James Kehoe
Executive Vice President and Global Chief Financial Officer at Walgreens Boots Alliance
Thank you, Ros, 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 our 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 AmerisourceBergen of $0.05, prior year COVID-related one-time benefits in the U.K. of $0.03, and currency impacts and investment write-offs of $0.04. Despite the slow start to the quarter, we delivered 4.5% sales growth on a constant-currency basis with strong momentum exiting the quarter.
February saw a 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%. International sales advanced 9%, led by the U.K. 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 a 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 must 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 saw 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, the 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 U.K. 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 U.K. 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 13%. VillageMD delivered sales of over $1.1 billion, advancing 30% on a pro forma basis, driven by growth at existing clinics, expansion of the clinic footprint, and Summit Health growth. Excluding Summit, VillageMD grew 48% year-on-year. Shields continues to deliver, with sales of $125 million, and increasing 41% on a pro forma basis, driven by recent contract wins, including the addition of three new health system partners and further expansion of existing partnerships. CareCentrix sales were nearly $400 million with proforma 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 payor partners added new lines of business. As Ros mentioned, we've also added Horizon Blue Cross Blue Shield of New Jersey as our fourth payor 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're seeing benefits on the Walgreens side from our partnership with VillageMD. Roughly 50% of patients at 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 14 scripts per site per day, and this is an increase of 35% versus prior year. We will continue to build out our Walgreens Health Corners as we add new lives and partners. We ended the quarter with 117 Health Corners, up from 47 a year ago.
In summary, we are moving swiftly to implement our vision, leveraging our integrated best-in-class assets, and are excited with recent developments, including signing another payor 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 wild card 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 Ros for her closing remarks.
