Constellation Brands Inc (STZ) 2015 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Constellation Brands second-quarter FY15 Earnings Conference Call.

(Operator Instructions)

Thank you.

I will now 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 conference call.

In addition to our second-quarter FY15 results and outlook, we will also discuss our glass-sourcing strategy and incremental brewery expansion.

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

This call complements our two news releases which have 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 the news release or are 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.

While those 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 releases and Constellation's SEC filings.

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

Thanks, Patty, and good morning to everyone.

Welcome to our discussion of our second-quarter financial results as well as other important key events that will shape the strategic direction of our Company going forward.

It has certainly been an exciting few months at Constellation.

Since last quarter, we announced the acquisition of the Casa Noble tequila brand, an award-winning, handcrafted super premium tequila which will be a great addition to our portfolio.

Adding Casa Noble to our portfolio is important because tequila and Mexican beer share similar target consumers and drink occasions, both on- and off-premise.

This fast-growing tequila brand naturally complements our Mexican beer brands and fits well into our existing wine and spirits distribution infrastructure.

Now during the quarter, we were challenged by a Corona extra product recall which was caused by defects in glass bottles caused by a production error at a glass plant run by one of our glass suppliers.

I am very proud of the dedication and hard work of our employees, distributors, and retailers who have worked tirelessly and diligently to remove potentially affected product from our retail and distribution system.

While the recall impacted our financial results slightly for the quarter, we expect to replenish second-quarter lost sales in the third quarter, and we are currently working with our glass supplier to recover the cost of the recall.

We announced this morning that we have begun a new 5 million hectoliter expansion at our Nava brewery in Mexico that will extend production capacity of that facility to 25 million hectoliters by the end of calendar-year 2017.

This project is being driven by the exceptional portfolio momentum of our beer business which has significantly outperformed the US beer market and our own expectations.

Lastly, we are pleased to announce that we are in the process of finalizing the long-term glass strategy for our beer business under favorable terms with key industry players.

The multifaceted approach of this strategy includes the following components.

We have agreed to purchase from ABI their state-of-the-art glass plant in Nava, Mexico which is located adjacent to our brewery in that location.

While this facility currently has one operational furnace, we plan to initially scale it to four furnaces which will ultimately be able to supply us with more than 50% of our glass requirements.

This transaction also includes the purchase of a high density warehouse, land and rail infrastructure and is subject to US Department of Justice and Mexican regulatory approvals, both of which we expect to receive by the end of this calendar year.

We have also agreed to enter into a 50-50 joint venture with Owens-Illinois to own and operate the glass plant that we are purchasing from ABI.

As the world's leading glass producer, OI has more than 100 years of experience in producing glass containers.

They have built and expanded dozens of plants and participate in joint ventures in several different countries throughout the world.

We also currently use OI as a glass supplier for our wine business.

OI will primarily have responsibility for plant operations including purchasing, technical services, and the plant expansion.

OI is also expected to become a secondary glass supplier outside of the joint venture arrangement.

And, the final piece of our strategy, we have entered into a long-term seven-year supply agreement with [Vitra], who is a well-established leader in glass manufacturing in Mexico.

And, we will expect will ultimately supply 25% to 30% of the glass needs for our beer business.

Overall, this sourcing strategy provides the best outcome in terms of quality, flexibility, cost effectiveness, and control for this critical area of our beer production.

Now because it will take some time for the glass plant to become fully operational at optimal capacity, we will continue to work with ABI to purchase glass supply needed for production at the Nava brewery under our existing transition services agreement through mid-calendar year 2015.

In addition, we plan to continue to procure finished product from ABI under our interim supply agreement until the initial Nava expansion to 20-million hectoliters is complete in calendar 2016.

Overall, our additional investments in production capacity and glass sourcing are designed to ensure that we are well-positioned to capture the continued momentum and growth opportunities we see in the marketplace for our beer portfolio well into the future.

Our second-quarter beer results are a testament to this portfolio momentum as we achieved depletion growth of 8% and posted the 18th consecutive quarter of market share gains for our US beer business.

This level of growth for Constellation's beer business represents the most significant contribution to total US beer dollar growth in IRI channels across all suppliers during our second quarter.

These results were driven by Corona extra's momentum from increased media support during the summer as well as the success of our fill your summer advertising campaign that was our first-ever multicultural, bilingual summer program.

In IRI measured channels, Corona extra continues to gain share and is currently the number five beer brand in the US market.

In addition, Corona extra and Modelo Especial teamed up this year to share a broadcast sponsorship of World Cup games on Spanish-language TV.

Modelo Especial's Hispanic real world campaign helped to propel the continued growth of this brand which posted consumer retail dollars takeaway trends in IRI channels of more than 30% during the quarter.

In addition, Modelo Especial's summer soccer sweepstakes promotion surpassed all sales and consumer engagement targets set for this initiative.

Modelo Especial Chelada has already become the number seven Mexican import brand in less than a year since launch.

The growth of this product is being driven by Spanish language TV ads on national Spanish networks.

Consumer sampling at retail, PR events in key markets, social media engagements, and C-store print trade ads.

Lastly, the draft beer format continues to have significant momentum achieving sales growth of more than 40% during the quarter driven by the continued market expansion of Corona light.

The five core brands within the Constellation beer portfolio all experienced growth in the quarter and are ranked in the top 15 US imported beer brands.

From a brewery and operational perspective, all areas of brewery expansion are well underway and proceeding on schedule from both a timing and budget perspective.

Key performance metrics are being achieved with no disruption to existing brewery operations.

In many areas, crews are working around the clock.

In fact, the brewery recently achieved record capacity utilization with a record number of cases produced and shipped in August.

Brewery tank fabrication and installation are being completed on schedule and the packaging building is tracking to plan with steel erection in process.

A new line was recently installed, which is one of the largest in the world, and the first beer run from this line is expected to come in coming weeks.

From a wine and spirits perspective, the business performed well during the second quarter with depletions improving sequentially as expected.

The depletion growth in the quarter was driven by excellent performance by a number of our fast-growing brands including Mark West, Kim Crawford, Svedka vodka, Ruffino, black box, and the dreaming tree.

Our expectation is that you should continue to see improving depletion trends as we progress throughout the year similar to last year.

As we head into our key holiday selling season in the second half of the year, we, we will be executing programming to ensure that we drive growth for our key brands that are mix- and margin-accretive, have scale, and the greatest growth potential.

We are well-positioned to achieve this goal with initiatives that include the launch of our first-ever holiday TV advertising for Woodbridge by Robert Mondavi.

After the success of last year's combined Corona-Woodbridge-butterball Turkey promotion, we will once again repeat this program in advance of the Thanksgiving holiday.

We have committed to incremental feature and display activity on several margin-accretive brands including Clos du Bois, Robert Mondavi private selection, and Rosatello.

And, we have dedicated more sales focus on the route to market for our spirits business now that we have Casa Noble tequila as part of the portfolio.

During the second quarter, we received several awards for some of our key brands.

Some of the most noteworthy accolades include the leader's choice award, which recently saluted the industry's hottest new products in wine and spirits by awarding the best new wine product to honor our thorny rose brand.

Wines across the Constellation portfolio earned a total of 47 medals at the 2014 San Francisco International Wine competition including a AA Gold and 98-point score for the 2011 Clos du Bois [milestone].

In addition, gold medals were awarded for the 2013 Woodbridge Chardonnay, 2012 Ruffino Chianti, 2012 Robert Mondavi private selection Cabernet Sauvignon, and the 2012 Robert Mondavi coastal crush.

We are also proud to receive a 90-point score for both the Wine spectator and wine and spirits for some of our well-known wines including Robert Mondavi 2012 Oakville Fume Blanc and the 2010 Mount Veeder reserve and the Franciscan estate magnificat.

Now from a spirits perspective, we experienced strong sales growth in our spirits business during the second quarter driven by the recent launch of new flavor line extensions across our portfolio including Svedka mango pineapple and strawberry lemonade as well as the Paul Masson grand Amber Brandy peach flavor.

As is typical at this point in the year, I would like to provide an update related to the California grape harvest, which is currently underway, running nearly a month ahead of last year with more than 70% complete at this time.

The current California industry estimate is for a total harvest yield of 3.8 million to 4 million tons versus approximately 4.4 million tons last year.

The quality of this year's harvest looks to be very good if not excellent.

From a pricing perspective, we continue to expect grape pricing to be flat to down slightly compared to last year depending on the variety, location, and demand.

Before I close, I would like to take a minute to discuss our assessment of the impact of the recent California earthquake that occurred near Napa.

We have assessed the extent of the earthquake's impact on our operations, and we are very fortunate that the impact is minor.

Most importantly, we are relieved that our employees and their families are safe as the earthquake occurred overnight when our facilities were closed.

While there was minor damage inside of some of our northern California wineries, none of them have sustained structural damage, and our vineyards have not been impacted.

In closing, we are excited about the favorable outcome of our glass-sourcing strategy, and we look forward to working with our excellent supply partners as they support our efforts to build upon our leading imported beer position in the US.

We are working diligently on the Nava brewery expansion in Mexico while maintaining the strong momentum of the beer commercial business.

And, within our wine and spirits business, we are well-positioned to drive our great portfolio of brands during the upcoming holiday season.

I now would like to turn the call over to Bob for a financial discussion of our second-quarter business results.

Thanks, Rob.

Good morning, everyone.

We have a lot of significant good news to talk about today both for the quarter and the longer term.

First off, we continue to deliver beer sales that greatly outpace the industry.

And, despite the glass recall, we are affirming full-year beer guidance.

In addition, we are providing medium-term volume guidance that also outpaces our estimate of the total beer industry growth.

We believe we have good portfolio and demographic evidence to support our projections.

We've also completed a comprehensive year-long glass sourcing strategy product.

The outcome of these efforts are expected to provide Constellation a continual and diversified source of beer glass supply from leading industry providers at a cost lower than that we currently pay today.

We're also increasing our medium-term operating target for beer which indicates considerable margin upside from our FY15 year-to-date run rate of 32%.

As a result of these factors, we foresee a continuation of a fast-growing top line and an increase to our already healthy beer profit margin.

Finally, we will discuss increased capital spending in brewery and glass capacity to support the robust growth we are targeting.

This represents investments with very high returns as the beer segment enjoys strong and growing margins and quite a high operating ROIC.

I'll provide more details on the longer-term items just highlighted, but now let's start looking at our second-quarter results where my comments will generally focus on comparable basis financial results.

Our comparable basis diluted EPS for Q2 came in at $1.11, a 16% increase versus Q2 last year.

We continued to see robust marketplace momentum for our beer business with depletion growth of 8%.

Depletions were essentially not impacted by the recall as wholesalers worked to replenish supply at retailers before the end of Q2 from their existing inventory levels.

However, the recall impacted our sales as we reversed shipments to wholesalers for approximately 2 million cases of Corona Extra.

This translated into a reduction of approximately $37 million of net sales and $0.06 of diluted EPS for the quarter.

This reduction is reflected in the $1.11 Q2 EPS.

We expect to replenish this volume with shipments to wholesalers primarily during the third quarter as we work to bring wholesaler inventories back to more normal levels.

Wine and spirits results for Q2 benefited from higher volume and lower promotional expense during the quarter.

Both businesses remain on track to reach their full-year profit goals, and we are affirming our FY15 comparable basis EPS outlook of $4.10 to $4.25 a share.

Given those brief highlights, let's look at Q2 performance in more detail.

As you can see from our earnings news release, consolidated net sales grew 10%.

This result included $73 million of incremental beer net sales as we consolidated an additional week of sales in Q2 FY15 versus Q2 FY14 as a result of the timing of the beer business acquisition.

Excluding the benefit of these acquired sales, consolidated organic net sales growth for the quarter was 5%.

For the full quarter of Q2 FY15 versus the full quarter of Q2 FY14, beer segment organic net sales increased 9%.

This was primarily from volume growth driven by strong consumer demand.

This result includes the impact of the recall that I just outlined.

Wine and spirits net sales on a constant currency basis increased 3%.

This primarily reflected volume growth of 1% and lower promotional expense.

For the quarter, consolidated gross profit increased $109 million, and our consolidated gross margin was 43% versus 40% from the prior-year second quarter.

The increase in gross profit primarily reflects $33 million of incremental benefit from consolidating the beer business for one additional week in Q2 of FY15 as well as the growth of the base beer business and lower promotional expense and favorable mix for wine and spirits.

The increase in consolidated gross margin primarily reflects higher brewery profits, beer volume, and pricing benefits and the wine and spirit gross profit factors that I just mentioned.

SG&A for the quarter increased $48 million.

The incremental SG&A associated with consolidating the beer business was $12 million.

The remainder of the increase was primarily due to higher marketing and SG&A for the beer business.

Due to the factors just mentioned, Q2 consolidated operating income increased $62 million, and consolidated operating margin improved 160 basis points.

Interest expense for the quarter was $85 million down 6% versus Q2 last year.

The decrease was primarily due to lower average interest rates.

That provides a good spot to discuss our debt position.

At the end of August, our total debt was $7.2 billion.

When factoring in cash on hand, our net debt totaled $7.1 billion an increase of $131 million since the end of FY14.

The increase primarily reflects the funding of the $558 million post-closing purchase price adjustment payment made during the quarter for the beer transaction offset by our free cash flow generation.

We have $500 million of 8 3/8% notes coming due in December.

We're evaluating funding alternatives for the repayment of this debt including utilizing existing credit facilities and tapping into the senior note market.

Our comparable basis effective tax rate came in at 32% and compares to a 29% rate for Q2 FY14.

The Q2 FY14 rate included the favorable outcome of various tax items.

We continue to expect our full-year FY15 comparable basis tax rate to approximate 30%.

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

For the first half of FY15, we generated $360 million of free cash flow compared to $440 million for the same period last year.

Operating cash flow for the first half of the year totaled $668 million versus $489 million for the prior-year period.

This increase was primarily due to the incremental cash generated by the consolidated beer business.

CapEx for the first half of FY15 totaled $308 million compared to $49 million last year.

CapEx for the beer segment totaled $229 million as activities for the initial 10-million hectoliter brewery expansion continue to progress.

For FY15, we are updating our free cash flow projection, and now expect free cash flow to be in the range of $275 million to $350 million versus the previous range of $425 million to $500 million.

The change was primarily driven by additional CapEx requirements for the incremental 5-million hectoliter brewery expansion and glass-sourcing initiatives that Rob mentioned earlier.

Total CapEx is now projected to be in the range of $725 million to $775 million versus our previous $575 million to $625 million.

Our new CapEx projection includes $600 million to $650 million for the beer segment.

We view this as very positive news as we have the opportunity to invest in a growing, high-margin, high-ROIC business.

We are still targeting operating cash flow to reach at least $1 billion for FY15, and we expect to continue deleveraging.

Now, let's move to our full-year FY15 P&L outlook.

We continue to forecast comparable basis diluted EPS to be in the range of $4.10 to $4.25 a share.

For FY15, we continue to target net sales growth for the beer segment to approximate 10% with high single-digit shipment and depletion volume growth and operating income growth in the range of 25% to 30%.

When factoring in estimated full year of brewery for FY14, underlying operating income growth for the beer segment is still expected to be in the mid-teens.

For wine and spirits, we continue to target net sales and EBIT growth for FY15 to be in the low- to mid-single digit range.

Our comparable basis guidance excludes unusual items which are detailed on the last page of the press release.

Now, I'd like to provide some financial highlights related to our strategies around glass sourcing and beer production capacity that Rob outlined.

Our beer business has great momentum in the marketplace growing ahead of our expectations since the acquisition and well ahead of the total beer category.

We believe we are positioned to continue outpacing the beer category behind positive demographic and portfolio factors.

Some of which include -- consumers trading up to high-end beer.

Growth and increasing influence of the Hispanic consumer who have a high propensity for our brands.

Great alignment with our gold distributor network.

Distribution gains for all brands, draft and can format expansion, and packaging and product innovation.

As a result of these factors, we are targeting annual volume growth to be in the mid-single-digit range over FY16 to FY18 time frame, a sales trend that we believe would outpace growth projections of the total US beer industry.

To ensure we are best positioned to capture this growth opportunity, we have begun a new 5-million hectoliter expansion at our Nava brewery which will take it to 25-million hectoliters of production capacity.

The estimated cost for this investment is $450 million to $550 million and is expected to be completed by the end of calendar 2017.

When you combine this with our initial 10-million hectoliter expansion, our total brewery capacity investment is estimated to be $1.45 billion to $1.65 billion.

As part of our beer glass sourcing strategy, we have reached an agreement with ABI to acquire their glass plant, warehouse and rail infrastructure, and land that is adjacent to our Nava brewery for an acquisition purchase price of about $300 million.

We've also agreed to form a 50-50 joint venture with Owens-Illinois to own and operate this glass plant.

OI will contribute approximately $100 million for its 50% share of the joint venture.

The joint venture will not include the acquired warehouse, rail infrastructure, or land.

The JV will provide bottles exclusively for the Nava brewery.

The glass JV partners plan to expand the capacity of the plant from one furnace to four furnaces over the next four years at a cost of approximately $300 million to $400 million.

The expansion cost will be shared equally between Constellation and Owens-Illinois.

Since we expect to consolidate the JV results, the full expansion costs would be included in our CapEx line in our statement of cash flows with OI's contribution being displayed as a separate benefit in the financing Section of our cash flow statement.

Constellation also expects to spend approximately $175 million to $225 million outside of the JV to enhance the site infrastructure for the rail and warehouse at the newly acquired site.

For the beer business projects just highlighted, we have summarized the associated CapEx estimates and time frames in a table that was included in our glass-sourcing and capacity expansion press release issued earlier today.

Given the collective activities just outlined, we are targeting our beer segment operating margin to be in the mid-30% range in FY18 which we believe is best in class among North American competitors.

With the incremental CapEx investment, our goal of exceeding free cash flow generation of $1 billion is now targeted to move out to FY18.

Even with the higher CapEx requirements, we still expect to delever at a good pace and reach our goal of debt to comparable basis EBITDA ratio below 4 times in FY16 as operating cash flow and EBITDA growth of the business allow us to delever despite the increased capital spend.

Operating within our three to four times target leverage range provides us the financial flexibility to assess the initiation of a dividend and/or additional stock buybacks.

Once we move past the heavy FY16 and FY17 peak CapEx spend years, free cash flow should grow dramatically, which will provide us even more financial flexibility, while we stay within our targeted leverage ratio range.

In summary, we're very pleased with how FY15 is progressing.

The wine segment is expected to grow EBIT in line with sales and see strong execution in the marketplace during the key holiday season.

Our beer business has tremendous momentum in the marketplace and continues to gain market share.

It has a very strong financial profile and is among the industry leaders from a sales growth and profit margin perspective.

Our high return investments in beer production capacity position us to support the momentum and significant growth opportunity we see for the beer business.

With that, we'll open up the line for questions.

(Operator Instructions)

Bryan Spillane, Bank of America Merrill Lynch.

We feel that a few questions this morning -- just trying to reconcile the margin expectations in beer relative to some of the new news we had today.

And, I guess maybe if you can walk through some of the puts and takes.

Because right now, it looks like if you look back at the last four quarters or so, the operating profit margins in beer are in the low 30%.

And, I guess what we're expecting to see over the next three years is more capacity, more production in-house, which should be accretive to margins.

Sounds like glass costs would be lower which would be accretive to margins.

There's been some pricing.

There's been some pricing in this model over the last year or so, and I would assume that there should be some pricing as we look forward.

So, I'm just trying to understand why it wouldn't be better if there's some other cost that you're expecting to incur, whether it's increased marketing or something else that might dampen the margin expectation?

Yes.

So, year-to-date, we're at a 32% operating profit margin which is increased from last year.

And, what we're saying is we're going to go to the mid-single digits as we build out the brewery and glass plant, right?

So, depending where you pick in the mid-single digits, that's pretty good margin expansion.

The other thing to factor in is, we think mid-single digits is pretty much the highest operating profit margin of beer companies in North America.

Right?

The mid-30%?

So, in our models, we have factored in all that's going on with glass.

We put assumption in there of what we think is going to go on with pricing based on history.

And, we have in there what we think is going to go on with commodity inflation in the beer segment.

Right?

So, for me personally, right?

I'm thrilled with the mid-30% profit margin.

I'm not sure why people are disappointed.

There's nobody with a higher-margin than that in North America.

I guess -- I hear you.

I think it's just of knowing what we know now, and there seemingly to be more of a list of tailwind versus headwinds.

I think that's the component that people are stuck on today.

Just if there's two things you can clarify, when we're talking about mid-30%, is that 34% to 36%?

And then, I guess the second piece -- if there's going to be some JV income associated with glass, should that be -- is that Incorporated in that mid-30% margin target?

Or, would that be on top of?

Yes.

So, mid-30%, I guess most math people would say that's 34% to 36%.

I think that's a reasonable comment.

The other thing, just to factor this in, Brian, and you would have done that, right?

This increased capital spend does increase depreciation expense, right?

Now, our brewery assets, our long-lived assets, the majority is probably 15 years to 20 years, but there's a lot of capital going in which is going to start depreciating which does cause some reported headwinds on margins.

Right?

And, what was the last piece?

JV income?

Good question.

And again, you understand this.

We will be consolidating the JV because under GAAP, based on the contract with us and Owens-Illinois, we are considered to control the JV.

Right?

So, what will happen there is as consolidation, we will just -- our Cost of Goods Sold will be lower.

We'll essentially be recording the cost of the bottles.

Right?

Which helps margins.

Okay?

We will also consolidate the balance sheet.

Right?

So, you'll see all that capital spending coming on our balance sheet.

And, the Owens-Illinois contribution will come in down -- I think it's going to be a separate line of net income.

And, the cash contribution will be in the financing Section of the cash flow statement.

So, that would be outside -- that makes its outside of the operating profit and the margins?

(multiple speakers)

That's correct.

Well, JV, yes, because we'll be consolidating.

So, the JV will not exist in our financial statements.

Right?

The JV is going to be a private Company.

How that will work.

Okay.

Great.

Thank you.

Judy Hong, Goldman Sachs.

I guess I wanted to just follow-up on the EBIT margin on beer.

And, I agree that the mid-30% is obviously a very good margin for this business.

I guess I would just challenge you though in just terms of thinking about compared to the other beer companies, you do have higher price points which obviously raises your gross margin versus some of the peers.

So, I'm just trying to really understand how this margin outlook is being impacted by the cost savings that you're generating really on the packaging cost?

In particular as you think about what you're paying for glass today, and then with all these different relationships that you're building?

And then, the JV that you're owning in-house, it seems like your packaging costs could be a lot higher?

So, maybe just starting off just a little bit more color on that particular topic?

Yes.

And, it's a little bit difficult, right?

Because a lot of data is not out there, but we have a very different business model from the North American -- most of the North American competitors, right?

We're making all our product in one site, which is quite a distance from a lot of our consumers.

Take the New York City consumers.

So, we have a reasonable amount more freight versus -- and freight, as you know, Judy, freight is a very big component of costs in beer.

So, we have a lot more freight costs.

We probably also have higher cost of goods sold.

Right?

Thicker bottles, higher-quality ingredients.

All that kind of stuff.

So, it's difficult to compare them apples-to-apples.

But, as I look at our beer model, right?

We've got the growth that the craft Brewers have coupled with the margins that the large domestic guys have.

So, we're almost the best of both worlds from a beer perspective.

And, if you look at some of the data that's out there, right?

Generally speaking, you could say we're probably paying around -- I don't know -- $0.16 a bottle right now.

That data is out there from InBev, and we've said that that will come down.

We're not really saying how much that will come down because we think that's competitive data, but we went through a full year of negotiations with all the big glass players in the world.

And, we're pretty happy where we end up there, both from a cost and a quality perspective.

Okay.

And, just to clarify, the $0.16 includes the freight costs that you're paying to get the bottles delivered to your production facility?

That's correct.

But remember, the glass we'll be getting going forward is going to be coming from a number of different sources which will all have different -- I'll say, manufacturing costs and different freight costs depending where it's coming from.

Right.

Okay.

And then, maybe just in terms of the Corona Extra trend, and I think the depletion certainly in the quarter doesn't appear to have been impacted by the recall.

The more recent Nielsen or IRI data has shown a bit of softer trends for Corona Extra, and some of this may just be a comparison issue.

But, really wanted to understand from your perspective, how do you assess the recall impact, if any, is having on the underlying trend of Corona Extra as you see it today?

So, Judy -- so right now, as you said, we look at IRI.

It's still pretty early in the game to say what's happened to Corona Extra, but I don't get overly alarmed over weekly IRI data because there's a lot of anomalies in just a week.

But, you can see the Corona Extra has slowed down a little bit.

But remember, there were actually some retailers -- not a ton -- where we were physically out of stock during the recall process.

We were off the shelf for a period of time so we would expect that to come across in IRI.

So, luckily, we're very happy with our overall depletion trends, right?

And, hopefully, if Corona the consumer wasn't grabbing a Corona, he would grab a Modelo Especial or a Pacifico.

And, I guess in future months, we'll see how the Corona Extra brand bounces back after this recall.

But, we couldn't ask for better cooperation from both our internal employees and from the distributors and from retailers.

It was just a really well done and unfortunate circumstance, but we think we minimized the damage.

Judy, I might add that we've been tracking the weekly IRIs pretty carefully.

We saw a little blip two weeks ago, but we also noticed a number of other products that were affected.

So, it looks like it might have been just a peculiarity with the week, and then the latest data was very robust and appears that the brand was completely unaffected.

So, as Bob said, we're pretty hopeful that, in general, the recall is not going to have any impact on the momentum on the brand.

And, clearly, the momentum on our other brands has been totally unaffected by the Corona recall.

The business in general remains very strong from a consumer takeaway point of view.

Got it.

Thank you.

Nik Modi, RBC Capital Markets.

Couple questions.

Just getting back to the beer market because I know, obviously, that's the most frequently asked question coming in from investors.

So, is it fair to assume that the target you have laid out, the mid-30%, 34% to 36%, is pegged to your mid-single-digit volume assumption?

And, the reason why I'm asking the question is, let's say that things are even better than you thought, which clearly has been the case the last couple of years.

Things have been coming in better than you expected, and volumes are actually higher.

I'm wondering how you think that will impact the margin given now you are a manufacturer, and you should get some operating leverage.

So, if you can address that question would be really helpful.

And the second question, more of a tactical thing.

Just curious how the repositioning of Victoria is doing.

If you can give us any more clarity around Modelo Chelada.

It looks like the SKU and the brand is really starting to gain some momentum so just trying to get an understanding of how big of a contributor that can be going forward?

Okay, Nik.

I'll take the first one, and Rob will take the commercial question.

So, when we give these guidance out, we try to tie in the whole P&L.

So, in your case, if we exceed the volumes that we put out there, obviously we would get good fixed cost leverage, especially on that big depreciation number.

So, that would certainly help margins.

Right?

I'll let Rob answer the Victorian.

Victoria -- we did reposition Victoria originally when we introduced it.

We introduced it above Corona Extra in pricing, and we brought the pricing on that down to the Corona level.

And, we've expanded distribution nationally, and I would say that there's a lot of momentum behind the brand right now.

Actually, I'd say that we're pretty excited about the prospects for Victoria for the future.

And, with the repositioning, we're seeing a lot of very, very positive momentum in that.

Chelada, great product.

Tastes great.

We really think that from a competitive point of view, it's the best product out there.

Again, a lot of momentum.

We're a bit constrained on the package at the moment until we get our can line up and running shortly.

And, that's really been the only limiting factor on the brand.

Otherwise, we could actually sell a lot more of it than in fact we have been selling, and we will as soon as that can line is up and running.

Which is, it's actually up and running right this second, but in terms of being fully operational, it's a few weeks away.

So, we're extremely optimistic in Chelada and think that that's going to be a very successful new product introduction for us.

Great.

One last question.

Thanks for that, Rob.

Bob, on the Nava brewery, if we look at it year-over-year, is the brewery running more efficiently?

Same as last year?

Less efficient?

Can you give us some perspective on how things have progressed over the last year within the brewery?

Yes.

It's operating more efficiently.

Right?

We're getting -- and we're defining that.

We're actually getting more hectoliters of beer out of it at a lower cost per hectoliter.

And actually, it's almost like every quarter, it gets a little bit better.

Great.

That's it for me.

Thanks.

Caroline Levy, CLSA.

Just a question on your assumptions on price and mix for -- you gave us a good idea on volumes for beer going forward.

How you're thinking about the mix component?

And also, whether you think there's room to get some pricing?

You're talking beer, I take it?

In this case, beer, yes.

I don't think we assumed any dramatic increase in mix.

But, as you said, the thing supporting the volume growth called for a lot of growth in cans and kegs.

So, they would have a mix impact.

On pricing, we would have assumed probably historical pricing going forward.

But, as you know, you pricing gets determined based on the local geographies and all the competitive dynamics.

But, for an Excel model, you have to assume something so we would have just assumed probably close to continuation of historical trends.

Right.

So, you're saying mix will go slightly negative as you roll out cans and kegs?

No.

Cans would be positive mix.

Kegs, kind of neutral.

Cans would be positive --

Positive mix because aluminum is cheaper than glass.

And, cans cube out better with freight.

You can fit more on a freight car than bottles because you don't have to insulate them, and they're just better physics.

Right.

Bit of margin mix, but on revenue?

On price mix?

Cans -- we are line-priced on cans except for Modelo Especial cans which are at a slightly lower price.

But, Modelo Especial specifically right now, bottles are growing faster than cans.

Probably the big can upside is on Corona Extra where we expect to have the same price as bottles.

(inaudible)

Got it.

How is your can capacity doing for the Corona Extra product?

It will be doing well very shortly.

As soon as that new can line is fully operational which as I said is shortly.

So, you'll run -- ?

It's actually up and running right now, but in test mode.

But, you'll run all cans on that line then, and you'll be able to therefore drive this much faster on Corona Extra as well as on Chelada?

Yes.

What you'll be seeing, and we're actually coming out with a really gorgeous Victoria can as well.

But, our can capacity will be going up, and we'll be able to support all this can growth.

Also, on Corona Extra specifically, we've actually already have a media campaign specifically, I'll say, describing the activities you would do with the can that you wouldn't do with the bottle.

Same great Corona liquid, right?

But, you can do certain things with cans that you can't with bottles and shots of the beach, the boats, sporting events, things like that.

Just to get people's heads around -- hey, Corona is great.

Let me try a can.

Right now, Corona Extra, probably less than 2% of the mix is cans.

So, we think that's a pretty big opportunity to drive growth.

And, if you look at the industry in general, what you'll see is cans is really where the vast majority of the growth is in the industry.

Even if you look at the domestics, which as you know, are volumetrically, in general, down.

Cans are actually growing and are being more than offset by glass.

In craft, cans are the latest craze.

As Bob said in our case, we see a huge opportunity in cans because it's such a low percentage of our business.

And, there's so much momentum from an industry perspective against cans, period.

So, we're pretty excited about the can potential of our business.

That's great.

And then, if I might ask -- it's back to margins.

The components of what you think will drive the margins to the mid-30% and how much of that is this glass transaction?

Glass is certainly factored in there.

And, essentially what will happen as the additional glass JV furnaces come up, we will be able to reduce the glass that we're buying from other furnaces.

The upside -- the guaranteed upside will be there is freight because the glass JV is attached to the brewery.

So, there is no freight cost.

As those furnaces come up, our landed glass costs comes down.

So, glass is a pretty good component of our margin expansion from the 32% that we have year-to-date to the mid-30% we said we'll have in the very near future.

Thank you so much.

Alice Longley, Buckingham Research.

I have a couple questions.

One is a follow-up to that.

I think that you gave us originally a target of getting to the mid-30% margin without glass.

So, I'd like to -- what other things are going right between now and then besides glass to get the margin?

The guidance we gave without glass was low to mid-30%.

Okay.

So, you can go back to the investor meeting to a lot of stuff.

That was the guidance that we provided.

Now, with glass and with new news, whatever positives and negatives, were increasing that to mid-30%.

Which again is depending where you pick, in the 34% to 36%, is a pretty big increase in margins and the highest anybody has in North America.

Maybe I shouldn't be belaboring this, but you had said low to mid-30% without glass so there was something that made you think you could get to the mid-30% without glass, and it looks like maybe that contribution has gone away?

Could you comment on that?

Yes.

I could.

But I do think we're past the belabored part here with this question.

Right?

All right.

We give ranges because this is a business with many moving parts.

Okay?

And, especially this business as you know, Alice, has many moving parts because we're growing so fast.

Most of the moving parts are really good as are our margin assumptions, I think, to have the volume growth amongst the top of the industry and to be saying that we're getting to the margins in the top of the industry.

I think -- I'm looking at this as very good news.

And then, the ability, right, to reinvest the enormous free cash flow that this business spins off into a very high return on invested capital business, right?

It really helps the shareholder value creation that I think Constellation is driving out of this beer segment.

Okay.

My next question is on your cash flow for next year, for FY16?

You've said that with all the incremental CapEx and your acquisition costs you still think you'll be generating cash to reduce debt?

You must have a pretty good sense of what CapEx will be in FY16 in order to say that?

With all the bits and pieces you've given us, it looks like CapEx might be around $1 billion in FY16, and then you've got $300 million for the acquisition.

And, I'm having trouble getting cash left over after that.

Are those assumptions for CapEx too high?

No.

I think what I would do is we've given you the bigger pieces of capital spending.

Albeit we haven't said what specifically in FY16 because that would be part of the guidance we provide in April, right?

But, we have said it's kind of front-end loaded right now.

What we provided in that table in the glass press release is not holistically comprehensive.

It excludes wine.

It excludes maintenance CapEx.

It excludes buying kegs.

It's specifically for these projects.

Now, my comment on deleveraging, because of all the capital spend, free cash flow probably won't be an enormous number next year.

Operating cash flow could be a very good number.

But, what the leverage ratio of course is happening is the EBITDA portion, the numerator of that calculation based on the volume growth in the margin expansion is probably going up quite a bit which helps the EBITDA leverage ratio come down.

So, it's not necessarily the free cash flow.

It's more the EBITDA generation.

Well, that's helpful.

Will there be cash left over after the acquisition cost to reduce debt?

We're not providing that kind of specific guidance and yet for next year because we haven't finished this year yet.

So, that will be, Alice -- that will be like an April discussion most likely.

Okay.

But, a lot of the improvement in the ratio is the EBITDA going up?

I hear that.

And then, I have one final question.

If I adjust your beer margins in the quarter you just reported for the recall, it looks like they were 31%.

They were a lot higher in the first quarter.

Could you comment on why they came down?

And, should we be using the 31% for the second half?

Is there some reason to expect an improvement in the second half versus that 31%?

I think we've given guidance for the full year that expect beer operating profit margins to be around 32%.

This quarter, there was a pretty big increase in marketing spend in beer specifically as we really tried to hit home in the peak summer season with a lot of media flights.

So, that would have been a timing component, but I think year-to-date we're at about 32%, and we've said full-year we'll be at about 32%.

Thank you very much.

It's marketing.

Thank you.

Mark Swartzberg, Stifel Nicolaus.

Also, on this topic of margin, Bob.

Question about the glass component of it.

Is it reasonable to think that the fact that this OI arrangement is with facility that's state-of-the-art and right next door to where you're brewing is better economically than the Vitro arrangement?

Well, I think that probably would make sense given the fact, as you said, it's a brand-new facility, right?

And, of course, freight will be less.

Right.

Okay.

And then, on the Vitro component, because there wasn't quite the level of detail back in August that we can get into today.

Did that agreement -- the new Vitro agreement you have, is that going to does that -- the cost that you're paying there for those bottles?

Does that include transportation cost?

We haven't commented on that.

That's competitive information.

Okay.

All right.

That was Vitro's release.

That wasn't our release.

Right.

Okay.

Fair enough.

And then, just more on the accounting for this JV, clear that it's going to be consolidated.

Can you help us -- it sounds like it affects only your COGS line.

Does it have any effect on other consolidated lines, and then there's just a minority interest coming out below the EBIT line?

Is that how the accounting will be?

I think that's right.

It's just the COGS line.

Got it.

And then, the minority interest -- that's correct.

It will come out as a component of net income and then cash.

And then, of course, the balance sheet is consolidated.

So, all the capital spending will end up there.

And, the cash coming in from Owens-Illinois, and they will be funding 50% of all capital investments at the glass JV.

But, that's going to come through the financing line.

Got it.

Okay.

Great.

Thanks, Bob.

Bill Chappell, SunTrust.

A few quick ones.

On the new expansion at Nava, does that come in place of a potential West Coast facility down the road?

Just -- you went through the math, and it made more sense from a freight and efficiency standpoint to do it all at Nava?

I think a couple things.

I think it was probably the fastest thing to do because the facility is up and growing, and we want to make sure that we can support the high-growing, high-margin beer business.

So, I think as we weigh the alternatives, we felt that both cost and speed and confidence around execution was highest for Nava to bring that up to 25 million hectoliters.

Got it.

Believe it or not, I have a wine question.

(laughter)

Thanks, Bill.

Just on in terms of the lower promotions this quarter, is that just more timing?

You're weighting it more?

Is that what you had planned all along?

Maybe some color there?

Yes.

The timing of our promotional activities is more geared towards the second half of the year.

Obviously to coincide with the OND period -- the holiday period.

Okay.

So, just on a year-over-year basis, it has been shifted a little bit?

Yes.

Okay.

And then, last one on taxes.

To get to your full-year rate of 30% equates to 28% for the back half, is that equal in both quarters?

Or, would there be one catch-up one quarter?

Yes.

The timing of taxes is hard to predict.

So, we're just saying for the full year, it would be 30%.

We're not saying which quarter it will hit -- what quarter will be what.

But, the balance of year will have to be a lower rate than the year-to-date.

Got it.

Thanks so much.

Robert Ottenstein, ISI Group.

Given the increased amount of CapEx, and in a sense, business outside of the US, how should we think about any impact on the cash tax rate going forward?

The long-term numbers?

And, the effective tax rate?

Maybe you can give us an update in terms of the long-term guidance on those two items?

Yes.

As we generate a lot of income from, as you said, outside the US, that will carry a lower cash tax rate.

As far as effective tax rate, it should also have a lower effective tax rate when everybody gets aligned that we stop accruing US taxes on the foreign earnings.

We are still accruing US taxes on the foreign earnings, and there's just a lot of discussions going on as to when or if we will stop accruing those taxes.

That's from an ETR not a cash tax rate.

Right.

Just in terms of the guidance that you gave us for cash for FY18, what cash tax rate would you be using for that?

I think we're assuming like mid-20%.

Mid-20%.

And, there would be potential for that to go down in the following years?

Well, no.

Cash is cash, right?

The thing that could go down if we stop accruing the APB 23 US accruals, the ETR could go down.

The cash tax -- of course if we grow the beer business faster than we say, that will have a lower cash tax rate.

It's kind of a mix of tax rates depending where your EBIT growth is coming from.

Great.

I know you've got significant initiative on the canned side.

Can you give us any rough idea, as you think about it, between the relative margins for glass and cans for your business?

Yes.

Cans are higher margin.

Right?

Than bottles.

It's not tremendously material nor is it immaterial.

So, it's a difference that we like.

If you line-price with bottles.

So, like 100 basis points on the margin type difference?

Yes.

We're not going to get into that kind of specifics.

Understood.

Congratulations on all the glass contracts.

I'm sure that was a tremendous amount of work.

It sounds like you've come to a great solution.

Excellent.

Thanks, Robert.

Carla Casella, JPMorgan.

This is Paul Simenauer.

I just have a couple of questions.

First, let's see.

What's your view of tapping the bank loan versus bond market for your 2014 debt maturity?

And, do you have limitations on how much bank debt you can add?

We don't feel there's any limitations that would hold us back.

We're looking at the markets as we speak, and I think we're in a great position.

We can utilize our revolver, which is at a very good rate, or we can go to the senior market if we want to increase the duration of our debt.

It's going to be based on what we think the market's rates are.

So, it will be a decision that we can make without any pressure from the outside world or covenants or anything like that.

There's a lot of flexibility that we have.

And then, have you spoken with the rating agencies at all regarding your expectation that leverage will remain over four times through 2016?

We have, yes.

So, the rating agencies are insiders.

They have a look at how we think the financials will pan out.

And, I think they'd be pretty happy with how quickly we are delevering.

And again, mostly it's because we're growing EBITDA so fastly -- so quickly which just shows the fundamental positive economics of the business.

Great.

Thank you so much.

Tim Ramey, Pivotal Research.

Just to put one final point on the overly belabored beer margin question.

You don't give EBITDA margin targets on that, but it sounds to me like it would be fair to say, well, OI margins are going up modestly.

EBITDA margins are going to go up more meaningfully.

Is that a fair statement?

Because of -- (multiple speakers)

I'm not sure if I understand the question, Tim.

We're not commenting at all around OI margins.

But, EBITDA is certainly growing which is helping bring down the EBITDA leverage.

We don't really talk about margins -- (multiple speakers)

What people seem to be missing is that the depreciation is impacting the OI margin.

And so, the EBITDA will be a better number based on the -- (multiple speakers)

Sure.

So, as we said earlier, there's a lot of DA coming into the P&L as we spend all this capital.

I don't know why you keep saying OI.

This has nothing to do with OI.

They're not on our books.

But, yes.

The EBITDA, to your point, will be much higher than the EBIT because DA is going up so much.

Right?

Is your point, which is -- that's a good point.

Thank you.

Okay.

And then, just finally on wine, it is a beautiful crop out there.

(laughter) I'm almost done harvest.

Looks to me like margins have the ability to expand a bit going into FY16.

Would you agree with that statement just directionally?

Yes.

We think that margins can expand a little bit going into FY16.

Okay.

We're seeing growth.

We're seeing positive mix.

And, we're seeing a little pricing.

Yes.

Beautiful time for --

So, that's a good combination.

As you said, Tim, the crops coming in, very high quality.

And, we think overall, the cost per ton will be similar to last year so not a lot of great cost inflation which is good news for margins.

And, I think a generally balanced supply-and-demand situation.

Because we're a month ahead, is there any meaningful impact on cash flow this year from just the timing of harvest?

Or, is that not material?

No.

There won't be anything meaningful.

Okay.

Thanks so much.

That was our final question.

I would like to turn the floor back over to Rob Sands for any additional remarks.

Yes.

Well, thanks, everyone for joining our call today.

Needless to say it's an exciting time to be at Constellation.

We believe we have very significant growth opportunity within our beer business.

And, glass, of course, is a critical component of our beer production.

As such, I'm very pleased with the final outcome of our long-term glass strategy with key industry players in order to ensure that we have the quality, capability, and flexibility to meet the growing demand for our iconic beer portfolio.

We also have solid momentum for our wine and spirits business as we head into the second half of the year.

And, we are well-positioned for a great holiday selling season.

Our next quarterly call is scheduled after the new year, so please be sure to enjoy some of our excellent products during the holidays.

So, thanks again, everybody, for your participation.

Thank you.

This concludes today's conference call.

You may now disconnect.