STZ

Business Context and Reporting Period

Company: Constellation Brands, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: February 28, 2007 (Fiscal 2007)
Business Overview: Constellation Brands is the world's largest wine business and a leading international producer and marketer of beverage alcohol, including wine, spirits, and imported beer. The company operates primarily in the U.S., Canada, the U.K., Australia, and New Zealand.

Strategic Developments:

• Crown Imports: On January 2, 2007, the company formed a 50/50 joint venture with Grupo Modelo to import and sell Mexican beer brands (e.g., Corona) in the U.S. This shifted the imported beer business from consolidation to equity method accounting.
• Matthew Clark: On April 17, 2007 (post-period), the company formed a 50/50 joint venture with Punch Taverns for its U.K. wholesale business, receiving $178.8 million in cash proceeds.
• Acquisitions: Acquired the Svedka Vodka brand in March 2007 for $383.7 million. Completed the acquisition of Vincor International Inc. in June 2006, significantly expanding its Canadian and global wine portfolio.

Key Financial Metrics

Material Changes vs. Prior Period

Revenue Growth: Net sales increased 13% primarily due to the inclusion of Vincor International Inc. sales ($405.8 million) and growth in base branded wine sales. Branded wine sales grew 22% to $2,755.7 million.

Profitability: Operating income grew 5% despite increased costs. Net income growth was modest (2%) due to higher interest expense ($268.7 million vs. $189.6 million) and a higher effective tax rate (38.0% vs. 31.8%).

Segment Performance:

• Constellation Wines: Operating income increased 19% to $629.9 million, driven by Vincor and U.S. volume/mix growth, partially offset by competitive pricing pressures in the U.K. and Australia.
• Constellation Beers: Operating income decreased 5% to $208.1 million. This segment only includes results prior to January 2, 2007, before the transition to the Crown Imports joint venture.
• Crown Imports: New segment reporting operating income of $78.4 million for the period from January 2, 2007, to February 28, 2007.

Unusual Items: The company incurred $143.6 million in acquisition-related integration costs, restructuring charges, and unusual costs in Fiscal 2007. This included a $13.4 million loss on the sale of the branded bottled water business and $32.5 million in restructuring charges.

Guidance, Outlook, and Risks

Outlook and Guidance:

• Inventory Reduction: Management plans to reduce distributor wine inventory levels in the U.S. during Fiscal 2008. This is expected to reduce net sales by $160 million to $190 million and diluted earnings per share by $0.15 to $0.20 in Fiscal 2008.
• Restructuring: Expected restructuring and related charges for Fiscal 2008 are approximately $4.5 million, with additional accelerated depreciation and other charges totaling roughly $8.9 million.
• Capital Expenditures: Planned capital expenditures for Fiscal 2008 are approximately $165 million.

Key Risks and Contingencies:

• Debt Levels: Total debt increased significantly to finance acquisitions (Vincor, Svedka). The debt-to-capitalization ratio rose to 55.1%. High leverage limits financial flexibility and increases vulnerability to economic downturns.
• Competition: Intense competition in the U.K. and Australia due to oversupply of Australian wine and retailer consolidation has pressured pricing and margins.
• Raw Materials: Reliance on a limited number of glass bottle suppliers and exposure to grape price fluctuations and supply shortages.
• Joint Ventures: Risks associated with the new Crown Imports and Matthew Clark joint ventures, including partner alignment and operational integration.

Investor Verification Checklist

• Debt Covenants: Verify compliance with the 2006 Credit Agreement covenants (Debt Ratio and Interest Coverage Ratio) given the high leverage levels.
• Inventory Valuation: Assess the risk of inventory write-downs, particularly in the U.K. and Australia where oversupply has pressured prices.
• Joint Venture Accounting: Confirm the impact of the shift from consolidation to equity method accounting for the beer business (Crown Imports) and U.K. wholesale (Matthew Clark) on future revenue recognition.
• Restructuring Progress: Monitor the execution of the "Fiscal 2007 Wine Plan" and "Vincor Plan" to ensure expected cost synergies are realized.
• FX Exposure: Evaluate the effectiveness of hedging strategies given significant operations in the U.K., Australia, and Canada.