James Kehoe
Executive Vice President and Global Chief Financial Officer at Walgreens Boots Alliance
Thank you, Roz, and good morning. In summary, while we returned to adjusted EPS growth in the third quarter, earnings were below our expectations as we encountered lower COVID contributions, shifting consumer behaviors and a recent slowdown in respiratory incidences. Overall, we delivered 8.9% sales growth on a constant currency basis, ahead of our plan, led by our U.S. Pharmacy business, up 10%; our Boots U.K. Retail business, which delivered a solid 13% comp; and our scale in Healthcare business, which added $1.4 billion in sales versus the prior year.
Adjusted EPS increased 3.6% on a constant currency basis despite a 19 percentage point headwind due to a lower COVID-19 contribution and 8 percentage points from reduced ownership of AmerisourceBergen. These were partly offset by favorabilities from sale and leaseback, incentive accruals and tax. All of these items net out to be a 4.7 percentage point headwind to EPS growth and this demonstrates overall good quality of earnings in the quarter. As Roz discussed, we are lowering our fiscal '23 adjusted EPS guidance to $4 to $4.05. This updated outlook reflects consumer and category trends, a lower contribution from COVID and an overall more cautious forward view given the continued macroeconomic uncertainty.
Later, I will provide more color around the key assumptions underpinning our revised guidance, but first, let's look at the third quarter results in more detail. Adjusted operating income increased 0.6% on a constant currency basis. This included a 22 percentage point headwind from COVID-19 and a 7% drag from reduced AmerisourceBergen ownership, partly offset by sale and leaseback gains and incentive accruals. All of these items net out to an approximately 6% headwind to AOI growth. GAAP net earnings of $118 million declined $171 million compared to prior year. The current quarter included a $323 million after-tax impairment charge related to pharmacy licenses in the U.K. Adjusted net earnings increased 3.4% on a constant currency basis to $860 million.
Now let's move to the year-to-date highlights. Year-to-date sales increased 4.8% on a constant currency basis. Adjusted EPS was down 20.7%, reflecting a lower COVID-19 contribution of 20 percentage points and reduced AmerisourceBergen ownership of 3 percentage points. GAAP earnings were a loss of $2.9 billion compared to net earnings of $4.8 billion in 2022 with the current year including a $5.5 billion after-tax charge for opioid-related claims and lawsuits.
Now let's move to the U.S. Retail Pharmacy segment. Sales increased 4.4% in the quarter with comp sales up 7%. Adjusted gross profit declined 3.2% year-on-year, reflecting a 5 percentage point negative impact from COVID-19. A 5% reduction in SG&A expense more than offset the gross profit decline and led to AOI growth of 8.4% before the inclusion of AmerisourceBergen equity income. The sell down of our ABC stake led to a slight AOI decline of 0.4%.
Let me now turn to U.S. Pharmacy. Pharmacy sales increased 6.3% and advanced 9.8% on a comparable basis, driven by both script growth and brand inflation. Excluding immunizations, comp scripts grew 2.8%, a slight deceleration from the prior quarter and reflecting broader prescription market trends. As expected, adjusted gross profit declined year-on-year, although, excluding COVID, gross profit increased as script growth and lower cost of goods sold more than offset reimbursement pressure.
Turning next to our U.S. Retail business. Following several quarters of very good performance, the Retail business encountered some headwinds in the third quarter as the consumer navigated through a difficult macroeconomic backdrop. Excluding tobacco, comp sales grew 0.2%, held back by 90 basis points due to holiday seasonal weakness as consumers pulled back on discretionary spending and 80 basis points due to lower sales of COVID-19 OTC test kits.
We saw solid growth in grocery and household up 4.7% and beauty up 3.7%. Cough cold flu sales were flat, but slowed significantly in May due to a decline in respiratory incidences. IQVIA FAN data shows flu cold and respiratory activity down 8% in the third quarter versus a 15% increase in the second quarter with May down in the mid-20% range. Following several consecutive quarters of year-on-year margin expansion, Retail gross margin came under modest pressure in the third quarter. We've seen similar trends as the broader market with our promotional units up around 7% in the most recent 13-week period. However, on a year-to-date basis, gross margin has increased by more than 100 basis points, driven by effective margin management.
Turning next to the International segment. And as always, I'll talk to constant currency numbers. The International segment continues to perform very well. Sales increased 7% with good growth across all international markets. Boots U.K. was up 10% and Germany wholesale grew 4%. Adjusted operating income of $208 million increased 21% despite a $40 million year-on-year headwind from sale and leaseback transactions.
Let's now look in more detail the Boots U.K. Boots U.K. sales advanced 10%, pharmacy comp sales increased 6% and comp retail sales grew 13%. And this comes on top of a 24% comp in the same quarter last year. Boots grew market share for the ninth consecutive quarter with gains across all categories. We successfully launched Future Renew, a range of innovative new skincare with very positive consumer response. This product line was recently launched in Walgreens. Boots.com sales grew 25% year-on-year and up more than doubled versus the equivalent pre-COVID quarter. Over 14% of our U.K. Retail sales now comes from boots.com.
Turning next to U.S. Healthcare. The U.S. Healthcare business continues to rapidly scale with sales reaching $2 billion, more than doubling from the prior year. Pro forma sales growth was 22%. VillageMD sales were $1.5 billion, up 22% on a pro forma basis. Legacy VillageMD growth was driven by expansion of the clinic footprint with an additional 93 clinics opened in the past year and the ongoing maturation of existing clinics. Summit Health was however impacted by a weaker respiratory season that led to fewer CityMD visits and fewer referrals across the Summit Health network.
Shields delivered another strong quarter, up 35% and driven by contract wins, including the addition of six new health system partners and further expansion of existing partnerships. CareCentrix sales were approximately $360 million with pro forma sales growth of 15%. Adjusted EBITDA reflects weaker than expected results at VillageMD and Summit Health, partly offset by continued growth at Shields. CityMD has been impacted by lower visit volume, whereas the VillageMD EBITDA loss reflects new clinic expansions. We anticipate improvement in the fourth quarter as we build the patient panels and traffic and align the cost profile with sales.
Let's now look at some of the key metrics for the U.S. Healthcare business. VillageMD managed 850,000 value-based lives at quarter end, reflecting year-over-year growth of approximately 27% in the legacy VillageMD business and the addition of 309,000 value-based lives from Summit. Total value-based lives include 179,000 full risk lives. Our clinical trials business continues to expand with eight contracts signed and a robust pipeline.
Turning next to cash flow. We generated $1.2 billion of operating cash flow with free cash flow of $116 million. The year-over-year decline reflected lower earnings due to COVID-19, a lower contribution from working capital and increased capital expenditures related to growth initiatives. Looking ahead, we are re-prioritizing capital projects to reduce planned spend and are rolling out a comprehensive set of working capital optimization initiatives to enhance our cash generation.
Turning now to guidance. We are updating our full year '23 adjusted EPS guidance to $4 to $4.05, a constant currency decline of around 20%. Excluding the impact of COVID-19 and forex, core adjusted EPS is plus to up 1%. The EPS contribution from COVID-19 is $0.23 lower than our original assumptions at the start of the year. At the beginning of the fiscal year, we expected 16 million vaccinations. And despite the spring booster recommendation, we have reduced our full year expectations to 12.5 million vaccinations. COVID testing has decelerated at an even faster pace. Additionally, we have incorporated the impacts of a more cautious consumer outlook, leading to a $0.20 to $0.25 impact as we realign our fourth quarter sales and margin goals to reflect recent trends. Finally, while reducing our ownership stake in AmerisourceBergen has improved our debt position, it has however led to a $0.05 headwind.
Let me now walk you through our assumptions for each of our business segments. Starting with U.S. Retail Pharmacy, we now project sales of around $110 billion, up low-single-digits year-on-year. AOI is projected at $3.8 billion to $3.9 billion, a decline of 22% to 24%, reflecting a 23 percentage point headwind from COVID-19 and 3 percentage points from our reduced ownership stake in AmerisourceBergen. Excluding these two impacts, AOI growth is up 2% to 4%.
Turning next to the International segment, which is performing well this year. Sales are projected to grow 6% to 8% on a constant currency basis, reflecting strong execution, especially in the U.K. Adjusted operating income of around $900 million represents constant currency growth of approximately 30%. This performance is toward the top-end of our original expectations.
Our revised outlook for U.S. Healthcare reflects lower visits at CityMD, the continued ramp-up of new VillageMD sites and the slower integration of prior acquisitions into Summit's Multi-Specialty business. We expect sales of $6.3 billion to $6.8 billion, an increase of $4.8 billion versus prior year and growing approximately 25% on a pro forma basis. We are projecting an adjusted EBITDA loss of $340 million to $380 million, including the factors I mentioned earlier. While the profit performance so far this year has been below planned, rapid correction actions are underway and we expect to drive sequential adjusted EBITDA improvement in the fourth quarter and beyond.
Turning now to our corporate assumptions. Our full year tax rate is now expected to be around 12% and this basically reflects the favorability we have seen so far in fiscal '23 with some of the benefits reversing in the fourth quarter. More specifically, we expect the fourth quarter tax rate of around 23%. Full year guidance of $4 to $4.05 implies fourth quarter EPS of approximately $0.70 to $0.75.
The result is weighed down by a much higher average tax rate and the fourth quarter typically is the lowest quarter of the year. As such, it would be incorrect to extrapolate the quarter as a proxy for 2024. First, normalizing for the tax rate would result in an additional $0.08 in the quarter. Second, seasonality impacts all of our businesses. Looking back over the past five years and excluding the impact from COVID-19 and ABC, approximately 20% of our adjusted operating income comes in the fourth quarter. To conclude, adjusting the fourth quarter for tax rate and accounting for seasonality would result in annual adjusted EPS of around $4 per share.
Next, I would like to cover the key factors that will influence 2024 performance. Overall, we expect the long-term tailwinds to outweigh the near-term pressures. Some of the challenges we faced in fiscal '23 are expected to continue into '24. We do expect to see some continued weakness in consumer spending together with moderate increases in labor costs. While reimbursement pressure has eased somewhat over the past 18 months, it is not going away and we will continue to identify ways to offset the pressure.
In addition, we expect lower sale and leaseback activity in fiscal '24 and the tax rate will be higher as we lap a very favorable fiscal '23 performance and higher statutory tax rates are introduced in both the U.K. and Switzerland. However, we have multiple profit drivers and initiatives that will drive sustainable profit growth. Our U.S. Healthcare business will be a significant profit driver, including the first full year of Summit Health and maturing VillageMD clinic profile and strong actions to accelerate their path to profitability. We expect continued script volume growth and strong contribution from front of store initiatives. These include own brand penetration gains and the further expansion of our successful category performance improvement program. Lastly, the Transformational Cost Management Program will deliver at least $800 million of savings next year.
Next, let's take a deeper look into 2024. We expect fiscal 2024 adjusted operating income to grow low-to mid single-digits, led by the U.S. Healthcare segment and solid execution in U.S. Retail Pharmacy. We are expecting U.S. Healthcare to be the largest driver of total company AOI growth as the business is rapidly gaining scale and we will now accelerate the path to profitability. John Driscoll will provide much more color on the immediate actions we are taking to accelerate EBITDA delivery. We expect the U.S. Retail Pharmacy AOI to be flat-to-down slightly due to lower COVID contributions of approximately $290 million and a $260 million step-down in sale and leaseback gains. Absent these items, we anticipate solid core growth led by Transformational Cost Management Program savings and expanding gross profit.
Finally, we expect international AOI to decline year-on-year as we lap sizable real estate gains and lose the relatively small AOI contribution from the sale of our business in Chile. Core profit growth will be flat as the business manages through high levels of cost and labor inflation. That being said, our International business is well positioned for long-term success with market share gains and an advantaged and growing e-commerce presence. We do expect AOI growth to outpace EPS due to a higher tax rate and non-controlling interest.
Next, we'll look at the U.S. Pharmacy in more detail. Excluding COVID, we expect to grow pharmacy gross profit. Underpinning the growth is our differentiated tech-enabled operating model, which frees up capacity for pharmacists to spend more time on clinical programs and supporting our expanding pharmacy service offerings. We are projecting solid script growth benefiting from improved operating hours, increased access to lives and growth in specialty. We are integrating AllianceRx community-based specialty pharmacy and Shields under a new go-to-market strategy with a payer-agnostic provider-centric approach. In addition, we have launched multiple programs across our Pharmacy and U.S. Healthcare business and continue to see engagement from payers and partners for clinical quality initiatives that leverage our integrated assets.
Moving now to our U.S. Retail business. Gross profit growth will be driven by low-single-digit comp growth and continued margin improvement. We are creating significant value through category performance management where assortment decisions should deliver at least $200 million of savings in fiscal 2024. We are accelerating our own brand penetration through innovation and increased points of distribution and display. Our own brands have margins that are significantly higher than national brands. We are creating more value for consumers as we scale our e-commerce platform and evolve our store formats, including a new digital forward store concept and a health and wellness focused store with favorable early feedback on both concepts.
Let me now hand it over to John to discuss our U.S. Healthcare strategy and profit growth drivers.