Constellation Brands Inc (STZ) — Q1 2022 Earnings Call Transcript

Thanks, Jiji. Good morning, and welcome to Constellation's first-quarter fiscal '22 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 everyone to our first quarter conference call. Picking right up where we left off in Q4, our Constellation Brands team, with the help of our distributors and retailers, delivered another strong performance in Q1 of fiscal '22. While we overlap the pantry-loading phase of the pandemic, which led to record trends in off-premise tracked channels last year, our continued focus on brand building, aggressive investments in growth, and the continued efforts of our team and trade partners positioned us to deliver another strong year of performance consistent with our long-term goals. As Garth and I detailed some of the highlights from Q1, there are several key factors we'd like you to keep in mind that constitute our points of differentiation, our competitive strengths, and reasons to continue to believe in the future growth potential of our business and our ability to drive industry-leading, total shareholder returns over the long term. Number one, our strong portfolio of core brands across beer, wine, and spirits continues to gain momentum while offering significant runway for growth in the years ahead. Nowhere is this more evident than in our beer business, which is off to an exceptional start delivering double-digit depletions, shipments, net sales, and operating income growth due to ongoing strong consumer demand. Number two, we continue to be relentless about keeping consumers at the forefront of our decision-making, and this is nowhere more apparent than in the strides we're making to strengthen our innovation capabilities and ensure we're capturing our fair share of growth in emerging categories. Number three, our investment in Canopy Growth, along with the continued efforts of the Canopy team, are positioning this business to emerge as a leader in the global cannabis market as it comes to fruition and we inch closer to legalization in the US. And number four, our continued strong operating performance and cash flow generation enabled us to resume share buyback activity with significant repurchases of more than $500 million during the first four months of our fiscal year. In addition, we announced this morning that we will execute an accelerated share repurchase program throughout the remainder of the second quarter to repurchase an additional incremental $500 million of shares. We believe this demonstrates our strong commitment to maximize shareholder value, and we are on our way to achieving our $5 billion goal of which about 50% will be in the form of share repurchases. This activity is also driving an increase in our EPS guidance for this year. Let's transition to a more detailed discussion of our performance in the quarter. As mentioned, our beer business is off to an exceptional start, delivering double-digit net sales and operating income growth as well as depletion growth of almost 11% in the quarter. Excellent execution during the Cinco de Mayo and Memorial Day holidays led to market share gains as Constellation remains a leading growth driver in the high end of the US beer market. Modelo Especial led the way as the number one share gainer in the entire US beer category and solidified its position as the number one brand in the high-end. It also became the number two brand in dollar sales in IRI channels, posting depletion growth of 12% for the quarter. Modelo Especial continues to fire on all cylinders with no signs of letting up driven by ongoing strong execution of retail, impactful execution of high-profile marketing activations, and a significant increase in digital, social, and e-commerce media for properties like UFC, Gold Cup soccer, and the Summer Olympic Games to name just a few. Corona brand family growth was driven by a return to growth in on-premise channels, which now represent approximately 11% of our beer business volume, which accelerated and nearly doubled since fiscal '21. During the quarter, we launched Corona Hard Seltzer Variety Pack #2, which continues to gain shelf space and is already more than half the size of Variety Pack #1 in dollar sales and appears to have about the same incrementality as Variety Pack #1 has to the entire portfolio. Meanwhile, Variety Pack #1 has held its distribution and velocity levels since the launch of Variety Pack #2, and our Hard Seltzer family remains in the number four market position. Earlier this month, we launched Corona Hard Seltzer Limonada, and while it's early in the launch cycle, initial consumer response has been very favorable. Ultimately, we believe the Hard Seltzer category will be dominated by a few large brands in the long run, similar to the light beer category, and we are positioning Corona Hard Seltzer to be one of those brands. We have plans to more than double our Seltzer and ABA capabilities this fiscal year and expect to bring another 5 million hectoliters of capacity online next fiscal year giving us the flexibility to continue to expand with new flavors, new packages, and even new platforms in this space. Overall, the Seltzer category remains competitive. We believe it's an important part of the high-end, and we plan to drive for success with our ambition to ultimately be a top-three player in this space. Pacifico continued its strong momentum posting depletion growth of more than 35% for the quarter as the number four share gainer within the import segment driven by our focus on Gen Z consumers. As expected, during the quarter, Constellation's consumer takeaway trends in the off-premise IRI and Nielsen channels were muted due to lapping last year's pantry loading behavior at the start of the pandemic. Conversely, we experienced robust growth, especially in some of the more sizable, non-tracked channels, including the on-premise which grew depletions 250% versus last year when this channel was essentially closed, and the liquor chains, which grew almost 13% in the first quarter. These levels of robust consumer demand are impacting availability for certain pack sizes and certain geographies. We are working with our distributor partners to ensure consumers can continue to find our brands on shelf throughout the summer, and we plan to make up some of this impact beginning in the third quarter. As a reminder, beginning in April of last year, our beer business had to significantly slow down production in Mexico due to COVID-19 restrictions. This led to out of stocks in the US marketplace during the summer months. Therefore, as we progress through our second quarter, which runs June through August, we'll start to lap these out-of-stock issues, and we're already beginning to see improving IRI trends. Despite the short-term supply challenges we're facing, the momentum of our portfolio is stronger than ever, and our outlook for the remainder of the year remains extremely bullish. Our view is reinforced by recent four-week IRI trends that show Constellation's beer business is outpacing the high-end and continues to significantly outpace the total US beer industry. Now, moving on to wine and spirits. Our transformation of this business to a higher growth, higher margin operation continues to gain traction, and we made additional progress during the first quarter on a number of fronts, including furthering our fine wine and craft spirits strategy, building a robust innovation pipeline, advancing our DTC e-commerce and digital capabilities, while also implementing disciplined pricing actions, taking out stranded costs and executing other cost and efficiency improvements. During the quarter, we made progress with the evolution of our fine wine and craft spirits business, especially as consumers returned to bars and restaurants in the on-premise channel. Our fine wine and craft spirits performance in the quarter was driven primarily by The Prisoner Wine Company, Robert Mondavi Winery, and High West. And we expect our enhanced capabilities in this space to begin to meaningfully inflect our wine and spirits business towards the higher end. Impactful innovations were also a driving force for growth during the quarter, including Meiomi Cabernet Sauvignon, Kim Crawford Illuminate, and The Prisoner Unshackled which were among the top 10 innovations across the high end of the US wine segment in IRI channels during the quarter. And we have a strong innovation pipeline planned for the remainder of the year, which includes the introduction of Woodbridge wine seltzers, The Prisoner's Saldo, Red Blend, and Unshackled Sauvignon Blanc plus Robert Mondavi Private Selection 100, a new lineup composed of 100% Cabernet Sauvignon and Chardonnay varietals. We've also been investing to build a world-class three-tier e-commerce team by expanding our sales and marketing resources, building new selling capabilities, investing millions of dollars where consumers shop, and integrating our teams to put focus and expertise closer to our accounts. While our three-tier e-commerce business is cycling the tremendous acceleration that was experienced last spring at the beginning of the pandemic, it is still growing 3 to 4 times compared to the spring of 2019 across beer, wine, and spirits. And the DTC portion of our e-commerce business saw impressive growth of 45% versus last year in the first quarter. We continued to forge partnerships with existing and emerging pure-play retailers like Amazon, Gopuff, and Wine.com. Omnichannel retailers like Walmart, Kroger, and Albertsons. And third-party marketplaces like Instacart and Drizly so that our consumers can shop whenever and wherever on their own terms. In addition, as part of our commitment to invest $100 million over 10 years in Black, Latinx, and minority-owned small businesses, we recently made investments in La Fete du Rose and Sapere Aude Sparkling Wine, both of these brands aligned with Constellation's premiumization strategy and present significant growth opportunities with differentiated high-end brands in growing sectors of the market. La Fete du Rose has taken a consumer-first approach to building a distinctive, authentic Rose brand that appeals to multicultural consumers. And Sapere Aude has taken an entrepreneurial approach to build a uniquely Californian sparkling wine with no residual sugars, low alcohol content, fine bubbles, and a refreshing brand identity that is simple and clean. We look forward to working with these brands and their dynamic founders to expand our access to key markets and consumers, and to help realize their full potential. At the same time, our Wine & Spirits results for the quarter were impacted by a convergence of isolated factors. First, our international brands like Kim Crawford and Ruffino, which are produced in their respective regions but sold primarily in the US are experiencing global supply chain logistics issues, including shipping delays and transport interruptions like so many other imported products. Second, we've experienced some start-up issues in certain markets associated with our route to market transition to Southern Glazer's Wine & Spirits, which now has distribution responsibilities across 70% of our US Wine & Spirits brand portfolio. This transition became effective April 1, and we expect the transition issues to be resolved in the second quarter. Lastly, like many ERP system implementations with a cutover to SAP, we have encountered a few transitional challenges which we don't see as a prolonged issue. Collectively, these issues caused some supply challenges in retail for some of our larger key brands which drove the negative depletion trend during the quarter. And while we are seeing lower inventory levels than normal for Kim and Ruffino, they continue to drive growth. Despite these temporary challenges, we are confident in our ability to accelerate the growth and profitability of this higher-end portfolio of industry-leading brands and achieve our targeted goal of 2% to 4% organic sales growth for the fiscal year. Moving on to Canopy Growth; the synergies between Constellation and Canopy Growth continue to create value for both companies. Canopy recently signed a US distribution agreement with Southern Glazer's Wine & Spirits for Canopy's Quattro CBD beverage portfolio which will be launched across seven US states with additional states to be added later this year, as well as their Martha Stewart CBD product lineup, which has seen early success extending into top-selling gifts for occasions, including Mother's Day and Valentine's Day which was sold out prior to the holidays due to high consumer demand. Constellation and Canopy will continue to work closely together to develop Canopy's route to market strategy in the US. We remain optimistic about the prospects for federal US legalization during this congressional session and are bullish about Canopy's growth prospects and their ability to achieve profitability by the end of their fiscal year. As I close, I want to take a minute to thank our Constellation team members and our distributors and retailers for an excellent first quarter of business performance. Thanks to all of you, our strong portfolio of core brands across beer, wine, and spirits continues to gain momentum and we are well-positioned to deliver another strong year of performance consistent with our long-term goals. Our beer business continues to be a top growth driver within the US beer market and will deliver market share gains and accelerating depletion trends as consumer demand and take away remain extremely strong. Our higher-end Wine & Spirits brands continue to outpace the overall US market. We continue to strengthen our innovation capabilities to ensure we're capturing our fair share of growth in emerging categories. Our continued strong operating performance and strong cash flow generation allowed us to make significant share repurchases in line with our commitment to return $5 billion to shareholders by fiscal '23 and drove an increase in our EPS guidance for the year. And with that, I would like to turn the call over to Garth, who will review our financial results in the quarter.

Thank you, Bill. Hello, everyone. Our fiscal 2022 is off to a strong start, as evidenced by our segment operating results and cash flow generation. As Bill noted, our Beer business saw double-digit growth in depletion volume, revenue, and operating income. Our Wine & Spirits segment is well-positioned for accelerated growth and profitability with its portfolio of high-end brands, and our strong cash flow has allowed us to resume share buyback activities, reaffirming our intention to return $5 billion to shareholders through dividends and share repurchases by the end of fiscal 2023. Up to June, we have repurchased 2.2 million shares of common stock for $523 million. Additionally, this morning, we announced an accelerated share repurchase agreement to buy $500 million of additional shares, expected to be completed by October 2021. This agreement is included in the $500 million share repurchase mentioned in our earnings release. Consequently, we have raised our full-year diluted EPS guidance to between $10 and $10.30, excluding the impact of Canopy equity earnings and reflecting the reduction in diluted shares outstanding due to year-to-date buybacks and the ASR agreement, totaling about $1 billion in repurchases. We are projecting approximately 193 million diluted shares outstanding for fiscal 2022. We plan to repurchase more shares in the latter half of the fiscal year beyond the previously mentioned $1 billion, although the timing is uncertain, and therefore, these anticipated repurchases are not included in our guidance assumptions. We will provide updates on our outstanding shares when reporting quarterly earnings throughout the fiscal year. Now, let's delve into our Q1 fiscal 2022 performance in more detail, focusing on comparable basis financial outcomes. In the Beer segment, net sales rose 14% driven by over 11% growth in shipment volume and favorable pricing. Some missed shipping days and supply shortages due to severe weather in Texas and Northern Mexico early in the quarter impacted the increase in beer net sales. Depletion volume improved from fiscal 2021 trends, achieving nearly 11% growth for the quarter, even with last year's pandemic-related pantry loading behavior. This growth was fueled by strong demand in tracked and non-tracked off-premise channels and a recovery in the on-premise channel. On-premise volume accounted for 11% of total beer depletions this quarter, showing significant recovery compared to fiscal 21 when it accounted for only 3%. When adjusted for one extra selling day, the beer business saw nearly 10% depletion volume growth. Q2 will have flat depletion selling days year-over-year. Due to continued strong consumer demand alongside limited shipment volume from supply challenges related to severe winter weather, depletion volume surpassed shipment volume during Q1, leading to lower than average distributor inventory at the quarter's end. We assure you that production and shipping from our breweries are fully operational; however, inventories will likely remain tight through the second quarter as we enter our peak summer selling season. We anticipate distributor inventory levels to normalize in the latter half of the fiscal year. Regarding beer margins, operating margin increased by 110 basis points from the prior year to 42.8%. Favorable pricing, SG&A as a percentage of net sales, and foreign exchange benefits were somewhat offset by higher logistics and operational costs and increased marketing spending. Increased logistics costs stemmed from higher obsolescence from initial conservative expiration dates on new SKUs, partially mitigated by the transition of part of our co-packing capabilities to our Nava Brewery. Operational costs rose mainly due to labor inflation in Mexico, increased headcount, and spending to bring an additional 5 million hectoliters online at Obregon, though these were partly offset by favorable fixed cost absorption related to reduced production during Q1 of fiscal 2021 due to COVID-19. Depreciation had minimal impact this quarter, as we began depreciating the extra capacity at Obregon late in Q1 but expect it to rise in Q2. Marketing as a percentage of net sales increased by 70 basis points to 9.4% compared to last year, reflecting our return to usual spending patterns, which focus more heavily on the first half of the fiscal year. Marketing spend in the first half of the previous year was significantly reduced due to COVID-19-related cancellations and postponements. As we discussed last quarter, we cannot repurpose the Mexicali site for future use, resulting in a recorded impairment of about $665 million for the quarter, excluded from our comparable basis results. For the full year, we continue to target 7% to 9% net sales growth, which includes 1 to 2 percentage points of price increases in our Mexican product portfolio and 3% to 5% operating income growth. We expect operating margins to land in the low to mid-point of our stated 39% to 40% range. We anticipate our gross margins to face challenges this fiscal year, as benefits from pricing and our cost-saving measures are expected to be outweighed by a notable increase in depreciation expenses and brewery expansion costs, substantial inflation across various cost components, and negative mix effects as we grow our ABA and Hard Seltzer portfolios. Concerning timing, we will start seeing impacts from depreciating the additional capacity at Obregon during Q2, which will negatively affect margins for the remainder of the fiscal year. Despite benefits from our commodity hedging program protecting us from expected cost inflation during this quarter, we foresee significant inflation headwinds in the second half of the fiscal year as current hedges expire. We also believe that the extent and duration of inflationary pressures are becoming more unpredictable as the year progresses. Lastly, we expect marketing as a percentage of net sales to remain in the 9% to 10% range for the full year, consistent with last year's 9.7%. We plan to invest substantially in Q2 to support strategic initiatives and maintain strong performance throughout the crucial summer selling season. Thus, Q2 marketing as a percentage of net sales is expected to be between 10% and 11%, up from 8.4% in Q2 fiscal 21. Turning to Wine & Spirits, net sales for Q1 fiscal 2022 fell 22% due to a 38% drop in shipment volumes. Excluding the impact from divestitures, organic net sales rose 16% thanks to organic shipment volume growth of 6%, smoke-tainted bulk wine sales, and favorable price and mix, despite an 8% decline in depletion volume. Several factors influenced organic net sales and shipment and depletion volume trends this quarter. Smoke-tainted bulk wine sales contributed approximately 4 percentage points to the year-over-year organic net sales growth. Additionally, we under shipped depletions in Q1 fiscal 2021, resulting in easier shipment comparisons for Q1 fiscal 2022. Conversely, in Q1 fiscal 2022, we over shipped to ensure adequate distributor inventory due to delays transitioning from canceled distributors to Southern Glazer's. Regarding depletion volume trends; the 8% decrease was affected by various factors, including tough comparisons to last year's pandemic-related consumer behavior. Additionally, the SAP transition created early shipping process challenges in Q1. While we resolved these issues within the quarter, shipment timing negatively affected depletions and resulted in out-of-stocks for key brands. Global supply chain logistics problems, including shipping delays and transport disruptions, also caused out-of-stocks for certain products imported from New Zealand and Italy. However, we believe these challenges are temporary and improving, and we aim to replenish retailer inventory in Q2. Turning to Wine & Spirits margins, the operating margin decreased by 540 basis points to 22.9%, as the benefits from divestitures and favorable pricing were outweighed by the margin-diluting smoke-tainted bulk wine sales and increased marketing expenses. It's essential to note that we are comparing against lower marketing and SG&A spending in Q1 fiscal 2021 due to COVID while operating on a smaller base post-divestitures, resulting in substantial marketing and SG&A deleveraging affecting our operating margins. For the full fiscal 2022, we expect net sales and operating income in the Wine & Spirits business to decline by 22% to 24% and 23% to 25%, respectively. This implies an approximate operating margin of 24%, flatter than the previous year on a reported basis but showing considerable organic margin expansion. Excluding the divestitures, we expect organic net sales to grow in the 2% to 4% range. Moreover, we will continue to see the effects of significantly lower marketing spends in Q2, as many planned media and sponsorship investments were suspended or canceled in Q2 fiscal 2021. We also anticipate continued marketing and SG&A deleveraging from the divestitures, which will likely weigh on our operating margins in Q2 fiscal 2022. Moving on to the P&L, Q1 corporate expenses were approximately $55 million, up 8% compared to Q1 fiscal 2021, mainly due to increased consulting costs and compensation, while being partially offset by favorable foreign currency effects. We continue to anticipate full year corporate expenses to be around $235 million. Our comparable basis interest expense for the quarter decreased by 13% to about $87 million due to lower average borrowings as we reduced our net leverage ratio, ending the quarter at 3.06 times, excluding Canopy equity earnings. Our previous guidance indicated free cash flow would be allocated to debt repayment rather than share buybacks. However, as we’ve noted, the updated guidance now includes around $1 billion in share repurchases for the first half, leading to an anticipated increase in fiscal interest expense in the range of $360 million to $370 million. Our comparable basis effective tax rate, excluding Canopy equity earnings, stood at 21.1%, up from 19.3% last year due to higher effective tax rates from our foreign operations. We expect the comparable tax rate for Q2 fiscal 22, excluding Canopy equity earnings, to be around 20%. Nonetheless, we still project that the full year will average about 19%, as anticipated stock-based compensation benefits are more loaded in the second half of the fiscal year. Turning to free cash flow, defined as net cash from operating activities minus CapEx, we generated $602 million in Q1, an 11% increase year-over-year, reflecting strong operating cash flow and reduced CapEx. CapEx was $114 million, 21% lower than last year's spending, including about $86 million for beer, mainly for expansions in our Mexican facilities. The lower CapEx is mainly due to timing, as we have significant spending planned for the rest of the fiscal year. Consequently, our full-year CapEx guidance remains at $1 billion to $1.1 billion, including a target of approximately $900 million for beer operation expansions in Mexico. Furthermore, we still expect fiscal 2022 free cash flow between $1.4 billion and $1.5 billion, reflecting operational cash flow of $2.4 billion to $2.6 billion and the previously mentioned CapEx. Regarding Canopy, we recognized an unrealized loss of $745 million in Q1 due to the decreased fair value of our investments in Canopy, which is excluded from our comparable basis results. Since our initial investment in Canopy in November 2017, we’ve recorded a total pre-tax net gain of $366 million. In conclusion, I want to emphasize our capability to maintain significant capital allocation flexibility throughout fiscal 2022, enabling ongoing efforts to return cash to shareholders while making strategic investments for long-term growth opportunities. We believe the combination of strong cash flow and future growth potential in both our Beer and Wine & Spirits segments positions Constellation for success. The growth and margin profile of our premium beer business is exceptional, and we expect that to continue. Meanwhile, we are transforming our Wine & Spirits business, with an expectation of ongoing margin improvement as we work towards operating margins of around 30%. Bill and I are now happy to take your questions.

Thank you. Hi, everyone.

Hey, Bonnie.

Hi. I was actually just hoping to get a little more color on the out-of-stock pressures you've been facing. We're aware that you guys had temporarily paused orders during the end of May given how strong demand was in relation to your forecasted supply. So, first, are these caps still in place? And then specifically, have you seen these pressures maybe get better or worse in June? And finally, are there any specific impacts on certain SKUs or pack sizes or was this just more broad-based in your portfolio? Thanks.

Sure. Obviously, the two main things driving the tightness of inventory are first and foremost, robust consumer demand. Our consumer demand has been well in excess of what we anticipated. And in my opinion, that's always good news. The second piece of that obviously was the point that Garth made and I made in my script, which is the power outage that occurred at the end of February, which has made for a somewhat tighter inventory position than we would normally want to hold. With that said, all of that will take care of itself over the course of the fiscal year. It's quite different, quite frankly, from last year where we mainly produced the SKUs that represented 75% of our total portfolio. This year, we're producing all of our SKUs. So, it's very different from what we saw last year, and while we do expect tightness during the course of the summer, we're working actively with our distributors to make sure that we are providing the right mix of product to make sure that we continue to supply the very strong demand we're seeing against our portfolio.

Yes. Good morning, everyone. So, just quick housekeeping, Bill, you wouldn't mind sharing perspective on June depletions. I know the month isn't over yet, but any early color would be helpful? And then, the broader question is, during the pandemic, many brands, including Constellation's portfolio of beer brands gained a lot of new households, and I was just wondering have you done a postmortem on what those new households look like? Have you recruited new consumers into the portfolio that you weren't recruiting prior? I mean any context around that would be really interesting.

Certainly. Regarding your first question about June, you're correct that it's not over yet. We're very excited about how June is shaping up and it aligns with our long-term expectations, assuming we finish the month strongly. We believe June will turn out well. In terms of households, we are continuing to expand our reach across our core brands, especially in beer. Regarding Modelo, as mentioned in previous quarters, we are quickly increasing our presence in the non-Hispanic community. It's challenging to determine how much of that growth is due to COVID compared to non-COVID impacts, given the rapid acceleration of Modelo's success not only in its primary Hispanic market but also in the broader market. We find it difficult to assign an exact percentage to these factors. However, it's clear that we are attracting consumers to our portfolio, and we anticipate this trend will persist. Much of this growth is driven by our innovation efforts, as we are better meeting consumer needs and preferences than ever before. As a result, we expect to continue welcoming new consumers by creating more opportunities for them to engage with our brands.

Great, thanks. Good morning. I was curious about the beer pricing. It’s price mix was north of 2%, and I was just curious if you could talk a little bit about how much of that was driven by mix or if there is some greater pricing starting to come through in the market and your thoughts broadly on pricing for beer this year? Thanks.

Sure. We continue to keep our algorithm about beer pricing as we have said on prior calls. We see it as a 1% to 2% growth profile over the course of the year, and we're sticking with that. We think that's appropriate given all the factors that we weigh when we decide about what we're going to do with our pricing. I think it's also important to say our number one growth driver in our business continues to be Modelo, which is very accretive on a mix basis. So, as we continue to see all of our businesses grow, when you see that kind of acceleration in Modelo, it certainly is mix accretive to us as well. So, I think both of those things were additive in the quarter, and we would expect them to be additive over the course of the year.

Thank you, everyone. Regarding the supply challenges and their connection to depletions, how do you see inventory improving in the second half of the year? Do you think that in order to bring inventories back to your desired levels, depletions need to return to that high-single-digit range, or do you believe that simply alleviating the supply pressures will be sufficient? Thank you.

We'd expect that the abatement of supply issues to take care of themselves over the course of the year. Remember, I think we probably made this reasonably clear. We lost several points of top-line growth because of the power outage that occurred at the end of February in Northern Mexico and Texas. So, we certainly had a muted shipping scenario. We will expect to pick that up over the course of the remainder of the year. And we're still expecting demand to be very solid. So, we are fully expecting to meet the demand that we'll see in the marketplace, which we continue to say will be in that 7% to 9% range over the course of the year.

Great, thanks for the question. Yes, I appreciate the color you gave on the on-premise at 11% and I guess that's greater than 250% growth for beer. But was that at the close of the quarter? Is that like the average of the quarter overall? And inside that, what are you seeing in terms of draft amount?

Yes, that's the average over the course of the quarter. As Garth pointed out in his remarks, that still is below what we were pre-pandemic but it's a really big increase to what it was last year. So, we still think certain markets are developing more quickly than others as we've said in prior discussions as well. So, we certainly expect that's going to continue to be an accelerator over the course of the summer. And let's face it, I think it would be fair to say there's a lot of pent-up consumer demand to simply go out of your home, that people are looking forward to the opportunity as some of the COVID restrictions come off. We would expect to see some continuing acceleration in the on-premise channel as we progress through the summer, recalling that the on-premise channel was a fraction of what it was last year versus the prior year. So, we think that's all are going to take good care of itself as the year goes on.

Good morning, everyone. I have a question for Garth regarding the uncertainty around inflation. Could you please comment on which inputs are becoming more predictable? Are we talking about freight, packaging, or labor costs? I’m looking to understand where the pressure points might be. Additionally, compared to the beginning of the fiscal year, can you provide insight into how much inflation has impacted your flexibility to achieve your profit growth targets this year? Thank you.

Thank you, Bryan. As a reminder, when we provided our Q4 guidance, we mentioned inflation and indicated that we expected it to be in the low to mid-single-digit range overall. This included the low to high single-digit range for individual cost items. We have a solid hedging policy in place, and we started the year in a good position. Looking ahead, our inflation outlook remains unchanged; we anticipate a temporary spike in inflation. The key question is how long it will last. It seems like this blip might take a while to subside. Currently, we are primarily focused on logistics, transportation, and labor, all of which are interconnected. The tight labor market has made securing dedicated trucking lines more competitive, which is concerning. We're also monitoring aluminum prices and the impact of natural gas on glass production. As of now, we feel equipped to manage our inflationary challenges, assuming they do not worsen significantly through the year.

Great, thank you. Bill, hoping to get a little bit more granularity as to what you're expecting from the Hard Seltzer category and the broader ABA category or the ABA category more broadly? And related to that, you reiterated that you're more than doubling Corona Seltzer's capacity this year and you'll have the additional 5 million hectoliters of ABA capacity at Nava I believe for next year. If your forecast on ABA growth don't pan out, how flexible is that capacity to produce traditional beer?

We anticipate that the Hard Seltzer category will grow between 30% and 50% this year. Last year, we sold around 10 million cases with one SKU, and we've now launched our second Variety Pack. We're thrilled about this development, and the Limonada flavor is just making its debut. It's important to note that even with our expanded ABA and Hard Seltzer capacity this year, the primary growth driver in our portfolio will continue to be Modelo, regardless of this significant growth. We feel confident in our growth trajectory across the board. We have considerable flexibility regarding the capacity we implement and how it can be leveraged throughout the business. Factors like packaging contribute overall to our operations, so we are prepared to adapt based on any shifts within the specific sub-segments of the beer category. We've put in a lot of effort to ensure our production capacity is flexible enough to respond to changes in consumer demand.

Hi, thank you. So, I actually have a question just about Wine & Spirits. Price mix has been a good story in the business, that's accelerated this quarter, obviously, margins got hit. I'm just trying to frame where you think we are on the path to the medium and longer-term margin targets here? We knew there was always going to be a step back before recovery and certainly, it seems like the price mix and premiumization of the portfolio can deliver what you think it can. But we also have a much more inflationary backdrop and things are evolving. So, I wonder if you can just maybe take a look at this quarter and how it informs how you're continuing to look at the capacity of this business to deliver those margin targets over time and perhaps the timeline on what you think that can happen?

Yes, Chris. Thank you for your question. As you mentioned, our top-line performance is strong, and we are pleased with the progress we have made in this area. Regarding our margins, we have previously stated that it would take about two years after the divestiture to achieve 30% operating margins. To reach that goal, we will need to implement several strategies, including pricing adjustments, product mix changes, and cost reductions. We anticipate a reduction of around $130 million in stranded costs, though not all of this will directly improve our bottom line, as some will be reinvested back into our brands to support further top-line growth. Additionally, we are focusing on optimizing our footprint following the Gallo divestiture, which involved sharing several brands and seven wineries. We are actively pursuing cost optimizations to ensure our products align with consumer expectations. We have already started executing these initiatives and did not wait for the transaction to close to identify savings. However, we are currently experiencing a transitional period where the business is somewhat deleveraged. Consequently, until we fully realize these cost savings, you may observe some short-term challenges this year as we strive towards our 30% operating margin goal within the two-year timeframe post-divestiture.

This is actually Greg on the line for Kevin. Just one quick follow-up question on some of the on-premise channel trends that you guys have been seeing. Many of your peers have noted that it's been running in front of plan so far in terms of the number of reopenings, the velocity that they've seen. You guys gave some helpful context on what you've seen over the last quarter, but maybe could you talk about how your expectations for the full year have changed? Have you seen the reopening phase faster than you thought it would be? And maybe how you think that would impact full year results? Thank you.

Sure. Let me address that, Greg. We've observed a significant acceleration. However, throughout the past 18 months during the pandemic, we experienced some fluctuations where improvements occurred in certain states while others lagged. It's important to note that although we've achieved 250% growth in our depletions this quarter compared to last year, the proportion of our business from the on-premise sector is still slightly lower than it was in 2019. This suggests there are still opportunities for further acceleration. Our distributor network has excelled during key times, including holidays such as the 4th of July, Labor Day, Cinco de Mayo, and Memorial Day. Therefore, we anticipate more chances for growth. The challenge lies in predicting the extent of channel shifts that happened a year ago when there was a significant transition to off-premise sales. Now, with the on-premise segment returning, the IRI and Nielsen data has shown muted results. Additionally, we've also recorded a notable rise in our three-tier e-commerce and direct-to-consumer sales across the business. How these channels will evolve is uncertain. Nevertheless, the encouraging aspect is that consumer demand for our offerings across all measurable channels has been exceptionally strong, and we are optimistic that this trend will persist regardless of the channel consumers decide to engage with.

Thank you for taking the question. I wanted to follow up on your recent comments about where consumers are engaging. You mentioned that engagement is still below the levels seen in 2019. Can you elaborate on how you see that progression? It appears that consumers are still engaging at home, and the consumption of your major brands remains strong despite these shifts. Additionally, could you clarify the situation regarding inventory and shipments? Given that production in April will be an easy comparison, is it safe to say you have a considerable amount of inventory still in transit from Mexico? While you mentioned normalization may not occur until the third quarter, does that indicate the second quarter will still be a strong period for shipments?

Sure. So, let's start with the question around the on-premise. Keep in mind, based on what we can see, per capita consumption has remained pretty steady throughout the pandemic. It's just that where and how people consume has moved around quite a bit. So, it's really difficult to precisely predict how consumers are going to operate. And I think it's going to vary, as I said a moment ago, quite a bit by state depending on the individual restrictions and whether or not certain states are still allowing takeaway from a restaurant environment for alcoholic beverages; some are not. So, until all this dynamic plays itself out, I think it's going to be very difficult to predict exactly how the consumer will land. Other than I would say some of the sheer shopping behavior where you see three-tier e-commerce and direct-to-consumer changes are going to continue. As we've said in prior calls, we have made major investments to increase our capability in three-tier e-commerce and direct-to-consumer, and I'm very glad that we did. It's playing out well and it's showing tremendous takeaway in those sectors which have grown around the pandemic. As it relates to inventory, we continue to believe we're going to have a very solid year. We're in a good position to make up the challenge that was the one-time challenge around the power outage that occurred in February, and we expect to have, as we've said, a very strong year and that I would expect would include the second quarter which is upon us.

Thank you very much. I know you have a lot of questions, Bill, but to follow up on the last topic about beer supply, is there a limit we should consider regarding how much you can physically ship in the second quarter? I think the consensus expects around 100 million cases in Q2 compared to 85 million in Q1. Given everything you mentioned, I'm trying to gauge whether this increase is feasible in general terms or if more adjustments will be needed later. Additionally, Garth, you detailed several factors that will influence the beer margin trajectory and what might affect beer margins for the rest of the year. Could you provide more details on that, perhaps prioritizing the items that will have the most significant impact? That would be very helpful. Thank you to both.

Yes, absolutely. I'll begin with the first part, and then Garth will address the latter part. One aspect we haven't touched on today, which is significant, is the delay we experienced with the opening of the Obregon extension. This was postponed by about a quarter at the end of last year due to construction challenges during COVID. However, this facility is now operational, which will certainly improve our inventory situation moving forward. While it's not functioning at peak efficiency yet due to the typical challenges of ramping up operations, it is making a positive impact. We are confident we will meet consumer demand during the crucial summer selling season as I mentioned earlier. We are collaborating closely with our distributor network and retail partners to ensure we satisfy that demand. The demand has been strong and remains robust, but we believe we can meet it, and the Obregon facility will play a significant role in that effort. Garth, would you like to elaborate?

Yes. To address the margin question, as mentioned in Q4, the main factors affecting margins are depreciation, inflation, and product mix, all of which have an equal impact. Regarding depreciation, we saw an increase of around $65 million this year, which includes Obregon's full year depreciation along with some other factors. Inflation is anticipated to have a greater effect in the second half of the year as our hedges expire. As for product mix, this will also increasingly influence us as the year progresses. We started the year primarily with one SKU in the Corona Hard Seltzer Variety Pack #1, and recently launched Corona Hard Seltzer Variety Pack #2 and Limonada in June. Thus, we expect a more significant mix impact as the year continues. Ultimately, the effects are fairly balanced across these three areas.

Thank you. And hi, everyone, and thanks for squeezing me in the queue. Up to recently, penetrate most from these spending households about 15% for the right kinds were to a record as a test was not pleasing. So, now with new bolder flavors, Seltzer and brown/black targeting specifically Hispanic, we are seeing household penetration within Hispanic going up to 25 to 35. So, my question is do you see that as a risk to your portfolio of Mexican beer? And if not, why? And what are you doing to reach more Hispanic consumer with your current Seltzer portfolio? Thank you.

Certainly. We are fortunate to have a strong Mexican beer portfolio with iconic and authentic brands that resonate with the Hispanic community. We've observed continued growth and potential, particularly with Modelo, which, despite its rapid expansion, still has room for increased household penetration compared to Corona. We're also noticing significant engagement with our Corona Hard Seltzer within the Hispanic community. This allows us to connect with consumers by addressing new occasions and needs. We are confident about the growth prospects within the Hispanic market for our renowned Mexican brands, and we believe that our Seltzer offerings will play a crucial role in strengthening our relationship with this community, while we also successfully expand these brands into the non-Hispanic market.

Hi, good afternoon, Garth, and Bill. Two quick questions from my side, please. As you sit today and you compare with three months ago, have anything changed to change your point of view either for F22 or the outlook? I think the second thing related to that, given the cadence of inflation you talked about given the aluminum spot price staying as high as these and those hedges rolling off, historically, you've had that 1% to 2% pricing algorithm. Do you think that might need to change 12 months out?

I'll take the price part, Garth. Maybe you take the first part. Relative to the price, we continue to believe 1% to 2% is going to be our long-term expectation. We think that balances appropriately the dynamics that occur with price sensitivity when you raise your price and recognizing, it does obviously help you cover any inflationary effects during the course of the year. So, we're pretty comfortable that algorithm of 1% to 2% is the right answer, that balances all of those factors, and we would see that continuing well into the future.

Yes, regarding the initial question, the first quarter has shifted our perspective for the entire year. At this stage, it is too soon for us to adjust our outlook for the year based on just one quarter. I want to point out that, as Bill mentioned, the depletions in our beer business were better than we anticipated and exceeded the expectations of our distributors and retail partners. This is something we will closely monitor as we progress through the second quarter and the rest of the year. As we see developments in our business throughout the year, we will update you on our guidance expectations. For now, we are very confident in the guidance we provided and reaffirmed today, with a slight increase in our earnings per share linked to the share repurchase program.

Thank you, everyone for joining our call today. I think it should be clear, the fiscal '22 is off to a strong start, providing us with continued momentum as we head into our key summer selling season. Our powerful collection of consumer connected brands across beer, wine, and spirits continues to gain traction, and we are well-positioned to deliver another strong year of performance consistent with our long-term goals. Our robust cash flow generation allowed us to make significant share repurchases in line with our commitment to return $5 billion to shareholders by fiscal '23 and we look forward to updating everyone throughout the fiscal year, as we expect to make continued progress during fiscal '22. In closing, I'd like to wish all of you a happy 4th of July and hope that your celebrations with family and friends include our fantastic beer, wine, and spirit products. Thank you, again, everyone and have a good summer.