Financial Instruments

6 Months Ended

Feb. 28, 2015

Financial Instruments [Abstract]

Financial Instruments

10. Financial Instruments

The Company uses derivative instruments to manage its exposure to interest rate and foreign currency exchange risks.  As a result of the Second Step Transaction, the Company acquired all the derivative instruments held by Alliance Boots at their acquisition date fair values.

The notional amounts, fair value and balance sheet presentation of derivative instruments outstanding as of February 28, 2015, excluding warrants which are presented separately in this footnote, were as follows (in millions):

	Notional(1)		Fair Value		Location in Consolidated Condensed Balance Sheets
Derivatives designated as fair value hedges:
Interest rate swaps	$	1,000	$	22	Other non-current assets
Derivatives designated as cash flow hedges:
Basis swap		71		6	Other current assets
Derivatives not designated as hedges:
Interest rate swaps		1,542		-	Other current assets
Interest rate caps		3,879		-	Other current assets
Foreign currency forwards		2,037		60	Other current assets
Foreign currency forwards		104		7	Other current liabilities

⁽¹⁾ Amounts in U.S. dollar equivalents, where appropriate.

The notional amounts, fair value and balance sheet presentation of derivative instruments outstanding as of August 31, 2014, excluding warrants which are presented separately in this footnote, are as follows (in millions):

	Notional		Fair Value		Location in Consolidated Condensed Balance Sheets
Derivatives designated as fair value hedges:
Interest rate swaps	$	1,000	$	16	Other non-current assets
Derivatives designated as cash flow hedges:
Forward interest rate swaps		1,500		44	Other non-current liabilities

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

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-US 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 entered into a series of interest rate swaps, converting $750 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 and an interest rate swap converting $250 million of its 5.250% fixed rate notes to a floating interest rate based on the one-month LIBOR in arrears plus a constant spread. All swap termination dates coincide with the notes maturity date, January 15, 2019. These swaps were designated as fair value hedges.

The gains and losses due to changes in fair value on the swaps and on the hedged notes attributable to interest rate risk were recognized as follows (in millions):

	Location in Consolidated Condensed Statements of Earnings	Three Months Ended February 28,						Six Months Ended February 28,
			2015			2014			2015			2014
Interest rate swaps	Interest expense, net	$	4		$	(6	)	$	(6	)	$	(17	)
Notes	Interest expense, net		(4	)		6			6			18

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 short-term and long-term debt on the Consolidated Condensed Balance Sheets (see Note 9, Short-Term Borrowings and Long-Term Debt). At February 28, 2015 and August 31, 2014, the cumulative fair value adjustments resulted in an increase in long-term debt of $18 million and $12 million, respectively. No material gains or losses were recorded from ineffectiveness during the three and six month periods ended February 28, 2015 or during the three and six month periods ended February 28, 2014.

Cash Flow Hedges

In fiscal 2014, the Company entered into a series of forward starting interest rate swap transactions locking in the then current three-month LIBOR interest rate on $1.5 billion of the then anticipated issuance of debt, with expected maturity tenures of 10 and 30 years. The swap transactions were designated as cash flow hedges of the variability in the expected cash outflows of interest payments on the then forecasted debt due to changes in the benchmark interest rates. In November 2014, in conjunction with the issuance of the $2.0 billion notes maturing in fiscal 2024 and the $1.5 billion notes maturing in fiscal 2044, the Company terminated these forward starting interest rate swaps, locking in the effective yields on the related debt. Cash of $45 million was paid to settle the 10-year swap and cash of $18 million was paid to settle the 30-year swap in November 2014. The changes in fair value of the swaps until their termination were included in other comprehensive income, and any ineffectiveness was recorded directly to interest expense in the Consolidated Condensed Statements of Earnings. The cumulative changes included in other comprehensive income will be amortized into earnings in the same periods during which interest expense on the identified debt is recognized.

As a result of the Second Step Transaction, the Company assumed $9.0 billion of Alliance Boots existing debt, a portion of which was hedged using interest rate swaps and interest rate caps. In January 2015, the Company repaid substantially all of the assumed debt and simultaneously terminated swaps converting £1.0 billion of outstanding debt from floating to fixed rates with no material gain or loss recognized. At February 28, 2015, £1.0 billion of floating to fixed rate swaps with no material fair value remain outstanding. The swaps mature in July 2015 and are not designated as hedging instruments. Interest rate caps with notional principal amounts of £1.5 billion and €2.0 billion to protect the Company from rising interest rates on the corresponding amounts of assumed Alliance Boots existing debt were in place on completion of the Second Step Transaction. In January 2015, interest rate caps with an aggregate notional principal of €600 million were terminated with no material gain or loss recognized. The remaining caps mature in July 2015, have no material fair value and are not designated as hedging instruments.

There were no material gains and losses due to the change in fair value of derivatives designated as cash flow hedges recognized in other comprehensive income during the three and six month periods ended February 28, 2015 and 2014.

In addition, the Company acquired a basis swap held by Alliance Boots which is designated as a hedge of future contracted interest payments on Unidades de Fomento ("UF") denominated bonds in Chile. The basis swap matures in May 2015.

No portion of the derivatives designated as cash flow hedges was excluded from hedge assessment. No material gains or losses were recorded in earnings from ineffectiveness during the three and six month periods ended February 28, 2015 or during the three and six month periods ended February 28, 2014.

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 interest rate and 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):

	Location in Consolidated Condensed Statements of Earnings	Three Months Ended February 28, 2015			Six Months Ended February 28, 2015
Interest rate swaps	Interest expense, net	$	(1	)	$	(1	)
Foreign currency forwards	Selling, general and administrative expense	$	(28	)	$	(28	)
Second Step Transaction foreign currency forwards	Other income (expense)	$	(70	)	$	(166	)

Warrants

As discussed in Note 2, Basis of Presentation, the Company holds (a) a warrant to purchase up to 22,696,912 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 22,696,912 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 warrants issued to Alliance Boots were acquired by the Company as part of the Second Step Transaction.

The Company reports its warrants at fair value. The fair value and balance sheet presentation of warrants was as follows (in millions):

	Location in Consolidated Condensed Balance Sheets	February 28, 2015		August 31, 2014
Asset derivatives not designated as hedges:
Warrants	Other non-current assets	$	2,231	$	553

The gains and losses due to changes in fair value of the warrants recognized in earnings were as follows (in millions):

	Location in Consolidated Condensed Statements of Earnings	Three Months  Ended February 28,					Six Months Ended February 28,
		2015		2014			2015		2014
Warrants	Other income (expense)	$	559	$	(64	)	$	849	$	156

Derivatives Credit Risk

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

Derivatives Offsetting

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