Welcome to the Constellation Brands third quarter 2017 earnings conference call. At this time, all participants have been placed in a listen-only mode. Following the prepared remarks, the call will be opened for your question. Instructions will be given at that time. [Operator Instructions]. I will now turn the call over to Patty Yahn-Urlaub, Vice President of Investor Relations. Please go ahead.

Thank you, Laurie. Good morning everyone Happy New Year and welcome to Constellation's third quarter fiscal 2017 conference call. I am here this morning with Rob Sands, our President and Chief Executive Officer and David Klein, 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 measures are included in the 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. 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 release and Constellation's SEC filings. Before turning the call over to Rob, I would like to ask that we continue our practice of limiting each Q&A session participants to two questions which will help us to end our call on schedule. Thanks in advance. And now here is Rob.

Thanks, Patty, and good morning and Happy New Year. I hope you enjoyed the holiday and had the opportunity to include some of our great Constellation products in your celebrations with family and friends. Now before we get started with our discussion of third quarter results, I would like to thank those of you who participated in our recent New York Investor Meeting. I hope one of your key takeaways from that meeting is that Constellation is better positioned today than it has ever been to generate growth and build value. Our business has never been stronger and the prospects across our beer, wine and spirits portfolio are compelling. We sell a diversified portfolio of fast growing premium brands from the U.S. as well as other parts of the world. Our business continues to produce very impressive results. We are gaining share, improving margins and making smart investments to fuel growth. Consumer demand for our iconic brands remains very strong and we have no reason to expect this to abate. We are so confident about our future business prospects that we recently repurchased more than $800 million worth of our outstanding shares because we believe our stock is undervalued at current levels. I believe it's the changing political and legislative landscape in the U.S. that has recently impacted our stock price, particularly as it relates to potential changes to tax structure, tariffs and trade policies, but I will address this topic in a few moments. With that said, let's focus our discussion on some of the industry leading results we delivered for the third quarter. Our beer business continues to be a powerhouse for growth delivering third quarter depletion trends of almost 11% while contributing 60% of total U.S. beer industry IRI dollar growth and significantly outperforming the high-end of…

Thank you Rob and good morning everyone. We are pleased with our impressive financial results for Q3 and our recent business accomplishments as we continue to grow share and outperform the competition. Our continued strong topline and operating results were accompanied by a favorable tax rate benefit related to APB 23 accounting as we determined that a portion of our foreign earnings will be indefinitely reinvested. This assertion allows the company to record income taxes on certain foreign earnings using the applicable foreign jurisdiction tax rates rather than the higher U.S. tax rate. The fiscal 2017 year-to-date impact of this change was recorded in the third quarter of fiscal 2017 and helped drive comparable basis diluted EPS growth of 38%. As a result, we are now projecting a lower tax rate for the year and this is driving an increase in our full-year comparable basis diluted EPS target to a range of $6.55 to $6.65 versus our previous guidance of $6.30 to $6.45. Looking at our Q3 fiscal 2017 performance in more detail, we are all generally focused on a comparable basis financial results. You can see beer net sales grew 16%, organic beer, net sales increased 12% primarily due to volume growth of 10% and favorable pricing. Beer depletion growth for the quarter came in at 11%. Wine and spirits net sales increased 5%. This reflects the acquisition benefit from The Prisoner Wine Brands and favorable mix, partially offset by lower volume due to timing as U.S. depletion volume outpaced shipment volume during the quarter. Our U.S. depletions grew a little over 3% in Q3. Beer operating margin decreased 30 basis points to 34.8%. The impact of planned marketing investments and consolidation of the Ballast Point business were mostly offset by benefits from pricing and foreign currency. For the…

[Operator Instructions]. Your first question comes from the line of Dara Mohsenian of Morgan Stanley.

Hi. Good morning.

Hi Dara.

First on the SG&A side. Clearly you posted a high increase year-over-year as a percent of sales at the corporate level in the quarter that was driven by both beer and wine and the beer comments were helpful. But I was hoping in wine, you could also give us a sense of how much of the increase in SG&A was due to marketing moving up as a percent of sales versus maybe other factors? And what those other factors are and how long they might last?

So as a dollar amount delta year-over-year the wine increase similar to the beer increase was about half marketing spend as we invest more in our brands on the wine side and the other half was just investments primarily in people to drive our execution and NPD capabilities.

Okay. And are those people costs and those execution capabilities, is that something you lap over in a couple more quarters in cycle or is it something that's just beginning at this point? Last quarter you had some spending in those areas too. So I am just wondering when you cycle over that?

Yes. I would expect fundamentally that our SG&A range, really in both of our business, will remain in line with where it's been historically over time as a percentage of sales.

Okay. And then on border adjustability, the comments were helpful. I am curious if you did need to take a large price increase to offset any changes in taxes, could you clarify if you think distributors and retailers would more just pass on the dollar profit impact of any price increases from Constellation or do you think they might look to more to maintain margins not just offsetting the profit dollar impact? And then also you have showed a willingness to price to offset cost historically in beer. Conceptually, if the tax change was large in nature, would you be willing to consider a mid to high single digit price increase, if needed, to offset taxes? Is that kind of in the range of scenarios you run when thinking about the tax changes that you mentioned earlier?

So Dara, when we look at the tax changes and I just really want to caution everybody because we are talking to people in Congress on this topic and the border adjustability provision haven't even been written, right. So it's hypothetical and of course, we are trying to understand the effects that could take place, but it's hard to get into a lot of specifics when answering. But I would say that we still would suspect that our pricing algorithm would remain consistent where it's been in the past in the range of 1% to 2% a year and in order to mitigate any sort of a border tax, we would be more inclined to address elements of the supply chain that we would put into the deductible category. So for example, if you look at elements of our cost inputs that currently come from the U.S. that we could make deductible, I would put, say, the energy cost of producing glass in Mexico. That's just one example of things we can do in our supply chain. So we turn that into a U.S. cost instead of a Mexican cost and we then have a deductible expense for U.S. tax purposes. We think that combined with a lower U.S. tax rate and a reasonable phase-in period for any border adjustment tax would be a more appropriate and value creating approach than to really just jump on the price lever.

Your next question comes from the line of Vivien Azer of Cowen.

Hi. Good morning.

Good morning Viv.

So just in thinking about the beer trends, I think there has been a little bit of anxiety from some of the investors that we have talked to this morning around the [3Q plan] [ph] and beer results coming in a little bit below expectations and I think that's being exacerbated by some of the press reports about the preliminary Nielsen numbers through December. So two part question for me, please. Number one, can you walk us through the phasing of your beer trends through the quarter to help kind of put the December numbers that we are seeing from Nielsen in context? And number two, can you offer any perspective on why you thought December might have been soft? And in particular, what's going on with craft beer in that context? Thank you.

Yes. Vivian, number one, we don't think that the quarter was soft at all. And if you look at IRI trends, for instance consumer takeaway, this quarter our growth was up to the most recent reporting period 16% whereas last quarter, right, it was below that at approximately 14%. So we are actually seeing an acceleration at retail on consumer takeaway. And then if you look at our depletion results for the quarter, we were at 10.7% depletion growth, but this quarter we were overlapping 16.2% depletion growth for the same quarter last year. And if you look at last quarter, we had 13.8% growth, which was higher than the same quarter or second quarter last year, which was 10.2%. Now, the fundamental point is that these kind of fluctuations quarter-by-quarter in depletions are not indicative of much of anything as long as they are in a range, right, of the kind of growth we have been experiencing, which is double digit growth in the low teens. You are going to continue to see fluctuations of this nature quarter-to-quarter in depletions based on what's happening with inventories at retail, shipments into our retail customers, et cetera. So you can't go by changes of, say, 100 basis points to judge whether the business is soft or not. The simple fact is that consumer takeaway for our products is accelerating, okay, sequentially as we look at our results. So I don't think that we believe or see any softness whatsoever in the business and in fact I would say, it's the opposite, okay, at the consumer level to the extent that it can be measured. We are actually seeing acceleration and I am sure that that will shake out from a depletion point of view over the medium term meaning throughout the year and into next year. So very, very, very strong results. We are the leader in growth in beer in every possible respect and contributing most of the growth to the entire industry. So we think our results are, in actuality, outstanding. They have double-digit growth. Following a 16.2% overlap is actually almost unbelievable.

Understood. That's helpful. And could you comment at all, please, on December, if you had a chance to take a look at that data and your view on some of the softness in the scanner data for December? And then if you could comment please on the broader slowdown that we are seeing in craft beer? Thanks.

I think that number one, December continues to be strong. We don't really see, I mean, we don't pay that much attention to month-over-month fluctuations, but December continues to be strong results. Yes, we were up, what, 13% in IRI in December. So actually it continues to be very strong trends. And as far as craft goes, look, I mean craft is a tale of two cities, right. You can't look at the craft number as a total number. I mean what continues to go on in craft is the major brands, Sam, Sierra Nevada, Blue Moon, which are all on the craft numbers, those continued to be down big time, right, like in the, I don't know, about 8% range. And then you have sort of everything else which continues to be up significantly and is not being dragged by those numbers. And you have also got the, what I will call, the local effect which is a lot of the smaller local craft players eating up many of those larger older brands, which are now 25 years old. So as I said, it's really a tale of two cities, but most importantly Ballast Point's IRI trends were up 54%, okay, for the quarter and it continues to be the fastest-growing major craft brand in the category and it is certainly the most premium significantly sized brand in the category. So while you are you are seeing a lot of stuff kind of going out in craft, it's really not something that you can think of, I think, in terms of like a total category because it's almost a meaningless term. It's a brand-by-brand phenomenon. And so you really have to look at the specific brands and companies that you are concerned about as to how they are performing.

Okay. Thank you very much.

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

Hi Judy.

Hi. Good Morning. So a couple of follow-ups on the border adjustability comment. First, just in terms of and I completely understand it's not even written as part of the legislation, but what are you hearing in terms of the potential carve-out if indeed the border adjustability is included as a part of the tax reform? And then David, you have talked about some portion of your beer costs already classified as U.S. costs. So can you give us the number today and potentially what that can get to?

Yes. So thank you for caveating that it hasn't been written because I think I am going to say that every time anyone asks about border adjustability, right. So we are in the field of concepts here. Our understanding is that U.S. based COGS will be deductible. And right now our U.S. based component of our beer COGS, inclusive of freight, is about 40%. I mean 60% of the COGS is from Mexico. Now we have things that we can do within our supply chain over time, but we are talking about long-term supply agreements. We would have to take into account changes in freight and of course, any changes or fluctuations in currency between the countries before you make final plans like that. So I would say, when we do our modeling, we are looking at kind of staying in the range of foreign COGS that we have today and then picking up the benefits that are included in the rest of the tax package and assuming a reasonable phase-in period which is how we come back to having a great deal of comfort in saying that we can grow EPS greater than 10% as we described in November.

Okay. And then just any color just you are hearing in terms of the carve-out prospects?

What do you mean by a carve-out prospects, Judy?

So if border adjustability is included, could Mexican beer be exempt from that adjustability?

Sure. It's possible that Mexican beer could be exempt because it's an inherently Mexican product and it's not the kind of thing that perhaps is being targeted, i.e., the movement of production from the U.S. to Mexico. In fact, in our particular case it's the complete opposite in which you have a U.S. company that bought an inherently Mexican company and actually resulted in the creation of jobs in the U.S. as opposed to the opposite. So of course we are making that point with our legislators and I would say they fully understand and comprehend that point. So yes, there could be a carve-out. But I think more importantly, I would reiterate what David said, number one, we are not necessarily relying upon a carve-out. Number two, what we have been told, if you believe that border adjustability will in fact occur, which is a big maybe in the first place, if it does, there will be a relatively lengthy phase-in period. That's what our legislators and the people on Ways and Means, et cetera are saying. And then, furthermore as David pointed, we would have significant ability to mitigate the effect of it by moving COGS, right, from Mexico to the U.S. So David gave a good example of it. Energy, which is a very large component in the manufacture of glass, glass being the largest component of COGS we buy out of Mexico right now. We could shift our purchase of natural gas from Mexico to the U.S. and increase our cost of goods sold component that's U.S. based and therefore mitigate the impact of the lack of deductibility of foreign COGS. So it's those kind of things that we are looking at, planning of, if this comes to pass so that we can maintain, as David said, our current pricing algorithm which is sort of in the 1% to 2%. And therefore we don't expect consumer demand for our product to be effected by border adjustability in any timeframe that's probably relevant to our investors.

Got it. That's helpful. And then just a quick follow-up on Ballast Point.

And Judy, I would also point out that the other benefits of tax reform is being suggested in the Better Way Plan being put forth by the House, right, has very significant other benefits which will also offset any negative from border adjustability. So I think it could be a net positive when all is said and done, but it remains to be seen. As David has said, the only details we get are from talking to the legislators who are involved right now in, I will say, contemplating the details of these proposals. And that's the best anybody can know. And I would say, we probably know more about this than anybody, any corporation.

Yes. That's really helpful. So thanks for that. Just if I can ask a quick question on Ballast Point. So just in terms of the contribution to your sales, it looks like it's slowed pretty meaningfully versus first half and then maybe even implying a down year-over-year. So just wondering if there's any kind of a destocking going on, just from a shipment perspective for Ballast? And then just in terms of --

There is nothing going on with Ballast. The business is up double digits. The IRI is up 54%. There is nothing going on with it at all. And it's a very small contributor to the results. I mean it's a very small business, right. So it's not meaningfully contributing to any of the numbers that we are talking about, but it will and one of these days, because it is a very fast grower and it continues to grow well. So it's part of our strategy to continue to drive the portfolio towards growth brands and that strategy is working very well, by the way

Got it. Thank you for that.

Your next question comes from the line of Bonnie Herzog of Wells Fargo.

Good morning everyone.

Hi Bonnie.

Hi. I just have a couple of quick follow-on questions. First on your total beer business. Could you drill down on how your on-premise business has been performing versus off-premise? And then curious to hear how your beer business has been performing in the untracked channels off-premise? And then could you touch on where you are at with national distribution for Ballast Point, please? Thanks.

Yes. So in terms of on-premise and off-premise, our beer business is up high single digits in the on-premise. We think the market's down low to mid single digits in the on-premise. So we are gaining share and feeling very, very comfortable there. And on your last question, I have it here, as it relates to Ballast Point's distribution, I think Ballast Point is about 25. So ACV is about 25 and we are in about 45 states. But what I want to caution when we talk about expanding into incremental states is that if we sell a case in a state we say that we are in that state. We really need to continue to drive the sales execution and broadening of the base in each state that we go into with Ballast Point. So there is a lot of runway in front of us as it relates to Ballast Point.

So you expect that continued push on distribution to continue well into next year before you feel like you have gained additional --

Well, it will continue way beyond next year.

Yes.

It's hardly in distribution outside of California, right.

Okay. And then just circling back on maybe the untracked channels off-premise, just trying to get a sense of how your business is performing there, just since we are all looking at scanner data.

I would say that our business is performing similar to what you are seeing in the tracked off-premise channel in the untracked off-premise channels. So that's about the best we can tell you, but we have no reason to believe otherwise. So I suppose taking a look at, well, we have no reason to believe otherwise. Let me put it that way.

Okay. All right.

Based on our shipment to distributors and they reported depletions. Business is, as I had said, very, very strong.

All right. Thank you so much.

Thanks Bonnie.

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

Great. Thank you.

Hi Mark.

Hi Rob. Hi Dave. Morning everyone. So a few questions. I will try to leave Mexico for the moment, but I will come back there. You are doing very well with your balance sheet. You have been very aggressive recently buying your shares. It picked up further in terms of monthly pace in December. You have got this new authorization that, in a sense you are close to being done with, if you take the pace you had already acted out in December. So, the simple question is, the two of you as people advising the Board and saying, hey, we want to do this or that, how interested are you in presenting to the Board another $1 billion dollar authorization?

Well, first of all, Mark, we have $800 million approximately remaining on the recent authorization. And just for clarity, I think that we had $600 million or $700 million remaining on our previous authorization that we spent as part of these repurchases and then we went into the new authorization by about $200 million.

Right. And so my question is, the pace you are going at implies you are going to be done with that new authorization rather quickly. So what's your appetite for asking for an additional authorization?

The Board would be completely amenable to giving us any authorization that we ask for because of the fact that David mentioned was, we think that our shares are, especially today, significantly undervalued. That said, we have $800 million left on our authorization. So it's really not much of an issue at the moment. We will continue to make share repurchases opportunistically as we have in the past and the only caveat on that is that we do desire to stay within our debt target of approximately 3.5, which is also important and to therefore maintain our investment grade ratings. So that's probably the only real caveat on making stock repurchases, but hey, we are gung ho on stock repurchases. So no on needs to convince us of that strategy.

All right. And your balance sheet is much more suited. Okay. Fair enough. And then on the beer business on the front, so to speak, you mentioned how we should think about the increase in SG&A and part of it is just an accounting change, but the portion that you referred to as half, you said half of the increases is attributable to increase in marketing spend. And I think one of the things that we are all trying to understand is, how much should we think that that's already shown up in a sense in the quarter and the way the depletion is already performed? And how much of that is kind of a yet to come benefit? And I realize, no one has a crystal ball, but can you give us a sense, like how much of that was trade related, how much of that increase was consumer related? Because we are just trying to get a sense of, do we already see the benefits or other some benefits yet to come and maybe trade versus consumer is one way to think about that?

So, the increase in marketing spend was mostly at the consumer level. And when I talked about increase, I am really talking about the dollar increase. We haven't really changed our overall strategy in terms of marketing expense as a percent of net sales. And so we still expect that to be in the 8.5% to 9% range and we track that very diligently to make sure that we are getting a return for it and we continue to see the returns as we invest in our brands and the best example I can give is that this year we started investing from a marketing standpoint in Pacifico and we are seeing Pacifico, for example, in the last 12 weeks is up 27% in IRI. So you can expect us to continue to do that but I think as a percentage of sales, we really haven't changed our strategy.

That's great. Okay. And then specifically in the case of border adjustability and sort of an immediate benefit that's come with Donald Trump being elected President is the peso has depreciated. So with the peso depreciating, you have talked to us historically about the portion of your COGS that are denominated in pesos. Is there any benefit above simply that depreciation benefit we should be thinking about? Is there something that's affecting your peso denominated inputs themselves? Or the hiring dynamics? I realize we are only kind of two months since November 8, but I am just trying to get a sense of how Mexico's economy, so to speak, is affecting your cost in Mexico?

Yes. So about 25% of our costs are peso denominated which disconnects a little bit from the percentage that I said earlier, so 60% of our COGS being Mexican. And the difference is dollar denominated contracts for goods that we purchase in Mexico, those contracts themselves really have an underlying FX component to them. They are denominated in dollars and it may take longer for any benefit from that to flow through. And as it relates to the Mexican economy, we are not seeing any issues from a hiring or a labor standpoint or costs within Mexico. So we are seeing no problem. We are also not seeing any significant benefits.

Great. And then final question, I don't know if you touched on this or not, but you have drawn our attention again to the fact that 60% of your COGS for the beer business are relating to the operations in Mexico and your openness to moving glass or some other element to a location north of the border. But can you tell us, if we take a long view, a three-year view, a five-year view, a 10-year view, what portion of that 60% in your mind is eligible for movement north of the border?

Yes. That's harder to get to and I think you have to take into account any discussion of this we could really only have after we know the specifics of any sort of border tax because I think you would have to look at the actual cost of purchase of changing moving supply chain components to the U.S.. You would have to take into account freight and then of course you would have to take into account the currency delta. And maybe there is a scenario where the currency delta makes moving the supply chain irrelevant, right. So I think we would have to play that through when we actually know the conditions on the ground and we can't really know that today.

But I think your question, as you are really talking about the longer-term, it could be the majority of it because although the beer has to be made in Mexico, a lot of the components could be shifted if it was really determined to be advantageous and labor which is required to make and bottle the beer is a very small percentage of the total tax. So it's only 15% of the COGS. So you get the vast majority of it in one way or another U.S. based.

If the currency supports that. Got it. Okay. Very helpful. Thank you guys.

And you also --

And the details of everything else and all of the puts and takes with everything else. I mean, we wouldn't just totally disrupt the supply chain over the long run if it's not necessary. But we do have quite a bit of flexibility in what we can do. So hence our optimism obviously relative to this whole matter and as also evidenced by our view on our own stock value and our buyback activity.

I wanted to ask one last legislative thing, this isn't so much a Constellation question, but your point, Rob, about having better insight into what's happening to Washington in the many companies is simply the Senate. So we know what Kevin Brady and the House have put out there. We know what Donald Trump thinks. We know what Paul Ryan thinks. But do you have any sense of either timing or leadership in the Senate when we are going to actually hear some of it from the Senate speaking with some clarity about how they are thinking about this matter?

Well, I think that Hatch made some comments yesterday saying that he doesn't know yet what their view or opinion is on any of this. I have talked to Schumer myself personally and I would say that on the Senate side everybody is pretty reserved as to where this whole thing is going. So I would say that there is a lot less clarity on the Senate side than there is on the House side. And I would say we know a lot more about it than anybody else and that we are told that other companies that should be concerned about this are just waking up to the whole matter whereas we have been focused on it from the very beginning, having met ourselves with Ryan several months ago, really over the last summer. So we have been quite aware of this and thinking about it. Hence as David has pointed out, we have been thinking well in advance of strategically all of the things that we can do and will do if necessary to mitigate the impacts of this. So I think we are totally ahead of the game, which is good because I think as our comfort level now is indicative of that fact, which is that we have been so far ahead of the game that we sort of know what we are going to do and we are not sort of relying upon or hopefully this won't happen or what the probabilities are because that's like nobody can predict any of that stuff. So all we can do is around and determine what our action items will be if something occurs and how we are going to do it. So as I said, we are pretty far advanced in that thinking.

Very helpful. Thank you guys.

Our next question comes from the line of Tim Ramey of Pivotal Research Group.

Thanks very much. Hi. Good morning. Just going back to your commentary on wanting to stay within the investment grade bounds, sort of a more liberal interpretation of debt ceilings has really served Constellation well over the couple decades and certainly over the last five or six years. What is that makes you more comfortable in that 3.5 times or below range? And is this a change in the rating agencies viewing 3.5 times as investment grade which maybe wasn't done in the past? Or is this comfort on your level that you don't need to lever beyond that?

I think David will answer this as well. I will just give you my quick view on this which is that, it's really a size and scale thing, right. Our EBIT and margins and the cash flow that this company is and will be generating, especially as we complete over the next couple of years, our large capital projects pretty much give us, I would say, the flexibility to do everything that we could possibly want to do without really having to deviate from sort of that mid three range. That could deviate a little bit from time-to-time but I don't really see that it's important. I mean we are going to have so much cash generation that we feel pretty comfortable that we can pretty much internally fund just about anything that you could conceivably do in the alcoholic beverage business, right.

Sure.

So that's just my view on it. David?

Yes. I would just reiterate that $2.5 billion of EBITDA that's generated every year, you can stay at the 3.5 times and you have fair amount of capital to allocate to other activities. And I would say that where we are focused on saying that we will stay at the 3.5 times. We are not looking to be leveraged below 3.5 times and if we go above 3.5 times, we would then want to get back to that number, but we are really thinking about it, Tim, as a target.

Yes. Thanks so much.

Your next question comes from the line of Rob Ottenstein of Evercore.

Great. Thank you very much and congratulations on the investment grade rating and the continued tremendous business momentum. On that point, you mentioned very interestingly, that you have actually seen on a sequential basis an acceleration in the beer business. And I am wondering if you could be perhaps a little bit more specific in terms of what you think the potential triggers of that acceleration are? Is it particular new SKUs? Is it Corona cans? Your c-store initiatives? The increased marketing? Probably a little bit all of the above, but I would love to get your thoughts on that.

Yes. Well, I think first of all, you gave it pretty good litany of all of the things that are driving it. Our marketing, our advertising, cans, SKUs, those are all things that continue to drive our consumer takeaway. And then there's some increased distribution is another big focus of ours and getting the right distribution in the right places. I mean it is not just the increased distribution by the numbers, it’s quality of distribution so that all relates to sales execution. So that's kind of motherhood and apple pie and we are doing a great job with it. I think also, if you sort of look at what's going on retail with even the craft segment, there is definitely now a movement to reduce the number of SKUs. That is causing some regained focus at retail which we always thought that at this ought to happen. The really fast growing high margin bread and butter items that they have, which happens to be our portfolio and therefore more attention, more space, more distribution is being given to what they know is working versus what hasn't worked. I think that takes us back to a Ballast Point point of, okay, which is as you see some slowdown in the older more established craft types brands, a brand like Ballast Point which will be supported, has strong sales execution behind it, these are the types of brands that will be the beneficiary as things shake out a little more in the craft segment as well our import portfolio because it's clear-cut that that's what's driving all the growth in the beer business at retail. So I think that we will see our sort of total portfolio be the beneficiary of sort of constant or anticipated changes that will occur over time, as has always occurred. I mean there's always been these kind of changes in the business. On the one hand, it's a slow business to change. On the other hand, there is constant change going on with all three categories.

And in terms of that retailer re-spacing or kind of re-looking at their SKUs and we certainly heard about that from Walmart, about when do you think that's started? Has that been going on throughout 2016, calendar 2016? Or did you see that really pick up in the second half of the year?

I think that it's actually in its infancy. I think it's just starting. But you take a Walmart, for instance, I mean they love our products because they are trying to, they want higher margin fast moving growing products on their shelf, because they don't have that much space devoted to the category. So they want all the best stock.

Terrific.

I think it's just starting and I think that you will see us, as I said, there's always changes that are going on in the industry across all three categories and the key, strategically, is to make sure that you are positioned to be the positive beneficiary of those changes. And that's why we make some of the comments that we do about being better positioned as a company than we have ever have been because it's pretty clear to us that given our whole portfolio and our strategy and our premiumization strategy and our focus towards high margin, high growth brands that that's really positions us to be the key, not one of but the key beneficiary of all of the changes that are going on. And look, you see that in our results versus every other beverage alcohol company, right. Frankly versus almost any other company in consumer goods, period. There is no companies in consumer goods in general that are performing like we are that I am aware of.

No. It's tremendous.

Even some of the ones that are outside of our industry and category and have not consistently performed as we have. So we are a bit of an outlier in that regard. And we hope to continue to be so.

Absolutely. And then just on cost side, I believe in the last quarter you mentioned that you thought advertising spend as a percent of sales would be flattish in the second half of the big chunk in the third quarter as we just saw versus the fourth quarter. Do you still stand by that?

Yes. I would say that on an absolute dollar basis, once again we will see some year-over-year growth in marketing spend. But from a model perspective, our marketing spend will end up in that 8.5% to 9% range for the full year.

Great. Thank you very much.

Your next question comes from the line of Bill Chappell of SunTrust.

Thanks. So just quick question on the taxes. I think you talked about a lower tax rate for 2018. I assume there's no change in kind of the outlook there.

No. So we talked about having a mid 20s sort of ETR as a target over the next three years and we are not really giving guidance for FY 2018, but there's no reason to expect that would be outside of that.

Okay. Thanks. And then also just to make sure I understood, the net leverage at the end of the quarter, that includes the cash used for share repurchase? I am just trying to understand kind of where we stand as of today.

Yes. So that 3.5 times was at the end of the quarter. I would say, if the year were to end today we are probably more in the 3.6 to 3.7 range, given the repurchases that took place in December.

And in terms of future share repurchases, you are comfortable going above four times?

I would say, again, we are focused on the 3.5 times range and if appropriate opportunities present themselves from a capital allocation standpoint, we will go above the 3.5 times but our objective is to always be able to quickly get back to that level. But again, we have maintain on the 3.5 times versus trying to just how high we could actually go.

Got it. Thanks so much.

Your next question comes from the line of Laurent Grandet of Credit Suisse.

Yes. Hello. Thanks for the opportunity. So I would like to come back to this SG&A point. SG&A went up to 19.5% in the quarter from about 17%, 17.5% in the previous quarters and you mentioned at the same time that the marketing spend was of roughly 8.5% to 9% of sales, roughly similar to the previous quarters. So I really would like to understand, I mean where is the balance of the SG&A? And is it something we should see in the future quarters? And is it some kind of initiatives, I mean, to support new brand introductions or to go after the on-premise channel? So I like to really have more color about these SG&A and how we should think about it going forward?

Yes. So again from holding aside quarter-to-quarter volatility in total SG&A spend, I would say that for, just focused only on the beer business, our marketing spend will be somewhere between 8.5% to 9% of net sales. In terms of SG&A spend in our beer business, we expect that it stays in the historical range that's really in 5.5% to 6% range, specifically in our beer business. And the incremental growth in SG&A in both businesses, really any incremental spend there is put in place to really drive innovation and better sales execution. But again, our SG&A algorithm is not changing. These are just quarter-over-quarter anomalies.

Okay. Thank you very much. And an in terms of focus, I would like to come back on this final question on Ballast Point. I understand we do have vision on sales of 45% to ball park it, similarly to IRI. But if we dig more into the numbers and we see that the distribution now has been plateauing at about 23% for the last six quarters. And same store sales seems to be now at minus 25 and that's for the last few quarters. So was the plan here to kind of push even further Ballast Point? I understand it's still a small part of your algorithm but also it's important for the future of the gross of the beer segment of your business.

No. We have got all kinds of programs to drive distribution of the product. And throughout the United States we have taken the brand national. We have very strong relationships with our distributors. We are increasing our support levels behind the brand and doing all of the standard things that one would do in this particular category and that's an important caveat to drive the business. So it's all about doing things like driving national accounts. These kind of brands require a lot of grassroots type efforts. We continue to develop new products. We continue to develop our retail model. We continue to win awards, which is important in the craft segment because it's a lot like wine and ratings and I think we are on the forefront of that in actuality. So it's all good. There is just nothing to be concerned about or to complain about.

Thanks for adding some comfort on this.

Your next question comes from the line of Stephen Powers of UBS.

Hi. Great. Thank you. Back to taxes, I guess really two questions, if I could. First, your comments on board adjustability have been very helpful. But I am wondering if you could comment also on what discussions you may have had around interest expense deductibility and how that aspect of potential tax reform has factored into the scenarios you have talked about? And then second, I just wanted to test whether your confidence in the 10% growth algorithm through 2020 under potential tax reform depends on the phase-in assumptions that you mentioned? Or if you have modeled scenarios where sort of the adverse aspects may take effect more quickly and you could still hit the 10% number?

Yes. So in terms of interest deductibility, I think the general assumption, under the Better Way Plan, is that it wouldn't be deductible on a go-forward basis. Our assumption there is that existing interest would remain deductible. And then in terms of phase-in, the last time there was tax reform, I think the phase-in period was four years. But this sort of tax reform really isn't about just setting up back office accounting departments to manage the new tax code. This kind of tax reform would require a time horizon that would allow companies to change their entire supply chain. So our expectation is that it would at least be four years and our objective would be to advocate to make that as long as possible so that we could actually get through up in supply agreements and so forth. And so I would say that when we start looking at the three-year numbers, I think there are a couple of things that play into it. And one is the phase-in period, of course and we are not assuming that it's just an immediate phase-in. And then I think the other component that you have to keep in mind is, if you look at in particular peso rates historically, for us, versus the current peso rates, so not incremental currency movement, but the current peso rate, it actually provides benefits to us that would be somewhat offsetting as we sit here today.

But I think that it's not just phase-in, right. When do you think that the actual tax reform legislation will be enacted?

Right.

I mean it's probably a year off at best.

Yes.

Right.

Yes. No, okay. That's all fair. Just wanted to get someone to clarify.

We can only tell you what our legislators have been telling us, right. But the first thing that's going to happen in Congress, which you are seeing right now is Obamacare.

Yes.

So Congress has a lot on its plate right now. And to work through all of the details and get legislation like that passed, well, Congress is telling us it's going to be a while in any event. And it is clear cut and again this is literally what we have been told by the leaders that Obamacare is the first thing on their plate.

Okay. That's helpful.

And that's going to take a while.

Okay. And I don't want to get too far into the weeds here, but I just want to make sure I am thinking about this correctly from what you are currently doing. It looks to me like today what you are doing in terms of, you are essentially leveraging some pretty high transfer prices from Mexico to the U.S. to keep profits today outside the U.S. I think 60% of your pre-tax income effectively is booked outside the U.S. today. So I am assuming in the future you would theoretically be able to reduce those transfer prices, shift dollars, shift profits back to the U.S., hopefully at a lower tax rate and that's as part of the levers you can pull. Can you just talk me through the transfer pricing algorithm there?

Yes. You shouldn't even think about that, right. So the transfer prices so still at market rates. You just have to think about the deductible component of COGS, which really doesn't change. What matters is where you incur the costs, not necessarily where you have put the revenue.

Okay. So you put the revenue wherever the tax rate was most advantaged?

Yes. So it's a shift in mindset on border adjustability. It's really all about the COGS sourcing.

Okay. The last thing, not on tax, I just wanted to see if you could just add some comments on Corona Premier. There's been some, I guess from my perspective, some degree of apprehension from the marketplace in terms of maybe pushing that too far to the detriment of mainline Corona. So just wanted to get a sense for what your rollout plan was there and how big, how small, how fast, how slow, that kind of thing?

We are going to test market it in three or four different markets of different types, meaning more mature and less mature markets to get a good handle on how it interacts with our other products and then make a decision as to whether we will continue the product and roll it out or not. I don't see any big issue with it. Our distributors, they are excited about it. The category is a good category. Mic Ultra is one of the leading growth drivers in the industry right now. That product is differentiated from our other products. I would say that we continue to believe that it's got a high probability of success. It's priced at Corona, right. So we are not worried necessarily about a cannibalization factor where we would be only worried about the product fundamentally their not being successful, well that's really it. Because otherwise, it's going to be one plus one equals three so there aren't any margin concerns relative to cannibalization.

Okay. Thank you very much.

I guess it's only whether it's additive and successful and that will be determined pretty easily in the test market scenarios. So it's real straightforward low risk stuff.

Appreciate it. Thank you.

Your next question comes from the line of Brett Cooper of Consumer Edge Research.

Hi guys. Thanks for the question. And there's two. I just wanted to confirm on the comments, so when you are saying that you are able to grow earnings 10%, that's off of the guided basis, $6.55 to $6.65 and that you will be able to exceed $1 billion in free cash flow in 2019? That's my first one.

Yes. We stand by the targets we put out there in November.

Okay. Perfect. And then can you guys talk about the retailer receptivity that you --

Hang on. The only thing that, when we look at the targets for the individual businesses, you do have to remove Canada but our EPS target remains.

Okay. Perfect. And then can you talk about retailer receptivity to taking on some of your smaller brands? I mean I guess they are not all that small, but things like Pacifico and Negra, relative to their willingness to do some of the craft brands? And then talk about your expectations for incremental placements in smaller brands and/or packages into the coming year.

Yes. I would say that they are dying for them, especially Pacifico.

So we should be able to see --

The only thing that's held us back our Pacifico is not retailer demand. I mean retailers are dying to get the product. Up till now we have been sort of production constrained just trying to feed the growth that we have had, now that we have got Nava up to speed and we will see the addition of another five million hectoliters at Nava in the next few months and we have bought Obregon. That sort of cleared up and now we are beginning to drive those brands like Pacifico. I mean look, I don't want to necessarily predict the future, but Pacifico has got a good chance of being the next Modelo Especial while Modelo Especial still continues to have a huge runway and grow 20%. So I think the good news is, we have got Pacifico coming right behind Modelo Especial with huge retail demand and excitement about the product. I mean there's all kinds of anecdotes about Pacifico and what consumers are thinking relative to the product. I mean probably the most interesting anecdote being that it is the fashionable choice of craft drinkers.

Perfect. Thank you guys.

Many craft drinkers when they get sick of drinking double IPAs, their beer of choice is Pacifico.

Your final question comes from the line of Caroline Levy of CLSA.

Thank you for being so generous with your time. Just wondering what your people in Mexico are saying about what the Mexican government's reaction might be to Trump-onomics, border taxes, et cetera? Whether there is any risk or opportunity there for you? And then also just given that you have invested in these glass plants, does that put at risk your investments, be it the glass plants or your big production capacity? Would any change in where you source goods lead some of that capacity to be unnecessary?

So I will answer the second point and then Rob can maybe comment on the Mexican point. But what I would say, Caroline, is that I don't see a scenario where our glass joint venture wouldn't be by far and away the cheapest source of glass even in the new tax regime, just simply because of the freight benefit of having that plant and it's a highly efficient plant sitting next door to our brewery and so about half of our glass needs will ultimately come from that joint venture facility. And I would say that if we needed to move our other packaging sourcing elsewhere, we could do that, given enough time because we are sitting under quite long-term contracts with our packaging vendors.

And I guess my comment on the Mexicans and of course we do talk to the Mexican politicians as well as Peña Nieto, et cetera, et cetera. I think they are taking a measured view of the whole thing. Not necessarily being overly aggressive in their comments about what they will do other than they are prepared to engage in reasonable negotiations. And they do not believe that the U.S., in the end, will enter into or will take actions that would violate WTO principles and other principles of that nature. So I would say, that the Mexicans are being measured in their comments, but on the other hand if pushed they are certainly prepared to say that they will act accordingly if the U.S. violates their agreements.

Got it. My last question, if you don't mind, would just be to understand the margin expansion, the gross margin expansion in beer? The key drivers, like how much of a role did the peso play? How much of a drag was Ballast?

Yes. So I don't have the exact components of each of it. But I would say, the first thing is that when we talk about the SG&A re-class last year that gave us a year-over-year comparable benefit on COGS on GP versus the negative hit on the SG&A. And then in the current year, even though the peso has weakened substantially, in the current year we are probably 75% hedged on the peso, right. So that effect is mitigated to a certain extent. And then we just continue to see improvements in overall performance at our Nava facility. So I think it's just the biggest chunk, maybe the year-over-year re-class. And then beyond that, we are just seeing some kind of expected improvements in total GP.

And just fair to say then that the benefit of the weak peso will continue to be felt next year because of hedging?

Yes. So we talk about, so we use a three-year hedging program for currency. As I said, we are 70% to 75% hedged on the peso for this fiscal year. Next fiscal year, we usually go into year about 50% of our exposure hedged and then as we roll forward into the 24 and 36 month time horizon, it's lower numbers. So, yes. So assuming that peso stays where it is, we will continue to see benefits coming into our P&L.

Thank you so much.

Thank you. I will now return the call to Rob Sands for any additional or closing remarks.

Okay. Well thank you everybody for joining our call today. As we have delivered fantastic results for the first nine months of fiscal 2017, we have never been more confident in our future prospects of our business. We look to capitalize on our business' tremendous momentum as we execute our strategy and continue to build shareholder value. Just as a reminder, during our next quarterly call, which is scheduled for April, we will be providing our guidance for the upcoming fiscal year. So thanks again, everybody, for joining our call and have a great rest of your day.

Thank you for participating in the Constellation Brands third quarter 2017 earnings conference call. You may now disconnect.