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STZ > SEC Filings for STZ > Form 10-K on 29-Apr-2014All Recent SEC Filings

Show all filings for CONSTELLATION BRANDS, INC.

Form 10-K for CONSTELLATION BRANDS, INC.


29-Apr-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Introduction

This MD&A, which should be read in conjunction with our Financial Statements,
provides additional information on our businesses, current developments,
financial condition, cash flows and results of operations. It is organized as
follows:

         Overview.  This section provides a general description of our business,
          which we believe is important in understanding the results of our
          operations, financial condition and potential future trends.

Strategy. This section provides a description of our strategy on a business segment basis and discussion of recent acquisitions.

         Results of operations.  This section provides an analysis of our
          results of operations presented on a business segment basis. In
          addition, a brief description of transactions and other items that
          affect the comparability of the results is provided.



         Financial liquidity and capital resources.  This section provides an
          analysis of our cash flows and our outstanding debt and commitments.
          Included in the analysis of outstanding debt is a discussion of the
          amount of financial capacity available to fund our ongoing operations
          and future commitments, as well as a discussion of other financing
          arrangements.



         Critical accounting estimates.  This section identifies those
          accounting policies that are considered important to our results of
          operations and financial condition, require significant judgment and
          involve significant management estimates. Our significant accounting
          policies, including those considered to be critical accounting
          policies, are summarized in Note 1 of the Notes to the Financial
          Statements.

Overview

We are a leading international beverage alcohol company with a broad portfolio of consumer-preferred premium imported beer, wine and spirits brands complemented by other select beverage alcohol products. We are the third-largest producer and marketer of beer for the U.S. market and the world's leading premium wine company. We are the largest Multi-category Supplier of beverage alcohol in the U.S., the leading producer and marketer of wine in Canada, and a leading producer and exporter of wine from New Zealand and Italy.

Our internal management financial reporting consists of two business divisions: (i) Beer and (ii) Wine and Spirits, and we report our operating results in three segments: (i) Beer (imported beer), (ii) Wine and Spirits (wine and spirits), and (iii) Corporate Operations and Other. The business segments reflect how our operations are managed, how operating performance is evaluated by senior management and the structure of our internal financial reporting. Amounts included in the Corporate Operations and Other segment consist of costs of executive management, corporate development, corporate finance, human resources, internal audit, investor relations, legal, public relations and global information technology. The amounts included in the Corporate Operations and Other segment are general costs that are applicable to the consolidated group and are therefore not allocated to the other reportable segments. All costs reported within the Corporate Operations and Other segment are not included in our chief operating decision maker's evaluation of the operating income performance of the other reportable segments.


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Strategy

Our business strategy in the Beer segment is twofold: (i) continued focus on growing the premium Mexican beer portfolio in the U.S. through expanding distribution for key brands, as well as new product development and innovation within the existing portfolio of brands, and (ii) completion of the required Brewery expansion in Mexico by December 31, 2016, with a goal to complete the expansion within three years from the date of acquisition (see additional discussion below under "Acquisitions - Beer Business Acquisition").

Our business strategy in the Wine and Spirits segment is centered on continued focus on consumer-preferred premium wine brands, complemented by premium spirits. In this segment, we continue to focus on growing premium product categories. We have consolidated our U.S. distribution network in markets where it was feasible, which currently represents about 70% of our branded wine and spirits volume in the U.S., in order to obtain dedicated selling resources which focus on our U.S. wine and spirits portfolio to drive organic growth. Throughout the terms of these contracts, we generally expect shipments on an annual basis to these distributors ("Shipments") to essentially equal the distributors' shipments to retailers ("Depletions"). In addition, we dedicate a large share of our sales and marketing resources to our U.S. Focus Brands as they represent a majority of our U.S. wine and spirits revenue and profitability, and have strong positions in their respective price segments.

We believe the current overall supply of wine is generally in balance with demand within the U.S. The calendar 2013 U.S. grape harvest overall yield came in similar to the calendar 2012 U.S. grape harvest. Accordingly, we expect that the calendar 2013 U.S. grape harvest may continue to provide some relief from the recent tightening of supply within certain U.S. varietals due to relatively smaller U.S. grape harvests in calendar 2011 and calendar 2010.

We remain committed to our long-term financial model of growing sales, expanding margins and increasing cash flow in order to achieve earnings per share growth and reduce borrowings.

Marketing, sales and distribution of our products are managed on a geographic basis in order to fully leverage leading market positions. In addition, market dynamics and consumer trends vary across each of our markets. Within our primary market in the U.S., we offer a range of beverage alcohol products across the imported beer, branded wine and spirits categories, with separate distribution networks utilized for our imported beer portfolio and our wine and spirits portfolio. Within our next largest market in Canada, we offer a range of beverage alcohol products primarily across the branded wine category. The environment for our products is competitive in each of our markets.

Acquisitions

Beer Business Acquisition

In June 2013, we completed the Beer Business Acquisition for an aggregate
purchase price of $5,226.4 million. The Beer Business Acquisition resulted in
the acquisition of:

 the remaining 50% equity interest in Crown Imports;


         all of the equity interests of a company which owns and operates the
          Brewery and of a company which provides personnel and services for the
          operation and maintenance of the Brewery; and


         an irrevocable, fully-paid license to produce in Mexico (or worldwide
          under certain circumstances) and exclusively import, market and sell
          Modelo's Mexican beer portfolio sold in the U.S. and Guam as of the
          date of the acquisition, and certain extensions.

In connection with the Beer Business Acquisition, we are required to build out and expand the Brewery to a nominal capacity of at least 20 million hectoliters of packaged beer annually by December 31, 2016. In addition, an interim supply agreement and a transition services agreement were entered into in association with the Beer Business Acquisition. The interim supply agreement obligates the supplier to provide us with a supply of product not produced by the Brewery and the transition services agreement provides for certain specified services and production materials, both for a specified period of time. The associated agreements provide, among other things,


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that the United States will have approval rights, in its sole discretion, for amendments or modifications to the associated agreements and the United States will have a right of approval, in its sole discretion, of any extension of the term of the interim supply agreement beyond three years. The Beer Business Acquisition has positioned us as the third-largest producer and marketer of beer for the U.S. market and the largest Multi-category Supplier of beverage alcohol in the U.S.

The results of operations of the Beer Business Acquisition are reported in the Beer segment and are included in our consolidated results of operations from the date of acquisition. It is a significant acquisition that has had and will continue to have a material impact on our future results of operations, financial position and cash flows.

Mark West

In July 2012, we acquired Mark West for $159.3 million. The transaction primarily includes the acquisition of the Mark West trademark, related inventories and certain grape supply contracts. The results of operations of Mark West are reported in the Wine and Spirits segment and are included in our consolidated results of operations from the date of acquisition.

Ruffino

In October 2011, we acquired the remaining 50.1% equity interest in Ruffino (which we did not previously own) for 50.3 million ($68.6 million). As a result of this acquisition, we assumed indebtedness of Ruffino, net of cash acquired, of 54.2 million ($73.1 million). The results of operations of the Ruffino business are reported in the Wine and Spirits segment and are included in our consolidated results of operations from the date of acquisition.

For more information on these acquisitions see Note 3 of the Notes to the Financial Statements.

Results of Operations

Financial Highlights

Financial Highlights for Fiscal 2014:

         Our Beer Business Acquisition solidified our position in the U.S. beer
          market for the long term and makes us the third-largest brewer and
          seller of beer for the U.S. market. Combining this with our strong
          position in wine and spirits makes us the largest Multi-category
          Supplier of beverage alcohol in the U.S. In addition, the Beer Business
          Acquisition resulted in the realization of operating efficiencies and
          the strengthening of relationships with wholesalers and distributors.



         Our net sales increased 74% primarily due to the Beer Business
          Acquisition and strong consumer demand within the Mexican beer
          portfolio.



         Operating income increased significantly primarily due to a nontaxable
          gain on the remeasurement to fair value of our preexisting 50% equity
          interest in Crown Imports combined with the benefit from the Beer
          Business Acquisition, partially offset by an impairment of
          nondeductible goodwill and intangible assets for the Wine and Spirits
          segment's Canadian reporting unit.



         Net income also increased significantly primarily due to the items
          discussed above, partially offset by lower equity in earnings (Crown
          Imports) and an increase in interest expense, net, driven largely by
          financing for the Beer Business Acquisition.

The significant increase in our diluted earnings per share resulted largely from the Beer Business Acquisition.


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References to organic throughout the following discussion exclude the impact of branded wine acquired in the acquisitions of Mark West and Ruffino, as appropriate.

Unusual items

Management excludes items that affect comparability ("Unusual Items") from its evaluation of the results of each operating segment as these Unusual Items are not reflective of continuing operations of the segments. Segment operating performance and segment management compensation is evaluated based upon continuing segment operating income. As such, the performance measures for incentive compensation purposes for segment management do not include the impact of these items.

As more fully described herein and in the related Notes to the Financial Statements, the Unusual Items that impacted comparability in our results for each period are as follows:

                                                  Fiscal 2014     Fiscal 2013      Fiscal 2012
(in millions)
Cost of Product Sold
Flow through of inventory step-up                $      11.0     $       7.8     $         1.6
Amortization of favorable interim supply
agreement                                                6.0               -                 -
Other costs                                             (1.0 )             -               0.3
Total Cost of Product Sold                              16.0             7.8               1.9

Selling, General and Administrative Expenses
Transaction and related costs associated with
pending and completed acquisitions                      51.5            27.7                 -
Deferred compensation                                    7.0               -                 -
Restructuring charges and other                         (2.8 )          (1.7 )            13.5
Total Selling, General and Administrative
Expenses                                                55.7            26.0              13.5

Impairment of Goodwill and Intangible Assets           300.9               -              38.1

Gain on Remeasurement to Fair Value of Equity
Method Investment                                   (1,642.0 )             -                 -

Equity in Losses of Equity Method Investees              0.1             1.0                 -

Loss on Write-Off of Financing Costs                       -            12.5                 -
Unusual Items                                    $  (1,269.3 )   $      47.3     $        53.5

Cost of Product Sold

Inventory Step-Up

In connection with acquisitions, the allocation of purchase price in excess of book value for certain inventory on hand at the date of acquisition is referred to as inventory step-up. Inventory step-up represents an assumed manufacturing profit attributable to the acquired company prior to acquisition. For Fiscal 2014, Fiscal 2013 and Fiscal 2012, flow through of inventory step-up was primarily related to the Beer Business Acquisition, the Mark West acquisition and the Ruffino acquisition, respectively.

Favorable Interim Supply Agreement

In connection with the Beer Business Acquisition, a temporary supply agreement was negotiated under a favorable pricing arrangement for the required volume of beer needed to fulfill U.S. demand in excess of the Brewery's capacity until the Brewery acquires the necessary capacity to fulfill 100% of the U.S. demand. For Fiscal 2014, amortization of favorable interim supply agreement reflects amounts associated with non-Brewery product purchased from the date of acquisition which has been sold to our U.S. customers during Fiscal 2014.


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Other Costs

For Fiscal 2014, other costs represent unrealized gains from the mark to fair value of undesignated commodity swap contracts which are reported outside of segment operating results until such time that the underlying exposure is realized in the segment operating results. At that time, the realized gains or losses from the mark to fair value of the undesignated commodity swap contracts are reported in the appropriate operating segment, allowing our operating segments to realize the economic effects of the commodity swap contracts without the resulting unrealized mark to fair value volatility. For Fiscal 2012, other costs represent amounts recognized in connection with certain of our restructuring activities.

Selling, General and Administrative Expenses

Transaction and Related Costs Associated With Pending and Completed Acquisitions

For Fiscal 2014 and Fiscal 2013, transaction and related costs were associated primarily with the Beer Business Acquisition.

Deferred Compensation

For Fiscal 2014, deferred compensation relates to a prior period correction of previously unrecognized deferred compensation costs that were associated with certain employment agreements.

Restructuring Charges and Other

For Fiscal 2014, Fiscal 2013 and Fiscal 2012, restructuring charges and other consist primarily of restructuring and related charges associated with previously announced restructuring plans as well as certain (gains) losses on prior period acquisitions and divestitures.

Impairment of Goodwill and Intangible Assets

For Fiscal 2014, we recorded impairment losses of $300.9 million for the second quarter consisting of impairments of goodwill and certain trademarks of $278.7 million and $22.2 million, respectively, related to our Wine and Spirits segment's Canadian reporting unit. No such impairments were recorded for Fiscal 2013. For Fiscal 2012, we recorded an impairment loss for the fourth quarter consisting of impairments of certain trademarks related to our Wine and Spirits segment's Canadian business.

Gain on Remeasurement to Fair Value of Equity Method Investment

Prior to the Beer Business Acquisition, we accounted for our investment in Crown Imports under the equity method of accounting. In applying the acquisition method of accounting, our preexisting 50% equity interest was remeasured to its estimated fair value of $1,845.0 million, and we recognized a gain of $1,642.0 million for the second quarter of Fiscal 2014 in connection with the Beer Business Acquisition.

Loss on Write-off of Financing Costs

We recorded a loss on the write-off of financing costs for Fiscal 2013 primarily in connection with the redemption of the August 2012 Senior Notes.


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Fiscal 2014 Compared to Fiscal 2013

Net Sales

The following table sets forth net sales for each of our reportable segments for
Fiscal 2014 and Fiscal 2013.
                                                                 % Increase
                                Fiscal 2014      Fiscal 2013     (Decrease)
(in millions)
Beer                           $    2,835.6     $    2,588.1        10 %
Wine and Spirits:
Wine                                2,554.2          2,495.8         2 %
Spirits                               291.3            300.3        (3 %)
Total Wine and Spirits              2,845.5          2,796.1         2 %
Total Reportable Segments           5,681.1          5,384.2         6 %
Consolidation and Eliminations       (813.4 )       (2,588.1 )      69 %
Consolidated Net Sales         $    4,867.7     $    2,796.1        74 %

Net sales increased to $4,867.7 million for Fiscal 2014 from $2,796.1 million for Fiscal 2013, an increase of $2,071.6 million, or 74%. This increase resulted primarily from $2,022.2 million of net sales of products acquired in the Beer Business Acquisition. Prior to the Beer Business Acquisition, the results of operations of the Beer segment were eliminated in consolidation as our preexisting 50% equity interest in Crown Imports was accounted for under the equity method of accounting.

Beer
                                                  Fiscal 2014       Fiscal 2013      % Increase
(in millions, branded product, 24 pack, 12
ounce case equivalents)
Net Sales                                       $     2,835.6     $     2,588.1           9.6 %

Shipment Volume                                         182.4             170.6           6.9 %

Depletion Volume Growth (1)                                                               7.6 %

(1) Depletions are based on third party data.

The increase in net sales for the Beer segment resulted primarily from volume growth within the Mexican beer portfolio which benefited from continued consumer demand and increased advertising spend, combined with a favorable impact from pricing in select markets.


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Wine and Spirits
                                                  Fiscal 2014       Fiscal 2013      % Increase
(in millions, branded product, 9 liter case
equivalents)
Net Sales                                       $     2,845.5     $     2,796.1           1.8 %

Shipment Volume
Total                                                    66.8              64.2           4.0 %
Organic                                                  66.5              64.2           3.6 %

U.S. Domestic                                            51.3              49.3           4.1 %
Organic U.S. Domestic                                    51.0              49.3           3.4 %

U.S. Domestic Focus Brands                               35.9              34.0           5.6 %
Organic U.S. Domestic Focus Brands                       35.6              34.0           4.7 %

Depletion Volume Growth (1)
U.S. Domestic                                                                             3.5 %
U.S. Domestic Focus Brands                                                                5.6 %

The increase in net sales for the Wine and Spirits segment is due primarily to an increase in wine net sales of $58.4 million, or 2%. This increase resulted primarily from organic branded wine volume growth (predominantly in the U.S.) and $18.6 million of net sales of branded wine acquired in the acquisition of Mark West, partially offset by higher promotional expense and unfavorable product mix (predominantly within the organic U.S. branded wine portfolio) and an unfavorable year-over-year foreign currency translation impact of $18.5 million. Spirits net sales decreased $9.0 million, or (3%), primarily due to lower bulk spirits net sales and higher promotional expense.

For the first quarter of fiscal 2015, we expect a low-to-mid single-digit percent decrease in wine and spirits net sales from the first quarter of fiscal 2014 as we work with one of our exclusive distributors to reduce their inventory levels. However, gross profit for the first quarter of fiscal 2015 is not expected to be significantly impacted as a result of this inventory reduction as the distributor is contractually required to pay us an amount approximately equal to the profit lost on the reduced sales.

Gross Profit

Gross profit increased to $1,991.7 million for Fiscal 2014 from $1,108.3 million for Fiscal 2013, an increase of $883.4 million, or 80%. This increase is primarily due to gross profit from the Beer Business Acquisition of $890.6 million, partially offset by an increase in Unusual Items of $8.2 million.

The Beer segment's gross profit increased $376.7 million, or 50%, primarily due to incremental gross profit from the Brewery Purchase, the favorable impact from pricing in select markets and the volume growth.

Wine and Spirits' gross profit increased slightly, primarily due to the organic branded wine volume growth, partially offset by the higher promotional expense and higher branded wine product costs.

Gross profit as a percent of net sales increased to 40.9% for Fiscal 2014 compared to 39.6% for Fiscal 2013 primarily due to the benefit from the Beer Business Acquisition, partially offset by the higher wine and spirits promotional expense and the increase in Unusual Items.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased to $895.1 million for Fiscal 2014 from $585.4 million for Fiscal 2013, an increase of $309.7 million, or 53%. This increase is due to $260.3 million of selling, general and administrative expenses from the Beer Business Acquisition, combined with increases in (i) Unusual


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items of $29.7 million, (ii) Wine and Spirits of $13.4 million and
(iii) Corporate Operations and Other of $6.3 million.

The Beer segment's selling, general and administrative expenses increased $51.8 million, or 17%, primarily due to increases in general and administrative expenses, advertising expenses and selling expenses. The increase in general and administrative expenses is primarily attributable to higher allocated information technology expense in the Beer segment (which was offset by a decrease in allocated information technology expense in the Wine and Spirits segment) and higher compensation and benefit costs associated largely with higher annual management incentive expense. Information technology expense is allocated to each of our segments to reflect utilization of central support services and costs associated with our information technology systems. The reallocation of information technology expense resulted from the Beer Business Acquisition and the associated consolidation of the Beer segment's results of operations. The increase in advertising expenses is due largely to planned investment behind the Mexican beer portfolio. The increase in selling expenses is due largely to increased headcount to support the Beer segment's growth.

The increase in Wine and Spirits' selling, general and administrative expenses is primarily due to an increase in selling expenses of $15.4 million and advertising expenses of $4.4 million, partially offset by a decrease in general and administrative expenses of $6.4 million. The increase in selling and advertising expenses is driven largely by a planned increase in spend behind the segment's branded wine and spirits portfolio. The decrease in general and administrative expenses is primarily attributable to the lower allocated information technology expense discussed above, partially offset by a number of smaller increases in certain general and administrative expenses supporting the Wine and Spirits' branded portfolio.

The increase in Corporate Operations and Other's selling, general and administrative expenses is primarily due to an increase in general and administrative expenses primarily attributable to higher compensation and benefit costs associated largely with higher annual management incentive expense.

Selling, general and administrative expenses as a percent of net sales decreased to 18.4% for Fiscal 2014 as compared to 20.9% for Fiscal 2013 primarily due to the Beer Business Acquisition and the associated lower fixed overhead, partially offset by the higher Unusual Items.

Operating Income

The following table sets forth operating income (loss) for each of our
reportable segments for Fiscal 2014 and Fiscal 2013.
                                                                % Increase
                                Fiscal 2014      Fiscal 2013    (Decrease)
(in millions)
Beer                           $      772.9     $     448.0        73 %
Wine and Spirits                      637.8           650.2        (2 %)
Corporate Operations and Other        (99.8 )         (93.5 )      (7 %)
Total Reportable Segments           1,310.9         1,004.7        30 %
Unusual Items                       1,269.4           (33.8 )      NM
Consolidation and Eliminations       (142.6 )        (448.0 )      68 %
. . .
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