Business context and reporting period
Constellation Brands, Inc. filed this unaudited Form 10-Q for the quarter and six months ended August 31, 2014 (fiscal 2015). The company operates Beer and Wine and Spirits businesses, plus Corporate Operations and Other. Comparisons are materially affected by the 2013 Beer Business Acquisition: acquired operations are included only from the acquisition date in the prior-year reported results.
Key financial results
| Metric | Three months ended Aug. 31, 2014 | Six months ended Aug. 31, 2014 | Prior-year comparable reported period |
|---|---|---|---|
| Net sales | $1,604.1 million (+10%) | $3,130.1 million (+47%) | $1,459.8 million; $2,133.2 million |
| Gross profit / margin | $672.0 million / 41.9% | $1,342.1 million / 42.9% | $577.0 million / 39.5%; $833.1 million / 39.1% |
| Operating income | $378.7 million | $770.9 million | $1,674.0 million; $1,744.5 million |
| Net income | $195.8 million | $402.5 million | $1,522.0 million; $1,574.9 million |
| Diluted EPS, Class A | $0.98 | $2.01 | $7.74; $8.03 |
| Operating cash flow | Not separately provided | $668.1 million | $489.0 million |
- For the quarter, Beer segment sales were $891.8 million (+9%); Wine and Spirits sales were $715.8 million (+3%). Beer shipment volume rose 7.2% and depletion volume rose 8.1%. Wine and Spirits sales growth reflected branded volume and lower promotional expense.
- Six-month reported sales growth primarily reflects $941.1 million of acquired Beer Business sales. The filing’s pro forma prior-year six-month comparison, assuming the acquisition from March 1, 2013, shows net sales of $2,750.6 million and net income of $22.5 million, rather than reported sales of $2,133.2 million and net income of $1,574.9 million.
- Reported prior-year income included a $1,642.0 million non-taxable gain on remeasurement of the pre-existing Crown Imports interest and $300.9 million of goodwill and intangible impairment charges. These unusual items make the large reported year-over-year declines in operating income and net income poor indicators of underlying performance.
- Six-month net interest expense increased 18% to $171.4 million, mainly reflecting acquisition-related borrowings, partly offset by lower average interest rates. Effective tax rate was 32.4% for the six months, versus 5.7% a year earlier; the prior period benefited from the non-taxable acquisition gain.
Cash, debt and liquidity
- Cash and cash investments were $104.3 million at August 31, up from $63.9 million at February 28, 2014. Six-month operating cash flow was $668.1 million; investing used $306.2 million, including $308.2 million of capital expenditures; financing used $325.0 million, including the $543.3 million delayed acquisition payment.
- Total debt, including bank notes, was $7,191.9 million at August 31. Balance-sheet long-term debt including current maturities was $6,938.9 million; notes payable to banks were $253.0 million. Current maturities of long-term debt were $615.7 million.
- At August 31, $725.9 million was available under the revolving credit facility; accounts-receivable facilities had a further $424.0 million available. Management said cash flows and financing capacity should adequately fund working capital, scheduled debt service and planned capital spending, subject to market and lender conditions.
Changes, outlook and material risks
- Beer Business acquisition integration and strong demand for Mexican beer supported segment growth. Management cited continued operating efficiencies and stronger wholesaler and distributor relationships.
- The company must expand its Mexican brewery from 10 million to at least 20 million hectoliters of annual capacity by December 31, 2016. In October 2014, it announced a further 5-million-hectoliter expansion, targeting 25 million hectoliters by the end of calendar 2017.
- Fiscal 2015 capital expenditure outlook was raised to $725–$775 million, including $600–$650 million for Beer, primarily brewery expansion. Subsequent to quarter-end, the company agreed to acquire a glass plant and related assets for approximately $300 million, subject to regulatory approvals, and entered an equally owned joint venture with Owens-Illinois to operate the plant. No specific revenue or EPS guidance is provided in the supplied filing text.
- An August 2014 voluntary recall of select Corona Extra 12-ounce clear glass bottles followed detection of possible glass fragments. The company recorded an estimated $9.2 million reduction to operating income, net of recoveries, and warned of possible additional costs over the next three to six months; manufacturer reimbursement was uncertain. Approximately $37 million of beer sales, or 2 million case shipments, were reversed, with replenishment expected primarily in the third fiscal quarter.
- Other risks include substantial acquisition-related debt, execution and cost risks for brewery and glass investments, foreign-exchange, commodity and interest-rate exposure, and reliance on third-party lenders and suppliers. A private antitrust case relating to the Modelo transaction was on appeal; management said it considered the claims baseless and intended to defend the company. Indemnification liabilities were recorded at $11.3 million; potential payments were estimated up to $292.5 million, of which $278.9 million was recoverable from third parties, and management considered material payment unlikely.
Important facts for investors to verify
- Separate acquisition-driven growth from organic Beer performance and use pro forma, not only reported, prior-year comparisons when assessing the six-month trend.
- Reconcile underlying earnings with the prior-year $1.642 billion remeasurement gain and $300.9 million impairment, and review the company’s unusual-item adjustments.
- Track brewery expansion spending, capacity milestones, the glass plant transaction and joint venture approvals, costs, and expected operating contribution.
- Monitor debt maturities, borrowing availability, interest expense and cash generation against the elevated capital expenditure plan.
- Check recall-related costs, actual third-party recoveries and shipment replenishment, as well as developments in the antitrust appeal.