Constellation Brands Inc (STZ) — Q1 2021 Earnings Call Transcript

Thanks, Shannon. Good morning, and welcome to Constellation’s First Quarter 2021 Conference Call. I’m here this morning with Bill Newlands, our CEO; and Garth Hankinson, our CFO. 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 Bill, similar to prior quarters, I would like to ask that we limit everyone to one question per person which will help us to end our call on time. Thanks in advance, and now here’s Bill.

Thank you, Patty. Good morning, and welcome to our first quarter call, everyone. Before getting into a discussion of our quarterly results, I'd like to address two topics that have become extremely relevant to our business and our society at large. First, our thoughts and prayers go out to all those who have been impacted by racial injustice and associated acts of violence in both this most recent time period and throughout the years. We stand in solidarity with the black community, and our belief that black lives do, in fact, and have always mattered. We categorically denounce bigotry, racism, social injustice, and acts of senseless violence in all forms. They are clearly inconsistent with our company values and our commitment to embracing diversity and creating an inclusive environment for all employees to feel safe, respected, and valued. Earlier this week, we announced our commitment to invest $100 million to support African-American, black, and minority-owned startups in the beverage alcohol space and related categories over the next 10 years. These small businesses serve as the fabric of their respective communities. And we must make it more equitable for them to access the capital needed to have a fighting chance at success. In addition, we've made a $1 million commitment over five years to the Equal Justice Initiative and their efforts to educate the public about the history of racial injustice in this country and to support their quest for equity in the criminal justice system. Furthermore, we've made a commitment within our company to enhance representation and access to opportunity for black team members at Constellation by strengthening our recruiting, hiring, and development programs. The conditions that have allowed systemic racial injustice to persist have existed far too long. We all have a role to play in creating a more equitable experience for African-Americans in this country, and we are committed to doing our part to make this happen. Switching gears, our organization has responded and adapted to the challenges of the COVID-19 operating environment in an incredible and agile manner, which is reflected in our results for the first quarter. I'm especially proud of the efforts of the Constellation team members, our distributors, and our retail partners who worked together to ensure our customers' needs were met under very challenging circumstances. As I've said before, the health and well-being of our employees is our number one priority, and we've taken a number of preventative measures to keep them safe in our operations and out at retail to ensure our continued ability to meet the needs of the market. We've provided support and relief to our customers and our channel partners by donating more than $4 million in COVID-19 relief efforts and by donating PPE and sanitizer produced in our own facilities. Bottom-line, I'm extremely proud of the way our team and industry partners have risen to the occasion, and I remain confident our business and our brands will emerge even stronger on the other side. Now, let's transition to a discussion of our performance in the quarter. As Garth and I run through the highlights, there are three key points I'd like you to take away. Number one, despite various headwinds, we delivered solid first quarter business performance and strong cash flow generation. We are winning in sales channels that are open. Beer depletions remain strong and consistent with long-term trends despite the lost selling day in the quarter and the virtual shutdown of on-premise sales. And our wine and spirit power brands continued to gain traction. Number two, the slowdown of our beer production in Mexico due to COVID impacted shipments and net sales in Q1, and this impact will extend into Q2 as well. We will make up some of that impact in the back half of the year as our beer production in Mexico has returned to normal levels. Number three, this short-term disruption to our import beer business does nothing to dampen our long-term prospects. Consumer demand and takeaway for our brands remains extremely strong, and our outlook for the year and over the long-term remains extremely bright. Now, let's talk more specifically about our performance in the first quarter, starting with our beer business. Imports continue to be one of the primary growth contributors in the high end and total U.S. beer market, with Constellation delivering more than 80% of that import growth, driven by the Modelo Especial and Corona brand families. Solid first quarter depletion trends of 7% adjusted for one less selling day were driven by strong off-premise growth of almost 20%, due to the grocery and C-store channels, offset by a drag from the closure of the on-premise channel, which was down about 75% year-over-year. This is excellent performance considering that the country really began to feel the impact of the COVID-19 pandemic in earnest in early March, which coincided with the beginning of our fiscal year. Our brands over-index to densely populated states, such as New York and California that have been significantly impacted for a prolonged period. One of the highlights of the quarter was the successful launch of Corona Hard Seltzer. As expected, the brand name Corona drove extremely good trial of Corona Hard Seltzer, and the great taste profile is driving a repeat purchase intent of almost 80%, which exceeded our expectations. Corona Hard Seltzer is already the number four hard seltzer brand and recently achieved IRI market share of almost 6% of the U.S. seltzer market. Ongoing distribution gains have led to IRI ACV distribution approaching 65% since product launched in March, with early results for Corona Hard Seltzer incrementality trending at around 90%, also exceeding our original expectations. We're also seeing high Hispanic penetration rates for the brand versus other Hard Seltzers, which we believe will be a key growth driver going forward and a major point of differentiation within the fast-growing demographic in this country. We believe the refreshment attributes of seltzer, combined with the halo effect of the Corona brand, which remains one of the most loved beer brands, provides an opportunity to build one of the strongest Hard Seltzer brands in our industry. During the quarter, we kicked off the summer selling season and gained share during the Memorial Day and Cinco de Mayo holidays. Cinco is a great example of changing consumer behavior during the pandemic, when people enjoyed our great brands in Cinco celebrations at home. As a result, our Cinco performance increased two to three times what we would normally see in the off-premise. Our beer portfolio contributed nearly 20% of total U.S. beer category growth during Cinco and claimed four of the top 20 share gaining brand in IRI channels, driven by Modelo Especial as the top share gaining non-seltzer beer brand, Corona Hard Seltzer, Pacifico, and Modelo Chelada, Limon y Sal. As previously mentioned, we have returned to normal production levels at our breweries in Mexico. During the mandated production slowdown in the quarter due to COVID-19, we prioritized production of our top-selling SKUs, which represent about 75% of total volume, helping minimize disruption at retail. While supply will continue to be tight on select slower moving SKUs throughout the remainder of the summer, due to continued strong consumer demand for our brands in the off-premise, we expect to return to normal inventory levels in the third quarter. Let's now move to quarterly results for our Wine & Spirits business, which experienced the same market dynamics as our beer business during the quarter, with strong demand in the off-premise, offset by a decline in the on-premise of almost 80%. We continued to see staying power of the premiumization trend, with premium price segments continuing to outpace value price segments, further reinforcing our Wine & Spirits business strategy. In fact, we saw excellent consumer takeaway trends of over 25% for our Power Brands in the IRI off-premise channels during the quarter. Our Power Brands are winning in the high end and across the majority of price segments in the U.S. wine category, with strong velocity and distribution gains that are outpacing the market. First Quarter depletions for our collection of Power Brands grew 5%, driven by Kim Crawford, Meiomi, SVEDKA, The Prisoner brand family, and Woodbridge by Robert Mondavi. We continue to invest in additional ways to fuel portfolio growth through innovation, capitalizing on priority consumer trends, with successful product introductions, like the Prisoner Unshackled, Ruffino organic Prosecco, and Robert Mondavi Private Selection Buttery Chardonnay, all performing well in the marketplace. As you know, some of our biggest success stories in innovation have come from the spirit barrel age category, where we currently enjoy a 40% market share. The newest addition to this portfolio comes from the Woodbridge family, where we’re seeing early success from the Bourbon barrel-aged Cabernet and Red Blend, as well as the rum barrel-aged Chardonnay. You should expect to see continuing premium category-leading innovation from us as we emerge from the COVID environment, including line extensions for Meiomi in the Cabernets space, and from The Prisoner Brand Family with the addition of Cabernet and Chardonnay neighbor islands. In the Spirits category, you'll see SVEDKA pure infusions, as well as High West and SVEDKA premix cocktail in the RTD space. We continue to invest in capabilities that position our Wine & Spirits business for long-term success. As a result of sheltering-in-place restrictions and the shutdown of on-premise accounts due to COVID-19, eCommerce for beverage alcohol has exploded, increasing three to seven times in volume versus prior year, depending on the channel. Consumer awareness for eCommerce and beverage alcohol has significantly increased and accelerated change in consumer behaviors by several years. With two-thirds of consumers saying they are planning to continue their eCommerce habits post-COVID, eCommerce is gaining share through platforms like Instacart, Drizly, and other retailer online sites as consumers seek the convenience of these channels. In line with this accelerated trend, we acquired Empathy Wines in June. This acquisition fits in nicely with our broader premiumization strategy and strengthens our position in the direct-to-consumer and three-tier eCommerce channel, where we'll utilize Empathy’s digitally native platform to reach new as well as thousands of existing loyal consumers. In addition, Empathy focuses on producing high-quality sustainably made wines sold direct to consumers from its winery via its eCommerce platform at the $20 price point in three variants, like Blend, Red Blend, and Roget launched in 2019. The brand has sold approximately 15,000 cases and acquired more than 2,000 subscription customers. We are already a leading player in three-tier eCommerce and have seen growth in this channel of more than 500% in the last three months. We plan to leverage this acquisition as an opportunity to strengthen our position and outpace the market. As you know, we recently revised the Gallo transaction to exclude our Mission Bell facility as the FTC wanted to ensure that we have adequate production capability for our J. Roget and Cooks brands, which we decided to retain once they were excluded from the original transaction. We're also one step closer to the finish line on this transaction with the signing of separate agreements to sell Nobilo New Zealand Sauvignon Blanc and Paul Masson Grande Amber Brandy. As you will recall, in December, we entered into a separate pub-related agreement with Gallo to divest our Nobilo brand for $130 million. This fits with Gallo’s portfolio strategy and allows them to expand in the New Zealand wine category without affecting our long-term goals nor our opportunity in this category at the greater than $11 price point. In addition, we've signed an agreement to sell Paul Masson Grande Amber Brandy to Sazerac for $255 million. As a reminder, last December, we announced that Paul Masson had been excluded from the original transaction due to FTC concerns and we indicated that we were pursuing opportunities to divest this brand at that time. These transactions are subject to final FTC review and are expected to close in the second quarter, concurrent with or closely following the close of the Gallo transaction. All proceeds will primarily be used to reduce debt. Finally, we continue to be encouraged by steps David Klein and the Canopy team are taking to position the company to win in key markets and product categories over the long-term. The business continues to work through its transformational strategy with a leaner approach that will allow Canopy to be more flexible and adapt more quickly to changes in this dynamic cannabis market. Canopy has seen early success from its Rec 2.0 products in the Canadian cannabis market, including beverages, which we are very excited about. The company's Tweed and Houndstooth brand have been some of the most raved about cannabis beverages in the market with overwhelmingly positive consumer feedback. We believe that beverages and other Rec 2.0 products will attract new consumers to the market and further drive conversion from the illicit market. We continue to believe that Canopy remains best-positioned to win long-term in the emerging cannabis space and is well-capitalized to face the challenges associated with this current economic environment. As I close, let me again reiterate the three main takeaways from this forum. First, despite various headwinds, we've delivered solid first quarter business performance and strong cash flow generation. We are winning in the sales channels that are open. Beer depletions remain strong and consistent with our growth outlook for the future, despite the less selling day in the quarter and the virtual shutdown of on-premise sales and our Wine & Spirits Power Brands continued to gain traction. Number two, the slowdown of our beer production in Mexico due to COVID impacted shipments and net sales in Q1, and this impact will extend into Q2 as well. We will make up some of that impact beginning in the third quarter as our beer production in Mexico has returned to normal levels. And number three, this short-term disruption to our import beer business does nothing to dampen our long-term prospects. Consumer demand and takeaway from our brand remains extremely strong, and I remain optimistic about our outlook for this year. With that, I would like to turn the call over to Garth who will review our financial results for the first quarter.

Thank you, Bill, and hello everyone. Well, the start with our fiscal year marked the beginning of a global pandemic, resulting in rapidly changing market conditions. Constellation Brands delivered solid performance in Q1, driven by our ability to remain agile and prudently navigate through these uncertain and volatile times. During Q1, we improved margins in both our Beer and Wine & Spirits segments, delivering solid Beer and Wine & Spirits Power Brand depletion volume trends due to strong brand performance despite closures in the on-premise channel and shelter-in-place guidelines that impacted a majority of the quarter. We increased operating cash flow and free cash flow by 16% and 24%, respectively. These strong cash flow results provide us with the financial flexibility needed to continue to focus on debt pay-down and liquidity. During the quarter, we were able to issue debt at very favorable rates and use the proceeds to satisfy $700 million of debt coming due in November and pay down other near-term maturities. Now, let's review Q1 performance in more detail. We're all generally focused on capital basis financial results, starting with Beer. Net sales declined 6%, excluding the impact of the Ballast Point divestiture, organic net sales declined 4%, and organic shipment volume down 6%, partially offset by favorable pricing. Q1 shipment volume was negatively impacted by reduced production levels at our breweries in Mexico as part of COVID-19 safety measures. Depletion volume growth for the quarter came in at 5.6%, driven by Modelo Especial and the successful launch of Corona Hard Seltzer. A strong performance in the off-premise channel more than offset the impact of the reduction in the on-premise channel due to COVID-19 related shutdowns. When adjusted for one less selling day in the quarter, the Beer business generated nearly 7% of depletion volume growth, an impressive result in this operating environment. A large gap between shipment and depletion volume trends for Q1 was driven by the reduced production levels for roughly two-thirds of the quarter and robust consumer demand. This resulted in lower than normal distributor inventory on hand at the end of the quarter. I'm happy to report and reiterate that beer production in Mexico returned to normal levels in June, and we expect distributor inventory levels to return to more normal levels during the third quarter of our fiscal year, as some shipment volume shifts from Q1 and Q2 into Q3. Beer gross margin of 55.6% was flat to the prior year, as favorable pricing and the benefit of the Ballast Point divestiture was offset by increased operational costs driven primarily by higher material costs and reduced throughput at our breweries resulting in unfavorable fixed cost absorption. Marketing as a percent of net sales decreased 220 basis points to 8.8%, as marketing spend decreased due to the implications of COVID-19—essentially canceling and/or postponing most sporting and sponsorship events. With most sports programming on hold during Q1, and big events such as the NCAA Basketball Tournament canceled, in the short-term, we are reallocating marketing dollars to lower-cost digital marketing efforts and TV programming that consumers are engaging with in this current environment. We are recalibrating our marketing spend and strategy for the remainder of the fiscal year. However, currently, we still expect to spend in the range of 9.5% to 10% of net sales on a full-year basis. As such, the marketing related margin benefit in Q1 is mostly related to timing. As a result of the abovementioned factors, beer operating margins increased 240 basis points to 41.7%. Looking ahead to Q2, we expect shipment volume to be negatively impacted as we ramp back to normal production levels in June. Keep in mind that we expect to see some residual margin compression in Q2, as the reduced production levels in Q1 and the start of Q2 will create unfavorable fixed cost absorption, which is expected to continue to work its way through the Beer business results during Q2. Moving to Wine & Spirits Power Brand depletion volume accelerated and achieved 5% growth as these brands continue to win in the higher end and across the majority of price segments in the U.S. Wine category. Overall, depletion wine declined 1%, reflecting the impact of the brands to be divested. Net sales declined 7% and shipment volume down 13%. The decline in net sales was driven by the following: lower volume and unfavorable comparison to Q1 prior year due to a very strong quarter last year for the brands to be divested; on-premise and retail tasting room closures throughout most of the quarter as a result of COVID-19; and net sales of the Black Velvet brands are not included in this year's Q1 as a result of its divestiture late last year. The decline in net sales is an improvement from our Q1 pre-COVID targets we provided for the Wine & Spirits business during our last sales and earnings call driven by the strength of some of our fast moving power brands such as Kim Crawford, Meiomi and SVEDKA, and an improvement in some of the brands to be divested such as Black Box and Paul Masson, which saw accelerated and robust consumer takeaway trends during Q1. Excluding the impact of the Black Velvet divestiture, organic net sales declined 4%, reflecting shipment volume decline of 9%, partially offset by strong price and mix benefits in the quarter. Operating margin increased 240 basis points to 28.3% as benefits from price index, along with favorable SG&A were partially offset by the Black Velvet divestiture and higher COGS. In Q1, we saw the benefits of shipment volume mix driven by Meiomi and Kim Crawford and favorable pricing for Woodbridge and SVEDKA. In addition, we saw lower promotion expenses as scheduled incentive programming activities did not occur due to the current operating environment and COVID-19-related closures for the on-premise. While we expect to continue to see positive price and mix benefits the remainder of our fiscal year, they should temper versus the very strong price and mix results we saw in Q1. Depletion and shipment volume for our power brands is expected to temper in Q2 as we do not plan to replicate some lower return incentive programs that ran during our Q2 fiscal 2020. However, we plan to shift some programming resources for these brands to the back half of the year to better align with timing for our key selling season for our Wine & Spirits business. In addition, we are assuming a Q2 close for the Gallo and other divestiture transactions, which will negatively impact the quarter. Therefore, we are expecting a decline of 25% to 30% in reported Wine & Spirits sales and operating income for Q2. Q1 corporate expenses came in at approximately $51 million, up 16% versus last fiscal year. The increase was primarily driven by unfavorable foreign currency losses and an increase in charitable contributions, primarily driven by COVID-19 support efforts. Comparable basis interest expense for the quarter decreased approximately 13% to $100 million, primarily due to lower average borrowings. Our comparable basis effective tax rate excluding Canopy equity and earnings came in at 19.3% versus 18.6% last year, primarily driven by lower levels of stock-based compensation benefits this year. Moving to free cash flow, which we defined as net cash provided by operating activities, less CapEx, we generated free cash flow of $542 million for the first quarter of fiscal 2021. This represents an impressive 24% increase. Cash flow improvements reflect strong operating cash flow and lower CapEx. CapEx totaled $144 million or 7% below last year’s spend. This included approximately $110 million of beer CapEx, primarily driven by the five million hectoliter expansion project at our Obregon Brewery. While COVID-19 safety precautions slowed expansion activities at our Obregon Brewery during Q1, construction activities are ramping back up. And we expect the five million hectoliter addition to be completed by the end of fiscal 2021. Let me remind you that with the completion of the Obregon capacity expansion, we believe we will have ample capacity at Nava and Obregon to meet consumer needs over the medium term. Moving to Canopy, in Q1, we recognized a $197 million decrease in the fair value of Canopy investments. These impacts were excluded from our comparable basis results. The total pre-tax net gain recognized since our initial Canopy investment in November of 2017 is $112 million. On May 1st, we exercised the original warrants with Canopy for $174 and increased our ownership position by approximately 3% to 38.6%. The warrants were in the money, and the amount was manageable from a liquidity and leverage standpoint. We continue to believe in the long-term and substantial opportunity in the emerging cannabis market and remain confident that Canopy is best positioned to win in this space. As a reminder, the expiration of future and much larger warrant tranches were extended to calendar years 2020, 2023, and 2026. We will evaluate the exercise of each of these warrants prior to expiration as we continue to see how the cannabis industry unfolds in both Canada and the U.S. Furthermore, we do not plan to make any additional cash contributions to Canopy beyond the potential exercise of these warrants. Now let's shift the discussion to outlook and guidance. Given the unprecedented COVID-19 events that began to abruptly and dramatically impact consumers and the marketplace almost concurrently with the start of our fiscal year, and given the related uncertainty, volatility, and fast-moving developments that have evolved during the first quarter of our fiscal year, we still do not believe it is prudent or appropriate to provide formal financial guidance for fiscal 2021 at this time. However, let me take a moment to reiterate that in a normalized environment, our medium-term growth algorithm remains unchanged for both our Beer and Wine & Spirits segments. This is a good spot to discuss our capital allocation strategy. While we remain focused on our goal of returning $4.5 billion to shareholders in the short term, given the uncertainty of the current environment, we will be focusing on maximizing free cash flow and utilizing that free cash to reduce debt and leverage, creating the flexibility needed to fulfill our $4.5 billion commitment longer term. As a result, we are moving this goal out to cover the fiscal 2020 to 2023 time frame and the total cash return in the form of dividends and share repurchases to approximately $5 billion as we add another year of dividends into the mix. In closing, I want to reiterate that our cash generation profile remains strong, our quarterly dividend rate has been maintained, and we remain focused on actively and prudently navigating through the challenging environment presented by COVID-19, and we look to provide updates as more factors become known. With that, Bill and I are happy to take your questions.

Hey, good morning everyone.

Hey Bryan.

I have a question regarding the wine business, specifically about the price increases you implemented earlier this year for Woodbridge and other brands. How did the market respond to those increases? Were you able to implement them successfully? Additionally, I’m curious about the planned repositioning in the wine business this year concerning brand positioning and marketing. Is that still on track given the current market conditions? Thank you.

Sure, you bet. So we did in fact take price increases on Woodbridge, and I must say one of the things that has been a benefit of COVID is that if there are any, is that consumers have continued to buy tried and true brands, of which Woodbridge is one. And it was certainly helpful that we put our price through concurrently with that and Woodbridge has actually been outperforming our expectations around the pricing increase throughout the first quarter. So, so far, so good. We’re going to continue to watch that as you would expect, but so far that's gone very well. I would also say that some of the new product introductions that we have put into Woodbridge have performed and we're expecting to continue to perform very well. That's a very important brand for us. A lot of the work that we're doing more broadly around our brands is continuing. We've seen a tremendous increase in direct-to-consumer and three Tier commerce, which goes very well to strong brands like The Prisoner and Meiomi and brands of that ilk. So we’re going to continue to put focus on those brands. We think they're very well positioned, and those brands are tried and true brands in the mind of the consumer, which at the moment is where the consumer is spending their dollars.

All right. Thank you. Good morning everyone. I had a question on out of stocks. It's a key summer holiday this week with the Fourth, so hoping you guys could share with us how you feel specifically about the holiday and your supply? Also, maybe love to hear some more color on what you're doing to minimize the disruption for out of stocks? For instance, I've heard from some of the distributors that you're doing drop loads. So, I guess I'm trying to get a sense from you how flexible you can be on the production side with all of this, and then maybe finally can you touch on how big of a drag some of these shortages and maybe any initiatives you might be taking to minimize the situation. How big of a drag it might be on your margins, if at all? Thanks.

Sure. Our operations team is top-notch, and we are doing everything possible right now to speed up shipments from our breweries to our distribution centers and from our distributors to consumers. The reduced production over the past 70 days, mainly in the first quarter, has impacted our ability to ship at normal levels. However, the demand for our brands, Modelo and Corona, has never been stronger. We experienced nearly a 20% increase in the off-premise channel during the quarter, and we are seeing consistent depletion levels as we enter Q2. Therefore, we are in a very strong position. During the mandated COVID-19 production reduction, we focused on producing the SKUs that accounted for 75% of our sales. While a consumer might not find a specific SKU available, we expect that those wanting to purchase Modelo or Corona will likely have access to those during the holidays.

Yes. Good afternoon, everyone. Bill, there's a lot of noise in the numbers. The main question many investors have is how the growth curve for the beer business will look not just in the next six months, but also in the next two to three years. I would appreciate it if you could provide some context on three points. First, what has been the number of new households or trial surge you've seen, along with the repeat rates on those new trials since the pandemic began? Second, I understand the out of stock situation has been challenging, and while you were able to provide some products, I'm curious about how much business growth you would have seen on depletion if there had been no out of stock issues. Lastly, retailers are reconsidering their shelf space, something you have been working on for the past two to three years. How do you think this environment may influence or accelerate some of your Shopper-First initiatives and increase shelf space for your brands in the long term?

Sure. Let's discuss this in reverse order. Regarding the shelf, one notable change during this period is that some resets that usually happen have been delayed, as many retailers are prioritizing throughput from their current shelf sets. We believe that as they approach the fall season and execute fall resets, the likelihood of a Shopper-First approach will continue to rise. It's becoming increasingly evident that brands with strong demand, like our Modelo and Corona franchises, are seeking more shelf space because of the demand for takeout. It's challenging to provide a specific example of potential growth due to the many factors influencing the quarter. Our quarter began almost simultaneously with the pandemic, which was different from a typical calendar quarter. Notably, while on-premise sales were essentially halted, off-premise sales increased by almost 20%, indicating many dynamics at play. We genuinely believe that consumers will be able to purchase Corona and Modelo. The launch of Corona Hard Seltzer has also been quite successful, with over 3 million cases already shipped. As I mentioned earlier, both takeaway and repeat purchases have been exceptional. In response to your initial question about consumer purchasing, around 30 percent of consumers are increasing their consumption of brands they traditionally use. Given the strong presence of our brands, particularly Corona and Modelo, it is not unexpected to see an increase in takeout demand during this time. This aligns with what I previously mentioned about trusted brands, which applies to many of our Wine & Spirits brands as well. The consumer's interest in purchasing brands they trust and feel comfortable with is certainly working to our benefit.

Hi. Thank you, Garth, for the insights on the marketing spend outlook. Could you share your thoughts on how you plan to phase that and if we might see any changes as we move into a post-COVID recovery? Also, Bill, I really liked your comments at the beginning of the call and I'm curious if there are any changes to your social media advertising spend? Thanks.

Yes, Vivien. Thanks for the question. As it relates to marketing spend and the phasing of that, I'd say, it's still too early to tell exactly what that will know, as we sort of come out of COVID-19 and we don’t know exactly when some of these sponsorships and sporting events might get rescheduled. So other than that, we still believe that we’re going to spend in that 9.5% to 10% of net sales for the full year. The phasing is still a little bit up in the air.

So relative to social media, there's obviously been a lot of discussion around social media. I would say, and let me reiterate what I said earlier. We think it's very important to protect users from disinformation and hate-speech. Those things run directly counter to our commitment to social justice and to racial equality. We have decided that we are going to do a comprehensive review of our social media work, and along with that for the month of July, we are pausing our Facebook engagement until we can do a thorough review and to make sure that all of our social media efforts match up with what I just said, which is the commitment to social justice and racial equality.

Great. Thank you very much. Just one point of clarification and then my question. Just can you just break out the price/mix in the quarter and maybe separate out headline pricing from promos? And then, my main question really is unbelievable growth, right, in the seltzer category. You're now in the mix, big time with Corona Seltzer which, I think, you said is 90% incremental. What have you learned about the category now year-to-date and how big do you think it can be as a percentage of overall beer sales? And is your latest thought in terms incrementality to the entire beer category at this point? Thank you.

So relative to those two or three questions in that, we continue to have our long-term algorithm particularly as it relates to beer, of expecting that price will grow 1% to 2% annually. We've done that consistently over time, and we expect that that algorithm is going to continue. Relative to seltzer, earlier this year, we said we thought the category, which was roughly 60 million cases last year, could double and probably triple in the long run. If anything, that's starting to look conservative. The consumer certainly enjoys the refreshment characteristics of this particular category. And I think our introduction of Corona Hard Seltzer is a great example of leveraging a tremendously strong brand into a new category. I think it would be important to not simply lump seltzer in with beer. Given the incrementality that we've seen is roughly 90%, which again is more than we frankly expected, suggests to us that it is not necessarily a direct trade-off with beer. And I think that it has category dynamics that are different and understanding of the role. So, our view is that this continues to have a lot of longevity, and we are certainly planning to be a critical part of it. As you know, we've already gotten to number four in the category with a roughly 6% share. And as you also know, we've just warming up.

Great, thanks. I was hoping that you guys could give us a little bit of help on the gross margin range of this quarter. And particularly in beer I am curious across those businesses. I know you mentioned that you'll see some of this start going into Q2 of the lower production volumes. And anything maybe just a little bit of visibility on the drivers of gross margin quarter and thinking about how that develops into 2Q it could be really helpful. Thanks.

Bill, you?

Yes. So, gross margins per beer is what we had some drags there as it relates to materials and to fixed overhead absorption. That drag was offset by finding balance point divestiture as well as pricing. Going forward into Q2, we expect that there will be further downward margin pressure as it relates to fixed overhead absorption as we work through the inventory or the slowdown that we had in Q1 at the very beginning of Q2. At gross margin, they were flattish gross margin and beer. That resulted in about 240 basis points of improvement at the operating line because of primarily the timing of the marketing spend that we talked about earlier.

Thanks for the question. I apologize if I missed this. But do you provide any update on Mexicali? And I guess the potential options you're exploring there?

We continue to be in discussions with the Mexican government about what our long-range plans are for Mexico. As you know, and as we've stated, based on the expansions that we already have in play, our medium-term is already set. We believe there's going to be plenty of opportunity. And we spend more than 30 years working very well with the Mexican governments, both local and federally. And we expect that to continue and we expect to have a strong long-range solution for our continuing supply for the long run. So I don't have anything new to report on Mexicali other than to say, we fully expect to be able to service our needs for the long run.

Hey, good afternoon guys.

Thank you, Dara.

First, just a clarification, you mentioned depletion levels in Q2 in beer so far consistent with Q1. Is that versus the reported 5.6% depletion result or is that more 7% on a days adjusted basis? And then just on Corona Hard Seltzer, with the strong repeat rates you mentioned, can you give us a sense for what share level you think that brand can ultimately reach within the Hard Seltzer category and also what distribution level it'd be reasonable to expect that brand to get to? Thanks.

Sure. To address the question about hard seltzer, we are currently seeing an ACV distribution in IRI channels of approximately 65, which is quite strong, especially considering that many retailers have not implemented the resets they had planned for earlier this year. The long-term outlook is still uncertain. We are currently around 6% market share, and as you know, we have only launched a variety pack thus far. We plan to expand beyond just the variety pack later this year and into the coming years. We are very optimistic about having a significant role in the seltzer category and expect to be among the top three brands in that category moving forward.

Hey, thanks. Good afternoon and congrats on the strong quarter. Just to follow up on the last question, I'm not sure there was clarity on where depletions were running for Q2, if it was close to the 7% on a selling day adjusted basis. So clarity there I think would be helpful for folks? And then more broadly, maybe you can just comment on the biggest variables impacting your decision to withhold guidance and the context being particularly strong starts at a year, sounds like June is off to a good start. Bill, you commented the portfolio has never been stronger. We're seeing that in really strong Nielsen data, production is ramping it breweries. You've had the strong start to the second quarter, commodity is still relatively benign, enough confidence to deploy some cash towards small wine deals. We are kind of putting this all together. And then in addition, the company is obviously very definitely managing through this very sharp and unprecedented channel shift. So with all of that said, comment on the biggest swing factors here that leave the company a little bit reluctant to provide guidance at this point? So thanks for all that.

Thank you. I want to acknowledge some of the nice points made earlier. First, I need to apologize for not addressing Dara's question a moment ago. Regarding depletions, we see that the second quarter, starting in June, is aligning well with our expectations. The takeout remains strong; you can see it in the IRI and Nielsen data each week. The challenge with guidance is that if anyone had predicted in February what we've experienced this past quarter, it would have been hard to believe. In the first quarter, on-premise sales were down about 75%, particularly in the wine and spirits categories. There was a brief improvement as the situation eased, with declines of around 40% for a time. Now, we're facing new closures in states like Arizona, Texas, and Florida, making forecasting difficult in this environment. What we should all be paying attention to is how our brands are performing amid these fluctuations. Our brands are doing exceptionally well. This year will see considerable volatility, and making predictions is challenging. However, I am confident that strong brands with a loyal consumer base will prevail. We've noted that a significant portion of our existing customers are purchasing more than they ever have before, indicating good brand strength. Once we navigate through this unpredictable pandemic phase, we expect to return to our long-term beer sales growth trend of 7% to 9%, which I know many of you are interested in, and all indicators suggest that our long-term outlook remains intact.

Thank you. Good afternoon. I have a question and a clarification. Can you provide details about the beer depletions for the quarter, particularly in the U.S. for May and now June? Bill mentioned that the non-adjusted number for June is around 5% to 6%, but I would like to know what happened in the previous quarter. Additionally, I believe the June numbers were likely affected by the stock-outs you previously mentioned. Could you also give us insights into the 75% decline and how it progressed over time? I assume the situation was worse in May than at the start of the quarter. For clarification regarding the wine guidance for the second quarter, Garth mentioned sales and EBIT are down 25% year-over-year. Is this figure organic, or does it include the impact of divestitures that closed during the quarter? Thank you.

I will address the second part about Wine & Spirits first. The decrease of 25% to 30% primarily reflects the impact of the wine divestiture. Since we are now expecting this to affect our second quarter results, we do not anticipate moving much of the divested brands during that period. Additionally, we expect to see a slight decline in depletions for our Power Brands because we will not be replicating some promotional and shipping activities that were not productive.

Going back to your question about how we think about the month, it highlights why we have not provided guidance because predicting outcomes is very difficult. At the start of March, on-premise conditions seemed fairly normal. However, by the end of the quarter, there was a 75% increase. As skilled as Garth is at forecasting, that was unpredictable. Currently, we are seeing some markets returning to closures or experiencing significantly reduced volumes in restaurants and pubs. Thus, it remains a challenge for us to provide an exact figure for future performance. If you could predict how the pandemic will progress, we could offer a clearer response. Nevertheless, as we observe daily developments in the news, predicting the pandemic's trajectory is impossible, which is why we focus on the reality that we have exceptionally strong brands that are excelling in the markets and channels available to us, and that's how we will measure our success.

Thanks. Good afternoon. Just a follow-up on the marketing spends and trying to understand how you're looking at it, as you said, some events like the NCAA tournament have been canceled. There could be a case where you're advertising at the World Series and the NBA Championship at the same time. So, how do you look at the spend for the back half of the year, especially around sports spending, when a lot of it's going to concur and it seems like it would be very duplicative to advertise all over the place?

Well, you're right. It's more challenging than it would usually be. And as Garth pointed out in his remarks, the first quarter was a great example as there were a lot of live events and many of the things on which we normally advertise, like using the NBA as an example, just didn't exist. So, we are going to be focused in real-time on where we can implement our marketing spend. What I think is most important overall, as Garth noted, we still expect to spend between 9% and 10% on our marketing of our brands. When you look at historical results of companies that continued to spend in recessions, and admittedly, we're in one, or we're about to be in one. Those companies that continued to support their brands came out the back end even stronger. We believe in that, and we are going to continue to spend. As you pointed out, that will mean some real-time adjustments as we go. Because, admittedly, it's been very tough to predict what will in fact occur and when it will occur as you’re seeing with things like the baseball schedule, which has moved all over the place in terms of number of games and how they're actually going to execute those. Same is true in basketball; same is true in many of the live activities. So the reality is we will be doing this in real time. But it doesn't change our intent, which is we’re going to spend against our brands to make sure they are top of mind in the consumer's view.

Thank you for your insight. I'd like to discuss how you're evaluating the potential effects of recessionary economic conditions on your categories and brands. So far, as you've pointed out, premiumization trends have remained strong. Do you anticipate any risks that could pressure this trend, even temporarily, in either beer or Wine & Spirits? Also, what specific indicators are you monitoring to stay informed as the situation evolves? Thank you.

Certainly. As you would expect, we watch things like unemployment rates. We are overdeveloped, as you know, with the Hispanic community, and the unemployment rates in the Hispanic community have been significantly higher than the average unemployment rates in the marketplace today, although all of it's in double digits. So, that's something that we watch very carefully. Again, it's the same point: the brand awareness, brand loyalty of our brands within those communities are very strong. But we watch those things very, very carefully. Certainly, one of the other things that you see, and I think it's been exacerbated in the pandemic because of people sheltering, is people look for those small moments of joy in their lives. And fortunately, our brands can often offer those to people. So, we think that the strength of our brands in conjunction with people engaging more at home than they would naturally and normally do, will be important to the continued success of our business, albeit, we're watching a lot of those characteristics like unemployment very carefully.

Good morning everyone, and thanks for the opportunity for the questions. So, I'd like to come back to the wine divestiture to Gallo. It looks like, I mean, the $250 million earn-out is based on volume depletion performance in fiscal year 2020 and 2021 versus fiscal year 2019. And if I read it correctly in depletion orders between minus 10% from the payment to minus 2% for 100% payments, so could you please tell us, as we're kind of almost in the middle of it, the current volume depletion performance of the portfolio brands you’re applying to divest to Gallo? Thank you.

Yes. Thanks for the question. And what I would tell you is that the earn-out portion of that transaction is really based on the 24 months after we closed the transaction. So we'll measure how those brands performing at the end of year one, and then again, the end of year two. Those brands have benefited recently from what Bill has described as the change in consumer behavior to shift consumer behavior toward these tried and true brands or back to tried and true brands. And so some of the brands that we are divesting to Gallo have actually recovered quite nicely in that portfolio. Those brands are performing much better than it was a year ago at this time. So we feel is that as we transition that portfolio of brands to Gallo, that they're in a very good position, and they're in a good state of health that we've got a very good chance of getting into that earn-out meaningful way.

Thank you. And you'll have to forgive me, I'm still a bit confused. Did you say June beer's shipments are roughly minus 7% or are you saying June is down a bit more than minus 7%, and July and August will help make up for to get the total quarter beer shipments to minus 7%?

We didn't comment on shipments at all. We talked about depletions. As we’ve said we have ramped up our production during June to normal levels, which will allow us in subsequent quarters. My personal suggestion would be that many of you think about the first quarter and the second and the third as in combination. Because as our production has ramped up, you will see some continuing stress on the shipment side of our business during Q2, and we would expect depletes to outperform shipments during the quarter with a lot of that flipping as you go to the latter part of the year. Again, it still goes back to our long-range algorithm around beer being up 7% to 9% is very consistent. We expect that in the long run, and we view this short-term pandemic blip as being just that, a blip in our long-term success.

Great. Thank you. Thanks everybody for joining our call today. Despite the challenges and extremely volatile environment that were concurrent with the start of our fiscal year, we've delivered solid performance and strong cash flow generation during Q1, which provides us with great momentum as we head into our key summer selling season. Let me reiterate that the short-term production disruption to our import beer business that we experienced during Q1 does not hinder our long-term outlook as consumer demand and takeaway for our brands remains extremely robust in the channels that remain open, and we remain optimistic about our outlook for the remainder of the fiscal year. In closing, I'd like to wish everyone a Happy Fourth of July and hope that your celebrations with your family and friends includes our fantastic beers, our wines, and our spirit products. Thanks again everyone and please have a healthy and safe summer season.