WASHINGTON, D.C. 20549
The number of shares outstanding with respect to each of the classes of common stock of Constellation Brands, Inc., as of December 31, 2005, is set forth below:
CONSTELLATION BRANDS, INC. AND SUBSIDIARIES
| 17) | BUSINESS SEGMENT INFORMATION: |
The Company reports its operating results in three segments: Constellation Wines (branded wine, and U.K. wholesale and other), Constellation Beers and Spirits (imported beers and distilled spirits) and Corporate Operations and Other. Amounts included in the Corporate Operations and Other segment consist of general corporate administration and finance expenses. These amounts include costs of executive management, corporate development, corporate finance, human resources, internal audit, investor relations, legal and public relations. Any costs incurred at the corporate office that are applicable to the segments are allocated to the appropriate segment. 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 the chief operating decision maker’s evaluation of the operating income performance of the other operating segments.
The business segments reflect how the Company’s operations are being managed, how operating performance within the Company is being evaluated by senior management and the structure of its internal financial reporting. In addition, the Company excludes acquisition-related integration costs, restructuring and related charges and unusual items that affect comparability from its definition of operating income for segment purposes.
For the nine months ended November 30, 2005, acquisition-related integration costs, restructuring and related charges and unusual costs consist of the flow through of adverse grape cost (as described below), acquisition-related integration costs, and the flow through of inventory step-up associated primarily with the Robert Mondavi acquisition of $20.2 million, $15.9 million, and $6.6 million, respectively; restructuring and related charges associated primarily with the Fiscal 2006 Plan and the Robert Mondavi Plan of $8.4 million; accelerated depreciation costs in connection with the Fiscal 2006 Plan of $7.2 million; and the write-off of due diligence costs associated with the Company’s evaluation of a potential offer for Allied Domecq of $3.4 million. For the nine months ended November 30, 2004, acquisition-related integration costs, restructuring and related charges and unusual costs consist of financing costs associated with the redemption of the Company’s senior subordinated notes of $10.3 million, restructuring and related charges of $4.4 million, and the flow through of inventory step-up associated with the Hardy Acquisition of $4.2 million. For the three months ended November 30, 2005, acquisition-related integration costs, restructuring and related charges and unusual costs consist of accelerated depreciation costs and restructuring and related charges associated primarily with the Fiscal 2006 Plan of $7.2 million and $4.3 million, respectively; the flow through of adverse grape cost, the flow through of inventory step-up, and acquisition-related integration costs associated primarily with the Robert Mondavi acquisition of $6.2 million, $2.1 million, and $1.6 million, respectively; and the reimbursement of certain due diligence costs associated with the Company’s evaluation of a potential offer for Allied Domecq of $0.4 million. For the three months ended November 30, 2004, acquisition-related integration costs, restructuring and related charges and unusual costs consist of restructuring and related charges of $1.6 million, and the flow through of inventory step-up associated with the Hardy Acquisition of $1.9 million. Adverse grape cost represents the amount of historical inventory cost on Robert Mondavi’s balance sheet that exceeds the Company’s estimated ongoing grape cost and is primarily due to the purchase of grapes by Robert Mondavi prior to the acquisition date at above-market prices as required under the terms of their then existing grape purchase contracts.
The Company evaluates performance based on operating income of the respective business units. The accounting policies of the segments are the same as those described for the Company in the Summary of Significant Accounting Policies in Note 1 to the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended February 28, 2005, and include the recently adopted accounting pronouncements described in Note 2 herein. Transactions between segments consist mainly of sales of products and are accounted for at cost plus an applicable margin.
Segment information is as follows:
| | | For the Nine Months Ended November 30, | | For the Three Months Ended November 30, | |
| | | 2005 | | 2004 | | 2005 | | 2004 | |
(in thousands) | | | | | | | | | |
Constellation Wines: | | | | | | | | | |
| Net sales: | | | | | | | | | |
Branded wine | | $ | 1,724,557 | | $ | 1,286,966 | | $ | 672,196 | | $ | 509,520 | |
Wholesale and other | | | 743,913 | | | 769,720 | | | 245,472 | | | 264,324 | |
| Net sales | | $ | 2,468,470 | | $ | 2,056,686 | | $ | 917,668 | | $ | 773,844 | |
| Segment operating income | | $ | 404,145 | | $ | 283,104 | | $ | 184,410 | | $ | 127,700 | |
| Equity in earnings of equity method investees | | $ | 5,720 | | $ | 621 | | $ | 6,516 | | $ | 359 | |
| Long-lived assets | | $ | 1,314,542 | | $ | 1,027,897 | | $ | 1,314,542 | | $ | 1,027,897 | |
| Investment in equity method investees | | $ | 163,110 | | $ | 6,454 | | $ | 163,110 | | $ | 6,454 | |
| Total assets | | $ | 6,811,268 | | $ | 5,217,548 | | $ | 6,811,268 | | $ | 5,217,548 | |
| Capital expenditures | | $ | 84,267 | | $ | 71,946 | | $ | 26,397 | | $ | 25,588 | |
| Depreciation and amortization | | $ | 78,625 | | $ | 57,944 | | $ | 29,655 | | $ | 19,372 | |
| | | | | | | | | | | | | | |
Constellation Beers and Spirits: | | | | | | | | | | | | | |
| Net sales: | | | | | | | | | | | | | |
Imported beers | | $ | 837,432 | | $ | 751,879 | | $ | 262,800 | | $ | 225,846 | |
Spirits | | | 249,679 | | | 241,392 | | | 86,619 | | | 86,021 | |
| Net sales | | $ | 1,087,111 | | $ | 993,271 | | $ | 349,419 | | $ | 311,867 | |
| Segment operating income | | $ | 236,903 | | $ | 223,023 | | $ | 73,328 | | $ | 71,360 | |
| Long-lived assets | | $ | 84,234 | | $ | 82,590 | | $ | 84,234 | | $ | 82,590 | |
| Total assets | | $ | 832,552 | | $ | 801,497 | | $ | 832,552 | | $ | 801,497 | |
| Capital expenditures | | $ | 5,546 | | $ | 4,051 | | $ | 1,868 | | $ | 958 | |
| Depreciation and amortization | | $ | 7,959 | | $ | 8,303 | | $ | 2,777 | | $ | 2,825 | |
| | | | | | | | | | | | | | |
Corporate Operations and Other: | | | | | | | | | | | | | |
| Net sales | | $ | - | | $ | - | | $ | - | | $ | - | |
| Segment operating loss | | $ | (43,929 | ) | $ | (38,964 | ) | $ | (15,346 | ) | $ | (13,839 | ) |
| Long-lived assets | | $ | 15,359 | | $ | 13,583 | | $ | 15,359 | | $ | 13,583 | |
| Total assets | | $ | 58,685 | | $ | 60,839 | | $ | 58,685 | | $ | 60,839 | |
| Capital expenditures | | $ | 1,815 | | $ | 2,359 | | $ | 401 | | $ | 900 | |
| Depreciation and amortization | | $ | 5,725 | | $ | 7,365 | | $ | 1,739 | | $ | 2,348 | |
| | | | | | | | | | | | | | |
Acquisition-Related Integration Costs, Restructuring and Related Charges and Unusual Costs: | | | | | | | | | | | | | |
| Operating loss | | $ | (61,746 | ) | $ | (18,896 | ) | $ | (21,039 | ) | $ | (3,534 | ) |
| | | | | | | | | | | | | | |
Consolidated: | | | | | | | | | | | | | |
| Net sales | | $ | 3,555,581 | | $ | 3,049,957 | | $ | 1,267,087 | | $ | 1,085,711 | |
| Operating income | | $ | 535,373 | | $ | 448,267 | | $ | 221,353 | | $ | 181,687 | |
| Equity in earnings of equity method investees | | $ | 5,720 | | $ | 621 | | $ | 6,516 | | $ | 359 | |
| Long-lived assets | | $ | 1,414,135 | | $ | 1,124,070 | | $ | 1,414,135 | | $ | 1,124,070 | |
| Investment in equity method investees | | $ | 163,110 | | $ | 6,454 | | $ | 163,110 | | $ | 6,454 | |
| Total assets | | $ | 7,702,505 | | $ | 6,079,884 | | $ | 7,702,505 | | $ | 6,079,884 | |
| Capital expenditures | | $ | 91,628 | | $ | 78,356 | | $ | 28,666 | | $ | 27,446 | |
| Depreciation and amortization | | $ | 92,309 | | $ | 73,612 | | $ | 34,171 | | $ | 24,545 | |
| 18) | ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED: |
In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 151 (“SFAS No. 151”), “Inventory Costs - an amendment of ARB No. 43, Chapter 4.” SFAS No. 151 amends the guidance in Accounting Research Bulletin No. 43 (“ARB No. 43”), “Restatement and Revision of Accounting Research Bulletins,” Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). SFAS No. 151 requires that those items be recognized as current period charges. In addition, SFAS No. 151 requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The Company is required to adopt SFAS No. 151 for fiscal years beginning March 1, 2006. The Company is currently assessing the financial impact of SFAS No. 151 on its consolidated financial statements.
In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004) (“SFAS No. 123(R)”), “Share-Based Payment.” SFAS No. 123(R) replaces Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation,” and supersedes Accounting Principles Board Opinion No. 25 (“APB Opinion No. 25”), “Accounting for Stock Issued to Employees.” SFAS No. 123(R) requires the cost resulting from all share-based payment transactions be recognized in the financial statements. In addition, SFAS No. 123(R) establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a grant date fair-value-based measurement method in accounting for share-based payment transactions. SFAS No. 123(R) also amends Statement of Financial Accounting Standards No. 95 (“SFAS No. 95”), “Statement of Cash Flows,” to require that excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid. SFAS No. 123(R) applies to all awards granted, modified, repurchased, or cancelled after the required effective date (see below). In addition, SFAS No. 123(R) requires entities that used the fair-value-based method for either recognition or disclosure under SFAS No. 123 to apply SFAS No. 123(R) using a modified version of prospective application. This application requires compensation cost to be recognized on or after the required effective date for the portion of outstanding awards for which the requisite service has not yet been rendered based on the grant date fair value of those awards as calculated under SFAS No. 123 for either recognition or pro forma disclosures. For periods before the required effective date, those entities may elect to apply a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods by SFAS No. 123. In March 2005, the Securities and Exchange Commission ("SEC") staff issued Staff Accounting Bulletin No. 107 (“SAB No. 107”), “Share-Based Payment,” to express the views of the staff regarding the interaction between SFAS No. 123(R) and certain SEC rules and regulations and to provide the staff’s views regarding the valuation of share-based payment arrangements for public companies. The Company is required to adopt SFAS No. 123(R) for interim periods beginning March 1, 2006. The Company is currently assessing the financial impact of SFAS No. 123(R) on its consolidated financial statements and will take into consideration the additional guidance provided by SAB No. 107 in connection with the Company’s adoption of SFAS No. 123(R).
In March 2005, the FASB issued FASB Interpretation No. 47 (“FIN No. 47”), “Accounting for Conditional Asset Retirement Obligations - an interpretation of FASB Statement No. 143.” FIN No. 47 clarifies the term conditional asset retirement obligation as used in FASB Statement No. 143, “Accounting for Asset Retirement Obligations.” A conditional asset retirement obligation is an unconditional legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Therefore, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. FIN No. 47 is effective for the Company no later than the end of the fiscal year ending February 28, 2006. The Company is currently assessing the financial impact of FIN No. 47 on its consolidated financial statements.
In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154 (“SFAS No. 154”), “Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3.” SFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS No. 154 applies to all voluntary changes in accounting principle and requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of changing to the new accounting principle. SFAS No. 154 requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change of estimate effected by a change in accounting principle. SFAS No. 154 also carries forward without change the guidance in APB Opinion No. 20 with respect to accounting for changes in accounting estimates, changes in the reporting unit and correction of an error in previously issued financial statements. The Company is required to adopt SFAS No. 154 for accounting changes and corrections of errors made in fiscal years beginning after March 1, 2006. The Company's consolidated financial statements will only be impacted by the adoption of SFAS No. 154 if the Company implements a voluntary change in accounting principle or corrects accounting errors in future periods.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
The Company is a leading international producer and marketer of beverage alcohol brands with a broad portfolio across the wine, imported beer and spirits categories. The Company has the largest wine business in the world and is the largest multi-category supplier of beverage alcohol in the United States; a leading producer and exporter of wine from Australia and New Zealand; and both a major producer and independent drinks wholesaler in the United Kingdom.
The Company reports its operating results in three segments: Constellation Wines (branded wines, and U.K. wholesale and other), Constellation Beers and Spirits (imported beers and distilled spirits) and Corporate Operations and Other. Amounts included in the Corporate Operations and Other segment consist of general corporate administration and finance expenses. These amounts include costs of executive management, corporate development, corporate finance, human resources, internal audit, investor relations, legal and public relations. Any costs incurred at the corporate office that are applicable to the segments are allocated to the appropriate segment. 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 the chief operating decision maker’s evaluation of the operating income performance of the other operating segments. The business segments reflect how the Company’s operations are being managed, how operating performance within the Company is being evaluated by senior management and the structure of its internal financial reporting. In addition, the Company excludes acquisition-related integration costs, restructuring and related charges and unusual items that affect comparability from its definition of operating income for segment purposes.
The Company’s business strategy is to remain focused across the beverage alcohol industry by offering a broad range of products in each of the Company’s three major categories: wine, imported beer and spirits. The Company intends to keep its portfolio positioned for superior top-line growth while maximizing the profitability of its brands. In addition, the Company seeks to increase its relative importance to key customers in major markets by increasing its share of their overall purchasing, which is increasingly important in a consolidating industry. The Company’s strategy of breadth across categories and geographies is designed to deliver long-term profitable growth. This strategy allows the Company more investment choices, provides flexibility to address changing market conditions and creates stronger routes-to-market.
Marketing, sales and distribution of the Company’s products, particularly the Constellation Wines segment’s products, are managed on a geographic basis in order to fully leverage leading market positions within each geographic market. Market dynamics and consumer trends vary significantly across the Company’s three core geographic markets - North America (primarily the U.S.), Europe (primarily the U.K.) and Australasia (primarily Australia and New Zealand). Within the U.S. market, the Company offers a wide range of beverage alcohol products across the Constellation Wines segment and the Constellation Beers and Spirits segment. In Europe, the Company leverages its position as the largest wine supplier in the U.K. In addition, the Company leverages its U.K. wholesale business as a strategic route-to-market for its imported wine portfolio and as a key supplier of a full range of beverage alcohol products primarily to large national on-premise accounts. Within Australasia, where consumer trends favor domestic wine products, the Company leverages its position as one of the largest wine producers in Australia.
The Company remains committed to its long-term financial model of growing sales (both through acquisitions and organically), expanding margins and increasing cash flow to achieve superior earnings per share growth and improve return on invested capital.
The environment for the Company’s products is competitive in each of the Company’s key geographic markets, due, in part, to industry and retail consolidation. Specifically, in the U.K., the market for branded wine continues to be challenging; furthermore, retailer consolidation is contributing to increased competition and promotional activities among suppliers. Competition in the U.S. beers and spirits markets is normally intense, with domestic beer producers increasing brand spending in an effort to gain market share.
Additionally, the supply of certain raw materials, particularly grapes, as well as consumer demand, can affect the overall competitive environment. Two years of lighter than expected California grape harvests in calendar 2004 and 2003, combined with a reduction in wine grape acreage in California, brought the U.S. grape supply more into balance with demand. This led to an overall firming of the pricing of wine grape varietals from California. Although the final calendar 2005 California grape harvest report is not yet available, all indications are that the harvest was stronger than the prior year. However, following two years of lighter harvests, this is not expected to significantly change the balance between supply and demand. Two years of record Australian grape harvests have contributed to an oversupply of Australian grapes, particularly for certain red varietals. This has led to an overall reduction in grape costs for these varietals, which may affect markets for Australian wines around the world.
For the three months ended November 30, 2005 ("Third Quarter 2006"), the Company’s results of operations benefited from the inclusion of a full quarter of operations of Robert Mondavi (as defined below). The Company’s net sales increased 17% over the three months ended November 30, 2004 ("Third Quarter 2005"), primarily from increases in branded wine net sales and imported beer net sales. Operating income increased 22% over the comparable prior year period primarily due to the favorable sales mix shift to higher margin wine brands acquired in the Robert Mondavi acquisition partially offset by increased acquisition-related integration costs, restructuring and related charges and unusual costs. Lastly, as a result of the above factors partially offset by increased interest expense and a higher effective tax rate for Third Quarter 2006, net income increased 12% over the comparable prior year period.
For the nine months ended November 30, 2005 ("Nine Months 2006"), the Company’s results of operations benefited from the inclusion of a full nine months of operations of Robert Mondavi. The Company’s net sales increased 17% over the nine months ended November 30, 2004 ("Nine Months 2005"), primarily from increases in branded wine net sales and imported beer net sales. Operating income increased 19% over the comparable prior year period primarily due to the favorable sales mix shift to higher margin wine brands acquired in the Robert Mondavi acquisition partially offset by increased acquisition-related integration costs, restructuring and related charges and unusual costs. Net income increased 17% over the comparable prior year period as a result of the above factors combined with increased interest expense partially offset by a lower effective income tax rate.
The following discussion and analysis summarizes the significant factors affecting (i) consolidated results of operations of the Company for Third Quarter 2006 compared to Third Quarter 2005, and for Nine Months 2006 compared to Nine Months 2005, and (ii) financial liquidity and capital resources for Nine Months 2006. This discussion and analysis also identifies certain acquisition-related integration costs, restructuring and related charges and unusual items expected to affect consolidated results of operations of the Company for the year ending February 28, 2006 (“Fiscal 2006”). This discussion and analysis should be read in conjunction with the Company’s consolidated financial statements and notes thereto included herein and in the Company’s Annual Report on Form 10-K for the fiscal year ended February 28, 2005 (“Fiscal 2005”).
Common Stock Splits
During April 2005, the Board of Directors of the Company approved two-for-one stock splits of the Company’s Class A Common Stock and Class B Common Stock, which were distributed in the form of stock dividends on May 13, 2005, to stockholders of record on April 29, 2005. Share and per share amounts in this Quarterly Report on Form 10-Q are adjusted to give effect to these common stock splits.
Acquisition in Fiscal 2005 and Equity Method Investment
Acquisition of Robert Mondavi
On December 22, 2004, the Company acquired all of the outstanding capital stock of The Robert Mondavi Corporation (“Robert Mondavi”), a leading premium wine producer based in Napa, California. Through this transaction, the Company acquired various additional winery and vineyard interests, and, additionally produces, markets and sells premium, super-premium and fine California wines under the Woodbridge by Robert Mondavi, Robert Mondavi Private Selection and Robert Mondavi Winery brand names. In the United States, Woodbridge is the leading domestic premium wine brand and Robert Mondavi Private Selection is the leading super-premium wine brand. As a result of the Robert Mondavi acquisition, the Company acquired an ownership interest in Opus One, a joint venture owned equally by Robert Mondavi and Baron Philippe de Rothschild, S.A. During September 2005, the Company’s president and Baroness Philippine de Rothschild announced an agreement to maintain equal ownership of Opus One. Opus One produces fine wines at its Napa Valley winery.
The acquisition of Robert Mondavi supports the Company’s strategy of strengthening the breadth of its portfolio across price segments to capitalize on the overall growth in the premium, super-premium and fine wine categories. The Company believes that the acquired Robert Mondavi brand names have strong brand recognition globally. The vast majority of sales from these brands are generated in the United States. The Company intends to leverage the Robert Mondavi brands in the United States through its selling, marketing and distribution infrastructure. The Company also intends to further expand distribution for the Robert Mondavi brands in Europe through its Constellation Europe infrastructure. Distribution of the Robert Mondavi Woodbridge brand in the U.K. market is underway and the brand has been introduced into certain U.K. retailers.
The Robert Mondavi acquisition supports the Company’s strategy of growth and breadth across categories and geographies, and strengthens its competitive position in certain of its core markets. The Robert Mondavi acquisition provides the Company with a greater presence in the growing premium, super-premium and fine wine sectors within the United States and the ability to capitalize on the broader geographic distribution in strategic international markets. In particular, the Company believes there are growth opportunities for premium, super-premium and fine wines in the United Kingdom and other “new world” wine markets. Total consideration paid in cash to the Robert Mondavi shareholders was $1,030.7 million. Additionally, the Company incurred direct acquisition costs of $12.0 million. The purchase price was financed with borrowings under the Company’s 2004 Credit Agreement (as defined below). In accordance with the purchase method of accounting, the acquired net assets are recorded at fair value at the date of acquisition. The purchase price was based primarily on the estimated future operating results of the Robert Mondavi business, including the factors described above, as well as an estimated benefit from operating cost synergies. The results of operations of the Robert Mondavi business are reported in the Constellation Wines segment and are included in the consolidated results of operations of the Company from the date of acquisition.
In connection with the Robert Mondavi acquisition and Robert Mondavi’s previously disclosed intention to sell certain of its winery properties and related assets, and other vineyard properties, the Company has realized net proceeds of $170.8 million and $6.8 million from the sale of certain of these assets during Nine Months 2006 and Third Quarter 2006, respectively. Sales of these assets are essentially complete, and, since the date of acquisition through November 30, 2005, net proceeds from these asset sales total $180.7 million. No gain or loss has been recognized upon the sale of these assets.
Investment in Ruffino
On December 3, 2004, the Company purchased a 40 percent interest in Ruffino S.r.l. (“Ruffino”), the well-known Italian fine wine company, for $89.6 million, including direct acquisition costs of $7.5 million. As of February 1, 2005, the Constellation Wines segment began distributing Ruffino’s products in the United States. The Company accounts for the investment under the equity method; accordingly, the results of operations of Ruffino from December 3, 2004, are included in the equity in earnings of equity method investees line in the Company’s Consolidated Statements of Income.
Results of Operations
Third Quarter 2006 Compared to Third Quarter 2005
Net Sales
The following table sets forth the net sales (in millions of dollars) by operating segment of the Company for Third Quarter 2006 and Third Quarter 2005.
| | | Third Quarter 2006 Compared to Third Quarter 2005 | |
| | | Net Sales | |
| | | 2006 | | 2005 | | % Increase / (Decrease) | |
| Constellation Wines: | | | | | | | |
Branded wine | | $ | 672.2 | | $ | 509.5 | | | 32% | |
Wholesale and other | | | 245.5 | | | 264.3 | | | (7)% | |
| Constellation Wines net sales | | $ | 917.7 | | $ | 773.8 | | | 19% | |
| Constellation Beers and Spirits: | | | | | | | | | | |
Imported beers | | $ | 262.8 | | $ | 225.9 | | | 16 % | |
Spirits | | | 86.6 | | | 86.0 | | | 1 % | |
| Constellation Beers and Spirits net sales | | $ | 349.4 | | $ | 311.9 | | | 12 % | |
| Consolidated Net Sales | | $ | 1,267.1 | | $ | 1,085.7 | | | 17 % | |
Net sales for Third Quarter 2006 increased to $1,267.1 million from $1,085.7 million for Third Quarter 2005, an increase of $181.4 million, or 17%. This increase resulted primarily from an increase in branded wine net sales of $172.0 million (on a constant currency basis) and imported beer net sales of $37.0 million partially offset by an unfavorable foreign currency impact of $23.1 million. The increase in branded wine net sales is due primarily to $129.0 million of net sales of branded wines acquired in the Robert Mondavi acquisition and $10.7 million of net sales of Ruffino brands, which the Company began distributing in the U.S. on February 1, 2005.
Constellation Wines
Net sales for Constellation Wines increased to $917.7 million for Third Quarter 2006 from $773.8 million in Third Quarter 2005, an increase of $143.8 million, or 19%. Branded wine net sales increased $162.7 million primarily from $129.0 million of net sales of branded wines acquired in the Robert Mondavi acquisition and $10.7 million of net sales of Ruffino brands. Wholesale and other net sales decreased $18.9 million primarily due to an unfavorable foreign currency impact of $13.8 million.
Constellation Beers and Spirits
Net sales for Constellation Beers and Spirits increased to $349.4 million for Third Quarter 2006 from $311.9 million for Third Quarter 2005, an increase of $37.6 million, or 12%. This increase resulted primarily from an increase in imported beers net sales of $37.0 million. The growth in imported beers net sales is due to volume growth in the Company’s Mexican beer portfolio.
Gross Profit
The Company’s gross profit increased to $384.2 million for Third Quarter 2006 from $313.7 million for Third Quarter 2005, an increase of $70.6 million, or 22%. The Constellation Wines segment’s gross profit increased $80.5 million primarily from the additional gross profit of $66.6 million due to the Robert Mondavi acquisition. The Constellation Beers and Spirits segment’s gross profit increased $3.7 million primarily due to volume growth in the Company’s Mexican beer portfolio partially offset by higher Mexican beer product costs and transportation costs. However, in connection with certain supply arrangements, the higher Mexican beer product costs were offset by a corresponding decrease in advertising expenses resulting in no impact to operating income. In addition, unusual items, which consist of certain costs that are excluded by management in their evaluation of the results of each operating segment, were higher by $13.6 million in Third Quarter 2006 versus Third Quarter 2005. This increase resulted from increased flow through of adverse grape cost and inventory step-up associated primarily with the Robert Mondavi acquisition of $6.2 million and $0.2 million, respectively, and accelerated depreciation costs associated with the Fiscal 2006 Plan (as defined below in Acquisition-Related Integration Costs) of $7.2 million. Gross profit as a percent of net sales increased to 30.3% for Third Quarter 2006 from 28.9% for Third Quarter 2005 primarily due to sales of higher-margin wine brands acquired in the Robert Mondavi acquisition, partially offset by the higher unusual items and increased Mexican beer product costs and transportation costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $157.0 million for Third Quarter 2006 from $130.3 million for Third Quarter 2005, an increase of $26.6 million, or 20%. The Constellation Wines segment’s selling, general and administrative expenses increased $23.7 million due to increased general and administrative expenses, advertising expenses and selling expenses to support the growth in the segment’s business, primarily due to the costs related to the brands acquired in the Robert Mondavi acquisition. The Constellation Beers and Spirits segment’s selling, general and administrative expenses increased slightly as increased selling and general and administrative expenses were partially offset by lower advertising expenses. The Corporate Operations and Other segment’s selling, general and administrative expenses increased slightly primarily due to increased general and administrative expenses to support the Company’s growth. Selling, general and administrative expenses as a percent of net sales increased to 12.4% for Third Quarter 2006 as compared to 12.0% for Third Quarter 2005 primarily due to the increase in the Constellation Wines segment’s selling, general and administrative expenses growing at a faster rate than the increase in the segment’s net sales. The Constellation Wines segment’s selling, general and administrative expenses as a percent of net sales was impacted by the inclusion of the Robert Mondavi business, which has a higher percentage of selling, general and administrative expenses to net sales than the segment’s base business.
Acquisition-Related Integration Costs
The Company recorded $1.6 million of acquisition-related integration costs for Third Quarter 2006 in connection with the Company’s decision to restructure and integrate the operations of Robert Mondavi (the “Robert Mondavi Plan”). Acquisition-related integration costs included $0.9 million of employee-related costs and $0.7 million of facilities and other one-time costs. For Fiscal 2006, the Company expects to incur total acquisition-related integration costs of $17.3 million associated with the Robert Mondavi Plan.
Restructuring and Related Charges
The Company recorded $4.3 million of restructuring and related charges for Third Quarter 2006 associated primarily with certain Constellation Wines segment personnel reductions in connection with the Company’s U.K. operations and the Company’s program to consolidate certain west coast production processes in the U.S. (together, the “Fiscal 2006 Plan”). Restructuring and related charges included $4.2 million of employee termination benefit costs, $0.2 million of contract termination costs and a credit of $0.1 million of facility consolidation and relocation costs. The Company recorded $1.6 million of restructuring and related charges for Third Quarter 2005 associated with the realignment of business operations within the Constellation Wines segment (the “Fiscal 2004 Plan”).
For Fiscal 2006, the Company expects to incur total restructuring and related charges of $11.0 million associated primarily with the Fiscal 2006 Plan and the Robert Mondavi Plan. In addition, the Company recorded accelerated depreciation charges of $7.2 million for Third Quarter 2006 in connection with the Company’s investment in new assets and reconfiguration of certain existing assets under the Fiscal 2006 Plan. The accelerated depreciation charges were recorded on the Cost of Product Sold line within the Consolidated Statement of Income. The Company expects to incur total accelerated depreciation charges of $13.4 million for Fiscal 2006.
Operating Income
The following table sets forth the operating income (loss) (in millions of dollars) by operating segment of the Company for Third Quarter 2006 and Third Quarter 2005.
| | | Third Quarter 2006 Compared to Third Quarter 2005 | |
| | | Operating Income (Loss) | |
| | | 2006 | | 2005 | | % Increase | |
| Constellation Wines | | $ | 184.4 | | $ | 127.7 | | | 44% | |
| Constellation Beers and Spirits | | | 73.3 | | | 71.3 | | | 3% | |
| Corporate Operations and Other | | | (15.3 | ) | | (13.8 | ) | | 11% | |
Total Reportable Segments | | | 242.4 | | | 185.2 | | | 31% | |
Acquisition-Related Integration Costs, Restructuring and Related Charges and Unusual Costs | | | (21.0 | ) | | (3.5 | ) | | 500% | |
| Consolidated Operating Income | | $ | 221.4 | | $ | 181.7 | | | 22% | |
As a result of the factors discussed above, consolidated operating income increased to $221.4 million for Third Quarter 2006 from $181.7 million for Third Quarter 2005, an increase of $39.7 million, or 22%. Acquisition-related integration costs, restructuring and related charges and unusual costs of $21.0 million for Third Quarter 2006 consist of certain costs that are excluded by management in their evaluation of the results of each operating segment. These costs represent accelerated depreciation costs and restructuring and related charges associated primarily with the Fiscal 2006 Plan of $7.2 million and $4.3 million, respectively; the flow through of adverse grape cost, the flow through of inventory step-up, and acquisition-related integration costs associated primarily with the Company’s acquisition of Robert Mondavi of $6.2 million, $2.1 million, and $1.6 million, respectively; and reimbursement of costs associated with professional service fees incurred for due diligence in connection with the Company’s evaluation of a potential offer for Allied Domecq of $0.4 million. Acquisition-related integration costs, restructuring and related charges and unusual costs of $3.5 million for Third Quarter 2005 represent the flow through of inventory step-up associated with the Hardy Acquisition of $1.9 million and restructuring and related charges associated with the Fiscal 2004 Plan of $1.6 million.
Equity in Earnings of Equity Method Investees
The Company’s equity in earnings of equity method investees increased to $6.5 million in Third Quarter 2006 from $0.4 million in Third Quarter 2005, an increase of $6.2 million due primarily to the acquisition of an ownership interest in Opus One as a result of the Robert Mondavi acquisition. Opus One’s earnings are very seasonal with most of their annual earnings recognized upon the release of the latest year’s vintage, which is typically done just prior to the annual fall grape harvest. Opus One’s 2002 vintage was released for retail distribution during Third Quarter 2006.
Interest Expense, Net
Interest expense, net of interest income of $1.0 million and $0.3 million for Third Quarter 2006 and Third Quarter 2005, respectively, increased to $48.1 million for Third Quarter 2006 from $30.7 million for Third Quarter 2005, an increase of $17.4 million, or 57%. The increase resulted from higher average borrowings in Third Quarter 2006 primarily due to the Robert Mondavi acquisition and the investment in Ruffino in the fourth quarter of fiscal 2005.
Provision for Income Taxes
The Company’s effective tax rate was 39.4% for Third Quarter 2006 and 36.0% for Third Quarter 2005, an increase of 3.4%. This increase is due primarily to higher estimated foreign withholding taxes and residual U.S. taxes on increased foreign dividends.
For Fiscal 2006, the Company expects the effective tax rate to more closely approximate its prior year’s effective tax rate before giving effect to a non-cash reduction in the Company’s provision for income taxes of $16.2 million as a result of adjustments to income tax accruals in the first quarter of fiscal 2006 in connection with the completion of various income tax examinations.
Net Income
As a result of the above factors, net income increased to $109.0 million for Third Quarter 2006 from $96.9 million for Third Quarter 2005, an increase of $12.1 million, or 12%.
Nine Months 2006 Compared to Nine Months 2005
Net Sales
The following table sets forth the net sales (in millions of dollars) by operating segment of the Company for Nine Months 2006 and Nine Months 2005.
| | | Nine Months 2006 Compared to Nine Months 2005 | |
| | | Net Sales | |
| | | 2006 | | 2005 | | % Increase / (Decrease) | |
| Constellation Wines: | | | | | | | |
Branded wine | | $ | 1,724.6 | | $ | 1,287.0 | | | 34% | |
Wholesale and other | | | 743.9 | | | 769.7 | | | (3)% | |
| Constellation Wines net sales | | $ | 2,468.5 | | $ | 2,056.7 | | | 20 % | |
| Constellation Beers and Spirits: | | | | | | | | | | |
Imported beers | | $ | 837.4 | | $ | 751.9 | | | 11 % | |
Spirits | | | 249.7 | | | 241.4 | | | 3 % | |
| Constellation Beers and Spirits net sales | | $ | 1,087.1 | | $ | 993.3 | | | 9 % | |
| Consolidated Net Sales | | $ | 3,555.6 | | $ | 3,050.0 | | | 17% | |
Net sales for Nine Months 2006 increased to $3,555.6 million from $3,050.0 million for Nine Months 2005, an increase of $505.6 million, or 17%. This increase resulted primarily from an increase in branded wine net sales of $424.2 million (on a constant currency basis) and imported beer net sales of $85.6 million. The increase in branded wine net sales is due primarily to $329.0 million of net sales of branded wines acquired in the Robert Mondavi acquisition and $35.9 million of net sales of Ruffino brands, which the Company began distributing in the U.S. on February 1, 2005. In addition, net sales benefited from a favorable foreign currency impact of $5.5 million.
Constellation Wines
Net sales for Constellation Wines increased to $2,468.5 million for Nine Months 2006 from $2,056.7 million for Nine Months 2005, an increase of $411.8 million, or 20%. Branded wine net sales increased $437.6 million primarily from $329.0 million of net sales of branded wines acquired in the Robert Mondavi acquisition, $35.9 million of net sales of Ruffino brands, an increase in branded wine net sales in the U.S. (excluding sales of Robert Mondavi and Ruffino brands) of $45.5 million and a favorable foreign currency impact of $13.4 million. Wholesale and other net sales decreased $25.8 million ($18.2 million on a constant currency basis) as growth in the U.K. wholesale business was more than offset by a decrease in other net sales. The decrease in other net sales is primarily due to the Company’s fiscal 2004 decision to exit the commodity concentrate business during fiscal 2005.
Constellation Beers and Spirits
Net sales for Constellation Beers and Spirits increased to $1,087.1 million for Nine Months 2006 from $993.3 million for Nine Months 2005, an increase of $93.8 million, or 9%. This increase resulted from increases in imported beers net sales of $85.6 million and spirits net sales of $8.3 million. The growth in imported beers net sales is primarily due to volume growth in the Company’s Mexican beer portfolio. The growth in spirits net sales is attributable to an increase in the Company’s contract production net sales partially offset by a slight decrease in branded spirits net sales.
Gross Profit
The Company’s gross profit increased to $1,038.2 million for Nine Months 2006 from $853.8 million for Nine Months 2005, an increase of $184.4 million, or 22%. The Constellation Wines segment’s gross profit increased $196.1 million primarily from the additional gross profit of $170.3 million due to the Robert Mondavi acquisition. The Constellation Beers and Spirits segment’s gross profit increased $18.2 million primarily due to volume growth in the Company’s Mexican beer portfolio partially offset by higher Mexican beer product costs and transportation costs. However, in connection with certain supply arrangements, the higher Mexican beer product costs were offset by a corresponding decrease in advertising expenses resulting in no impact to operating income. In addition, unusual items, which consist of certain costs that are excluded by management in their evaluation of the results of each operating segment, were higher by $29.9 million in Nine Months 2006 versus Nine Months 2005. This increase resulted from increased flow through of adverse grape cost and inventory step-up associated with the Robert Mondavi acquisition of $20.2 million and $2.5 million, respectively, and accelerated depreciation costs associated with the Fiscal 2006 Plan of $7.2 million. Gross profit as a percent of net sales increased to 29.2% for Nine Months 2006 from 28.0% for Nine Months 2005 primarily due to sales of higher-margin wine brands acquired in the Robert Mondavi acquisition, partially offset by the higher unusual items and higher Mexican beer product costs and transportation costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $478.6 million for Nine Months 2006 from $401.1 million for Nine Months 2005, an increase of $77.4 million, or 19%. The Constellation Wines segment’s selling, general and administrative expenses increased $75.1 million due to increased selling expenses, general and administrative, and advertising expenses to support the growth in the segment’s business, primarily due to the costs related to the brands acquired in the Robert Mondavi acquisition. The Constellation Beers and Spirits segment’s selling, general and administrative expenses increased $4.3 million as increased selling and advertising expenses were partially offset by lower general and administrative expenses. The Corporate Operations and Other segment’s selling, general and administrative expenses increased $5.0 million primarily due to increased general and administrative expenses to support the Company’s growth. Lastly, there was a decrease of $6.9 million of unusual costs which consist of certain items that are excluded by management in their evaluation of the results of each operating segment. Nine Months 2006 included costs associated with professional service fees incurred for due diligence in connection with the Company’s evaluation of a potential offer for Allied Domecq of $3.4 million. Nine Months 2005 costs consisted of financing costs recorded in connection with the Company’s redemption of its $200.0 million aggregate principal amount of 8 1/2% Senior Subordinated Notes due March 2009 (the “Senior Subordinated Notes”) of $10.3 million. Selling, general and administrative expenses as a percent of net sales increased to 13.5% for Nine Months 2006 as compared to 13.2% for Nine Months 2005 primarily due to the increase in the Constellation Wines segment’s selling, general and administrative expenses growing at a faster rate than the increase in the segment’s net sales partially offset by the lower unusual costs. The Constellation Wines segment’s selling, general and administrative expenses as a percent of net sales was impacted by the inclusion of the Robert Mondavi business, which has a higher percentage of selling, general and administrative expenses to net sales than the segment’s base business.
Acquisition-Related Integration Costs
The Company recorded $15.9 million of acquisition-related integration costs for Nine Months 2006 in connection with the Robert Mondavi Plan. Acquisition-related integration costs included $5.6 million of employee-related costs and $10.3 million of facilities and other one-time costs. For Fiscal 2006, the Company expects to incur total acquisition-related integration costs of $17.3 million associated with the Robert Mondavi Plan.
Restructuring and Related Charges
The Company recorded $8.4 million of restructuring and related charges for Nine Months 2006 associated with (i) the Fiscal 2004 Plan, (ii) the Robert Mondavi Plan, and (iii) the Fiscal 2006 Plan. Restructuring and related charges recorded in connection with the Fiscal 2004 Plan included $0.6 million of employee termination benefit costs and $0.8 million of facility consolidation and relocation costs. Restructuring and related charges recorded in connection with the Robert Mondavi Plan included $1.6 million of employee termination benefit costs, $0.8 million of contract termination costs and $0.4 million of facility consolidation and relocation costs. Restructuring and related charges recorded in connection with the Fiscal 2006 Plan included $4.2 million of employee termination benefit costs. The Company recorded $4.4 million of restructuring and related charges for Nine Months 2005 associated with the Fiscal 2004 Plan.
For Fiscal 2006, the Company expects to incur total restructuring and related charges of $11.0 million associated primarily with the Fiscal 2006 Plan and the Robert Mondavi Plan. In addition, the Company recorded accelerated depreciation charges of $7.2 million for Nine Months 2006 in connection with the Company’s investment in new assets and reconfiguration of certain existing assets under the Fiscal 2006 Plan. The accelerated depreciation charges were recorded on the Cost of Product Sold line within the Consolidated Statement of Income. The Company expects to incur total accelerated depreciation charges of $13.4 million for Fiscal 2006.
Operating Income
The following table sets forth the operating income (loss) (in millions of dollars) by operating segment of the Company for Nine Months 2006 and Nine Months 2005.
| | | Nine Months 2006 Compared to Nine Months 2005 | |
| | | Operating Income (Loss) | |
| | | 2006 | | 2005 | | % Increase | |
| Constellation Wines | | $ | 404.1 | | $ | 283.1 | | | 43% | |
| Constellation Beers and Spirits | | | 236.9 | | | 223.0 | | | 6% | |
| Corporate Operations and Other | | | (43.9 | ) | | (38.9 | ) | | 13% | |
Total Reportable Segments | | | 597.1 | | | 467.2 | | | 28% | |
Acquisition-Related Integration Costs, Restructuring and Related Charges and Unusual Costs | | | (61.7 | ) | | (18.9 | ) | | 226% | |
| Consolidated Operating Income | | $ | 535.4 | | $ | 448.3 | | | 19% | |
As a result of the factors discussed above, consolidated operating income increased to $535.4 million for Nine Months 2006 from $448.3 million for Nine Months 2005, an increase of $87.1 million, or 19%. Acquisition-related integration costs, restructuring and related charges and unusual costs of $61.7 million for Nine Months 2006 consist of certain costs that are excluded by management in their evaluation of the results of each operating segment. These costs represent the flow through of adverse grape cost, acquisition-related integration costs, and the flow through of inventory step-up associated primarily with the Company’s acquisition of Robert Mondavi of $20.2 million, $15.9 million, and $6.6 million, respectively; restructuring and related charges of $8.4 million associated primarily with the Fiscal 2006 Plan and the Robert Mondavi Plan; accelerated depreciation costs of $7.2 million associated with the Fiscal 2006 Plan; and costs associated with professional service fees incurred for due diligence in connection with the Company’s evaluation of a potential offer for Allied Domecq of $3.4 million. Acquisition-related integration costs, restructuring and related charges and unusual costs of $18.9 million for Nine Months 2005 represent financing costs associated with the redemption of the Company’s Senior Subordinated Notes of $10.3 million, restructuring and related charges associated with the Fiscal 2004 Plan of $4.4 million, and the flow through of inventory step-up associated with the Hardy Acquisition of $4.2 million.
Equity in Earnings of Equity Method Investees
The Company’s equity in earnings of equity method investees increased to $5.7 million in Nine Months 2006 from $0.6 million in Nine Months 2005, an increase of $5.1 million due primarily to the acquisition of an ownership interest in Opus One as a result of the Robert Mondavi acquisition. Opus One’s earnings are very seasonal with most of their annual earnings recognized upon the release of the latest year’s vintage, which is typically done just prior to the annual fall grape harvest. Opus One’s 2002 vintage was released for retail distribution during the third quarter of fiscal 2006.
Interest Expense, Net
Interest expense, net of interest income of $2.7 million and $1.2 million for Nine Months 2006 and Nine Months 2005, respectively, increased to $142.3 million for Nine Months 2006 from $91.3 million for Nine Months 2005, an increase of $50.9 million, or 56%. The increase resulted primarily from higher average borrowings in Nine Months 2006 primarily due to the Robert Mondavi acquisition and the investment in Ruffino in the fourth quarter of fiscal 2005.
Provision for Income Taxes
The Company’s effective tax rate was 33.0% for Nine Months 2006 and 36.0% for Nine Months 2005, a decrease of 3.0%. This decrease is due primarily to a non-cash reduction in the Company’s provision for income taxes of $16.2 million, or 4.1%, as a result of adjustments to income tax accruals in connection with the completion of various income tax examinations, partially offset by higher estimated foreign withholding taxes and residual U.S. taxes on increased foreign dividends. The Company expects the effective tax rate for Fiscal 2006 to more closely approximate its prior year’s effective tax rate before giving effect to the $16.2 million adjustment.
Net Income
As a result of the above factors, net income increased to $267.1 million for Nine Months 2006 from $228.8 million for Nine Months 2005, an increase of $38.2 million, or 17%.
Financial Liquidity and Capital Resources
General
The Company’s principal use of cash in its operating activities is for purchasing and carrying inventories and carrying seasonal accounts receivable. The Company’s primary source of liquidity has historically been cash flow from operations, except during annual grape harvests when the Company has relied on short-term borrowings. In the United States, the annual grape crush normally begins in August and runs through October. In Australia, the annual grape crush normally begins in February and runs through May. The Company generally begins taking delivery of grapes at the beginning of the crush season with payments for such grapes beginning to come due one month later. The Company’s short-term borrowings to support such purchases generally reach their highest levels one to two months after the crush season has ended. Historically, the Company has used cash flow from operating activities to repay its short-term borrowings and fund capital expenditures. The Company will continue to use its short-term borrowings to support its working capital requirements. The Company believes that cash provided by operating activities and its financing activities, primarily short-term borrowings, will provide adequate resources to satisfy its working capital, scheduled principal and interest payments on debt, preferred stock dividend payment requirements, and anticipated capital expenditure requirements for both its short-term and long-term capital needs.
Nine Months 2006 Cash Flows
Operating Activities
Net cash provided by operating activities for Nine Months 2006 was $282.3 million, which resulted from $267.1 million of net income, plus $127.5 million of net non-cash items charged to the Consolidated Statement of Income and $42.9 million of cash proceeds credited to accumulated other comprehensive income (“AOCI”) within the Consolidated Balance Sheet, less $155.2 million representing the net change in the Company’s operating assets and liabilities.
The net non-cash items consisted primarily of depreciation of property, plant and equipment and deferred tax provision. The cash proceeds credited to AOCI consisted of $30.3 million in proceeds from the unwinding of certain interest rate swaps (see discussion below under Senior Credit Facilities) and $12.6 million in proceeds from the early termination of certain foreign currency derivative instruments related to the Company’s change in its structure of certain of its cash flow hedges of forecasted foreign currency denominated transactions. As the forecasted transactions are still probable, this amount was recorded to AOCI and will be reclassified from AOCI into earnings in the same periods in which the original hedged items are recorded in the Consolidated Statement of Income. The net change in operating assets and liabilities resulted primarily from seasonal increases in accounts receivable and inventories, partially offset by seasonal increases in accounts payable and accrued advertising and an increase in accrued income taxes payable.
Investing Activities
Net cash provided by investing activities for Nine Months 2006 was $24.8 million, which resulted primarily from $172.9 million of net proceeds from sales of assets, equity method investment, and businesses, primarily attributable to sales of non-strategic Robert Mondavi assets, partially offset by $91.6 million of capital expenditures and net cash paid of $45.8 million for purchases of businesses.
Financing Activities
Net cash used in financing activities for Nine Months 2006 was $297.5 million resulting primarily from principal payments of long-term debt of $425.3 million partially offset by net proceeds of $111.1 million from notes payable.
During June 1998, the Company’s Board of Directors authorized the repurchase of up to $100.0 million of its Class A Common Stock and Class B Common Stock. The repurchase of shares of common stock will be accomplished, from time to time, in management’s discretion and depending upon market conditions, through open market or privately negotiated transactions. The Company may finance such repurchases through cash generated from operations or through its current senior credit facility. The repurchased shares will become treasury shares. As of January 9, 2006, the Company had purchased a total of 8,150,688 shares of Class A Common Stock at an aggregate cost of $44.9 million, or at an average cost of $5.51 per share. No shares were repurchased during Nine Months 2006 under the Company’s share repurchase program.
Debt
Total debt outstanding as of November 30, 2005, amounted to $2,945.2 million, a decrease of $344.1 million from February 28, 2005. The ratio of total debt to total capitalization decreased to 50.3% as of November 30, 2005, from 54.2% as of February 28, 2005.
Senior Credit Facilities
2004 Credit Agreement
In connection with the acquisition of Robert Mondavi, on December 22, 2004, the Company and its U.S. subsidiaries (excluding certain inactive subsidiaries), together with certain of its subsidiaries organized in foreign jurisdictions, JPMorgan Chase Bank, N.A. as a lender and administrative agent, and certain other agents, lenders, and financial institutions entered into a new credit agreement (the “2004 Credit Agreement”). The 2004 Credit Agreement provides for aggregate credit facilities of $2.9 billion (subject to increase as therein provided to $3.2 billion), consisting of a $600.0 million tranche A term loan facility due in November 2010, a $1.8 billion tranche B term loan facility due in November 2011, and a $500.0 million revolving credit facility (including a sub-facility for letters of credit of up to $60.0 million) which terminates in December 2010. Proceeds of the 2004 Credit Agreement were used to pay off the Company’s obligations under its prior senior credit facility, to fund the cash consideration payable in connection with its acquisition of Robert Mondavi, and to pay certain obligations of Robert Mondavi, including indebtedness outstanding under its bank facility and unsecured notes of $355.4 million. The Company uses its revolving credit facility under the 2004 Credit Agreement for general corporate purposes, including working capital, on an as needed basis.
The tranche A term loan facility and the tranche B term loan facility were fully drawn on December 22, 2004. As of November 30, 2005, the required principal repayments of the tranche A term loan and the tranche B term loan for the remaining three months of fiscal 2006 and for each of the five succeeding fiscal years and thereafter are as follows:
| | | Tranche A Term Loan | | Tranche B Term Loan | | Total | |
(in thousands) | | | | | | | |
| 2006 | | $ | - | | $ | - | | $ | - | |
| 2007 | | | 33,382 | | | - | | | 33,382 | |
| 2008 | | | 89,853 | | | - | | | 89,853 | |
| 2009 | | | 110,588 | | | 14,563 | | | 125,151 | |
| 2010 | | | 117,500 | | | 14,563 | | | 132,063 | |
| 2011 | | | 103,677 | | | 353,161 | | | 456,838 | |
| Thereafter | | | - | | | 1,026,713 | | | 1,026,713 | |
| | | $ | 455,000 | | $ | 1,409,000 | | $ | 1,864,000 | |
The rate of interest on borrowings under the 2004 Credit Agreement, at the Company’s option, is a function of LIBOR plus a margin, the federal funds rate plus a margin, or the prime rate plus a margin. The margin is adjustable based upon the Company’s debt ratio (as defined in the 2004 Credit Agreement) and, with respect to LIBOR borrowings, ranges between 1.00% and 1.75%. As of November 30, 2005, the LIBOR margin for the revolving credit facility and the tranche A term loan facility is 1.25%, while the LIBOR margin on the tranche B term loan facility is 1.50%.
The Company’s obligations are guaranteed by substantially all of its U.S. subsidiaries and by certain of its foreign subsidiaries. These obligations are also secured by a pledge of (i) 100% of the ownership interests in most of the Company’s U.S. subsidiaries and (ii) 65% of the voting capital stock of certain of the Company’s foreign subsidiaries.
The Company and its subsidiaries are also subject to customary lending covenants including those restricting additional liens, the incurrence of additional indebtedness (including guarantees of indebtedness), the sale of assets, the payment of dividends, transactions with affiliates, the disposition and acquisition of property and the making of certain investments, in each case subject to numerous baskets, exceptions and thresholds. The financial covenants are limited to maximum total debt and senior debt coverage ratios and minimum fixed charges and interest coverage ratios. As of November 30, 2005, the Company is in compliance with all of its covenants under its 2004 Credit Agreement.
As of November 30, 2005, under the 2004 Credit Agreement, the Company had outstanding tranche A term loans of $455.0 million bearing a weighted average interest rate of 5.6%, tranche B term loans of $1,409.0 million bearing a weighted average interest rate of 5.7%, revolving loans of $108.0 million bearing a weighted average interest rate of 5.1%, undrawn revolving letters of credit of $27.5 million, and $364.5 million in revolving loans available to be drawn.
At February 28, 2005, the Company had outstanding five year interest rate swap agreements to minimize interest rate volatility. The swap agreements fixed LIBOR interest rates on $1,200.0 million of the Company’s floating LIBOR rate debt at an average rate of 4.1% over the five year term. In March 2005, the Company monetized the value of the interest rate swaps by replacing them with new five year delayed start interest rate swap agreements effective March 1, 2006, which extended the hedged period through fiscal 2010. The Company received $30.3 million in proceeds from the unwinding of the original swaps. This amount will be reclassified from AOCI (as defined in Note 13) ratably into earnings in the same period in which the original hedged item is recorded in the Consolidated Statement of Income. The effective interest rate remains the same under the new swap structure at 4.1%. For the nine months and three months ended November, 30, 2005 the Company reclassified $4.4 million and $1.6 million, respectively, from AOCI to Interest Expense, net in the Company's Consolidated Statements of Income. This non-cash operating activity is included on the Other, net line in the Company's Consolidated Statement of Cash Flows. The Company had no outstanding interest rate swap agreements during the nine months and three months ended November 30, 2004.
Foreign Subsidiary Facilities
The Company has additional credit arrangements available totaling $171.9 million as of November 30, 2005. These arrangements support the financing needs of certain of the Company’s foreign subsidiary operations. Interest rates and other terms of these borrowings vary from country to country, depending on local market conditions. As of November 30, 2005, amounts outstanding under the foreign subsidiary credit arrangements were $46.7 million.
Senior Notes
As of November 30, 2005, the Company had outstanding $200.0 million aggregate principal amount of 8 5/8% Senior Notes due August 2006 (the “Senior Notes”). The Senior Notes are currently redeemable, in whole or in part, at the option of the Company.
As of November 30, 2005, the Company had outstanding £1.0 million ($1.7 million) aggregate principal amount of 8 1/2% Series B Senior Notes due November 2009 (the “Sterling Series B Senior Notes”). In addition, as of November 30, 2005, the Company had outstanding £154.0 million ($265.9 million, net of $0.4 million unamortized discount) aggregate principal amount of 8 1/2% Series C Senior Notes due November 2009 (the “Sterling Series C Senior Notes”). The Sterling Series B Senior Notes and Sterling Series C Senior Notes are currently redeemable, in whole or in part, at the option of the Company.
Also, as of November 30, 2005, the Company had outstanding $200.0 million aggregate principal amount of 8% Senior Notes due February 2008 (the “February 2001 Senior Notes”). The February 2001 Senior Notes are currently redeemable, in whole or in part, at the option of the Company.
Senior Subordinated Notes
As of November 30, 2005, the Company had outstanding $250.0 million aggregate principal amount of 8 1/8% Senior Subordinated Notes due January 2012 (the “January 2002 Senior Subordinated Notes”). The January 2002 Senior Subordinated Notes are redeemable at the option of the Company, in whole or in part, at any time on or after January 15, 2007.
Accounting Pronouncements Not Yet Adopted
In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151 (“SFAS No. 151”), “Inventory Costs - an amendment of ARB No. 43, Chapter 4.” SFAS No. 151 amends the guidance in Accounting Research Bulletin No. 43 (“ARB No. 43”), “Restatement and Revision of Accounting Research Bulletins,” Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). SFAS No. 151 requires that those items be recognized as current period charges. In addition, SFAS No. 151 requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The Company is required to adopt SFAS No. 151 for fiscal years beginning March 1, 2006. The Company is currently assessing the financial impact of SFAS No. 151 on its consolidated financial statements.
In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004) (“SFAS No. 123(R)”), “Share-Based Payment.” SFAS No. 123(R) replaces Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation,” and supersedes Accounting Principles Board Opinion No. 25 (“APB Opinion No. 25”), “Accounting for Stock Issued to Employees.” SFAS No. 123(R) requires the cost resulting from all share-based payment transactions be recognized in the financial statements. In addition, SFAS No. 123(R) establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a grant date fair-value-based measurement method in accounting for share-based payment transactions. SFAS No. 123(R) also amends Statement of Financial Accounting Standards No. 95 (“SFAS No. 95”), “Statement of Cash Flows,” to require that excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid. SFAS No. 123(R) applies to all awards granted, modified, repurchased, or cancelled after the required effective date (see below). In addition, SFAS No. 123(R) requires entities that used the fair-value-based method for either recognition or disclosure under SFAS No. 123 to apply SFAS No. 123(R) using a modified version of prospective application. This application requires compensation cost to be recognized on or after the required effective date for the portion of outstanding awards for which the requisite service has not yet been rendered based on the grant date fair value of those awards as calculated under SFAS No. 123 for either recognition or pro forma disclosures. For periods before the required effective date, those entities may elect to apply a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods by SFAS No. 123. In March 2005, the Securities and Exchange Commission ("SEC") staff issued Staff Accounting Bulletin No. 107 (“SAB No. 107”), “Share-Based Payment,” to express the views of the staff regarding the interaction between SFAS No. 123(R) and certain SEC rules and regulations and to provide the staff’s views regarding the valuation of share-based payment arrangements for public companies. The Company is required to adopt SFAS No. 123(R) for interim periods beginning March 1, 2006. The Company is currently assessing the financial impact of SFAS No. 123(R) on its consolidated financial statements and will take into consideration the additional guidance provided by SAB No. 107 in connection with the Company’s adoption of SFAS No. 123(R).
In March 2005, the FASB issued FASB Interpretation No. 47 (“FIN No. 47”), “Accounting for Conditional Asset Retirement Obligations - an interpretation of FASB Statement No. 143.” FIN No. 47 clarifies the term conditional asset retirement obligation as used in FASB Statement No. 143, “Accounting for Asset Retirement Obligations.” A conditional asset retirement obligation is an unconditional legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Therefore, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. FIN No. 47 is effective for the Company no later than the end of the fiscal year ending February 28, 2006. The Company is currently assessing the financial impact of FIN No. 47 on its consolidated financial statements.
In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154 (“SFAS No. 154”), “Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3.” SFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS No. 154 applies to all voluntary changes in accounting principle and requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of changing to the new accounting principle. SFAS No. 154 requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change of estimate effected by a change in accounting principle. SFAS No. 154 also carries forward without change the guidance in APB Opinion No. 20 with respect to accounting for changes in accounting estimates, changes in the reporting unit and correction of an error in previously issued financial statements. The Company is required to adopt SFAS No. 154 for accounting changes and corrections of errors made in fiscal years beginning after March 1, 2006. The Company's consolidated financial statements will only be impacted by the adoption of SFAS No. 154 if the Company implements a voluntary change in accounting principle or corrects accounting errors in future periods.
Information Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond the Company’s control, which could cause actual results to differ materially from those set forth in, or implied by, such forward-looking statements. All statements other than statements of historical facts included in this Quarterly Report on Form 10-Q, including statements regarding the Company’s future financial position and prospects, are forward-looking statements. All forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q. The Company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In addition to the risks and uncertainties of ordinary business operations, the forward-looking statements of the Company contained in this Form 10-Q are also subject to the following risks and uncertainties: the Company achieving certain sales projections and meeting certain cost targets; wholesalers and retailers may give higher priority to products of the Company’s competitors; raw material supply, production or shipment difficulties could adversely affect the Company’s ability to supply its customers; increased competitive activities in the form of pricing, advertising and promotions could adversely impact consumer demand for the Company’s products and/or result in higher than expected selling, general and administrative expenses; a general decline in alcohol consumption; increases in excise and other taxes on beverage alcohol products; and changes in interest rates and foreign currency exchange rates. For additional information about risks and uncertainties that could adversely affect the Company’s forward-looking statements, please refer to the Company’s Annual Report on Form 10-K for the fiscal year ended February 28, 2005.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company, as a result of its global operating and financing activities, is exposed to market risk associated with changes in foreign currency exchange rates and interest rates. To manage the volatility relating to these risks, the Company periodically purchases and/or sells derivative instruments including foreign currency exchange contracts and interest rate swap agreements. The Company uses derivative instruments solely to reduce the financial impact of these risks and does not use derivative instruments for trading purposes.
Foreign currency forward contracts and foreign currency options are used to hedge existing foreign currency denominated assets and liabilities, forecasted foreign currency denominated sales both to third parties as well as intercompany sales, and intercompany principal and interest payments. As of November 30, 2005, the Company had exposures to foreign currency risk primarily related to the Australian dollar, British pound sterling, euro, New Zealand dollar, Canadian dollar, Chilean peso and Mexican peso.
As of November 30, 2005, and November 30, 2004, the Company had outstanding foreign exchange derivative instruments with a notional value of $726.7 million and $708.6 million, respectively. Approximately 61% of the Company’s total exposures were hedged as of November 30, 2005. Using a sensitivity analysis based on estimated fair value of open contracts using forward rates, if the contract base currency had been 10% weaker as of November 30, 2005, and November 30, 2004, the fair value of open foreign exchange contracts would have been decreased by $70.7 million and $68.9 million, respectively. Losses or gains from the revaluation or settlement of the related underlying positions would substantially offset such gains or losses on the derivative instruments.
The fair value of fixed rate debt is subject to interest rate risk, credit risk and foreign currency risk. The estimated fair value of the Company’s total fixed rate debt, including current maturities, was $1,002.8 million and $1,092.8 million as of November 30, 2005, and November 30, 2004, respectively. A hypothetical 1% increase from prevailing interest rates as of November 30, 2005, and November 30, 2004, would have resulted in a decrease in fair value of fixed interest rate long-term debt by $28.4 million and $38.9 million, respectively.
As of November 30, 2005, the Company had outstanding five year delayed start interest rate swap agreements effective March 1, 2006, to minimize interest rate volatility. The swap agreements fix LIBOR interest rates on $1,200.0 million of the Company’s floating LIBOR rate debt at an average rate of 4.1% over the five year term. A hypothetical 1% increase from prevailing interest rates as of November 30, 2005, would have increased the fair value of the interest rate swaps by $43.5 million. As of November 30, 2004, the Company had no interest rate swap agreements outstanding.
In addition to the $1,002.8 million and $1,092.8 million estimated fair value of fixed rate debt outstanding as of November 30, 2005, and November 30, 2004, respectively, the Company also had variable rate debt outstanding (primarily LIBOR based) as of November 30, 2005, and November 30, 2004, of $2,003.6 million and $1,049.3 million, respectively. Using a sensitivity analysis based on a hypothetical 1% increase in prevailing interest rates over a 12-month period, the approximate increase in cash required for interest as of November 30, 2005, and November 30, 2004, is $20.0 million and $9.1 million, respectively.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
The Company’s Chief Executive Officer and its Chief Financial Officer have concluded, based on their evaluation as of the end of the period covered by this report, that the Company’s “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) are effective to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 (i) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (ii) is accumulated and communicated to the Company’s management, including its Chief Executive Officer and its Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Internal Control Over Financial Reporting
There has been no change in the Company’s “internal control over financial reporting” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(f) and 15d-15(f)) that occurred during the Company’s fiscal quarter ended November 30, 2005 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II - OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
ISSUER PURCHASES OF EQUITY SECURITIES
| Period | | Total Number of Shares Purchased | | Average Price Paid Per Share | | Total Number of Shares Purchased as Part of a Publicly Announced Program | | Approximate Dollar Value of Shares that May Yet Be Purchased Under the Program (1) | |
| September 1 - 30, 2005 | | | - | | $ | - | | | - | | $ | 55,122,140 | |
| October 1 - 31, 2005 | | | - | | | - | | | - | | | 55,122,140 | |
| November 1 - 30, 2005 | | | - | | | - | | | - | | | 55,122,140 | |
Total | | | - | | $ | - | | | - | | $ | 55,122,140 | |
(1) In June 1998, the Company’s Board of Directors authorized the repurchase from time to time of up to $100.0 million of the Company’s Class A and Class B Common Stock. The program does not have a specified expiration date. The Company did not repurchase any shares under this program during the period September 1, 2005 through and including November 30, 2005.
Item 6. Exhibits
Exhibits required to be filed by Item 601 of Regulation S-K.
For the exhibits that are filed herewith or incorporated herein by reference, see the Index to Exhibits located on page 46
of this report. The Index to Exhibits is incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | CONSTELLATION BRANDS, INC. |
| | | |
| Dated: January 9, 2006 | By: | /s/ Thomas F. Howe |
| | | Thomas F. Howe, Senior Vice President, Controller |
| | | |
| Dated: January 9, 2006 | By: | /s/ Thomas S. Summer |
| | | Thomas S. Summer, Executive Vice President and Chief Financial Officer (principal financial officer and principal accounting officer) |
