STZ

Constellation Brands, Inc. 10-Q Summary

Business Context and Reporting Period

This Quarterly Report on Form 10-Q covers the period ended August 31, 2009 (Second Quarter of Fiscal 2010). Constellation Brands, Inc. is the world's leading wine company, with operations in the U.S., Canada, U.K., Australia, and New Zealand. The company reports results in three segments: Constellation Wines (branded wine, spirits, and other), Corporate Operations and Other, and Crown Imports (imported beer, reported via equity method). Following the divestiture of its value spirits business in March 2009, the company integrated remaining spirits brands into the Constellation Wines segment.

Key Financial Metrics

Note: Debt figures represent total debt outstanding as of August 31, 2009, and February 28, 2009 (comparable prior year period).

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 12% for the six months and 8% for the quarter compared to the prior year. This was primarily driven by unfavorable foreign currency translation ($141.5M impact for six months) and the divestiture of the value spirits business and a Canadian distilling facility.
• Profitability Improvement: Despite lower sales, Operating Income increased 98% for the six months and significantly for the quarter. This improvement was largely due to a reduction in "unusual items" (restructuring and impairment charges) compared to the prior year, which included significant costs related to the "Australian Initiative."
• Turnaround to Profit: The company reported Net Income of $99.7M for the quarter, a reversal from a Net Loss of $22.7M in the same period last year. This was aided by lower interest expense (due to debt repayment from divestiture proceeds) and a lower effective tax rate.
• Debt Reduction: Total debt decreased by $269.5M from the prior fiscal year-end, reducing the debt-to-capitalization ratio from 69.9% to 62.3%.

Guidance, Outlook, and Risks

• Restructuring Outlook: The company expects to incur approximately $54.9M in restructuring charges and $1.8M in acquisition-related integration costs for the remainder of Fiscal 2010. These costs are associated with the "Global Initiative" to simplify the business and reduce costs.
• Market Conditions: Management notes challenging economic conditions in key markets (U.K., Australia, U.S.) and intense competition, particularly from private label brands in the U.K. and Australia due to a surplus of Australian bulk wine. Gross margins in international businesses remain under pressure.
• U.S. Distributor Consolidation: The company is consolidating its U.S. distributor network. While this drove sales growth in the second quarter, management expects a timing benefit that may negatively impact sales in the second half of Fiscal 2010.
• Internal Controls: The company disclosed a material weakness in internal controls over financial reporting related to inventory reconciliation at its Australian operations. While remediation steps have been implemented, testing was not complete as of the report date, and the weakness has not yet been formally remediated.

Key Facts for Investor Verification

• Divestiture Impact: Verify the long-term strategic impact of selling the value spirits business and the integration of remaining spirits brands into the wine segment.
• Foreign Currency Sensitivity: Assess the exposure to currency fluctuations, particularly the Australian dollar and British pound, which significantly impacted reported sales and margins.
• Inventory Controls: Monitor the progress of remediation regarding the material weakness in Australian inventory accounting controls.
• Debt Covenants: Review the company's compliance with debt covenants under the 2006 Credit Agreement, specifically the Debt Ratio and Interest Coverage Ratio, given the high leverage.
• Unusual Items: Distinguish between core operating performance and the impact of one-time restructuring and impairment charges when evaluating earnings quality.