Manmohan Mahajan
Executive Vice President and Global Chief Financial Officer at Walgreens Boots Alliance
Thank you, Mary, and good morning, everyone. Overall, second quarter operational results were in line with our expectations. Sales grew 5.7% on a constant-currency basis. U.S. Retail Pharmacy increased 4.7%, International was up 3.2%, and U.S. Healthcare delivered pro forma sales growth of 14%.
Adjusted EPS of $1.20 increased year-over-year by 2.8% on a constant-currency basis, reflecting improved profitability in our U.S. Healthcare segment, impact of cost savings, and a lower adjusted effective tax rate, offset by the lower U.S. retail performance and lower sale-leaseback gains. The lower adjusted effective tax rate reflects the initial recognition of a deferred tax asset in certain international jurisdictions.
GAAP net loss for the second quarter included a $5.8 billion non-cash impairment charge related to VillageMD goodwill. During the fourth quarter of fiscal '23, we disclosed that our annual goodwill impairment test for our VillageMD reporting unit resulted in its fair value exceeding its carrying value by a narrow margin. As a result, we have been closely monitoring the performance of the business for potential indicators of impairment.
In February, we received a downward revised longer-term forecast from VillageMD management, including the impact of closing approximately 160 clinics, inclusive of the 60 previously communicated, slower than expected trends in patient panel growth and multispecialty productivity, and recent changes in Medicare reimbursement models. These impacts were partly offset by actions taken in an attempt to rightsize the cost structure.
Given this revised forecast, we performed an interim test of VillageMD reporting unit goodwill that resulted in a fair value below its carrying value. Accordingly, we recognized a $12.4 billion non-cash goodwill impairment charge prior to the attribution of loss to non-controlling interests. On an after-tax basis and net a 47% non-controlling interest, this resulted in a net loss of $5.8 billion in the quarter. This charge is excluded from non-GAAP earnings measures.
The fair value of the business was determined using a combination of the income and market approaches. The impairment charge is due to the lower than previously expected longer-term financial performance expectations, challenged market multiples for VillageMD's peer group, which have continued to decline, and increased discount rates.
As a reminder, our share of VillageMD's net assets carrying value also included a $2 billion gain recognized on the equity interest owned by the company immediately prior to the acquisition of majority equity interest in VillageMD during the first quarter of fiscal '22. This goodwill write-off is non-cash, and we do not believe it will have a significant impact on our financial position or our ability to invest across businesses going forward.
During the first half of fiscal '24, we have seen positive financial impacts from the recent actions taken by VillageMD management team to accelerate profitability. We believe the focused approach on improving performance in core markets as well as rightsizing the cost structure will provide VillageMD a platform for future growth.
The second quarter also included a $455 million non-cash impairment charge related to certain long-lived assets in the U.S. Retail Pharmacy segment. As part of a deep dive exercise over the last several months, we concluded during the quarter that instead of continuing to build a new technology platform for pharmacy operations in the U.S., it would be better to modernize our existing system over time with new capabilities in an agile and capital efficient manner with much lower disruption risk. As a result, we recognize the charge against the underlying software and development asset.
Finally, similar to last quarter, we recognized a $474 million gain on the sale of Cencora shares, partly offset by a $396 million after-tax non-cash charge for fair value adjustments on variable prepaid forward derivatives related to Cencora shares.
Now let's move on to the first half highlights. Sales increased 7.2% on a constant-currency basis. Adjusted EPS declined 20.5% on a constant-currency basis due to softer U.S. retail performance and lower sale-leaseback gains, partly offset by improved profitability in U.S. Healthcare and a lower adjusted effective tax rate.
GAAP net loss was $6 billion compared to a loss of $3 billion in the first half of fiscal '23. As I explained earlier, the first half of fiscal '24 included certain non-cash impairment charges. The prior year 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 Cencora shares.
Now let me cover U.S. Retail Pharmacy segment. Note that all comparable figures are on a leap year adjusted basis for all segments. Sales grew 4.7% year-on-year, driven by brand inflation in pharmacy, prescription volume and a higher contribution from pharmacy services, which was partly offset by a 4.5% decline in the retail business.
AOI declined 29.5% versus the prior year quarter due to lower retail sales volume, elevated levels of shrink and lower sale-leaseback gains, partially offset by continued progress on cost-savings initiatives. Looking ahead, we are winding down the sale-leaseback program and we do not anticipate any material benefit going forward. Sale-leaseback gains net of incremental rent expense were an approximately $125 million headwind to AOI in the quarter.
Let me now turn to U.S. Pharmacy. Pharmacy comp sales increased 8.7%, mainly driven by brand inflation, volume growth and contribution from pharmacy services. Comp scripts grew 2.9%, excluding immunizations, in line with the overall prescription market. The ongoing impact of Medicaid redeterminations continued to negatively impact overall market growth.
Pharmacy services performed better than expectations driven by our vaccines portfolio. Pharmacy adjusted gross profit was down slightly versus the prior year quarter, with margin negatively impacted by brand mix impacts and reimbursement pressure, net of procurement savings.
Turning next to our U.S. Retail business. We continue to see a challenging retail environment with a shift in discretionary spend away from the drug channel as consumers seek value. Comparable retail sales declined 4.3% in the quarter. There were three main drivers.
First, as consumers continued to pull back on discretionary spending, we saw an impact of approximately 170 basis points from weaker sales in holiday seasonal and general merchandise categories.
Second, as expected, we saw a weaker-than-normal respiratory season, which directly impacted comparable sales by approximately 90 basis points. Third-party data showed flu, cold and respiratory activity was down 6% compared to the prior year quarter. In addition, as cough, cold, flu serves as a primary trip driver, there was also an incremental impact from the lower attachment sales.
Lastly, weather conditions in January led to a headwind of approximately 40 basis points in the quarter. Retail gross margin declined year-on-year, impacted by higher shrink, partly offset by benefits from category performance improvement program.
Turning next to the International segment, and as always, I will talk in constant-currency numbers. The International segment again exceeded our expectations in the quarter. Total sales grew 3.2% with Boots UK increasing 3% and Germany wholesale up 5.3%. Segment adjusted gross profit increased by 3.2%. Adjusted operating income was down 32% entirely due to lapping the real estate gains in the year ago period, with underlying growth offsetting inflationary pressures.
Let's now cover Boots UK in detail. Comp pharmacy sales were up 1.7%. Comp retail sales increased 5.9%, with all categories showing growth led by beauty and personal care. Across formats, destination health and beauty, flagship and travel locations performed particularly well. Boots.com sales increased 16.8% year-on-year and represented over 17% of our U.K. retail sales.
Turning next to U.S. Healthcare. The U.S. Healthcare segment delivered its first quarter of positive adjusted EBITDA. This was the third consecutive quarter of significant year-on-year improvement in adjusted EBITDA. Second quarter sales of $2.2 billion increased 33% compared to the prior year quarter, aided by the acquisition of Summit Health. On a pro forma basis, segment sales increased 14%. VillageMD sales of $1.6 billion grew 20% on a pro forma basis. The year-on-year increase was driven by same clinic performance and growth in full-risk lives.
Shields sales were up 13% as new health system contracts and expansion of existing partnerships led to an over 40% increase in the number of patients on service in the quarter versus the prior year. Adjusted EBITDA was $17 million, an improvement of $127 million compared to last year, mainly driven by VillageMD and Shields. We believe VillageMD continues to make progress to accelerate profitability by rightsizing its cost structure and growing its patient panel. Shields saw robust adjusted EBITDA growth compared to the prior year period.
Turning next to cash flow. Operating cash flows in the first half of fiscal '24 was negatively impacted by roughly $700 million in payments related to legal matters, $380 million annuity premium contributions related to Boots Pension Plan, and underlying seasonality. Capital expenditures declined by $250 million versus the first half of fiscal '23. As a result, free cash flow was down by approximately $2 billion versus the prior year. We expect second half free cash flow improvement compared to the first half, driven by several factors.
First, we expect lower payments related to legal matters in the second half of fiscal '24. Second, we remain on track to reduce capital expenditure by approximately $600 million year-over-year. Third, we expect to deliver working capital improvement of $500 million during fiscal '24. While we did see some benefit of these initiatives during the first half of '24, we expect the majority of these benefits will impact the second half.
Lastly, similar to prior years, we believe the underlying working capital seasonality in the U.S. Retail Pharmacy and International segments will have a favorable impact on the second half of the year compared to the first half.
I will now turn to guidance. We are narrowing our fiscal '24 adjusted EPS guidance to $3.20 to $3.35. The updated range incorporates a challenging U.S. retail environment, lower sale-leaseback gains and reduced Cencora equity income, offset by the execution in pharmacy services and a lower adjusted effective tax rate.
On the tailwinds, we continue to see strong execution in our pharmacy services business, which has delivered results ahead of our initial plan to date. In addition, we now expect our adjusted effective tax rate to be under 5%.
On the headwinds, we expect the challenging retail backdrop will continue to negatively impact our U.S. retail sales in the short term. We now expect fiscal '24 retail comp sales to be down approximately 3%. Second, with the early wind down of the sale-leaseback program, no material gains are expected in the future. Third, the block sale of Cencora shares in February will reduce equity earnings going forward.
Lastly, as discussed with the first quarter results, we forecast slightly lower market growth in U.S. Pharmacy business compared to our initial guidance. Importantly, based on the progress made in the U.S. Healthcare segment through the first half, we continue to expect segment adjusted EBITDA to be breakeven at the midpoint of the guidance range. This represents an increase of $325 million to $425 million over fiscal '23.
Next, I will provide additional details on the factors impacting earnings in the second half. In the second half, we will be lapping adjusted EPS of $1.66 in prior year period. We expect several key factors to impact the year-over-year comparison. First, the wind down of the sale-leaseback program is expected to be a significant headwind in the second half. Second, we will lap incentive accruals reduction in the third and fourth quarter of fiscal '23. Third, our updated guidance implies a higher tax rate over the remainder of the year.
The U.S. Healthcare segment remains on track to achieve $165 million of year-over-year adjusted EBITDA improvement in the second half based on the midpoint of the guidance range. And finally, within our U.S. Retail Pharmacy business, we expect year-on-year improvement in the second half driven by cost-savings initiatives.
With that, let me now pass it back to Tim for his closing remarks.
