Results of Operations
Second Quarter 2007 Compared to Second Quarter 2006
Net Sales
The following table sets forth the net sales (in millions of dollars) by operating segment of the Company for Second Quarter 2007 and Second Quarter 2006.
| | | Second Quarter 2007 Compared to Second Quarter 2006 | |
| | | Net Sales | |
| | | 2007 | | 2006 | | % Increase | |
| Constellation Wines: | | | | | | | |
Branded wine | | $ | 716.5 | | $ | 557.0 | | | 29 | % |
Wholesale and other | | | 275.8 | | | 243.2 | | | 13 | % |
| Constellation Wines net sales | | $ | 992.3 | | $ | 800.2 | | | 24 | % |
| Constellation Beers and Spirits: | | | | | | | | | | |
Imported beers | | $ | 341.6 | | $ | 314.2 | | | 9 | % |
Spirits | | | 83.6 | | | 77.6 | | | 8 | % |
| Constellation Beers and Spirits net sales | | $ | 425.2 | | $ | 391.8 | | | 9 | % |
| Consolidated Net Sales | | $ | 1,417.5 | | $ | 1,192.0 | | | 19 | % |
Net sales for Second Quarter 2007 increased to $1,417.5 million from $1,192.0 million for Second Quarter 2006, an increase of $225.5 million, or 19%. This increase was due primarily to $128.9 million of net sales of products acquired in the Vincor acquisition, an increase in base branded wine net sales of $35.9 million (on a constant currency basis) and an increase in imported beer net sales of $27.4 million.
Constellation Wines
Net sales for Constellation Wines increased to $992.3 million for Second Quarter 2007 from $800.2 million in Second Quarter 2006, an increase of $192.1 million, or 24%. Branded wine net sales increased $159.5 million primarily due to $121.2 million of net sales of branded wine acquired in the Vincor acquisition and increased base branded wine net sales for North America (primarily the U.S.). The increase in net sales for the U.S. was driven by both volume gains and higher average selling prices as the consumer continues to trade up to higher priced premium wines. Wholesale and other net sales increased $32.6 million primarily due to growth in the Company’s U.K. wholesale business, a favorable foreign currency impact of $10.7 million, and $7.7 million of net sales of products acquired in the Vincor acquisition.
Constellation Beers and Spirits
Net sales for Constellation Beers and Spirits increased to $425.2 million for Second Quarter 2007 from $391.8 million for Second Quarter 2006, an increase of $33.4 million, or 9%. This increase resulted primarily from an increase in imported beers net sales of $27.4 million. The growth in imported beers net sales is due primarily to volume growth in the Company’s Mexican beer portfolio.
Gross Profit
The Company’s gross profit increased to $414.8 million for Second Quarter 2007 from $348.0 million for Second Quarter 2006, an increase of $66.8 million, or 19%. The Constellation Wines segment’s gross profit increased $60.3 million primarily from gross profit of $49.7 million due to the Vincor acquisition and the increased sales for the U.S. base branded wine business partially offset by increased competition and promotional activities among suppliers in the U.K. and Australia/New Zealand, reflecting, in part, the effects of retailer consolidation in the U.K. and an oversupply of Australian wine, plus a late March 2006 increase in duty costs in the U.K. The Constellation Beers and Spirits segment’s gross profit increased $5.7 million primarily due to the volume growth in the Company’s Mexican beer portfolio partially offset by higher Mexican beer product costs and higher spirits material 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 lower by $0.8 million in Second Quarter 2007 versus Second Quarter 2006. This decrease resulted from decreased flow through of adverse grape cost associated with the acquisition of The Robert Mondavi Corporation (“Robert Mondavi”) of $5.4 million, partially offset by increased (i) flow through of inventory step-up associated with the Vincor and Robert Mondavi acquisitions of $3.3 million and (ii) accelerated depreciation costs associated with the Fiscal 2006 Plan and Fiscal 2007 Wine Plan (as each of those terms is defined below in Restructuring and Related Charges) of $1.3 million. Gross profit as a percent of net sales increased slightly to 29.3% for Second Quarter 2007 from 29.2% for Second Quarter 2006 primarily as a result of the factors discussed above.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $204.4 million for Second Quarter 2007 from $163.7 million for Second Quarter 2006, an increase of $40.7 million, or 25%. The Constellation Wines segment’s selling, general and administrative expenses increased $20.2 million due primarily to increased advertising expenses, selling expenses and general and administrative expenses associated with the Vincor acquisition. The Constellation Beers and Spirits segment’s selling, general and administrative expenses increased slightly as increased selling expenses 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 $3.7 million primarily due to expenses associated with the above-described formation of the beer joint venture and the recognition of stock-based compensation expense. Lastly, unusual items increased $15.1 million for Second Quarter 2007 as compared to Second Quarter 2006, primarily due to financing costs recorded in Second Quarter 2007 of $11.8 million related to the Company’s new senior credit facility entered into in connection with the Vincor acquisition and foreign currency losses of $5.4 million on foreign denominated intercompany loan balances associated with the Vincor acquisition. Selling, general and administrative expenses as a percent of net sales increased to 14.4% for Second Quarter 2007 as compared to 13.7% for Second Quarter 2006 primarily due to the increased unusual items discussed above as well as the recognition of stock-based compensation expense for Second Quarter 2007 of $4.1 million.
Restructuring and Related Charges
The Company recorded $21.7 million of restructuring and related charges for Second Quarter 2007 associated primarily with the Company’s plan to invest in new distribution and bottling facilities in the U.K. and to streamline certain Australian wine operations (collectively, the “Fiscal 2007 Wine Plan”) within the Constellation Wines segment. Restructuring and related charges included $4.6 million of employee termination benefit costs, $16.7 of contract termination costs and $0.4 million of facility consolidation/relocation costs. In addition, in connection with the Company’s worldwide wine reorganizations announced during fiscal 2006 and the Company’s program to consolidate certain west coast production processes in the U.S. (collectively, the “Fiscal 2006 Plan”) and the Fiscal 2007 Wine Plan, the Company recorded (i) $1.3 million of accelerated depreciation charges and (ii) $1.6 million of other related costs which were recorded in the selling, general and administrative expenses line. The Company recorded $2.2 million of restructuring and related charges for Second Quarter 2006 associated primarily with the Company’s decision to restructure and integrate the operations of Robert Mondavi (the “Robert Mondavi Plan”).
For Fiscal 2007, the Company expects to incur total restructuring and related charges of $56.7 million associated primarily with the Fiscal 2007 Wine Plan, the Fiscal 2006 Plan, and the Vincor Plan (as defined below). In addition, with respect to the Fiscal 2007 Wine Plan and the Fiscal 2006 Plan, the Company expects to incur total accelerated depreciation charges and other related costs for Fiscal 2007 of $10.7 million and $20.1 million, respectively.
Acquisition-Related Integration Costs
Acquisition-related integration costs decreased to $7.4 million for Second Quarter 2007 from $7.9 million for Second Quarter 2006, a decrease of $0.5 million, or (6%). For Second Quarter 2007, acquisition-related integration costs consist of costs recorded primarily in connection with the Company's decision to restructure and integrate the operations of Vincor (the "Vincor Plan"). For Second Quarter 2006, acquisition-related integration costs consist of costs recorded in connection with the Robert Mondavi Plan.
For Fiscal 2007, the Company expects to incur total acquisition-related integration costs of $26.2 million and $0.9 million in connection with the Vincor Plan and the Robert Mondavi Plan, respectively.
Operating Income
The following table sets forth the operating income (loss) (in millions of dollars) by operating segment of the Company for Second Quarter 2007 and Second Quarter 2006.
| | | Second Quarter 2007 Compared to Second Quarter 2006 | |
| | | Operating Income (Loss) | |
| | | 2007 | | 2006 | | % Increase | |
| Constellation Wines | | $ | 163.8 | | $ | 123.7 | | | 32 | % |
| Constellation Beers and Spirits | | | 91.6 | | | 87.6 | | | 5 | % |
| Corporate Operations and Other | | | (18.0 | ) | | (14.3 | ) | | 26 | % |
Total Reportable Segments | | | 237.4 | | | 197.0 | | | 21 | % |
Acquisition-Related Integration Costs, Restructuring and Related Charges and Unusual Costs | | | (56.1 | ) | | (22.8 | ) | | 146 | % |
| Consolidated Operating Income | | $ | 181.3 | | $ | 174.2 | | | 4 | % |
As a result of the factors discussed above, consolidated operating income increased to $181.3 million for Second Quarter 2007 from $174.2 million for Second Quarter 2006, an increase of $7.1 million, or 4%. Acquisition-related integration costs, restructuring and related charges and unusual costs of $56.1 million for Second Quarter 2007 consist of certain costs that are excluded by management in their evaluation of the results of each operating segment. These costs represent restructuring and related charges of $21.7 million associated primarily with the Fiscal 2007 Wine Plan; financing costs of $11.8 million related to the Company’s new senior credit facility entered into in connection with the Vincor acquisition; acquisition-related integration costs of $7.4 million associated primarily with the Vincor Plan; the flow through of inventory step-up of $5.9 million associated with the Company’s acquisitions of Vincor and Robert Mondavi; foreign currency losses of $5.4 million on foreign denominated intercompany loan balances associated with the acquisition of Vincor; other related charges of $1.6 million associated primarily with the Fiscal 2006 Plan; accelerated depreciation of $1.3 million associated with the Fiscal 2006 Plan and the Fiscal 2007 Wine Plan; the flow through of adverse grape cost of $0.9 million associated with the acquisition of Robert Mondavi; and additional loss on the sale of the Company’s branded bottled water business of $0.1 million. Acquisition-related integration costs, restructuring and related charges and unusual costs of $22.8 million for Second Quarter 2006 represent acquisition-related integration costs, adverse grape cost, and the flow through of inventory step-up associated with the Company’s acquisition of Robert Mondavi of $7.9 million, $6.3 million and $2.6 million, respectively, 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 $3.8 million, and restructuring and related charges of $2.2 million associated primarily with the Robert Mondavi Plan.
Equity in Earnings of Equity Method Investees
The Company’s equity in earnings (losses) of equity method investees increased slightly to $0.2 million in Second Quarter 2007 from a loss of ($0.3) million in Second Quarter 2006, an increase of $0.5 million.
Gain on Change in Fair Value of Derivative Instrument
In April 2006, the Company entered into a foreign currency forward contract in connection with the acquisition of Vincor to fix the U.S. dollar cost of the acquisition and the payment of certain outstanding indebtedness. For Second Quarter 2007, the Company recorded a gain of $2.6 million in connection with this derivative instrument. Under SFAS No. 133, a transaction that involves a business combination is not eligible for hedge accounting treatment. As such, the gain was recognized separately on the Company’s Consolidated Statements of Income.
Interest Expense, Net
Interest expense, net of interest income of $1.6 million and $0.8 million for Second Quarter 2007 and Second Quarter 2006, respectively, increased to $72.5 million for Second Quarter 2007 from $46.9 million for Second Quarter 2006, an increase of $25.6 million, or 55%. The increase resulted from both higher average borrowings in Second Quarter 2007 primarily as a result of the financing of the Vincor acquisition and higher average interest rates.
Provision for Income Taxes
The Company’s effective tax rate increased to 38.7% for Second Quarter 2007 from 35.1% for Second Quarter 2006, an increase of 3.6%. The increase in the Company’s effective tax rate for Second Quarter 2007 was due primarily to the amount of assumed distributions of foreign earnings for Fiscal 2007. In addition, a nonrecurring benefit was recorded in Second Quarter 2006 in connection with the Company’s preliminary conclusion regarding the impact of the American Jobs Creation Act of 2004 (“AJCA”) on distributions of certain foreign earnings for the year ended February 28, 2006 (“Fiscal 2006”).
Net Income
As a result of the above factors, net income decreased to $68.4 million for Second Quarter 2007 from $82.4 million for Second Quarter 2006, a decrease of $14.0 million, or (17%).
Six Months 2007 Compared to Six Months 2006
Net Sales
The following table sets forth the net sales (in millions of dollars) by operating segment of the Company for Six Months 2007 and Six Months 2006.
| | | Six Months 2007 Compared to Six Months 2006 | |
| | | Net Sales | |
| | | 2007 | | 2006 | | % Increase | |
| Constellation Wines: | | | | | | | |
Branded wine | | $ | 1,233.7 | | $ | 1,052.4 | | | 17 | % |
Wholesale and other | | | 523.1 | | | 498.4 | | | 5 | % |
| Constellation Wines net sales | | $ | 1,756.8 | | $ | 1,550.8 | | | 13 | % |
| Constellation Beers and Spirits: | | | | | | | | | | |
Imported beers | | $ | 649.7 | | $ | 574.6 | | | 13 | % |
Spirits | | | 166.9 | | | 163.1 | | | 2 | % |
| Constellation Beers and Spirits net sales | | $ | 816.6 | | $ | 737.7 | | | 11 | % |
| Consolidated Net Sales | | $ | 2,573.4 | | $ | 2,288.5 | | | 12 | % |
Net sales for Six Months 2007 increased to $2,573.4 million from $2,288.5 million for Six Months 2006, an increase of $284.9 million, or 12%. This increase was due primarily to $128.9 million of net sales of products acquired in the Vincor acquisition, an increase in imported beer net sales of $75.1 million and an increase in base branded wine net sales of $66.6 million (on a constant currency basis).
Constellation Wines
Net sales for Constellation Wines increased to $1,756.8 million for Six Months 2007 from $1,550.8 million in Six Months 2006, an increase of $206.0 million, or 13%. Branded wine net sales increased $181.3 million primarily due to $121.2 million of net sales of branded wine acquired in the Vincor acquisition and increased base branded wine net sales for North America (primarily the U.S.), partially offset by decreased base branded wine net sales for Europe. The increase in base branded wine net sales for the U.S. was driven by both volume gains and higher average selling prices as the consumer continues to trade up to higher priced premium wines. The decrease in base branded wine net sales for Europe resulted primarily from a reduction in retailer inventory levels during the first quarter of fiscal 2007 in the U.K. and increased promotional activities for Six Months 2007, reflecting, in part, the effects of retailer consolidation in the U.K. and an oversupply of Australian wine. Wholesale and other net sales increased $24.7 million primarily due to a favorable foreign currency impact of $16.4 million and $7.7 million of net sales of products acquired in the Vincor acquisition.
Constellation Beers and Spirits
Net sales for Constellation Beers and Spirits increased to $816.6 million for Six Months 2007 from $737.7 million for Six Months 2006, an increase of $78.9 million, or 11%. This increase resulted primarily from an increase in imported beers net sales of $75.1 million. The growth in imported beers net sales is due primarily to volume growth in the Company’s Mexican beer portfolio.
Gross Profit
The Company’s gross profit increased to $733.4 million for Six Months 2007 from $654.0 million for Six Months 2006, an increase of $79.4 million, or 12%. The Constellation Wines segment’s gross profit increased $59.1 million primarily from gross profit of $49.7 million due to the Vincor acquisition and the increased sales for the U.S. base branded wine business partially offset by increased competition and promotional activities among suppliers in the U.K. and Australia/New Zealand, reflecting, in part, the effects of retailer consolidation in the U.K. and an oversupply of Australian wine, plus a late March 2006 increase in duty costs in the U.K. The Constellation Beers and Spirits segment’s gross profit increased $13.2 million primarily due to the volume growth in the Company’s Mexican beer portfolio partially offset by higher Mexican beer product 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 lower by $7.2 million in Six Months 2007 versus Six Months 2006. This decrease resulted from decreased flow through of adverse grape cost associated with the acquisition of Robert Mondavi of $11.5 million, partially offset by increased accelerated depreciation costs of $2.4 million associated with the Fiscal 2006 Plan and Fiscal 2007 Wine Plan and increased flow through of inventory step-up of $1.9 million associated with the Vincor and Robert Mondavi acquisitions. Gross profit as a percent of net sales decreased to 28.5% for Six Months 2007 from 28.6% for Six Months 2006 primarily as a result of the factors discussed above.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $377.0 million for Six Months 2007 from $321.6 million for Six Months 2006, an increase of $55.4 million, or 17%. This increase is due primarily to a $30.7 million increase in unusual costs which consist of certain items that are excluded by management in their evaluation of the results of each operating segment, an increase in the Constellation Wines segment’s selling, general and administrative expenses of $18.9 million, and the recognition of $7.7 million of stock-based compensation expense. The increase in the Constellation Wines segment’s selling, general and administrative expenses is primarily due to increased advertising expenses, selling expenses and general and administrative expenses associated with the products acquired in the Vincor acquisition. The Constellation Beers and Spirits segment’s selling, general and administrative expenses increased slightly as increased general and administrative expenses and selling expenses were partially offset by lower advertising expenses. The Corporate Operations and Other segment’s selling, general and administrative expenses were also up slightly, primarily due to the recognition of stock-based compensation expense and expenses associated with the formation of the beer joint venture. The increase in unusual costs was primarily due to (i) a $14.2 million loss on the sale of the Company’s branded bottled water business resulting from the write-off of $27.7 million of non-deductible intangible assets, primarily goodwill, (ii) financing costs of $11.8 million related to the Company’s new senior credit facility entered into in connection with the Vincor acquisition; and (iii) foreign currency losses of $5.4 million on foreign denominated intercompany loan balances associated with the Vincor acquisition. Selling, general and administrative expenses as a percent of net sales increased to 14.6% for Six Months 2007 as compared to 14.1% for Six Months 2006 primarily due to the increase in unusual costs and the recognition of stock-based compensation expense.
Restructuring and Related Charges
The Company recorded $24.0 million of restructuring and related charges for Six Months 2007 associated primarily with the Fiscal 2007 Wine Plan and Fiscal 2006 Plan. Restructuring and related charges included $7.1 million of employee termination benefit costs, $16.5 of contract termination costs and $0.4 million of facility consolidation/relocation costs. In addition, in connection with the Fiscal 2006 Plan and the Fiscal 2007 Wine Plan, the Company recorded (i) $2.4 million of accelerated depreciation charges and (ii) $3.2 million of other related costs which were recorded in the selling, general and administrative expenses line. The Company recorded $4.1 million of restructuring and related charges for Six Months 2006 associated primarily with the Robert Mondavi Plan.
For Fiscal 2007, the Company expects to incur total restructuring and related charges of $56.7 million associated primarily with the Fiscal 2007 Wine Plan, the Fiscal 2006 Plan, and the Vincor Plan (as defined below). In addition, with respect to the Fiscal 2007 Wine Plan and the Fiscal 2006 Plan, the Company expects to incur total accelerated depreciation charges and other related costs for Fiscal 2007 of $10.6 million and $20.1 million, respectively.
Acquisition-Related Integration Costs
Acquisition-related integration costs decreased to $8.1 million for Six Months 2007 from $14.3 million for Six Months 2006, a decrease of $6.2 million, or (43%). Acquisition-related integration costs consist of costs recorded in connection with the Vincor Plan and the Robert Mondavi Plan of $7.5 million and $0.6 million, respectively.
For Fiscal 2007, the Company expects to incur total acquisition-related integration costs of $26.2 million and $0.9 million in connection with the Vincor Plan and the Robert Mondavi Plan, respectively.
Operating Income
The following table sets forth the operating income (loss) (in millions of dollars) by operating segment of the Company for Six Months 2007 and Six Months 2006.
| | | Six Months 2007 Compared to Six Months 2006 | |
| | | Operating Income (Loss) | |
| | | 2007 | | 2006 | | % Increase | |
| Constellation Wines | | $ | 260.0 | | $ | 219.7 | | | 18 | % |
| Constellation Beers and Spirits | | | 174.4 | | | 163.6 | | | 7 | % |
| Corporate Operations and Other | | | (32.2 | ) | | (28.6 | ) | | 13 | % |
Total Reportable Segments | | | 402.2 | | | 354.7 | | | 13 | % |
Acquisition-Related Integration Costs, Restructuring and Related Charges and Unusual Costs | | | (77.9 | ) | | (40.7 | ) | | 91 | % |
| Consolidated Operating Income | | $ | 324.3 | | $ | 314.0 | | | 3 | % |
As a result of the factors discussed above, consolidated operating income increased to $324.3 million for Six Months 2007 from $314.0 million for Six Months 2006, an increase of $10.3 million, or 3%. Acquisition-related integration costs, restructuring and related charges and unusual costs of $77.9 million for Six Months 2007 consist of certain costs that are excluded by management in their evaluation of the results of each operating segment. These costs represent restructuring and related charges of $24.0 million associated primarily with the Fiscal 2007 Wine Plan and Fiscal 2006 Plan; loss on sale of the branded bottled water business of $14.2 million; financing costs of $11.8 million related to the Company’s new senior credit facility entered into in connection with the Vincor acquisition; acquisition-related integration costs of $8.1 million associated with the Vincor Plan and Robert Mondavi Plan; the flow through of inventory step-up of $6.5 million associated with the Company’s acquisitions of Vincor and Robert Mondavi; foreign currency losses of $5.4 million on foreign denominated intercompany loan balances associated with the Vincor acquisition; other related costs of $3.1 million associated with the Fiscal 2006 Plan and Fiscal 2007 Wine Plan; the flow through of adverse grape cost of $2.4 million associated with the acquisition of Robert Mondavi; and accelerated depreciation of $2.4 million associated with the Fiscal 2006 Plan and Fiscal 2007 Wine Plan. Acquisition-related integration costs, restructuring and related charges and unusual costs of $40.7 million for Six Months 2006 represent acquisition-related integration costs, adverse grape cost, and the flow through of inventory step-up associated with the Company’s acquisition of Robert Mondavi of $14.3 million, $13.9 million and $4.6 million, respectively; restructuring and related charges of $4.1 million in the Constellation Wines segment associated primarily with the Robert Mondavi 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 $3.8 million.
Equity in Earnings of Equity Method Investees
The Company’s equity in earnings (losses) of equity method investees increased slightly to $0.3 million in Six Months 2007 from a loss of ($0.8) million in Six Months 2006, an increase of $1.1 million.
Gain on Change in Fair Value of Derivative Instrument
In April 2006, the Company entered into a foreign currency forward contract in connection with the acquisition of Vincor to fix the U.S. dollar cost of the acquisition and the payment of certain outstanding indebtedness. For Six Months 2007, the Company recorded a gain of $55.1 million in connection with this derivative instrument. Under SFAS No. 133, a transaction that involves a business combination is not eligible for hedge accounting treatment. As such, the gain was recognized separately on the Company’s Consolidated Statements of Income.
Interest Expense, Net
Interest expense, net of interest income of $2.5 million and $1.7 million for Six Months 2007 and Six Months 2006, respectively, increased to $121.2 million for Six Months 2007 from $94.2 million for Six Months 2006, an increase of $27.0 million, or 29%. The increase resulted from both higher average borrowings in Six Months 2007 primarily as a result of the financing of the Vincor acquisition and higher average interest rates.
Provision for Income Taxes
The Company’s effective tax rate increased to 40.5% for Six Months 2007 from 27.8% for Six Months 2006, an increase of 12.7%. In Six Months 2007, the Company sold its branded bottled water business that resulted in the write-off of $27.7 million of non-deductible intangible assets, primarily goodwill. The provision for income taxes on the sale of the branded bottled water business as well as the amount of assumed distributions of foreign earnings increased the Company’s effective tax rate for Six Months 2007. In addition, the effective tax rate for Six Months 2006 reflects the benefits recorded for adjustments to income tax accruals of $16.2 million in connection with the completion of various income tax examinations as well as the preliminary conclusion regarding the impact of the AJCA on Fiscal 2006 distributions of certain foreign earnings.
Net Income
As a result of the above factors, net income decreased to $153.9 million for Six Months 2007 from $158.1 million for Six Months 2006, a decrease of $4.2 million, or (3%).
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, and anticipated capital expenditure requirements for both its short-term and long-term capital needs. In addition, the Company has used cash provided by financing activities to repurchase shares under the Company’s share repurchase program (see below) during Six Months 2007, and has since repurchased additional shares under the share repurchase program and intends to utilize cash provided by financing activities to fund the repurchase of those shares.
Six Months 2007 Cash Flows
Operating Activities
Net cash provided by operating activities for Six Months 2007 was $84.9 million, which resulted from $153.9 million of net income, plus $131.4 million of net non-cash items charged to the Consolidated Statement of Income, less $145.3 million representing the net change in the Company’s operating assets and liabilities and $55.1 million of proceeds from maturity of derivative instrument reflected in investing activities.
The net non-cash items consisted primarily of depreciation of property, plant and equipment, the deferred tax provision, and the loss on the sale of the branded bottled water business. The net change in operating assets and liabilities resulted primarily from seasonal increases in accounts receivable.
Investing Activities
Net cash used in investing activities for Six Months 2007 was $1,111.4 million, which resulted primarily from $1,091.8 million for the purchase of a business and $103.1 million of capital expenditures, partially offset by $55.1 million of proceeds from maturity of derivative instrument entered into to fix the U.S. dollar cost of the acquisition of Vincor.
Financing Activities
Net cash provided by financing activities for Six Months 2007 was $1,075.2 million resulting primarily from proceeds from issuance of long-term debt of $3,695.0 million partially offset by principal payments of long-term debt of $2,771.5 million.
Share Repurchase Program
In February 2006, the Company’s Board of Directors replenished the June 1998 authorization to repurchase up to $100.0 million of the Company’s 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 the senior credit facility. The repurchased shares will become treasury shares. During Six Months 2007, the Company purchased 3,243,018 shares of Class A Common Stock at an aggregate cost of $82.0 million, or at an average cost of $25.28 per share, under this share repurchase program. Subsequent to August 31, 2006, the Company completed its share repurchase program with the purchases of 651,960 shares of Class A Common Stock at an aggregate cost of $18.0 million, or at an average cost of $27.65 per share. In total under this share repurchase program, the Company purchased 3,894,978 shares of Class A Common Stock at an aggregate cost of $100.0 million, or at an average cost of $25.67 per share.
Debt
Total debt outstanding as of August 31, 2006, amounted to $4,316.4 million, an increase of $1,506.6 million from February 28, 2006. The ratio of total debt to total capitalization increased to 57.7% as of August 31, 2006, from 48.6% as of February 28, 2006, primarily as a result of the additional borrowings in Second Quarter 2007 to finance the acquisition of Vincor.
Senior Credit Facility
2006 Credit Agreement
In connection with the acquisition of Vincor, on June 5, 2006, the Company and certain of its U.S. subsidiaries, 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 “2006 Credit Agreement”). The 2006 Credit Agreement provides for aggregate credit facilities of $3.5 billion, consisting of a $1.2 billion tranche A term loan facility due in June 2011, a $1.8 billion tranche B term loan facility due in June 2013, and a $500 million revolving credit facility (including a sub-facility for letters of credit of up to $200 million) which terminates in June 2011. Proceeds of the 2006 Credit Agreement were used to pay off the Company’s obligations under its prior senior credit facility, to fund the acquisition of Vincor and to repay certain indebtedness of Vincor. The Company uses its revolving credit facility under the 2006 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 June 5, 2006. In August 2006, the Company used proceeds from the August 2006 Senior Notes (as defined below) to repay $180.0 million of the tranche A term loan and $200.0 million of the tranche B term loan. In addition, the Company prepaid an additional $100.0 million on the tranche B term loan in August 2006. As of August 31, 2006, the required principal repayments of the tranche A term loan and the tranche B term loan for the remaining six months of Fiscal 2007 and for each of the five succeeding fiscal years and thereafter are as follows:
| | | Tranche A Term Loan | | Tranche B Term Loan | | Total | |
(in millions) | | | | | | | |
| 2007 | | $ | - | | $ | - | | $ | - | |
| 2008 | | | 90.0 | | | 7.6 | | | 97.6 | |
| 2009 | | | 210.0 | | | 15.2 | | | 225.2 | |
| 2010 | | | 270.0 | | | 15.2 | | | 285.2 | |
| 2011 | | | 300.0 | | | 15.2 | | | 315.2 | |
| 2012 | | | 150.0 | | | 15.2 | | | 165.2 | |
| Thereafter | | | - | | | 1,431.6 | | | 1,431.6 | |
| | | $ | 1,020.0 | | $ | 1,500.0 | | $ | 2,520.0 | |
The rate of interest on borrowings under the 2006 Credit Agreement 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 2006 Credit Agreement) and, with respect to LIBOR borrowings, ranges between 1.00% and 1.50%. The initial 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 certain of its U.S. subsidiaries. These obligations are also secured by a pledge of (i) 100% of the ownership interests in certain 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 covenants that are contained in the 2006 Credit Agreement, including those restricting the incurrence of additional indebtedness (including guarantees of indebtedness), additional liens, mergers and consolidations, disposition or acquisition of property, the payment of dividends, transactions with affiliates and the making of certain investments, in each case subject to numerous conditions, exceptions and thresholds. The financial covenants are limited to maximum total debt and senior debt coverage ratios and minimum interest and fixed charge coverage ratios.
As of August 31, 2006, under the 2006 Credit Agreement, the Company had outstanding tranche A term loans of $1.0 billion bearing an interest rate of 6.7%, tranche B term loans of $1.5 billion bearing an interest rate of 6.9%, revolving loans of $125.0 million bearing an interest rate of 6.5%, outstanding letters of credit of $60.5 million, and $314.5 million in revolving loans available to be drawn.
As of August 31, 2006, the Company had outstanding interest rate swap agreements which fixed LIBOR interest rates on $1,200.0 million of the Company’s floating LIBOR rate debt at an average rate of 4.1% through fiscal 2010. For Six Months 2007 and Six Months 2006, the Company reclassified $2.3 million, net of tax effect of $1.5 million, and $1.7 million, net of tax effect of $1.1 million, respectively, from AOCI to Interest Expense, net in the Company’s Consolidated Statements of Income. For the Second Quarter 2007 and Second Quarter 2006, the Company reclassified $1.5 million, net of tax effect of $1.0 million, and $1.0 million, net of tax effect of $0.6 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 Statements of Cash Flows.
Foreign subsidiary facilities -
The Company has additional credit arrangements available totaling $376.0 million as of August 31, 2006. 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 August 31, 2006, amounts outstanding under the foreign subsidiary credit arrangements were $216.1 million.
Senior Notes
On August 4, 1999, the Company issued $200.0 million aggregate principal amount of 8 5/8% Senior Notes due August 2006 (the “August 1999 Senior Notes”). On August 1, 2006, the Company repaid the August 1999 Senior Notes with proceeds from its revolving credit facility under the 2006 Credit Agreement.
On August 15, 2006, the Company issued $700.0 million aggregate principal amount of 7 1/4% Senior Notes due September 2016 at an issuance price of $693.1 million (net of $6.9 million unamortized discount, with an effective interest rate of 7.4%) (the “August 2006 Senior Notes”). The net proceeds of the offering ($686.1 million) were used to reduce a corresponding amount of borrowings under the Company’s 2006 Credit Agreement. Interest on the August 2006 Senior Notes is payable semiannually on March 1 and September 1 of each year, beginning March 1, 2007. The August 2006 Senior Notes are redeemable, in whole or in part, at the option of the Company at any time at a redemption price equal to 100% of the outstanding principal amount and a make whole payment based on the present value of the future payments at the adjusted Treasury rate plus 50 basis points. The August 2006 Senior Notes are senior unsecured obligations and rank equally in right of payment to all existing and future senior unsecured indebtedness of the Company. Certain of the Company’s significant operating subsidiaries guarantee the August 2006 Senior Notes, on a senior basis.
As of August 31, 2006, the Company had outstanding £1.0 million ($1.9 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 August 31, 2006, the Company had outstanding £154.0 million ($293.3 million, net of $0.3 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 August 31, 2006, 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 August 31, 2006, 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 July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. (“FIN No. 48”), “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109.” FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109. FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Additionally, FIN No. 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company is required to adopt FIN No. 48 for fiscal years beginning March 1, 2007, with the cumulative effect of applying the provisions of FIN No. 48 reported as an adjustment to opening retained earnings. The Company is currently assessing the financial impact of FIN No. 48 on its consolidated financial statements.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (“SAB No. 108”), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB No. 108 addresses how the effects of prior year uncorrected misstatements should be considered when quantifying misstatements in current year financial statements. SAB No. 108 requires companies to quantify misstatements using a balance sheet and income statement approach and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. The Company is required to adopt SAB No. 108 for its annual financial statements for the fiscal year ending February 28, 2007. The Company believes that the initial adoption of SAB No. 108 will not have a material impact on its consolidated financial statements.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 (“SFAS No. 157”), “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and states that a fair value measurement should be determined based on assumptions that market participants would use in pricing the asset or liability. The Company is required to adopt SFAS No. 157 for fiscal years and interim periods beginning March 1, 2008. The Company is currently assessing the financial impact of SFAS No. 157 on its consolidated financial statements.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158 (“SFAS No. 158”), “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R).” SFAS No. 158 requires companies to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. The Company is required to adopt this provision of SFAS No. 158 and to provide the required disclosures as of February 28, 2007. SFAS No. 158 also requires companies to measure the funded status of a plan as of the date of the company’s fiscal year-end (with limited exceptions), which provision the Company is required to adopt as of February 28, 2009. The Company is currently assessing the financial impact of SFAS No. 158 on its consolidated financial statements.
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, that 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 without limitation statements under Part I - Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” regarding the Company’s expectations relative to its anticipated joint venture with Modelo and the Company's expected restructuring and related charges, accelerated depreciation charges and other related costs, and acquisition-related integration costs, are forward-looking statements. When used in this Quarterly Report on Form 10-Q, the words “anticipate,” “intend,” “expect,” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. 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. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct. In addition to the risks and uncertainties of ordinary business operations, the forward-looking statements of the Company contained in this Quarterly Report on Form 10-Q are also subject to risks and uncertainties discussed in "Risk Factors" under Part II - Items 1A of this Quarterly Report on Form 10-Q and the risk and uncertainty that the Company’s restructuring and related charges, accelerated depreciation charges and other related costs, and acquisition-related integration costs may exceed current expectations due to, among other reasons, variations in anticipated headcount reductions, contract terminations or greater than anticipated implementation costs. For additional information about risks and uncertainties that could adversely affect the Company’s forward-looking statements, please refer to Item 1A “Risk Factors” of the Company’s Annual Report on Form 10-K for the fiscal year ended February 28, 2006.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company, as a result of its global operating, acquisition 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 are or may be used to hedge existing foreign currency denominated assets and liabilities, forecasted foreign currency denominated sales both to third parties as well as intercompany sales, intercompany principal and interest payments, and in connection with acquisitions or joint venture investments outside the U.S. As of August 31, 2006, the Company had exposures to foreign currency risk primarily related to the Australian dollar, euro, New Zealand dollar, British pound sterling, Canadian dollar and Mexican peso.
As of August 31, 2006, and August 31, 2005, the Company had outstanding foreign exchange derivative instruments with a notional value of $2,195.3 million and $741.7 million, respectively. Approximately 71% of the Company’s total exposures were hedged as of August 31, 2006. 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 August 31, 2006, and August 31, 2005, the fair value of open foreign exchange contracts would have been decreased by $140.2 million and $77.9 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 $1,528.6 million and $1,031.8 million as of August 31, 2006, and August 31, 2005, respectively. A hypothetical 1% increase from prevailing interest rates as of August 31, 2006, and August 31, 2005, would have resulted in a decrease in fair value of fixed interest rate long-term debt by $70.8 million and $26.3 million, respectively.
As of August 31, 2006, and August 31, 2005, the Company had outstanding interest rate swap agreements 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% through fiscal 2010. A hypothetical 1% increase from prevailing interest rates as of August 31, 2006, and August 31, 2005, would have increased the fair value of the interest rate swaps by $41.8 million and $43.7 million, respectively.
In addition to the $1,528.6 million and $1,031.8 million estimated fair value of fixed rate debt outstanding as of August 31, 2006, and August 31, 2005, respectively, the Company also had variable rate debt outstanding (primarily LIBOR based) as of August 31, 2006, and August 31, 2005, of $2,845.0 million and $2,034.5 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 August 31, 2006, and August 31, 2005, is $28.5 million and $20.3 million, respectively.
