Constellation Brands, Inc. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

Fair Value of Financial Instruments

Fair Value of Financial Instruments

12 Months Ended

Feb. 29, 2020

Authoritative guidance establishes a framework for measuring fair value, including a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. The hierarchy includes three levels:


•	Level 1 inputs are quoted prices in active markets for identical assets or liabilities;


•	Level 2 inputs include data points that are observable such as quoted prices for similar assets or liabilities in active markets, quoted prices for identical assets or similar assets or liabilities in markets that are not active, and inputs (other than quoted prices) such as volatility, interest

rates and yield curves that are observable for the asset and liability, either directly or indirectly; and


•	Level 3 inputs are unobservable data points for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability.

Fair value methodology

The following methods and assumptions are used to estimate the fair value for each class of our financial instruments:

Foreign currency and commodity derivative contracts

The fair value is estimated using market-based inputs, obtained from independent pricing services, entered into valuation models. These valuation models require various inputs, including contractual terms, market foreign exchange prices, market commodity prices, interest-rate yield curves, and currency volatilities, as applicable (Level 2 fair value measurement).

Interest rate swap and treasury lock contracts

The fair value is estimated based on quoted market prices from respective counterparties. Quotes are corroborated by using discounted cash flow calculations based upon forward interest-rate yield curves, which are obtained from independent pricing services (Level 2 fair value measurement).

Canopy investments

Equity securities, Warrants – The terms of the November 2018 Canopy Warrants were modified in June 2019 and now consist of three tranches of warrants: New Tranche A Warrants, New Tranche B Warrants, and New Tranche C Warrants. The exercise price for the New Tranche C Warrants is based on the volume-weighted average of the closing market price of Canopy’s common shares on the Toronto Stock Exchange (“TSX”) for the five trading days immediately preceding the exercise date (“VWAP Exercise Price”), accordingly, no fair value is assigned. For additional information on the November 2018 Canopy Warrants and the related modification, refer to Note 10.

The inputs used to estimate the fair value of the Canopy warrants (all as defined in Note 10) are as follows:



	February 29, 2020 ⁽¹⁾									February 28, 2019
	New Tranche A Warrants ⁽²⁾			New Tranche B Warrants ⁽³⁾			November 2017 Canopy Warrants ⁽²⁾			November 2018 Canopy Warrants ⁽²⁾			November 2017 Canopy Warrants ⁽²⁾
Exercise price⁽⁴⁾	C$	50.40		C$	76.68		C$	12.98		C$	50.40		C$	12.98
Valuation date stock price⁽⁵⁾	C$	25.17		C$	25.17		C$	25.17		C$	62.38		C$	62.38
Remaining contractual term⁽⁶⁾	3.7 years			6.7 years			0.2 years			2.7 years			1.2 years
Expected volatility ⁽⁷⁾	70.0		%	70.0		%	105.3		%	79.3		%	87.8		%
Risk-free interest rate ⁽⁸⁾	1.1		%	1.1		%	1.5		%	1.8		%	1.8		%
Expected dividend yield ⁽⁹⁾	0.0		%	0.0		%	0.0		%	0.0		%	0.0		%


⁽¹⁾	New Tranche C Warrants are not included in the table as there is no fair value assigned.


⁽²⁾	The fair value is estimated using the Black-Scholes option-pricing model (Level 2 fair value measurement).


⁽³⁾	The fair value is estimated using Monte Carlo simulations (Level 2 fair value measurement).


⁽⁴⁾	Based on the exercise price from the applicable underlying agreements.


⁽⁵⁾	Based on the closing market price for Canopy common stock on the TSX as of the applicable date.


⁽⁶⁾	Based on the expiration date of the warrants.


⁽⁷⁾	Based on consideration of historical and/or implied volatility levels of the underlying equity security and limited consideration of historical peer group volatility levels.


⁽⁸⁾	Based on the implied yield currently available on Canadian Treasury zero coupon issues with a remaining term equal to the expiration date of the warrants.


⁽⁹⁾	Based on historical dividend levels.

Debt securities, Convertible – In June 2018, we acquired convertible debt securities issued by Canopy for C$200.0 million, or $150.5 million (the “Canopy Debt Securities”). We have elected the fair value option to account for the Canopy Debt Securities, which, at that time, provided the greatest level of consistency with the accounting treatment for the November 2017 Canopy Warrants. Interest income on the Canopy Debt Securities is calculated using the effective interest method and is recognized separately from the changes in fair value in interest expense. The Canopy Debt Securities have a contractual maturity of five years from the date of issuance, but may be converted prior to maturity by either party upon the occurrence of certain events. At settlement, the Canopy Debt Securities can be settled at the option of the issuer, in cash, equity shares of the issuer, or a combination thereof. The fair value is estimated using a binomial lattice option-pricing model (Level 2 fair value measurement), which includes an estimate of the credit spread based on the implied spread as of the issuance date of the notes.

The inputs used to estimate the fair value of the Canopy Debt Securities are as follows:



	February 29, 2020			February 28, 2019
Conversion price⁽¹⁾	C$	48.17		C$	48.17
Valuation date stock price⁽²⁾	C$	25.17		C$	62.38
Remaining term ⁽³⁾	3.4 years			4.4 years
Expected volatility ⁽⁴⁾	58.2		%	45.9		%
Risk-free interest rate ⁽⁵⁾	1.1		%	1.8		%
Expected dividend yield ⁽⁶⁾	0.0		%	0.0		%


⁽¹⁾	Based on the rate which the Canopy Debt Securities may be converted into equity shares, or the equivalent amount of cash, at the option of the issuer.


⁽²⁾	Based on the closing market price for Canopy common stock on the TSX as of the applicable date.


⁽³⁾	Based on the contractual maturity date of the notes.


⁽⁴⁾	Based on historical volatility levels of the underlying equity security reduced to account for certain risks not incorporated into the option-pricing model.


⁽⁵⁾	Based on the implied yield currently available on Canadian Treasury zero coupon issues with a term equal to the remaining contractual term of the debt securities.


⁽⁶⁾	Based on historical dividend levels.

Short-term borrowings

The revolving credit facility under our senior credit facility is a variable interest rate bearing note which includes a fixed margin which is adjustable based upon our debt rating (as defined in our senior credit facility). Its fair value is estimated by discounting cash flows using LIBOR plus a margin reflecting current market conditions obtained from participating member financial institutions (Level 2 fair value measurement). The remaining instruments, including our commercial paper, are variable interest rate bearing notes for which the carrying value approximates the fair value.

Long-term debt

The term loans under our Term Credit Agreement and 2019 Term Credit Agreement (both as defined in Note 13) are variable interest rate bearing notes which include a fixed margin which is adjustable based upon our debt rating. The senior floating rate notes are variable interest rate bearing notes which include a fixed margin. The fair value of the term loans and the senior floating rate notes are estimated by discounting cash flows using LIBOR plus a margin reflecting current market conditions obtained from participating member financial institutions (Level 2 fair value measurement). The fair value of the remaining long-term debt, which is primarily fixed interest rate, is estimated by discounting cash

flows using interest rates currently available for debt with similar terms and maturities (Level 2 fair value measurement).

The carrying amounts of certain of our financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, and short-term borrowings, approximate fair value as of February 29, 2020, and February 28, 2019, due to the relatively short maturity of these instruments. As of February 29, 2020, the carrying amount of long-term debt, including the current portion, was $11,945.7 million, compared with an estimated fair value of $12,935.9 million. As of February 28, 2019, the carrying amount of long-term debt, including the current portion, was $12,825.0 million, compared with an estimated fair value of $12,768.5 million.

Recurring basis measurements

The following table presents our financial assets and liabilities measured at estimated fair value on a recurring basis:



	Fair Value Measurements Using
	Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
(in millions)
February 29, 2020
Assets:
Foreign currency contracts	$	—	$	96.3	$	—	$	96.3
Commodity derivative contracts	$	—	$	0.6	$	—	$	0.6
Equity securities ⁽¹⁾	$	—	$	991.5	$	—	$	991.5
Canopy Debt Securities ⁽¹⁾	$	—	$	125.6	$	—	$	125.6
Liabilities:
Foreign currency contracts	$	—	$	34.4	$	—	$	34.4
Commodity derivative contracts	$	—	$	40.9	$	—	$	40.9
Interest rate swap contracts	$	—	$	0.8	$	—	$	0.8
Treasury lock contracts	$	—	$	7.6	$	—	$	7.6

February 28, 2019
Assets:
Foreign currency contracts	$	—	$	38.2	$	—	$	38.2
Commodity derivative contracts	$	—	$	8.7	$	—	$	8.7
Equity securities ⁽¹⁾	$	—	$	3,023.2	$	—	$	3,023.2
Canopy Debt Securities ⁽¹⁾	$	—	$	211.5	$	—	$	211.5
Liabilities:
Foreign currency contracts	$	—	$	15.7	$	—	$	15.7
Commodity derivative contracts	$	—	$	11.6	$	—	$	11.6



⁽¹⁾	Unrealized net gain (loss) from the changes in fair value of our securities measured at fair value recognized in income (loss) from unconsolidated investments, are as follows:
			February 29, 2020			February 28, 2019
	(in millions)
	November 2017 Canopy Investment ⁽ⁱ⁾		$	—		$	292.5
	November 2017 Canopy Warrants		(543.7		)	465.5
	November 2018 Canopy Warrants ⁽ⁱⁱ⁾		(1,488.1		)	1,157.7
	Canopy Debt Securities		(94.6		)	55.5
			$	(2,126.4	)	$	1,971.2

	⁽ⁱ⁾	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. For additional information on the November 2017 Canopy Investment, refer to Note 10.
	⁽ⁱⁱ⁾	The terms of the November 2018 Canopy Warrants were modified in June 2019. For additional information on the November 2018 Canopy Warrants and the related modification, refer to Note 10. For the year ended February 29, 2020, amounts are net of a $1,176.0 million unrealized gain resulting from the June 2019 Warrant Modification.

Nonrecurring basis measurements

The following table presents our assets and liabilities measured at estimated fair value on a nonrecurring basis for which an impairment assessment was performed for the periods presented:



	Fair Value Measurements Using
	Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Losses
(in millions)
For the Year Ended February 29, 2020
Long-lived assets held for sale	$	—	$	—	$	949.3	$	449.7
Trademarks ⁽¹⁾	—		—		—		11.0
	$	—	$	—	$	949.3	$	460.7

For the Year Ended February 28, 2019
Trademarks	$	—	$	—	$	28.0	$	108.0

For the Year Ended February 28, 2018
Trademarks	$	—	$	—	$	136.0	$	86.8


⁽¹⁾	The balance at February 29, 2020, has been reclassified to assets held for sale (see “Trademarks” below for further discussion).

Long-lived assets held for sale

For the second quarter of fiscal 2020, in connection with the Wine and Spirits Transaction, long-lived assets held for sale were written down to their estimated fair value, less costs to sell, resulting in a loss of $27.0 million. For the third quarter and fourth quarter of fiscal 2020, in connection with the New Wine and Spirits Transactions, additional losses of $340.0 million and $20.0 million were recognized, respectively. Additionally, in the fourth quarter of fiscal 2020, in connection with the Other Wine and Spirits Transactions, long-lived assets held for sale were written down to their estimated fair value, less costs to sell, resulting in a loss of $20.0 million. Of the total Wine and Spirits segment long-lived assets held for sale with a carrying value of $1,479.4 million, $1,291.2 million were written down to their current estimated fair value of $908.2 million, less costs to sell, resulting in a total loss of $407.0 million for the year ended February 29, 2020. This loss is included in impairment of assets held for sale. These assets consisted primarily of goodwill, intangible assets, and certain winery and vineyard assets which had satisfied the conditions necessary to be classified as held for sale. Our estimate of fair value was

determined based on the expected proceeds from the New Wine and Spirits Transactions and Other Wine and Spirits Transactions, excluding the contingent consideration, which we will recognize when it is determined to be realizable.

For the third quarter of fiscal 2020, in connection with the Ballast Point Transaction, long-lived assets held for sale were written down to their estimated fair value, less costs to sell, resulting in a loss of $50.0 million. Subsequently, for the fourth quarter of fiscal 2020, a reduction to the loss on long-lived assets held for sale of $7.3 million was recognized. The long-lived assets held for sale with a carrying value of $77.8 million were written down to their estimated fair value of $41.1 million, less costs to sell. As a result, a loss of $42.7 million, inclusive of costs to sell and other losses is included in impairment of assets held for sale for the year ended February 29, 2020. These assets consisted primarily of intangible assets and certain production and warehouse assets which had satisfied the conditions necessary to be classified as held for sale. Our estimate of fair value was determined based on the expected proceeds from the Ballast Point Transaction. The Ballast Point craft beer portfolio is a component of the Beer segment and was included in our beer reporting unit. Accordingly, goodwill was allocated to the Ballast Point craft beer portfolio assets held for sale based on the relative fair value of the business being sold compared to the relative fair value of the reporting unit. Goodwill not allocated to assets held for sale remains in the beer reporting unit.

Trademarks

For the second quarter of fiscal 2020, certain continuing negative trends within our Beer segment’s Ballast Point craft beer portfolio, including increased rate of revenue decline and increased competition, indicated that it was more likely than not that the fair value of our indefinite-lived intangible asset associated with the Ballast Point craft beer trademarks might be below its carrying value. Accordingly, we performed a quantitative assessment for impairment. As a result of this assessment, the Ballast Point craft beer trademark asset with a carrying value of $28.0 million was written down to its estimated fair value of $17.0 million, resulting in an impairment of $11.0 million. This impairment is included in selling, general, and administrative expenses for the year ended February 29, 2020. The Ballast Point craft beer trademarks have been reclassified to assets held for sale as of February 29, 2020.

For the fourth quarter of fiscal 2019, in connection with certain continuing negative trends within our Beer segment’s Ballast Point craft beer portfolio, including slower growth rates and increased competition, we implemented a change in strategy for our Ballast Point craft beer portfolio. This change in strategy, when combined with the continuing negative trends, indicated that it was more likely than not that the fair value of our indefinite lived intangible asset associated with the craft beer trademarks might be below its carrying value. The change in strategy for our Ballast Point craft beer portfolio focuses on improving profitability by rationalizing the number of product offerings while targeting distribution growth in select strategic markets. This change in strategy resulted in updated long-term financial forecasts with lower revenues, and cash flows for the related portfolio. Accordingly, we performed a quantitative assessment for impairment of the Ballast Point craft beer trademark asset. As a result of this assessment, the Ballast Point craft beer trademark asset with a carrying value of $136.0 million was written down to its estimated fair value of $28.0 million, resulting in an impairment of $108.0 million.

For the first quarter of fiscal 2018, we identified certain negative trends within our Beer segment’s Ballast Point craft beer portfolio which, when combined with the then-recent negative craft beer industry trends, including slower growth rates and increased competition, indicated that it was more likely than not that the fair value of our indefinite lived intangible asset associated with the craft beer trademarks might be below its carrying value. These negative trends were the result of (i) a disruption in our distribution network transition plan, (ii) an unexpected decrease in sales from product innovations, and (iii) a significant shift in market conditions for our craft beer portfolio, all of which resulted in a decline in net sales and depletion trends, which represent distributor shipments of our branded products to retail customers, for the first quarter of fiscal 2018 as compared to the first quarter of fiscal 2017. Additionally, net sales for the first quarter of fiscal 2018 were below our forecasted net sales for the first quarter of fiscal 2018. Accordingly, we performed a quantitative assessment for impairment of the craft beer trademark asset. As a result of this assessment, the craft beer trademark asset with a carrying value of

$222.8 million was written down to its estimated fair value of $136.0 million, resulting in an impairment of $86.8 million.

When performing a quantitative assessment for impairment of a trademark asset, we measure the amount of impairment by calculating the amount by which the carrying value of the trademark asset exceeds its estimated fair value. The estimated fair value is determined based on an income approach using the relief from royalty method, which assumes that, in lieu of ownership, a third party would be willing to pay a royalty in order to exploit the related benefits of the trademark asset. The cash flow projections we use to estimate the fair value of our trademark assets involve several assumptions, including (i) projected revenue growth rates, (ii) estimated royalty rates, (iii) after-tax royalty savings expected from ownership of the trademarks, and (iv) discount rates used to derive the estimated fair value of the trademark assets.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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