Constellation Brands, Inc. Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

Fair Value of Financial Instruments

Fair Value of Financial Instruments

6 Months Ended

Aug. 31, 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 November 2017 Canopy Warrants were exercised on May 1, 2020. For additional information on the November 2017 Canopy Warrants and the related exercise, refer to Note 8.

The inputs used to estimate the fair value of the Canopy warrants (all as defined in Note 8) are as follows:


	August 31, 2020 ^{(1) (2)}									February 29, 2020 ⁽²⁾
	Tranche A Warrants⁽³⁾			Tranche B Warrants ⁽⁴⁾			Tranche A Warrants ⁽³⁾			Tranche B Warrants ⁽⁴⁾			November 2017 Canopy Warrants ⁽³⁾
Exercise price ⁽⁵⁾	C$	50.40		C$	76.68		C$	50.40		C$	76.68		C$	12.98
Valuation date stock price ⁽⁶⁾	C$	21.51		C$	21.51		C$	25.17		C$	25.17		C$	25.17
Remaining contractual term⁽⁷⁾	3.2 years			6.2 years			3.7 years			6.7 years			0.2 years
Expected volatility ⁽⁸⁾	75.0		%	75.0		%	70.0		%	70.0		%	105.3		%
Risk-free interest rate ⁽⁹⁾	0.3		%	0.4		%	1.1		%	1.1		%	1.5		%
Expected dividend yield ⁽¹⁰⁾	0.0		%	0.0		%	0.0		%	0.0		%	0.0		%

⁽¹⁾The November 2017 Canopy Warrants were exercised on May 1, 2020 and as such are not included in the table as of August 31, 2020.

⁽²⁾The exercise price for the 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”) and are not included in the table as there is no fair value assigned.

⁽³⁾The fair value is estimated using the Black-Scholes option-pricing model (Level 2 fair value measurement).

⁽⁴⁾The fair value is estimated using Monte Carlo simulations (Level 2 fair value measurement).

⁽⁵⁾Based on the exercise price from the applicable underlying agreements.

⁽⁶⁾Based on the closing market price for Canopy common stock on the TSX as of the applicable date.

⁽⁷⁾Based on the following expiration dates for the November 2017 Canopy Warrants and November 2018 Canopy Warrants (all as defined in Note 8):


November 2017 Canopy Warrants						May 1, 2020
Tranche A Warrants						November 1, 2023
Tranche B Warrants						November 1, 2026

⁽⁸⁾Based on consideration of historical and/or implied volatility levels of the underlying equity security and limited consideration of historical peer group volatility levels.

⁽⁹⁾Based on the implied yield currently available on Canadian Treasury zero coupon issues with a remaining term equal to the expiration date of the applicable warrants.

⁽¹⁰⁾Based on historical dividend levels.

Debt securities, Convertible – We have elected the fair value option to account for convertible debt securities issued by Canopy for C$200.0 million, or $150.5 million (the “Canopy Debt Securities”). 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 and changes in market spreads through the valuation date of the notes.

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


	August 31, 2020			February 29, 2020
Conversion price ⁽¹⁾	C$	48.17		C$	48.17
Valuation date stock price ⁽²⁾	C$	21.51		C$	25.17
Remaining term⁽³⁾	2.9 years			3.4 years
Expected volatility ⁽⁴⁾	61.9		%	58.2		%
Risk-free interest rate ⁽⁵⁾	0.3		%	1.1		%
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 for certain risks associated with debt securities.

⁽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 with a fixed margin, 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 loan under our March 2020 Term Credit Agreement (as defined in Note 9) is a variable interest rate bearing note with a fixed margin, adjustable based upon our debt rating. The senior floating rate notes are variable interest rate bearing notes which include fixed margins. The carrying value approximates the fair value of the term loan. 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 August 31, 2020, and February 29, 2020, due to the relatively short maturity of these instruments. As of August 31, 2020, the carrying amount of long-term debt, including the current portion, was $11,600.6 million, compared with an estimated fair value of $12,975.1 million. 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.

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)
August 31, 2020
Assets:
Foreign currency contracts	$	—	$	16.9	$	—	$	16.9
Commodity derivative contracts	$	—	$	5.5	$	—	$	5.5

Equity securities ⁽¹⁾	$	—	$	635.9	$	—	$	635.9
Canopy Debt Securities ⁽¹⁾	$	—	$	128.1	$	—	$	128.1

Liabilities:
Foreign currency contracts	$	—	$	64.5	$	—	$	64.5
Commodity derivative contracts	$	—	$	31.0	$	—	$	31.0



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


⁽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:
		For the Six Months Ended August 31,						For the Three Months Ended August 31,
		2020		2019		2020		2019
	(in millions)
	November 2017 Canopy Warrants⁽ⁱ⁾	$	(61.8)	$	(450.8)	$	—	$	(316.7)
	November 2018 Canopy Warrants ⁽ⁱⁱ⁾	(180.6)		(1,134.4)		(57.6)		(473.6)
	Canopy Debt Securities	(2.5)		(81.4)		10.0		(48.8)
		$	(244.9)	$	(1,666.6)	$	(47.6)	$	(839.1)

⁽ⁱ⁾	The November 2017 Canopy Warrants were exercised in May 2020. For additional information on the November 2017 Canopy Warrants and the related exercise, refer to Note 8.
⁽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 8. The amounts for the six months and three months ended August 31, 2019, 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 Six Months Ended August 31, 2020
Long-lived assets held for sale	$	—	$	—	$	795.2	$	3.0

For the Six Months Ended August 31, 2019
Long-lived assets held for sale	$	—	$	—	$	1,444.4	$	27.0
Trademarks	—		—		17.0		11.0
Total	$	—	$	—	$	1,461.4	$	38.0

Long-lived assets held for sale

For the first quarter of fiscal 2021, in connection with the Wine and Spirits Transactions and the Concentrate Business Transaction, long-lived assets held for sale were written down to their estimated fair value, less costs to sell, resulting in a loss of $25.0 million. Subsequently, for the second quarter of fiscal 2021, a reduction to the loss on long-lived assets held for sale of $22.0 million was recognized. The long-lived assets held for sale with a carrying value of $798.2 million were written down to their estimated fair value of $795.2 million, less costs to sell, resulting in a total loss of $3.0 million for the six months ended August 31, 2020. This loss was included in impairment of assets held for sale within our consolidated results of operations. 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 current estimate of fair value was determined based on the expected proceeds from the Wine and Spirits Transactions and the Concentrate Business Transaction as of August 31, 2020, excluding the contingent consideration, which we will recognize when it is determined to be realizable.

For the six months and three months ended August 31, 2019, in connection with the Original Wine and Spirits Transaction, long-lived assets held for sale with a carrying value of $1,471.4 million were written down to their estimated fair value of $1,444.4 million, less cost to sell, resulting in a loss of $27.0 million. These losses are included in impairment of assets held for sale within our consolidated results of operations. 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. As such, these assets were written down to a value based on our estimate of fair value less cost to sell. Our estimate of fair value was determined based on the expected proceeds from the Original Wine and Spirits Transaction as of August 31, 2019.

Trademarks

For the six months and three months ended August 31, 2019, 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 trademark 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 within our consolidated results of operations.

- 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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