Welcome to the Constellation Brands Q2 Fiscal Year 2020 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode. Following the prepared remarks, the call will be open for your questions. Instructions will be given at that time. I will now turn the call over to Patty Yahn-Urlaub, Senior Vice President of Investor Relations. Please go ahead.

Thanks, Joelle. Good morning and welcome to Constellation’s second quarter 2020 conference call. I am here this morning with Bill Newlands, our CEO; and David Klein, our CFO. As a reminder, reconciliations between the most directly comparable GAAP measure and any other non-GAAP financial measures discussed on this call are included in our news release or otherwise available on the company’s website at www.cbrands.com. Please refer to the news release and Constellation’s SEC filings for risk factors which may impact forward-looking statements we make on this call. Before turning the call over to Bill, similar to prior quarters, I would like to ask that we limit everyone to one question per person, which will help us to end our call on time. Thanks in advance. And now here is Bill.

Thank you, Patty and good morning everyone. Welcome to our discussion of Constellation’s second quarter sales and earnings results. We delivered an excellent quarter driven by strong performance of our beer business. And while our wine and spirits portfolio continues to be impacted by transition activities related to the Gallo transaction, I am pleased with the pace of progress and the strategic transformation of this business. Now that we are at the halfway point in the year, I would like you to focus on two key points as the second half of the year unfolds. Number one, Constellation and Gallo are working in full cooperation with the FTC, while they continue to review our wine and spirits deal. We are confident in our ability to close the transaction, which we now expect will occur by fiscal year-end 2020. For now, we have updated our fiscal 2020 EPS guidance to assume that we close at the end of the third quarter, but we will adjust accordingly as we get more clarity on exact timing. Meanwhile, we are fully committed to supporting our entire portfolio throughout the transition. Number two, during the second quarter, Constellation’s beer business remained the number one market share leader in the high-end of the U.S. beer market, representing 25% of high-end growth with Constellation growing share in every summer holiday. This is the 38th consecutive quarter of growth for our beer business and I remain confident in the prospects for this collection of iconic consumer-loved brands well into the future. Why are David and I so confident? Several reasons, high-end trade-up is a continuing trend for the entire U.S. total beverage alcohol market. Premiumization is becoming more prevalent in U.S. middle market states like Ohio and Michigan, where a significant amount of beer consumption occurs. Legal drinking…

Thanks, Bill and good morning everyone. In Q2, we continue to produce strong beer operating performance and we delivered superior cash flow results. Our wine business delivered results in line with our expectations as we execute this transition year. Share repurchases during the quarter reflect confidence in our ability to produce top tier growth well into the future and our commitment to generate returns for shareholders. We have increased and narrowed our full year comparable basis diluted EPS range to $9 through $9.20. This range excludes Canopy equity earnings impact. Our increased guidance now assumes the transaction with Gallo closes at the end of Q3 and the divestiture of Black Velvet Canadian Whisky closes on November 1. Now, let’s review Q2 performance and our full year outlook in more detail, where I will generally focus on comparable basis financial results starting with beer. Net sales increased 7% on volume growth of 5%. The reversal of the shipment timing benefit in Q2 was less than expected. This helped Q2 net sales coming ahead of our mid single-digit growth guidance, which we provided last quarter. Depletion growth showed continued strength at more than 6%. When adjusted for 1 less selling day in the quarter, the business generated 7.5% depletion growth, reflecting accelerating trends for some of our key brands during the summer selling season. We expect this acceleration to continue into the second half of the year when we are no longer of lapping the Corona Premier and Familiar launches. As a note, in Q3, selling days are flat year-over-year. Beer operating margin increased 50 basis points to a record 41.8%. Benefits from pricing in foreign currency were partially offset by higher COGS. The higher COGS primarily reflect materials inflation mostly driven by contractual increases in glass and cartons. I am pleased…

Thank you. [Operator Instructions] Our first question comes from Bryan Spillane with Bank of America. Your line is now open.

Hey, good morning, everyone.

Hi, Bryan.

Hi. So I guess, my question is, given the pipeline of innovation that you will have going into next year and kind of the spending levels that you had this year behind the beer business, this is to support the innovation and initiatives yet this year, is that 10% or so of revenue still a good sort of basis baseline to use in terms of marketing investment to support the business going forward or if innovation is going to step up or will it potentially have to step up more?

Bryan, we’re still in the process of finalizing our - all of our spend plans for next year, but we do expect it to be consistent with the range that we’ve done in this fiscal year, so somewhere in that 9% to 10% range.

Thank you. And our next question comes from Kaumil Gajrawala with Credit Suisse. Your line is now open.

Hey, guys. Good afternoon. Hey, how are you? Can you talk a little bit about the contribution from some of these innovations over the last couple of years to your depletions at the moment, and then maybe if you want to give some insight on how you expect it to contribute going forward?

Certainly, the Premier introduction has been everything we expected. It’s appeal to a new consumer sub-segment, which is those individuals who are looking for a low-carb offering. And as we noted, we continue to see acceleration, particularly in the on-premise during this quarter. So, we’re very pleased with that. We’ve seen the addition of the bottle format for Familiar, the smaller bottle format has been very good for us as well. As David noted, we overlapped all of those early introductions during this quarter, which I think shows the strength of our overall beer business with our depletion growth on a days adjusted basis of roughly 7.5%. It’s pretty powerful given the lapping that we had from last year of those two introductions. You then add Refresca, which has exceeded our expectations as well. As I noted in my script, the velocity of that is better than one of our key competitors in the FMB space, [indiscernible] and we expect strong things from that in the future as well. It shows that the strength of the Corona franchise and its refreshment DNA that we are able to extend that brand into other sub-categories.

Yes. And I would add to that Kaumil that in our algorithm, we say that we’re going to grow net sales in our beer business high-single digits over the next few years, and 25% of that growth is really made up of innovation, and clearly that includes Premier and the new Corona seltzer that we’re talking about. The other thing I just want to point out to as it relates to our overall growth in the business, we called out the last sell day in Q2, which really drives our depletion growth to that 7.5% range. That has us continuing to grow significant share in the beer business, and a big driver of that is the innovation work within the beer business.

Thank you. And our next question comes from Kevin Grundy with Jefferies. Your line is now open.

Hey, good afternoon, guys.

Hello.

Question, Bill, on the spiked seltzer rollout for next year, so a handful of questions all related to that, based on your internal models, how big do you think the category can become over, say the next 3 to 5 years? How are you defining success for the Corona spike seltzer rollout? And then, how do you think this product is differentiated in what is a fairly undifferentiated product category at this point. The ABV calories and sugar content all sounded pretty similar to the existing brands, of course pace will be paramount, but any comments you have there would be helpful? Thank you.

Sure. I think that’s an evolving answer. I think, everyone has been somewhat surprised by the aggressive growth that we’ve seen in the seltzer business, particularly over the course of this selling season. What I would say is this. I think Corona brings a unique refreshment profile to this particular category. We would expect to gain a significant amount of share in the high-end as we have with anything else that we introduce amongst our franchises relative to the product. I would look very carefully at what we said. This is a zero carb, zero sugar product. I don’t think you will find that with any of the other products that have been introduced into the market. And I’d add one more point. We said on our prior quarter discussions that we would not be entering this category unless we felt we could do it with a superior product with superior margin and profitability structure. I can assure you that this will be a superior product with superior margin and profitability structure versus other competitors in the marketplace.

Thank you. And our next question comes from Bill Kirk with MKM Partners. Your line is now open.

Hey, thank you for taking the question. So just one for me on the transition of the divested wine brands, it seems you are saying the loss cases have had negative growth is the result of distributors maybe not giving those brands as much attention since they may be leaving their houses. One, is that fair? And two, is there an additional aspect of maybe you are not putting as many trade dollars or putting as much spending into those brands since they are leaving your system?

Yes. So Bill, look, we continue to support the brands, but when distributors understand that Brands won’t be in their house, as you said, it’s difficult to get them to continue to drive the brands the way we would like them to. In general, to switch back to our portfolio, we have called out full year depletions for our power brands of mid-single digits. Year-to-date, we’re below that, but we remain confident that we’ll get to that number over the course of the year as a result of the more disciplined execution strategy that Bill talked about in his comments.

Thank you. And our next question comes from Andrea Teixeira with JPMorgan. Your line is now open.

Thank you. So, I was just hoping to be able to kind of reconcile. I know there is definitely a difference between the track channel and obviously what you deplete. But obviously when you when you still look at, so I was just hoping to see if you can reconcile some of the comments on the on-premise and off-premise and granted that you’ve been making a lot of inroads on the on-premise, on cans and also on draft. So I was hoping to see if you’re saying, obviously as the track channels skew more into California where you are, and then always going to trail your numbers, but if you can clarify, I think it would be helpful for investors. Thank you.

Yes. So, Andrea, thank you for that question, because we normally operate with a 200 to 300 basis point disconnect between depletions – our depletions and IRI. Meaning, our depletions run lower than IRI. When you adjust for the sell day and remember that the market data, the IRI data is just 12 rolling weeks. We are back within that 200 to 300 basis point delta, right. So there is not really a disconnect. It’s any more unusual than we normally experienced. So then when you look at individual channel, when we look at the on-premise in aggregate, we continue to grow share in the on-premise being up, we were up in the quarter low single-digits. I think the industry was down low-single digits or somewhere in that area. So, we continue to perform well across all channels for our beer business.

Thank you. And our next question comes from Amit Sharma with BMO. Your line is now open.

Hey, good morning, everyone.

Good morning.

Just two clarifications. One, Bill, you talked about South having a superior margin to competitors, is it also superior to your beer margins as you think about it? And then, the second – for David, so if there’s 200 to 300 basis point delta to IRI is the right metric I mean IRI trends show pretty meaningful acceleration in August and September. So what does it say about Q3 depletions certainly going to be at least looking back at the data, much stronger than what you did in Q2?

Yes. So, I think, to take the first question, we expect all up all into be over time when we’re fully yet scale production in seltzer that we will deliver kind of a similar margin case to the one that we have for the rest of our beer business. And we without really commenting on September depletions, we expect our depletions as I said in my comments to continue to accelerate as we go through the year and we’re past to the launch of last year of Corona Premier and Corona Familiar.

Thank you. And our next question comes from Nik Modi with RBC. Your line is now open.

Thanks. Good morning, everyone.

Good morning, Nik.

I had two quick – good morning, two quick questions. Bill, have you guys tested the seltzer concept yet? I mean I know you’ve already go this pretty fast in terms of the turnaround here, but just curious if you have any things you can share with us on the test market. And then, the bigger picture question is, on the wine and spirits transaction with Gallo, I mean, is – can this deal be revised? Is there a potential to realize more value from some of the brand, but maybe the FTC is looking at with other buyers. I mean, any context around that would be helpful?

Sure. Relative to the question of testing, we obviously have not done a market test. But we, as we always do, when we introduce any new product, we do a battery of consumer testing around it to make sure that we both have the right look. And by that I mean packaging that we have the right flavor profiles that will perform at our better than the competition. As I said in my prepared remarks, we think this product is going to be a demonstrable winner in the category or we wouldn’t have launched it. David, do you want to answer the other?

Yes. So, Nik, we remain confident that the Gallo transaction will get done. We need to work our way through the process to see kind of the final form that it takes. As I called out in my script, and you’ll see in the Q, we will recognize in the third quarter of $300 million loss on part of the dispositions that right and what I mean by that is we have a set of brands including the Gallo brands that we listed out and the Black Velvet brand that we’ve also talked about that. We’re disposing of as a result of the wine transformation that we’re going through, and we’re pretty confident that when we’re done with all of the work that’s required around that portfolio that we’re dealing with that, we’ll end up with neither a loss nor a gain will end up with about a push in that regard. And then, we’ll have our business really well positioned to focus on the high end of the industry and a portfolio that can grow mid-single digits and deliver 30% operating margins.

Thank you. Our next question comes from Rob Ottenstein with Evercore. Your line is now open.

Great, thank you very much and my apologies. But, some – a few more questions on Corona seltzer, tried the product in Atlanta yesterday, it’s a great product, very exciting. What are your thoughts on cannibalization both in terms of your beers and then also in terms of the category how accretive is it’s in the beer category in your view as you kind of 50-50 cannibalizing beer 50 wine and spirits, are you thinking about it differently? And then finally, do you – are you set up for automated lines for the variety pack? Thank you.

Sure. Well, I’m glad you liked it, will add you to our consumer panel next time, Robert. So, we like it as well. Here’s what I would say. We expect that this to be heavily accretive to our overall beer franchise. Obviously the growth that we’ve all seen in seltzers had some impact on our franchise and many other beer franchises during the summer months. But if – I will take you back to what we have done most recently, which is Premier and Familiar, both of which had more than 50% accretion to our overall brand portfolio, with Premier being closer to 75%. So, we would certainly expect that this is going to be very additive to our overall portfolio for the Corona brand franchise going forward, and a big factor is going to be just what you said. These are delicious tasting products.

Thank you. Our next question comes from Lauren Lieberman of Barclays. Your line is now open.

Great. Thanks. Good morning.

Good morning.

Bill, you went through like bunch of stuff in all of the major brand franchises and trends. So when I was thinking about the depletion number, in total with Modelo growing as strongly as it is, they feel like it medium size of rest of the portfolio. In aggregate, it’s sort of flattish. And I guess, is that reasonable and if so like what are the pieces we didn’t really talk about today? Is Corona Extra, Corona Light, we expect you to cannibalize by Premier, but what are you seeing from Corona Extra? And as you think about stepping up spending from here, outside of the seltzer launch, what are the areas in particular that you’re targeting on Corona to accelerate performance? What do you think you can do differently? Thanks.

Sure. We obviously are increasing our support for Corona Extra for the remainder of this fiscal year. And you are correct. Year-to-date, Corona Extra itself is roughly flattish. And there are some obvious interaction between Modelo, which is, as I noted on fire, and Corona. So we would expect a little bit of that movement within our own franchise, but overall the Corona brand family continues to grow. And a lot of that growth remains in things like Premier Refresca with continued strong performance with Corona Extra, given there is a lot of other family members now than there was not so long ago. Pacifico as I noted on the call was up double-digits in depletions during the quarter and we continue to be happy with the acceleration in that area. I realize, Robert – going back to Robert for just a second, I apologize I did not answer your second question about automation. We have an approach that we think is ready to go to create efficiencies within how you pack for a variety pack, which is I am sure the real answer to your question – the real question that you have in your mind. So, we are set up to do that within our current operation structure.

Thank you. Our next question comes from Vivien Azer with Cowen. Your line is now open.

Hi. This is Gerald Pascarelli on for Vivien. Thanks very much for taking the question.

Yes. You don’t sound like Vivien.

So, Bill, mine is on Corona Refresca, just based on some of the share gain commentary that you offered, can you just provide us some color on where you believe you’re sourcing share? And then, maybe some color on specific consumer demographic trends around the brand. Thank you.

Sure. We are still developing some of those answers. As you can imagine, we’re still in the early stage. One of the things that we have noted is that the Hispanic demographic had been generally less aggressive in their adoption of FMBs, but because of their strong affiliation with the Corona franchise, we have noted a strong uptick with our strong demographic base the Hispanic community around Refresca. However, we are also seeing, as you can imagine, this product is largely shelved and largely placed in the cold box in a different place and competes much more with the FMB categories rather than competing with our core Corona offerings. So, we’re very pleased that we’re broadening our audience and broadening our appeal to new use occasions with Refresca and are very bullish on the future for that sub-brand as well.

Thank you. And our next question comes from Dara Mohsenian with Morgan Stanley. Your line is now open.

Yes, hey, guys. So, a follow-up question on Corona seltzer. I guess, can you help us understand why an existing beer brand, albeit one with incredible equity, and Corona is the right choice for a brand in the seltzer category, given it looks like hard seltzer is more of a distinct segment versus traditional beer. And a lot of the companies that have launched brands there have used new brand names instead of the traditional beer brands. So, maybe are you seeking what others is adding but help me understand why that’s the right decision in your minds and what your consumer research is telling you. And then, the second, any concerns over a longer-term brand equity to the traditional Corona beer business from a hard seltzer launch and how do you guys think through that? Right?

You bet. As you can imagine, we tested that question very, very deeply. The whole essence in the whole DNA of Corona is all around refreshment. I mean, when you discuss that across any of the sub-brands, that’s the first thing that comes back in the consumers’ mind is, this is a refreshing beer. It’s a refreshing product no matter in which category falls – fall it fall similarly as a response to Refresca. One of the key elements that the consumer is looking for in seltzer is refreshment. Therefore, the match with that DNA is perfect, to go along with Corona’s core DNA and why we felt that if we were going to enter this category, we would do it with a brand that had deep trust with the consumer. As we noted earlier, it is the number one trusted brand with Hispanics and non-Hispanics 21 to 54. Therefore, we believe this will be a very strong entry in the seltzer space.

Thank you. Our next question comes from Bill Chappell with SunTrust. Your line is now open.

Thank you. Good morning.

Good morning, Bill.

Good morning.

Follow-up on the wine business can you just give us a little more color on the distribution changes, and how that’s – it sounds like there are some collateral damage at least in the near term to your existing brands from the divestiture, and so trying to understand if more color on that and then how you then going forward reduce the dissynergies, it would seem like you would need to continue to have a fair amount of spending behind their – personnel behind there to kind of keep their presence the same?

We have focused our attention on continuing to deliver results against the entire business. There is no question that the transition that is occurring has been distracting to our distributors and to our internal population. With that said, we continue to remain excited by the power brand results of up 6% in IRI during the most recent quarter, and SVEDKA falls into the exact same number 6% growth during the most recent quarter as well. So, we remain very bullish that as we get this transaction completed that what will remain will be high-margin, high growth potential businesses and franchises and brands that are going to be a very strong consumer products play for a long time to come.

Thank you. I’m not showing any further questions at this time, I would now like to turn the call back over to Bill Newlands for any further remarks.

Well, thank you, everyone. I appreciate your joining the call. And let me say, as we close out the discussion of our quarterly results, David and I are both pleased with the strong start to the first half of this year and we remain very bullish on the future performance of our powerful collection of consumer connected brands. Our next quarterly call is scheduled for early January. Please be sure to have a safe and happy holiday season and remember to enjoy some of our great products during your celebrations with family and friends. Thanks again for coming on the call and have a great day.

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.