Constellation Brands Inc (STZ) — Q2 2016 Earnings Call Transcript

Thank you, Jackie. Good morning, everyone. And welcome to Constellation’s second quarter fiscal 2016 conference call. I’m here this morning with Rob Sands, our President and Chief Executive Officer; and David Klein, 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 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. 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. Before turning the call over to Rob, I would like to ask that we limit the number of questions asked during Q&A session today to two questions per person. We received Investor feedback in the past indicating that the call ran long because we allowed questioners to ask unlimited questions. So I would appreciate your cooperation in helping us to end our call on schedule this morning. Thanks in advance, and now here is Rob.

Thank you, Patty, and good morning. And welcome to our discussion of Constellation’s second quarter 2016 sales and earnings results. I am very pleased with our excellent quarterly results. Our Beer business continues to deliver industry-leading results. Our Wine and Spirits business is on track to meet its goals for the year and we continue to progress as planned with our Nava brewery and glass plant expansions. Let’s drive right into the commercial and operational results we saw this quarter for our Beer business. During the second quarter, the Beer business generated double-digit depletion growth driven by exceptional consumer demand for our products across the Beer portfolio. In fact, the second quarter marks the 22nd consecutive quarter of volume market share growth for our Beer portfolio. Constellation beers represented 45% of total U.S. beer industry volume growth during the quarter, as all of our Beer brands grew across most channels and package sizes. Excellent execution by the beer team during the peak summer selling season with the 120 days of summer marketing campaign drove market share gains during the 4th of July, which continued throughout the heart of the summer and into the Labor Day holiday. This performance was led by Corona Extra and Modelo Especial. Corona Extra posted accelerating depletion and consumer takeaway trends during the summer months, driven by continuing velocity, growth and distribution gains, including the can launch and ongoing investments in media and merchandising with the new Always Summer marketing campaign. The new Corona cans continue to expand consumption occasions for the brand and are a hit with consumers. Cans represented more than 40% of the growth of the Corona Extra brand during the quarter. Throughout the summer we dedicated significant media support behind the can launch with English and Spanish language TV and digital advertising, especially during the July 4th and Labor Day holidays. We see great opportunity with this format, as it currently represents only about 5% of total Corona Extra volume. Modelo Especial delivered depletion growth of nearly 20% during the second quarter driven by continuing velocity and distribution gains. The brand's increased media investments, including the continuation of Modelo Especial's national English language TV and Video campaign continued throughout the summer months reaching the general market and bicultural Hispanic beer drinkers through targeted entertainment and sports programming. National Hispanic media included the Gold Cup Broadcast Sponsorship on Univision throughout the month of July, including in-game advertising and sponsorships. Corona Light continued to gain share with all core Corona Light packages posting growth during the quarter. Three new brand TV spots were showcased on national TV throughout the summer and the brand sponsored Kenny Chesney Tour continued with 29 tour dates from June through August. For the remainder of the year, we have solid marketing programs in place in order to maintain the excellent brand momentum we are experiencing across the portfolio. For Corona Extra, the football season continues to grow in importance through our returning partnership with Coach Jon Gruden and maintenance of key investments with the NFL, the number one program on TV. Boxing also remains a priority with Corona Extra through an integrated marketing plan to support highly anticipated fights. The momentum of the Corona can format will be supported through general market and Hispanic TV support into the fall football tailgating season. And you should expect to see our iconic Corona Feliz TV spot leading into Thanksgiving Holiday, which will be accompanied by robust on-and-off premise promotional programs designed to drive brand affinity for Corona during the holiday season. For Modelo Especial, we have added six weeks of live TV sports program on national English language TV during the start of the NFL season across CBS, FOX, ESPN and ESPN2. National Hispanic media will also continue for Modelo Especial with the weekly TV exposure to Spanish language consumers. Before moving now to a discussion of our Beer operations, I am pleased to announce today that we are launching our new Tocayo Hominy White Ale, a craft Belgian style wheat beer inspired by the culture and flavors of Mexico. The idea for this new beer brand was developed by our beer team working in conjunction with Chef Rick Bayless. It will be available beginning next week at several of Rick Bayless’ Chicago, Frontera restaurants and other key Chicago area on-premise accounts. Our Beer operations continued to run smoothly. The brewery and glass plant expansions are proceeding as planned. All key performance metrics related to cost, quality, capacity utilization and service are better than target this quarter. New bottling lines are currently being commissioned and will become fully operational by year end. Support for the expansion such as co-generation, wastewater, engine room and fire protection are all on schedule. Work continues on the next expansion phase as we increase production capability from 20 million to 25 million hectoliters and continue to expand the rail and logistics capabilities around the site. Overall, the strong results that the Beer business achieved in the second quarter are the primary driver of the upward revision to Constellation’s EPS guidance for 2016. We are now targeting EBIT growth for the Beer business in the 15% to 18%, which is expected to drive an enhanced operating margin of approximately 34% for this segment in fiscal 2016 versus our previous margin estimate of 33%. While we are currently experiencing favorable commodity and foreign currency benefits, which combined are the most significant drivers of the revised Beer margin for fiscal 2016, we have also experienced better than planned operational results driven by our glass plant performance. We are on track to bring the first 5 million hectoliters of capacity online at Nava by calendar year end. Once this capacity is operational we will be positioned to bring the next 5 million hectoliters into service by next summer. Upon completion of this 10 million hectoliters expansion, the interim supply agreement with ABI for finished goods will no longer be required as we will be fully self-sufficient from a supply perspective to fulfill our needs for the U.S. market. We expect to receive the full benefits of our targeted mid-30% operating margin goal on a more sustainable basis once we are fully operational at 20 million hectoliters at Nava. And although we are already approaching this longer term margin target, we will still have much to accomplish. I would like to remind everybody that the 5 million hectoliters of capacity that will increase Nava capacity from 20 million to 25 million hectoliters is expected to be completed by calendar 2017. Finally, given the continued strength of our Beer business, we continue to make progress in evaluating plans for our future capacity needs beyond 25 million hectoliters and we will have more to say as we finalize our plans in coming months. And now I would like to discuss the business results for our Wine and Spirits business. In the Wine and Spirits business during the second quarter we achieved earnings growth and solid margin expansion while delivering strong spirit performance and excellent overall results for our Canadian business. In the U.S., our net sales are benefiting from positive mix trends and we are maintaining IRI volume share in the U.S. wine market. We have successfully integrated our new Meiomi wine brand into our existing wine portfolio and are working to expand distribution to drive incremental growth for this brand. The most recent four-week IRI trends show that Meiomi is growing more than 80% in multi-outlet and convenience channels, which is contributing to the fact that our premium plus dollar growth improved in recent periods. Throughout the quarter our focused investments within Wine and Spirits could be seen in the marketplace. As a reminder, we are concentrating our investments and our resources on a key subset of our focus brands, because we believe they have the right combination of scale, high margins and growth potential to drive our overall business results. Let’s talk about a few examples of these programs, our TV advertising for Woodbridge aired over the summer and helped drive strong IRI growth for this brand during this timeframe. This program will rev up again in advance of our winter holiday selling season. Our Kim Crawford brand is the unrivaled leader of the New Zealand category with its distinct flavor profile and extraordinary marketing platform. This summer it kicked off an exclusive national campaign with Cirque du Soleil and executed promotional programs with co-branded advertising, offers, sweepstakes, and sampling events. Kim Crawford posted dollar growth of more than 30% in the recent IRI period. Mark West, America’s number one Pinot Noir, five-time consecutive winner of Impact's Hot Brand award is harnessing the power of its unique majority male shopper base with targeted digital Facebook ads and expanded print media in conjunction with its healthy growing campaign. And this month, we are launching Mark West’s Black to take further advantage of the Pinot Noir craze. Overall, we experienced completion trends of more than 6% for our focus brands during the second quarter, which demonstrates that this strategy is paying off. We’ve also taken some exciting steps toward our goal of developing new brands and have potential for winning big with consumers. The newest wine brand in the portfolio, Tom Gore, is named for Tom, a second-generation grape farmer, who has a passion for cultivating fruit with exceptional flavor and quality from his wines. This brand resonates with consumers' search for authenticity of the origin, ingredients and people involved in what they eat and drink. And we are very pleased with its preliminary results. During the quarter, our spirits portfolio experienced excellent net sales growth of 19% and solid depletion growth across the portfolio, driven by Paul Masson Grande Amber Brandy and the success of its peach flavor offering as well as SVEDKA Vodka led by its hit flavors, mango, pineapple, strawberry, lemonade and grapefruit jalapeno. Casa Noble Tequila is exceeding our expectations so far this year with continuing share gains after particularly strong depletion growth surrounding Cinco de Mayo. And we continue to make focused Casa Noble marketing investments in four key local markets, L.A., New York, Chicago, and Texas, where activation programs include tastings, cocktail features in collaboration with our beer portfolio for local events. Print ads targeting millennial consumers are also running in regional publications. This quarter we launched the national rollout of SERPENT'S BITE, a bold whisky infused with apple cider flavors. This product targets the intersection of three of the hardest trends in alcoholic beverages, flavored whisky, hard cider, and the shot occasion. Though it is too early to comment on long-term expectations for this brand, our retailer, and consumer feedback has been very positive. And we are pleased with what has been a fantastic start to the development of this brand. As we head into the key holiday seasons for our Wine and Spirits business, we will be executing programming design to ensure that we continue to drive growth especially for our focus brands. Our expectation is that you should see improving depletion trends as we progress throughout the remainder of the year. As is typical at this point in the year, I would like to provide an update relative to the California grape harvest which is currently more than 80% complete and is expected to be completely finished by mid-October. The current California industry estimate is for total harvest yield of 3.6 million to 3.8 million tons versus approximately 4 million tons last year. While the crop is down this year versus last, quality looks to be very good with excellent color and flavors, and our winemakers are smiling. From a pricing perspective, we continue to expect grape pricing to be flat-to-down slightly versus last year depending on the variety, locations, and demand with the exception of Cabernet, which continues to be in high demand. In closing, we are at the halfway point in the year and I’m very gratified with our impressive results so far this year. We are working diligently on the Nava brewery and glass plant expansions while maintaining the strong momentum of the beer commercial business. And within our Wine and Spirits business, we are making good progress overall and I believe we are well positioned to drive our great portfolio of brands during the upcoming holiday selling season. This December marks the 70th anniversary of our company’s founding. We are proud of our heritage and look forward to positioning our company for the next 70 years of living our vision to elevate life with every glass raised. With that, I would now like to turn the call over to David Klein for a financial discussion of our second quarter results.

Thank you, Rob, and good morning everyone. Let’s start with some Q2 highlights. Comparable basis diluted EPS was up 41%. Stellar execution by the beer business drove strong marketplace and financial results during the key summer selling season. The strong beer performance along with some favorability in our interest expense are driving our full year comparable basis diluted EPS projection up $0.20 to a range of $5 to $5.20 per share for fiscal '16. The beer performance along with lower than previously expected payments for taxes and interest are also helping to push our fiscal '16 free cash flow projection up $100 million to a range of $200 million to $300 million. And our glass plant and brewery expansion activities continue to progress as planned as we are positioned to bring the first 5 million hectoliters of additional capacity online during the second half of fiscal '16. Let’s take a closer look at our Q2 results where my comments will generally focus on comparable basis financial results. Consolidated net sales on an organic constant currency basis grew 9% through the quarter. We continue to see robust marketplace momentum for our Beer business with depletion growth of 10%. Beer net sales increased 14% on volume growth of 13%. As a reminder, during Q2 fiscal '15, we estimated that beer recall activities resulted in the reversal of approximately 2 million case shipments to wholesalers and the $37 million reduction in net sales. If you adjust last year's second quarter for the impact of this activity, volume growth in this year's second quarter would have been closer to 9% and net sales growth closer to 10%. We replenished the Q2 fiscal '15 recall volume with shipments to wholesalers during the third quarter of fiscal '15. In addition to that activity, wholesalers also increased their inventory position during the third quarter of last year to bring inventory more in line with historical levels. As a result of these activities, we will be facing a difficult beer sales and EBIT growth comparison for Q3 fiscal '16. Beer sales growth for the first half of fiscal 2016 totaled 13%. However, the difficult third quarter comparison is a primary driver of why we continue to expect full year fiscal '16 beer net sales growth to approximate 10%. We continue to expect solid third quarter depletion growth. Wine and Spirit net sales on an organic constant currency basis increased 3%. This primarily reflects higher spirit shipment volume. For the quarter, consolidated gross profit increased $93 million, up 13% with gross margin increasing 220 basis points. Beer gross profit increased $89 million, primarily due to volume growth, lower COGS, and favorable pricing and our beer gross profit margin increased 310 basis points to 48.4%. Wine and Spirits gross profit was up slightly as volume and COGS benefits were partially offset by unfavorable foreign currency translation. Gross margin increased 60 basis points to 41.6%. Consolidated SG&A for the quarter increased $5 million. Due to the factors just mentioned, consolidated operating income increased $88 million and consolidated operating margin improved 320 basis points. Beer operating margin increased 450 basis points. This improvement reflects the gross profit benefits that I just highlighted, plus favorability in marketing spend on a per case basis for the quarter. The marketing spend benefit is timing-related as we expect to see higher marketing spend during Q3 and for the full year. Wine and Spirits operating margin improved 90 basis points, primarily due to the gross profit benefits discussed earlier. Interest expense for the quarter was $77 million, down 9%. The decrease was primarily due to lower average interest rates. At the end of August, our total debt was $7.4 billion. When factoring in cash on hand, our net debt totaled $7.1 billion, a decrease of $144 million since the end of fiscal 2015. This activity primarily reflects our free cash flow generation, partially offset by the funding for the Meiomi acquisition. We now expect interest expense for fiscal 2016 to be in the range of $310 million to $320 million. The improvement in this target reflects favorability in short-term interest rates and timing of our CapEx spending versus our original plan. Our effective tax rate for the quarter came in at 24.6% compared to a 32.3% rate last year. The decrease was primarily driven by the favorable outcome of various tax items that were effectively settled in connection with IRS examinations. We still expect our full year tax rate to approximate 30.5%. As a result, we expect our tax rate for the second half of the year to run above our projected full year rate. Now, let’s review free cash flow, which we define as net cash provided by operating activities less capital expenditures. For the first half of fiscal '16, we generated $508 million of free cash flow compared to just $360 million for the same period last year. Operating cash flow totaled $803 million versus $668 million for the prior year periods. This increase was primarily due to the higher earnings generated by the Beer business. Given higher projected earnings for the Beer business and lower projected tax and interest payments, we now expect to generate operating cash flow in the range of $1.25 billion to $1.45 billion for fiscal '16. CapEx for the first half of fiscal '16 totaled $295 million and was slightly below our CapEx spending during the same timeframe last year. Our Brewery expansion activities continued to progress as planned, but we have seen some shifting in the timing of our CapEx, with higher levels of spending expected to come in the second half of the year. Overall, we are still targeting CapEx of $1.05 billion to $1.15 billion for fiscal '16, which includes $950 million to $1.05 billion for beer. Due to the factors just mentioned, we now expect fiscal '16 free cash flow to be in the range of $200 million to $300 million. Now let’s move to our full year fiscal '16 P&L outlook. As discussed earlier, due to continued strong results for our Beer business and lower than expected interest expense, we are increasing our comparable basis diluted EPS projection to $5 to $5.20 per share versus our previous $4.80 to $5 range. The Beer business continues to target mid to high single-digit volume growth and net sales growth of approximately 10%. As a reminder, fiscal '15 beer shipments went ahead of depletions as distributors brought inventories back to historical levels. As a result, we expect our fiscal '16 depletion growth rate to be in the high single-digit range and above the shipment growth rate of mid to high single-digits. We are currently experiencing favorable commodity and foreign currency benefits along with better than expected glass plant performance that are helping to drive improved operational results. Therefore, we now expect the Beer business to generate 15% to 18% operating income growth. This guidance has us targeting a beer operating margin of approximately 34% for fiscal '16. For the Wine and Spirits business, we continue to expect net sales and operating income growth to be in the low to mid single-digit range before any benefits from the Meiomi acquisition. While we anticipate improving depletion trends in the second half of fiscal '16, we expect to see most of the Wine and Spirits sales growth to be driven in Q4 versus Q3 due to shipment timing and comparisons versus the second half of fiscal '15. Our fiscal '16 comparable basis guidance excludes comparable adjustments, which are detailed in the release. Overall, we are very pleased with our results for the first half of the year and our projected sales, earnings, and operating cash flow growth for the full year of fiscal '16. And with that, we are happy to take your questions.

Hey. Good morning.

Good morning.

The fiscal 2016 beer guidance implies near 34% margins already with the FX and cost favorability. So you are really at the mid-30s long-term target rate. So, I guess why haven’t you raised the long-term guidance and when can we expect more clarity on that guidance?

We typically do not provide long-term guidance, but we have offered medium-term guidance to give an idea of our Beer business. We still aim to achieve beer margins comparable to the industry leaders in North America, and if we reach our mid-30s guidance in the medium term, we could set the benchmark. It is important to note that we are in the early stages of bringing our capacity online with Nava, and once we have that production capacity established, we will be better positioned to adjust our medium-term guidance if necessary.

Okay. That makes sense. And then I was hoping you could discuss the level of cannibalization you are seeing on Corona, with the can business doing so well, doesn’t look like it’s had much impact and also maybe conceptually, can you discuss where you think can mix for Corona can move over time versus the 5% level you had highlighted earlier?

Yeah. So, we do know there is cannibalization between the can and the bottle. When we pick apart our business and we look at the drivers and drags of our business, we see a little cannibalization. But you have to look at our numbers year-to-date and you see that our bottle depletions are up mid single-digits while our cans have expanded from 3% of our mix last year to 6% of our mix this year. So, we are seeing some cannibalization, but we are not seeing it affect the overall brand of Corona. In terms of where we think the mix can get to, our Modelo brand is more of a can-centric brand. We don’t really see Corona becoming a can-centric brand. The purpose of the can is to just provide incremental consumption occasions for our consumers.

All right. Great. Thanks.

Hi, Nik.

Yes. Thanks. Good morning. Two questions from my side. Just a quick update on the Corona Draft tests that you have been running, just any early thoughts on that. And then, I guess, the bigger picture question is on wine. Just tell me if I have this right in terms of thinking about the long-term strategy, effectively given you still have a big chunk of your portfolio in the low end of the wine category, more about harvesting those brands for profit and reinvesting in the premium end of the portfolio so you can rebalance the portfolio over time. Am I thinking about that in the right way?

Yes, Nik. So I guess I will start with the wine question first. You know in volumetric terms, it’s a large chunk of our portfolio that sort of sub-premium, but in actuality, in terms of what’s really generating our profits and the bulk of our sales, it’s our focused brands, and that’s all largely premium. And then to your question, the answer is, is basically yes as to what you have described. The strategy is definitely about not worrying too much about the non-strategic part of the portfolio, which is the sub-premium. And we did take some pricing very successfully this year in that part of the portfolio. And we are reinvesting against, as I mentioned in my script, a smaller subset of our focused brands. And we think that sort of that mix of activity will drive stronger overall results which I believe that it is and I believe that it will. So we are pretty optimistic about the Wine and Spirits business in general. This year, it’s going to be a good year. And then what’s your question on beer?

Yes. On the Corona Draft test?

Yes. I think that we continue to test Corona Draft in a number of places. And I would say that the Corona Draft test is proving to be very successful. And I guess you could ask what do we mean by that, okay? And what we do mean by that is, we see it thus far as being additive as opposed to just sort of a peer swap out on-premise. And then where we do have it, we see some positive effects in the marketplace around it, meaning in the off-premise. There seems to be a positive effect when we have Corona on Draft on the on-premise on than our off-premise sales in the area. So the test is positive, but at the same time Corona is our by far most important brand. And we are going to be very thoughtful about how we proceed basically with anything new with that brand. So good news is the brand is performing better than ever right now or at least as it relates to shorter-term history. So again, Beer business is extremely strong.

Okay. Thanks, guys.

Thank you. Good morning.

Hi, Judy.

So first on the beer depletion, the second quarter performance, 10%, pretty healthy number, but I guess that’s a little bit softer than what the Nielsen or some of the measured channel data has shown. So first, can you talk about maybe what the disconnect is there? And then your full year guidance also implies some slowdown in the back half, which also seems to be at odds with very strong acceleration that we are seeing in the measured channel data. So just wanted to get a little bit more color just in terms of the depletion trend in the second quarter and then the growth in the back half?

Yes. Our guidance indicated high single-digit growth for beer depletion performance, and we are currently surpassing that at 10%. This suggests our performance has exceeded expectations. However, given the strong growth we experienced last year, we must remain cautious about our growth predictions. I hope we can significantly surpass those figures, but maintaining a high single-digit depletion growth estimate seems prudent. We are implementing price increases in the 1% to 2% range, as we've historically mentioned. While we believe the brand is well-positioned to handle this pricing, it may still impact depletion growth. Regarding the IRI data, it only measures about half of the market, excluding segments that are currently underperforming, like the on-premise and liquor store channels. Although we are doing better than others in those areas, they aren't the highest performing. The IRI data focuses on grocery and convenience channels, which are performing strongly, hence the observed disconnect.

Okay. And David, just in terms of the glass cost, I think in your prepared comment you had called out gross margins on beer benefiting some better glass plant performance. So number one, I just wanted to get clarifications on what that means? Secondly, just in terms of your mix of what you’re now sourcing from the OI JV as well as Vitro, if you can just get a mix of where the sourcing of glass comes from as of the second quarter? And then the O-I’s proposed acquisition of Vitro, does that have any impacts on your glass sourcing arrangement going forward?

When I mentioned the performance of the glass joint venture, I was referring to the information that will be included in our quarterly report, which we plan to file today for the first time alongside our earnings call. You will see that our glass joint venture is profitable, which was unexpected due to initial startup costs. The team on the ground in Nava, along with our partners at Owens-Illinois, has done an excellent job in ensuring our facility in Nava operates smoothly. This success has led to improved profitability for the joint venture, allowing us to slightly adjust our sourcing mix towards our own glass plant rather than relying on third-party providers. This adjustment offers us immediate freight benefits related to the glass plant. Regarding our relationship with Owens-Illinois and their potential acquisition of Vitro, we are confident that we can manage our joint venture effectively along with O-I, so we're not worried about the impact of that acquisition on our operations.

Got it. Okay. Thank you.

Hi. Good morning.

Hi, Bryan. Morning.

Just wanted to ask one question or one topic just capital allocation. And maybe, David, if you could sort of remind us or update us on your current thinking in terms of share repurchases, kind of where you’re comfortable in terms of leverage on the balance sheet? And I guess, as you’re contemplating additional brewing capacity, just how we should think about kind of where cash is going to go, whether its dividends, repurchases, or CapEx over the next couple of years?

As we aim to enhance total shareholder returns in the medium term, our primary focus is ensuring we have sufficient capacity to support our high-margin Beer business. In terms of capital allocation, our top priority is the capital expenditure needed for the expansion of Nava and the potential development of a second site in the future. Beyond that, our capital allocation strategy remains unchanged. We are committed to maintaining our dividend, engaging in share repurchases, and pursuing tuck-in acquisitions. We are pleased to conclude the quarter with a net debt leverage ratio of approximately 3.7 times, which fits within our target range of 3 to 4 times. However, I want to exercise caution regarding that leverage ratio, as we have significant expenditures planned for the completion of the Nava build-out in the latter half of the year. Therefore, we will be very prudent with our capital decisions throughout this expansion process.

Could you provide a rough estimate of the cost per hectoliter for the brewery expansion? Additionally, considering the potential need for increased capital expenditures, should we view share repurchases more as a means to cover stock options rather than as a strategy for reducing the share count significantly?

Yeah. So as it relates to a new green field facility, what we’ve stated in the past is that, we haven’t made a decision on a specific location, although we are planning for Western Mexico. We haven’t made a decision on the size of the build-out and then we have provided a really large range of $100 to $150 a hectoliter, recognizing that a green field will be completely starting from scratch with no basic infrastructure, which we benefited from at the Nava facility. So we will come back to you within the next several months with definitive plans around our build-out. And I would say, based upon our volume growth numbers that we demonstrated this quarter and for the last while, we will be spending the capital on a green field sooner than later, because it's going to take four years to build out another brewery and with these kind of growth rates we will need to keep up with capacity. I think to then answer your question on share repurchases, again, we’re going to evaluate our circumstances as we go forward and depending upon the capital requirements and our leverage ratio and understanding the requirements from our dividends, we’ll then consider share repurchases. I don’t see anything in the very near-term though, we said this publicly as well around a large accelerated kind of program. It’s likely to be methodical and it’s likely to start out with absorbing dilution.

Excellent. Thank you.

Good morning, everyone. Thank you. I just want to check that the delay in the capital spending that you talked about is not in anywhere reflection that there is a delay in when the plant might open?

None whatsoever. We’re actually pretty happy with the progress we made in the build out at Nava. In fact, we’ve now run beer down our premium glass line. So for the first time, we put labels and foil on bottles because our previous production has been Corona, primarily Corona Extra and Corona Light using the applied ceramic label bottles. And so now our premium glass line, which is Modelo Especial has run beer down the line, which is a little bit ahead of where we thought we would be at this moment. So we’re very pleased with our progress on the brewery build out.

That’s great. And on the wine side we never really discussed CapEx there, but do you see any significant needs in the next couple of years?

I think you’ll continue to see our wine CapEx in the range it has been for the past several years. We don’t expect a big change in that regard.

Okay. Thank you. Then the peso benefit, any way you could call that out and tell us what do you think it will do in the back half of the year?

Yes. See that’s the problem with the FX and commodity related items. There is a fair amount of variability when you’re trying to predict it. But you know that we’ll say about our peso exposure, it’s about 15% or so of our COGS and from that you have to exclude the COGS that are attributable to ABI. And generally, we run a three-year layer hedging program across our currency and commodities. And so for the remainder of this year, we are roughly 80% hedged on FX.

Okay. Thank you. One of the big drivers of your business is clearly being the big incremental advertising spend behind your brands. And I mean, you mentioned in the second quarter that as a percentage of sales, it wasn’t up a lot, but I think it was down a bit. But basically, do you see keeping that pressure on the brands, because I think that’s going to be critical to the ongoing momentum? Do you have budgets to go up significantly on ad spend going forward?

Yes. So we expect in our Beer business for our marketing expense to be somewhere between 8.5% to 9% of net sales which implies we will continue spending at kind of the second quarter rate. As a percent of net sales, our case rate I think goes up a little bit in Q3. I will also say that that’s going to be Q3 weighted as we take advantage of the fall sports season, which we found to be a successful platform for driving our brands. But we measure and are very pleased with the returns we get from our marketing investment in our beer brands and we will continue to keep that pressure on.

Right. Yes, I mean, I think that’s going to be critical. So your returns have obviously been incredible. Would you see going to the higher end than the 9%?

Caroline, I think those were the longest two questions we've ever had.

Sorry.

That’s okay. No worry. I guess we’ll take the next question Operator.

Good morning, everyone. A couple here mostly related. One is, this year is being called the year of the can. And I’m trying to understand, it’s clear you have a lot of opportunities for share within your portfolio. But what might be the priority from here? I heard you, David just mentioned premium glass for Modelo Especial and putting an SKU into an existing account is easier than trying to add account, which is part of the job with the Especial. But what might be your next priority if you will after the year of the cans for Corona?

I would say that you’re right on in calling out distribution. So we know, for example, that Modelo Especial roughly has 65 ACV across the market, but we also know that we have packs Light, our 12 packs bottle, which is more like 45, right. So we have a lot of ground that we can cover from a distribution standpoint. I do want to come back on the year of the can, however. We’ve seen a lot of growth in Corona Extra from our year of the can program. We’ve also seen a lot of growth on the Corona Light, which was a bit of ancillary benefit that came from our focus on cans and Corona. So yes, I think there are a lot of opportunities for future growth in our brands.

I’m looking at these numbers and trying to figure out if next year will be an 8 or a 12. I’m not asking for a crystal ball, but I want to understand where we actually stand moving forward. Will we continue to focus on cans? It seems like Especial has slowed down this year in terms of growth rates, which is expected with large numbers. I’m trying to grasp where the priority will shift next for Corona.

Yes. I think around Modelo Especial on your particular point, we have a year-to-date depletions that are in the high 20% on the bottle itself. So that’s a package that’s growing really well for us. And so the momentum behind the brand continues. I see us continuing our strategy of focusing on building out our strong distribution network, gaining more distribution at retail, getting our brewery completed and continuing to execute across the entire portfolio of beers that we have.

Okay. And I know I’m pressing here, but I do want to understand the brand Modelo overall, the Especial that is has rate of growth has slowed overall of all packages. Is that right and you are saying the glass is a priority there?

No. In the recent 12-week IRI, Modelo Especial was up 30%.

It has not slowed. Where are you getting that idea?

Okay. Great. I’m just referring to some of the materials you put out back in early September, 16% at fiscal ‘15 and accelerating this year. Got it. Okay. And then the brewery expansion or the added brewery, you are saying the next several months, can you be more specific, should we think about that as third quarter?

I would say roughly by end of the calendar year. Likely on our third quarter earnings call.

Got it. Okay. Great. Thank you, guys.

Hi, Vivien.

Hi. So, I have one question on Wine and Spirits please. Given the diverging trends that we continue to see between those two sub-segments, can you offer a little color around the margin profile of those two independent businesses?

I believe it's important to note that while we are focused on the U.S. business, this market accounts for 80% of our overall net sales. When we analyze the margins for wine and spirits, we find that they are approximately consistent across the portfolio.

Okay. That’s helpful. David…

That’s largely because our spirits business is really sort of a mid premium as opposed to higher premium. So, the margins are roughly the same as the wine business.

Terrific. Thank you. And my second question has to do with the outlook for the tax rate. David, if I think back a couple of years ago, we’ve seen these tax benefits before and then over time the step-up in the tax rate doesn’t actually happen and so your overall tax rate ends up coming in lower than previously expected. So, I’m just curious, kind of what gives you kind of confidence, the step-up in the back half?

Yes. As we move further into the year, we have a clearer understanding of the settlement opportunities we might explore, and I feel confident about our outlook for the full-year rate. Additionally, our initial guidance of 30.5% for the year included the benefits we experienced in the second quarter. However, we did not have a clear understanding of when we would receive these benefits.

Thank you and congratulations on a great quarter. I'm curious about your pricing strategy for beer. You mentioned you're targeting 1% to 2% in the market now. Given your impressive success, have you adjusted your approach? It seems you have initiated price increases in California and Texas, which appears to diverge from your past role as more of a follower. Is there a shift in strategy? Considering the strong demand for your product, could there be more aggressive pricing to enhance your premium image and bridge the price gap from a decade ago? Additionally, how are you approaching your overall pricing structure across the brands? Thank you.

Yeah. So, first of all, as it relates to pricing, it is pretty much what we’ve said all along throughout the year, which is that we’ve expected to take in the 1% to 2% pricing range and that’s what we are doing. So the strategy really hasn’t changed. I mean like every other business, we’ve got costs to cover and our brands are strong enough to bear that kind of pricing. If there is any change in our strategy, I would say that the marketplace is changing somewhat in terms of sort of the makeup of the types of products that are out there. The market, I mean the industry is definitively premiumizing, while volume remains sort of flat so that there is a shift internally towards more premium products. And I would say that that probably has given us the opportunity to be less focused on what’s going on with competitive products and to be more focused on what do we think is good for our brand and what do we think will work and won’t work. So we continue to be very strategic in our pricing. We are doing it on a market-by-market, brand-by-brand basis. Our guidance nevertheless hasn’t changed. We are still looking at the 1% to 2% range. And you can call it leading or not leading. We are sort of I would say marching to our own beat as opposed to too worried about what some of our competitors are doing overall. And that’s sort of up to them. And we will do what we think the market will bear for our brands and what’s good for the health of our brands. So in some cases that will mean that we will lead pricing. But as I said, the market has changed, it’s premiumizing. 10% of the industry now is craft, selling at very high prices, right. And the other 10% of the market is basically us. And those are the two segments, that 20% obviously taking share from the other 80%. So things are a little different out there than they have been in the past.

Right. I mean, it’s interesting, if you look at the Corona brand outside of U.S. and Mexico, ABI is taking a very strong strategy of really making a super, super premium brand, generally priced significantly higher than Heineken for instance in most areas. Obviously, the reference point in Mexico is paramount. But did you think perhaps there is a way to kind of increase the gap with premium, with U.S. mainstream brands, with Corona, and just develop a little bit longer kind of pricing architecture for your brands, a little more differentiated than it is now?

Yes. I would say in general, we are not overly focused on the pricing gap with the domestic premiums. I mean, the domestic premiums have sort of taken on the life of their own. I am not sure how relevant it is at this stage.

All right. So that definitely sounds like a departure in strategy than what you had said a few years ago.

Yes. I would say that you have identified that nuance correctly.

Great. Terrific. Thank you very much.

We are less concerned about that gap today than we were several years ago.

Thanks. And congratulations, And Rob, your family must be incredibly proud to in 70 years to build a $26 billion company, that’s amazing.

Well, thank you.

David, just a clarification on the end pointing of the TSA was. I think I heard you say, is it end of calendar 2016 that you expect that to be largely wound down?

We have largely reduced our dependence on ABI for supply chain procurement, although we will continue to source finished goods from ABI’s breweries until June of next year, 2016.

Great. And then Rob on the wine outlook, you said of the overall harvest but ultra-premium was a little bit short in Napa and Sonoma. I’m just wondering if you think that might provide somewhat of a pricing umbrella for mid-tier premium price products and any challenges you foresee in terms of pinot noir sourcing or some of the rates that are more.

I don’t anticipate any challenges with sourcing pinot noir, as we are successfully obtaining it from Mark West, Robert Mondavi, and the various tiers at Meiomi. Our supply chain is well established. Regarding your question about marketplace pricing, the answer is likely yes. Even in the higher-end segment, I don't expect pricing to decline. The market has not been particularly strong for several years regarding pricing, but discussions in industry circles suggest that the market is generally leaning towards more stable pricing than it has in recent times.

All right. Thanks so much.

Hey. Thanks for taking my question. Just clarification on the 34% margins. Did you quantify as how much FX and commodity benefited that number and then, am I right in what you said with the hedges, we won’t see any incremental benefit in the back half? I mean, this is probably the watermark for the rest of the year.

Yes. The guidance indicates that margins will return to the 34% range, but we expect some compression in the second half of the year due to several challenges. These include bringing new assets into service, which will increase our depreciation costs, line commissioning expenses, hiring additional employees where training is necessary, and lower throughput at Nava due to seasonal production factors. Therefore, our current estimate for the 34% margin includes anticipated foreign exchange and commodity rates for the remainder of the year.

Okay. But just trying to understand it, especially on the commodity front. Would you expect as we move past the hedges that you would see an incremental benefit as we move into next year or is it less on, is it more on productivity benefits than it is freight, commodities?

It's a combination of both. From a hedging perspective, we operate a three-year layering program, which helps stabilize our returns somewhat, though it does mean we may miss out on some gains when commodity prices and FX values are declining while benefiting on the other side. Assuming commodity rates remain stable, particularly with diesel and aluminum, we anticipate some advantages next year. However, it's still too early to determine the exact impact at this stage.

Got it. Thanks so much.

Good morning, everyone. I have a couple of questions on Modelo Especial. The first point is that to me, the brand to bottle and the can are really totally different products. It’s a different demographic, it’s a different price point and obviously it’s a different packaging. And I’m just trying to understand how can they work in the long-term? The person buying the cheap Modelo Especial can is very different from the one that you are advertising for the bottle? And the second question, which is related to this also. Obviously, Modelo Especial is driving the growth. You provided ACVs for cans and bottles? Can you give some color in terms of what’s the growth in bottles? What the growth in cans? I understand the bottles are starting from a lower base. But the reason I ask the question is that, when you say 65% ACV for Modelo Especial, I’m not too sure there’s a big market for Modelo Especial in states like Alabama or South Carolina. So because your ACV has already capped on Modelo Especial and the cans or maybe not, I mean, obviously given the growth rate, it hasn’t. But just give some color there, I find the brand is a fascinating brand where the business will grow, but it has its own challenges because of the way the cans and the bottles are marketed. Thanks.

From a consumer experience perspective, our research and feedback indicate that as more people in the U.S. try Modelo Especial, they often continue to enjoy it. It is a high-quality, well-respected authentic brand from Mexico. Regarding the can versus bottle situation, we have seen year-to-date depletions of approximately 12 percent for cans, while bottles have experienced a growth rate in the high 20s from a depletion standpoint. Therefore, we are observing growth across all offerings of Modelo Especial.

Yeah. And I would say that as far as the consumer goes, I’m not sure that we agree with you that it’s two completely different consumer bases. I think that we’ve seen a shift somewhat at least in the growth from cans to bottles. The can is only slightly priced less than the bottle. It’s really almost irrelevant the pricing difference. Interestingly enough cans have in general taken on a very premium image since it’s becoming the package of choice in the craft segment of the market. So the whole view towards cans in general I would say is shifting quite significantly from a consumer perspective. So we don’t see any difficulties in marketing the cans and the bottles together, like everybody else does markets cans and bottles. So that’s not a particularly unique aspect of our Modelo Especial business, which, as we said earlier, is actually growing more than it ever has on an incredibly large base. So the strength of that brand is phenomenal at this stage without it really having fully transitioned to a general market product and it is transitioning to a general market product. Again, with our own help as we turned on general market TV advertising, which has been very successful and we know that there is huge room for distribution growth in that brand and you will see it. You will see it as we continue to move forward and execute with that brand. You’ll see the ACV continue to go up. That’s simply going to be the case as we believe quite strongly at the current time. So the cans are strong. The bottles are strong. It’s following the same pattern as many brands that have become a major brands and Corona is probably the best example of that.

That's very helpful information. Can I ask a follow-up? With all the discussion surrounding the potential Anheuser-Busch InBev and SABMiller transaction, I recall that about 65% of your volumes in the U.S. go through MillerCoors wholesalers, who are independent, with the remainder mostly with Anheuser-Busch InBev. I understand this is hypothetical, but could there be any future involvement with MillerCoors or Molson Coors? Are there likely to be changes at the wholesaler level? I assume they would want the MillerCoors wholesalers to carry their portfolio of Mexican brands, though the wholesalers will have their own sales and your business is considerably larger. Is there a reason for that? Additionally, regarding your U.S. volume at the wholesaler level, what percentage overlaps with the Spencer brands? Do wholesalers that carry your brands typically not carry the Spencer brands? Thank you, and sorry for all the details.

There is some overlap among wholesalers who carry both the Spencer brands and our brands, but I would say that this is completely irrelevant to us. The Spencer brands are relatively small, and while they have seen some growth in their brand, it's less than half the size of Modelo Especial, and that growth is slowing down. Tecate, on the other hand, is struggling, and although Tecate Light has experienced some growth, it is priced at the domestic premium level. Therefore, we do not see them as strong competition and we are indifferent to whether they are associated with MillerCoors, ABI, or any other distributor, since we do not focus on that portfolio much and Heineken is a completely different situation.

Right. Yeah.

I believe we are targeting a different consumer base compared to our Mexican portfolio, so this isn't a major focus for us. Generally, our strategy is to concentrate more on our own portfolio and the opportunities it presents. Successful execution will be crucial as we move forward, particularly in seizing distribution opportunities and increasing the number of SKUs per account. This is where our potential lies because we can drive significant growth for ourselves and our retailers with a modest shelf presence. Currently, we have too few SKUs relative to our sales velocity and dollar volume at retail, which highlights a substantial opportunity for both us and our retailers. Our retailers are naturally inclined to boost their sales and margins per unit of shelf space, which represents a considerable opportunity for them to enhance dollar sales and margins through an expanded SKU selection and shelf space for our portfolio. When we discuss this with retailers, they often understand the compelling statistics that support this strategy for boosting profitability. Therefore, enhancing our SKU count per retail account will be one of our main focuses going forward.

Thank you. It was very helpful.

Thanks guys. Two questions on the Beer business. Can you talk about what your volume assumption is for capacity planning for the Beer business going forward? And then we have seen the cans come in and if memory serves, ACV has gotten pretty stable over the last few months. Where do you see the potential for distribution on Corona can in the medium term?

Yeah. I think in terms of capacity, it’s sort of like high single digit is what we have said in the past. So you could infer that right from sort of our comments about doubling the business over a long period of time, 10 years, that just sort of simple math. Our real guidance for the year continues to be high single digits for the Beer business in general. And then your second question was?

How much more room is there for distribution on Corona can?

A lot. We’ve just introduced it really and made it a priority over the last relatively short period of time. So I think that there is a big opportunity for more distribution on that. Right, it’s only about 5% of our volume at the current time and we should be growing that to more like 15% or 20%. So that will be achieved through continuing to build distribution and doing what I said, focusing on SKUs per count.

Perfect. Thanks.

Okay. Well, thanks everybody for joining our call today. As we close the discussion of our second quarter results for fiscal 2016, I’m very, very pleased with what our business has achieved so far. Though the year is far from complete, our new guidance reflects the confidence we have in our ability to execute in the second half and achieve our goals for the full year. We look forward to the next time we speak with you in early January when we will share the results of our third quarter. Until then we wish you a safe and happy holiday season. This time of the year is a great opportunity to share our fine beer, wine and spirits products with friends and family. And we encourage you to make Constellation Brands a part of your celebrations this holiday. So thanks again everybody and have a great day.