Walgreens Boots Alliance, Inc.
Walgreens Boots Alliance, Inc. (Form: 10-Q, Received: 06/29/2017 16:24:45)
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
 
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended May 31, 2017
or
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______to _______
Commission File Number
001-36759
WALGREENS BOOTS ALLIANCE, INC.
(Exact name of registrant as specified in its charter)
Delaware
47-1758322
(State of Incorporation)
(I.R.S. Employer Identification No.)
108 Wilmot Road, Deerfield, Illinois
60015
(Address of principal executive offices)
(Zip Code)
(847) 315-2500
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes  þ        No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes   þ      No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
Accelerated filer ☐
Non-accelerated filer ☐  (Do not check if a smaller reporting company)
Smaller reporting company ☐
 
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to the Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐        No þ
The number of shares outstanding of the registrant’s Common Stock, $.01 par value, as of May 31, 2017 was 1,070,096,486 .
 


Table of Contents

WALGREENS BOOTS ALLIANCE, INC.

FORM 10-Q FOR THE THREE AND NINE MONTHS ENDED MAY 31, 2017

TABLE OF CONTENTS

PART I.  FINANCIAL INFORMATION
 
Item 1.
Consolidated Condensed Financial Statements (Unaudited)
 
 
a)
 
 
b)
 
 
c)
 
 
d)
 
 
e)
 
 
f)
 
Item 2.
 
Item 3.
 
Item 4.

PART II. OTHER INFORMATION
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 6.

- 2 -

Table of Contents

Part I. Financial Information

Item 1.
Consolidated Condensed Financial Statements (Unaudited)

WALGREENS BOOTS ALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(UNAUDITED)
(in millions, except shares and per share amounts)
 
May 31, 2017
 
August 31, 2016
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
12,253

 
$
9,807

Accounts receivable, net
6,339

 
6,260

Inventories
8,681

 
8,956

Other current assets
879

 
860

Total current assets
28,152

 
25,883

Non-current assets:


 
 

Property, plant and equipment, net
13,535

 
14,335

Goodwill
15,516

 
15,527

Intangible assets, net
10,208

 
10,302

Equity method investments (see note 4)
6,323

 
6,174

Other non-current assets
439

 
467

Total non-current assets
46,021

 
46,805

Total assets
$
74,173

 
$
72,688

 
 
 
 
Liabilities and equity
 

 
 

Current liabilities:
 

 
 

Short-term borrowings
$
4,838

 
$
323

Trade accounts payable (see note 18)
11,528

 
11,000

Accrued expenses and other liabilities
5,065

 
5,484

Income taxes
282

 
206

Total current liabilities
21,713

 
17,013

Non-current liabilities:
 

 
 

Long-term debt
14,372

 
18,705

Deferred income taxes
2,403

 
2,644

Other non-current liabilities
4,201

 
4,045

Total non-current liabilities
20,976

 
25,394

Commitments and contingencies


 


Equity:
 

 
 

Preferred stock $.01 par value; authorized 32 million shares, none issued

 

Common stock $.01 par value; authorized 3.2 billion shares; issued 1,172,513,618 at May 31, 2017 and August 31, 2016
12

 
12

Paid-in capital
10,389

 
10,111

Employee stock loan receivable

 
(1
)
Retained earnings
29,744

 
27,684

Accumulated other comprehensive loss
(3,303
)
 
(2,992
)
Treasury stock, at cost; 102,417,132 shares at May 31, 2017 and 89,527,027 at August 31, 2016
(6,242
)
 
(4,934
)
Total Walgreens Boots Alliance, Inc. shareholders’ equity
30,600

 
29,880

Noncontrolling interests
884

 
401

Total equity
31,484

 
30,281

Total liabilities and equity
$
74,173

 
$
72,688


The accompanying notes to Consolidated Condensed Financial Statements are an integral part of these statements.

- 3 -

Table of Contents

WALGREENS BOOTS ALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENT OF EQUITY
(UNAUDITED)
For the nine months ended May 31, 2017
(in millions, except shares)
 
Equity attributable to Walgreens Boots Alliance, Inc.
 
 
 
 
 
Common stock
shares
 
Common
stock
amount
 
Treasury
stock
amount
 
Paid-in
capital
 
Employee
stock
loan
receivable
 
Accumulated
other
comprehensive
(loss) income
 
Retained
earnings
 
Noncontrolling
interests
 
Total
equity
August 31, 2016
1,082,986,591

 
$
12

 
$
(4,934
)
 
$
10,111

 
$
(1
)
 
$
(2,992
)
 
$
27,684

 
$
401

 
$
30,281

Net earnings

 

 

 

 

 

 
3,276

 
18

 
3,294

Other comprehensive income (loss), net of tax

 

 

 

 

 
(311
)
 

 
(38
)
 
(349
)
Dividends declared

 

 

 

 

 

 
(1,216
)
 
(12
)
 
(1,228
)
Treasury stock purchases
(17,419,955
)
 

 
(1,457
)
 

 

 

 

 

 
(1,457
)
Employee stock purchase and option plans
4,529,850

 

 
149

 
26

 
1

 

 

 

 
176

Stock-based compensation

 

 

 
71

 

 

 

 

 
71

Noncontrolling interests acquired and arising on business combinations

 

 

 
181

 

 

 

 
515

 
696

May 31, 2017
1,070,096,486

 
$
12

 
$
(6,242
)
 
$
10,389

 
$

 
$
(3,303
)
 
$
29,744

 
$
884

 
$
31,484


The accompanying notes to Consolidated Condensed Financial Statements are an integral part of these statements.

- 4 -

Table of Contents

WALGREENS BOOTS ALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS
(UNAUDITED)
(in millions, except per share amounts)
 
Three months ended

Nine months ended
 
May 31, 2017

May 31, 2016

May 31, 2017

May 31, 2016
Sales
$
30,118

 
$
29,498

 
$
88,065

 
$
88,715

Cost of sales
22,973

 
22,065

 
66,243

 
65,996

Gross profit
7,145

 
7,433

 
21,822

 
22,719

 
 
 
 
 
 
 
 
Selling, general and administrative expenses
5,712

 
5,903

 
17,522

 
17,861

Equity earnings in AmerisourceBergen
84

 
3

 
143

 
3

Operating income
1,517

 
1,533

 
4,443

 
4,861

 
 
 
 
 
 
 
 
Other income (expense)
(8
)
 
28

 
(22
)
 
(525
)
Earnings before interest and income tax provision
1,509

 
1,561

 
4,421

 
4,336

 
 
 
 
 
 
 
 
Interest expense, net
155

 
147

 
500

 
425

Earnings before income tax provision
1,354

 
1,414

 
3,921

 
3,911

Income tax provision
168

 
322

 
634

 
790

Post tax earnings from other equity method investments
(21
)
 
15

 
7

 
35

Net earnings
1,165

 
1,107

 
3,294

 
3,156

Net earnings attributable to noncontrolling interests
3

 
4

 
18

 
13

Net earnings attributable to Walgreens Boots Alliance, Inc.
$
1,162

 
$
1,103

 
$
3,276

 
$
3,143

 
 
 
 
 
 
 
 
Net earnings per common share:
 

 
 

 
 

 
 

Basic
$
1.08

 
$
1.02

 
$
3.03

 
$
2.90

Diluted
$
1.07

 
$
1.01

 
$
3.02

 
$
2.88

 
 
 
 
 
 
 
 
Dividends declared per share
$
0.375

 
$
0.360

 
$
1.125

 
$
1.080

 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 

 
 

 
 

 
 

Basic
1,077.1

 
1,080.8

 
1,079.6

 
1,083.3

Diluted
1,082.6

 
1,088.2

 
1,085.5

 
1,091.7


The accompanying notes to Consolidated Condensed Financial Statements are an integral part of these statements.

- 5 -

Table of Contents

WALGREENS BOOTS ALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
(in millions)
 
Three months ended
 
Nine months ended
 
May 31, 2017
 
May 31, 2016
 
May 31, 2017
 
May 31, 2016
Comprehensive income:
 
 
 
 
 
 
 
Net earnings
$
1,165

 
$
1,107

 
$
3,294

 
$
3,156

 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax:
 

 
 

 
 
 
 

Pension/postretirement obligations
5

 
3

 
1

 
4

Unrealized gain on cash flow hedges
1

 

 
3

 
2

Unrecognized loss on available-for-sale investments
(1
)
 
(172
)
 
(2
)
 
(259
)
Share of other comprehensive loss of equity method investments
2

 

 
(3
)
 

Currency translation adjustments
504

 
769

 
(348
)
 
(837
)
Total other comprehensive income (loss)
511

 
600

 
(349
)
 
(1,090
)
Total comprehensive income (loss)
1,676

 
1,707

 
2,945

 
2,066

 
 
 
 
 
 
 
 
Comprehensive income (loss) attributable to noncontrolling interests
8

 
12

 
(20
)
 
(15
)
Comprehensive income (loss) attributable to Walgreens Boots Alliance, Inc.
$
1,668

 
$
1,695

 
$
2,965

 
$
2,081


The accompanying notes to Consolidated Condensed Financial Statements are an integral part of these statements.


- 6 -

Table of Contents

WALGREENS BOOTS ALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in millions)
 
Nine months ended
 
May 31, 2017
 
May 31, 2016
Cash flows from operating activities :
 
 
 
Net earnings
$
3,294

 
$
3,156

Adjustments to reconcile net earnings to net cash provided by operating activities:
 

 
 

Depreciation and amortization
1,244

 
1,271

Change in fair value of warrants and related amortization

 
845

Deferred income taxes
(211
)
 
(250
)
Stock compensation expense
71

 
87

Equity earnings from equity method investments
(150
)
 
(38
)
Other
289

 
(14
)
Changes in operating assets and liabilities:
 

 
 

Accounts receivable, net
(153
)
 
8

Inventories
259

 
(481
)
Other current assets
22

 
21

Trade accounts payable
821

 
686

Accrued expenses and other liabilities
(268
)
 
(247
)
Income taxes
6

 
135

Other non-current assets and liabilities
13

 
10

Net cash provided by operating activities
5,237

 
5,189

 
 
 
 
Cash flows from investing activities :
 

 
 

Additions to property, plant and equipment
(912
)
 
(904
)
Proceeds from sale leaseback transactions
436

 
60

Proceeds from sale of businesses

 
68

Proceeds from sale of other assets
39

 
116

Business and intangible asset acquisitions, net of cash acquired
(63
)
 
(115
)
Investment in AmerisourceBergen

 
(1,169
)
Other
48

 
(17
)
Net cash used for investing activities
(452
)
 
(1,961
)
 
 
 
 
Cash flows from financing activities :
 

 
 

Proceeds and payments from short-term borrowings, net
277

 
(658
)
Payments of long-term debt
(40
)
 
(31
)
Stock purchases
(1,457
)
 
(1,152
)
Proceeds related to employee stock plans
174

 
175

Cash dividends paid
(1,228
)
 
(1,174
)
Other
(59
)
 
(54
)
Net cash used for financing activities
(2,333
)
 
(2,894
)
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
(6
)
 
(43
)
 
 
 
 
Changes in cash and cash equivalents :
 

 
 


- 7 -


Net increase in cash and cash equivalents
2,446

 
291

Cash and cash equivalents at beginning of period
9,807

 
3,000

Cash and cash equivalents at end of period
$
12,253

 
$
3,291


The accompanying notes to Consolidated Condensed Financial Statements are an integral part of these statements.

- 8 -


WALGREENS BOOTS ALLIANCE, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)

Note 1. Accounting policies
Basis of presentation
The Consolidated Condensed Financial Statements of Walgreens Boots Alliance, Inc. (“Walgreens Boots Alliance” or the “Company”) included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. The Consolidated Condensed Financial Statements include all subsidiaries in which the Company holds a controlling interest. Investments in less than majority-owned subsidiaries in which the Company does not have a controlling interest, but does have significant influence, are accounted for as equity method investments. All intercompany transactions have been eliminated.

The Consolidated Condensed Balance Sheets as of May 31, 2017 and August 31, 2016 , the Consolidated Condensed Statements of Equity for the nine months ended May 31, 2017 , the Consolidated Condensed Statements of Cash Flows for the nine months ended May 31, 2017 and May 31, 2016 , the Consolidated Condensed Statements of Earnings and the Consolidated Condensed Statements of Comprehensive Income for the three and nine months ended May 31, 2017 and May 31, 2016 are unaudited. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. These unaudited Consolidated Condensed Financial Statements should be read in conjunction with the audited financial statements and the notes thereto included in the Walgreens Boots Alliance Annual Report on Form 10-K for the fiscal year ended August 31, 2016 . The Company has evaluated subsequent events from the balance sheet date through the date the financial statements were issued and determined there were no subsequent events to disclose other than as disclosed in notes 1, 7 and 10.

In the opinion of the Company, the unaudited Consolidated Condensed Financial Statements for the interim periods presented include all adjustments (consisting only of normal recurring adjustments) necessary to present a fair statement of the results for such interim periods. The influence of certain holidays, seasonality, foreign currency rates, changes in vendor, payer and customer relationships and terms and other factors on the Company’s operations, net earnings for any period may not be comparable to the same period in previous years. With respect to the Company’s Retail Pharmacy USA segment, the positive impact on gross margins and gross profit dollars typically has been significant in the first several months after a generic version of a drug is first allowed to compete with the branded version, which is generally referred to as a “generic conversion.” In any given year, the number of major brand name drugs that undergo a conversion from branded to generic status can increase or decrease, which can have a significant impact on the Company’s Retail Pharmacy USA segment’s sales, gross margin and gross profit dollars making the Company’s operations or net earnings for any period incomparable.

To improve comparability, certain classification changes were made to prior periods to conform to current year classifications. These reclassifications were made in the fourth quarter of fiscal 2016.

Terminated acquisition of Rite Aid Corporation (“Rite Aid”) and related matters
On October 27, 2015, Walgreens Boots Alliance entered into an Agreement and Plan of Merger with Rite Aid and Victoria Merger Sub, Inc., a wholly-owned subsidiary of Walgreens Boots Alliance (as amended as described below, the “Merger Agreement”), pursuant to which the Company agreed, subject to the terms and conditions thereof, to acquire Rite Aid, a drugstore chain in the United States. The Merger Agreement was amended by Amendment No. 1 thereto on January 29, 2017.

In connection with regulatory review of the merger contemplated by the Merger Agreement, on December 20, 2016, Walgreens Boots Alliance and Rite Aid announced that they had entered into an agreement (the “Fred’s Asset Purchase Agreement”), subject to the terms and conditions thereof, to sell certain Rite Aid stores and certain assets related to store operations to Fred’s, Inc. (“Fred’s”) for $950 million in an all-cash transaction. The transaction was subject to the approval and completion of the acquisition of Rite Aid by Walgreens Boots Alliance pursuant to the Merger Agreement.

On June 28, 2017, Walgreens Boots Alliance and Rite Aid entered into a mutual termination agreement (the “Termination Agreement”) pursuant to which the parties agreed to terminate the Merger Agreement, including all schedules and exhibits thereto, and all ancillary agreements contemplated thereby, or entered pursuant thereto (other than as expressly specified) (collectively with the Merger Agreement, the “Transaction Documents”), effective as of June 28, 2017. Pursuant to the Termination Agreement, the Company agreed to pay Rite Aid the termination fee of $325 million , which amount the Company plans to pay on or before June 30, 2017 in full satisfaction of any amounts required to be paid by the Company under the Merger Agreement and other Transaction Documents. The parties also agreed to release each other from, among other things,

- 9 -


any and all liability, claims, rights, actions, causes of action, damages, expenses and fees, however arising, in connection with, arising out of or related to the Transaction Documents, the transactions contemplated therein or thereby or certain related matters.

On June 28, 2017, following the termination of the Merger Agreement, the Fred’s Asset Purchase Agreement was terminated. In connection with the termination of the Fred’s Asset Purchase Agreement, the Company agreed to reimburse certain of Fred’s transaction costs in an amount not to exceed $25 million in full satisfaction of any amounts required to be paid by the Company under the Fred’s Asset Purchase Agreement. The Company expects to pay the applicable amount during the fourth quarter of fiscal 2017.

See note 7, Borrowings and note 10, Commitments and contingencies for additional information relating to the termination of the Merger Agreement and related matters.

Pending acquisition of certain Rite Aid assets
On June 28, 2017, the Company entered into an Asset Purchase Agreement (the “Asset Purchase Agreement”) with Rite Aid, pursuant to which the Company agreed, subject to the terms and conditions thereof, to acquire 2,186 stores, three distribution centers and related inventory from Rite Aid. The consideration for the transaction will be $5.175 billion in cash, the assumption by the Company of the related real estate leases and the grant of an option to Rite Aid, exercisable through May 2019 and subject to certain conditions, to become a member of the Company’s group purchasing organization, Walgreens Boots Alliance Development GmbH. The Company will also assume certain limited store-related liabilities as part of the transaction.

The transaction is subject to the expiration or termination of applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and other customary closing conditions. The initial closing is expected to occur within the next six months. Upon the initial closing of the transaction, the Company will begin acquiring the stores and related assets on a phased basis.

Note 2. Restructuring
On April 8, 2015, the Walgreens Boots Alliance Board of Directors approved a plan to implement a new restructuring program (the “Cost Transformation Program”) as part of an initiative to reduce costs and increase operating efficiencies. The Cost Transformation Program implemented and built on the cost-reduction initiative previously announced by the Company on August 6, 2014 and included plans to close stores across the U.S.; reorganize corporate and field operations; drive operating efficiencies; and streamline information technology and other functions. The actions under the Cost Transformation Program focus primarily on the Retail Pharmacy USA segment. From inception through May 31, 2017 , the Company incurred pre-tax charges of $1.6 billion ( $677 million related to asset impairment charges, $557 million in real estate costs and $324 million in severance and other business transition and exit costs) related to the Cost Transformation Program, which are primarily recorded within selling, general and administrative expenses. Restructuring charges are recognized as the costs are incurred in accordance with GAAP.

Restructuring costs by segment are as follows (in millions):
Three months ended May 31, 2017
Retail Pharmacy USA
 
Retail Pharmacy International
 
Pharmaceutical Wholesale
 
Walgreens Boots Alliance, Inc.
Asset impairments
$
96

 
$
18

 
$

 
$
114

Real estate costs
15

 

 

 
15

Severance and other business transition and exit costs
18

 
8

 
16

 
42

Total restructuring costs
$
129

 
$
26

 
$
16

 
$
171

 
 
 
 
 
 
 
 
Three months ended May 31, 2016
 

 
 

 
 

 
 

Asset impairments
$
48

 
$

 
$

 
$
48

Real estate costs

 

 

 

Severance and other business transition and exit costs
12

 
6

 
7

 
25

Total restructuring costs
$
60

 
$
6

 
$
7

 
$
73


- 10 -


Nine months ended May 31, 2017
Retail Pharmacy USA
 
Retail Pharmacy International
 
Pharmaceutical Wholesale
 
Walgreens Boots Alliance, Inc.
Asset impairments
$
207

 
$
21

 
$
1

 
$
229

Real estate costs
264

 

 

 
264

Severance and other business transition and exit costs
46

 
30

 
23

 
99

Total restructuring costs
$
517

 
$
51

 
$
24

 
$
592

 
 
 
 
 
 
 
 
Nine months ended May 31, 2016
 

 
 

 
 

 
 

Asset impairments
$
73

 
$

 
$

 
$
73

Real estate costs
52

 

 

 
52

Severance and other business transition and exit costs
45

 
14

 
7

 
66

Total restructuring costs
$
170

 
$
14

 
$
7

 
$
191


The changes in accrued expenses and other liabilities related to the Cost Transformation Program include the following (in millions):
 
Asset
impairments
 
Real estate
costs
 
Severance and
other business
transition and
exit costs
 
Total
Balance at August 31, 2016
$

 
$
248

 
$
27

 
$
275

Restructuring costs
229

 
264

 
99

 
592

Payments

 
(51
)
 
(80
)
 
(131
)
Other - non cash
(229
)
 

 

 
(229
)
Currency translation adjustments

 

 

 

Balance at May 31, 2017
$

 
$
461

 
$
46

 
$
507


Note 3. Operating leases
Initial lease term for premises in the U.S. is typically 15 to 25 years, followed by additional terms containing renewal options at five -year intervals, and may include rent escalation clauses. Non-U.S. leases are typically for shorter terms and may include cancellation clauses or renewal options. The commencement date of all lease terms is the earlier of the date the Company becomes legally obligated to make rent payments or the date the Company has the right to control the property. The Company recognizes rent expense on a straight-line basis over the term of the lease. In addition to minimum fixed rentals, some leases provide for contingent rentals based upon a portion of sales.

The Company continuously evaluates its real estate portfolio in conjunction with its capital needs. The Company has entered into several sale-leaseback transactions. For the nine months ended May 31, 2017 and May 31, 2016 , the Company recorded proceeds from sale-leaseback transactions of $436 million and $60 million , respectively. The Company has determined it no longer has continuing involvement related to these transactions and in accordance with the accounting standards related to sale-leaseback transactions has recognized any loss on sale immediately, any gain on sale was deferred and amortized over the life of the lease. Gains and losses are recorded within selling, general and administrative expenses in the Consolidated Condensed Statements of Earnings.

The Company provides for future costs related to closed locations. The liability is based on the present value of future rent obligations and other related costs (net of estimated sublease rent) to the first lease option date. During the three and nine months ended May 31, 2017 , the Company recorded charges of $25 million and $289 million for facilities that were closed or relocated under long-term leases, including stores closed through the Company’s restructuring activities. This compares to $16 million and $91 million for the three and nine months ended May 31, 2016 . These charges are reported in selling, general and administrative expenses in the Consolidated Condensed Statements of Earnings.


- 11 -


The changes in reserve for facility closings and related lease termination charges primarily in other non-current liabilities, include the following (in millions):
 
For the nine months ended May 31, 2017
 
For the twelve months ended August 31, 2016
Balance at beginning of period
$
466

 
$
446

Provision for present value of non-cancellable lease payments on closed facilities
271

 
134

Assumptions about future sublease income, terminations and changes in interest rates
(7
)
 
(34
)
Interest accretion
25

 
27

Cash payments, net of sublease income
(100
)
 
(107
)
Balance at end of period
$
655

 
$
466


As of May 31, 2017 , the Company remains secondarily liable on 70 leases. The maximum potential undiscounted future payments are $330 million as of May 31, 2017 .

Note 4. Equity method investments
Equity method investments as of May 31, 2017 and August 31, 2016 , are as follows (in millions, except percentages):
 
May 31, 2017
 
August 31, 2016
 
Carrying
value
 
Ownership
percentage
 
Carrying
value
 
Ownership
percentage
AmerisourceBergen
$
5,051

 
26%
 
$
4,964

 
24%
Others
1,272

 
8% - 50%
 
1,210

 
12% - 50%
Total
$
6,323

 
 
 
$
6,174

 
 

AmerisourceBergen investment
As of May 31, 2017 and August 31, 2016 , the Company owned 56,854,867 AmerisourceBergen Corporation (“AmerisourceBergen”) common shares, representing approximately 26% and 24% of the outstanding AmerisourceBergen common stock, respectively. The Company accounts for its equity investment in AmerisourceBergen using the equity method of accounting, with the net earnings attributable to the Company’s investment being classified within the operating income of its Pharmaceutical Wholesale segment. Due to the timing and availability of financial information of AmerisourceBergen, the Company accounts for this equity method investment on a financial reporting lag of two months . Equity earnings from AmerisourceBergen is reported as a separate line in the Consolidated Condensed Statements of Earnings. The level 1 fair market value of the Company’s equity investment in AmerisourceBergen common stock at May 31, 2017 is $5.2 billion .

The Company’s investment in AmerisourceBergen carrying value exceeded its proportionate share of the net assets of AmerisourceBergen by $4.4 billion . This premium of $4.4 billion was recognized as part of the carrying value in the Company’s equity investment in AmerisourceBergen. The difference was primarily related to goodwill and the fair value of AmerisourceBergen intangible assets.

Other investments
The Company’s other equity method investments include its investments in Guangzhou Pharmaceuticals Corporation and Nanjing Pharmaceutical Corporation Limited, the Company’s pharmaceutical wholesale investments in China; and the equity method investment retained through the sale of a majority interest in Option Care Inc. in fiscal 2015. The Company reported $21 million of post-tax equity losses and $15 million of post-tax equity earnings from equity method investments other than AmerisourceBergen for the three months ended May 31, 2017 and May 31, 2016 , respectively. The Company reported $ 7 million of post-tax equity earnings and $35 million of post-tax equity earnings from equity method investments other than AmerisourceBergen for the nine months ended May 31, 2017 and May 31, 2016 , respectively.

Note 5. Acquisitions

AllianceRx Walgreens Prime
On March 31, 2017, Walgreens Boots Alliance and pharmacy benefit manager Prime Therapeutics LLC ("Prime") closed a transaction to form a combined central specialty pharmacy and mail services company AllianceRx Walgreens Prime, as part of a strategic alliance. AllianceRx Walgreens Prime is consolidated by Walgreens Boots Alliance and reported within the Retail

- 12 -


Pharmacy USA division in its financial statements. The Company accounted for this acquisition of Prime’s specialty pharmacy and mail services business as a business combination involving noncash purchase consideration of $720 million consisting of the issuance of an equity interest in AllianceRx Walgreens Prime.

As of May 31, 2017 , the Company had not completed the analysis to assign fair values to all tangible and intangible assets acquired and therefore the purchase price allocation has not been completed. The preliminary purchase price allocation will be subject to further refinement and may result in material changes. These changes will primarily relate to the allocation of consideration and the fair value assigned to all tangible and intangible assets acquired and identified. The following table summarizes the consideration for the acquisition and the preliminary amounts of identified assets acquired and liabilities assumed at the date of the transaction (in millions).
 
May 31, 2017
Total consideration
$
720

 
 
Identifiable assets acquired and liabilities assumed
 
Accounts receivable, net
$
233

Inventories
149

Property, plant and equipment, net
11

Intangible assets, net
331

Trade accounts payable
(89
)
Accrued expenses and other liabilities
(2
)
Total identifiable net assets
633

Goodwill
$
87


The preliminary identified intangible assets primarily include payer contracts. These contracts are estimated to have a weighted average useful life of 15 years. The preliminary goodwill of $87 million arising from the transaction consists of expected purchasing synergies, operating efficiencies by benchmarking performance and applying best practices across the combined company, consolidation of operations, reductions in selling, general and administrative expenses and combining workforces. Substantially all of the goodwill recognized is not expected to be deductible for income tax purposes.

In accordance with ASC Topic 810, Consolidation, the noncontrolling interest was recognized based on its proportionate interest in the identifiable net assets of AllianceRx Walgreens Prime. The difference between the carrying amount of the noncontrolling interest and the fair value recognized as consideration in the business combination is recognized as additional paid in capital.

The Company incurred legal and other professional services costs related to the transaction, which were included in selling, general and administrative expenses, of $4 million and $8 million , respectively, for the three and nine month periods ended May 31, 2017.

Pro forma net earnings and sales of the Company, assuming the acquisition had occurred at the beginning of each period presented, would not be materially different from the results reported. The acquisition did not have a material impact on net earnings or sales of the Company for the three and nine month periods ended May 31, 2017.

Note 6. Goodwill and other intangible assets
Changes in the carrying amount of goodwill by reportable segment consist of the following (in millions):
 
Retail
Pharmacy USA
 
Retail
Pharmacy
International
 
Pharmaceutical
Wholesale
 
Walgreens
Boots
Alliance, Inc.
August 31, 2016
$
9,036

 
$
3,369

 
$
3,122

 
$
15,527

Acquisitions
87

 

 

 
87

Currency translation adjustments

 
(36
)
 
(62
)
 
(98
)
May 31, 2017
$
9,123

 
$
3,333

 
$
3,060

 
$
15,516


The carrying amount and accumulated amortization of intangible assets consist of the following (in millions):

- 13 -


 
May 31, 2017
 
August 31, 2016
Gross amortizable intangible assets
 
 
 
Customer relationships and loyalty card holders
$
1,830

 
$
1,867

Purchased prescription files
669

 
932

Favorable lease interests and non-compete agreements
536

 
619

Trade names and trademarks
502

 
532

Purchasing and payer contracts
390

 
94

Total gross amortizable intangible assets
3,927

 
4,044

 
 
 
 
Accumulated amortization
 

 
 

Customer relationships and loyalty card holders
$
371

 
$
275

Purchased prescription files
376

 
600

Favorable lease interests and non-compete agreements
355

 
388

Trade names and trademarks
135

 
105

Purchasing and payer contracts
44

 
71

Total accumulated amortization
1,281

 
1,439

Total amortizable intangible assets, net
$
2,646

 
$
2,605

 
 
 
 
Indefinite lived intangible assets
 

 
 

Trade names and trademarks
$
5,507

 
$
5,604

Pharmacy licenses
2,055

 
2,093

Total indefinite lived intangible assets
$
7,562

 
$
7,697

 
 
 
 
Total intangible assets, net
$
10,208

 
$
10,302


Amortization expense for intangible assets was $98 million and $287 million for the three and nine months ended May 31, 2017 , and $104 million and $320 million for the three and nine months ended May 31, 2016 , respectively.

Estimated annual amortization expense for intangible assets recorded at May 31, 2017 is as follows (in millions):
 
2018
 
2019
 
2020
 
2021
 
2022
Estimated annual amortization expense
$
361

 
$
333

 
$
273

 
$
205

 
$
185



- 14 -


Note 7. Borrowings
Borrowings consist of the following (all amounts are presented in millions of U.S. dollars and debt issuances are denominated in U.S. dollars, unless otherwise noted)
 
May 31, 2017
 
August 31, 2016
Short-term borrowings   1
 
 
 
$6 Billion note issuance   2,3
 
 
 
1.750% unsecured notes due 2018
$
1,248

 
$

2.600% unsecured notes due 2021
1,494

 

3.100% unsecured notes due 2023
745

 

$8 Billion note issuance   2,3
 
 
 
1.750% unsecured notes due November 2017
749

 

Unsecured Pound Sterling variable rate term loan due 2019
105

 
63

Other 4
497

 
260

Total short-term borrowings
$
4,838

 
$
323

 
 
 
 
Long-term debt 1
 

 
 

Unsecured Pound Sterling variable rate term loan due 2019
$
1,736

 
$
1,833

$6 Billion note issuance   2,3
 

 
 

1.750% unsecured notes due 2018

 
1,246

2.600% unsecured notes due 2021

 
1,493

3.100% unsecured notes due 2023

 
744

3.450% unsecured notes due 2026
1,886

 
1,885

4.650% unsecured notes due 2046
590

 
590

$8 Billion note issuance   2,3
 

 
 

1.750% unsecured notes due 2017

 
746

2.700% unsecured notes due 2019
1,246

 
1,244

3.300% unsecured notes due 2021
1,243

 
1,242

3.800% unsecured notes due 2024
1,988

 
1,987

4.500% unsecured notes due 2034
495

 
494

4.800% unsecured notes due 2044
1,492

 
1,492

£700 Million note issuance   2,3
 

 
 

2.875% unsecured Pound Sterling notes due 2020
513

 
521

3.600% unsecured Pound Sterling notes due 2025
384

 
391

€750 Million note issuance   2,3
 

 
 

2.125% unsecured Euro notes due 2026
838

 
830

$4 Billion note issuance   3,7
 

 
 

3.100% unsecured notes due 2022
1,194

 
1,194

4.400% unsecured notes due 2042
492

 
492

$1 Billion note issuance   3,7
 

 
 

5.250% unsecured notes due 2019 5
250

 
249

Other 6
25

 
32

Total long-term debt, less current portion
$
14,372

 
$
18,705


1  
Carry values are presented net of unamortized discount and debt issuance costs, where applicable, and foreign currency denominated borrowings have been translated using the spot rates at May 31, 2017 and August 31, 2016 , respectively.
2  
Notes are unsubordinated debt obligations of Walgreens Boots Alliance and rank equally in right of payment with all other unsecured and unsubordinated indebtedness of Walgreens Boots Alliance from time to time outstanding.

- 15 -


3  
The fair value and carrying value of the $6 billion , $8 billion , £0.7 billion , €0.75 billion , $4 billion and $1 billion note issuances as of May 31, 2017 was $6.1 billion  and $6.0 billion $7.5 billion  and $7.2 billion , $1.0 billion  and $0.9 billion , $0.9 billion  and $0.8 billion , $1.7 billion  and $1.7 billion , and $0.3 billion  and $0.3 billion , respectively. The fair values of the notes outstanding are level 1 fair value measures and determined based on quoted market price and translated at the May 31, 2017 spot rate, as applicable.
4  
Other short-term borrowings represent a mix of fixed and variable rate borrowings with various maturities and working capital facilities denominated in various currencies.
5  
Includes interest rate swap fair market value adjustments. See note 9, Fair value measurements for additional fair value disclosures.
6  
Other long-term debt represents a mix of fixed and variable rate borrowings in various currencies with various maturities.
7  
Notes are senior debt obligations of Walgreens and rank equally with all other unsecured and unsubordinated indebtedness of Walgreens. On December 31, 2014, Walgreens Boots Alliance fully and unconditionally guaranteed the outstanding notes on an unsecured and unsubordinated basis. The guarantee, for so long as it is in place, is an unsecured, unsubordinated debt obligation of Walgreens Boots Alliance and will rank equally in right of payment with all other unsecured and unsubordinated indebtedness of Walgreens Boots Alliance.

2017 Term Loan Credit Agreements
On February 22, 2017, the Company entered into (a) a $4.8 billion unsecured term loan facility with the lenders party thereto (the “Syndicated Credit Agreement”) and (b) a $1.0 billion unsecured term loan facility with Sumitomo Mitsui Banking Corporation, as lender and administrative agent (the “Sumitomo Credit Agreement” and, together with the Syndicated Credit Agreement, the “2017 Term Loan Credit Agreements”). The obligations of the lenders party to each of the 2017 Term Loan Credit Agreements to fund the loans thereunder were to become effective upon the date of closing of the transactions contemplated by the Merger Agreement. Each of the 2017 Term Loan Credit Agreements and the commitments contemplated thereby terminated on June 28, 2017 upon the termination of the Merger Agreement. See note 1, Basis of presentation. As of May 31, 2017 , there were no borrowings under either of the 2017 Term Loan Credit Agreements.

2017 Revolving Credit Agreement
On February 1, 2017, the Company entered into a $1.0 billion revolving credit facility (the “2017 Revolving Credit Agreement”) with the lenders from time to time party thereto. The Company will be the borrower under the 2017 Revolving Credit Agreement, which terminates on the earlier of (a)  364 days following the effective date thereof, subject to the extension thereof pursuant to provisions specified in the Revolving Credit Agreement, and (b) the date of termination in whole of the aggregate commitment pursuant to the Revolving Credit Agreement. The ability of the Company to request the making of loans under the 2017 Revolving Credit Agreement is subject to the satisfaction (or waiver) of certain customary conditions set forth therein. As of May 31, 2017 , there were no borrowings under the 2017 Revolving Credit Agreement.

$6.0 billion note issuance
On June 1, 2016, Walgreens Boots Alliance received net proceeds (after deducting underwriting discounts and offering expenses) of $6.0 billion from a public offering of five series of U.S. dollar notes: $1.2 billion of 1.750% notes due 2018 (the “2018 notes”), $1.5 billion of 2.600% notes due 2021 (the “2021 notes”), $0.8 billion of 3.100% notes due 2023 (the “2023 notes”), $1.9 billion of 3.450% notes due 2026 (the “2026 notes”) and $0.6 billion of 4.650% notes due 2046 (the “2046 notes”). Total issuance costs relating to the notes, including underwriting discounts and offering expenses, were $30 million . The notes contain redemption terms which allow or require the Company to redeem the notes at defined redemption prices plus accrued and unpaid interest at redemption dates set forth in the applicable series of notes. Interest on the notes issued on June 1, 2016 is payable semi-annually. Because the merger with Rite Aid was not consummated on or prior to June 1, 2017, the 2018 notes, the 2021 notes and the 2023 notes (but not the 2026 notes or 2046 notes, which remain outstanding in accordance with their respective terms) were redeemed on June 5, 2017 under the special mandatory redemption terms of the indenture governing such notes. Walgreens Boots Alliance was required to redeem all of the 2018 notes, the 2021 notes and the 2023 notes then outstanding, at a special mandatory redemption price equal to 101% of the aggregate principal amount of such notes, plus accrued and unpaid interest of approximately $1 million to, but excluding, the date of redemption. Accordingly, the 2018 notes, the 2021 notes and the 2023 notes were classified as Short-term borrowings on the Consolidated Condensed Balance Sheet as of May 31, 2017 .

Debt covenants
The Company’s credit facilities contain a covenant to maintain, as of the last day of each fiscal quarter, a ratio of consolidated debt to total capitalization not to exceed 0.60 :1.00. The credit facilities contain various other customary covenants.

Other borrowings
The Company periodically borrows under its commercial paper program. There were no commercial paper borrowings outstanding as of May 31, 2017 or August 31, 2016 , respectively. The Company had no activity under its commercial paper

- 16 -


program for the nine months ended May 31, 2017 . The Company had average daily short-term borrowings of $18 million of commercial paper outstanding at a weighted average interest rate of 0.66% for the nine month period ended May 31, 2016 .

Note 8. Financial instruments
The Company uses derivative instruments to manage its exposure to interest rate and foreign currency exchange risks.

The notional amounts, fair value and balance sheet presentation of derivative instruments outstanding as of May 31, 2017 and August 31, 2016 are as follows (in millions):
 
May 31, 2017
 
August 31, 2016
 
 
 
Notional 1
 
Fair value
 
Notional 1
 
Fair value
 
Location in Consolidated
Condensed Balance Sheets
Derivatives designated as fair value hedges:
 
 
 
 
 
 
 
 
 
Interest rate swaps
$
250

 
$

 
$

 
$

 
Other non-current liabilities
Interest rate swaps

 

 
250

 
3

 
Other non-current assets
Derivatives not designated as hedges:
 
 
 
 
 
 
 
 
 
Foreign currency forwards
133

 

 
1,177

 
16

 
Other current assets
Foreign currency forwards
976

 
5

 
41

 

 
Accrued expenses and other liabilities
Basis swaps
2

 

 

 

 
Accrued expenses and other liabilities
Basis swaps

 

 
2

 
1

 
Other current assets

1  
Amounts are presented in U.S. dollar equivalents, as applicable.

The Company uses interest rate swaps to manage the interest rate exposure associated with some of its fixed-rate borrowings and designates them as fair value hedges. The Company uses forward starting interest rate swaps to hedge its interest rate exposure of some of its anticipated debt issuances.

The Company utilizes foreign currency forward contracts and other foreign currency derivatives to hedge significant committed and highly probable future transactions and cash flows denominated in currencies other than the functional currency of the Company or its subsidiaries. The Company has significant non-U.S dollar denominated net investments and uses foreign currency denominated financial instruments, specifically foreign currency derivatives and foreign currency denominated debt, to hedge its foreign currency risk.

Fair value hedges
The Company holds interest rate swaps converting $250 million of its 5.250% fixed rate notes to a floating interest rate based on the six-month LIBOR in arrears plus a constant spread. All swap termination dates coincide with the notes maturity date, January 15, 2019. These swaps were designated as fair value hedges.

The gains and losses due to changes in fair value on the swaps and on the hedged notes attributable to interest rate risk were not material. The changes in fair value of the Company’s debt that was swapped from fixed to variable rate and designated as fair value hedges are included in long-term debt on the Consolidated Condensed Balance Sheets (see note 7, Borrowings).


- 17 -


Derivatives not designated as hedges
The Company enters into derivative transactions that are not designated as accounting hedges. These derivative instruments are economic hedges of foreign currency risks. The gains and (losses) due to changes in fair value of these derivative instruments were recognized in earnings as follows (in millions):
 
 
 
Three months ended

Nine months ended
 
Location in Consolidated Condensed
Statements of Earnings
 
May 31, 2017

May 31, 2016

May 31, 2017

May 31, 2016
Foreign currency forwards
Selling, general and administrative expenses
 
$
(19
)
 
$
24

 
$
28

 
$
(1
)
Foreign currency forwards
Other income (expense)
 
(1
)
 
4

 
(15
)
 
37


Derivatives credit risk
Counterparties to derivative financial instruments expose the Company to credit-related losses in the event of counterparty nonperformance, and the Company regularly monitors the credit worthiness of each counterparty.

Derivatives offsetting
The Company does not offset the fair value amounts of derivative instruments subject to master netting agreements in the Consolidated Condensed Balance Sheets.

Note 9. Fair value measurements
The Company measures certain assets and liabilities in accordance with ASC Topic 820, Fair Value Measurements and Disclosures, which defines fair value as the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. In addition, it establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels:

Level 1 - Quoted prices in active markets that are accessible at the measurement date for identical assets and liabilities. The fair value hierarchy gives the highest priority to level 1 inputs.
Level 2 - Observable inputs other than quoted prices in active markets.
Level 3 - Unobservable inputs for which there is little or no market data available. The fair value hierarchy gives the lowest priority to level 3 inputs.

Assets and liabilities measured at fair value on a recurring basis are as follows (in millions):
 
May 31, 2017
 
Level 1
 
Level 2
 
Level 3
Assets :
 
 
 
 
 
 
 
Money market funds 1
$
10,491

 
$
10,491

 
$

 
$

Available-for-sale investments 2
1

 
1

 

 

Foreign currency forwards 3

 

 

 

Liabilities :
 

 
 

 
 

 
 

Foreign currency forwards 3
5

 

 
5

 

Basis swaps 3

 

 

 

Interest rate swaps 4

 

 

 

 
August 31, 2016
 
Level 1
 
Level 2
 
Level 3
Assets :
 
 
 
 
 
 
 
Money market funds 1
$
9,133

 
$
9,133

 
$

 
$

Available-for-sale investments 2
32

 
32

 

 

Foreign currency forwards 3
16

 

 
16

 

Interest rate swaps 4
3

 

 
3

 

Liabilities :
 

 
 

 
 

 
 

Basis swaps 3
1

 

 
1

 



- 18 -



1  
Money market funds are valued at the closing price reported by the fund sponsor.
2  
Fair values of quoted investments are based on current bid prices as of the balance sheet dates.
3  
The fair value of basis swaps and forward currency contracts is estimated by discounting the difference between the contractual forward price and the current available forward price for the residual maturity of the contract using observable market rates.
4  
The fair value of interest rate swaps is calculated by discounting the estimated future cash flows based on the applicable observable yield curves. See note 8, Financial instruments for additional information.

There were no transfers between levels for the three and nine months ended May 31, 2017 .

The Company reports its debt instruments under the guidance of ASC Topic 825, Financial Instruments, which requires disclosure of the fair value of the Company’s debt in the footnotes to the consolidated financial statements. Unless otherwise noted, the fair value for all notes was determined based upon quoted market prices and therefore categorized as level 1. See note 7, Borrowings for further information. The carrying values of accounts receivable and trade accounts payable approximated their respective fair values due to their short-term nature.

Note 10. Commitments and contingencies
Litigation and regulatory proceedings
The Company is involved in legal proceedings and is subject to investigations, inspections, audits, inquiries and similar actions by governmental authorities, arising in the normal course of the Company’s business, including the matters described below. Legal proceedings, in general, and securities and class action litigation, in particular, can be expensive and disruptive. Some of these suits may purport or may be determined to be class actions and/or involve parties seeking large and/or indeterminate amounts, including punitive or exemplary damages, and may remain unresolved for several years. From time to time, the Company is also involved in legal proceedings as a plaintiff involving antitrust, tax, contract, intellectual property and other matters. Gain contingencies, if any, are recognized when they are realized. The results of legal proceedings are often uncertain and difficult to predict, and the costs incurred in litigation can be substantial, regardless of the outcome. The Company believes that its defenses and assertions in pending legal proceedings have merit, and does not believe that any of these pending matters, after consideration of applicable reserves and rights to indemnification, will have a material adverse effect on the Company’s consolidated financial position. However, substantial unanticipated verdicts, fines and rulings do sometimes occur. As a result, the Company could from time to time incur judgments, enter into settlements or revise its expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on its results of operations in the period in which the amounts are accrued and/or its cash flows in the period in which the amounts are paid.

On a quarterly basis, the Company assesses its liabilities and contingencies for outstanding legal proceedings and reserves are established on a case-by-case basis for those legal claims for which management concludes that it is probable that a loss will be incurred and that the amount of such loss can be reasonably estimated. Substantially all of these contingencies are subject to significant uncertainties and, therefore, determining the likelihood of a loss and/or the measurement of any loss can be complex. With respect to litigation and other legal proceedings where the Company has determined that a loss is reasonably possible, the Company is unable to estimate the amount or range of reasonably possible loss due to the inherent difficulty of predicting the outcome of and uncertainties regarding such litigation and legal proceedings. The Company’s assessments are based on estimates and assumptions that have been deemed reasonable by management, but that may prove to be incomplete or inaccurate, and unanticipated events and circumstances may occur that might cause the Company to change those estimates and assumptions. Therefore, it is possible that an unfavorable resolution of one or more pending litigation or other contingencies could have a material adverse effect on the Company’s consolidated financial statements in a future fiscal period. Management’s assessment of current litigation and other legal proceedings, including the corresponding accruals, could change because of the discovery of facts with respect to legal actions or other proceedings pending against the Company which are not presently known. Adverse rulings or determinations by judges, juries, governmental authorities or other parties could also result in changes to management’s assessment of current liabilities and contingencies. Accordingly, the ultimate costs of resolving these claims may be substantially higher or lower than the amounts reserved.

On December 29, 2014, a putative shareholder filed a derivative action in federal court in the Northern District of Illinois against certain current and former directors and officers of Walgreen Co., and Walgreen Co. as a nominal defendant, arising out of certain public statements the Company made regarding its former fiscal 2016 goals. The action asserts claims for breach of fiduciary duty, waste and unjust enrichment. On April 10, 2015, the defendants filed a motion to dismiss. On May 18, 2015, the case was stayed in light of a securities class action that was filed on April 10, 2015. After a ruling issued on September 30, 2016 in the securities class action, which is described below, on November 3, 2016, the Court entered a stipulation and order extending the stay until the securities case is fully resolved.


- 19 -


On April 10, 2015, a putative shareholder filed a securities class action in federal court in the Northern District of Illinois against Walgreen Co. and certain former officers of Walgreen Co. The action asserts claims for violation of the federal securities laws arising out of certain public statements the Company made regarding its former fiscal 2016 goals. On June 16, 2015, the Court entered an order appointing a lead plaintiff. Pursuant to the Court’s order, lead plaintiff filed an amended complaint on August 17, 2015, and defendants moved to dismiss the amended complaint on October 16, 2015. Lead plaintiff filed a response to the motion to dismiss on December 22, 2015, and defendants filed a reply in support of the motion on February 5, 2016. On September 30, 2016, the Court issued an order granting in part and denying in part defendants’ motion to dismiss. Defendants filed their answer to the amended complaint on November 4, 2016 and filed an amended answer on January 16, 2017. Plaintiffs filed their motion for class certification on April 21, 2017. Briefing on the motion is scheduled to be completed by August 25, 2017.

As of May 31, 2017 , the Company was aware of two putative class action lawsuits filed by purported Rite Aid stockholders against Rite Aid and its board of directors, Walgreens Boots Alliance and Victoria Merger Sub, Inc. for claims arising out of the transactions contemplated by the original Merger Agreement (prior to its amendment on January 29, 2017) (such transactions, the “Rite Aid Transactions”). One action was filed in the State of Pennsylvania in the Court of Common Pleas of Cumberland County (the “Pennsylvania action”), and one action was filed in the United States District Court for the Middle District of Pennsylvania (the “federal action”). The Pennsylvania action primarily alleged that the Rite Aid board of directors breached its fiduciary duties in connection with the Rite Aid Transactions by, among other things, agreeing to an unfair and inadequate price, agreeing to deal protection devices that preclude other bidders from making successful competing offers for Rite Aid, and failing to disclose all allegedly material information concerning the proposed merger, and also alleged that Walgreens Boots Alliance and Victoria Merger Sub, Inc. aided and abetted these alleged breaches of fiduciary duty. The federal action alleged, among other things, that Rite Aid and its board of directors disseminated an allegedly false and misleading proxy statement in connection with the Rite Aid Transactions. The plaintiffs in the federal action also filed a motion for preliminary injunction seeking to enjoin the Rite Aid shareholder vote relating to the Rite Aid Transactions. That motion was denied, and the Rite Aid shareholders approved the Rite Aid Transactions at a special meeting on February 4, 2016. In the federal action, plaintiffs agreed to stay the litigation until after the Rite Aid Transactions have closed, but on March 17, 2017, moved to lift the stay to allow plaintiffs to file an amended complaint. The Company filed a response opposing this motion, and the plaintiffs filed a reply in support of this motion on April 14, 2017. The Company was also named as a defendant in eight putative class action lawsuits filed in the Court of Chancery of the State of Delaware (the “Delaware actions”). Those actions were consolidated, and plaintiffs filed a motion for preliminary injunction seeking to enjoin the Rite Aid shareholder vote relating to the Rite Aid Transactions. That motion was denied and the plaintiffs in the Delaware actions agreed to settle this matter for an immaterial amount. The Delaware actions all have been dismissed.

Terminated acquisition of Rite Aid and related matters
On June 28, 2017, the Company and Rite Aid entered into the Termination Agreement pursuant to which the parties agreed to terminate the Merger Agreement and other Transaction Documents. Pursuant to the Termination Agreement, the Company agreed to pay Rite Aid the termination fee of $325 million in full satisfaction of any amounts required to be paid by the Company under the Merger Agreement and other Transaction Documents. The Company plans to pay Rite Aid such fee on or before June 30, 2017. See note 1, Basis of presentation.

On June 28, 2017, following the termination of the Merger Agreement, the Fred’s Asset Purchase Agreement was terminated. In connection with the termination of the Fred’s Asset Purchase Agreement, the Company agreed to reimburse certain of Fred’s transaction costs in an amount not to exceed $25 million in full satisfaction of any amounts required to be paid by the Company under the Fred’s Asset Purchase Agreement. The Company expects to pay the applicable amount during the fourth quarter of fiscal 2017. See note 1, Basis of presentation.

Note 11. Retirement benefits
The Company sponsors several retirement plans, including defined benefit plans, defined contribution plans and a postretirement health plan.

Effective September 1, 2016, for UK and U.S. benefit plans previously using the yield curve approach to establish discount rates, the Company changed the method used to calculate the service cost and interest cost components of net periodic benefit costs for pension and postretirement benefit plans and will measure these costs by applying the specific spot rates along the yield curve to the plans’ projected cash flows. The Company believes the new approach provides a more precise measurement of service and interest costs by improving the correlation between projected cash flows and the corresponding spot yield curve rates. The change does not affect the measurement of the Company’s pension and other postretirement benefit obligations for those plans and is accounted for as a change in accounting estimate, which is applied prospectively.

Defined benefit pension plans (non-U.S. plans)

- 20 -


The Company has various defined benefit pension plans outside the United States. The principal defined benefit pension plan is the Boots Pension Plan, which covers certain employees in the United Kingdom (the “Boots Plan”). The Boots Plan is a funded final salary defined benefit plan providing pensions and death benefits to members. The Boots Plan was closed to future accrual effective July 1, 2010, with pensions calculated based on salaries up until that date. The Boots Plan is governed by a trustee board, which is independent of the Company. The plan is subject to a full funding actuarial valuation on a triennial basis.

Components of net periodic pension costs for the defined benefit pension plans (in millions):
 
Three months ended
 
Nine months ended
 
May 31, 2017
 
May 31, 2016
 
May 31, 2017
 
May 31, 2016
Service costs
$
1

 
$
1

 
$
3

 
$
3

Interest costs
43

 
77

 
129

 
236

Expected returns on plan assets/other
(41
)
 
(62
)
 
(112
)
 
(189
)
Total net periodic pension costs
$
3

 
$
16

 
$
20

 
$
50


The Company made cash contributions to its defined benefit pension plans of $48 million for the nine months ended May 31, 2017 , which primarily related to committed funded payments. The Company plans to contribute an additional $18 million to its defined benefit pension plans in fiscal 2017 .

Defined contribution plans
The principal retirement plan for U.S. employees is the Walgreen Profit-Sharing Retirement Plan, to which both the Company and participating employees contribute. The Company’s contribution is in the form of a guaranteed match which is approved annually by the Walgreen Co. Board of Directors and reviewed by the Compensation Committee and Finance Committee of the Walgreens Boots Alliance Board of Directors. The profit-sharing provision was an expense of $58 million and $164 million for the three and nine months ended May 31, 2017 compared to an expense of  $58 million and $169 million in the three and nine months ended May 31, 2016 .

The Company also has other contract based as well as statutory defined contribution schemes, including the Alliance Healthcare & Boots Retirement Savings Plan, to which both the Company and participating employees contribute. The cost recognized in the Consolidated Condensed Statements of Earnings for the three and nine months ended May 31, 2017 was $26 million and $82 million compared to a cost of $33 million and $102 million in the three and nine months ended May 31, 2016 .

Postretirement Healthcare Plan
The Company provides certain health insurance benefits to retired U.S. employees who meet eligibility requirements, including age, years of service and date of hire. The costs of these benefits are accrued over the service life of the employee. An amendment to this plan in the third quarter of fiscal 2017 resulted in a $109 million curtailment gain.

Note 12. Earnings per share
The dilutive effect of outstanding stock options on earnings per share is calculated using the treasury stock method. Stock options are anti-dilutive and excluded from the earnings per share calculation if the exercise price exceeds the average market price of the common shares. There were 6.4 million outstanding options to purchase common shares that were anti-dilutive and excluded from the third quarter earnings per share calculation as of May 31, 2017 compared to 2.8 million as of May 31, 2016 . Anti-dilutive shares excluded from the year to date earnings per share calculation were 5.7 million compared to 2.4 million for the periods ended May 31, 2017 and May 31, 2016 , respectively.

Note 13. Depreciation and amortization
The Company has recorded the following depreciation and amortization expense in the Consolidated Condensed Statements of Earnings (in millions):
 
Three months ended

Nine months ended
 
May 31, 2017

May 31, 2016

May 31, 2017

May 31, 2016
Depreciation expense
$
334

 
$
353

 
$
1,000

 
$
997

Intangible asset and other amortization
79

 
94

 
244

 
274

Total depreciation and amortization expense
$
413

 
$
447

 
$
1,244

 
$
1,271


Note 14. Supplemental information

- 21 -


The effective tax rate for the three months ended May 31, 2017 was 12.4% compared to 22.8% for the prior year period. The effective tax rate for the nine months ended May 31, 2017 was 16.2% compared to 20.2% for the prior year period. The decrease in the effective tax rate for the three months and nine months ended May 31, 2017 was primarily attributable to net incremental discrete tax benefits and a lower estimated annual tax rate. Cash paid for income taxes was $839 million and $812 million in the nine months ended May 31, 2017 and May 31, 2016 , respectively.

Interest paid was $573 million and $512 million for the nine months ended May 31, 2017 and May 31, 2016 , respectively.

Note 15. Accumulated other comprehensive income (loss)
The following is a summary of net changes in accumulated other comprehensive income by component and net of tax for the three and nine months ended May 31, 2017 and May 31, 2016 (in millions):
 
Pension/ post-
retirement
obligations
 
Unrecognized
gain (loss) on
available-for-
sale
investments
 
Unrealized
gain (loss) on
cash flow
hedges
 
Share of
OCI of
equity
method
investments
 
Currency
translation
adjustment
 
Total
Balance at February 28, 2017
$
(216
)
 
$
1

 
$
(35
)
 
$
(6
)
 
$
(3,553
)
 
$
(3,809
)
Other comprehensive income (loss) before reclassification adjustments
(102
)
 
(1
)
 

 
4

 
499

 
400

Amounts reclassified from accumulated OCI 1
109

 

 
1

 

 

 
110

Tax benefit (provision)
(2
)
 

 

 
(2
)
 

 
(4
)
Net other comprehensive income (loss)
5

 
(1
)
 
1

 
2

 
499

 
506

Balance at May 31, 2017
$
(211
)
 
$

 
$
(34
)
 
$
(4
)
 
$
(3,054
)
 
$
(3,303
)
 
Pension/ post-
retirement
obligations
 
Unrecognized
gain (loss) on
available-for-
sale
investments
 
Unrealized
gain (loss) on
cash flow
hedges
 
Share of
OCI of
equity
method
investments
 
Currency
translation
adjustment
 
Total
Balance at August 31, 2016
$
(212
)
 
$
2

 
$
(37
)
 
$
(1
)
 
$
(2,744
)
 
$
(2,992
)
Other comprehensive income (loss) before reclassification adjustments
(107
)
 
(2
)
 

 
(4
)
 
(310
)
 
(423
)
Amounts reclassified from accumulated OCI 1
109

 

 
4

 

 

 
113

Tax benefit (provision)
(1
)
 

 
(1
)
 
1

 

 
(1
)
Net other comprehensive income (loss)
1

 
(2
)
 
3

 
(3
)
 
(310
)
 
(311
)
Balance at May 31, 2017
$
(211
)
 
$

 
$
(34
)
 
$
(4
)
 
$
(3,054
)
 
$
(3,303
)


- 22 -


 
Pension/ post-
retirement
obligations
 
Unrecognized
gain (loss) on
available-for-
sale
investments
 
Unrealized
gain (loss) on
cash flow
hedges
 
Share of
OCI of
equity
method
investments
 
Currency
translation
adjustment
 
Total
Balance at February 29, 2016
$
30

 
$
172

 
$
(38
)
 
$

 
$
(2,032
)
 
$
(1,868
)
Other comprehensive income (loss) before reclassification adjustments
5

 
(6
)
 

 

 
762

 
761

Amounts reclassified from accumulated OCI

 
(268
)
 
1

 

 
(2
)
 
(269
)
Tax benefit (provision)
(2
)
 
102

 
(1
)
 

 

 
99

Net other comprehensive income (loss)
3

 
(172
)
 

 

 
760

 
591

Balance at May 31, 2016
$
33

 
$

 
$
(38
)
 
$

 
$
(1,272
)
 
$
(1,277
)

 
Pension/ post-
retirement
obligations
 
Unrecognized
gain (loss) on
available-for-
sale
investments
 
Unrealized
gain (loss) on
cash flow
hedges
 
Share of
OCI of
equity
method
investments
 
Currency
translation
adjustment
 
Total
Balance at August 31, 2015
$
29

 
$
259

 
$
(40
)
 
$

 
$
(462
)
 
$
(214
)
Other comprehensive income (loss) before reclassification adjustments
4

 
(150
)
 

 

 
(808
)
 
(954
)
Amounts reclassified from accumulated OCI

 
(268
)
 
4

 

 
(2
)
 
(266
)
Tax benefit (provision)

 
159

 
(2
)
 

 

 
157

Net other comprehensive income (loss)
4

 
(259
)
 
2

 

 
(810
)
 
(1,063
)
Balance at May 31, 2016
$
33

 
$

 
$
(38
)
 
$

 
$
(1,272
)
 
$
(1,277
)

1 Includes amendment to U.S. postretirement healthcare plan resulting in a curtailment gain. See note 11, Retirement benefits.

Note 16. Segment reporting
The Company has three reportable segments: Retail Pharmacy USA, Retail Pharmacy International, and Pharmaceutical Wholesale. The operating segments have been identified based on the financial data utilized by the Company’s Chief Executive Officer (the chief operating decision maker) to assess segment performance and allocate resources among the Company’s operating segments, which have been aggregated as described below. The chief operating decision maker uses adjusted operating income to assess segment profitability. The chief operating decision maker does not use total assets by segment to make decisions regarding resources, therefore the total asset disclosure by segment has not been included.

The Retail Pharmacy USA segment consists of retail drugstores and convenient care clinics and the provision of central specialty and mail pharmacy services. Sales for the segment are principally derived from the sale of prescription drugs and a wide assortment of general merchandise, including non-prescription drugs, beauty products, photo finishing, seasonal merchandise, greeting cards and convenience foods.

The Retail Pharmacy International segment consists primarily of pharmacy-led health and beauty stores and optical practices. Stores are located in the United Kingdom, Mexico, Chile, Thailand, Norway, the Republic of Ireland, the Netherlands and Lithuania. Sales for the segment are principally derived from the sale of prescription drugs and retail health, beauty, toiletries and other consumer products.

The Pharmaceutical Wholesale segment consists of pharmaceutical wholesaling and distribution businesses and an equity method investment in AmerisourceBergen reported on a two-month lag. Wholesale operations are located in France, the United Kingdom, Germany, Turkey, Spain, the Netherlands, Egypt, Norway, Romania, Czech Republic and Lithuania. Sales for the segment are principally derived from wholesaling and distribution of a comprehensive offering of brand-name pharmaceuticals (including specialty pharmaceutical products) and generic pharmaceuticals,

- 23 -


health and beauty products, home healthcare supplies and equipment, and related services to pharmacies and other healthcare providers.

Results for each reportable segment include the allocation of procurement rebates and corporate-related overhead costs. The “Eliminations” column includes intersegment sales and the profit on these intersegment sales to the extent the inventory has not been subsequently sold externally.

To improve comparability, certain classification changes were made to prior period sales, cost of sales and selling, general and administrative expenses. These changes had no impact on operating income or adjusted operating income. The reclassifications were made in the fourth quarter of fiscal 2016.

The following table reflects results of operations of the Company’s reportable segments (in millions):
 
Retail
Pharmacy
USA
 
Retail
Pharmacy
International
 
Pharmaceutical
Wholesale
 
Eliminations
 
Walgreens
Boots
Alliance, Inc.
Three months ended May 31, 2017
 
 
 
 
 
 
 
 
 
Sales to external customers
$
22,528

 
$
2,809

 
$
4,781

 
$