(Solved Homework): Case 2.3 Walgreens Co. and Subsidiaries…

Case 2.3 Walgreens Co. and Subsidiaries

The following excerpts are from the 2013 Walgreen Co. Form 10-K:

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CONSOLIDATED BALANCE SHEETS

Walgreens Co. and Subsidiaries at August 31,2013 and 2012

(in millions, except shares and per share amounts)

2012

2013

Assets

Current Assests

$2,106

$1,297

Cash and cash equivalents

$2,632

$2,167

Accounts Rec, net

$6,852

$7,036

Inventories

$284

$260

Other current assets

$11,874

$10,760

Total Current Assets

Noncurrent Assets

Property & equipment, at cost,less accumulated deprec & amortization

$12,138

$12,038

Equity investment in Alliance Boots

$2,410

$2,161

Alliance Boots call option

$6,261

$6,140

Goodwill

$839

$866

Other noncurrent assets

$1,959

$1,497

Total Assets

$23,607

$22,702

$35,481

$33,462

Liabilities and Shareholders’ Equity

Current Liabilities

Short-term borrowings

$570

$1,319

Trade accounts payable

$4,635

$4,384

Accrued expenses and other liabilities

$3,577

$3,019

Income Taxes

$101

Total Current Liabilites

$8,883

$8,722

Noncurrent liabilites

Long-term debt

$4,477

$4,073

Deferred income taxes

$600

$545

Other noncurrent liabilities

$2,067

$1,866

Total noncurrent liabilites

$7,144

$6,504

Commitments and contingencies(see note)

Shareholders’ Equity

Preferred stock, $.0625 per value; authorized 32 million shares;

issued 1,028,180,150 shares in 2013 and 2012

$80

Paid-in capital

$1,074

$936

Employee stock loan recievable

($11)

($19)

Retained Earnings

$21,523

$20,156

Accumulated other comprehensive (loss) income

($98)

$68

Treasury Stock at cost, 81,584,572 shares in 2013 and

84,124,816 shares in 2012

($3,114)

($2,985)

Total Shareholders’ Equity

$19,454

$18,236

Total Liabilites and Shareholder’s Equity

$35,481

$33,462

The accompanying Notes to Consolidated Financial Statements are integral parts of these statments.

Notes to Consolidated financial Statements

1.Summary of Major Accounting Policies

Description of Business

The company is principally in the retail drugstore business and its operations are within one reportable segment. At August 31,2013 there was 8,582 drugstore and other locations in 50 states, the District of Columbia, Guam, and Puerto Rico. Prescription sales were 62.9% of total sales for fiscal 2013 compared to 63.2% in 2012 and 64.7% in 2011.

Allowance for Doubtful Accounts

The provision for bad debt is based on both historical write-off percentages and specifically identified receivables. Activity in the allowance for doubtful accounts was as follows (In millions):

	2013	2012	2011
Balance at beginning of year	$99	$101	$104
Bad debt provision	$124	$107	$88
Write-offs	($69)	($109)	($91)
Balance at end of year	$154	$99	$101

Inventories

Inventories are valued on a lower of last-in, first-out (LIFO) cost or market basis. At August 31, 2013 and 2012, inventories would have been greater by $2.1 billion and $1.9 billion, respectively, if they had been valued on a lower of first-in, first-out (FIFO) cost or market basis. As a result of declining inventory levels, the fiscal 2013 and 2012 LIFO provisions were reduced by $194 million and $268 million of LIFO liquidation, respectively. Inventory includes product costs, inbound freight, warehousing costs, and vendor allowances not classified as a reduction of advertising expense.

3.Leases

The company owns 20.2% of its operating locations; the remaining locations are leased premises. Initial terms are typically 20 to 25 years, followed by additional terms containing renewal options at five-year intervals, and may include rent escalation clauses. 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 to 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.

Minimum rental commitments at August 31, 2013, under all leases having an initial or remaining non-cancelable term of more than one year are shown below (in Millions):

	Capital Lease	Operatin Lease
2014	$19	$2,536
2015	$19	$2,514
2016	$18	$2,464
2017	$17	$2,389
2018	$15	$2,292
Later	$270	$23,507
Total Minimum lease Payments	$358	$35,702

The capital lease amoutn includes $155 million of imputed interest and executory costs. Total minimum lease payments have not been reduced by minimum sublease rentals of approximately $140 million on leases due in the future under non-cancelable subleases.

The Company remains secondarily liable on 26 assigned leases. The maiximum potential undiscounted future payments are $18 million at August 31, 2013. Lease option dates vary, with some extending to 2041.

WALGREEN CO. INFORMATION FROM CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME
For the Years Ended August 31,2013 and 2012 (in millions)
	2013	2012
Sales	$72,217	$71,633
Net Income	$2,450	$2,127

Required:

a. Using the consolidated balance sheets for Walgreen Co. for August 31,2013 and 2012, prepare a common-size balance sheet.

b. Which current asset is the most significant? Which noncurrent asset is the most significant? Are the relative proportions of current and noncurrent assets what you would expect for a drug store?

c. Analyze accounts recievable and allowance for doubtful accounts.

d. What inventory is used to value inventories? Has Walgreen experienced inflation or deflation? Explain your answer. Explain the reference in the inventory note to the LIFO liquidation and what this means with regard to net income reported.

e. Assess the level of debt and risk that Walgreen has by looking only at the balnce sheet.

f. Estimate the dollar amount of dividends Walgreens paid in 2013.

g. Does Walgreen use off-balance sheet fiancing? Explain your answer.

h. Evaluate the creidtworthiness of Walgreen based on the Balance sheet and the excerpts from the notes.

Expert Answer

CONSOLIDATED BALANCE SHEETS
Walgreens Co. and Subsidiaries at August 31,2013 and 2012
(in millions, except shares and per share amounts)	ANSWER to a.
	2012	% to Total	2013	% to Total
Assets
Current Assests	2106	5.94%	1297	3.88%
Cash and cash equivalents	2632	7.42%	2167	6.48%
Accounts Rec, net	6852	19.31%	7036	21.03%
Inventories	284	0.80%	260	0.78%
Other current assets
Total Current Assets	11874	33.47%	10760	32.16%
Noncurrent Assets
Property & equipment, at cost,less accumulated deprec & amortn.	12138	34.21%	12038	35.98%
Equity investment in Alliance Boots	2410	6.79%	2161	6.46%
Alliance Boots call option	6261	17.65%	6140	18.35%
Goodwill	839	2.36%	866	2.59%
Other noncurrent assets	1959	5.52%	1497	4.47%
Total Assets	23607	66.53%	22702	67.84%
	35481	100.00%	33462	100.00%
Liabilities and Shareholders’ Equity
Current Liabilities
Short-term borrowings	570	1.61%	1319	3.94%
Trade accounts payable	4635	13.06%	4384	13.10%
Accrued expenses and other liabilities	3577	10.08%	3019	9.02%
Income Taxes	101	0.28%		0.00%
Total Current Liabilites	8883	25.04%	8722	26.07%
Noncurrent liabilites
Long-term debt	4477	12.62%	4073	12.17%
Deferred income taxes	600	1.69%	545	1.63%
Other noncurrent liabilities	2067	5.83%	1866	5.58%
Total noncurrent liabilites	7144	20.13%	6504	19.44%
Commitments and contingencies(see note)
Shareholders’ Equity
Preferred stock, $.0625 per value; authorized 32 million shares;
issued 1,028,180,150 shares in 2013 and 2012	80	0.23%	80	0.24%
Paid-in capital	1074	3.03%	936	2.80%
Employee stock loan recievable	-11	-0.03%	-19	-0.06%
Retained Earnings	21523	60.66%	20156	60.24%
Accumulated other comprehensive (loss) income	-98	-0.28%	68	0.20%
Treasury Stock at cost, 81,584,572 shares in 2013 and
84,124,816 shares in 2012	-3114	-8.78%	-2985	-8.92%
Total Shareholders’ Equity	19454	54.83%	18236	54.50%
Total Liabilites and Shareholder’s Equity	35481	100.00%	33462	100.00%

b.
Most significant
Current asset —- Accounts Receivables
Non-current asset—- Property & equipment, at cost,less accumulated deprec & amortn.
Ratio of Current to Non-Current assets —– 2012 =11874/23607=50.30% & 2013—-10760/22702=47.40%
Proportion of Non-current asset is too large for a retail drug store,which need no large investments in fixed assets (which can be the case for a manufacturing company)


e. On an average 12% outside long-term debt in both years ,compared to 54% of equity participation —- augurs well –with a debt/equity ratio of 12/54= 22% (approx.)


f.
Retained Earnings Ledger account
Fiscal 2013	Debit	Credit
Opening Balance		21523
2013 Net Income		2450
Dividends paid(Plug-in Fig.)	3817
Closing Balance	20156
	23973	23973

So, dollar amount of dividends Walgreens paid in 2013

3817

d. Inventories are valued on a lower of last-in, first-out (LIFO) cost or market basis.

The statement in the Notes ,

“At August 31, 2013 and 2012, inventories would have been greater by $2.1 billion and $1.9 billion, respectively, if they had been valued on a lower of first-in, first-out (FIFO) cost or market basis” implies that older (FIFO) prices are greater than the Current LIFO prices.

So, Walgreen experienced deflation or decrease in inventory price levels.

LIFO liquidation is said to occur when a company, using LIFO inventory valuation method, sells its old stock of inventory–ie. When using LIFO method ,it sells or issues,for more than it purchases.

This gives a highly distorted or inflated net operating income resulting in higher tax bill in the current period. When LIFO inventory is liquidated, the older costs are matched with the current revenues and thus the financial statements show a higher margin/income,thereby causing a higher tax liability,especially in inflationary periods.

Off-balance sheet financing means that a company incurs but does not include the same as a liability on its balance sheet

It influences the company’s level of debt and liability.

The existence of operating & capital leases as seen in the Notes to the statements ,are off-balance sheet items

The company is recording only the lease rentals, which is significantly lower than any on account purchase , resulting in a balance sheet without any liability

h. Evaluating the creidtworthiness of Walgreen based on the Balance sheet
1. Current Ratio= Current Assets/Current Liabilities	2012	2013
Current assets	11874	10760
Current Liabilities	8883	8722
Current Ratio= Current Assets/Current Liabilities	1.34	1.23

By comparing the ratio of current assets to current liabilities,the potential lender can assess the liquidity of the company as well as its ability to meet the short-term obligations.As current assets ,normally can be converted to cash within one year so as to the current liabilities or obligations that become payable within one year.
Normally a ratio of 2:1 is acceptable .
Walgreens current ratio is well below the norm in both the years & has also decreased in 2013


2. Quick Ratio=( Current Assets-Inventory)/Current Liabilities	2012	2013
Quick assets	11590	10500
Current Liabilities	8883	8722
Quick Ratio=( Current Assets-Inventory)/Current Liabilities	1.30	1.20

Another measure of ready & immediate liquidity, without having to wait to sell inventory.
Normally a ratio of 1:1 is acceptable .
Walgreens Quick ratio is well above the norm in both the years, thanks to its receivables position.
Read along with receivables turn-over(as done below) , shows a strong short-term liquidity.


3. Debt-to-Equity Ratio
The debt-to-equity ratio compares non-trade liabilities with the owner’s total equity. This shows how much of the company is financed by debt when compared to that by equity. Increasing ratios over time ,indicates increasing risk, as with taking on too much debt. This ratio is a very good indicator of the solvency of a company and its ability to continue operations in the long run.
	2012	2013
Long-term debt	4477	4073
Total Shareholders’ Equity	19454	18236
Debt/Equity	23%	22%

Less than 25% participation of debt in both the years indicate low level of interest expenses and reasonable long-term commitments

4. Receivables turnover
365/(Credit Sales/Accounts Receivables)
	2012	2013
Sales	71633	72217
Accounts Rec, net	6852	7036
Receivables turnover in days.	35	36

Walgreens is very regular in collecting trade-receivables.


5. Total Assets to Total Outside Liabilities	2012	2013
Total assets	35481	33462
Total Outside Liabilities(Total of liabilities side-Total Equity)	16027	15226
Total Assets to Total Outside Liabilities	2.21	2.20

A ratio over 2 indicates that the company is meeting all its liabilities/outside obligations very well and has enough assets as cushion that can produce adequate income to cover debts and earn profits


But for current ratio, all other ratios point to a credit-worthy Walgreens.

c.
Allowance for doubtful account
	Debit 2012 Credit			Debit 2013 Credit
Op.bal.		101	Op.bal.		99
New provn		107	New provn		124
Write-offs	109		Write-offs	69
Cl.bal	99		Cl.bal	154

Accounts Rec, Gross (Net+Cl. Bal.)6852+99	6951		Accounts Rec, Gross (Net+Cl.bal.)7036+154	7190
New prov. % 107/6951=		1.54%	New prov. % 124/7190=		1.72%
Write-off % 109/6951=		1.57%	Write-off % 69/7190=		0.96%


Sales		71633	Sales		72217
Gross A/cs/Rec./ Sales		9.70%	Gross A/cs/Rec./ Sales		9.96%
6951/71633=			7190/72217=

(Solved Homework): Case 2.3 Walgreens Co. and Subsidiaries…

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