Walgreens Boots Alliance Inc (WBA) — Q1 2023 Earnings Call Transcript

Good morning. Thank you for joining us for the Walgreens Boots Alliance Earnings Call for the first 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 of Pharmacy and Healthcare at Walgreens will participate in Q&A. Today's call will be approximately 1 hour in length, including Q&A. Let me note that all references to the COVID-19 headwind include U.S. vaccines, drive-thru 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 non-GAAP financial measures that we will discuss today during this call. I will now turn the call over to Roz.

Thanks, Tiffany. And good morning, everyone. WBA entered fiscal 2023 with good momentum, and we delivered a solid start to the year. Sales grew 1% in constant currency or over 3%, excluding the headwind from AllianceRx Walgreens and tailwinds from our new healthcare assets. The decline in adjusted EPS comes against very strong growth of 53% last year and reflects the anticipated headwinds from lapping COVID execution and our investments in the U.S. Healthcare segment and labor. Our core business remains resilient despite historic macro challenges. We are driving healthy retail comp growth on top of record prior year performances. Our script volume growth is on track with plan as our restaffing and marketing initiatives are gaining traction. We made an important announcement on our opioid legal matters in November, reaching an agreement in principle to pay approximately $5.7 billion over 15 years to resolve a substantial majority of our opioid-related litigation brought by states, political subdivisions and tribes. This allows us to move forward and focus on our purpose, helping consumers lead more joyful lives through better health. We are making great progress to accelerate our transformation to healthcare, most notably in the quarter with the VillageMD acquisition of Summit Health. At the same time, we're unlocking value and strengthening the company by simplifying the portfolio. Our execution to date reinforces our confidence in achieving our full year guidance for adjusted EPS of $4.45 to $4.65. We are raising our sales guidance, and we have greater visibility toward the strong 8% to 10% core growth that underpins our results, offsetting the COVID headwind of 16% to 18%. We are quickly scaling U.S. Healthcare with a defined path to achieve profitability exiting this fiscal year. Our strategic actions are working to create sustainable shareholder value as we reimagine local healthcare and wellness for all. We are making progress against each of our four strategic priorities. U.S. and Boots UK retail comp sales were both strong, with the U.S., excluding tobacco, up over 2% on top of almost 12% last year and boots up 9% on top of 16% last year. I am especially pleased with this good performance against a tougher consumer backdrop. The convenience and value that we offer are resonating well, and our initiatives to align the core are driving traffic and margin expansion. Walgreens launched 24 hours same-day delivery, offering the widest range of retail items for around-the-clock delivery across the country. This adds to our broad range of channel access, including 1-hour delivery and 30-minute pickup. The Boots consumer responded very favorably to holiday campaigns and promotions delivering record Black Friday online sales. Boots.com was one of the UK's top 10 most visited retail websites on that day. And we're maintaining price positioning versus competitors and benefiting from inventory availability through our proactive buying ahead of this year's cold, cough and flu season. In the pharmacy, our team members administered over 8 million COVID-19 vaccinations in the quarter against our goal of 16 million for the full year. Walgreens has been a leading contributor to the national pandemic response with the study from the Commonwealth Fund showing that total industry efforts have prevented 18.5 million hospitalizations, saved 3.2 million patient lives and prevented 120 million COVID infections. This adds up to an estimated over $1 trillion in medical cost savings through the U.S. vaccination program. I could not be prouder of our pharmacy team's tireless execution being among the most trusted health resources available. We continue to care for our local communities in countless ways and we are focusing investments to return stores to normal pharmacy operating hours. Pharmacy staffing has been positive nearly every week since mid-July, and we are leveraging our digital platform to reconnect on a personal level with customers. Our efforts are on pace, resulting in over 2% comp script growth excluding immunizations in the quarter, up 220 basis points sequentially. Importantly, we are seeing mid-single-digit growth in stores with normal hours. We have also opened our ninth automated micro fulfillment center, now supporting about 3,000 total stores. These facilities remove routine tasks and excess inventory from the pharmacy supporting our team and the path to script recovery. They give pharmacists more time for services and outreach that drive adherence and improve patient health. Turning to our second strategic priority. This was a landmark quarter for accelerating the build-out of our next growth engine, the U.S. Healthcare segment. We invested $3.5 billion to support VillageMD's acquisition of Summit Health, creating one of the leading independent provider groups in the country. We recognize the critical importance of scale in value-based care delivery and density in attractive markets. This highly strategic transaction expands VillageMD's addressable market with primary care, multi-specialty and urgent care and reinforces our approach across the care continuum. We see meaningful synergy potential over time. The deal is also immediately EPS accretive and accelerates profitability for U.S. Healthcare. We expect to exit fiscal '23 with positive adjusted EBITDA. Shields Health Solutions and CareCentrix continue to perform well, which led to the accelerated acquisition of both entities. Shields closed on December 28, and CareCentrix is scheduled to close in the third quarter of fiscal '23. VillageMD is leading the way in value-based care for the country, with 393 clinics as of year-end, including 200 co-located with Walgreens, achieving the calendar 2022 target. Following the close of the Summit transaction earlier this week, VillageMD now operates over 680 locations across 26 markets. We also exceeded our goal for Health Corners with 112 now versus the 100 we had expected by the end of December. Our healthcare strategy is coming to life through all of our best-in-class assets, which drove a combined 38% pro forma sales growth in the quarter. This growth is funded through actions we continue to take to better align our investment portfolio and simplify the business. In November and December, we unlocked $3 billion in after-tax cash proceeds from the sale of 19 million AmerisourceBergen shares executing with tight discounts and near 52-week highs. We also realized approximately $150 million in proceeds from the sale of our stake in GPC. Lastly, we have a strong team that is fully aligned with our strategy, including a new structure for U.S. Retail Pharmacy and John Driscoll leading U.S. Healthcare. Perhaps most crucially, we are continuing to invest in our people to recruit and retain the very best talent, which is key to providing a superior customer experience. Fiscal '23 includes further investments in our pharmacy team and minimum wage, as previously stated. We're also reinventing the role of the pharmacists through micro fulfillment centers and eliminating task-based metrics, further enabling them to practice at the top of their license while creating a differentiated work environment. Our retail pharmacy business provides the foundation for our leading healthcare assets to deliver value across the full care continuum. We are able to unite digital and physical models to guide consumers through the complex healthcare landscape. We are building the scale and resources to help health plans and patients improve outcomes and lower costs as only Walgreens can do. There are significant opportunities for synergies, allowing us to pursue value-based care and risk arrangements, which will demonstrate the value of an integrated approach. We are focused on expanding our risk business supporting integrated care models, expanding our pharmacy value proposition and driving operational efficiencies. I'm looking forward to sharing more with you ahead. With that, I'll hand it over to James to provide more color on our results and our outlook.

Thank you, Roz, and good morning. In summary, we had a solid start to the fiscal year. Despite the expected headwinds, the first quarter results were broadly in line with our expectations, and we are maintaining our full year EPS outlook. Adjusted EPS of $1.16 declined by 29.9% on a constant currency basis as we were lapping a very strong prior year quarter when we delivered EPS growth of over 53%. The year-over-year decline was mainly due to a 19% headwind from COVID-19, U.S. Healthcare growth investments of 5% and labor investments of 5%. These were partly offset by good retail performance in both the U.S. and International segments and a favorable tax rate. Excluding AllianceRx and U.S. Healthcare M&A, sales grew 3.2% on a constant currency basis. The core business remained resilient in a challenging operating environment. Comparable sales were up 3.8% in the U.S., despite lapping a very strong prior year comp of 7.9%. International sales grew 4.6% led by the UK and Germany. And our U.S. Healthcare business continues to rapidly scale with almost $1 billion of sales in the quarter and growing 38% on a pro forma basis. With the first quarter broadly in line, we are maintaining our full year adjusted EPS guidance of $4.45 to $4.65 with 8% to 10% constant currency core growth offset by a COVID-19 headwind of around 17 percentage points. Our guidance now includes the EPS accretion from Summit Health and dilution from our reduced ownership stake in AmerisourceBergen. We have raised our full year sales guidance by over $3 billion to reflect the closing of the Summit Health transaction, refreshed currency rates and a good start to the year. Let's now look at the results in more detail. Sales of $33 billion rose 1.1% on a constant currency basis, despite an adverse impact of 485 basis points from the anticipated decline at AllianceRx. This headwind will stop after December. Adjusted operating income declined 42% on a constant currency basis due to three factors. Firstly, a much lower contribution from COVID-19 vaccinations and testing led to a negative impact of approximately 20%. Secondly, the U.S. Healthcare adjusted operating loss was $139 million higher in the quarter, with an impact of 8 percentage points. The current quarter includes higher Walgreens Health organic investments and a full quarter of results for VillageMD compared to only 6 days of losses in the prior year quarter. Thirdly, our previously disclosed labor investments in pharmacy staffing and minimum wage are a $100 million headwind, equivalent to 6 percentage points of AOI growth. Adjusted EPS was $1.16, a constant currency decline of 29.9%, due entirely to operating income. This was despite a favorable tax rate which benefited from the release of valuation allowances related to capital losses. GAAP earnings were a loss of $3.7 billion compared to net earnings of $3.6 billion in the year-ago quarter. The current quarter included a $5.2 billion after-tax charge for opioid-related losses, partly offset by a $900 million after-tax gain on the sale of AmerisourceBergen shares. Additionally, we are comparing to a prior year quarter 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. While the U.S. performance was impacted by the anticipated COVID-19 headwinds, we do expect year-on-year performance to improve in the second half as the COVID headwind lessens and initiatives to drive script volume gain traction. Sales decreased 3% in the quarter, but if you exclude the negative impact of Alliance Rx, sales increased by 3%. The comp sales increased 3.8% despite lapping a very strong prior year comp of 7.9%. Adjusted operating income of $1.1 billion declined 35%, broadly in line with our expectations. Headwinds from fewer COVID-19 vaccinations and PCR tests and increased labor investments were partly offset by retail sales growth and gross margin expansion and savings from the Transformational Cost Management Program. Let me now turn to U.S. Pharmacy. Pharmacy sales declined 4%, held back by a 7.8 percentage point headwind from AllianceRx and by significantly lower contributions from COVID-19 vaccinations and testing. Comparable pharmacy sales were up 4.8% despite lapping a solid 6.8% comp last year. The sales growth was favorably impacted by branded drug inflation. Comp scripts were flat. And excluding immunizations, comp scripts were up 2.1%, a sequential improvement of over 200 basis points. We administered 8.4 million COVID-19 vaccinations in the first quarter, down 46% versus the prior year quarter. Flu vaccinations were up versus prior year due to higher flu incidences. Season to-date, we have administered over 9 million flu shots. As expected, pharmacy-adjusted gross profit and gross margin declined in the quarter due to fewer COVID-19 vaccinations, a mix shift to lower margin at-home COVID-19 tests and ongoing reimbursement pressure net of procurement savings. Reimbursement was broadly in line with our expectations and represented a lower level of pressure compared to the prior year. Turning next to our U.S. Retail business. We saw good retail performance in the quarter with continued growth in both sales and margin. Retail comp sales increased 1.4% despite lapping a very strong 10.6% comp in the prior year quarter. Excluding tobacco, comps were up 2.1%. And on a 2-year stack basis, comp sales growth was 13.8%. We benefited from a 220 basis point tailwind from cough, cold, flu. However, this was largely offset by a 170 basis point headwind from lower sales of at-home COVID-19 tests. Comp sales were led by 4.9% growth in Beauty and a 2.9% increase in consumables and general merchandise. Both categories benefited from own brand offerings and decisions to invest early in inventory availability. We delivered another quarter of strong retail gross margin performance, reflecting effective margin management, including strategic pricing and promotional optimization and favorable shrink trends. Turning next to the International segment, and I'll talk to constant currency numbers. Sales increased 4.6%, with growth across all international markets. Boots UK was up 4.3% and Germany wholesale grew 4.2%. Adjusted operating income was $116 million, down 20% versus prior year. Strong UK retail sales and good operational execution in the Germany wholesale business were offset by lower demand for COVID-19 pharmacy services in the UK, the adverse gross margin impact of NHS pharmacy funding and the expiration of temporary rental reductions received in the prior year. On a combined basis, these three items had an impact of around 27 percentage points. Looking forward, we do expect the International segment to return to strong profit growth in the second quarter. Early indications show that Boots had a strong Christmas season with comp sales growth of around 15%. Key categories, including gifting, beauty and fragrance performed extremely well along with an uptick in OTC, cold and immunity categories. Let's now look in more detail at Boots UK. Boots UK sales growth of 4% was led by continued strong retail performance. Comparable retail sales advanced 8.7% and this is coming on top of a 16% comp growth in the year-ago quarter. Footfall grew 8% with flagship and travel locations again showing robust improvement. Foods continued to gain market share with personal care and health and wellness performing particularly well. Comparable pharmacy sales declined 0.9% reflecting lower demand for COVID-19 services. Boots.com continues its strong performance with sales more than doubling versus the pre-COVID period. Approximately 18% of our UK retail sales came from Boots.com in the quarter, which compares to roughly 9% in the equivalent pre-COVID quarter. November was a very strong month with Black Friday being our biggest ever online event. Turning next to U.S. Healthcare. We are very excited about developments in our U.S. Healthcare segment as the business continues to rapidly scale. Sales were almost $1 billion in the quarter compared to only $50 million in the year-ago quarter, pro forma combined sales growth of 38% compared to 34% in the fourth quarter of fiscal '22. VillageMD had sales of $550 million, advancing 49% on a pro forma basis, with growth driven by existing clinic growth and expansion of the clinic footprint. Shields again showed very strong growth with sales of over $100 million and pro forma growth of 44%, driven by recent contract wins, further expansion of existing partnerships and strong executional focus. In its first full quarter, CareCentrix delivered sales of over $330 million. Pro forma sales growth was 22%. Segment adjusted operating income was a loss of $152 million. This was flat sequentially and compares to a loss of only $13 million in the year-ago quarter. Adjusted EBITDA was a loss of $124 million in the quarter compared to a loss of $11 million in the prior year. The year-over-year increase in losses largely reflects a full quarter of VillageMD in the current year versus 6 days in the prior year quarter and higher Walgreens Health organic investments. These headwinds more than offset positive profit contributions from Shields and CareCentrix. Let's now look at some of the key metrics for U.S. Healthcare. As Roz mentioned earlier, VillageMD ended the calendar year with 393 clinics, including 200 clinics co-located with Walgreens. This was in line with our target. VillageMD had 440,000 value-based patients at quarter end, up 46% from 300,000 at the end of the prior year quarter. At quarter end, the Walgreens Health organic business had 2.9 million contracted lives, up from 2.3 million at the end of the fourth quarter as existing payers added new lines of business. We exceeded our original goal of 2 million lives. As we scale our access to lives and add new partners, we will continue to build out our Walgreens Health Corners. We ended the quarter with 112 Health Corners ahead of our goal of 100. Health Corners play an important role in engaging patients, addressing care gaps and improving health outcomes. In summary, we performed strongly against our key objectives and we are well positioned for future success in the coming year. The addition of Summit Health will further enhance our portfolio of leading assets across the care continuum, drive meaningful synergy opportunities and accelerate the path to profitability. Turning next to cash flow. We generated almost $0.5 billion of operating cash flow in the first quarter, while free cash flow was negative $117 million. Operating cash flow was negatively impacted by increased inventories, including successful advance pays to secure product availability in the U.S. and UK holiday seasons. The year-over-year decline in free cash flow was due to lower earnings, some phasing of working capital and increased capital expenditures related to growth initiatives, including the VillageMD footprint expansion, the rollout of micro fulfillment centers and digital and omnichannel investments. Turning now to guidance. Overall, we are confirming our full year EPS guidance. The guidance now incorporates EPS accretion from the recently closed Summit Health transaction and this offsets the dilution from our reduced ownership stake in AmerisourceBergen. Our projection for the total number of COVID-19 vaccinations is unchanged. But we do now expect a slightly greater headwind from COVID-19 testing due to a demand shift from drive-thru testing to lower margin at-home tests. This has had a negative impact of roughly 1 percentage point of EPS. Currency rates are somewhat favorable, and this has reduced the year-on-year currency headwind from 2% to 1%. Excluding these items, we continue to project core business growth of 8% to 10%. In terms of phasing, at the midpoint of our guidance, we see a balanced 50-50 cadence between the first half and second half versus our original expectations. This assumes a shift of COVID-19 vaccinations from the second quarter into the third quarter with an impact of approximately $0.09. Second quarter earnings growth will continue to be adversely impacted by the ongoing headwind from COVID-19, continued investments in U.S. Healthcare and labor and the higher tax rate. In the second half of the year, EPS will grow around 30% with good visibility into the key drivers. Firstly, we expect significant second half momentum in U.S. Retail Pharmacy, including ongoing script recovery as we normalize store operations and implement marketing win-back initiatives; favorable trends in reimbursement net of procurement, lower levels of shrink and continued strong retail performance. Additionally, while COVID-19 will remain a headwind in the second half of the year, it will be a lot lower. And we expect an impact that is less than 50% of what we saw in the first half of the year. Secondly, International has delivered a strong Christmas trading period, and we expect to see strong ongoing performance through the balance of the year. Our international business, particularly in the UK, has emerged in a competitively strengthened position and is well positioned for growth. Finally, the first half of the year is the peak investment period for U.S. Healthcare. And consistent with prior guidance, we expect the segment to achieve positive adjusted EBITDA exiting the year. The overall segment will flip from being a headwind in the first half to a significant mid-teens EPS tailwind. Let me now provide some additional detail around our segment sales and profit assumptions. We are raising our WBA sales guidance by $3 billion to $3.5 billion. The increase is driven by VillageMD's acquisition of Summit Health, refreshed currencies and better-than-expected sales in the first quarter. Adjusted operating income is unchanged at $4.7 billion to $4.9 billion. The acquisition of Summit is offset by a lower contribution from AmerisourceBergen as we reduced our ownership stake. For U.S. Retail Pharmacy, we have raised our sales guidance by $500 million due to a better-than-expected first quarter, which benefited from brand inflation and broad-based retail strength. The AOI range is lowered by $150 million to reflect the sale of the AmerisourceBergen shares in November and December. These actions have reduced our stake from around 26% to 17%. We have raised our guidance for the International segment to reflect a lower headwind from currencies. We now expect sales of $21.2 billion to $21.7 billion up $800 million versus the prior range. We are also raising our AOI forecast to $870 million to $900 million. For the U.S. Healthcare segment, we expect sales of $6.5 billion to $7.3 billion and an adjusted EBITDA range from a loss of $50 million to positive $25 million. Both of these are consistent with the goals we provided when the Summit Health transaction was announced in November. We continue to expect to exit fiscal '23 with positive adjusted EBITDA for the U.S. Healthcare segment. Moving on to our corporate assumptions. The full year tax rate is unchanged at around 16%. Interest expense is expected to be $560 million to $580 million, an increase of $70 million to $80 million compared to prior guidance, and this is mostly due to the Summit transaction. We are raising our forecast for equity method investments and non-controlling interest with the combined range increasing by nearly $100 million versus our prior guidance. This reflects the Summit Health transaction and the acceleration of the full acquisitions of Shields and CareCentrix. In summary, we are raising our fiscal year '23 sales guidance for WBA and we are confirming our full year EPS guidance.

Thank you, James. Before we kick off Q&A, let me sum up what you've heard. We are executing against our fiscal 2023 plans with solid first quarter results reported today, broadly in line with our expectations. We performed well against our record levels of growth in the first quarter last year. Our core business is resilient, and we are accelerating our healthcare transformation with a well-defined path to profitability exiting this year. Given our first quarter execution and the Summit Health acquisition, we are raising full year sales guidance, and I'm comfortable reconfirming our adjusted EPS guidance. Our strategy is working. And we will be relentless in driving continued progress ahead. I remain confident in our future growth potential, enabled through our bold investments today and the long-term sustainable value that WBA can create for our customers, our partners, our people and our shareholders. Now I'd like to open the line for questions.

This is Lucas on for Charles. I wanted to talk about script recovery and the investments to return stores to normal hours. I wanted to ask and see how script recovery has gone for the locations that you've returned to normal hours. And how those have trended versus your expectations going into it? And then on the $100 million in investments in Q1, that's close to 40% of the $265 million that you guys guided for fiscal '23. I want to understand if we should expect the rest of that investment to come be front-loaded in the first half? And then how the timing of that investment will impact script recovery as we move throughout the year.

Thank you for your question. I’ll begin, and Rick Gates from our pharmacy operations is here with us to help with the answers, and we will include James if necessary. To start with our script recovery, it begins with the investment we have made in our labor position. Last quarter, we announced our commitment to improving our pharmacy positions. With these investments, our applications have increased by approximately 23%, and we are nearing 40% in accepted offers. We believe our brand remains strong, and our focus on recruiting pharmacists to our stores is yielding results. Furthermore, stores operating without reduced hours had Q1 prescription comp trends, excluding immunizations, in the mid-single digits, showing a 9 percentage point improvement compared to stores with limited hours. We are optimistic about our progress. We are enhancing recruiting efforts with new incentive policies and utilizing our micro fulfillment capacity, leading to better engagement among pharmacists in our stores. We have seen a net gain of around 600 new pharmacists joining Walgreens, particularly in some of our more challenging markets, which we are prioritizing for pharmacy recovery. We are implementing marketing incentives on a one-to-one basis to reengage consumers back to the store, which reinforces our confidence in our direction. These labor investments have been essential for our progress, and we are pleased with the developments we are seeing. Additionally, we are noticing a favorable balance between maintenance scripts and ongoing scripts. We are confident that this is not a long-term concern, as we are successfully reintroducing pharmacists into stores and reopening them appropriately.

Yes, to clarify your question about the timing of the payroll investment spending, the $100 million we mentioned includes both minimum wage and pharmacy investments. This amount represents approximately 19% to 20% of our total for the year. It's worth noting that the full-year pharmacy investment was $265 million, and we also communicated a minimum wage investment of $260 million. Is that clear?

Maybe just to talk a little bit about capital priorities. And if there's any updated thoughts, obviously, with VillageMD, closing Summit? There's discussion about synergies, and you talked a little bit about updated growth objectives there. Can you just comment on how you sort of see the cash flow needs laying out, if there's any updated thinking and priorities?

Yes. Just I think from the point of view of funding, we've basically announced anything we intend to do in the short term. So we disposed of ABC, our partial stake in ABC and we raised that to fund the $3.5 billion transaction. We raised about $1 billion. And this puts us in a fairly comfortable place with the rating agencies. Looking at some of it, it's too early to say because, frankly, you can't get involved until the deal closes. So Village and Summit will be moving very, very quickly on the integration and synergies. As Roz pointed out in her material, we have pretty good line of sight to about $150 million of synergies. The cost synergies, we would go after very rapidly. That's about 40% and 60%, which is coming from migration of risk, will be over a longer period of time. There were some items not captured in there. For example, we haven't made any assumptions on synergy between Walgreens stores and Summit locations. So there's probably a fair amount of upside to the $150 million. I don't know, A.J., does that answer your question? By the way, we're not considering any M&A type activity in the short term. We're taking a pause. We need to focus on integration activities.

So that was the one other thing is you had talked previously about maybe another leg to the Walgreens Health story over time. So that's not a short-term priority. That's a longer-term thing once we get clarity on how all the integration is going with VillageMD and Summit.

I think it still is a priority in the short and medium term, but I think the scale of the acquisition won't even trigger on your radar. So we're more likely to buy smaller companies with specific, call it, capabilities that we need to advance our organic business. So we're not going to go out and do a $2 billion or $3 billion acquisition on a health tech company, we're likely to be very targeted, and it will be in the hundreds of millions, not in the billions.

Also, James, I know that you guys don't provide quarterly guidance, but could you maybe talk a little bit about expectations for cadence this quarter had a good portion of COVID and COVID pull forward into it. Fiscal Q2 seems like it's going to be a little bit below The Street. And maybe the question to focus on here is kind of what inflects the most as you think about the back half of the year? And if we think about earnings risk, like maybe talk about the biggest points of inflection, which we would see as the biggest points of risk.

Yes, that’s an unexpected question. I want to start by providing some context regarding the first quarter because there’s a perception that it was overly reliant on the tax rate. As we review our internal budget, we actually performed $0.01 better, with only $0.03 attributed to tax. The tax upside we forecasted for the full year, which is 16%, remains intact, and we had already anticipated this tax rate for the quarter. The $0.03 improvement was positive, but we experienced a $0.04 shortfall in our operating business, all of which stemmed from international operations. To be candid, it was a planning error. They did not accurately forecast the reimbursement timing from the NHS, leading to a short-term margin issue. I want to reassure everyone that we expect a strong rebound in profit growth in the International segment for the second quarter. Relative to market expectations, we anticipated $0.03 from tax. So, while the $0.04 beat might suggest it was entirely driven by tax, the core business was on track. The only surprise was in the international sector, which was more about planning than execution. I want to highlight that we excelled during the Black Thursday events in the UK, where we generate 40% of our profits in December. Growth in December was 15% in front-of-store sales, accounting for 70%. Now, regarding your main question about the performance comparison between the first and second halves, we looked ahead to the second quarter, and based on market consensus, which felt a bit inflated, the primary factor for that was a shift currently happening. Vaccinations and booster shots have slowed, causing a slight movement of revenue from Q2 to Q3, which impacts us by about $0.09. That’s the only adjustment we’re making to our original outlook for the first half. I want to be very clear about this. When analyzing performance against consensus models—which we do quite regularly—our actual gross profit for the quarter exceeded consensus by $60 million and was $94 million higher than FactSet estimates. The disconnect we’re observing appears to be in SG&A, where currency fluctuations and labor investment strategies have influenced the outlook. We recognize that we need to communicate more clearly about SG&A on a quarterly basis. We feel that operationally, most aspects of the business are on track as we exit the quarter, especially since the U.S. business outperformed the budget. Looking at the first and second halves, we’ve concluded that it’s a 50-50 split, suggesting the first half will see EPS decline by roughly 28% to 30%, primarily due to COVID, labor investments, and healthcare costs. This narrative remains consistent for the second quarter, aligning with our original guidance. To address your inquiry about the key drivers differentiating the first half from the second half, vaccinations and testing have contributed a headwind of 20 to 21 percentage points in the first half, which will decline to below 10% in the second half, presenting an improvement of about 11 to 12 percentage points. The healthcare sector is another significant factor; in the first half, it negatively impacted income in the low single digits, while we expect it to boost EPS around mid-teens, approximately 15%. The transition between the first and second halves shows 11 to 12 points of improvement from COVID and around 15 to 18 points from healthcare. Additionally, while we haven’t provided extensive guidance on reimbursement, we anticipate that by the second half of the year—given that around 95% of contracts are closed—reimbursement will be less than 50%. This translates to a tailwind of approximately $350 million in the second half. Consequently, compared to the first half, we expect around 14 percentage points of growth due to reimbursement timing. Volume will also significantly increase in the second half, particularly within pharmacy, where volume contributions are expected to triple compared to the first half, largely due to later marketing programs, contributing about another $200 million, which equates to around 8 points of growth. This indicates a notable shift in the pharmacy business trajectory between the first and second halves. Finally, although we achieved solid gross profit this quarter, pharmacy margins were lower than anticipated due to timing issues with the cost of goods sold, which should balance out in the remainder of the year. We’re observing a challenging start in quarter one due to significant costs concentrated in the first half, while the second half shows promise with reimbursement, volume growth in pharmacy, and favorable cost of goods sold dynamics, which collectively represent substantial figures. We’re anticipating considerable growth in the U.S. business during the second half, and I want to reiterate that the international business will also exhibit similar trends. I may have provided too much detail, but I hope this gives you the insights you need.

Maybe to piggyback just off of that last question, thanks for all the details there. Could you specifically comment on some of the other things you called out in terms of shrink the strong retail performance? And then also what your expectations are for cold, cough and flu given some of the product shortages we've been hearing about?

Yes, I believe the shrink is accounted for in the forecast. We may have overreacted last year when we were reaching numbers that represented 3.5% of sales. Now, we are down to the lower 2s, around 2.5% to 2.6%, and it has stabilized. We have invested significantly in security measures in the stores during the first quarter, and we might have gone overboard with that investment, so we may scale back a bit. We are now focusing more on law enforcement instead of relying on security companies, which have proven to be mostly ineffective. Therefore, we are allocating more resources to reduce shrink, and we are pleased with our current position, which is around 2.5% to 2.6%, significantly lower than last year's levels. We have a good outlook on new programs being implemented. Regarding the second part of your question about cough, cold, and flu, we did experience a boost from this category in the quarter. The comps showed that cough, cold, and flu contributed about 220 basis points. However, the COVID OTC tests posed a headwind of 170 basis points. In fact, if you disregard the fluctuations caused by these factors, the business is performing at around a 2% comp. Looking back at the guidance we provided three months ago, we indicated we expected the retail business to achieve a 2% to 3% comp excluding COVID. Although we noted some weaknesses in other categories, our strong performance in the first quarter was due to aggressive inventory levels and our positioning in cough, cold, and flu, where we have gained market share. There is potential for further gain this year from cough, cold, and flu, but it’s too early to predict the second quarter. We have observed a slight slowdown in recent weeks, although flu vaccinations are still up about 9% to 10% compared to last year, so we do not foresee any issues in that area. While cough, cold, and flu have provided us with a boost, they were offset by some pharmacy cost items I mentioned, which will diminish in the second half.

I'm going to take it more from a strategic standpoint. So when I think about your U.S. Healthcare business and Summit, CityMD as well as VillageMD. Can you maybe just spend a minute and talk about how you think about them, integrating and fitting together. As I understand it, both Summit and CityMD today are primarily fee-for-service. I think the reason that VillageMD was at a loss is that they have at-risk lives. So as you think about this over the next few years, is the goal to move more people onto the platform from an at-risk perspective. Where do you see those opportunities? Summit is in a single market. Do you think you can replicate some of that multispecialty and other markets? James I know you did some numbers around some of the synergies. But just more conceptually, I want to try to understand how you're viewing this going forward?

Yes. I believe I touched on this earlier. There are two aspects to consider. The first is relatively straightforward, while the second is more challenging. The easier aspect pertains to VillageMD's capabilities in value-based care. Currently, they manage around 440,000 patients within a value-based framework out of approximately 1.6 million total patients, indicating their ongoing growth. Of those 440,000, 125,000 are fully at risk, meaning they have complete delegated risk from the insurance provider. VillageMD aims to expand both the number of fully at-risk patients and increase the proportion of value-based care patients relative to the total patient count. It's crucial to highlight the importance of having commercial patients, as they are essential for covering expenses and enable effective procurement and negotiation in local markets. From a strategic standpoint, there is a noticeable shift compared to a year ago; Village has decided to focus on scaling in fewer markets, highlighting the significance of local presence. This strategy is why the acquisition of Summit and CityMD was appealing. Village will likely operate its businesses somewhat independently for some time while transferring value-based care management to Summit Health, which in turn will increase its at-risk patient population. The second aspect is more intricate. The strength of the Summit model lies in its multi-specialty and primary care physician businesses, which can facilitate patient referrals between the two sectors. If they take on risk, they can manage a larger portion of the overall cost of care, given the high costs associated with specialty care. Unlike Village, which outsources to local providers, Summit can utilize its own providers to control care costs more directly, potentially yielding higher returns on at-risk patients. The challenge lies in integrating the multispecialty services into Village practices. The Village team is exploring more extensive primary care physician practices that include multi-specialty activities and testing. I expect the shift towards value-based care to occur within the current contract year. However, advancing the multispecialty integration will likely span five years, requiring investment to restructure local practices. This presents an exciting opportunity, as none of the multispecialty potential or synergies between Walgreens and Summit were factored into the projections shared with the market last November. Therefore, we see significant growth potential ahead.

I know you know there's a lot of debate on The Street of the company's ability to gain back that 30 million of scripts that is embedded in guidance. And I know some of that 30 million scripts is just regaining market share, of stores closed, hiring pharmacies. But I know Summit also is just regaining like people that haven't left Walgreens that maybe have been compliant to therapy and pharmacists during COVID due to the basic blocking and tackling. And to me, that feels like an easier get than bringing someone back to Walgreens. So could you let us know how much of that 30 million maybe break it down, what is actually having people come back to a Walgreens versus what is versus people being more compliant to therapy? And secondly, your free cash flow was negative. Can you give us any type of free cash flow guidance for the year? That would be great.

James, why don't we start with the free cash flow? And then, Rick, just go into the detail around the script performance on the core script business.

Yes, we're not going to give guidance on the full year. Honestly, we're still working through some of the implications of the Summit acquisition. But I think you'll see some progress year-on-year on an absolute basis. The first quarter is traditionally quite weak as a start in the company. So I wouldn't get very concerned by it. We are looking carefully at the investments in the rest of the business and to optimize cash flow for the rest of the year. But we're not going to start giving guidance on that.

This is Rick. To discuss the 5% script growth, there are several foundational elements involved. You are right; market growth is the initial component. Following that, adherence and services play a significant role in the programs we have invested in. This aspect is crucial for our ongoing script growth. The third factor is our marketing win-back plans, which are reliant on staffing, and then core staffing and the reopening of store hours form the fourth element. As we look at the progression of scripts and their anticipated growth in the second half of the year, Roz has mentioned the hiring aspects extensively, but there is a timeline involved. We need to hire, train our pharmacists properly, and then fully reopen our stores to the previous operating hours before we can fully implement the win-back program. Therefore, the growth of scripts will experience a timing factor that will contribute to a significant increase in the second half of the year.

I guess one just quick clean-up question and one broader one. First, on the clean-up side, is it possible if you could give us the after-tax proceeds from sale-leaseback transactions for the quarter? That would be great. And then maybe on the international side, I understand the success that you've had on the various different holiday items for the UK. But can you give us a sense whether it's FX oriented beyond that, how to think about the confidence level you have in raising the adjusted OI for segment for the year and all the moving pieces beyond simply the contribution that you got from the Black Friday, Black Thursday, I apologize if I missed a couple of the holidays there, James.

Yes. I'm looking at the sale and leaseback which I believe was around 170 pre-tax. I don't have an after-tax figure. However, on a cash tax basis, we don't incur much tax on this due to capital allowances and capital losses. In the UK, we made a technical update to account for currencies, meaning that if there are future currency changes, we would adjust accordingly. I have a high level of confidence in the base forecast for the international business. Given that our December performance surpassed expectations with 15% growth, and since 40% of our profit comes from December, this significantly reduces the risk in the international forecast. While it's important not to assume anything is guaranteed, I believe the international figures are fairly secure. Additionally, regarding the 5% script growth rate that everyone seems to be focused on, half of that growth comes from marketing programs related to store reopenings, while the other half stems from market growth, adherence programs, and other factors. There's potential for us to exceed expectations in some of these areas, which could mitigate some perceived risks. Moreover, to give some context, the shift in procurement direction amounts to $350 million, with a volume change of 200. If we're considering what will have the most significant impact in the second half versus the first half, it's primarily reimbursement and changes in the cost of goods sold, along with volume in the pharmacy sector. While these are important, we have a clear understanding of the reimbursement landscape and a good grasp on the cost of goods sold, coupled with active programs for script volumes. I wanted to touch on that to address your previous question.

First of all, thank you, everyone, for joining us this quarter. We'll conclude our Q&A but I want to end briefly by just recapping the main points that you heard from us today and then touch again on some of your questions. First of all, we have had a solid start to the year. Our results are broadly in line with expectations and our underlying sales growth is over 3% despite the tough environment we've all been in. Secondly, our core business is resilient, the convenience and value that we're offering customers continue to resonate as we cycle from the COVID surge. And it reminds us every day that our brand remains strong and our customers are very loyal to us. Thirdly, our healthcare growth engine is showing great progress. We've closed and accelerated major acquisitions, and this segment is expected to exit fiscal '23 with positive adjusted EBITDA so we're investing to grow in a very difficult time frame but we remain committed to our strategy. Fourthly, we're optimizing our portfolio. So our shares in AmerisourceBergen were sold with tight discounts and near 52-week highs, and we continue to have significant access to capital. And lastly, we're maintaining guidance for the fiscal year, while controlling costs and investing to grow to deliver our long-term sustainable value for all of you on this call. So thanks again for your support, and we wish you all a very Happy New Year. Thank you.