Walgreens Boots Alliance Inc (WBA) — Q2 2023 Earnings Call Transcript

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.

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. 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.

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. 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 masked 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 virus 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, 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, 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.

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.

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 drawing 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.

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, we're 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 is 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.

Yes, A.J., thank you for your question. We are now 90 days into the integration process, and it has highlighted the benefits of merging Medicare, Medicaid, multi-specialty groups, professional services, and urgent care in our Village Summit offering. We don't anticipate any significant cash needs at this time. We plan to continue making thoughtful acquisitions. However, we see the potential to enhance cost and growth synergies from our diverse assets, which could be very significant as we enhance our market presence with a broader range of services in targeted markets.

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 question.

Yes, I can't share too much about March, but I can tell you that we had a strong exit rate from the second quarter, with February performing better than December and January. Additionally, in our script comp business, we've managed to return 500 stores to normal operating hours. We've also seen a 6% improvement in our normal operating stores, and there's potential for us to enhance this further through better execution. We're leveraging the momentum in our well-performing stores, and we're actively working on inventory management and operational efficiency on a daily basis. We believe we are progressing positively in this area. Rick, do you have anything to add regarding scripts?

Yes, George, I would just say we bucketed in three different areas as we look at kind of acceleration in the second half. The first is staffing. I don't know if we talked about quite a bit and the improvements we're making in staffing, so they can get our stores reopened. Roz talked about operations in stores and those stores that are opened are much stronger obviously than those that we're bringing back online, and we're continuing to work to obviously accelerate the performance of our stores that are at full hours. The third area, I think you're going to see us work really hard at is integration with U.S. Healthcare. So how do we work with our assets like VillageMD and Shield and others to really optimize scripts recapture and those types of opportunities. So I would just say, in summary, the focus really is on execution of operations, optimizing our store hours by market, to really win back patients and improve our shares. So I think we have a lot going on in the second half that should help us continue the trend.

Yes. And George, let me just cover the sale and leaseback. But before I do, maybe just a bit of context. First of all, we believe we delivered a good in-line quarter with decent quality, and this gives us the confidence to confirm the full-year guidance. And just to point out the key stat is the EPS was down 25.8%, and 26 points is due to COVID. As we look at the sale and leaseback, the program in the U.S. has contributed an incremental year-on-year net benefit of $0.03. And on a full-year basis, as we've said before, it will be flat. On a full year, there'll be no incremental benefit. So this is kind of timing within the quarters. The one thing that stands out a little this quarter is a cash mobilization program in Germany, as we harmonize warehouses with an acquisition from more than 12 months ago, and that contributed $0.09. But as I mentioned in the prepared comments, these combined $0.12 are completely offset by other onetime type items going in a different direction. I pointed out that ABC sale of the stock, which cost us $0.05 year-on-year. Some prior year benefits in the UK unit relating to COVID, which was $0.03, and obviously, then we mentioned ForEx and asset impairment. So the way we look at it, we have this sale and leaseback $0.12 and an offsetting $0.12. So we had decent quality in the quarter on onetime items. So just in summary, this gave us the confidence because we're pretty much in line with good quality. It gave us the confidence to maintain full-year guidance.

I was wondering if you could comment a little bit more on the payroll investments that you talked about in the U.S. Is that still sort of tracking towards the $525 million that you guys guided to initially? And is there any kind of reaction to some of the other retailers have moved up to $18 now? I just wanted to see if that was something that was helpful. And then secondly, can you talk about what the main drivers are for Summit EBITDA as you think about the back half of the year?

I'll start off with your question on labor. So we've continued to make progress. A lot of our labor investments came in, in the form of two areas. And so as a reminder, we did go to $15 an hour, and that's spreading out over a period of time at our hourly rate. And then we also made the investment to regain the pharmacy talent in our stores. And it's working for us. Right now, we don't see any advanced needs in that area to move on labor any further. A couple of things that we've learned in this process is we're closing the shortage by adjusting our pay practices and it's allowing us to return some of our operating hours in there. So what I would say to you is that we're steady in this position and don't have plans to take any further increases in that area.

We appreciate your question about Summit. While we won't provide specific guidance on individual units, we're optimistic about Summit's strong performance in the second half of the year. Notably, we have four new businesses coming on board that weren't fully included in our previous forecasts. These include two acquisitions from the end of fiscal '21, NJU and Westmed, and we are currently working to realize the revenue and cost synergies from these acquisitions. Additionally, a new lab opened at the end of '22, which is now the largest private lab in the U.S., and will significantly contribute to our growth in the latter half of the year. We also recently acquired Starling, a substantial multi-specialty practice that is expected to enhance both revenue and EBITDA in the second half. The only negative impact we noticed was in January due to a lower incidence of virus cases, which affected our OTC business and slowed traffic at CityMD. Despite this, Summit's multi-specialty and primary care physician businesses are performing well, and we are confident about the outlook for the second half. John, do you have anything to add?

I think you took all the revenue and profit drivers, in good shape.

Yes. Maybe I know there's been a lot of recent discussions on the impact of changes in Medicare around the scoring, coding of CMS moves to ICD-10 from ICD-9. Have you guys done an analysis here at the VillageMD and Summit in regards to this? Because I know that on a relative basis, the states like Florida have the most risk. And so maybe can you remind us what your geographic mix locations generally? And what percent of VillageMD Summit’s mix is Medicare?

Thank you for the question. Regarding the geographic reach, we currently have a relatively small and early-stage presence in Florida, leading to low exposure in that area. Concerning risk adjustment and rate changes, we are closely monitoring the situation. However, it would be too early to discuss specifics since the final rule has not been released yet, and we are uncertain how the health plans will adjust their benefit designs. Nevertheless, considering our positioning and the various strategies we can employ, we are cautiously optimistic about managing the anticipated changes. We need to wait for the information coming out on April 4. As for Florida, our exposure there is minimal.

James, I wanted to just start with how should I think about margins in the U.S. Retail business on a go-forward basis? So if I look at the margin this quarter, I know there's like puts and takes, and you talked about growth rates and what's happening with COVID, et cetera. But how do we think about a sustainable margin, one, in that business? And two, do you have a longer-term goal of what you'd like the margin to look like? And then just secondly, John, I wanted to follow up to your comments on VillageMD as you think about capitated relationships. I think that James earlier talked about 177,000 fully at-risk MA lives. And I understand we'll wait for the floors and see what the potential is there. But can you maybe just talk about vintages or what you're seeing right now around the profitability of some of those MA lives as we move into the back half of this year and going forward? Are there any key things that we should be looking at or thinking about for moving those members to profitability?

Let me address the first question regarding margins. Some of this relates back to the JPMorgan Conference, where we discussed the differences between the first half and the second half of the year. You'll remember that we mentioned the U.S. pharmacy's reimbursement and cost of goods sold, both of which are expected to be a much smaller challenge in the second half compared to the first half. Therefore, I wouldn't consider the first half margins to be indicative of the entire year. There will be a significant difference between the first and second halves. Regarding long-term margins, if you look at our Retail performance over the past eight quarters, we've consistently grown both same-store sales and margins. We believe we're still in the early stages because we have not yet fully leveraged the potential of the Walgreens brand and our own-label offerings, aiming for a penetration rate in the low 20s, while currently at 16%. This will support margin growth in the long run. Additionally, we've made progress in strategic margin management through effective promotions and selective pricing adjustments in stores, which we expect to continue as a lever going forward. We anticipate positive gross margin gains in the front-end business, which has already seen significant improvement over the last eight quarters. The pharmacy sector faces different challenges, particularly surrounding reimbursement pressure. As we mentioned at your conference, reimbursement in 2023 is about 85% of what it was last year. The negotiation landscape is more focused on health outcomes and the value we can deliver to payers by reducing overall costs, rather than on the exact reimbursement numbers. While it's too soon to declare any success, it's worth noting that this year presents a lower level of reimbursement pressure compared to the previous year, and we are observing some encouraging indicators for the future. Rick, would you like to add your thoughts?

Yes. I want to share a couple of data points regarding the second half before addressing your initial question. Lisa, about 98% of our contracts are secured for the calendar year 2023, and we have strong visibility on reimbursements that align with our expectations. We're optimistic about what we're observing in this area. We're consistently pursuing ways to enhance procurement savings, boost volume, and improve pharmacy services, which will help offset our margins and will continue into the second half. Additionally, we're focusing on pay-for-performance contracts, engaging in adherence-based programs that aim to meet the needs of both our organization and our payers, resulting in improved outcomes, as James mentioned. We're seeing significant improvements in our store performance and our effectiveness in meeting these contracts, which should translate to pay-for-performance advantages for us as well. So...

Yes, Lisa, Rick brings up a good point. I would characterize the second quarter as being especially weak in terms of generic procurement savings, and there will be more strength in the second half. And this we covered in this first half versus second half bridge back at your conference.

Just, Lisa, on the Village question, the Village model works, and we've seen it work with some of the legacy businesses in multiple geographies. I think what you'll see us do the bless and learn is perhaps concentrate our growth and our investments in specific markets where we can be hyper-relevant in a concentrated geography. But we're confident, and we don't see any challenges to the actual model of what we're delivering for patients and with providers in those markets. So the trends are positive. The one thing that I think you'll see us do is really focus our investments so that we can get more of a return on that in specific markets where we can be particularly relevant.

A question on International. Just trying to sort through a couple of moving parts here. And I think beyond real estate, and NHS, I would love to hear your views on what the underlying business is running today? And a little bit more on where the NHS benefit or detriment fell in Q1, Q2 versus the second half and expectations for second half normalized growth rates?

We believe they had a very strong second quarter. If we exclude the real estate and one-time items, last year included some one-time advantages, such as a government adjustment related to COVID services and rental contracts we negotiated and didn’t pay out last year, which we are now seeing this year. In the UK, revenue increased by 16%, with a 22% comparison to last year. Any business achieving teen revenue growth is essentially a moneymaking machine, especially in a UK market that is quite depressed. This growth comes from the fact that, when looking back to before COVID, the UK business gained between 200 to 300 basis points of market share depending on the category. This demonstrates our execution capabilities. Among the top retailers in the UK, which includes Aldi and Lidl, Boots is performing the best, particularly as a premium retailer. We have a strong brand franchise. Looking ahead, we might not see as much growth in the upcoming periods because we are comparing against an Omicron period, but we do anticipate continued strong revenue growth from the retail sector, sustained market share, and margin stability. I don’t expect margin expansion in the UK at this time. The UK business benefits from a strong brand presence and is likely the leading player in beauty and personal care there. We’ve also boosted our online presence to 15% penetration, compared to 9% before COVID. Overall, the company is much stronger now than it was at the onset of COVID, and we feel positive about the future. Does that answer your question, Eric? Regarding the NHS, I didn't catch your earlier point about it. We didn't observe any changes in NHS timing or margins between the first half of last year and don't anticipate any negatives moving forward. However, it's important to highlight that our primary business in the UK is retail. The pharmacy sector is limited by NHS regulations, which cap overall pharmacy spending, leaving the profit pool stagnant. To increase profitability in the pharmacy sector, we need to focus on providing value-added services to the NHS rather than relying solely on prescriptions. It’s a challenging situation, but our services business is experiencing significantly faster growth compared to the traditional prescription business in the UK.

This is Austin on for Justin. Just real quickly turning to kind of the store footprint and this return to normalized operating hours. You guys called out 1,900 kind of incremental stores that you're still targeting. Wondering kind of underpinned in the full year guide. Like is there an assumption that you guys clear through the rest of those, or sort of a target number by year-end to sort of return? And do you feel like the level of investment at this point is adequate there or any need to revisit that?

Yes. Rick, why don't you take that?

Yes. So the 1,900 is where we came out of Q2, obviously, we've continued to make progress as we've started into Q3 as well. I think as you look at the second half, we have to understand kind of the exiting rate for the year on short hours. We don't believe we're going to get through all of the stores by the end of year-end. And so I would say that the expectation should be that we will still have a subset of stores that are still on short hours exiting the year. We also have to take a look market by market to really understand dynamics of hours within those markets so that we could also take adjustments to hours as necessary based off of what's happening with competition in those locales as well. So the primary focus is still to get pharmacists hired to reopen our stores. But we do believe given the current trends and what's happened throughout the first half of the year that we will have a subset of our stores that are still on short hours exiting the year.

We feel optimistic about the stores that have reopened, with those currently operating without restrictions showing approximately 6% growth. There may be opportunities to enhance this growth through operational improvements, focusing not only on restoring store hours but also on the operations within the pharmacy and patient engagement. We plan to implement these changes across our entire portfolio rather than just in the stores that are currently closed.

Also to, let me just add on VillageMD and what we're seeing with our scripts at Village. So in our co-located sites that have been open for more than two years, we're driving an incremental 40 scripts per site per day, and this is an increase of about 35% versus prior year. So when we begin to look at our script business, it's three areas. It's the return to store hours, the second piece is better execution in the stores, and the third is to begin to drive our relationships from our acquisition partners, both the work that we can do with Shields, but most importantly, with our Village co-located clinics.

On capital deployment here, how are you weighing the priorities now? And how are you thinking about further rationalization of certain investments or businesses, particularly Boots and what's your commitment to the Boots business now? And are you keeping your options open? And then just second, more of a housekeeping question. But are there any changes from a segment level guidance perspective that we should be thinking about for the second half? And anything we should be thinking about in terms of third quarter versus fourth quarter? Anything above or below the line that may have changed relative to your initial thinking, for instance, tax rate?

Yes. I'll address the last question first. I want to highlight that we believe we delivered a solid quarter, which gives us confidence to affirm our full-year guidance. There will always be ups and downs in a business like ours, and we've discussed some of these. We're seeing strong performance across the retail segment, although COVID remains a concern. We’re balancing all these factors, so it's not the right time to adjust the specific guidance for any part of the business. We're comfortable with our position if we stay below consensus, which I think is at 451. We feel good about where we are, and many of the factors influencing this can counterbalance each other. Regarding the quarterly sequence, we've been clear that we expect mid-20s growth, and I would say that the growth rate will be higher in the fourth quarter compared to the third as we work through some negative factors and incorporate positive ones. Overall, we feel confident in our profile. For capital allocation, our current focus is on paying down debt and likely small tuck-on acquisitions, specifically within the healthcare sector. You also asked about Boots; would you like to address that?

Sure. So on the Boots business, we've been pleased with their performance as Jim talked about in comparison to U.S. business, our healthcare business. What we feel like is we've got a balanced business here in terms of what we're seeing in Boots, and they are continuing to take market share. And it's a business that is nice to have. It's been complementary. And until further notice, it's a good business for us to have.

Yes. In the quarter, we divested a significant portion of Option Care, reducing our stake to just under 10%, specifically around 6%. We are still making progress toward our goals of simplifying the portfolio. We’ve also taken steps with parts of ABC, and Option Care is now in the 6% range. We're carefully evaluating the right timing for all of these simplification efforts to ensure we have the resources needed to build a successful healthcare services business. That is our goal and strategy, which Roz has outlined, and we are committed to executing this strategy.

Thanks. So thanks, everyone, for joining us. Let me sum up what you heard today, particularly in the Q&A portion. So just in short, the U.S., we've really achieved a balanced performance. Our core retail sales are up mid-single digits, better-than-expected sequential improvement in our comp scripts. And then internationally, Boots has delivered eight consecutive quarters with strong comp performance which accelerated to 16% this quarter. So we feel really good about leaving this quarter. So when we talk about what are we thinking about recession, inflation? Our business is not only strong, but is showing resiliency. We've been able to absorb various industry-wide shocks such as rising labor costs and the inflationary pressures. So at the same time, though, we're moving beyond our peak investment period in healthcare, and we've turned the corner on comping last year's COVID demand. So that's what we're referencing in terms of an inflection point. I'm really happy about this team. We're clearly executing against our plans and is showing up in the results. We've achieved a really solid first half performance and broadly in line with our expectations. The investments that you all have been tracking very carefully, they're accelerating, and they're building out our healthcare growth engine as we designed and planned. And then the portfolio simplification is working, and it's unlocking the value that we need and funding our transformation. So I would just reiterate that we're maintaining guidance and pivoting to a strong second half of the year. And I appreciate your time on the call. Thank you. Have a great rest of the day.