Walgreens Boots Alliance, Inc. (NASDAQ:WBA) Q1 2024 Earnings Call Transcript

Walgreens Boots Alliance, Inc. (NASDAQ:WBA) Q1 2024 Earnings Call Transcript January 4, 2024

Walgreens Boots Alliance, Inc. beats earnings expectations. Reported EPS is $0.66, expectations were $0.63. WBA isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning. My name is Christa and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Walgreens Boots Alliance Incorporated First Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the conference over to Tiffany Kanaga, Vice President of Global Investor Relations. Tiffany, you may begin your conference.

Tiffany Kanaga: Good morning. Thank you for joining us for the Walgreens Boots Alliance earnings call for the first quarter of fiscal year 2024. I’m Tiffany Kanaga, Vice President of Global Investor Relations. Joining me on today’s call are Tim Wentworth, our Chief Executive Officer; and Manmohan Mahajan, our Interim Global Chief Financial Officer. In addition, John Driscoll, President of US Healthcare; Rick Gates, Senior Vice President and Chief Pharmacy Officer at Walgreens; and Tracey Brown, President of Walgreens Retail and Chief Customer Officer, will participate in Q&A. As always, during the conference call, we anticipate making projections and forward-looking statements based on our current expectations. Our actual results could differ materially due to a number of factors, including those listed on slide two, and those outlined in our latest Form 10-K filed with the Securities and Exchange Commission.

We undertake no obligation to publicly update any forward-looking statement after this presentation, whether as a result of new information, future events, changes in assumptions or otherwise. You can find our press release and the slides referenced on this call in the Investors section of the Walgreens Boots Alliance website. During this call, we will discuss certain non-GAAP financial measures. These measures are reconciled to the most directly comparable GAAP financial measures and the reconciliations are set forth in the press release. You may also refer to the slides posted to the Investors section of our website, for reconciliations of non-GAAP measures to the most comparable GAAP measures discussed during this earnings call. I will now turn the call over to Tim.

Tim Wentworth: Thanks, Tiffany, and good morning, everyone. When I joined you for the last earnings call in October, I have not yet begun my role as CEO. But I shared how I believe that leading WBA is a once in a lifetime opportunity with a tremendous brand, legacy and neighbourhood presence. Today, 10 weeks into my tenure, I’m even more certain of my decision. I am pleased to be here today to share our results, our outlook and my broader convictions around how we can build on our strong pharmacy foundation to partner across healthcare services and drive sustainable value. As you are by now aware, WBA started fiscal 2024 with unplanned results despite a weak retail environment in the U.S. First quarter adjusted EPS came in at $0.66, reflecting execution and cost discipline in U.S. Retail Pharmacy, continued strong performance in International, and progress with profitability initiatives in U.S. Healthcare.

We are maintaining full year adjusted EPS guidance against the challenging backdrop. I must give credit here to the hard work and dedication of our teams. We are navigating the accumulating consumer pressures from inflation and depleted savings and somewhat slower-than-anticipated market trends in pharmacy script volumes, including impacts from a weaker respiratory season and Medicaid redetermination. Retail customers in the United States are under stress and making deliberate choices to seek value evidenced in our own brands up 90 basis points in the quarter, while demand for seasonal and discretionary categories remains weak. At the same time, our teams executed well during the quarter on delivering pharmacy services, including vaccines and maintaining our overall share of script volume in the US.

International was once again a bright spot in the quarter, building on last year’s solid growth, upside was led by Boots UK with further share gains in retail, while both retail and pharmacy delivered gross profit improvements despite inflationary cost pressures. Germany also achieved share gains. In U.S. Healthcare, we are on track to achieve significant year-on-year profit improvement. VillageMD is rapidly realigning operating costs with sales. The team is executing on several initiatives, from revenue cycle management to procurement with operational actions spanning the organization. As VillageMD focuses on increasing density in their highest opportunity markets, remember the previously announced plans to optimize their footprint and exit approximately 60 clinics in nonstrategic markets.

As of today, they are nearly halfway there, having already exited 27. Additionally, VillageMD is driving patient panel growth and achieved 23% year-over-year growth in full risk lives and 9% growth in fee-for-service volumes. Work is underway to implement targeted marketing efforts, leveraging Walgreens’ expertise and patient touch points, and we expect benefits over time as we learn and further develop our provider-based risk strategy. So macroeconomic conditions are clearly difficult for retailers and I fully acknowledge the structural headwinds in our core pharmacy business and the growing pains in our Healthcare segment. None of this is a surprise to me. I came to WBA eyes wide open with a clear mandate to act with everything on the table in terms of putting our business on the right track.

In that context, we are taking swift actions to right-size costs and increase cash flow across the company. We remain on pace toward $1 billion in cost savings this year. Our U.S. organizational efforts have resulted in a planned headquarter support office workforce reduction of approximately 20%. Over the past two months, we have prioritized projects and capital spend to focus on the customer-facing activities that matter most. First quarter CapEx was over $100 million lower year-over-year, on track to a $600 million reduction for the full year. We also remain on schedule to deliver $500 million in working capital benefits in fiscal 2024. An additional meaningful and necessary step to strengthen our long-term balance sheet and cash position, today, we are announcing a 48% reduction in our quarterly dividend payment to $0.25 per share starting in March.

This action will free up capital to invest in driving sustainable growth in the pharmacy and health care businesses, as well as paying down debt. At the same time, we will continue to deliver a competitive dividend yield as the Board and I continue to view the dividend as a critical component to overall attractiveness of WBA to many of our shareholders. Our financial flexibility is also supported by other strategic actions, with some already underway and others under consideration. In November, we monetized an additional portion of our Cencora stake with nearly $700 million of proceeds. We also took advantage of the higher interest rate environment to secure a full buy-in for the Boots pension plan with legal and general to ensure the benefits of all 53,000 members.

A buyout scheduled in calendar 2025 will eliminate the company’s plan obligations and commitments. Furthermore, we continue to evaluate our existing portfolio, sharpening our strategic focus on the U.S. Retail Pharmacy and Healthcare with our remaining investments in Cencora, BrightSpring and other minority interests providing financial flexibility. Let me be clear. We have hard work ahead of us in our journey to simplify and strengthen WBA, but also good momentum with important early actions that we’ve taken. And there are a number of building blocks already in place for a sharper health care strategy, positioning us well for long-term profitable growth. Walgreens is a dependable, trusted and convenient local health care destination for patients, and we have the ability and, frankly, the market mandate to be a valued independent partner of choice in health care services.

As John Driscoll detailed last quarter, we are leveraging our local presence to engage with patients across our thousands of stores and through our assets across the care continuum on behalf of payors, providers and pharma to help them achieve their objectives at scale. I can tell you from my early days with the team and from meetings with our partners and prospects, there is a lot to be excited about here. But our competitive advantage is not just our neighbourhood footprint and convenience with 10 million customers visiting us at Walgreens in store or online every day, our stores are access points on the best corners in America. And more specifically, we have over 85,000 people on our teams who directly engage with patients and are trusted providers in their communities.

Walgreens has the unique ability through our well-established physical presence and iconic brand for our people to drive trusted, meaningful connections. We are enabling pharmacists to spend less time on tasks and more time on meaningful interactions and providing essential care, from health screenings to immunizations to diagnostic testing and treatment. Our network of micro fulfillment centers is helping to stabilize staffing and pharmacy hours, reduce work full pain points and free up capacity to drive the outcomes that matter most to our patients and partners. You’ll remember in October, we mentioned a pause in the rollout to optimize productivity. We are happy with our continued progress and the importance of these centers in our overall strategy.

We are also piloting virtual pharmacy to redefine connected care, further increase patient access, enhance workplace flexibility, and extend our pharmacist reach. Finally, we are partnering with academia, and specifically, key schools of pharmacy to explore ways to attract, recruit and create a dynamic workplace for the next generation of pharmacists. Our relationships with pharmacy deans are integral to our strategy and can help us advance the profession, and so we are forming an advisory council to guide us in our transformation. I look forward to personally working with the deans with our first meeting in March to ensure Walgreens is the preferred employer in the pharmacy space. And I want to thank our pharmacy teams for their tireless efforts on the front lines of health care delivery in this country.

Let me give you one example of how we can build on our established assets in a capital-efficient way to expand services and support patients and partners. Our clinical trials offering. We are partnering with pharma companies and leveraging our community presence and patient engagement to help drive greater patient diversity in clinical research. In a short span, we are already improving participation and equity at double the national average. To date, we have signed over 25 contracts, with a robust pipeline of opportunities ahead. Shields is another example of our strength serving hospital systems and has consistently delivered strong margin accretive results ahead of plan. Sales were up 27% in the first quarter, driven by meaningful growth at existing customers as well as new partner contract signings.

We expect Shields to continue to leverage and benefit from the rapid growth in the broader specialty market and our intense focus on accelerating hospital-owned specialty pharmacy programs. Our specialty pharmacy assets will be an important focus going forward. And while we have work to do, we are pleased to be executing our next steps with gene and cell therapy. The FDA anticipates approval of more than 20 gene and cell therapies by 2025, and this is an exciting opportunity for patients with rare conditions and for Walgreens specialty pharmacies. In the coming months, you will hear more from us on our initiatives in specialty. Finally, let me touch on reimbursement models and dynamics. We continue to see the benefits of more comprehensive and responsive discussions with payors as they are realizing the broad set of value drivers that WBA can deliver.

We are committed to and entering into pay-for-performance contracts beyond core dispensing as we advance our adherence and outcomes capabilities within our pharmacy platform. In addition, we welcome and will work with payor and PBM partners on any model that recognizes and reimburses pharmacies for the unmatched value we provide patients, including pharmacy services, as well as those models that can ensure more transparency and predictability in reimbursement. With that, I’ll hand it over to Manmohan to review our financial results and recent execution in further detail.

Manmohan Mahajan: Thank you, Tim, and good morning, everyone. Overall, first quarter results were in line with our expectations. Sales increased 8.7% on a constant currency basis. US Retail Pharmacy grew at 6.4%. International delivered 4.4% growth. And US Healthcare pro forma sales increased 12%. Adjusted EPS of $0.66 declined 44% on a constant currency basis, mainly driven by lower US retail sales and a 21 percentage point headwind from a higher adjusted effective tax rate. Strong international growth and improved profitability in our U.S. Healthcare segment positively impacted adjusted EPS. GAAP net loss for the first quarter included $278 million after-tax charge for fair value adjustments on variable prepaid forward derivatives related to Cencora shares.

Remember, in the first quarter of last year, we recognized a $5.2 billion after-tax charge for opioid-related claims and lawsuits and a $0.9 billion after-tax gain on sale of Cencora shares. Now I will cover the US Retail Pharmacy segment. Sales increased 6.4% versus the prior year quarter, driven by brand inflation in pharmacy and higher contributions from pharmacy services. Sales growth was partially offset by a 6.1% decline in the retail business. AOI declined 37.2% year-on-year, mainly driven by lower retail sales volume and margin, including higher levels of shrink. AOI was positively impacted by execution in our pharmacy services and progress on cost savings initiatives. Let me now turn to US Pharmacy. Pharmacy comp sales increased 13.1%, mainly driven by brand inflation and higher contribution from pharmacy services.

COVID-19 vaccines have now shifted to a commercial model consistent with other vaccinations. Comp scripts grew 1.8%, excluding immunizations, in line with the overall prescription market. The ongoing impact of Medicaid redeterminations and a weaker flu and respiratory season continued to negatively impact overall market growth. Third-party data showed flu, cold and respiratory activity was down 13.5% compared to the prior year quarter. Within Pharmacy Services, our vaccines portfolio, which includes flu, COVID, RSV and other routine vaccinations, performed well in the quarter. Pharmacy adjusted gross profit declined slightly in the quarter, with margin negatively impacted by reimbursement pressure net of procurement savings and brand mix impacts.

Turning next to our US Retail business. Challenging macroeconomic conditions and an anticipated slow start to the cough, cold, flu season contributed to a weaker retail performance year-on-year. Comparable sales declined 5% in the quarter. There are three main drivers. First, a weaker respiratory season had an impact of approximately 160 basis points through the health and wellness category. Cough, cold, flu serves as a primary scripts driver. As a result, we also experienced lower attachment sales due to the weaker season, which are incremental to the 160 basis points impact. Second, customers continue to pull back on discretionary spending, and actively seek out promotional opportunities. As a result, we saw an approximately 90 basis points impact from weaker holiday seasonal sales.

Lastly, our decision to close most of our stores on Thanksgiving this year to further support our store team members led to a headwind of about 60 basis points. While these factors resulted in lower sales across all categories, we experienced more pronounced declines in consumables and general merchandise and in health and wellness. Retail gross margin was negatively impacted by 110 basis points due to higher shrink. Retail shrink continues to be a systemic issue across the retail industry. Turning next to the International segment. And as always, I will talk in constant currency numbers. The International segment performed better than our expectations in the quarter. Total sales increased 4.4%, with Boots UK up 6.2% and Germany wholesale growing 3.7%.

Segment adjusted gross profit increased by 7%, outpacing sales growth, with Boots UK driving strong retail growth. Adjusted operating income grew 15%, including the impact from inflationary cost pressures. Let’s now cover Boots UK in detail. Comp pharmacy sales grew 0.8%. Comp retail sales increased 9.8%, with growth across all categories, led by beauty and health and wellness. We also saw a year-on-year growth across all store formats, with flagship and travel locations performing particularly well. Boots increased retail market share for the 11th consecutive quarter, led by beauty. Boots.com sales increased 17.5% year-on-year and represented 19.2% of our UK retail sales. Turning next to US Healthcare. US Healthcare segment results were in line with our expectations.

This is the second consecutive quarter of significant improvement in AOI and adjusted EBITDA compared to prior year. First quarter sales of $1.9 billion increased by 95% compared to the prior year, reflecting the acquisition of Summit Health by VillageMD and growth across all businesses. On a pro forma basis, segment sales increased 12%. VillageMD sales of $1.4 billion were up 14% on a pro forma basis. The year-on-year increase was driven by growth in full risk lives, better same clinic performance, and increased productivity in the Summit Health multi-specialty business. Shields increased sales by 27% as new health system contracts and expansion of existing partnerships led to a 42% increase in the number of patients on service in the quarter versus the prior year.

Adjusted EBITDA was a loss of $39 million, reflecting investment in VillageMD, partly offset by profitable growth at Shields and CareCentrix. Adjusted EBITDA increased $84 million compared to last year, with improvement across all businesses. We are making progress to accelerate profitability at VillageMD, and profit growth from all other businesses contributed positively in the quarter. Turning next to cash flow. Overall, free cash flows were in line with our expectations. Operating cash flows in the quarter was negatively impacted by anticipated seasonal inventory build and timing of payor reimbursement. Capital expenditures declined by $104 million versus the first quarter of fiscal ’23. Free cash flow was down $671 million versus the prior year, driven by the phasing of working capital and lower earnings, partially offset by lower capital expenditures.

As Tim mentioned, we are on track to reduce capital expenditures by approximately $600 million year-over-year and to deliver working capital improvement of $500 million. I will now turn to guidance. We are maintaining our fiscal ’24 adjusted EPS guidance. We expect certain incremental tailwinds and headwinds in a challenging environment compared to our prior outlook. On the tailwinds, with strong execution to date, we now expect pharmacy services to deliver ahead of our initial plan. We also anticipate an improvement in our full year adjusted effective tax rate as a result of tax planning initiatives, with a revised range of 15% to 17%, compared to the prior outlook of 19% to 20%. On the headwinds. First, we expect the pullback in consumer spending and shifting behaviors will continue to impact our retail sales in the US in the short term, while improving in the second half.

We now expect retail comp sales for fiscal ’24 to decline low single-digits compared to the prior outlook of flat. Second, we expect approximately $125 million in reduced sale and leaseback gains versus our prior outlook. As we explained in October, this is the last year of anticipated sale leaseback transactions. Lastly, we also forecast slightly lower overall market volume growth for prescriptions compared to our previous expectations. Importantly, as we build on the first quarter progress in US Healthcare, we continue to expect segment adjusted EBITDA to be breakeven at the midpoint of the guidance range. This represents an increase of $325 million to $425 million over fiscal ’23. The improvement is mainly driven by actions taken to accelerate profitability at VillageMD, robust growth at Shields, and cost discipline.

Next, I will discuss factors impacting the phasing of earnings in the second quarter versus second half of the fiscal year. In the second quarter, we will be lapping adjusted EPS of $1.16 in the prior year quarter. Three factors are expected to have an outsized impact on the year-over-year comparison. First, we anticipate lower contributions from sale and leaseback activity. Second, we’re incorporating impacts of consumer pressures on spending and sentiment, and higher shrink on our retail business. Lastly, we expect these headwinds to be partly offset by a lower tax rate in the second quarter due to the phasing of tax planning initiatives. Looking ahead to the second half of fiscal ’24, there are four key drivers for our improving earnings profile.

First, as we have previously discussed, we expect actions to lower our cost base will continue to ramp over the year. Second, we expect US Healthcare segment profitability will scale over the balance of the year, mainly driven by benefits from optimizing the clinic footprint, growing patient panels and realigning cost at VillageMD, and growth across all of the businesses. Third, we cautiously expect modest level of retail market growth against an easier second half comparison. Finally, our tax rate was elevated in the first quarter. We expect favorability in the remainder of the year. With that, let me now pass it back to Tim for his closing remarks.

Tim Wentworth: To summarize what you’ve heard from us today, we executed on our plans in the first quarter despite the challenging environment, and we also recognize there is still plenty of work to be done. The future of health care and of this company both require innovative new thinking. My headline to you is that everything is on the table to deliver greater shareholder value. We have the experience and the license to deeply examine our business and make the changes that position us well going forward. Having spent time with our team members and our business, I’m encouraged by the significant opportunity to build on our legacy pharmacy strength and our trusted brand, to evolve health care and the customer experience. We are not pivoting away from our position as the premier neighbourhood retail pharmacy, but we are instead redefining what we can do to help payors, providers and pharma achieve their goals.

The reasons I joined WBA weren’t just validated in these discussions, they are even more true than I had anticipated. I have a strong team in place to drive execution who are effectively working together to deliver for all of our stakeholders while I work through several leadership transitions. In the coming weeks and months, we look forward to engaging with you, our customers, our fellow teammates and our shareholders as we are listening, learning and moving quickly to create sustainable value. Now I would like to open the line for questions.

Operator: [Operator Instructions] Your first question comes from the line of Lisa Gill from JPMorgan. Please go ahead. Your line is open.

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Q&A Session

Lisa Gill: Good morning. Thanks for all the comments, Tim. I want to go back to your comments around the reimbursement model. You talked about pay-for-performance, you talked about the unmatched value, transparency, predictability. How much of that do you think can be driven by Walgreens and Walgreens putting a new model in place? And as we think about just what’s happened with the margins in drug retail over a number of years, what do you think can be a sustainable margin when we think about the drug retail business?

Tim Wentworth: Good morning, Lisa. Thanks. So, first of all, as it relates to sort of how much can Walgreens drive market shift, I think we certainly, as a major retail player and partner to PBMs and health plans, are in a position to bring value to the table in different ways that they will look at and determine — help them win in their marketplaces. And so I actually think we can play a fairly significant role in the relationships that we have, the contracts that we write and the risk that we’re willing to take in terms of the value we know we will create at the back of the store with the way we can interact with patients on behalf of those payors. So I don’t think, as you know, any change in a reimbursement model is a speedy change.

But I think there’s very, very strong clear messaging in the marketplace from us and others that would point to the fact that the way that retail pharmacies will create value in the next 10 years isn’t going to simply be lowering the cost of — the unit cost of the drugs that we’re purchasing and distributing because, quite frankly, that largely now is not where the real gains can be made for payors and for patients. And so from our standpoint, we’re going to drive hard at it. We can work inside of, and we’ve proven, we’re inside of cost-plus models now, transparent models now. We have a very robust cash program. And we think we’re a terrific partner to others that want to win in the marketplace with these more innovative models that they have talked about and that they are pushing into the market.

So I feel super good. Now in terms of — I’m not going to give you guidance on the, as you would expect, on the margins for drugs, other than to say that most of the — if you look at the innovation and reimbursement in pharmacy that’s likely to evolve, it’s likely to evolve in such a way that the margin per drug is going to be largely based on how much service do we provide to patients that’s receiving it. And I think we’ve seen what that looks like in models like specialty. We’ve also seen, when it disconnects, what it looks like. And those are things that we’re working against as well, where we’re not compensated for the kind of services we provide. And we are pretty confident that the value that we can build in what we call our pharmacy services, but also our use of pharmacists to help patients take the drugs and stay on them safely and get the benefits and make sure the payors are getting what they’re paying for, we’re super well positioned to evolve those models as a leader.

Lisa Gill: Thank you, and congrats on your first quarter.

Tim Wentworth: Thank you.

Operator: Your next question comes from the line of George Hill from Deutsche Bank. Please go ahead. Your line is open.

George Hill: Yes. Good morning, guys, and I’ll echo Lisa’s sentiment, is welcome aboard, Tim. I guess, Tim, as you look at the business from where you stand right now, you’ve kind of said that everything is on the table. But I guess, could you spend a little bit talking about what you think is part of the Walgreens core business, the WBA core business, and kind of what might be ancillary? And kind of maybe talk about how you’re spending your time and where you think your strategic focus is most important to be spent right now.

Tim Wentworth: Sure. Thanks, George. I appreciate the question. That’s a great way to ask what’s on the table. And from that standpoint, let me answer your question though. Because we have a terrific group of assets that I think are going to be, on a go-forward basis, critical. But again, let me be clear, I’m 60 days in. We have a lot of work to do. We’re working to get our cash flows, our balance sheet, all of our financial models aligned with being able to invest in our company to grow. The first and most easy answer is our stores. And so lest anyone think that where we were headed was a meaningful pivot away from being committed to a community-based engagement model with patients, both with what we do in pharmacy and what we do to create a great experience for them in the front of our store, that is central, a central element to what we will have going forward, and that is not on the table.

Now what is on the table is what’s the right footprint in stores. And we’ve announced already that, for example, this year, we’re going to optimize our footprint by roughly 200 stores and we’re on track to do that. We will continually look at sort of the model through the lens of where do we need to be and where do we not need to be, and what is creating value and what is destroying value. So – but there’s no question for me that we are going to be a major community-based, neighbourhood, point of engagement for patients with human beings touching human beings, which I believe is the long-term how health care in this country is going to evolve. Besides that, though, we very much — and you’ve seen — I get asked, why did you come off the couch that you were sitting on to get back into the CEO chair?

It was real simple. Walgreens called me. I had had three years of experience during the worst pandemic, hopefully, in my life with the pharmacy services part of our business, with the vaccines that my family and I were able to obtain. And so for me, I viewed Walgreens as a fundamental public health utility as much as a business, and something that literally has the potential to be meaningful, not just in a pandemic, but on a go-forward basis. And we have proven that with our pharmacy services businesses. So we are clearly investing around being able to both free up pharmacists, centralize certain activities and so forth using technology to then expand the things that we can do in store, be they testing, be they — including working with LabCorp, but also using our own employees, vaccines and adherence programs and other things that we do to counsel patients.