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Business Context and Reporting Period

Company: Constellation Brands, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: February 28, 2009 (Fiscal 2009)
Industry: Beverage Alcohol (Wine, Spirits, Imported Beer)

Constellation Brands is the world's largest wine company and a leading producer of premium spirits and imported beer. The company operates globally with core markets in the U.S., Canada, the U.K., Australia, and New Zealand. During Fiscal 2009, the company faced a challenging global economic environment, which contributed to slowing premium wine growth and significant market deterioration in the U.K. and Australia.

Key Financial Metrics

Margins: Gross profit margin decreased to 33.7% in Fiscal 2009 from 34.0% in Fiscal 2008, primarily due to higher unusual costs including inventory write-downs.

Material Changes vs. Prior Period

• Net Sales: Decreased 3% to $3,654.6 million. The decline was driven by divestitures of the Almaden and Inglenook wine brands and the Pacific Northwest wine brands ($128.4 million impact), unfavorable foreign currency translation ($108.8 million), and the shift of the U.K. wholesale business (Matthew Clark) to equity method accounting. These were partially offset by sales from the Beam Wine Estates (BWE) acquisition ($147.3 million).
• Operating Income: Improved significantly from a loss of $356.7 million to a profit of $23.0 million. This improvement was primarily due to a substantial reduction in impairment losses ($300.4 million in 2009 vs. $812.2 million in 2008) and benefits from the BWE acquisition.
• Net Loss: Narrowed to $301.4 million from $613.3 million, reflecting the lower impairment charges and improved operating income, partially offset by a decrease in equity earnings from joint ventures due to impairments.
• Impairments: Recorded $300.4 million in goodwill and intangible asset impairments, primarily related to the U.K. reporting unit ($252.7 million goodwill, $25.9 million trademarks). Additionally, recorded $79.2 million in impairments of equity method investments (Matthew Clark and Ruffino).

Guidance, Outlook, and Risks

Management Commentary & Initiatives:

• Global Initiative: Announced on April 7, 2009, a plan to simplify the business, eliminate approximately 5% of the global workforce, and close certain facilities to reduce costs and improve efficiency.
• Divestitures: Sold the value spirits business in March 2009 for $330.5 million (net), retaining premium brands like Svedka Vodka and Black Velvet. Previously sold the Pacific Northwest wine business ($204.2 million) and Almaden/Inglenook brands ($133.5 million) to streamline the portfolio.
• Outlook: Management expects the global economic downturn to continue impacting consumer spending. The company is focusing on operating efficiencies and cash flow optimization.

Risks and Contingencies:

• Economic Conditions: Adverse global and domestic economic conditions could further impact consumer spending and liquidity of suppliers/distributors.
• Debt: High indebtedness ($4.4 billion) limits financial flexibility and increases vulnerability to economic downturns. The company is subject to restrictive covenants regarding additional debt and dividends.
• Internal Control Weakness: The company identified a material weakness in internal controls over financial reporting related to inventory reconciliation and review at its Australian subsidiary. This resulted in an adverse opinion from auditors on internal controls, though the financial statements received an unqualified opinion.
• Market Risks: Exposure to foreign currency fluctuations (AUD, GBP, NZD, CAD) and interest rate volatility.

Key Facts for Investor Verification

• Impairment Drivers: Verify the specific assumptions used in the discounted cash flow models for the U.K. goodwill impairment ($252.7 million) and the equity method investment impairments ($79.2 million), as these were driven by revised long-term forecasts reflecting market deterioration.
• Inventory Valuation: Review the $83.7 million in inventory write-downs (primarily Australian) and the material weakness in Australian inventory controls to assess the risk of future write-downs.
• Debt Covenants: Confirm compliance with the 2006 Credit Agreement covenants, specifically the debt coverage and interest coverage ratios, given the high leverage and economic uncertainty.
• Joint Venture Performance: Monitor the performance of Crown Imports (50% interest with Grupo Modelo) and Matthew Clark (50% interest with Punch Taverns), as their results are recorded via the equity method and significantly impact consolidated earnings.
• Restructuring Costs: Track the execution and cost realization of the "Global Initiative" announced in April 2009, which is expected to incur costs through Fiscal 2011.