Constellation Brands, Inc. — Form 10-Q Summary
Reporting period: Quarter ended November 30, 2013 (the third quarter of fiscal 2014); results also cover the nine months ended November 30, 2013. Dollar amounts are in millions unless stated otherwise.
Business context and reporting period
Constellation sells wine, spirits and imported beer. On June 7, 2013, it acquired the remaining 50% of Crown Imports and the Mexican brewery business, consolidating the beer operations from that date. Comparisons with the prior year are therefore not fully like-for-like; the acquisition materially increased reported beer sales and assets.
Financial performance and position
| Metric | Three months ended Nov. 30, 2013 | Prior-year quarter | Nine months ended Nov. 30, 2013 | Prior-year nine months |
|---|---|---|---|---|
| Net sales | $1,443.3 | $766.9 | $3,576.5 | $2,100.2 |
| Gross profit | $609.7 | $310.8 | $1,442.8 | $846.5 |
| Gross margin | 42.2% | 40.5% | 40.3% | 40.3% |
| Operating income | $363.8 | $158.8 | $2,108.3 | $395.5 |
| Net income | $211.0 | $109.5 | $1,785.9 | $306.1 |
| Diluted Class A EPS | $1.07 | $0.58 | $9.07 | $1.62 |
| Net cash from operating activities | Not presented for quarter alone | $629.1 | $389.0 |
- Quarterly net sales rose 88%; acquired beer products contributed $661.6. Beer segment sales increased 21% to $661.6, while Wine and Spirits sales grew 2% to $781.7. Wine sales rose 3%; spirits sales fell 5%.
- Quarterly gross margin improved to 42.2%, reflecting the acquisition and full-quarter recognition of acquired beer profits, partly offset by higher wine costs and promotions. Wine and Spirits segment operating income declined 5% to $186.1; Beer segment operating income was $212.5.
- Nine-month reported operating income and net income include a $1,642.0 gain from remeasurement of the prior Crown Imports interest. Results also include $300.9 of impairment charges. The nine-month effective tax rate was 9.0%, favorably affected by the largely nontaxable remeasurement gain; the quarterly rate was 27.8%.
- Operating cash flow was $629.1, versus $389.0 a year earlier. Investing cash outflow was $4,757.5, primarily the $4,681.0 acquisition payment; capital expenditures were $85.9. Financing cash inflow was $3,865.1, mainly debt issuance. Cash declined by $266.3 to $65.2.
- At November 30, current assets were $2,835.4 and current liabilities $1,755.0. Total debt, including bank notes payable, was $7,134.6, up $3,829.2 from February 28, 2013. Net interest expense for the quarter increased 46% to $89.6 and for the nine months increased 41% to $234.7.
Material changes versus the prior comparable period
- Consolidation of Crown Imports and the brewery drove most of the reported sales and earnings growth and substantially increased assets and debt.
- Nine-month equity-method earnings declined to $88.3 from $183.6, principally because Crown Imports’ results were consolidated after the acquisition rather than reported as equity earnings.
- Wine and Spirits’ nine-month segment operating income decreased 4% to $471.9; spirits sales weakened, while wine sales increased modestly.
- Goodwill and intangible assets rose substantially following acquisition accounting, while the Canadian Wine and Spirits reporting unit recorded $278.7 of goodwill impairment and $22.2 of trademark impairment.
Outlook, risks and unusual items
- Management expects a fiscal 2014 effective tax rate of approximately 11%, and approximately 32% for each of the following three fiscal years, subject to stated assumptions.
- The company must expand the Mexican brewery to nominal capacity of at least 20 million hectoliters annually by December 31, 2016; management stated a goal of completing the expansion within three years of acquisition.
- Management’s long-term financial model targets sales growth, margin expansion, higher cash flow, EPS growth and debt reduction. It said it expects operating and financing cash flows, including short-term borrowing capacity, to meet working-capital, debt-service and capital expenditure needs, absent deteriorating market conditions.
- A further $558.0 acquisition-related payment, comprising the finalized purchase-price adjustment and imputed interest, is due by June 7, 2014. Purchase accounting remained preliminary, and working-capital adjustments were also subject to finalization.
- Key risks include acquisition integration and brewery expansion execution, elevated leverage and debt covenants, wine supply and consumer demand, foreign exchange, fuel and interest-rate exposure, and the assumptions used in impairment and acquisition valuations. A private antitrust action had been dismissed, but plaintiffs’ motion for relief remained pending, with oral argument scheduled for January 24, 2014. The DOJ’s final judgment approving the transaction had been entered.
Important facts for investors to verify
- Separate the recurring operating performance of the acquired beer business from the $1,642.0 remeasurement gain, $300.9 impairment and acquisition-related costs; reported nine-month earnings are materially affected by these items.
- Review acquisition pro forma results: nine-month pro forma net sales were $4,193.9 in 2013 versus $4,110.8 in 2012, and pro forma net income was $234.7 versus $541.8. These unaudited figures use specified assumptions and are not a forecast.
- Track the $558.0 purchase-price payment, final acquisition accounting and any working-capital adjustments, as well as the brewery expansion’s cost, timing and progress.
- Assess debt repayment capacity, refinancing needs, covenant headroom and available liquidity. The filing reported $836.0 available under the revolving credit facility at November 30 and $260.4 and $1.0 available under the CBI and Crown receivables facilities, respectively.
- Monitor Canadian Wine and Spirits performance and the valuation assumptions behind the impairment, along with the pending litigation motion and the expected tax-rate outlook.