CONSTELLATION BRANDS, INC. annual report, FY2012

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Constellation Brands, Inc. — FY2012 Form 10-K

Business context and period. Fiscal year ended February 29, 2012; comparisons are with the year ended February 28, 2011. Constellation is a beverage-alcohol company focused on premium wine and spirits, with a 50% interest in Crown Imports, its Modelo beer joint venture. Crown Imports is accounted for under the equity method, so its sales are not included in consolidated net sales.

Financial performance and liquidity

  • Net sales: $2.654 billion, down 20% from $3.332 billion, primarily reflecting the 2011 sale of 80.1% of the Australian and U.K. business (CWAE). Continuing CWNA net sales rose 4% to $2.654 billion.
  • Profit and margins: Gross profit was $1.062 billion, down 11%; gross margin increased to 40.0% from 35.7%. Operating income was $486.5 million, down 3%, with an 18.3% operating margin versus 15.1%. Net income fell 20% to $445.0 million; diluted EPS was $2.13 for Class A and $1.96 for Class B.
  • Equity-method earnings: $228.5 million, down 6%. Crown Imports reported sales of $2.470 billion, up 3%, but operating income declined 5% to $431.0 million, mainly as advertising spending increased.
  • Cash flow: Operating cash flow was $784.1 million, versus $619.7 million. Investing used $135.1 million, including $68.4 million of capital expenditures and $51.5 million for Ruffino. Financing used $575.1 million, including $475.9 million of debt principal payments and $413.7 million of share repurchases.
  • Debt and liquidity: Total debt was $3.130 billion at year-end, down $106.8 million; cash was $85.8 million. The current portion of long-term debt was $330.2 million and bank notes payable were $377.9 million. The company reported $339.8 million of revolving availability at year-end and $636.6 million as of April 20, 2012. The revolving facility and $624.7 million of term loans were scheduled to mature in June 2013.
  • Other indicators: Total assets were $7.110 billion; inventories were $1.375 billion. Goodwill was $2.633 billion. The company recorded $38.1 million of intangible-asset impairment, principally Canadian wine trademarks.

Material changes versus prior year

  • The CWAE divestiture drove most of the reported sales decline; it also changed the company’s operating footprint and segment reporting. CWNA sales increased, but lower U.S. base branded wine volume, higher product costs and promotional spending pressured its gross profit.
  • Gross margin improved despite lower gross profit, reflecting the removal of the divested businesses and changes in product mix and costs. Operating income declined modestly as restructuring charges and unusual items increased.
  • Net income was affected by a higher tax provision: the effective tax rate was 16.7%, compared with a negative 1.5% in FY2011, which included a substantial tax benefit related to the CWAE divestiture.
  • Cash from operations increased, while year-end debt declined. The company also repurchased $413.7 million of shares during FY2012.

Outlook, commentary, risks and unusual items

  • Management’s stated priorities include growing premium branded sales, expanding margins, increasing cash flow and improving return on invested capital. It described U.S. wine supply as generally balanced, while noting the smaller 2011 grape harvest could tighten supply of some varieties over time.
  • For FY2013, management expected $70–$80 million of capital expenditures and approximately $6.8 million of additional restructuring-related SG&A costs plus $1.1 million of restructuring charges. No full-year sales, earnings or EPS guidance is provided in the supplied filing text.
  • The company planned to continue its U.S. distributor-contract strategy; existing contracts were expected to provide stable shipment patterns through FY2015. It also anticipated approximately $500 million of repurchases in FY2013 under a new $1.0 billion authorization. These plans depend on market conditions, cash and debt levels, and execution.
  • Unusual items included the $38.1 million trademark impairment, $16.0 million of restructuring charges, Ruffino acquisition-related gains and costs, and divestiture-related items. The company acquired Ruffino’s remaining 50.1% interest in October 2011 for €50.3 million ($68.6 million) and assumed $73.1 million of net debt.
  • Management cited risks including substantial indebtedness and the June 2013 credit-facility maturity, refinancing terms, distributor and customer concentration, competition, grape and glass supply and cost volatility, weather and water availability, foreign-exchange exposure, and possible further intangible-asset impairment. The five largest customers represented 61.0% of sales; Southern Wine and Spirits alone represented 32.4%.
  • Potential CWAE-divestiture indemnification payments were estimated at up to $303.5 million, with $282.1 million potentially recoverable from third parties; management said material payments were not expected. Ordinary-course litigation and regulatory matters were not expected by management to have a material adverse effect. A Clean Air Act matter was settled for a $95,000 civil penalty.
  • Management and KPMG reported effective internal control over financial reporting, and KPMG issued unqualified opinions on the financial statements and controls. Project Fusion system upgrades began phased implementation in FY2012 and were planned to continue through FY2013; the filing notes risks of cost overruns, disruption and control issues.

Important facts for investors to verify

  • How FY2013 sales, volume and margins trend after separating the divested CWAE business from ongoing operations.
  • Whether the company refinanced or replaced its 2006 credit facility before the June 2013 maturities, and the resulting rates, covenants and available liquidity.
  • Whether planned share repurchases and capital spending are supported by operating cash flow without materially increasing leverage.
  • How Crown Imports’ earnings and distributions evolve, including the implications of its joint-venture and import arrangements.
  • Whether grape supply, input costs, customer concentration, restructuring, Project Fusion and Canadian trademark performance develop as management expected.