Loblaw Companies Limited

Janet Craig - Senior Vice President, Investor Relations Galen Weston - Executive Chairman and President Richard Dufresne - Chief Financial Officer

Irene Nattel - RBC David Hartley - Credit Suisse Jim Durran - Barclays Perry Caicco - CIBC Vishal Shreedhar - National Bank Michael Van Aelst - TD Securities Keith Howlett - Desjardins Securities Peter Sklar - BMO Chris Li - Bank of America

Thanks, Michelle, and good morning. And welcome to the Loblaw Companies Limited first quarter 2015 results conference call.

I am joined by Galen Weston, Executive Chairman and President; and Richard Dufresne, Chief Financial Officer. Before we begin today's call, I want to remind you that the discussion will include forward-looking statements, such as the company's beliefs and expectations regarding certain aspects of the financial performance in 2015 and future years.

These statements are based on certain assumptions and reflect management's current expectations and they are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from our expectations. These risks and uncertainties are discussed in the company's materials filed with the Canadian Regulators from time-to-time.

Any forward-looking statements speak only as of the date they are made. The company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, other than as required by law.

Certain non-GAAP measures may be discussed or referred to today. Please refer to our Annual Report and other materials filed with the Canadian Securities regulators for a reconciliation of these measures to the most directly comparable GAAP financial measures.

I will now turn the call over to Richard.

Thank you, Janet, and good morning, everyone. In Q1 we continued to deliver against our financial plan, and we are pleased with our progress to date.

We maintained a stable trading environment with positive same-store sales and stable gross margin. We achieved 30 basis points of SG&A efficiencies in food retail, $44 million in net synergies, we remain on track with our deleveraging plan and increased our dividend.

Our 4% same-store sales growth for food retail business was aided by inflation and we saw increased basket and traffic. Our internal inflation was higher than food CPI of 4.6%, mostly driven by fresh, particularly meat and produce, but also aided by some inflation in grocery.

Both our market and discount divisions had solid comp growth. At Shoppers Drug Mart the positive trend for same-store sales continued with pharmacy same-store sales growth of 3.5% and front of store same-store sales growth of 2.7%.

Market share growth in pharmacy grew prescription count up 4.7%, however, this was offset by deflation in the average value of script dispense of 1.1%. In front of store, our performance was led by OTC, food, confection and cosmetics.

We did see some benefit in front of store from the timing of Easter as well. Traffic and basket were up.

With positive same-store sales growth in food and drug retail, the topline was strong with sales of $10 billion in the quarter, up 38% over last year on a consolidated basis. Revenue in our retail segment was $9.8 billion, up 38.5% year-over-year, with our food retail business growing 2% to $7.2 billion.

Shoppers Drug Mart revenue grew 3.1% to $2.6 billion in the quarter. As we talked about in our last quarter's result, the company restructured its fee arrangements with the franchisees of certain banners.

This change has no impact on our earnings. What it does is reduce our gross profit and our SG&A.

In Q1 gross profit and SG&A were reduced by $33 million. Our Retail segment gross margin improved due to the addition of the Shoppers Drug Mart business with adjusted gross margin of 26.7%, up from 22.6% last year.

Food retail gross margin of 22.1% was flat after adjusting for the change in franchise agreement. Synergies offset shrink, which came in higher than last year due to a catch up in inventory count following the implementation of a CP at store level in 2014.

In our drug retail business, gross margin grew about 100 basis points to 39.4%, largely driven by synergies. Cost of goods sold in the quarter also benefited from higher retail margins in front of store.

Turning to expenses. We remain focused on improving core SG&A expense and seek to better manage volatility in SG&A as well as providing visibility into the drivers.

Excluding the benefit to SG&A, as a result of the change in our franchise agreement, food retail SG&A improved in Q1. We improved SG&A by 30 basis points in Q1, largely coming from labor, supply chain and IT.

We believe these efficiencies to be sustainable. Shoppers Drug Mart's SG&A increased 10 basis points year-over-year, as expected, due to higher store level expense, primarily labor and occupancy, largely driven by script count growth.

Moving to synergies. We continue to make good progress against our target.

We have achieved $145 million of net synergies since closing, including $44 million in the quarter. We remain on track and feel comfortable with our 2015 target of close to $200 million.

At PC Financial, Q1 revenue increased by $19 million or 10.6%, driven by higher interchange income as a result of increased credit card transaction values, higher interest income and an increase in mobile shop sales. Operating income grew 16.7% to $42 million, primarily driven by the increase in revenue, offset by higher costs associated with the Financial Services loyalty program and costs, as a result of an increase in the active customer base.

Our adjusted interest expense for Q1 quarter was $131 million, and our full year guidance on interest continues to be approximately $575 million. The acquisition of Shoppers Drug Mart, our consistent execution against our strategic priorities, operational effectiveness, the realization of discrepancies and synergies, all contributed to us achieving net earnings of $301 million and adjusted net earnings per share of $0.73.

We generated free cash flow of $144 million in Q1. Since the closing of the acquisition last March, we have reduced our adjusted debt by over $1 billion.

As we noted on our Q4 conference call, our adjusted debt increased $43 million, due to seasonal working capital requirements. We continue to remain on track to achieve our target of $1.7 billion reduction by the end of Q1 next year.

Our CapEx this quarter were $231 million, including $45 million of CapEx in Shoppers Drug Mart. Also as a reminder, we modified our CapEx definition in Q4 to include intangible, which represented $27 million for the quarter.

In closing, we continue to remain confident in our strategy, business performance and financial plan. We continue to be on track to achieve our full year guidance, including growing adjusted net earnings year-over-year.

Having said that, our adjusted net earnings growth for the balance of the year is not expected to achieve the same level as Q1, as we outperform our plan for Q1 and expect to be on plan for the rest of the year. Thank you.

I'll now turn over the call to Galen.

Thank you, Richard, and good morning, everyone. As you just heard, Loblaw continues to execute against its financial plan.

We are maintaining a stable trading platform, synergies are in line with expectations, efficiencies are on track and our deleveraging targets is unchanged. This quarter we saw reasonable tonnage performance in our food retail business, the Shoppers Drug Mart continues to see a sales lift from market share gains in pharmacy and continued strength in OTC, beauty, food and confection.

Traffic and basket were up across our divisions. Our leadership team is working together within and across our businesses to achieve our strategic and operational goals.

These include enhancing the health and beauty offer in our grocery stores, expanding and improving the food offer at Shoppers Drug Mart and achieving efficiencies. Establishing e-commerce platform and making the investments require to play a larger role in the delivery of healthcare services in Canada.

It's hard to believe that it's been just over a year since the Shoppers Drug Mart acquisition closed. We have made tremendous progress and are excited about the possibilities going forward.

Many acquisitions can create distractions for companies. But the acquisition of Shoppers Drug Mart in many ways, I believe, we have become more focused, focused on our strategic framework of delivering the best in food experience, best in health and beauty, operational excellence and growth.

We are also starting to incorporate best of breed practices across the company to further enhance our effectiveness and competitive advantage. The industries in which we operate remain intensely competitive.

But on balance, we expect to see continued momentum based on our competitive position and moderating square footage growth. Our outlook remains unchanged.

As you are aware, we announced a 2% quarterly dividend that increase. And while we remain committed to deleveraging the balance sheet, we believe it is important to maintain the cadence of discipline of a dividend increase every year.

As we have discussed, we do not expect to engage in stock buybacks, except to offset dilution until our deleveraging target is met. We remain focused on a balanced capital return strategy.

Looking forward, I'm confident that as we build our portfolio of strong complementary, but independent businesses along with a balanced capital return strategy, we will accrue long-term value for shareholders. Thanks.

Thanks, Galen. And Michelle, we're ready to take questions.

Richard, in your opening remarks you mentioned that you exceeded plan in Q1. And I was wondering if you could just walk us through in which areas that would be the case and what the drivers were placed?

I guess, Irene, overall all our businesses did well in Q1 like without exceptions. So I'd say it's across the board.

So that would go to both topline and efficiency gains?

Topline, gross margin, SG&A, for all businesses.

You also noted that you're starting to see some inflation creeping into the center of the store. It's the first time we've heard that in quite a while.

Just wondering if you could walk us through that please?

We are expecting to see this really as a result of the depreciation in the Canadian dollar, and product coming through the U.S., pressure from the big multinationals to try and put cost increases through. So in itself that's not a bad thing.

The inflation levels in grocery are certainly not anywhere near the levels that we've seen in fresh over the last 12 months. But it is moving and there is pressure.

And remember these are the categories that tend to be the most price sensitive, and so we're cautious and watching very carefully the extent to which the consumer will accept these increases. And I think we said in a couple of occasions over the last few quarters that, yes, we're able to pass on some of the cost inflation, but not all of it.

So that leads me to my next question, which is, can you talk a little bit about consumer behavior in the quarter, trade down, reaction to the inflation, and also what you're seeing in terms of proportion of transaction on promotion?

I think it continues to be reasonably stable. There is not a big shift in terms of the mix of promotional intensity at this point.

Everybody is focused in a pretty razor sharp way of not getting outpriced. And the discount businesses, I think, are continuing to trying to make sure that they are delivering the best value in the market.

And so what we're sort of flagging is, when you have mid-single digit increases in fresh over multiple quarters, quarter-after-quarter, you worry that you're going to see a meaningful shift. We've talked before about people trading down specific proteins, trading from meat into pork or chicken, that's been going on for the last basically year-and-a-half.

It's not accelerating at this stage. So we'll get back to you in Q2 to see if any of those trends are starting to accelerate, but we're watching it very carefully.

Just quickly on the market share. What would you characterize happened to your market share in the quarter.

I know that you're tonnage, I guess, looked to be down, but could you let me know about that?

There is sort of the street math calculation of tonnage, which is inflation versus comp store sales. We look at the numbers, we see what's happening in our business, and we feel satisfied with our tonnage performance.

So customer traffic is up. Items are flat.

And our tonnage share is outperforming or its growing relative to the rest of the market. So those are positive indicators, despite the fact that we see this CPI inflation and even our own internal inflation calculations running ahead of our comp store sales.

I'm just trying to square that all up. I mean, is Loblaw's less interested relative to the street in chasing after promotional sales.

Is that part of the answer to why that square is up or could you give me a little bit more color around that?

I mean look it sort of go back to this basic math calculation doesn't provide the level of precision that I think folks might like it to. And we're looking at an additional level of detail.

And you have three measures that are sending us efficiently positive message. I have said before that our approach under the mantra of stable trading is we're not chasing anything.

We want to incrementally improve our business. We want to make sure that we're doing the right thing for our customers and then we watch very carefully what's happening to market share, what's happening to tonnage share, what's happening to customer traffic, what's happening in the baskets.

And at this stage we're quite comfortable with where we sit.

And just as a follow-up, finally, just I think one of your competitors recently said that sales on promotion has actually been increasing perhaps by their math, perhaps by their geographies, but you're saying I believe that it's reasonably stable. Am I characterizing that right?

What are you seeing that maybe different than your competitors? Is it a mix effect, what would it be?

Our strategies appear to be working, and we're not feeling that we need to substantially ramp up our promotional intensity. But what you are hearing is a little bit of caution that that could change.

We are watching to see the way the consumer reacts. We're watching to see whether some of those metrics that we follow in terms of tonnage or tonnage shares starting to move the wrong way.

And without question, one of the easiest reactions that a merchant can make when you start to lose ground in any of those areas is to drop up promotional intensity. I think it doesn't surprise me that you've heard that from others and you may hear it from us, but you're not hearing it yet today.

I have a number of questions, first of all, Alberta. Have you seen any noticeable change in their sales performance in Alberta?

You mean, driven by the economic circumstances or the political circumstances, what -- ?

I'll admit it, there is more than one contributor right now, but let's stick with the drop in oil price for now.

So look, I think the western market is -- we don't typically talk about sort of performance by region. And as Richard mentioned, the performance across the board in the company was pretty strong.

But we do feel very good about how things are going in the west. We're not seeing a change in the consumer behavior that is negatively affecting us.

This is worth remembering that the bulk of our market share there is in the discount side of our business. Our price points are very strong.

And so that's probably contributing to a little bit stronger performance there. And at this stage, if I was to speculate, we're probably more insulated from an increased economic deterioration for the consumer than perhaps others.

So we feel all right there at the moment.

If you could, could you update us on a number of your sort of initiatives that are in place, the e-commerce test, the Shoppers food test, are you ready to roll into more stores now? And how we're progressing on Inspire?

Yes, so three good ones, three initiatives that we're feeling pretty optimistic about at the moment. As you know the Inspire program has kind of moved from pilot to rollout, and we've got a couple of more stores under renovation in Ontario as we speak.

We're continuing to open that and our neighbor format in Western Canada. We feel good about the way those stores are performing.

We're still very much in the pilot stage, when it comes to e-commerce, although, we're moving from three-store pilot to increase the number of stores. We're going to try click-and-collect in a few superstores over the next four, five months to see how the proposition works there.

So far the consumer response has been really positive. That's not an easy thing to run a click-and-collect proposition with different assortments across multiple different stores.

But so far I think the team is really doing a terrific job. And all indication suggests that the consumer, a certain type of consumer responds well to the proposition.

On the food pilots, so six stores in downtown Toronto. And while it's still early to determine the long-term performance, I can tell you we're encouraged by the progress pretty much across the board, both the incremental impact on sales for the store itself, the performance of food sales specifically, and the fresh food proposition is being well-responded to by the consumers as well.

And so it's encouraging, so much so, that in our sort of second stage pilot we launched it publicly, I think it was on Monday, I'm looking at -- maybe, it was Sunday, which is nine stores in Regina. The difference between Toronto and Regina is that we've taken an entire market with what we think is a disproportionate mix towards suburban as opposed to downtown urban.

And this is a test to determine really how much reach a convenience fresh food preposition has in small stores in some of the more suburban markets in Canada. The other thing about what we're able to do when we launched it in an entire market that we can start to incorporate those products in the marketing and promotional strategies.

So you can start to promote some of those more sophisticated fresh food offers in the flyer, and you can do some institutional marketing. And I think our hope is that that should turbo-charge customer awareness around the offer, which should contribute to more positive sales.

But I do want to reiterate that despite the increased number of stores, it still very much fits in pilot stage for us, and we're not in a position to push the button, and say, this is a program that's going to go over a specific number of stores over a specific timeframe. But as we get more comfortable we'll try and communicate with a little bit more precisions what the big picture is with regards to the food pilot.

Back to the discussion on tonnage. Is the negative same-store tonnage when you drill down a particularly bigger problem in certain categories, maybe those that have inflated the most?

Is there any sign that it's just related to price inflation?

So there are some interesting things happening in the business. But it's pretty consistent with what we've shared with you before.

This shift that's taking place from the center of the store into sort of the fresh side of the store is something that we see not only in the Inspire business, but also we see it in the discount division as well. And it's not driven exclusively by the disproportionate inflation that's taking place on the fresh side.

There are categories where the consumers are changing behavior, not because the promotional environment has changed, but we believe because their shopping habits are changing. So the carbonated beverage category continues to be under pressure.

The cereal category continues to be under pressure. A number of those sort of the big traditional categories in the center of the store, customers are shifting away from, and where they're going?

They're going to fresh. They're moving into natural value.

And we don't see that shifting back in any meaningful way at this point. I'd say there is a price point where the customer might switch back, but actually we're seeing price points go the other way at this point, because of that little bit of inflation pressure.

So just if you play that forward, what you're seeing is that sort of gap between price inflation and your same-store sales should continue, although it's not of concern, because of the category shift. Is that a fair statement?

Yes, look again, I think people are right to focus on this question and you're going to have to come to your own conclusions. But the important takeaway is that the market data, which shows the performance of all the different food companies, say, coming from Nielsen shows that we have tonnage share gains.

And when you add that to items and traffic, we feel reasonably good about our tonnage position. The underlying trend in terms of what's actually happening to tonnage in grocery is customers shift their patterns.

That is a different thing to our relative competitive performance. And so to answer your question, Perry, I would say if that consumer shift continues at the rate that it's been on in the last 18 or 24 months, yes, then you might continue to see this sort of, perceived, sort of, overall, sort of tonnage decline, but that's pure speculation at this point based on the past 18 months.

And so on the last call you indicated that your outlook for comp store sales was growth that would be slightly in line with or slightly ahead of inflation. Would you moderate that particular statement at this point?

Our expectation is that we should be able to grow our sales a little bit more than inflation, and that's how we try and plan the business, that's how we think about the medium in the long term. But we're not going to chase that number, especially if the underlying indicators suggest that the business is healthy from an underlying customer perspective and also healthy from a competitive positioning perspective.

I just want to, if I could, just switch gears a little bit to the renovation program. How are your recently renovated stores, particularly Inspire, impacting your numbers?

Are they contributing to same-stores sales and gross margins, maybe impacting SG&A negatively? Just talk a bit about how that program impact to your business?

So just to again put it in perspective, if you focus specifically on the food business and our Shoppers for a second, we'd have somewhere in the range of 1,000 supermarkets just to keep it, sort of, simple math. And we have sort of 27 Inspire stores on the way to 32.

So I think the impact of the Inspire business on the overall performance of the company is not something that people should overweight. And if you focus on markets where we are specifically investing in the Inspire concept, where we expect a big disproportionate market impact, then Toronto would be a great example of that.

We are seeing an effect. We're seeing the effects that you would expect.

Each one of those Inspire stores is driving strong sales performance, each one of those Inspire stores is driving strong margin performance improvement, and it's also having the effect of drawing some customers away from the unrenovated stores, which is a negative impact, not unexpected, but certainly something that we look at. And so we'd like to get as many as those Inspire stores converted in a particular market as we can, so that the erosion are coming at the expense of our competitors as opposed to at the expense of ourselves.

And we're on a journey to do that and feel that in the meantime we're certainly able to manage that renovation program within the context of not just the overall company budget, but actually the banner and divisional budgets that are experiencing the biggest investments.

And my last question and it's related to Inspire, is the investment in a particular store for Inspire is fairly heavy. As you move the program forward, will you change the investment to fit the store and the site?

Is there a sort of lighter versions of Inspire?

So a great question. And you can imagine, our expectation is that the cost of the Inspire stores will continue to go down.

Go down because you get better at doing it, goes down because you're able to fixtures at scale. Those are all the things that come with moving from the pilot program to an extended rollout.

And then as we move into markets where perhaps the sales density of the store is not as high, then we look at it, and say, well, you can't afford to spend that full amount to generate the satisfactory return, and so you pullback on certain elements that maybe choosing not to move a bakery from the back corner of the store to the front side of the threshold, that's a great way of saving some money. And in a store that doesn't do the business to warrant it, these are important trade-offs that we make.

So yes, you'll start to see -- you may not see it although, Perry you noticed this stuff pretty well as sort of an Inspire light. And if we can do an Inspire light with the same sales uplift, then you might see more of those, because that's more efficient from a capital perspective.

With Shoppers, with the ongoing drug reforms, just wondering if the average generic prescription drug still generates more gross profit dollars than the average branded?

Yes.

I just want to dig a bit deeper on the synergy number. You had $44 million in Q1, and if you kind of annualize that and subtract what you did last year, it looks like the run rate is $94 million, and the synergy target is about $100 million.

So the implication is that there is no further synergies captured above what's in the $44 million. Is my math right?

Your math is right, but our objective continues to be that we're going to finish the year at $200 million, and after Q1 we remain committed to that number. So we should continue to meet our target.

So just on the synergy -- just on the reasoning for that $100-ish million in 2015, is it because there is more cost to get the new synergy, so it will take more time or is it because the synergies don't really start to kick-in until next year?

No, it takes more time, because last year we did the easy stuff, which was the COG piece, and now there's still a bit of COG that's annualizing this year, but we're getting more into GNFR piece, which is a much harder work, much smaller dollars. But we're seeing traction with that program already, but it's going to be slower this year than it was last year.

But we have good visibility on that program as of today. And so therefore, we remain committed with that number for 2015.

So given that you have good visibility, it's probably unlikely that there will be a larger deviations from what you target?

Yes.

In terms of the ROC calculation, that you disclosed, just a quick one here. The ROC; does that exclude the REIT and financial?

The ROC, the return on capital?

Yes, you disclosed it in your MD&A.

Good question. I don't have the answer to that, so I'll get back to you.

But one thing with that figure you need to be careful is we have not lapped Shoppers yet, so the denominator is still moving a lot. So you will see that figure actually go down as the year progress, because it's going to capture all the capital that was issued as part of the transaction, I guess next quarter.

But I'll get back to you with the answer to your question.

A peer of yours noted that inflation has peaked at least from their perspective. Do you guys feel the same way?

Well, I'm not sure that we're quite as definitive on the subject, so P-3 was an important lapping period for us to try and assess that, and that's because we're coming up against strong fresh inflation from the prior year. And so you would expect it to compress dramatically.

I think we haven't seen it compresses as dramatically as we thought that it might. And so again, the indication suggests that you have slightly higher than anticipated fresh shrink or fresh inflation and an accelerating over moderate inflation on the grocery side.

We're not calling the peak just yet, but I would say it's slowing. It's not going to get a whole lot rapidly higher, but I wouldn't say it's flattening out.

And just a last one here. You mentioned to shrink, and I think in the materials you said that the shrink cost went up, but as you implement SAP, shouldn't those go down, and maybe, if you could just help me understand that?

So on that one, Vishal, I guess, last year because we were rolling out our corporate stores, we actually decreased the number of counts significantly. It was very tough to actually count stores as they were converting.

So now, we're catching up. And so therefore, we've been capturing shrink that has not been, I guess, accounted for a while, so that's a factor.

Plus, as we've talked about a few times over the last few quarters, we're in sort of the new world of working with SAP and there is some costing issues that are entering into the system, and that's resulting in an additional shrink. And so we are working through those right now.

And hope, I guess, to close those all in 2015. But clearly in 2015, we're going to reset the new levels of shrink, and that will form the base by which we'll be measuring the performance of the business going forward.

You've covered most of it, but just on inflation, when you say you're just over the 4.6% CPI, at least one of your competitors was closer to 4%. The difference between your numbers, and say, where the CPI date is and your competitors', you think that's more mix or is that difference in timing of price investments or how would you explain that?

I think it's probably a combination of things. Look, I wish there was more precision that we could deliver as an industry to everybody when it comes to inflation, but the fact of the matter is you can't rely on one specific measure, so there is a little bit of judgment.

And that's why I keep going to looking -- we look at multiple metrics. We're not trying to kid ourselves.

Our objective is to determine what's actually happening in the business. And it's the second and third level metrics that are more robust indicators of what's actually happening.

And again, that's why we're not driving tonnage at an accelerated rate, it's progressing in a manner that we're satisfied with. Is mix playing a role?

Yes, for sure it's playing a role. So this mix shift into fresh drives inflation if you're buying and your tonnage can go down on that basis.

I always use the example of the coffee pods, coffee pods in the grocery aisle, we had massive inflation. You're going from $0.02 a cup to $0.60 a cup, and you're not seeing any increase in tonnage based on the way that the calculation is done.

So for sure, there is a mix element in there, but you can spend a whole lot of time trying to chase this down item-by-item or category-by-category and what you got to do is look at the overall directional indicators to get a sense of it.

And are you able to quantify the Easter shift benefit?

On food it was minimal, Michael, like really minimal.

And on drug?

On drug a few percent, not that significant. It was more like the shift and promotion that puts up some sales from one quarter to the other, but nothing to worry about.

So of the 2.7% in the front store, it wasn't a meaningful portion of that?

No.

So I was wondering if you could give some directional on your capital spending this year in terms of the formats. What weighting different formats are getting or regions of the country, sort of what's the broad direction of the capital spend?

So again, I'll give you sort of a bit of a directional sense. So where are we spending capital?

We're spending capital on new stores, unbalance disproportionately in the West and in Shoppers Drug Mart, okay, which you would expect in the West, because the food business has lower market share penetration there. We also only have representation of two of our sort of key formats, so no neighbor stores and Inspire stores going new in the West.

The Inspire program is an important driver for renovation. In terms of capital I've already mentioned that you're seeing not a 100% of the investment there going into Toronto, but certainly a disproportionate amount of it.

And you're seeing a little bit less in terms of investment in renovations and new stores right now in Quebec and the Atlantic. So that's because, if you remember the Atlantic went through its renovation cycle upgrade about three years ago.

So you would expect that to the less. And in Quebec sort of we're moving a little bit more slowly when it comes to Inspire, but still pretty comfortable with the way they're performing in that province.

I think there is an Inspire store in North Vancouver, but when you refer to the neighbor store, what do you mean there?

So the neighbor stores would be, if you went through a recently renovated Zehrs', most of your independent grocers that we have renovated in recent years that sort of gets classified under a bucket of neighbor. And neighbor is really important.

It represents, let's just say, somewhere in the range of 80% of the total market division network. And these are markets where sort of the sophistication that we offer in Inspire just isn't suited to the customer, the demographic, or the price point.

And so that is an important part of the market division strategy.

Just if I could ask sort of a broad philosophical question. You have a lot of very large format stores particularly in the West.

Do those stores have more of a challenge as the center of the store is under pressure, as people sort of flee to the fresh perimeter or whatever, or is it proportionally about the same problem as any grocery store would have?

It's a fair question. I'd say, it maybe slightly more impacted, but of course you have to remember there is a lot more promotional intensity and volume driving investment going into the center of the store in discount, which has an offsetting impact, but its certainly not a meaningful shift that we see at this stage that would cause us any incremental concern or cause us to change our strategy in a meaningful way.

Just two questions at this point. We thought that your performance in Shoppers was particularly strong.

Was there anything in addition to the synergies, and as well as earlier in your comments you referred to some strength in particular categories. Was there anything unusual going on in Shoppers beyond that?

Well, as we start to learn the drug store business with a little bit more depth, there are a few things that can shift performance on the topline, and can do so in a positive way on the bottomline as well. So the cold and flu season, you've heard it many times over the years, when you listen to the Shoppers, it was pretty good, late winter, and for us.

And then we've also had a pretty good early allergy season, which is kind of would surprise you. So those things are contributing to stronger sales performance.

The prescription volume has been running a little bit ahead of probably what we expected, so we feel good about that. But these are all kind of around the edges as opposed to real disproportionate sort of swings in the business itself.

And then just lastly on a different topic. Going to your food retail business in the write-up, you talked about cost related to higher investment in the franchise business.

Can you elaborate what you mean by that?

It's just that, Peter, that in an effort to simplify the way we do business, we've restructured our arrangement, which are franchisees to make it more simple, and the accounting impact of that was that it actually shifted more from the gross margin to SG&A, so it's just the change in geography from the income statement perspective, but it's just going to help manage our business in a much better way with our franchises going forward.

Just on the Shoppers business. Gross margin was stable excluding synergies this quarter.

Do you expect this trend to remain stable for the rest of the year or do you expect the trend to deteriorate a little bit as you continue to hit some drug reform headwinds?

Well, I guess, we're always striving to keep our gross margin stable. There is always pressure that has affected Shoppers gross margin over the last few years.

And right now, we're trying to hold it as best we can and we're being successful. So I'm not going to comment specifically about gross margin for the rest of the year, but our plan is always to keep it as close as possible to where they are.

And, Galen, I think last quarter you mentioned that you weren't quite satisfied with your private label brands in the Shoppers stores with respect to the in-stall precisions and branding. Just wanted to see, if you could give us an update of what's been proved since the last call?

Yes, thank you for asking. I'm pleased to say that the service levels have improved quite substantially.

And I think the team that have been working on it are proud of what they've accomplished. It's not quite there yet, but there is some great positive momentum, and the particularly gratifying thing is that when those products are in stock, they sell really well at Shoppers.

So we've made progress.

And just a question on your leverage target. I guess, you are still looking to pay down about $600 million of debt by Q1 of next year.

Do you think this is conservative? Do you think you can do it sooner?

Or are there other expenditures that you think you have to spend that wouldn't allow you to achieve that target sooner than Q1 of next year?

Chris, where we stand today, we feel very confident that we'll meet our target by Q1 of next year.

So just a couple of follow-up questions. So first of all, any update on the Target stores, Canadian Target out today that it's hoping to land 12 of the remaining stores?

No update, I mean beyond what everybody already knows, which is if the stores closed faster than folks expected, that's a positive impact. We expect somewhere in the range of 50% of them to go to sort of the large retailers, and some capacity Canadian Target we always thought would be one, Walmart we think will be one, and there will be a few others.

We are certainly involved in discussions there, although we don't expect it to be meaningful from our perspective. There is not a huge number of sites that would be particularly complementary to us.

So you shouldn't expect any meaningful news from us in the coming months on that.

And just going back to your food gross margins, so indication was that it was flat year-over-year excluding the adjustment for franchisees? If we looked at it x gasoline, you provided the topline impact of gas prices obviously, but it would look like gas margins as a percentage might be supportive of the margin.

Would food have been still now flattish if we extract that?

On GAAP margin, yes, you are right. They are benefiting from the current situation, but on the absolute gross margin of the business it grow in dollar.

And we have time for two last callers.

Your comments Galen, on coffee pods in particular and other things categories is just very helpful. I just was wondering how the company feels on the food side about how the stores and the offering has evolved versus the competition.

It sounds like food services pushing forward well, first to market in offerings. And perhaps your PC products and private label are doing well.

Can you provide any commentary on that that would be supportive of that?

Yes. I mean I think there is two elements where we believe the business is delivering improvements in terms of the customer proposition.

The first is that basic blocking and tackling that you've heard from us over the last two or three years, which is a bigger commitment to strategic category management, a bigger commitment to just good planogramming and working to bring vendor's most recent innovation to the market in a timely fashion. So these are areas that we consider to be a weakness relative to the rest of the market probably two years ago.

I think we would now say that we're at least at par with the rest and looking to continue to improve our capabilities there. Obviously, President's Choice and our commitment to control label continues as a competitive advantage, and we're innovating there.

A good example of that is our free front program, particularly in pork. It's been a big positive impact in terms of changing the way that customers think about certain types of protein that they buy, really strong, strong response there.

Another good category that we've seen terrific outstanding growth would be on the pet food side when it comes to our control label program there, nutrition first. And then the other things that I think we've benefited from as the business has got more stable and more focused on the customer and more outward looking, we're bringing specialty item to market in, I think, a more comprehensive and compelling way.

With the market division needs would be artisanal product, local products from different parts of the region, where we're getting a great response. Natural value, though it's been a strength of ours, as it continues to improve.

And then on the discount side, we're really starting to pick up the pace in terms of the strategic implementation of our multicultural program. So you remember we have bought QNF, which is a leading foundation distributor.

We've got T&T, which has an agent distributor attached to it. And then we also bought this in Middle Eastern business called RF, and this is giving us an insight to the product assortment that we should carry almost by location in those key multicultural areas.

And we are seeing steady and quite encouraging improvement across the board there. So this is gives you a sense of how we think we're pushing the customer proposition forward.

Then I would be remiss if I didn't also mention, we've retained our commitment to delivering value, whether that's a no-frills in center of the store, we've got a great add-on the street today that represents our commitment to that. But also across the super store business, we feel better position from a competitive perspective than we have.

It just continues to improve. And then we're focused on value as well in the neighbor stores.

And you might not believe it, but center of the store price proposition in Inspire is also something that we watch carefully to make sure that there is real value on the shelf.

Just to finish off on that point. I mean, how impactful are some of these strategies around ethnic offering, whether it be your own source products or others, and then your private label President's Choice no name offering.

I mean, how much does that affect that relationship between on the street math between inflation and tonnage, et cetera?

You know what I don't know, but my guess is if you're looking for that set of initiatives as an explanation for this inflation element. I think it could be contributing for sure, like lots of things will be contributing.

But I couldn't tell you specifically if that represented 20% of the GAAP or 50% of the GAAP or 2% of the GAAP. And it's not something that we would be spending a ton of time on, trying to figure out here.

And again, that's because the underlying metrics suggest to us that our business performance is just fine.

Talking about Target. There was a lot of pre-positioning in retail in advance of their entry, and then obviously a lot of competition that continued after.

What change in the market behavior have you seen in either of your businesses since Target has closed their stores?

So is the question, how much of a tailwind is the Target business delivering to our performance, is that kind of what you're getting at?

Well, I'm sure it wasn't a big sales impact on your business. But from a market competitiveness standpoint, it seems like it was and on the industries in general.

I was wondering if any of that has started to fall off?

So you're asking, is it getting less competitive because target is closed up, is that the question?

Yes.

Not that we see at this point. There are two forces at work in terms of impacting your topline sales.

The first and the disproportionate force is new square footage. So new square footage growth, if it's rapid it has a big impact on your topline if you have high market share and you're not growing your square footage very much.

That's been what we've faced into over the last three or four years. As the comparative square footage growth has slowed, that does advantage us.

And I think systemically, not just because of target, it's easier for us and it's easier for the market in general to have more satisfactory sales growth. In terms of the competitive possession for sure, everybody sharpened their pencils when target came into market, they focused on renovating stores, they wanted to make sure their programs were up to snuff, that their innovation was in the right place.

And I think by in large across the categories Target competed in, people delivered on that promise. Now that they are gone, I don't think it's changing much.

I think there is still a lot of competition here, and people are still fighting hard in different circumstances to grow their sales and deliver market shares. So haven't really seen an easing off.

And the way to think about it is the way I think about it is, if you can pass through a 100% of the cost inflation that you're getting from the market, which is the circumstance that exists here, then there continues to be meaningful pressure on your gross margin. And the job of a merchant is to mix that back in some way to deliver on our commitment to have flat gross margin, and also to continue to deliver the right competitive proposition to the stores.

And that's what we are doing. That's what our other competitors are endeavoring to do, and so far we're doing alright.

And just a brief follow up to that. Are you hearing of any potential of other entrants coming into the market, whether it be Aldi or others like that?

No. Not much, suggesting we know everything that's going on out there.

But there is certainly no drumbeat that we've picked up. Are you hearing anything?

Let us know if you do.

And just before we toss it back over to Michelle, I think Richard was going to follow-up on Vishal.

Yes, Vishal, I've got the answer to your question. The return on capital that we show in our result is on a consolidated basis.

It includes the bank and the REITs and everything.

Great. Thanks, Richard.

And back over to you Michelle. End of Q&A