Constellation Brands, Inc.

Welcome to the Constellation Brands Third Quarter 2019 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 questions. Instructions will be given at that time. I will now turn the call over to Patti Jan Erlaub, Senior Vice President of Investor Relations. Please go ahead.

Thanks, Brian. Good morning and welcome to Constellation Third Quarter Fiscal 2019 Conference Call. I'm here this morning with Rob Sands, our CEO, Bill Newlands, our President and COO, and David Klein, our CFO. As a reminder, reconciliations between the most directly comparable Gap Measure and any non-Gap financial measures discussed on this call are included in our news release or otherwise available on the company's website at .cbrands.com. Please refer to the news release and Constellation's SEC filings for risk factors, which may impact forward-looking statements that we make on this call. Before turning the call over to Rob, 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 Rob.

Thank you, Patti. Good morning and happy New Year to everyone. I hope you enjoyed the holidays and got the chance to enjoy some of our fine products during the holiday season. As I reflect on 2018, I'm reminded that I'm very fortunate to be part of the exciting dynamic and ever-changing beverage alcohol industry. I'm also proud of the fact that Constellation continues to be one of the best growth stories in the industry, led by our remarkable high-end beer business, which is generating double-digit top and bottom line growth. Overall, our business is strong and has excellent prospects for future growth, and that's why it's the right time to hand over my CEO responsibilities to Bill Nulands while I assume the role of Executive Chair at the beginning of our next fiscal year on March 1st. Bill has an excellent understanding and appreciation for the values and strategy that have made Constellation Brands one of the top performing S&P 500 companies over the last decade. Since joining Constellation in 2015, Bill has made a significant impact on our company as he's assumed increasing levels of responsibility, finding ways to leverage our unique capabilities as a leader in total beverage alcohol and reinvigorating our innovation engine. The company is in good hands with Bill at the helm, and I look forward to continuing to collaborate on key strategic initiatives as I transition to my position as Executive Chair. As such, Bill will be taking the lead with David and the IR team on all future investor calls and meetings. Over the years, I've valued and appreciated the ideas, suggestions, and feedback I've received from the investment community, and I'd like to thank you for your ongoing support. I'd like to mention that my brother Richard and I recently acquired in excess of one million shares to take advantage of the tremendous value that Constellation stock currently represents. With that said, and as a precursor to my transition to Executive Chair, I believe it's the appropriate time to turn the call over to Bill who will review our business results for the quarter. Bill? Thank

you, Rob. I'm honored to be selected as Constellation's next CEO, and I couldn't be more excited about the opportunity to lead one of the best growth stories in the CPG category. As many of you are aware, in Rob's tenure as CEO, Constellation has delivered an incredible total shareholder return of almost 800%. Rob, that's quite a legacy and certainly a tough act to follow, so congratulations to you. Let's now turn to the business. I have five key takeaways that I would like to emphasize on this morning's call. Number one, Constellation's beer business continues to outperform the U.S. beer market by a wide double-digit margin. Number two, we have plenty of beer capacity in Mexico to meet the incredible demand for our products well into the future. Number three, we're disappointed with the performance of our wine and spirits business as we're facing challenges with the low end of the portfolio. As a result, we've changed our guidance for the year and have taken action by pursuing strategic alternatives to optimize the value of that business. I personally have assumed short-term responsibility for the business to accelerate this effort, and we expect to have more to say in the coming months as a final outcome is determined. Number four, Canopy Growth is committed to achieving their one billion Canadian revenue run rate target within the next 18 months. Number five, we plan to provide 4.5 billion in cash returns to shareholders within the next three years in the form of share repurchases and dividends. So let's take a moment to discuss each of these points in the order that I outlined them, starting with beer. High-end beer is driving virtually all the U.S. beer category growth, and Constellation, as the leader in the high-end beer, is driving a significant portion of that growth. As a matter of fact, in the month of December, which is the largest month of our fourth quarter, beer depletions accelerated to a rate that was ahead of our fiscal -to-date growth rate of 9%. Our beer business marked the highlight of our third quarter, driven by Corona and Modelo brand families, which continue to be fueled by strong velocities, excellent distribution gains, and highly incremental innovation. Corona Premier, Corona Familiar, and Modelo Especial achieved winning spots as the top three high-end U.S. beer industry share gainers for the quarter, while Constellation's overall high-end beer business was the most significant share gainer in the U.S. beer market during this time frame. Modelo Especial continues to have incredible momentum as the number one growth driver in U.S. beer, and it is now the number one beer overall in the state of California. Strong NFL media support during the quarter for this brand provided the reach to expand market share with general market consumers, while maintaining its leading position with the growing Hispanic consumer base. The Corona brand family's depletion growth has roughly doubled to 8% this fiscal year, fueled by -than-expected performance from our fiscal year 19 innovation initiatives, Corona Premier and Familiar. And we continue to see growing household penetration with Hispanic and non-Hispanic consumers for our Corona brands. I'm extremely pleased with Premier's -in-class incrementality, which is driving value for distributors and retailers as a trade-up option for consumers in the growing -for-you space. Corona Premier has already become one of the top growth contributors in the high end, and we believe Premier continues to have ample runway for growth, as it's sourcing much of its volume from the more than one billion cases of declining domestic lights. Corona Extra continues to provide the strong foundation needed for the portfolio to grow, with strong brand equity as the number one most loved brand among Hispanic and total population drinkers aged 21 to 54. There also continues to be plenty of runway for future Corona Extra growth, with incremental contributions from draft and canned formats, as well as the Coronita product. We also have a very strong beer innovation pipeline now and for the future, with ample opportunities to increase distribution and space across our portfolio. Corona Refresca is one of these opportunities, and based on our consumer research, is more than 80% incremental to our growth. It's our strategy to complement our import portfolio and lay the foundation for future success, with domestic, sustainable, and alternative beverage alcohol products that appeal to general market and Hispanic consumers. Now, turning to the operations side of our business, we are currently putting the finishing touches on the final NAVA capacity expansion, which we expect to be complete by this fiscal year-end. This marks an incredible feat of expanding capacity to 30 million hectoliters over the last five years, on time and on budget, while providing ample supply to meet the growing demand for our beer portfolio. We also continued the new expansion phase at our Overgon Brewery, with design, site work, and utility installations in various phases of completion. Based on our progress to date, we now believe the new 5 million hectoliters expansion at Overgon will be completed ahead of schedule by the end of fiscal 21, which is about one year ahead of the original timeline for this project. Construction also continues at Mexicali, with brew house tanks in place and warehouse and packaging buildings near completion. While the political environment in Mexicali has been challenging, Constellation has adhered to all regulatory obligations in accordance with Mexican law, which has been verified by the Secretary of the Interior in Mexico. In any event, upon completion of our planned 5 million hectoliters expansion project, Mexicali will only represent 10% of Constellation's total beer capacity in Mexico. The capacity we have built in Nava, plus Overgon when completed, will provide more than 400 million cases of beer, which is ample supply for several years to come. Shifting now to wine and spirits, we are currently taking advantage of the premiumization trends that have accelerated in the U.S. wine market, with virtually all the growth being driven at the greater than $11 retail price point. And that's where we're focused. In the last 52 weeks, we outperformed the U.S. wine market at the greater than $11 level, with several of our focus brands growing double digits in IRI channels during this time frame. We believe we have unique and ownable positions with powerhouse brands like The Prisoner, Kim Crawford, Mayomi, Robert Mondavi, and Schrader, to name just a few. Not only do we have powerful brands at these price points, but our innovation engine is focused on premiumizing the portfolio with mixed and margin-accretive brands. Our innovation efforts are paying off with successes like Mayomi Rose, Spedka Blue Raspberry, and Cooper and Thief Rye Barrel-aged Cabernet, all of which are exceeding our expectations. Another great example of innovation success, and a turnaround story as well, is Robert Mondavi Private Selection, which is currently the second most significant growth contributor to the Cabernet Sauvignon category, driven by the Robert Mondavi Urban Barrel-aged Cabernet, a brand that equally has exceeded our expectations. My goal for the wine and spirits business is really quite simple. It's to drive a powerful portfolio of high-end wine brands that consistently deliver growth, exceeding the trends in the U.S. market, with an operating margin profile in the 30% range. Now turning to our leading position in the cannabis market through our investment in Canobie Growth, we are seeing strong consumer demand in the Canadian recreational cannabis market. According to the Canadian government, as of the third quarter of calendar 2018, Canadians spent at a run rate of almost $6 billion on cannabis products, the majority of which were purchased illegally for non-medical use. As we've discussed, we believe the emerging cannabis space represents one of the most significant global growth opportunities of the next decade, and frankly, our lifetime, an opportunity that is opening up much more rapidly than originally anticipated. And on that point, the 2018 U.S. Farm Bill was recently passed with one of the key components of the legislation legalizing production of industrial hemp, including CBD, a non-psychoactive cannabis compound that is believed to have significant medical benefits. It also amends the U.S. Control Substances Act by removing hemp-derived CBD products from Schedule I and allows states to regulate the production and sale of hemp. Canobie Growth provides a single platform for Constellation to address all global markets and product formats, including both CBD and THC. They announced in a press release earlier this week their position and advantages relating to the U.S. market entry for CBD products, and they are currently awaiting FDA guidelines pertaining to the sale of these products in the United States. Since our investment in August, Canobie has used the proceeds to bolster their global leadership position in the cannabis industry with strategic partnerships and acquisitions, including EBU, a leading hemp research and innovation firm, Storz and Bickel, a profitable global leader in vaporizer design and manufacturing, and Battelle, who is the world's largest nonprofit R&D organization. Canobie and Battelle will work together to advance cannabis medical research and product development. In addition, Canobie continues to focus on intellectual property development across medical and recreational opportunities, while also preparing and creating brands and products for new legal recreational cannabis markets across various product formats that will be sold through new and existing channels. It is these initiatives that give me confidence that Canobie can and will achieve their $1 billion Canadian revenue run rate target within the next 18 months. In closing, as the growth leader in the total U.S. beverage alcohol space, Constellation has a stable, core consumer franchise market with growth prospects that exceed those of our competitors in this sector. And our investment in Canobie growth provides an even greater long-duration growth play, which we believe is being valued as a free-call option today with significant value in the future. Combine this with our powerful cash generation capability and our desire to quickly de-lever and return $4.5 billion in cash to shareholders through a combination of share repurchases and dividends. Those in combination make Constellation a compelling investment for the future. And with that, I would like to turn the call over to David, who will review our financial results for this quarter. Thanks, Bill,

and

good

morning, everyone. With a lot of volatility in the equity market and knowing that our investors must continue to assess where they can get the best returns, I want to offer to you why we believe that Constellation provides the best combination of growth and cash returns to shareholders within the CPG space. We've grown comparable basis diluted EPS at almost a 20% CAGR over the past three years using the midpoint of our updated FY19 guidance. We remain committed to our algorithm of a 10% comparable basis EPS growth CAGR on a mid to high single-digit net sales growth CAGR over the medium term. This may not be straight-line performance, giving change in consumer preferences and economic volatility, but we're confident we'll deliver on this commitment. In addition to our growth prospects, we believe Constellation is also a cash return story. We plan to return approximately $4.5 billion to our investors over the next three fiscal years in the form of dividends and share repurchases. This goal is supported by our historically strong cash flow generation and the ramping down of the capex needs in our beer business. It assumes we quickly delever back into and operate within our three and a half times targeted leverage ratio range as we remain committed to maintaining our investment grade rating. It also assumes we exercise the canopy warrants that expire in November of 2021. Our canopy investment is like a venture's investment, which positions us to use our capabilities in building brands in a regulated industry to take advantage of the legitimization of an emerging $200 billion global industry. The impact of canopy on our income statement will be reflected as non-cash equity and earnings from an unconsolidated investment. This will not limit our ability to return cash to our shareholders. In terms of non-cash performance today, we recognize $1.2 billion of unrealized net gains on our investment through the end of Q3. As Bill said, we fully expect canopy to achieve a $1 billion Canadian net sales run rate within 18 months, and we continue to expect to receive outsized returns on our total investment in canopy. Now let's look at our Q3 performance where I'll generally focus on comparable basis financial results. Q3 represents another quarter of strong execution by our beer business, which generated double-digit net sales in operating income growth. These strong results coupled with tax favorability helped us to deliver 18% comparable basis diluted EPS growth for the quarter. For beer, we continue to outpace the rest of the beer category by a consistently wide double-digit margin. Net sales increased 16% on volume growth of 14%. In addition to strong demand, shipment volume also benefited from timing as fiscal -to-date shipment and depletion volume are now fairly aligned. -to-date depletion grew 9%. Beer operating margin decreased 60 basis points to 37.3%. This reflects higher marketing as a percent of net sales, which increased 70 basis points to almost 11%. Favorability in pricing, FX, and SG&A were offset by higher COGS primarily related to increased transportation. In addition, we experienced higher glass costs in the quarter due to a non-recurring raw material supply issue that impacted glass production at the Nava Glass Plant. This supply issue has been rectified. Gross margins for the quarter would have been flat when excluding this impact. Depreciation expense increased $10 million to $52 million for Q3 and $30 million to $152 million for the fiscal -to-date period. For wine and spirits, shipment volumes and net sales were flat. Operating margin increased 70 basis points to 27% as SG&A favorability and pricing benefits were partially offset by unfavorable mix. Our comparable basis interest expense increased 14% for the quarter and our net debt to comparable basis EBITDA leverage ratio moved up to 4.6 times at the end of November from 3.6 times at the end of fiscal 18 primarily due to the additional canopy investment financing. Our cash generation profile is strong as we expect our business to produce over $2 billion of operating cash flow annually. This positions us to quickly de-lever back into our targeted leverage range and return cash to our shareholders as I outlined earlier. Our comparable basis effective tax rate came in at .1% versus 19% last year. The decrease primarily reflects benefits from tax reform and increased stock-based compensation benefits. This rate came in lower than our previous guidance due to higher than forecasted stock-based compensation benefits and a lower than expected effective tax rate on our foreign business. Now I'd like to provide an update on fiscal 19 guidance. For BEER, we expect fiscal 19 net sales growth to be at the high end of the 9% to 11% range including 1% to 2% pricing benefit on our Mexican portfolio. This guidance implies depletion growth above the 9% -to-date depletion rate. Volume growth will lag depletion growth in Q4 due to timing in a tough compare. We also expect operating margin for BEER to approximate 39%. This would represent a 50 basis point decrease versus last year's .5% operating margin and our previous guidance which implied a relatively flat operating margin result in fiscal 19. Forecasted transportation costs are driving gross margins to be fairly flat compared to our previous goal of gross margin improvement for the year as the benefit from pricing is being largely offset by the higher transportation costs as well as higher depreciation expense. We believe holding gross margin for the year is an impressive result given the unfavorable gross margin impact we've experienced from transportation costs for the first three quarters of the year. We've been able to accomplish this result in part from the operational cost and efficiency initiative that we have underway and which we expect to continue into next year. These efforts are important as we continue to expect some transportation cost headwinds as we move into fiscal 20 as drivers and freight lanes are expected to remain in short supply. We expect fiscal 19 marketing as a percent of net sales to be at the low end of our targeted range of .5% to 10%. This compares to last year's 9% result. This year's incremental marketing investments are primarily in support of our very successful Corona Premier and Corona Familiar product introductions along with Medello Especial which along with Medello Especial were top share gainers this quarter. Going forward, we expect our marketing as a percent of net sales to fluctuate within the 9% to 10% range and may move toward the higher end of that range depending on the magnitude of our innovation. Moving to wine and spirits, year to date US shipment volume has outpaced depletion volume primarily due to timing. This timing benefit is expected to reverse in Q4. As a result, we now expect fiscal 19 wine and spirits net sales and operating income to decrease low single digits compared to our previous guidance of 2 to 4% net sales and operating income growth. In addition, we've updated our interest expense projection to a range of $380 to $390 million. This now includes $55 million in additional interest expense related to the financing of our $4 billion canopy growth investment. This has an approximate 25 cent impact on our fiscal 19 comparable basis diluted EPS. We continue to expect our fiscal 19 comparable basis effective tax rate to approximate 18% which implies a Q4 rate of approximately 19%. This higher Q4 rate is primarily due to lower than expected benefits from stock based compensation. Finally, I'd like to note for fiscal 19, we expect weighted average diluted shares outstanding to approximate 196 million shares, corporate segment expense as a percentage of net sales to approximate .5% and net income attributable to non-controlling interest to approximately 20 to $25 million. Due to the factors I just outlined, we now expect comparable basis diluted EPS to be in the range of $9.20 to $9.30 per share. Excluding the impact of the incremental canopy related interest expense, comparable basis diluted EPS for our core business will grow almost 10% for fiscal 19. We remain on track to generate over $2.3 billion of operating cash flow and $1.2 to $1.3 billion of free cash flow. And now a few additional words about our canopy investment. We'll be accounting for our November 2017 initial common share investment and the additional common share investment which closed on November 1st of 2018 under the equity method of accounting. As of November 1st, our canopy ownership totaled 123 million shares. This represented approximately 37% of the outstanding common shares of canopy growth. This portion of our canopy investment will not change in subsequent periods due to the fluctuation in canopy stock price. Instead, we'll see fluctuation based upon our share of canopy earnings. The equity in earnings for our share of canopy earnings will be reported on a two-month lag. Therefore, canopy's earnings for November and December, which is included in their Q3 results, will be recognized in Constellations Q4 results. Our canopy warrants are recorded at fair value. Market fluctuations will therefore flow through our reported earnings. We'll continue to exclude changes in the fair value of these warrants from our comparable basis earnings. I'd like to emphasize that the recognition of our share of canopy earnings in our income statement will not impact Constellations cash flow. To reiterate, canopy's equity in earnings are a non-cash flow item for Constellation. We continue to evaluate the potential equity in earnings impact to fiscal 19 and fiscal 20 results from the canopy investment, including any potential comparable adjustments related to the transaction. As a result, canopy's equity in earnings impact is not factored into our updated fiscal 19 comparable basis diluted EPS guidance range of 920 to 930. When we begin recognizing our share of canopy earnings, we will adjust canopy's reported IPRS results to U.S. gap. As such, the fair value accounting impacts related to canopy's biological assets and inventory will not be reflected in our gap or comparable basis results. However, our gap and comparable basis results will reflect amortization expense related to the fair value allocated to canopy's intangible assets. In addition, I would also note we currently expect stock-based expense related to canopy's acquisition milestone payments, as well as other certain fair value changes to be excluded from our comparable basis results. When we provide guidance for fiscal 20 in early April, we will continue to provide net sales and operating income growth targets for our beer, wine and spirits businesses in order to highlight the underlying earnings power of our core business. Separately, we expect to provide guidance related to canopy's non-cash equity in earnings and the estimated interest expense associated with the canopy investment and how these items will impact Constellation's P&L. This approach will highlight the strong financial growth and cash generation capability of our core business, which we believe is not currently reflected in our valuation. With that, we're now happy to take your questions.

Thank you, sir. Ladies and gentlemen, at this time, if you would like to ask a question over the phone, please press star and then one on your telephone keypad. To everybody participating in today's Q&A session, we ask that you limit yourself to one question in the interest of time. If your questions have been answered or you do wish to move yourself in the queue, simply press the power key. And our first question will come from the line of Dara Monsain with Morgan Stanley. Your line is now open.

Hey, Dara.

Hey, good morning, guys. So my question is around the trajectory of beer depletions going forward. Fiscal Q3 was a bit softer than we've seen from you guys historically at 8%, but it sounds like you're off to a good start so far in fiscal Q4. So, you know, help me understand that slowdown in Q3. Was it more just industry softness is dissipating a bit now? And just any thoughts around if your forward beer depletion growth can hold up if the industry trends remain softer would help? And then specifically on the innovation front going forward, can you give us some detail on if you think Premier can grow next year, year two post the launch, and the reasons why, and just any frame of reference for how big you think for Fresca can be next year? Thanks.

Sure. Dara, a couple of things on the depletion trends. As I mentioned during my prepared remarks, our depletion trends in December were actually up higher than our -to-date rate, which was at 9%. So we're still very comfortable with the growth profile of our business. What's also important to note is that our share gaining performance during that quarter remained consistent with our share gaining performance over the course of the year. So our delta to the market remained very, very strong, and we're confident that this is going to be a continuing trend. Relative to innovation, we think there's a lot of runway yet to go in Premier. We continue to see accelerating velocities in that business, and we expect that that's going to be an important part of our overall mix for our Corona brand family going forward. Lastly, Refresca, well, it's a little early to tell. We're extremely excited about this. Our research and our testing that we've done on Refresca suggests this will be over 80% incremental to our core franchise, and will bring new customers into our business. So we think this is going to be a tremendous launch that will occur during the early part of our next fiscal year.

Thank you. And our next question will come from the line of Bonnie Herzog with Wells Fargo. Your line is now open.

Thank you. Good morning. Hi. I have a question on beer gross margins. I guess I'm still trying to reconcile what you guys said during your last quarterly call in terms of costs and things being more transitory, especially transportation. And then you also talked about several COGS improvement initiatives that were underway to help offset some of the cost headwinds. So could you give us an update on those initiatives? You know, did something change with timing since they didn't really help to offset some of the gross margin headwinds that you faced in the quarter? I guess I'm still trying to reconcile maybe what went wrong in the quarter and then how we should think about gross margins for the full year. You did mention they'd be flat instead of improving, but I just want to make sure they're not worse than flat. Thank

you. Yeah, no, we're still comfortable with flat, Bonnie, and if we kind of break down the Q3 gross margin, the transportation and logistics headwind accelerated a little bit for us in Q3, but we still, because of the productivity initiatives, we still were well on track to at least maintain our margins in the quarter. And then we had an issue with some raw material inputs into our glass facility in Nava, which caused us to have to slow down the furnaces and lower throughput for the plant in Q3. That's a one-time issue, but it created a headwind that the other, you know, that in addition to the freight headwinds, we weren't able to overcome. But again, other than a slight acceleration of transportation and logistics cost headwind and the glass issue, you know, we remain on track with where we thought we would be with gross margins.

Thank you. And our next question will come from Nick Muddy with RBC Capital Markets. Your line is now open.

Thanks. Good morning, everyone. So I guess the question is on the wine business and you're talking about some of the strategic alternatives. I know it's probably too early for you to give us some finite viewpoints, but maybe help us understand some of the options you might have available to you. I think there are some discussions in prior meetings about perhaps regionalizing some brands, or, you know, even making some of the brands private label, certain retailers, and maybe you could just help us understand kind of how we should think about it.

Sure. I think, Nick, the way we're thinking about the wine business is this. We have an entire stable of brands that generate outstanding gross margins and have high-growth profiles at the high end of our business. You know, as you've heard me say before, something like Kim Crawford has a 68% gross margin. It's a terrific business, as is Naomi and many of our other brands, and the prisoner and things of that nature. We have been challenged by the lower end of our business, which in totality has been flat to down and we continue to be slightly overweighted into that sector of the business. So we, as we've said before, are taking a strategic look at what our portfolio should look like going forward, which could include disposition of some of the lower end of our portfolio. Our long-term view is that the high end of the business, which is in our judgment primarily driven by over $11 price point, is where we're going to get the kind of margin structure and growth profile that we think we would like to see for our wine business going forward.

Thank you. And our next question will come from Steve Powers with Deutsche Bank. Your line is now open.

Yes. Hey, thanks. So I really want to just pick on the $4.5 billion in cash return and just some clarifications around that. I'm assuming that's a fiscal 20 to 22 statement. Just want to get that out of there. And then any color you can provide on sort of the cadence of that cash return. And as you think about the cash return alongside maintaining the targeted leverage ratio, I know you said you want to de-lever to three and a half times and then exercise the warrants, which presumably puts you back above three and a half. So as we think about the capital structure over that alongside that $4.5 billion in cash return at the end of it, are you anticipating to be at three and a half times or be above that as you think about the next three years? Thanks.

So Steve, when we think about that, first of all, this isn't necessarily new news in that our company generates a lot of cash and we know that we're going to have capex ramping down over the next few years, the capex related to our beer business. And so we have a targeted leverage ratio of three and a half times, although we're willing to operate in that three to four times range. And we're really confident that we'll be able to both return $4.5 billion worth of cash within our targeted leverage ratio range and exercise the canopy warrants. And I think that's a pretty powerful view of the ability of our business to generate cash. And we don't expect that there would be any share repurchases in the remainder of FY19 just given where our leverage ratio is. So clearly your point about it being an FY20 through FY22 statement is accurate.

Thank you. And our next question will come from Vivian Azer with Cowan. Your line is now open.

Thank you. Good morning.

Hey, Bill. I'm Joe Lee.

I wanted to touch on wine as well, a two-part question, please. Number one, can you call out anything specific that drove the magnitude of the deterioration over the last three months in the low end? Bill, I heard you loud and clear that the low end has been a problem, but given the magnitude of the guide down, it seems like something changed and changed pretty recently. And then the follow-up to that is, how do you think about the impact of potential asset sales in wine impacting your ability to be a category captain or a category leader in that category? Because I think historically one of the cases for having a broad wine portfolio was that scale gave you a lot of influence at retail. Thank you.

Well, certainly the growth profile of the wine business, I think, is going to continue to be in that $11 and up. We've seen premiumization be an ongoing play for years and years and years, and I don't see that changing any. Therefore, I wouldn't see that there would be a lot of difference in the whole question of being able to put category captaincy. People look for organizations that have growth profiles and for people that have deep consumer understanding of where the market's going and why. Relative to the decline in our low end business, which is reflective in the earnings position, we've certainly seen that, and we said this last quarter, our shipments have been ahead of our depletions. That is partially driven by our desire to make sure we had adequate inventory levels heading into the holiday season, and frankly that needs to correct in Q4. The low end of the business, which we've said we are looking at strategic alternatives, has suffered the most, and that's not surprising when you make a statement of that ilk.

Thank you. And our next question will come from Lauren Lieberman with Barclays. Your line is now open.

Thanks. Good morning. I think you've been pretty clear on the Canopy impact on the P&L and delineating cash versus non-cash impacts to net income. But I do think that there's a lot of concern out there around the degree to which you will see dilution to your earnings base in fiscal 20 and beyond from Canopy. So you talked about the billion Canadian in revenue. Anything that you can add in terms of the current outlook for Canopy's earnings, my understanding from them is that they intend to report Canada separately, so even if they reinvest profit dollars to establish U.S. or whatever it may be, that we'll see they're executing in Canada. But anything you can offer I think would be really helpful because people are struggling with the 20 kind of number that we should be relying with here. Thanks.

Yes, Lauren. So we expect and we've said this, this isn't Canopy now, this is really Constellations View. We expect the Canadian business to be at that billion dollar Canadian run rate. We expect them to have very attractive CPG-like operating margins within their business. And that's focused on Canada. And we also know, as you pointed out, that there will be drags on their business from investment in R&D and the cost of opening additional markets. So, you know, we said that we expect that this transaction will be accretive to us by FY21 and we expect that to be the case, or we continue to expect that to be the case. In terms of actual guidance in the near term for Canopy, we're not in a position to provide that primarily because they've just closed their recent quarter. They'll produce results in mid-February. And shortly after that mid-February results come out from Canopy, we'll then provide a bit of a walkthrough for the market on how those actual results will flow through our P&L and that'll be the first time we do it. And then clearly when we provide guidance, we'll provide more specificity around the Canopy Equity and Earnings number. But, and I know you said we've been clear on this, but it's a non-cash measure. We're viewing this as a venture's investment. We've already made that investment. That was the four billion dollar investment that we closed on in November. And, you know, we expect to get an outsized return on that investment understanding there's going to be some volatility in our P&L. However, that volatility will be non-cash in nature.

Thank you. And our next question will come from the line of Amit Sharma with BMO Capital Markets. Your line is now open.

Hi, good morning everyone. Amit. Well, a quick clarification on wine and then beer business. So you said overshipping will clear in four quarters. Should we expect that impact to drag into fiscal 20 or by the end of 4Q you would have achieved the right inventory level for wine? And I have a beer business question.

Sure. No, we expect the way we have traditionally run is no matter what our situation is coming into the fourth quarter, we get our depletions and our shipments to balance during the course of the fourth quarter. So we would not expect that this would have impact on next fiscal year. Thank you.

And our next question will come from the line of Andrea Taxiera with JP Morgan. Your line is now open.

Thank you. Good morning. So in terms of the capital allocation for the strategic alternatives for the wine brands, would an outright sale be doable in their view? And if so, what is the prior views of capital as you said before in the prepared remarks? But could you please rank if that would be based on the debt first, buybacks and leaving the warrants for canopy for after when you see your own cash flow generation?

Yes. So in terms of any proceeds of any asset dispositions that may come up over a period of time, we would first make sure that we're comfortably within our targeted leverage ratio range. And then beyond that, as we've committed today, we'd be focused on returning cash to our shareholders. You know, with respect to the canopy warrants, and I want to be really clear about this, we're going to return four and a half billion dollars to our investors and we can fund the canopy warrants. However, we'll only fund the canopy warrants if it makes sense and the business is unfolding as we expect when we get into November of 2021. So if that business is going well, we think our investors will be happy for us to exercise those warrants. And if the business isn't going well, we'll have a lot more cash to return to our investors.

Thank you. And our next question will come from Judy Hong with Goldman Sachs. Your line is now open.

Thank you. Good morning. So I guess my question is around the Corona brand family performance and, you know, recognizing that obviously this year you had a very good performance on Premier and Familiair. Bill, I'm just wondering, what do you think is going on with the extra in terms of velocity being down this year? And then as you think about next year, do you think that the broader Corona franchise can continue to grow at this 70% even if Corona Extra is down a bit next year?

Yeah, one of the things that you see going on with Corona Extra is a good news, what I would call a good news, bad news situation. Premier has done so well. And even though the incrementality is over 70%, which is phenomenal, the better it does, the more it has some impact on our other franchises from which it does take some cannibalization. So, you know, and obviously as you have all seen, Corona Premier has virtually done twice what we expected it to do heading into this fiscal year. So it's been a phenomenal success. What I do believe is that the Corona franchise continues to have significant upside across the entire brand family. And just as a marketing belief, I think that the more Corona brand family we can provide to the consumer and that the consumer buys is outstanding for the long-term equity of the Corona brand family. So we're very optimistic. And if you then in turn add Corona Refresca, which brings a whole different consumer profile to the table, as I said during my prepared remarks, it appears that that will be at the high end of the incrementality that we saw with Premier, which was best of class. So again, this will help to enhance the number of times that consumers in this country are picking up a Corona brand family product. And I think that speaks very well to the long-term franchise of Corona.

Thank you. And our next question will come from the line of Robert Ottenstein with Evercore ISI. Your line is now open.

Great. Thank you very much. So a lot of questions came in to us on the gross margin for beer. And you addressed some of it, but I just want to kind of touch on a couple of points. One, you know, shipment's really strong. All things equal, you would think the shipments would have been a benefit for the gross margin in the quarter. However, there could have been additional transportation costs related to that. Can you address that? Second, on the gross margin, looks like you got around 2% pricing for beer. Is that right? And then finally, roughly what quarter do you think the transportation costs will start to ease? Thank you.

Yeah, so Robert, the pricing, so if I do kind of a bridge out of our gross margin numbers, we got about 110 basis point benefit from pricing. We got a little bit of benefit from AFFACS. We had about 160 basis point drag from transportation and logistics, which is larger than it's been on a -to-date basis. That's the acceleration that we were talking about. And then as I said, we had some drag from the glass issue, which was in aggregate, that and maybe some depreciation amounted to about 80 basis points. So a couple of things happen when we get into Q3, and that's that even though we're shipping more, we're actually slowing down our production because it's our lowest kind of production quarter of the year. And so I think, you know, taken all together, the gross margin worked out as we expected, but for the glass plant, the glass production issue, which is behind us.

Thank you. And our next question will come from Kevin Grundy with Jeffreys. Your line is now open.

Thank you. Good morning, everyone. I wanted to come back to Canopy, just given the importance here in the focus among the investment community. Can you drill down a little bit on the Canada rec rollout? I think you said you're seeing strong demand. I'm not sure if there's anything more you can add to that, even relative market share, 30 to 40%. Another question, beverage rollout expectations. I think the discussion has been around calendar Q4. Maybe if you can sort of frame the opportunity and what you're expecting there. And then just last on the long-term guidance, what gives you confidence at this point on the billion within 18 months? And then, David, maybe you could just confirm the 30 to 40% operating margins as well for Canopy. I think you said CPG-like margins. I just want to confirm that you're still confident that 30 to 40% is operating margins, the right number. Thank you.

Sure. Why don't I take the first piece of that, and I think David will take the last piece of that. Let me just remind everyone up front that we are in a quiet period. They are in a quiet period at this point in time. So we will be reflecting things that have been in the public domain. Yes, Canopy has been progressing with the kind of market share, which we have said before, is in the 30-plus percent range of the total cannabis business in Canada. We also, if you recall, projected that the Canadian market, as part of our total global projections of where we thought the market would go, would be in the five to seven billion range. And just this past week, the Canadian government has estimated that the consumption of cannabis by Canadians in the third quarter was at a run rate of 5.9 billion, which of course is right smack in the middle of what the initial projections were. I'll remind everyone, beverages are not currently available in Canada. We expect, and Canopy expects, that that will change later this calendar year, but an exact date of that has not been defined yet. But I can assure you when and if that eventuality occurs, and we certainly expect that it will, the Canopy will be in a position to take advantage of that opportunity.

And the only thing I might add to that, Bill, is the 5.9 billion number quoted by the Canadian government includes, a majority of that is illegal sales. So really, the build to a billion dollars is dependent upon the channel shift, if you will, from illegal markets to legal markets, of which we're comfortable with the market share that we've outlined before for Canopy. And I would say that after Canopy's results are released in mid-February, they will have a lot more to say about their margins as will we.

Thank you. And our next question will come from the line of Pablo Osanic with SIG. The line is now open.

Thank you, and congratulations, Bill, on your appointment. Look, just a quick question. I want to go back to what Judy was discussing. I'm trying to understand better the cannibalization or the opportunity for Premier and Familiar in terms of further distribution gains. The numbers we are looking at, Corona Extra, the core brand is down about 10%, Corona Light down about 20%, Modero Especial, which I think has been cannibalized with Familiar, has accelerated from the 19% range to 10%, 11%. So there is an impact. And according to our data, 80% of your growth in the fourth quarter of November was really Premier and Familiar. Yes, the two brands have done great. So the simple question is, as you rolled out those brands, did you have to take existing space from your current portfolio or did you gain new space or are you in the process of converting that and expanding space? What are the opportunities for Premier and Familiar or even Refresca eventually if it does well in on-premise restaurants, in draft, if you can expand on that? Because I think there is a question mark here. Depletions up 10% in the last two years, this year running 9%. What happens next year when you're so dependent on these line extensions? And I'm going to stick to one question, but if you can just at the very end, as you have more extensions and you add more complexity to a portfolio, does that in any way affect your profit margins in beer? Thanks.

Sure. So let me answer the last one first. Any of the products that we have discussed, meaning Familiar and Premier and so forth, we're agnostic as to which product actually gets sold. The margin and profit profile, those individual products are virtually the same. Relative, so let's go back for just a minute to the question of cannibalization. As we have seen the cannibalization exactly as we expected, in fact, if anything, it's been slightly less, meaning more incremental than we had expected with Premier and Familiar. One of the things that we have done extensively and we are continuing to do, and I think your point's a good one, is we have had the Shopper First initiative where our emphasis has been based on in-store research as to what an appropriate shelf should look like that focuses on the right set of brands for retailers to maximize their benefit in the beer section. Of course, the beauty of that is we actually come out pretty well on that issue and that opens up significant opportunities for us to expand distribution and shelf space. And frankly, we need that shelf space because our portfolio, with its sheer gaining performance, really demands that kind of shelf placement improvement. I would also mention that Refresca, which you asked a question about, will probably not be sitting in the middle of the beer section. This is an alternative beverage alcohol product that will be placed in a different door of the cold box and will compete with other brands not necessarily directly within our franchise and we think this is great because it opens up another window coming from the great equity that Corona has and has had for many years.

Thank you. And our next question will come from the line of Tim Renne with Pivotal Research Group. Your line is now open.

Thanks so much. I understand your commentary on the -$11 wine business, but is there enough other than Woodbridge in the portfolio that would really make a difference there? Is this a Woodbridge problem? Can you speak directly to the performance of Woodbridge?

Sure. We're actually very happy with Woodbridge. Woodbridge is in a category that's actually in decline, but Woodbridge is gaining share within that category. And obviously it benefits from the Madabi franchise halo. As you know, we have Madabi franchise covered at a number of price points. And so Woodbridge will continue to be an important part of our portfolio. And yes, we have a substantial amount of assets in the under $11 price point outside of Woodbridge and that gives us significant options of what to do going forward. And as we said earlier, in fairly recent time, we'll be able to talk about that more extensively. Yes,

and we've also said in the past that about 30% of our volume comes at the greater than $11 price point. And then if you look at Woodbridge, Woodbridge by itself is about 20% of our volume. And of course, when we're looking at the greater than $11 price point, we get a lot more dollars out of that volume, but that gives you a sense for what else is in the portfolio.

Thank you. And our next question will come from Bill Chappelle with SunTrust. Your line is now open.

Hi, good morning. This is actually Grant on for Bill. We just had a question on the spirit side of the wine spirits business. We haven't talked about that much this morning. So we're going to get some comments maybe on the Svetka National marketing program and any other more kind of commentary on the general portfolio.

Sure. It's early days on the new creative that we have put out in the marketplace. But I can assure you from our initial testing, this is one of the stronger campaigns certainly that this organization has put out in the recent past. So we're very excited of how that campaign could work for us. And I think it's a great example of some of the work that Jim Sabia has done to bring some of his outstanding marketing efforts in beer into our wine and spirit efforts as well. So we're very optimistic about it. Svetka has already been performing in a positive manner versus the vodka category. And we think this can only help it. I'm sure you've also seen we have very good results as it relates to High West and Casanova and continue to see the more premium aspects of our spirits portfolio as important going forward as well.

Thank you. And our next question will come from Laurence Grandet with Guggenheim. Your line is now open.

Yes, good morning everyone. And thanks for the opportunity. I'd like to discuss about the Mexicali water issue. There are more and more reports in the Mexican press that there are potentially some risks associated to water rights at the Mexicali brewery and the impact it has on the local community. So could you please give us some more color about that issue and let us understand how you are planning to mitigate those risks?

Sure. As I said in my prepared remarks, our efforts in Mexicali have been totally in compliance with all Mexican law and has been done with a deep understanding of water usage. We do not believe this is a major issue and we believe that all is going to proceed as planned with our Mexicali site. I will say, and I said this also, with the completion of our NAVA facility as well as our expansion at Obregon that after the five million hectoliters of Mexicali comes online, that facility will only represent 10% roughly of our total capacity in Mexico one way or the other.

Yeah, and said another way, more from an investor standpoint, I would say that we can, with Obregon and NAVA, Bill said this in his script, we have the ability to produce 400 million cases of beer from Obregon and NAVA.

Thank you. And our next question will come to the line of Brian Spillane with Bank of America. Your line is now open.

Hey, good morning everyone. David, I just wanted to follow up. You had referenced, I think, in your prepared remarks just the medium term growth targets and so just had a couple of follow-ups on that. One is the diluted EPS expectation, EPS growth of around 10%, does that now include sharing purchases given what you've said about capital allocation? And I think the second, you kind of referenced that it's not linear. So I guess as we're kind of looking into fiscal 20, it's kind of sounding like beer margins may be under pressure for a little bit while longer. I'm not sure what the path to low, -single-digit growth on operating income in wine and spirits is. So it's kind of meant to offer that next year could potentially be an off-algorithm year. Thanks.

Look, Brian, we haven't even finished rolling up our estimates for next year. What we do know is when we look out over the medium term with our beer business, we still expect that high single-digit net sales growth. We still expect to have very robust margins. And then Bill talked about the wine and spirits view which is kind of -single-digit growth and 30% operating margins. So we think that along with our ability to make investments in the business and buy back our stock as well as getting, working our way through the early years and the choppiness in the equity and earnings in the canopy investment, we expect that we'll continue to see that 10% EPS growth target that we put out before.

Thank you. There are no further questions in the queue. So now I'd like to hand the conference back over to Mr. Bill Newlands for any closing comments or remarks.

Thank you everyone for joining our call today. I want to take this opportunity to wish all of you a safe and happy and prosperous new year. And as Rob said at the beginning, hopefully you'll do that while enjoying some of our fine products. I'm honored to assume the role of Constellation CEO in just a few short months. And I look forward to capturing the great opportunities that lie ahead of us for our company. We look forward, David and I, to seeing many of you at the Cagney Conference in late February where we'll be providing an update on our strategic business initiatives. As a reminder, during our next quarterly call, we will provide our guidance for the upcoming fiscal year. So thanks again to everyone for joining the call and have a great day.

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude our program and we may all disconnect. Everybody have a wonderful day.