filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Introduction
This MD&A, which should be read in conjunction with our Financial Statements, provides additional information on our businesses, current developments, financial condition, cash flows and results of operations. It is organized as follows:
| • | Overview. This section provides a general description of our business, which we believe is important in understanding the results of our operations, financial condition and potential future trends. |
| • | Strategy. This section provides a description of our strategy and a discussion of recent developments, investments, acquisitions and divestitures. |
| • | Results of operations. This section provides an analysis of our results of operations presented on a business segment basis. In addition, a brief description of transactions and other items that affect the comparability of the results is provided. |
| • | Financial liquidity and capital resources. This section provides an analysis of our cash flows and our outstanding debt and commitments. Included in the analysis of outstanding debt is a discussion of the amount of financial capacity available to fund our ongoing operations and future commitments, as well as a discussion of other financing arrangements. |
| • | Critical accounting estimates and policies. This section identifies those accounting policies that are considered important to our results of operations and financial condition, require significant judgment and involve significant management estimates. Our significant accounting policies, including those considered to be critical accounting policies, are summarized in Note 1 of the Notes to the Financial Statements. |
Effective March 1, 2018, we adopted the FASB amended guidance regarding the recognition of revenue from contracts with customers using the retrospective application method. Accordingly, unless otherwise noted, we have restated net sales, gross profit, operating income, provision for income taxes and net income attributable to CBI for the years ended February 28, 2018, and February 28, 2017. For additional information, refer to Note 1 of the Notes to the Financial Statements.
Overview
We are an international beverage alcohol company with a broad portfolio of consumer-preferred, high-end imported and craft beer brands, and higher-end wine and spirits brands. We are the third-largest producer and marketer of beer for the U.S. market and a leading, higher-end wine company in the U.S. market. We are the largest multi-category supplier (beer, wine and spirits) of beverage alcohol in the U.S., and a leading supplier of wine from New Zealand and Italy to North America.
Our internal management financial reporting consists of two business divisions: (i) Beer and (ii) Wine and Spirits, and we report our operating results in three segments: (i) Beer, (ii) Wine and Spirits, and (iii) Corporate Operations and Other. In the Beer segment, our portfolio consists of high-end imported and craft beer brands. We have an exclusive perpetual brand license to import, market and sell in the U.S. our Mexican beer portfolio. In the Wine and Spirits segment, our portfolio 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 in Canopy and those 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 chief operating decision maker’s evaluation of the operating income 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
Our overall strategy is to drive industry-leading growth and shareholder value by building brands that people love when celebrating big moments or enjoying quiet ones. We position our portfolio to benefit from the consumer-led trend towards premiumization, which we believe will continue to result in faster growth rates in the higher-end of the beer, wine and spirits categories. We focus on developing our expertise in consumer insights and category management as well as our strong distributor network, which provides an effective route-to-market. Additionally, we leverage our scale across the total beverage alcohol market and our level of diversification hedges our portfolio risk. In addition to growing our existing business, we focus on targeted acquisitions of, and investments in, businesses that are higher-margin, higher-growth, consumer-led, have a low integration risk and/or fill a gap in our portfolio. We also strive to identify, meet and stay ahead of evolving consumer trends and market dynamics (see “Recent Developments” and “Investments, Acquisitions and Divestitures – Canopy Investments” below).
We strive to strengthen our portfolio of higher-end beer, wine and spirits brands and differentiate ourselves through:
| • | leveraging our leading position in total beverage alcohol and our scale with wholesalers and retailers to expand distribution of our product portfolio and to provide for cross promotional opportunities; |
| • | strengthening relationships with wholesalers and retailers by providing consumer and beverage alcohol insights; |
| • | investing in brand building and innovation activities; |
| • | positioning ourselves for success with consumer-led products that identify, meet and stay ahead of evolving consumer trends and market dynamics; |
| • | realizing operating efficiencies through expanding and enhancing production capabilities and maximizing asset utilization; and |
| • | developing employees to enhance performance in the marketplace. |
Our business strategy for the Beer segment focuses on leading the high-end segment of the U.S. beer market and includes continued focus on growing our beer portfolio in the U.S. through expanding distribution for key
brands, as well as new product development and innovation within the existing portfolio of brands, and continued expansion, construction and optimization activities for our Mexico beer operations. Additionally, in an effort to more fully compete in growing sectors of the high-end segment of the U.S. beer market, we’ve made several acquisitions of high-quality, regional craft beer brands and leveraged our innovation capabilities to introduce new brands that align with consumer trends.
In connection with our business strategy for the Beer segment, we have more than tripled the production capacity of our Nava Brewery since its June 2013 acquisition. In addition, construction of the Mexicali Brewery is progressing and we are continuing to invest to expand the Obregon Brewery, which was acquired in December 2016. Expansion, construction and optimization efforts continue under our previously-announced Mexico Beer Expansion Projects (as defined below in “Capital Expenditures”) to align with our anticipated future growth expectations (see “Capital Expenditures” below).
Our business strategy for the Wine and Spirits segment is to build an industry-leading portfolio of higher-end wine and spirits brands. We are investing to meet the evolving needs of consumers; building brands through consumer insights, sensory expertise and innovation; and refreshing existing brands, as we continue to focus on moving our branded wine and spirits portfolio towards a higher-margin, higher-growth portfolio of brands. We dedicate a large share of our sales and marketing resources to our U.S. Focus Brands as they represent a majority of our U.S. wine and spirits revenue and profitability, and generally hold strong positions in their respective price categories. We focus our innovation and investment dollars on those brands within our portfolio which position us to benefit from the consumer-led trend towards premiumization. Additionally, in connection with the Wine and Spirits Transaction, we expect to optimize the value of our wine and spirits portfolio by driving increased focus on our higher-end priority brands to accelerate growth and improve overall operating margins. In markets where it is feasible, we entered into contractual arrangements to consolidate our U.S. distribution network in order to obtain dedicated distributor selling resources which focus on our U.S. wine and spirits portfolio to drive organic growth. This consolidated U.S. distribution network currently represents about 70% of our branded wine and spirits volume in the U.S. Throughout the terms of these contracts, we generally expect shipments on an annual basis to these distributors to essentially equal the distributors’ shipments to retailers.
Marketing, sales and distribution of our products are managed on a geographic basis in order to fully leverage leading market positions. In addition, market dynamics and consumer trends vary across each of our markets. Within our primary market in the U.S., we offer a range of beverage alcohol products across the imported beer, craft beer, 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.
Within our Corporate Operations and Other segment, we complemented our total beverage alcohol strategy in an adjacent category by making investments in Canopy, a world-leading, diversified cannabis company. These investments are consistent with our long-term strategy to identify, meet and stay ahead of evolving consumer trends and market dynamics, and they represent a significant expansion of our strategic relationship to position Canopy as a global leader in cannabis production, branding, intellectual property and retailing.
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 leverage ratio and pay quarterly cash dividends.
Recent Developments
Wine and Spirits Transaction
In April 2019, we entered into a definitive agreement to sell a portion of our wine and spirits business, including approximately 30 lower-margin, lower-growth wine and spirits brands, wineries, vineyards, offices and facilities, for approximately $1.7 billion, subject to certain adjustments. The Wine and Spirits Transaction is subject to the satisfaction of certain closing conditions, including receipt of required regulatory approval. We expect to use the net cash proceeds from this transaction primarily to reduce outstanding borrowings. We are in the process of
developing a plan to eliminate any remaining costs in the Wine and Spirits segment from the brands we are selling and expect to incur a restructuring charge for the first quarter of fiscal 2020. We expect the Wine and Spirits Transaction to close around the end of the first quarter of fiscal 2020. The Wine and Spirits Transaction is consistent with our strategic focus on higher-margin, higher-growth brands.
We are selling approximately $1.3 billion in tangible and intangible assets, excluding goodwill, in connection with the Wine and Spirits Transaction. Selected financial information included in our results of operations for Fiscal 2019 for the portion of the wine and spirits business we expect to sell is as follows:
| Net Sales | Gross Profit | Marketing | |||||||||
| (in millions) | |||||||||||
| Wine and Spirits segment results | $ | 1,106.7 | $ | 419.5 | $ | 30.5 |
Canopy Warrants Modification
In April 2019, we agreed to modify the terms of the November 2018 Canopy Warrants and certain other rights. Modification of the November 2018 Canopy Warrants is subject to, among other things, approval by Canopy’s shareholders. These changes are a result of Canopy’s intention to acquire Acreage Holdings, Inc. upon U.S. Federal cannabis legalization, subject to certain conditions. We expect the New November 2018 Canopy Warrants to be accounted for at fair value. If Canopy shareholder approval is received, we expect the modifications to the November 2018 Canopy Warrants will result in a fair value adjustment related to the warrants. Additionally, we expect the fair value of the New November 2018 Canopy Warrants to be volatile in future periods. For additional information regarding the Canopy warrants modification, see Note 10 of the Notes to the Financial Statements.
Investments, Acquisitions and Divestitures
Corporate Operations and Other Segment
Canopy Investments
Our investments in Canopy, and the method of accounting for these investments, consist of the following:
| Date of Investment | Investment Acquired | Purchase Price | Method of Accounting | |||||
| (in millions) | ||||||||
| Nov 2017 | Common shares | $ | 130.1 | Fair value / equity method (1) | ||||
| Nov 2017 | Warrants | 61.2 | Fair value | |||||
| $ | 191.3 | |||||||
| June 2018 | Convertible debt securities | $ | 150.5 | Fair value | ||||
| Nov 2018 | Common shares | $ | 2,740.3 | Equity method | ||||
| Nov 2018 | Warrants | 1,146.8 | Fair value | |||||
| $ | 3,887.1 | (2) |
We recognized an unrealized net gain from the changes in fair value of these investments accounted for at fair value in income from unconsolidated investments, as follows:
| Date of Investment | Investment | Fiscal 2019 | Fiscal 2018 | |||||||
| (in millions) | ||||||||||
| Nov 2017 | Common shares (1) | $ | 292.5 | $ | 272.3 | |||||
| Nov 2017 | Warrants | 465.5 | 192.0 | |||||||
| June 2018 | Convertible debt securities | 55.5 | — | |||||||
| Nov 2018 | Warrants | 1,157.7 | — | |||||||
| $ | 1,971.2 | $ | 464.3 |
| (1) | Accounted for at fair value from the date of investment in November 2017 through October 31, 2018. Accounted for under the equity method from November 1, 2018 (refer to Note 10 of the Financial Statements). |
| (2) | Includes $17.2 million of direct acquisition costs capitalized under the equity method cost accumulation model. Excludes $7.3 million of direct acquisition costs associated with the investment in warrants which are expensed as incurred in selling, general and administrative expenses. See “Financial Liquidity and Capital Resources – General” for a discussion of financing for this transaction. |
We expect the fair value of the Canopy investments accounted for at fair value to be volatile in future periods. Equity in earnings (losses) for our Canopy Equity Method Investment are reported in the Corporate Operations and Other segment and are expected to be volatile in future periods. Additionally, since November 1, 2018 we recognize equity in earnings (losses) for our Canopy Equity Method Investment on a two-month lag. Accordingly, we recognized our share of Canopy’s losses from November and December 2018, which was included in Canopy’s third quarter fiscal 2019 results, in our fourth quarter fiscal 2019 results.
As of February 28, 2019, the conversion of Canopy equity securities held by its employees and/or held by other third parties would not have a significant effect on our share of Canopy’s reported earnings or losses. Additionally, under an amended and restated investor rights agreement, we have the option to purchase additional common shares of Canopy at the then-current price of the underlying equity security to allow us to maintain our relative ownership interest.
As previously noted, these investments are consistent with our long-term strategy to identify, meet and stay ahead of evolving consumer trends and market dynamics, and they represent a significant expansion of our strategic relationship to position Canopy as a global leader in cannabis production, branding, intellectual property and retailing.
Beer Segment
Four Corners Acquisition
In July 2018, we acquired Four Corners, which primarily included the acquisition of operations, goodwill, property, plant and equipment, and trademarks. This acquisition included a portfolio of high-quality, dynamic and bicultural, Texas-based craft beers which further strengthened our position in the high-end segment of the U.S. beer market. The results of operations of Four Corners are reported in the Beer segment and have been included in our consolidated results of operations from the date of acquisition.
Funky Buddha Acquisition
In August 2017, we acquired Funky Buddha, which primarily included the acquisition of operations, goodwill and trademarks. This acquisition included a portfolio of high-quality, Florida-based craft beers which further strengthened our position in the high-end segment of the U.S. beer market. The results of operations of Funky Buddha are reported in the Beer segment and have been included in our consolidated results of operations from the date of acquisition.
Obregon Brewery Acquisition
In December 2016, we acquired the Obregon Brewery, which primarily included the acquisition of operations, goodwill, property, plant and equipment and inventories. This acquisition provided us with immediate functioning brewery capacity to support our fast-growing, high-end Mexican beer portfolio and flexibility for future innovation initiatives. It also enabled us to become fully independent from an interim supply agreement with Modelo, which was terminated at the time of this acquisition. The results of operations of the Obregon Brewery are reported in the Beer segment and have been included in our consolidated results of operations from the date of acquisition.
Wine and Spirits Segment
Schrader Cellars Acquisition
In June 2017, we acquired Schrader Cellars, which primarily included the acquisition of goodwill, inventories, trademarks and certain grape supply contracts. This acquisition included a collection of highly-rated, limited-production fine wines which aligned with our strategic focus on higher-end wine and spirits brands and strengthened our position in the fine wine category. The results of operations of Schrader Cellars are reported in the Wine and Spirits segment and have been included in our consolidated results of operations from the date of acquisition.
Canadian Divestiture
In December 2016, we sold our Canadian wine business, which included Canadian wine brands such as Jackson-Triggs and Inniskillin, wineries, vineyards, offices, facilities and Wine Rack retail stores, at a transaction value of C$1.03 billion, or $775.1 million. Accordingly, our consolidated results of operations include the results of operations of our Canadian wine business through the date of divestiture. We received cash proceeds of $570.3 million, net of outstanding debt and direct costs to sell. We will continue to export certain of our brands into the Canadian market, which remains our largest export market. This transaction is consistent with our strategic focus on higher-margin, higher-growth brands. We recognized a net gain on the sale of the business in the fourth quarter of fiscal 2017 of $262.4 million.
Selected financial information included in our historical financial statements for Fiscal 2017 that are no longer part of our results after the Canadian Divestiture is as follows:
| Net Sales | Gross Profit | Depreciation and Amortization | Operating Income | Income Before Income Taxes | Cash Flows From Operating Activities | ||||||||||||||||||
| (in millions) | |||||||||||||||||||||||
| Consolidated results (1) | $ | 311.2 | $ | 131.2 | $ | 9.1 | $ | 49.8 | $ | 46.6 | $ | 47.2 | |||||||||||
| Wine and Spirits segment results (1) | $ | 311.2 | $ | 131.2 | $ | 9.1 | $ | 50.1 |
| (1) | Amounts have not been adjusted to reflect the adoption of the amended guidance for revenue recognition as the impact is not deemed material. Additionally, the Wine and Spirits segment results do not include the impact of comparable adjustments (see “Comparable Adjustments” below). |
Charles Smith Acquisition
In October 2016, we acquired Charles Smith, which primarily included the acquisition of goodwill, trademarks, inventories and certain grape supply contracts. This acquisition included a collection of five super and ultra-premium, high-quality Washington State wine brands with strong consumer affinity and demand. The results of operations of Charles Smith are reported in the Wine and Spirits segment and have been included in our consolidated results of operations from the date of acquisition.
High West Acquisition
In October 2016, we acquired High West, which primarily included the acquisition of operations, goodwill, trademarks, inventories and property, plant and equipment. This acquisition included a portfolio of distinctive, award-winning, fast-growing and higher-end craft whiskeys and other select spirits. The results of operations of High West are reported in the Wine and Spirits segment and have been included in our consolidated results of operations from the date of acquisition.
Prisoner Acquisition
In April 2016, we acquired Prisoner, which primarily included the acquisition of goodwill, inventories, trademarks and certain grape supply contracts. This acquisition, which included a portfolio of five higher-margin, fast-growing, super-luxury wine brands, aligned with our strategic focus on higher-end wine and spirits brands and strengthened our position in the super-luxury wine category. The results of operations of Prisoner are reported in the Wine and Spirits segment and have been included in our consolidated results of operations from the date of acquisition.
For additional information on these investments, acquisitions and divestitures, refer to Notes 2, 7 and 10 of the Notes to the Financial Statements.
Results of Operations
Financial Highlights
References to organic throughout the following discussion exclude the impact of acquired brand activity in connection with our more significant acquisitions, consisting of Prisoner, High West and Charles Smith (wine and spirits), and divested brand activity in connection with the Canadian Divestiture (wine and spirits), as appropriate.
Financial Highlights for Fiscal 2019:
| • | Our results of operations benefited primarily from continued improvements within the Beer segment, an unrealized net gain from the changes in fair value of our investments in Canopy and a net gain on the sale of the Accolade Wine Investment. |
| • | Net sales increased 7% primarily due to an increase in Beer net sales driven predominantly by volume growth and a favorable impact from pricing within our Mexican beer portfolio. |
| • | Operating income increased 6% largely due to the net sales volume growth and favorable impact from pricing within our Mexican beer portfolio. Operating income growth was tempered by planned increases in marketing spend and higher cost of product sold across both the Beer and Wine and Spirits segments. |
| • | Net income attributable to CBI and diluted net income per common share attributable to CBI increased significantly primarily due to the factors discussed above. |
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 segment management compensation are evaluated based on core segment operating income (loss). As such, the performance measures for incentive compensation purposes for segment management do not include the impact of these Comparable Adjustments.
As more fully described herein and in the related Notes to the Financial Statements, the Comparable Adjustments that impacted comparability in our segment results for each period are as follows:
| Fiscal 2019 | Fiscal 2018 | Fiscal 2017 | |||||||||
| (in millions) | |||||||||||
| Cost of product sold | |||||||||||
| Accelerated depreciation | $ | (8.9 | ) | $ | — | $ | — | ||||
| Settlements of undesignated commodity derivative contracts | (8.6 | ) | 2.3 | 23.4 | |||||||
| Flow through of inventory step-up | (4.9 | ) | (18.7 | ) | (20.1 | ) | |||||
| Loss on inventory write-down | (3.3 | ) | (19.1 | ) | — | ||||||
| Net gain on undesignated commodity derivative contracts | 1.8 | 7.4 | 16.3 | ||||||||
| Other losses | (6.0 | ) | — | (2.2 | ) | ||||||
| Total cost of product sold | (29.9 | ) | (28.1 | ) | 17.4 | ||||||
| Selling, general and administrative expenses | |||||||||||
| Impairment of intangible assets | (108.0 | ) | (86.8 | ) | (37.6 | ) | |||||
| Net loss on foreign currency derivative contracts associated with acquisition of investment | (32.6 | ) | — | — | |||||||
| Restructuring and other strategic business development costs | (17.1 | ) | (14.0 | ) | (0.9 | ) | |||||
| Deferred compensation | (16.3 | ) | — | — | |||||||
| Transaction, integration and other acquisition-related costs | (10.2 | ) | (8.1 | ) | (14.2 | ) | |||||
| Loss on contract termination | — | (59.0 | ) | — | |||||||
| Costs associated with the Canadian Divestiture and related activities | — | (3.2 | ) | (20.4 | ) | ||||||
| Other gains (losses) | 10.1 | 10.5 | (2.6 | ) | |||||||
| Total selling, general and administrative expenses | (174.1 | ) | (160.6 | ) | (75.7 | ) | |||||
| Gain on sale of business | — | — | 262.4 | ||||||||
| Comparable Adjustments, Operating income (loss) | $ | (204.0 | ) | $ | (188.7 | ) | $ | 204.1 | |||
| Income (loss) from unconsolidated investments | $ | 2,084.9 | $ | 452.6 | $ | (1.7 | ) |
Cost of Product Sold
Accelerated Depreciation
We recognized accelerated depreciation for certain assets primarily in connection with our current multi-year implementation of a new ERP system which is intended to replace our existing operating and financial systems.
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.
Inventory Step-Up
In connection with acquisitions, the allocation of purchase price in excess of book value for certain inventories on hand at the date of acquisition is referred to as inventory step-up. Inventory step-up represents an assumed manufacturing profit attributable to the acquired business prior to acquisition.
Loss on Inventory Write-Down
We recognized a loss on the write-down of certain bulk wine inventory as a result of smoke damage sustained during the Fall 2017 California wildfires (Fiscal 2019 and Fiscal 2018).
Selling, General and Administrative Expenses
Impairment of Intangible Assets
We recognized trademark impairment losses related to our Beer segment’s Ballast Point craft beer trademark asset (Fiscal 2019 and Fiscal 2018) and certain of our Wine and Spirits trademark assets associated with our decision to discontinue certain small-scale, low-margin U.S. brands (Fiscal 2017). See “Costs Associated with the Canadian Divestiture and Related Activities” below for information about an additional impairment of intangible assets recognized in connection with the Canadian Divestiture. For additional information, refer to Note 7 of the Notes to the Financial Statements.
Net Loss on Foreign Currency Derivative Contracts Associated with Acquisition of Investment
We recognized a net loss in connection with the settlement of foreign currency option contracts entered into to fix the U.S. dollar cost of the November 2018 Canopy Transaction.
Restructuring and Other Strategic Business Development Costs
We recognized costs primarily in connection with the development of a program specifically intended to identify opportunities for further streamlining of processes and improving capabilities, linking strategy with execution, prioritizing resources and enabling a new enterprise resource planning system (Fiscal 2019 and Fiscal 2018).
Deferred Compensation
We recognized an adjustment related to prior periods to correct for previously unrecognized deferred compensation costs associated with certain employment agreements.
Transaction, Integration and Other Acquisition-Related Costs
We recognized transaction, integration and other acquisition-related costs in connection with our acquisitions and investments.
Loss on Contract Termination
We recognized a loss in connection with the early termination of a beer glass supply contract with Owens-Illinois, a related-party entity with which we have an equally-owned joint venture which owns and operates a glass production plant located adjacent to our Nava Brewery.
Costs Associated with the Canadian Divestiture and Related Activities
We recognized costs in connection with the evaluation of the merits of executing an initial public offering for a portion of our Canadian wine business (Fiscal 2017) and net costs incurred in connection with the sale of the Canadian wine business (Fiscal 2018 and Fiscal 2017). In addition, in connection with the Canadian Divestiture, we recognized a trademark impairment loss for trademarks associated with certain U.S. brands within our Wine and Spirits portfolio sold exclusively through the Canadian wine business, for which future sales of these brands were expected to be minimal subsequent to the Canadian Divestiture (Fiscal 2017).
Other Gains (Losses)
We recognized gains primarily in connection with the sale of certain non-core assets (Fiscal 2019) and the reduction in estimated fair value of a contingent liability associated with a prior period acquisition (Fiscal 2018).
Gain on Sale of Business
We recognized a net gain on sale of the Canadian wine business.
Income (Loss) from Unconsolidated Investments
We recognized an unrealized net gain from the changes in fair value of our securities measured at fair value (Fiscal 2019 and Fiscal 2018), and a net gain in connection with the sale of our Accolade Wine Investment (Fiscal 2019). For additional information, refer to Notes 2, 7 and 10 of the Notes to the Financial Statements.
Fiscal 2019 Compared to Fiscal 2018
Net Sales
| Fiscal 2019 | Fiscal 2018 | Dollar Change | Percent Change | |||||||||||
| (in millions) | ||||||||||||||
| Beer | $ | 5,202.1 | $ | 4,660.4 | $ | 541.7 | 12 | % | ||||||
| Wine and Spirits: | ||||||||||||||
| Wine | 2,532.5 | 2,556.3 | (23.8 | ) | (1 | %) | ||||||||
| Spirits | 381.4 | 363.6 | 17.8 | 5 | % | |||||||||
| Total Wine and Spirits | 2,913.9 | 2,919.9 | (6.0 | ) | — | % | ||||||||
| Consolidated net sales | $ | 8,116.0 | $ | 7,580.3 | $ | 535.7 | 7 | % |
Beer Segment
| Fiscal 2019 | Fiscal 2018 | Dollar Change | Percent Change | |||||||||||
| (in millions, branded product, 24-pack, 12-ounce case equivalents) | ||||||||||||||
| Net sales | $ | 5,202.1 | $ | 4,660.4 | $ | 541.7 | 12 | % | ||||||
| Shipment volume | 294.1 | 268.0 | 9.7 | % | ||||||||||
| Depletion volume (1) | 8.8 | % |
| (1) | Depletions represent distributor shipments of our respective branded products to retail customers, based on third-party data. |
The increase in Beer net sales is primarily due to (i) $446.5 million of volume growth within our Mexican beer portfolio, which benefited from continued consumer demand, increased marketing spend and new product introductions, and (ii) a $102.8 million favorable impact from pricing in select markets within our Mexican beer portfolio. Shipment volume growth outpaced depletion volume growth primarily due to timing. We expect this shipment timing benefit to reverse during Fiscal 2020.
Wine and Spirits Segment
| Fiscal 2019 | Fiscal 2018 | Dollar Change | Percent Change | |||||||||||
| (in millions, branded product, 9-liter case equivalents) | ||||||||||||||
| Net sales | $ | 2,913.9 | $ | 2,919.9 | $ | (6.0 | ) | — | % | |||||
| Shipment volume | ||||||||||||||
| Total | 58.5 | 59.0 | (0.8 | %) | ||||||||||
| U.S. Domestic | 54.4 | 54.7 | (0.5 | %) | ||||||||||
| U.S. Domestic Focus Brands | 33.9 | 33.1 | 2.4 | % | ||||||||||
| Depletion volume (1) | ||||||||||||||
| U.S. Domestic | (2.6 | %) | ||||||||||||
| U.S. Domestic Focus Brands | 0.6 | % |
Wine and Spirits net sales remained relatively flat as $21.4 million of lower branded wine and spirits volume and $16.2 million of unfavorable product mix shift were largely offset by a $35.5 million favorable impact from pricing. As noted in the table above, the decline in the U.S. shipment volume was not as unfavorable as the decline in U.S. depletion volume. As U.S. shipment volume should generally be aligned with U.S. depletion volume, we expect this timing difference to reverse primarily in the first quarter of fiscal 2020. As a result, first quarter of fiscal 2020 net sales are expected to decrease 10% as compared with the first quarter of fiscal 2019.
Gross Profit
| Fiscal 2019 | Fiscal 2018 | Dollar Change | Percent Change | |||||||||||
| (in millions) | ||||||||||||||
| Beer | $ | 2,830.7 | $ | 2,531.2 | $ | 299.5 | 12 | % | ||||||
| Wine and Spirits | 1,279.5 | 1,309.4 | (29.9 | ) | (2 | %) | ||||||||
| Comparable Adjustments | (29.9 | ) | (28.1 | ) | (1.8 | ) | (6 | %) | ||||||
| Consolidated gross profit | $ | 4,080.3 | $ | 3,812.5 | $ | 267.8 | 7 | % |
The increase in Beer is primarily due to $247.2 million of volume growth and the $102.8 million favorable impact from pricing, partially offset by $46.3 million of higher cost of product sold for our Mexican beer business. The higher cost of product sold is predominantly due to $57.8 million of increased transportation costs, partially offset by $17.2 million of foreign currency transactional benefits within our Mexican beer portfolio. The Beer segment also recognized higher operational costs for Fiscal 2019, largely attributable to higher depreciation, brewery maintenance and compensation and benefits; however, these costs were offset by brewery sourcing benefits.
The decrease in Wine and Spirits is largely due to $37.4 million of higher cost of product sold and an unfavorable product mix shift of $26.3 million, partially offset by the $35.5 million favorable impact from pricing. The higher cost of product sold is largely attributable to higher raw material costs, including grape, bulk wine and imported vodka costs, as well as increased transportation costs.
Gross profit as a percent of net sales remained flat for Fiscal 2019 compared to Fiscal 2018 at 50.3%. This was largely due to the higher cost of product sold within both the Beer and Wine and Spirits segments, which resulted in approximately 25 basis points and 20 basis points of rate decline, respectively, partially offset by the favorable impact from Beer pricing in select markets, which contributed approximately 30 basis points of rate growth.
Selling, General and Administrative Expenses
| Fiscal 2019 | Fiscal 2018 | Dollar Change | Percent Change | |||||||||||
| (in millions) | ||||||||||||||
| Beer | $ | 787.8 | $ | 691.0 | $ | 96.8 | 14 | % | ||||||
| Wine and Spirits | 508.3 | 515.3 | (7.0 | ) | (1 | %) | ||||||||
| Corporate Operations and Other | 197.9 | 165.8 | 32.1 | 19 | % | |||||||||
| Comparable Adjustments | 174.1 | 160.6 | 13.5 | 8 | % | |||||||||
| Consolidated selling, general and administrative expenses | $ | 1,668.1 | $ | 1,532.7 | $ | 135.4 | 9 | % |
The increase in Beer is primarily due to an increase of $63.6 million in marketing spend and $33.7 million in general and administrative expenses. The increase in marketing spend is due largely to planned investment to support the growth of our Mexican beer portfolio, including support of the new product introductions. The increase in general and administrative expenses is largely driven by unfavorable foreign currency transaction losses and higher expenses supporting the growth of the business, including compensation and benefits associated primarily with increased headcount and information technology costs.
The decrease in Wine and Spirits is primarily due to a decrease of $18.2 million in general and administrative expenses, partially offset by an increase of $12.0 million in marketing spend. The decrease in general and administrative expenses is largely driven by certain cost savings initiatives. The increase in marketing spend is primarily attributable to planned investment supporting the portfolio.
The increase in Corporate Operations and Other is due to higher general and administrative expenses driven predominantly by an increase of approximately $28 million in compensation and benefits largely attributable to supporting our growth initiatives.
Selling, general and administrative expenses as a percent of net sales increased to 20.6% for Fiscal 2019 as compared with 20.2% for Fiscal 2018. The increase is primarily attributable to the growth in Corporate Operations and Other general and administrative expenses, which resulted in approximately 30 basis points of rate growth.
Operating Income
| Fiscal 2019 | Fiscal 2018 | Dollar Change | Percent Change | |||||||||||
| (in millions) | ||||||||||||||
| Beer | $ | 2,042.9 | $ | 1,840.2 | $ | 202.7 | 11 | % | ||||||
| Wine and Spirits | 771.2 | 794.1 | (22.9 | ) | (3 | %) | ||||||||
| Corporate Operations and Other | (197.9 | ) | (165.8 | ) | (32.1 | ) | (19 | %) | ||||||
| Comparable Adjustments | (204.0 | ) | (188.7 | ) | (15.3 | ) | (8 | %) | ||||||
| Consolidated operating income | $ | 2,412.2 | $ | 2,279.8 | $ | 132.4 | 6 | % |
The increase in Beer is primarily attributable to the strong net sales growth, partially offset by the planned increase in marketing spend and the higher cost of product sold. The decrease in Wine and Spirits was driven by the higher cost of product sold and unfavorable product mix shift, partially offset by pricing. As previously discussed, Corporate Operations and Other reduction in operating income is due largely to the higher costs supporting our growth initiatives.
Income from Unconsolidated Investments
Income from unconsolidated investments increased to $2,101.6 million for Fiscal 2019 from $487.2 million for Fiscal 2018, an increase of $1,614.4 million. This increase is driven largely by an unrealized net gain from the changes in fair value of our securities measured at fair value of $1,971.2 million for Fiscal 2019 as compared with an unrealized net gain of $464.3 million recognized for Fiscal 2018. Fiscal 2019 also benefited from a net gain in connection with the sale of our Accolade Wine Investment of $99.8 million.
Interest Expense
Interest expense increased to $367.1 million for Fiscal 2019 from $332.0 million for Fiscal 2018, an increase of $35.1 million, or 11%. This increase is predominately due to higher average borrowings of approximately $2.0 billion. The higher average borrowings are primarily attributable to the significant purchases of treasury stock for Fiscal 2018 and the November 2018 Canopy Transaction.
Loss on Extinguishment of Debt
Loss on extinguishment of debt for Fiscal 2018 consists of a make-whole payment of $73.6 million in connection with the early redemption of our April 2012 senior notes and the write-off of debt issuance costs of $23.4 million in connection with the May and November 2017 repayments of outstanding obligations under the European Term A loan facility and the U.S. Term A loan facility under our applicable senior credit facility, the July 2017 amendment and restatement of the 2016 Credit Agreement and the early redemption of our April 2012 senior notes.
Provision for Income Taxes
Our effective tax rate for Fiscal 2019 was 16.5% as compared with 1.0% for Fiscal 2018 driven primarily by the recognition of a $351.2 million income tax benefit for Fiscal 2018 associated with the enactment of the TCJ Act, which was signed into law on December 22, 2017. For Fiscal 2018, we recognized a provisional net income tax benefit comprised primarily of benefits from (i) the remeasurement of our deferred tax assets and liabilities to the new, lower federal statutory rate and (ii) the reversal of deferred tax liabilities previously provided for unremitted earnings of foreign subsidiaries which were not considered to be indefinitely reinvested; partially offset by the recording of the mandatory one-time transition tax on unremitted earnings of our foreign subsidiaries. We completed our analysis of the income tax implications of the TCJ Act for the third quarter of fiscal 2019 and recognized an additional income tax benefit of $37.6 million resulting from a decrease in the mandatory one-time transition tax on unremitted earnings of our foreign subsidiaries.
For additional information, refer to Note 13 of the Notes to the Financial Statements.
We expect our effective tax rate for the next fiscal year to be in the range of 16% to 18%. This includes an estimated impact for (i) benefits related to the recognition of the income tax effect of stock-based compensation awards in the income statement when the awards vest or are settled, (ii) lower effective tax rates applicable to our foreign businesses and (iii) closing of the Wine and Spirits Transaction in accordance with the expected timeline. Since estimates are not currently available, this range does not assume (i) any future changes in the fair value of our Canopy investments measured at fair value, (ii) any gain (loss) recognized in connection with the Wine and Spirits Transaction and (iii) any equity in earnings (losses) from the Canopy Equity Method Investment.
Net Income Attributable to CBI
Net income attributable to CBI increased to $3,435.9 million for Fiscal 2019 from $2,303.4 million for Fiscal 2018, an increase of $1,132.5 million. This increase is largely attributable to the increase in income from unconsolidated investments discussed above. Solid operating performance from Beer contributed an additional $202.7 million of operating income. These increases were partially offset by the higher provision for income taxes discussed above.
Fiscal 2018 Compared to Fiscal 2017
Net Sales
| Fiscal 2018 | Fiscal 2017 | Dollar Change | Percent Change | |||||||||||
| (in millions) | ||||||||||||||
| Beer | $ | 4,660.4 | $ | 4,227.3 | $ | 433.1 | 10 | % | ||||||
| Wine and Spirits: | ||||||||||||||
| Wine | 2,556.3 | 2,732.7 | (176.4 | ) | (6 | %) | ||||||||
| Spirits | 363.6 | 361.1 | 2.5 | 1 | % | |||||||||
| Total Wine and Spirits | 2,919.9 | 3,093.8 | (173.9 | ) | (6 | %) | ||||||||
| Consolidated net sales | $ | 7,580.3 | $ | 7,321.1 | $ | 259.2 | 4 | % |
Beer Segment
| Fiscal 2018 | Fiscal 2017 | Dollar Change | Percent Change | |||||||||||
| (in millions, branded product, 24-pack, 12-ounce case equivalents) | ||||||||||||||
| Net sales | $ | 4,660.4 | $ | 4,227.3 | $ | 433.1 | 10 | % | ||||||
| Shipment volume | 268.0 | 246.4 | 8.8 | % | ||||||||||
| Depletion volume (1) | 9.8 | % |
| (1) | Depletions represent distributor shipments of our respective branded products to retail customers, based on third-party data, including acquired brands from the date of acquisition and for the comparable prior year period. |
The increase in Beer net sales is primarily due to (i) the volume growth within our Mexican beer portfolio of $371.4 million, which benefited from continued consumer demand and increased marketing spend, and (ii) a favorable impact from pricing in select markets within our Mexican beer portfolio of $78.1 million.
Wine and Spirits Segment
| Fiscal 2018 | Fiscal 2017 | Dollar Change | Percent Change | |||||||||||
| (in millions, branded product, 9-liter case equivalents) | ||||||||||||||
| Net sales | $ | 2,919.9 | $ | 3,093.8 | $ | (173.9 | ) | (6 | %) | |||||
| Shipment volume | ||||||||||||||
| Total | 59.0 | 69.2 | (14.7 | %) | ||||||||||
| Organic | 58.6 | 59.3 | (1.2 | %) | ||||||||||
| U.S. Domestic | 54.7 | 55.0 | (0.5 | %) | ||||||||||
| Organic U.S. Domestic | 54.4 | 55.0 | (1.1 | %) | ||||||||||
| U.S. Domestic Focus Brands | 33.6 | 31.8 | 5.7 | % | ||||||||||
| Organic U.S. Domestic Focus Brands | 33.4 | 31.8 | 5.0 | % | ||||||||||
| Depletion volume (1) | ||||||||||||||
| U.S. Domestic | 0.9 | % | ||||||||||||
| U.S. Domestic Focus Brands | 6.6 | % |
The decrease in Wine and Spirits net sales is due to the Canadian Divestiture of $311.2 million, partially offset by net sales from acquired brands of $50.4 million and organic net sales growth of $86.9 million. The organic growth is due largely to favorable product mix shift of $129.5 million, partially offset by lower branded wine and spirits volume of $39.9 million driven predominantly by brands within our wine and spirits portfolio other than our Focus Brands.
Gross Profit
| Fiscal 2018 | Fiscal 2017 | Dollar Change | Percent Change | |||||||||||
| (in millions) | ||||||||||||||
| Beer | $ | 2,531.2 | $ | 2,149.3 | $ | 381.9 | 18 | % | ||||||
| Wine and Spirits | 1,309.4 | 1,352.3 | (42.9 | ) | (3 | %) | ||||||||
| Comparable Adjustments | (28.1 | ) | 17.4 | (45.5 | ) | NM | ||||||||
| Consolidated gross profit | $ | 3,812.5 | $ | 3,519.0 | $ | 293.5 | 8 | % | ||||||
| NM = Not meaningful |
The increase in Beer is primarily due to (i) the volume growth and the favorable impact from pricing in select markets within our Mexican beer portfolio of $190.2 million and $78.1 million, respectively, and (ii) lower cost of product sold for our Mexican beer business of $140.5 million. The lower cost of product sold is primarily due to operational and foreign currency transactional benefits within our Mexican beer portfolio of $89.6 million and $30.3 million, respectively.
The decrease in Wine and Spirits is due to the Canadian Divestiture of $131.2 million, partially offset by organic gross profit growth of $62.2 million and gross profit from the acquired brands of $26.1 million. The organic growth is due largely to favorable product mix shift of $93.2 million, partially offset by higher branded wine and spirits cost of product sold of $25.9 million.
Gross profit as a percent of net sales increased to 50.3% for Fiscal 2018 compared with 48.1% for Fiscal 2017 primarily due to (i) lower cost of product sold for the Beer segment, (ii) the favorable impact from Beer pricing in select markets and (iii) the favorable Wine and Spirits product mix shift, which contributed approximately 185 basis points, 55 basis points and 40 basis points of rate growth, respectively; partially offset by an unfavorable change in Comparable Adjustments, which resulted in approximately 60 basis points of rate decline.
Selling, General and Administrative Expenses
| Fiscal 2018 | Fiscal 2017 | Dollar Change | Percent Change | |||||||||||
| (in millions) | ||||||||||||||
| Beer | $ | 691.0 | $ | 616.9 | $ | 74.1 | 12 | % | ||||||
| Wine and Spirits | 515.3 | 559.9 | (44.6 | ) | (8 | %) | ||||||||
| Corporate Operations and Other | 165.8 | 139.9 | 25.9 | 19 | % | |||||||||
| Comparable Adjustments | 160.6 | 75.7 | 84.9 | NM | ||||||||||
| Consolidated selling, general and administrative expenses | $ | 1,532.7 | $ | 1,392.4 | $ | 140.3 | 10 | % |
The increase in Beer is primarily due to increases in marketing spend of $46.1 million and general and administrative expenses of $27.9 million. The increase in marketing spend is due largely to planned investment to support the growth of our Mexican beer portfolio. The increase in general and administrative expenses is predominantly driven by higher expenses supporting the growth of the business. The decrease in Wine and Spirits is primarily driven by the Canadian Divestiture of $81.1 million, partially offset by an increase in marketing spend primarily due to planned investment to support our organic growth and acquired businesses of $32.4 million. The increase in Corporate Operations and Other is due to higher general and administrative expenses primarily attributable to increases in consulting of $12.8 million and compensation and benefits of $11.0 million, both largely attributable to supporting the growth of the business.
Selling, general and administrative expenses as a percent of net sales increased to 20.2% for Fiscal 2018 as compared with 19.0% for Fiscal 2017. The increase is primarily attributable to the unfavorable change in Comparable Adjustments and the growth in Corporate Operations and Other general and administrative expenses, which resulted in approximately 135 basis points of rate growth, partially offset by a benefit of approximately 25
basis points from the divestiture of the Canadian wine business, which had a higher rate of selling, general and administrative expenses as a percent of net sales as compared with the rest of the Wine and Spirits business.
Operating Income
| Fiscal 2018 | Fiscal 2017 | Dollar Change | Percent Change | |||||||||||
| (in millions) | ||||||||||||||
| Beer | $ | 1,840.2 | $ | 1,532.4 | $ | 307.8 | 20 | % | ||||||
| Wine and Spirits | 794.1 | 792.4 | 1.7 | — | % | |||||||||
| Corporate Operations and Other | (165.8 | ) | (139.9 | ) | (25.9 | ) | (19 | %) | ||||||
| Comparable Adjustments | (188.7 | ) | 204.1 | (392.8 | ) | NM | ||||||||
| Consolidated operating income | $ | 2,279.8 | $ | 2,389.0 | $ | (109.2 | ) | (5 | %) |
Operating income growth in our Beer segment was driven predominantly by the factors discussed above. Wine and Spirits remained relatively flat as the loss of operating income in connection with the divestiture of the Canadian wine business was offset by the growth factors discussed above.
Income from Unconsolidated Investments
Income from unconsolidated investments increased to $487.2 million for Fiscal 2018 from $27.3 million for Fiscal 2017, an increase of $459.9 million. This increase is driven largely by an unrealized net gain from the changes in fair value of our securities measured at fair value of $464.3 million.
Interest Expense
Interest expense remained relatively flat for Fiscal 2018 as compared to Fiscal 2017 as a lower average interest rate of approximately 30 basis points was offset by higher average borrowings of approximately $645 million. The lower average interest rate is predominantly due to the issuance of the lower rate December 2016 Senior Notes, May 2017 Senior Notes and November 2017 Senior Notes and the repayment of the higher rate August 2006 senior notes and January 2008 senior notes. The higher average borrowings are primarily attributable to the purchases of businesses and treasury stock, net of proceeds from the Canadian Divestiture, during Fiscal 2017.
Provision for Income Taxes
Our effective tax rate for Fiscal 2018 was 1.0% as compared with 26.4% for Fiscal 2017 driven primarily by the recognition of a $351.2 million income tax benefit for Fiscal 2018 associated with the enactment of the TCJ Act, which was signed into law on December 22, 2017. For Fiscal 2018, we recognized a provisional net income tax benefit comprised primarily of benefits from (i) the remeasurement of our deferred tax assets and liabilities to the new, lower federal statutory rate and (ii) the reversal of deferred tax liabilities previously provided for unremitted earnings of foreign subsidiaries which were not considered to be indefinitely reinvested; partially offset by the recording of the mandatory one-time transition tax on unremitted earnings of our foreign subsidiaries.
Our effective tax rate for Fiscal 2018 as compared with Fiscal 2017 was also favorably impacted by:
| • | lower effective tax rates applicable to our foreign businesses; |
| • | the recognition of the income tax effect of stock-based compensation awards in the income statement when the awards vest or are settled in connection with our March 1, 2017, adoption of FASB amended share-based compensation guidance; and |
| • | the new, lower federal statutory rate of 32.7% associated with the TCJ Act, as compared to the federal statutory rate of 35% in effect for Fiscal 2017. |
Net Income Attributable to CBI
Net income attributable to CBI increased to $2,303.4 million for Fiscal 2018 from $1,528.6 million for Fiscal 2017, an increase of $774.8 million. This increase was driven largely by the factors discussed above, including the net unrealized gain from the changes in fair value of our securities measured at fair value of $464.3 million, the net income tax benefit of $351.2 million resulting from the TCJ Act and the strong operating performance for the Beer segment of $307.8 million.
Financial Liquidity and Capital Resources
General
Our ability to consistently generate cash flow from operating activities is one of our most significant financial strengths. Our strong cash flows enable us to invest in our people and our brands, make appropriate capital investments, provide a quarterly cash dividend program, and from time-to-time, repurchase shares of our common stock and make strategic investments and acquisitions that we believe will enhance shareholder value. Our primary source of liquidity has been cash flow from operating activities. Our principal use of cash in our operating activities is for purchasing and carrying inventories and carrying seasonal accounts receivable. Historically, we have used cash flow from operating activities to repay our short-term borrowings and fund capital expenditures. Additionally, we have a commercial paper program which we use to fund our short-term borrowing requirements and to maintain our access to the capital markets. We will continue to use our short-term borrowings, including our commercial paper program, to support our working capital requirements and capital expenditures.
We have maintained 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 activities and financing activities, primarily short-term borrowings, will provide adequate resources to satisfy our working capital, scheduled principal and interest payments on debt, anticipated dividend payments and anticipated capital expenditure requirements for both our short-term and long-term capital needs.
In November 2018, we completed the November 2018 Canopy Transaction for C$5,078.7 million, or $3,869.9 million. In addition, we incurred $24.5 million of direct acquisition costs. The aggregate cash paid at closing was financed with (i) the net proceeds from the issuance of $2,150.0 million aggregate principal amount of October 2018 Senior Notes, (ii) $1,500.0 million in term loans under the Term Credit Agreement and (iii) the remainder from proceeds of borrowings under our commercial paper program. Based on our ability to consistently generate strong cash flow from operating activities, we expect to be able to return to our targeted leverage ratio within 24 months following the close of this transaction, while continuing to make appropriate investments in our business that we believe will enhance shareholder value.
In April 2019, we entered into an agreement to sell a portion of our wine and spirits business for approximately $1.7 billion, subject to closing adjustments. We expect to use the net cash proceeds from this transaction primarily to reduce outstanding borrowings.
Cash Flows
| Fiscal 2019 | Fiscal 2018 | Fiscal 2017 | |||||||||
| (in millions) | |||||||||||
| Net cash provided by (used in): | |||||||||||
| Operating activities | $ | 2,246.3 | $ | 1,931.4 | $ | 1,696.0 | |||||
| Investing activities | (4,831.8 | ) | (1,423.1 | ) | (1,461.8 | ) | |||||
| Financing activities | 2,593.3 | (601.2 | ) | (134.8 | ) | ||||||
| Effect of exchange rate changes on cash and cash equivalents | (4.5 | ) | 5.8 | (5.1 | ) | ||||||
| Net increase (decrease) in cash and cash equivalents | $ | 3.3 | $ | (87.1 | ) | $ | 94.3 |
Operating Activities
Fiscal 2019 Compared to Fiscal 2018
The increase in net cash provided by operating activities for Fiscal 2019 is largely due to strong cash flow from the Beer segment driven primarily by the segment’s solid operating results, including a benefit from decreased inventory levels due to strong shipments in the fourth quarter of fiscal 2019. Additionally, net cash provided by operating activities for Fiscal 2019 benefited from lower income tax payments predominantly due to (i) the receipt of a federal tax refund for Fiscal 2019 and (ii) lower federal tax payments resulting from the reduction in the U.S. corporate income tax rate associated with the enactment of the TCJ Act.
Fiscal 2018 Compared to Fiscal 2017
The increase in net cash provided by operating activities for Fiscal 2018 is primarily due to strong cash flow from the Beer segment driven largely by the segment’s strong operating results, partially offset by (i) the timing of collections for recoverable value-added taxes and (ii) an increase in cash outflow from accounts payable primarily attributable to the timing of payments. Net cash provided by operating activities also benefited from our March 1, 2017, adoption of the FASB amended share-based compensation guidance, which resulted in the classification of excess tax benefits (resulting from an increase in the fair value of an award from grant date to the vesting or settlement date) as an operating activity in the statement of cash flows instead of as a financing activity where they were previously presented prior to March 1, 2017.
Investing Activities
Fiscal 2019 Compared to Fiscal 2018
The increase in net cash used in investing activities for Fiscal 2019 is primarily due to the November 2018 Canopy Transaction. The increase in net cash used in investing activities was partially offset by (i) lower capital expenditures of $171.3 million, (ii) proceeds from the May 2018 sale of our Accolade Wine Investment of $110.2 million and (iii) the lower level of business acquisition activity of $104.5 million.
Fiscal 2018 Compared to Fiscal 2017
The decrease in net cash used in investing activities for Fiscal 2018 is primarily due to the lower level of net business acquisition and divestiture activity of $380.6 million. The decrease in net cash used in investing activities was partially offset by the November 2017 Canopy Investment of $191.3 million and higher capital expenditures of $150.2 million.
Business acquisitions consist primarily of the following:
| Fiscal 2019 | Fiscal 2018 | Fiscal 2017 | ||
| ● Four Corners (July 2018) | ● Schrader Cellars (June 2017) | ● Prisoner (April 2016) | ||
| ● Funky Buddha (August 2017) | ● High West (October 2016) | |||
| ● Charles Smith (October 2016) | ||||
| ● Obregon Brewery (December 2016) |
Financing Activities
Fiscal 2019 Compared to Fiscal 2018
The increase in net cash provided by financing activities consists of:
| Fiscal 2019 | Fiscal 2018 | Dollar Change | |||||||||
| (in millions) | |||||||||||
| Net proceeds from debt, current and long-term, and related activities | $ | 3,605.7 | $ | 819.7 | $ | 2,786.0 | |||||
| Dividends paid | (557.7 | ) | (400.1 | ) | (157.6 | ) | |||||
| Purchases of treasury stock | (504.3 | ) | (1,038.5 | ) | 534.2 | ||||||
| Net cash provided by stock-based compensation activities | 49.6 | 17.7 | 31.9 | ||||||||
| Net cash provided by (used in) financing activities | $ | 2,593.3 | $ | (601.2 | ) | $ | 3,194.5 |
Fiscal 2018 Compared to Fiscal 2017
The increase in net cash used in financing activities consists of:
| Fiscal 2018 | Fiscal 2017 | Dollar Change | |||||||||
| (in millions) | |||||||||||
| Net proceeds from debt, current and long-term, and related activities | $ | 819.7 | $ | 1,176.8 | $ | (357.1 | ) | ||||
| Dividends paid | (400.1 | ) | (315.1 | ) | (85.0 | ) | |||||
| Purchases of treasury stock | (1,038.5 | ) | (1,122.7 | ) | 84.2 | ||||||
| Net cash provided by stock-based compensation activities | 17.7 | 126.2 | (108.5 | ) | |||||||
| Net cash used in financing activities | $ | (601.2 | ) | $ | (134.8 | ) | $ | (466.4 | ) |
Debt
Total debt outstanding as of February 28, 2019, amounted to $13,616.5 million, an increase of $3,429.8 million from February 28, 2018. This increase was predominately due to the financing of the November 2018 Canopy Transaction, including the issuance of the October 2018 Senior Notes and borrowings under the Term Credit Agreement, partially offset by the conversion of $248.2 million from long-term debt to noncontrolling equity interests associated with the noncash settlement of a prior contractual agreement with our glass production plant joint venture partner.
Senior Credit Facility
In August 2018, we entered into the August 2018 Restatement Agreement that amended and restated our 2017 Credit Agreement, primarily for technical amendments. In September 2018, we entered into the 2018 Restatement Agreement that amended and restated the August 2018 Credit Agreement. Among other things, the 2018 Restatement Agreement increased our revolving credit facility by $500.0 million to $2.0 billion and extended its maturity to September 14, 2023. Additionally, the 2018 Restatement Agreement modified certain financial covenants and added various representations and warranties, covenants and an event of default in connection with the then-pending additional investment in Canopy.
General
The majority of our outstanding borrowings as of February 28, 2019, consisted of fixed-rate senior unsecured notes, with maturities ranging from calendar 2019 to calendar 2048, and variable-rate senior unsecured
term loan facilities under our 2018 Credit Agreement and Term Credit Agreement, with maturities ranging from calendar 2021 to calendar 2024.
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 2018 Credit Agreement. Accordingly, outstanding borrowings under our commercial paper program reduce the amount available under our revolving credit facility under our 2018 Credit Agreement.
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 outstanding commercial paper borrowings mature, we will utilize unused commitments under our revolving credit facility under our 2018 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 under our 2018 Credit Agreement.
We had the following borrowing capacity available under our 2018 Credit Agreement:
| Remaining Borrowing Capacity | |||||||
| February 28, 2019 | April 17, 2019 | ||||||
| (in millions) | |||||||
| Revolving Credit Facility (1) | $ | 1,196.7 | $ | 1,176.8 |
| (1) | Net of outstanding revolving credit facility borrowings and outstanding letters of credit under our 2018 Credit Agreement and outstanding borrowings under our commercial paper program. |
The financial institutions participating in our 2018 Credit Agreement have complied with prior funding requests and we believe such financial institutions 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 the 2018 Credit Agreement, including those restricting the incurrence of additional indebtedness (including guarantees of indebtedness) by subsidiaries that are not guarantors, 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 the 2018 Credit Agreement. As of February 28, 2019, under the 2018 Credit Agreement, the minimum interest coverage ratio was 2.5x and the maximum net leverage ratio was 5.25x.
The obligations under the Term Credit Agreement are guaranteed by certain of our U.S. subsidiaries. In addition, the representations, warranties, covenants and events of default set forth in the Term Credit Agreement are substantially similar to those set forth in the 2018 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 (iii) restrictions on mergers, consolidations and the transfer of all or substantially all of our assets to another person.
As of February 28, 2019, we were in compliance with all of our covenants under the 2018 Credit Agreement, the Term Credit Agreement and our indentures, and have met all debt payment obligations.
For a complete discussion and presentation of all borrowings and available sources of borrowing, refer to Note 12 of the Notes to the Financial Statements.
Common Stock Dividends
On April 3, 2019, our Board of Directors declared a quarterly cash dividend of $0.75 per share of Class A Common Stock, $0.68 per share of Class B Convertible Common Stock and $0.68 per share of Class 1 Common Stock payable on May 24, 2019, to stockholders of record of each class on May 10, 2019. We expect to return approximately $567 million to stockholders in Fiscal 2020 through cash dividends.
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 this Annual Report on Form 10-K.
Share Repurchase Program
Our Board of Directors have authorized the repurchase of up to $3.0 billion of our Class A Common Stock and Class B Convertible Common Stock under the 2018 Authorization. Shares repurchased under this authorization have become treasury shares.
As of February 28, 2019, total shares repurchased under this 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 | $ | 995.9 | 4,632,012 |
Share repurchases under the 2018 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 will become treasury shares.
For additional information, refer to Note 16 of the Notes to the Financial Statements.
Contractual Obligations and Commitments
The following table sets forth information about our contractual obligations outstanding at February 28, 2019. It brings together data for easy reference from our balance sheet and Notes to the Financial Statements. For a detailed discussion of the items noted in the following table, refer to Notes 11, 12, 13, 14 and 15 of the Notes to the Financial Statements.
| PAYMENTS DUE BY PERIOD | |||||||||||||||||||
| Total | Less than 1 year | 1-3 years | 3-5 years | After 5 years | |||||||||||||||
| (in millions) | |||||||||||||||||||
| Short-term borrowings | $ | 791.5 | $ | 791.5 | $ | — | $ | — | $ | — | |||||||||
| Long-term debt (excluding unamortized debt issuance costs and unamortized discounts) | 12,910.1 | 1,067.4 | 2,474.6 | 3,699.3 | 5,668.8 | ||||||||||||||
| Interest payments on long-term debt (1) | 4,197.0 | 477.8 | 853.4 | 635.7 | 2,230.1 | ||||||||||||||
| Operating leases | 559.5 | 59.0 | 109.3 | 89.1 | 302.1 | ||||||||||||||
| Other long-term liabilities (2) | 284.2 | 58.1 | 68.1 | 69.8 | 88.2 | ||||||||||||||
| Purchase obligations (3) | 7,194.2 | 1,568.7 | 2,591.6 | 1,568.9 | 1,465.0 | ||||||||||||||
| Total contractual obligations | $ | 25,936.5 | $ | 4,022.5 | $ | 6,097.0 | $ | 6,062.8 | $ | 9,754.2 |
| (1) | Interest rates on long-term debt obligations range from 2.0% to 5.3% as of February 28, 2019. Interest payments on long-term debt do not include interest related to capital lease obligations, which represent approximately 0.2% of our total long-term debt, as amounts are not material. |
| (2) | Includes $36.3 million associated with expected payments for unrecognized tax benefit liabilities as of February 28, 2019, $0.3 million of which is expected to be paid in the less than one year period. The payments are reflected in the period in which we believe they will ultimately be settled based on our experience in these matters. Other long-term liabilities do not include payments for unrecognized tax benefit liabilities of $188.0 million due to the uncertainty of the timing of future cash flows associated with these unrecognized tax benefit liabilities. In addition, other long-term liabilities do not include expected payments for interest and penalties associated with unrecognized tax benefit liabilities as amounts are not material. For a detailed discussion of these items, refer to Note 13 of the Notes to the Financial Statements. |
| (3) | Consists primarily of $5,955.1 million for contracts to purchase certain raw materials and supplies over the next sixteen fiscal years and $649.8 million for contracts to purchase equipment and services over the next three fiscal years. For a detailed discussion of our purchase obligations, refer to Note 15 of the Notes to the Financial Statements. |
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that either have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
Capital Expenditures
During Fiscal 2019, we incurred $886.3 million for capital expenditures, including $720.0 million for the Beer segment primarily for (i) our Nava Brewery and glass production plant expansions, (ii) our Obregon Brewery optimization and expansion and (iii) our Mexicali Brewery construction (collectively, the “Mexico Beer Expansion Projects”). Management reviews the capital expenditure program periodically and modifies it as required to meet current business needs. We plan to spend from $800.0 million to $900.0 million for capital expenditures for Fiscal 2020, including approximately $750.0 million for the Beer segment associated primarily with the Mexico Beer Expansion Projects. The remaining Fiscal 2020 capital expenditures consist of improvements of existing operating facilities and replacements of existing equipment and/or buildings. The Mexico Beer Expansion Projects are expected to be completed over the next four fiscal years.
Effects of Inflation and Changing Prices
Our results of operations and financial condition have not been significantly affected by inflation and changing prices. We intend to pass along rising costs through increased selling prices, subject to normal competitive conditions. There can be no assurances, however, that we will be able to pass along rising costs through increased selling prices. In addition, we continue to identify on-going cost savings initiatives.
Critical Accounting Estimates and Policies
Our significant accounting policies are more fully described in Note 1 of the Notes to the Financial Statements. However, certain of our accounting policies are particularly important to the portrayal of our financial position and results of operations and require the application of significant judgment by management; as a result, they are subject to an inherent degree of uncertainty. In applying those policies, management uses its judgment to determine the appropriate assumptions to be used in the determination of certain estimates. Those estimates are based on our historical experience, our observance of trends in the industry, information provided by our customers and information available from other outside sources, as appropriate. On an ongoing basis, we review our estimates to ensure that they appropriately reflect changes in our business. Our critical accounting estimates include:
| • | Goodwill and other intangible assets. We account for goodwill and other intangible assets by classifying intangible assets into three categories: (i) intangible assets with definite lives subject to |
amortization, (ii) intangible assets with indefinite lives not subject to amortization and (iii) goodwill. For intangible assets with definite lives, impairment testing is required if conditions exist that indicate the carrying value may not be recoverable. For intangible assets with indefinite lives and for goodwill, impairment testing is required at least annually or more frequently if events or circumstances indicate that these assets might be impaired. We perform annual impairment tests and re-evaluate the useful lives of other intangible assets with indefinite lives at the annual impairment test measurement date of January 1 or when circumstances arise that indicate a possible impairment or change in useful life might exist. The guidance for goodwill impairment testing allows an entity to assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the estimated fair value of a reporting unit is less than its carrying amount or to proceed directly to performing a quantitative impairment test. Under the quantitative assessment, the estimated fair value of each reporting unit is compared to its carrying value, including goodwill. The estimate of fair value of the reporting unit is generally calculated based on an income approach using the discounted cash flow method supplemented by the market approach. If the estimated fair value of the reporting unit is less than the carrying value of the reporting unit, a goodwill impairment will be recognized. The amount of impairment charge for goodwill is equal to the excess of the carrying value of the goodwill over the implied fair value of the goodwill. Our reporting units with goodwill include the Beer segment and the Wine and Spirits segment. In estimating the fair value of the reporting units, management must make assumptions and projections regarding such items as future cash flows, future revenues, future earnings and other factors. The assumptions used in the estimate of fair value are based on historical trends and the projections and assumptions that are used in current strategic operating plans. These assumptions reflect management’s estimates of future economic and competitive conditions and are, therefore, subject to change as a result of changing market conditions. If these estimates or their related assumptions change in the future, we may be required to recognize an impairment loss for these assets. The recognition of any resulting impairment loss could have a material adverse impact on our financial statements.
In the fourth quarter of fiscal 2019, we performed our annual goodwill impairment analysis using the qualitative assessment. Our decision to utilize the qualitative assessment was based primarily on the significant amount of excess fair value over the carrying amount of goodwill for our reporting units noted in the prior year assessment. As part of the qualitative assessment, we first identified the key drivers of fair value used in the prior year valuations for each of the reporting units noting that the most significant assumptions used in the discounted cash flow calculations were: (i) the discount rate, (ii) the expected long-term growth rate and (iii) the annual cash flow projections. We then evaluated whether those drivers had subsequently been affected by events and circumstances that could have positive, negative or neutral impacts on the valuation inputs. No indication of impairment was noted for either of our reporting units; therefore, no quantitative assessment was performed. For Fiscal 2018 and Fiscal 2017, as a result of our annual goodwill impairment analyses, we concluded that there were no indications of impairment for either of our reporting units.
We performed sensitivity analyses on our qualitative assessment for each reporting unit, by updating the reporting unit’s carrying value for all assets and liabilities, as well as prior year’s estimated fair value, using actual reporting unit operating results for Fiscal 2019, with any forecast versus actual variances carried through estimated future periods. These analyses further supported our qualitative conclusion of no indication of impairment for either of our reporting units.
Our other intangible assets consist primarily of customer relationships and trademarks obtained through business acquisitions. Customer relationships are amortized over their estimated useful lives. The trademarks that were determined to have indefinite useful lives are not amortized. The guidance for indefinite lived intangible asset impairment testing allows an entity to assess qualitative factors to determine whether the existence of events or circumstances indicates that it is more likely than not that the indefinite lived intangible asset is impaired or to proceed directly to performing the quantitative impairment test. Under the quantitative assessment, our trademarks are evaluated for impairment by comparing the carrying value of the trademarks to their estimated fair value. The estimated fair value of trademarks is calculated based on an income approach using the relief from royalty method. The
estimate of fair value is then compared to the carrying value of each trademark. If the estimated fair value is less than the carrying value of the trademark, then an impairment charge is recognized to reduce the carrying value of the trademark to its estimated fair value. In estimating the fair value of the trademarks, management must make assumptions and projections regarding future cash flows based upon future revenues and other factors. The assumptions used in the estimate of fair value are consistent with historical trends and the projections and assumptions that are used in current strategic operating plans. These assumptions reflect management’s estimates of future economic and competitive conditions and are, therefore, subject to change as a result of changing market conditions. If these estimates or their related assumptions change in the future, we may be required to recognize an impairment loss for these assets. The recognition of any resulting impairment loss could have a material adverse impact on our financial statements.
In the fourth quarter of fiscal 2019, we performed our annual indefinite lived intangible asset impairment analysis utilizing the qualitative assessment for our import beer, total wine and total spirits trademark assets and the quantitative assessment for the Ballast Point and Funky Buddha trademark assets. Our decision to utilize the qualitative assessment for the import beer, total wine and total spirits trademark assets was based primarily on the significant amount of excess fair value over the carrying amount for the trademark assets noted in the prior year assessment. No indication of impairment was noted for any of the trademark assets tested under the qualitative assessment. As the aforementioned more likely than not criteria was not met, no quantitative assessment was performed. Additionally, under the quantitative assessment, no indication of impairment was noted for the Funky Buddha trademark asset.
For the fourth quarter of fiscal 2019, the Beer segment’s Ballast Point business recognized a trademark impairment loss of $108.0 million in connection with certain continuing negative trends within its craft beer portfolio and a change in strategy for this portfolio focused on improving profitability by rationalizing the number of product offerings while targeting distribution growth in select strategic markets. In the first quarter of fiscal 2018, the Beer segment’s Ballast Point business recognized a trademark impairment loss of $86.8 million in connection with certain negative trends within its craft beer portfolio. In the fourth quarter of fiscal 2017, the Wine and Spirits’ U.S. business recognized a trademark impairment loss of $37.6 million in connection with our decision to discontinue certain small-scale, low-margin U.S. brands. Additionally, in the fourth quarter of fiscal 2017, the Wine and Spirits’ U.S. business recognized a trademark impairment loss of $8.4 million in connection with certain U.S. brands sold exclusively through the Canadian wine business, for which we expect future sales of these brands to be minimal subsequent to the Canadian Divestiture (refer to Note 7 of the Notes to the Financial Statements for further discussion).
The most significant assumptions used in the relief from royalty method to determine the estimated fair value of intangible assets with indefinite lives in connection with impairment testing are: (i) the estimated royalty rate, (ii) the discount rate, (iii) the expected long-term growth rate and (iv) the annual revenue projections. As of January 1, 2019, if we used a royalty rate that was 50 basis points lower or used a discount rate that was 50 basis points higher or used an expected long-term growth rate that was 50 basis points lower or used annual revenue projections that were 100 basis points lower in our impairment testing of the Funky Buddha trademark, then each change individually would not have resulted in its carrying value exceeding its estimated fair value.
| • | Accounting for income taxes. We estimate our deferred tax assets and liabilities, income taxes payable, provision for income taxes and unrecognized tax benefit liabilities based upon various factors including, but not limited to, historical pretax operating income, future estimates of pretax operating income, differences between book and tax treatment of various items of income and expense, interpretation of tax laws and tax planning strategies. We are subject to income taxes in Canada, Luxembourg, Mexico, Switzerland, the U.S. and other jurisdictions. We are regularly audited by federal, state and foreign tax authorities, but a number of years may elapse before an uncertain tax position, for which we have unrecognized tax benefit liabilities, is audited and finally resolved. |
We believe that all tax positions are fully supported. However, we recognize tax assets and liabilities in accordance with the FASB guidance for income tax accounting. Accordingly, we recognize a tax benefit from an uncertain tax position when it is more likely than not that the position will be sustained upon examination. We measure and recognize the tax benefit from such a position based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the unrecognized tax benefit liabilities. In addition, changes in existing tax laws or rates could significantly change our current estimate of our unrecognized tax benefit liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which they are determined. Changes in current estimates, if significant, could have a material adverse impact on our financial statements.
We recognize our deferred tax assets and liabilities based upon the expected future tax outcome of amounts recognized in our results of operations. If necessary, we recognize a valuation allowance on deferred tax assets when it is more likely than not that they will not be realized. We evaluate our ability to realize the tax benefits associated with deferred tax assets by assessing the adequacy of future expected taxable income, historical and projected operating results, and the availability of prudent and feasible tax planning strategies. The realization of deferred tax assets is evaluated by jurisdiction and the realizability of these assets can vary based on the character of the tax attribute and the carryforward periods specific to each jurisdiction. We believe it is more likely than not that the results of future operations will generate sufficient taxable income to realize our existing deferred tax assets, net of valuation allowances. Changes in the realizability of our deferred tax assets will be reflected in our effective tax rate in the period in which they are determined.
Accounting Guidance
Accounting guidance adopted for Fiscal 2019 did not have a material impact on our consolidated financial statements. For additional information on recently adopted accounting guidance and accounting guidance not yet adopted, refer to Note 1 in the Notes to the Financial Statements.
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