Constellation Brands Inc (STZ) 2014 Q2 法說會逐字稿

Good morning.

My name is Jackie, and I will be your conference Operator today.

At this time, I would like to welcome everyone to the Constellation Brands second-quarter 2014 earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions)

Thank you.

I would now like to turn the call over to Patty Yahn-Urlaub, Vice President of Investor Relations.

Please go ahead.

Thank you, Jackie.

Good morning, everyone and welcome to Constellation's second-quarter fiscal 2014 conference call.

I'm here this morning with Rob Sands, our President and Chief Executive Officer, and Bob Ryder, our Chief Financial Officer.

This call complements our news release, which has also been furnished to the SEC.

During this call, we may discuss financial information on a GAAP comparable organic and constant currency basis, however discussions will generally focus on comparable financial results.

Reconciliations between the most directly-comparable GAAP measure and these and other non-GAAP financial measures are included in our news release or otherwise available on the Company's website at www.CBrands.com.

Please also be aware that we may make forward-looking statements during this call.

Although statements represent our best estimates and expectations, actual results could differ materially from our estimates and expectations.

For a detailed list of risk factors that may impact the Company's estimates please refer to the news release and Constellation's SEC filings.

And now I'd like to turn the call over to Rob.

Thanks, Patty.

Good morning, and welcome to our discussion of Constellation's second-quarter fiscal 2014 sales and earnings results.

The second quarter marks the first time that we are reporting consolidated results for Crown and our new Mexican brewery, and I'm pleased to report that the transition of our new beer business has been successful and seamless.

Operations are running smoothly.

There has been no disruptions to service or delays in shipment, and our beer supply chain is operating efficiently.

Most importantly, the Crown commercial business, which by the way, had a great quarter, has not been impacted by the transition.

Maintaining this high level of performance during the transition is a true testament to the talent and commitment of the Crown team and the Nava employees in Mexico.

The Nava Brewery is extremely important to us, and we're proud that it is now an integral part of Constellation.

As you know, one of our top priorities is expanding the brewery.

We've been fully immersed in the initial planning stages of the brewery expansion project, which includes the build-out of the brew house, packaging, warehousing, and site infrastructure.

We have already selected those companies that will support us in these key areas, strategically choosing the ones we believe to be the most experienced business partners.

From a project management perspective, we are building the best team, as it relates to engineering, supply chain, procurement, quality, finance, HR, legal, and IT, doing our best to ensure that every aspect of the brewery integration and expansion will be successful.

Closing the beer transaction has also been very important for our wholesalers.

No one should underestimate the goodwill that has been created with our Crown distributor network, with the assurance that Constellation will be their long-term business partner.

As I mentioned, Crown has had a great quarter, generating sales growth of 3% while continuing to gain market share, with depletion and underlying earnings growth of about 7%.

All core Modelo brands posted notable depletion growth during the quarter, with Modelo Especial up 17%, and Corona Extra and Corona Light growing in the 4% to 5% range.

Corona Extra has posted its best Corona Summer since the inception of the Crown JV.

The summer season success of Corona Extra was driven by a number of factors, including its well-executed Summer retail promotion and TV advertising campaign called Live It, Share It, Win It, which resulted in increased features and displays at retail.

In addition, Crown leveraged its Hispanic boxing sponsorship with limited edition Corona packaging, featuring boxing legends and rising champions.

The recently launched Corona Light draft is growing in every market where we have introduced this new format, which is also having a positive impact on the overall growth of the brand.

Now during the second quarter, Modelo Especial launched its biggest summer promotion ever with its win a trip to Brazil program.

This promotion was supported with new TV advertising in English and Spanish, and dedicated TV support across Fox properties, as well as promotional packaging.

Pacifico introduced its national digital media campaign, as well as television advertising in key focus markets during the quarter.

Initial results show strong increases in awareness and trial resulting from these efforts.

Pacifico continues to be the number-one draft brand in the Crown portfolio, posting a second-quarter 34% depletion increase for this format.

And during the quarter, Negro Modelo officially introduced the Chef Rick Bello sponsorship, including TV advertising, impact offers, and sampling opportunities, which collectively are contributing to the success of the brand in priority markets.

Overall, we are well positioned to generate organic growth throughout the remainder of the year, with the following plans for our portfolio of iconic brands.

Corona Extra will have a strong support throughout the football season, including new TV ads featuring Jon Gruden.

In addition, we will air new Spanish language creative on TV, while also featuring game day football promotions.

Modelo Especial's Hispanic real world campaign will continue to air across national Spanish language television, and while we're on the subject of Modelo Especial, Modelo Especial Chelada will roll-out in key markets earlier this week and will be supported by national Hispanic TV advertising.

We have plans for a national product roll-out in time for next year's key summer selling season.

Now I recently had the opportunity to sample the Chelada, and its refreshing taste is really great.

I would encourage you to give it a try.

The draft beer opportunity for the Crown portfolio continues to have significant momentum, with draft depletions increasing nearly 40% during the second quarter.

And finally, while Somersby Cider has done well in initial test markets, Crown and Carlsberg have mutually agreed that Crown will no longer represent the Somersby brand in the US.

At this time, we need to focus our efforts from a Crown perspective on growing our current portfolio of great brands, in order to realize our long-term goals.

Now before we review the operational results for our wine and spirits business, I would like to take a moment to discuss the impairment charge that we have taken for our Canadian wine business.

As part of our acquisition of the Vincor Canadian wine business in 2006, we purchased some strong leading brands like Jackson-Triggs and Inniskillin, that have been solid performers.

Today, much of the market growth is coming from consumer's desire for innovation and new brands, and from import wines, areas we have had some good success in the marketplace.

Given these market trends, we have experienced declining performance in certain parts of our legacy business, including refreshments, wine kits and certain value wine brands.

It is these areas that have contributed to the need to take the impairment charge.

As a result going forward, we will be focused on the following.

Sales of higher value, higher margin imports including Mondavi, Crawford, Kim Crawford and Ruffino; maintaining our focus on driving growth of our most important premium domestic wines, including Jackson-Triggs, Sawmill Creek and Inniskillin; and innovation as we continue to create new brands and products that meet the evolving taste preferences of consumers.

We believe this strategic evolution will generate the most profit for Constellation, and positively position us for future growth and strengthen market leadership in Canada.

Canada is a growing healthy market, and continues to be a strategic important business for Constellation.

And now, I would like to focus on the operational results for our wine and spirits business.

As expected, the overall second-quarter financial performance for wine and spirits was impacted by the timing of product shipments.

We expect most of the growth for this business to be generated in the second half of the year, which aligns with our highest seasonal selling period for the year, and a launch of most of our new product introductions.

Second-quarter segment net sales for wine increased 2%, driven by the US wine portfolio.

From a consumer takeaway perspective, within IRI channels, our wine portfolio outperformed overall US category growth during the quarter on a volume basis.

And from a depletion perspective, our focus brands grew almost three times the rate of our total portfolio, posting double digit growth bends for Black Box, Simi, Rex Goliath, Mark West, Ruffino, Kim Crawford and Nobilo.

The year over year spirits sales decline for the quarter can be attributed to the timing of new product launches and product shipments for the year, as well as the unfavorable comparison versus last year, when we had the benefit of some bulk spirits sales.

There are no fundamental issues with the underlying health of the spirits business.

As a matter of fact, from a consumer takeaway perspective, spirits increased about 4% across all channels during the quarter.

We also recently launched the new Black Velvet Cinnamon Rush, which is priced at a premium versus our base Black Velvet brand.

The cinnamon flavor category in Whiskey is currently on fire, experiencing triple-digit growth trends.

Now, as previously indicated, we are very excited about the second-half rollout of our line up of new wine brands and product extensions, including Rosatello, a sweet low-alcohol wine that is targeted to Hispanic and urban female consumers.

Milestone, focusing on the Millennial consumer, who is looking for a contemporary and aspirational offering.

V.NO, a multi-varietal wine that is positioned for Millennials who like to travel and explore, and Hidden Crush, an easy drinking on-premise only brand that is perfect by the glass for new drinkers, and SAVED, a new luxury price brand that is a collaboration between tattoo artists to the stars, Scott Campbell, and our award-winning wine maker from Wild Horse, Clay Brock.

Some of our successful new brands were recently honored by key industry publications, including The Dreaming Tree, which received the prestigious distinction of Best New Wine product by Market Watch, and a top Hot Prospect by Impact.

Primal Roots, Thorny Rose, Ruffino Prosecco, and Diseno joined The Dreaming Tree on the Hot Prospect list.

During the second quarter, we also redeemed several awards for some of our key focus brands, including Kim Crawford which has been recognized by Impact as a newcomer blue-chip brand.

The Robert Mondavi 2010 Cabernet Sauvignon Reserve received a 93 point rating from Robert Parker along with a 2010 Ruffino Modus, which received a 90-plus point score.

Our 2011 Robert Mondavi Napa Valley Pinot Noir was rated 92 points, and a Best Buy by Wine and Spirits Magazine.

And the 2009 Simi Landslide Cabernet Sauvignon received a Double Gold medal at the 33rd Annual San Francisco international Wine Competition.

And the Franciscan 2010 Merlot received a score of 90 points, an the Editor's Choice accolade in the September issue of the Wine Enthusiast.

As is typical at this point of the year, I'd like to provide an update relating to the US grape harvest, which is currently under way, and off to an early start, with almost 65% complete in California.

Growing conditions were very good in most regions, and 2013 yields are expected to be consistent with last year's crop, subject to variation in each region.

Quality is expected to be very good.

Overall, grape pricing is expected to decline slightly compared to last year, depending on variety, location and demand.

In closing we are working diligently on the brewery expansion in Mexico while maintaining the strong momentum of the Crown commercial business, and with our wine and spirits business, we are well-positioned to drive our great portfolio of brands during the upcoming holiday season.

I'm especially gratified by the fact that Constellation remains one of the best performing S&P 500 consumer staple stocks this year.

I'd now like to turn the call over to Bob for our financial discussion of our second-quarter results.

Thanks, Rob.

Good morning, everyone.

Our comparable basis diluted EPS for Q2 came in at $0.96.

This represents a sizable increase versus Q2 last year, as we begin to realize the tremendous accretion attributable to the beer business acquisition, which is significantly enhancing our sales, operating profit, operating margin, and free cash flow.

Our Q2 results also benefited from a lower than anticipated tax rate.

As a result, we are lowering our full-year comparable basis tax rate estimate, which is driving an increase in our fiscal 2014 comparable basis EPS guidance.

We'll now look closer at some of the highlights just mentioned, as we review Q2 performance in more detail.

My comments will generally focus on comparable basis financial results.

As you can see from our news release, consolidated net sales in Q2 included $763 million of incremental net sales related to the beer business acquisition, as we consolidated 100% of beer sales for all but six days of the second quarter.

For the full second quarter, the beer segment generated net sales of $815 million, an increase of 3% over the prior year second-quarter period.

While depletions were strong at 7% for the quarter, Crown faced a tough sales comparison versus Q2 last year, when net sales increased 8%, as there were some wholesaler buy-ins ahead of planned price increases in select markets in the Fall of last year.

Wine net sales increased 2% while spirits net sales decreased 18%, due to the timing of shipments.

Wine and spirits net sales on an organic constant currency basis decreased 1%, as an increase in wine shipment volume was more than offset by higher promotion expense, and a decrease in spirits volume.

As a reminder, from time to time, you'll see fluctuations in growth trends for shipments, depletions, and revenue on a quarter over quarter basis, due to various factors like the timing of new product introductions and promotional activities.

We expect spirit sales trends to improve in the back half of the year, as we just began the rollout of Black Velvet Cinnamon Rush and we look forward to see benefits from the restaging of our new packaging for the Svedka flavors.

We also expect to see better wine sales performance in the back half of the year, driven by the rollout of new products and improved mix from initiatives planned for our focus brands during the upcoming key holiday season.

For the quarter, gross profits increased $302 million.

As you know, under the Crown joint venture structure, we recognize our share of Crown's earnings on the equity earnings line.

Since the close of the beer transaction early in Q2, 100% of Crown's results, along with the Mexican beer production profit stream, are consolidated by Constellation.

Incremental gross profit from the consolidation of beer was $311 million.

This produced a beer gross margin of 41% for the quarter, based on the incremental beer sales discussed earlier.

For the quarter, our consolidated gross margin was 40.3%, versus 41% for the prior-year quarter.

After factoring in the impact of consolidating the beer business, the remaining change in gross margin is primarily the result of higher promotion expense and grape costs for the wine business, and lower spirit sales.

Some of the higher promotional expense reflects a shift from marketing spending that we originally planned.

SG&A for the quarter increased $91 million.

The incremental SG&A associated with consolidating the beer business was $89 million, so essentially all of the SG&A for the beer business is related to Crown, as the brewery has very little costs classified as SG&A.

Based on what I just outlined, the incremental operating income generated by the beer business was $221 million for the quarter.

This result produced an operating margin of approximately 29%.

The inclusion of the beer business results was the primary driver behind the 400 basis point improvement in our consolidated operating margin for the quarter.

Equity earnings for Crown totaled $4 million versus $71 million in the prior year second quarter.

The decrease was due to the consolidation of the beer business, as of June 7. Interest expense for the quarter was $90 million, up 65% versus last year.

The increase reflects higher average borrowings as a result of the acquisition, partially offset by a lower average interest rate.

That provides a good spot to discuss our debt position.

At the end of August, our total debt was $7.3 billion.

This represents a $4 billion increase from our debt level at the end of fiscal 2013.

The increase primarily reflects the financing for the beer business acquisition, partially offset by some of our cash build in advance of the transaction, and our free cash flow generation during the first half of fiscal 2014.

We continue to expect interest expense for the year to be in the range of $325 million to $335 million.

As you may recall, we did not include any potential impact of the beer acquisition in our initial fiscal 2014 effective tax rate guidance, as we were working to close the transaction and evaluating tax structures.

During Q2, we recognized the tax effect of this structure related to the beer business.

This structure complements the overseas debt we put in place as part of our transaction financing.

Our Q2 comparable basis effective tax rate came in at 29%, which reflected benefits from integrating the beer business, as well as the favorable outcome of various tax items related to previous years.

This compares to a 16% tax rate from the prior-year second quarter, which included the benefit of higher foreign tax credits.

Given the anticipated lower tax rates associated with our foreign beer profit streams, we now expect the comparable basis effective tax rate to approximate 32% for fiscal 2014.

We also expect the 32% rate to be a good target rate to assume for Constellation, as the brewery gets built out over the next three years.

Now, let's discuss free cash flow, which we define as net cash provided by operating activities, less CapEx.

For the first half of fiscal 2014, we generated $440 million of free cash flow, versus $333 million for the same period last year.

The increase was primarily due to benefits from the beer business acquisition, partially offset by higher interest payments and lower cash flow results for the wine business.

While we're quite pleased with the strong year-to-date free cash flow results, we are maintaining our fiscal 2014 free cash flow guidance of $475 million to $575 million, as we expect some acquisition-related integration costs and our targeted brewery capital expansion investments to temper free cash flow results in the second half of the year.

Now let's move to our full year fiscal 2014 P&L outlook.

We're now forecasting comparable basis diluted EPS to be in the range of $2.80 to $3.10 a share.

This represents a $0.20 increase versus our previous guidance, and is being driven by the lower tax rate projection I outlined earlier.

Our comparable basis guidance excludes restructuring charges and unusual items, which are detailed on the last page of the release.

Let's talk a bit about two significant non-comparable items that were recorded in the quarter.

During Q2, we recognized a $1.6 billion non-cash gain from the revaluation of our original 50% ownership interest in Crown, to reflect the fair value, as required by GAAP.

This gain is non-taxable.

Similar to Q2, we expect this accounting requirement to result in a very low reported effective tax rate for the year.

As outlined by Rob earlier, we recorded a $301 million in non-cash goodwill and intangible asset impairment charge, related to our Canadian business.

In addition, we continue to expect one-time costs associated with the beer transaction and integration activities to approximate $80 million in fiscal 2014.

Before we take your questions, I would like to reiterate how pleased we are to have completed the transformational beer business acquisition.

Our Q2 results started to demonstrate how this transaction enhances our financial profile, as it significantly increases our sales, operating profit, and operating margin.

The transition of Crown and the brewery has been positive, as our beer supply chain has been operating efficiently and Crown's execution in the marketplace has been outstanding.

For our wine and spirits business, our investments in innovation behind new brands and our key focus brands position us for strong marketplace execution during the key holiday season.

With that, we're happy to take your questions.

(Operator Instructions)

Our first question comes from the line of Bryan Spillane with Bank of America Merrill Lynch.

Two questions related to the beer business in the quarter.

First, Bob, if you can just talk about, I guess the cost structure in the quarter to the extent that this is the first quarter that you've owned the business, vertically integrated, and you're accruing for certain costs for the first time, things like security, I guess, and other items.

Just do you think that this quarter was reflective of what you expect in terms of those overhead costs going forward this year, or was there anything unusual about what you would have accrued or booked for expenses in the quarter?

No, I'd say in general, as Rob said, the brewery transition, I'd say, both operationally and financially, has gone very smoothly.

I don't think, well I know, we really haven't seen any surprises coming out of the financial statements or the manufacturing equipment.

So I'd say that it was a pretty smooth quarter, and I wouldn't expect any dramatic changes balance of year.

Okay, great and then second question, just in terms of depletions, beer depletions in the quarter, could you give us some color in terms of how much of that growth in the quarter was driven by new distribution versus just velocity or growth off of your existing base?

Just trying to get a sense for how much of the growth was just a greater lift, because you ran summer promotions this year, which you don't normally do, and how much of it was just truly from new distribution gains?

Thanks.

Yes, good question.

It was actually everything went well this quarter, so Corona actually experienced some of the best growth, brand Corona, some of the best growth that we've seen since the JV was formed.

And as you know, Corona is pretty much fully distributed.

There's probably some opportunities on cans, but it's pretty much everywhere you'd want to be, so you'd call that probably like per cap consumption growth for Corona.

In addition to that, Modelo Especial continues to grow rather well, and Modelo Especial is not nearly as well distributed as Corona.

So I'd say a lot of the Especial growth is from expanded distribution, but we see per cap consumption in Especial as well, so I'd say it was a combination of all of the above.

Okay, thank you.

Your next question comes from the line of Tim Ramey with Davidson.

Just another follow-up on beer.

Margins there might have been a little less than what I was working with in my model, and perhaps less than what you had pro formaed for 2012.

I know that's probably where Brian was going with his question, but can you shed any light on that?

Where we should be thinking about?

I think the margins were pretty much where we expected, Tim.

We had a gross margin in the low 40% range.

That's probably the neighborhood we expect until Nava gets up and operating, and we save some freight and start producing the beer in a more efficient facility, so I'd say margins were pretty much what we expected.

Okay, sounds good.

And in wine, the impact of the harvest, really I guess won't be felt for another 12 months at least, but can you describe what you see in the tone of the market right now?

It seems like it's fairly strong, but I'd love to hear your tone of market comments.

Yes, this is Rob, Tim.

I think that over the shorter term, wine consumption, or the market has been perhaps a little weaker than we anticipated, in the low single digits, maybe growing around 2% or so.

I think that's really being driven largely by the lower end of the market, so value wines, where a lot of pricing has been taken in the marketplace.

I think that in everything over value, premium plus, where we play, we continue to see flat pricing, IE, no pricing to perhaps a little bit on the upside or some slightly decreased promo.

I think consumer takeaway and premium plus continues to be strong, certainly in super premium, ultra premium, luxury, et cetera.

We still see very strong consumer takeaway.

I would say that relative to the harvest, it's going to be another relatively large harvest, two large harvests in a row, the grape under supply was greatly overstated.

If you could put that all together, meaning there isn't much of a grape under supply, in fact we see in general, bulk wine inventories have rebounded, are pretty strong right now.

Prices for grapes have been coming down for the last couple of years, ever since the perceived short harvest of I think three years ago, it disproportionately affected that harvest, because people got a hysterical over it.

And so in general, I would say that we see nothing in the wine business that is really unusual.

I think even the slight weakness in consumer takeaway is really nothing odd.

I think that it's really as I said mostly a function of some significant pricing that was taken in basically five liter bag in the box and jug wines, so I think it's a little artificial.

So that's basically what I would say is the tone of the wine business.

Thanks so much.

Your next question comes from the line of Judy Hong with Goldman Sachs.

So a couple questions from my end.

First, Bob, just in terms of your guidance, I know you've raised the full year EPS guidance on lower tax rate.

But I don't think you gave any update on how you see the wine and the beer businesses unfolding from both top and bottom line perspective.

And beer top line clearly seems like its accelerated a bit more in the second quarter so just if you can give us an update on how you're thinking about both line items from a guidance perspective for the full year?

Yes, sure.

You're right, Judy.

The only guidance we changed was for the tax rate.

Other than that, year-to-date, I'd say you're right.

Beer is probably a little better than we anticipated and wine might be a little bit worse than we anticipated, but we don't think that those changes were material enough to change our guidance, balance of year.

So we'll be reassessing it and update everybody on the January call.

Okay and on the beer side, at the beginning of the year you talked about brewery profit being down with some inflation, but Crown side of the business being up in profit.

Does that guidance still hold, and you'll reassess how sales play out for the balance of the year?

Yes, I think that's fair.

Nothing has changed materially around that.

Okay, and then just on the beer pricing environment, we know that you've announced select price increases in some of the markets.

If you could just give a little bit more clarity around the magnitude, and your sense of how well those price increases are sticking in the marketplace?

We've also been hearing some chatter about price increases about the major guys being rescinded in some of the markets, and just wondering if you're seeing that playing out in your major markets.

Yes, Judy.

In general, I would say that our pricing strategy has not changed at all.

Yes, we announced some pricing, and we fully expect that pricing to stick.

Our process is really to look at pricing market by market, strategically.

And of course we watch the price gaps very closely, but obviously our business is very, very strong, so we don't anticipate any change in our pricing strategy at all, relative to what anybody else is doing.

Okay, understood, thank you.

Your next question comes from the line of Alice Longley with Buckingham Research.

A couple of questions.

One is just more detail on the second-quarter wine performance in the US.

I think you said your depletions for wine in volume terms were up 2%, but you increased promotional activity.

So in value terms, how did your wine do in terms of depletion, and then also at retail?

That's the first question.

Yes, I'd say in value terms, it was probably flattish for the quarter.

Remember that wine was overlapping a real peak period last year, where we were really gaining a lot of market share, and saw some pretty good top line results.

So it was a difficult overlap for the quarter for wine, and we talked about in the spirits business, which caught up with wine and spirits in those numbers, we also had some odd overlaps year over year.

We expect the business for both wine and spirits to pick up quite a bit in Q3 and Q4.

Do you think the promotional activity in wine will lessen in your second half?

It will lessen a little bit, but remember because the second half has Christmas, and Christmas is a much richer mix of the higher price of product, that drags more higher promotion spending to it.

But yes, I would expect promotion spending to abate in the back half.

At least in the comps?

Correct.

Right, okay, and then my other question is an update on the guidance you've given us for beer margins between now and fiscal 2017.

I think you said that you aspired to get to the low to mid 30%s but that's a pretty big range, from 32% to 36%, I guess.

And can you tell us if you're more comfortable in the middle of that range, or the low end or the high end?

Well I'd say it's not really a statistically valid sample at this point, because we only had one quarter out of a three-year thing.

But there's nothing that we've seen in the beer business that would tell us that we're off materially from those estimates.

As we said, the things that are going to drive the big improvement in margins is moving more production to the Nava facility, which is number-one more efficient than the older breweries from which we're buying the product from InBev now, and in addition, we'll be saving quite a bit of freight because the Nava brewery is closer to its end consumer.

They are the two big drivers, and nothing we've learned has told us that won't be true when the brewery gets built out.

I guess to be more blunt about it, I think most of us are assuming you get nearer the upper end of that guidance for beer margins by the fiscal 2016 and 2017 period rather than the low end, and are we all being overly optimistic?

I would never accuse you of being overly optimistic, but as we look at our data, you're looking at your own data, we don't have enough visibility that far out to put a more aggressive plank in the sand.

So we still think the numbers that we've come out with are the best we have.

And remember, we're all trying to extrapolate from benchmarks, and the Crown business is a very unique business, coming out of one site south of the border, yet distributing throughout the United States, higher price points.

So it's difficult to get a benchmark with a similar business in the US, but I know you will keep trying.

Okay, thank you.

Our next question comes from the line of Bill Chappell with SunTrust.

On the beer trends, can you just maybe give us an update?

Certainly Modelo has done a phenomenal job today, but where we are in terms of ACV, if that's the right way to look at it, and when Modelo Light will start to, when we would see that, and what inning you think this whole roll-out is?

Yes, I'd say Modelo Especial, distribution of Modelo Especial is probably 30% to 40% less than distribution on Corona, and we firmly believe that Modelo Especial is the next Corona, so we still think there's considerable upside both from bottles and cans and draft.

We're also extremely underpenetrated in the draft industry.

Generally speaking, draft comprises about 10% of the domestic guys' sales, it's less than 2% for us, so we think there's a lot of opportunity.

Modelo Especial on draft is fantastic, so we're probably in the third on fourth inning on Especial.

And Modelo Light, any update there?

Yes, Modelo Light is being tested in one market and we're still tweaking the product to better align with consumers' desires.

Mostly right now around the bottle and the label.

We think the beer itself is very good, but we're trying to get the package right, so we're still -- I'd say tinkering with it.

And then just switching back to the comments on both the discontinued distribution of the cider and the changes in Canada, does that have a meaningful impact, or can you quantify the impact on sales going forward?

No, I mean the cider was tiny and the impairment charge has no impact on how you operate the business.

It's a theoretical Excel model calculation that for us resulted in a non-cash charge, and has no impact on how we run the business.

So you've already been doing that in Canada?

It's just the final charge to follow that up in terms of focus?

Correct.

Perfect.

Thanks so much.

Our next question comes from the line of Lauren Torres with HSBC.

Just to follow-up on beer and one on wine also.

On beer, I understand you're not ready, or you don't want to reveal your pricing strategy, but when you mention the fact that pricing is sticking, just curious, is this something that you took earlier this year?

It wasn't for the Summer selling season, I assume, and with that said, now that the Summer is over, do you think seeing what your competitors are doing there is more room for pricing for the next quarter or two?

First of all, our pricing and pricing in the beer industry is typically taken right about now, right?

October-ish, and as is publicly known, we sent out letters to our distributors with regard to our pricing.

Generally, it's not that we're not revealing our pricing strategy.

We've taken some pricing, we're focused on gaps, and we fully expect that we'll achieve the pricing that we've expected throughout the year.

So there is potential, now that we're in October?

We're not going to, typically pricing is largely taken once a year in beer.

That's the answer to your question.

Okay, fair enough and if I can ask on wine also, with the respect to the impairment charge.

We've seen some similar charges for some of your other brands particularly within the value segment so just curious to get the skew now of value versus premium, if there's a risk of more of these types of charges coming through where we're at the end of running the risk of more of these impairment charges?

It has nothing to do with value versus premium.

We don't take charges against specific brands.

It's against the acquired business in Canada, and no, we don't expect to take any further impairment charges.

As I said, it's really related to our strategy in Canada, and it's about the fact that we have focused on parts of the business which were not acquired which -- such as imports, which constitute 70% of the market and are much higher gross profit margin than our domestic business, and therefore don't really factor in as materially into the impairment charge versus some of our legacy business, which has been declining.

And we always anticipated would decline such as kits, refreshments, and some of the value part of the business, which we're strategically haven't been focused on, never been focused on, and basically since the acquisition in 2006.

As you know, we're only focused on our premium businesses in general, so it's really no surprise, and not indicative in any way of how the Canadian business is in fact performing.

It's an accounting artifice, in my opinion.

Okay, great.

Thanks.

Your next question comes from the line of Mark Swartzberg with Stifel.

Couple questions also on Crown.

One is, it seems like there's been a favorable disconnect between retail trends for your portfolio and depletion rates, and of course, we're looking at scanner data not capturing channels you're actually selling in.

So is that a fair characterization?

That's question one, and then question two, on the brands, specifically of Corona, can you remind us of how its structured in terms of seasonality?

Summer I think remains the most important period, but it's because you've had success expanding the brand in other parts of the year.

Just give us some flavor for how that seasonality looks, and what your plans are to sustain the lift in trend for that brand you saw over the Summer.

Yes, Mark.

In terms of depletions and IRI, there's really not a disconnect.

IRI only constitutes about, I don't know, a little bit less than 50% of the market.

Doesn't include the on-premise.

The on-premise has been relatively weak in general across all alcoholic beverages.

About 20% of the beer business, so that's one of the factors.

And then I would say that it's really timing.

I'd say that in general, if you really look at it channel by channel and figure out the weighting, there is not a disconnect between depletions and IRI.

Add to shipments, there is a bit of a disconnect but that's a short-term issue and strictly related to timing of shipments.

Which you basically can't look at timing of shipments on a month-by-month basis in that there can be different impacts on inventories and buy ins and things to that effect in very short periods of time, say September versus August.

So we fully expect the normal case to occur, which is that shipments and depletions will be equal for the year.

So you shouldn't count on anything weird there either.

Fair enough, and Corona?

What was your question on Corona?

Well, it's still comparatively a high volume in the Summer season but can you give us a sense of how its mapped out by the year, and what your intentions are for sustaining the improvement we saw over the Summer?

Yes, I'd say, Mark, this is Bob.

The beer business obviously is a Summer business, but Christmas period is one of the higher periods for Corona, because people tend to get better-quality products with their holiday parties, which tends to suit us.

So we've had tremendous momentum in the Summer.

I wouldn't expect that to continue balance of year, but we think that the marketing that's in the marketplace right now, especially the beer cooler promotion, has been incredibly powerful.

We plan on rerunning the Feliz Navidad commercial at Christmas, which year after year, people just really love.

And so we're expecting a pretty good balance of year, you'll be seeing, as Rob said, some Jon Gruden commercials.

We'll be advertising with the NFL and the NBA when they start out, so but I wouldn't expect the current momentum to continue, and probably slowdown a little bit.

And it's I'll say it's more off season than the Summer of course.

Our peak season starts with Cinco, right?

We start a little bit earlier than everybody else and it goes right through Labor Day and then we cool down a little bit, and then it picks up again at Christmas.

And that's very helpful.

Can you comment rate of depletion growth in the month of September, what trends you saw?

No, September, again, what we see in September, right?

Remember we had some distributor unloading at the end of the quarter in August, so they will start to replenish those inventories as they go into the Fall season.

Yes, September also had one extra selling day.

Got it.

Okay, one final question if I could.

The depletions will be looking good in September.

They will be, okay.

Due to just that fact, the 5% right there.

Sure, sure.

One final one if I could, on wine.

A nice trend we seen continuing here, the focus brands do better than the non-focus brands, but of course that gap implies your non-focus brands are declining.

You talked a little bit about that.

Can you talk a little bit more about why the non-focus brands are declining at the rate they are, and when you might actually get to a point where these non-focus brands are getting to just a scale level, where the rate of decline is more likely to moderate?

Well, I think every large wine business has focus brands and non-focus brands, as well as the spirits companies have focus brands and non-focus brands as well.

And no they aren't going to get to a level where they become so marginalized that they don't make a significant contribution to the business.

It's all about balancing, I'll say, how you're utilizing your cash flows and your profits from your non-focus brands against building the business and creating growth in your focus brand portfolio.

So just a normal business state for most of the large beverage alcohol companies, actually across all three segments, as to how we balance, how we balance that.

Crown is the unusual animal in that regard, right?

Because the Crown business is 100% focus brands.

Its only got eight brands in total, all growing, all focus brands, so that's very unusual.

I mean, compared to anybody else, it basically in the whole beverage alcohol business, the big brewers all have big portfolios, as you're well aware of, I'll call them non-focus brands or sub premiums, value-type products that they are employing the same strategy against it that I just talked about, spirits companies and for that matter the two or three other large wine companies.

Great.

Thank you.

Your next question comes from the line of Robert Ottenstein with ISI.

Nice quarter.

A couple things.

Can you give us an update on your latest thinking, in terms of, I don't know, quarter maybe, or half year, of when you'll be ready to start producing more volume at Piedras Negras?

Yes, I think what we said was it's three years out, because the brewery now has 10 million hectoliter capacity, we plan to get it up to 20 million hectoliter, but that's going to take about three years and it's all going to happen at once.

And in terms of timing, obviously no change in that right now?

No change in that, nope.

Okay, second, and I know we've talked about it a lot, and I know -- I understand the basic idea between the difference between shipments and depletions and timing differences, but this difference was a pretty big one.

And I know last year, you mentioned that 200 to 400 basis points of your shipments last year were pulled in from the third quarter as distributors did a big buy-in ahead of price increases last year.

I'm still a little bit puzzled, I mean you're doing a price increase again this year, why there would be that big a difference, and why there wouldn't be the same pull-in this year, so you wouldn't have that a difference between shipments and depletions?

Yes, this year it's a little later, that's all.

So the price increase was later?

(multiple speakers)

So you'll see it more in the third quarter.

The other thing Robert, is last year, the price increase was really the first Crown had taken in five years, so I think there was a bit of newness to it.

I think this year, people are a little bit more practiced at it.

But you'll see it all straighten itself out over the second quarter.

No, I understand that.

I'm trying to get a sense of the pattern and did you--

A little later, that is the point, and there was also some other, I'll say, fluctuations in our purchases in our shipments last year that are different than this year.

But again, it's going to straighten itself out, month to month, quarter to quarter you can't get too focused on it.

If there is something that was going to be strange from the year on a year throughout the year, I mean we would tell you, but there's nothing going on.

Okay, so the price increase this year was just maybe a couple weeks later?

Wasn't later but the buy-in was a little later.

Okay, and then in terms of, as you look at the Modelo brands, that you can now bring into the US, any new thoughts in terms of particular brands?

I think there was Leon and a couple of other ones that looked promising.

And also just wanted you to comment, the big guys there's this trend to increase ABV.

It would be my guess that you really can't change the ABV of any of your existing brands that are part of the Modelo portfolio.

Can you confirm that, and are there any opportunities for you to introduce brands with higher ABV?

First of all we can make formula changes to our brands but we have no intention at the current time of changing the ABV of any of our brands, not because we can't, but because we don't desire to.

If you see what's going on with ABV, it's largely new products that are being introduced at a higher ABV.

It's not that existing products are changing their ABV.

So we wouldn't do that, and as far as new products or line extensions that we might consider some time for the future, different style products that may or may not have a higher ABV, will certainly be on the table to look at so--

So, just so I get this right, you would be allowed to come out with a Corona XX at a 6% if you wanted to?

Absolutely.

Okay, terrific.

Thank you very much.

Your final question comes from the line of Vivien Azer with Citigroup.

I wanted to circle back, Rob, on your comment about bulk wine in the US.

Given how much more bulk wine there is this year versus last, as you think about the pricing that you've been seeing in the value wine segment, does that put that pricing at risk?

And then in turn, put more pressure on your premium business?

I don't think so.

Value-wide you're talking about two producers, right?

That produce most of the five liter bag in the box, Gallo and The Wine Group, I mean I don't think they're being highly influenced by the bulk wine market, necessarily.

It's probably fundamentally a non-strategic business for them, but I don't know.

In terms of pricing in general in the wine market, I would say that the fact that supply is not as tight as its been, it's interesting but we don't -- just like the perceived tighter supply and the higher cost of goods sold from a few harvests ago didn't make much of a difference in pricing, I don't think it's going to make much of a difference in pricing going forward in premium plus, either.

Okay, fair enough.

Thank you.

You don't see wine pricing at retail fluctuate with perceived over or under supply, pretty much period, in premium plus.

Okay, thank you.

That was our final question.

Now I'd like to turn the floor back over to Rob Sands for any closing remarks.

Well, thank you, everyone for joining our call today.

And needless to say, we are very excited about the fact that we've completed the consolidation of our new brewery in Mexico with our Crown commercial business, and I'm also very proud to have the team as an integral part of Constellation.

We have very strong momentum for our beer business as we head into the second half of the year, and our wine and spirits business is well-positioned for a great holiday selling season.

Our next quarterly call is scheduled after the New Year, so be sure to enjoy some of our excellent products during the upcoming holiday season.

So, thanks again, everyone, for your participation.

Thank you.

This concludes today's conference call.

You may now disconnect.