Jan 9, 2013
Executives
Patty Yahn-Urlaub - VP of IR Rob Sands - CEO, President Bob Ryder - CFO
Analysts
Kaumil Gajrawala - UBS Judy Hong - Goldman Sachs Lauren Torres - HSBC Bryan Spillane - Bank of America Reza Vahabzadeh - Barclays (Robert Hartenstein) - ISI Mark Swartzberg - Stifel Nicolaus Vivien Azer - Citigroup Carla Casella - JPMorgan Brent Cooper - Consumer Edge Research
Operator
Patty Yahn-Urlaub
And now I would like to focus our discussion on Constellation's third quarter fiscal 2013 sales and earnings results. This year is unfolding as expected.
As we continue to execute in achieving our overall strategic and financial goals across our beer line and spirits businesses. On a year-to-date basis through the third quarter, we gained market share for our Canadian wine business as well as our US wine and spirits businesses collectively cross all channels, posting solid depletion trends while maintaining excellent marketplace momentum, particularly for our collection of focus brands.
Our focused efforts in the area of brand building, innovation and new product development are also paying off as we are benefitting from positive mix trends and distribution gains at retail as well as receiving great consumer response to our new product introductions in the marketplace. As you know, these initiatives represent primary growth drivers for us going forward as they are also key contributors to overall US market growth, some of our strong marketplace momentum through calendar year and has been driven by this year's incremental investments in promotion and marketing, a portion of which is in connection with the launch of more than 50 new products this year.
And I would like to remind everybody that as we headed into this year's fiscal fourth quarter, we began to overlap last year's increase in promotional activity. One of the things of which I am particularly proud is the ongoing strain of awards and accolades that we continue to receive from several prominent wine industries and publications for many of our new products and our focus brands.
They include the following: the 2009 Robert Mondavi Cabernet Sauvignon Reserve was recently awarded a 94 point score from Robert Parkers, the line advocate; wine.com, the nation's number one online wine retailer recently released its top 100 list based entirely on consumer preferences. Some of the excellent Constellation brands that made the list include Robert Mondavi, Ruffino, Mt.
Veeder and Kim Crawford. Impact presented blue chip awards to Estancia and Robert Mondavi Private Selection (inaudible) while hot brand awards were given to Black Box, Franciscan, Kim Crawford and Rex Goliath.
In recent issues of Wine Enthusiast, several of our well recognized brands were awarded 90 plus point scores, including Robert Mondavi, Hogue, Ruffino, Wild Horse, Raven's Wood and (inaudible). From a new product perspective, beverage information grouped 2012 growth brand awards included the Dreaming Tree, Primal Roots, (Brio Halbega) and Simply Naked, while we also received impact hot prospect awards for Primal Roots, the Dreaming Tree, Simply Naked and (Escenia).
The Rex Goliath free range red won 2012 best red wine under $8 from the World Value Wine Challenge competition. Additionally, I would like to highlight the fact that our Mark West brand, which has been an exciting addition to our portfolio, posted third quarter marketplace volume growth of almost 30% while gaining share of the ultra premium price category in the symphony IRI channels.
From a spirits perspective, in an effort to enhance (spective)'s flavor lineup, we will soon be introducing two new unique flavors, strawberry colada and orange cream pop. For the third quarter, (Spectra) posted Symphony IRI growth of more than 20% in addition to gaining volume share of the boxed category.
Black Velvet Reserve whiskey recently earned a rating of 91 points and took best in class for Canadian whiskey at the Los Angeles 2012 International Wine and Spirits competition. In addition, the new Black Velvet Toasted Caramel has capitalized on the hot trend of flavored whiskeys, driving overall growth of the Black Velvet brand and Symphony IRI channels to more than 20% during the third quarter.
Before we move on to a discussion of the beer business, I would like to mention that one of the most frequently asked question I receive relates to the current pricing environment within the US wine industry.
Robert S. Sands
And now I would like to focus our discussion on Constellation's third quarter fiscal 2013 sales and earnings results. This year is unfolding as expected.
As we continue to execute in achieving our overall strategic and financial goals across our beer line and spirits businesses. On a year-to-date basis through the third quarter, we gained market share for our Canadian wine business as well as our US wine and spirits businesses collectively cross all channels, posting solid depletion trends while maintaining excellent marketplace momentum, particularly for our collection of focus brands.
Our focused efforts in the area of brand building, innovation and new product development are also paying off as we are benefitting from positive mix trends and distribution gains at retail as well as receiving great consumer response to our new product introductions in the marketplace. As you know, these initiatives represent primary growth drivers for us going forward as they are also key contributors to overall US market growth, some of our strong marketplace momentum through calendar year and has been driven by this year's incremental investments in promotion and marketing, a portion of which is in connection with the launch of more than 50 new products this year.
And I would like to remind everybody that as we headed into this year's fiscal fourth quarter, we began to overlap last year's increase in promotional activity. One of the things of which I am particularly proud is the ongoing strain of awards and accolades that we continue to receive from several prominent wine industries and publications for many of our new products and our focus brands.
They include the following: the 2009 Robert Mondavi Cabernet Sauvignon Reserve was recently awarded a 94 point score from Robert Parkers, the line advocate; wine.com, the nation's number one online wine retailer recently released its top 100 list based entirely on consumer preferences. Some of the excellent Constellation brands that made the list include Robert Mondavi, Ruffino, Mt.
Veeder and Kim Crawford. Impact presented blue chip awards to Estancia and Robert Mondavi Private Selection (inaudible) while hot brand awards were given to Black Box, Franciscan, Kim Crawford and Rex Goliath.
In recent issues of Wine Enthusiast, several of our well recognized brands were awarded 90 plus point scores, including Robert Mondavi, Hogue, Ruffino, Wild Horse, Raven's Wood and (inaudible). From a new product perspective, beverage information grouped 2012 growth brand awards included the Dreaming Tree, Primal Roots, (Brio Halbega) and Simply Naked, while we also received impact hot prospect awards for Primal Roots, the Dreaming Tree, Simply Naked and (Escenia).
The Rex Goliath free range red won 2012 best red wine under $8 from the World Value Wine Challenge competition. Additionally, I would like to highlight the fact that our Mark West brand, which has been an exciting addition to our portfolio, posted third quarter marketplace volume growth of almost 30% while gaining share of the ultra premium price category in the symphony IRI channels.
From a spirits perspective, in an effort to enhance (spective)'s flavor lineup, we will soon be introducing two new unique flavors, strawberry colada and orange cream pop. For the third quarter, (Spectra) posted Symphony IRI growth of more than 20% in addition to gaining volume share of the boxed category.
Black Velvet Reserve whiskey recently earned a rating of 91 points and took best in class for Canadian whiskey at the Los Angeles 2012 International Wine and Spirits competition. In addition, the new Black Velvet Toasted Caramel has capitalized on the hot trend of flavored whiskeys, driving overall growth of the Black Velvet brand and Symphony IRI channels to more than 20% during the third quarter.
Before we move on to a discussion of the beer business, I would like to mention that one of the most frequently asked question I receive relates to the current pricing environment within the US wine industry.
Bob Ryder
For the quarter, our consolidated gross margin was 41% versus 40.5% for the prior year. This reflects the benefits from favorable mix and the consolidation of the higher margin Ruffino and Mark West brands partially offset by the increase in promotional spending.
Wine and spirits segment operating income increased $24 million to $197 million primarily due to the positive sales and gross margin results I just outlined partially offset by an increase in SG&A expense which was primarily related to an overlap of a favorable trade mark related legal settlement in Q3 of last year. Corporate costs increased $4 million primarily due to the overlap of a benefit recognized in Q3 of last year from the early redemption of notes receivable from Accolade, our former Australian and UK business.
Consolidated equity earnings totaled $53 million and were level with the prior year quarter. Equity earnings for Crown totaled $39 million versus $43 million last year.
The remainder of the equity earnings in Q3 of both fiscal '13 and fiscal '12 are primarily generated by our Open Swan joint venture. For the quarter, Crown generated net sales of $547 million, an increase of 1% and operating income of $79 million, a decrease of 9%.
Third quarter net sales for Crown were tempered by the Q2 wholesaler buy-in of beer in advance of the planned price increases and the loss of St. Pauli Girl brand volume.
Crown's operating income was impacted by the volume shift and timing of marketing spend. Interest expense for the quarter was $61 million, up 33% versus last year.
The increase was primarily due to the higher average debt balances. To better help frame in the drivers of the interest increase, let me discuss our debt position.
At the end of November, our total debt was just under $4 billion. This represents an $866 million increase from our debt level at the end of fiscal '12.
We also finished November with $201 million of available cash on our balance sheet. The higher than normal cash balance primarily relates to the funding of the pending Crown acquisition.
As a reminder, in Q2, as part of securing the permanent financing for the $1.85 billion Crown transaction, we issued $650 million of 4.625% senior notes due in 2023. The cash proceeds from the notes issuance were placed in escrow and will be released when the Crown transaction closes.
As a result, this cash has been recorded as restricted cash on our balance sheet. After factoring in the cash and restricted cash, our net debt at the end of November was $3.1 billion and our net debt to comparable basis EBITDA ratio came in at 3.5 times.
Also, as an additional reminder, during the first quarter, we refinanced our senior credit facility and issued $600 million of 6% 10-year senior notes. Proceeds from this note issuance, along with our free cash flow generation and proceeds from stock option exercises have been effectively used to reduce borrowings under our revolving credit facility and to fund the Q1 share repurchases and the Mark West acquisition.
In December, we entered into an accounts receivable securitization facility, which can provide up to $250 million in liquidity at and interest rate that is generally expected to be about 75 basis points lower than our revolving credit facility. This new facility further enhances our financial flexibility as our $850 million revolving credit facility continues to remain in place.
We will reassess our revolving credit facility after the Crown acquisition closes. We continue to expect interest expense for fiscal 2013 to be in the range of $225 million to $235 million.
Our comparable basis effective tax rate came in at 28% compared to 37% for Q3 last year. The favorable rate in the quarter was driven by higher foreign tax credits.
As mentioned earlier, we now anticipate the full year fiscal '13 effective tax rate to approximately 27% as a result of the foreign tax credits and some anticipated state tax benefits.
Operator
So that could be the reason why we're really not seeing any slow down or impact of our pricing thus far because it was a pretty modest increase.
Kaumil Gajrawala - UBS
So that could be the reason why we're really not seeing any slow down or impact of our pricing thus far because it was a pretty modest increase.
Robert S. Sands
So that could be the reason why we're really not seeing any slow down or impact of our pricing thus far because it was a pretty modest increase.
Kaumil Gajrawala - UBS
So that could be the reason why we're really not seeing any slow down or impact of our pricing thus far because it was a pretty modest increase.
Robert S. Sands
So that could be the reason why we're really not seeing any slow down or impact of our pricing thus far because it was a pretty modest increase.
Operator
Your next question comes from the line of Judy Hong - Goldman Sachs.
Judy Hong - Goldman Sachs
So first on the wine business, so it sounds like you're pretty pleased with the turnaround that you're seeing on that business with stepped up innovation, increased investments this year. Do you think that you're at a point where we could potentially see some profit improvement or do you think that you should continue to see investments perhaps exceeding sales and that compromises margin because you want to sustain the volume momentum on the wine business?
Bob Ryder
Yes, where we are now, Judy, we're sticking with our guidance for the year, so we are going to see a profit improvement in the wine and spirits segment, albeit not as high as the sales improvement. But as we said at the beginning of the year, that was our conscious effort to keep the top line moving along, to maintain or grow share and continue our momentum and to see the results of all the new products we're introducing and some additional execution focus.
So I think we continue to stick with that and that's why we're staying with the guidance for this year. Of course, we haven't given guidance for next year either but that -- we'll be assessing that.
We actually haven't had our internal annual plan meetings yet, so we'll be providing guidance for fiscal '14 in around the April timeframe.
Judy Hong - Goldman Sachs
And then just in terms of the Crown side of the business, so I know there's a lot of innovation and growth that's coming from the price segment that's premium (inaudible) that's going pretty strongly but Black Crown is coming into the market. Do you think that that changes the competitive landscape and whether you see risk to import pricing if you do have that price points really gaining momentum?
Robert Sands
We don’t' see that impacting the import segment. The import segment remains very strong.
It's driven by completely different market dynamics. Our business' demographic is significantly different than those of some of the brands that you mentioned.
So I don't see it being any issue whatsoever. If anything, it's -- rising tide will float all boats.
So I don't think it's an issue for us. If anything it portends a stronger beer business in general.
Judy Hong - Goldman Sachs
Then my last question just if you can just give some commentary around the macro, some consumer behavior, particularly as you got into more December time period. If you look at some of the measured channel data, the beverage category seemed to have slowed a big in December, so just curious whether you're seeing a similar softening across both wine and beer, anything in terms of the channel dynamic on time versus off time.
Any color there would be great.
Bob Ryder
Yes, so I think we've seen all three categories -- wine, beer and spirits -- slow down as we have moved into the fourth quarter this year and we have seen the on premise slow down as well. The on premise was probably in positive territory at the beginning of the year and as we've moved into fourth quarter we're estimating that the on premise is probably down for beverage alcohol about 3%.
So we've seen a slow down there. The whys and wherefores of the slow down are hard to know for sure.
We pretty much think that it's probably related to all of this fiscal cliff business, which impacted retail in general across all consumer goods but that's about the only thing that we can really say with respect to that. That said, the beverage alcohol category still fundamentally remains pretty strong.
If we look at wine, there’s very, very strong trading up going on in wine. Just for example in the quarter, the wine industry was up about 2% in volume and 6% in dollars, with the premium plus and super premium plus categories growing double digits.So things are fundamentally good, although there has been a bit of a slowdown.
And if you look at our business, getting more granular here, I would say that our business performed pretty much on expectations for the holiday season. So we’re not seeing any issue with respect to the full year in that regard.
Operator
Lauren Torres - HSBC
Robert S. Sands
Lauren Torres - HSBC
Robert S. Sands
Operator
Bryan Spillane - Bank of America
Bob Ryder
Bryan Spillane - Bank of America
Robert Sands
Yes, we've discussed this before. It was a good harvest this year, both quantity and I spent a lot of time out in California with the wine makers and I've never seen them happier about the quality of the products.
We're going to have some just fantastic wines when these come out to the consumer. But, look, it's a competitive marketplace.
The price per ton for the grapes did go up for everybody and we were just as impacted as everybody else. Now, we're a little bit more broad, so it depends what geography you're buying the wine from.
But we're buying a lot from all the regions because we have wines that hit all the different price points. But our cost per ton of wine in our tanks as we sit now is -- will be higher year-over-year when that wine comes out and hits cost of sales.
Bryan Spillane - Bank of America
One last one just in terms of the mix dynamic in wine. Your mix was pretty good this quarter in terms of price mix even in context of having some promotion.
Can you talk a little bit about, A, just some of the drivers of mix within your wine and spirit segment first? And then second, are you seeing any evidence in the market at this point that as you're seeing prices rise at the value segment are consumers trading the next price tier at all?
Bob Ryder
Yes, if you look at IRI, you can see pricing in the below $5 a bottle and volumes aren't all that great in that price scheme but they really haven't been recently. When you play in that price segment you have a pretty thin margin, so if your cost of goods go up, you've got to pretty much price it on to stay profitable.
But I think in the wine categories, Rob said earlier, wine above $5 a bottle continues to grow much faster than wine below $5 a bottle and we are benefitting from that industry trend. In addition to that, because we've added global Ruffino sales and we've added Mark West to our portfolio year-over-year, they are both higher price point wines and higher gross profit margin wines, so that's also helping us from a mix perspective.
Operator
Your next question comes from the line of Reza Vahabzadeh - Barclays.
Reza Vahabzadeh - Barclays
Yes, just on the M&A front, obviously you have a big transaction pending right now but you were able to get some smaller tuck-in transactions done earlier this year. Are there more opportunities of that type that you are looking for, a type similar to Mark West as well as Ruffino or are you just really focused on the base business?
Bob Ryder
Yes, I think that if we see some strategic tuck-in opportunities manifest themselves we will consider taking advantage of them. Ruffino's worked real well.
Mark West has worked real well. Those are great opportunities to fill in niches in the portfolio that are very strategic and will generate a very good return for the company.
So if those type of opportunities present themselves, we will avail ourselves of it.
Reza Vahabzadeh - Barclays
And then as far as mix, are you seeing any sales mix or volume really moving from the $10 to $15 price range back down to the $5 to $10 range or any other volume shift within those price buckets that you operate in?
Bob Ryder
No, I think that mix is generally improving in the industry, favoring the higher price product, not the lower price product, so basically people are trading up period from the $5 to the above $5, from the $8 to $12 to the above $12. So we see very, very positive mix shift in general occurring in that whole segment, so from $0 to say $20.
Operator
Your next question comes from the line of (Robert Hartenstein) - ISI.
(Robert Hartenstein) - ISI
Mark West, I think you said volumes were up about 35%. Can you talk a little bit about where you are in terms of penetration of that brand and remind us on your acquisition criteria in terms of return on invested capital and how close are you to hitting your targets on Mark West and, if you aren't there yet, when do you think you will be?
Robert Sands
Yes, so first of all, I think we said the brand was up about 30%, which is very strong. And in terms of penetration, Mark West has very, very good on premise distribution as well as very good off premise distribution.
In terms of our targets, Mark West has exceeded our expectations with respect of what we thought the brand would do. We probably anticipated some transition risk in buying the brand.
The transition risk has not come to fruition. The brand has continued to grow basically at the same rates that it was growing prior to the acquisition.
In terms of our acquisition criteria, we are always looking and anticipate a return significantly in excess of our weighted average cost of capital and we fully expect that to be the case with the Mark West acquisition which is running ahead of our expectations.
Bob Ryder
Yes, just to follow up on that, Robert, Mark West, as you recall, we didn't buy any hard assets. So what we bought was the brand and the grape contracts, so to Rob's point, the returns can be better on that because we can plug it into an existing winery and it actually leverages existing fixed costs.
(Robert Hartenstein) - ISI
Can you just give us a sense of timing of when you'll hit -- when you think you'll hit your cost to capital on that or are you there already and when you may be able to exceed? I'm just trying to get a sense of how long it takes to get there.
Bob Ryder
Yes, I would say on a transaction like this we would expect to hit it within a couple years.
(Robert Hartenstein) - ISI
And then exceed it by several hundred basis points pretty soon after?
Bob Ryder
Yes.
Operator
Your next question comes from the line of Mark Swartzberg - Stifel Nicolaus.
Mark Swartzberg - Stifel Nicolaus
Rob, two-part question on the wine business, firstly, can you speak generally about how you think about promotions? It sounds like with the on premise trend you just cited to Judy in having this nice quality high level of inventory you have a bias for continued promotion.
Is that a fair way of thinking about it? That's question one.
And then question two is in the quarter, do you still think you'll have positive depletions in light of what you're saying about the on premise trade?
Robert Sands
Yes, so first of all, Mark, as it relates to promotions, yes, it really is vastly related to the off premise and how we sell in the off premise. Remember the on premise is only about 15% of our wine business.
So the promotional activity is really geared -- although there is some on the on premise -- but it's really geared around the off premise and it's all about driving merchandising of our brand, so basically ads, displays and deals for the consumer in the marketplace because that's what drives in the wine business, in particular, growth. It's getting the product on the floor and getting it in feature ads by the retailers.
So it's mostly an off premise activity. And then, no, we don't expect the slow down on the on premise to really affect the business overall because percentage wise, you're really talking about only 15% of the business and then to the extent that there is a slow down, it's a pretty small percent.
So it's a small percent of the small percent, so it's not going to have any significant impact on our results. Despite the fact that the on premise has slowed down, we have some pretty strong brands that continue to grow very nicely and rapidly in the on premise, Mark West being a really good example of that, Kim Crawford being a good example.
So we expect -- and Ruffino being a good example. Those were brands that regardless of the slowdown will continue to generate strong results in the on premise.
So we don't really expect that to have any impact on us.
Mark Swartzberg - Stifel Nicolaus
If I could follow up, it sounds like you think low-single digit depletions all channel is still a pretty good go for a rate of growth for you guys.
Robert Sands
Yes, more like -- yes, more like mid, low to mid. You're talking wine, right?
Mark Swartzberg - Stifel Nicolaus
Yes, yes, US wine.
Robert Sands
Yes, so mid and beer, too, for that matter. But year-to-date we're at about 3.5% depletion growth, which is ahead of the market by probably 100 basis points.
Mark Swartzberg - Stifel Nicolaus
So the thing that's driving my question -- I think you've answered it -- is that in the quarter you had plus 3.5% and in the prior quarter it was plus 7%, so I'm just trying to get a sense if you feel like you reached a leveling off steady state rate of growth. It sounds like you did.
Robert Sands
Well, as we've said for the full year we're anticipating mid-single digit depletion growth.
Bob Ryder
Yes, Mark, I would just repeat what I said in my script because there's just a lot of noise in line of beer by quarter. So year-to-date wine depletions are up about 3.6%.
That's growing faster than the category, so the category is healthy. We're a little bit healthier.
If you look at the full year -- and I think our full-year guidance is around that mid-single digit. So we're pretty happy with that level.
Operator
Your next question comes from the line of Vivien Azer - Citigroup.
Vivien Azer - Citigroup
My first question has to do with your new product introductions. In wine you clearly have been very active.
I'm curious if you can comment on the contribution that new innovation -- and the contribution you've seen from new innovation to your shipment or depletion growth.
Robert Sands
Yes, as we define it, new products, which are products that have been introduced in the last 24 months, are contributing about 5% to 6%. In terms of volume, a little bit more, in terms of net sales, about 7%.
Vivien Azer - Citigroup
And can you comment on what impact the absence of St. Pauli had on the Crown Imports business this quarter?
Robert Sands
It overall for the year we're looking at about 2 million cases and it's about maybe 1% with the impact. So yes, it's not a big deal here.
Operator
Your next question comes from the line of Carla Casella - JPMorgan.
Carla Casella - JPMorgan
I'm wondering if the impact, if you'll have any impact on the industry from the fires and the drought we're seeing in Australia right now.
Robert Sands
Well, not for us, but I don't think so. I don't think we're going to see too much impact.
I mean, Australia in general remains over supplied as a general proposition, so anything that impacts supply in Australia is probably good. Now, our participation in Australia at this stage is really largely through our 20% interest in Accolade, which were the Australian assets that we sold off a couple years ago.
So we're not impacted by it.
Carla Casella - JPMorgan
When you look at your total grape buy for I guess either last year or this coming year, how much of it is coming from US versus other key markets? I guess when you talk about buying bulk wine, is that coming from US or is that coming from other markets?
Robert Sands
Both. The vast majority is US but we buy lots of non-US bulk as well, especially for the Canadian market, which has particular -- which is quite different from the US market in that they have a segment of product called international -- yes, well, (inaudible) international content.
So we buy a lot of bulk wine for -- bulk imported wine for the Canadian market.
Carla Casella - JPMorgan
Then there's been a lot of talk about the on premise sales. How much of the -- I'm trying to get a sense of how much is the business' on versus off premise and how much it differs for wine versus beer.
Robert Sands
For wine, yes, it's about 15% for us and for beer it's a little bit more, more like a quarter, 20% to 25%.
Operator
Your final question comes from the line of Brent Cooper - Consumer Edge Research.
Brent Cooper - Consumer Edge Research
I think about 1.5 years ago on your analyst -- when you guys talked about blending technique, taking costs out and I'm trying to recall what the timeframe was that we're going to see that. So as we're going to calendar '13 and fiscal '14, can you just update us on those efforts and if we're likely to see the benefit of those.
Is that this year or is that a calendar '14, fiscal '15 benefit for you guys?
Robert Sands
Yes, I would say that we will start to see some of it in the fourth quarter this year. Most of it will come next year and what's ending up happening is those savings, which we can see and they are real, are helping to offset some of the input cost inflation from a higher cost per ton grapes that we've seen in the harvest for the calendar '11 harvest and the calendar '12 harvest.
Brent Cooper - Consumer Edge Research
And just to be clear, when you say the fourth quarter this year, you mean fiscal '13.
Robert Sands
Yes. Some in fiscal '13 but most of it will come next year, the whites this year and most of the reds and most of the whites next year.
Operator
This concludes the question-and-answer session for today. I would now like to turn the call back over to Rob Sands for any closing remarks.
Rob Sands
Well, thank, everybody, for joining our call today. As I mentioned, we are very excited about the Crown deal and I look forward to seeing you in New York once the deal is closed to discuss the strategy for our new business model.
I would say I'm very confident that we will meet our financial and strategic goals as our plan is to continue sell and execution of our initiatives throughout the final quarter of the year. So thanks, again, for your participation today.
Operator
Thank you. This concludes today's conference call.
You may now disconnect.