Empire Company's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Mar.13.14 | About: Empire Company (EMP.A)

Empire Company Limited (EMP.A) Q4 2013 Earnings Conference Call March 13, 2014 4:00 PM ET

Executives

Stewart Mahoney – SVP, Treasury and IR

François Vimard – CFO

Marc Poulin – President and CEO

Analysts

Perry Caicco – CIBC

Michael Van Aelst – TD Securities

Peter Sklar – BMO Capital Markets

Jim Durran – Barclays

Chris Li – Bank of America Merrill Lynch

Keith Howlett – Desjardins Securities

Patricia Baker – Scotiabank

Vishal Shreedhar – National Bank

Operator

Good afternoon. My name is Candice and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Empire Company Third Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

I’ll now turn the call over to Stewart Mahoney, Senior Vice President, Treasury and Investor Relations with Empire Company. You may begin.

Stewart Mahoney

Thank you. Thank you, Candice and good afternoon everyone. Thank you for joining us today. Our comments today will focus primarily on the financial results for the third quarter ended February 1. Following our comments, we will then be open to your questions. This call is being recorded and live audio on our website at www.empireco.ca. Joining me on the call this afternoon are Marc Poulin, President and Chief Executive Officer, François Vimard, Chief Financial Officer, and Clinton Keay, Executive Vice President, Finance.

Today’s discussion includes forward-looking statements. We want to caution you that such statements are based on management’s assumptions and beliefs. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. I refer to you to our news release and MD&A for more information on these assumptions and factors.

I will now turn the call over to François Vimard, who will provide a review of Empire’s consolidated financial results. Marc will then discuss Sobeys.

François Vimard

Thank you, Stewart and good afternoon everyone. Our third quarter results include the first full quarter of operation from the recently acquired Canada Safeway. Consolidated sales in the third quarter were $6.02 billion compared to $4.29 billion in the third quarter last year an increase of $1.73 billion or 40.4%. Excluding sales of $1.62 billion related to the acquisition of Canada Safeway, sales increased by $115.4 million or 2.7%. Sobeys same-store sales growth was negative 0.2% in the quarter, same-store sales were impacted by low food inflation which reflect around 0.5% lower in the published CPI. And also by increased competitive square footage in the market, ongoing competitive intensity and a severe ice storm in Ontario during the third quarter of fiscal 2014.

Consolidated EBITDA in the third quarter was $188.9 million compared to $195.6 million in the third quarter last year. EBITDA in the quarter was impacted by increased inventory shrink primarily associated with new standard we have rollout in our fresh department as well as shrink associated with the new and innovative merchandising program part of the Sobeys’ strategy to help Canadians to Eat Better, Feel Better, and Do Better. Also by a highly promotional environment, a weaker Canadian dollar relative to the U.S. dollar, ongoing drug regulatory reform which impacted generic prescription reimbursement rate and increased selling and administrative expenses which were primarily due to transaction cost associated with the Canada Safeway acquisition offset by $83.2 million and EBITDA related to the Canada Safeway acquisition during the quarter.

After adjusting for items which are considered not indicative of underlying business operating performance, third quarter adjusted EBITDA amounted to $277.4 million compared to $201.8 million in third quarter last year or $75.6 million, 37.5% increase. Finance costs, net of finance income for the 13 weeks ended February 1, 2014 were $49.7 million, an increase of $37.2 million compared to $12.5 million recorded in the same period last year. The increase is primarily a result of higher interest expense of $33.8 million due to the increased debt level this quarter as a result of financing for the Canada Safeway acquisition.

Empire recorded adjusted net earnings from continuing operations, net of non-controlling interest of $77.3 million or $0.84 per diluted share for the 13 weeks ended February 1, 2014 compared to $75.8 million $1.11 per diluted share recorded in the third quarter last year based on 92.1 million share this year shares outstanding versus 68.1 million last year. With respect to our overall consolidated financial condition, at the end of the third quarter Empire consolidated ratio of funded debt to total capital was 40.6% with cash and cash equivalent of $284.6 million.

Now, I would like to make a few remarks on Empire investment in other operation largely comprise of equity interest in Crombie REIT and Genstar. Total adjusted net earnings from continuing operations were $5.6 million in the quarter compared to $5.2 million last year. At the end of the third quarter, the fair value about 41.6% equity accounted ownership interest in Crombie REIT 39.3 fully diluted was $681 million on a carrying value of $336 million. For detailed information on Crombie REIT’s performance, please see their latest quarterly release dated February 27th. On the residential property side, Genstar contributed equity earnings to Empire of $8.4 million in the third quarter compared to $6.7 million last year.

Now, I would like to turn to Marc.

Marc Poulin

Thanks François and good afternoon everyone. Our growth in consolidated sales of 40.4% and adjusted EBITDA of 37.5% from the third quarter last year largely reflect the initial impact of the Canada Safeway acquisition and the continued launch of our new and innovative commercial programs as part of the company’s strategy to help Canadians Eat Better, Feel Better, and Do Better in what remains a highly-competitive marketplace. The market environment in the third quarter remains challenging. Promotional activity was – we can describe as intent. We continue to be price competitive this quarter to reflect our – and price protected market share and we fold up on the development and roll up of new commercial programs aligned with our better foot for our movement. This impacted our gross margin performance in the quarter.

Sobeys recorded gross profit for the 13 weeks ended February 1, 2014 of $1.47 million, an increase of $491.6 million or 50.2% compared to $980.2 million in the same quarter last year. The increase in gross profit is largely a result of a $483.3 million gross profit contribution related to the Canada Safeway acquisition, which is net of a one-time inventory adjustment of $17.1 million, and $6.3 million of cost reductions as a result of synergies realized during the quarter related to the acquisition. Gross margins increased 158 basis points to 24.51% in the third quarter compared to 22.93% for the quarter ended February 2, 2013. The increase is primarily a result of the Canada Safeway acquisition.

Excluding the impact related to Canada Safeway, gross margin would have been 22.53% of sales, a decrease of 40 basis points compared to the prior year. Overall gross profit and gross margin were impacted in the quarter by the following factors. Increased shrink primarily associated with new standard rollouts in our fresh departments as well as shrink associated with the new and innovative merchandising programs launched as part of Sobeys strategy to help Canadians Eat Better, Feel Better, and Do Better. A highly promotional environment, a weaker Canadian dollar relative to the U.S. dollar which affected the Canadian dollar cost of U.S. purchases, and ongoing drug regulatory reform which impacted generic prescription reimbursement rates.

We are working diligently successfully integrate the Canada Safeway business and our focus and continuing to secure our operational efficiencies and reducing cost across the network. I’ll provide here some highlights of our program. On Safeway integration, the technical integration of Safeway and Sobeys is underway which primarily involves the adoption of SAP functionality into the Safeway IT infrastructure. This includes the conversion of transactional systems which finance payroll stores merchandising and distribution. This integration when complete, will allow us to fully leverage Sobeys national SAP platform.

Everything is on track and our synergy work progress in each functional area and it’s really going as planned. Overall, we remain confident in our ability to secure $200 million in annual run-rate cost synergies over a three-year period and we’ll continue to update each of you and everyone of the quarter’s in the process.

On cost reduction, over the past number of years we have implemented shared services model where our transactional accounting, general accounting and master data management function have been centralized eliminating duplication of these services across the country. We intend to continue to leverage our centralized shared services model by continuing to eliminate unnecessary or duplicate cost. Most recently, we have communicated to employees in two regional offices, Calgary and Ottawa in Québec that we are moving rolls to shared services which will result in the elimination of rolls within those two offices.

Over the past six years, we have driven efficiencies in our distribution network through the development of automated distribution centers, one in Vaughan, Ontario and one in Terrebonne, Québec. We are moving forward with an expansion of the vast facility to handle frozen and dairy for our storm in Ontario product. When the expansion is completed in 2016, distribution of produce and meat categories will be consolidated into one of Sobeys existing conventional distribution center, either Milton or would be. The remaining distribution center will then close. While we continue to assess the manufacturing assets that we acquired as part of the Canada Safeway purchase we have made the decision to close the ice cream and cheese manufacturing facility in Winnipeg.

This facility is under capacity and as there is a similar facility in Edmonton, will be able to consolidate the ice cream volume production in the Edmonton facilities and therefore significantly improve our efficiency. And we are making good progress on non-core asset sales. As you may know on February 13, 2014 we announced that Sobeys entered into binding purchase agreements with the Overwaitea Food Group and with Federated Co-operatives to purchase 22 of the 23 retail stores required to be divested as part of the Canada Safeway acquisition as well as seven additional stores in British Columbia.

The sales are expected to occur during the company’s fourth quarter of fiscal 2014 and the first quarter of fiscal 2015. Sobeys has also signed a binding letter of intent with another retailer for the sale of one retail store which is also required to be divested as part of the Canada Safeway acquisition. Total proceeds from the transactions with Overwaitea Food Group and Federated Co-op will be approximately $430 million plus the value of inventory on closing, subject obviously to customary closing adjustments. Proceeds will be used to repay bank borrowings.

We will continue to assess our other non-core assets as it means to reduce our debt and are committed to making our operation more efficient. And we will continue to make important decisions to reduce cost within our business. As we have said before, the Canada Safeway acquisition represents a highly strategic opportunity for Sobeys to leverage its existing asset base and effectively create a new platform for growth. Notwithstanding the significant focus we put on the effective integration of Canada Safeway. We are also advancing our business by improving our overall customer value proposition through our Better Food for All movement. Certainly (ph), costs were incurred in the quarter related to the launch of new innovative programs. This is unless very important for the future growth of the company. I invite all of you to visit our new Sobeys Extra stores in Burlington and Castor, Aurora to get a taste of this offering. Since last October, we have also opened new concept stores in Winnipeg, Calgary, St. Catharines, London and Flamborough.

In closing, we know that any period of item promotional activity will generate quarter-to-quarter volatility. I mean this is simply the nature of this business. We have experienced it many times before and we know that the future will also experience periods like that but we are a long-term player and over time we are confident that we will continue to profitably grow the business remaining committed on long-term growth prospects for the business.

We are now happy to respond to your questions.

Question-and-Answer Session

Operator

(Operator Instructions). And your first question comes from Peter Caicco with CIBC. Your line is now open.

Perry Caicco – CIBC

Hey, it’s Perry Caicco calling. Can you tell us about the – what the same-store sales trend at Safeway might be, maybe the trend over the last few quarters and recently and to what extent you think you can impact those and how fast?

Marc Poulin

Clearly it’s the trend on the Safeway coming in through the acquisition was little bit below what we would have liked. And we are clearly taking advantage of what opportunities we have to direct merchandising program to address some concerns we have in some categories. And we’re diligently working on the overall picture from a Safeway point of view so it’s not only a question of integration but we’re also dynamically running the business.

Perry Caicco – CIBC

And on the topic of synergies, I know you’ve affirmed the target, how do you see the synergies tracking over the course of the remainder of this fiscal year into next fiscal year?

François Vimard

Marc Poulin

That’s clearly – clearly like we said I think we’re going to reach the run-rate of $100 million at the end of the first year which should be Q3 next year. So, you should see a ramp up, you saw a $6.3 million this quarter, part of that also because of some accounting rules we had to reserve against inventories so it was our intent in term of generation of pure net synergy but you should see the ramp up to get to the run-rate by Q3 next year will be that run-rate of $100 million.

Perry Caicco – CIBC

And lastly the SG&A cost at the core service business seem to – seemed quite high, just wondering you mentioned that you’re obviously spending on some of your new programs it’s the Better Food for All but I’m wondering if you could indicate what exactly has driven the SG&A up or there any sort of one-time items in there specific to the core business that seems to elevated the expenses in this quarter?

François Vimard

Yes. Let met clarify bit on the SG&A side because I think people through the press release were a bit confused about some numbers so that we clarify that. If you exclude the – because as we said on the Sobeys side [clearly] (ph) we’re doing business that’s generating $267 million of EBITDA and Safeway at $83.2 so it’s a track you arrive at that and EBITDA for the Sobeys business. And like Marc said on the gross profit side we did generate 22.5 – 53% of gross margin on the Sobeys side which is 40 basis points lower in the quarter – Q3 last year.

And net – if you look at EBITDA, the SG&A went down by 10 basis points and generate that EBITDA. So, on the core business excluding Safeway, our SG&A were down 10 basis points not as much as it was in Q2 and like Marc said we’re still working on many activities continuing to reduce SG&A but the trend wasn’t up it was down on the core business of Sobeys. On the Safeway side, because of the perspectives and the way the accounting was down on a GAAP basis, they were around 425 basis points as we’ll move from margin to SG&A so margin went up by 425 points but SG&A also went up by 425 points. So, that’s why if you merge the two you see that the SG&A went up but when you re-class I would say it was separated two between Sobeys and Safeway you can feel that gap is more on a gross profit than on the SG&A.

Perry Caicco – CIBC

And sorry, what are the items that you had to reclassify at Safeway?

François Vimard

Because on a GAAP basis, I would say our distribution cost for example manufacturing cost even some advertising expenses were all in net of the gross profit when Safeway was reporting their numbers in the past and now they are in SG&A.

Perry Caicco – CIBC

Okay, fair enough. Thank you.

François Vimard

Good.

Operator

And your next question comes from Michael Van Aelst [TD Securities]. Your line is now open.

Michael Van Aelst – TD Securities

Hi, yes. Thanks. We – just getting continuing on lines of Safeway. When they were reporting their results for the last few quarters, we saw the EBITDA trends at the Canadian business declining progressively more I guess as the – calendar 2013 went on. Can you give us an idea of how Safeway’s EBITDA may have trended year-over-year for the 13-week period that you reported it for. And give us an idea of what the seasonality might be across your four quarters?

François Vimard

Yes, so clearly it’s pretty down because the key pressure they have on their EBITDA, it comes from two side, the first on the pharmacy side as you can imagine because of the shrink of their pharmacy, they are more impacted than the rest of our Sobeys business on the pharmacy side and because of two elements, the first element clearly is the generate cost as you know and they generate reduction in terms of revenue you can get but also the fact that and we see they were a change in term of some regulation coming from the pharmacy association and then we can’t incent any more script revenue. So, people I would say moved some of their script to other pharmacy because they don’t get incentive of some of their amounts any more from our pharmacy. So, those two elements impacted our pharmacy numbers for sure on the Safeway side.

And one element also it becomes clearly there are some seasonality in their business like it is in our business Q3 is always a softer quarter for us than the three other quarter the four – the three other quarters. So, there is some element also in that so if you want to understand the full EBITDA level for Safeway you have to take that into consideration but clearly there are EBITDA numbers were softer than last year mainly impacted by pharmacy and impacted also by some impact coming from the softness on their sales and also the currency in term of the U.S. dollar going up so..

Michael Van Aelst – TD Securities

So, are you willing to tell us whether the EBITDA was – the degree to which EBITDA was down at Canada Safeway for that 13-week period?

François Vimard

Sorry, I didn’t understand your question, Mike.

Michael Van Aelst – TD Securities

Are you able to quantify the percentage decrease in EBITDA Canada Safeway for that 13-week period?

François Vimard

Yes, we were able to.

Michael Van Aelst – TD Securities

Are you able to dispose it [as of now] (ph).

François Vimard

No, it’s not something we want – because it’s overall business we want to talk.

Michael Van Aelst – TD Securities

Okay, okay. Second question is on the procurement savings that are part of your synergy targets typically procurement is a big part of the synergy numbers and it’s been reported pretty widely in the press that you’ve been looking for 1% reduction in your prices from suppliers, it sounds like there is a big push back there and I’m wondering if you can give us any kind of an update as to how procurement savings are coming on?

Marc Poulin

Well, the discussions with our suppliers are ongoing. We are pleased with what we’re seeing so far, I think suppliers are realizing that we have a lot to offer in terms of partnering with them to drive our mutual business. And to be honest, we believe everything is on plan in that report.

Michael Van Aelst – TD Securities

All right. Thank you.

Operator

Next question comes from Peter Sklar [BMO Capital Markets]. Your line is now open.

Peter Sklar – BMO Capital Markets

Thank you. I’m just wondering if you could go back to the shrink issue that you had talked about at Sobeys. Can you just elaborate a little bit further why it occurred, what was the financial impact and how do you see that unfolding, is it also going to have an impact in the fourth quarter and future quarters?

Marc Poulin

Well, we launched a number of new programs under the Better Food for All movement and it was not always supported from an advertising point of view but as you launch new programs at star level before these programs become fruitful you do incur additional shrink so that’s clearly an element that impacted the quarter. And but long-term, these programs will create differentiation that will make the business stronger so obviously it’s something that we feel is important and as a new manufacturer launches new program, they incur cost same thing as retail when you launch new program you do incur cost not only from a shrink point of view but training and everything else.

We also modified some standards in our merchandising programs how we – around some fresh programs and experienced some difficulties in ensuring that the appropriate level of stock versus the sales and the new standards were aligned and obviously this is something that is operational in nature that we need to correct and we’re working diligently on doing so. But, those were done for the benefit of our customers to make sure that we have the best offer that will long-term generate the healthcare business.

Peter Sklar – BMO Capital Markets

And then Marc, can you quantify the negative impact that the shrink issue had on earnings during the quarter?

Marc Poulin

We can quantify but I would say it’s a big part of it but we won’t specific number but it’s a big part of it.

Peter Sklar – BMO Capital Markets

And when is that kind of work its way through, is it going to be something that’s going to also impact the fourth quarter?

Marc Poulin

It takes always sometime to adjust those program as you know Peter because it takes time to understand not only the new program because you have to understand the sales of the stores and how the customer react all that stuff but also retraining some of our employee to make sure they understand the standard attached to it. So, it’s going to take some time.

Peter Sklar – BMO Capital Markets

Okay. And if I could just switch back to, you were talking before about the EBITDA at Safeway, would – with the additional rents – you listed a bunch of items that negatively impacted Safeway but there also have been the additional rents related to the sale and leaseback?

François Vimard

Yes, clearly Peter, for me it was obvious because we disclose it pretty clearly in our prospectus. As you know we sold $1 billion of asset Crombie and we have evaluated the rent attached $1 billion around $57 million a year so clearly that impact their EBITDA for the quarter for sure.

Peter Sklar – BMO Capital Markets

Yes. So, I believe that sale and leaseback happened at the beginning of the quarter so just be a quarter…

François Vimard

Yes, that was done at the time of transaction so it is for the full quarter.

Peter Sklar – BMO Capital Markets

Yes, okay. And just my last question, on the 29 stores that are going to be sold in Q4 and Q1 I just want to know what the accounting treatment is in Q4 will that be classified as discontinued or how were they…

François Vimard

Yes, some of them will be closed so we hope they won’t be on our balance sheet and we’ll have the cash in the back. And the others would be considered clearly has discontinued.

Peter Sklar – BMO Capital Markets

Sorry, I didn’t hear, they will be discontinued?

François Vimard

As discontinued, yes clearly.

Peter Sklar – BMO Capital Markets

Okay. Thank you.

Operator

Your next question comes from Jim Durran [Barclays]. Your line is now open.

Jim Durran – Barclays

Good afternoon. Just want to start-off with the inventory adjustment of $17.1 million. So, what is that related to actual product that you’re no longer going to be selling or a reduction in the value of that inventory and you’re still going to sell it?

Marc Poulin

Jim, I don’t want to go into detail of the accounting rules but I’m going to try to simplify that. When we acquired the business as per the rule of IFRS we have to evaluate the inventory at the fair market value. And so that fair market value was evaluated for those inventory were acquired with Safeway which include because they have inventory at store level and in DC so there is some cost that has to be, I would say put in the value of those product when we acquire so it was just at the time of the acquisition we did that and as you can imagine because we turn on inventory around almost every month. So the first month of that quarter we sold that inventory and also that $17 million came and impact us but going forward that would be a no issue because then we’re going to evaluate inventory as we always did. So it’s a fixed product it’s all the inventory we bought from Safeway that was evaluated at fair market value the day we acquire the business and that inventory was sold first period of that quarter.

Jim Durran – Barclays

And so when you provided the disclosure that Safeway’s EBITDA was $83.2 million the inventory adjustment was not included in that number or?

Marc Poulin

No, because we kept that number at the corporate level not to impact specifically the Safeway business.

Jim Durran – Barclays

But if I’m going to look at what the true earnings power was of Safeway can in a quarter and then looked at it as a way to sort of project the next subsequent quarters.

Marc Poulin

Yes.

Jim Durran – Barclays

Truthfully the profit of the business before the inventory adjustment would have been $100.3 million or $100.4 million not the $83.2 million then?

Marc Poulin

No, Jim like I said that $17 million of impact we didn’t put it because it was based on – caused by the acquisition.

Jim Durran – Barclays

Yes.

Marc Poulin

We didn’t want to put that in the Safeway number, we kept that at corporate level. So the 83 that’s the real generation of EBITDA for Safeway during the quarter was $83.2.

Jim Durran – Barclays

Okay. Thank you. On FX obviously there has been some commentary by your competitors about success of passing through the Canadian dollar weakness into higher retail prices. Can you give us some ideas to how that’s worked for you both at regular price and promo price?

Marc Poulin

On the FX especially as it relates perishable the market reacts sooner than it does on non-perishable items. So, that’s why some of it we’ve been able to pass through. But the reality is there is always a lie and in times of decreasing Canadian dollars especially this time around it was very impactful because everything we were purchasing was reported on the – partner for example, I mean it’s – so it was not a great period to get to experience the decline in the Canadian dollar so that lag had an impact on gross margin before we could actually pass some of it to our customers. But that being said, I mean the market remains very competitive and it’s hard to work to pass it down and so that’s why we probably experience a little bit more inflation this quarter than in the previous quarter and I would say mainly due to the ability to pass some of that but I would be lying if I were to say it was neutral in the quarter it’s not the case at all.

Jim Durran – Barclays

Okay. No, that’s good, that’s helpful. And last question François, just on the interest expense in the quarter, excluding the fact that when you divest – get them divest to your proceeds you’re going to reduce your debt. Is the $49 plus million in the quarter in your view a run-rate for the interest expense related to the existing debt?

François Vimard

Yes, there were some one-time cost but limited let’s say may be $2 million or $3 million it’s kind of one-time because of plans and cost that we account for that. But, yes it is, but as you know also with the divestiture we announced in February 2013 we’re going to reduce our debt by another $400 million there and like Marc said we’re looking at other potential non-core asset to disposal, over the next few quarters you’re going to see reduction of our debt which will impact our finance cost for sure.

Jim Durran – Barclays

And so you presumably reduced the term with evolving facility first right, it’s the most expensive vehicle?

François Vimard

Yes, the first one was still our outstanding at the $200 million bridge assets loan so that’s going to be the first one clearly and then after that it’s going to be to the term loan, clearly.

Jim Durran – Barclays

And what’s the effective rate on that term loan?

Stewart Mahoney

Yes, it’s little over 4% at this point Jim.

Jim Durran – Barclays

Okay great. Thanks Stewart.

Operator

And your next question comes from Chris Li. [Bank of America Merrill Lynch]. Your line is now open.

Chris Li – Bank of America Merrill Lynch

Good afternoon. Sorry just maybe just couple of follow up on the Safeway question. So thanks for the clarification first on the $83 million of EBITDA. So I guess based on that the 5.1% was really what the underlying EBITDA margin for the business and I think based on the last filings I think Safeway was – Canada was doing about 6.5% of EBITDA margin even including the $57 million of incremental rent expenses. So, I just want to make sure I heard you correctly, so the step down in margin is really mostly because of the former regulations and because of the weakness in the Canadian dollar that represented the bulk of that margin step down. Is that correct?

François Vimard

Yes, the two additional elements that I mentioned but you’re right those are the two key ones.

Chris Li – Bank of America Merrill Lynch

Okay.

François Vimard

But, is also because of the softness on the sale, it did affect also their operating cost. And the key point also like we said there is some seasonality in their numbers so their Q3 numbers is only a bit softer the others but you mentioned it eventually.

Chris Li – Bank of America Merrill Lynch

Okay. Yes, so I guess that my other question is understanding it is – there is some seasonal impact. I guess from a modeling perspective I mean sort of the mid 5% is sort of what we should be thinking about going forward on the Safeway business?

François Vimard

We don’t – as you know Chris we don’t give any forecast and we’re going to work hard to be as high as possible.

Chris Li – Bank of America Merrill Lynch

Okay. And then just on the gross margin again I just want to confirm the $483.3 million from Safeway that also exclude the $17 million inventory adjustment?

François Vimard

Yes, exactly.

Chris Li – Bank of America Merrill Lynch

Okay. So, on that that the margin on Safeway was about almost 30% which is I think a couple hundred basis point higher than what that business did before and I just want to make sure there is no sort of accounting reclassification…

François Vimard

No, no and like I said to Perry, because the re-class whether between the U.S. gap in IFRS, so the gross margin increased by around 425 basis point but the SG&A also increased by 425 basis point.

Chris Li – Bank of America Merrill Lynch

Okay. So, on a like-for-like basis?

François Vimard

Yes, compared to what you saw before when the U.S. were producing their numbers.

Chris Li – Bank of America Merrill Lynch

I understand. Okay. Thank you. I’ll just get back into line. Thank you.

François Vimard

Yes. Thanks a lot.

Operator

Next question comes from Keith Howlett [Desjardins Securities]. Your line is now open.

Keith Howlett – Desjardins Securities

Yes, I just wanted to ask on the shrink program, is that been rolled out to the whole system or is it just in some stores?

Marc Poulin

No it’s an initiative that’s launched across the, what we call the Sobeys multi format operation.

Keith Howlett – Desjardins Securities

So all the Sobeys stores…

Marc Poulin

All the Sobeys stores across the country and some 50 stores.

Keith Howlett – Desjardins Securities

And in terms of the standards is this to ensure sort of a higher degree of freshness or something of what’s actually sold?

Marc Poulin

It’s not something it’s a higher degree of freshness, yes.

Keith Howlett – Desjardins Securities

Okay. So…

Marc Poulin

That’s a better experience for the customer when purchasing products from our stores.

Keith Howlett – Desjardins Securities

So is that in the nature of sort of a bit of a one-time thing as you adjusted a new standard or does that take time to sort of more itself into the system consistently?

Marc Poulin

It’s clearly a growing pain as we adopt to those new standards some stores are adopting better than others and they need to – we need to readjust our production and ordering patterns so that, and some stores are doing a better job than others, and doing so. So we clearly need to work the tools we have and go back in some cases to properly execute around those new standards.

Keith Howlett – Desjardins Securities

And is it sort of evenly pretty much across the sea food meat perishables or produce or is it mostly and say produce or mostly in fish or?

Marc Poulin

It is – some departments are more impacted than others, I will – it’s not uniform but it does impact the fresh side of the store by our position to grocery as you can imagine.

Keith Howlett – Desjardins Securities

Great, thanks. Thanks very much.

Marc Poulin

Pleasure.

Operator

(Operator Instructions). And your next question comes from Patricia Baker [Scotiabank]. Your line is now open.

Patricia Baker – Scotiabank

Yes, good afternoon. I know – most of my questions have been answered but I just want to go back to this reclassification. And just you – I know you didn’t want to give us last year’s Safeway numbers but if you went back and reclassified last year’s Safeway numbers, will there been a discernable change in trend either on COGs or SG&A comparing year-over-year?

Marc Poulin

I would say that the key impact and that’s what we said it’s mainly on the gross profit side.

Patricia Baker – Scotiabank

Okay.

Marc Poulin

Because of the impact of pharmacy and currency.

Patricia Baker – Scotiabank

Okay. Yes.

Marc Poulin

From the sales so you’re going to see an impact more on that than non SG&A side.

Patricia Baker – Scotiabank

Okay. And the SG&A just would have been simply just this reclassification but that’s a good clarification.

François Vimard

Yes, yes. Clearly and if you look at our press release also we talked about yes we’re starting to invest a bit on the Safeway integration so there is a $2.2 million of investment falling for that so there is some cost associated with that but it’s mainly on the gross profit.

Patricia Baker – Scotiabank

Brilliant. Okay, thank you.

Operator

Your next question comes from Jim Durran [Barclays]. Your line is now open.

Jim Durran – Barclays

Well, I know everybody sort of focused on the same thing but if I look at the service SG&A and it was up say 2% in the quarter and you’ve been largely flattish up to now. But you are talking about continued cost savings initiatives and not necessarily being part of the synergy bucket. Do you expect your SG&A to be up 2 plus percent in the coming quarters or do you see opportunities to contain that even more?

François Vimard

Yes, you’re talking about up 2% but in term of percentage of sales it was down 10 basis points so we just make sure doing the same thing.

Jim Durran – Barclays

Yes.

François Vimard

Clearly and Marc mentioned many activities were going on so clearly our goal is to continue to see a decrease in SG&A going forward.

Jim Durran – Barclays

Great. Thank you.

Operator

Question comes from Vishal Shreedhar [National Bank]. Your line is now open.

Vishal Shreedhar – National Bank

Thank you very much. Just given the current EBITDA generation trends do you feel comfortable with your debt reduction targets over the next few years or will you change your views on potentially asset sales or something of that like?

François Vimard

No we’re pretty confident about that clearly. As you saw from the divestiture of the store we’re getting more capital there than we’re planning for. And from what we saw from other elements that we could sell we’re pretty confident about the target we have in terms of debt reduction.

Vishal Shreedhar – National Bank

Okay and just in terms of the way you go to market currently just given the difficult backdrop. Does the balance sheet you have right now impact the way that your merchandising strategy unfolds currently or is that another factor?

François Vimard

Not at all because we’re so successful in terms of that the financing of the acquisition I think we’re in good position.

Vishal Shreedhar – National Bank

Okay. Thank you. That’s it.

Operator

Question comes from Keith Howlett [Desjardins Securities]. Your line is now open.

Keith Howlett – Desjardins Securities

Good morning, guys. I just wanted to ask about the FreshCo stores and I notice you got some stores with license to fish and meat departments. I’m just wondering how that is working out and how you look at that going forward?

Marc Poulin

We’re still very happy with the way the FreshCo banner is evolving. I wouldn’t say that we’re not challenged like everybody in the marketplace by the dynamic of what’s happening and I’m sure on the pricing front. But, that being said, overall consumer acceptance of the FreshCo concept keeps on growing and that’s why we’re extremely pleased with, we’re clearly building a solid business on FreshCo. Initially that’s the one you just mentioned are an element of that and we will continue to offer those services in the markets where it wanted and allows us to basically differentiate our offering in specifically in markets where ethnic meat and fish are required to be relevant to the consumer.

Keith Howlett – Desjardins Securities

Thank you.

Operator

Next question comes from Chris Li [Bank of America Merrill Lynch]. Your line is now open.

Chris Li – Bank of America Merrill Lynch

Hi. Do you subsidize your franchisees when you in terms of pricing and promotions and if it so, do you expense that through your SG&A expense line?

François Vimard

We don’t want to talk specifically about our program with our franchisee but clearly we are always conservative that we will account for things, so clearly it’s part of the SG&A if we need to support in any way our franchisees.

Marc Poulin

But it’s also supportive to the gross margin on the wholesale line. So, if we need to give price support for higher activity for example this will also get – this will impact our wholesale gross margin line.

François Vimard

Yes, it can go [on board] (ph)line. You’re right.

Chris Li – Bank of America Merrill Lynch

Okay. And then, sorry if you covered this already, with respect to the impact of the weaker currency I think some of your other competitors have recently talked about able to pass through some of the cost increases. Are you finding now are you able to pass on the cost increases from the weaker dollar?

Marc Poulin

As I said previously on the call, we’ve had some success, there is a lag clearly between the actual timings of things. That being said, I don’t want to make it look like it’s the nirvana of price increase in this country right now it’s very difficult to get price movement even on commodities where everybody, the cost increase for everybody it’s not now. So, it’s unfortunately a market that’s digesting significant additional square footage, everybody is fighting for their ground to their [nail] (ph)and everybody is watching everybody and nobody wants to be the first to blink. So, these dynamics don’t make for market that’s where it’s easy to pass along any price increase any cost increase in pricing.

Chris Li – Bank of America Merrill Lynch

Okay. Just my last question is you mentioned I think in the opening remarks about eliminating some of the duplicate services in Calgary and in the marketing Quebec and also closing the ice cream facility in Winnipeg. Can you just remind us the timing of those two events and the charges that you expect to incur and what the expected cost savings will be?

Marc Poulin

Some announcements were done recently in Q4 and this is what we can – recently some move were done in the – like some reshuffling activity occurred as the business go. So, but I would say for example the ice cream facility announcement and the announcement in ruling are very recent events.

François Vimard

So some of those remaining when you see some charge in Q4 and some require way more work because there are lot of work to be done before being finalized but make sure we’re going to disclose it in a way you can understand that.

Chris Li – Bank of America Merrill Lynch

And then in terms of potential cost savings?

François Vimard

Savings, they’re going to be good.

Chris Li – Bank of America Merrill Lynch

Any sort of number around what you mean by good?

François Vimard

It’s supporting Chris like we said supporting a reduction of overall SG&A.

Chris Li – Bank of America Merrill Lynch

Okay.

François Vimard

And keeping that trend that we have done over the past few years.

Chris Li – Bank of America Merrill Lynch

Okay, thanks. Thank you.

Operator

Question comes from Jim Durran [Barclays]. Your line is now open.

Jim Durran – Barclays

I promise it’s my last question. Tax rate, the tax rate in the quarter was low for the reasons mentioned. Is that an isolated quarter incident or is that going to carry on for a few quarters?

François Vimard

It is, it is as you saw it’s pretty specific because of all the one-time and everything that happened during the quarter but you should foresee like we said in the past tax rate around 26%.

Jim Durran – Barclays

Great. Thank you.

Operator

And we have no further questions at this time. I turn the call back to our presenters.

Stewart Mahoney

Thank you Candice. And thank you ladies and gentlemen. We appreciate your continued interest in Empire and we look forward to having you joining us for Q4 conference call on June 26th. Good bye.

Operator

This concludes today’s conference call. You may now disconnect.

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