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EX-32.2 - EXHIBIT 32.2 - Walgreens Boots Alliance, Inc.a32818exhibit322.htm
EX-32.1 - EXHIBIT 32.1 - Walgreens Boots Alliance, Inc.a32818exhibit321.htm
EX-31.2 - EXHIBIT 31.2 - Walgreens Boots Alliance, Inc.a32818exhibit312.htm
EX-31.1 - EXHIBIT 31.1 - Walgreens Boots Alliance, Inc.a32818exhibit311.htm
EX-12 - EXHIBIT 12 - Walgreens Boots Alliance, Inc.a32818exhibit12.htm
 
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 February 28, 2018
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 February 28, 2018 was 991,665,577.
 



WALGREENS BOOTS ALLIANCE, INC.

FORM 10-Q FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2018

TABLE OF CONTENTS

PART I.  FINANCIAL INFORMATION

PART II. OTHER INFORMATION

- 2 -


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)
 
February 28, 2018
 
August 31, 2017
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,749

 
$
3,301

Accounts receivable, net
7,281

 
6,528

Inventories
10,316

 
8,899

Other current assets
1,012

 
1,025

Total current assets
20,358

 
19,753

Non-current assets:


 
 

Property, plant and equipment, net
14,045

 
13,642

Goodwill
17,017

 
15,632

Intangible assets, net
12,220

 
10,156

Equity method investments (see note 5)
6,431

 
6,320

Other non-current assets
745

 
506

Total non-current assets
50,458

 
46,256

Total assets
$
70,816

 
$
66,009

 
 
 
 
Liabilities and equity
 

 
 

Current liabilities:
 

 
 

Short-term debt
$
3,140

 
$
251

Trade accounts payable (see note 17)
13,301

 
12,494

Accrued expenses and other liabilities
5,675

 
5,473

Income taxes
443

 
329

Total current liabilities
22,559

 
18,547

Non-current liabilities:
 

 
 

Long-term debt
12,532

 
12,684

Deferred income taxes
1,946

 
2,281

Other non-current liabilities
5,601

 
4,223

Total non-current liabilities
20,079

 
19,188

Commitments and contingencies (see note 10)


 


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 February 28, 2018 and August 31, 2017
12

 
12

Paid-in capital
10,408

 
10,339

Retained earnings
31,513

 
30,137

Accumulated other comprehensive loss
(2,163
)
 
(3,051
)
Treasury stock, at cost; 180,848,041 shares at February 28, 2018 and 148,664,548 at August 31, 2017
(12,415
)
 
(9,971
)
Total Walgreens Boots Alliance, Inc. shareholders’ equity
27,355

 
27,466

Noncontrolling interests
823

 
808

Total equity
28,178

 
28,274

Total liabilities and equity
$
70,816

 
$
66,009


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

- 3 -


WALGREENS BOOTS ALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF EQUITY
(UNAUDITED)
For the six months ended February 28, 2018 and 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, 2017
1,023,849,070

 
$
12

 
$
(9,971
)
 
$
10,339

 
$

 
$
(3,051
)
 
$
30,137

 
$
808

 
$
28,274

Net earnings

 

 

 

 

 

 
2,170

 
1

 
2,171

Other comprehensive income, net of tax

 

 

 

 

 
888

 

 
20

 
908

Dividends declared

 

 

 

 

 

 
(794
)
 
(6
)
 
(800
)
Treasury stock purchases
(34,499,913
)
 

 
(2,525
)
 

 

 

 

 

 
(2,525
)
Employee stock purchase and option plans
2,316,420

 

 
81

 
2

 

 

 

 

 
83

Stock-based compensation

 

 

 
63

 

 

 

 

 
63

Noncontrolling interests contribution

 

 

 
4

 

 

 

 

 
4

February 28, 2018
991,665,577

 
$
12

 
$
(12,415
)
 
$
10,408

 
$

 
$
(2,163
)
 
$
31,513

 
$
823

 
$
28,178

 
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

 

 

 

 

 

 
2,114

 
15

 
2,129

Other comprehensive (loss), net of tax

 

 

 

 

 
(817
)
 

 
(43
)
 
(860
)
Dividends declared

 

 

 

 

 

 
(811
)
 
(6
)
 
(817
)
Treasury stock purchases
(5,600,000
)
 

 
(457
)
 

 

 

 

 

 
(457
)
Employee stock purchase and option plans
3,308,783

 

 
106

 
10

 
1

 

 

 

 
117

Stock-based compensation

 

 

 
52

 

 

 

 

 
52

Noncontrolling interests in businesses acquired

 

 

 
(11
)
 

 

 

 
(13
)
 
(24
)
February 28, 2017
1,080,695,374

 
$
12

 
$
(5,285
)
 
$
10,162

 
$

 
$
(3,809
)
 
$
28,987

 
$
354

 
$
30,421


- 4 -


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

- 5 -


WALGREENS BOOTS ALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS
(UNAUDITED)
(in millions, except per share amounts)
 
Three months ended
February 28,

Six months ended
February 28,
 
2018

2017

2018
 
2017
Sales
$
33,021

 
$
29,446

 
$
63,761

 
$
57,947

Cost of sales
24,925

 
21,885

 
48,324

 
43,270

Gross profit
8,096

 
7,561

 
15,437

 
14,677

 
 
 
 
 
 
 
 
Selling, general and administrative expenses
6,318

 
6,124

 
12,225

 
11,810

Equity earnings in AmerisourceBergen
202

 
42

 
90

 
59

Operating income
1,980

 
1,479

 
3,302

 
2,926

 
 
 
 
 
 
 
 
Other income (expense)
9

 
(15
)
 
(128
)
 
(14
)
Earnings before interest and income tax provision
1,989

 
1,464

 
3,174

 
2,912

 
 
 
 
 
 
 
 
Interest expense, net
151

 
172

 
300

 
345

Earnings before income tax provision
1,838

 
1,292

 
2,874

 
2,567

Income tax provision
503

 
246

 
730

 
466

Post tax earnings from other equity method investments
14

 
16

 
27

 
28

Net earnings
1,349

 
1,062

 
2,171

 
2,129

Net earnings attributable to noncontrolling interests

 
2

 
1

 
15

Net earnings attributable to Walgreens Boots Alliance, Inc.
$
1,349

 
$
1,060

 
$
2,170

 
$
2,114

 
 
 
 
 
 
 
 
Net earnings per common share:
 

 
 

 
 

 
 

Basic
$
1.36

 
$
0.98

 
$
2.17

 
$
1.96

Diluted
$
1.36

 
$
0.98

 
$
2.16

 
$
1.94

 
 
 
 
 
 
 
 
Dividends declared per share
$
0.400

 
$
0.375

 
$
0.800

 
$
0.750

 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 

 
 

 
 

 
 

Basic
991.0

 
1,079.7

 
998.6

 
1,080.9

Diluted
995.5

 
1,085.5

 
1,003.3

 
1,086.9


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

- 6 -


WALGREENS BOOTS ALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
(in millions)
 
Three months ended
February 28,
 
Six months ended
February 28,
 
2018
 
2017
 
2018
 
2017
Comprehensive income:
 

 
 

 
 

 
 

Net earnings
$
1,349

 
$
1,062

 
$
2,171

 
$
2,129

 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax:
 

 
 

 
 
 
 

Pension/postretirement obligations
(2
)
 
5

 
(2
)
 
(4
)
Unrealized gain on cash flow hedges
1

 
1

 
1

 
2

Unrecognized loss on available-for-sale investments

 

 

 
(1
)
Share of other comprehensive loss of equity method investments

 
(4
)
 
2

 
(5
)
Currency translation adjustments
387

 
3

 
907

 
(852
)
Total other comprehensive income (loss)
386

 
5

 
908

 
(860
)
Total comprehensive income
1,735

 
1,067

 
3,079

 
1,269

 
 
 
 
 
 
 
 
Comprehensive income (loss) attributable to noncontrolling interests
6

 
5

 
21

 
(28
)
Comprehensive income attributable to Walgreens Boots Alliance, Inc.
$
1,729

 
$
1,062

 
$
3,058

 
$
1,297


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


- 7 -


WALGREENS BOOTS ALLIANCE, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in millions)
 
Six months ended February 28,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net earnings
$
2,171

 
$
2,129

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

 
 

Depreciation and amortization
858

 
831

Deferred income taxes
(474
)
 
(226
)
Stock compensation expense
63

 
52

Equity earnings from equity method investments
(117
)
 
(87
)
Other
87

 
184

Changes in operating assets and liabilities:
 

 
 

Accounts receivable, net
(637
)
 
189

Inventories
(314
)
 
(507
)
Other current assets
(66
)
 
17

Trade accounts payable
592

 
789

Accrued expenses and other liabilities
182

 
(309
)
Income taxes
903

 
154

Other non-current assets and liabilities
(72
)
 
166

Net cash provided by operating activities
3,176

 
3,382

 
 
 
 
Cash flows from investing activities:
 

 
 

Additions to property, plant and equipment
(666
)
 
(639
)
Proceeds from sale-leaseback transactions

 
436

Proceeds from sale of other assets
18

 
22

Business and intangible asset acquisitions, net of cash acquired
(3,375
)
 
(52
)
Other
(133
)
 
36

Net cash used for investing activities
(4,156
)
 
(197
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Net change in short-term debt with maturities of 3 months or less
836

 
76

Proceeds from debt
3,089



Payments of debt
(1,279
)
 
(9
)
Stock purchases
(2,525
)
 
(457
)
Proceeds related to employee stock plans
83

 
116

Cash dividends paid
(815
)
 
(817
)
Other
(5
)
 
(31
)
Net cash used for financing activities
(616
)
 
(1,122
)
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
44

 
(48
)
Changes in cash and cash equivalents:
 

 
 

Net decrease in cash and cash equivalents
(1,552
)
 
2,015

Cash and cash equivalents at beginning of period
3,301

 
9,807

Cash and cash equivalents at end of period
$
1,749

 
$
11,822


- 8 -



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

- 9 -


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 Financial Statements included herein are unaudited. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States (“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, 2017.

In the opinion of management, 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, strategic transactions including acquisitions, changes in laws, and general economic conditions in the markets in which the Company operates, and other factors on the Company’s operations and 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 profit 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 profit margins and gross profit dollars making the Company’s operations or net earnings for any period incomparable.

Note 2. Acquisitions
Acquisition of certain Rite Aid Corporation (Rite Aid) assets
On September 19, 2017, the Company announced that it had secured regulatory clearance for an amended and restated asset purchase agreement to purchase 1,932 stores, three distribution centers and related inventory from Rite Aid for $4.375 billion in cash and other consideration. The purchases of these stores have been accounted for as business combinations and occurred in waves during fiscal 2018. The Company purchased 1,445 stores for total cash consideration of $3.1 billion for the three months ended February 28, 2018 and 1,542 stores for total cash consideration of $3.3 billion for the six months ended February 28, 2018. From March 1, 2018 through the date of this report, the Company purchased the 390 remaining stores for total cash consideration of $820 million, which completed the purchase of stores pursuant to the amended and restated asset purchase agreement. The transition of the three distribution centers and related inventory is expected to begin during fiscal 2019 and remain subject to closing conditions set forth in the amended and restated asset purchase agreement.

As of February 28, 2018, 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 finalized. 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 purchases and the preliminary amounts of identified assets acquired and liabilities assumed as of the six months ended February 28, 2018.


- 10 -


Consideration
$
3,509

 
 
Identifiable assets acquired and liabilities assumed
 
Inventories
$
998

Property, plant and equipment
431

Intangible assets
1,624

Accrued expenses and other liabilities
(41
)
Deferred income taxes
3

Other non-current liabilities
(516
)
Total identifiable net assets
2,499

Goodwill
$
1,010


The preliminary identified definite-lived intangible assets were as follows:

Definite-lived intangible assets
Weighted-average useful life (in years)
Amount (in millions)
Customer relationships
12
$
1,463

Favorable lease interests
7
145

Trade names and trademarks
2
16

Total
 
$
1,624


Consideration includes cash of $3,336 million and the fair value of the option granted to Rite Aid to become a member of the Company’s group purchasing organization, Walgreens Boots Alliance Development GmbH. The fair value for the WBAD option was determined using the income approach methodology.  The fair value estimates are based on the market compensation for such services and appropriate discount rate, as relevant, that market participants would consider when estimating fair values.

The goodwill of $1,010 million arising from the business combinations primarily reflects the expected operational synergies and cost savings generated from the Store Optimization Program (discussed in note 3, exit and disposal activities, below) as well as the expected growth from new customers. The goodwill was allocated to the Retail Pharmacy USA segment. Substantially all of the goodwill recognized is expected to be deductible for income tax purposes.

The fair value for customer relationships was determined using the multi-period excess earnings method, a form of the income approach. Real property fair values were determined using primarily the income approach and sales comparison approach. The fair value measurements of the intangible assets are based on significant inputs not observable in the market, and thus represent Level 3 measurements. The fair value estimates for the intangible assets are based on projected discounted cash flows, historical and projected financial information, and attrition rates, as relevant, that market participants would consider when estimating fair values.

The following table presents supplemental unaudited condensed pro forma consolidated sales for the three and six months ended February 28, 2018 and 2017 as if all 1,932 stores acquired under the amended and restated asset purchase agreement had occurred on September 1, 2016. Pro forma net earnings of the Company, assuming these purchases had occurred at the beginning of each period presented, would not be materially different from the results reported. See note 3, exit and disposal activities, for additional disclosures. The unaudited condensed pro forma information has been prepared for comparative purposes only and is not intended to be indicative of what the Company’s results would have been had the purchases occurred at the beginning of the periods presented or results which may occur in the future.

 
Three months ended February 28,
 
Six months ended February 28,
(in millions)
2018
 
2017
 
2018
 
2017
Sales
$
34,567

 
$
31,928

 
$
67,693

 
$
62,882



- 11 -


Actual sales from the 1,542 Rite Aid stores acquired for the three and six months ended February 28, 2018 included in the Consolidated Statement of Earnings are as follows:

(in millions)
Three months ended February 28, 2018
 
Six months ended February 28, 2018
Sales
$
789
 
 
$
815
 

The 1,542 Rite Aid stores acquired did not have a material impact on net earnings of the Company for the three and six months ended February 28, 2018.

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 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 February 28, 2018, the Company had not completed the analysis to determine the fair value of the consideration acquired or to assign fair values to all tangible and intangible assets acquired, and therefore the purchase price allocation has not been finalized. 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 amounts of identified assets acquired and liabilities assumed at the date of the transaction (in millions).
Consideration
$
720

 
 
Identifiable assets acquired and liabilities assumed
 
Accounts receivable
$
217

Inventories
149

Property, plant and equipment
11

Intangible assets
331

Trade accounts payable
(90
)
Accrued expenses and other liabilities
(1
)
Total identifiable net assets
617

Goodwill
$
103


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 $103 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.

Note 3. Exit and disposal activities
On October 24, 2017, the Company’s Board of Directors approved a plan to implement a program (the “Store Optimization Program”) as part of an initiative to optimize store locations within the Company’s Retail Pharmacy USA segment upon completion of the acquisition of certain stores and related assets from Rite Aid. The Store Optimization Program includes plans to close approximately 600 stores and related assets across the U.S. The actions under the Store Optimization Program commenced in March 2018 and are expected to take place over an 18 month period.

- 12 -



The Company currently estimates that it will recognize cumulative pre-tax charges to its GAAP financial results of approximately $450 million, including costs associated with lease obligations and other real estate costs, employee severance and other exit costs. The Company expects to incur pre-tax charges of approximately $270 million for lease obligations and other real estate costs and approximately $180 million for employee severance and other exit costs. The Company estimates that substantially all of these cumulative pre-tax charges will result in future cash expenditures.

The Company did not incur any charges related to the Store Optimization Program for the three and six months ended February 28, 2018.

On April 8, 2015, the Walgreens Boots Alliance Board of Directors approved a plan to implement a 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 focused primarily on the Retail Pharmacy USA segment, but included activities from all segments. The Company completed the Cost Transformation Program in the fourth quarter of fiscal 2017.

The changes in accrued expenses and other liabilities related to the Cost Transformation Program for the six months ended February 28, 2018 include the following (in millions):
 
 
Real estate
costs
 
Severance and
other business
transition and
exit costs
 
Total
Balance at August 31, 2017
 
$
521

 
$
79

 
$
600

Payments
 
(79
)
 
(63
)
 
(142
)
Other - non cash
 
9

 

 
9

Balance at February 28, 2018
 
$
451

 
$
16

 
$
467


Restructuring costs by segment included in the three and six months ended February 28, 2017 are as follows (in millions):
Three Months Ended February 28, 2017
Retail Pharmacy USA
 
Retail Pharmacy International
 
Pharmaceutical Wholesale
 
Walgreens Boots Alliance, Inc.
Asset impairments
$
65

 
$
1

 
$
1

 
$
67

Real estate costs
240

 

 

 
240

Severance and other business transition and exit costs
11

 
18

 
4

 
33

Total restructuring costs
$
316

 
$
19

 
$
5

 
$
340


Six Months Ended February 28, 2017
Retail Pharmacy USA
 
Retail Pharmacy International
 
Pharmaceutical Wholesale
 
Walgreens Boots Alliance, Inc.
Asset impairments
$
111

 
$
3

 
$
1

 
$
115

Real estate costs
249

 

 

 
249

Severance and other business transition and exit costs
28

 
22

 
7

 
57

Total restructuring costs
$
388

 
$
25

 
$
8

 
$
421


Note 4. Operating leases
Initial terms for leased premises in the U.S. are 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.


- 13 -


The Company continuously evaluates its real estate portfolio in conjunction with its capital needs. Historically, the Company has entered into several sale-leaseback transactions. For the six months ended February 28, 2018, the Company did not record any proceeds from sale-leaseback transactions. For the six months ended February 28, 2017, the Company recorded proceeds from sale-leaseback transactions of $436 million.

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 six months ended February 28, 2018, the Company recorded charges of $28 million and $67 million for facilities that were closed. This compares to $247 million and $264 million for the three and six months ended February 28, 2017. These charges are reported in selling, general and administrative expenses in the Consolidated Condensed Statements of Earnings.

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 six months ended February 28, 2018
 
For the twelve months ended August 31, 2017
Balance at beginning of period
$
718

 
$
466

Provision for present value of non-cancellable lease payments on closed facilities
32

 
344

Changes in assumptions
(2
)
 
13

Accretion expense
37

 
37

Cash payments, net of sublease income
(109
)
 
(142
)
Balance at end of period
$
676

 
$
718


As of February 28, 2018, the Company remains secondarily liable on 72 leases. The maximum potential undiscounted future payments are $315 million as of February 28, 2018.

Note 5. Equity method investments
Equity method investments as of February 28, 2018 and August 31, 2017, are as follows (in millions, except percentages):
 
February 28, 2018
 
August 31, 2017
 
Carrying
value
 
Ownership
percentage
 
Carrying
value
 
Ownership
percentage
AmerisourceBergen
$
5,076

 
26%
 
$
5,024

 
26%
Others
1,355

 
8% - 50%
 
1,296

 
8% - 50%
Total
$
6,431

 
 
 
$
6,320

 
 

AmerisourceBergen investment
As of February 28, 2018 and August 31, 2017, the Company owned 56,854,867 AmerisourceBergen Corporation (“AmerisourceBergen”) common shares, representing approximately 26% of the outstanding AmerisourceBergen common stock. 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 are 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 February 28, 2018 is $5.4 billion.

As of February 28, 2018 the Company’s investment in AmerisourceBergen carrying value exceeded its proportionate share of the net assets of AmerisourceBergen by $4.3 billion. This premium of $4.3 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 (“Guangzhou Pharmaceuticals”) and Nanjing Pharmaceutical Corporation Limited, the Company’s pharmaceutical wholesale

- 14 -


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 $14 million and $16 million of post-tax equity earnings from equity method investments other than AmerisourceBergen for the three months ended February 28, 2018 and February 28, 2017, respectively. The Company reported $27 million and $28 million of post-tax equity earnings from equity method investments other than AmerisourceBergen for the six months ended February 28, 2018 and February 28, 2017, respectively. During the six month period ended February 28, 2018, the Company recorded an impairment of $170 million in its equity interest in Guangzhou Pharmaceuticals, which was included in other income (expense) in the Consolidated Condensed Statements of Earnings. The fair value of the Company’s equity interest in Guangzhou Pharmaceuticals was determined using the proposed sale price and thus represents Level 3 measurement.

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, 2017
$
9,139

 
$
3,392

 
$
3,101

 
$
15,632

Acquisitions
1,010

 

 

 
1,010

Currency translation adjustments

 
201

 
174

 
375

February 28, 2018
$
10,149

 
$
3,593

 
$
3,275

 
$
17,017


The carrying amount and accumulated amortization of intangible assets consist of the following (in millions):
 
February 28, 2018
 
August 31, 2017
Gross amortizable intangible assets
 
 
 
Customer relationships and loyalty card holders 1
$
4,036

 
$
2,510

Favorable lease interests and non-compete agreements
618

 
523

Trade names and trademarks
509

 
504

Purchasing and payer contracts
390

 
391

Total gross amortizable intangible assets
5,553

 
3,928

 
 
 
 
Accumulated amortization
 

 
 

Customer relationships and loyalty card holders 1
$
873

 
$
780

Favorable lease interests and non-compete agreements
338

 
355

Trade names and trademarks
182

 
155

Purchasing and payer contracts
64

 
51

Total accumulated amortization
1,457

 
1,341

Total amortizable intangible assets, net
$
4,096

 
$
2,587

 
 
 
 
Indefinite lived intangible assets
 

 
 

Trade names and trademarks
$
5,919

 
$
5,514

Pharmacy licenses
2,205

 
2,055

Total indefinite lived intangible assets
$
8,124

 
$
7,569

 
 
 
 
Total intangible assets, net
$
12,220

 
$
10,156


1 
Includes purchased prescription files.

Amortization expense for intangible assets was $121 million and $217 million for the three and six months ended February 28, 2018, respectively, and $94 million and $189 million for the three and six months ended February 28, 2017, respectively.


- 15 -


Estimated future annual amortization expense for the next five fiscal years for intangible assets recorded at February 28, 2018 is as follows (in millions):
 
2019
 
2020
 
2021
 
2022
 
2023
Estimated annual amortization expense
$
504

 
$
440

 
$
388

 
$
362

 
$
325


Note 7. Debt
Debt 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)
 
February 28, 2018
 
August 31, 2017
Short-term debt 1
 
 
 
Commercial paper
2,140

 

Credit facilities 2
449

 

$1 billion note issuance 3,4
 

 
 

5.250% unsecured notes due 2019 5
248

 

Other 6
303

 
251

Total short-term debt
3,140

 
251

 
 
 
 
Long-term debt 1
 

 
 

$6 billion note issuance 3,7
 

 
 

3.450% unsecured notes due 2026
1,888

 
1,887

4.650% unsecured notes due 2046
590

 
590

$8 billion note issuance 3,7
 

 
 

2.700% unsecured notes due 2019
1,247

 
1,246

3.300% unsecured notes due 2021
1,244

 
1,244

3.800% unsecured notes due 2024
1,989

 
1,988

4.500% unsecured notes due 2034
495

 
495

4.800% unsecured notes due 2044
1,492

 
1,492

£700 million note issuance 3,7
 

 
 

2.875% unsecured Pound sterling notes due 2020
551

 
513

3.600% unsecured Pound sterling notes due 2025
412

 
384

€750 million note issuance 3,7
 

 
 

2.125% unsecured Euro notes due 2026
911

 
884

$4 billion note issuance 3,4
 

 
 

3.100% unsecured notes due 2022
1,195

 
1,195

4.400% unsecured notes due 2042
492

 
492

$1 billion note issuance 3,4
 

 
 

5.250% unsecured notes due 2019 5

 
250

Other 8
26

 
24

Total long-term debt, less current portion
$
12,532

 
$
12,684


1 
Carry values are presented net of unamortized discount and debt issuance costs, where applicable, and foreign currency denominated borrowings have been translated using spot rates at February 28, 2018 and August 31, 2017, respectively.
2 
Credit facilities includes borrowings outstanding under the February 2017 Revolving Credit Agreement, the August 2017 Revolving Credit Agreement and the 2017 Term Loan Credit Agreement, which are described in more detail below.
3 
The $6 billion, $8 billion, £0.7 billion, €0.75 billion, $4 billion and $1 billion note issuances as of February 28, 2018 had fair values and carrying values of $2.4 billion and $2.5 billion$6.5 billion and $6.5 billion, $1.0 billion and $1.0 billion, $0.9 billion and $0.9 billion, $1.7 billion and $1.7 billion, and $0.3 billion and $0.2 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

- 16 -


February 28, 2018 spot rate, as applicable. The fair values and carrying values of these issuances do not include notes that have been redeemed or repaid as of February 28, 2018.
4 
Notes are senior debt obligations of Walgreen Co. and rank equally with all other unsecured and unsubordinated indebtedness of Walgreen Co. 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.
5 
Includes interest rate swap fair market value adjustments. See note 9, fair value measurements for additional fair value disclosures.
6 
Other short-term debt represents a mix of fixed and variable rate borrowings with various maturities and working capital facilities denominated in various currencies.
7 
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.
8 
Other long-term debt represents a mix of fixed and variable rate borrowings in various currencies with various maturities.

August 2017 Credit Agreements
On August 24, 2017, the Company entered into a $1.0 billion revolving credit agreement with the lenders from time to time party thereto (the “August 2017 Revolving Credit Agreement”) and a $1.0 billion term loan credit agreement with Sumitomo Mitsui Banking Corporation (the “2017 Term Loan Credit Agreement” and together with the August 2017 Revolving Credit Agreement, the “August 2017 Credit Agreements”).

The August 2017 Revolving Credit Agreement is an unsecured revolving credit facility with a facility termination date of the earlier of (a) January 31, 2019, subject to any extension thereof pursuant to the terms of the August 2017 Revolving Credit Agreement and (b) the date of termination in whole of the aggregate commitments provided by the lenders thereunder. The 2017 Term Loan Credit Agreement is an unsecured “multi-draw” term loan facility maturing on March 30, 2019. The aggregate commitments of Sumitomo Mitsui Banking Corporation under the 2017 Term Loan Credit Agreement are initially equal to $1.0 billion, which shall be reduced on June 1, 2018 to the lesser of $500 million and the aggregate remaining undrawn commitments thereunder. Any remaining undrawn commitments thereunder and the ability of the Company to request loans under such commitments shall terminate on September 1, 2018. As of February 28, 2018, Walgreens Boots Alliance had $400 million of borrowings outstanding under the 2017 Term Loan Credit Agreement and there were no borrowings outstanding under the August 2017 Revolving Credit Agreement.

February 2017 Revolving Credit Agreement
On February 1, 2017, the Company entered into a $1.0 billion revolving credit facility (as amended, the “February 2017 Revolving Credit Agreement”) with the lenders from time to time party thereto and, on August 1, 2017, the Company entered into an amendment agreement thereto. The terms and conditions of the February 2017 Revolving Credit Agreement were unchanged by the amendment other than the extension of the facility termination date to the earlier of (a) January 31, 2019 and (b) the date of termination in whole of the aggregate commitments provided by the lenders thereunder. As of February 28, 2018, there were $50 million of borrowings outstanding under the February 2017 Revolving Credit Agreement.

$6.0 billion note issuance
On June 1, 2016, Walgreens Boots Alliance received net proceeds of $6.0 billion from a public offering of five series of U.S. dollar notes with varying maturities and interest rates. 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 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. The 2026 notes and 2046 notes remain outstanding in accordance with their respective terms.

Debt covenants
Each of 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.

Commercial paper
The Company periodically borrows under its commercial paper program and may borrow under it in future periods. The Company had average daily short-term borrowings of $1.2 billion of commercial paper outstanding at a weighted average interest rate of 1.81% for the six months ended February 28, 2018. The Company had no activity under its commercial paper program for the six months ended February 28, 2017.


- 17 -


Interest
Interest paid was $281 million and $375 million for the six months ended February 28, 2018 and February 28, 2017, respectively.

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 February 28, 2018 and August 31, 2017 are as follows (in millions):
 
February 28, 2018
 
August 31, 2017
 
 
 
Notional 1
 
Fair value
 
Notional 1
 
Fair value
 
Location in Consolidated
Condensed Balance Sheets
Derivatives designated as hedges:
 
 
 
 
 
 
 
 
 
Interest rate swaps
$

 
$

 
$
250

 
$

 
Other non-current assets
Interest rate swaps
250

 
2

 

 

 
Other current liabilities
Foreign currency forwards

 

 
24

 

 
Other current assets
Derivatives not designated as hedges:
 
 
 
 
 
 
 
 
 
Foreign currency forwards
198

 
1

 
221

 

 
Other current assets
Foreign currency forwards
3,177

 
61

 
2,816

 
19

 
Other current liabilities

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. From time to time, the Company may use forward starting interest rate swaps to hedge interest rate exposure of some or all 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 an interest rate swap 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. The swap termination date coincides with the January 15, 2019 maturity date of the notes. This swap was designated as a fair value hedge.

The gains and losses due to changes in fair value on the swaps and on the hedged notes attributable to interest rate risk did not have a material impact on the Company’s Financial Statements. 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, debt).

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
February 28,
 
Six months ended
February 28,
 
Location in Consolidated Condensed
Statements of Earnings
 
2018
 
2017
 
2018
 
2017
Foreign currency forwards
Selling, general and administrative expenses
 
$
(164
)
 
$
(2
)
 
$
(183
)
 
$
47

Foreign currency forwards
Other income (expense)
 
(1
)
 
(15
)
 
33

 
(14
)

Derivatives credit risk

- 18 -


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):
 
February 28, 2018
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
Money market funds1
$
824

 
$
824

 
$

 
$

Available-for-sale investments2
1

 
1

 

 

Foreign currency forwards3
1

 

 
1

 

Liabilities:
 

 
 

 
 

 
 

Foreign currency forwards3
61

 

 
61

 

Interest rate swaps4
2

 

 
2

 

 
August 31, 2017
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
Money market funds1
$
2,096

 
$
2,096

 
$

 
$

Available-for-sale investments2
1

 
1

 

 

Liabilities:
 

 
 
 
 

 
 

Foreign currency forwards3
19

 

 
19

 



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 forward currency contracts are 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 six months ended February 28, 2018.

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, debt 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

- 19 -


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.

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.

As of August 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 Rite Aid 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

- 20 -


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 plaintiffs agreed to stay the litigation until after the Rite Aid Transactions closed. On March 17, 2017, plaintiffs moved to lift the stay to allow plaintiffs to file an amended complaint. On August 4, 2017, that motion was granted for the limited purpose of allowing plaintiffs to file a motion seeking leave to amend their complaint in light of the termination of the Merger Agreement. Plaintiffs filed such a motion on September 22, 2017. The Company filed its response on October 6, 2017. The Court granted the motion on November 27, 2017, ordering the plaintiffs to file their amended complaint within 10 business days. Plaintiffs filed their amended complaint on December 11, 2017. Pursuant to a briefing schedule set by the Court, the Company filed a motion to dismiss on February 16, 2018. Response briefs are due by April 17, 2018 and reply briefs by May 17, 2018.

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.

Note 11. Income taxes
The effective tax rate for the three and six months ended February 28, 2018 was 27.4% and 25.4% respectively, compared to 19.0% and 18.2% for the three and six months ended February 28, 2017. As further described below, the increase in the effective tax rate for the three and six months ended February 28, 2018 was significantly impacted by recording a provisional net discrete tax expense of $184 million, as a result of the U.S. tax law changes described below, which were enacted on December 22, 2017, and higher net discrete tax benefits in the prior year periods. In addition, the Company's results for the three and six months ended February 28, 2018 also include a net reduction to the Company’s estimated annual tax rate for the current year as a result of the U.S. tax law changes.

Income taxes paid for the six months ended February 28, 2018 were $301 million, compared to $537 million for the six months ended February 28, 2017.

U.S. tax law changes
The United States government enacted comprehensive tax legislation in December 2017. The accounting guidance on income taxes generally requires the effects of new tax legislation to be recognized in the period of enactment. The SEC issued Staff Accounting Bulletin 118 (“SAB 118”), which provides for a measurement period of up to one year from the enactment date for companies to complete their accounting for the U.S. tax law changes. In accordance with the SEC staff guidance, companies must reflect the income tax effects of those aspects of the U.S. tax law changes for which the accounting is complete. To the extent a company’s accounting for the income tax effect of certain provisions of the U.S. tax law changes is incomplete but the Company is able to determine a reasonable estimate, a provisional estimate must be recorded in the Company’s financial statements. If companies cannot determine a provisional estimate for the effects of an aspect of the U.S. tax law changes, they should continue applying the accounting guidance on income taxes on the basis of the provisions of the tax laws in effect immediately before the U.S. tax law changes were enacted.

The U.S. tax law changes include broad and complex changes affecting the Company’s fiscal 2018 results. Among other things, the U.S. tax law changes reduce the federal corporate tax rate from 35% to 21% effective January 1, 2018 and require companies to immediately accrue for and pay over an eight year period a one-time transition tax on certain un-repatriated earnings of foreign subsidiaries. The U.S. tax law changes also alter the taxation of foreign earnings, repeal of the deduction for domestic production activities and establish a global intangible low tax income (GILTI) regime, as well as base erosion anti-avoidance tax (BEAT).

In connection with the Company’s initial analysis of the impact of the U.S. tax law changes, which is provisional and subject to change, the Company recorded a net discrete tax expense of $184 million during the three and six months ended February 28, 2018. This provisional net discrete tax expense arises from the Company’s accrual for the transition tax of $794 million, partly offset by a benefit of $610 million from re-measuring the Company’s net U.S. deferred tax liabilities. The Company’s deferred tax assets and liabilities were re-measured at an estimated blended federal corporate tax rate of 25.7% for fiscal 2018 as a result of the reduction in the corporate tax rate and certain other of the U.S. tax law changes.

Based on the effective dates of certain aspects of the U.S. tax law changes as well as estimated data required to be used in the corresponding measurement calculations, the Company’s analysis of the income tax effects of the U.S. tax law changes could not be finalized as of February 28, 2018.

- 21 -



As of February 28, 2018, while the Company made reasonable estimates of the impact of the transition tax and the remeasurement of its deferred tax assets and liabilities, the final impact of the U.S. tax law changes may differ from these estimates, due to, among other things, changes in its interpretations and assumptions, additional guidance and actions the Company may take. The Company expects to finalize such provisional amounts within the time period prescribed by SAB 118. The U.S. tax law changes created new rules that allow the Company to make an accounting policy election to either treat taxes due on future Global Intangible Low Tax Income (“GILTI”) inclusions in taxable income as either a current period expense or reflect such inclusions related to temporary basis differences in the Company’s measurement of deferred taxes. The Company’s analysis of the new GILTI rules is not complete; therefore, the Company has not made a policy election regarding the tax accounting treatment of the GILTI tax.

The U.S. tax law changes have the potential to change the Company’s assertions with respect to whether earnings of the Company’s foreign subsidiaries should remain indefinitely reinvested. The Company continues to evaluate these changes, therefore, the Company has not made any changes to its indefinite reinvestment assertions.

Note 12. Retirement benefits
The Company sponsors several retirement plans, including defined benefit plans, defined contribution plans and a postretirement health plan.

Defined benefit pension plans (non-U.S. plans)
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
February 28,
 
Six months ended
February 28,
 
2018
 
2017
 
2018
 
2017
Service costs
$
1

 
$

 
$
3

 
$
2

Interest costs
49

 
43

 
96

 
86

Expected returns on plan assets
(53
)
 
(36
)
 
(104
)
 
(73
)
Curtailments

 
2

 

 
2

Total net periodic pension costs
$
(3
)
 
$
9

 
$
(5
)
 
$
17


The Company made cash contributions to its defined benefit pension plans of $11 million for the six months ended February 28, 2018, which primarily related to committed funded payments. The Company plans to contribute an additional $51 million to its defined benefit pension plans in fiscal 2018.

Defined contribution plans
The principal retirement plan for U.S. employees is the Walgreen Profit-Sharing Retirement Trust, 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 $55 million and $111 million for the three and six months ended February 28, 2018 compared to an expense of $49 million and $106 million in the three and six months ended February 28, 2017.

The Company also has certain contract based defined contribution arrangements. The principal one is the Alliance Healthcare & Boots Retirement Savings Plan, which is United Kingdom based and to which both the Company and participating employees contribute. The cost recognized in the Consolidated Condensed Statements of Earnings for the three and six months ended February 28, 2018 was $31 million and $61 million compared to a cost of $28 million and $56 million in the three and six months ended February 28, 2017.

Note 13. Earnings per share

- 22 -


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 10.6 million outstanding options to purchase common shares that were anti-dilutive and excluded from the second quarter earnings per share calculation as of February 28, 2018 compared to 6.7 million as of February 28, 2017. Anti-dilutive shares excluded from the year to date earnings per share calculation were 9.1 million for the period ended February 28, 2018 compared to 5.4 million for the period ended February 28, 2017.

Note 14. 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
February 28,
 
Six months ended
February 28,
 
2018
 
2017
 
2018
 
2017
Depreciation expense
$
347

 
$
332

 
$
682

 
$
666

Intangible asset and other amortization
95

 
81

 
176

 
165

Total depreciation and amortization expense
$
442

 
$
413

 
$
858

 
$
831


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 six months ended February 28, 2018 and February 28, 2017 (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 November 30, 2017
$
(139
)
 
$

 
$
(33
)
 
$

 
$
(2,371
)
 
$
(2,543
)
Other comprehensive income (loss) before reclassification adjustments

 

 

 
1

 
381

 
382

Amounts reclassified from accumulated OCI
(3
)
 

 
1

 

 

 
(2
)
Tax benefit (provision)
1

 

 

 
(1
)
 

 

Net other comprehensive income (loss)
(2
)
 

 
1

 

 
381

 
380

Balance at February 28, 2018
$
(141
)
 
$

 
$
(32
)
 
$

 
$
(1,990
)
 
$
(2,163
)
 
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, 2017
$
(139
)
 
$

 
$
(33
)
 
$
(2
)
 
$
(2,877
)
 
$
(3,051
)
Other comprehensive income (loss) before reclassification adjustments
(1
)
 

 

 
4

 
887

 
890

Amounts reclassified from accumulated OCI
(3
)
 

 
2

 

 

 
(1
)
Tax benefit (provision)
2

 

 
(1
)
 
(2
)
 

 
(1
)
Net other comprehensive income (loss)
(2
)
 

 
1

 
2

 
887

 
888

Balance at February 28, 2018
$
(141
)
 
$

 
$
(32
)
 
$

 
$
(1,990
)
 
$
(2,163
)


- 23 -


 
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 November 30, 2016
$
(221
)
 
$
1

 
$
(36
)
 
$
(2
)
 
$
(3,552
)
 
$
(3,810
)
Other comprehensive income (loss) before reclassification adjustments
6

 

 

 
(7
)
 
(1
)
 
(2
)
Amounts reclassified from accumulated OCI

 

 
1

 

 

 
1

Tax benefit (provision)
(1
)
 

 

 
3

 

 
2

Net other comprehensive income (loss)
5

 

 
1

 
(4
)
 
(1
)
 
1

Balance at February 28, 2017
$
(216
)
 
$
1

 
$
(35
)
 
$
(6
)
 
$
(3,553
)
 
$
(3,809
)

 
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
(5
)
 
(1
)
 

 
(8
)
 
(809
)
 
(823
)
Amounts reclassified from accumulated OCI

 

 
3

 

 

 
3

Tax benefit (provision)
1

 

 
(1
)
 
3

 

 
3

Net other comprehensive income (loss)
(4
)
 
(1
)
 
2

 
(5
)
 
(809
)
 
(817
)
Balance at February 28, 2017
$
(216
)
 
$
1

 
$
(35
)
 
$
(6
)
 
$
(3,553
)
 
$
(3,809
)

Note 16. Segment reporting
The Company has aligned its operations into 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 the Walgreens business, which includes the operation of retail drugstores and convenient care clinics; and operation of mail and central specialty pharmacy services. Sales for the segment are principally derived from the sale of prescription drugs and a wide assortment of retail products, including health and wellness, beauty, personal care and consumables and general merchandise.

The Retail Pharmacy International segment consists of pharmacy-led health and beauty retail businesses and optical practices. These businesses include Boots branded stores in the United Kingdom, Thailand, Norway, the Republic of Ireland and the Netherlands; Benavides in Mexico and Ahumada in Chile. Sales for the segment are principally derived from the sale of prescription drugs and health and wellness, beauty, personal care and other consumer products.

The Pharmaceutical Wholesale segment consists of the Alliance Healthcare pharmaceutical wholesaling and distribution businesses and an equity method investment in AmerisourceBergen. Wholesale operations are located in the United Kingdom, Germany, France, 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,

- 24 -


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

The results of operations for each reportable segment include procurement benefits and an allocation of corporate-related overhead costs. The “Eliminations” column contains items not allocable to the reportable segments, as the information is not utilized by the chief operating decision maker to assess segment performance and allocate resources.

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 February 28, 2018
 
 
 
 
 
 
 
 
 
Sales to external customers
$
24,478

 
$
3,317

 
$
5,226

 
$

 
$
33,021

Intersegment sales

 

 
529

 
(529
)
 

Sales
$
24,478

 
$
3,317

 
$
5,755

 
$
(529
)
 
$
33,021

 
 
 
 
 
 
 
 
 
 
Adjusted operating income
$
1,649

 
$
280

 
$
231