Ladies and gentlemen, thank you for standing by, welcome to the Constellation Brands Third Quarter FY 2016 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. If you should require assistance at any time, please press star zero. I'll now turn the call over to Patty Yahn-Urlab, Vice President of Investor Relations. Please go ahead.
Thank you, Laurie. Good morning, everyone, welcome to Constellation's Conference Call. In addition to our third quarter fiscal 2016 results and outlook, we will also discuss our Mexicali and Nava Brewery projects and their related outlook. I'm here this morning with Rob Sands, our President and Chief Executive Officer, and David Klein, our Chief Financial Officer. This call complements our news release, which has also been furnished to the SEC. During this call, we may discuss financial information on a GAAP comparable organic and constant currency basis. However, discussions will generally focus on comparable financial results. Reconciliations between the most directly comparable GAAP measure and these and other non-GAAP financial measures are included in the news releases or otherwise available on the company's website at www.cbrands.com. Please also be aware that we may make forward-looking statements during this call.
While those statements represent our best estimates and expectations, actual results could differ materially from our estimates and expectations. For a detailed list of risk factors that may impact the company's estimates, please refer to the news releases and Constellation's SEC filings. Before turning the call over to Rob, I would like to ask that we limit the number of questions asked during the Q&A session today to two questions per person. This has been our practice for the last few quarters and helps us to end our call on schedule. Thanks in advance, now here's Rob.
Thanks, Patty, good morning and Happy New Year to everybody. I hope you enjoyed the holidays and had the opportunity to include some of our fine Constellation products in your celebrations with family and friends. Welcome to our discussion of Constellation's third quarter fiscal 2016 sales and earnings results. Before we get started with the review of the quarter, I am pleased to report that we posted another year of exceptional stock price performance, with Constellation stock increasing more than 45% for calendar year 2015 versus the S&P 500, which declined 1% for the year. This is the fourth consecutive year that Constellation was one of the best-performing stocks in the S&P 500 Consumer Staples Index. I believe this excellent stock price performance is being driven by our strong financial results led by our beer business, which has incredible momentum and strong prospects for future growth.
It is because of this tremendous growth opportunity that we are making smart investments now to ensure that we have the capacity, quality, control, and flexibility to help us meet expected demand for our iconic beer brands well into the future. These investments include the construction of a new state-of-the-art brewery in Mexicali, Mexico. Details of our plans were announced earlier this morning. Initially, this brewery will be built to operate at 10 million hectoliters of production capacity with future scalability to 20 million hectoliters. The Mexicali location is ideal given its close proximity to the state of California, Constellation's largest beer market. The new brewery is being built with similar technology and operational advancements as our Nava Brewery and is designed to ensure consistency in brewing and production processes with the highest level of product quality expected between the two facilities.
Let's take a moment to discuss the progress at our Nava facility, which had production capacity of 10 million hectoliters with the ability to expand at the time we acquired it. As previously discussed, we currently have work underway to expand Nava to 25 million hectoliters by the summer of calendar 2017 via three incremental 5 million hectoliter expansions. In addition to our plans to build the Mexicali brewery, we also announced today that we have plans to further expand Nava with a 2.5 million hectoliter capacity expansion that will bring production from 25 to 27.5 million hectoliters when completed in early calendar year 2018. Now, I am pleased to report that as expected, our first incremental 5 million hectoliters of Nava production capacity recently became operational and is in the process of ramping to optimal capacity utilization levels.
We now have 15 million hectoliters of functioning brewing capacity at Nava. Two packaging lines have been running to support this new brewing capacity and ramp up to full utilization is expected shortly for these lines, which will provide additional capacity for premium glass products like Modelo Especial and Coronitas. The second incremental 5 million hectoliters of new brewing capacity at Nava is underway, with this piece of the expansion to be expected to be completed by June of this year. Work continues on the third expansion phase as we increase Nava production capacity from 20 million to 25 million hectoliters and continue to expand the rail and logistics capability around the site with completion expected by the summer of calendar 2017.
As these expansion activities continue, we have worked with ABI to extend the interim supply agreement we currently have in place for finished goods in order to support our robust growth and enable a smooth transition as we increase capacity. This agreement is expected to remain in place through June of 2017 for a select number of products that are expected to represent about 15%-20% of the company's need for the U.S. marketplace. Overall, we remain on track with all expansion activities, and I'm excited to be in a position to continue investing in Mexico and enhancing our operational platform to support the industry-leading growth levels of our incredible beer business.
Our additional investments in production capacity are designed to ensure that we are well-positioned to capture the continued momentum and growth opportunities we see in the high-end segment of the U.S. beer market, which has consistently grown in the mid to high single-digit range and is expected to grow at these levels into the foreseeable future. Our third quarter beer results are a testament to this momentum. As we achieved depletion growth of more than 16%, leading volume gains amongst all U.S. brewers and outperforming the U.S. beer industry, key competitors, and all other imports, with double-digit growth achieved by nearly every brand in our Mexican beer portfolio.
Corona Extra posted accelerating depletion in consumer takeaway trends during the quarter by gaining distribution for key packages, accelerating velocities behind investments in media and merchandising, and continuing to grow the can format, which represented nearly 25% of the growth of the Corona Extra brand during the quarter. Marketing initiatives for the brand included Corona Football with Jon Gruden, two major boxing matches, general market and Hispanic TV advertising throughout the fall football tailgating season, and the airing of the O Tannenpalm holiday spot for the 25th consecutive year. Modelo Especial also delivered accelerating depletion growth of more than 20% during the third quarter, with all core Especial packages growing double digits. This brand's media investments included the continuation of Modelo Especial's national English language TV and video campaign, with the addition of sports programming during the start of the NFL season across CBS, Fox, ESPN, and ESPN2.
National Hispanic media continued throughout the quarter with weekly TV exposure to Spanish language consumers. Now, given some of these marketing highlights, it's important to note that the beer team was recently recognized by earning a top spot on Ad Age's 2015 Marketers A-List. Constellation is the only beer, wine, and spirits company to make the list, and I am very, very proud of this accomplishment. Collectively, these activities resulted in Modelo Especial becoming the number one dollar share gainer amongst established U.S. beer brands in the IRI channels during the third quarter, followed by Corona Extra as the number two share gainer. Overall, the strong results that the beer business achieved in the third quarter are the primary driver of the upward revision to Constellation's EPS guidance for fiscal 2016. David will have more to say about this in a few moments.
When you put all of these pieces together, the exceptional growth and strong consumer demand for our Mexican beer brands, the exciting opportunity to invest in Mexico to expand our brewery operations, and the on-schedule progress we are making to meet our expansion goals. It is clearly an exciting time at Constellation, where the opportunities to build upon our growth as a leader in the high end of the U.S. beer segment keep getting better and better. As you know, we acted upon another such opportunity for the future growth when we entered the U.S. craft beer market with the acquisition of Ballast Point, one of the most awarded major craft breweries in the industry. Ballast Point provides a high growth premium platform that will enable Constellation to compete in the fast-growing craft beer segment, further strengthening our position in the high end of the U.S. beer market.
Ballast Point is currently growing at more than 125% in IRI channels and remains on track to sell nearly 4 million cases and generate approximately $115 million in net sales for calendar 2015, representing growth of more than 100% versus the prior calendar year. I am pleased to welcome the Ballast Point founder, Jack White, and the entire Ballast Point team to Constellation. Now I would like to discuss the business results for our wine and spirits business. In our wine and spirits business during the third quarter, we achieved earnings growth and strong margin expansion driven primarily by the Meiomi Wine acquisition, as well as favorable mix and COGS trends. As I mentioned last quarter, we have successfully integrated our new Meiomi Wine brand into our existing wine portfolio, and our efforts to expand distribution are working to drive incremental growth for the brand.
The most recent IRI trends corresponding with our quarterly results show that the Meiomi Pinot Noir is growing more than 80% in IRI channels, a trend which has accelerated since we first acquired the brand this past summer. Third quarter depletions for the brand were also strong across all channels, growing more than 50%. Meiomi Pinot Noir is one of the hottest wines of the year, listed as number 20 in the Wine Spectator's Top 100 Wines for 2015, and number 1 on wine.com's Top 100 list, which is based entirely on consumer preferences. We believe the brand has plenty of room to continue driving healthy growth for our business. Just this quarter, we began shipping the 2014 vintage of Meiomi Chardonnay, following the success of the 2013 Chardonnay in the marketplace.
Our Mark West brand is also known as a leader in the premium Pinot Noir category, and we are pleased to announce that the new line extension, Mark West Black, is now shipping. This higher price tier of the Mark West brand welcomes consumer to the dark side of Pinot Noir with a more full-bodied and rich taste profile. One of our newer brands, Tom Gore Vineyards, has been gaining consumer acceptance for its high quality and authentic second-generation grape farmer brand story. It has also been featured in publications like Wine Enthusiast, Celebrating Wine Around the World, and The Wall Street Journal's My Ride series.
Our focus brands are gaining, driving positive results for the quarter in our wine and spirits portfolio, led by brands like Woodbridge by Robert Mondavi, which is America's favorite Cabernet, holding the number 1 Cabernet Sauvignon position with the highest dollar and volume sales. Other focus brand leaders include Kim Crawford, which was named number 11 on wine.com's Top 100 Wines of 2015, and The Dreaming Tree, which launched its Pinot Noir varietal earlier this year. Our luxury brand and tiers continue to maintain their reputation for excellence among the critics, with outstanding reviews, rankings, and 90-plus scores for our brands like Robert Mondavi Winery, Simi, and Mount Veeder, from publications like the Wine Spectator, Wine Enthusiast, and Wine & Spirits.
During the quarter, our spirits portfolio posted net sales growth of 2%, driven by Paul Masson Grande Amber Peach flavor, as well as SVEDKA Vodka Mango, Pineapple, and Strawberry Lemonade flavors. Casa Noble Tequila is exceeding our expectations so far this year with continuing share gains and was recently awarded a 94-point score in the Wine Enthusiast and a Top 10 Best Tequila designation by Liquor.com. In closing, it is certainly shaping up to be yet another eventful year at Constellation. With the year quickly drawing to a close, I am very pleased with our progress to date. Our efforts have produced a year of strong financial performance, notable business and brand milestones, industry accolades, and healthy growth within several areas of the business. I am particularly pleased that we have finalized our investment plans in Mexicali, Mexico, to support the future growth we see within our beer business.
We are working diligently on the Nava Brewery and glass plant expansions while maintaining the strong momentum of the commercial side of the beer business. In calendar 2015, amid all of our hard work and accomplishments achieved throughout the year, we also celebrated the 70th anniversary of our company founding. While we are proud of our most recent accomplishments, taking a longer view of our 70-year heritage gives us perspective of how far we have come and even greater resolve to continue challenging our own expectations as we look forward to the next 70 years. With that, I would now like to turn the call over to David Klein for a financial discussion of our third quarter results.
Thank you, Rob, and good morning, everyone. Let's start with some Q3 highlights. Comparable basis diluted EPS was up 15%. Stellar execution by the beer business drove strong marketplace and financial results for the quarter. The strong beer performance, along with some slight favorability in our tax rate and better than expected Meiomi results, are driving our full year fiscal 2016 comparable basis diluted EPS projection up to a range of $5.30-$5.40, versus our previous guidance range of $5-$5.20. Operational activities related to bringing new capacity online at Nava continue to progress as planned. The beer business performance, timing of capital expenditures related to the Nava expansion, and lower than planned income tax payments are helping to increase our fiscal 2016 free cash flow projection to a range of $475 million-$525 million, versus our previous range of $200 million-$300 million.
In addition to our quarterly results, we recently completed the Ballast Point craft beer acquisition, and this morning we outlined our plans to build a new 10 million hectoliter brewery in Mexicali, Mexico, and further expand our Nava Brewery. Let's take a closer look at all of this activity, starting with our Q3 results, where my comments will generally focus on comparable basis financial results. Consolidated net sales on an organic constant currency basis grew 6% for the quarter. We continue to see robust marketplace momentum for our beer business, with depletion growth coming in over 16%. Beer net sales increased 8% on volume growth that came in a little under 7%.
Beer net sales growth for the quarter was impacted by the overlap of a shift of approximately 2 million cases and $37 million of net sales from Q2 fiscal 2015 into Q3 fiscal 2015 related to the beer product recall. In addition to that activity, wholesalers also increased their inventory position during the third quarter of fiscal 2015 to bring inventory more in line with historical levels. Given the Q3 fiscal 2015 overlaps just mentioned, it is worth noting that beer net sales growth for the first nine months of fiscal 2016 totaled 11%, and we now expect full year fiscal 2016 beer net sales growth to be in the range of 12%-14%. Wine and spirits net sales on an organic constant currency basis increased 3%. This primarily reflects favorable mix across the business.
As mentioned by Rob, Meiomi continues to demonstrate excellent marketplace momentum as the brand generated approximately $35 million of incremental sales during the quarter. For the quarter, consolidated gross profit increased $89 million, up 13%, with gross margin increasing 280 basis points. Beer gross profit increased $58 million, primarily due to volume growth, favorable pricing, and lower COGS. Our beer gross profit margin increased 360 basis points to 48.9%. Wine and spirits gross profit was up $31 million. This primarily reflects the benefit from the Meiomi acquisition, favorable mix, and lower COGS. Wine and spirits gross profit margin increased 190 basis points to 43.6%. Consolidated SG&A for the quarter increased $29 million. This reflects marketing investments made by the beer and wine and spirits businesses.
Corporate expense was up due primarily to an increase in payroll-related taxes associated with employee stock option exercises, higher incentive compensation expense, and investments to support the growth of the business, including the establishment of our chief growth officer function. We continue to expand margins across the business as consolidated operating income increased $61 million and consolidated operating margin improved 210 basis points. Beer operating margin increased 360 basis points to 35.1%, and wine and spirits operating margin improved 170 basis points to 27.5%. Equity earnings increased $6 million due to strong results for Opus One. Interest expense for the quarter was $76 million, down 12%. The decrease was primarily due to lower average interest rates. At the end of November, our debt totaled $7.4 billion. When factoring in cash on hand, our net debt totaled $6.9 billion, a decrease of $326 million since the end of fiscal 2015.
This primarily reflects our free cash flow generation, partially offset by the funding for the Meiomi acquisition. Our net debt to comparable basis EBITDA leverage ratio came in at 3.5 times at the end of Q3. Even with the funding of the Ballast Point acquisition, we expect to end fiscal 2016 below the 4 times level. Additionally, we continue to expect fiscal 2016 interest expense to be in the range of $310 million-$320 million. Our effective tax rate for the quarter came in at 32.3% compared to 29.2% last year, which reflected the benefit of certain tax credits. We now expect our full-year tax rate to approximate 30%. Now let's review free cash flow, which we define as net cash provided by operating activities less CapEx.
For the first nine months of fiscal 2016, we generated $578 million of free cash flow compared to $209 million for the same period last year. Operating cash flow totaled $1.1 billion versus $750 million for the prior year period. This increase was primarily generated by the beer business. Given higher projected earnings for the beer business and lower projected income tax payments, we now expect to generate operating cash flow in the range of $1.35 billion to $1.45 billion for fiscal 2016. CapEx for the first nine months of fiscal 2016 totaled $514 million and was slightly below our CapEx spending from the same time frame last year. While our initial 10 million hectoliters expansion at Nava continues to progress as planned, payment timing for some of the capital expenditures associated with this activity has shifted into fiscal 2017.
In a few moments, I will outline the CapEx requirements we are targeting for the new Mexicali brewery and the additional 2.5 million hectoliters expansion at Nava. Even with the incremental capital expenditures projected from these initiatives, we are decreasing our total capital expenditure estimate for 2016 to a range of $875 million to $925 million, versus our previous guidance of $1.05 billion to $1.15 billion for fiscal 2016. Due to the factors just mentioned, we now expect fiscal 2016 free cash flow to be in the range of $475 million to $525 million. Let's move to our full year fiscal 2016 P&L outlook. As discussed earlier, we are increasing our comparable basis diluted EPS projection to $5.30 to $5.40. Our fiscal 2016 comparable basis guidance excludes comparable adjustments, which are detailed in the release.
For the wine and spirits business, we continue to expect organic net sales and operating income growth to be in the low to mid-single digit range. Meiomi's volume performance has exceeded our initial expectations, and we now expect fiscal 2016 diluted EPS accretion from this acquisition to be around $0.07 to $0.08 versus our previous $0.03 to $0.04 accretion projection. The beer business is the primary driver of our diluted EPS guidance increase. We now expect volume growth of 10%-12%, net sales growth of 12%-14%, and operating income growth in the range of 22%-24% before any benefit from the Ballast Point acquisition. We closed the Ballast Point acquisition in December.
We funded the $1 billion purchase price with a combination of net proceeds from the issuance of $400 million of 4.75% senior notes due in 2025, borrowings under our accounts receivable securitization facilities, and cash on hand. For calendar 2015, Ballast Point is expected to sell nearly 4 million cases and generate approximately $115 million in sales. On a comparable basis, the acquisition is expected to be neutral to diluted EPS for fiscal 2016 and $0.05 to $0.06 accretive for fiscal 2017. Our current beer segment guidance has us targeting a beer operating margin of approximately 34%-35% for fiscal 2016. The improvement versus our previous 34% target primarily relates to Q3 benefiting from lower depreciation as well as lower line commissioning and optimization costs than originally anticipated. Now that this incremental capacity has become operational, we expect these costs to ramp up in the fourth quarter.
We are pleased that we have already achieved our mid 30% operating margin goal for our beer business. We expect the beer operating margin to continue to run in the mid 30% range over the next one to two years, as we still have much to accomplish at Nava and expect some margin volatility as we bring online and optimize new capacity. As Rob mentioned earlier, we have extended the interim supply agreement with ABI to ensure a smooth transition as we increase capacity. This could temper operating margin expansion in fiscal 2017, as utilization at Nava will likely run below the utilization targeted before the extension of the supply agreement. Rob also outlined our plans to build a new 10 million hectoliter brewery in Mexicali and further expand capacity at our Nava brewery.
In the press release we issued this morning, we included a table summarizing the collective investments we are making in our Mexican operating platform. Let me provide a few highlights around the capital expenditures associated with this activity, starting with Nava. The additional 2.5 million hectoliters we are adding to Nava is estimated to cost approximately $250 million. This, combined with our previously announced Nava brewery and glass plant expansion projects, puts our total targeted Nava capital expenditures at $2.5 billion. After fiscal 2016, we expect to spend $1.1 billion over the fiscal 2017 and 2018 timeframe, with most of that occurring in fiscal 2017. The new 10 million hectoliter Mexicali brewery is expected to cost $1.5 billion, and the associated land, water rights and infrastructure and other site requirements to accommodate scalability to 20 million hectoliters is estimated at $500 million.
For this total $2 billion investment, we expect some initial spend to occur in fiscal 2016, a little over half of the spend to come in fiscal 2017 and 2018, and the remaining spend to happen in the fiscal 2019 to fiscal 2021 timeframe. Given the strong demand we see for our beer portfolio and our best-in-class margin profile, the investments I just outlined are expected to generate high returns with a fast payback. Even with the capital requirements associated with these initiatives, our strong projected earnings and operating cash flow will allow us to operate below our targeted 4x leverage range and continue to provide us with significant capital allocation flexibility. With that, we are happy to take your questions.
If you would like to ask a question at this time, please press star one on your touch-tone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We ask that while you pose your question, that you please pick up your handset to allow optimal sound quality. Your first question comes from the line of Dara Mohsenian of Morgan Stanley.
Hey, good morning.
Good morning.
It's obviously been a great couple of years here on the beer business with steady acceleration. I was hoping maybe you could take a step back on the Modelo Especial brand, which has driven a lot of the growth, and peel back how much of that growth has been driven by distribution expansion in the last couple of years versus organic sales growth per distribution point. More importantly, how sustainable is that as you look going forward over the next few years in both buckets, and particularly in terms of how much distribution expansion is left for the brand? Thanks.
Yeah. Dara, clearly, it's been both. It's been both distribution expansion as Modelo Especial has, I'll say, migrated to the general market and as, of course, we have begun our general market advertising for the brand. Velocity has also increased. I think that there's plenty of room left for Modelo Especial distribution expansion. It does not have the ACV of, say, Corona Extra. Right now, the ACV on Modelo Especial is about 65%. We see lots of room for continued expansion in both distribution, and we see opportunity for expansion of velocity. I.e., sales per point of distribution, as the brand continues to gain momentum with general market consumers. This is a real growth story for beer in general, not only just for Constellation Brands. I mean, it's a phenomenon.
Okay. On the Corona brand, that's obviously accelerated nicely this year, or last year, I should say now. Cans are driving a big piece of that, but it looks like glass is also doing very well, and even more so probably if you assume some cannibalization on it. Was just hoping for an update on what's driving the overall brand acceleration in your mind over the last few quarters here. Is it mainly cans, or do you think there are other factors behind it and the sustainability of those factors going forward? Thanks.
Well, cans only, I think, represented about 25% of the growth of Corona Extra. I shouldn't say only. It did represent a significant portion of the growth, but clearly cans has been very important. Probably more importantly is our continued increased investment in the brand behind our marketing activities, as well as investments in SG&A. Basically, our sales organization as well. We're investing, I would say, even ahead of the growth on Corona Extra. We're investing very effectively, probably more importantly, in the brand. I've talked about the consistency of our advertising. Clearly, that advertising and marketing, it works, and therefore, when we do invest more, we see the results of those investments. It's a very strong brand with a very strong marketing campaign behind it.
Okay. That's helpful. Thanks.
Your next question comes from the line of Judy Hong of Goldman Sachs.
Hi, Judy.
Thank you. Hi, how are you? Couple of questions. First, just on the brewery capacity expansion. If I think about the expansion you're doing for the next few years, by end of calendar 2019, it looks like you'll be getting to about 32.5 million hectoliters, which implies a CAGR of around sort of mid-teens level. I was just hoping to sort of get your color just in terms of how this jives with your volume outlook over the next few years. To the extent that if you see some changes in terms of that trajectory, how much flexibility do you have to either expand more quickly or scale back on that expansion?
Yeah. The only thing I would say about that, and I'll let David comment in more detail on it, is that that's maximum capacity. Okay. No one runs breweries flat out 24/7. I don't think that you can take those numbers and just assume that we're going to utilize 100% of the capacity. In fact, an important element of our brewery expansion is to make sure that we have the total capacity, okay, to run these breweries at, I would say, more normalized production levels as opposed to absolutely flat out, which isn't the best way to run a brewery. David, did you want to comment more on that?
Yeah. I would say from a growth rate perspective, Judy, we're still focused on the high single-digit kind of growth rate that we're seeing in the high-end beer business as being applicable to our business. Right? That's point one. We're not expecting outsized growth beyond the high end of the beer business in order to support the capacity we're putting in. I would say the second thing is that having the capacity in a redundant facility on the West Coast closest to our biggest market is actually very important to us, and in and of itself generates a return.
Okay. The second question is just on your Ballast acquisition and just broadly your craft beer strategy. On the Ballast acquisition, I think some people have looked at the $1 billion price tag in the context of the current volume size and thought it was at the high end of some of the recent deals. If you can sort of give us your view of why that price tag was appropriate and the growth opportunities, perhaps beyond maybe even distribution expansion that you see with Ballast. More broadly, if you think about your ambition to really get bigger in the craft beer industry, do you think that you would have to have more collection of some of the more regional brands and expand distribution or more of a large scale kind of brand like Ballast and just getting more scale with that brand?
Yeah. Purchase price and size of the brand. First of all, the purchase price is not related to the size of the brand. It's related to the growth percentage and the size of the brand, okay? Obviously the multiple that we paid for it in relationship to the growth, is actually a pretty reasonable purchase price, right? As you recall from my initial comments, the brand grew over 100% this year and 125% in IRI. When you look at purchase price and multiple, as a function of growth rate, it's pretty reasonable. We don't see that growth rate changing much in the short term. We expect another pretty robust year, with Ballast Point. Also, you've got to realize that Ballast Point has the highest average retail selling price, basically of any significantly sized craft, right?
If you go buy some Ballast Point, you're going to see that Ballast Point sells for around $15, $16 a six-pack, okay, versus competitors, that you'll see at under $10 or just a bit over $10 a six-pack. It's a very high growth, high margin product. Now, our strategy with Ballast Point is actually pretty simple, and it's why we were so particularly interested in the brand, which is our strategy, is we don't really have to do too much other than what they're doing right now. The key to Ballast Point is maintaining the growth, and I think the maintenance of the growth, is going to be a function of maintenance of sort of the award-winning stature and high quality of the brand. It's a very sought-after product. All of the people that have been involved in making Ballast Point what it is today continue.
That's Jack White, the founder, it's Jim Buechler, the CEO. All of these people are brewmasters. The incredible group of people that we have there continue to be 100% behind the brand, and have continued very enthusiastically with Constellation. Part of the motivation for them wanting to sell the business to Constellation was, of all the buyers, they saw Constellation as the best fit because of our incredibly strong position in the beer industry and the fact that we are only a high-end beer manufacturer and seller, as well as being in the high end of the wine business, which makes us a completely different animal, okay? We're not big beer, okay, in the sense of being one of the two U.S. premium domestic producers.
The strategy with Ballast Point is all about continuing to do what the company has been doing, and I would say bringing incrementally to that some of the areas where I think that Constellation can be of help, and that would be with major key accounts, and I would say other places, where a smaller company wouldn't necessarily have the ability to play right off the bat.
Okay. It's $18.99 for a six-pack in Manhattan, but I hear you on the pricing point, and thanks for the color.
Our next question comes from the line of Mark Swartzberg of Stifel Nicolaus.
Thanks. Morning, everyone, and congratulations, and also to the Crown team, very impressive trends here.
Thanks, Mark
Two questions. Hey, Rob. Two questions. One is just, as you think about the third quarter depletion number of +16% and change, obviously a great number. Is there anything in that number that you think is unique to the quarter, either weather or some particular practice you engaged in that would cause the depletion trend to take down? I really don't mean to get at like, whether it's going to be 12% or 10% or 15% in the fourth quarter. I'm just trying to get at what's underlying this kind of performance that might go away as we all try to update our models and think about sustainable growth. Then I had a Ballast Point question after that.
Yeah, Mark, we try not to factor in weather all that much, clearly, a warmer fourth quarter was beneficial, I think, for our beer business. I would also say that we continued some of the activity that we had been working throughout the first two quarters related to marketing spend along with the NFL and within other venues to continue to drive the brands. I don't think it's anything outside of those items.
That's great. Okay. Then on Ballast Point, I want to try to probe a little bit more on the consumer proposition. We've all seen the multiple, and I still want to press here. It's clear on what the distribution opportunity you present for a brand that already has some pretty clear distribution opportunities because of its award-winning qualities. I'm kind of still stuck on the consumer proposition from a longer-term perspective. When I hear you emphasize growth in a multiple, I'm reminded of wine deals in the past, going back far enough where growth was a rationale. Then when I look at the craft beer segment, I think, the segment's been around for a long time, and we'd probably all argue over whether there's more than really one brand. Sam Adams, it's become a national brand and really has that session ability associated with it.
The price point and the IPAs, these are not brands that you see people kind of having in. You get a group of five people together, one's going to be having Sculpin and another's going to be having another craft beer. It just doesn't seem to lend itself to being a big brand the way your imported beer portfolio does. Could you just speak about that consumer proposition and how you're thinking about that?
Yeah, I think that there is opportunity, okay, for Ballast Point to become a big brand. When we say big, okay, I think that may be a relative kind of a number. We're not talking volumetrically Bud Light big, okay?
Right. Sure.
Versus where it is right now, okay, it can be a lot bigger. If you look at sort of the competitors in the marketplace and where they are volumetrically, okay, that implies a huge amount of growth for Ballast Point. Obviously, at the kind of price point and margins that we're talking about, big is a relative term. You look at some of the other competitors, and we clearly see plenty of craft brands in the 10 million-30-plus million case ranges, right? We start out at four million cases right now as we end the year with over 100% growth rate, and incredible margins. Big's relative. I think that what we really
Sure
are talking here financially is about the kind of contribution, right, economically and financially that a Ballast Point can make to our bottom line. With all that said, maintaining the quality and the award-winning position of the brand with craft consumers is going to be key to that, and I am 100% sure that the team that's running Ballast Point will do that. We have some unbelievable, great new products that are coming out, like a Watermelon Dorado, which is a double IPA. These are very sort of breakthrough products that I think are going to potentially set the craft world, vis-a-vis the consumers, on fire. That's why it's been so successful. We've got a totally award-winning team producing these products and incredible innovation behind it.
That's helpful. That watermelon actually sounds like it will bring in women. Okay. That's very helpful. Okay, great. Thank you, Rob.
Our next question comes from the line of Vivien Azer of Cowen and Company.
Hi, good morning. I wanted to follow up on Ballast Point as well, and then I've got a follow-up question on beer. On Ballast, the growth clearly remarkable, but as I understand it, the company did enter some new markets. I'm curious, as you guys think about FY 2017 sustaining that growth, how much of your accretion expectations and top-line expectations are dependent on new distribution opportunities?
Well, you're talking about this year?
Yes, for calendar 2016, yeah.
Well, we obviously aren't giving guidance for our next fiscal year, but we don't see anything impeding our Ballast Point performance in general. There will continue to be expanded distribution, and Ballast Point continues to increase its velocity per point of distribution, even in its major markets where it's already a big brand, like its home market in San Diego. We don't see any real catalyst for change in that regard. The company will continue to expand its distribution, and I think it'll be very successful in doing so.
Fair enough. That's perfect. Then on beer, David, I appreciate the two call-outs in terms of kind of the disconnect between shipments and depletions being the bottler recall and the wholesaler inventory true-up. I'm still having a hard time kind of getting comfortable with the delta, given how large it was. Is there anything else that was driving that disconnect?
Yeah, I think, because depletions accelerated the way they did in Q3, our wholesaler inventories dropped a little bit on a year-over-year basis, and we're comfortable in getting those back in line by year-end. I think that may be the other component, if you feel there's a disconnect there, Vivien. It's why we took our guidance up for the year, basically across all of our P&L line items.
Understood. Thank you very much.
Your next question comes from the line of Robert Ottenstein of Evercore.
Great. Thank you very much. I'd like to switch over a little bit to the wine business. Two questions on wine. One, big picture in terms of the industry, can you talk a little bit, I guess there's some data that there was a slowing of the wine industry in 2015. Perhaps you can address that and trends in pricing. Then second, more specifically on Meiomi, perhaps give us a little bit of color in terms of what you're doing differently with the brand and why it's beating your expectations. Thank you.
I think it's the opposite, Robert. The wine industry has actually accelerated quite considerably, and is probably, as we sit here right now, at one of the most robust points that it's ever been in. You look at IRI dollars for the last 12 weeks, the wine industry has accelerated to over 6% growth. Probably even more importantly, if you look at the premium plus segment, which is the segment of $8 plus, which is what we would be primarily interested in, the industry has accelerated to double-digit growth in dollar terms over the last 12 weeks, 11.2%. That's the industry. As it relates to Meiomi, number one, basically the brand has a tremendous amount of momentum, in and of itself. We bring a lot to that party. Obviously, we bring distribution strength.
We bring strength where we're major players, number one players for that matter, with key customers. If you look at our position today in beverage alcohol, total beverage alcohol, which is really important, and you look at major customers like the mass merchandisers, like the big grocery chains, when you combine our beverage alcohol portfolio, we tend to be a number one supplier, certainly in terms of the kind of profit that we're providing these key customers. That's been helpful in driving the Meiomi results as well. Also, I think that like everything, whether we're talking Corona, whether we're talking Modelo Especial, whether we're talking Meiomi, it's all about the consumer voting with their feet. All right? Meiomi has just a tremendous amount of consumer acceptance, and that's building. It's a very strong brand.
I've talked about this before, somewhat of a unique taste profile for Pinot Noir, and it's sort of fitting squarely into what the consumer is looking for that kind of product. Price point, everything, it's just a tremendous wine by the glass opportunity in higher end on-premise venues. It just meets every kind of criterion for success.
In terms of your expectations, you're saying it's looking like it's going to be a good bit more accretive than you thought. Is that because the distribution's going faster, there's an acceleration in velocity? How to think about that?
All of the above.
Terrific. Thank you very much.
Your next question comes from the line of Tim Ramey of Pivotal Research.
Hey, thanks so much. I think those are the best wine margins I've ever seen, and I've been hanging around this company for a long time. Any further commentary that you would give us on that? Was there any significant contribution from spirits? Doesn't look like spirits was really the driver in the quarter.
Yeah, it's really a premiumization of the portfolio, Tim. You know the wine industry, right now the high end of the wine industry is growing probably better than it's ever grown before. Meiomi fits right into that. It's part of our premiumization strategy. As we continue to drive sort of products now in the, call it $15-$20 range, you're going to see margin expansion because those products have higher margins, okay, than the lower end of the business. There continues to be a premiumization shift in the wine industry in general, which Meiomi fits full square into, and our increase in margins is directly related to that. Right now, the sweet spot of the industry is basically moved up into, as I said, that sort of $15-$20 or even above range, and margins are significantly better in that range.
We're operating under some pretty good external conditions.
Sounds good. Well, we have some good 2015 bulk Pinot. Have your people call my people for the Meiomi.
We'll give you a call, Tim.
Thanks a lot.
Your next question comes from the line of John Faucher of J.P. Morgan.
Yes. Thank you. Wanted to talk a little bit about following up on Tim's question here in terms of the mix impact as we look at the wine business going forward, and the potential for, let's say, pricing on top of that, or is it just going to continue to be the consumer trading up? How do you really sort of track the value that they're getting as they trade up? Do you get better brand differentiation as they trade up? How are consumers really sort of understanding that value equation as you get that mix trade up? Thanks.
Yeah. Yes, I would say that you do get higher quality, definitely, and perhaps more brand differentiation. For sure, as you trade up, wine is a very unique product, and there's a lot of differentiation between products. As you move up in price, you're definitely moving up in quality in terms of the type of grapes that are used to make the wine, i.e., where did they come from? Did they come from the best places? They certainly have to come from better places as you move up the price scale, and then how the wine is made, in particular, things that add quite a bit of cost to wine, like how much oak is used. If it's white, how much of the product is fermented on oak, and age of barrels, quality of barrels, where the wood came from, et cetera.
Those things both contribute to the quality of the product as well as contribute to the cost and the pricing of the product. What was your other question, John?
That basically covers it. I guess, is it a similar consumer dynamic as we see on the wine side? Obviously consumers have traded up on wine for years, but it seems as though the overall impact on the pricing and the pricing differentials they trade up on beer seems even greater than the pricing differential on wine. I'm wondering if we could see something that pushes that wine differential even further from a mix standpoint. Does that make sense?
Well, I think so. I think you'll see trading up on wine is accelerating, and I think that you'll continue to see it be extremely robust, and I think that you'll continue to see us benefit from that trading up. Oh, yeah, you asked about pricing and wine. We're doing both. We both have significant trading up going on within the portfolio, and therefore our sales growth is running considerably ahead of our volume growth, which is representative of that positive mix shift. We're taking pricing where we think that it's applicable, and that would be in sort of the lower end of our portfolio, for instance, products like Vendange where we're not so focused on, I would say, share and volume, and there's opportunity to enhance profitability nominally, and they're not the most strategic areas of the business.
We're now into an environment where we're sort of getting the best of both worlds in that regard. Beer, okay? Yes, beer is becoming like wine. The high end of the beer business is a very exciting part of the business because there's huge trading up going on in beer, okay? The consumer is definitely premiumizing. It's premiumizing into our import. They're premiumizing into our import brands and craft. You see the high end of the beer business be very robust. You can see it coming right out of the premium part of the beer. We definitely think that that's going to continue, although the price differential seems big in beer, that's really in percentage terms, okay? You're still talking about a super affordable luxury. Way even more affordable than wine, right?
It's a big deal for the consumer to go into a grocery store and buy two $25 bottles of wine. That's $50, okay? To trade up to Corona at $1 a bottle versus whatever else they were purchasing at $0.50 or less a can, big percentage increase, but fundamentally not something that takes the product outside of the realm of an affordable luxury. I don't think the consumer's proving to be pretty insensitive to those kind of changes at those sort of nominal prices.
Okay, great. Thanks.
Your next question comes from the line of Nik Modi of UBS.
Hi, thanks. Obviously your guys' pace of growth has been great. My question is, as you try to deliver against that growth in the marketplace while also taking on two large-scale manufacturing initiatives while also trying to expand Ballast. How are you guys thinking about execution risk? For example, managing out-of-stock, service delivery, et cetera.
We have a lot of confidence in our supply chain in our Mexican beer business, right? We've been doing this a long time. We have no concerns about our ability to continue to supply in the U.S. market over the foreseeable future. Thus far, our Nava expansion has gone according to plan. We are on schedule. We continue to actually run a little bit ahead of schedule in certain areas in our production build-out. Lastly, on Ballast Point, we're keeping those businesses operating separately. We're allowing Jim and Jack and the team at Ballast Point to continue to run Ballast Point, working with our beer teams, but we're not integrating the sales teams in such a way that would cause us to lose focus either at Ballast Point or in our import beer business.
Okay. All right. Thank you. Actually, I had a follow-up, an unrelated follow-up. Just from a free cash flow perspective, on one hand, you guys are clearly delivering better than expected P&L results. On the other, you're also increasing CapEx to fund that growth. Kind of looking from a long-term perspective, how do those dynamics impact your free cash flow outlook for the next few years, net of this CapEx, and then how do you see that being deployed?
We believe that we can complete the Nava expansion, complete the Mexicali expansion, stay well within our four times leverage ratio range, and still have the flexibility to continue to grow our dividend, and do share repurchases, and we will remain opportunistic around M&A.
Okay, great. Thank you.
Your next question comes from the line of Pablo Zuanic of SIG.
Good morning. This is actually Tzadi Stefanovich on behalf of Pablo. We have two questions, please. First, you disclosed beer depletions of 16%, the scanner data is pointing to a 20% growth. We realize this difference has been there in recent quarters also, does this mean that given that your on-premise business is about 15% of sales, that your on-premise business is down by about 6%? If this is the case, why would there be such a big gap between your on-premise performance and your off-premise performance?
There's not that big of a gap between our on-premise and off-premise performance. The IRI measures you're looking at measure a portion of the off-premise channel, not the entirety of it. When you look at on-premise, we are up in mid to high single digits in the on-premise, even though the on-premise channel itself is flat to slightly down. Yes, there's a disconnect between the IRI and depletions, I would hypothesize that in particular in our beer business, that depletions are the best measure of the performance of our business.
Got it. Thank you. The second question is, we have been doing a lot of work looking at your beer market share by state, we realize that in border states like New Mexico, Arizona, Texas, you're below your average national share. Given the demographics, we would expect you to have higher share there. The question is, should we assume that those states represent a significant distribution expansion opportunity for you, or is there something structural that explains the lower shares? Thank you.
Yeah, I think that it depends on the state. California, which is obviously a border state, we have some of our highest shares, right? Southern California, our shares are over 20%, versus our national share, and therefore, twice as much. In other places, yeah, there's plenty of opportunity, but traditionally, our business has been focused on those places, and we have tremendous share in the largest population area in the country bordering Mexico, which is Southern California. Is there opportunity in Texas, Arizona, as you've suggested? Yes, sure. Big opportunity.
Okay. Thank you very much. I appreciate it.
Your final question comes from the line of Carla Casella of J.P. Morgan.
Hi. I'm wondering on the financing side, do you contemplate coming back to the market this year or next to pre-fund some of the expansions you've got planned?
No. Carla, we feel comfortable that we will be able to fund the expansion out of operating cash flows. What I would say is that we will likely at least consider our options in coming to the market so that we can continue to layer in a nice maturity ladder of 10-year notes as it makes sense to us. In particular, we have a note coming due next September that we'll possibly look to come to the market to refinance.
Okay, great. Thanks.
At this time, there are no further questions. I'll now return the call to Rob Sands for any additional or closing remarks.
Okay. Well, thanks everybody for joining our call today. Needless to say, we are incredibly pleased with our fiscal 2016 year-to-date results. Our beer business has tremendous momentum and continues to gain market share and our high return investments and beer production capacity position us to support the significant growth in this business. We are growing EBIT and have significantly improved margins in our wine and spirits business. During our next quarterly call, which is scheduled for early April, we will provide guidance for our upcoming fiscal year. In the interim, we will be working diligently to continue to execute our strategy and deliver excellent results for the remainder of the year. Thank you again, everybody, for your participation.
Thank you. That does conclude the Constellation Brands third quarter FY 2016 earnings conference call. You may now disconnect.