Risk Management and Derivatives

9 Months Ended

Feb. 29, 2020

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Risk Management and Derivatives

NOTE 9 — RISK MANAGEMENT AND DERIVATIVES

The Company is exposed to global market risks, including the effect of changes in foreign currency exchange rates and interest rates, and uses derivatives to manage financial exposures that occur in the normal course of business. As of and for the nine months ended February 29, 2020, there have been no material changes to the Company's hedging program or strategy from what was disclosed within the Annual Report on Form 10-K. For additional information about the Company's derivatives and hedging policies refer to Note 1 — Summary of Significant Accounting Policies and Note 14 — Risk Management and Derivatives of the Annual Report on Form 10-K for the fiscal year ended May 31, 2019.

The majority of derivatives outstanding as of February 29, 2020 are designated as foreign currency cash flow hedges, primarily for Euro/U.S. Dollar, British Pound/Euro, Japanese Yen/U.S. Dollar and Chinese Yuan/U.S. Dollar currency pairs. All derivatives are recognized on the Unaudited Condensed Consolidated Balance Sheets at fair value and classified based on the instrument's maturity date.

The following tables present the fair values of derivative instruments included within the Unaudited Condensed Consolidated Balance Sheets as of February 29, 2020 and May 31, 2019:

	DERIVATIVE ASSETS
	BALANCE SHEET LOCATION	FEBRUARY 29,		MAY 31,
(Dollars in millions)		2020		2019
Derivatives formally designated as hedging instruments:
Foreign exchange forwards and options	Prepaid expenses and other current assets	$	261	$	509
Foreign exchange forwards and options	Deferred income taxes and other assets	27		—
Total derivatives formally designated as hedging instruments		288		509
Derivatives not designated as hedging instruments:
Foreign exchange forwards and options	Prepaid expenses and other current assets	36		102
Embedded derivatives	Prepaid expenses and other current assets	2		5
Embedded derivatives	Deferred income taxes and other assets	—		6
Total derivatives not designated as hedging instruments		38		113
TOTAL DERIVATIVE ASSETS		$	326	$	622
	DERIVATIVE LIABILITIES
	BALANCE SHEET LOCATION	FEBRUARY 29,		MAY 31,
(Dollars in millions)		2020		2019
Derivatives formally designated as hedging instruments:
Foreign exchange forwards and options	Accrued liabilities	$	37	$	5
Foreign exchange forwards and options	Deferred income taxes and other liabilities	1		—
Total derivatives formally designated as hedging instruments		38		5
Derivatives not designated as hedging instruments:
Foreign exchange forwards and options	Accrued liabilities	10		46
Embedded derivatives	Accrued liabilities	1		1
Embedded derivatives	Deferred income taxes and other liabilities	—		2
Total derivatives not designated as hedging instruments		11		49
TOTAL DERIVATIVE LIABILITIES		$	49	$	54

The following tables present the amounts in the Unaudited Condensed Consolidated Statements of Income in which the effects of cash flow hedges are recorded and the effects of cash flow hedge activity on these line items for the three and nine months ended February 29, 2020 and February 28, 2019:

	THREE MONTHS ENDED
	FEBRUARY 29, 2020					FEBRUARY 28, 2019
(Dollars in millions)	TOTAL		AMOUNT OF GAIN (LOSS) ON CASH FLOW HEDGE ACTIVITY			TOTAL			AMOUNT OF GAIN (LOSS) ON CASH FLOW HEDGE ACTIVITY
Revenues	$	10,104	$	(21	)	$	9,611		$	1
Cost of sales	5,631		110			5,272			34
Demand creation expense	870		—			865			—
Other (income) expense, net	297		44			(55		)	18
Interest expense (income), net	12		(2		)	12			(2		)

	NINE MONTHS ENDED
	FEBRUARY 29, 2020					FEBRUARY 28, 2019
(Dollars in millions)	TOTAL		AMOUNT OF GAIN (LOSS) ON CASH FLOW HEDGE ACTIVITY			TOTAL			AMOUNT OF GAIN (LOSS) ON CASH FLOW HEDGE ACTIVITY
Revenues	$	31,090	$	(12	)	$	28,933		$	9
Cost of sales	17,202		287			16,092			—
Demand creation expense	2,769		(3		)	2,739			—
Other (income) expense, net	223		121			(50		)	9
Interest expense (income), net	39		(5		)	37			(5		)

The following tables present the amounts affecting the Unaudited Condensed Consolidated Statements of Income for the three and nine months ended February 29, 2020 and February 28, 2019:

(Dollars in millions)	AMOUNT OF GAIN (LOSS) RECOGNIZED IN OTHER COMPREHENSIVE INCOME (LOSS) ON DERIVATIVES(1)					AMOUNT OF GAIN (LOSS) RECLASSIFIED FROM ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) INTO INCOME(1)
	THREE MONTHS ENDED					LOCATION OF GAIN (LOSS) RECLASSIFIED FROM ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) INTO INCOME	THREE MONTHS ENDED
	FEBRUARY 29, 2020		FEBRUARY 28, 2019				FEBRUARY 29, 2020			FEBRUARY 28, 2019
Derivatives designated as cash flow hedges:
Foreign exchange forwards and options	$	17	$	(50	)	Revenues	$	(21	)	$	1
Foreign exchange forwards and options	39		(1		)	Cost of sales	110			34
Foreign exchange forwards and options	1		2			Demand creation expense	—			—
Foreign exchange forwards and options	7		7			Other (income) expense, net	44			18
Interest rate swaps(2)	—		—			Interest expense (income), net	(2		)	(2		)
Total designated cash flow hedges	$	64	$	(42	)		$	131		$	51

(1) For the three months ended February 29, 2020 and February 28, 2019, the amounts recorded in Other (income) expense, net as a result of the discontinuance of cash flow hedges because the forecasted transactions were no longer probable of occurring were immaterial.

(2) Gains and losses associated with terminated interest rate swaps, which were previously designated as cash flow hedges and recorded in Accumulated other comprehensive income (loss), will be released through Interest expense (income), net over the term of the issued debt.

(Dollars in millions)	AMOUNT OF GAIN (LOSS) RECOGNIZED IN OTHER COMPREHENSIVE INCOME (LOSS) ON DERIVATIVES(1)						AMOUNT OF GAIN (LOSS) RECLASSIFIED FROM ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) INTO INCOME(1)
	NINE MONTHS ENDED						LOCATION OF GAIN (LOSS) RECLASSIFIED FROM ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) INTO INCOME	NINE MONTHS ENDED
	FEBRUARY 29, 2020			FEBRUARY 28, 2019				FEBRUARY 29, 2020			FEBRUARY 28, 2019
Derivatives designated as cash flow hedges:
Foreign exchange forwards and options	$	(45	)	$	(31	)	Revenues	$	(12	)	$	9
Foreign exchange forwards and options	185			273			Cost of sales	287			—
Foreign exchange forwards and options	1			2			Demand creation expense	(3		)	—
Foreign exchange forwards and options	67			112			Other (income) expense, net	121			9
Interest rate swaps(2)	—			—			Interest expense (income), net	(5		)	(5		)
Total designated cash flow hedges	$	208		$	356			$	388		$	13

(1) For the nine months ended February 29, 2020 and February 28, 2019, the amounts recorded in Other (income) expense, net as a result of the discontinuance of cash flow hedges because the forecasted transactions were no longer probable of occurring were immaterial.

(2) Gains and losses associated with terminated interest rate swaps, which were previously designated as cash flow hedges and recorded in Accumulated other comprehensive income (loss), will be released through Interest expense (income), net over the term of the issued debt.

	AMOUNT OF GAIN (LOSS) RECOGNIZED  IN INCOME ON DERIVATIVES											LOCATION OF GAIN (LOSS)   RECOGNIZED IN INCOME   ON DERIVATIVES
	THREE MONTHS ENDED						NINE MONTHS ENDED
(Dollars in millions)	FEBRUARY 29, 2020			FEBRUARY 28, 2019			FEBRUARY 29, 2020			FEBRUARY 28, 2019
Derivatives not designated as hedging instruments:
Foreign exchange forwards and options	$	12		$	(59	)	$	(9	)	$	129	Other (income) expense, net
Embedded derivatives	(2		)	(2		)	(7		)	2		Other (income) expense, net

CASH FLOW HEDGES

All changes in fair value of derivatives designated as cash flow hedges are recorded in Accumulated other comprehensive income (loss) until Net income is affected by the variability of cash flows of the hedged transaction. Effective hedge results are classified in the Unaudited Condensed Consolidated Statements of Income in the same manner as the underlying exposure. Derivative instruments designated as cash flow hedges must be discontinued when it is no longer probable the forecasted hedged transaction will occur in the initially identified time period. The gains and losses associated with discontinued derivative instruments in Accumulated other comprehensive income (loss) will be recognized immediately in Other (income) expense, net, if it is probable the forecasted hedged transaction will not occur by the end of the initially identified time period or within an additional two-month period thereafter. In all situations in which hedge accounting is discontinued and the derivative remains outstanding, the Company accounts for the derivative as an undesignated instrument as discussed below.

The total notional amount of outstanding foreign currency derivatives designated as cash flow hedges was approximately $8.2 billion as of February 29, 2020. Approximately $322 million of deferred net gains (net of tax) on both outstanding and matured derivatives in Accumulated other comprehensive income (loss) as of February 29, 2020, are expected to be reclassified to Net income during the next 12 months concurrent with the underlying hedged transactions also being recorded in Net income. Actual amounts ultimately reclassified to Net income are dependent on the exchange rates in effect when derivative contracts currently outstanding mature. As of February 29, 2020, the maximum term over which the Company hedges exposures to the variability of cash flows for its forecasted transactions was 23 months.

UNDESIGNATED DERIVATIVE INSTRUMENTS

The Company may elect to enter into foreign exchange forwards to mitigate the change in fair value of specific assets and liabilities on the Unaudited Condensed Consolidated Balance Sheets and/or the embedded derivative contracts. These undesignated instruments are recorded at fair value as a derivative asset or liability on the Unaudited Condensed Consolidated Balance Sheets with their corresponding change in fair value recognized in Other (income) expense, net, together with the re-measurement gain or loss from the hedged balance sheet position and/or embedded derivative contract. The total notional amount of outstanding undesignated derivative instruments was $3.6 billion as of February 29, 2020.

EMBEDDED DERIVATIVES

Embedded derivative contracts are treated as foreign currency forward contracts that are bifurcated from the related contract and recorded at fair value as a derivative asset or liability on the Unaudited Condensed Consolidated Balance Sheets with their corresponding change in fair value recognized in Other (income) expense, net, through the date the foreign currency fluctuations cease to exist.

At February 29, 2020, the total notional amount of embedded derivatives outstanding was approximately $350 million.

CREDIT RISK

The Company's bilateral credit-related contingent features generally require the owing entity, either the Company or the derivative counterparty, to post collateral for the portion of the fair value in excess of $50 million should the fair value of outstanding derivatives per counterparty be greater than $50 million. Additionally, a certain level of decline in credit rating of either the Company or the counterparty could also trigger collateral requirements. As of February 29, 2020, the Company was in compliance with all credit risk-related contingent features, and derivative instruments with such features were in a net liability position of approximately $1 million. Accordingly, the Company was not required to post any collateral as a result of these contingent features. Further, as of February 29, 2020, the Company had $86 million of cash collateral received from various counterparties to its derivative contracts. The Company considers the impact of the risk of counterparty default to be immaterial.

For additional information related to the Company's derivative financial instruments and collateral, refer to Note 4 — Fair Value Measurements.