Constellation Brands, Inc. — Form 10-Q Summary
Business context and period. This report covers the three months ended May 31, 2013, the company’s first quarter of fiscal 2014. Before the subsequent acquisition, the company reported wine and spirits, corporate, and Crown Imports beer results; Crown Imports was accounted for under the equity method. On June 7, 2013, after quarter-end, Constellation completed its acquisition of the remaining Crown Imports interest and the Mexican brewery business and related Modelo brand rights.
Financial performance
| Metric (millions, except per-share data) | Q1 FY2014 | Q1 FY2013 | Change |
|---|---|---|---|
| Sales | $766.2 | $725.3 | +6% |
| Net sales | $673.4 | $634.8 | +6% |
| Gross profit | $256.1 | $250.6 | +2% |
| Operating income | $70.5 | $106.1 | -34% |
| Equity in earnings of investees | $66.6 | $60.6 | +10% |
| Interest expense, net | $54.8 | $50.7 | +8% |
| Net income | $52.9 | $72.0 | -27% |
| Diluted EPS, Class A | $0.27 | $0.38 | Lower |
| Operating cash flow | $3.3 | $96.4 | Lower |
| Capital expenditures | $22.0 | $19.6 | Higher |
- Gross margin was 38.0%, down from 39.5%; SG&A was $186.5 million, up 30% year over year. Operating margin was approximately 10.5%, versus 16.7%.
- Wine and spirits net sales rose 6% to $673.4 million, helped by base wine volume growth and $14.3 million of Mark West sales; higher promotional spending and grape costs partly offset the benefit. Spirits sales increased 4%.
- Crown Imports’ sales rose 5% to $761.6 million and operating income rose 9% to $134.0 million. These amounts are not consolidated sales: the segment was eliminated in consolidation, with the company recognizing its equity earnings.
- Operating cash flow fell to $3.3 million, primarily reflecting working-capital outflows, including reductions in accrued expenses and accounts payable. Cash and cash investments were $609.3 million at May 31, versus $331.5 million at February 28.
Debt, liquidity and balance sheet
- Total debt was $5.072 billion at May 31, up $1.767 billion from February 28, largely following issuance of $1.550 billion of senior notes intended to finance the acquisition. Long-term debt including current maturities was $4.851 billion; bank notes payable were $221.0 million.
- Current assets were $2.723 billion and current liabilities $797.2 million. The current ratio was approximately 3.4. The $1.550 billion of restricted cash at quarter-end was held in escrow for the acquisition and was not general-purpose liquidity.
- Under the then-current credit agreement, $835.5 million of revolving loans was available at May 31. Following the acquisition and credit agreement restatement, the company reported $300.9 million of revolving availability at June 30, 2013.
- On May 14, the company issued $500 million of 3.75% notes due 2021 and $1.050 billion of 4.25% notes due 2023. The notes carried a mandatory redemption provision if the acquisition failed to close by December 30, 2013; the acquisition subsequently closed.
Material changes, outlook and risks
- Acquisition: The June 7 transaction’s estimated aggregate purchase price was $5.210 billion, including estimated additional payments of $571.5 million, expected within 12 months, for a 2012 EBITDA adjustment and working-capital items. The EBITDA-related adjustment could range from a $558 million payment to a refund, depending on final results. Purchase accounting was preliminary at filing.
- The company expected to recognize a non-taxable $1.641 billion gain in fiscal Q2 from remeasuring its previously held 50% Crown Imports interest. It expected a fiscal 2014 effective tax rate of 10%–15% including that gain, or 32%–37% before the gain; it was still assessing the acquisition’s full tax effect. Pro forma results assuming the acquisition had occurred a year earlier showed net sales of $1.239 billion and net income of $142.0 million for the quarter, but were expressly not forecasts.
- Management stated its long-term financial model remained sales growth, margin expansion, increased cash flow, EPS growth and debt reduction. It expressed confidence that operating and financing cash flows would meet expected needs, subject to market conditions. No specific full-year sales or earnings guidance was provided.
- The acquisition requires expansion of the Mexican brewery to at least 20 million hectoliters of annual packaged-beer capacity by December 31, 2016. Execution, financing, construction timing, product supply transition and integration are material risks.
- Other risks include competitive and consumer-demand conditions, wine supply and grape costs, foreign-exchange, fuel and interest-rate exposure, debt covenants, and litigation. A private antitrust action seeking injunctive relief and damages remained pending after closing; the company had moved to dismiss. The DOJ settlement also imposed brewery expansion and oversight requirements.
- Other unusual items included $27.5 million of acquisition-related transaction costs and a $7.0 million prior-period deferred-compensation adjustment in SG&A. The filing calls the latter adjustment immaterial. The company reported $15.1 million of recorded prior-divestiture indemnification liabilities, with potential gross payments of up to $296.2 million, substantially offset by third-party recovery rights; management said material payments were not expected.
Important facts for investors to verify
- Final purchase-price adjustment, working-capital settlement, and purchase-price allocation, including the estimated $543.3 million fair value of the EBITDA-related additional payment.
- Post-acquisition debt balances, interest costs, covenant headroom, liquidity and the company’s capacity to reduce leverage while funding brewery expansion.
- Realized acquisition synergies, beer-brand demand, interim supply arrangements and progress toward the mandated brewery capacity and construction milestones.
- Whether the expected tax-rate range and the $1.641 billion remeasurement gain are recorded as anticipated, and the resulting impact on reported versus underlying earnings.
- Resolution and potential financial effect of the private antitrust litigation, and any material indemnification or other contingent payments.