Constellation Brands Inc (STZ) — Q3 2018 Earnings Call Transcript

Thank you, Lori. Good morning, and welcome to our third quarter fiscal 2018 conference call. I'm 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 measure and any non-GAAP financial measures discussed on this call are included in our news release or otherwise available on the company's website at www.cbrands.com. 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. Before turning the call over to Rob, similar to prior quarters I’d like to ask that we limit everyone to one question per person, which will have us end our call on schedule. Thanks in advance. And now here's Rob.

Thank you, Patty, and good morning, and Happy New Year. I hope you enjoyed the holidays and had the opportunity to include some of our fine Constellation products in your celebrations with family and friends. As I reflect on 2017, I am reminded that it has been a dynamic time for our business. We posted another year of exceptional stock price performance, with Constellation stock increasing almost 50% for the calendar year 2017 versus the S&P 500, which grew about 20% for the year. Overall, Constellation was one of the best performers among the S&P 500 Consumer Staples stocks. I believe our excellent stock price performance continues to be driven by our strong financial results and the ongoing growth prospects for our business. The confidence in our future business prospects compelled us to seek board authorization for a new multiyear $3 billion share repurchase program, subsequent to the recent repurchases of more than 200 million of our outstanding shares. I'm also excited about our recent investment in Canopy Growth Corporation, the largest publicly traded cannabis supplier in the world and a leader in the medical cannabis market in Canada. Founded in 2014 and based in Ontario, Canopy Growth is one of the earliest commercial players in Canada's legal cannabis market and has a global presence via numerous joint ventures and partnerships. Canopy is traded on the Toronto Stock Exchange and currently has a market cap in the $5 billion range. This investment provides Constellation with a first-mover advantage for a potentially significant emerging consumer opportunity and aligns with our long-term strategy to identify, meet and stay ahead of evolving consumer trends and market dynamics while maintaining focus on our core total beverage alcohol business. Our plan is to jointly collaborate with Canopy in a number of areas. Initially, we will be learning the cannabis business and the related consumer space and route-to-market while building and developing a successful cannabis beverage business. Now recreational cannabis is scheduled to become legal in Canada this coming summer with recreational edibles, including beverages, expected to become legal in the summer of 2019. We have no current plans to sell cannabis products in the U.S. or any other market, and we will not consider doing so until it is legal at all levels of government. Our initial investment of approximately $190 million represents an ownership interest of 9.9% of Canopy Growth plus warrants which give Constellation the option to purchase an additional ownership interest in the future. In a few moments, David will review how we are accounting for this investment. And speaking of growth prospects, we posted another great quarter for our beer business, which generated 80% of the total U.S. beer category growth and claimed four of the top 10 share-gainer positions with Modelo Especial, Corona Extra, Modelo Chelada, Tamarindo Picante and Pacifico. Overall, Constellation's beer business remains the leader in the high end of the U.S. beer market and was the clear winner for the Labor Day and Thanksgiving holidays, with excellent execution that drove share gains led by Corona Extra and Modelo Especial. These brands continue to drive the growth of the portfolio with ongoing distribution and velocity gains. Throughout the quarter, Corona Extra maintained strong media support and became the official imported beer of four NFL teams while also featuring Jon Gruden in football promotions during the season. Corona Extra also increased relevance with Hispanic consumers through its partnerships with Latin music superstars Enrique Iglesias and Maná. The Modelo Especial fighting spirit campaign continued throughout our third quarter including national TV and promotional activities during the NFL schedule. In addition, national Spanish-language TV support ran through November including a strong presence with live soccer programs and top-rated Spanish-language TV networks. Social media on Facebook and Instagram also supported the NFL, the Mexican Independence Day, and the Dia de los Muertos for this brand. Collectively, these initiatives drove depletion growth of almost 17% for the Modelo Especial family of brands for our third quarter. Pacifico continues to make its mark within our portfolio and recently was named Impact Beer Brand of the Year by Market Watch. In addition, Pacifico has become the fastest-growing beer brand among the top 40 beer brands based on 52-week IRI dollar growth of nearly 24%. Our plans for Corona Premier and Corona Familiar continue to evolve as we finalize our launch strategies for next year. Corona Premier is the first national Corona line extension in more than 25 years, and we plan to make our largest-ever launch investment of more than $35 million to support the effort. This includes a robust media plan with general market and Spanish language TV advertising beginning in April. Additional support will include print, social media and Hispanic-targeted advertising as well as on-premise sampling and new point-of-sale materials. Corona Familiar will roll out during the same time frame to major Hispanic markets, a key demographic for this brand. Now turning to the operations side of the beer business. During the quarter, we continued to make progress as we put the finishing touches on our Nava capacity addition to complete the 27.5 million hectoliter expansion while also nearing the finishing line with our fourth glass furnace, both of which are expected to come online in the coming months. Glass furnace three is now fully operational and running at peak efficiency levels. The Obregon brewery continues to perform at a very high utilization level, and we remain on track with our brewing and packaging capacity additions, which are expected to be completed before the end of the fiscal year. And construction continues in Mexicali with brewhouse tank fabrication and installation currently underway. During the quarter, we reached an agreement with Owens-Illinois to restructure and expand our contracts for glass supply including our joint venture agreement. As you know, the joint venture operates a glass production plant in Nava, Mexico and provides bottles exclusively for Constellation's adjacent brewery, which is our lowest-cost source of supply for glass. The original joint venture agreement included the expansion of the glass production plant from one furnace to four furnaces, and initial expansion plans have been progressing as scheduled, as I just mentioned. The expanded relationship with OI provides for the addition of a fifth furnace, which is expected to come online by the end of calendar 2019 and will be included in our future capital investment plans. Following the installation of the fifth furnace, the Nava plant will be the largest, most modern glass container facility in the world. In recognition of the value-added contributions from both partners, the term of the joint venture agreement has also been extended for an additional 10 years to 2034. David will discuss the high-level details of this new contract in a few moments. Now turning to the wine and spirits business. It certainly has been an interesting quarter for our wine and spirits division. Early in the quarter, hurricanes hit some of our key markets. And shortly thereafter, we were faced with one of the worst natural disasters in California state history as we dealt with widespread wildfires in Northern California. Overall, we are fortunate that these events are expected to have only a minor impact on our business both near term and in the future. To put things in perspective, about 80% of the harvest was already completed when the wildfires started, and less than 5% of our wine portfolio is Napa or Sonoma appellated. Constellation has a long history in Napa and Sonoma, and we're committed to helping our neighbors and our communities rebuild by driving consumer engagement and continuing to encourage purchase and consumption of Napa and Sonoma wines. Please help us support this effort. Third quarter wine and spirits depletions were a bit muted following a strong finish to our second quarter. Key Focus Brands drove depletion growth led by double-digit trends for Kim Crawford, Meiomi, Black Box, Ruffino, Robert Mondavi Private Selection, and High West Whiskey. Throughout the quarter, our focused investments for some of these brands were visible in the marketplace and drove excellent results, including the first-ever national TV advertising campaign for Kim Crawford, which drove accelerating growth trends for this brand during the key holiday selling season. Now on a year-to-date basis, the business is expanding margins, generating positive mix, driving innovation, and seeing excellent results from acquired brands including Meiomi, The Prisoner, Charles Smith, and High West. And our innovation efforts are paying off with successes like Cooper & Thief, which has become the #2 super-luxury red blend; and Robert Mondavi Private Selection Bourbon Barrel-Aged Cabernet and Chardonnay, which together are growing more than 120% in IRI channels. I'm also pleased to report that Constellation Ventures has been busy, recently making two minority investments, both of which align with our strategy of investing in emerging unique and distinctive brands. The first is The Real McCoy, a high-end rum aged in American oak bourbon barrels. This line of 3, 5, and 12-year aged rum is produced by Richard Seale, a legendary fourth-generation master distiller and made at Foursquare Distillery in Barbados. This product has a premium price point of the $20 to $50 range and uses an authentic farm-to-glass production process using high-quality blackstrap molasses with no added sugars, flavors or aromas. The second is Copper & Kings, a high-end American craft brandy founded in 2014 in Louisville, Kentucky. These brandies are naturally distilled in copper pot stills, and the liquid is matured in Kentucky bourbon barrels and retails for $35 a bottle. While the U.S. wine industry remains healthy overall with trends that continue to exceed U.S. CPG category growth, we have seen a bit of a slowdown in the market growth rate versus what we anticipated when we set our original guidance estimates earlier this year. In addition, our SKU rationalization efforts are creating a headwind as we continue to carefully rationalize our portfolio of tail brands. Despite these challenges, we are targeting wine and spirits net sales and EBIT growth for fiscal 2018 at the low end of our previous stated guidance ranges of 4% to 6% and 5% to 7%, respectively. Before I turn the call over to David, I'd like to take a moment to address the topic of tax reform. As a U.S.-based beverage alcohol company, Constellation has been supportive of tax reform that allows U.S. companies to remain competitive globally. While we continue to review the legislation, we are very pleased with the outcome of this historic legislation and believe that it'll be very positive for us going forward. David will provide additional details in a few minutes. In closing, it is certainly shaping up to be yet another eventful year at Constellation. With the fiscal year quickly drawing to a close, I am very pleased with our progress to date. We established a first-mover advantage in the emerging consumer category with our Canopy Growth investment, and we continue to make smart investments, including the planned addition of a fifth furnace at our glass plant in Nava. We continue to build shareholder value through ongoing share repurchases and stock appreciation driven by our strong results and future business prospects. And I am pleased with the outcome of tax reform legislation. We look forward to leveraging the opportunities that this will bring for our business and continue to thrive. With that, I'd now like to turn the call over to David, who will review our financial results for the third quarter.

Thanks, Rob, and good morning, everyone. I'm pleased to be here with you today to discuss another quarter of strong execution. On a year-to-date basis, we've grown market share, expanded margins, and improved our capital structure while investing in growth initiatives that will benefit us as we go forward. Our fiscal '18 year-to-date comparable basis diluted EPS is up 29% versus last year. Q3 comparable basis diluted EPS increased 2%. The low Q3 EPS growth rate was primarily due to timing as we're increasing our full year comparable basis diluted EPS guidance to a range of $8.40 to $8.50 from $8.25 to $8.40. This improvement is primarily due to anticipated favorability in our full year tax rate and better margin performance in our beer business, which I'll talk about in a moment. We now expect our fiscal '18 comparable effective tax rate to approximate 20% versus our previous 21% guidance. Our EPS and tax rate guidance excludes any impacts from recently enacted tax reform. Before I move further into our results, let me provide some comments on the new tax legislation. First of all, we're pleased with the bill that was enacted and want to thank our friends in Congress for their work to reform the corporate tax code. Like most companies, we're in the process of evaluating the specific impacts of tax reform, but it is clearly favorable to our previous low-to-mid-20s long-term effective tax rate guidance. For fiscal '18, we expect to benefit in our U.S. federal statutory tax rate. The new 21% corporate tax rate will apply for the last two months of our fiscal year, resulting in a lower blended statutory tax rate versus the historical 35% rate. We expect the new tax legislation, including the impact of the tax rate deduction or reduction and the transition to a territorial system of taxation, will result in a reduction in our existing net deferred tax liabilities by $300 million to $400 million. This onetime noncash benefit will be reported in our fourth quarter fiscal '18 results and will be excluded from our comparable basis financial results. We expect to provide an update to our long-term effective tax rate guidance as part of our upcoming investor presentation at the CAGNY conference in late February. Now let's take a closer look at Q3 performance and our full year outlook, where I'll generally focus on comparable basis financial results. For beer, we continued to see strong operational performance and robust marketplace momentum. Depletion growth came in at 9% as we won the Labor Day and Thanksgiving holidays. This result was in line with our depletion growth performance year-to-date and our high-single-digit depletion growth target for fiscal '18. Net sales increased 8% on volume growth of 6%. Depletion growth ran ahead of shipment growth primarily due to timing. Year-to-date shipments grew more than 8%, putting us on track to meet our net sales target 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 benefit in our Mexican beer portfolio. Beer operating margin increased 290 basis points to 37.7% primarily due to lower COGS and favorable pricing. The lower COGS reflect operational benefits driven by glass and material sourcing along with foreign currency favorability. These benefits were partially offset by a $12 million increase in depreciation expense, which totaled $42 million for Q3. We now expect beer operating income growth to be in the range of 18% to 19%. Although we're increasing our guidance to the upper end of our previous range, our Q4 operating margin is expected to moderate primarily due to lower seasonal production volume combined with the continued ramp-up in depreciation, line commissioning costs, and headcount additions. In addition, SG&A leverage is expected to be impacted by the seasonality of the business. For wine and spirits, organic net sales were flat due primarily to mix benefits being mostly offset by lower volumes. Operating margin decreased 110 basis points to 26.2% as mix benefits from portfolio premiumization efforts were more than offset by higher COGS and marketing investments. The higher COGS primarily reflect higher operational costs including increased transportation costs and the overlap of a supplier cost reimbursement in Q3 last year. We expect to realize benefits from the increased marketing spend on brands like Kim Crawford, Ruffino, and Charles Smith over the next several quarters. For the year-to-date period, organic net sales are up 1% and operating margin has expanded 170 basis points. Excluding the impact of the Canadian wine business divestiture, net sales are up 4%, and operating income grew 5% for the first 9 months of fiscal '18. For fiscal '18, when excluding the Canadian wine business divestiture, we expect net sales and operating income growth rates to be at the low end of our targeted 4% to 6% and 5% to 7% ranges, respectively, for the reasons Rob mentioned. As a reminder, as part of our premiumization efforts, we've 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 increased 5% primarily due to higher average debt balances. We also continue to benefit from our investment-grade status. In October, to improve short-term borrowing costs, we implemented a commercial paper program, which provides for the issuance of up to $1 billion of commercial paper. In November, we issued $2 billion of senior notes at attractive fixed rates and used the proceeds to repay amounts outstanding under our variable-rate European term A loan facility. Our net debt to comparable basis EBITDA leverage ratio moved down to 3.4x at the end of November from 3.7x at the end of fiscal '17 while we invested in our Mexican operation, our portfolio, and Canopy Growth and returned cash to shareholders with $301 million worth of dividends paid and $239 million of stock repurchases during the first nine months of the year. The stock repurchases represent a little over 1.1 million shares at an average price of $213 with most of this activity occurring during the third quarter. At the end of Q3, there was $308 million remaining on our existing share repurchase authorization. As Rob mentioned, we're pleased that our Board of Directors authorized an additional $3 billion for share repurchases, which we expect to utilize over the next several years. Our significant capital allocation flexibility allows us to continue to invest in our business and return cash to shareholders while remaining committed to our 3.5x leverage target. Our comparable basis effective tax rate came in at 18.9% versus 16.4% last year. This increase reflects the overlap from recording the year-to-date impact of our election of indefinitely reinvested foreign earnings under APB 23 in the third quarter of fiscal '17, partially offset by the fiscal '18 adoption of ASU 2016-09, which requires excess tax benefits from stock-based payment award activity to be recognized in the income statement. We now expect the fiscal '18 effective tax rate to approximate 20% versus our previous guidance of 21%. The lower projected rate is primarily due to an increased benefit from lower taxes on foreign earnings. As noted earlier, our updated guidance doesn't include any impact from tax reform. I'd 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 noncontrolling interest to approximate $10 million to $15 million. As mentioned earlier, we're now projecting our full year comparable basis diluted EPS to be in the range of $8.40 to $8.50. The midpoint of this guidance has us targeting 25% year-over-year growth. Our comparable basis guidance excludes comparable adjustments, which are detailed in the release. I'd like to highlight two significant comparable adjustments that occurred in Q3. The first is the $217 million pretax gain from the change in fair value of the Canopy investment and Canopy warrants. This gain is primarily based upon a CAD 18.43 share price for Canopy at the end of our third quarter as compared to a CAD 12.98 share price at the time of our initial investment. The Canopy share price has moved significantly higher since the end of the third quarter as well. Going forward on a quarterly basis, we will continue to record a comparable adjustment for the change in fair value of this investment and warrants and update reported EPS guidance accordingly. Our current reported guidance assumes that the Canopy share price at the end of our fourth quarter will equal the share price at the end of our third quarter. The second is related to glass sourcing initiative highlighted by Rob, where we reached an agreement with Owens-Illinois to restructure supply contracts and expand our joint venture agreements for the operation of the Nava glass plant by 10 years to 2034. The expanded relationship provides for a fifth furnace to be added at an estimated cost of $140 million. This will be financed by equal contributions from both partners and will be included in Constellation's future capital investment plans. The fifth furnace is targeted to come online at the end of calendar 2019. During Q3, we recorded a $59 million pretax charge associated with the restructuring of our agreement with OI. This initiative will result in more glass being efficiently provided to the Nava Brewery from our lowest-cost source of glass supply, providing Constellation additional opportunities for margin enhancement and a higher return on our investment. Moving to free cash flow, which we define as net cash provided by operating activities less CapEx. For the first nine months of FY '18, we generated $763 million of free cash flow versus $824 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. 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 Mexican beer operations. At this point, I'd like to highlight ASU 2014-09, the new revenue recognition accounting standard, which will be effective for Constellation at the beginning of fiscal '19. Upon adoption, certain sales incentives will be recognized earlier than they are currently, and we'll make an adjustment to increase accrued expenses with an offset to retained earnings as of the end of fiscal '16. We will recast the full year of fiscal '17 and fiscal '18 along with fiscal '18 quarters. We're in the process of quantifying the changes, but we don't expect there to be a material impact on net sales. We expect to provide recast information when we file our fiscal '18 10-K. In closing, we're well positioned to deliver another year of top-tier financial performance as we close out fiscal '18, and we're excited about our financial prospects heading into fiscal '19. And with that, Rob and I are happy to take your questions.

My question is on the beer division. First, David, you mentioned a number of reasons behind the expected large year-over-year decline in beer operating margins in Q4. Are those more discrete factors in Q4 causing the year-over-year compression? Are you comfortable those factors don't linger and you get back to expansion beyond Q4? And then also on the top line front in beer, can you help frame the magnitude of contribution you expect from Premier next fiscal year based on what you're seeing in test markets so far and in light of the heavy investment of more than $35 million that you mentioned earlier in the call?

Yes. Dara, so in terms of Q4 margins for beer, the real issue for us is that we haven't seen a full seasonality picture of our business really until this year because of being under the interim supply agreement prior to this. And so in Q4, it's our lowest net sales quarter of the year, so we get a bit of a deleveraging effect at the fixed cost line in the plant as well as on the SG&A line. And then on top of that, we're bringing in employees. So we're adding headcount in Q4 that we will be able to deploy when we get into the peak production season, and we have some line commissioning costs. So I think there's just a bit of a seasonality built in, but we're pretty confident in the margins and being able to deliver strong margins going forward. I'd also say, Dara, that we had concerns both for Q3 and Q4 about some headwinds from FX within our beer margins, but with the peso sitting around 19, we're just not seeing those headwinds this year. And then from a top-line perspective, we expect the majority of the benefit from the Premier launch will be seen in Q1 of next year versus Q4 of this year, and so we simply expect to have our distributor inventory kind of at our normal 30-ish days at the end of the quarter when we get to the end of the fiscal year, which is why we expect our net sales to be in that 9% to 11% range for the year.

Just as we kind of approach the February shelf set resets and obviously you're launching some new products into the marketplace, I'm just curious on what the retailers and distributors are saying in terms of incremental space because I know that's been a big initiative that you guys have been pushing for a number of years now. Can you just provide some context on kind of how it looks now and how it's changed from where you were a year ago?

Yes. So I think that in general, we're making good progress on our efforts to increase our space commensurate with how we're growing at retail and our contribution from a profitability point of view at retail. So we continue to see good distribution growth. And so I'd say, everything is on track. We've also made some significant organizational additions to bolster our category management activities and have brought in some really great people to continue to drive those efforts. So in general, we're pleased with the progress that we're making. But we start from a position, as I've stated a number of times, of not being where we think we should be or would like to be from a space allocation point of view at retail.

Nik, I'd also add that on a year-to-date basis, our effective points of distribution are up double digits, so we continue to do really well in gaining distribution.

So I was hoping to get your thoughts on the outlook for the beer category. The results from a category perspective despite your very good depletion growth continue to look increasingly sluggish in Nielsen. That's also mirrored in the deceleration we're seeing in PCE growth. And so with your largest market, California, transitioning to legal cannabis, how are you thinking about the overall beer category for calendar '18 and any impact from cannabis?

Yes. We believe the beer category will continue to perform similarly to how it has been, with the market showing flat to slightly declining volumes. Growth is primarily in the high-end segment, while the premium category is losing share. We don’t anticipate any changes as we move into 2018 or our next fiscal year. Regarding cannabis in California, we don’t expect any significant impact. It’s important to note that cannabis has been accessible as medical marijuana for 16 years, so the recent legalization for recreational use is likely to be insignificant. Additionally, our analysis shows no real impact on beverage alcohol in states where cannabis has been legalized, including California. As I've mentioned before, it's not necessary to debate whether cannabis is cannibalistic or complementary to alcohol, as there isn't enough data to determine its future effect on the beverage alcohol sector. However, we do recognize that it is expected to be a substantial market globally.

Just following on the last question. I'm wondering if you could give us any details or further details on your plans in Canada in terms of building out a sales team there, the sort of products you will be looking to develop or co-develop and kind of the general strategy. And I understand this is very early days and it's still very much a learning process, but would just love to get a sense of how you're thinking about it and what sort of investments on the ground that you'd be looking to put in place and thoughts on route-to-market.

Yes. We are making investments and have begun establishing our organization in Canada. I'd describe it more as a marketing organization rather than a sales organization since our partner, Canopy, already has a sales team and will keep developing that aspect. We aim to collaborate with them. We've assembled a team to work with Canopy on various aspects like consumer research and marketing, where we have substantial expertise. Canopy, being a newer company focused on a rapidly growing category, hasn't fully developed yet. Our team will collaborate with theirs to tackle the market together, especially when beverages become legal, anticipated either with the initial recreational legalization in 2018 or in 2019. The current official government position suggests that edibles might be introduced in 2019, but it’s uncertain if beverages will be included in that timeline. As of now, the best estimate is that beverages will likely be available in 2019. Regarding our developments with Canopy, we are focusing on nonalcoholic beverages infused with cannabis. At present, we are working on product development and aspects such as branding. Given the timeline, we don’t have everything finalized regarding flavors, packaging, or branding yet. Canopy already has a strong brand called Tweed in the medical marijuana sector, which shows significant potential.

Great. And just following up on that, what sort of organization would you need in Québec?

Well, we haven't really, I'd say, gotten that far that we're thinking about organizations by province. But as I said, in terms of like a larger sales organization, that will really be done through Canopy as it specifically relates to Canada. So I wouldn't see us building a huge sales organization necessarily, but we will build some significant capabilities and make some investments next year.

Yes. So Robert, when we provide guidance for the year on our next call, we'll talk about investments in cannabis. But clearly, there will be some.

Just had a couple of follow-up questions, David, I guess, on the comments on tax. One was just I wanted to clarify the benefit that you're expecting. Is that relative to the fiscal '18 20% rate? Or is it a benefit relative to your long-term guidance on tax rate?

Well, Bryan, what we said in the script was that it would be beneficial to the low-to-mid-20s kind of long-term guidance rate. But we'll have a lot more specifics when we get to CAGNY because, as you can imagine, it's complicated even to understand what's in the regs as well as working through how to apply it to our business. But I can say that we're pretty confident that it's going to be below the long-term guidance and likely in line with the 20% rate that we threw out for the remainder of this year or for this year.

Do you think it will positively impact free cash flow? As you evaluate cash taxes and rates, do you have any insights on whether there will be a tangible cash benefit expected?

We are still working through this. Previously, we provided guidance on an effective tax rate and mentioned that the cash tax rate would be approximately 500 basis points lower. As we continue to amortize some of our intellectual property over time, we believe this could actually increase a bit beyond 500 basis points, but we do not have final answers yet. We expect to have more clarity in several weeks at CAGNY.

But there's a chance that, that relationship between your cash tax rate and your new lower effective tax rate would be maintained?

A question on wine and spirits, Rob, but just as a point of information, this group called Smart Approaches to Marijuana points out that alcohol consumption has risen in Colorado post legalization. There's a lot of just really useful data there, I found. But wine and spirits, your year-to-date organic revenue was like plus 1%. Your fiscal '18 through fiscal '20 target is mid-single digits annually, and I hear you on the SKU rationalization. But how are you thinking about what's necessary to deliver that mid-single digits? Or do you think the mid-single digits is too high?

We expect mid-single net sales growth for the year, which was our initial guidance range. We feel confident that we will stay within that range based on our current position and the outlook for the fourth quarter. Year-to-date, we've seen around 4% growth in net sales, excluding Canada, so we are optimistic. The market has slowed somewhat, by about 100 to 200 basis points compared to our earlier expectations for the year, and this slowdown is the main factor affecting our range. We believe we are more likely to end up at the low end of the range primarily due to market conditions. Lower-end wines below premium are facing challenges, but this could ultimately be positive news as we continue to observe a trend towards premiumization. The growth in the wine business is increasingly concentrated in price points significantly higher than before. We used to see strong performance in the $8 to $12 range, but now we're seeing robust growth in the $15 to $20 range, which may be impacting lower-priced segments. We are well positioned in the higher price points and will maintain our focus there. Over the past few years, we've shifted our focus from the $8 to $12 range to the $15 and above price points, where future growth is anticipated. We expect a slight slowdown in the wine category in the second half of the year, possibly around a couple of hundred basis points. However, we believe that the category will continue to be one of the faster-growing consumer product categories, outperforming the broader market. The overall growth rate has been mid-single digits, around 4%. While we prefer to be at the high end of our growth range, we do not see any unusual factors that could signal concerns. In fact, the growth we are experiencing in the premium $15 to $20 range is very encouraging for many of our brands.

I could have been clearer. I was thinking about your fiscal '18 through fiscal '20 objective of mid-single digits. And in the current fiscal year, you're getting about 300 basis points from acquisitions, so the underlying business is doing a 1%. So I was really thinking about, is it just keeping up the pace of acquisitions because mid-single digits is not how your business is growing on an organic basis?

Yes. I would say that excluding acquisitions, the underlying business has been a bit softer than we would like. The numbers you mentioned are mostly accurate, but I don't believe the short-term or quarterly results are truly representative of anything significant. In fact, it's likely just a matter of timing, whether we're discussing the market or our overall business, which we expect to align with the mid-single digit figures you cited.

Yes, we don't think we need to continue to add to the portfolio to hit those numbers. We expect that our portfolio can hold or grow share as it stands.

And so do you think you can get margin expansion next year if you want that lift in organic growth?

Yes.

So on the $3 billion share buyback announcement, it's a multiyear program. So it seems to leave you still with plenty of room for additional cash usage, especially with your free cash flow stepping up in fiscal '19 and with some other tax benefits also accruing. So I guess I'm just wondering why the board came up with this number. And to the extent that you don't have a big M&A opportunity, do you think that you can complete the program earlier than you expected? Just kind of thoughts around that program.

Yes. We asked the board for authorization to act opportunistically without a specific time frame. They granted us a multiyear authorization, which aligns with our past practices. As we've mentioned before, after investing in our expansion needs, especially in beer, our plan is to maintain our leverage ratio around 3.5x. We aim to achieve this by returning cash to shareholders through dividends and share repurchases, along with engaging in M&A activities similar to what we've done in recent years. I would say we are looking for flexibility in the multiyear repurchase and will be opportunistic.

Okay, and then just a quick follow-up on beer depletion. Can you comment at all on the December trend? Just because obviously, last year, we had a pretty weak December, and just wanted to see if you have any color just in terms of what you saw this December.

Yes, we're expecting a pretty strong fourth quarter on beer depletions is the bottom line.

And December is performing in line with us getting to that strong quarter, so we're comfortable.

In general, our beer depletions are right where we expected them to be, around that 10% mark. This quarter, it was 9.1%. We are anticipating a strong fourth quarter for beer.

I just want to stay on this topic, just in terms of depletions versus shipments. And certainly recognize, there's usually some seasonality, timing differences, but there's still a decent delta between the two during this quarter, and even the last quarter or two. So could you help us better understand the dynamic? And are these two then tracking more closely right now? Or is there still a pretty big delta? And then curious if you could comment on the end or consumer demand, and how you expect this to progress throughout the year given the planned marketing campaigns that you mentioned as well as your new innovation.

In the quarter, shipments were significantly lower than depletions, approximately 6% compared to 9%. This discrepancy is mainly due to the timing of shipments, and we do not anticipate this difference continuing as we near the end of the year. Year-to-date shipments have increased by 8.4%, while depletions have risen by 9.5%, indicating that both metrics are aligning more closely. However, in the third quarter, shipments lagged behind depletions more than usual, although there’s nothing unusual about it. This might simply be related to how shipments are processed at the end of the day. We do not expect this to become a trend. Now, what was your other question, Bonnie?

Just trying to get a sense of the current consumer demand right now. You have touched on that with the previous question, but I'm more curious how you expect that to progress throughout the year.

If you're talking about the business, we think that it's very strong. This is evident from the measured consumer takeaway with IRI, which was around 16.5% for the quarter. We don't see any issues with the consumer at all. In fact, consumer takeaway is particularly strong right now, especially in the measured channels.

I wanted to address the tax issue, not regarding its impact on your rate. In the wine industry, there are many advantages available. Given that most of your competitors are privately held, do you anticipate this will positively affect your margins, possibly allowing for increased promotions or maintaining prices? How do you envision this impacting the market?

We believe the outlook is positive. Consumers are expected to have more disposable income, which should be beneficial for premium products and overall healthy for the industry. So, we see it as all good news with no negative implications.

David, I want to revisit Dara's original question about beer margins for Q4 and look at it in sequential terms compared to Q3. Your comments on seasonality suggest some reduced P&L leverage in Q4. However, by my calculations, your implied guidance for Q4 does not indicate any decline in sales compared to Q3. Could you explain the difference you see between Q3 and Q4? I know you mentioned some hiring in anticipation of demand in the first half of 2019. Is there anything else contributing to this? While I understand that depreciation continues to increase, the peso appears to be favorable, and I would assume the advantages from glass will keep growing. Is the increase in hiring the only factor impacting the difference between Q3 and Q4, or are there other elements at play?

It's a combination of factors. We're experiencing incremental depreciation as we bring more assets online, along with ongoing commissioning costs associated with these assets. Once we put something into production, the added costs are reflected in the income statement rather than being capitalized. We are also hiring around 100 production employees in Q4 to prepare for the increased production season. Historically, there is seasonality in net sales in the beer business this time of year. Therefore, while I don't want to apologize for the margins in the fourth quarter, they are expected to be a bit lower than the all-time high we achieved in Q2. Understanding our margin trajectory is actually what led us to raise our guidance or, at least, tighten it to the upper end of the EBIT growth range year-over-year.

I'd like to follow up on the beer volumes commentary. I just wanted to clarify. Did you mean that the fourth-quarter shipment will be more in line with depletions or just for the year as you do the year-to-date? As you correctly pointed out, the difference year-to-date is definitely narrower. But you're talking about fourth quarter coming up to be obviously, catching up with depletions and with shipments against depletions accelerating above shipments, accelerating above depletions to match the year-to-date. And then I'd also like to follow up on the capital structure. Is your new buyback plan an indication that the uses of capital will be more heavily weighted toward cash return to shareholders compared to strategic M&A?

At the end of the year, we expect to deplete and ship approximately the same number of cases. The percentages might vary slightly due to last year's starting point. The best way to calculate would be to align with the 9% to 11% net sales growth and a 1% to 2% pricing strategy, which would bring us to high-single digits in net sales, reflecting our current year-to-date performance on depletions. Regarding our capital structure, the authorization indicates that we are nearing a point where we will have more free cash flow to allocate. We plan to use that in the same ways as before, particularly by repurchasing a significant amount of our stock, as we believe the company remains undervalued.

My question's around Corona, your flagship brand. If you could talk about what the trends were like in the last quarter, in the third quarter, and how you're thinking about potential cannibalization with Corona Premier or with Familiar on your existing brand. Is that something you're going to be watching very closely, where you don't want to see your flagship Corona dip, even if it is a positive margin trade? So just to talk a little bit about how should we be thinking about that April launch.

Yes. So we think Corona remains healthy, very healthy in fact, given its maturity. It was up about 3% in the quarter.

Beer depletions, right?

Yes, regarding depletions, we see consistent tracking and good growth. Corona Extra is the most mature brand in our portfolio, but given its maturity and significant market shares in certain regions, we believe it is performing well and will continue to do so. You inquired about Premier and cannibalization. We have examined this, and the cannibalization was notably less than we initially anticipated, which is encouraging. It’s not a significant issue because it’s not a lower-margin product. However, we aim for an overall positive effect in the market, as indicated by our test results. We will continue to monitor cannibalization, but we anticipate that Premier will attract a different consumer base, mainly those who already prefer light and low-carbohydrate beers like Mich Ultra. In contrast, those who choose Corona do so without concerns over being low in calories or carbohydrates, leading us to believe that cannibalization will be minimal.

I'll try to do two quick ones. One, just following up on tax. I understand you're still trying to figure out the final benefit. But has there been any discussion from the board of the company of kind of how much of that will be spent back or reinvested? Or how you would spend the extra money in your pocket? And then my other question, just on the business. Any kind of update on on-premise and kind of how that's trending? We heard from different sources that there've been a lot of taps added for craft and all types of brands on-premise. And it seems maybe, you're not getting the volume terms, and so maybe there's some reversal there. So if you could you give us some update there, that would be great.

So in terms of tax, our situation is a bit different from many companies that have large amounts of cash overseas and are looking to utilize it soon. We have already invested significantly in our overseas operations, such as our breweries in Mexico and our investment in Canopy in Canada. We believe that the cash flow benefits will be aligned with our previously outlined capital allocation strategy, which focuses on investing back in the business, returning cash to shareholders through dividends and share repurchases, and pursuing growth-accretive and return-on-investment-capital-enhancing acquisitions when possible. I want to emphasize that this approach remains unchanged. Regarding our on-premise performance, our beer business continues to excel, showing high single-digit growth this quarter, a trend we've observed consistently over recent quarters. Our brands are performing strongly in the on-premise market, even as overall trends in that sector have declined by low single digits.

Thank you, everyone, for joining our call today. We apologize for the brief disruption in the line, but that has been resolved. Our business has performed exceptionally well for the first nine months of fiscal '18, and we are confident that we will continue to maintain our profitable growth by pursuing our TBA premiumization strategy. As a reminder, during our next quarterly call, we will provide guidance for the upcoming fiscal year. Before that, we look forward to seeing many of you at the Beer Industry Summit conference in a couple of weeks and at the CAGNY conference in late February, where we will share updates on our strategic business initiatives. Thank you again for joining the call, and have a great day.