Constellation Brands Q2 2022 Earnings Report

Constellation Brands EPS Results

• Actual EPS: $2.38
• Consensus EPS: $2.78
• Beat/Miss: Missed by -$0.40
• One Year Ago EPS: $2.76

Constellation Brands Revenue Results

• Actual Revenue: $2.37 billion
• Expected Revenue: $2.30 billion
• Beat/Miss: Beat by +$69.49 million
• YoY Revenue Growth: +4.90%

Constellation Brands Announcement Details

• Quarter: Q2 2022
• Date: 10/5/2021
• Time: Before Market Opens
• Conference Call Date: Tuesday, October 5, 2021
• Conference Call Time: 8:00PM ET

Constellation Brands (NYSE:STZ), Inc. is a leading producer and marketer of beer, wine and spirits, with operations spanning production, importation, marketing and distribution. The company’s beverage portfolio includes a range of premium and mainstream wines and spirits alongside major imported beer brands; in the U.S. market Constellation is widely known for its role in bringing Mexican imports such as Corona and Modelo to American consumers. Constellation supplies retail, on‑premise and foodservice channels and supports its brands with national sales and marketing platforms and supply‑chain capabilities.

The company traces its roots to the Canandaigua Wine Company, founded by Marvin Sands in 1945, and evolved through organic growth and acquisition into a diversified beverage company. Constellation expanded its wine and spirits footprint over time by adding regional and premium wine labels and investing in production and distribution assets. In recent years the company has also pursued strategic diversification, including an investment in the Canadian cannabis sector as part of an effort to explore adjacent opportunities in adult consumer products.

Constellation Brands operates primarily in the United States while maintaining significant international relationships and business activities in markets such as Mexico, Canada and other wine‑producing regions. The company has a history of family leadership—originating with founder Marvin Sands and with subsequent generations playing prominent roles in executive management—while functioning as a publicly traded company listed on the New York Stock Exchange under the symbol STZ. Its business model emphasizes brand building, category management and channel distribution to support growth across beverage categories and geographies.

Constellation Brands Q2 2022 Earnings Call Transcript

Key Takeaways

• Constellation raised its full‐year beer guidance, now targeting 9%–11% net sales growth and 4%–6% operating income growth, driven by strong consumer demand for imported core beer brands despite supply constraints set to normalize by end Q4.
• The company took an $80 million obsolescence charge on Corona Hard Seltzer inventory and lowered its growth expectations, planning to focus on differentiated ABAs and new seltzer innovations like Refresca and Limonata.
• Premiumization in wine and spirits showed healthy performance in the high‐end segment, with strong growth from brands like The Prisoner and Naomi Cabernet, while e-commerce and direct-to-consumer channels grew 3–4× versus 2019.
• Constellation’s disciplined innovation strategy will emphasize consumer-led, margin-accretive products across beer, wine and spirits, including ready-to-drink expansions such as Stedka, Woodbridge Wine Seltzers and boxed wine.
• Capital allocation remains focused on debt reduction and shareholder returns, with $1.4 billion of share repurchases in Q2 toward a $5 billion target by fiscal 2023, while reinvesting in Mexican beer capacity expansions.

Presentation

[Operator]

Welcome to the Constellation Brands Q2 full year 2022 earnings conference call. At this time, all participants have been placed in a listen-only mode. Following the prepared remarks, the call will be open for your questions. Instructions will be given at that time. I will now turn the call over to Patty Yahn-Urlaub, Senior Vice President of Investor Relations. Please go ahead.

[Patty Yahn-Urlaub, SVP of Investor Relations at Constellation Brands]

Thanks, Josh. Good morning, welcome to Constellation's second quarter fiscal 2022 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 GAAP measure and any non-GAAP financial measures discussed on this call are included in our news release or are 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 we make on this call. Before turning the call over to Bill, similar to prior quarters, I'd 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, now here's Bill.

[Bill Newlands, CEO at Constellation Brands]

Thank you, Patty. Good morning and welcome to our second quarter call. Let's dive right into a discussion about the quarter. There were a number of puts and takes impacting our results in Q2, and Garth and I will spend time walking through them. However, the fundamentals of our business remain solid, and consumer demand for our brands, particularly our core beer portfolio, remains strong. This gives us confidence to increase our EPS guidance for the year, which we outlined in our press release earlier today, and Garth will review in more detail shortly. In addition, we repurchased a significant number of shares in Q2 at prices that are favorable, as we believe Constellation stock is undervalued at current levels. We've received some feedback from investors on this topic in recent weeks and will address key themes that emerge from these discussions in our remarks.

[Bill Newlands, CEO at Constellation Brands]

As we walk through our Q2 performance and outlook for the remainder of the year, there are several key takeaways we'd ask you to keep in mind. Number one, the momentum of our core imported beer brands provides a point of competitive strength versus industry peers, as we're the leading share gainer in the high end of the U.S. beer market. The majority of our growth continues to be driven by Modelo Especial, supported by strong consumer demand for Corona Extra and Pacifico, and we expect this to continue for the foreseeable future. We continue to believe that Modelo Especial, in particular, has a long runway for growth, given the steadily increasing household penetration for this brand among non-Hispanic consumers and continued strong velocity.

[Bill Newlands, CEO at Constellation Brands]

Now, we've admittedly had some supply challenges this fiscal year driven by several external factors, the most relevant being the ongoing robust demand for our beer brands. We expect to return to more normal inventory levels by the end of Q4. Despite these challenges, we continue to be on track to deliver a better than expected year for our beer business. In fact, our strong performance to date gives us the confidence to increase guidance for our beer business, as we now expect to achieve 9%-11% net sales growth and 4%-6% operating income growth for fiscal year 2022. Our view is reinforced by recent 12-week IRI trends showing that Constellation's beer business is significantly outpacing the high end and total U.S. beer industry.

[Bill Newlands, CEO at Constellation Brands]

Point two, as it relates to our hard seltzer business and building off our last point, we're unique in our position versus our competitors in this space, as our primary growth is coming from our core beer portfolio, and we're not reliant on the growth of hard seltzers and ABAs to achieve the medium-term growth goals for our beer business. The hard seltzer landscape has shifted considerably in recent months. Therefore, we've lowered our growth expectations for Corona Hard Seltzer, resulting in a sizable obsolescence charge taken for Q2, which includes our view of the total impact for the fiscal year.

[Bill Newlands, CEO at Constellation Brands]

Let's be clear, we continue to see the hard seltzer and broader ABA space as a meaningful sector in the beer market, and we continue to believe it's important to participate in and gain our fair share in this segment to complement the growth of our core imported beer portfolio and to maintain our position as a leader in the high end of the U.S. beer market. Going forward, we plan to focus on competing in this space in ways where we offer meaningful points of differentiation and unique value to consumers. I'll have more to say on this topic in a moment.

[Bill Newlands, CEO at Constellation Brands]

Number three, while our wine and spirits business was challenged in the quarter by underperformance of several mainstream brands due to tough COVID comparisons, our recent route-to-market transition, and supply chain challenges for our imported wine brands, we continue to see the benefits of our premiumization strategy take hold. We're performing well in the high end of the wine segment, which represents the vast majority of expected industry growth over the next several years, and we continue to strengthen our capabilities in emerging growth channels key to long-term success, such as e-commerce and DTC.

[Bill Newlands, CEO at Constellation Brands]

Number four, we continue to enhance our approach to innovation with a more consistent, strategic, disciplined, and consumer-led approach with a focus on high-growth segments aligned with consumer trends. Our innovation agenda is designed to complement our organic growth, and we're developing sustainable products that are incremental to our business while further premiumizing our portfolio into margin-accretive price points. Over the years, we've been able to extend some of our brands into new spaces, recruiting new drinkers and expanding occasions, and we've achieved a healthy balance between growth from the core and from innovation. Number five, our capital allocation strategy remains unchanged since I assumed the role of CEO almost three years ago. Since then, we've made significant progress in reducing debt and achieving our goal of returning $5 billion in value to shareholders by the end of fiscal year 2023, through a combination of dividends and share repurchases.

[Bill Newlands, CEO at Constellation Brands]

In fact, to date this fiscal year, we have repurchased $1.4 billion of our shares, and when combined with our dividends, we have achieved nearly 60% of our $5 billion goal. To be clear, our shareholder value equation is based on outsized growth combined with return of dollars to shareholders. One of the most important capital allocation priorities is to continue reinvesting in our beer business to keep up with robust demand for our products. Despite initial challenges associated with the build-out of a third brewery in Mexico, we have moved on to other capacity alternatives in the country. Our expansions in Nava and Obregón help ensure we have adequate production capacity for the medium term and will create much needed redundant capacity that better enables us to manage through unexpected events like we've experienced these past two years.

[Bill Newlands, CEO at Constellation Brands]

We continue to work with Mexican government to solidify plans for a new brewery in southeastern Mexico with adequate water supply and an available, talented workforce. Let's move on to a more fulsome discussion about our performance within the quarter. During the quarter, the Modelo brand family posted depletion growth of 17% for the quarter and single-handedly drove total import share gains in IRI channels on a dollar basis. As the number two beer brand in dollar sales in the entire U.S. beer category, Modelo Especial is the only major beer brand growing household penetration and is leading the way as the number one share gainer among high-end brands. Modelo Chelada has become the number two brand family in the Chelada space, posting depletion growth of more than 50% for the second quarter.

[Bill Newlands, CEO at Constellation Brands]

Corona Extra continues its growth trajectory as the second fastest share gainer and the number one loved brand in the import category, driven by a return to growth in the on-premise, which currently represents approximately 11% of our beer business volume. In addition to the comments I made earlier about our hard seltzers, I'd like to discuss industry trends and our refreshed approach to this sector of the beer market going forward. In the short to medium term, we believe that there will be consolidation within the hard seltzer/ABA space, primarily due to the chaos of SKU and brand proliferation, with too many new entrants that don't have the velocity or consumer demand to warrant shelf space. We also believe this subcategory will evolve beyond low-calorie, low-carb offerings and open up to more distinctive consumer value propositions that include things like more flavor, different alcohol bases, and functional benefits.

[Bill Newlands, CEO at Constellation Brands]

We've already started to innovate in this way with distinct products like Refresca and Limonada. We've also discovered that consumers are looking for more robust taste and flavor in their seltzers. As a result, we will be altering the flavor and taste profile of our seltzer portfolio to better align with the changing consumer preferences, while also introducing single-serve packages to better serve the growing convenience channel, our largest trade channel. We have a solid lineup of innovations that we have yet to introduce. We have several great examples of our innovation strategy at work within our wine and spirits portfolio. This business continues to drive growth from recently launched innovations including Meiomi Cabernet Sauvignon, Kim Crawford Illuminate, The Prisoner Cabernet, and Chardonnay, all of which are amongst the top 10 innovations across high-end wine in IRI channels during the quarter.

[Bill Newlands, CEO at Constellation Brands]

Our wine and spirits innovation pipeline is ready to go with further consumer-led new products as we head into our peak selling period, including the expansion of our SVEDKA ready-to-drink platform and the introduction of Woodbridge wine seltzers and boxed wines. In addition to driving growth through innovation, we're making progress with our core wine and spirits portfolio, despite the previously mentioned challenges. We continue to take price to further premiumize our mainstream portfolio as these steps are critical to maintain brand equity and to improve profitability, which will serve our brands well over the long term. We're putting points on the board in a number of areas where we're outperforming the U.S. wine market. Our high-end super premium plus portfolio grew net sales double digits during the quarter. In on-premise channels, our investments are paying off with enhanced wine offerings at major restaurant chains.

[Bill Newlands, CEO at Constellation Brands]

We're thriving in critical emerging channels like three-tier e-commerce and direct-to-consumer, which continue to drive high-end growth, where we're outpacing category performance at key accounts such as Instacart, Amazon, and Albertsons, with the resurgence of online shopping due to the COVID-19 pandemic. For example, Constellation's fine wine share has expanded significantly in the latest 12 weeks due to the robust growth of The Prisoner on Instacart and Robert Mondavi Winery on wine.com. In fact, e-commerce and DTC sales are up nearly 3-4 times versus 2019, they comprise roughly 3%-5% of our business versus 1% pre-pandemic. Going forward, we will continue to focus on becoming a category leader in e-commerce and DTC, as we believe these channels will make up a significant portion of our mix over time and will continue to be an opportunity for high-end growth.

[Bill Newlands, CEO at Constellation Brands]

I'd also like to provide you an update on our U.S. harvest, which is about 70% complete at this point, while our production facilities, wineries, and tasting rooms remain untouched by recent wildfire activity. This quarter, our ventures activities included investments in adaptogen infused HOP WTR, and Aaron Paul and Bryan Cranston's artisanal Dos Hombres Mezcal. HOP WTR is a non-alcoholic, calorie-free sparkling water infused with adaptogens and nootropics to provide the perfect balance of function and flavor for health-conscious consumers. The non-alcoholic segment of total beverage alcohol grew almost 40% in 2020 in dollar sales through IRI channels. According to IWSR research, 60% of consumers are switching between non-alcoholic or low alcoholic and full-strength drinks within the same occasion. Dos Hombres is an award-winning, handcrafted mezcal brand created by "Breaking Bad" co-stars who have developed an exceptional liquid that receives frequent praise from both the industry and consumers.

[Bill Newlands, CEO at Constellation Brands]

The overall U.S. mezcal category grew 14% in 2020, according to IWSR, and super premium mezcal priced above $30 per bottle is projected to be the largest and fastest growing segment within the category. Moving on to Canopy Growth. We're encouraged by the recent introduction of the Cannabis Administration and Opportunity Act draft bill, which was introduced by Senators Booker, Wyden, and Schumer in July. More than 90% of Americans are in favor of cannabis legislation for medical purposes, and two thirds of those are in favor of legalizing for recreational use as well. In fact, nearly two out of three Americans already have legal cannabis access, as 37 states have legalized for medical use and 18 states for adult use. While we're optimistic about federal legislation within this Congress, Canopy is not waiting for this reality to materialize.

[Bill Newlands, CEO at Constellation Brands]

Canopy's U.S. business grew 91% year-over-year in their most recent quarter, driven by robust consumer demand for their CBD and CPG products, including Martha Stewart branded products, Quatreau beverages, Storz & Bickel baked products, and BioSteel's new RTDs. Over the coming years, revenue from Canopy's U.S. business is expected to grow significantly as it benefits from increasing distribution and new product introductions. Once THC permissibility becomes a reality in the U.S., Canopy expects their U.S. business to make a substantially greater contribution to their results. Canopy has scaled a multi-state route-to-market plan ready for legalization and has leveraged Constellation's distributor relationships to fuel their U.S. non-THC business with more opportunities in a world post federal permissibility. We're comfortable with Canopy's progress, and we're looking forward to the growth in legalization prospects for the business. In closing, I'd like to reiterate our main takeaways for this quarter.

[Bill Newlands, CEO at Constellation Brands]

First, continued strong demand for our core imported beer brands provides a point of competitive strength versus industry peers, led by the number one share gainer in the beer category, Modelo Especial, which we feel has ample runway for growth well into the future, given the steadily increasing household penetration rates among non-Hispanic consumers and continued strong velocity. The short-term supply disruption to our imported beer business does nothing to dampen our long-term prospects as we expect to return to more normal inventory levels by the end of Q4, and we're on track to deliver a better than expected year for our beer business. Second, we continue to see the hard seltzer and broader ABA space as a meaningful sector within the beer market.

[Bill Newlands, CEO at Constellation Brands]

Going forward, we plan to focus on competing in this space in ways where we can offer meaningful points of differentiation and unique value to consumers, and we have some upcoming innovations in this space that we're optimistic about. Number three, we continue to see benefits of our wine and spirits premiumization strategy take hold. We're performing well in the higher end of the wine segment, and we continue to strengthen our capabilities in emerging growth channels key to long-term success such as e-commerce and DTC. Fourth, we continue to enhance our approach to innovation with a more consistent, disciplined, and consumer-led approach focused on high growth segments, aligned with consumer trends to complement our organic growth, while developing sustainable products that are incremental to our business at margin-accretive price points.

[Bill Newlands, CEO at Constellation Brands]

Fifth, and certainly not least, our shareholder value equation continues to be based on outsized growth, combined with the return of dollars to shareholders. Let me reiterate, our capital allocation strategy remains unchanged. We remain committed to our goal of returning $5 billion in value to shareholders by the end of fiscal year 2023 through a combination of dividends and share repurchases. Our strong operational performance and cash flow generation allowed us to make significant share repurchases in Q2, aligned with our commitment, which contributed to the increase in our EPS guidance for the year. At the same time, we remain committed to continuing to reinvest in our business, with an emphasis on our beer business, to keep up with the robust demand for our products. With that, I'd like to turn the call over to Garth, who will review our financial results in the quarter. Garth?

[Garth Hankinson, CFO at Constellation Brands]

Thank you, Bill, and hello, everyone. Q2 certainly reflected yet another strong quarter of marketplace performance for our beer business. Due to continued robust consumer demand for our core beer portfolio, we now expect to exceed our initial top line and operating income targets for our beer business. Additionally, our strong cash flow generation enabled us to continue to repurchase shares during the quarter, and through September, we've repurchased 6.2 million shares of common stock for $1.4 billion. As a result, we've increased our full year fiscal 2022 comparable basis diluted EPS target, and we now expect to be in the range of $10.15-$10.45.

[Garth Hankinson, CFO at Constellation Brands]

This range excludes Canopy equity and earnings impact and reflects the increase in beer operating income guidance and decrease in the weighted average diluted shares outstanding based on shares repurchased through September, partially offset by an increase in the tax rate for fiscal year 2022. Let's review Q2 performance and our full-year outlook in more detail, where I'll generally focus on comparable basis financial results. Starting with beer. Net sales increased 14%, driven by shipment volume growth of nearly 12% and favorable price, partially offset by unfavorable mix. Depletion volume growth for the quarter came in above 7%, driven by the continued strength of Modelo Especial and Corona Extra, as well as the continued return to growth in the on-premise channel.

[Garth Hankinson, CFO at Constellation Brands]

Depletion trends tempered in Q2 versus Q1, driven by out of stocks due to ongoing robust consumer demand, as well as lost shipping days for some of our distributors due to severe weather events, including hurricanes and wildfires. We estimate that these factors hampered Q2 growth by approximately two to three points. As Bill mentioned, on-premise volume accounted for approximately 11% of the total beer depletions during the quarter and grew strong double digits versus last year. As a reminder, the on-premise accounted for approximately 15% of our beer depletion volume pre-COVID-19 and accounted for only 6% of our depletion volume in Q2 fiscal 2021 as a result of the on-premise shutdowns and restrictions due to COVID-19. Selling days in the quarter were flat year-over-year and will also be flat in Q3.

[Garth Hankinson, CFO at Constellation Brands]

Wholesaler depletions continued to outpace cases shipped during Q2, resulting in lower than normal distributor inventory on hand at the end of the quarter. To rectify this gap, shipment case volume is expected to exceed depletion case volume throughout the second half of the fiscal year, resulting in a gradual improvement of distributor inventories during Q3 and Q4 as inventories are expected to return to normal levels by the end of the fiscal year. Moving on to beer margins. Beer operating margin decreased 530 basis points versus prior year to 37.2%. Benefits from favorable pricing, mix, and foreign currency were more than offset by unfavorable COGS, increased marketing investments, and higher SG&A. The increase in COGS was driven by several headwinds that include the following. First, a Q2 obsolescence charge of $66 million.

[Garth Hankinson, CFO at Constellation Brands]

As a result of our production constraints earlier in the year, we pre-built hard seltzer inventory in advance of the key summer selling season based on our best estimates for fiscal year 2022. Due to the overall slowdown in the hard seltzer category in the U.S., some of that growth is not going to materialize in the fiscal year, resulting in excess inventory. Second, increased brewery costs driven by labor inflation in Mexico, increased headcount, and incremental spend related to capacity expansion. Third, a step-up in depreciation expense, largely due to the incremental 5 million hL at Obregon. Finally, as expected, increased material costs predominantly driven by increased commodity prices and inflationary headwinds on pallets, cartons, and aluminum. These COGS headwinds were partially offset by favorable fixed cost absorption.

[Garth Hankinson, CFO at Constellation Brands]

Marketing as a percent of net sales increased 150 basis points to 9.9% versus prior year as we return to our typical spending cadence, which is weighted more heavily towards the first half of the fiscal year. As a reminder, marketing spend in the first half of the prior year was significantly muted, resulting from COVID-19 related sporting and sponsorship event cancellations and/or postponements. Lastly, the increase in SG&A was primarily driven by an by an increase of approximately $12 million in legal expenses, as well as higher compensation and benefits. As mentioned earlier, we are increasing full year fiscal 2022 net sales and operating income guidance for our beer business. We are now targeting net sales growth of 9%-11%, reflecting the strength of our core beer portfolio and pricing actions that are higher than initially planned.

[Garth Hankinson, CFO at Constellation Brands]

Furthermore, we are now targeting operating income growth of 4%-6%, which implies operating margin in the low to midpoint of our stated 39%-40% range. Please note that the updated guidance includes all obsolescence charges and legal expenses incurred in the first half of the fiscal year. We continue to expect our gross margin to be negatively impacted for the fiscal year as benefits from price and our cost savings agenda are expected to be more than offset by several cost headwinds. However, the mix and magnitude of these headwinds have changed from our original assumptions presented at the beginning of our fiscal year. First, we're still estimating a significant step-up in depreciation expense, which began to accelerate in Q2. However, some of this depreciation started later in the year versus planned.

[Garth Hankinson, CFO at Constellation Brands]

As such, we are now estimating total beer depreciation expense to approximate $250 million, an increase of approximately $55 million versus last year, or a $10 million decrease versus our original planned estimate. Second, we still expect substantial inflationary headwinds across numerous cost components to continue during the second half of our fiscal year as commodity prices continue to rise, specifically across aluminum, diesel, and pallets, resulting from a rather volatile inflationary market. Third, due to the growth moderation within the hard seltzer market, as well as lower ACV levels across the category on new items, we do not expect our hard seltzer SKUs to meet originally planned volume expectations, which results in a positive mix benefit versus our original estimate. Conversely, due to the slowdown in the hard seltzer sector, excess inventory resulted in a fiscal year-to-date obsolescence charge of approximately $80 million.

[Garth Hankinson, CFO at Constellation Brands]

Please note that these losses cover our hard seltzer obsolescence exposure. As such, we do not expect to take any additional obsolete charges in the back half of the fiscal year for hard seltzers. From a marketing perspective, we continue to expect full year spend as a percentage of net sales to land in the 9%-10% range, which is in line with fiscal 2021 spend of 9.7% of net sales. Looking ahead to Q3, I'd like to remind everyone of the difficult volume overlaps we will encounter as we're facing a 28% and 12% growth comparison for shipment volume and depletion volume, respectively. Additionally, we expect to perform our normal annual brewery maintenance during Q3, which will result in less throughput versus Q2, as we have to shut down production for a few days. As such, we are estimating low single-digit shipment volume growth for Q3.

[Garth Hankinson, CFO at Constellation Brands]

Moving to wine and spirits. Q2 fiscal year 2022 net sales declined 18% on shipment volume down 36%. Excluding the impact of the wine and spirits divestitures, organic net sales increased 15%, driven by organic shipment volume growth of nearly 6%, favorable mix in price, and smoke-tainted bulk wine sales. Robust mix driven by The Prisoner Brand family, Meiomi, and Kim Crawford accounted for approximately nine points of the year-over-year organic net sales growth. Shipments were negatively impacted by port delays for our international brands and route to market changes, which also impacted depletions. Depletion volume declined 2% during the quarter and was additionally impacted by the challenging overlap to consumer pantry loading behavior, especially for our mainstream brands that experienced robust growth during the beginning of the COVID-19 pandemic.

[Garth Hankinson, CFO at Constellation Brands]

However, as we head into the second half of the fiscal year, we feel as though most of these challenges are behind us and expect shipment volume and depletion volume to generally align in the second half of fiscal year 2022. Moving on to wine and spirits margins. Operating margins decreased 620 basis points to 19.7% as mixed benefits from the existing portfolio and divestitures combined with favorable price were more than offset by increased marketing and SG&A spend, higher COGS, and margin dilute of smoke-tainted bulk wine sales. Higher COGS were driven by unfavorable fixed cost absorption and increased transportation costs. The unfavorable fixed cost absorption resulted from decreased production levels in New Zealand due to a frost during their harvest season earlier this year, as well as decreased production levels at our wineries in California due to the 2020 U.S. wildfires.

[Garth Hankinson, CFO at Constellation Brands]

These headwinds were partially offset by lower grape raw materials and other cost-savings initiatives. Keep in mind that we're lapping lower SG&A spend in Q2 fiscal year 2021 due to COVID and having smaller business post divestitures, resulting in significant marketing and SG&A de-leveraging, impacting operating margins. For full year fiscal year 2022, the wine and spirits business continues to expect net sales and operating income to decline 22%-24% and 23%-25%, respectively. This implies operating margin to approximate 24%, which is flattish to prior year on a reported basis, but shows significant margin expansion on an organic basis. Excluding the impact of the wine and spirits divestitures, organic net sales is expected to grow in the 2%-4% range.

[Garth Hankinson, CFO at Constellation Brands]

From a Q3 perspective, keep in mind that we are lapping unfavorable fixed cost absorption of $20 million in the prior year, resulting from decreased production levels as a result of the 2020 U.S. wildfires. We expect this favorable overlap to be partially offset by a continued increase in transportation costs and incremental unfavorable fixed cost absorption due to the New Zealand frost. Also, we continue to expect marketing and SG&A deleveraging as a result of the wine and spirits divestitures. As such, we expect marketing and SG&A to continue to be a significant drag to operating margins in Q3 fiscal year 2022. Now let's proceed with the rest of the P&L. Fiscal year to date corporate expenses came in at approximately $117 million, up 7% versus last fiscal year. The increase was primarily driven by higher consulting services and compensation benefits, partially offset by a favorable foreign currency impact.

[Garth Hankinson, CFO at Constellation Brands]

We now expect full-year corporate expenses to approximate $245 million, driven by increase in compensation and benefits. Comparable basis interest expense for the quarter decreased 4% to approximately $96 million versus prior year, primarily due to lower average borrowings. We now expect fiscal year 2022 interest expense to be in the range of $355 million-$365 million. The slight decrease versus our previous guidance reflects early redemption of higher interest rate debt, as well as $1 billion of senior notes issued in July at attractive rates. Our Q2 comparable basis effective tax rate, excluding Canopy equity earnings, came in at 21.8% versus 16.9% in Q2 of last year, primarily driven by the timing of stock-based compensation benefits and a higher effective tax rate on our foreign businesses. We now expect our full-year fiscal 2022 comparable tax rate, excluding Canopy equity earnings, to approximate 20% versus our previous guidance of 19%.

[Garth Hankinson, CFO at Constellation Brands]

This increase is primarily due to a higher effective tax rate on our foreign earnings than originally estimated. I would also note that we expect stock-based compensation tax benefits to be weighted towards Q4. As a result, we expect our Q3 tax rate to be higher than our full-year estimate at approximate 21%. We also now expect our 2022 weighted average diluted shares outstanding to approximate 192 million, reflecting the impact of our September year-to-date share purchases previously discussed. Moving to free cash flow, which we define as net cash provided by operating activities, less CapEx. We generated free cash flow of $1.2 billion for the first half of fiscal year 2022, which is flat to prior year, reflecting strong operating cash flows offset by an increase in CapEx. CapEx totaled $353 million, which included approximately $295 million of beer CapEx, primarily driven by expansion initiatives at our Mexico facilities.

[Garth Hankinson, CFO at Constellation Brands]

Our full-year CapEx guidance of $1 billion-$1.1 billion, which includes approximately $900 million targeted for Mexican beer operation expansions, remains unchanged. Furthermore, we continue to expect fiscal 2022 free cash flow to be in the range of $1.4 billion-$1.5 billion. This reflects operating cash flow in the range of $2.4 billion-$2.6 billion and the CapEx spend previously outlined. In closing, I want to iterate that while we had our fair share of challenges during the first half of our fiscal year, resulting in several puts and takes impacting our results, the fundamentals of our business remain strong, and consumer demand for our products, particularly our imported beer portfolio, remains robust, providing us with strong momentum as we head into the second half of our fiscal year. With that, Bill and I are happy to take your questions.

[Operator]

Thank you. Please limit yourself to one question. Please stand by. We compile a Q&A roster. Our first question comes from Dara Mohsenian with Morgan Stanley. You may proceed with your question.

[Dara Mohsenian, Analyst at Morgan Stanley]

Hey, guys. On the beer top-line front, first, just a detailed question. Given the volatility here and the tough comp in Q3, can you give us an update on how September depletions are trending so far? Also for the quarter, are you expecting depletions to still be above that low single-digit shipment rate that you mentioned? Is that tough with the difficult 12% depletion comp? Second, the longer-term question is, you raised your revenue guidance for this year. How much of that is underlying demand strength and depletions maybe versus shipments and perhaps getting more supply in in the balance of the year, versus pricing? On the pricing front, you've sounded more aggressive in terms of pricing expectations going forward publicly.

[Dara Mohsenian, Analyst at Morgan Stanley]

A, I guess, is that correct, and B, is that more just to combat higher commodity costs, or is it more confidence in market share gains or that the consumer environment is conducive to taking pricing here? Thanks.

[Bill Newlands, CEO at Constellation Brands]

Sure, Dara. Let me take a swing at that, and if I miss anything, Garth can fill in behind. Relative to depletes in September, we expect those to be fairly consistent with year-to-date trends. We're just about all wrapped up for September, keeping in mind that's going against the 20% increase that we had during September of last year. That's a pretty powerful start to the quarter. We do expect that depletions are going to continue to be above shipments for the reasons that Garth noted in his remarks. We would expect the depletions would be above it for that window of time. The pricing environment remains relatively strong.

[Bill Newlands, CEO at Constellation Brands]

As we said, we expect to be slightly ahead of our usual algorithm, driven more by taking pricing on some SKUs that we had not anticipated earlier in the year, more than we're doing anything unique to take additional pricing over what we had already planned. Garth, anything you want to add to that?

[Garth Hankinson, CFO at Constellation Brands]

I would just say on the depletions for the quarter, depletion growth will absolutely outpace shipment growth in the quarter, but on an absolute basis, shipments will outpace depletions, which helps us get into a better position from an inventory perspective.

[Bill Newlands, CEO at Constellation Brands]

Yeah. Keep in mind, as we've said, we have our inventory levels at our distributors below what we would like to see and what they would like to see on an ongoing basis. We would be expecting to fill some of that in as we get our inventory levels back to normal position by the end of the fiscal year.

[Operator]

Thank you. Our next question comes from Bonnie Herzog with Goldman Sachs. You may proceed with your question.

[Bonnie Herzog, Analyst at Goldman Sachs]

All right. Thank you. I actually had a question on your guidance as well. In thinking through it and thinking about the midpoints of your new beer guidance for the full year, this does imply a pretty big step down in the second half. For instance, your new guidance implies around 4%-4.5% beer shipment volume growth, 3% Of income growth, and then beer margins of 39% for the second half. That compares to your beer margins of 40% in the first half, which did include the $80 million obsolescence charge that you called out. I guess I'm trying to understand your level of conservatism with your new FY guidance, especially with margins given you mentioned there's going to be no more charges in the second half.

[Bonnie Herzog, Analyst at Goldman Sachs]

You highlighted you plan to take incremental pricing, there are a few other net positives, Garth, that you called out. I just want to make sure I'm not missing anything or maybe what's changed here. Thanks.

[Garth Hankinson, CFO at Constellation Brands]

Yeah. Thanks, Bonnie. Let me try to give you the walk on margins, right? You noted we've got some headwinds and we've got some tailwinds, right? Just on the tailwinds, obviously as we said in my opening remarks, we've got a bit of a benefit on depreciation just starting later than expected in the year, and so that's a net positive. As Bill just articulated, we're taking increased pricing across more SKUs than we had originally planned, so we'll be above our range there. That's a net positive. We also have the mixed benefit of seltzers. Again, a net positive there. The increase in core beer outlook is a net positive. Those are all the tailwinds. We still have the headwinds that we've been talking about all year long, right?

[Garth Hankinson, CFO at Constellation Brands]

Even though depreciation is coming in less than expected, we still have an uptick in depreciation in the second half of the year. We still are facing increase in commodity prices, including aluminum, diesel, natural gas, wood. Those will continue in the second half of the year. We think that the guidance we've provided takes into account all of those cost increases. We feel we have those covered. Again, we just continue to have these puts and takes, and we feel confident in the margin outlook that we've provided. Keep in mind too, that even though we're going to have a mixed benefit from seltzers, we still are going to sell seltzers, and those are margin dilutive, as we've noted previously.

[Operator]

Thank you. Our next question comes from Nik Modi with RBC Capital Markets. You may proceed with your question.

[Nik Modi, Analyst at RBC Capital Markets]

Thanks. I have two questions. One's a real quick one, just on the seltzer reformulation. Bill, I know you probably don't want to provide too many details until it's in the market, but will this change the calorie or the sugar levels? Just curious on that. My broader question is, Modelo's clearly doing very well. We see that in the data with non-Hispanic consumers. As we look at some of the numerator data and we look at different cohorts, what we notice is that Corona's kind of leveraged to some of these demographics that Modelo's doing much better with. We're seeing some of those numbers deteriorate. Just wanted to get a sense on incrementality of Modelo when you think about Modelo and Corona together.

[Nik Modi, Analyst at RBC Capital Markets]

Do you ever think that maybe there's a different merchandising scheme you can use, instead of putting both brands right next to one another to kind of reduce some of that cannibalization?

[Bill Newlands, CEO at Constellation Brands]

Sure. Relative to your first quick point, there won't be a radical change in the caloric formulation of our seltzer layout. Relative to Modelo and Corona, obviously there's interaction between those two brands as you would expect. As we've said before, Nik, and I'm sure you're quite familiar, our household penetration on Modelo is still significantly below where Corona is, to say nothing of it's below other brands that it competes against. While it is a true statement that as Modelo grows or as Corona grows, it does eat into some of our brands, we still see it as largely positive as we see that growth profile. As we've talked before, Modelo, it continues to grow velocity. There's still a lot of runway to expand distribution. The household penetration, which I touched on just a second ago, remains a massive opportunity for that.

[Bill Newlands, CEO at Constellation Brands]

We only started advertising to the non-Hispanic community about three and a half years ago. We're really just getting started on Modelo and the opportunity that presents itself there. While you continue to see some interaction, and clearly, I think, the idea of separating those at retail to some degree, has some opportunity. I think overall, we're still focused on expanding our presence of both of those brands. As you probably saw, Corona Extra had a very good quarter. It just shows the ongoing strength of the core Corona franchise, in addition to exceptional performance by Modelo.

[Operator]

Thank you. Our next question comes from Lauren Lieberman with Barclays. You may proceed with your question.

[Lauren Lieberman, Analyst at Barclays]

Great. Thanks. I want to hear a little bit about Corona Extra since you called out the 5% depletion growth for that brand and how that kind of shakes out between on-premise recovery versus track channels or, sorry, I should say, off-premise. I was hoping you could also talk a little about the Nielsen/IRI versus what you guys saw in terms of off-premise trends in total, including untracked outlets. Finally, just any kind of update on Pacifico, just continually intrigued to hear about progress you are making with that brand. Thanks.

[Bill Newlands, CEO at Constellation Brands]

Sure. Probably 50%, give or take, of the growth profile that we saw in Corona Extra is the reopening of the on-premise. As we said in prior calls, we were down as low as 3% of our business a few quarters ago during the sort of the peak of the initial COVID-19 pandemic issue. That's now up to 11%, clearly, with Corona being one of the most loved brands that exists in the category, the increase that you would expect to see as on-premise opens has been important. Don't underestimate, Corona Extra has done very well at retail as well. Relative to Pacifico, we continue to feel like Pacifico is another great opportunity. It's like a baby Modelo.

[Bill Newlands, CEO at Constellation Brands]

It's developing in a very similar way to what Modelo did, say, 20 years ago, with extensive growth profile on the West Coast, as it's starting to filter east. As you know, we're investing more against Pacifico than we have historically. We had a little bit of challenge in this quarter with brown glass, which had some impact on Pacifico during the quarter as it did with Modelo Negra as well. Those are ongoing supply chain challenges that we're working our way through. It does nothing to slow down what we expect to be another superb brand for us as time goes forward in Pacifico.

[Operator]

Thank you. Our next question comes from Chris Carey with Wells Fargo Securities. You may proceed with your question.

[Chris Carey, Analyst at Wells Fargo Securities]

Hi. Thank you very much. Just on hard seltzers, you had originally planned on investing pretty significantly behind the launch this year. Are you getting any savings from those investment plans now that the category has slowed, or are those locked? Presumably, that can be a good story going into fiscal 2023. In addition, you had mentioned that you had planned to double capacity for your ABAs, and so how are you thinking about flexing that capacity toward beer? Obviously, you're looking at building a new brewery in Southeast Mexico. Does this get to delay that new build-out over time because you have excess?

[Garth Hankinson, CFO at Constellation Brands]

Yeah. Thanks for the question. On the capacity piece first, as we announced last spring, we were investing in 5 million hL worth of ABA capacity. That is moving forward as planned and should come online earlier in our fiscal year 2023. That's still an important initiative for us because, as Bill outlined in his prepared remarks, while the seltzer category has slowed, the ABA segment within beer continues to be a dynamic and meaningful part of the high end, and it's one that we need to compete in. By having dedicated ABA capacity, that frees up capacity for our core Mexican beer portfolio. That goes on as planned. Furthermore, on the investments that you referenced in the first part in your question, we did indicate that we were going to spend $60 million this fiscal year behind Corona Hard Seltzer.

[Garth Hankinson, CFO at Constellation Brands]

Most of that spend was slated to be spent in the first half of the year, so that has been spent, and that which wasn't spent is being redirected to invest behind our core Mexican beer portfolio.

[Bill Newlands, CEO at Constellation Brands]

The only other thing I'd add to that on the last part of your question was about whether or not it causes any delay in what we would do to invest in the Southeast. I said, we're continuing to work with the Mexican government. We feel the Southeast is highly likely to be where we put our next brewery position. We said, because of robust demand, we're going to continue to invest to support our business. We would not expect to see any radical change of what our timeframe is all about. Demand has been higher than expected. We need to create some redundancy in our system, as we've noted on prior calls, and a brewery in the Southeast will be an integral part of that strategy.

[Operator]

Thank you. Our next question comes from Vivien Azer with Cowen. You may proceed with your question.

[Vivien Azer, Analyst at Cowen]

Hi. Good morning.

[Bill Newlands, CEO at Constellation Brands]

Hi, Vivien.

[Vivien Azer, Analyst at Cowen]

Bill, good morning. I was hoping you could comment, please, on intra-quarter trends in on-premise, whether you saw an evolution or a softening there around the Delta variant. As well, perhaps from an industry perspective, are you observing any changes in consumer alcohol preference across TBA, any cross-category switching, as consumers venture back out into bars and restaurants? Thanks.

[Bill Newlands, CEO at Constellation Brands]

Sure. We saw a lot of variation in on-premise, and at the risk of saying yes, no, yes, no, and yes, no, it largely depended on where you were geographically and what was going on in particular markets. While we would sit here and say, state X is coming up and we're seeing more on-premise, if you saw a wave of COVID challenges in another market, you saw stuff go the other way. What that basically, I think, means, Vivien, there wasn't an overarching answer to that question. It was really on a localized basis, that you saw many of the movements within the quarter. Again, in the aggregate, on-premise was better than it was in the prior year, and it continues to be increasing as a percentage of our business, but it's still not quite where it was before the pandemic. Hopefully that helps.

[Bill Newlands, CEO at Constellation Brands]

It's very hard to give a real aggregate of the thing because it's really made up of a lot of individual answers rather than something being an overarching trend across the marketplace. I think, relative to your question about cross-category, I think the overarching thing that you see there is the premiumization trends continue. Whether you think about it in ready-to-drinks or ABAs, you continue to see people premiumizing. You see it in the wine business, where the higher end of the wine business continues to outperform the mainstream sector of the business, and you continue to see that in spirits. I think that is an overarching trend that you see.

[Bill Newlands, CEO at Constellation Brands]

You also see what we've found for many years now, which is consumers are more interested in having an array of beverages, depending on the exact occasion in which they are consuming product, and are less likely than they used to be to consume only one type of product at any one occasion than what was perhaps the case historically. Hope that helps.

[Operator]

Thank you. Our next question comes from Kevin Grundy with Jefferies. You may proceed with your question.

[Kevin Grundy, Analyst at Jefferies]

Great. Thanks. Good morning, everyone. Bill, just picking up on the last question, really kind of lasering in, I guess, a little bit on wine, and broadly for the industry, because there's been some discussion in the marketplace about the recent slowdown, and it's not limited to the on-premise, and we've seen the Nielsen data. Your point's extremely well taken. The premiumization trends are still in place, obviously broad-based across total beverage alcohol. Even on a two-year average basis, we're seeing the trend slow down here. I'm not sure how much more you can add to your comment previously. Do you view this as transient at this point, some of this deceleration we're seeing in the category? Is there a bigger, maybe more difficult to quantify dynamic going on around ready-to-drink beverages in a way there hasn't been with wine before?

[Kevin Grundy, Analyst at Jefferies]

If you could comment on that. Garth, just sort of a cleanup, but I think important, the 30% operating margin target in the wine segment, is that still the target? In this FY 2024, so over the next couple of years, is that enough of a timeline to take out the stranded overhead? Your comments there would be helpful. Thank you both.

[Bill Newlands, CEO at Constellation Brands]

I think you got to keep in mind, relative to the higher end of the wine business, you're also seeing some, what I'll call, channel evolution, in things like three-tier e-commerce and direct-to-consumer. Those are up, for us, 3-4 times what it was in 2019. You're seeing that as 3%-5% of our business today, where it was 1% before. Some of what you're seeing in that is a difference in the way the consumer actually acquires, and it may or may not be reflective of some of the IRI/Nielsen data, because it's not picked up in those channels. Some of it is with three-tier e-commerce, but certainly the direct-to-consumer channel is not. You've got some of that dynamic in play. Of course, almost all of that tends to the higher end. That's where that consumer purchasing behavior occurs.

[Bill Newlands, CEO at Constellation Brands]

I do think there's ebbs and flows on all of those things. I think you saw probably more consumption behavior at home during COVID, so you're probably seeing a little bit of more challenging comparable versus prior year. I think as we get, hopefully, back to a bit more normalcy, I think you'll continue to see what the long-term trend is, which is that the higher end of the business continues to outperform, and that it's a strong growth play for that sector. Garth?

[Garth Hankinson, CFO at Constellation Brands]

Yeah. On the wine margins, certainly the target margin for wine is still 30%. As we've said all along, it was going to take us about two years post-divestiture of the low end for us to be able to achieve that 30% operating margin. By the time we get to the end of our fiscal year 2023, wine should be in that zip code. Obviously, the progress on that is underway. We're making good progress, as we've said before. In order to get there's a number of initiatives that we have to make progress on. That's pricing, mix, footprint optimization, making smart design-to-value choices. Like I said, we're making good progress and we're confident that we can get to the 30% by the end of 2023.

[Operator]

Thank you. Our next question comes from Robert Ottenstein with Evercore. You may proceed with your question.

[Robert Ottenstein, Analyst at Evercore]

Great. A couple of questions. First, obviously, the low inventories hurt depletions. Can you give us a sense of where you think depletions would've been if you had full inventory levels? I'm hearing it hurt Corona most. Can you verify that?

[Bill Newlands, CEO at Constellation Brands]

That's a little bit of a tough question to answer because, unlike a year ago, where we were very selective of what we produced, this year we've been producing all SKUs. We've just had trouble keeping up with the demand. Our best estimate would probably be in the two to three percentage points that we lost in this process. Again, in most instances, if a consumer's looking for our brand, they may have an issue at a particular point in time finding a SKU, but they don't have trouble finding our brand. I think that's probably the way to think about it.

[Robert Ottenstein, Analyst at Evercore]

Great. Second question. As you do a diagnostic on what happened with Corona Seltzer, I think I heard you say that flavor was an issue, that the consumer wants more flavor. As you think about it, was it a question of the taste not being differentiated, or is there an issue with having a brand that's associated with a beer, or are there other factors in addition to, obviously, the sector slowing a little bit? Just like to hear a little bit more of your diagnostic on the situation.

[Bill Newlands, CEO at Constellation Brands]

Well, I would put more emphasis on your very last point, which is the sector changed a lot versus what everybody anticipated. I think we were probably a bit on the conservative end compared to some of the competition as to what they expected going into this year, where some of them were predicting in excess of 50% growth. We projected less. Even as it was, we were wrong. That is the fundamental issue. When you combine that with the fact that we pre-produce, which again, at the time was about production scheduling, and in our judgment, was the right thing to do at the time, that in hindsight did not work out for us as well either. You got to keep in mind, despite all that, it's a relatively small percentage of our overall growth profile. It is additive to our growth.

[Bill Newlands, CEO at Constellation Brands]

It is not the majority of our growth. The majority of our growth continues to be the robust demand against our core beer portfolio. That's where we expect it to continue to be. Now, relative to the formulation, we obviously do a lot of consumer research. We track consumer perspectives. We have found that consumers are desiring a bit more flavor and a bit more differentiation within their seltzer preferences. We plan to address those consumer needs.

[Operator]

Thank you. Our next question comes from Sean King with UBS. You may proceed with your question.

[Sean King, Analyst at UBS]

Great. Thanks for the question. If thinking longer term on the margins front and some of the long-term exposures you have and hedges you have in place, is the second half of fiscal year 2022 the right way to be thinking about margins in 2023?

[Garth Hankinson, CFO at Constellation Brands]

Look, I think the right way to think about margins over the near and medium term is consistent with our long-term growth algorithm, which is that we're going to achieve margins in the range of 39%-40%. As we say in every call, those are best-in-class margins, and we're unapologetic about those. In any given fiscal year, margins might be slightly higher than that due to tailwinds, and in some years, they might be slightly lower than that due to too many headwinds. The right way over the medium term is to think about those in the range of 39%-40%.

[Operator]

Thank you. Our next question comes from Nadine Sarwat with Bernstein. You may proceed with your question.

[Nadine Sarwat, Analyst at Bernstein]

Hi. Thank you for taking my question. I want to circle back to Pacifico, and you had called out the brown glass challenges that you faced. Obviously that brand saw weaker Nielsen off-trade trends this quarter, and I noticed that you didn't call out its depletion figures in the release. Could you provide this and maybe give us some color as to if there were other issues outside of the glass issue you already called out? Thanks.

[Bill Newlands, CEO at Constellation Brands]

Sure. We had mid-single digit depletion growth in that brand during the quarter. Obviously it was constrained. We would have expected it to be higher without any supply chain issues that revolved around brown glass.

[Operator]

Thank you. Our next question comes from Andrea Teixeira with JPMorgan. You may proceed with your question.

[Andrea Teixeira, Analyst at JPMorgan]

Thank you. Good morning. I wanted to go back to the depletion and shipments commentary. You said depletion should outpace the low single-digit shipments you guided in the 3Q, which would imply a sequential acceleration in 3Q from the 12% on a two-year stack that you achieved in the 2Q. Given that you're facing tougher comparisons, as you grew depletion the same amount, about 12% in the 3Q of last year, is that acceleration on the two-year coming mostly from on-premise and at home decelerating but still growing? Is that the way we should be thinking? In other words, should we think about beer depletion growing around mid-single digits when you said, I think you said it emphatically that the 3Q depletions would outpace shipments as well.

[Andrea Teixeira, Analyst at JPMorgan]

Just a clarification on the pricing front, should we think that you will have about 3% price mix realization already in the 3Q? What are you seeing elasticity playing out so far? Thank you so much.

[Garth Hankinson, CFO at Constellation Brands]

Sure. Just on Q3 shipments and depletions. What we said in terms of from a growth perspective, shipments will grow in the low single digits and depletions will grow higher than that. We furthermore said that on a volume basis, shipments would outpace depletions, and therefore we'd make progress in returning inventory to more normal levels by the end of our fiscal year. On the pricing question, what we said on that was is that our typical pricing algorithm has us gaining one to two percentage points per year. Given the pricing environment that we're in this year, we're able to be a little bit more aggressive on products that we wouldn't otherwise take pricing on. We're going to take pricing on those SKUs, and as a result, we'll be slightly above our 2% this year.

[Operator]

Thank you. Our next question comes from Laurent Grandet with Guggenheim. You may proceed with your question.

[Laurent Grandet, Analyst at Guggenheim]

Yes. Good morning, everyone, and thanks for the question. I'd like to come back on the seltzer category. First, what is the gross realization for the category, and really I'm interested in the rationale behind it and thinking about the next, let's say, year or so. As you mentioned, there will be a consolidation with the elimination of lower velocity SKU. Do you see a risk potentially for the Corona seltzer, the white can, as that SKU has been significantly underperforming the category. Do you see a risk here that you could lose ACV? Finally, how you planning to gain the fair share of the seltzer category, especially as Mexican brand, I mean, Topo Chico, is really becoming more national beginning of next year and also launching a margarita-flavored, more flavored SKU. Like to understand how you play that.

[Bill Newlands, CEO at Constellation Brands]

Sure. If I understood the first part of your question correctly, keep in mind that the beer category has been roughly flat at a time when we are up roughly 8%. There is a significant delta between what the overall category is performing and what we are performing. We're radically outperforming the category. Relative to our desire in the seltzer/ABA space, there's a number of things. First of all, we're going to focus our attention on where we think we bring differentiated products that are distinct. Given what we have today, I would use Refresca and Limonada as two examples of that meet specific needs and are not what I would describe as me-too products. We also have, as we noted in our scripts, some innovation agenda items that we think are going to be distinctive and will bring unique value to the table as well.

[Bill Newlands, CEO at Constellation Brands]

We continue to believe this is going to be an additive portion of our growth, but certainly not the largest portion of our growth. That will continue to be our core beer portfolio.

[Operator]

Thank you. Our next question comes from [audio distortion] with Truist. You may proceed with your question.

[Analyst at Truist]

Thank you. Sorry to belabor the seltzer questions, but I guess two things, one simple, one bigger picture. two quarters ago, like you said, you have a lot of market research. You and everybody else was very bulled up about the market, and it seems like it was a soft summer, but it didn't seem like the category or it was a fad or it's over. In kind of redirecting marketing and advertising and moving to kind of focus SKUs, it seems that is what you're kind of saying. I guess, is that what you're saying? Do you see this as kind of a small niche permanently and everybody was kind of wrong that it was going to be a bigger place, or is this just a pause for the category?

[Analyst at Truist]

The second question is, with you redirecting kind of advertising marketing towards your core beer portfolio, does that result in the, I know it's small, but seltzer falling off a cliff over the next two quarters and creating kind of headwinds for your growth on beer? Thanks.

[Bill Newlands, CEO at Constellation Brands]

Sure. Relative to the category, our view of it is this: We still think that the overall ABA space is going to be a growth category. Whether or not how much of that is going to be driven by the seltzer sub-segment, remains to be seen. Quite frankly, it clearly is going to be a lot less than what everyone anticipated coming into this year. Again, for us, it's a relatively small percentage of our overall play. We are not entirely reliant on success in the seltzer category. In fact, we expect to achieve our algorithm through our core beer business. Relative to the question of will this put a damper on our growth in the beer business if seltzer is challenging, not really. The fact that we were able to raise our guidance is largely driven by the fact that we're able to make more beer.

[Bill Newlands, CEO at Constellation Brands]

We're able to make more beer because we're making a little less seltzer, and that is margin accretive, and it's a very high growth category. I realize there's a bad side and a good side to that answer, but the reality is, it's not inconsistent with what we've always seen, which is our core business portfolio of beer from Mexico continues to radically outperform the industry, and we continue to be the leader in the high end and the high-end growth. Is it going to be any different going forward? I think it's a little bit remains to be seen. We're going to have a little bit more of a watch and see effort than we had before. I think everyone got a little bit excited about seltzer, and frankly, the category has slowed significantly.

[Bill Newlands, CEO at Constellation Brands]

I think we will probably do a much better job of being guarded in terms of our expectation around that, while continuing to leverage our outstanding portfolio of core beer brands.

[Operator]

Thank you. I would now like to turn the call back over to Bill Newlands for any closing remarks.

[Bill Newlands, CEO at Constellation Brands]

All right. Thanks very much. Thank you all for joining our call today. Despite some challenges impacting our results this quarter, as you can see, we remain very confident in the strength and underlying fundamentals of our business. Our beer business in particular continues to be a top growth driver within the industry, while we continue to see the benefits of our wine and spirits premiumization take hold. We remain bullish on the future performance of our powerful collection of consumer-connected brands, which provides us with strong momentum as we head into the second half of our fiscal year. Our next quarterly call is scheduled for early January, we hopefully wish everyone a safe, happy, and holiday season. Please remember to enjoy some of our great products during your celebrations, and please remain safe. Thanks for joining the call.

[Operator]

Thank you. Thank you for participating. You may now disconnect.

Participants

Executives

• Bill Newlands, CEO
• Garth Hankinson, CFO
• Patty Yahn-Urlaub, SVP of Investor Relations

Analysts

• Andrea Teixeira, Analyst at JPMorgan
• Bonnie Herzog, Analyst at Goldman Sachs
• Chris Carey, Analyst at Wells Fargo Securities
• Dara Mohsenian, Analyst at Morgan Stanley
• Kevin Grundy, Analyst at Jefferies
• Lauren Lieberman, Analyst at Barclays
• Laurent Grandet, Analyst at Guggenheim
• Nadine Sarwat, Analyst at Bernstein
• Nik Modi, Analyst at RBC Capital Markets
• Robert Ottenstein, Analyst at Evercore
• Sean King, Analyst at UBS
• Vivien Azer, Analyst at Cowen
• Analyst at Truist