-Triggs Okanagan Estate was also awarded best Canadian producer. And moving on to SVEDKA and our spirits business, SVEDKA delivered strong year-to-date performance, posting double-digit sales and depletion growth.
We continue to build SVEDKA's on-premise brand awareness by leveraging new distributor roots to market. We are growing our national accounts in on- and off-premise channels, and are expanding in other core markets outside the U.S.
Moving to Crown Imports, we previously reported during the third quarter we settled our legal dispute with Modelo relating to the calendar 2010 funding of marketing and promotional spending, which was incremental to that [inaudible] original Crown joint venture agreement. As part of this settlement, the partners decided on future funding levels for these same expenditures for calendar 2011, through the remainder of the term of the joint venture agreement, which requires that Crown pay for a percentage of the incremental funding going forward.
This investment by Crown will ensure that the joint venture continues to have the world-class marketing and promotional programs that have made it the unrivaled leader in the U.S. imported beer category.
I would now like to move on to a discussion of Crown's operational results for the third quarter. During the third quarter, Crown worked closely with distributors to bring their inventories to more normal levels after experiencing supply chain disruptions this summer related to a combination of Hurricane Alex and a Modelo brewery strike in Mexico.
This effort, combined with the positive marketplace momentum that the Crown portfolio of products has experienced throughout the year, resulted in improved performance through the third quarter. During this timeframe, Crown outperformed the industry, the import category, and the other three major beer suppliers in the SymphonyIRI Food, Drug, Mass Merchant, and Convenience channels on a dollar sales basis.
Among the four major suppliers, Crown was the only one to gain dollar and case volume market share. This is the third consecutive quarter that Crown posted positive depletion results, which increased in the mid-single-digit range, including positive depletion trends for Corona Extra.
Based on Crown's year-to-date results, we are revising their depletion estimate upward for fiscal 2011 to growth in the low to mid-single-digit range with profits increasing low-single digits versus last year. Originally, Crown's estimated depletions were to be down slightly, with operating income declines in the mid-single-digit range.
Throughout the remainder of our fiscal 2011, we expect Crown to be focused on strong market execution, supported by new product introductions, package expansions, and solid promotional activities, which are planned for the balance of our fiscal year. Some examples include: Following the successful introduction of Modelo's Victoria beer brand in Chicago as an initial test market in June, Mexico's oldest beer was launched state-wide in Texas and in key Colorado markets in December.
Victoria is one of Mexico's most prestigious beer brands and is being introduced at a price point premium to Corona Extra, the brand that's scheduled for rollout in additional markets in early calendar 2011. Modelo Especial, one of the fastest-growing large beer brands, eclipsed yet-another major milestone by surpassing 30 million cases sold in the 12-month period through October.
Since its U.S. introduction in the 1980s, Modelo Especial has risen through the ranks to become the number three imported beer and the number 15 ranked beer on a dollar sales basis in the total U.S.
beer market. The Corona Extra "Find Your Beach" campaign was kicked off in September, and has been well received in the marketplace.
It includes a TV spot called "Moments" that encourages consumers to find their beach wherever it may be. And Corona Light's national multimedia campaign continues to carve out a distinct personality for this brand.
In fact, one measure of its success is the fact that the number of Facebook fans has increased from 3,000 to more than 200,000 in just two months. Before we turn the call over to Bob, I wanted to inform you that we have received notification by the majority shareholder of Ruffino of their exercise of its option to put its interest in Ruffino to Constellation.
Prior to this notification, we had initiated proceedings against the majority shareholder questioning the validity of the put option. This action should take some time to resolve.
In closing, we continue to execute and make great progress in a number of areas. We have strong marketplace momentum for our U.S.
wine and beer business, and the U.S. distributor transition is working well.
I'm especially pleased that we have found a suitable buyer for our U.K. and Australia operations who we believe is committed to growing the business and providing a home for our dedicated employees in these markets.
Collectively, these efforts reflect our diligent focus on achieving profitable organic growth. I would now like to turn the call over to Bob for our financial discussion of our third quarter business results.
Bob Ryder
Thanks Bob. Good morning everyone.
Q3 comparable basis diluted EPS came in at $0.66 versus $0.54 last year, as we saw improvement in interest expense and tax favorability versus the prior-year quarter. The third quarter also marks pretty significant progress in our strategy to drive profitable organic growth: improve the flow through of EBITDA to free cash flow and enhance the financial profile of the company.
Efforts to strengthen our organic business model under our new U.S. business structure and consolidated U.S.
distributor network continue to progress. These efforts have helped to drive continued positive depletion, retail, and mix trends for our U.S.
wine business. Our increased focus on improving free cash flow generation continues to drive benefits.
This is demonstrated by our very strong free cash flow performance during the first nine months of fiscal 2011 and our improved visibility to future cash flow generation. As a result, we're increasing our full-year cash flow target by $100 million to a new range of $475 million to $525 million.
In addition to reducing interest costs, cash, taxes, and restructuring costs, we continue to make progress in reducing our network and capital investment and we believe this new level of free cash flow is sustainable on a longer-term basis. This will be a new record of free cash flow generation at Constellation, and we are pleased with our results.
Many dedicated people, from grape buyers to wine makers, throughout the company, are thinking in new ways to generate better financial returns from our business. We completed our accelerated stock buyback transaction during the quarter.
Under this transaction we paid $300 million in April 2010 and received 17.2 million shares for an average cost of $17.42 a share. 13.8 million of the shares were received in the first quarter, and the remaining 3.4 million shares came in on November 30.
We estimate the transaction will generate about $0.09 of diluted earnings per share accretion in fiscal 2011, and this has been reflected in our guidance since the first quarter. We also delisted from the Australia Securities Exchange during the quarter, which helped us eliminate the cost and administrative burden associated with that listing.
As Rob noted, we've reached an agreement to sell our Australian and U.K. business.
The transaction is valued at $290 million Australian dollars, and should close by the end of January. We will retain 20% of this business.
We expect proceeds of about $230 million, which will be used to reduce borrowings. With interest and cost savings, we expect the transaction to be neutral to slightly dilutive to comparable basis EPS for fiscal 2012.
More importantly, this transaction is aligned with our strategy to premiumize the business and improve the financial profile of the company. Our consolidated comparable basis gross profit and operating margins should improve by about 400 to 500 basis points, and our earnings should be less volatile and we'll have much lower exposure to foreign currency swings.
Without this lower return business, our ROIC metrics will also be enhanced. Now let's look at our fiscal Q3 P&L performance in more detail, though my comments will generally focus on comparable basis financial results.
As you can see from our news release, consolidated reported net sales decreased 2%, primarily due to the divestiture of our U.K. cider business.
Excluding the cider sale and impact of currency, net sales were level with the prior-year quarter. My commentary for the following net sales comparisons will be on a constant currency basis.
North America wine net sales were even with the prior year, and reflected favorable product mix, offset by a decrease in U.S. shipment volume as the number of distributors under shipment commitments were less than a year ago.
Australia and Europe sales decreased 1%. Spirits organic net sales increased 8% for the quarter, with SVEDKA leading the way with a 34% growth rate.
It continues to maintain strong momentum in the marketplace, with sales and depletions growing double digits on a fiscal year-to-date basis. Now let's look at our profits on a comparable basis.
For the quarter, our consolidated gross margin was 36.5% versus 35.4% for the prior year. This primarily reflects product mix benefits.
U.S. promotion expense on a dollar basis was roughly even with the prior year, as we increased promotion spending in the back half of last year, following the implementation of the new distributor contracts, which commenced in September 2009.
An increase in U.S. freight costs from the higher-cost calendar 2008 red grape harvest were offset by grape cost benefits in Australia.
Our consolidated SG&A for the quarter increased $19 million and came in at 18.3% of net sales compared with 15.9% a year ago. This reflects incremental investments in technology around Project Fusion activities, some year-over-year incentive compensation variances, and an increase in marketing and selling expenses.
Consolidated operating income decreased 8% to $176 million, and operating margin decreased 1.2% to 18.2%. I'd now like to turn to our segment operating income results and provide highlights of our third quarter operating income [inaudible].
North America segment operating income decreased $18 million to $193 million. Improved sales mix in the current year's quarter was more than offset by higher grape costs, investments in technology, marketing and selling, and higher incentive compensation costs.
The Australian and Europe wine segment reported operating income of $9 million, a $2 million increase versus the prior-year quarter. The increase was mostly due to grape cost benefits in Australia.
Corporate and other expenses totaled $26 million versus $27 million for the prior-year quarter. Consolidated equity earnings totaled $71 million versus $60 million last year.
Equity earnings for Crown totaled $58 million versus $46 million for the prior-year quarter. The remainder of equity earnings in Q3 fiscal 2011 and Q3 fiscal 2010 are primarily generated by Opus One.
In the quarter, Crown generated net sales of $612 million, an increase of 22%, and operating income of $116 million, an increase of 27%. As Rob mentioned, sales and operating income primarily benefitted from volume growth as wholesaler inventories returned to more optimal levels following very low Q2 inventories resulting from supply chain issues experienced during the summer.
Crown's operating results also benefitted from lower promotional spending, but were unfavorably impacted by a legal arbitration decision regarding a former distributor and the contractual cost increase for Modelo products. As Rob mentioned, we now expect Crown to deliver growth in sales and depletions and a slight increase in operating income for fiscal 2011.
Interest expense for the quarter was $49 million, down 25% versus last year. The decrease was primarily driven by a lower average interest rate and reduced debt levels during the quarter.
Our average interest rate for the quarter was a little above 5%. Let's take a look at our debt position.
At the end of November, our debt totaled $3.7 billion. This represents a $109 million decrease from our debt level at the end of fiscal 2010.
This decrease is impressive given the funding of our $300 million stock buyback earlier in the year. Our debt to comparable basis EBITDA ratio at the end of November was 4.3 times.
With our increased free cash flow guidance, and expected proceeds from the sale of the Australian and U.K. business, we're targeting to be around the high 3 times range by the end of fiscal 2011.
Our comparable-basis effective tax rate benefitted from the favorable outcome of certain tax items and came in at 29%. This compares to a 35% rage for Q3 last year.
Given the favorable run rate for the first nine months of the year, we're now targeting a full-year tax rate of 31%. Now let's discuss free cash flow, which we define as net cash provided by operating activities, less cap ex.
For the nine months of fiscal 2011, we generated free cash flow of $299 million versus $100 million for the same period last year. This improvement reflects lower interest, tax, and restructuring payments.
We saw a sizable source of cash resulting from the reduction of inventory. There was also an increased use of cash from accounts receivable due to the timing of sales in the quarter.
Cap ex came in at $70 million versus $89 million for the first nine months of last year. As mentioned earlier, we're now targeting free cash flow for fiscal 2011 in the $475 million to $525 million range.
This includes cap ex in the region of $100 million to $120 million, a $10 million reduction from our previous projection. Now let's move to our full-year fiscal 2011 P&L outlook.
We are tightening our range and increasing our comparable basis EPS guidance to $1.80 to $1.85 from our previous range of $1.63 to $1.78 per share. This increase is primarily driven by the improvement of our targeted tax rate, which I discussed earlier.
The tax rate improvement represents about $0.10 of benefit per share. Please remember that in Q4 of last year, we reduced distributor inventories, so our FY11 Q4 EBIT should look very positive to the previous year.
Our full-year EBIT is essentially on our guidance, as the beer upside is being reinvested in U.S. wine promotion spending.
We now expect interest expense to be in the range of $195 million to $200 million, and weighted average diluted shares to be about $214 million. Our comparable basis EPS guidance excludes restructuring charges and unusual items, which are detailed in our news release.
Consistent with the past few years, we intend to provide next year's detailed financial guidance after we finalize our plan, and in connection with our fourth quarter press release and conference call, which is scheduled for early April. However, given our earlier discussion, I would like to frame in a couple of potential impacts to FY12 for you.
As highlighted by Rob, while we are pleased with our underlying U.S. depletion trends, our contracts with newly appointed distributors require specified product purchase levels.
This will result in shipments exceeding depletions during fiscal 2011. All product purchase requirements will have expired as of the end of fiscal 2011.
Going forward, shipments should align with depletions through the balance of the contracts on an annual basis. As we overlap the FY11 shipment commitments in FY12, we will face a difficult comparison, and as a result we currently anticipate nominal EBIT growth for our U.S.
wine business in fiscal 2012. Rob outlined the incremental marketing and promotional funding by Crown going forward.
This is expected to inhibit operating earnings growth in FY12. However, we expect slightly lower interest expense and a continued low comparable tax rate due to additional anticipated tax outcomes.
Given the factors just mentioned, directionally we currently anticipate comparable basis diluted EPS for FY12 to be slightly above FY11 guidance. As mentioned earlier, we feel the improvements we have made in generating free cash flow are sustainable and we currently estimate that free cash flow in FY12 will be at least in line with that in FY11.
With that level of free cash flow, [rough map] would indicate a comparable EBITDA leverage ratio in the low 3 times range by the end of fiscal 2012. That will be towards the lower end of our targeted leverage ratio, and we have not ruled out future stock buybacks.
Before we take your questions, I would like to note that our simplified U.S. organizational structure, streamlined brand portfolio, and consolidated U.S.
distributor network have contributed to improved depletion volumes and marketplace performance versus last year. Promotion spending has not yet abated in the U.S.
wine category, and we will need to keep an eye on market spending rates. In the beer business, we continue seeing positive depletion and retail results from Crown's branding and marketing initiatives.
The sale of our Australian and U.K. business will result in a dramatic improvement to most financial metrics.
Although the business constituted roughly a quarter of our net sales, it contributed very little of the profits. Our free cash flow generation profile has improved dramatically, and we are on track to produce an all-time high free cash flow result for the year, and we anticipate that level of free cash flow in future years.
This will provide opportunities for further deleveraging of stock buybacks. With that, we're happy to take your questions.
Operator
[Operator Instructions.] Your first question comes from Kaumil Gajrawala of UBS.
Kaumil Gajrawala - UBS
On these noncore brands, they're a small piece in terms of your profit but a good piece of your volume. Can you talk about what you're doing there to see if you can get trends to stabilize on some of those noncore wine assets?
Rob Sands
You're talking about our noncore brands?
Kaumil Gajrawala - UBS
Yes, outside of the 15 or 17 focused brands.
Rob Sands
There's about 17 focused brands, and then we have other categories which we describe as either tactical or protect and defend. The object is not really to stabilize those particular brands, and as I said in my talk our focus is really to operate those brands with a focus on margins and cash flow.
That will continue to be our focus for those brands.
Bob Ryder
There in, like, eroding categories, but they have very good financial profile, so you can't really turn them around on growth, but we're trying to sell as much as we can because they have very good financial metrics.
Kaumil Gajrawala - UBS
And then in talking about your fiscal 2012, it sounds like depletion should be ahead of shipments. Are you willing to give some sort of estimate on what you're expecting for the depletion in fiscal 2012?
Rob Sands
In our next fiscal year we expect depletions and shipments to be essentially equal.
Bob Ryder
So this gets a little confusing. The shipments, absent shipments and depletions, will be relatively aligned, but because of FY11, the base - when you do a growth calculation depletions will grow faster than shipments, but we'll ship in absolute numbers about the same number of cases as will be depleted, if that makes sense.
Operator
Your next question comes from Judy Hong of Goldman Sachs.
Judy Hong – Goldman Sachs
First, just from a big picture perspective, obviously you guys have been focusing on at least pacing your volume in line with the category growth in the U.S. wine business.
It looks like the category, I think you said is growing at a mid-single-digit rate. Your depletions are up about 2%.
I know there's some drag in terms of these noncore brands, but can you just give us some big-picture comment about how you think you're performing in terms of the market performance, especially in light of the heightened promotional environment that you continue to see in the marketplace as well as your stepped-up spending to gain some of that share in the market?
Rob Sands
I think our performance is actually pretty good. You quoted the 2% depletion in the third quarter, and that's only for the quarter.
For the whole year our depletion growth has been in excess of that, and very much in line with the marketplace. As you also mentioned, yes, there is some drag on that depletion growth as a result of how we operate our noncore brands.
But when we really look at our core brands, which is the vast majority, vast vast majority, of our profitability in only 17 brands, as I said we had about 10% depletion growth in the third quarter, and I think that that's really indicative of the strength of the business, and I think is really the critical thing in looking at how we're performing relative to the marketplace. And that performance is well in excess of industry growth rates, so we're pretty pleased about that.
Judy Hong – Goldman Sachs
And then just a little bit more color in terms of the promotional environment. Are you looking at certain price segments or certain channels, or certain brands that are being a little bit more aggressive here?
What is your strategy to tackle that situation going forward as you relate to more price discounts, or new products, innovation, marketing, and so forth.
Rob Sands
We're looking at that very carefully. I would characterize the current environment as promotional activity in general being slightly higher than it has been in the past, or let me say versus last year.
Our promotional activity similarly has been at the higher level, but we're balancing that out, in fact, by being judicious in the way that we promote our noncore brands versus how we promote our core brands, meaning we're investing more in promoting our core brands than in our noncore brands to balance our overall promotional activity. That's part of our strategy of how we're dealing with this to make sure that it stays within our own expectations.
In the future, our total strategy around driving profitable organic growth is all about brand-building, and brand-building is really all about having brands that are strong enough to not have the degree of price sensitivity that more commodicized brands have, so that they don't have to be promoted to an extent greater than we think is necessary. So that's how we're thinking about all of this, and a lot of our activities around how we're marketing our brands and advertising our brands and the new products and line extensions that we're developing, is all about our brand-building efforts.
Judy Hong – Goldman Sachs
And then Bob, just in terms of that mismatch between shipments and depletions, a few questions there. One is how does that play out in the fourth quarter, because last year you had a pretty significant destocking.
So I'm wondering if you're going to now benefit from a shipment perspective in the fourth quarter. Two, the 40% of the distributors that are not under the new distribution agreements, how is their inventory level right now.
And then finally, I guess the understanding in terms of fiscal '12 shipments and depletions now matching going forward, does that suggest basically the distributors that are under the new agreements will carry higher inventory than they have previously?
Bob Ryder
So your comment on Q4 is correct. I tried to indicate that a little bit in my script.
Your recollection is correct, we did reduce distributor inventories last year in the fourth quarter in return for some distributor investments in our brands. We thought that was a pretty good tradeoff.
So in the fourth quarter you should see pretty healthy sales and EBIT growth in the North American wine and spirit category. So that would be correct.
And for the full year, our EBIT should be pretty well aligned with the guidance we provided at the beginning of the year and actually might be slightly higher than what you guys think on average. So that's the Q4 comment.
On the other distributors, meaning the distributors that were not converted to a consolidated distributor system, that's been business as usual. So ships have pretty much equaled depletes all along.
There's not been a lot of action there. And as far as FY12, again you are correct.
The way we distribute our contracts, or agree to, was that there was this initial period of shipment guarantees and the day those shipment guarantees end the inventory on that day stays with the distributors through the end of the contract. So it does get a bit confusing.
So as of the end of this year, those shipment guarantees end, so next year we expect in general shipments to equal depletions. However, as you do a growth calculation, the sales growth will be less than the depletion growth, simply because of the respective denominators.
Operator
Your next question comes from Vivien Azer of Citi.
Vivien Azer – Citigroup
I'm just wondering, with respect to your distributors is there a difference in the product mix that they're selling, i.e. that the five distributors that have 60% of your volume do they skew more to your focus brands or is it pretty much even across your distribution system?
Rob Sands
No, there's not really a difference in - I mean there's differences in makes and markets and in distributors in general, but as a general proposition there's no difference in mix in the distributors that have contracts versus those that don't. We as a company are very focused on mix, and driving the mix towards our core brands, which are higher margin, higher gross profit as a general proposition, and that gives us the opportunity not only for depletion growth but also for a positive mix effect.
So that's what we try to do in general across all our markets, but there isn't a huge difference or there's nothing peculiar about mix in distributors with contracts versus those that don't have contracts.
Vivien Azer – Citigroup
The reason I asked is while I understand that there is a difference between the depletions and the shipments from a growth perspective and how that's going to impact FY12. I guess I'm still kind of surprised because you're putting up such good depletion growth for your higher margin brands that that's not going to show up any more in EBIT than what you've indicated for FY12.
Rob Sands
That also emanates from the fact that the shipment guarantees that were in place this year also took into account mix, and therefore shipments next year will be at a similar mix level as this year because we're comparing shipments not depletions. Whereas, as to what we're doing in the market place it's all about driving depletions for future growth and for future mix benefits.
I'm sorry that this is as confusing as it is, but it's shipments versus shipments from a financial point of view but from an underlying growth perspective it's depletions versus depletions, year-over-year.
Bob Ryder
And what we have seen, in the market and IRI, we have seen positive mix shift. The whole market has seen positive mix shifts.
We don't anticipate that changing dramatically next year, but the gravity is basically just overlapping the fact that shipments exceeded depletions in fiscal '11.
Operator
Your next question comes from Lauren Torres of HSBC.
Lauren Torres – HSBC
My question is on the beer business. You're benefitting, and we're seeing some upside here as a result of easy comps.
Also, coming back from some of these supply chain challenges. But with that said, I'm just curious about the actual health of the beer business, whether it be on-premise trends, also maybe with your competitors taking some pricing, how the narrowing of that price gap is helping your numbers.
Once again, just an overall sense of how these trends are improving ex the comps and ex some of these supply chain challenges.
Rob Sands
Our beer business, Crown, is, I would say, particularly healthy at the moment. As you know, we increased our guidance on what we expected on depletions this year, for the total year, to the low to mid-single-digit levels.
In the third quarter we actually experienced very solid mid-single depletion growth, up approximately 5%, and year-to-date depletions are running also in the mid-single digits. So I think that's indicative of a very healthy beer business.
Imports in general are outperforming the total beer business, the domestic beer business. Crown is outperforming the other three major suppliers.
As it relates to our specific brands, we probably have, in terms of scale brands, we have the hottest brand in the marketplace with Modelo Especial, which is now the third largest import, as I said. It's now the 15th largest beer overall.
On a dollar sales basis, it's the third-largest import. It's in excess of 30 million cases.
And it's got very strong growth. Corona Extra has returned back to growth.
So as I've said in the past, the beer business has proved to be one of the most cyclical parts of our business and the silver lining in that cloud is that as the economy continues to recover I think that the Crown business is going to continue to improve as well. So in general, we're really pleased with how Crown is performing and how that business is doing from an underlying depletion trend point of view.
Lauren Torres – HSBC
And just with respect to the relationship, obviously now that the litigation is out of the way, does that open more avenues to kind of grow your brands and open up discussions between the two? Has that changed at all?
Rob Sands
Well, the relationship is good, and the consequence of how we resolved that matter was an agreement relative to incremental spending against the brand for marketing and promotion. And I think that that's playing out well.
We've got great programs in place and I think that those programs are driving some of our results, our very positive results, really because I think that our marketing programs and advertising is truly a cut above really anything else in the industry in a lot of ways. I think that our execution is fantastic, and I think that more importantly, our brand, we have delivered a very consistent message relative to Corona Extra and our brand, which has resonated with the consumer.
As opposed to, I think, some of the herky jerky marketing programs and activities of some of the competitors, which I don't think has worked to their benefit. And it's hard to repair because the consistency hasn't been there for the number of years that it has been for Corona Extra in particular.
Lauren Torres – HSBC
And lastly, can I Bob, the cap ex guidance for this year now is $100 million to $120 million? Is that what you said?
Bob Ryder
Correct.
Lauren Torres – HSBC
So that would imply $30 million to $50 million in the fourth quarter. Just wondering why that seems a bit high relative to the last couple of quarters?
Bob Ryder
You know, if you've spent as much time with engineers as I have, they like to kind of wait until the fourth quarter to spend all their cap ex. Every company I've been at.
So it's all like year-over-year timing stuff.
Operator
Your next question comes from Dara Mohsenian of Morgan Stanley.
Dara Mohsenian - Morgan Stanley
Bob, what tax rate are you assuming in the 2012 earnings guidance range you gave us? Comparable tax rate?
Bob Ryder
Good question. I expected a lot of tax questions.
We're not giving a specific rate right now. We will on the April call, but what we're saying is the rate will not be above the rate guidance for this year, which is about 31%.
So you shouldn't expect any tax rate in FY12 above 31%.
Dara Mohsenian - Morgan Stanley
I assume that's not an ongoing tax rate, and what kind of range do you think your ongoing long-term tax rate is? Does that include some one-time benefits next year?
Bob Ryder
We generally don't give longer-term guidance, but we have, and it kind of sorted out a little bit last year, more this year, and we expect some of it in future years, some relatively positive outcomes with some tax jurisdictions we have around the world. So we're seeing that flow through a lower effective tax rate, and you also see some lower cash tax payments as well, so we're very happy with our tax rates and we think that's why we can say this year will be a low rate and next year will be a low rate.
But when the dust settles, and this could be a number of years out, if we're just a North American business, generally in the U.S. tax rates are higher than anywhere else in the world.
So I wouldn't assume that we're going to have a 31% tax rate for like a 12-year duration, but I think we'll have some positive tax outcomes for the relative near future.
Dara Mohsenian - Morgan Stanley
And then Rob, you commented promotional levels in wine were worse than you expected. Can you give us more detail there?
Is it a significant gap? And it sounds like you'll be matching that with higher than expected promotional levels on your part than you originally expected?
Rob Sands
I said that they're a little higher than perhaps we had expected. I wouldn't say that it's anything particularly outstanding.
Our promotional levels have been higher throughout the year, but we've also had the benefit of that in our depletion trends and we don't expect anything outside of our communicated expectations for the remainder of the year. So we expect them to continue to remain moderately higher than they have in the past, but at this stage not beyond our expectations, and it's baked into all of our thinking and our guidance for the year, so that's where we're at.
Operator
Your next question comes from Mark Swartzberg of Stifel Nicolaus.
Mark Swartzberg – Stifel Nicolaus
A few questions, but staying here on wine, the promotional spending being a little bit higher in the quarter than expected, a little higher in the coming quarter than expected. I wonder if we could kind of step back a little bit here.
And the game plan here circa summer of 2009, I guess, was to do things that are going to allow you to improve share and we're yet to see that happening. And the spending is going to be greater than what you had anticipated.
So sometimes these things take longer than anticipated, but can you just kind of give us a state of the union in terms of what you think from a one-year, two-year, three-year timeframe from here. Do you think there's going to be the things that are going to allow you to actually deliver on that hope of indeed being a share taker without dollars being the only driver of that?
Rob Sands
Yeah, when you're looking at the longer range, the thing that we're trying to accomplish as I said is all about the underlying depletion growth. And we've established some pretty good trends in our underlying depletion growth as it relates to both actual percentage growth and mix, meaning that if you look at our depletion mix, in terms of dollar sales of depletions, it would be significantly ahead of our actual physical case growth.
Therefore, as we move into periods next year and the year after and so on and so forth where the depletions equal shipments and we don't have this overlap and the imbalance issue, and we won't. That's going to bode very well for our underlying growth, and let me put it this way, as that starts to flow through to sales, we ought to be able to leverage that throughout the P&L to a positive net income result.
Mark Swartzberg – Stifel Nicolaus
So you feel like it's early innings - I guess I'm still struggling, but okay. Fair enough.
As we look at the contract you have with these larger distributors and that 60% of volume, can you remind us what the duration on them is, how much time is left on them? And then if we think, and I realize there's confidentiality here, but if we think from their perspective in terms of early termination rights, are there share objectives that have to be achieved?
Are there certain absolute rates of depletion growth? Can you talk a little bit about what rights they have it there comes a point where they're not happy with the relationship?
Rob Sands
Contracts generally run for about 5.5 years from our fiscal 2010 and [inaudible] includes fiscal 2010. So partially through '15, fiscal year '15.
Mark Swartzberg – Stifel Nicolaus
And any thoughts on early termination or performance provisions that would make it earlier?
Rob Sands
No. There's generally, related to performance, no early termination.
In fact, it's the opposite, in that there are incentives and disincentives in the contracts for distributor performance, meaning if distributors overperform there's incentives for them. If they underperform there's disincentives for them.
But there's not early termination so to speak.
Mark Swartzberg – Stifel Nicolaus
And then just shifting over to the Ruffino comment, can you just - I realize it's a dispute, but from Ruffino's perspective what kind of number are we talking about in terms of the put they're trying to implement here?
Bob Ryder
It was in last year's Q and there will be a little bit more verbiage in this quarter's Q as in last quarter's Q. The maximum amount of the put is EUR55 million.
We're disputing the put in total. But under SEC regs we have to disclose the maximum amount of the put, so that's EUR55 million.
Mark Swartzberg – Stifel Nicolaus
And Bob, also on the tax rate, can you talk a little bit more, kind of flesh it out a little bit more in terms of what's driving this improvement? It seems like you think it will be multi-year in nature.
Can you talk in a little bit more detail about what is the source of these improvements?
Bob Ryder
In the tax world, it gets so complicated. And the other thing is there's these big time lags between, you know, when the original tax return was filed and when the ultimate settlement happens that we'd rather not talk about specifics.
Mark Swartzberg – Stifel Nicolaus
And then last one, over on beer, can you give us some sense of how December was? Obviously weather was an issue, but the industry, or at least your business, picked up nicely in the quarter, your quarter.
Can you talk about December?
Bob Ryder
I don't know if we can talk about December specifically, but right now both us and the Crown business are very happy with the momentum that our beer business has. In the third quarter, Corona Extra, as Rob had mentioned, actually registered positive growth, which is the first time since the JV was formed, so we're very happy about that.
We think that's some of our nice marketing, and we've done some restructuring in our sales organization, so we think our execution is getting a little bit better there. And we remain quite bullish on Modelo Especial, which you know as Rob said, is at 30 million cases, and it's still growing at 15-20%.
It's pretty amazing. And we're very bullish, although very early days, on the launch of Victoria.
We're bringing it into new states next year, so we expect pretty good things from that brand, which also has a high deal of brand equity and resonates pretty immediately with, especially the Hispanic community, but we think it could even have legs beyond that.
Operator
Your next question comes from Timothy Ramey of D.A. Davidson.
Tim Ramey – D.A. Davidson
Just as we think about the target inventory levels before the end of the fourth quarter, the idea of freezing them, are there levers that the distributors can pull in terms of incremental promotion to kind of work those down since there, I assume, would be a multi-year incentive for them to do extra-well this quarter.
Rob Sands
To work what down?
Tim Ramey – D.A. Davidson
Their distributor inventory.
Rob Sands
Yeah, there are some mechanisms in the contract that the distributors can utilize to pull down inventory through overperformance, yes.
Tim Ramey – D.A. Davidson
Does any of that require copayment along with you, or co-investment, or how does that work?
Rob Sands
That's up to them how they generate the performance other than they can't generate performance in a manner that's not to the benefit of the brand. But they can increase their investment against the brand to drive growth as long as it's done in a manner that's consistent with the brand health.
Bob Ryder
And they can't, irrespective of what they do, they can't force us to do anything that we do not want to do, so we're kind of independent. So they can spend more promotion out of their pocket if they want, but it has to be consistent with what we both agree is the brand equity.
And no matter what they do, they cannot force us to follow them.
Tim Ramey – D.A. Davidson
So in general, the fourth quarter performance could be both organically and optically a little better than what -
Bob Ryder
Well, fourth quarter, again, on a year-over-year basis, we're overlapping the fact that we took inventories down last year, so that will make both sales and EBIT growth look pretty robust in the fourth quarter, but that's mostly a prior-year overlap issue. Normally, the third quarter is the Christmas build.
Everybody builds inventory in the third quarter. The normal cadence would be for the fourth quarter for depletions to actually exceed shipments as that Christmas inventory kind of gets [inaudible].
Operator
Your next question comes from Christine Farkas of Bank of America Merrill Lynch.
Christine Farkas – Bank of America Merrill Lynch
I had a question on Australia and grapes if I could. One of the beautiful things about the global structure of Constellation is your ability to source globally, and I'm just wondering if the sale of the Australian operations will change that ability to act as to or source the [inaudible] from Australia to use in some of your operations.
Rob Sands
Nope. Doesn't change that.
In fact, it gives us more flexibility over the longer range than less flexibility, because we're not tied any further to the bricks and mortars of our own operations and therefore if there are supply imbalances or oversupply around the world in various appellations, whether it's Australia or otherwise, we can take advantage of that and take advantage of favorable pricing trends to buy bulk wine if that's what we decide to do, from other operation. Whereas obviously if you've got your own vineyard, plants, etc.
your first instinct would be to utilize your own production regardless of how that matches up with other opportunities that are available in the marketplace. Or advantageous situations.
Christine Farkas – Bank of America Merrill Lynch
Then if the reverse were true, if there was a shortage, that's where your scale would potentially come into advantage as well?
Rob Sands
You could say that, but there's no shortages anticipated in the near future on a worldwide basis, and we certainly have sufficient production capabilities in the rest of the business overall to meet any demand needs that we think could be foreseeable as well as the ability to move or switch appellations in brand, certain brands, where it's appropriate, as we need to do. So we don't anticipate any issue in that regard in any timeframe that would be of concern to any of us, you or I.
Christine Farkas – Bank of America Merrill Lynch
And then just to round out on grapes, you did mention or highlight grape costs as a source of pressure on gross margins. I'm wondering if you could just highlight for us where we are in that inventory.
Is this high-cost inventory going to run through for the next few quarters, or are we at the end of that? Just kind of frame how that inventory situation is working out.
Bob Ryder
In the U.S. the harvest year '08 was a relatively expensive harvest, and that is flushing through cost of goods sold this year, which is making the fiscal '11 COGS look higher than fiscal '10.
We expect most of that to flush through this year. There might be a tiny amount in next year, but it probably won't be noticeable.
So that should be behind us. The opposite is happening on the Australia COGS, where last year they flushed through more expensive grapes in fiscal '10 than we are seeing in fiscal '11, but of course that won't be much more of a concern to us on a consolidated basis.
It will only be a concern for our 20% equity interest in the new entity.
Operator
Your final question comes from Carlos Laboy of Credit Suisse.
Carlos Laboy - Credit Suisse
Rob, how do you gauge, or what is the danger, that these line distributors build excessive inventories to meet these distribution commitments? And if it does happen, what do you do about it?
How do you go about it?
Rob Sands
Well, first of all, the distributors don't have excessive inventories, and the shipment guarantees are over, and so on average those distributors with shipment guarantees are running about 2-3 months of inventory, which is pretty standard in the industry. So if anything, you might argue that inventory levels are where we want them - that's we, meaning us, the supplier.
Distributors would always like to have lower inventories to higher inventories. And since the shipment guarantees are over, in one case halfway through this fiscal year and the rest of the cases at the end of the fiscal year, and then under the agreement shipments have to equal depletes, those inventory levels in terms of number of cases will remain where they are.
Now, they'll come down as the business grows, or if the business grows let me say, which of course we expect that it will, but they'll come down in a number of days as the business grows thereafter.
Carlos Laboy - Credit Suisse
And to close out with a beer question, Rob, would you buy back the other 50% of Crown if you could? And what keeps you from asking for it?
Rob Sands
My answer to that is I really can't comment on that. We have no intention at the current time of buying back the other 50% interest in Crown.
I did see what you wrote in Beer Business Daily, by the way, or your quote in Beer Business Daily. But obviously that's your own speculation and we as I said really have no plans that we can comment on.
Operator
That was your final question. I'll now turn the call back over to Rob Sands for closing remarks.
Rob Sands
Well thank you everybody for joining our call today. I am pleased with our third quarter, and would like to summarize the highlights as follows.
Number one, we did generate very strong free cash flow, which has enabled us to not only fund our share buyback, but has allowed us to continue our debt reduction efforts. We increased our free cash flow target for the year and believe it is sustainable for the longer term.
We are experiencing strong momentum in our imported beer business, and marketplace trends for our U.S. wine and spirits business are healthy and our U.S.
distributor initiative is working. Our plan is to continue solid execution of our initiatives throughout the final quarter of the year.
I would also like to mention that we are planning an investor day in New York City in the mid-May timeframe, so stay tuned for the details. Thanks again for your participation.