Garth Hankinson
Chief Financial Officer at Constellation Brands
Thank you, Bill, and good morning, everyone. Our second quarter results reflect the ongoing disciplined execution of our strategic initiatives and our relentless focus on continuing to deliver growth while enhancing our performance. As Bill noted, we achieved yet another strong quarter with double-digit net sales and operating income growth in our beer business while our wine and spirits business delivered solid performance across its largest premium, fine wine and craft spirits brands, which partially offset the category headwinds affecting our mainstream brands. We also continued to generate strong cash flow results and execute against our consistent and balanced capital allocation priorities.
Now let's review our Q2 fiscal '24 results in more detail, where I will mainly focus on comparable basis financial results. To begin, our beer business increased net sales by 12%, representing an uplift of $253 million. This was driven primarily by volume growth of 8.7% as demand for our beer brands accelerated through the first half of the fiscal year. This growth also benefited from favorable pricing which contributed $59 million of the overall net sales increase. As a reminder, we continue to expect pricing to account for 1% to 2% of our net sales increase this fiscal year from the combination of the wrap around impact from the significant pricing actions taken in Q3 of fiscal '23 and targeted pricing actions we are taking in fiscal '24.
For the second quarter of fiscal '24, beer shipment volume and depletions were generally in line with one another, and I'm pleased to report that our inventories are at healthy levels to support the ongoing growth of our brands. Beer depletion growth for the quarter came in at 7.9%, reflecting a successful summer selling season, driven by ongoing consumer demand across our industry-leading beer portfolio as evidenced by our share gain acceleration. Execution of our distribution and marketing strategies, including extending our category leadership across the key summer season and continued positive results from our shopper-first shelf initiative. And lastly, the accelerated growth in share gains across our core and emerging markets.
Before moving to on-premise performance, I'd like to take a moment to explain a notable recent development in off-premise channel observation. As many of you are aware, Circana track channel volume growth has historically been above depletion growth by a low single-digit variance. However, more recently, that variance has expanded to the mid-single-digit range as independent retailers not captured by Circana data have lagged in reversing the additional pricing they took beyond our October fiscal '23 pricing actions. We believe this has led certain consumers to ship from these independent retailers to chain retailers offering more competitive consumer pricing. While the shift in these variances has no impact on the overall demand of our brands, we continue to monitor channel performance and plan to provide further updates or insights needed to reconcile, track channel data with our overall performance as warrant. As a reminder, Circana captures approximately 50% of our total beer volumes.
Shifting back to the on-premise channel. Depletions were essentially flat year-over-year and accounted for approximately 10.3% of our total beer volume. Please note that while we did have some minor disruptions in our supply of kegs during the second quarter, this Q1 to Q2 step down largely reflects a normal seasonal pattern that we have seen in previous years. Importantly, while there is some disruption in the near term, we are currently producing and shipping kegs and fully expect to offset the impact of the disruptions as swiftly as possible. Looking forward to the second half of the year, as Bill noted, approximately 45% of our volumes will ship in the second half of the year as a result of it being our lower volume period. In addition, our Q3 shipment volumes are also normally more subdued due to routine maintenance activities.
Lastly, from a pricing perspective, we will start to overlap the uplift we saw from significant incremental pricing actions taken in October of fiscal '23. Nonetheless, as we have previously stated, we fully expect our full year shipments and depletions to be largely in line, both on an absolute and a year-over-year growth basis by fiscal year-end. In regards to selling days, they were flat year-over-year for the quarter. Please note, for the remainder of fiscal '24, Q3 sales days will be flat year-over-year, and there will be one more selling day in Q4.
Now let me review beer margins. For Q2, operating margin decreased by 60 basis points to 39.9%. This decrease was driven mostly by the ongoing inflationary pressures in our COGS as we faced an overall cost increase of approximately 17%. The largest drivers of these cost increases came from packaging and raw materials, incremental costs related to a voluntary product recall of select kegs for quality assurance and higher depreciation that amounted to $12 million or a 24% increase. To mitigate the inflationary and depreciation pressures, we continue to work across the business on cost efficiency and operational productivity programs that yielded meaningful and sustainable benefits. Building on the $30 million of net savings delivered by these initiatives in the first quarter, we realized an approximately $20 million in incremental net savings in the second quarter.
In addition to our cost saving initiatives, we incurred margin benefits from the following a $4 million or 2% decrease in marketing expense, primarily driven by the divestiture of our craft beer business; marketing as a percent of sales came in at 7.1% for the quarter; and a $3 million or 3% decrease in SG&A expense, which was primarily the result of favorable foreign currency impacts. Regarding Q2, our marketing spend as a percent of net sales was outside of our previously stated algorithm of 9% to 10%. As usual, part of this relatively low percentage in Q2 is a reflection of the strong volume and therefore, net sales performance of the business due to category seasonality. However, the impact of the reduction in marketing due to the previously noted exit from craft beer has further lowered that percentage. For the full year, we now expect to be closer to the lower end of our stated range of 9% to 10% of net sales due to the craft beer divestitures and our continued focus on ensuring our large marketing investments are prioritized to the highest return areas in our portfolio. As a result of the acceleration in the growth of beer business since the beginning of the year, we are shifting our expectations for fiscal '24 to the higher end of our initial ranges, resulting in an 8% to 9% expected increase in net sales growth and 6% to 7% expected increase in operating income growth.
Now moving on to our wine and spirits business. In line with the reshaping of our wine and spirits business to a higher end portfolio of offerings, we continue to benefit from the solid performance of our largest premium wine, fine wine and craft spirits brands. Meiomi, Kim Crawford, the Prisoner Wine Company and Mi Campo, which as Bill noted, outperformed the corresponding categories in tracked channels and delivered solid depletion growth. While we are pleased with the results with these leading higher-end brands, our overall wine and spirits organic sales were down 11%, driven primarily by the category headwinds we continue to face from the performance of our biometrically larger mainstream brands, Woodbridge and SVEDKA. Our plans to renovate Woodbridge and SVEDKA are underway, and our wine and spirits leadership team is looking forward to sharing updates on this progress at our upcoming Investor Day.
Shipments on an organic basis decreased by 15% and depletions decreased by approximately 8%. As a reminder, approximately 55% of the wine and spirits sales are anticipated to occur in the second half of the year, where we also expect to see consumer-led premiumization mixed shift towards the higher end to continue, supporting what we believe will be a notable acceleration in the growth trajectory of the business for the remainder of the year.
Wine & Spirits operating income, excluding the gross profit less marketing of the brands that are no longer part of the business following their divestiture, was down 12%, and operating margin decreased 10 basis points to 18.2%, also reflecting the same exclusion. The margin decline was primarily driven by the volume declines of our mainstream brands and partially offset by lower material costs, primarily from sustainable packaging projects, supply chain savings and lower marketing spend as we continue to focus on higher return areas of our portfolio. As we look forward, we continue to expect the wine and spirits business to significantly improve its net sales growth trajectory for the remainder of the fiscal year through a combination of increased contributions from our higher-end portfolio as well as incremental pricing actions. We expect this acceleration in net sales growth combined with our continued cost reductions and marketing efficiency initiatives to also support our operating income growth targets. As a result, we remain confident in the outlook for wine and spirits for the year and our guidance for that business for fiscal '24 remains unchanged.
Now let's proceed with the rest of the P&L. Corporate expense was approximately $67 million, an overall reduction of 19% when compared to the prior year, primarily driven by reduced spend in the second wave of our digital business acceleration program, lower headcount-related costs and lower compensation and benefits post our reclassification transaction.
Interest expense for the quarter was approximately $111 million, a 17% increase from the prior year, driven by higher weighted average interest rates on the portion of our debt with adjustable rates, which is approximately 5% of our debt obligations, and higher average borrowings due to the financing of the share reclassification. However, we now expect interest expense for the full year to be approximately $460 million, roughly $40 million lower than our prior guidance due to refinancing actions for some of our higher interest debt and faster-than-expected deleveraging throughout the year.
We ended the quarter with a net leverage ratio of approximately 3.2 times excluding Canopy equity earnings, and expect to continue to make progress towards our 3 times ratio target over the coming quarters. Our comparable effective tax rate, excluding Canopy equity and earnings for the quarter, was 17.8% versus 20.3% last year. For fiscal '24, we continue to expect the comparable effective tax rate, excluding Canopy equity and earnings to be approximately 19%.
Moving to free cash flow, which we define as net cash provided by operating activities less capex. For the second quarter, year-to-date of fiscal '24, we generated free cash flow of $1 billion, a 15% decrease versus prior year, driven by a 34% increase in capex investments, attributable to the capacity expansions at our Nava and Obregon facilities and the construction of our new brewery located in Veracruz. As of Q2, we have fully commissioned our latest additional brewing capacity project at our Obregon facility and now have approximately 47 million hectoliters of capacity across our two breweries. Looking ahead, we remain on track to bring our ABA facility online at Nava towards the end of this fiscal year. And the development of our additional expansion at Obregon and our third brewery site at Veracruz are advancing as planned. We continue to expect fiscal '24 free cash flow to be in the range of $1.2 billion to $1.3 billion, reflective of operating cash flow between $2.4 billion and $2.6 billion and capex of $1.2 billion to $1.3 billion.
Our comparable EPS for the quarter, excluding Canopy equity and earnings, was $3.80 as a result of the continued profitable and disciplined growth we have seen this year. We are raising fiscal '24 reported EPS guidance to between $9.60 and $9.80 and comparable EPS guidance, excluding Canopy equity and earnings to be between $12.00 and $12.20.
And finally, our announced dividend of $0.89 a share will result in approximately $163 million returned to shareholders for the quarter.
In closing, I'd like to say that our entire team continues to execute and deliver against our strategic priorities. We demonstrated solid execution in the first half of fiscal '24, and as we enter the back half of the year, we plan to remain disciplined as we seek to drive long-term profitable growth and enhance shareholder value. Our management team is excited to meet with many of you this coming November as we lay out our medium and long-term ambitions and vision for Constellation Brands at our Investor Day.
With that, Bill and I are happy to take your questions.
