Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Introduction
This MD&A provides additional information on our businesses, current developments, financial condition, cash flows, and results of operations. It should be read in conjunction with our Financial Statements and with our consolidated financial statements and notes included in our 2022 Annual Report. This MD&A is organized as follows:
Overview. This section provides a general description of our business, which we believe is important in understanding the results of our operations, financial condition, and potential future trends.
Strategy. This section provides a description of our strategy and a discussion of recent developments, global supply chain and COVID-19 related impacts, and significant acquisitions and investments.
Results of operations. This section provides an analysis of our results of operations presented on a business segment basis for the three months ended August 31, 2022, and August 31, 2021, and six months ended August 31, 2022, and August 31, 2021. In addition, a brief description of significant transactions and other items that affect the comparability of the results is provided.
Liquidity and capital resources. This section provides an analysis of our cash flows, outstanding debt, and a discussion of the amount of financial capacity available to fund our on-going operations and future commitments, as well as a discussion of other financing arrangements.
Overview
We are an international producer and marketer of beer, wine, and spirits with operations in the U.S., Mexico, New Zealand, and Italy with powerful, consumer-connected, high-quality brands like Corona Extra, Modelo Especial, the Robert Mondavi Brand Family, Kim Crawford, Meiomi, The Prisoner Wine Company, and High West. In the U.S., we are one of the top growth contributors at retail among beverage alcohol suppliers. We are the third-largest beer company in the U.S. and continue to strengthen our leadership position as the #1 high-end beer supplier and the #1 share gainer across the U.S. beer market. Within wine and spirits, we are making solid progress in refining our brand portfolio to shift to a higher-end focused business to deliver net sales growth and margin expansion. The strength of our brands makes us a supplier of choice to many of our consumers and our customers, which include wholesale distributors, retailers, and on-premise locations. We conduct our business through entities we wholly own as well as through a variety of joint ventures and other entities.
Our internal management financial reporting consists of three business divisions: (i) Beer, (ii) Wine and Spirits, and (iii) Canopy and we report our operating results in four segments: (i) Beer, (ii) Wine and Spirits, (iii) Corporate Operations and Other, and (iv) Canopy. Our Canopy Equity Method Investment makes up the Canopy segment.
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 30 |
In the Beer segment, our portfolio consists of high-end imported beer brands, craft beer, and ABAs. We have an exclusive perpetual brand license to import, market, and sell our Mexican beer portfolio in the U.S. In the Wine and Spirits segment, we sell a portfolio that includes higher-margin, higher-growth wine brands complemented by certain higher-end spirits brands. Amounts included in the Corporate Operations and Other segment consist of costs of executive management, corporate development, corporate finance, corporate growth and strategy, human resources, internal audit, investor relations, legal, public relations, and information technology, as well as our investments made through our corporate venture capital function. All costs included in the Corporate Operations and Other segment are general costs that are applicable to the consolidated group and are, therefore, not allocated to the other reportable segments. All costs reported within the Corporate Operations and Other segment are not included in our CODM’s evaluation of the operating income (loss) performance of the other reportable segments. The business segments reflect how our operations are managed, how resources are allocated, how operating performance is evaluated by senior management, and the structure of our internal financial reporting.
Strategy
Business strategy
Our overall strategic vision is to consistently deliver industry-leading total stockholder returns over the long-term through a focus on these key pillars:
•continue building strong brands people love with advantaged routes to market;
•build a culture that is consumer-obsessed and leverages robust innovation capabilities to stay on the forefront of consumer trends; and
•deliver on impactful ESG initiatives that we believe are not only good business, but also good for the world.
We will continue to strive for success by ensuring consumer-led decision making drives all aspects of our business; building a diverse talent pipeline with best-in-class people development; investing in data systems, architecture, and infrastructure that enables our business; and exemplifying intentional and proactive balance sheet management. We place focus on positioning our portfolio on higher-margin, higher-growth categories of the beverage alcohol industry to align with consumer-led premiumization trends, which we believe will continue to drive faster growth rates across beer, wine, and spirits. To continue capitalizing on consumer-led premiumization trends, become more competitive, and grow our business, we have employed a strategy dedicated to organic growth and supplemented by targeted investments and acquisitions. We also believe a key component to driving faster growth rates is to invest in and strengthen our leadership position within the DTC and 3-tier eCommerce channels. As a part of our strategy, we have launched Digital Business Acceleration which we believe will enable us to drive results by enhancing our business in key areas including procurement, end-to-end supply chain planning, and marketing optimization. For further information on Second Quarter 2023 and Six Months 2023 Digital Business Acceleration investments, see the respective “Selling, general, and administrative expenses” within Results of Operations below.
Our business strategy for the Beer segment focuses on upholding our leadership position in the high-end segment of the U.S. beer market through maintenance of leading margins, enhancements to our results of operations and operating cash flow, and exploring new avenues for growth. This includes continued focus on growing our beer portfolio in the U.S. through expanding distribution for key brands, including within the DTC and 3-tier eCommerce channels, as well as continued expansion, optimization, and/or construction activities for our Mexico beer operations. Additionally, in an effort to compete more fully in growing sectors of the high-end segment of the U.S. beer market, we have leveraged our innovation capabilities to create new line extensions behind celebrated, trusted brands and package formats that are intended to meet emerging needs.
Expansion, optimization, and/or construction activities continue under our Mexico Beer Projects to align with our anticipated future growth expectations. In April 2022, we announced that, with the assistance of the Mexican government and state and local officials in Mexico, we acquired land in Veracruz for the construction of the Veracruz Brewery where there is ample water and we will have a skilled workforce to meet our long-term
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 31 |
needs. The design and development process for the Veracruz Brewery is underway. Additionally, we continue to work with government officials in Mexico to determine next steps for our canceled Mexicali Brewery construction project following a negative result from a public consultation held in Mexico.
Our business strategy for the Wine and Spirits segment focuses on higher-end brands, improving margins, and creating operating efficiencies. We continue to refine our portfolio primarily through an enhanced focus on higher-margin, higher-growth wine and spirits brands. We recently reorganized this business into two distinct commercial teams, one focused on our fine wine and craft spirits brands and the other focused on our mainstream and premium brands. While each team has its own distinct strategy, both remain aligned to the goal of accelerating performance by growing net sales and expanding margins. In addition, we are advancing our aim to become a global, omni-channel competitor in line with consumer preferences. Our business continues to progressively expand into DTC channels (including hospitality), 3-tier eCommerce, and international markets, while continuing to grow in U.S. 3-tier brick-and-mortar distribution. In markets where it is feasible, we entered into a contractual arrangement to consolidate our U.S. distribution in order to obtain dedicated distributor selling resources which focus on our U.S. wine and spirits portfolio to drive organic growth. We expect U.S. wine and spirits shipment volume to be generally aligned with depletion volume for Fiscal 2023.
Marketing, sales, and distribution of our products are primarily managed on a geographic basis allowing us to leverage leading market positions. In addition, market dynamics and consumer trends vary across each of our markets. Within our primary market in the U.S., we offer a range of beverage alcohol products across the imported beer, craft beer, ABA, and branded wine and spirits categories, with generally separate distribution networks utilized for (i) our beer portfolio and (ii) our wine and spirits portfolio. The environment for our products is competitive in each of our markets.
We complement our strategy with our investment in Canopy by expanding our portfolio into adjacent categories. Canopy is a leading cannabis company with operations in Canada, the U.S., Germany, and certain other global markets. This investment is consistent with our long-term strategy to identify, address, and stay ahead of evolving consumer trends and market dynamics. Our strategic relationship with Canopy is designed to help position it to be successful in cannabis production, branding, and intellectual property.
We remain committed to our long-term financial model of: growing sales, expanding margins, and increasing cash flow in order to achieve earnings per share growth, maintain our targeted net leverage ratio, and deliver returns to stockholders through the payment of dividends and periodic share repurchases. Our results of operations and financial condition have been affected by inflation, changing prices, and reductions in discretionary income of consumers available to purchase our products, and we expect these impacts to continue throughout the remainder of Fiscal 2023. Our Fiscal 2023 results of operations have also been, and may continue to be, impacted by other unfavorable global and regional economic conditions, geopolitical events, and military conflicts, such as repercussions from the conflict in Ukraine. We intend to continue to monitor the inflationary environment and the impact on the consumer when we consider passing along rising costs through further selling price increases, subject to normal competitive conditions. In addition, we continue to identify on-going cost savings initiatives, including our commodity hedging program. However, there can be no assurance that we will be able to fully mitigate rising costs through increased selling prices and/or cost savings initiatives. Furthermore, to the extent climate-related severe weather events, such as droughts, floods, wildfires, and/or late frosts, continue to occur or accelerate in future periods, it could have a material impact on our results of operations and financial condition.
ESG strategy
We believe our ESG strategy enables us to better meet stakeholder expectations, reflect our Company values, and directly address pressing environmental and societal needs that are important to our communities, consumers, and employees. Specifically, we have focused on areas where we believe we have the greatest opportunities to make meaningful, positive impacts for people and the planet, and we dedicate our resources towards:
Serving as good stewards of our environment and natural resources – Modeling water stewardship for our industry; and reducing GHG emissions through energy conservation and renewable energy initiatives
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 32 |
Enhancing social equity within our industry and communities – Championing the professional development and advancement of women in the beverage alcohol industry and our communities; enhancing economic development and prosperity in disadvantaged communities; and championing an inclusive culture within our organization, characterized by diversity in background and thought, which reflects our consumers and the communities where we live and work
Promoting responsible beverage alcohol consumption – Ensuring the responsible promotion and marketing of our products; and empowering adults to make responsible choices in their alcohol (substance) consumption by supporting fact-based education, engagement programs, and policies
During Second Quarter 2023 we took the following steps to advance our ESG strategy by key area:
Serving as good stewards of our environment and natural resources
•in support of a multi-year collaboration with The Nature Conservancy, we pledged an additional $500,000 over the next two years for their Dynamic Water Management program
Enhancing social equity within our industry and communities
•as part of our Focus on Female Founders program, we completed an investment in the female-founded, eco-friendly wine brand Archer Roose. Through Second Quarter 2023, we have invested $75 million in female-founded or led companies through this program
•engaged six minority depository institutions as participants in the August 2022 Term Credit Agreement which provide opportunities often unavailable to smaller community banks including access to grow funded assets, diversify their loan portfolios, and develop broader relationships with corporate treasury teams
•to aid in creating an inclusive culture that allows all members of our workforce to thrive, we kicked off a self-identification campaign to capture data designed to help measure the impact of our DEI efforts and inform future initiatives that we believe will enhance employee engagement, retention, and recruiting efforts
Promoting responsible beverage alcohol consumption
•in collaboration with Responsibility.org, we updated our brand websites to redirect a visitor who self-identifies as being under the legal drinking age to Responsibility.org for information on prevention of underage drinking, ending drunk driving, and drinking responsibly
Recent Developments
2022 Wine Divestiture
On October 6, 2022, we sold certain of our mainstream and premium wine brands and related inventory. We expect to use the net cash proceeds from the 2022 Wine Divestiture primarily to reduce outstanding borrowings and for general corporate purposes, including working capital, funding capital expenditures, and other business opportunities.
Reclassification Agreement
On June 30, 2022, we announced the Reclassification. To effect the Reclassification, we will file the Amended and Restated Charter with the Secretary of State of the State of Delaware. If the Reclassification is completed, at the Effective Time, each share of Class B Stock issued and outstanding immediately prior to the Effective Time will be reclassified and converted into one validly issued, fully paid, and non-assessable share of Class A Stock and the right to receive $64.64 in cash, without interest, subject to any adjustment as provided in the Reclassification Agreement and the Amended and Restated Charter. We have called a special meeting of stockholders to be held on November 9, 2022, in connection with the Reclassification. See “Liquidity and Capital Resources” below for further discussion.
Global Supply Chain and COVID-19 Related Impacts
Fiscal 2023 has been, and is expected to continue to be, impacted by challenges with both global supply chain and transportation which contributed to higher cost of product sold. For example, wine produced in New Zealand and Italy and subsequently shipped to the U.S. for distribution continues to be affected by increased
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 33 |
costs of ocean freight shipping. In addition, during Fiscal 2022, we experienced a brown glass purchasing shortage, which impacted certain of our imported beer brands. This supply returned to normal levels in early Fiscal 2023. To the extent these circumstances continue to occur or accelerate in future periods it could have a material impact on our results of operations.
We have seen consumers shift more of their total shopping spend to online channels since the COVID-19 outbreak, which has led to increased eCommerce sales, including DTC, for our business. In response to COVID-19, we have ensured our on-going liquidity and financial flexibility through cash preservation initiatives, capital management adjustments, and cost control measures. We have used opportunities under the CARES Act, afforded to us earlier in the pandemic, to defer some payments including certain payroll taxes. We believe we have sufficient liquidity available from operating cash flow, cash on hand, and availability under our revolving credit facility and, in respect to a portion of amounts that may be payable in connection with the Reclassification, the August 2022 Term Credit Agreement. We expect to have continued access to capital markets and to be able to continue to return value to stockholders through dividends and periodic share repurchases.
Acquisitions and investments
Wine and Spirits segment
Austin Cocktails acquisition
In April 2022, we acquired the remaining 73% ownership interest in Austin Cocktails, which included a portfolio of small batch, RTD cocktails. This transaction primarily included the acquisition of goodwill and a trademark. The results of operations of Austin Cocktails are reported in the Wine and Spirits segment and have been included in our consolidated results of operations from the date of acquisition.
Lingua Franca acquisition
In March 2022, we acquired the Lingua Franca business, including a collection of Oregon-based luxury wines, a vineyard, and a production facility. This transaction also includes the acquisition of a trademark and inventory. The results of operations of Lingua Franca are reported in the Wine and Spirits segment and have been included in our consolidated results of operations from the date of acquisition.
My Favorite Neighbor acquisition
In November 2021, we acquired the remaining 65% ownership interest in My Favorite Neighbor, a super-luxury, DTC-focused wine business as well as certain wholesale distributed brands. This transaction primarily included the acquisition of goodwill, trademarks, inventory, and property, plant, and equipment. The results of operations of My Favorite Neighbor are reported in the Wine and Spirits segment and have been included in our consolidated results of operations from the date of acquisition.
Our recent acquisitions supported our strategic focus on consumer-led premiumization trends and meeting the evolving needs of our consumers.
Canopy segment
Impairment of Canopy Equity Method Investment
We evaluated the Canopy Equity Method Investment as of August 31, 2022, and determined that there was an other-than-temporary impairment. Our conclusion was based on several contributing factors, including: (i) the period of time for which the fair value had been less than the carrying value and the uncertainty surrounding Canopy’s stock price recovering in the near-term, (ii) Canopy recording a significant impairment of goodwill related to its cannabis operations during its three months ended June 30, 2022, and (iii) the uncertainty of U.S. federal cannabis permissibility. As a result, the Canopy Equity Method Investment with a carrying value of $1,695.1 million was written down to its estimated fair value of $634.8 million, resulting in an impairment of $1,060.3 million. This loss from impairment was included in income (loss) from unconsolidated investments within our consolidated results for Six Months 2023 and Second Quarter 2023.
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 34 |
Canopy investment
In July 2022, we received 29.2 million common shares of Canopy following the exchange of C$100.0 million principal amount of our Canopy Debt Securities. This exchange did not significantly change our Canopy ownership percentage.
For additional information on these recent developments, acquisitions, and investments refer to Notes 4, 5, 7, and 10.
Results of Operations
Financial Highlights
Second Quarter 2023 compared to Second Quarter 2022
•Our results of operations were negatively impacted by (i) an impairment of our Canopy Equity Method Investment for Second Quarter 2023 and (ii) an increase in equity in losses from Canopy’s results primarily driven by their goodwill impairment, partially offset by (i) a decrease in unrealized net loss from the changes in fair value of our investment in Canopy, (ii) improvements within the Beer segment driven by shipment volume growth, and (iii) a decrease in inventory obsolescence within the Beer segment, driven by a slowdown in the overall hard seltzer category in Fiscal 2022.
•Net sales increased 12% due to an increase in Beer net sales driven primarily by shipment volume growth and favorable impact from pricing.
•Operating income increased 10% largely due to improvements within the Beer segment, including the decrease in inventory obsolescence.
•Net income (loss) attributable to CBI and diluted net income (loss) per common share attributable to CBI decreased largely due to the items discussed above.
Six Months 2023 compared to Six Months 2022
•Our results of operations were negatively impacted by (i) an impairment of our Canopy Equity Method Investment and (ii) an increase in equity in losses from Canopy’s results primarily driven by their goodwill impairment, partially offset by (i) a decrease in unrealized net loss from the changes in fair value of our investment in Canopy, (ii) an impairment of long-lived assets for Six Months 2022 in connection with certain assets at the Mexicali Brewery, (iii) improvements within the Beer segment driven by shipment volume growth, and (iv) a decrease in inventory obsolescence within the Beer segment, driven by a slowdown in the overall hard seltzer category in Fiscal 2022.
•Net sales increased 14% due to an increase in Beer net sales driven primarily by shipment volume growth and favorable impact from pricing.
•Operating income increased 100% largely due to (i) the impact of the impairment of long-lived assets in connection with certain assets at the Mexicali Brewery for Six Months 2022 and (ii) improvements within the Beer segment, including the decrease in inventory obsolescence.
•Net loss attributable to CBI and diluted net loss per common share attributable to CBI decreased largely due to the items discussed above, partially offset by higher provision for income taxes.
Comparable Adjustments
Management excludes items that affect comparability from its evaluation of the results of each operating segment as these Comparable Adjustments are not reflective of core operations of the segments. Segment operating performance and the incentive compensation of segment management are evaluated based on core segment operating income (loss) which does not include the impact of these Comparable Adjustments.
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 35 |
As more fully described herein and in the related Notes, the Comparable Adjustments that impacted comparability in our segment results for each period are as follows:
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| Second Quarter 2023 | | Second Quarter 2022 | | Six Months 2023 | | Six Months 2022 |
(in millions) | | | | | | | |
Cost of product sold | | | | | | | |
Settlements of undesignated commodity derivative contracts | $ | (31.3) | | | $ | (8.9) | | | $ | (54.6) | | | $ | (12.3) | |
Net gain (loss) on undesignated commodity derivative contracts | (15.4) | | | 24.0 | | | 33.1 | | | 48.1 | |
Flow through of inventory step-up | (0.9) | | | 0.1 | | | (1.9) | | | 0.1 | |
Net flow through of reserved inventory | 1.2 | | | — | | | 1.2 | | | — | |
Recovery of inventory write-down | — | | | — | | | 0.2 | | | — | |
Strategic business development costs | — | | | — | | | — | | | (2.6) | |
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Total cost of product sold | (46.4) | | | 15.2 | | | (22.0) | | | 33.3 | |
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Selling, general, and administrative expenses | | | | | | | |
Costs associated with the Reclassification | (20.6) | | | — | | | (21.3) | | | — | |
Transition services agreements activity | (4.5) | | | (4.9) | | | (7.9) | | | (7.2) | |
Restructuring and other strategic business development costs | (1.2) | | | 0.8 | | | (2.6) | | | (0.1) | |
Transaction, integration, and other acquisition-related costs | (0.5) | | | — | | | (0.7) | | | — | |
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Other gains (losses) | 3.6 | | | (2.2) | | | 8.8 | | | 1.1 | |
Total selling, general, and administrative expenses | (23.2) | | | (6.3) | | | (23.7) | | | (6.2) | |
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Impairment of brewery construction in progress | — | | | — | | | — | | | (665.9) | |
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Comparable Adjustments, Operating income (loss) | $ | (69.6) | | | $ | 8.9 | | | $ | (45.7) | | | $ | (638.8) | |
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Income (loss) from unconsolidated investments | $ | (1,685.5) | | | $ | (439.6) | | | $ | (1,820.9) | | | $ | (1,295.2) | |
Cost of product sold
Undesignated commodity derivative contracts
Net gain (loss) on undesignated commodity derivative contracts represents a net gain (loss) from the changes in fair value of undesignated commodity derivative contracts. The net gain (loss) is reported outside of segment operating results until such time that the underlying exposure is recognized in the segment operating results. At settlement, the net gain (loss) from the changes in fair value of the undesignated commodity derivative contracts is reported in the appropriate operating segment, allowing the results of our operating segments to reflect the economic effects of the commodity derivative contracts without the resulting unrealized mark to fair value volatility.
Selling, general, and administrative expenses
Costs associated with the Reclassification
We recognized costs primarily related to professional and consulting fees and all filing and other fees paid to the SEC in connection with the Reclassification. For additional information, refer to Note 10.
Transition services agreements activity
We recognized costs in connection with transition services agreements related to the previous sale of a portion of our wine and spirits business.
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 36 |
Other gains (losses)
We recognized other gains (losses) primarily from (i) a gain recognized on the remeasurement of our previously held equity interest in Austin Cocktails to the acquisition-date fair value (Six Months 2023) and (ii) a decrease in estimated fair value of a contingent liability associated with a prior period acquisition (Second Quarter 2023, Six Months 2023).
Impairment of brewery construction in progress
We recognized an impairment of long-lived assets in connection with certain assets at the Mexicali Brewery. For additional information, refer to Note 4.
Income (loss) from unconsolidated investments
We recognized an unrealized gain (loss) primarily from (i) an impairment of our Canopy Equity Method Investment (Second Quarter 2023, Six Months 2023), (ii) equity in earnings (losses) from Canopy’s results, and (iii) the changes in fair value of our securities measured at fair value. For additional information, refer to Notes 4 and 7.
Business Segments
Second Quarter 2023 compared to Second Quarter 2022
Net sales
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| Second Quarter 2023 | | Second Quarter 2022 | | Dollar Change | | Percent Change |
(in millions) | | | | | | | |
Beer | $ | 2,139.3 | | | $ | 1,861.3 | | | $ | 278.0 | | | 15 | % |
Wine and Spirits: | | | | | | | |
Wine | 442.0 | | | 447.2 | | | (5.2) | | | (1 | %) |
Spirits | 73.8 | | | 62.6 | | | 11.2 | | | 18 | % |
Total Wine and Spirits | 515.8 | | | 509.8 | | | 6.0 | | | 1 | % |
Canopy | 86.3 | | | 110.8 | | | (24.5) | | | (22 | %) |
Consolidation and eliminations | (86.3) | | | (110.8) | | | 24.5 | | | 22 | % |
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Consolidated net sales | $ | 2,655.1 | | | $ | 2,371.1 | | | $ | 284.0 | | | 12 | % |
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| Beer segment | Second Quarter 2023 | | Second Quarter 2022 | | Dollar Change | | Percent Change |
(in millions, branded product, 24-pack, 12-ounce case equivalents) |
Net sales | $ | 2,139.3 | | | $ | 1,861.3 | | | $ | 278.0 | | | 15 | % |
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Shipments | 113.2 | | | 101.0 | | | | | 12.1 | % |
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Depletions | | | | | | | 8.9 | % |
The increase in Beer net sales is largely due to (i) $226.3 million of shipment volume growth within our Mexican beer portfolio, which benefited from continued consumer demand, and (ii) $67.5 million of favorable impact from pricing in select markets within our Mexican beer portfolio, partially offset by $13.8 million of unfavorable product mix primarily from a shift in package types.
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 37 |
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| Wine and Spirits segment | Second Quarter 2023 | | Second Quarter 2022 | | Dollar Change | | Percent Change |
(in millions, branded product, 9-liter case equivalents) | | | | | | |
Net sales | $ | 515.8 | | | $ | 509.8 | | | $ | 6.0 | | | 1 | % |
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Shipments | | | | | | | |
Total | 7.4 | | | 7.4 | | | | | — | % |
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U.S. Domestic | 6.4 | | | 6.3 | | | | | 1.6 | % |
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Depletions | | | | | | | (2.2 | %) |
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The increase in Wine and Spirits net sales is due to (i) a $4.5 million increase in non-branded net sales primarily from bulk spirits and (ii) $1.8 million of favorable impact from pricing. For the remainder of Fiscal 2023, we expect U.S. depletion volume to exceed U.S. shipment volume.
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| Canopy segment Our ownership interest in Canopy allows us to exercise significant influence, but not control, and, therefore, we account for our investment in Canopy under the equity method. Amounts included for the Canopy segment represent 100% of Canopy’s reported results on a two-month lag. Accordingly, we recognized our share of Canopy’s earnings (losses) for the periods (i) April through June 2022, in our Second Quarter 2023 results, (ii) April through June 2021, in our Second Quarter 2022, (iii) January through June 2022, in our Six Months 2023 results, and (iv) January through June 2021, in our Six Months 2022 results. Although we own less than 100% of the outstanding shares of Canopy, 100% of its results are included and subsequently eliminated to reconcile to our consolidated financial statements. See “Income (loss) from unconsolidated investments” below for a discussion of Canopy’s net sales, gross profit (loss), selling, general, and administrative expenses, and operating income (loss). This discussion is based on information Canopy has publicly disclosed. |
Gross profit
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| Second Quarter 2023 | | Second Quarter 2022 | | Dollar Change | | Percent Change |
(in millions) | | | | | | | |
Beer | $ | 1,147.6 | | | $ | 984.0 | | | $ | 163.6 | | | 17 | % |
Wine and Spirits | 224.7 | | | 230.5 | | | (5.8) | | | (3 | %) |
Canopy | (1.1) | | | 22.2 | | | (23.3) | | | (105 | %) |
Consolidation and eliminations | 1.1 | | | (22.2) | | | 23.3 | | | 105 | % |
Comparable Adjustments | (46.4) | | | 15.2 | | | (61.6) | | | NM |
Consolidated gross profit | $ | 1,325.9 | | | $ | 1,229.7 | | | $ | 96.2 | | | 8 | % |
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 38 |
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| The increase in Beer is primarily due to $120.5 million of shipment volume growth and the $67.5 million favorable impact from pricing, partially offset by $19.1 million of unfavorable product mix and $7.0 million of higher cost of product sold. The higher cost of product sold is largely due to (i) $62.6 million of higher material costs, including aluminum, glass, cartons, pallets, malt, steel, and corn, driven by inflation and global supply chain constraints, (ii) a $6.5 million increase in brewery costs primarily driven by increased maintenance, utilities, and administrative costs, and (iii) $4.8 million of increased transportation costs, largely offset by (i) $62.9 million of decreased obsolescence primarily from excess inventory of hard seltzers resulting from a slowdown in the overall category in Fiscal 2022 and (ii) $4.4 million of favorable fixed cost absorption related to increased production levels as compared to Second Quarter 2022. |
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| The decrease in Wine and Spirits gross profit is primarily due to $20.5 million of higher cost of product sold, driven by global supply chain constraints and inflation, partially offset by (i) $13.1 million of higher non-branded gross profit and (ii) the $1.8 million favorable impact from pricing. The increase in cost of product sold was largely attributable to (i) increased transportation and warehousing costs, including ocean freight shipping, and (ii) higher material costs, including grapes and glass, partially offset by favorable fixed cost absorption as a result of the Second Quarter 2022 impact of a late frost in New Zealand and the 2020 U.S. wildfires. |
Gross profit as a percent of net sales decreased to 49.9% for Second Quarter 2023 compared with 51.9% for Second Quarter 2022. This decrease was largely due to (i) an unfavorable change of approximately 230 basis points in Comparable Adjustments, (ii) approximately 75 basis points and 25 basis points of rate declines from cost of product sold within the Wine and Spirits and Beer segments, respectively, driven by the increase in operational and logistics costs, and (iii) 45 basis points related to unfavorable product mix shift within the Beer segment, partially offset by (i) approximately 120 basis points of favorable impact from Beer pricing in select markets and (ii) 40 basis points of favorable impact from non-branded product within the Wine and Spirits segment.
Selling, general, and administrative expenses
| | | | | | | | | | | | | | | | | | | | | | | |
| Second Quarter 2023 | | Second Quarter 2022 | | Dollar Change | | Percent Change |
(in millions) | | | | | | | |
Beer | $ | 282.0 | | | $ | 291.0 | | | $ | (9.0) | | | (3 | %) |
Wine and Spirits | 125.3 | | | 130.3 | | | (5.0) | | | (4 | %) |
Corporate Operations and Other | 82.3 | | | 62.9 | | | 19.4 | | | 31 | % |
Canopy | 1,438.7 | | | 175.0 | | | 1,263.7 | | | NM |
Consolidation and eliminations | (1,438.7) | | | (175.0) | | | (1,263.7) | | | NM |
Comparable Adjustments | 23.2 | | | 6.3 | | | 16.9 | | | NM |
Consolidated selling, general, and administrative expenses | $ | 512.8 | | | $ | 490.5 | | | $ | 22.3 | | | 5 | % |
| | | | | |
| The decrease in Beer is driven by $9.5 million of decreased marketing spend due largely to a timing shift for media to the second half of Fiscal 2023, partially offset by planned event sponsorships to support the growth of our Mexican beer portfolio. We expect marketing spend to range from 9% to 10% of net sales for Fiscal 2023. General and administrative expenses remained flat as decreased legal expenses were offset by (i) higher compensation and benefits, primarily related to incremental headcount to support the growth of our Mexican beer portfolio, (ii) unfavorable foreign currency transaction losses, and (iii) higher travel as compared to Second Quarter 2022. |
| | | | | |
Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 39 |
| | | | | |
| The decrease in Wine and Spirits is primarily due to an $8.2 million decrease in marketing spend, driven by timing, partially offset by $4.3 million of increased general and administrative expenses. The increase in general and administrative expenses was largely driven by compensation and benefits, primarily related to higher headcount as compared to Second Quarter 2022, expenses associated with an initiative to improve our marketing effectiveness, and higher travel as compared to Second Quarter 2022, partially offset by favorable foreign currency impact. We expect marketing spend to range from 9% to 10% of net sales for Fiscal 2023. |
| | | | | |
| The increase in Corporate Operations and Other is primarily due to approximately (i) a $16 million increase in third-party services, driven by Digital Business Acceleration investments, and (ii) a $3 million increase in compensation and benefits as compared to Second Quarter 2022. |
Selling, general, and administrative expenses as a percent of net sales decreased to 19.3% for Second Quarter 2023 as compared to 20.7% for Second Quarter 2022. The decrease is driven by approximately 275 basis points and 30 basis points of rate decline from the decreases in Beer and Wine and Spirits’ selling, general, and administrative expenses, respectively, partially offset by approximately 90 basis points of rate growth from an increase in the Corporate Operations and Other segment’s selling, general, and administrative expenses and an unfavorable change in Comparable Adjustments, contributing approximately 75 basis points of rate growth.
Operating income (loss)
| | | | | | | | | | | | | | | | | | | | | | | |
| Second Quarter 2023 | | Second Quarter 2022 | | Dollar Change | | Percent Change |
(in millions) | | | | | | | |
Beer | $ | 865.6 | | | $ | 693.0 | | | $ | 172.6 | | | 25 | % |
Wine and Spirits | 99.4 | | | 100.2 | | | (0.8) | | | (1 | %) |
Corporate Operations and Other | (82.3) | | | (62.9) | | | (19.4) | | | (31 | %) |
Canopy | (1,439.8) | | | (152.8) | | | (1,287.0) | | | NM |
Consolidation and eliminations | 1,439.8 | | | 152.8 | | | 1,287.0 | | | NM |
Comparable Adjustments | (69.6) | | | 8.9 | | | (78.5) | | | NM |
Consolidated operating income (loss) | $ | 813.1 | | | $ | 739.2 | | | $ | 73.9 | | | 10 | % |
| | | | | |
| The increase in Beer is largely attributable to the strong shipment volume growth within our Mexican beer portfolio, favorable pricing impact, and decreased obsolescence, partially offset by the higher operational costs, as described above, and the unfavorable product mix shift. |
| | | | | |
| The decrease in Wine and Spirits is largely attributable to the increase in cost of product sold, driven by global supply chain constraints and inflation, and increased general and administrative expenses, as described above, largely offset by higher non-branded net sales, the lower marketing spend, and favorable impact from pricing. |
| | | | | |
| As previously discussed, the Corporate Operations and Other increase in operating loss is largely due to the Second Quarter 2023 Digital Business Acceleration investments and increased compensation and benefits. |
| | | | | |
Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 40 |
Income (loss) from unconsolidated investments
General
| | | | | | | | | | | | | | | | | | | | | | | |
| Second Quarter 2023 | | Second Quarter 2022 | | Dollar Change | | Percent Change |
(in millions) | | | | | | | |
Impairment of Canopy Equity Method Investment | $ | (1,060.3) | | | $ | — | | | $ | (1,060.3) | | | NM |
Unrealized net gain (loss) on securities measured at fair value | (9.3) | | | (590.0) | | | 580.7 | | | 98 | % |
Equity in earnings (losses) from Canopy and related activities (1) | (650.7) | | | 120.5 | | | (771.2) | | | NM |
Equity in earnings (losses) from other equity method investees | 1.2 | | | (1.3) | | | 2.5 | | | NM |
| | | | | | | |
| $ | (1,719.1) | | | $ | (470.8) | | | $ | (1,248.3) | | | NM |
(1)Includes $460.8 million of a goodwill impairment related to Canopy’s cannabis operations for Second Quarter 2023 and $45.4 million of costs designed to improve their organizational focus, streamline operations, and align production capability with projected demand for Second Quarter 2022.
For additional information regarding our equity method investments, refer to Notes 4 and 7.
| | | | | |
| Canopy segment Canopy net sales decreased to $86.3 million for Second Quarter 2023 from $110.8 million for Second Quarter 2022. This decrease of $24.5 million, or 22%, is largely attributable to lower global cannabis sales. The decline in global cannabis sales primarily resulted from (i) a decrease in Canadian recreational cannabis sales, largely driven by continuing impacts of price compression resulting from increased competition and Canopy’s strategic decision to shift their focus to higher-margin, premium and mainstream products and (ii) a decrease in medicinal sales driven by the January 2022 divestiture of C3, an international pharmaceutical business. These declines were partially offset by Canadian THC recreational sales driven by Canopy’s Fiscal 2022 acquisition of Supreme Cannabis Company, Inc. Additionally, other consumer products sales in Second Quarter 2023 as compared to Second Quarter 2022 were flat, as growth in their BioSteel Sports Nutrition Inc. business was largely offset by declines in their Storz & Bickel GmbH & Co. KG and This Works Products Limited businesses. Canopy gross profit (loss) decreased to $(1.1) million for Second Quarter 2023 from $22.2 million for Second Quarter 2022. This decrease of $23.3 million is primarily driven by (i) decreased net sales, (ii) price compression and unfavorable cost absorption in the Canadian recreational channel, (iii) unfavorable product mix shift, and (iv) a decrease in payroll subsidies received from the Canadian government in Second Quarter 2022 pursuant to a COVID-19 relief program. Canopy selling, general, and administrative expenses increased $1,263.7 million driven by a goodwill impairment related to their cannabis operations. The combination of these factors were the main contributors to the increase in operating loss of $1,287.0 million. |
Interest expense
Interest expense decreased to $94.3 million for Second Quarter 2023 as compared to $95.8 million for Second Quarter 2022. This decrease of $1.5 million, or 2%, is due to an increase in capitalized interest in connection with the Mexico Beer Projects, largely offset by higher average borrowings of $345 million and approximately five basis points of higher weighted average interest rates.
Loss on extinguishment of debt
Loss on extinguishment of debt consist of make-whole payments in connection with the early redemption of our (i) 3.20% February 2018 Senior Notes and 4.25% May 2013 Senior Notes (Second Quarter 2023) and (ii) 2.70% May 2017 Senior Notes and 2.65% November 2017 Senior Notes (Second Quarter 2022).
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 41 |
(Provision for) benefit from income taxes
The provision for income taxes increased to $132.4 million for Second Quarter 2023 from $131.3 million for Second Quarter 2022. Our effective tax rate for Second Quarter 2023 was (13.1)% as compared with 91.7% for Second Quarter 2022. In comparison to prior year, our income taxes were impacted primarily by:
•an increase in the valuation allowance related to our investment in Canopy; partially offset by
•a net income tax benefit recognized from the realization of tax losses related to a prior period divestiture.
For additional information, refer to Note 9.
Net income (loss) attributable to CBI
Net income (loss) attributable to CBI decreased to $(1,151.2) million for Second Quarter 2023 from $1.5 million for Second Quarter 2022. This decrease of $1,152.7 million is largely attributable to (i) the impairment of our Canopy Equity Method Investment and (ii) the increase in equity in losses from Canopy’s results, partially offset by (i) the decrease in unrealized net loss from the changes in fair value of our investment in Canopy and (ii) improvements within the Beer segment.
Six Months 2023 compared to Six Months 2022
Net sales
| | | | | | | | | | | | | | | | | | | | | | | |
| Six Months 2023 | | Six Months 2022 | | Dollar Change | | Percent Change |
(in millions) | | | | | | | |
Beer | $ | 4,037.5 | | | $ | 3,433.3 | | | $ | 604.2 | | | 18 | % |
Wine and Spirits: | | | | | | | |
Wine | 846.1 | | | 844.9 | | | 1.2 | | | — | % |
Spirits | 134.7 | | | 119.4 | | | 15.3 | | | 13 | % |
Total Wine and Spirits | 980.8 | | | 964.3 | | | 16.5 | | | 2 | % |
Canopy | 174.5 | | | 228.1 | | | (53.6) | | | (23 | %) |
Consolidation and eliminations | (174.5) | | | (228.1) | | | 53.6 | | | 23 | % |
| | | | | | | |
Consolidated net sales | $ | 5,018.3 | | | $ | 4,397.6 | | | $ | 620.7 | | | 14 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Beer segment | Six Months 2023 | | Six Months 2022 | | Dollar Change | | Percent Change |
(in millions, branded product, 24-pack, 12-ounce case equivalents) |
Net sales | $ | 4,037.5 | | | $ | 3,433.3 | | | $ | 604.2 | | | 18 | % |
| | | | | | | | |
| | | | | | | |
Shipments | 212.7 | | | 185.8 | | | | | 14.5 | % |
| | | | | | | |
| | | | | | | | |
Depletions | | | | | | | 8.8 | % |
The increase in Beer net sales is largely due to (i) $500.6 million of shipment volume growth within our Mexican beer portfolio, which benefited from continued consumer demand, and (ii) $131.8 million of favorable impact from pricing in select markets within our Mexican beer portfolio, partially offset by $24.8 million of unfavorable product mix primarily from a shift in package types.
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 42 |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Wine and Spirits segment | Six Months 2023 | | Six Months 2022 | | Dollar Change | | Percent Change |
(in millions, branded product, 9-liter case equivalents) | | | | | | |
Net sales | $ | 980.8 | | | $ | 964.3 | | | $ | 16.5 | | | 2 | % |
| | | | | | | | |
Shipments | | | | | | | |
Total | 14.2 | | | 14.1 | | | | | 0.7 | % |
| | | | | | | |
| | | | | | | | |
U.S. Domestic | 12.2 | | | 12.3 | | | | | (0.8 | %) |
| | | | | | | |
| | | | | | | | |
| | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | |
Depletions | | | | | | | (0.8 | %) |
| | | | | | | |
The increase in Wine and Spirits net sales is due to (i) $11.2 million of favorable impact from pricing, (ii) a $3.1 million increase in branded wine and spirits volume, and (iii) a $2.2 million increase in non-branded net sales primarily from bulk spirits. The increase in net sales was hindered by global supply chain constraints.
Gross profit
| | | | | | | | | | | | | | | | | | | | | | | |
| Six Months 2023 | | Six Months 2022 | | Dollar Change | | Percent Change |
(in millions) | | | | | | | |
Beer | $ | 2,167.1 | | | $ | 1,877.7 | | | $ | 289.4 | | | 15 | % |
Wine and Spirits | 435.8 | | | 438.0 | | | (2.2) | | | (1 | %) |
Canopy | (126.8) | | | 29.9 | | | (156.7) | | | NM |
Consolidation and eliminations | 126.8 | | | (29.9) | | | 156.7 | | | NM |
Comparable Adjustments | (22.0) | | | 33.3 | | | (55.3) | | | (166 | %) |
Consolidated gross profit | $ | 2,580.9 | | | $ | 2,349.0 | | | $ | 231.9 | | | 10 | % |
| | | | | |
| The increase in Beer is primarily due to $275.5 million of shipment volume growth and the $131.8 million of favorable impact from pricing, partially offset by $82.8 million of higher cost of product sold and $35.7 million of unfavorable product mix. The higher cost of product sold is largely due to (i) $106.5 million of higher material costs, including aluminum, pallets, cartons, glass, malt, steel, and corn, driven by inflation and global supply chain constraints, (ii) $21.6 million of higher depreciation, (iii) $19.7 million of increased transportation costs, and (iv) a $19.5 million increase in brewery costs primarily driven by increased maintenance, utilities, and administrative costs, largely offset by (i) $70.3 million of decreased obsolescence primarily from excess inventory of hard seltzers resulting from a slowdown in the overall category in Fiscal 2022 and (ii) $18.6 million of favorable fixed cost absorption related to increased production levels as compared to Six Months 2022. |
| | | | | |
| The decrease in Wine and Spirits gross profit is due to $30.4 million of higher cost of product sold, driven by global supply chain constraints and inflation, partially offset by (i) $15.7 million related to an increase of non-branded gross profit and (ii) the $11.2 million favorable impact from pricing. The increase in cost of product sold was largely attributable to (i) increased transportation and warehousing costs, including ocean freight shipping, and (ii) higher material costs, including grapes and glass, partially offset by favorable fixed cost absorption as a result of a late frost in New Zealand impacting Six Months 2022. |
Gross profit as a percent of net sales decreased to 51.4% for Six Months 2023 compared with 53.4% for Six Months 2022. This decrease was largely due to (i) approximately 160 basis points and 60 basis points of rate decline from cost of product sold within the Beer and Wine and Spirits segments, respectively, driven by the increase in operational and logistics costs, (ii) an unfavorable change of approximately 110 basis points in Comparable Adjustments, and (iii) approximately 45 basis points related to unfavorable product mix shift within the Beer segment, partially offset by (i) approximately 115 basis points of favorable impact from Beer pricing in
| | | | | |
Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 43 |
select markets, (ii) approximately 30 basis points of favorable impact from non-branded product within the Wine and Spirits segment, and (iii) approximately 15 basis points of rate growth from volume within the Beer segment.
Selling, general, and administrative expenses
| | | | | | | | | | | | | | | | | | | | | | | |
| Six Months 2023 | | Six Months 2022 | | Dollar Change | | Percent Change |
(in millions) | | | | | | | |
Beer | $ | 538.7 | | | $ | 511.6 | | | $ | 27.1 | | | 5 | % |
Wine and Spirits | 245.4 | | | 233.6 | | | 11.8 | | | 5 | % |
Corporate Operations and Other | 143.6 | | | 117.4 | | | 26.2 | | | 22 | % |
Canopy | 1,731.2 | | | 366.9 | | | 1,364.3 | | | NM |
Consolidation and eliminations | (1,731.2) | | | (366.9) | | | (1,364.3) | | | NM |
Comparable Adjustments | 23.7 | | | 6.2 | | | 17.5 | | | NM |
Consolidated selling, general, and administrative expenses | $ | 951.4 | | | $ | 868.8 | | | $ | 82.6 | | | 10 | % |
| | | | | |
| The increase in Beer is primarily due to $15.0 million of increased general and administrative expenses and $12.1 million of higher marketing spend. The increase in general and administrative expenses was primarily driven by compensation and benefits, primarily related to incremental headcount to support the growth of our Mexican beer portfolio, strategic asset relocation, and higher travel as compared to Six Months 2022, partially offset by decreased legal expenses and favorable foreign currency transaction gains. The higher marketing spend was driven by our planned investments to support the growth of our Mexican beer portfolio. |
| | | | | |
| The increase in Wine and Spirits is primarily due to $17.1 million of increased general and administrative expenses, partially offset by $3.5 million of lower marketing spend, driven by timing. The increase in general and administrative expenses was primarily driven by compensation and benefits, primarily related to higher headcount as compared to Six Months 2022, expenses associated with an initiative to improve our marketing effectiveness, and higher travel as compared to Six Months 2022, partially offset by favorable foreign currency impact. |
| | | | | |
| The increase in Corporate Operations and Other is largely due to approximately (i) a $27 million increase in third-party services, driven by our Digital Business Acceleration investments, and (ii) a $5 million increase in compensation and benefits as compared to Six Months 2022, partially offset by a decrease of approximately $6 million resulting from the completion of an ERP implementation in Fiscal 2022. |
Selling, general, and administrative expenses as a percent of net sales decreased to 19.0% for Six Months 2023 as compared with 19.8% for Six Months 2022. The decrease is driven largely by approximately 245 basis points of rate decline as the increase in Beer net sales exceeded the increase in selling, general, and administrative expenses, partially offset by (i) approximately 80 basis points of rate growth from an increase in the Corporate Operations and Other segments selling, general, and administrative expenses, (ii) the unfavorable change in Comparable Adjustments, contributing 55 basis points of rate growth, and (iii) approximately 30 basis points of rate growth from the increase in Wine and Spirits selling, general, and administrative expenses exceeding the increase in net sales.
| | | | | |
Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 44 |
Operating income (loss)
| | | | | | | | | | | | | | | | | | | | | | | |
| Six Months 2023 | | Six Months 2022 | | Dollar Change | | Percent Change |
(in millions) | | | | | | | |
Beer | $ | 1,628.4 | | | $ | 1,366.1 | | | $ | 262.3 | | | 19 | % |
Wine and Spirits | 190.4 | | | 204.4 | | | (14.0) | | | (7 | %) |
Corporate Operations and Other | (143.6) | | | (117.4) | | | (26.2) | | | (22 | %) |
Canopy | (1,858.0) | | | (337.0) | | | (1,521.0) | | | NM |
Consolidation and eliminations | 1,858.0 | | | 337.0 | | | 1,521.0 | | | NM |
Comparable Adjustments | (45.7) | | | (638.8) | | | 593.1 | | | 93 | % |
Consolidated operating income (loss) | $ | 1,629.5 | | | $ | 814.3 | | | $ | 815.2 | | | 100 | % |
| | | | | |
| The increase in Beer is largely attributable to the strong shipment volume growth within our Mexican beer portfolio, favorable pricing impact, and decreased obsolescence, partially offset by higher operational costs, general and administrative expenses, and marketing spend, as described above, and the unfavorable product mix shift. |
| | | | | |
| The decrease in Wine and Spirits is largely attributable to global supply chain constraints, inflation, and increased general and administrative expenses, as described above, partially offset by the increase in non-branded net sales and the favorable pricing impact. |
| | | | | |
| As previously discussed, the Corporate Operations and Other increase in operating loss is largely due to the Six Months 2022 Digital Business Acceleration investments and increased compensation and benefits, partially offset by the decrease in ERP-related consulting services. |
Income (loss) from unconsolidated investments
General
| | | | | | | | | | | | | | | | | | | | | | | |
| Six Months 2023 | | Six Months 2022 | | Dollar Change | | Percent Change |
(in millions) | | | | | | | |
Impairment of Canopy Equity Method Investment | $ | (1,060.3) | | | $ | — | | | $ | (1,060.3) | | | NM |
Unrealized net gain (loss) on securities measured at fair value | (31.7) | | | (1,335.1) | | | 1,303.4 | | | 98 | % |
Equity in earnings (losses) from Canopy and related activities (1) | (815.7) | | | (35.3) | | | (780.4) | | | NM |
Equity in earnings (losses) from other equity method investees | 0.7 | | | 0.4 | | | 0.3 | | | 75 | % |
| | | | | | | |
| $ | (1,907.0) | | | $ | (1,370.0) | | | $ | (537.0) | | | (39 | %) |
(1)Includes $460.8 million of a goodwill impairment related to Canopy’s cannabis operations for Six Months 2023. Also includes $102.7 million and $70.0 million of costs designed to improve their organizational focus, streamline operations, and align production capability with projected demand for Six Months 2023 and Six Months 2022, respectively.
For additional information regarding our equity method investments, refer to Notes 4 and 7.
| | | | | |
Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 45 |
| | | | | |
| Canopy segment Canopy net sales decreased to $174.5 million for Six Months 2023 from $228.1 million for Six Months 2022. This decrease of $53.6 million, or 23%, is largely attributable to lower global cannabis sales. The decline in global cannabis sales primarily resulted from (i) a decrease in Canadian recreational cannabis sales, largely driven by Canopy’s strategic decision to shift their focus to higher-margin, premium and mainstream products and the continuing impacts of price compression resulting from increased competition and (ii) a decrease in medicinal sales driven by the January 2022 divestiture of C3, an international pharmaceutical business. These declines were partially offset by growth in Canadian THC recreational sales driven by Canopy’s Fiscal 2022 acquisitions including the Supreme Cannabis Company, Inc. and AV Cannabis Inc. (“Ace Valley”). Additionally, other consumer products sales in Six Months 2023 as compared to Six Months 2022 were flat, as growth in their BioSteel Sports Nutrition Inc. business was largely offset by declines in their Storz & Bickel GmbH & Co. KG and This Works Products Limited businesses. Canopy gross profit (loss) decreased to $(126.8) million for Six Months 2023 from $29.9 million for Six Months 2022. This decrease of $156.7 million is primarily driven by (i) the write-down of excess inventory balances related to its organizational and strategic review of its business, (ii) decreased net sales and price compression in the Canadian recreational channel, (iii) higher shipping, distribution, and warehousing costs in North America, and (iv) unfavorable product mix shift. Canopy selling, general, and administrative expenses increased $1,364.3 million largely driven by a goodwill impairment related to their cannabis operations and restructuring costs for Six Months 2023, partially offset by a continued focus on reducing costs and the closure of certain research and development facilities in Fiscal 2022. The combination of these factors were the main contributors to the $1,521.0 million increase in operating loss. |
Interest expense
Interest expense remained relatively flat at $182.8 million for Six Months 2023 as compared to $182.5 million for Six Months 2022 as approximately $220 million of higher average borrowings were largely offset by an increase in capitalized interest in connection with the Mexico Beer Projects.
Loss on extinguishment of debt
Loss on extinguishment of debt primarily consist of a premium payment and the write-off of debt issuance costs in connection with the May 2022 tender offers of our 3.20% February 2018 Senior Notes and 4.25% May 2013 Senior Notes (Six Months 2023) and make-whole payments in connection with the early redemption of our (i) 3.20% February 2018 Senior Notes and 4.25% May 2013 Senior Notes (Six Months 2023) and (ii) 2.70% May 2017 Senior Notes and 2.65% November 2017 Senior Notes (Six Months 2022).
(Provision for) benefit from income taxes
The provision for income taxes increased to $257.8 million for Six Months 2023 from $117.8 million for Six Months 2022. Our effective tax rate for Six Months 2023 was (53.3)% as compared with (15.3)% for Six Months 2022. In comparison to prior year, our income taxes were impacted primarily by:
•an increase in the valuation allowance related to our investment in Canopy;
•the effective tax rates applicable to our foreign businesses, including the impact of the Six Months 2022 long-lived asset impairment of brewery construction in progress; partially offset by
•a net income tax benefit recognized from the realization of tax losses related to a prior period divestiture.
For additional information, refer to Note 9.
We expect our reported effective tax rate for Fiscal 2023 to be in the range of 70% to 72%. Since estimates are not currently available, this range does not reflect any future changes in the fair value of our Canopy investment measured at fair value and any future equity in earnings (losses) from the Canopy Equity Method Investment and related activities.
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 46 |
Net income (loss) attributable to CBI
Net loss attributable to CBI decreased to $761.7 million for Six Months 2023 from $906.6 million for Six Months 2022. This decrease of $144.9 million, or 16%, is largely attributable to (i) a decrease in unrealized net loss from the changes in fair value of our investment in Canopy, (ii) the impairment of long-lived assets for Six Months 2022 in connection with certain assets at the Mexicali Brewery, and (iii) the improvements within the Beer segment, partially offset by (i) the impairment of our Canopy Equity Method Investment, (ii) the increase in equity losses from Canopy’s results, and (iii) the increase in the provision for income taxes.
Liquidity and Capital Resources
General
Our primary source of liquidity has been cash flow from operating activities. Our ability to consistently generate robust cash flow from our operations is one of our most significant financial strengths; it enables us to invest in our people and our brands, make capital investments and strategic acquisitions, provide a cash dividend program, and from time-to-time, repurchase shares of our common stock. Our largest use of cash in our operations is for purchasing and carrying inventories and carrying seasonal accounts receivable. Historically, we have used this cash flow to repay our short-term borrowings and fund capital expenditures. Additionally, our commercial paper program is used to fund our short-term borrowing requirements and to maintain our access to the capital markets. We use our short-term borrowings, including our commercial paper program, to support our working capital requirements and capital expenditures.
We seek to maintain adequate liquidity to meet working capital requirements, fund capital expenditures, and repay scheduled principal and interest payments on debt. Absent deterioration of market conditions, we believe that cash flows from operating and financing activities will provide adequate resources to satisfy our working capital, scheduled principal and interest payments on debt, anticipated dividend payments, periodic share repurchases, and anticipated capital expenditure requirements for both our short-term and long-term capital needs.
We expect the Reclassification may require significant cash outlays in the near-term. If the Reclassification is completed, each share of Class B Stock issued and outstanding immediately prior to the Effective Time will be reclassified and converted into one share of Class A Stock and the right to receive $64.64 in cash, without interest. We expect the aggregate cash payment to holders of Class B Stock at the Effective Time will be $1.5 billion. In addition, we have incurred $21.3 million of non-recurring costs and expenses for Six Months 2023 and will continue to incur substantial non-recurring costs and expenses in connection with the negotiation and completion of the Reclassification. In August 2022, we entered into a $1.0 billion delayed draw three-year term loan facility to partially fund the aggregate cash payment to holders of Class B Stock. We expect to also finance up to $500 million of short-term debt, which may be in the form of commercial paper or borrowings under our revolving credit facility to fund the remainder of the aggregate cash payment to holders of Class B Stock. In addition to our commercial paper program and revolving credit facility, we also have historically had access to obtain additional financing through the issuance of long-term debt, and we expect to continue to have the ability to do so. Given that we expect to use drawings under the August 2022 Term Credit Agreement to finance a portion of the $1.5 billion cash payment to the holders of Class B Stock and the other potential sources of funding described above, we do not expect the Reclassification to have a material impact on our liquidity and we do not presently have any alternative financing plans.
We have an agreement with a financial institution for payable services and plan to facilitate a voluntary supply chain finance program through this participating financial institution in Fiscal 2023. The program will be available to certain of our suppliers allowing them the option to manage their cash flow. We will not be a party to the agreements between the participating financial institution and the suppliers in connection with the program. Our rights and obligations to our suppliers, including amounts due and scheduled payment terms, will not be impacted. We are still evaluating the impact of this program on future liquidity.
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 47 |
As of August 31, 2022, the exercise of the November 2018 Canopy Warrants would have required a cash outflow of approximately $5.7 billion based on the terms of the warrants. The exercise price for the November 2018 Canopy Warrants exceeded Canopy’s stock price as of August 31, 2022.
Cash Flows
| | | | | | | | | | | | | | | | | | | | | | | |
| Six Months 2023 | | Six Months 2022 | | Dollar Change | | Percent Change |
(in millions) | | | | | | | |
Net cash provided by (used in): | | | | | | | |
Operating activities | $ | 1,654.3 | | | $ | 1,525.9 | | | $ | 128.4 | | | 8 | % |
Investing activities | (486.0) | | | (377.1) | | | (108.9) | | | (29) | % |
Financing activities | (1,198.6) | | | (1,506.4) | | | 307.8 | | | 20 | % |
Effect of exchange rate changes on cash and cash equivalents | (4.0) | | | 0.4 | | | (4.4) | | | NM |
Net increase (decrease) in cash and cash equivalents | $ | (34.3) | | | $ | (357.2) | | | $ | 322.9 | | | 90 | % |
Operating activities
The increase in net cash provided by (used in) operating activities consists of:
| | | | | | | | | | | | | | | | | | | | | | | |
| Six Months 2023 | | Six Months 2022 | | Dollar Change | | Percent Change |
(in millions) | | | | | | | |
Net income (loss) | $ | (741.4) | | | $ | (885.4) | | | $ | 144.0 | | | 16 | % |
Unrealized net (gain) loss on securities measured at fair value | 31.7 | | | 1,335.1 | | | (1,303.4) | | | (98) | % |
Deferred tax provision (benefit) | 208.6 | | | (19.2) | | | 227.8 | | | NM |
Equity in (earnings) losses of equity method investees and related activities, net of distributed earnings | 815.6 | | | 35.3 | | | 780.3 | | | NM |
Impairment of Canopy Equity Method Investment | 1,060.3 | | | — | | | 1,060.3 | | | NM |
Impairment of brewery construction in progress | — | | | 665.9 | | | (665.9) | | | NM |
Other non-cash adjustments | 374.3 | | | 234.5 | | | 139.8 | | | 60 | % |
Change in operating assets and liabilities, net of effects from purchase and sale of business | (94.8) | | | 159.7 | | | (254.5) | | | (159) | % |
Net cash provided by (used in) operating activities | $ | 1,654.3 | | | $ | 1,525.9 | | | $ | 128.4 | | | 8 | % |
The net change in operating assets and liabilities was largely driven by (i) a net income tax benefit recognized from the realization of tax losses related to a prior period divestiture, (ii) an exclusivity payment received in connection with distribution arrangements for our U.S. wine and spirits brand portfolio in Six Months 2022, and (iii) accounts payable primarily attributable to the timing of payments for both the Beer and Wine and Spirits segments. These changes were partially offset by the timing of collections for (i) recoverable value-added taxes for the Beer segment and (ii) accounts receivable for the Wine and Spirits segment. Additionally, the overall increase in net cash provided by operating activities benefited from lower income tax payments in Six Months 2023 as compared to Six Months 2022.
Investing activities
Net cash used in investing activities increased to $486.0 million for Six Months 2023 from $377.1 million for Six Months 2022. This increase of $108.9 million was primarily due to $81.6 million of higher capital expenditures and $37.2 million of business acquisitions for Six Months 2023, consisting of Lingua Franca and Austin Cocktails.
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 48 |
Financing activities
The decrease in net cash provided by (used in) financing activities consists of:
| | | | | | | | | | | | | | | | | | | | | | | |
| Six Months 2023 | | Six Months 2022 | | Dollar Change | | Percent Change |
(in millions) | | | | | | | |
Net proceeds from (payments of) debt, current and long-term, and related activities | $ | 499.7 | | | $ | 96.0 | | | $ | 403.7 | | | NM |
Dividends paid | (295.3) | | | (289.3) | | | (6.0) | | | (2) | % |
Purchases of treasury stock | (1,400.5) | | | (1,305.0) | | | (95.5) | | | (7) | % |
Net cash provided by stock-based compensation activities | 20.0 | | | 13.1 | | | 6.9 | | | 53 | % |
Distributions to noncontrolling interests | (22.5) | | | (21.2) | | | (1.3) | | | (6) | % |
Net cash provided by (used in) financing activities | $ | (1,198.6) | | | $ | (1,506.4) | | | $ | 307.8 | | | 20 | % |
Debt
Total debt outstanding as of August 31, 2022, amounted to $10,950.2 million, an increase of $533.7 million from February 28, 2022. This increase consisted of:
| | | | | | | | | | | | | | | | | |
| | Debt repayment | | Debt issuance | |
Bank facilities
In August 2022, we entered into the August 2022 Term Credit Agreement. The August 2022 Term Credit Agreement provides for a $1.0 billion delayed single draw three-year term loan facility and is not subject to amortization payments, with the balance due and payable on the earliest of (i) three years after the funding date (as defined in the August 2022 Term Credit Agreement) and (ii) December 31, 2025.
In April 2022, we entered into the 2022 Restatement Agreement that amended and restated our then-existing senior credit facility. The 2022 Restatement Agreement resulted in (i) the refinance and increase of the existing revolving credit facility from $2.0 billion to $2.25 billion and extension of its maturity to April 14, 2027, (ii) the refinement of certain negative covenants, and (iii) the replacement of LIBOR rates with rates based on term SOFR. There are no borrowings outstanding under the 2022 Credit Agreement.
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 49 |
In April 2022, the Company and the Administrative Agent and Lender amended the June 2021 Term Credit Agreement. The principal changes effected by the April 2022 amendment were the refinement of certain negative covenants and replacement of LIBOR rates with rates based on term SOFR.
Senior notes
In May 2022, we issued the May 2022 Senior Notes. Proceeds from this offering, net of discount and debt issuance costs, of $1,837.4 million were used towards a series of cash tender offers, the June 2022 repayment of the 3.20% February 2018 Senior Notes and the 4.25% May 2013 Senior Notes, and for general corporate purposes, including working capital, funding capital expenditures, retirement of debt, and other business opportunities.
General
The majority of our outstanding borrowings as of August 31, 2022, consisted of fixed-rate senior unsecured notes, with maturities ranging from calendar 2024 to calendar 2050, and a variable-rate senior unsecured term loan facility under our April 2022 Term Credit Agreement with a calendar 2024 maturity date.
Additionally, we have a commercial paper program which provides for the issuance of up to an aggregate principal amount of $2.0 billion of commercial paper. Our commercial paper program is backed by unused commitments under our revolving credit facility under our 2022 Credit Agreement. Accordingly, outstanding borrowings under our commercial paper program reduce the amount available under our revolving credit facility.
We do not have purchase commitments from buyers for our commercial paper and, therefore, our ability to issue commercial paper is subject to market demand. If the commercial paper market is not available to us for any reason when commercial paper borrowings mature, we intend to utilize unused commitments under our revolving credit facility under our 2022 Credit Agreement to repay commercial paper borrowings. We do not expect that fluctuations in demand for commercial paper will affect our liquidity given our borrowing capacity available under our revolving credit facility.
We had the following remaining borrowing capacity available under our 2022 Credit Agreement:
| | | | | | | | | | | |
| August 31, 2022 | | September 30, 2022 |
(in millions) | | | |
Revolving credit facility (1) | $ | 1,573.5 | | | $ | 1,728.8 | |
| | | |
| | | |
(1)Net of outstanding revolving credit facility borrowings and outstanding letters of credit under our 2022 Credit Agreement and outstanding borrowings under our commercial paper program.
The financial institutions participating in our 2022 Credit Agreement have complied with prior funding requests and we believe they will comply with any future funding requests. However, there can be no assurances that any particular financial institution will continue to do so.
We and our subsidiaries are subject to covenants that are contained in our 2022 Credit Agreement, the April 2022 Term Credit Agreement, and the August 2022 Term Credit Agreement, including those restricting the incurrence of additional subsidiary indebtedness, additional liens, mergers and consolidations, transactions with affiliates, and sale and leaseback transactions, in each case subject to numerous conditions, exceptions, and thresholds. The financial covenants are limited to a minimum interest coverage ratio and a maximum net leverage ratio, both as defined in our 2022 Credit Agreement. As of August 31, 2022, under our 2022 Credit Agreement, the minimum interest coverage ratio was 2.5x and the maximum net leverage ratio was 4.0x.
The representations, warranties, covenants, and events of default set forth in our April 2022 Term Credit Agreement and August 2022 Term Credit Agreement are substantially similar to those set forth in our 2022 Credit Agreement.
Our indentures relating to our outstanding senior notes contain certain covenants, including, but not limited to: (i) a limitation on liens on certain assets, (ii) a limitation on certain sale and leaseback transactions, and
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 50 |
(iii) restrictions on mergers, consolidations, and the transfer of all or substantially all of our assets to another person.
As of August 31, 2022, we were in compliance with our covenants under our 2022 Credit Agreement, our April 2022 Term Credit Agreement, and our indentures, and have met all debt payment obligations.
For further discussion and presentation of our borrowings and available sources of borrowing, refer to Note 12 of our consolidated financial statements included in our 2022 Annual Report and Note 8.
Common Stock Dividends
On October 5, 2022, our Board of Directors declared a quarterly cash dividend of $0.80 per share of Class A Stock, $0.72 per share of Class B Stock, and $0.72 per share of Class 1 Stock payable on November 18, 2022, to stockholders of record of each class as of the close of business on November 4, 2022.
We currently expect to continue to pay a regular quarterly cash dividend to stockholders of our common stock in the future, but such payments are subject to approval of our Board of Directors and are dependent upon our financial condition, results of operations, capital requirements, and other factors, including those set forth under Item 1A. “Risk Factors” of our 2022 Annual Report as supplemented by the additional factors set forth under Item 1A. “Risk Factors” included in this Form 10-Q.
Share Repurchase Program
Our Board of Directors authorized the repurchase of up to $3.0 billion of our Class A Stock and Class B Stock under the 2018 Authorization and an additional repurchase of up to $2.0 billion of our Class A Stock and Class B Stock under the 2021 Authorization. The 2018 Authorization was fully utilized during the three months ended May 31, 2022, through a combination of open market transactions and an ASR that was announced in April 2022.
As of August 31, 2022, total shares repurchased under the 2018 Authorization and 2021 Authorization are as follows:
| | | | | | | | | | | | | | | | | | | |
| | | Class A Common Shares | | |
| Repurchase Authorization | | Dollar Value of Shares Repurchased | | Number of Shares Repurchased | | |
(in millions, except share data) | | | | | | | |
| | | | | | | |
2018 Authorization | $ | 3,000.0 | | | $ | 3,000.0 | | | 13,331,156 | | |
2021 Authorization | $ | 2,000.0 | | | $ | 836.9 | | | 3,463,417 | | |
Share repurchases under the 2021 Authorization may be accomplished at management’s discretion from time to time based on market conditions, our cash and debt position, and other factors as determined by management. Shares may be repurchased through open market or privately negotiated transactions. We may fund future share repurchases with cash generated from operations and/or proceeds from borrowings. Any repurchased shares become treasury shares, including shares repurchased under the 2018 Authorization and the 2021 Authorization.
We currently expect to continue to repurchase shares in the future, but such repurchases are dependent upon our financial condition, results of operations, capital requirements, and other factors, including those set forth under Item 1A. “Risk Factors” of our 2022 Annual Report as supplemented by the additional factors set forth under Item 1A. “Risk Factors” included in this Form 10-Q.
For additional information, refer to Note 17 of our consolidated financial statements included in our 2022 Annual Report and Note 10.
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 51 |
Accounting Guidance
Accounting guidance adopted for Six Months 2023 did not have a material impact on our Financial Statements.
Information Regarding Forward-Looking Statements
This Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. These forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond our 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 fact included in this Form 10-Q are forward-looking statements, including without limitation:
•The statements under Part I - Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” regarding:
◦our business strategy, future operations, innovation, and Digital Business Acceleration strategies, new products, future financial position and liquidity, future net sales, expected volume, inventory, and depletion trends, future marketing spend, long-term financial model, including our targeted net leverage ratio, future effective tax rates and anticipated tax liabilities, access to capital markets, and prospects, plans, and objectives of management;
◦anticipated inflationary pressures and our responses thereto as well as other unfavorable global and regional economic conditions, geopolitical events, and military conflicts, such as repercussions from the conflict in Ukraine;
◦our ESG strategy;
◦the potential impact to supply, production levels, and costs due to global supply chain constraints and transportation;
◦the Reclassification, including associated non-recurring costs and expenses, financings, and requisite stockholder approvals;
◦the COVID-19 pandemic;
◦expected or potential actions of third parties, including possible changes to laws, rules, and regulations;
◦the future expected balance of supply and demand for and inventory levels of our products;
◦the refinement of our wine and spirits portfolio;
◦the availability of a supply chain finance program;
◦the manner, timing, and duration of the share repurchase program and source of funds for share repurchases; and
◦the amount and timing of future dividends.
•The statements regarding our beer expansion, optimization, and/or construction activities, including anticipated scope, capacity, costs, capital expenditures, timeframes for completion, discussions with government officials in Mexico, and potential future impairment of non-recoverable brewery construction assets and other costs and expenses.
•The statements regarding:
◦the volatility of the fair value of our investment in Canopy measured at fair value;
◦our activities surrounding our investment in Canopy;
◦Canopy’s expectations and the transaction with Acreage;
◦the timing and source of funds for operating activities and exercises of the November 2018 Canopy Warrants, if any;
◦a potential future impairment of our Canopy Equity Method Investment; and
◦our future ownership level in Canopy and our future share of Canopy’s reported earnings and losses.
•The statements regarding the future reclassification of net gains from AOCI.
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 52 |
When used in this 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 Form 10-Q. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. In addition to the risks and uncertainties of ordinary business operations and conditions in the general economy and markets in which we compete, our forward-looking statements contained in this Form 10-Q are also subject to the risk, uncertainty, and possible variance from our current expectations regarding:
•water, agricultural and other raw material, and packaging material supply, production, and/or shipment difficulties which could adversely affect our ability to supply our customers;
•the ability to respond to anticipated inflationary pressures, including reductions in consumer discretionary income and our ability to pass along rising costs through increased selling prices, and unfavorable global or regional economic conditions, including economic slowdown or recession;
•the actual impact to supply, production levels, and costs from global supply chain constraints, transportation challenges, wildfires, and severe weather events, due to, among other reasons, actual supply chain and transportation performance and the actual severity and geographical reach of wildfires and severe weather events;
•the actual balance of supply and demand for our products and the performance of our distributors due to, among other reasons, actual raw material and water supply, actual shipments to distributors, and actual consumer demand;
•the actual demand, net sales, channel proportions, and volume trends for our products due to, among other reasons, actual shipments to distributors and actual consumer demand;
•beer operations expansion, optimization, and/or construction activities, scope, capacity, costs (including impairments), capital expenditures, and timing due to, among other reasons, market conditions, our cash and debt position, receipt of required regulatory approvals by the expected dates and on the expected terms, results of discussions with government officials in Mexico, the actual amount of non-recoverable brewery construction assets and other costs and expenses, and other factors as determined by management;
•the duration and impact of the COVID-19 pandemic, including but not limited to the impact and severity of new variants, vaccine efficacy and immunization rates, the closure of non-essential businesses, which may include our manufacturing facilities, and other associated governmental containment actions, and the increase in cyber-security attacks that have occurred while non-production employees work remotely;
•the impact of the military conflict in Ukraine and associated geopolitical tensions and responses, including on inflation, supply chains, commodities, energy, and cyber-security;
•the amount, timing, and source of funds for any share repurchases or future exercises of the November 2018 Canopy Warrants, if any, which may vary due to market conditions; our cash and debt position; the impact of the beer operations expansion, optimization, and/or construction activities; the impact of our investment in Canopy; and other factors as determined by management from time to time;
•the amount and timing of future dividends which are subject to the determination and discretion of our Board of Directors and may be impacted if our ability to use cash flow to fund dividends is affected by unanticipated increases in total net debt, we are unable to generate cash flow at anticipated levels, or we fail to generate expected earnings;
•the fair value of our investment in Canopy due to market and economic conditions in Canopy’s markets and business locations;
•the accuracy of management’s projections relating to the Canopy investment due to Canopy’s actual results and market and economic conditions;
•the timeframe and amount of any potential future impairment of our Canopy Equity Method Investment if our expectations about Canopy’s prospective results and cash flows decline, which could be influenced by various factors including adverse market conditions or if Canopy records another significant impairment of goodwill or intangible or other long-lived assets, makes significant asset sales, or has changes in senior management;
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 53 |
•the amount of contingent consideration, if any, received in the divestiture of a portion of our wine and spirits business which will depend on actual future brand performance;
•the expected impacts of wine and spirits portfolio refinement activities;
•purchase accounting with respect to any transaction, or the assumptions used regarding the assets purchased and liabilities assumed to determine their fair value;
•any impact of U.S. federal laws on Canopy Strategic Transactions or upon the implementation of such Canopy Strategic Transactions, or the impact of any Canopy Strategic Transaction upon our future ownership level in Canopy or our future share of Canopy’s reported earnings and losses;
•failure to receive the requisite approvals of our stockholders necessary to achieve the Reclassification, any other delays with respect to, or the failure to complete, the Reclassification, the ultimate outcome of any litigation matter related to the Reclassification, the ability to recognize the anticipated benefits of the Reclassification, the impact of the Reclassification on the market price of our common stock, and the incurrence of substantial non-recurring costs and expenses in connection with the negotiation and completion of the Reclassification; and
•our targeted net leverage ratio due to market conditions, our ability to generate cash flow at expected levels, and our ability to generate expected earnings.
For additional information about risks and uncertainties that could cause actual results to differ materially from those set forth in or implied by our forward-looking statements, please refer to Item 1A. “Risk Factors” of our 2022 Annual Report.
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 54 |
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
As a result of our global operating, investment, acquisition, divestiture, and financing activities, we are exposed to market risk associated with changes in foreign currency exchange rates, commodity prices, interest rates, and equity prices. To manage the volatility relating to these risks, we periodically purchase and/or sell derivative instruments including foreign currency forward and option contracts, commodity swap contracts, interest rate swap contracts, and Pre-issuance hedge contracts. We use derivative instruments to reduce earnings and cash flow volatility resulting from shifts in market rates, as well as to hedge economic exposures. We do not enter into derivative instruments for trading or speculative purposes.
Foreign currency and commodity price risk
Foreign currency derivative instruments are or may be used to hedge existing foreign currency denominated assets and liabilities, forecasted foreign currency denominated sales/purchases to/from third parties as well as intercompany sales/purchases, intercompany principal and interest payments, and in connection with investments, acquisitions, or divestitures outside the U.S. As of August 31, 2022, we had exposures to foreign currency risk primarily related to the Mexican peso, Canadian dollar, euro, and New Zealand dollar. Approximately 100% of our balance sheet exposures and 83% of our forecasted transactional exposures for the remaining six months of Fiscal 2023 were hedged as of August 31, 2022.
Commodity derivative instruments are or may be used to hedge forecasted commodity purchases from third parties as either economic hedges or accounting hedges. As of August 31, 2022, exposures to commodity price risk which we are currently hedging include aluminum, corn, diesel fuel, and natural gas prices. Approximately 87% of our forecasted transactional exposures for the remaining six months of Fiscal 2023 were hedged as of August 31, 2022.
We have performed a sensitivity analysis to estimate our exposure to market risk of foreign exchange rates and commodity prices reflecting the impact of a hypothetical 10% adverse change in the applicable market. The volatility of the applicable rates and prices is dependent on many factors which cannot be forecasted with reliable accuracy. Gains or losses from the revaluation or settlement of the related underlying positions would substantially offset such gains or losses on the derivative instruments. The aggregate notional value, estimated fair value, and sensitivity analysis for our open foreign currency and commodity derivative instruments are summarized as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Aggregate Notional Value | | Fair Value, Net Asset (Liability) | | Increase (Decrease) in Fair Value – Hypothetical 10% Adverse Change |
| August 31, 2022 | | August 31, 2021 | | August 31, 2022 | | August 31, 2021 | | August 31, 2022 | | August 31, 2021 |
(in millions) | | | | | | | | | | | |
Foreign currency contracts | $ | 2,733.8 | | | $ | 1,927.9 | | | $ | 95.6 | | | $ | 59.4 | | | $ | (187.2) | | | $ | (120.4) | |
Commodity derivative contracts | $ | 328.9 | | | $ | 187.0 | | | $ | 66.5 | | | $ | 53.3 | | | $ | (34.6) | | | $ | (23.0) | |
Interest rate risk
The estimated fair value of our fixed interest rate debt is subject to interest rate risk, credit risk, and foreign currency risk. In addition, we also have variable interest rate debt outstanding (primarily SOFR-based), certain of which includes a fixed margin subject to the same risks identified for our fixed interest rate debt.
There were no cash flow designated or undesignated interest rate swap contracts or Pre-issuance hedge contracts outstanding as of August 31, 2022, or August 31, 2021.
We have performed a sensitivity analysis to estimate our exposure to market risk of interest rates reflecting the impact of a hypothetical 1% increase in the prevailing interest rates. The volatility of the applicable rates is dependent on many factors which cannot be forecasted with reliable accuracy.
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 55 |
The aggregate notional value, estimated fair value, and sensitivity analysis for our outstanding fixed-rate debt, including current maturities, are summarized as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Aggregate Notional Value | | Fair Value, Net Asset (Liability) | | Increase (Decrease) in Fair Value – Hypothetical 1% Rate Increase |
| August 31, 2022 | | August 31, 2021 | | August 31, 2022 | | August 31, 2021 | | August 31, 2022 | | August 31, 2021 |
(in millions) | | | | | | | | | | | |
Fixed interest rate debt | $ | 10,068.1 | | | $ | 9,869.2 | | | $ | (9,309.1) | | | $ | (10,897.6) | | | $ | (648.4) | | | $ | (852.4) | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
A 1% hypothetical change in the prevailing interest rates would have increased interest expense on our variable interest rate debt by $4.0 million and $2.1 million for the six months ended August 31, 2022, and August 31, 2021, respectively.
Equity price risk
The estimated fair value of our investment in the November 2018 Canopy Warrants and the Canopy Debt Securities are subject to equity price risk, interest rate risk, credit risk, and foreign currency risk. This investment is recognized at fair value utilizing various option-pricing models and has the potential to fluctuate from, among other items, changes in the quoted market price of the underlying equity security. We manage our equity price risk exposure by closely monitoring the financial condition, performance, and outlook of Canopy.
As of August 31, 2022, the fair value of our investment in the November 2018 Canopy Warrants and the Canopy Debt Securities was $80.3 million, with an unrealized net gain (loss) on this investment of $(31.7) million recognized in our results of operations for the six months ended August 31, 2022. We have performed a sensitivity analysis to estimate our exposure to market risk of the equity price reflecting the impact of a hypothetical 10% adverse change in the quoted market price of the underlying equity security. As of August 31, 2022, such a hypothetical 10% adverse change would have resulted in a decrease in fair value of $3.5 million.
For additional discussion on our market risk, refer to Notes 3 and 4.
Item 4. Controls and Procedures.
Disclosure controls and procedures
Our Chief Executive Officer and our 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 Exchange Act Rules 13a-15(e) and 15d-15(e)) are effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Internal control over financial reporting
In connection with the foregoing evaluation by our Chief Executive Officer and our Chief Financial Officer, no changes were identified in the Company’s “internal control over financial reporting” (as defined in the Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during our fiscal quarter ended August 31, 2022, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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Constellation Brands, Inc. Q2 FY 2023 Form 10-Q | #WORTHREACHINGFOR I 56 |