NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
In these notes, “we,” “us,” “our,” “Brown-Forman,” and the “Company” refer to Brown-Forman Corporation and its consolidated subsidiaries, collectively.
1.
Condensed Consolidated Financial Statements
We prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (SEC) for interim financial information. In accordance with those rules and regulations, we condensed or omitted certain information and disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP). In our opinion, the accompanying financial statements include all adjustments, consisting only of normal recurring adjustments (unless otherwise indicated), necessary for a fair statement of our financial results for the periods covered by this report. The results for interim periods are not necessarily indicative of future or annual results.
We suggest that you read these condensed financial statements together with the financial statements and footnotes included in our Annual Report on Form 10-K for the fiscal year ended April 30, 2018 (2018 Annual Report). Except for adopting the new accounting standards discussed below, we prepared the accompanying financial statements on a basis that is substantially consistent with the accounting principles applied in our 2018 Annual Report.
Recently adopted accounting standards.
As of May 1, 2018, we adopted the following Accounting Standards Updates (ASUs) issued by the Financial Accounting Standards Board (FASB):
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•
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ASU 2014-09
: Revenue from Contracts with Customers. This update, codified along with various amendments as Accounting Standards Codification Topic 606 (ASC 606), replaces previous revenue recognition guidance. The core principle of ASC 606 requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration that it expects to be entitled to in exchange for those goods or services. ASC 606 also requires more financial statement disclosures than were required by previous revenue recognition standards. We applied this new guidance on a modified retrospective basis through a cumulative-effect adjustment that reduced retained earnings as of May 1, 2018, by
$25 million
(net of tax). See Note 2 for additional information about our revenues and the impact of adopting ASC 606.
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•
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ASU 2016-15
: Classification of Certain Cash Receipts and Cash Payments. This new guidance addresses eight specific issues related to the classification of certain cash receipts and cash payments on the statement of cash flows. The impact of adopting the new guidance was limited to a change in our classification of cash payments for premiums on corporate-owned life insurance policies, which we previously reflected in operating activities. Under the new guidance, we classify those payments as investing activities. We retrospectively adjusted prior period cash flow statements to conform to the new classification. As a result, we reclassified payments of
$3 million
from operating activities to investing activities for the three months ended July 31, 2017.
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•
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ASU 2016-16
: Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory. This revised guidance requires the recognition of the income tax consequences (expense or benefit) of an intercompany transfer of assets other than inventory when the transfer occurs. It maintains the existing requirement to defer the recognition of the income tax consequences of an intercompany transfer of inventory until the inventory is sold to an outside party. We applied the guidance on a modified retrospective basis through a cumulative-effect adjustment that increased retained earnings as of May 1, 2018, by
$20 million
.
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•
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ASU 2017-04
: Simplifying the Test for Goodwill Impairment. This updated guidance eliminates the second step of the previous two-step quantitative test of goodwill for impairment. Under the new guidance, the quantitative test consists of a single step in which the carrying amount of the reporting unit is compared to its fair value. An impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the amount of the impairment would be limited to the total amount of goodwill allocated to the reporting unit. The guidance does not affect the existing option to perform the qualitative assessment for a reporting unit to determine whether the quantitative impairment test is necessary. The prospective adoption of the new standard had no impact on our consolidated financial statements.
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•
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ASU 2017-07
: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. This new guidance addresses the presentation of the net periodic cost (NPC) associated with pension and other postretirement benefit plans. The guidance requires the service cost component of the NPC to be reported in the
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income statement in the same line item(s) as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of the NPC are to be presented separately from the service cost and outside of income from operations. In addition, the guidance allows only the service cost component of NPC to be eligible for capitalization when applicable. We applied the guidance retrospectively for the presentation in the income statement and prospectively for the capitalization of service cost. The retrospective application increased previously-reported operating income by
$2 million
for the three months ended July 31, 2017. As the retrospective application merely reclassified amounts from operating income to non-operating expense, there was no effect on previously-reported net income or earnings per share.
New accounting standards to be adopted.
The FASB has issued the ASUs described below that we are not required to adopt until May 1, 2019 (although early adoption is permitted). We are currently evaluating their potential impact on our financial statements.
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•
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ASU 2016-02
: Leases. This update, codified along with various amendments as Accounting Standards Codification Topic 842 (ASC 842), replaces existing lease accounting guidance. Under ASC 842, a lessee should recognize on its balance sheet a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. ASC 842 permits an entity to make an accounting policy election not to recognize lease assets and liabilities for leases with a term of 12 months or less. It also requires additional quantitative and qualitative disclosures about leasing arrangements. We will adopt ASC 842 as of May 1, 2019, using a modified retrospective transition approach for leases existing at that date.
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•
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ASU 2017-12
: Targeted Improvements to Accounting for Hedging Activities. This new guidance is intended to better align hedge accounting with an entity’s risk management activities and improve disclosures about hedges. The guidance expands hedge accounting for financial and nonfinancial risk components, eliminates the requirement to separately measure and report hedge ineffectiveness, simplifies the way assessments of hedge effectiveness may be performed, and amends some presentation and disclosure requirements for hedges. It is to be applied using a modified retrospective transition approach for cash flow and net investment hedges existing at the date of adoption. The amended presentation and disclosure guidance is required only prospectively. We have not yet determined our plans for adoption, but are considering the possibility of adopting this new guidance before the required adoption date.
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•
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ASU 2018-02
: Reclassification of Certain Effects from Accumulated Other Comprehensive Income. This new guidance would allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act enacted by the U.S. government in December 2017. It is to be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. We have not yet determined our plans for adoption, but are considering the possibility of adopting this new guidance before the required adoption date.
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There are no other new accounting standards to be adopted that we currently believe might have a significant impact on our consolidated financial statements.
Reclassifications
. We have reclassified some previously reported expense amounts related to certain marketing research and promotional agency costs to conform to the current year classification. These immaterial reclassifications between advertising expenses and selling, general, and administrative expenses had no impact on net income.
2.
Net Sales
Effective May 1, 2018, we updated our policy for recognizing revenue (“net sales”) to reflect the adoption of ASC 606. We describe the updated policy below. Also, we show how the adoption impacted our financial statements and we present disaggregated net sales information in accordance with the new standard.
Revenue recognition policy.
Our net sales predominantly reflect global sales of beverage alcohol consumer products. We sell these products under contracts with different types of customers, depending on the market. The customer is most often a distributor, wholesaler, or retailer.
Each contract typically includes a single performance obligation to transfer control of the products to the customer. Depending on the contract, control is transferred when the products are either shipped or delivered to the customer, at which point we recognize the transaction price for those products as net sales. The transaction price recognized at that point reflects our estimate of the consideration to be received in exchange for the products. The actual amount may ultimately differ due to the effect of various customer incentives and trade promotion activities. In making our estimates, we consider our historical
experience and current expectations, as applicable. Adjustments recognized during the three months ended July 31, 2018, for changes in estimated transaction prices of products sold in prior periods were not material.
Net sales exclude taxes we collect from customers that are imposed by the government on our sales, and are reduced by payments to customers unless made in exchange for distinct goods or services with fair values approximating the payments.
Net sales include any amounts we bill customers for shipping and handling activities related to the products. We recognize the cost of those activities in cost of sales during the same period in which we recognize the related net sales.
Sales returns, which are permitted only in limited situations, are not material.
Customer payment terms generally range from 30 to 90 days. There are no significant amounts of contract assets or liabilities.
Impact of adoption.
We adopted ASC 606 using the modified retrospective method. As a result, we recorded an adjustment that decreased retained earnings as of May 1, 2018, by
$25 million
(net of tax). The adjustment reflects the cumulative effect on that date of applying our updated revenue recognition policy, under which we recognize the cost of certain customer incentives earlier than we did before adopting ASC 606. Although we do not expect this change in timing to have a significant impact on a full-year basis, we do anticipate some change in the pattern of recognition among fiscal quarters. Additionally, some payments to customers that we classified as expenses before adopting the new standard are classified as reductions of net sales under our new policy.
The following table shows how the adoption of ASC 606 impacted our consolidated statement of operations for the three months ended July 31, 2018:
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Three Months Ended July 31, 2018
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Under Prior
|
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As Reported Under
|
|
Effect of
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(Dollars in millions, except per share amounts)
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Guidance
|
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ASC 606
|
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Adoption
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Sales
|
$
|
997
|
|
|
$
|
987
|
|
|
$
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(10
|
)
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Excise taxes
|
221
|
|
|
221
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|
|
—
|
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Net sales
|
776
|
|
|
766
|
|
|
(10
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)
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Cost of sales
|
243
|
|
|
243
|
|
|
—
|
|
Gross profit
|
533
|
|
|
523
|
|
|
(10
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)
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Advertising expenses
|
101
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|
|
98
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|
|
(3
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)
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Selling, general, and administrative expenses
|
169
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|
|
168
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|
|
(1
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)
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Other expense (income), net
|
(7
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)
|
|
(7
|
)
|
|
—
|
|
Operating income
|
270
|
|
|
264
|
|
|
(6
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)
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Non-operating postretirement expense
|
2
|
|
|
2
|
|
|
—
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Interest income
|
(2
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)
|
|
(2
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)
|
|
—
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Interest expense
|
22
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|
|
22
|
|
|
—
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Income before income taxes
|
248
|
|
|
242
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|
|
(6
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)
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Income taxes
|
44
|
|
|
42
|
|
|
(2
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)
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Net income
|
$
|
204
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|
|
$
|
200
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|
|
$
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(4
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)
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Earnings per share:
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Basic
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$
|
0.43
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$
|
0.42
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|
$
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(0.01
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)
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Diluted
|
$
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0.42
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|
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$
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0.41
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|
|
$
|
(0.01
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)
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The following table shows how the adoption of ASC 606 impacted our consolidated balance sheet as of July 31, 2018:
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As of July 31, 2018
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Under Prior
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As Reported Under
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Effect of
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(Dollars in millions)
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Guidance
|
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ASC 606
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Adoption
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Assets
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Other current assets
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$
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307
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$
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305
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$
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(2
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)
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Deferred tax assets
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15
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|
|
16
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|
|
1
|
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Total assets
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5,026
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5,025
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(1
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)
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Liabilities
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|
|
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Accounts payable and accrued expenses
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$
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527
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$
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564
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$
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37
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Accrued income taxes
|
53
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|
|
52
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|
|
(1
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)
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Deferred tax liabilities
|
127
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|
|
119
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|
|
(8
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)
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Total liabilities
|
3,629
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|
|
3,657
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|
|
28
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|
|
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|
|
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Stockholders’ Equity
|
|
|
|
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Retained earnings
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$
|
1,796
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|
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$
|
1,767
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|
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$
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(29
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)
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Total stockholders’ equity
|
1,397
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|
1,368
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(29
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)
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Disaggregated revenues.
The following table shows our net sales by geography:
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Three Months Ended
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July 31,
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(Dollars in millions, except per share amounts)
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2017
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2018
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United States
|
$
|
355
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|
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$
|
357
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Developed International
1
|
193
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|
|
215
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Emerging
2
|
123
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|
|
131
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Travel Retail
3
|
30
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|
|
38
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Non-branded and bulk
4
|
22
|
|
|
25
|
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Total
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$
|
723
|
|
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$
|
766
|
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1
Represents sales of branded products to “advanced economies” as defined by the International Monetary Fund (IMF), excluding the United States. Our largest developed international markets are the United Kingdom, Australia, and Germany.
2
Represents sales of branded products to “emerging and developing economies” as defined by the IMF. Our largest emerging markets are Mexico and Poland.
3
Represents sales of branded products to global duty-free customers, travel retail customers, and the U.S. military regardless of customer location.
4
Includes sales of used barrels, bulk whiskey and wine, and contract bottling regardless of customer location.
The following table shows our net sales by product category:
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Three Months Ended
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July 31,
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(Dollars in millions, except per share amounts)
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2017
|
|
2018
|
Whiskey
1
|
$
|
557
|
|
|
$
|
602
|
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Tequila
2
|
58
|
|
|
62
|
|
Vodka
3
|
31
|
|
|
26
|
|
Wine
4
|
42
|
|
|
40
|
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Rest of portfolio
|
13
|
|
|
11
|
|
Non-branded and bulk
5
|
22
|
|
|
25
|
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Total
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$
|
723
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|
|
$
|
766
|
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1
Includes all whiskey spirits and whiskey-based flavored liqueurs, ready-to-drink, and ready-to-pour products. The brands included in this category are the Jack Daniel's family of brands, Woodford Reserve, Canadian Mist, GlenDronach, BenRiach, Glenglassaugh, Old Forester, Early Times, Slane Irish Whiskey, and Coopers' Craft.
2
Includes el Jimador, Herradura, New Mix, Pepe Lopez, and Antiguo.
3
Includes Finlandia.
4
Includes Korbel Champagne and Sonoma-Cutrer wines.
5
Includes sales of used barrels, bulk whiskey and wine, and contract bottling regardless of customer location.
3.
Income Taxes
Our consolidated interim effective tax rate is based upon our expected annual operating income, statutory tax rates, and income tax laws in the various jurisdictions in which we operate. Significant or unusual items, including adjustments to accruals for tax uncertainties, are recognized in the quarter in which the related event or a change in judgment occurs. The effective tax rate of
17.4%
for the
three months ended
July 31, 2018
, is lower than the expected tax rate of
21.1%
on ordinary income for the full fiscal year, primarily due to (a) the impact of the current year adjustment to the provisional repatriation U.S. tax charge that was made during fiscal 2018 (discussed below) and (b) the excess tax benefits related to stock-based compensation. Our expected tax rate includes current fiscal year additions for existing tax contingency items.
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (Tax Act). The Tax Act significantly revised the future ongoing U.S. corporate income tax by, among other things, lowering U.S. corporate income tax rates and implementing a territorial tax system. As we have an April 30 fiscal year-end, the lower corporate income tax rate was phased in, resulting in a U.S. statutory federal rate of
30.4%
for our fiscal year ended April 30, 2018, and
21%
for our current and subsequent fiscal years. For the quarter ended July 31, 2018, the impact of the lower tax rate resulted in a tax benefit of approximately
$27 million
. With the enactment of the Tax Act, we continue to evaluate our global working capital requirements and may change our current permanent reinvestment assertion in future periods.
There are also certain transitional impacts of the Tax Act. As part of the transition to the new territorial tax system, the Tax Act imposed a one-time repatriation tax on deemed repatriation of historical earnings of foreign subsidiaries. In addition, the reduction of the U.S. corporate tax rate caused us to adjust our U.S. deferred tax assets and liabilities to the lower federal base rate of
21%
. These transitional impacts resulted in a provisional net charge of
$43 million
for the year ended April 30, 2018, comprised of a provisional repatriation U.S. tax charge of
$91 million
and a provisional net deferred tax benefit of
$48 million
. In the quarter ended July 31, 2018, we recorded a provisional benefit of
$6 million
as an adjustment to the provisional repatriation charge.
The Tax Act also established new tax laws that impact our financial statements beginning in the current fiscal year. These new laws include, but are not limited to (a) Global Intangible Low-Tax Income (GILTI), a new provision for tax on low-tax foreign earnings; (b) Base Erosion Anti-abuse Tax (BEAT), a new minimum tax; (c) Foreign-Derived Intangible Income (FDII), a new provision for deductions related to foreign-derived intangibles; (d) repeal of the domestic production activity deduction; and (e) limitations on certain executive compensation. For the quarter ended July 31, 2018, the net impact of these provisions was approximately
$2 million
of additional tax.
As noted, certain income earned by foreign subsidiaries must be included in U.S. taxable income under the GILTI provisions. The FASB allows an accounting policy election of either recognizing deferred taxes for temporary differences expected to reverse as GILTI in future years or recognizing such taxes as a current period expense when incurred. We have elected to recognize these taxes as a current period expense when incurred.
The changes included in the Tax Act are broad and complex. The final transition impacts of the Tax Act may differ from the current estimates, due to, among other things, changes in interpretations of the Tax Act, any legislative action to address questions that arise because of the Tax Act, any changes in accounting standards for income taxes or related interpretations in response to the Tax Act, or any updates or changes to estimates we have used to calculate the transition impacts, including impacts from changes to current year earnings estimates and foreign currency exchange rates. The SEC has issued rules that allow for a measurement period of up to one year after the enactment date of the Tax Act to finalize the recording of the related tax impacts. As of July 31, 2018, the amounts recorded for the Tax Act remain provisional for the one-time repatriation tax and the adjustment to our U.S. deferred tax assets and liabilities. We will finalize and record any additional adjustments within the allowed measurement period.
4.
Earnings Per Share
We calculate basic earnings per share by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share further includes the dilutive effect of stock-based compensation awards. We calculate that dilutive effect using the “treasury stock method” (as defined by GAAP).
The following table presents information concerning basic and diluted earnings per share:
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|
|
|
|
|
|
|
|
Three Months Ended
|
|
July 31,
|
(Dollars in millions, except per share amounts)
|
2017
|
|
2018
|
Net income available to common stockholders
|
$
|
178
|
|
|
$
|
200
|
|
|
|
|
|
Share data (in thousands):
|
|
|
|
Basic average common shares outstanding
|
480,048
|
|
|
480,964
|
|
Dilutive effect of stock-based awards
|
2,936
|
|
|
3,477
|
|
Diluted average common shares outstanding
|
482,984
|
|
|
484,441
|
|
|
|
|
|
Basic earnings per share
|
$
|
0.37
|
|
|
$
|
0.42
|
|
Diluted earnings per share
|
$
|
0.37
|
|
|
$
|
0.41
|
|
We excluded common stock-based awards for approximately
1,719,000
shares and
100,000
shares from the calculation of diluted earnings per share for the three months ended
July 31, 2017
and
2018
, respectively. We excluded those awards because they were not dilutive for those periods under the treasury stock method.
5.
Inventories
Inventories are valued at the lower of cost or market. Some of our consolidated inventories are valued using the last-in, first-out (LIFO) method, which we use for the majority of our U.S. inventories. If the LIFO method had not been used, inventories at current cost would have been
$290 million
higher than reported as of
April 30, 2018
, and
$295 million
higher than reported as of
July 31, 2018
. Changes in the LIFO valuation reserve for interim periods are based on a proportionate allocation of the estimated change for the entire fiscal year.
6.
Goodwill and Other Intangible Assets
The following table shows the changes in goodwill (which includes no accumulated impairment losses) and other intangible assets during the three months ended July 31, 2018:
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|
|
|
|
|
|
|
|
(Dollars in millions)
|
Goodwill
|
|
Other Intangible
Assets
|
Balance at April 30, 2018
|
$
|
763
|
|
|
$
|
670
|
|
Foreign currency translation adjustment
|
(8
|
)
|
|
(12
|
)
|
Balance at July 31, 2018
|
$
|
755
|
|
|
$
|
658
|
|
Our other intangible assets consist of trademarks and brand names, all with indefinite useful lives.
7.
Commitments and Contingencies
We operate in a litigious environment, and we are sued in the normal course of business. Sometimes plaintiffs seek substantial damages. Significant judgment is required in predicting the outcome of these suits and claims, many of which take years to adjudicate. We accrue estimated costs for a contingency when we believe that a loss is probable and we can make a reasonable estimate of the loss, and then adjust the accrual as appropriate to reflect changes in facts and circumstances. We do not believe it is reasonably possible that these existing loss contingencies, individually or in the aggregate, would have a material adverse effect on our financial position, results of operations, or liquidity. No material accrued loss contingencies are recorded as of
July 31, 2018
.
We have guaranteed the repayment by a third-party importer of its obligation under a bank credit facility that it uses in connection with its importation of our products in Russia. If the importer were to default on that obligation, which we believe is unlikely, our maximum possible exposure under the existing terms of the guaranty would be approximately
$10 million
(subject to changes in foreign currency exchange rates). Both the fair value and carrying amount of the guaranty are insignificant.
As of
July 31, 2018
, our actual exposure under the guaranty of the importer’s obligation is approximately
$4 million
. We also have accounts receivable from that importer of approximately
$6 million
at July 31, 2018, which we expect to collect in full.
Based on the financial support we provide to the importer, we believe it meets the definition of a variable interest entity. However, because we do not control this entity, it is not included in our consolidated financial statements.
8.
Debt
Our long-term debt (net of unamortized discount and issuance costs) consists of:
|
|
|
|
|
|
|
|
|
(Principal and carrying amounts in millions)
|
April 30,
2018
|
|
July 31,
2018
|
2.25% senior notes, $250 principal amount, due January 15, 2023
|
$
|
248
|
|
|
$
|
248
|
|
3.50% senior notes, $300 principal amount, due April 15, 2025
|
296
|
|
|
296
|
|
1.20% senior notes, €300 principal amount, due July 7, 2026
|
361
|
|
|
349
|
|
2.60% senior notes, £300 principal amount, due July 7, 2028
|
408
|
|
|
389
|
|
4.00% senior notes, $300 principal amount, due April 15, 2038
|
293
|
|
|
293
|
|
3.75% senior notes, $250 principal amount, due January 15, 2043
|
248
|
|
|
248
|
|
4.50% senior notes, $500 principal amount, due July 15, 2045
|
487
|
|
|
487
|
|
|
$
|
2,341
|
|
|
$
|
2,310
|
|
As of April 30, 2018, our short-term borrowings consisted of
$215 million
of commercial paper, with an average interest rate of
2.04%
, and an average remaining maturity of
23 days
. As of
July 31, 2018
, our short-term borrowings of
$176 million
included
$161 million
of commercial paper, with an average interest rate of
2.17%
, and an average remaining maturity of
20 days
.
9.
Fair Value Measurements
The following table summarizes the assets and liabilities measured or disclosed at fair value on a recurring basis:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
April 30, 2018
|
|
July 31, 2018
|
|
Carrying
|
|
Fair
|
|
Carrying
|
|
Fair
|
(Dollars in millions)
|
Amount
|
|
Value
|
|
Amount
|
|
Value
|
Assets
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
$
|
239
|
|
|
$
|
239
|
|
|
$
|
211
|
|
|
$
|
211
|
|
Currency derivatives
|
1
|
|
|
1
|
|
|
5
|
|
|
5
|
|
Liabilities
|
|
|
|
|
|
|
|
Currency derivatives
|
39
|
|
|
39
|
|
|
7
|
|
|
7
|
|
Short-term borrowings
|
215
|
|
|
215
|
|
|
176
|
|
|
176
|
|
Long-term debt
|
2,341
|
|
|
2,386
|
|
|
2,310
|
|
|
2,347
|
|
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. We categorize the fair values of assets and liabilities into three levels based upon the assumptions (inputs) used to determine those values. Level 1 provides the most reliable measure of fair value, while Level 3 generally requires significant management judgment. The three levels are:
|
|
•
|
Level 1
–
Quoted prices (unadjusted) in active markets for identical assets or liabilities.
|
|
|
•
|
Level 2
–
Observable inputs other than those included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in inactive markets; or other inputs that are observable or can be derived from or corroborated by observable market data.
|
|
|
•
|
Level 3
–
Unobservable inputs supported by little or no market activity.
|
We determine the fair values of our currency derivatives (forward contracts) using standard valuation models. The significant inputs used in these models, which are readily available in public markets or can be derived from observable market transactions, include the applicable spot rates, forward rates, and discount rates. The discount rates are based on the historical U.S. Treasury rates. These fair value measurements are categorized as Level 2 within the valuation hierarchy.
We determine the fair value of long-term debt primarily based on the prices at which similar debt has recently traded in the market and also considering the overall market conditions on the date of valuation. These fair value measurements are categorized as Level 2 within the valuation hierarchy.
The fair values of cash, cash equivalents, and short-term borrowings approximate the carrying amounts due to the short maturities of these instruments.
We measure some assets and liabilities at fair value on a nonrecurring basis. That is, we do not measure them at fair value on an ongoing basis, but we do adjust them to fair value in some circumstances (for example, when we determine that an asset is impaired). No material nonrecurring fair value measurements were required during the periods presented in these financial statements.
10.
Derivative Financial Instruments
and Hedging Activities
Our multinational business exposes us to global market risks, including the effect of fluctuations in currency exchange rates, commodity prices, and interest rates. We use derivatives to help manage financial exposures that occur in the normal course of business. We formally document the purpose of each derivative contract, which includes linking the contract to the financial exposure it is designed to mitigate. We do not hold or issue derivatives for trading or speculative purposes.
We use currency derivative contracts to limit our exposure to the currency exchange risk that we cannot mitigate internally by using netting strategies. We designate most of these contracts as cash flow hedges of forecasted transactions (expected to occur within three years). We record all changes in the fair value of cash flow hedges (except any ineffective portion) in accumulated other comprehensive income (AOCI) until the underlying hedged transaction occurs, at which time we reclassify that amount into earnings. We assess the effectiveness of these hedges based on changes in forward exchange rates. The ineffective portion
of the changes in fair value of our hedges (recognized immediately in earnings) during the periods presented in this report was not material.
We had outstanding currency derivatives, related primarily to our euro, British pound, and Australian dollar exposures, with notional amounts totaling
$1,098 million
at
April 30, 2018
and
$1,203 million
at
July 31, 2018
.
We also use foreign currency-denominated debt to help manage our currency exchange risk. As of July 31, 2018,
$606 million
of our foreign currency-denominated debt instruments were designated as net investment hedges. These net investment hedges are intended to mitigate foreign exchange exposure related to non-U.S. dollar net investments in certain foreign subsidiaries. Any change in value of the designated portion of the hedging instruments is recorded in AOCI, offsetting the foreign currency translation adjustment of the related net investments that is also recorded in AOCI. There was no ineffectiveness related to our net investment hedges in any of the periods presented.
We do not designate some of our currency derivatives and foreign currency-denominated debt as hedges because we use them to at least partially offset the immediate earnings impact of changes in foreign exchange rates on existing assets or liabilities. We immediately recognize the change in fair value of these instruments in earnings.
We use forward purchase contracts with suppliers to protect against corn price volatility. We expect to physically take delivery of the corn underlying each contract and use it for production over a reasonable period of time. Accordingly, we account for these contracts as normal purchases rather than as derivative instruments.
The following tables present the pre-tax impact that changes in the fair value of our derivative instruments and non-derivative hedging instruments had on AOCI and earnings:
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
July 31,
|
(Dollars in millions)
|
Classification
|
2017
|
|
2018
|
Derivative Instruments
|
|
|
|
|
Currency derivatives designated as cash flow hedges:
|
|
|
|
|
|
|
Net gain (loss) recognized in AOCI
|
n/a
|
$
|
(36
|
)
|
|
$
|
27
|
|
Net gain (loss) reclassified from AOCI into earnings
|
Sales
|
2
|
|
|
(2
|
)
|
Currency derivatives not designated as hedging instruments:
|
|
|
|
|
|
|
Net gain (loss) recognized in earnings
|
Sales
|
(3
|
)
|
|
3
|
|
Net gain (loss) recognized in earnings
|
Other income
|
9
|
|
|
3
|
|
Non-Derivative Hedging Instruments
|
|
|
|
|
Foreign currency-denominated debt designated as net investment hedge:
|
|
|
|
|
Net gain (loss) recognized in AOCI
|
n/a
|
(16
|
)
|
|
28
|
|
Foreign currency-denominated debt not designated as hedging instrument:
|
|
|
|
|
Net gain (loss) recognized in earnings
|
Other income
|
(16
|
)
|
|
4
|
|
We expect to reclassify
$2 million
of deferred net
losses
on cash flow hedges recorded in AOCI as of
July 31, 2018
, to earnings during the next 12 months. This reclassification would offset the anticipated earnings impact of the underlying hedged exposures. The actual amounts that we ultimately reclassify to earnings will depend on the exchange rates in effect when the underlying hedged transactions occur. As of
July 31, 2018
, the maximum term of our outstanding derivative contracts was
36 months
.
The following table presents the fair values of our derivative instruments:
|
|
|
|
|
|
|
|
|
|
|
(Dollars in millions)
|
Classification
|
|
Fair value of derivatives in a
gain position
|
|
Fair value of derivatives in a
loss position
|
April 30, 2018
|
|
|
|
|
|
Designated as cash flow hedges:
|
|
|
|
|
|
Currency derivatives
|
Other current assets
|
|
$
|
2
|
|
|
$
|
(2
|
)
|
Currency derivatives
|
Other assets
|
|
1
|
|
|
—
|
|
Currency derivatives
|
Accrued expenses
|
|
4
|
|
|
(23
|
)
|
Currency derivatives
|
Other liabilities
|
|
2
|
|
|
(18
|
)
|
Not designated as hedges:
|
|
|
|
|
|
Currency derivatives
|
Other current assets
|
|
—
|
|
|
—
|
|
Currency derivatives
|
Accrued expenses
|
|
1
|
|
|
(5
|
)
|
July 31, 2018
|
|
|
|
|
|
Designated as cash flow hedges:
|
|
|
|
|
|
Currency derivatives
|
Other current assets
|
|
5
|
|
|
(3
|
)
|
Currency derivatives
|
Other assets
|
|
7
|
|
|
(5
|
)
|
Currency derivatives
|
Accrued expenses
|
|
4
|
|
|
(9
|
)
|
Currency derivatives
|
Other liabilities
|
|
1
|
|
|
(2
|
)
|
Not designated as hedges:
|
|
|
|
|
|
Currency derivatives
|
Other current assets
|
|
1
|
|
|
—
|
|
Currency derivatives
|
Accrued expenses
|
|
—
|
|
|
(1
|
)
|
The fair values reflected in the above table are presented on a gross basis. However, as discussed further below, the fair values of those instruments subject to net settlement agreements are presented on a net basis in our balance sheets.
In our statement of cash flows, we classify cash flows related to cash flow hedges in the same category as the cash flows from the hedged items.
Credit risk.
We are exposed to credit-related losses if the counterparties to our derivative contracts default. This credit risk is limited to the fair value of the contracts. To manage this risk, we contract only with major financial institutions that have earned investment-grade credit ratings and with whom we have standard International Swaps and Derivatives Association (ISDA) agreements that allow for net settlement of the derivative contracts. Also, we have established counterparty credit guidelines that are regularly monitored, and we monetize contracts when we believe it is warranted. Because of these safeguards, we believe we have no derivative positions that warrant credit valuation adjustments.
Some of our derivative instruments require us to maintain a specific level of creditworthiness, which we have maintained. If our creditworthiness were to fall below that level, then the counterparties to our derivative instruments could request immediate payment or collateralization for derivative instruments in net liability positions. The aggregate fair value of all derivatives with creditworthiness requirements that were in a net liability position was
$38 million
at
April 30, 2018
and
$6 million
at
July 31, 2018
.
Offsetting.
As noted above, our derivative contracts are governed by ISDA agreements that allow for net settlement of derivative contracts with the same counterparty. It is our policy to present the fair values of current derivatives (i.e., those with a remaining term of 12 months or less) with the same counterparty on a net basis in the balance sheet. Similarly, we present the fair values of noncurrent derivatives with the same counterparty on a net basis. Current derivatives are not netted with noncurrent derivatives in the balance sheet.
The following table summarizes the gross and net amounts of our derivative contracts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in millions)
|
Gross Amounts of Recognized Assets
(Liabilities)
|
|
Gross Amounts Offset in
Balance Sheet
|
|
Net Amounts Presented in
Balance Sheet
|
|
Gross Amounts Not Offset in
Balance Sheet
|
|
Net Amounts
|
April 30, 2018
|
|
|
|
|
|
|
|
|
|
Derivative assets
|
$
|
10
|
|
|
$
|
(9
|
)
|
|
$
|
1
|
|
|
$
|
(1
|
)
|
|
$
|
—
|
|
Derivative liabilities
|
(48
|
)
|
|
9
|
|
|
(39
|
)
|
|
1
|
|
|
(38
|
)
|
July 31, 2018
|
|
|
|
|
|
|
|
|
|
Derivative assets
|
18
|
|
|
(13
|
)
|
|
5
|
|
|
(1
|
)
|
|
4
|
|
Derivative liabilities
|
(20
|
)
|
|
13
|
|
|
(7
|
)
|
|
1
|
|
|
(6
|
)
|
No cash collateral was received or pledged related to our derivative contracts as of
April 30, 2018
or
July 31, 2018
.
11.
Pension and Other Postretirement Benefits
The following table shows the components of the net cost of pension and other postretirement benefits recognized for our U.S. benefit plans. Information about similar international plans is not presented due to immateriality.
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
July 31,
|
(Dollars in millions)
|
2017
|
|
2018
|
Pension Benefits
:
|
|
|
|
Service cost
|
$
|
6
|
|
|
$
|
6
|
|
Interest cost
|
7
|
|
|
9
|
|
Expected return on plan assets
|
(10
|
)
|
|
(12
|
)
|
Amortization of net actuarial loss
|
5
|
|
|
5
|
|
Net cost
|
$
|
8
|
|
|
$
|
8
|
|
|
|
|
|
Other Postretirement Benefits
:
|
|
|
|
Interest cost
|
$
|
1
|
|
|
$
|
1
|
|
Amortization of prior service cost (credit)
|
(1
|
)
|
|
(1
|
)
|
Net cost
|
$
|
—
|
|
|
$
|
—
|
|
12.
Stockholders’ Equity
The following table shows the changes in stockholders’ equity during the three months ended July 31, 2018:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in millions)
|
Class A Common
Stock
|
|
Class B Common
Stock
|
|
Additional Paid-in
Capital
|
|
Retained
Earnings
|
|
AOCI
|
|
Treasury
Stock
|
|
Total
|
Balance at April 30, 2018
|
$
|
25
|
|
|
$
|
47
|
|
|
$
|
4
|
|
|
$
|
1,730
|
|
|
$
|
(378
|
)
|
|
$
|
(112
|
)
|
|
$
|
1,316
|
|
Cumulative effect of changes in accounting standards (Note 1)
|
|
|
|
|
|
|
(5
|
)
|
|
|
|
|
|
(5
|
)
|
Net income
|
|
|
|
|
|
|
200
|
|
|
|
|
|
|
200
|
|
Net other comprehensive income (loss)
|
|
|
|
|
|
|
|
|
14
|
|
|
|
|
14
|
|
Cash dividends
|
|
|
|
|
|
|
(152
|
)
|
|
|
|
|
|
(152
|
)
|
Acquisition of treasury stock
|
|
|
|
|
|
|
|
|
|
|
(6
|
)
|
|
(6
|
)
|
Stock-based compensation expense
|
|
|
|
|
5
|
|
|
|
|
|
|
|
|
5
|
|
Stock issued under compensation plans
|
|
|
|
|
|
|
|
|
|
|
9
|
|
|
9
|
|
Loss on issuance of treasury stock issued under compensation plans
|
|
|
|
|
(7
|
)
|
|
(6
|
)
|
|
|
|
|
|
(13
|
)
|
Balance at July 31, 2018
|
$
|
25
|
|
|
$
|
47
|
|
|
$
|
2
|
|
|
$
|
1,767
|
|
|
$
|
(364
|
)
|
|
$
|
(109
|
)
|
|
$
|
1,368
|
|
Dividends.
The following table shows the cash dividends declared per share on our Class A and Class B common stock during the three months ended July 31, 2018:
|
|
|
|
|
|
|
|
Declaration Date
|
|
Record Date
|
|
Payable Date
|
|
Amount per Share
|
May 24, 2018
|
|
June 6, 2018
|
|
July 3, 2018
|
|
$0.158
|
July 26, 2018
|
|
September 6, 2018
|
|
October 1, 2018
|
|
$0.158
|
Accumulated other comprehensive income.
The following table shows the change in each component of AOCI, net of tax, during the three months ended July 31, 2018:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in millions)
|
Currency Translation
Adjustments
|
|
Cash Flow Hedge
Adjustments
|
|
Postretirement Benefits
Adjustments
|
|
Total AOCI
|
Balance at April 30, 2018
|
$
|
(180
|
)
|
|
$
|
(17
|
)
|
|
$
|
(181
|
)
|
|
$
|
(378
|
)
|
Net other comprehensive income (loss)
|
(12
|
)
|
|
23
|
|
|
3
|
|
|
14
|
|
Balance at July 31, 2018
|
$
|
(192
|
)
|
|
$
|
6
|
|
|
$
|
(178
|
)
|
|
$
|
(364
|
)
|
13.
Other Comprehensive Income
The following table shows the components of net other comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Three Months Ended
|
|
July 31, 2017
|
|
July 31, 2018
|
(Dollars in millions)
|
Pre-Tax
|
|
Tax
|
|
Net
|
|
Pre-Tax
|
|
Tax
|
|
Net
|
Currency translation adjustments:
|
|
|
|
|
|
|
|
|
|
|
|
Net gain (loss) on currency translation
|
$
|
28
|
|
|
$
|
6
|
|
|
$
|
34
|
|
|
$
|
(5
|
)
|
|
$
|
(7
|
)
|
|
$
|
(12
|
)
|
Reclassification to earnings
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Other comprehensive income (loss), net
|
28
|
|
|
6
|
|
|
34
|
|
|
(5
|
)
|
|
(7
|
)
|
|
(12
|
)
|
Cash flow hedge adjustments:
|
|
|
|
|
|
|
|
|
|
|
|
Net gain (loss) on hedging instruments
|
(36
|
)
|
|
14
|
|
|
(22
|
)
|
|
27
|
|
|
(6
|
)
|
|
21
|
|
Reclassification to earnings
1
|
(2
|
)
|
|
1
|
|
|
(1
|
)
|
|
2
|
|
|
—
|
|
|
2
|
|
Other comprehensive income (loss), net
|
(38
|
)
|
|
15
|
|
|
(23
|
)
|
|
29
|
|
|
(6
|
)
|
|
23
|
|
Postretirement benefits adjustments:
|
|
|
|
|
|
|
|
|
|
|
|
Net actuarial gain (loss) and prior service cost
|
1
|
|
|
—
|
|
|
1
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Reclassification to earnings
2
|
4
|
|
|
(2
|
)
|
|
2
|
|
|
4
|
|
|
(1
|
)
|
|
3
|
|
Other comprehensive income (loss), net
|
5
|
|
|
(2
|
)
|
|
3
|
|
|
4
|
|
|
(1
|
)
|
|
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other comprehensive income (loss), net
|
$
|
(5
|
)
|
|
$
|
19
|
|
|
$
|
14
|
|
|
$
|
28
|
|
|
$
|
(14
|
)
|
|
$
|
14
|
|
1
Pre-tax amount is classified as sales in the accompanying condensed consolidated statements of operations.
2
Pre-tax amount is classified as non-operating postretirement expense in the accompanying condensed consolidated statements of operations.