Walgreen (WAG) Q3 2011 Earnings Call June 21, 2011 8:30 AM ET
Operator
Good day, ladies and gentlemen. Welcome to this Walgreen Company Third Quarter 2011 Earnings Conference Call. Today's call is being recorded. At this time, I would like to turn things over to Mr. Rick Hans. Please go ahead.
Rick Hans
Thank you, and good morning, everyone. Welcome to our third quarter conference call. Today, Greg Wasson, our President and CEO, and Wade Miquelon, Executive Vice President and Chief Financial Officer, will discuss the quarter and the additional announcement this morning regarding Express Scripts. Also joining us on the call and available for questions is Kermit Crawford, our President of Pharmacy, Health & Wellness Services and Solutions; and Mark Wagner, President of Community Management. When we get to your questions, please limit yourself to one.
As a reminder, today's presentation includes certain non-GAAP financial measures, and I would direct you to our website at investor.walgreens.com for reconciliations. Also, I'm available throughout the day by phone to answer additional questions.
You can find a link to our webcast under Investor Relations website. After the call, the presentation and the podcast will be available in archives on our website for 12 months.
Certain statements and projections of future results made in this presentation constitute forward-looking information that is based on current market, competitive and regulatory expectations that involve risk and uncertainty. Except to the extent required by law, we undertake no obligation to update publicly any forward-looking statement after this presentation, whether as a result of new information, future events, changes in assumptions or otherwise. Please see our latest Form 10-K and 10-Q filings for a discussion of risk factors as they relate to forward-looking statements.
Now I'll turn the call over to Greg.
Gregory Wasson
Thank you, Rick, and good morning, everyone. And thank you for joining us on our call. I'll give you an abbreviated review of our strong third quarter financial results and then Wade will take you through the details of our performance. And finally, we'll spend more time on our announcement this morning regarding the PBM Express Scripts.
Starting with our results today, we had a very solid quarter, which demonstrates that our strategies are generating strong financial results. We reported record third quarter sales of $18.4 billion, up 6.8% from $17.2 billion a year ago. Net earnings for the quarter were up 30.3% to a record $603 million compared to $463 million a year ago. Third quarter earnings per diluted share were $0.65, an increase of 38.3% versus last year's $0.47 per diluted share, marking our fourth consecutive quarter of double-digit earnings per share growth.
Strong cash flow trends continued in the quarter with cash flow from operations of $1.2 billion and free cash flow of $1 billion. In the quarter, we grew our gross profit by 8.5% and our SG&A by 7.2%. Our performance this quarter was a result of our ability to grow gross profit dollars faster than SG&A dollars, allowing us to deliver on our goal of double-digit earnings per share growth.
This quarter, gross profit dollar growth was $122 million above SG&A dollar growth, yielding an EBIT growth of 14.8%. Driving our gross profit dollar growth, we saw solid performance across a number of categories including retail pharmacy, over-the-counter medications, beauty and personal care. While we continue to grow our business and invest in the future, our strategies are implemented against a backdrop of economic and regulatory uncertainties.
Persistent high unemployment, a weak housing market, high fuel prices and inflation all put pressure on consumers. In response, we believe our customers are managing their overall spending by buying more ad and private brand items, as well as continue to see mix shift to consumables and nondiscretionary items.
Regarding inflation, we constantly monitor the competition and believe we are achieving the right balance between margin and traffic in our front-end comp. In addition, we continue to experience both commercial and governmental reimbursement pressure. On the government side of the issue, it's too early to speculate on the eventual timing and impact of AMP.
And on the regulatory front, we are pleased that the Senate took action on debit card reform. While the substance of the Durbin Amendment to the Dodd-Frank financial reform bill is clear, both the timing and financial implications are still unknown, and it's premature to speculate on any impact to our business. As we respond to a changing business climate, we also focus on solid execution to generate results. Throughout this quarter, we continued with our Customer Centric Retailing conversions, and in early June, reached a milestone of 4,000 CCR stores. We're on track to achieve our goal of 5,500 stores transitioned to CCR by the end of October this calendar year.
Overall, we're very pleased with the pace and success of our CCR conversions. With Walgreen employees responsible for much of the work, we're completing stores 30% faster this year than last, with costs running at about $45,000 per store. Customer satisfaction is up in converted stores and we believe that the success of CCR is being reflected in our solid front-end comp store sales numbers.
In addition to our focus on our core business, we also recently made significant strategic advancements as we continue to align our assets with our strategies. In the quarter, we announced the sale of our PBM and the acquisition of drugstore.com. On June 3, we closed on our transaction with drugstore, and we're pleased to welcome our new team members to the Walgreens family.
With the acquisition, we strengthen our position as the most convenient, multichannel provider of health and daily living, giving our customers more ways to connect and buy our wide range of products and services. I also want to acknowledge and thank the employees of WHI. We closed that transaction with Catalyst Health Systems on June 13, and I want to wish the team all the best in their new positions with Catalyst.
The sale sharpened our focus on our strategy to leverage the best community store network in America. In addition, the strategic relationship gives us the opportunity to expand all pharmacy products and services, including retail pharmacy, both 30- and 90-day supplies, mail service and specialty and infusion pharmacy, while Catalyst grows its PBM.
Also, during the quarter, we developed collaborations with a number of hospitals and health systems designed to improve patient care, provide greater access to important pharmacy and healthcare services and lower costs. These collaborative relationships demonstrate how Walgreen pharmacists, nurse practitioners and other professionals are integrating our services and solutions into the healthcare systems within our communities for our patients' and customers' benefit.
In May, we announced a wide-ranging agreement with Johns Hopkins Medicine. The agreement promotes collaboration on population-based research. We'll also jointly review and develop protocols to improve outcomes for patients with chronic diseases. Continuing our focus on patient outcomes and chronic care, we launched a program with Northwestern Memorial Physicians Group of Chicago. Through the program, Walgreens and Northwestern Memorial employees will receive specialized care for chronic conditions. We will share important clinical information on the patient's care in progress with their primary care physicians to help enhance decision-making.
And finally, Take Care Health Systems, a wholly owned subsidiary of Walgreens, has developed relationships with Ochsner Health Systems in New Orleans and Memorial Health in Jacksonville, Florida. With these agreements in place, physicians will share information with their patients on Take Care Clinics and on other healthcare options when their practices are closed or they are unable to schedule an appointment within a patient's desired timeframe.
With that, I'll turn the call over to Wade for more detail on our results.
Wade Miquelon
Thank you, Greg, and good morning to everyone. Let me begin by saying we are pleased with our strong performance on our key financial metrics in what continues to be a challenging economic environment. As Greg mentioned, our net sales increased 6.8% to $18.4 billion. And our net earnings increased by 30.3% to $603 million, resulting in earnings per diluted share of $0.65, a 38.3% increase.
Our comparable sales trends have improved from a year ago with prescription sales up 4.1%, front-end sales up 3.9% and total sales up 4.1%. And our prescriptions filled were up 4.6% for the quarter. Looking at our comp trends more closely, our quarterly script trends, shown in the green bars, increased by 4.6% in the quarter, up from last year's 2.5%, continuing to outpace the industry growth rate of 1.1% excluding Walgreens.
On a 2-year stack basis, represented by the blue line, comparable prescription increases remain in the 6% to 8% range, with a spike in the first quarter of 2010 caused by the unusual timing and severity of the 2010 flu season. Retail prescription market share for the quarter was 20.1% compared to a 19.7% a year ago.
Our quarterly front-end sales comps increased to 3.9%, up from 0.1% a year ago. And we believe the CCR initiative, including expansion of and focus on core product categories and the rollout of beer and wine, continue to gain traction and drive our comps. The CCR initiative also helped drive the holiday sales comp this past Easter. And finally, the 2-year stack, shown by the blue line, continued to trend up after bottoming out in the second quarter of fiscal 2010.
Compared to the industry, our sales continued to perform well. When viewing a true to apples-to-apples time period that compares our front-end comps to our top 3 competitors based on their most recent reporting, we outperformed all by a wide margin as shown on this chart. We also continued to outperform on a 2-year stack basis as well.
Turning to margin, our gross margin as a percentage of sales was 28.1% in the quarter compared to 27.6% last year. Overall margins in the quarter were positively impacted by higher retail pharmacy margins as the effect of generic drug sales more than offset market-driven reimbursements and front-end margins were driven by OTC drugs, beauty and personal care and several private-label categories. And that was partially offset by a higher provision for LIFO. Taking a look at our longer-term gross margin trends, our front-end margins, while flat in the second quarter of 2011, increased in the other 5 quarters as shown.
Pharmacy gross margin in the quarter improved with the impact of generics. As we discussed in recent quarters, additional progress obviously becomes increasingly difficult to achieve on these strong numbers. And please keep in mind that we will continue to believe that gross profit dollar growth and increases in traffic and basket are the most relevant measures of our progress. Two-year stack SG&A trends continue to improve with 15.8% growth in the third quarter of 2011, down from 17.1% last year and 18.7% in 2009.
After adjusting for restructuring-related costs and cost associated with the Duane Reade acquisition, our 2-year stack SG&A trends also showed steady improvement to 12.4%, down from 13.4% last year and 17.6% in 2009.
Finally, walk through the progression of our reported SG&A dollar growth rate of 7.2% to our adjusted core SG&A rate of 6.4% you can see the impact versus a year ago. Lower Duane Reade integration expenses offset SG&A dollar growth by 60 basis points. Higher Duane Reade operating expenses added about 150 basis points and lower net cost associated with our Rewiring for Growth initiative offset our SG&A growth by 10 basis points, all versus a year ago.
Taking you through our income statement, this quarter included a LIFO provision of $50 million versus $18 million a year ago. Our estimated annual inflation rate for the current year remained at 2.25% versus 1.25% a year ago. Restructuring costs were $11 million, down from $17 million last year. Net interest expense was $80 million, down from $24 million a year ago, primarily as a result of reduced interest rates associated with our interest rate swaps.
Our effective tax rate was 35.4% versus 42.5% last year and recall that last year's effective tax rate included a $43 million charge in deferred taxes related to the Medicare Part D subsidy for retiree medical benefits. This year's third quarter benefited from a favorable state tax settlement. For the fourth quarter and the year, we expect our effective income tax rate to be about 37%.
Average diluted shares outstanding were 922 million versus 982 million a year ago, due primarily to our share repurchase program. Cash and cash equivalents were $2.7 billion at May 31, up 14.7%. Overall working capital decreased by 2.3% versus a year ago while working capital as a percent of sales decreased by 8.5%.
Total FIFO inventory increased by 7.7% in the quarter and by 5% on a per-store basis. For the 9 months ended May 31, 2011, we generated $3.3 billion in cash from operations compared to $2.8 billion a year ago, primarily as a result of higher net earnings. Capital expenditures were $699 million, down from $786 million last year.
As one of our core capital allocation priorities, we continue to return surplus cash to shareholders, and in the third quarter, we returned $535 million, including $160 million in dividends and $375 million through share repurchases. As of May 31, 2011, we repurchased $825 million against our $1 billion authorization. And as you can see year-to-date, we have returned a total of nearly $1.7 billion to shareholders.
Now this slide shows our gross profit dollar growth trends for the past 7 quarters, with the blue line representing 2010 and the green line representing the first 3 quarters of 2011. The red line above shows the 2-year stack trend. Last year's fourth quarter benefited from the initial inclusion of Duane Reade, a higher level of organic store openings and the rollout of beer and wine to about 3,500 stores, all of which we'll be cycling in the upcoming quarter.
As you can see the fourth quarter, one of the most difficult gross profit dollar comparisons of the year. And we'll continue to see some volatility resulting from the timing of generic introductions. As an example, we received greater gross profit dollar help from new generics in the third quarter versus a year ago. In the fourth quarter, we expect the help from generics to be significantly less than it was last year.
We have a similar construct for SG&A dollar growth for the last 7 quarters, with the blue line representing 2010 and the green line representing the first 3 quarters of fiscal 2011 and the red line showing the 2-year stack trend. As you can see, we're cycling a higher rate of SG&A dollar growth this year due to Duane Reade acquisition, so the comparative there will be easier than the prior quarters in the year.
As Greg said, we closed both the WHI and drugstore.com transactions in June. We expect the sale of WHI to be accretive to earnings by about $0.30 in fiscal 2011, largely due to the onetime gain on the sale and neutral in 2012, not including the reinvestment of the proceeds. As we indicated at the announcement, we anticipate the drugstore.com transaction will be dilutive to earnings per share in the fourth quarter of 2011 by about $0.03 to the transaction related and onetime cost.
Based on Walgreens' intention to reinvest in the business, the company further anticipates the transaction to be dilutive to earnings per share by about $0.03 to $0.04 in fiscal 2012 and about $0.01 to $0.02 in 2013.
Well, in closing, we are pleased with our quarterly results, which represented record third quarter sales, net income, earnings per diluted share and free cash flow, all notwithstanding an unforgiving economic environment. It is a validation that our strategies are translating into solid financial performance. And I want to acknowledge every one of our 244,000 employees who work hard every single day to help drive these results. And now I'll turn the call back to Greg for details regarding the developments with Express Scripts.
Gregory Wasson
Thanks, Wade. First, let me start by saying while not easy, this was a very clear decision for us. And one that we believe is in the best interest of our shareholders, our patients, our customers and our company.
Based on the terms and rates that Express Scripts has insisted on and after months of unsuccessful negotiations, we have reluctantly concluded it does not make sense for our business and the strategic direction of our company to continue our relationship with them. As a result, we're planning not to be a part of Express Scripts pharmacy provider network as of January 1, 2012.
This means that in January, Express Scripts provider network will no longer include our 7,700 Walgreen stores and Duane Reade pharmacies. Despite today's announcement, we remain committed to serving all of our patients' pharmacy and healthcare needs in the Express Scripts plan through end of this calendar year. To give you more context on our decision, as the largest provider in the Express Scripts network, we no longer felt like a valued partner for several reasons.
They were insistent on unacceptable reimbursement for the value we provide. In fact, their proposed reimbursement rates were below the published industry average cost to provide each prescription. Express Scripts attempted to define unilaterally what does and does not constitute a brand and generic drug despite existing industry standards, which when combined with the unacceptable rates further compounds the problem.
And third, they wanted the ability to move Walgreens into lower reimbursement networks and benefit designs without our approval and without fair compensation, reducing the predictability we need to forecast our business adequately. As I said as I began my comments, I want to emphasize this was not a decision we made lightly. We considered all alternatives. But based on Express Scripts' position, it was very clear, principled decision for us.
We believe the long-term ramifications of accepting Express Scripts' position with below market rates and minimal predictability would have been much worse than any short-term impact to our earnings. Given that, accepting Express Scripts' position would not have been in the long-term interest of our company, our customers, our pharmacists and our shareholders.
Furthermore, in a world where cost effectiveness and access to healthcare is so important, any time an intermediary continues to disproportionally grow its profit per prescription at the expense of the provider delivering the service, the relationship's out of balance.
The fact is we feel one out of 5 retail prescriptions in America, patients and payers value the trust and relationship they have with their pharmacist. They value the high quality, cost effectiveness and convenience we provide, which is why we work with hundreds of PBM and health plan networks across the country.
To give you some of the history, we've been in negotiations with Express Scripts for many months. Our team worked hard in a concerted effort to come to an agreement on a contract renewal that makes sense for both parties. They came in to our discussions with Express Scripts with what we thought was a market-based reasonable approach to terms and rate. We proposed to lower rates on the behalf of the Department of Defense TRICARE program, the pharmacy benefit plan managed by Express Scripts that serves active and retired military personnel. We also offered to contract separately with Express Scripts for TRICARE beneficiaries in order to continue providing services for all active and retired military personnel.
Under our proposal, the reimbursement costs of the DOD [Department of Defense] would have been lower than under Walgreens' new proposed commercial rates. For all other plans managed by Express Scripts, we offered to hold rates for a new contract at the level that will be in effect with Express Scripts at year end, which will be lower than current rates.
As for the impact on our business from this decision, we estimate that Express Scripts will reimburse Walgreens approximately $5.3 billion in fiscal 2011. This figure represents about 7% of our total company sales. Those sales divide into 4 distinct categories. Managed care represents 45% of the business, 18% goes to the Department of Defense, 26% to employers and 11% is Medicare Part D. Express Scripts processes approximately 90 million prescriptions that are expected to be filled by Walgreens in fiscal 2011.
To mitigate that impact, we intend to work closely with our PBM and health plan partners. We've heard loud and clear over the past year from employers and payers that they value the choice, cost effectiveness, convenience and service of Walgreens. As a result, over time, we are optimistic employers and others are going to want Walgreens in their network.
Second, during the open enrollment period, we will reach out to the Medicare beneficiaries to make sure they know how to have access to Walgreens pharmacies they have known and trusted for years. We will assist them in finding Medicare Part D plans with access to Walgreens. And finally, we will work directly with employers and payers, who have the ability to work directly with Walgreens.
For all of these reasons, we are optimistic about our ability over time to regain these customers and grow our business. For now, however, we're not going to speculate publicly about the amount of business we can retain in fiscal year 2012 or the potential impact on our financial metrics and stated goals. In the long run, we believe employers will want plans with Walgreens in the network.
With that said, Walgreens is moving forward with our strategies, and I'm confident in our future. Never in my years with this company have I seen so much interest from key stakeholders within the industry for the services Walgreens can deliver. We're prepared to live without Express Scripts in our world and work together with companies that understand the course we, in the healthcare industry, are taking.
As we've demonstrated in this and recent quarters, we're focused on helping our patients live well and on our strategy to transform community pharmacy to improve the overall cost and quality of care. With that, I'll turn the call back to Rick.
Rick Hans
Thank you, Greg. Ladies and gentlemen, that concludes our prepared remarks. We're now ready to take your questions.
Operator
Good day, ladies and gentlemen. Welcome to this Walgreen Company Third Quarter 2011 Earnings Conference Call. Today's call is being recorded. At this time, I would like to turn things over to Mr. Rick Hans. Please go ahead.
Rick Hans
Thank you, and good morning, everyone. Welcome to our third quarter conference call. Today, Greg Wasson, our President and CEO, and Wade Miquelon, Executive Vice President and Chief Financial Officer, will discuss the quarter and the additional announcement this morning regarding Express Scripts. Also joining us on the call and available for questions is Kermit Crawford, our President of Pharmacy, Health & Wellness Services and Solutions; and Mark Wagner, President of Community Management. When we get to your questions, please limit yourself to one.
As a reminder, today's presentation includes certain non-GAAP financial measures, and I would direct you to our website at investor.walgreens.com for reconciliations. Also, I'm available throughout the day by phone to answer additional questions.
You can find a link to our webcast under Investor Relations website. After the call, the presentation and the podcast will be available in archives on our website for 12 months.
Certain statements and projections of future results made in this presentation constitute forward-looking information that is based on current market, competitive and regulatory expectations that involve risk and uncertainty. Except to the extent required by law, we undertake no obligation to update publicly any forward-looking statement after this presentation, whether as a result of new information, future events, changes in assumptions or otherwise. Please see our latest Form 10-K and 10-Q filings for a discussion of risk factors as they relate to forward-looking statements.
Now I'll turn the call over to Greg.
Gregory Wasson
Thank you, Rick, and good morning, everyone. And thank you for joining us on our call. I'll give you an abbreviated review of our strong third quarter financial results and then Wade will take you through the details of our performance. And finally, we'll spend more time on our announcement this morning regarding the PBM Express Scripts.
Starting with our results today, we had a very solid quarter, which demonstrates that our strategies are generating strong financial results. We reported record third quarter sales of $18.4 billion, up 6.8% from $17.2 billion a year ago. Net earnings for the quarter were up 30.3% to a record $603 million compared to $463 million a year ago. Third quarter earnings per diluted share were $0.65, an increase of 38.3% versus last year's $0.47 per diluted share, marking our fourth consecutive quarter of double-digit earnings per share growth.
Strong cash flow trends continued in the quarter with cash flow from operations of $1.2 billion and free cash flow of $1 billion. In the quarter, we grew our gross profit by 8.5% and our SG&A by 7.2%. Our performance this quarter was a result of our ability to grow gross profit dollars faster than SG&A dollars, allowing us to deliver on our goal of double-digit earnings per share growth.
This quarter, gross profit dollar growth was $122 million above SG&A dollar growth, yielding an EBIT growth of 14.8%. Driving our gross profit dollar growth, we saw solid performance across a number of categories including retail pharmacy, over-the-counter medications, beauty and personal care. While we continue to grow our business and invest in the future, our strategies are implemented against a backdrop of economic and regulatory uncertainties.
Persistent high unemployment, a weak housing market, high fuel prices and inflation all put pressure on consumers. In response, we believe our customers are managing their overall spending by buying more ad and private brand items, as well as continue to see mix shift to consumables and nondiscretionary items.
Regarding inflation, we constantly monitor the competition and believe we are achieving the right balance between margin and traffic in our front-end comp. In addition, we continue to experience both commercial and governmental reimbursement pressure. On the government side of the issue, it's too early to speculate on the eventual timing and impact of AMP.
And on the regulatory front, we are pleased that the Senate took action on debit card reform. While the substance of the Durbin Amendment to the Dodd-Frank financial reform bill is clear, both the timing and financial implications are still unknown, and it's premature to speculate on any impact to our business. As we respond to a changing business climate, we also focus on solid execution to generate results. Throughout this quarter, we continued with our Customer Centric Retailing conversions, and in early June, reached a milestone of 4,000 CCR stores. We're on track to achieve our goal of 5,500 stores transitioned to CCR by the end of October this calendar year.
Overall, we're very pleased with the pace and success of our CCR conversions. With Walgreen employees responsible for much of the work, we're completing stores 30% faster this year than last, with costs running at about $45,000 per store. Customer satisfaction is up in converted stores and we believe that the success of CCR is being reflected in our solid front-end comp store sales numbers.
In addition to our focus on our core business, we also recently made significant strategic advancements as we continue to align our assets with our strategies. In the quarter, we announced the sale of our PBM and the acquisition of drugstore.com. On June 3, we closed on our transaction with drugstore, and we're pleased to welcome our new team members to the Walgreens family.
With the acquisition, we strengthen our position as the most convenient, multichannel provider of health and daily living, giving our customers more ways to connect and buy our wide range of products and services. I also want to acknowledge and thank the employees of WHI. We closed that transaction with Catalyst Health Systems on June 13, and I want to wish the team all the best in their new positions with Catalyst.
The sale sharpened our focus on our strategy to leverage the best community store network in America. In addition, the strategic relationship gives us the opportunity to expand all pharmacy products and services, including retail pharmacy, both 30- and 90-day supplies, mail service and specialty and infusion pharmacy, while Catalyst grows its PBM.
Also, during the quarter, we developed collaborations with a number of hospitals and health systems designed to improve patient care, provide greater access to important pharmacy and healthcare services and lower costs. These collaborative relationships demonstrate how Walgreen pharmacists, nurse practitioners and other professionals are integrating our services and solutions into the healthcare systems within our communities for our patients' and customers' benefit.
In May, we announced a wide-ranging agreement with Johns Hopkins Medicine. The agreement promotes collaboration on population-based research. We'll also jointly review and develop protocols to improve outcomes for patients with chronic diseases. Continuing our focus on patient outcomes and chronic care, we launched a program with Northwestern Memorial Physicians Group of Chicago. Through the program, Walgreens and Northwestern Memorial employees will receive specialized care for chronic conditions. We will share important clinical information on the patient's care in progress with their primary care physicians to help enhance decision-making.
And finally, Take Care Health Systems, a wholly owned subsidiary of Walgreens, has developed relationships with Ochsner Health Systems in New Orleans and Memorial Health in Jacksonville, Florida. With these agreements in place, physicians will share information with their patients on Take Care Clinics and on other healthcare options when their practices are closed or they are unable to schedule an appointment within a patient's desired timeframe.
With that, I'll turn the call over to Wade for more detail on our results.
Wade Miquelon
Thank you, Greg, and good morning to everyone. Let me begin by saying we are pleased with our strong performance on our key financial metrics in what continues to be a challenging economic environment. As Greg mentioned, our net sales increased 6.8% to $18.4 billion. And our net earnings increased by 30.3% to $603 million, resulting in earnings per diluted share of $0.65, a 38.3% increase.
Our comparable sales trends have improved from a year ago with prescription sales up 4.1%, front-end sales up 3.9% and total sales up 4.1%. And our prescriptions filled were up 4.6% for the quarter. Looking at our comp trends more closely, our quarterly script trends, shown in the green bars, increased by 4.6% in the quarter, up from last year's 2.5%, continuing to outpace the industry growth rate of 1.1% excluding Walgreens.
On a 2-year stack basis, represented by the blue line, comparable prescription increases remain in the 6% to 8% range, with a spike in the first quarter of 2010 caused by the unusual timing and severity of the 2010 flu season. Retail prescription market share for the quarter was 20.1% compared to a 19.7% a year ago.
Our quarterly front-end sales comps increased to 3.9%, up from 0.1% a year ago. And we believe the CCR initiative, including expansion of and focus on core product categories and the rollout of beer and wine, continue to gain traction and drive our comps. The CCR initiative also helped drive the holiday sales comp this past Easter. And finally, the 2-year stack, shown by the blue line, continued to trend up after bottoming out in the second quarter of fiscal 2010.
Compared to the industry, our sales continued to perform well. When viewing a true to apples-to-apples time period that compares our front-end comps to our top 3 competitors based on their most recent reporting, we outperformed all by a wide margin as shown on this chart. We also continued to outperform on a 2-year stack basis as well.
Turning to margin, our gross margin as a percentage of sales was 28.1% in the quarter compared to 27.6% last year. Overall margins in the quarter were positively impacted by higher retail pharmacy margins as the effect of generic drug sales more than offset market-driven reimbursements and front-end margins were driven by OTC drugs, beauty and personal care and several private-label categories. And that was partially offset by a higher provision for LIFO. Taking a look at our longer-term gross margin trends, our front-end margins, while flat in the second quarter of 2011, increased in the other 5 quarters as shown.
Pharmacy gross margin in the quarter improved with the impact of generics. As we discussed in recent quarters, additional progress obviously becomes increasingly difficult to achieve on these strong numbers. And please keep in mind that we will continue to believe that gross profit dollar growth and increases in traffic and basket are the most relevant measures of our progress. Two-year stack SG&A trends continue to improve with 15.8% growth in the third quarter of 2011, down from 17.1% last year and 18.7% in 2009.
Finally, walk through the progression of our reported SG&A dollar growth rate of 7.2% to our adjusted core SG&A rate of 6.4% you can see the impact versus a year ago. Lower Duane Reade integration expenses offset SG&A dollar growth by 60 basis points. Higher Duane Reade operating expenses added about 150 basis points and lower net cost associated with our Rewiring for Growth initiative offset our SG&A growth by 10 basis points, all versus a year ago.
Taking you through our income statement, this quarter included a LIFO provision of $50 million versus $18 million a year ago. Our estimated annual inflation rate for the current year remained at 2.25% versus 1.25% a year ago. Restructuring costs were $11 million, down from $17 million last year. Net interest expense was $80 million, down from $24 million a year ago, primarily as a result of reduced interest rates associated with our interest rate swaps.
Our effective tax rate was 35.4% versus 42.5% last year and recall that last year's effective tax rate included a $43 million charge in deferred taxes related to the Medicare Part D subsidy for retiree medical benefits. This year's third quarter benefited from a favorable state tax settlement. For the fourth quarter and the year, we expect our effective income tax rate to be about 37%.
Average diluted shares outstanding were 922 million versus 982 million a year ago, due primarily to our share repurchase program. Cash and cash equivalents were $2.7 billion at May 31, up 14.7%. Overall working capital decreased by 2.3% versus a year ago while working capital as a percent of sales decreased by 8.5%.
Total FIFO inventory increased by 7.7% in the quarter and by 5% on a per-store basis. For the 9 months ended May 31, 2011, we generated $3.3 billion in cash from operations compared to $2.8 billion a year ago, primarily as a result of higher net earnings. Capital expenditures were $699 million, down from $786 million last year.
As one of our core capital allocation priorities, we continue to return surplus cash to shareholders, and in the third quarter, we returned $535 million, including $160 million in dividends and $375 million through share repurchases. As of May 31, 2011, we repurchased $825 million against our $1 billion authorization. And as you can see year-to-date, we have returned a total of nearly $1.7 billion to shareholders.
Now this slide shows our gross profit dollar growth trends for the past 7 quarters, with the blue line representing 2010 and the green line representing the first 3 quarters of 2011. The red line above shows the 2-year stack trend. Last year's fourth quarter benefited from the initial inclusion of Duane Reade, a higher level of organic store openings and the rollout of beer and wine to about 3,500 stores, all of which we'll be cycling in the upcoming quarter.
As you can see the fourth quarter, one of the most difficult gross profit dollar comparisons of the year. And we'll continue to see some volatility resulting from the timing of generic introductions. As an example, we received greater gross profit dollar help from new generics in the third quarter versus a year ago. In the fourth quarter, we expect the help from generics to be significantly less than it was last year.
We have a similar construct for SG&A dollar growth for the last 7 quarters, with the blue line representing 2010 and the green line representing the first 3 quarters of fiscal 2011 and the red line showing the 2-year stack trend. As you can see, we're cycling a higher rate of SG&A dollar growth this year due to Duane Reade acquisition, so the comparative there will be easier than the prior quarters in the year.
As Greg said, we closed both the WHI and drugstore.com transactions in June. We expect the sale of WHI to be accretive to earnings by about $0.30 in fiscal 2011, largely due to the onetime gain on the sale and neutral in 2012, not including the reinvestment of the proceeds. As we indicated at the announcement, we anticipate the drugstore.com transaction will be dilutive to earnings per share in the fourth quarter of 2011 by about $0.03 to the transaction related and onetime cost.
Based on Walgreens' intention to reinvest in the business, the company further anticipates the transaction to be dilutive to earnings per share by about $0.03 to $0.04 in fiscal 2012 and about $0.01 to $0.02 in 2013.
Well, in closing, we are pleased with our quarterly results, which represented record third quarter sales, net income, earnings per diluted share and free cash flow, all notwithstanding an unforgiving economic environment. It is a validation that our strategies are translating into solid financial performance. And I want to acknowledge every one of our 244,000 employees who work hard every single day to help drive these results. And now I'll turn the call back to Greg for details regarding the developments with Express Scripts.
Gregory Wasson
Thanks, Wade. First, let me start by saying while not easy, this was a very clear decision for us. And one that we believe is in the best interest of our shareholders, our patients, our customers and our company.
Based on the terms and rates that Express Scripts has insisted on and after months of unsuccessful negotiations, we have reluctantly concluded it does not make sense for our business and the strategic direction of our company to continue our relationship with them. As a result, we're planning not to be a part of Express Scripts pharmacy provider network as of January 1, 2012.
This means that in January, Express Scripts provider network will no longer include our 7,700 Walgreen stores and Duane Reade pharmacies. Despite today's announcement, we remain committed to serving all of our patients' pharmacy and healthcare needs in the Express Scripts plan through end of this calendar year. To give you more context on our decision, as the largest provider in the Express Scripts network, we no longer felt like a valued partner for several reasons.
They were insistent on unacceptable reimbursement for the value we provide. In fact, their proposed reimbursement rates were below the published industry average cost to provide each prescription. Express Scripts attempted to define unilaterally what does and does not constitute a brand and generic drug despite existing industry standards, which when combined with the unacceptable rates further compounds the problem.
And third, they wanted the ability to move Walgreens into lower reimbursement networks and benefit designs without our approval and without fair compensation, reducing the predictability we need to forecast our business adequately. As I said as I began my comments, I want to emphasize this was not a decision we made lightly. We considered all alternatives. But based on Express Scripts' position, it was very clear, principled decision for us.
We believe the long-term ramifications of accepting Express Scripts' position with below market rates and minimal predictability would have been much worse than any short-term impact to our earnings. Given that, accepting Express Scripts' position would not have been in the long-term interest of our company, our customers, our pharmacists and our shareholders.
Furthermore, in a world where cost effectiveness and access to healthcare is so important, any time an intermediary continues to disproportionally grow its profit per prescription at the expense of the provider delivering the service, the relationship's out of balance.
The fact is we feel one out of 5 retail prescriptions in America, patients and payers value the trust and relationship they have with their pharmacist. They value the high quality, cost effectiveness and convenience we provide, which is why we work with hundreds of PBM and health plan networks across the country.
To give you some of the history, we've been in negotiations with Express Scripts for many months. Our team worked hard in a concerted effort to come to an agreement on a contract renewal that makes sense for both parties. They came in to our discussions with Express Scripts with what we thought was a market-based reasonable approach to terms and rate. We proposed to lower rates on the behalf of the Department of Defense TRICARE program, the pharmacy benefit plan managed by Express Scripts that serves active and retired military personnel. We also offered to contract separately with Express Scripts for TRICARE beneficiaries in order to continue providing services for all active and retired military personnel.
Under our proposal, the reimbursement costs of the DOD [Department of Defense] would have been lower than under Walgreens' new proposed commercial rates. For all other plans managed by Express Scripts, we offered to hold rates for a new contract at the level that will be in effect with Express Scripts at year end, which will be lower than current rates.
As for the impact on our business from this decision, we estimate that Express Scripts will reimburse Walgreens approximately $5.3 billion in fiscal 2011. This figure represents about 7% of our total company sales. Those sales divide into 4 distinct categories. Managed care represents 45% of the business, 18% goes to the Department of Defense, 26% to employers and 11% is Medicare Part D. Express Scripts processes approximately 90 million prescriptions that are expected to be filled by Walgreens in fiscal 2011.
To mitigate that impact, we intend to work closely with our PBM and health plan partners. We've heard loud and clear over the past year from employers and payers that they value the choice, cost effectiveness, convenience and service of Walgreens. As a result, over time, we are optimistic employers and others are going to want Walgreens in their network.
Second, during the open enrollment period, we will reach out to the Medicare beneficiaries to make sure they know how to have access to Walgreens pharmacies they have known and trusted for years. We will assist them in finding Medicare Part D plans with access to Walgreens. And finally, we will work directly with employers and payers, who have the ability to work directly with Walgreens.
For all of these reasons, we are optimistic about our ability over time to regain these customers and grow our business. For now, however, we're not going to speculate publicly about the amount of business we can retain in fiscal year 2012 or the potential impact on our financial metrics and stated goals. In the long run, we believe employers will want plans with Walgreens in the network.
With that said, Walgreens is moving forward with our strategies, and I'm confident in our future. Never in my years with this company have I seen so much interest from key stakeholders within the industry for the services Walgreens can deliver. We're prepared to live without Express Scripts in our world and work together with companies that understand the course we, in the healthcare industry, are taking.
As we've demonstrated in this and recent quarters, we're focused on helping our patients live well and on our strategy to transform community pharmacy to improve the overall cost and quality of care. With that, I'll turn the call back to Rick.
Rick Hans
Thank you, Greg. Ladies and gentlemen, that concludes our prepared remarks. We're now ready to take your questions.
