Welcome to the Constellation Brands Third Quarter Fiscal Year 2020 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode. Following the prepared remarks, we will -- the call will be opened 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 Liz. Good morning and welcome to Constellation's third quarter 2020 conference call. I'm here this morning with Bill Newlands, our CEO; and David Klein, our CFO. As a reminder, reconciliations between the most directly comparable GAAP measure 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 also refer to the news release and Constellation's SEC filings for risk factors, which may impact forward-looking statements we make on this call. Before turning the call over to Bill, similar to prior quarters, I would like to ask that we limit everyone to one question per person, which will help us to end our call on time. Thanks in advance, and now here's Bill.

Thank you, Patty. Good morning and Happy New Year to everyone. I certainly hope you enjoyed the holidays and have the opportunity to include some of our awesome Constellation products in your celebrations with your family and friends. The end of every year is a time of reflection for me, and this year is no exception. As I reflect on 2019 I'm reminded that we're not only ending a certain fiscal year but a dynamic decade the Constellation Brands. Since 2010 constellation has been on an incredible journey marked by strong financial performance and notable business milestones. Over the last 10 years, we've significantly increased the value of our stock and produced double-digit growth in sales, operating income and operating cash flow. As a matter of fact, the closing price of Constellation's stock on December 31, 2009 was just more of than $15. Fast forward to December 31, 2019 we closed at almost 190. This incredible increase of more than 1000% over the last 10 years made Constellation, the best performing stock in the S&P 500 Consumer Staples Index during this timeframe. One of the biggest drivers of our success with the game changing beer acquisition that was executed almost half way through the last decade. It enables Constellation to buy Grupo Modelo brands in the United States where we successfully built these brands for many years, while positioning ourselves for this transformational opportunity. At that time, this deal allowed us to double the sales of our company, diversify our profit stream, significantly enhance our margin, earnings and free cash flow while providing new avenues for growth. Since then, our beer business has made significant contribution to the overall sales, profit and cash flow results for our business and continues to be a powerhouse for growth as the number one…

Good morning everyone and thank you, Bill. It's truly -- pleasure working with you and all of the wonderful people at Constellation. My time as CFO has been exciting, as well as personally and professionally fulfilling. On leaving the company in good hands with Garth as the new CFO throughout his 18 years at Constellation Garth has been a significant contributor to our premiumization and growth efforts while developing an in-depth understanding of the company's business operations and finance activities/. Going forward, we will continue to collaborate on key initiatives as they relate to Constellation's investment in Canopy Growth. I'll certainly miss my interactions with our investors and the sales side analysts who cover Constellation. Over the years I've valued your ideas suggestions and feedback and I thank you for your ongoing support. I look forward to continuing to interact with many of you in my new role at Canopy growth. Now moving to the financials in Q3, we continued to produce strong beer operating performance and cash flow results, our wine and spirits Power Brand strategy is gaining momentum as marketplace performance for these brands continues to outpace the overall category. We also recently closed the Black Velvet transaction revised the original Wine and Spirits deal with Gallo, including a separate but related agreement to divest the Nobilo Wine brand and signed an agreement with Brewing to divest Ballast Point. Before we jump into the financial results, I'd like to provide an update on guidance, we've increased and narrowed our full year comparable basis, diluted EPS range to $9.45 to $9.55. Our increased guidance range primarily reflects the updated Gallo transactions and related timing as well as strong beer operating performance. This range excludes Canopy equity earnings which better reflects the Underlying performance of our core business. We strongly…

[Operator instructions] Our first question comes from the line of Kaumil Gajrawala with Credit Suisse. Your line is now open.

Hey, good afternoon everybody. David Congratulations question on seltzer it's obviously going to be an incredibly competitive category for calendar 2020. What's going to make your your proposition different and how are you thinking about of our marketing spend and investment given that it seems like it's really building up to be a pretty significantly competitive category this summer? And then second separately, on your deleverage comments are you happy to keep the levels that where they are now and everything incremental from here is a buyback to manage to those levels or should we be thinking about it differently? Thank you.

Sure, I'll take the first half of that, we're very excited about Corona hard seltzer in part, just because of the refreshment DNA that's attached to the Corona brand. We obviously have done a lot of product testing a lot of product research to make sure that we have a product that meets or exceeds the other key players in the marketplace. So we are quite comfortable with the sheer quality of the product that we're going to bring to the table. And as usual

Marketing department will bring outstanding consumer communications as I always do around our critical brands. The last thing I would say is, we still believe that there is a lot of upside in the total size of the Seltzer business. It was roughly 60 million cases in 2019. And we believe there could be a 2 to 3 times -- two to three opportunity going forward and we expect to take a significant share of that opportunity.

Yeah comment on the buybacks, our targeted range is three to four times. Our preference would be at the midpoint of the range but now that we're now that we're back in the range we will definitely look to be opportunistic as we move forward.

Our next question comes from the line of Nik Modi with RBC Capital Markets. Your line is now open.

Yeah, thanks, good morning everyone. David, let me -- secondly , congratulations on your new opportunity. So the question is really around, if I can go back to capital allocation still, obviously a lot of investors for years have been concerned about constellation, capital allocation decision and the last few months have been tough right with Ballast Point with Canopy value declines. So maybe just kind of give us a state of the union, from your perspective, kind of what you've learned as an organization from Ballast point in particular and how you think about just capital deployment outside of obviously the buyback stuff that you guys have already committed to you can get people a sense of kind of how you're thinking about it Philosophically as you kind of go into year two of being CEO of this company?

Sure. I think I think one of the things and David just pointed out, we remain as committed as we always have to getting ourselves into the range and as he said, we're pleased that we have gotten into the top end of our range, earlier than we had anticipated. We have a tremendous amount of opportunity with our core existing franchisees you have seen and you will continue to see a relentless focus on the critical categories and brands that we see as high margin, high-growth opportunities and we will invest to take significant share within those where we see issues and problems, much like you point out the Ballast Point or the low end of our wine business, we are prepared to take action to make sure we are focused on where the consumer is going rather than where they have been. And those are two examples of that. I think what that will do -- that will allow us to continue to focus all of our attention on the premiumization play both in the beer business and the Wine and spirits business so that we continue to be the leader and when someone sits in this chair 10 years from now, they'll be able to tell the same story that I just told, which is a great decade of tremendous growth for our company and for our shareholders.

Our next question comes from the line of Vivian -- with Cowen. Your line is now open.

Hi, good morning. My congrats to you, David I really look forward to working with you. It's part of my coverage of Canopy. So, Bill I just wanted to follow up on your commentary around the dislocation that you think hard seltzer is driving based on the consumer insights you offered. You think it's kind of broad-based and it's under indexing to imported beer. How are you think not asking for guidance for fiscal '21, but are you expecting that dynamic to shift given the introduction of Corona hard seltzer and perhaps put it more specifically how much cannibalization might you guys be expecting in terms of interaction between your core Corona offerings and that hard seltzer proposition, thank you.

Well, I think that excites us about the Corona seltzer introduction is that first of all, the category appears to continue to have real strength. And this is a lot of growth potential in it. As I said a moment ago I think there's probably 2x to 3x where it sits today, which creates tremendous opportunity for those of us, we're going to play in the category. I think on our expectation would be that we would have a similar type of cannibalization profile that we saw around Premier, which is as you might recall, was in the 70% to 75% range Incremental so this, we think this is a great opportunity for us. But, I would also encourage all of you on the call to keep in mind as they -- exciting is this launch will be Modelo Especial is likely to be our single biggest grower next year. This continues to be a brand that is absolutely on fire. It grew 15% and the most recent period and it had 30 plus consecutive years of double-digit growth. This is a brand that's going to be and remain a significant foundational play for this company for many, many years to come.

Our next question comes from the line of Kevin Grundy with Jefferies. Your line is now open.

Hey, good morning everyone. And David, I want to extend my congratulations as well. I wanted to pick up on the beer guidance so Bill, you sounded pretty positive. Despite some of the slowing that we saw on the Nielsen data . I think you attributed to pricing, but as I look at the midpoint, if my math is right, it implies about 7.5% organic sales growth. The year-over-year comp is easier if you do get an additional selling day. Can you talk about maybe what you're seeing in the business -- Corona looks a little bit light, Premier looks like it's decelerated a bit, is there anything that gives you cause a bit of pause here with the base portfolio in terms of some deceleration. And then given that as we look at the 7% to 9% longer-term growth that you've expressed confidence in over the intermediate term the fact that we had to tweak it modestly lower this year should that be at all concerning for investors looking out to next year. Thank you?

Sure. No, I think you should be very positive about our expectations around our core business. We were particularly excited that the Corona Extra business returned and renewed in growth in the third quarter. As I stated, certainly the price increases that we talk, particularly in the State of California gave us a very brief factor that you saw in the most recent IRI data, but we do not expect that to have any impact on our longer-term trends in the back as I alluded to earlier, our December depletion growth profile overall was in the high single-digit range, which is ahead of our year-to-date trends. So we remain very very bullish. And when you think about things like Modelo and Pacifico and the addition of our seltzer business. I think you're going to see a continued strong delivery against our business in the range that we had said we would do. And with that we will deliver for this year.

Our next question comes from the line of Dara Mohsenian with Morgan Stanley. Your line is now open.

Hey, good morning guys. Also want to extend my congrats to David. Just two quick clarifications on the beer business. Bill, you mentioned that the high single-digit depletion growth in December. I think that included an extra day though, so ex the extra day what type of rate are you trying to get and then David, you mentioned the contractor and inventory timing benefit of margins in the quarter, can you give us a sense of how much that was. And those are more clarifications, if you give me the benefit of additional question. You guys did comment on the fabulous track record of beer volume growth over the last decade and kudos for that obviously an amazing track record, but if you do look at the year-to-date depletion growth of 7%. It's below that 9% to 10% pace from the prior few years. I know it's close to what you guys originally expected. But just at a high level, taking a step back, just curious for your perspective on if the slowdown this fiscal year, that's just more of a natural maturation as you move the larger case volumes if we should expect sort of a gradual slowdown in depletion over time on larger numbers or if there were more discrete issues driving the sequential slowdown this year and this is not sort of the start of a moderation trend as you look out longer term. Thanks.

So relative to the our depletion trends for the fourth quarter we expect fully expect that our depletion trends for the fourth quarter are going to be in the high single-digit range much like December presented itself. Look we remain extremely bullish about the long-range prospects for our beer business

We are significantly, significantly outperforming the overall category as well as the high end of the category as well and that's before we introduced hard seltzer product, which will compete [indiscernible] admittedly has gotten very big, very fast. So this will provide us with I think renewed opportunity for growth and we are very excited about the cost base for that going into the new fiscal year, obviously as a reminder, we will give fiscal guidance during our next call. So we will refrain from doing that at this point in time but certainly, we're very excited not only about the fourth quarter and finishing our year very strongly but for next year as well.

Yeah there on the contractor settlement even in the year S/4HANA kind of production build that we did in Q3 that gave us a benefit you know these are all a few to several million dollars each. And if you think about last year -- rewind to last year I think in Q3, we had an issue with glass production in the quarter. So we get these impacts every single quarter that are -- call it $3 million to $7 million each and sometimes they kind of aggregate in our favor, sometimes they go against us. But if you look at our total operating margins in say FY '18 we're at 39.5% FY19 we're at 39.3% and this year we're saying we're going to be between 39.5 million to 40 million. I think by the time you get to the end of the year all these little timing let's go away and we end up in a pretty consistent margin range in this business, which I'll point out maybe for the last time is by far our best-in-class in North American.

Our next question comes from the line of Amit Sharma with BMO Capital Markets. Your line is now open.

Hi, good morning everyone.

Hi good morning.

Just a couple of questions, one on beer. Bill talked about the long-term outlook and it looks like you're still confident on high-single digit. Can you talk about Modelo in particular -- still growing double-digit but some people are little bit concerned about the detail that we saw recently. Can you talk about what is in the pipeline from a Modelo perspective. As you look to continue this momentum and then wine David good to hear 30% operating margin outlook still intact with that business. Can you talk about the timeline of the stranded cost as they come out post the divestiture of the lower price brands. Thanks.

Sure, I'd say, and I've said this many times I think Modelo remains the single largest opportunity for this company.

It is just beginning to craft into the general market if this had a very, very strong run with its core Hispanic base and continues to grow with that audience and as many of you know, we do have a great tailwind with the growth of the Hispanic consumer. In the United States, which will continue to give us a tailwind for a fair amount of time, but as you know our advertising in our marketing activities around the Gallo have been expanded to a broader audience and the growth profile within the non-Hispanic consumer is tremendous. So we see our remaining tremendous upside in Modelo going to your question that about what else we will be introducing the more products, so in different size we have size opportunities. And as you all know we have done nothing truly to innovate around Modelo outside of the business which has done extremely well for us. So we think Modelo is going to continue to be a not well into the next decade, and we will likely be the single largest growth product and brand for us going forward.

Yeah, on the topic of stranded costs, it's a bit of the story we told at the beginning of this year, almost on a one-year delay. We, we're saying it's a $130 million stranded costs without getting into specifics, that will be included, when we provide guidance next quarter. You can assume that a quarter to a third of those costs come out in FY '21 the rest in FY '22, because we have the flow through COGS to hit before it hits our P&L, so like FY '23 will be the first real clean year where we can take a look at that, seeing a lot of stranded costs coming up or being [indiscernible].

Our next question comes from the line of Lauren Lieberman with Barclays. Your line is now open.

Great, thanks, good morning. So I was hoping you can talk a little bit about the increased marketing spend on Corona because last quarter. Right you took the opportunity to say look beer profitability is coming in a bit of had a plan, we'll put some extra money behind Corona clearly, there's been some reaction at the same time, the marketing spend on beer came in a little bit light of plan. So if you can just give us some color on why the spend was a little bit lighter kind of plans looking forward, and what in that marketing mix is particularly had a particularly attractive return would be interesting. Thanks.

Sure, and I'll comment on, on the kind of timing of spend and it really is, it's a timing issue. We expect that we will finish the year that said, in the 9.5% to 10% range of net sales. At the same time, we expect

That we will see an uptick in our marketing spend in Q4 this year versus Q4 last year. Some of that having to do with incremental investment behind our core brands, but also some of it having to do with basically production costs around the seltzer marketing campaign that Bill outlined earlier. So I think for marketing for us, it really is just a function of timing as we still are focused on a 9.5% to 10% range.

Our next question comes from the line of Robert Ottenstein with Evercore ISI. Your line is now open.

Great, thank you very much. A couple of just kind of follow up clarifications. First, it looks to us that the price mix was about 1.6%. Can you give us a sense of what that would have been without Ballast Point and then second, following up on some of the comments on Corona seltzer you made some comments that it's being well received by retailers, can you give us a sense of how you see the shelf sets coming out next year where Corona seltzer is going to be positioned on the shelf versus beer versus other white claw. And then if you look at the White claw trends they've been unbelievable. Right. I mean, they've been they're actually increasing share. I think the latest share is something like 67% up from 60. What gives you the confidence that this is actually a hard seltzer segment as opposed to a white claw segment and that there is room for a lot of new competitors. Thank you.

Sure. So let's talk about the sets and where we expect to see Seltzer. Seltzer is in all likelihood not going to take space from our core beer franchise the consumer views it is something different. The retailers viewing it as something different, whether it's on the shelf or in the cold box. So we think there will be a distinct differentiation of product location versus just cannibalizing existing shelf space. That's the way it's been so far, we believe that will continue. This -- the answer to your question regarding whether this is a category or a brand. I think we've solved that answer for ourselves with Research. Our consumer and the seltzer consumer is very interested in the idea of Corona hard seltzer. In part because of what I said earlier, which is a whole refreshment DNA around the core Corona brand. The strength of Corona in that whole refreshment

The Beach experience is perfect for this. As we said earlier, that the these seltzer consumer -- has generally been increasing their overall consumption of the total alcoholic beverage category, which I think speaks well for the overall category of seltzers going forward and the strength of the Corona brand name together with the investment that we're going to make against it, we're quite bullish on it.

And Robert on the price mix question, it might be, if we were just looking at imports, it might be 10 to 15 basis points, but not -- additional to that -- not much more .

Our next question comes from the line of Steve Powers with Deutsche Bank. Your line is now open.

Thanks and congratulations from me to David maybe coming at the beer outlook from another direction. Just coming back and coming into calendar '19 at the beer event in Chicago, you guys are pretty adamant the beer margins would trend flattish, more or less in line with where you finished last year, call it 39.5 as you said. But now we're three quarters into fiscal '20 beer margins have exceeded expectations three quarters in a row, raising the full-year outlook and arguably 4Q would seem to have potential upside embedded in that -- as well. Acknowledging some of the 3Q benefits that could reverse, I guess as you step back does any of that change your go-forward thinking as to where beer margins could ultimately aspire to especially without the recent drag from Ballast. I mean is there, I guess is there a structural upside to your prior outlook or do you attribute the recent strength. Just to some of those timing that's that you had mentioned earlier, David.

So I'll start with that, David, can add as we would like. During that discussion. One of the things we were quite clear about relative to our guidance is there will be some years where things go our way cost are better, FX is better certain things just simply are favorable to what we would view as sustainable long-term proposition around our margin structure, this year has been one of those and we're certainly happy to take it, but it's also realistic to recognize that those things can go either way. As I said, this year it has gone in our favor, and we continue to work. As you would expect on our, on our operational footprint to make sure we are extracting every ounce of opportunity as it relates to cost, but this year on our way and we're quite pleased that it has. David, you want to.

Yeah, -- Steve, I would say that we are, please. I'm convinced we have some of the best operations people on the planet. In order to produce the results that we do on a consistent basis. A new -- caution

Is that -- I think we've been clear about this is that when we are in the launch year from a seltzer standpoint. We know that we're going to be driving towards the high end of our marketing spend as a percent of SG&A range. We also know as I said in my script that there are going to be some drag on gross margins as we come out of the gate on Seltzers. However, we've also said that we believe over time Seltzers don't have to be a drag and we don't expect them to be a drag over time. Right, so I think you're going to see puts and takes in our business as Bill outlined, but I'm actually pretty pleased with the consistency of margins in, as I said 39.5% percent range for three years in a row.

I would just add to David's comments that much like our beer margin structure is best of class. I think you would expect that our seltzer margin structure as we get to critical mass, will also be best-in class versus the competition.

Our next question comes from the line of Andrea Teixeira with JPMorgan. Your line is now open.

Hi, good morning, David. Congratulations also on your promotion and thank you for your work as a CFO on Constellation. So my question is a follow-up on the comment about increased investment on the Seltzer marketing should we budget part of it already in the fourth quarter and also increase in early first quarter in fiscal 2021 because I understand the launch is early -- fiscal year in March, -- early March. So relative to the typical launches or the typical innovation that happens around [indiscernible]. And a clarification, if I will in Shifting gears a little bit for wine and spirits. So the implied fourth quarter wine and spirits profit guidance it's down so far it's down 13% year to date. So the full year is down 8 to 10, which implies that you have an improved performance in the fourth quarter. So if you can elaborate on that as well? Thank you.

Yes, so on marketing spend. Yeah. We expect that that our spend will be up on a year-over-year basis in Q4. And that's -- you can kind of calculate back to get into that 9.5% to 10% range. As I said, that's most likely to be seltzer production marketing production costs and then we think that this has been -- will be a little bit weighted to the first quarter and certainly the first half of the year. Well, we're just getting the product on the shelf. We'll want to make sure that we're driving a consumer activity at that point in time.

Our next question comes from the line of Bill Kirk with MKM Partners. Your line is now open.

Thank you, so I have a quick question on cannabis obviously you've worked with Canopy on the beverage launch up in Canada, and as I understand it Acreage can bring Canopy IP technology including that beverage technology to the US. So I guess my question is, would you want acreage in the US to start making the products that you developed with Canopy.

Yeah, I think the best thing that, so it's not our decision. Let me just be clear about that is acreages decision, but to the extent that we develop outstanding products for use in the Canadian market if Acreage can bring those to the US and they’re comfortable to do so, we think that's a home run all around like throughout our cannabis ecosystem, if you will, that's a benefit to Canopy that's a benefit to acreage in some of our Constellation team has been helpful in making sure that the products are meeting the expectations of the consumer in the marketplace.

Our next question comes from the line of Sean King with UBS. Your line is now open.

Hi, thanks, you called out Refresca as the growth driver, but it's still, it's pretty small in the track channels. Where do you stand in terms of I guess the national rollout strategy and how do you expect Seltzer to interact with Refresca I guess on the shelf.

Yes, we're very pleased with the Refresca, it has outperformed what our expectations were. And we're going to continue to invest behind it to make sure it continues to grow, as I said a little earlier, we don't expect the shelf interaction to get in the way between our Seltzer and our and our Refresca businesses. We think they serve different needs although admittedly, there is some interaction between in FMB consumer and Seltzer consumer. But we think there is room for both of those products in the market and we're looking forward to seeing continued acceleration of both the Refresca franchise as well as the, as well as -- Hard Seltzer when it comes out.

Our next question comes from the line of Bill Chappell with SunTrust. Your line is now open.

Thank you so much. And David, congratulations -- two quick ones. Any kind of guidance on what the peso versus the dollar impacted a beer margins this quarter or is that more to come. In future quarters and then also in terms of kind of what you talked about marketing spend in following Andreas question

Is this, similar, when we look at the first quarter of 2021 to what we saw 18 months ago with the rollout of Premier in terms of kind of pulling forward marketing more spending very front-end loaded or is it more balanced throughout the year?

Yes, so on FX and again, we get some volatility in FX in the IR team. I think that’s a nice job of trying to lock in bumps in the peso which gives us a little tailwind -- especially given the volatility between the USD and the peso over the last couple of years. Right, so we think that in the quarter that was about 60 basis points of impact on margins. And then -- yeah, I think you can think about it a lot like Premier. So kind of the spread throughout the quarters of the year should look just like the Premier launch.

Our next question comes from the line of Laurent Grandet with Guggenheim. Your line is now open.

Yes, good morning, Bill. And David, I'd like to have a question on Corona Premier and Familiar, specifically regarding Familiar when looking at the Nielsen data over the last few payouts. We are seeing an accelerated decline, so is it deliberate choice as it seems, and you keep mentioning it -- you are incurring Corona in the refreshment space that Familiar may not fit and to provide pretty more space for Modelo to grow. And then on Corona Premier growth is plateauing. It seems like it's getting to the size of Corona. So is there any sense you can revamp that brand and reaccelerate the growth or are you satisfied with the current performance of Corona Premier so just one. Thank you.

So relative to Familiar. Familiar continues to do very well, particularly in the core Hispanic community, which is where it was originally targeted. So we continue to think that Familiar is going to be an important part, particularly with the Hispanic consumer in very specific demographics and very specific geographic regional opportunities. Relative to Premier, Premier continues to do very nicely and we're excited about it, obviously there has been some impact. The cannibalization that has occurred has been impacting Light as you would expect to some degree. But Premier also opens up a bunch of new consumers to our franchise as well who are looking more for that low-carb positioning that Premier presents. So we remain very bullish on the future for Premier, and we're going to continue to invest against that franchise going forward. And again, it goes right back to -- we are always pleased when more and more consumers spend more and more dollars against the overall Corona franchise. People believe in this franchise. It is the number one, as I said before, number one most trusted brand with both Hispanic and non-Hispanic consumers 21 to 54 and that gives us the chance to continue to leverage -- new introductions like Refresca, Premier, and Hard Seltzer which is obviously coming in this coming fiscal year. So we remain very bullish on the overall Corona franchise and I think the fact that franchise was one of the few growth brand franchises over the course of the last decade, shows the real longevity for that brand.

I'm showing no further questions in queue at this time, I would like to turn the call back to Bill Newlands for closing remarks.

Well, thanks very much. And I guess I'd be remiss David if I didn't say that all the congratulations you just received are well deserved. We're certainly going to miss you on this side, but we'll be happy to get our 37%. Thank you everyone for joining our call today. Before our closing, I'd like to reiterate what a powerful decade this year been for Constellation our results over the past 10 years are a testament to the dynamic strategic efforts made by our strong management team, through our current initiatives and priorities. We are positioning this company for a sustained long-term success and therefore we are just as excited and optimistic that the next 10 years will continue the momentum into the fourth quarter as well as a strong finish to this fiscal year. As a reminder, during our next quarterly call. As I said earlier, we will be providing guidance for the upcoming fiscal year. So thanks again everyone for joining the call. I wish you all a safe happy and prosperous New Year and new decade thanks everyone.

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