Constellation Brands Inc (STZ) — Q2 2018 Earnings Call Transcript

Thank you, Laurie. Good morning and welcome to our second quarter fiscal 2018 conference call. I am here this morning with Rob Sands, our President and Chief Executive Officer; and David Klein, our Chief Financial Officer. As a reminder, reconciliations between the most directly comparable GAAP measures and any non-GAAP financial measures discussed on this call are included in our news release or otherwise available on the company's website. Please refer to the news release and Constellation's SEC filings for risk factors which may impact forward-looking statements we make on this call. With regard to unregistered security offerings discussed during the call, please note that the securities subject to those offerings have not been registered under the Security Act of 1933 and may not be offered or sold in the U.S. absent registration or an available exemption from registration requirements. Before turning the call over to Rob, I would like to ask that we limit each Q&A session participant to one question, which will help us to end our call on schedule. Thanks in advance and now, here is Rob.

Thank you, Patty and good morning everyone. Before we get started with our quarterly review, I would like to convey my sincere sympathy to all who have been affected by the string of recent natural disasters and tragedies. Thankfully the earthquakes in Mexico did not have an impact on our production operations there, but our sympathies are with all of our affected families. So now, let's get started with our discussion of Constellation's second quarter fiscal 2018 sales and earnings results. We delivered exceptional results for the second quarter of our fiscal year. Throughout the business, we gained share overall, improved margins, continued to generate strong free cash flow, and executed exceptionally well both operationally and in the end market. These results are a testament to the fact that our total beverage alcohol or TBA strategy is paying off. We remained a leader in the high end of the U.S. beer market, and we are reaping the benefits of our wine and spirits premiumization strategy. As a matter of fact, our beer business, which remains the number one growth driver in the high end of the U.S. beer market, generated more than 60% of the growth of this market segment during the quarter. Overall, Constellation has been the clear winner during the 120 days of summer for the past four years, growing dollar share of the total beer market more than any other leading supplier. Excellent execution during the July 4 holiday, the most important holiday for the U.S. beer industry, drove significant market share gains for the quarter. During this timeframe, Constellation had five brands in the top $20 share gainers, including Modelo Especial and Corona Extra in the number two and number three positions, as well as Pacifico, Modelo Negra, Modelo Chelada, and Tamarindo Picante, for example. Record-level distribution gains and increased media activities continued to drive greater than 60% of our overall depletion growth. Across the portfolio, you can see excellent results from these efforts. Additional TV advertising and digital support propelled Corona Extra, which was recently named by InterBrand as one of the best global brands of 2017 for the eighth year in a row. The Corona can format grew more than 20% during the quarter, with the launch of its limited edition, Beach in a Can packaging. Corona Extra was the official beer sponsor of the Mayweather versus McGregor fight, which set a new record for the largest viewing boxing audience. Modelo Especial increased TV advertising and promotional investments beginning with the NBA finals in early June and was also named the official beer of two prominent soccer tournaments, including the Gold Cup, all of which led to gains in trial and awareness versus a year ago. Modelo Chelada Especial was recently named the 2017 Nielson Breakthrough Innovation Award Winner. These activities drove depletion growth of almost 20% for the Modelo Especial family of brands for the quarter. Pacifico continues to capture new consumers by building brand awareness and trial across the brand’s priority geographies. During the quarter, Pacifico TV advertising aired across the Western U.S., Colorado, and Texas. This activity was complemented by year-round social media support on both Facebook and Instagram. In addition, the Summer X Games chose Pacifico as their exclusive beer partner for their competition in July. As we head into the second half of the year, the beer portfolio is well positioned from a marketing and promotional perspective, supporting the professional and college football season, as well as key boxing and soccer sponsorships. Our innovation test markets for Corona Premier and Corona Familiar continue to be very successful. As a result, we plan to nationally launch Premier beginning in fiscal 2019, with Familiar rolling out to all major Hispanic markets, a key demographic for this brand during the same timeframe. I’d like to remind everyone that the benefits of these new product introductions have already been included in the growth goals that we outlined at our New York City Investor Day last November. During the quarter, we added Funky Buddha Brewery to our newly established Craft and Specialty Beer business. Florida-based Funky Buddha is a regional craft beer player and South Florida's largest craft microbrewery by size and volume. The acquisition of Funky Buddha is a continuation of our beer strategy to be the leader in the high end of the U.S. beer market. This brand has great potential and plenty of runway for future growth, and we plan to leverage that potential to begin building a stronger presence in the high-end craft beer as this market segment continues to be one of the key growth drivers within the U.S. beer market. Our goal is to continue to grow distribution of the brand throughout the state of Florida, as well as targeted expansions into key new states. From an operations perspective, our capital expansion projects in Mexico continue to be on track on all fronts. The Nava Brewery achieved record production volumes during the second quarter, and we look forward to completing the next phase of expansion, taking the brewery to 27.5 million hectoliters of capacity by calendar year-end. Glass Furnace number 3 is now fully operational and ramping to peak efficiency levels. The Obregon Brewery continues to perform at very high utilization levels, and we are currently optimizing existing capacity as we plan to increase capacity in both brewing and packaging before the end of the fiscal year. Construction continues in Mexicali, and we are making solid progress. Brewhouse tank fabrication and installation are currently in process, and building structures for brewing, packaging, and utilities are well underway. Overall, the strong results that the beer business achieved in the second quarter are driving the upward revision in our EPS guidance for the year. David will have more to say in this regard in a few moments. Now turning to our wine and spirits business, during the second quarter, we gained momentum for our wine business, gaining market share and delivering strong depletion growth of 5%. While we continue to improve margins for this business, the significant margin enhancement that we saw in the first quarter from positive mix and a divestiture of the Canadian business were somewhat offset by planned investments in marketing, primarily for our focused brands, as well as promotional activity as shipments and depletions became aligned through the first half of the year. These investments are obviously paying off as we posted depletion growth of more than 12% for our focused brands during the quarter, driven by Black Box, Robert Mondavi Private Selection, Kim Crawford, Meiomi, Woodbridge by Robert Mondavi, and SVEDKA Vodka. Within our focused brand portfolio, our top five profit contributors are collectively growing volume 10%, with profits also growing double-digits year-to-date. As we head into our key selling season for the wine and spirits business, we have solid programming in place and are well positioned to develop our goals for the year. Planned investments include Black Box digital advertising, the launch of a new TV campaign for Kim Crawford beginning this fall, as well as the continuation of Woodbridge TV and digital advertising to increase awareness and fuel momentum for this brand. Additionally, the new first-ever national digital advertising program for Meiomi will continue leading up to the holidays. From an innovation perspective, the 7 Moons Red Blend Wine brand is gaining momentum and has already become a top 10 premium Red Blend. Our recent Rosé line extensions have taken off, including Meiomi, Kim Crawford, and Black Box Rosé brands. Our acquired wine and spirits brands are performing exceptionally well, including High West Whiskey and Casa Noble Tequila, as well as the Prisoner, Meiomi, and Charles Smith Wine Brands. On a year-to-date basis, through the first half, these brands collectively delivered depletion growth of 23%, with a gross margin in the 60% range. Following the recent Schrader acquisition, Constellation has become a top $100 plus Cabernet Sauvignon wine producer. Our spirits portfolio posted net sales growth of 2% for the quarter, driven primarily by High West Whiskey. Additionally, SVEDKA Vodka gained market share in the vodka category, due in part to the successful launch of the new SVEDKA Blue Roseberry flavor. Now in closing, I am pleased with our second quarter results and what we have accomplished in the first half of the year. The total beverage alcohol portfolio remains strong as many of our high-end beer and premium wine and spirits brands gain share. It is these products that remain growth drivers within the TBA category, which is expected to continue in the future. In addition, our portfolio performance and execution by our commercial and operational teams continue to drive margin benefits, giving us the confidence to raise our guidance for the year. With that, I would now like to turn the call over to David, who will review our financial results for the second quarter.

Thanks, Rob and good morning, everyone. I hope everyone saw our new press release format and found it helpful. We decided to provide the financial press, analysts, and investors with our financial results, accomplishments, and strategic initiatives in a more concise and easy to use format. Our Q2 results demonstrated continued strong financial performance as we generated 8% organic net sales growth, expanded our consolidated comparable basis operating margin by 340 basis points, and increased comparable basis EBIT by 14%. These results include particularly strong operational performance by our beer business, which, along with anticipated favorability in our tax rate, is driving an increase in our full-year comparable basis diluted EPS goal to a range of $8.25 to $8.40 per share. We believe the recent natural disasters had a minor impact on our Q2 results and may have some minimal impact on Q3 results, which we factored into our new guidance. However, we continue to monitor the situation in these affected areas. Let's look at Q2 performance and our full-year outlook in more detail, where I'll generally focus on comparable basis financial results. For beer, net sales increased 13% on volume growth of 12%. Depletion growth came in at 8% as we won the 4th of July holiday and the rest of the key summer selling season. We overlapped a difficult 14% depletion growth comparison for Q2 fiscal '17. Shipment growth ran ahead of depletion growth after we saw the opposite trend in Q1. For the first half of the year, shipment and depletion growth rates are both in the 9% to 10% range; this has us on track to meet our net sales goal for fiscal '18 as we continue to expect net sales growth to be in the 9% to 11% range. This includes 1% to 2% of pricing targeted for our Mexican portfolio. Beer operating margin increased 420 basis points to 41.1%, primarily due to lower COGS, favorable pricing, and foreign currency benefits. The lower COGS reflect benefits from supply independence from ABI and glass sourcing as we saw strong operational performance at our breweries and glass plant during the peak summer production period. Our Nava Brewery generated record production volume and performed ahead of our expectations for the quarter. These benefits were partially offset by a $13 million increase in depreciation expense, which totaled $40 million for Q2. Given the strong operational performance, we now expect beer operating income growth to be in the range of 17% to 19%. The expected moderation in beer operating income growth and margin for the back half of the year compared to the first half is being primarily driven by lower production volume due to normal seasonality, combined with the continued ramp up in depreciation and line commissioning costs, including headcount additions to support our expanding operating platform. Additionally, SG&A leverage is impacted by the lower volumes that occur in the second half of the year as a result of the seasonality of the business. Last quarter, we indicated that we expected an unfavorable foreign currency impact due to tougher peso comparisons in the back half of fiscal '18. However, this headwind has been mitigated through our hedging program, and we currently expect an unfavorable currency impact to be fairly minimal. For wine and spirits, we saw strong Q2 U.S. depletion growth of 5%, which outpaced U.S. shipment volume primarily due to timing, as we reported shipments ahead of depletions in Q1. This contributed to Q2 organic net sales being down 1% as favorable mix was more than offset by lower volume. Promotional expense was higher in Q2 than Q1 due to the increase in depletions we saw in Q2 versus Q1. At the halfway mark of fiscal '18, organic net sales are up 2%, and U.S. depletions are also up 2%, while operating margin increased 330 basis points, driving operating income growth of 5%. For the quarter, wine and spirits operating margin increased 40 basis points to 26.2%. This improvement primarily reflects the divestiture of the lower margin Canadian wine business and favorable mix, partially offset by higher marketing investments. For fiscal '18, we continue to expect wine and spirits reported net sales to decrease in the range of 4% to 6% and operating income to be flat. These projections include the negative impact of the Canadian wine business divestiture and the estimated incremental benefits from the High West, Charles Smith, and Prisoner acquisitions. When excluding the impact of the Canadian wine business divestiture from our fiscal '17 wine and spirits results, we continue to expect net sales growth of 4% to 6% and operating income growth of 5% to 7%. The moderation of our wine and spirits operating growth in the back half of fiscal '18 implied by our guidance is being driven primarily by Q3 activities, including planned marketing and SG&A investments during the key holiday season and loss of $17 million of operating income from the Canadian wine business, which was recognized in Q3 last year. As a result of these factors, we are targeting wine and spirits operating income to be down in the low to mid-teens range for Q3 fiscal '18 on a reported basis. I’d also like to note that as part of our premiumization efforts, we have been rationalizing lower margin, value brand SKUs. These actions are expected to impact wine and spirits revenue growth by almost 100 basis points for fiscal '18, while improving operating margin and ROIC. Interest expense decreased 14% as the benefit of lower average interest rates was partially offset by higher average debt balances. We now expect fiscal year '18 interest expense to be in the range of $330 million to $340 million. The improvement is primarily related to short-term interest rates, trending more favorable than our earlier projections. We recently announced plans to launch a Commercial Paper Program to improve short-term borrowing costs, which is typical for investment-grade companies. The program is expected to be an unregistered private placement and provide for the issuance of up to $1 billion of commercial paper. The program is expected to be supported with available commitments under our revolving credit facility, so it will not result in an increase in the total amount of our authorized debt. When factoring in cash on hand, our net debt at the end of August totaled $8.8 billion, a $230 million decrease from our net debt balance at the end of fiscal 2017. Our net debt to comparable basis EBITDA leverage ratio moved down to 3.3 times at the end of August from 3.7 times at the end of fiscal '17, while we continue to invest in our Mexican operations, build our portfolio, and return cash to shareholders with $201 million worth of dividends paid and $14 million of stock repurchases during the first half of the year. Our comparable basis effective tax rate came in at 20.5% versus 31.8% last year. This improvement reflects the benefit of reinvesting foreign earnings under APB 23 and the adoption of ASU 2016-09, which requires excess tax benefits from stock-based payment awards to be recognized in the income statement. For fiscal '18 we now expect the effective tax rate to approximate 21% versus our previous guidance of 22%. The lower projected rate is primarily due to an increase in forecasted excess tax benefits from stock-based payment awards and lower effective tax rates on the foreign earnings of our beer business. We expect our Q3 tax rate to be higher than our full-year tax rate, and Q4 to be in line with that full-year rate. I would also like to note for fiscal '18 we continue to expect weighted average diluted shares outstanding to approximate 201 million shares, and net income attributable to non-controlling interest is now expected to approximate $10 million to $15 million versus our prior estimate of about $10 million. As mentioned earlier, we're now projecting our full-year comparable basis diluted EPS to be in the range of $8.25 to $8.40. The midpoint of this guidance has us targeting 23% growth. Our comparable basis guidance excludes comparable adjustments which are detailed in the release. Moving to free cash flow, which we define as net cash provided by operating activities less CapEx, we generated $598 million of free cash flow for the first half of fiscal '18 versus $676 million for the same period last year as operating cash flow growth was more than offset by an increase in CapEx. We continue to expect fiscal '18 free cash flow to be in the range of $725 million to $825 million. We did not revise our free cash flow as the benefit from our projected earnings increase is expected to be offset by unfavorable timing of recoverable value-added taxes. Our free cash flow guidance reflects operating cash flow in the range of $1.9 billion to $2.1 billion and CapEx of $1.175 billion to $1.275 billion, including approximately $1 billion of CapEx targeted for our Mexico beer operations expansion. In closing, our beer business continues to deliver impressive operational and marketplace execution while generating top-tier sales and profit growth. Our portfolio premiumization efforts continue to enhance the financial profile of our wine and spirits business. With that, Rob and I are happy to take your questions.

Hey, good morning guys.

Hey, Dara.

So first just a detail question. David, you indicated hedging offsets a lot of the peso FX margin impact in beer this fiscal year. I'm just wondering if you can quantify if we stayed at current spot rates, can you give us a sense for how much of a drag FX will be to beer margins in fiscal '19? And then the real question is Rob, I was hoping you could flush out a bit more detail on Corona Premier's success in test markets. It looks pretty solid at around 3% of sales in the test markets and tracked channels. So just any details around the magnitude of traction for the brand in test markets, the cannibalization that you're seeing on the rest of the portfolio, and then any expectations around the national launch next fiscal year. Thanks.

So Dara, on the first part the current effective FX rate, so kind of net of our hedges on a year-to-date basis is probably in that mid-18s range. So to the extent that current spot’s a little lower than that, it would be a bit of a drag next year, but not much.

Okay.

Yes, so as it relates to Premier, the test markets have been very successful. What do we mean by successful? What we are looking at is pretty much things like velocity per point of distribution, which for a new product, Premier’s velocity per point of distribution was high. And the other thing that we are looking at, which is in actuality a relatively minor concern is cannibalization, which actually turned out to be significantly lower than we expected. Now I’d say that cannibalization is a relatively minor concern and that’s cannibalization of our own products because there is no margin difference between Corona Premier and the other products. So, cannibalization isn’t really an issue as long as one plus one equals three. And right now I would say that it’s looking definitively like one plus one will equal three, because given our market shares versus the rest of the market, if cannibalization is the right term, we’re really taking share from competitors, not to a large degree from ourselves, which makes logical sense. So, it looks good.

Okay, great. Thanks.

Hey Bryan.

Hi, good morning everyone. My question was around advertising. Can you give us a sense David, sort of specifically in beer what type of increase you’ve had in advertising and promotion this year? And then, I guess some color on still are you getting the immediate lift when you are adding more marketing and advertising in the market, and I think that was the case last year. So just trying to get a sense if you are putting more into the market and if you are still getting that good sort of immediate lift off your advertising?

Yes, so, we are still running in general in that 8.5% to 9% range. Clearly, that means the dollars are up because of the growth of our business. And just kind of as a note, we will see as a percentage of net sales higher marketing spend in Q3, simply because of the lower sales quarter and we spend money with the NFL property. So again, we’re spending about the same percentage as we have in the past. And yet we continue to see really impressive returns on our marketing spend in our beer business, which I think is tribute to the quality of the advertising that our marketing team puts in place, as well as the power of the brands. But we monitor that return on an ongoing basis, and we’re going to continue to invest in our brands in our beer business, and you’re going to see us begin to invest more in our brands in our wine business, which will also see a fairly large increase on a percentage of net sales basis in Q3 versus where we have been in the past.

Okay, thank you.

Hi, good morning. It’s actually Adam Scott on line for Bonnie. Question on the wine and spirits business, obviously really great performance in Focus brands with depletions up 12%, but the implied growth of non-Focus brands was almost down 6%. So I was hoping you could talk a little bit about the strategy behind these brands and maybe whether at some point it might make sense to divest them or perhaps to reinvigorate them, since they are such a drag. So if you could just touch on that, that’d be great. Thanks.

Yes, so what you just suggested is not at all unusual in that our Focus brands constitute the vast majority of our sales and profit. It’s almost like a perfect Pareto principle type situation, which almost every company exhibits. A relatively small number of our brands, i.e., our Focus brands which are about 17 or so brands, constitute about 70% to 80% of our profits. Therefore, the rest of the portfolio does represent what we might call tail brands or perhaps more euphemistically technical brands. The interesting thing in the wine and spirits business is regardless of the growth rate, every brand is profitable and a contributor, therefore, to our overall profits. Hence it makes economic sense to keep them when you look at what the potential value would be to a third party from a discounted cash flow basis versus the value to ourselves. So, that’s why we don’t divest the tail. We also don’t spend a lot of time on it from an operational, marketing, or activity point of view. Now that said, we have divested lower margin, lower growth tail businesses and brands in the past, where it makes economic sense to do so in the manner that I just described, meaning taking a look at what the NPV of the future cash flows of those businesses are compared to what we think that we can sell that for. Canada is a good example of that. A number of years ago, we sold off our value wine business, Almaden and Inglenook. We sold off our value spirits business as an example, brands like Barton and Crystal Palace, and Mr. Boston, and so on and so forth. So we are always evaluating that, but I have given you basically the method under which we evaluate that. Generally speaking, the brands that are in our portfolio now are worth more to us than they would be to a third party, and that’s why we keep them. They are profitable and therefore they help fuel the investments we make in the focus brands.

Yes, just one other thing to add to that, Adam, as I said in my script that we have been doing some SKU rationalization, which creates about or creates about 100 basis points drag on growth. But that’s just good business where we can discontinue a SKU that has like low 30 margins and replace it with a SKU that has 50% or 60% margins using the same assets.

Great, thank you very much.

Thank you very much. It was a great quarter and I appreciated the press release, which I thought was well done and had a nice new format. I'm curious about the specific quarter's performance, as I noticed a significant discrepancy despite your shipments and depletions being aligned for the year. We anticipated they would be close, so could you clarify whether this difference was due to a year-end business slowdown or the addition of extra shelf space? I'm trying to understand the reasons behind the substantial difference for the quarter.

So you are talking about beer, Robert?

Yes, yes, beer shipments and depletions please.

Yes, when we examine the growth rate, in the first quarter of the year, we experienced a situation where we depleted more than we shipped. However, we managed to recover in the second quarter, and I would say we performed better in that recovery than we anticipated. Thanks to the outstanding performance from our operations, we were able to ship more beer than expected, returning our distributor inventory days to where we prefer them to be.

Okay. So your brewery operations ran more efficiently than you thought they would, so you were able to ship more is that the answer?

That's the majority of the answer. And yes, it's not even the efficiency the level of utilization at our breweries was quite high. And again, some amazing work by our teams in Mexico.

Terrific. Congratulations and thank you.

Yes, thank you and good morning everyone. Rob and David too, I'm confused why you haven't committed to repurchase. And the reason I say that is we heard you in November say, we've clarified our leverage objective, it's now 3.5 and we're now sitting at kind of 3.2, 3.3 levels. And there is no comment on repurchase and the cash flow is going to continue to come. So what's going on and as far as your priorities from an M&A perspective, is it fair to think spirits is your highest priority if you have to consider the comparative share you have there versus your other two businesses?

So I'll comment on the repurchase component and I'll let Rob comment on M&A. Our capital allocation philosophy, Mark, hasn't changed at all. We said when we were below 3.5 times we would look to buy back our dilution on a systematic basis and more than our dilution say opportunistically. Remember, we’ve repurchased $1.2 billion worth of stock towards the tail-end of last fiscal year. So we waited in Q2 until we got below 3.5 times and then we started with our systematic repurchase of our dilution, granted it only amounted to $14 million in the quarter. But that's more of a timing issue than anything else. So we remain committed to our capital allocation principles.

And then maybe there is a nuance I missed. But is 3.5 the objective or are you willing to go lower than that?

So we're going to continue to operate the business kind of targeting 3.5. Now that said, I'm not sure we'll be dogmatic to stay exactly at 3.5, but we will stay in that 3.5 times range over a medium-term period of time.

And what was your question on M&A, Mark?

Well spirits comparatively high priority versus beer in terms of the size of the assets you might purchase the spirits comparatively higher priority than the other two alcohol businesses.

Not necessarily. We continue to look across all three categories. Fundamentally, you could see tuck-in acquisitions across beer, wine, and spirits. I’d say we're fairly agnostic relative to the three categories; it's more a question of growth and margins and what we think is opportunistic. So there are good examples across all three categories of tuck-in acquisitions if they were available that would meet the growth and margin and economic criteria that we have. I wouldn't in any way expect to see from us either just spirits or just beer, just wine. I think you’re going to see more of the same kind of the thing that you've seen in the past. We bought High West, we bought Casa Noble, we bought Charles Smith, we bought Funky Buddha. It’s been a mix, and it will continue to be a mix.

Great, thank you.

Good morning and congratulations again; I believe you have set a new standard for press releases. I'm curious if you could clarify the growth in beer sales. Specifically, for your largest brands, Corona and Modelo, can you provide details on how much of their growth is due to distribution gains and how satisfied are you with the velocity trends at your current distribution points?

Yes, so from a distribution standpoint, we've said that about 60% of our growth has come from distribution gains, and in fact the beer sales team has done an outstanding job of executing against their distribution objectives for the year. Now we're seeing a bit of an acceleration of our distribution growth across the portfolio. So, a majority of it is based upon the growth in distribution in the business.

To the second part of your question, we're entirely unhappy and disappointed with our distribution growth because we don't have the distribution that we ought to have as a company meaning in beer. Given the growth and margins to the retailer of our portfolio, the good news in that is we're making progress, but there is a lot of room left to go in distribution, which basically means there is a big growth runway ahead of us.

Thank you. Just on the velocities, is Corona significantly higher than Modelo or vice versa?

Yes, velocity?

Yes.

Yes, Corona would have a higher velocity than Modelo, I believe; we'll double-check that.

Yes, I don't have the individual brand velocities with me.

I don't either.

Thank you.

Thank you, good morning.

Hey, Judy.

So, just, I guess, a couple of quick questions related to your guidance. So, when I kind of think about your depletion outlook for the balance of the year, I think it implies sort of stable growth versus what you've seen the first half of the year. The comparisons are a little bit easier; you had talked about maybe a minor impact from the hurricanes, you've got the Premier launch in kind of the beginning of next year. Just so trying to get a little bit more of an understanding where the upside versus kind of the downside case in terms of depletion guidance. And then David, just in terms of the margin for the back half for beer, obviously it does imply I think something like a 36% EBIT margin. So kind of the delta between first half versus the second half, is it mostly attributable to really the lower volume related to the seasonality of the business?

I will address the second question first. Looking at the business's seasonality over the past few years, we typically sell about 55% to 60% of our total annual beer volume in the first half of the year. Given our fixed costs and operating expenses, along with SG&A being fairly consistent throughout the year, the seasonality affects us by creating a notable impact in the latter half of the year, which we expect to remain consistent in the future. Additionally, this year we have ongoing projects at Nava and Obregon that will incur line commissioning costs and require extra labor to support expansion. We'll also see added depreciation as we bring new assets into service. Once this year concludes, we'll be in a better position to define a more accurate seasonality model, but this is what we are anticipating. Regarding depletions, I believe our guidance is well-balanced, as we anticipate a more favorable overlap in Q4 for depletions, especially with beer. Currently, we are experiencing just over 8% depletions in Q2, indicating we are in a good place with our depletion forecast.

Got it. Okay, thank you.

Good morning everyone. I have a follow-up regarding the beer segment. Could you provide us with an update on your commercial strategy to secure shelf space from slower-moving competitive brands, particularly craft beer and light beer? How are you measuring your progress in this area? Additionally, considering you are one of the top commercial beer organizations in the U.S., aside from mergers and acquisitions, could you see potential in importing or distributing beer from Europe or Japan to better utilize your assets in the U.S.? Thank you.

Yes, so first on shelf space. Our increases in distribution are specifically coming from the kind of thing that you mentioned, either shelf space coming from slower moving craft SKUs or slower moving domestic. As we increase our shelf space, because the overall beer shelf space, I wouldn’t say at this stage is growing. That is precisely the trust and the concept, and our discussion with retailers is that they can improve their growth rate and their profitability per unit shelf space by devoting more shelf space to our growth portfolio and high margin portfolio than either low-margin domestic beer or craft that is not moving. On your second question about imports other than our own, I would say at the moment they are not very exciting to us for a couple reasons. Number one, if you look at imports as a category in the United States, I would say the vast majority, if not almost all of the growth in imports, with a small exception of a couple of small brands, is coming from our portfolio. It’s a little bit of a misnomer to think that the growth in the beer category, to the extent that there is any, is coming from imports; it is not. It is coming from Constellations portfolio of Mexican beers. And then there’s also growth coming from the craft segment, and that’s about it. Number two, we’re completely uninterested in taking on imports of other companies at an agency basis, in fact we gave up those imports. We used to have brands like Ching-Dao in the portfolio and St. Pauli Girl, and those were agency brands. Now the margins on that kind of business are not consistent with the kind of businesses and the kind of business that we’re interested in. Point number one. And then point number two, there isn’t really much growth in imports from any country except Mexico, and that’s all coming from our portfolio and of course there are one or two small exceptions to what I am saying; but they literally are one or two small exceptions. So, hopefully that answers your question.

Yes, very clear. Thank you.

Thank you very much, good morning, and congratulations on another great performance. Rob, you’ve made a strong case for additional distributions and phasings in the beer segment. A couple of years ago, we conducted a major distributor realignment in wine, and given the 5% depletion growth in wine this quarter, along with the particularly strong growth in the focus brands, I’d like to know if you have the capacity to approach retailers and argue that we’re not receiving a fair share of phasings in wine or make that case to your distribution. How do you view this?

Well, I mean the answer to that is yes, especially when you look at our focus brands and some of our most key brands. What you are describing, and I know you know this, is sort of the essence of what we call sales execution. But okay, in wine and spirits, it’s slightly different than beer, although very slightly, because what I am about to say really applies to all three categories. But in wine and spirits in particular, because of the very, very high degree of fragmentation versus beer for argument's sake. The total key is merchandising. When we talk about merchandising, it’s all about getting the product on the floor and advertised by the retailer with some kind of a deal; that’s really the key to execution in really wine and spirits, a little less so in beer where it’s about getting more of that shelf, which continues to be dominated by really just a couple of companies that represent the vast majority of the market share in beer in the country but have declining portfolios. That said, merchandising in beer is important too; getting the floor is also important. But now in wine, a wine bottle on a shelf is one wine bottle and one label amongst 1,000. If you really want to have your product in danger of being purchased, there is no better way than to have a display of your product on the floor in front of the cash register and have stores add it with a discount so that consumers can easily pick up a bottle of it as they checkout at the cash register. As I said, that is the essence of sales execution.

So would you argue that the point of leverage is with the retailer with a discussion on total beverage alcohols, or is it I need to go back to blocking and tackling with the distributor?

I would say that it’s both, but as far as TBA goes, total beverage alcohol, I think it’s a retail story. What I mean by that is that there are a number of facts that are extremely important that the retailer needs to understand and really probably doesn’t understand; two facts. If you were back to school, Bill Newlands, our COO, and David talked about this. A very large percentage of consumers right now are shopping across all three categories at once. They are buying wine, beer, and spirits; I think the number is something like 55% of consumers are shopping and drinking across all three categories, which is far different than it used to be years ago. We need to address those consumers’ desires and we can do that at retail by offering our TBA portfolio of premium and growing brands. Point number two to the retailer is almost even a more important point, and that is that if a retail basket contains all three beverage alcohol products, meaning beer, wine, and spirits, the total value of the ring will be larger by several hundred percent than a basket that only has one category of the three or even two categories of the three. So, that's what retail is all about, and the most successful retailers in the country are all about how do we increase the average size of the ring i.e., the basket as the shopper leaves the store. There probably is no better way to do that than to get the consumer to purchase all three categories. Because if I do that, that consumer is going to be a very big purchaser in that store.

Perfect, thanks so much.

Thanks and good morning. Just wanted to follow up on Funky Buddha and just kind of the decision on that and based on kind of the learnings from Ballast Point, how might that be different? How does that lead to maybe looking at other type acquisitions? I mean, you had kind of taken a break from Ballast Point to this. So just trying to understand how this might be different in terms of your thought process after having Ballast Point for a couple of years.

Yes, that’s an interesting question. There are some very significant learnings relative to that, and what we are doing with Ballast Point relates to that, and how we're treating Funky Buddha also relates to that. I would say that when the craft beer business as a general proposition was growing at a much faster rate, the modus operandi that most craft businesses had, including Ballast Point before we bought it and for a period of time after we bought it, was to create a whole bunch of products, throw them out, try to throw them out there everywhere and anywhere you can and see what happens and let the consumer decide. As the business has slowed down, as there is a SKU contraction going on, that modus operandi really doesn't work anymore because what you found is that just putting the product out everywhere and anywhere around the country in stores that may not have a very high what we call CDI, or category development index, doesn't make a lot of sense because the stuff just sits on the shelf. Consumers are sort of realizing that. What we've done with Ballast Point is, number one, we're consolidating the distribution network into our gold network. That's a very important learning and very important to us. Funky Buddha, if and when we expanded outside of Florida, that will be a key tenant, number one. Number two, focusing on key SKUs that are really driving the growth as opposed to overly fragmenting the portfolio and then driving our marketing against those key SKUs where we know that there is velocity and consumer interest. That’s another key learning as opposed to just putting out 50 different things. So driving this usually two or three or four key SKUs that are important. The third element, which is really important, is not expanding geographically too quickly and therefore into markets where there is no consumer awareness of the brand; there is really no marketing, just throwing the product out there to retailers. Because that will just sit there and won’t be reordered and that’s where you sort of see a bit of a slowdown. A lot of these companies are cycling through having thrown a lot out there and then finding out that it's not repeat business. With Funky Buddha, we get the beauty of being able to apply those tenants straight off the bat, and therefore I would say building a stronger, more consistent, and more measured growth story with Ballast Point; we’re retreating to that approach and philosophy a bit, and hence that's why you see some of the shorter-term negative impact in Ballast Point, which I would say that as we move into our next fiscal, you will see us cycle that. We’re pretty hopeful that our activities there will take hold because we have moved it to our gold network; they are extremely highly motivated to drive the brand, and the liquids are award-winning and fantastic. There is nothing fundamentally wrong with it other than the approach that was previously taken was not, I’d say, the kind of professional approach that we as a major company could really bring to it. So we’re in that process right now, and those are new learnings from our Ballast Point experience. More to come.

Thanks so much, I appreciate it.

Hey, Tom.

Hey guys, how are you doing? Great job. I got a question, no one has asked it, very important question. How did you guys know to stick with the New York Jets’ Corona Red Zone promotion? Who figured that out, that they were going to be two in two after four weeks?

It’s pure luck. We’re not going to go into gambling because we’d probably all be arrested, Tom.

Good job, good job.

Because of these forward knowledge that we have of these matters.

Exactly alright, well fantastic quarter, hope to see you guys soon.

Thank you.

Thanks, Tom.

Okay, as we close out the discussion for our second quarter results, I want to thank everyone, everyone who contributed to the strong performance of our business for the first half of the year. Though the year is far from complete, our new guidance reflects the confidence we have in our ability to sustain our growth momentum in the second half. Our next quarterly call is scheduled for early January, when we will share the results of our third quarter. Until then, we wish you all a safe and happy holiday season; certainly in our business this time of the year is great. And it’s a great opportunity to responsibly share Constellation’s fine beer, wine, and spirits products with friends and family. So thanks again, everybody, for joining our call and have a great day.