STZ

Business Context and Reporting Period

Company: Constellation Brands, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: May 31, 2010 (First Quarter of Fiscal 2011)
Business Overview: The Company is the world's leading wine company with a portfolio of premium wine brands, spirits, and imported beer. Effective May 1, 2010, the Company reorganized its reportable segments into four divisions: Constellation Wines North America (CWNA), Constellation Wines Australia and Europe (CWAE), Corporate Operations and Other, and Crown Imports (imported beer joint venture).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue: Net sales decreased 1% to $787.5 million, primarily due to the divestiture of the U.K. cider and value spirits businesses ($42.5 million impact), partially offset by favorable foreign currency translation ($34.8 million).
• Profitability: Operating income increased 14% to $96.3 million, driven by a significant reduction in restructuring charges and unusual items ($6.9 million in Q1 2011 vs. $40.2 million in Q1 2010).
• Net Income: Net income surged to $49.1 million from $6.5 million. This was driven by lower restructuring costs, reduced interest expense (due to lower rates and borrowings), and a lower effective tax rate (52.0% vs. 91.8% in the prior year, which included a $37.5 million tax charge related to the value spirits sale).
• Cash Flow: Operating cash flow turned positive at $59.7 million compared to a use of $54.8 million in the prior year, aided by a decrease in inventory levels.
• Debt & Liquidity: Total debt increased to $4,017.8 million, largely due to borrowing $300.0 million to fund a share repurchase program. Cash balances decreased from $43.5 million to $20.9 million.

Guidance, Outlook, and Risks

• Segment Strategy:
  • CWNA: Focused on premium wine and spirits growth. The Company is consolidating its U.S. distributor network, which is expected to cause a negative sales trend in Q2 2011 compared to Q2 2010 due to transition timing.
  • CWAE: Strategy involves tightening portfolio focus, increasing efficiencies, and reducing costs to address competitive pressures in the U.K. and Australia markets.
• Restructuring Outlook: The Company expects to incur approximately $31.2 million in restructuring charges and $5.5 million in other costs for the remainder of Fiscal 2011.
• Equity Method Investment (Ruffino): The Company settled a put option for a 9.9% stake in Ruffino S.r.l. for $29.6 million. A remaining 50.1% stake has a put option exercisable through Dec 31, 2010, with a potential settlement value estimated up to $68 million. If exercised, this would require consolidation of Ruffino.
• Risks: Adverse global economic conditions, intense competition in U.K. and Australia (including private label pressure), foreign exchange volatility, and the impact of the U.S. distributor consolidation.

Investor Verification Checklist

• Share Repurchase Impact: Verify the final share count and cost basis of the $300 million accelerated stock buyback (ASB) transaction, as the final number of shares is subject to a calculation period ending November 2010.
• Ruffino Put Option: Monitor the status of the 50.1% Ruffino put option; exercise would trigger consolidation and potential goodwill impairment or acquisition accounting adjustments.
• U.K. Tax Position: Review the $28.1 million valuation allowance recognized against U.K. deferred tax assets and its impact on future effective tax rates.
• Distributor Transition: Assess the operational impact of the U.S. distributor consolidation on Q2 2011 sales volumes and service levels.
• Debt Covenants: Confirm compliance with debt covenants given the increase in total debt to $4.0 billion and the debt-to-capitalization ratio of 63.6%.