Business context and reporting period
Constellation Brands, Inc. filed this unaudited Form 10-Q for the quarter ended November 30, 2012, its third quarter of fiscal 2013. The company sells wine and spirits and has a 50% equity-method interest in Crown Imports, which imports Mexican beer brands into the U.S. Crown Imports’ sales are not consolidated; the company records its share of Crown’s earnings.
The period’s major strategic development was the planned acquisition of the remaining 50% of Crown Imports for approximately $1.85 billion. The company expected to close in the first quarter of calendar 2013, subject to regulatory and other closing conditions.
Financial results and position
Amounts are in millions of dollars except per-share data. Results below compare the three and nine months ended November 30, 2012, with the corresponding 2011 periods.
| Metric | Quarter | Nine months |
|---|---|---|
| Net sales | $766.9; +9% | $2,100.2; +4% |
| Gross profit / gross margin | $310.8 / 40.5%, versus $282.9 / 40.4% | $846.5 / 40.3%, versus $816.9 / 40.3% |
| Operating income | $158.8; down 1% | $395.5; down 3% |
| Net income | $109.5; +4% | $306.1; down 10% |
| Diluted EPS, Class A | $0.58, versus $0.52 | $1.62, unchanged |
| Equity in earnings of investees | $52.5, versus $53.3 | $183.6, versus $179.5 |
| Interest expense, net | $61.4, up 33% | $166.7, up 25% |
Quarterly sales growth reflected base wine volume, Mark West and Ruffino sales, and favorable product mix, partly offset by higher promotions. Nine-month operating income and net income fell despite higher sales, principally reflecting higher selling, general and administrative costs and interest expense. The nine-month tax rate was 25.3%, versus 24.6%; the quarter rate declined to 27.0% from 37.4%, helped by additional foreign tax credits.
Operating cash flow was $389.0, down from $640.8. Working capital absorbed cash, including $196.7 from higher inventories and $104.2 from higher receivables, partly offset by a $170.7 increase in accounts payable. Investing cash outflow was $200.2, including the $159.3 Mark West acquisition and $52.2 of capital expenditures. Financing cash outflow was $72.0; cash and cash investments ended at $200.5, versus $85.8 at fiscal year-end.
At November 30, total debt was $3,995.4, up $865.9 from February 29. Cash was $200.5 and restricted cash was $650.3; the restricted funds were escrowed for the Crown transaction and were not ordinary available liquidity. Current assets were $2,480.6 and current liabilities $787.8. The company reported $835.6 of available revolving loans under its credit agreement and $14.4 of outstanding letters of credit. Stockholders’ equity was $2,775.3.
Material changes and unusual items
- SG&A rose 25% in the quarter and 13% year to date. Acquisition-related transaction costs were $8.5 for the quarter and $17.6 year to date; other drivers included planned marketing and selling spend, higher corporate costs, and the absence of prior-year gains.
- Restructuring charges were $0.3 for the quarter and $1.0 year to date, versus $0.8 and $11.6, respectively, in the prior-year periods. Management expected a further $8.3 of restructuring-related other costs and $0.7 of restructuring charges in fiscal 2013.
- Mark West was acquired in July 2012 for $159.3, financed with revolver borrowings. The company issued $600.0 of 6% senior notes due 2022 and $650.0 of 4.625% senior notes due 2023; the latter proceeds were escrowed for the Crown acquisition.
- The company repurchased $383.0 of shares during the nine months. This included $296.7 under the $1.0 billion repurchase authorization; no shares were repurchased under that authorization in the third quarter.
- On December 4, 2012, after quarter-end, the company established a 364-day receivables securitization facility with borrowing capacity ranging from $65 million to $250 million, subject to eligibility and other limits. No borrowings had been made as of January 9, 2013.
Outlook, risks, and contingencies
Management described its longer-term aims as sales growth, margin expansion, increased cash flow, EPS growth, and improved return on invested capital. It said U.S. wine supply was generally in balance with demand and expected the larger 2012 grape harvest to ease tightness in some varietals. The company also said it had adequate liquidity for operating needs and expected operating cash flow and financing availability to support its requirements, while noting this depended in part on market conditions and lender funding.
The Crown acquisition was expected to materially affect future results, financial position, and cash flows. Its completion, timing, approvals, and financing were uncertain. If it did not close by December 30, 2013, the $650.0 of August senior notes were subject to mandatory redemption. The company expected to fund the transaction with the delayed-draw term loan, escrowed note proceeds, cash, receivables-facility and revolving borrowings, with a committed bridge facility available if expected sources were unavailable.
Other disclosed exposures include interest rates, foreign exchange and diesel prices; the company uses derivatives for hedging and not trading. It estimated potential indemnification payments of up to $303.4 related to the prior divestiture, with $282.0 potentially recoverable from third parties, and up to $39.2 under a Crown office-lease indemnity. Management said material payments were not expected and considered a material adverse effect remote. The filing also identifies ordinary business and economic risks, wine supply and demand uncertainty, restructuring-cost variability, and the possibility that share repurchases may vary with cash, debt, and acquisition needs.
Important facts for investors to verify
- Whether the Crown acquisition closed on the anticipated terms and timing, and the resulting purchase accounting, financing, leverage, and integration effects.
- Whether operating cash flow recovers as seasonal inventory and receivables convert to cash, and how much liquidity remains after acquisition funding.
- Whether sales growth and gross margin can offset higher SG&A, promotional spending, and interest costs.
- The reconciliation of reported operating performance to management’s segment results, including acquisition costs, inventory step-up, restructuring, and other unusual items.
- Debt maturities, covenant headroom, variable-rate exposure, and actual use of the receivables facility and share-repurchase authorization.
- Developments in the disclosed indemnifications, regulatory approvals, and other acquisition closing conditions.