Constellation Brands, Inc.

Welcome to the Constellation Brands Q3 Fiscal Year 2021 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 would now like to turn the call over to Patty Yonderlab, Senior Vice President of Investor Relations. Please go ahead.

Thanks, Jonathan. Good morning, and welcome to Constellation's third quarter 2021 conference call. I'm here this morning with Bill Newlands, our CEO, and Garth Hankinson, 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 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 schedule. Thanks in advance, and now here's Bill.

Thank you, Patty. Good morning, and Happy New Year, everyone. Welcome to our third quarter call. I hope you enjoyed the holidays and had an opportunity to enjoy some of our fine products in whatever form your celebrations took. Before I jump into my prepared remarks, Let me first acknowledge the disheartening and tragic events that unfolded in our nation's capital yesterday. I join other leaders across the country in condemning the violence that occurred, instead calling for a peaceful transfer of power that upholds our democracy and calling for peace, unity, and civility as we move forward as a nation. Now let's move on to a discussion of our business performance. 2020 was certainly a challenging year, and like many of you, we are happy to turn the page. As we do so, I'm mindful of the words of American novelist James Lane Allen, who said, adversity does not build character, it reveals it. This is certainly the case for us. Our team rose to meet many challenges that surfaced in 2020. This included overcoming many negative impacts from COVID, most notably a significant volume reduction in the on-premise, a slowdown in production of our Mexican beer portfolio heading into our busiest selling season, and threats to the safety, health, and well-being of our team members. Despite all that, we continued to build momentum for our high-performing beer brands and launched Corona Hard Seltzer just as the pandemic started to gain steam in the U.S., Impressively, this remains one of the most successful new product launches in our company's history. We continue to transform our wine and spirits business, leveraging innovation to drive higher growth and margin performance while investing in capabilities needed to win long-term, such as DTC and three-tier e-commerce, and successfully working through the complexities of our transaction with Gallup, which, now that it is complete, positions our wine and spirits business to become a more meaningful contributor to our overall growth profile. And we've also supported our communities by providing much-needed assistance to those impacted by COVID and West Coast fires, by taking steps to achieve greater racial equity within our company, our industry, and our surrounding communities, by once again earning recognition from the Corporate Equality Index as a great place to work for members of the LGBTQ community and by improving our carbon disclosure project ratings for climate and water stewardship. While 2020 will be remembered for many things, what I will remember most is the character that was revealed by our leaders and team. Preventative measures implemented across our business help mitigate impacts related to COVID while maintaining full employment resource levels. I continue to be impressed by the inspired by their resilience, focus, and determination for driving the success of our business, and this bodes extremely well for our future. Thanks to the tireless efforts of our team, our business partners, we delivered excellent third quarter results. As Garth and I run through the highlights of the quarter, there are three things that I ask you to keep in mind. Number one, Our beer business, the biggest catalyst of our growth, remains extremely strong, with accelerating trends in IRI. Consumer demand for our core beer brands continues to be robust. The introduction of Corona Hard Seltzer has exceeded our expectations, and we're back to gaining share in IRI as we continue to recover from the slowdown in production earlier this year due to COVID. Number two. The completion of our transaction with Gallo to divest a number of our lower-end wine brands priced at $11 and below in retail has set the stage for accelerated growth and profitability, driving focus more fully on a tighter set of powerful brands that already have traction with consumers. And number three, despite the challenges faced in 2020, we're on track to deliver another strong year of growth, consistent with our long-term goals. I'm proud to say that our business remains healthy, allowing us to provide fiscal 21 guidance that I'm sure you will agree reinforces our strategic growth priorities and strong cash generation capabilities. This is truly a testament to the strength of our team and our brands. So let's dig a little deeper with a more fulsome discussion of our beer business performance in the quarter. Despite the challenges posed by COVID-19, including the continued partial closure of the on-premise, which was down about 35% year over year, Constellation's beer business continues to be one of the largest contributors to U.S. beer industry growth, delivering depletion trends of plus 12% in the quarter. And while some depletion growth we saw this quarter included benefits from inventory restocking, the portfolio delivered accelerating underlying trends that aligned with our sales growth projection of 7% to 9% for the foreseeable future, as consumer demand remains exceptionally strong for our products across the majority of the portfolio. In fact, Constellation's beer portfolio posted IRI consumer takeaway dollar growth of more than 15% for the third quarter. As you know, the COVID-related slowdown of our beer production in Mexico earlier this year has impacted this year's shipment and volume net sales trends. The good news is that we've returned to a position of gaining share in IRI track channels as we continue to replenish inventories to more normal levels, which we expect to accomplish by fiscal year-end, a process that's actually taken a little longer than originally planned due to continued strong consumer demand for our brands. So let's take a deeper dive into the key brands that drove these excellent trends for our beer business. The Corona brand family grew nearly 12% in IRI channels, led by particularly strong contributions from Corona Premier, Corona Hard Seltzer, and Corona Extra. With a launch of only one, one skewed to date, Corona hard seltzer continues to exceed our expectations and remains in a strong number four position in the hard seltzer category. It also has the distinction of being the second fastest moving hard seltzer among major seltzer brands, while continuing to maintain strong incrementality levels at nearly 90%. Early next fiscal year, we plan to launch Corona hard seltzer variety pack number two which will offer consumers the same great Corona taste and refreshment attributes while expanding to new flavors, including pineapple, strawberry, raspberry, and passion fruit. Variety pack number two will be followed shortly thereafter by the introduction of another exciting new hard seltzer initiative. We believe these product launches will help further strengthen our competitive position in the fast-growing hard seltzer category, broaden our distribution reach, and enhance our market share in the high end of the U.S. beer market. These initiatives will be supported with impactful marketing campaigns to strengthen and build upon our hard seltzer portfolio. 2020 marked the 30th consecutive year of Corona's iconic O-Tan and Palm commercial that was airing on TV during the holiday season. As the longest-running beer commercial of all time, Eau Tannin Palm demonstrates the strength and resilience of the Corona brand, including Corona Hart Seltzer, which continues to resonate with consumers and remains one of the most beloved consumer brands in the world. Modelo Especial was the most significant growth contributor within our portfolio for the quarter. This exceptional brand has excellent marketplace momentum, and achieved the number one spot as the top share-gaining imported beer in the U.S. beer category, with depletion growth of almost 20%. Modelo continues to gain traction with general market consumers while sustaining momentum with its core Hispanic consumer, driven by the authenticity of the brand and our marketing efforts. The success of Modelo has been driven in part by impactful marketing initiatives that include high-profile sports programming with the NFL, NBA, NCAA football, Spanish language soccer, as well as an ongoing presence on Facebook and Instagram. Finally, Pacifico was also a top share gainer within the import segment during the quarter, continuing its strong momentum with depletion growth of nearly 20%. We remain excited about the future growth prospects for this brand as we continue to increase awareness and expand distribution beyond its core market of Southern California. As we've said before, Pacifico has all the makings of the next big brand in our beer portfolio. From an operational perspective, we plan to complete the 5 million hectoliter expansion of our Obregon facility in early fiscal 22, which is a slight delay versus our original plans due to pandemic-related construction slowdowns for this project last year. After the completion of the Obregon capacity expansion, we believe we will have ample capacity at the Nava and Obregon breweries to meet consumer demand over the medium term, which includes more than doubling our seltzer production capacity heading into the next fiscal year. Overall, our excellent year-to-date results provide confidence in our ability to achieve 7 to 9 percent next sales growth fiscal 21. In addition, we have increased our operating income growth target to 8 to 10 percent for the year. Now let's move on to the quarterly results for our wine and spirits business. As I mentioned earlier, the closure of the Gallo deal and other pending transactions will include a series of actions which positions our wine and spirits business for accelerated revenue growth and operating margin performance going forward. We are grateful for the dedication of our Constellation team and the support and collaboration from Gallo and our business partners as we ensure a smooth transition. With the completion of the divestitures, we believe the Wine and Spirits business is positioned to grow net sales low to mid-single digits while producing operating income growth ahead of net sales growth as the business works to take out stranded costs and execute against other cost, price mix, and efficiency improvements to achieve a 30% operating margin over the medium term. In the near term, we expect the remaining portfolio post the Gallo deal to generate fiscal 21 net sales growth in the 2% to 4% range. With these transactions now behind us, our team can more fully concentrate resources and focus behind a smaller set of more premium brands that better align with consumer-led premiumization trends. During the quarter, we continued to see the staying power of these trends as premiumization continues to drive elevated growth across the total beverage alcohol segment, further reinforcing the transformation strategy for our business. Our higher-end wine power brands at the greater than $11 retail price point outpaced the U.S. high-end wine category IRI channels driven by Naomi, Kim Crawford, the prisoner wine company portfolio, all of which posted double-digit growth in IRI channels for the quarter. Overall, we expect these brands to be key growth drivers of the business long-term, and we are extremely bullish on the future runway for these higher growth, higher margin brands. During the quarter, successful new innovation initiatives also contributed to top-line growth with power brand introductions like the Prisoner Cabernet Sauvignon and Chardonnay varietals, along with Mayomi Cabernet Sauvignon, which has become this year's biggest ultra-premium wine introduction in IRI channels based on dollar sales. In addition, several other innovation initiatives launched earlier this year continue to gain traction and drive growth, including brands like Unshackled from the Prisoner Wine Portfolio, Kim Crawford Illuminate, and Woodbridge Spirits Barrel Aged Varietals, just to name a few. And let's not forget Woodbridge Wine Gopaks, which became the number two innovation this year in IRI channels based on dollar sales. We are also successfully driving our digital commerce initiatives, which are gaining momentum. Since our acquisition of Empathy Wines, we have continued to make significant progress in leveraging their unique platform and capabilities across our portfolio within the DTC and three-tier e-commerce space. We have launched several new DTC sites leveraging the Empathy platform, including the Prisoner Wine Company, Double Diamond, and See Me. We believe this category will be a meaningful pillar of growth for Constellation in the future. In fact, our wine power brands competing in the e-commerce space are outpacing the overall wine category as our early investment in the category has provided us with a meaningful first mover advantage. During the quarter, we became the first CPG company to partner with Instacart to feature our products on Facebook ads, propelling Constellation to the next level of three-tier e-commerce media by enabling us to refine and optimize our ad creative and targeting based on real-time data. Furthermore, it is important to our growth and margin profile that we continue to invest in this space, since DTC is heavily weighted toward the higher end of the wine category, as wines priced $20 and up make up nearly 90% of total DTC sales. Now moving on to a discussion of our investment in cannabis growth. We're pleased with the progress the cannabis growth team has made in defining and strategically positioning themselves in the U.S. CBD and legal THC cannabis markets, which will be beneficial upon U.S. federal permissibility, which was probably enhanced with the change in the Senate that's occurred in the last 48 hours. Canopy's core biosteel beverages are now the official sports drink of the Dallas Mavericks, the Philadelphia 76ers, and the Toronto Raptors, and has several standout athlete and influencer partners, including the reigning NFL and Super Bowl MVP, Patrick Mahomes. In fact, Canopy predicts that CBD beverages can grow at a 35% CAGR through 2025, as consumer realized the compelling benefits from CBD beverages. In addition, BioSteel now has two exclusive partnerships with Manhattan Beer and the Reyes Beer Division, two key Constellation distributors, which will give Canopy the ability to gain traction in the U.S. market well ahead of its competitors in the emerging CBD space. In September, Canopy launched a Martha Stewart branded CBD product line, which is available on shopcanopy.com and several other outlets, including its new national distribution agreement with the Vitamin Shop retail locations, just in time for the holidays. Canopy will continue to seek strategic partnerships like the one with Martha Stewart to drive consumer awareness of these products. Overall, we believe that Canopy will be a significant long-term growth opportunity for Constellation, and we believe they remain best positioned to win long-term in the emerging cannabis space. In closing, I want to take you back to the key takeaways mentioned earlier. I'm extremely proud of the results of our team and what they have driven in the face of continued adversity. Our beer business, the biggest catalyst of our growth, remains extremely strong with accelerating trends in IRI. The completion of our transaction with Gallo to divest a number of lower-end brands priced at $11 and below at retail has set the stage for accelerated growth and profitability. Despite the challenges faced in 2020, we're on track to deliver another strong year of growth consistent with our long-term goals. Our excellent third quarter performance drove strong cash generation, which coupled with the finalization of the Gallo deal enhances the financial profile of our business, enables further debt reduction, and allows us to continue to execute our commitment to return $5 billion in value to our shareholders through fiscal 23. our business remains extremely healthy, and these strong results are truly a testament to the strength of our team and our brands. And with that, I would now like to turn the call over to Garth, who will review our financial results for the quarter. Garth?