Constellation Brands, Inc. — FY2013 Form 10-K
Reporting period: Fiscal year ended February 28, 2013; comparisons are primarily with the year ended February 29, 2012. Although the request metadata says “2012 Q4,” this filing is an annual report for FY2013. Amounts are in U.S. dollars unless stated otherwise.
Business context
Constellation is a beverage-alcohol company focused on premium wine and spirits, with a 50% equity-method interest in Crown Imports, which imports Modelo beers in the U.S. The company acquired premium wine brand Mark West for $159.3 million in July 2012. At filing, its proposed $4.75 billion Beer Business Acquisition—Crown Imports’ remaining 50%, the Piedras Negras brewery and perpetual U.S. Modelo brand rights—was still pending. The DOJ settlement process had advanced, but closing conditions remained.
Key financial results
| Metric | FY2013 | FY2012 | Change |
|---|---|---|---|
| Net sales | $2,796.1 million | $2,654.3 million | +5% |
| Gross profit / margin | $1,108.3 million / 39.6% | $1,062.1 million / 40.0% | +4%; margin down 0.4 percentage points |
| Operating income / margin | $522.9 million / 18.7% | $486.5 million / 18.3% | +7% |
| Equity in earnings of investees | $233.1 million | $228.5 million | +2% |
| Interest expense, net | $227.1 million | $181.0 million | +25% |
| Net income / net margin | $387.8 million / 13.9% | $445.0 million / 16.8% | −13% |
| Diluted EPS, Class A | $2.04 | $2.13 | −4% |
| Cash from operating activities | $556.3 million | $784.1 million | −29% |
| Capital expenditures | $62.1 million | $68.4 million | −9% |
Wine and spirits sales rose on U.S. base-brand volume growth, favorable mix, and $55.5 million of Mark West and Ruffino sales, partly offset by higher promotions. Crown Imports’ sales grew 5% to $2,588.1 million and operating income rose 4% to $448.0 million, primarily on Mexican beer volume growth and advertising.
Liquidity, debt and balance sheet
- Cash and cash investments were $331.5 million, versus $85.8 million a year earlier. Total assets were $7,638.1 million.
- Total debt, including current maturities, was $3,305.4 million, up $553.8 million from FY2012-end; the filing’s selected-data table reports long-term debt including current maturities of $3,305.4 million. Current liabilities were $677.9 million and current assets $2,471.2 million.
- Operating cash flow declined to $556.3 million. Management attributed cash use in working capital chiefly to inventory growth of $90.0 million, higher receivables and increased tax payments; inventory totaled $1,480.9 million.
- The company reported $835.5 million of undrawn revolving availability at February 28, 2013 ($835.6 million as of April 22, 2013). A new receivables securitization facility provided seasonal capacity of $65 million to $250 million; it had not been drawn through April 29, 2013.
- FY2013 financing activity included $383.0 million of share repurchases. The company had a further $1.0 billion repurchase authorization, subject to management’s discretion and cash and debt considerations. It had not paid common dividends since its 1973 IPO.
Material changes and unusual items
- Sales increased 5% and operating income increased 7%, but net income fell 13%, as higher interest expense, a higher tax provision and a $12.5 million financing-cost write-off more than offset operating growth.
- The effective tax rate rose to 24.9% from 16.7%; FY2012 benefited from tax examination settlements and other tax adjustments. Management expected an approximately 37% effective tax rate in FY2014.
- FY2013 operating results included $33.8 million of restructuring and unusual items, including $27.7 million of acquisition-related costs and $7.8 million of inventory step-up expense, partly offset by a $7.1 million divestiture-related gain. Restructuring charges were $0.7 million, compared with $16.0 million in FY2012.
- No intangible-asset impairment was recorded in FY2013, compared with $38.1 million in FY2012. However, the company disclosed sensitivity in the valuation of Canadian trademarks.
- Cash from operations was lower year over year, while debt increased. The company redeemed $650 million of August 2012 senior notes in February 2013 after the original acquisition financing conditions no longer matched the revised transaction.
Outlook, risks and contingencies
- Beer Business Acquisition: The company expected closing around the end of FY2014’s first quarter or shortly thereafter, subject to conditions and approvals. It planned to fund the approximately $4.75 billion price with cash and new debt; committed bridge financing was available up to $4.375 billion through December 30, 2013. Closing, financing terms, integration and expected benefits were not assured.
- Brewery investment: DOJ settlement terms require expansion to nominal annual capacity of at least 20 million hectoliters by December 31, 2016. The company forecast FY2014 capital expenditures of $200–$230 million, including $120–$140 million for the brewery; it expected $500–$600 million of brewery expansion spending over three fiscal years.
- Operational exposure: Management considered U.S. wine supply generally balanced and said the 2012 U.S. grape harvest was larger than 2011’s. Risks include crop and weather variability, water availability, commodity and glass costs, and reliance on a concentrated supplier base. The brewery would become a key, ultimately sole, source for Modelo beer; disruption or delayed expansion could constrain supply.
- Customer concentration: The five largest customers represented 57.8% of sales. Southern Wine and Spirits accounted for 30.0% of sales and Republic National Distributing Company for 15.6%.
- Legal and governance: Private antitrust actions concerning the related ABI/Modelo transaction were pending; management said it intended to defend the company. The Sands family held majority voting control through the high-vote Class B shares. The company reported no material adverse outcome expected from ordinary-course litigation or regulatory matters, while noting outcomes were uncertain.
- Other material risks include high leverage and restrictive covenants, integration execution, consumer preference and competition, foreign exchange and interest rates, product quality and reputation, and impairment of goodwill or trademarks. KPMG issued unqualified opinions on the financial statements and internal control over financial reporting.
Most important facts for investors to verify
- Whether and when the Beer Business Acquisition closed, its final purchase-price adjustment, funding mix, interest costs and resulting leverage.
- Actual brewery expansion spending, delivery against DOJ milestones, production capacity and the transition from interim supply arrangements.
- Whether wine and spirits growth and Crown Imports’ volume and profit gains continued without disproportionate promotional or advertising expense.
- Cash conversion and inventory levels, debt repayment capacity, covenant headroom, and the realized tax rate versus management’s approximately 37% FY2014 expectation.
- Customer concentration and Canadian trademark valuation assumptions, including any subsequent impairment indicators.