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Executives

Maureen Sabia - Chairman

Stephen Wetmore - Chief Executive Officer

Michael Medline - President

Dean McCann - Executive Vice President and Chief Financial Officer

Allan MacDonald - Chief Operating Officer

Chad McKinnon - Chief Operating Officer, FGL Sports

Rick White - Chief Operating Officer, Mark’s

Analysts

Mark Petrie - CIBC World Markets

Patricia Baker - Scotia Capital

Derek Dley - Canaccord Genuity

Irene Nattel - RBC Capital Markets

Peter Sklar - BMO Capital Markets

Jim Durran - Barclays Capital

Brian Morrison - TD Newcrest

David Hartley - Credit Suisse

Vishal Shreedhar - National Bank Financial

Canadian Tire Corporation Limited (OTC:CDNTF) Q2 2014 Earnings Conference Call August 7, 2014 12:00 PM ET

Operator

Good afternoon. My name is Heather and I will be your conference operator today. At this time, I would like to welcome everyone to the Canadian Tire Corporation Limited 2014 Second 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)

Earlier today, Canadian Tire Corporation Limited released their financial results for the second quarter of 2014. A copy of the earnings disclosure is available on their website and includes cautionary language about forward-looking statements, risks and uncertainties, which also will apply to the discussion during today’s conference call.

I will now turn the call over to Maureen Sabia, Chairman of the Board, Canadian Tire Corporation Limited. Chairman?

Maureen Sabia

Good afternoon. I don’t usually participate in our quarterly call, but this is a special day for Canadian Tire. And on behalf of the Board, I wanted to speak to you very briefly about this morning’s leadership announcement. And after I have done that, I will turn the call back to management to discuss the quarter.

First, I want to say how delighted the Board is to be able to announce that we were able to have developed Stephen’s successor from within and how delighted we are that Michael will become our new CEO. The Board is also delighted that Stephen will remain as a member of the Board of Directors in his new Non-Executive position as Deputy Chairman. We will have as our CEO one of our most innovative leaders and we will still have on our Board the wisdom of Stephen.

Given the leadership transition will not take place until the end of the year, this is not the time or place for me to thank Stephen for the enormous contribution he has made to our success and the huge impact he has had on Canadian Tire. But you are all well aware of where the company is today compared to where it was six years ago, when Stephen was appointed CEO.

To give you some context on how all this came to be, early last year Stephen informed the Board that he had accomplished many of his objectives with the remaining ones well on the way to completion and that he believed the time was right to begin the transition to his successor. The Board had previously identified Michael Medline as the natural successor to Stephen, given his long experience with and his unique knowledge of Canadian Tire and his strategic strengths. It was clear that he shared Stephen and the Board’s commitment to enhancing the Canadian Tire brand to our continued growth, to our strategic direction and to adapting to the continually changing needs of our customers.

The Board agreed with Stephen that the company was in a position of strength and the timing was good to start an orderly transition. And so last year, the Board approved Michael’s appointment as President of the Enterprise, which gave him direct responsibility for all our business units and operations. Moreover, Michael and Stephen worked together to present the Board with a multi-year strategy for growth at our recent June strategy meetings. And today, the Board appointed Michael Medline as CEO, effective December 1, 2014.

This is a good day for Canadian Tire. And as Chairman of the Board, I wanted to share these few thoughts with you and say once again how lucky we are to have leaders like Michael and Stephen in our midst. Congratulations to both Michael and Stephen. And now, I will let you get down to the business of the quarter.

Stephen Wetmore

Well, thank you, Maureen and good afternoon everyone. It’s Stephen speaking. Let me comment on today’s announcement briefly and then I will just touch on a few items about the second quarter results. Michael Medline has been my colleague and an important part of the leadership team at Canadian Tire during my entire tenure as President and CEO. He has helped reshape our retail businesses and he has been instrumental in executing on strong acquisitions that have created tremendous growth and opportunities for the future. And I know I share the Board’s full confidence in Michael’s abilities to steer Canadian Tire through the next chapter of growth. And I congratulate him wholeheartedly on his promotion and the next stage of his career.

So with that, I will now make a few comments on the second quarter results, which we released this morning. And I should also inform you that the complete team is here as well to field any of your questions during the Q&A period. Michael and Dean will be walking you through this in more detail in a few moments, but I do want to say how extremely pleased I am to see our assets performing so well. We saw strong sales across our retail businesses and another great quarter of receivables growth at financial services.

As I have talked about before, CT REIT continues to outperform our expectations. CT REIT issued strong second quarter earnings results and continued to execute on their investment strategy during the quarter through the completion of seven acquisitions totaling $94.1 million. They also announced a further two acquisitions that took place subsequent to quarter end, including a one-third leasehold interest in Canada Square. This is a 844,000-square foot mixed use commercial development here at Yonge and Eglinton in Toronto, which also houses our head office where we are sitting right now.

Additionally, CT REIT acquired a 201,000 square foot distribution center in Calgary, which is replacing an existing leased distribution facility and is very strategically located beside an existing CTC distribution center. As you know, real estate has always played a vital role in our success and through strategic acquisitions such as those I just mentioned CT REIT provides us a new opportunity for continuing and growing our investment in this core asset.

I would also like to provide an update on our normal course issuer bid or NCIB. Over the past two quarters, we have repurchased approximately $110 million or about half of our previously announced $200 million share repurchase target for this year. It remains our intention to continue repurchasing shares throughout the balance of the year. Finally, I will head off any questions about the Scotiabank partnership by telling you that we remain on track to close the transaction by September 1 as we announced last quarter. Before I wrap up, I would like to remind you of our Investor Day in the fall, which will be held on Thursday, October 9. And more details will obviously follow.

With that, I will now turn the call over to Michael. Michael?

Michael Medline

Thank you so much, Stephen and thank you Maureen, as well. This is an exciting time for retail in Canada and I am honored and excited to have the opportunity to lead Canadian Tire. This is a great and iconic organization. Stephen has done a tremendous job of leading and strengthening this company over the past six years. We have the brand, the assets, and the team to grow this company for our shareholders. I have met with many of you and look forward to talking with you on an ongoing basis about Canadian Tire’s opportunities, our strategy and the key executional and operational factors facing us.

With that, I will move on to our Q2 results, which as you have seen were strong. Q2 was an excellent quarter with top line sales results driven by solid execution on our existing strategies across all of our banners. Q2 is historically our second largest quarter, representing roughly 25% of our annual sales. For the Canadian Tire banner, Q2 is historically almost as large as Q4. Our revenue, margins and operating expenses all met our expectations. And all this occurred in a quarter, where weather was not our friend. The first six weeks of the quarter saw late arrival of spring weather, but non-seasonal businesses performed well across all of our banners. And when spring did occur, we were ready with the right seasonal merchandise in our stores. And I should note that we are particularly pleased with the results given we were comping against solid same-store sales across all of our banners in Q2 last year.

I am not going to repeat our numbers on this call. You have already seen them in our press release. I would, however, like to give you some color behind the results we posted in Q2. At Canadian Tire, we had positive comps across all businesses this quarter and our efforts are paying off by shifting our focus to thinking more like a group of specialty retailers and less like a general merchant. In automotive, a key business for us, the team is doing a great job. And we continue to see strong comps and positive results in that key category. We are particularly pleased by the continued momentum in hard parts sales, which as you know is core to the automotive business. This is a distinct change from a few years ago.

The fixing business generated solid sales, which are partly due to new marketing campaigns that really resonate with our customers. For example, you may have seen our wood stain commercial on TV, which helped to boost sales in our paint category. We have also been focused on bringing innovative products into this business as we review and optimize our assortments.

Our playing business also had a solid quarter. In fact, cycling saw the best season in history due to the great brands and assortments we have brought to our stores. Our hunting and fishing Pro Shops continue to outperform our expectations and are driving sales through increased traffic and above average basket size. And while we saw positive growth in sales and shipments in our living business, we did see softer sales of air-conditioners and fans due to the cooler weather this year. As well, the team has done a great job of repositioning the business in categories such as electronics, where we are deemphasizing the assortments.

At Canadian Tire we remain on track to rollout a loyalty card and app this year that focuses on utilizing the insights we have received through customer data to help enhance our product offering to customers. The key here, as we have been emphasizing for a while, is being able to serve our customers better through data while improving the retention of our most loyal customers.

Moving on to FGL Sports, this is our third consecutive quarter of double-digit growth for the Sport Chek banner. Results were good in each of our business categories and across the country. We had the benefit of the World Cup in Q2, but that was a very small portion of our sales growth. We continue on pace to add about 10% of new square footage per year at Sport Chek and I am happy to say that new stores are performing very well. We are still seeing great results from the West Edmonton flagship store, which is ahead of our forecast and will have the highest sales of any store at FGL Sports. Our Burnaby flagship will open later this year.

At Mark’s, results were solid, led by sales in our non-seasonal industrial wear category, but slightly lower in terms of comps than we would like. We know that historically Mark’s is not as strong in the shoulder seasons, which are typically some points in spring and fall. So when seasonal weather doesn’t arrive or is late, as it was in Q2 there is volatility in our sales patterns. To address this, Rick White and his team are enhancing transitional assortments in shoulder season apparel like rainwear and going deeper in weatherproofed categories like denim. This is exactly the strategy Rick successfully built in his years as the Chief Merchant at FGL to weatherproof the business as much as possible. Having said all that, Mark has still put up a 3.2% comp in Q2.

At Financial Services we had not planned on beating last year’s Q2 performance since we were comping against really strong results. But I am pleased to say we did. The strong receivables growth we saw both in this quarter and in Q1 is attributable to increases in average balances and new customers. Much of the growth in new customers is due to the implementation of the instant credit. We have launched this initiative in Canadian Tire stores back in Q4 of last year and it has since been rolled out to our gas bars. In a very short time this initiative has become a significant driver of our recent new customer growth, which speaks to the strengths that we can realize from this business when it is aligned to support our retail banners. Also this year we are looking to rollout an enhanced value proposition on our credit card, which we believe will also drive new business. And we will talk more about these value propositions at our October 9 investor meeting.

We continue at the Company to innovate in digital. We are shifting marketing dollars from print media to digital channels at Sport Chek and we are extremely pleased with the results to-date. We have also begun to shift marketing spend to digital advertising at Mark’s. And at Canadian Tire we have the most iconic and most successful paper flyer in the world and that continues to work for that division. But you will see us begin to use digital marketing and advertising far more going forward.

With that, I will turn – now turn the call over to Dean.

Dean McCann

Thanks, Michael. Michael has talked in detail about the results of the segments and individual business sales drivers, so I will keep my remarks focused on the consolidated results and metrics. As you all have seen in the documents released this morning, our diluted earnings per share was up 11%, this includes a $15 million premium we paid earlier in the quarter for the redemption of $200 million in medium turn notes. While we were required to pay the early redemption premium, we expect to realize interest savings of approximately $5.9 million pretax due to this transaction in 2014. Backing out the early redemption premium, our second quarter EPS would have risen 18.2%.

The earnings growth this quarter was really a result of the strength we saw in all our segments, but we were extremely pleased to see the strong results from the retail businesses. We saw this strength carry through to our ROIC metric, which was 7.76%, an improvement of 42 basis points over the prior year and up 44 basis points over the last quarter. We attribute this to higher retail earnings over the last four quarters and the cash we have deployed towards debt repayment and share repurchases.

Our gross margin performance also continued to be strong across all segments. At our retail businesses the gross margin dollar growth was led by higher shipment revenue to Canadian Tire dealers and stronger sales at both Mark’s and FGL. In addition, despite a slower start to the quarter due to the delayed start to the spring season, our gross margin rate, up 60 basis points for the segment, benefited from strong sales in non-seasonal products over the first six weeks, particularly at the Canadian Tire banner. We also realized benefits in cost of goods due to savings initiatives and the timing of certain payments to Canadian Tire. Strong gross margin results at financial services was led by gross average receivables growth as well as a reduction in the allowance for future write-offs due to improved account aging and a reduction in management's estimate of the allowance due to our comfort that the minimum payment changes adopted in 2012 are now fully reflected in the portfolio’s performance.

As well, operating expenses were well managed this quarter. As you have heard me say before, we are aiming to hold our full year OpEx as a percent of revenue roughly flat with last year’s results of 21.1%. The OpEx ratio on a year-to-date basis is currently higher than the same period last year. I expect the ratio to trend down as we move through the balance of the year. The Q2 year-over-year variance is largely due to the changes in our cost structure resulting from a higher number of corporate stores in our network than in the past as well as higher costs at financial services due in part to credit card operations and a one-time settlement of a contingency based contract. Inventory also continues to be very clean across all categories and businesses. Corporate inventory was up slightly versus the prior year, largely due to additional corporate stores in the network, particularly Sport Chek, PHL and PartSource.

Our outlook for capital expenditures in 2014 is trending towards the higher end of our stated range for base capital of $500 million to $525 million. Distribution center spending, which we previously anticipated would be in the $75 million to $100 million range, will likely come in at the lower end of that range. Stephen mentioned earlier the success of CT REIT – the success that CT REIT has had in executing on their growth strategy and our CapEx ranges exclude additional investment opportunities supporting CT REIT’s future growth. The REIT funded these external expenditures from a combination of their cash on hand, credit facilities and assumption of property mortgage debt. Although the REIT will continue to pursue multiple growth strategies and their external purchases will be consolidated into CTC’s results. The REIT is expected to be able to fund those external purchases from the various sources of funding that it has available.

And with that, I will turn the call back to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Mark Petrie with CIBC World Markets. Your line is open.

Mark Petrie - CIBC World Markets

Hi, good afternoon. Michael, wondering I mean if you could just sort of talk a bit about your vision for Canadian Tire over the next five years and specifically your priorities for allocating the abundant capital resources at the company? Thanks.

Michael Medline

Thanks Mark. Maybe I will just summarize where we are and I think where we are going really in short order, it could take the whole call, which I know you don’t want me to do. And we will talk more as we go forward, but when you look at all that has been accomplished under Stephen’s leadership. We have got a strong foundation of enviable assets that we can put to work for us in the coming years. As you know, chief among them are our brand, to be honest with you. I have been fortunate to work with Stephen closely and we have been working on the strategic direction, like Maureen talked about, the three year growth vision that we presented to our Board in June. Just when I think about some of the priorities we are facing, a lot of them have to do with taking advantage and exploiting a changing world. And I believe that we have now put in place a lot of the infrastructure and the assets and the brand and the people. You can never forget the people to set us up really well. We are digitizing retail as well as I think it was well as anyone is doing out there and this is going to be a big change to face our industry and a big challenge. It’s highly complex. We are figuring it out and it’s working for us. And this will be a strategic advantage for us going forward.

We will become more sophisticated in applying customer analytics. We have to use the tremendous amount of data we already have and we will expand with our new loyalty programs to grow the business and better serve the customers. We have to drive a culture of innovation and speed. You hear me say that a lot, being even more nimble in our decision-making, this industry is moving fast. This is not a sleepy retail industry decades ago. This is a very exciting place to be doing business. But like with everything, it’s winner takes all. So, we need to be very fast and very successful. And we have to do what we have been doing in the last 5 plus years. We have to stay on offense. I am very proud of where the especially the retail divisions and our financial services division are doing to stay ahead of the curve.

In terms of use of cash and I have spoken to so many of you about it, this is such a priority for us to be able to smartly use the excess cash and to use the balance sheet and the flexibility that we have created both through the operations of our business, but also through some smart moves, I think like the REIT and our great partnership with Scotia. And so you have heard us speak – we always speak about a balanced approach. And I do like the balanced approach. I can only think of a certain number of ways to use our cash. I think we keep increasing our dividend every year. We have a good policy on that. I am very supportive of our efforts to expand our share buyback program, which we have undertaken over the last couple of years, to use that in a smart way for our shareholders.

We are in a good debt position. Our balance sheet is smart. And I believe that for the most part we are giving our businesses all the cash they need at the current moment to be able to drive us forward and really put a hurt on competitors and make our customers happy. And the only other one is we in the past have done a couple of significant acquisitions. In my time in 13 years, we have only done two of them, but I think we are pleased with them. And Mark’s and Forzani Group acquisitions have worked well, but we are quite cognizant that money should not burn a hole in your pocket and we are most cognizant that – of doing the right thing by our shareholders and by all our stakeholders. So, you will see us employ a balanced approach. And I am very excited, more than I have been in a very long time, about our prospects for organic growth in our current businesses. I think that is – we have a lot of runway still to go there. So, that was a long answer, but I could even go longer and I may in October, but thanks for the question, Mark.

Mark Petrie - CIBC World Markets

Okay, thanks. No, that’s very helpful. And then just bringing it back to more of a tactical sort of near-term level, I mean, you have done a great job at balancing same-store sales growth with gross margins. And wondering if you could just talk a little bit about your attitude towards the flyer, paper versus digital – not really concerned about that, but just your attitude towards the flyer and the depth of promotions and sort of the strategy around price investments?

Michael Medline

I think, I will let Allan speak first, because he has what did I say the greatest flyer in the world. So he can speak to that, but – and obviously that print flyer is and still remains crucial to our success.

Allan MacDonald

Yes. I mean, hi, Mark it’s Allan. I think our flyer is I mean an enviable tool for any retailer. As a high or low retailer, Canadian Tire has been incredibly successful at being able to create demand and it’s lent itself really well to our seasonal nature. So, it’s a tool in our quiver that we are trying to continue to perfect. And I don’t know if you ever get it perfect. And as the world has changed over the last few decades, we have changed with it we are going to continue to do so. And with the advent of technology, that opens a few more doors for us. Our secret and our objective really is to get the investment in the flyer and the investment in driving our reg and non-seasonal products at the right balance. And we are continuing to work with that, which you can see in the results. So, for us, the flyer is part of who Canadian Tire is. It’s part of Canadiana. And it’s up to – it’s really incumbent on us to manage it really effectively, like you would any investment or any tool.

Michael Medline

Does that answer it, Mark, was there another part of it you wanted us to go further on?

Mark Petrie - CIBC World Markets

No. I mean, I guess I am just interested if there is any sort of change in terms of how deeply you want to be promoting or if there is a change in how much you want to be allocating to sort of price investments on the flyer specifically?

Allan MacDonald

Well, I mean, that’s always about remaining competitive. We don’t always get to decide what – we would always like to charge more of course, but we don’t always get to decide that. So, for us, it’s we have been changing the flyer. I don’t know if the evolution of it is as obvious to you as it is to us, because we deal with it everyday, but we are continuing to try to be really smart about, where we make investments to make sure that we are not giving back margin unnecessarily and remaining competitive in a market that as you know, has been really competitive over the last couple of years. So, that’s always that balance, but for us it’s about how do we make sure we walk the line between driving traffic to the store and capitalizing on margin opportunity and still remaining relevant. So, there is a lot of things at play, as you know in the flyer. And it’s always a balance, but I think if you look at it over the last two or three years, you will see that we have actually changed the flyer quite a bit. It’s been subtle, but it’s changed to a better place, I think today than it was maybe three or four years ago.

Mark Petrie - CIBC World Markets

Thanks a lot.

Operator

Your next question comes from the line of Patricia Baker with Scotia Capital. Your line is open.

Patricia Baker - Scotia Capital

Thank you very much. My question is a single question, but it’s a three-parter and it’s for Stephen. And Stephen, I am going to apologize in advance, because I don’t want you to misunderstand or misconstrue why I am asking the question that I am asking, but I do think it’s a really important one. So, when we look at your move in December to the role of Deputy Chairman, why do you believe that at this point in time the creation of a new role at Canadian Tire is warranted when you do – there is already an active Chairman of the Board? And then secondly, what are the duties and what will your mandate be as Deputy Chairman? And thirdly, are you really confident that you can truly leave your old role as CEO and permit Michael in his role as the new CEO to really get on with his job?

Stephen Wetmore

Thanks very much, Patricia. Well, firstly, I am a believer that in general if the past CEO wants to hang around and keep their hand on the rudder that they should have sailed off into the sunset. So, to me, Michael is in charge as of December 1 undoubtedly. It’s his to run at that point in time. The Board and Michael both asked me if I would stay on the Board. And it’s kind of a two-part thing. As us New Brunswickers say the porch light is always on for Michael. And as far as the Board is concerned then I think I can drive a lot of the initiatives that we had going and a special brand and values committee that we created last year. I think I can drive a lot of that for them and help them. And I think the coordination between the Board of Directors and management can only be assisted if I can be of assistance to the Board in that way. The day that I ever interfere with the Chief Executive Officer and President’s role is the day that I will leave. So, I wouldn’t worry too much about that, if that helps you. And I think the Deputy Chairman is of no particular significance. It’s non-executive. I think they were probably just trying to make me feel better by giving me a title on the Board as opposed to just being a director, if that’s the honest answer.

Patricia Baker - Scotia Capital

Okay, thank you very much for that Stephen. Just can I ask another question, please? This one, I guess is either for Michael or for Allan. One of the interesting things that you did this year was, exploit an opportunity that you had by opening that showroom in the Leaside market. And you have had several months of that being operational, probably gone through a season. So, anything you can share with us about your thinking on that, how it went, and how it might feed into things we might see from Canadian Tire Retail going forward?

Allan MacDonald

Yes, it’s Allan here, Patricia. Yes, sure. The showroom store for us is an interesting one, because we had the opportunity to get some incremental real estate in Leaside, which was adjacent to, but not immediately adjacent to an existing store. So, for us to take a department and look at something a little more specific, more category killer in one group was a little bit tricky. So, the showroom notion for us gave us an opportunity to almost extend Canadian Tire’s presence in a nice linear fashion without adding too much confusion to the market in the terms of the immediacy of Leaside. From a more national standpoint, what you will see as you go through it is we are testing a number of different components of some future thinking in that store, different ways of merchandising our products, different ways of introducing some extended assortments. And you are going to see that continue to change over the course of the next year. So it’s as much a seasonal store, in some respects as it is a showroom store.

What we found immediate response has been really good. Some categories worked way better than we expected they would; some categories didn’t perform to the expectations we had. So it’s been great learning. I think from a brand standpoint the feedback that I have gotten anecdotally was it’s a face of Canadian Tire that not all Canadians would be familiar with. And that’s really important for us to understand as we start to think about how we would like to introduce that across the country. And also gives us great insight into what categories lend themselves to that type of merchandising. So all around, I am incredibly pleased with it because I think it’s served our brand well and it’s we have learned a lot from it. So you are going to continue to see some changes over there in the next year.

Patricia Baker - Scotia Capital

Super. And actually you can think of it, I guess as being a face of Canadian Tire that people might not be familiar with but one that might be welcome?

Allan MacDonald

I think so. I mean that’s what I have been hearing is that, well, I didn’t know Canadian Tire had all that. And some of that is because we don’t display it and some of it’s because we don’t display it as well as we do there. And we are taking both of those things into consideration as we think about the future of Canadian Tire across the country.

Patricia Baker - Scotia Capital

Okay. And then just a final question, in the release it was noted that at CT Retail there were higher shipments, perhaps than normal, I can’t remember the exact wording, but can you talk about that?

Allan MacDonald

I wouldn’t say – yes, I wouldn’t say they were higher than normal. We were pleased with the shipments performance over the quarter. Whenever you have a quarter like – Q2 for us is always one as you can imagine, we go into with a lot of planning. And you are incumbent upon the change from winter to spring and sometimes that happens in Q1, sometimes it happens late in Q2. So your inventory position and your POS are always at balance and shipments are what’s in between that. So with a bit of a slow start weather wise to the quarter, of course we are always – you always leave yourself exposed to the fact that shipments may not follow suit, but we were really pleased with the sell-through. And for the most part, shipments performed really well. So I wouldn’t say it was different than expected. It was just didn’t come in quite the way that – it didn’t come in smoothly, let’s say it like that.

Patricia Baker - Scotia Capital

Okay. Thanks a lot, Allan.

Operator

Your next question comes from the line of Derek Dley with Canaccord Genuity. Your line is open.

Derek Dley - Canaccord Genuity

Yes. Hi guys, I was just wondering if I – if we could get an update on there has been some media reports about your digital initiative at Sport Chek that you guys piloted, can you just give us an update on some of the results and some of the takeaways that you got from that program?

Michael Medline

Yes, we are still – it’s Michel, thanks Derek. We are still piloting the digital flyer. And I have talked so much about the digital flyer I don’t want to go on and on about it because you have probably already heard me talk about what it is. But in a nutshell, for those of you who haven’t heard, it’s not taking a paper flyer and putting it online. It is disaggregating flyer items and putting them on YouTube or Instagram or Facebook or Google. And we have been pioneering that at Sport Chek. We just completed another two week period and the results were better than the other periods and but very consistent in what we are seeing the ability to be flexible, the ability to spend less than you would on a paper flyer, so that it’s more productive, the ability to move spending across the country to categories that you wish in the middle of a period and especially the ability to, during a flyer period to spend more equally across each day than just have sales on the first three or four days you drop a flyer. I don’t want to talk about it that much anymore, because it’s so good. I think I have said too much. But Rick White over at Mark’s is now doing some things digitally and Chad McKinnon continues to do that at FGL Sports. And you will also, as we progress, although we have the best paper flyer, we move with the new world as well. And Allan has plans of his own. So at some point it’s not a pilot, it’s just successful.

Derek Dley - Canaccord Genuity

Okay, great. Thank you very much for the color there. And then just shifting gears a little bit, your guys’ inventory position heading into Q3, given that you expect some strong organic growth to continue, how do you guys feel about your inventory position and what are you seeing out there in terms of the competitive or promotional environment?

Dean McCann

I mean – it’s Dean, just on the overall inventory position, maybe I will let Allan and the guys talk about the competitive position, but I mean we are coming out of the quarter very, very clean. I think our corporate inventory is up slightly. The stores are well stocked. So I would just summarize it as we are in great shape with respect to inventory and being positioned kind of going out of the summer into the fall.

Allan MacDonald

Yes. I mean I have said to you guys before, I think it’s Allan here, from a Canadian Tire retailer perspective our strategy is to be the best Canadian tire. So from a competitive standpoint we have got our plan for Q3 and Q4, you know the seasonal nature of our business and the categories we focus on. We are investing in inventory to be successful in those months. And from where we stand right now we are really comfortable with where we are. So our inventory position is really a function of our strategy as opposed to a response to the competition.

Derek Dley - Canaccord Genuity

Great. Thank you very much.

Operator

Your next question comes from the line of Irene Nattel with RBC Capital Markets. Your line is open.

Irene Nattel - RBC Capital Markets

Thanks and good afternoon everyone. I was really interested in your commentary around the evolution of the same store sales during the quarter and sort of the regular merchandise doing better earlier in the quarter, it seems to me this is a function of a lot of work you have been doing around your merchandise, so can you talk a little bit or give a little bit more detail around sort of the first half versus the second half and how we should think about that on a go forward basis?

Allan MacDonald

Yes. Hi Irene it’s Allan, from a CTR standpoint it’s akin to the strategy that we rolled out in automotive. And I don’t want to sound like a broken record on auto, but automotive was a bunch of small things that we did that eventually started to get momentum and add up to something that’s a little bit more material. And our reg sales growth those or – sorry our non-seasonal sales growth early in the quarter was really not one or two really big things or big strategies we deployed. It’s been kind of the fruits of our labor over the last couple of years and continuing to improve on our assortment, improve our merchandising, working with our stores in terms of awareness and as traffic comes in, we are seeing there is a pretty good response to our offering. So look – as I look at CTR, every category, every SKU counts and the more we can focus on marketing them well, merchandising them well, making sure we have the right inventory, addressing quality, price points, all those fundamental things, you start to get traction. And the automotive is a good example and of course a big contributor to that. So we are going to continue to be head down and focus on those fundamentals. And when traffic comes in, hopefully it will continue to appeal to our customers. I don’t know if the guys want to offer a comment in terms of the other groups.

Chad McKinnon

Irene, it’s Chad here. For FGL and Michael talked about it earlier, we are working on a 365 day initiative to build up our off-season or shoulder season business. And a prime example, the start of spring we had high-single digits comp growth in our casual apparel, but our wind wear climate protection was up high double teens, so it offset us through that. So we see that going on for quite some time and Rick spent a couple years building our assortment around that. So we have fortified ourselves against that. A couple of other things too, is we are moving with sport. So some of the sports like golf that are lower in participation today, we are watching that, but we are moving into soccer and basketball. So we are very aware of changes in sport and activity and we are moving with that. And there is also the emergence in sport, in technology in sport. We have had tremendous success with technology around wearables, drove the category up 38% for the quarter. So we are embracing that. It’s involved in almost every aspect of sport and real time feedback. So those are some of the things that we are winning with right now.

Rick White

Irene, it’s Rick here, Mark’s is a little bit different. Though Mark’s does incredibly well in summer and in winter and hasn’t traditionally done so well in the shoulder seasons of spring and fall, so my challenge there is to do a little bit of what I did at FGL. And we are trying to weatherproof the business. We are adding two categories or adding emphasis to two categories; one is denim, one is footwear. You will see more of that happening, in fact footwear was our largest percentage increase in category, seeing it was up over 25% in Q2. But we are also going to be adding in the categories that we work in, some additional products such as winter rainwear, fleece tops, soft-shells, hoodies and the like just to de-risk the business a little bit. And we will have a similar program happening in the fall. So, we can kind of take some of those peaks and valleys out of the sales curve there. Thank you.

Irene Nattel - RBC Capital Markets

That’s great. Thank you. And just final one other question in related fashion, you did mentioned automotive. And on the last couple of calls, you have talked a little bit about using automotive as the template in other categories like, for example, tools. And just wondering where you stand on some of those category reviews and resets?

Allan MacDonald

I am still all for them. No, we are doing really well. These categories are, as Michael mentioned, fixing had a good quarter. Playing had a good quarter. There are – the fundamentals of these categories we continue to be very focused on. You would have seen a paint commercial come out this spring, which is a bit of our commitment to the fixing business and the components of it that we think offer the most opportunity. You are going to see more of that coming into the fall. So, I would – as you look at these categories and what you see coming out in store in terms of some brand work that we are doing, some marketing work that we are doing and some assortment adjustments, you are going to see a continued commitment to making sure they are relevant, that we are filling in assortment gaps and that we are working on some – in some cases, quality issues have plagued us in the past. So, I don’t want to get too sort of specific on that for reasons that are probably obvious, but these categories are incredibly important. Sustainable growth by strong fundamentals is what we are focusing on. And I am really pleased at how the teams embrace it. I think our customers are responding really well and we are going to continue to stay the course.

Irene Nattel - RBC Capital Markets

That’s great. Thank you.

Operator

Your next question comes from the line of Peter Sklar with BMO Capital Markets. Your line is open.

Peter Sklar - BMO Capital Markets

Okay, thank you. Michael, I am wondering if you could touch upon your thinking on the acquisition opportunities for Canadian Tire, you mentioned that very briefly in your opening remarks. And maybe you could talk about things, what criteria you are looking at? Would you stray from the current categories that Canadian Tire and the other banners are involved in? Would you look at new retail concepts? What geographies you would consider? So, maybe you can give us some of your thinking on acquisitions?

Michael Medline

Yes. Peter, this is going to be a big highlight in October for Investor Day. So, you should all buy your ticket to that. But I can say and as I have been saying to the investors we have been meeting, that we are – I will say a few things. I think you can expect us to stay in what we consider to be our heritage categories, where we know the businesses. What are examples of heritage categories? I think automotive and sports are obviously heritage categories for us. I think that you should continue to expect us to be incredibly picky and slow to the trigger in terms of acquisitions, because when we do them, we want to have the returns that you expect from us. And although we have, I think a good track record in making acquisitions we don’t do a lot of them. And at the same time, I don’t want to take the focus too much off of also growing the businesses we currently have.

So, yes, I mean what I have honestly said is you never stop. People are coming all the time. They were sending e-mails about this is for sale, this is for sale. And you look and you will obviously say that doesn’t fit. And those of you who know us well know there aren’t that many acquisition targets. And so that’s why – and so not only are we choosy, but there is not a lot to choose from. So, I think that you should look to the record we have in terms of especially the Forzani acquisition as a template. If something like that was available, we would look at it, but that was a pretty good deal and there are not a ton of Forzani IIs. Did that give you a bit of perspective? Is there anything else?

Peter Sklar - BMO Capital Markets

It does. Just – like it would seem to me that given the landscape, there is limited opportunities in Canada. So, is it fair to say that a lot of things you are looking at are in the U.S. as opposed to Canada?

Stephen Wetmore

Peter, it’s Stephen. We have as active a program in taking a look at potential add-ons to Canadian Tire’s kind of strength businesses as any company would. We are very aggressive with it. We look at everything. And we have for years and years and years, since I started. And we have binders in my office on every organization you could possibly think of. Did we go back and take a look at the auto collision business? Yes, we did. Of course, we did. It’s a growing business and it’s in automotive. We ruled it out, because it doesn’t attach and doesn’t bring anything specific to us in terms of utilization of our existing assets, but we look at absolutely everything. It doesn’t mean that there isn’t something in Canada at all. It’s limited, obviously, from size. But to Michael’s point, we have to be able to handle it. We have to be able to get some synergies and natural kind of understanding of the business out of it. We are not going to wander and it doesn’t make much sense to wander away to do things that we are not very good at.

We are not manufacturers, so it’s highly unlikely that you will see us go in and buy in a big manufacturing plant and where we specialize. We will look very, very hard at it. But to exactly what – to reiterate what Michael said, we are choosy. We will prepare for it. And if we are going to execute on anything, it’s going to be extremely well executed with a high success factor. So, we will look. I don’t know personally – I mean, I guess there is only four more months of my personal opinion on it, but I would look anywhere. That’s not an issue. It’s a matter of it fitting in and that’s being able to execute it flawlessly that we are most focused on.

Peter Sklar - BMO Capital Markets

Okay. Those comments were helpful. Thank you.

Operator

Your next question comes from the line of Jim Durran with Barclays Capital. Your line is open.

Jim Durran - Barclays Capital

Michael, I just wanted to go back to your opening comments and say like there wasn’t any commentary about extraordinary effort on cost savings. And I just wanted to have a sense of what role you see costs playing in terms of your earnings enhancement and return on invested capital enhancement?

Michael Medline

Thanks, Jim. I think that to have a great company and to grow in the way that you want is you have to pay attention to your costs. And I think that we are doing that and we have an initiative underway to examine our costs and margins and how we can enhance revenue across our entire company and that I don’t – we don’t do these initiatives a lot. So, I am not going to tell you to put it in your model or anything like that like you should believe it when you see it, but we are deadly serious about making this a more efficient, productive and higher return company for our shareholders and for – so that we can grow and to have more money drop to the bottom line. And I think we have done a pretty good job at being able to control our expenses. And I am speaking for all of us here, including Stephen and Dean that we need to do an even better job at being more efficient, productive and getting our ROIC up. And I think that that’s a big theme that Stephen has introduced to the company. It’s not just making money it’s being efficient at making money and we have more work to do and we are committed to it.

Stephen Wetmore

Yes. Just to add a bit, it's Stephen. If we are doing so much work, if it’s – if we feel it’s ready for prime time, we will talk more about it in October for sure, but productivity to us relates throughout the organization. It relates to our revenue productivity therefore back to what Allan said earlier in terms of regular pricing and discount pricing. It relates to cost of sales and processes and efficiencies within that and obviously, expense management, capital expenditures. So, we look at all cash going out the door. And so we have got all those fronts started.

And one thing I didn’t hit during my tenure was a 10% ROIC, but I – at least for the next four months, I am on that 10%. I mean, it’s a great aspiration and I think that’s really what kind of Michael and the team will be telling you too that we should always be heading towards that and so, yes, huge focus in the years to come. And it requires money to invest in technology to make us more efficient. So, anyway, that’s – and at Investor Day to flesh it out a bit more for you.

Jim Durran - Barclays Capital

Great. Thanks to both of you.

Michael Medline

Thank you. Thanks Jim.

Operator

Your next question comes from the line of Brian Morrison with TD Newcrest. Your line is open.

Brian Morrison - TD Newcrest

Good afternoon. Congratulations on a good quarter. I have a follow-up question on the capital structure question for Michael and then a question for Dean. Michael, with the REIT and the financial services transaction, it implies a very low multiple upon your retail operations, I appreciate you support the buyback and in light of your acquisition commentary you just gave, could you see your financial position of strength as an opportunity to really surface value being applied to retail by like considering – potentially considering a meaningful acceleration of the buyback. And then second, for Dean, how do you look at the intercompany balance going between financial services and retail and should we anticipate a repatriation or a change to that balance post the closure of the Scotia deal?

Dean McCann

Maybe I will start with that, if the guys want to chip anything in. But in terms of the approach to capital, Brian as I reiterated a number of times, a balanced approach, we are focused on primarily on investing in the existing businesses. And obviously protecting the debt rating and returning capital to shareholders is absolutely a priority. We have recognized that over the long-term as our financial performance remain – we have had a terrific quarter here. You hear what the team is doing and we are doing some great things in terms of running the businesses. And as we get more productive, we would hope to see that even improve further. And as that happens, we have to consider to – constantly consider the strength of our balance sheet and the cash available and make those decisions as we move along. But long answer to basically say that we continue to kind of follow our balanced approach, we have taken some big strides in the last while in terms of sharing capital with – back to shareholders and appropriately so. And we have a lot of financial flexibility to pursue both organic and inorganic growth opportunities. And the reality is this will be a topic that you will hear more about when we are together in October. And Michael, do you want to add?

Michael Medline

Yes, I do. Thanks Dean. That was great. I have been we – I do talk a lot and we all do that and you hear it a lot from most companies. But I think especially true here that we believe we are undervalued as a company on our share price. And we have talked about that with many of the analysts on the sell and buy side. And I think that one of the reasons that it’s not just share buybacks that drive our multiple, it’s our performance. And we continue to have to put up results, which I think we did this quarter and we have been doing recently to get that multiple up to where we think it should be. Having said all that, I am a very big supporter of what we have done in terms of returning money directly to the shareholders, especially through the share buyback program. And that we can continue as a company to assess that as the right use of cash. And obviously, I don’t want to go any further than that. I mean but that is something that we are dedicated to doing. And I knew you have seen we are serious about that and we have to continue to assess it.

Dean McCann

And Brian, just on the comment around financial services, you are right; there is I mean we have a portion of the capital structure of financial services being provided by Canadian Tire. And that frankly is just an efficiency measure at this point, right rather than tucking away at the corporate level. We have got the opportunity to kind of fund CTFS and it’s just another source of flexibility, quite frankly, for us as we go forward so.

Brian Morrison - TD Newcrest

Okay, that was helpful. If I can ask one more question potentially to Allan on the operational side on CTR and specifically on the auto, I have realized its early days and potentially this is going to be addressed at the Investor Day as well, but are there any new notable initiatives being brought forth by Mr. Broderick in order to further build upon the auto outlook at this point in time?

Allan MacDonald

Yes. I think you are right and that will be more of a topic for Investor Day, but the work that’s been done in automotive isn’t as much as it was. We had an immediate view to get automotive to its rightful place in terms of being an engine for growth and a sustainable competitive advantage for Canadian Tire. That was really about changing the vector of the business. And now we have a litany of things that we think we can do to secure that position and even strengthen it. Some of them are external and market focused, some of them are internal and operations focused. So I think as we get together later in the year we will welcome the opportunity to take you through that in a little more detail. But it’s early days right now.

Brian Morrison - TD Newcrest

Thank you, all.

Operator

Your next question comes from the line of David Hartley with Credit Suisse. Your line is open.

David Hartley - Credit Suisse

Hi thanks. Good afternoon. First of all, I am going to say great quarter. I just want to ask a little bit about the gross profit margin in the quarter is fantastic in retail and I appreciate the comments you made about spring and summer and so on and it makes a lot of sense. I am just wondering as we approach next year, given we will assume we have a normalized weather pattern next year. Would you look at the gross margin like giving back some gross margin, but potentially seeing better sales in its place? How should we think about that as we look forward a year, because I mean that gross margin is the best we have seen ever in that quarter?

Dean McCann

So, David, it’s Dean, not to talk for the businesses, but just in terms of the gross margin, obviously it was very strong, up the 60 basis points on the retail segment as you saw. And we are extraordinarily pleased with that. If I was doing a model, I wouldn’t be budgeting 60 basis points increase forever and ever on in. So, I think we had some very, very good performance in the quarter. And I think the question around the competitive set – as we have talked before, I think Allan and all of the guys have done some very, very good work about basically being much smarter about how we handle, if you will, the mix between sales and margin. You heard some of the comments from Rick and Chad in terms of how they plan to kind of manage their businesses. And I just look at it – I mean I love the word flexibility. It gives you flexibility to do whatever you need to do in order to be competitive, because we have no plans on sort of giving way to the marketplace. So, that’s how I would kind of answer it, because obviously I am not going to tell you what I think margins are going to be down the road, so...

David Hartley - Credit Suisse

Alright. No, I appreciate that. Did someone else want to answer? No, okay. Just on the debt rating and protecting the debt rating, I believe your net debt to EBITDA is somewhere around 2.3 times, ex the Glacier, I am not sure if you agree with that. But I mean, how high a figure can you get to, to protect that rating?

Dean McCann

Well, David, I think we should take that offline, right, as we get into that, but the reality is the credit metrics used by kind of the S&P and DBRS, they have changed kind of how they do their methodology. So, there is complexity to that calculation. That said, I mean, it’s no secret. We have room in our balance sheet, alright, in terms of protecting our credit rating. So, we have got a lot of room right now. And that is all part of building the financial flexibility that we have talked about over the last while and obviously buoyed up by performance over the – certainly the last couple of years. So, we are in a very strong position and we have got lots of room. But I think a detailed answer to that would be better taken offline.

Stephen Wetmore

It’s not a function of just ratios, either.

Dean McCann

No.

Stephen Wetmore

It’s a function of what you borrowed the money for.

Dean McCann

Right.

David Hartley - Credit Suisse

Alright, thanks.

Operator

Your next question comes from the line of Vishal Shreedhar with National Bank Financial. Your line is open.

Vishal Shreedhar - National Bank Financial

Thanks for taking my questions. Just a few quick ones here. What was the – I was just hoping to clarify the total value of the legal settlement and the real estate gains in the other section under retail?

Dean McCann

Vishal, the other income line – I mean, roughly speaking, kind of about two-thirds of it, I think is relative to real estate gains. And I think we laid that out. And then about a third of it is related to the settlement. And I think that’s – you can find that in the MD&A, you just have to dig around a little bit for it.

Vishal Shreedhar - National Bank Financial

Okay, fair enough. So, I saw about 12 points, 12 and change is in the cash flow for the real estate. That sounds about right?

Dean McCann

Yes, that’s the two-thirds.

Vishal Shreedhar - National Bank Financial

Okay. Gross margins in retail, while strong we are were still trending a bit below the last few quarters, let’s call it and that’s ex-gas, wondering if there is any reason for this? I am talking about our rate perspective, was it seasonality late start to the season, strategic shift, maybe in promos, any thoughts there?

Dean McCann

That wouldn’t be where I kind of had it, Vishal. So, I am not sure what you are looking at. I think gross margin was very, very strong up to 60 basis points versus the prior year. So, I think we better take that offline and just try and figure out what you are looking at versus what we are looking at, because I wouldn’t say that.

Vishal Shreedhar - National Bank Financial

Okay, fair enough. And then – and just one more quick question, this maybe for offline as well, but there is two gross margin dollar values disclosed, there is one in the notes of the MD&A and then there is one kind of – sorry, in the notes of the financial statements and one in the MD&A, where you exclude D&A and one where you don’t underneath the gross margin line. I was wondering if that same 3 and change was excluded from the SG&A dollar value as well to come up with…

Dean McCann

Vishal, let’s take that offline. It has to do with distribution costs and some of the specific transportation costs, but we should really take that offline.

Vishal Shreedhar - National Bank Financial

Fair enough. That’s it for me. Thanks.

Dean McCann

Okay.

Operator

As there are no further questions at this time, I will turn the call over to Stephen Wetmore, CEO for any closing remarks.

Stephen Wetmore

Thank you everybody for joining us and we appreciate the interest and obviously give us a call if there is any further information you would require, but have a good day. Thank you very much.

Operator

Thank you, ladies and gentlemen. A telephone replay of today’s conference call will be available for one month and the webcast will be archived on Canadian Tire Corporation Limited Investor Relations website for 12 months. Please contact Lisa Greatrix or any member of the IR team if there are any follow-up questions regarding today’s call or the materials provided. This concludes today’s conference call. You may now disconnect.

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Source: Canadian Tire's (CDNTF) CEO Stephen Wetmore on Q2 2014 Results - Earnings Call Transcript
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