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 opened for your questions. Instructions will be given at that time. I will now turn the call over to Patty Yahn-Urlaub, Senior Vice President of Investor Relations. Please go ahead.

Thanks, Josh, and good morning and 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 otherwise available on the company's website at www.cbrands.com. Please refer to the news release and Constellation's SEC filings for risk factors, which may impact forward-looking statements we make on this call. Before turning the call over to Bill, similar to prior quarters, I would like to ask that we limit everyone to one question per person which will help us to end our call on time. Thanks in advance. And now, here's Bill.

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's stock is undervalued at current levels. We've received some feedback from investors on this topic in recent weeks, and we will address key themes that emerge from these discussions in our remarks. As we walk through our Q2 performance and outlook for the remainder of the year, there are several key takeaways we would 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 are 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. 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 do 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 today gives us the confidence to increase guidance for our beer business as we now expect to achieve 9% to 11% net sales growth and 4% to 6% operating income growth for fiscal 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. Point two, as it relates to our Hard Seltzer business, and building off our last point, we are 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 Seltzer and ABA’s 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 sizeable obsolescence charge taken for Q2, which includes our view of the total impact for the fiscal year. But 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. 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 are 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. 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 both 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. In fact, to date this fiscal year, we have repurchased $1.4 billion of our shares, and when combined with our dividend, 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 Obregon 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. We continue to work with the Mexican government to solidify plans for a new brewery in Southeastern Mexico with adequate water supply and an available talented workforce. Now, let's move on to a more fulsome discussion about our performance within the quarter. During the quarter, the McDowell brand family posted depletion growth of 17% for the quarter and single-handedly drove total import share gains in the 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. Corona Extra continues its growth trajectory as the second best 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 brand. 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 skew 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 sub-category 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. 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. And we have a solid lineup of innovation 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. And 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 pride 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. We're thriving in critical emerging channels like three-tier e-commerce and direct-to-consumer, which continued to drive high-end growth where we are outpacing category performance at key accounts such as Instacart, Amazon, and Albertsons with the resurgence of online shopping due to the COVID 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 online. In fact, e-commerce and DTC sales are up nearly three to four times versus 2019, and they comprise roughly 3% to 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. I would 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, and according to IWSR research, 60% of consumers are switching between non-alcoholic or low-alcohol 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. 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 opportunity in Administration 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 it for recreational use as well. In fact, nearly two out of three Americans already have legal cannabis access, as 37 states have legalized it for medical use and 18 states for adult use. While we're optimistic about Federal legislation within this Congress, Canopy is now waiting for this reality to materialize. Canopy's U.S. business grew 91% year-over-year in the most recent quarter, driven by robust consumer demand for their CBD and CBG products including Martha Stewart branded products, quarto beverages, storage and baked products, and BioSteel's new RTDs. Over the coming years, revenue for 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-PHD business with more opportunities in a world post Federal permissibility. Overall, we're comfortable with Canopy's progress, and we're looking forward to the growth and legalization prospects for the business. In closing, I'd like to reiterate our main takeaways for this quarter. First, continued strong demand for our core imported beer brands provides a point of competitive strength versus industry peers, led by their 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. 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 innovation in this space that we're optimistic about. Number three, we continue to see benefits from our wine and spirits premiumization strategy take hold. We are 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. Four, 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. And 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 that 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. And with that, I'd like to turn the call over to Garth, who will review our financial results in the quarter.

Thank you, Bill, and hello everyone. The second quarter showcased another strong performance for our beer business in the marketplace. With ongoing solid consumer demand for our core beer portfolio, we now anticipate surpassing our initial revenue and operating income targets for the beer segment. Furthermore, our strong cash flow allowed us to continue share repurchases during this quarter, and through September, we've bought back 6.2 million shares of common stock for $1.4 billion. Consequently, we've raised our full year fiscal 2022 diluted EPS target to a range of $10.15 to $10.45. This range excludes the impact of Canopy equity and earnings and reflects the increase in beer operating income guidance and a decrease in the weighted average diluted shares outstanding based on shares repurchased through September, partly offset by an increase in the tax rate for fiscal year 2022. Now, let's delve into our future performance and full year outlook in more detail, where I will primarily focus on comparable financial results. Starting with beer, net sales rose 14%, motivated by nearly 12% growth in shipment volume and favorable pricing, though partially offset by an unfavorable mix. Depletion volume growth for the quarter exceeded 7%, spurred by the continued popularity of Modelo Especial and Corona Extra, along with the recovery of the on-premise channel. Depletion trends moderated in Q2 compared to Q1, affected by out-of-stocks due to persistent strong consumer demand and lost shipping days for some distributors caused by severe weather events like hurricanes and wildfires. We estimate these factors impacted Q2 growth by about two to three points. As Bill noted, the on-premise volume represented around 11% of total beer depletions for the quarter and experienced strong double-digit growth relative to last year. To remember, the on-premise made up around 15% of our beer depletion volume before COVID and was only 6% in Q2 fiscal 2021 because of shutdowns and restrictions due to the pandemic. Selling days in the quarter were flat year-over-year and are expected to remain flat in Q3. Wholesaler depletions continued to outstrip cases shipped during Q2, leading to lower than usual distributor inventory at the quarter’s end. To address this gap, we expect shipment case volume to exceed depletion case volume throughout the latter half of the fiscal year, gradually improving distributor inventories in Q3 and Q4, with inventories anticipated to return to normal levels by the close of the fiscal year. Moving on to beer margins, the operating margin declined by 530 basis points compared to the previous year to 37.2%. While we saw benefits from favorable pricing, mix, and foreign currency, they were more than counterbalanced by higher costs of goods sold, increased marketing investments, and higher selling, general, and administrative expenses. The rise in costs of goods sold was due to several challenges, including a $66 million obsolescence charge for Q2. Earlier in the year, due to production constraints, we pre-built Hard Seltzer inventory for the key summer season based on our best estimates for the fiscal year 2022. However, the slowdown in the Hard Seltzer category in the U.S. led to excess inventory that we couldn't utilize as planned. Additionally, brewery cost increases stemmed from labor inflation in Mexico, an increase in headcount, and additional spending for capacity expansion. We also saw a rise in depreciation expenses primarily due to an increment of 5 million hectoliters at our Obregon facility. Lastly, material costs increased largely because of rising commodity prices and inflationary pressures on pallets, cartons, and aluminum. Some of these cost of goods sold challenges were counteracted by favorable fixed cost absorption. Marketing as a percentage of net sales grew by 150 basis points to 9.9 compared to the previous year, as we returned to our normal spending pattern, which leans more heavily on the first half of the fiscal year. It's worth noting that marketing expenditure in the first half of last year was significantly lower due to COVID-19-related event cancellations and postponements. The rise in SG&A was mostly due to around $12 million in increased legal expenses, alongside higher compensation and benefits. As mentioned earlier, we are raising our full-year fiscal 2022 net sales and operating income guidance for our beer business, now targeting net sales growth of 9% to 11%, based on the strength of our core beer portfolio and pricing actions that exceeded our initial plans. We are also targeting operating income growth of 4% to 6%, which suggests operating margins in the lower to mid-range of our stated 39% to 40%. Note that the updated guidance includes all obsolescence charges and legal expenses accrued in the first half of the fiscal year. We still expect our gross margin to be negatively influenced for the fiscal year as the benefits from pricing and our cost-saving initiatives are anticipated to be overshadowed by several cost challenges. However, the nature and extent of these challenges have evolved from our original forecasts presented at the beginning of the fiscal year. We're estimating a significant bump in depreciation expense, which began to accelerate in Q2, though some of this depreciation started later in the fiscal year than initially planned. We now estimate the total beer depreciation expense to be around $250 million, an increase of approximately $55 million compared to last year, but a $10 million reduction from our initial estimate. We expect substantial inflationary pressures across various cost components to continue in the second half of the fiscal year as commodity prices, particularly for aluminum, diesel, and pallets, keep rising due to a volatile inflationary environment. Furthermore, due to the moderation in the Hard Seltzer market and lower levels across the category for new items, we do not anticipate our Hard Seltzer SKUs to achieve our original volume expectations, resulting in a beneficial mix compared to our earlier estimate. Conversely, the downturn in the Hard Seltzer sector has led to excess inventory and a fiscal year-to-date obsolescence charge of about $80 million. Please note that these losses cover our Hard Seltzer obsolescence exposure, and we do not expect to incur any additional obsolete charges for Hard Seltzers in the back half of the fiscal year. From a marketing standpoint, we still expect full year spending as a percentage of net sales to be in the range of 9% to 10%, aligning with fiscal 2021 spending, which was 9.7%. Looking ahead to Q3, I would like to highlight the challenging year-over-year comparisons we will face, as we are up against growth rates of 28% and 12% for shipment volume and depletion volume respectively. Additionally, we anticipate performing our regular annual brewery maintenance during Q3, which will limit throughput compared to Q2, necessitating a temporary production shut down. Therefore, we’re estimating low single-digit shipment volume growth for Q3. Transitioning to the wine experience, Q2 fiscal 2022 net sales fell 18% with shipment volume down by 36%. Excluding the effects of wine and spirits divestitures, organic net sales increased by 15%, propelled by nearly 6% organic shipment volume growth, positive mix and pricing, as well as smoke-tainted bulk wine sales. The favorable mix, predominantly from the Prisoner brand family, Meiomi, and Kim Crawford, contributed approximately nine points of the year-over-year organic net sales growth. Shipments faced delays due to port issues for our international brands and changes in routes to market that also affected depletions. Depletion volume dropped 2% for the quarter, further impacted by challenging consumer pantry loading patterns, especially for mainstream brands that saw significant growth at the onset of the COVID-19 pandemic. Nevertheless, as we move into the latter part of the fiscal year, we believe that most of these challenges are behind us and expect shipment volume and depletion volume to generally align in the second half of fiscal 2022. Regarding wine and spirits margins, the operating margin decreased by 620 basis points to 19.7%, as mix benefits from the current portfolio and divestitures combined with favorable pricing were outweighed by increased marketing and SG&A expenditures, higher costs of goods sold, and margin-sapping smoke-tainted bulk wine sales. The increase in costs of goods sold was driven by unfavorable fixed cost absorption and elevated transportation costs. The unfavorable fixed cost absorption was a result of reduced production in New Zealand due to frost during the earlier harvest season and decreased production levels at our California wineries from the 2020 U.S. wildfires. These challenges were somewhat offset by lower-grade raw materials and various cost-saving initiatives. Keep in mind that we are overcoming smaller SG&A expenditures in Q2 fiscal 2021 due to COVID and managing a smaller business post-divestitures, leading to significant marketing and SG&A leverage impacting operating margins. For full year fiscal 2022, the wine and spirits segment continues to forecast a 22% to 24% decline in net sales and a 23% to 25% decline in operating income, suggesting operating margins around 24%, which would be flat compared to the previous year on a reported basis but show significant expansion on an organic basis. Excluding the impact of the wine and spirits divestitures, organic net sales are expected to rise in the 2% to 4% range. As we look to Q3, remember that we are overcoming unfavorable fixed cost absorption of $20 million from the prior year due to decreased production levels from the 2020 U.S. wildfires. We expect this positive overlap to be counteracted by a continued rise in transportation costs and further unfavorable fixed cost absorption resulting from the frost in New Zealand. Additionally, we still expect marketing and SG&A leverage due to the wine and spirits divestitures. Therefore, we expect marketing and SG&A to continue to exert significant pressure on operating margins in Q3 fiscal 2022. Now, let's continue with the rest of the profit and loss statement. Year-to-date corporate expenses came in around $170 million, a 7% increase compared to last fiscal year. This rise was mainly driven by heightened consulting services and compensation benefits, partially mitigated by favorable foreign currency effects. We now anticipate full year corporate expenses to be approximately $245 million, propelled by increased compensation and benefits. Comparable basis interest expense for the quarter fell 4% to about $96 million compared to the previous year, mainly owing to lower average borrowings. We now expect fiscal 2022 interest expenses to range between $355 million and $365 million. This slight reduction from our previous guidance results from the early redemption of higher interest rate debt and $1 billion in senior notes issued in July at favorable rates. Our Q2 comparable effective tax rate, excluding Canopy equity earnings, stood at 21.8%, up from 16.9% in Q2 of last year, driven mainly by the timing of stock-based compensation benefits and a higher effective tax rate on our foreign operations. We now predict our full year fiscal 2022 comparable tax rate, excluding Canopy equity earnings, will be around 20%, an increase from our previous guidance of 19%. This adjustment is primarily due to a higher effective tax rate on our core earnings than we originally estimated. I would also like to point out that we foresee stock-based compensation tax benefits being more prominent in Q4. Thus, we expect our Q3 tax rate to be higher than our full year estimate, around 21%. We also expect our 2022 weighted average diluted shares outstanding to be about 192 million, reflecting the impact of our share repurchases discussed earlier. In terms of free cash flow, defined as net cash from operating activities minus capital expenditures, we produced free cash flow of $1.2 billion for the first half of fiscal 2022, consistent with the prior year, supported by strong operating cash flows, despite an increase in capital expenditures. Capital expenditures totaled $353 million, which included about $295 million for beer capital expenditures, mainly driven by expansion efforts at our Mexico operations. Our full year capital expenditures guidance of $1 billion to $1.1 billion, including around $900 million earmarked for Mexican beer operation expansions, remains unchanged. Additionally, we expect fiscal 2022 free cash flow to be between $1.4 billion and $1.5 billion, reflecting operating cash flow in the range of $2.4 billion to $2.6 billion and the previously mentioned capital expenditure spend. In conclusion, I want to emphasize that while we faced numerous challenges in the first half of our fiscal year resulting in various impacts on our results, the fundamentals of our business remain sound, and consumer demand for our products, particularly our imported beer portfolio, stays strong, giving us momentum as we enter the latter half of our fiscal year. Bill and I are now ready to take your questions.

Our first question comes from Dara Mohsenian with Morgan Stanley. You may proceed with your question.

Hey guys, so on the beer topline 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 and also for the quarter are you expecting depletions to still be above that low single-digit shipment rate that you mentioned, or is that tough with the difficult 12% depletion comp? And then 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 into the balance of the year versus pricing? And on the pricing front, you've sounded more aggressive in terms of pricing expectations going forward; 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? Thanks.

Sure, Dara. Let me address that and if I overlook anything, Garth can provide additional insight. Regarding depletions in September, we anticipate they will align closely with year-to-date trends. We're nearing completion for September, keeping in mind that this follows a 20% increase we experienced in September last year, which was a significant start to the quarter. We expect depletions to continue outpacing shipments for the reasons Garth mentioned in his comments. The pricing environment remains relatively robust. As we've indicated, we anticipate being slightly ahead of our typical expectations, primarily due to implementing pricing adjustments on certain products that we did not foresee earlier in the year, rather than making any unusual moves to hike prices beyond what we had initially planned. Garth, do you have anything to add?

No, I will just say on the depletions for the quarter, depletion growth will absolutely outpace shipment growth in the quarter. But on an absolute basis, the shipments will outpace depletions which helps us get into a better position from an inventory perspective.

Yes, 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. So we would be expecting to fill some of that as we get our inventory levels back to normal position by the end of the fiscal year.

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

Hi, thank you. I had a question about your guidance as well. Considering the midpoints of your updated beer guidance for the full year, it seems to suggest a significant decline in the second half. For example, your new guidance indicates approximately 4% to 4.5% growth in beer shipment volume, 3% growth in income, and beer margins of 39% for the second half, compared to beer margins of 40% in the first half, which included an $80 million obsolescence charge that was excluded. I'm trying to understand the level of conservatism in your new fiscal year guidance, particularly regarding margins, given that you mentioned there will be no further charges in the second half. You indicated that you plan to implement incremental pricing and mentioned a few other net positives. I want to ensure I’m not overlooking anything or to find out what has changed. Thanks.

Thanks, Bonnie. Let me outline the margins. As you've observed, we have both headwinds and tailwinds. Regarding the tailwinds, we mentioned in my opening remarks that we have a slight benefit from depreciation starting later than expected this year, which is a positive. As Bill mentioned, we are implementing increased pricing across more products than we initially planned, which will also help us exceed our projections. Additionally, the favorable mix from Seltzers contributes positively, along with an improved outlook for core beer. However, we still face some persistent headwinds. Even though depreciation is coming in lower than expected, we anticipate an uptick in depreciation during the second half of the year. We're also contending with rising commodity prices, such as aluminum, diesel, natural gas, and wood, which are expected to persist. We believe our guidance accounts for all these cost increases, so we feel prepared. Nonetheless, we are navigating these fluctuations and remain confident in our margin outlook. It's important to remember that while we'll benefit from the mix of Seltzers, these products can dilute margins as we have previously indicated.

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

Yes, thank you. Good morning everyone. I have two questions. First, regarding the self-service formulation, will it affect the calorie or sugar levels? I'm just curious about that. Secondly, Modelo is clearly performing well, especially among non-Hispanic consumers. However, when reviewing various data segments, it appears that Corona is also appealing to some of those demographics. Consequently, while Modelo is thriving, we are observing these trends in the data. I'm interested in understanding the incremental impact of Modelo when considered alongside Corona. Additionally, do you think there might be a different merchandising strategy to implement instead of placing both brands adjacent to each other to mitigate potential cannibalization?

Sure. So relative to your first quick point, there won't be radical change in the core formulation of our Seltzer layout. Relative to Modelo and Corona, obviously, there's interaction between those two brands as you would expect. However, 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 is below other brands that it competes against. So 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. And as we have talked before, Modelo continues to grow velocity; there's still a lot of runway to expand distribution. Household penetration, which I touched on just a second ago, remains a massive opportunity for that. And we only started advertising to the non-Hispanic community about three and a half years ago. So, we're really just getting started on Modelo and the opportunity that presents itself there. So, 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. And it just shows the ongoing strength of the core Corona franchise in addition to exceptional performance by Modelo.

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

Great. Thanks. I wanted to know 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? And then I was hoping you could also talk a little bit at Nielsen/IRI versus what you guys saw in terms of off-premise trends in total, including on track outlets? And then finally, do any kind of update on Pacifico, just continually intrigued to hear about progress you are making with that brand? Thanks.

Sure. So 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 pandemic issue. That's now up to 11%, and clearly with the Corona being one of the most loved brands that exist in the category, the increase that you would expect to see in on-premise has been important. But don't underestimate, Corona actually 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. It's developing in a very similar way to what Modelo did say 20 years ago with extensive growth profile on the West Coast and it is starting to filter East. As you know, we're investing more against Pacifico than we have historically. We have 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. But those are ongoing supply chain challenges that we're working our way through. It does nothing, nothing to slow down what we expect to be another superb brand for us as time goes forward in Pacifico.

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

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 and presumably that can be a good story going into fiscal 2023? In addition, you had mentioned that you had plans to double capacity for your ABAs, so how are you thinking about flexing that capacity towards 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 capacity?

Yes, yes, thanks for the question. So, on the capacity piece first, as we announced last spring, we were investing in 5 million hectoliters 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 it's built 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. And by having dedicated ABA capacity, that frees up capacity for our core Mexican beer portfolio. So, that goes on as planned. And then furthermore, on the investment that you referenced in the first part of your comment and your question, we did indicate that we were going to spend $60 million this fiscal year behind Corona Hard Seltzer. 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.

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. As 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. And as we said, because of robust demand we're going to continue to invest to support our business. So, we would not expect to see any radical change in 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 our brewery in the Southeast will be an integral part of that strategy.

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

Hi. 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? And as well, perhaps from an industry perspective, are you observing any changes in consumer alcohol preference across kind of TBA, and across category switching as consumers central back out and deposit in restaurants? Thanks.

Sure. We saw a lot of variation in on-premise, and at the risk of saying yes, no, yes, no, and yes no it is largely depended on where you were geographically and what was going on in particular markets. So, 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. So what that basically I think there was 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. So, hopefully that helps. 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 across 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. So, I think that is an overarching trend that you see. 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 the 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. So hope that helps.

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

Good morning everyone. Bill, I'd like to follow up on the last question, specifically focusing on wine and the industry as a whole. There has been some talk in the market about the recent slowdown, which isn't just confined to on-premise sales, and we've observed the Nielsen data. Your point about the premiumization trends remaining strong across total beverage alcohol is well taken, but we're noticing a slowdown in this trend on a two-year average basis. I’m curious if you see this deceleration as temporary. Is there a more complex issue at play regarding ready-to-drink beverages that we haven't seen with wine before? Additionally, Garth, I wanted to clarify the 30% operating margin target in the wine segment. Is that still the goal, and is fiscal 2024 a sufficient timeframe to eliminate the stranded overhead? Your insights would be appreciated. Thank you both.

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 and things like three-tier e-commerce and direct-to-consumer. Those are for us three to four times what it was in 2019, and you're seeing that as sort of 3% to 5% of our business today, where it was 1% before. So 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. So, you've got some of that dynamic in place and of course almost all of that tends to the higher end. That's where that consumer purchasing behavior occurs. So, 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. So, 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 then it's a strong growth play for that sector. Garth.

Yeah. On the wine margins, certainly the target margin for wine is still 30%. As we've said all along that 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. So, by the time we get to the end of our fiscal 2023, wine should be in that zip code. Obviously, the progress on that is underway. We're making some good progress as we've said before in order to get there. 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. And like I said, we're making good progress and we're confident that we can get that 30% by the end of 2023.

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

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

Obviously, that's a little bit of a tough question to answer because unlike a year ago where we were very selective about what we produced, this year we've been producing all skews. We've just had trouble keeping up with the demand. Our best estimate would probably be in the 2 to 3 percentage points that we lost in this process. But again, in most instances, the consumer is looking for our brand; they may have an issue out of particular point time finding a skew, but they don't have trouble finding our brand. So, I think that's probably the way to think about it.

Great. And then second question, as you kind of 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. So, 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 the 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.

I want to emphasize your last point about how much the sector has changed compared to what was anticipated. We likely took a more conservative stance than some competitors who were expecting over 50% growth, while we projected less. In hindsight, we were mistaken. This is a key issue. Additionally, we pre-produced based on our production scheduling judgment at the time, which did not yield the expected results. However, despite these challenges, they represent a relatively small part of our overall growth. It contributes to our growth but is not the primary source. Our main growth continues to come from strong demand for our core beer portfolio, and we expect this to persist. Regarding the formulation, we conduct extensive consumer research and monitor consumer feedback. We've noted that consumers are seeking more flavor and differentiation in their Seltzer choices, and we plan to address those preferences.

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

Great, thanks for the question. 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 fiscal 2022 the right way to be thinking about margins for 2023?

Okay, 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% to 40%, and as we say in every call, those are best in class margins and we're not apologetic 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 just due to too many headwinds. But the right way over the medium term is to think about those in the range of 39% to 40%.

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

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. So 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. So, 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.

Sure. We had mid-single-digit depletion growth in that brand during the quarter. And obviously it was constrained; we would have expected it to be higher without any supply chain issues that revolve around Brown Glass.

Thank you. Our next question comes from Andrea Teixeira with J.P. Morgan. You may proceed with your question.

Thank you. Good morning. I wanted to revisit the discussion on depletion and shipments. You mentioned that depletion is expected to outpace the low single-digit shipments you projected for the third quarter, suggesting a sequential acceleration from the 12% on a two-year basis achieved in the second quarter. Considering the more challenging comparisons, you will be depleting a similar amount to the 12% from the third quarter of last year. Should we think of this acceleration on a two-year basis as primarily driven by on-premise and at-home deceleration, although still growing? Should we anticipate depletion growth around mid-single digits, given your strong emphasis that third quarter depletions would exceed shipments? Additionally, regarding pricing, should we expect about a 2% realization from price mix in the third quarter, and what are you seeing so far? Thank you.

In terms of Q3 shipments and depletions, we expect shipments to grow in the low single digits, while depletions will grow at a higher rate. We also mentioned that on a volume basis, depletions will outpace shipments, which means we are making progress in normalizing inventory levels by the end of our fiscal year. Regarding pricing, our usual pricing strategy allows us to achieve an increase of one to two percentage points per year. However, due to the current pricing environment, we can be more aggressive with certain products that we wouldn't typically increase prices on. Consequently, we plan to adjust pricing on these products and anticipate ending up slightly above our 2% increase this year.

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

Yes. Good morning everyone, and thanks for the question. So, I'd like to come back on the Seltzer category. So first, what is the growth for the category, and really I am interested in the rationale behind it and thinking about the next year or so? And then, 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 severely underperforming the category? So do you see a risk here that you could lose ACV? And finally, how are you planning to gain the fair share of the Seltzer category, especially as a Mexican brand? I mean, Top Chico is really becoming more national beginning of next year and they are also launching a margarita flavored, more flavor than that SKU, so would like to understand how you will play that?

Sure. If I understood the first part of your question correctly, I mean, keep in mind that the beer category has been roughly flat at a time when we are up roughly 8%. So 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 that meet specific needs and are not what I would describe as need-to 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. So, 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.

Thank you. Our next question comes from Bill Chappell with Truist. You may proceed to your question.

Thank you for the opportunity to ask a question. I’d like to touch on the Seltzer market. A couple of months back, there was a lot of optimism surrounding it, but this summer seemed to be a bit disappointing. However, I don’t think the category is a passing trend. You mentioned shifting your marketing focus towards specific SKUs; is that correct? Do you view the Seltzer segment as a smaller niche that was misjudged in terms of its potential, or is this merely a temporary slowdown? My second question is regarding your decision to channel your advertising towards your main beer products. Could this lead to a significant decline in Seltzer sales over the coming quarters, potentially hindering your beer growth? Thank you.

Sure. Regarding the category, we believe the overall ABA space will continue to grow. The impact of the Seltzer sub-segment of the beer category is uncertain, and it will likely be less significant than expected this year. However, it represents a small part of our overall strategy, so we are not solely dependent on its success. We anticipate achieving our growth targets mainly through our core beer business. Concerning whether challenges in the Seltzer market will hinder our beer growth, it won't significantly affect us. We have raised our guidance primarily because we can produce more beer, which is made easier by reducing Seltzer production—this is beneficial and aligns with our high-growth strategy. While there are pros and cons to this situation, it aligns with our historical performance, showing that our beer portfolio from Mexico continues to outperform the industry, and we remain leaders in both high-end and high-end growth segments. Whether this trend will change remains uncertain, and we need to be more cautious in our expectations regarding Seltzer while still leveraging our strong core beer brands.

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

Alright. Thanks very much. And thank you all for joining our call today. Despite some challenges impacting our results this quarter, as you can see, we remain very confident on the strength and underlying fundamentals of our business. Our beer business in particular continues to be a tight 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, so 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.

Thank you. Thank you for participating. You may now disconnect. That concludes today's conference call.