Constellation Brands, Inc. — FY2011 Form 10-K
Reporting period: Fiscal year ended February 28, 2011 (not calendar 2010). Financial amounts are in U.S. dollars unless stated otherwise.
Business context
Constellation sells wine and spirits, and holds an equal interest in Crown Imports, the U.S. importer and marketer of Modelo and other beer brands. In January 2011, it sold 80.1% of its Australian and U.K. wine business, retaining 19.9%. Management described the sale as part of a strategy to focus on premium brands, improve margins and returns on invested capital, generate cash, and reduce debt.
Key financial metrics
| Metric | FY2011 | FY2010 |
|---|---|---|
| Net sales | $3,332.0 million | $3,364.8 million |
| Gross profit / margin | $1,190.1 million / 35.7% | $1,144.8 million / 34.0% |
| Operating income / margin | $502.5 million / 15.1% | $311.5 million / 9.3% |
| Income before taxes | $551.0 million | $259.3 million |
| Net income | $559.5 million | $99.3 million |
| Diluted EPS, Class A | $2.62 | $0.45 |
| Operating cash flow | $619.3 million | $402.5 million |
| Capital expenditures | $89.1 million | $107.7 million |
| Total debt outstanding | $3,236.3 million | $3,835.5 million |
| Cash and cash investments | $9.2 million | $43.5 million |
At February 28, 2011, current assets were $2,083.0 million and current liabilities $662.9 million. The company reported $3,152.6 million of long-term debt, including current maturities, in selected financial data; total debt of $3,236.3 million also includes notes payable. It reported $619.3 million of cash from operations and $188.1 million of cash provided by investing activities, which included business-sale proceeds. Financing activities used $845.7 million, including $328.5 million of long-term debt payments, $289.7 million of net repayments of notes payable, and $300.0 million of share repurchases.
Material changes versus FY2010
- Net sales declined 1%, primarily reflecting the Australian/U.K. divestiture and the earlier U.K. cider and value spirits divestitures. CWNA sales increased 5% to $2,557.3 million; CWAE sales fell 17% to $774.7 million. Crown Imports’ sales rose 6% to $2,392.9 million, but are eliminated in consolidation because it is accounted for as an equity-method investment.
- Gross margin increased 1.7 percentage points, reflecting higher-margin product mix and the exit from lower-margin businesses, partly offset by promotional spending and higher grape costs.
- Operating income increased 61%, but the comparison includes substantially lower restructuring and unusual charges: $31.2 million in FY2011 versus $248.7 million in FY2010. FY2011 also included $83.7 million of gains associated with the Australian/U.K. sale and related activities, a $60.0 million Ruffino put-option loss, $23.6 million of intangible-asset impairments, and $23.1 million of restructuring charges.
- Net income rose sharply, helped by lower interest expense ($195.3 million versus $265.1 million) and an $8.5 million income-tax benefit. The effective tax rate was negative 1.5%, driven in large part by a $207.0 million tax deduction related to investments and loans associated with the divestiture, plus a $36.0 million benefit from tax examinations and expiring statutes of limitation.
- Total debt decreased $599.2 million year over year. Share repurchases totaled $300.0 million for FY2011; a further $500.0 million authorization was approved in April 2011, with no repurchases under that authorization reported as of April 28, 2011.
Outlook, commentary and risks
- Management’s stated long-term model is to grow sales, expand margins and cash flow, reduce borrowings, and grow EPS. It expects U.S. wine supply and demand to remain generally balanced. The filing provides no specific FY2012 revenue, earnings or EPS guidance.
- Management expects FY2012 capital expenditures of $85 million to $95 million and no material costs from existing restructuring plans. It expects distributor inventories to stabilize after FY2011 shipments had exceeded distributor sales to retailers under new U.S. distributor agreements; management said those shipments should broadly align thereafter.
- The company identifies substantial indebtedness, debt covenants and refinancing needs as risks. It also highlights competition, reliance on distributors and major customers, changing consumer demand, grape and packaging costs and availability, weather and water exposure, foreign-exchange and interest-rate movements, and possible impairment of goodwill and trademarks.
- Five largest customers represented 41.7% of sales; the largest, Southern Wine and Spirits, represented 19.5%. Its share of receivables was 35.7% at year-end, up from 19.4% a year earlier.
- Ruffino-related exposure remains uncertain: the company recorded a $60.0 million loss on a put-option obligation and was discussing a potential purchase of the remaining 50.1% interest on revised terms. A separate terminated-investee agreement could result in a loss of up to $55 million, although management said loss was not probable and recorded no liability.
- For divestiture-related indemnities, the company recorded a $26.1 million liability and estimated potential payments of up to $331.9 million, with $282.1 million potentially recoverable from third parties; management did not expect material payments. The EPA proposed a $226,000 penalty concerning historical ammonia-system compliance deficiencies at a winery; the company said corrections were made and it would dispute the penalty.
- Project Fusion, a multi-year finance and technology systems initiative, was targeted to begin phased deployment in FY2012; implementation could involve cost, disruption and internal-control risks. Management and KPMG reported effective internal control over financial reporting, and KPMG issued unqualified opinions on the financial statements and controls.
Important facts for investors to verify
- How much of FY2011 earnings growth is sustainable after adjusting for divestiture gains, the unusual tax benefit, pension settlement costs, impairments and restructuring items.
- Whether underlying consumer demand and retailer depletions support continued growth, given the effect of distributor inventory movements and the higher customer concentration.
- The timing and terms of any Ruffino resolution, and the ultimate exposure from divestiture indemnities, the EPA matter and the separate potential $55 million contingency.
- Debt maturities, covenant headroom, available credit and the effect of future buybacks on deleveraging and liquidity; reported cash was only $9.2 million at year-end.
- Progress and costs of Project Fusion, and whether the stated FY2012 capital-spending and restructuring expectations are met.