Walgreens Boots Alliance, Inc. (NASDAQ:WBA) Q2 2023 Earnings Call Transcript

Walgreens Boots Alliance, Inc. (NASDAQ:WBA) Q2 2023 Earnings Call Transcript March 28, 2023

Operator: Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Walgreens Boots Alliance Second Quarter 2023 Earnings Conference Call. Tiffany Kanaga, Vice President of Global Investor Relations, you may begin your conference.

Tiffany Kanaga: Good morning. Thank you for joining us for the Walgreens Boots Alliance earnings call for the second quarter of fiscal year 2023. I’m Tiffany Kanaga, Vice President of Global Investor Relations. Joining me on today’s call are Roz Brewer, our Chief Executive Officer; and James Kehoe, our Chief Financial Officer. Rick Gates, Senior Vice President and Chief Pharmacy Officer at Walgreens; and John Driscoll, President of U.S. Healthcare, will participate in Q&A. Today’s call will be approximately one hour in length, including Q&A. Let me note that all references to the COVID-19 headwind include U.S. vaccines, drive-through tests and OTC tests. 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 2 and those outlined in our latest forms 10-K and 10-Q 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. The slides in the press release also contain further information about the non-GAAP financial measures that we will discuss during this call. I’ll now turn the call over to Roz.

Rosalind Brewer: Thanks, Tiffany, and good morning, everyone. WBA has delivered a solid second quarter. Overall, results were in line with our expectations as the slow start earlier in the quarter was offset by strong acceleration in February. The overall decline in adjusted EPS was against growth of 26.5% last year and again reflects the anticipated headwind from lower COVID demand and our investments in labor and the U.S. Healthcare segment. This is our final quarter of lapping last year’s peak COVID contributions, and we are looking forward to accelerated growth ahead. Second quarter sales grew 4.5% in constant currency. U.S. script volume growth exceeded guidance and our resilient retail business is successfully lapping record prior year performances.

This was also a landmark quarter for our transformation to healthcare. We invested $3.5 billion to support VillageMD’s acquisition of Summit Health, creating one of the leading independent provider groups in the country. At the same time, we are taking decisive action to unlock value and strengthen the company by simplifying the portfolio. Our strategy is working. We are performing against our plans, and we will be relentless in driving continued progress ahead. We are maintaining our full year guidance for adjusted EPS of $4.45 to $4.65 with good visibility into the key drivers of robust and accelerated growth in the second half. Importantly, the inflection is here. We are clearly pivoting to strong projected EPS growth in the mid-20s in the second half.

I am very confident in our future, enabled by our execution and the bold investments we are making today. We are making progress against each of our four strategic priorities. Let’s start with the core business. U.S. Pharmacy comp scripts grew 3.5%, excluding immunization, exceeding our guidance of 3% growth and improving from 2.1% last quarter. Through our focused investments, we have returned an incremental 500 stores to normal pharmacy operating hours. Our market share trends are improving, and we saw 6% growth in stores with normal hours. While we have more work ahead of us to achieve our full year script recapture goals, I’m very encouraged by our momentum with strong acceleration into January and February. Our pharmacist team is supported by our nine micro-fulfillment centers, which allow our pharmacists more time to focus on patient care and clinical services, expanding on the critical role they already provide in communities.

In Retail, U.S. comp sales, excluding tobacco, declined slightly. A very solid performance against the 15.7% growth we delivered last year. We achieved mid-single-digit growth after backing out the COVID OTC test headwind from last year’s Omicron surge. The convenience and real value that Walgreens offers is resonating with consumers in a challenging environment. In fact, our comp accelerated to high single digits in February, while we also drove another quarter of margin expansion. In our International segment, Boots had a stellar quarter with retail comp growth of 16% on top of 22% last year. The business achieved its eighth consecutive quarter of retail market share gains. Now turning to our second strategic priority. We are accelerating the build-out of our healthcare growth engine.

The addition of Summit Health is transformational. It creates one of the largest integrated provider platforms in the U.S., delivering quality affordable care for all patient populations regardless of insurance or payer type. This highly strategic transaction expands VillageMD’s addressable market with primary care, multi-specialty and urgent care and reinforces our approach across the entire care continuum. Summit will accelerate the U.S. Healthcare segment to scale and profit. We see meaningful synergy potential over time with integration activities already begun. We have also added our fourth payer partner for the organic business, Horizon Blue Cross Blue Shield of New Jersey and now have signed 5 clinical trials contracts. Shields Health Solutions and CareCentrix both continue to perform well, which led to the accelerated acquisition of both entities.

Shields closed on December 28, and CareCentrix is scheduled to close this quarter. On a combined basis, our best-in-class assets drove pro forma sales growth of 30% in the quarter. Investments in this growth are funded through actions we continue to take to better align our portfolio and streamline the business. We’ve unlocked meaningful value fiscal year-to-date with over $3.6 billion in after-tax proceeds. Our Retail Pharmacy business provides a solid foundation for our leading healthcare assets to deliver value across the full care continuum driving our long-term growth strategy. We are able to reach across both digital and physical channels to guide consumers through the complexities in healthcare. We are building the scale and resources to help health plans and patients improve outcomes and lower costs and only Walgreens can do.

There are significant opportunities for synergies, allowing us to pursue value-based care and risk arrangements, which will demonstrate the importance of an integrated approach. We are focused on expanding our risk business, supporting integrated care models, broadening our pharmacy value proposition and driving operational efficiencies. The combination of our best-in-class healthcare assets, a physical presence through our pharmacy footprint, our trusted brand and a scale digital offering creates a platform that is unmatched in the industry. Walgreens will increasingly be viewed as a partner of choice. We are uniquely positioned to engage consumers to manage their individual health and wellness whenever and wherever they need. With that, I’ll hand it over to James to provide more color on our results and our outlook.

James Kehoe: Thank you, Roz, and good morning. In summary, we delivered a strong performance in the quarter. While we saw some favorable phasing, core operating performance was mostly in line with our internal expectations. Second quarter adjusted EPS of $1.16 declined by 25.8% on a constant currency basis, and this was entirely due to a 26% headwind from COVID-19 vaccinations and testing. Strong retail performance in both the U.S. and International and sequential improvement in U.S. comp scripts more than offset 10 percentage points of headwinds from payroll investments in the U.S. and expansion of our healthcare business. Gains from a planned cash mobilization in Germany and sale and leaseback net gains in the U.S. contributed approximately $0.12 to adjusted EPS growth.

However, this was entirely offset by reduced ownership of our AmerisourceBergen of $0.05, prior year COVID-related onetime benefits in the UK of $0.03 and currency impacts and investment write-offs of $0.04. Despite a slow start to the quarter, we delivered 4.5% sales growth on a constant currency basis with strong momentum exiting the quarter. February saw core sales growth up high single digits, more than offsetting weather-related challenges in December and a noticeable slowdown in respiratory virus cases in January. Comparable sales in U.S. Retail Pharmacy were up 3.1%, despite lapping a very strong prior year comp of 9.5%. Comp script growth of 3.5% exceeded our guidance of 3%. The International sales advanced 9% led by the UK Retail business, which delivered a 16% comp.

And our U.S. Healthcare business continues to rapidly scale with sales exceeding $1.6 billion in the quarter and growing 30% on a pro forma basis. So in summary, we had a solid quarter. And based on the in-line performance, we are maintaining our full year adjusted EPS guidance of $4.45 to $4.65. Let’s now look at the results in more detail. Adjusted operating income declined 25% on a constant currency basis and this was entirely due to a much lower contribution from COVID-19 vaccinations and testing, which led to a headwind of 28%. Labor investments in pharmacy and minimum wage were a 9 percentage point headwind, whereas the expansion of the U.S. Healthcare segment was an impact of 5 percentage points. The labor and healthcare headwinds were offset by strong performance across U.S. Retail and International.

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Excluding COVID-19 OTC test kits, U.S. Retail contributed 12 percentage points of growth and continued strength in International contributed 9 percentage points. Adjusted EPS was $1.16, a constant currency decline of 25.8%, entirely due to a much lower contribution from COVID-19. GAAP net earnings were $703 million, a decline of 20% versus prior year. The current quarter included a $454 million after-tax gain from the sale of ABC shares and a $266 million after-tax charge for opioid-related claims and lawsuits. Now let’s move to the year-to-date highlights. Year-to-date sales increased 2.8% on a constant currency basis. Adjusted EPS was down 28% on a constant currency basis, mostly due to a much lower contribution from COVID-19 with an adverse impact of approximately 22%.

GAAP earnings were a loss of $3 billion compared to net earnings of $4.5 billion in 2022. The year-to-date period included a $5.4 billion after-tax charge for opioid-related claims and lawsuits partly offset by a $1.4 billion after-tax gain on the sale of ABC shares. Additionally, we are comparing to a prior year period that included a $2.5 billion after-tax gain on the company’s investments in VillageMD and Shields. Now let’s move to the U.S. Retail Pharmacy segment. Sales declined slightly in the quarter, reflecting a 3% drag from lower COVID-19 contributions and a 2.5% headwind from AllianceRx. The good news is that AllianceRx has now cycled through its contract losses and the COVID-19 headwind will lessen in subsequent quarters. Comp sales increased 3.1% and this comes on top of a very strong prior year comp of 9.5%.

Adjusted operating income declined 32.8% year-on-year, broadly in line with our expectations. This was entirely due to a 29% decline from lower COVID-19 contribution and 10% from planned labor investments. Ongoing reimbursement pressure was offset by retail gross profit growth and SG&A savings. We continue to expect AOI growth to accelerate in the second half, due to a lower COVID-19 headwind, less reimbursement pressure, favorable cost of goods sold timing and script recapture initiatives gaining traction. Let me now turn to U.S. Pharmacy. Pharmacy sales increased 0.3% despite a 3 percentage point headwind from AllianceRx and 2 percentage points from lower COVID-19 contributions. Comp pharmacy sales were up 4.9%, lapping a 7.3% comp last year.

Comp scripts were up 0.2%. We administered 2.4 million COVID-19 vaccinations in the second quarter, down a significant 80% versus prior year and about 600,000 COVID-19 PCR tests, down over 90%. Excluding immunizations, comp scripts grew 3.5%, exceeding our forecast of 3%. We are encouraged by the 140 basis point sequential improvement, driven in part by ongoing script recapture initiatives, including the return of an incremental 500 stores to normal operating hours. As expected, adjusted gross profit and margin declined due to the lower contribution from COVID-19 vaccinations and testing and ongoing reimbursement pressure net of procurement savings. Pharmacy reimbursement was broadly in line with our expectations and represented a lower level of pressure compared to the prior year.

Looking forward, we expect year-over-year growth in the second half as the COVID headwind lessens, script comps continue to build and second half reimbursement is less of a year-on-year headwind compared to the first half of the year. Turning next to the U.S. Retail business. Overall, we were happy with the retail performance in the quarter, with good underlying sales trends and continued margin improvement. While Retail comp sales decreased 1% in the quarter, we were up against a record 14.7% comp in the prior year, which, as you will recall, included strong OTC testing volume related to the Omicron surge. Excluding tobacco, comp sales were down 0.5%. But on a two-year stack basis, comp sales advanced by more than 15%. Looking at the quarter, lower sales of at-home COVID-19 tests led to a 500 basis point headwind, and this massed strong underlying trends, led by a 13% increase in cough, cold, flu, 9% growth in beauty and a 6% increase in consumables and general merchandise.

We had a slower start than expected with December weather impacts leading to weak seasonal sales and some seasonal write-downs, and we sold lessening respiratory various cases in January. However, February was very strong with high single-digit comp growth. Retail gross margin performance remained strong in the quarter, reflecting effective margin management including strategic pricing and promotional optimization and improved shrink. Looking ahead, we expect a return to positive comp trends in the second half as we will be facing a smaller headwind from COVID-19 test kits, and we have meaningful opportunities to drive AOI growth from own brands to myWalgreens loyalty program and strategic margin management. Turning next to the International segment.

And as always, I’ll talk to constant currency numbers. The International segment continues to perform well. Sales increased 9% with growth across all International markets. Boots UK was up 11% and Germany wholesale grew 7.5%. Adjusted operating income was $352 million, up 66% versus prior year. Adjusted operating income benefited from $110 million in real estate gains from the planned cash mobilization program in Germany. These gains were included in our guidance at the beginning of the year, but were initially assumed to be more evenly split between the first and second quarters. Offsetting this, we are lapping COVID-19-related temporary benefits in the year ago quarter of approximately $40 million. Excluding these two items, we estimate that core AOI grew by around 40%.

This excellent performance was led by UK retail sales with a successful holiday trading season and strong operational execution in the Germany wholesale business. We are encouraged by our continued positive trends and looking ahead, we expect the International segment to deliver year-on-year AOI growth in the second half of 2023. Let’s now look in more detail at Boots UK. Boots UK sales advanced 11%, led by continued strength in retail. Comparable pharmacy sales increased 2%, held back by lower demand for COVID-19 services. Comparable retail sales advanced 16%, which follows on from a 22% comp in the year ago quarter and benefiting from strong execution over the holiday season. Boots grew market share for the eighth consecutive quarter with gains across all categories, led by beauty up 1.8 percentage points, and consumables and general merchandise up 1.7 percentage points.

Boots.com sales were up nearly 80% versus the equivalent pre-COVID period. Over 15% of our UK retail sales now come from Boots.com, up from approximately 9% in the pre-COVID quarter. Turning next to U.S. Healthcare. The U.S. Healthcare business is rapidly scaling with VillageMD’s acquisition of Summit Health and strong pro forma sales growth at VillageMD, Shields and CareCentrix. U.S. Healthcare sales exceeded $1.6 billion compared to $527 million in the year ago quarter. Pro forma sales growth was 30%. VillageMD delivered sales of over $1.1 billion, advancing 30% on a pro forma basis, driven by growth at existing clinics, expansion of the clinic footprint and Summit Health growth. Excluding Summit, VillageMD grew 48% year-on-year. Shields continues to deliver with sales of $125 million and increasing 41% on a pro forma basis, driven by recent contract wins, including the addition of three new health system partners and further expansion of existing partnerships.

CareCentrix sales were nearly $400 million with pro forma sales growth of 25%, driven primarily by new service offerings with existing partners. Adjusted SG&A in the quarter increased by $177 million to $269 million, primarily due to the acquisitions of CareCentrix and Summit which were not included in the prior year quarter. Adjusted EBITDA was a loss of $109 million compared to a loss of $62 million in the prior year. This largely reflects the increased VillageMD clinic count and higher Walgreens Health organic investments, partly offset by positive contributions from Shields and CareCentrix. Let’s now look at some of the key metrics for the U.S. Healthcare business. At quarter end, the Walgreens Health organic business had 2.9 million contracted lives, up over 50% year-on-year as existing payer partners added new lines of business.

As Roz mentioned, we’ve also added Horizon Blue Cross Blue Shield of New Jersey as our fourth payer partner. Under this agreement, we will provide preventative health and wellness services to a select group of Horizon’s Medicare and commercial members. These services will be available at Walgreens Health Corners and pharmacies across New Jersey, starting this summer. VillageMD managed 806,000 value-based lives at quarter end, reflecting year-over-year growth of 38% in the legacy VillageMD business and the addition of 309,000 value-based lives from Summit. The total includes 177,000 full-risk Medicare lives. VillageMD ended the quarter with 729 locations, including Summit Health and CityMD. The 403 clinics for the legacy VillageMD business compared to 270 at the end of the prior year period and included 210 clinics co-located with Walgreens, up from 94 co-located clinics a year ago.

We were seeing benefits on the Walgreens side from our partnership with VillageMD. Roughly 50% of patients had co-located VillageMD clinics opt to get their prescriptions filled at Walgreens. VillageMD co-located sites that have been open for over two years are driving an incremental 40 scripts per site per day, and this is an increase of 35% versus prior year. We will continue to build out our Walgreens Health Corners as we add new lives and partners. We ended the quarter with 117 Health Corners, up from 47% a year ago. In summary, we are moving swiftly to implement our vision, leveraging our integrated best-in-class assets and are excited with recent developments including signing another payer partner in the Walgreens Health organic business.

Turning next to cash flow. We generated over $1.2 billion of operating cash flow in the first half of ’23, with free cash flow of $560 million. The year-over-year decline reflected lower earnings due to the COVID-19 headwind and increased capital expenditures related to growth initiatives. This was partially offset by ongoing working capital optimization. Turning now to guidance. We are maintaining our full year adjusted EPS guidance. We delivered a solid first half, which was broadly in line with expectations. Our core Retail Pharmacy business has performed well in both the U.S. and International as we lapped very strong prior year comps. We also drove better-than-anticipated U.S. comp script growth in the second quarter. We continue to expect robust and accelerating EPS growth in the second half and have good visibility and strong execution plans against the key drivers.

COVID was a major headwind in the first half. And heading into the second half, we will see lower year-over-year impacts. In the U.S., we have clear line of sight to less reimbursement pressure relative to the first half of the year. Additionally, our script volume recovery is progressing and we are benefiting from some favorable cost of goods sold timing. In the International segment, the business is well positioned to extend the second quarter’s very good performance and we are moving past the peak investment period for U.S. Healthcare. COVID vaccinations and testing do remain a wildcard as the FDA has not yet issued guidance on spring boosters. In summary, at the midpoint of the guidance range, we expect second half adjusted EPS growth in the mid-20s.

With that, let me now pass it back to Roz for her closing remarks.

Rosalind Brewer: Thank you, James. Before we kick off Q&A, let me sum up what you’ve heard. We continue to execute against our fiscal 2023 plan with solid first half results broadly in line with our expectations. Our Retail Pharmacy business is performing well, and we are progressing our healthcare business to scale and profitability. We exited the quarter with acceleration in February, adding to our confidence in achieving strong growth ahead. We have good visibility into the back half drivers. As I said earlier, the inflection is here. Our bold strategic actions are working, and I’m very excited for our future. Now I’d like to open the line for questions. Operator?

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Q&A Session

Operator: And your first question comes from the line of Adrian Rice from Credit Suisse.

A.J. Rice : Actually, it’s A.J. Rice. Thanks for taking the call. Obviously, it’s still early days in the integration of VillageMD with CityMD and Summit. But any learnings that you’ve seen positive or challenges in the early days of that integration and maybe articulate a little bit whether there’s any incremental cash needs that you see drawn on Walgreens capabilities, as they build out their growth strategy? And then maybe the other question I’ll just ask quickly would be on the front of store sales. It seems like that’s still hanging in there very well. Are you seeing any impact either in the U.S. or UK from the sluggish economic backdrop? It’s sort of hard to see it, but I wanted to just ask the question.

Rosalind Brewer : Sure. Thank you, A.J. This is Roz. Let me start with — your second question about the front end of store and the recession that we’re seeing, not only in the U.S. but in the UK. So first of all, the U.S. retail comps at 4.5% and that’s excluding our test kits, really show that we’re running pretty strong right now. As you know, we’ve had a lot of work going on with our cost management, and that’s played forward for us. Secondly, the work that we’ve been doing with private label. So we’ve seen some trade down to private label over a period of time, probably about 100 basis points of improvement in our private label business. And then I would also tell you that we are pretty much a convenient place. So as gas prices go up, where that convenient neighborhood access point.

And then lastly, I would tell you, too, that in both our U.S. business and the UK business, we’re seeing our online growth above 30% in many of those areas. So where — people are switching over to online, particularly UK, it is in a deep recession, but we’re pretty proud of the work that going on over there, achieving 16 comp. They’re one of the top players over there selling pretty nicely in personal care and their over-the-counter business. So we’ve been fairly resilient. We did take some time, A.J., to go back and look at ’08 and ’09. And during that time frame, we only saw maybe about a 0.5 percentage point dip and so we think we’re pretty resilient at this point, but cost improvement has helped us the trend towards private label and our online business is helping us kind of weather the storm.

I’m going to turn it over to John to talk a little bit about the VillageMD business.

John Driscoll : Yes. A.J., thanks for the question. I think we’re 90 days into the integration. And I think what it has reinforced is the value of combining Medicare, Medicaid, multi-specialty group, professional services and urgent care in our Village Summit offering. I don’t think there’s any interest — and I don’t think we’re seeing excess cash needs. I think we’ll continue to invest in sensible acquisitions. But actually, what we’re seeing is the opportunity to, I think, drive more cost and growth synergies off of kind of a set of assets that we think could be very impactful, particularly as we concentrate market power with more service offerings in specific markets.

Operator: Your next question comes from the line of George Hill from Deutsche Bank.

George Hill : Yes. I guess, Roz, I would come back to kind of the core pharmacy business. You talked about the acceleration you saw in February. But I guess for the full quarter, it looks like the company is still losing share in pharmacy. So I guess I’d ask kind of talk about trends intra-quarter and maybe even to the grade in which you can, what are you seeing in March? And James, if I can tackle on some housekeeping questions for you. Can you talk about the gains from the cash mobilization program in Germany and the impact of sale leasebacks in the quarter? Just a housekeeping questions.