Walgreens 2013 Annual Report Download - page 43

The notional amounts of derivative instruments outstanding at August 31, 2013 and
2012, were as follows (In millions) :
2013 2012
Derivatives designated as hedges:
Interest rate swaps $ 1,000 $ 1,800
Forward interest rate swaps — 1,000
The changes in fair value of the notes attributable to the hedged risk are included in
long-term debt on the Consolidated Balance Sheets (see Note 9) and amortized
through maturity. At August 31, 2013, the Company had a net unamortized asset fair
value change of $3 million compared to a $40 million liability at August 31, 2012.
Changes in fair value of the cash flow hedges are included in other comprehensive
income, with any ineffectiveness recorded directly to interest expense. Upon termina-
tion of the cash flow hedges, cumulative changes included in other comprehensive
income will be amortized with the debt’s cash flow. No material fair value changes or
ineffectiveness was recorded through other comprehensive income in fiscal 2013.
The fair value and balance sheet presentation of derivative instruments at August 31,
2013, were as follows (In millions) :
Location in
Consolidated Balance Sheets 2013 2012
Asset derivatives designated as hedges:
Interest rate swaps Other current assets $ — $ 24
Forward interest rate swaps Other non-current assets — —
Interest rate swaps Other non-current assets 1 39
Gains and losses relating to the ineffectiveness of the Company’s derivative
instruments are recorded in interest expense on the Consolidated Statements of
Comprehensive Income. The Company recorded a $4 million loss in fiscal 2013
and a $2 million gain in fiscal 2012 due to ineffectiveness.
Warrants
The Company, Alliance Boots and AmerisourceBergen Corporation entered into a
Framework Agreement dated as of March 18, 2013, pursuant to which (1) Walgreens
and Alliance Boots together were granted the right to purchase a minority equity position
in AmerisourceBergen, beginning with the right, but not the obligation, to purchase up
to 19,859,795 shares of AmerisourceBergen common stock (approximately 7 percent
of the then fully diluted equity of AmerisourceBergen, assuming the exercise in full of
the warrants described below) in open market transactions; (2) the Company and
Alliance Boots were each issued (a) a warrant to purchase up to 11,348,456 shares of
AmerisourceBergen common stock at an exercise price of $51.50 per share exercisable
during a six-month period beginning in March 2016, and (b) a warrant to purchase up
to 11,348,456 shares of AmerisourceBergen common stock at an exercise price of
$52.50 per share exercisable during a six-month period beginning in March 2017.
The parties and affiliated entities also entered into certain related agreements governing
relations between and among the parties thereto, including the Shareholders
Agreement, the Transaction Rights Agreement and the Limited Liability Company
Agreement of WAB Holdings LLC, a newly formed limited liability company jointly owned
by the Company and Alliance Boots for the purpose of acquiring and holding
AmerisourceBergen common stock, described in the Company’s Current Report
on Form 8-K filed on March 20, 2013.
The Company reports its warrants at fair value. See Note 11 for additional fair value
measurement disclosures. The fair value and balance sheet presentation of derivative
instruments not designated as hedges at August 31, 2013, was as follows (In millions):
Location in August 31,
Consolidated Balance Sheets 2013
Asset derivatives designated as hedges:
Warrants Other non-current assets $ 188
11. Fair Value Measurements
The Company measures certain assets and liabilities in accordance with ASC Topic
820, Fair Value Measurements and Disclosures. ASC Topic 820 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 unob-
servable 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 were as follows
(In millions):
August 31, 2013 Level 1 Level 2 Level 3
Assets:
Money market funds $ 1,636 $ 1,636 $ — $ —
Interest rate swaps (1) 1 — 1 —
Investment in AmerisourceBergen (2) 225 225 — —
Warrants (3) 188 — 188 —
Forward interest rate swaps — — — —
August 31, 2012 Level 1 Level 2 Level 3
Assets:
Money market funds $ 820 $ 820 $ — $ —
Interest rate swaps (1) 63 — 63 —
Forward interest rate swaps — — — —
(1) Interest rate swaps are valued using the six-month and one-month LIBOR in arrears
rates. See Note 10 for additional disclosure regarding financial instruments.
(2) The investment in AmerisourceBergen Corporation is valued using the closing stock price
of AmerisourceBergen as of August 31, 2013. See Note 6 for additional disclosures on
available-for-sale investments.
(3) Warrants were valued using a Monte Carlo simulation. Key assumptions used in the valuation
include risk-free interest rates using constant maturity treasury rates; the dividend yield
for AmerisourceBergen’s common stock; AmerisourceBergen’s common stock price at valuation
date; AmerisourceBergen’s equity volatility; the number of shares of AmerisourceBergen’s
common stock outstanding; the number of AmerisourceBergen employee stock options
and the exercise price; and the details specific to the warrants.
Assets measured at fair value on a nonrecurring basis were as follows (In millions):
August 31, 2013 Level 1 Level 2 Level 3
Assets:
Alliance Boots call option $ 839 — — $ 839
The call option was valued using a Monte Carlo simulation using assumptions
surrounding Walgreens equity value as well as the potential impacts of certain
provisions of the Purchase and Option Agreement dated June 18, 2012, by and
among the Company, Alliance Boots and AB Acquisitions Holdings Limited.
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. See Note 9 for
further details.
12. Commitments and Contingencies
The Company is involved in legal proceedings and is subject to investigations, inspec-
tions, audits, inquiries and similar actions by governmental authorities, arising in the
normal course of the Company’s business, including the matters described below.
Litigation, 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 contin-
gencies, 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
2013 Walgreens Annual Report 41