Constellation Brands, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended August 31, 2013 (fiscal 2014). All dollar amounts are in millions unless stated otherwise. The filing is unaudited.
Business context
Constellation sells wine, spirits and imported beer. On June 7, 2013, it acquired the remaining 50% of Crown Imports, the Mexican brewery business and related Mexican beer-brand rights. Crown Imports’ results were consolidated from that date, materially changing the company’s scale and reported year-over-year comparisons.
Key financial results
| Metric | Three months ended Aug. 31, 2013 | Prior year | Six months ended Aug. 31, 2013 | Prior year |
|---|---|---|---|---|
| Net sales | $1,459.8 | $698.5 | $2,133.2 | $1,333.3 |
| Gross profit | $577.0 | $285.1 | $833.1 | $535.7 |
| Operating income | $1,674.0 | $130.6 | $1,744.5 | $236.7 |
| Net income | $1,522.0 | $124.6 | $1,574.9 | $196.6 |
| Diluted EPS, Class A | $7.74 | $0.67 | $8.03 | $1.05 |
| Gross margin | 39.5% | 40.8% | 39.1% | 40.2% |
Cash flow: Six-month operating cash flow was $489.0, compared with $368.5 in the prior year. Investing cash outflow was $4,719.4, including $4,672.9 for the acquisition; capital expenditures were $49.2. Financing cash inflow was $4,020.8, principally from debt issuance and borrowings. Cash declined to $116.8 from $331.5 at fiscal year-end.
Debt and liquidity: Total debt was approximately $7,300.5 at August 31, up $3,995.1 from February 28. This comprised $7,028.4 of long-term debt, including current maturities, and $272.1 of bank notes. Current liabilities were $1,810.6. The company reported $757.9 of revolving-credit availability at August 31 and $802.3 at September 30. The credit agreement includes financial covenants and restrictions on certain activities.
Material changes and unusual items
- Reported sales rose 109% in the quarter and 60% for the six-month period, primarily because the acquisition added $762.8 of net sales. Beer results were consolidated only from June 7; prior Crown Imports results were generally reflected through equity earnings.
- Reported operating income and net income included a noncash, nontaxable $1,642.0 gain from remeasuring the company’s prior Crown Imports stake to fair value. The quarter also included $300.9 of impairment charges: $283.6 for Canadian reporting-unit goodwill and $17.3 for trademarks.
- The acquisition increased goodwill and intangible assets and was largely debt-financed. The estimated aggregate purchase price was $5,226.4; purchase accounting remained preliminary. An estimated additional payment of $588.2 was accrued, subject to final 2012 EBITDA and working-capital adjustments; the potential undiscounted EBITDA-related payment was between zero and $558.0.
- Reported gross margin declined year over year. Management cited acquisition-related inventory step-up and other unusual costs, higher U.S. wine promotions and grape costs. Spirits sales fell 18% in the quarter, primarily from shipment timing; wine sales rose 2%.
- For comparison, unaudited pro forma results assuming the acquisition occurred at the start of the periods showed six-month net income of $18.3 versus $329.9 in the prior-year pro forma period, and a quarterly net loss of $115.3 versus net income of $204.0. These are pro forma, not reported results, and exclude the one-time remeasurement gain.
Outlook, risks and contingencies
- Management expected the fiscal 2014 effective tax rate to be approximately 11%, largely reflecting acquisition-related tax items, and approximately 32% for each of the following three fiscal years.
- The company’s stated long-term objectives are sales growth, margin expansion, increased cash flow, EPS growth and debt reduction. It planned to grow the Mexican beer portfolio and expand the brewery to nominal capacity of at least 20 million hectoliters annually by December 31, 2016.
- Management expected the 2013 U.S. grape harvest to be similar in overall yield to 2012 and said wine supply was generally in balance with demand. It also described a strategic shift in Canada toward imported brands after weaker domestic-market trends and missed improvement initiatives.
- The Canadian impairment depended on forecasts and valuation assumptions; management said reasonably adverse changes in key trademark assumptions could cause an additional impairment of $1.0–$12.0. Further impairment remains a risk if estimates or market conditions change.
- Acquisition execution, brewery expansion timing and cost, debt service, covenant compliance, wine supply and demand, foreign exchange, fuel prices and interest rates are among the risks discussed. The company uses derivatives to hedge exposures and states they are not used for trading.
- The DOJ had moved for entry of the proposed final judgment governing the acquisition; the company was awaiting the court’s determination. A separate private antitrust complaint was dismissed in September 2013. The filing also disclosed indemnification exposure of up to $296.2, with $281.9 potentially recoverable from third parties; management considered material payments unlikely.
Important facts for investors to verify
- How much of reported earnings and EPS reflects the one-time $1,642.0 remeasurement gain, and what normalized results show after acquisition costs and impairment charges.
- Final acquisition purchase accounting, the actual EBITDA and working-capital adjustment, and the amount and timing of any remaining purchase-price payment.
- Integration results and cash generation from the acquired beer business, progress and required spending on the brewery expansion, and the effect on leverage and debt-reduction plans.
- Canadian wine-and-spirits performance, impairment assumptions and any further write-downs; also monitor U.S. wine promotional spending, grape costs and spirits volumes.
- Available borrowing capacity, seasonal working-capital needs, debt maturities, interest costs, credit-agreement covenants and the outcome of the pending DOJ final-judgment process.