Alimentation Couche-Tard's (ANCUF) CEO Brian Hannasch on Q2 2017 Results - Earnings Call Transcript

Alimentation Couche-Tard Inc. (OTCPK:ANCUF) Q2 2017 Earnings Conference Call November 22, 2016 2:30 PM ET

Executives

Brian Hannasch - Chief Executive Officer

Claude Tessier - Chief Financial Officer

Mathieu Descheneaux - VP, Finance

Analysts

Patricia Baker - Scotia Capital

Derek Dley - Canaccord Genuity

Christopher Li - Bank of America Merrill Lynch

Irene Nattel - RBC Capital Markets

Martin Landry - GMP Securities

Peter Sklar - BMO Capital Markets

Michael Van Aelst - TD Securities

Keith Howlett - Desjardins Securities

Mark Petrie - CIBC

Jim Durran - Barclays Research

Vishal Shreedhar - National Bank Financial

Bob Summers - Macquarie Securities Group

Tal Woolley - Dundee Capital Markets

Operator

Good afternoon. My name is Sylvie, and I will be your conference operator today.

I will now introduce you to Mr. Mathieu Descheneaux, Vice President, Finance of Alimentation Couche-Tard.

Mathieu Descheneaux

I would like to welcome everyone to this web conference presenting the Q2 Financial Results of Alimentation Couche-Tard Inc. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, we will be answering questions that were forwarded to us beforehand by analysts. We would like to remind everyone that this webcast presentation will be available on our Web site for a 90-day period.

Also, please remember that some of the issues discussed during this webcast might be forward-looking statements, which are provided by the corporation with its usual caveats. These caveats or risks and uncertainties are outlined in our financial reporting. Therefore, our future results could differ from the information discussed today.

Our financial results will be presented by Mr. Brian Hannasch, President and Chief Executive Officer; and Mr. Claude Tessier, Chief Financial Officer.

Brian, you may begin your conference.

Brian Hannasch

All right. Thank you, Mathieu, and welcome everyone and thank you for joining us for the presentation of our results for the second quarter of our fiscal year 2017. For this quarter, adjusted net earnings were approximately 331 million compared to 375 million for the second quarter of fiscal 2016.

Our adjusted diluted net earnings per share were $0.58 for the second quarter of fiscal '17 compared to $0.66 for the same quarter last year. This is a decrease of 11.7% which is mostly due to unusually high fuel margins we experienced in the U.S. last year in the same quarter, and also to the impact of a higher consolidated tax rate which Claude will touch on a bit later.

This quarter, the floods in Louisiana in August, the Colonial Pipeline leak in September as well as Hurricane Matthew in October directly affected more than 500 of our stores operations in the U.S. during the quarter, mainly leading to the loss of merchandise and fuel sales and certainly incremental expenses including inventory losses and cleanup expenses.

We were, however, able to mitigate the impact of this. Our teams just did a fantastic job in the face of these events and I think we’ve done a good job minimizing the impact. That said, in addition to the 500 sites that were impacted directly, we certainly had significant demand destruction from each of these events, which is obviously larger than the 4 million that we referenced in our MD&A but very difficult to quantify for the quarter.

With that said, the items that contribute to the decrease in our net earnings were partially offset by our continued underlying organic growth as well as by the significant contributions from acquisitions in the quarter.

On the convenience side, same-store merchandise revenues were once again up at all of our geographies due to effective merchandising strategies to the encouraging reaction from our customers to the launch of our new global brand and then growing popularity of our expanded food service and private label offerings.

As we begin rolling out Simply Great Coffee in our North American network now completing over 400 of the 750 planned for this year, we're seeing this potential come to life. Our Simply Great Coffee concept recently won the CSNews Innovator of the Year Award for 2016 which adds to our confidence that we're doing the right thing for this category.

On the fuel side, we feel we’re gaining market share in several of our markets thanks to the positive response from customers to our rebranding initiatives, to our fuel branding and micro-market strategies as well as to a continued growing contribution from premium fuels.

In the U.S. Southeast, we believe their fuel volumes continue to be negatively impacted by disruptions caused from our fuel rebranding activities on more than 1,000 sites particularly in the Pantry network which adds to the negative impact that we had talked about earlier with the floods, the Pipeline and hurricane Matthew. The rebranding of the Pantry, however, is getting traction and we believe we'll see strong volume performance as these are completed in the coming months.

Our global Circle K brand rollout continues to proceed as planned and continues to gain momentum both in North America and Europe. We’re up to more than 1,400 sites rebranded globally of which over 650 are in Europe.

I'm very proud to say that in our European markets, which we deemed high risk at the beginning of this process when we were changing our name from a well-established and respected Statoil brand to our new Global Circle K brand, rebranding has in fact increased traffic to our stores compared to non-rebranded sites.

This performance certainly exceeds our expectations as a decline in customer traffic can easily be expected when replacing an established and well-recognized brand. Our teams have simply done a great job transitioning our brand and making the awareness of the Circle K brand come to life.

The past few months have been particularly active quarter on the acquisition front adding over 1,600 stores to our network in the quarter. In August of 2016, we signed an agreement to acquire CST Brands which encompasses over 2,000 stores in North America.

And parallel to the agreement with CST, we entered into an agreement with Parkland Fuel Corporation in which we would sell certain Canadian assets of CST after the merger for approximately $750 million in proceeds. The CST transaction was approved by CST's shareholders this week on November 16. It is still subject to regulatory approval in the United States and Canada and we expect it to close before the end of fiscal 2017.

Just a few days after the CST announcement, we also received approval from the Competition Authority in Canada to add to our network 278 high quality Imperial Oil sites in Ontario and Quebec. These sites have already been integrated into our network in October, then become a part of our growing Couche-Tard family. The sites in Quebec have already been remerchandised and rebranded. In Ontario, the rebrands will be combined with our Circle K rollout early in the new fiscal year.

Other activities include the finalization of the acquisition transaction in Denmark for 127 sites and an agreement to purchase 53 company-operated sites in Louisiana in the U.S. And last but not least, the completion of the acquisition of 23 company-operated sites in Estonia of which 11 are full service station with convenience stores and 12 are unmanned automated fuel locations.

As a growth-oriented company, we know every acquisition is only as good as its successful and full integration especially when it comes to anticipated synergies. Our integration teams are still hard at work at the Pantry, which while seems like a while ago was literally only 18, 19 months ago. We continue to identify additional synergies and operations haven't yet so far realized cost reductions of approximately $78 million and merchandise and service supply cost reductions of approximately $27 million.

With regard to fuel synergies associated with the fuel rebranding of approximately 1,000 stores, we've also exceeded our target.

The integration of Topaz, which we acquired in February of 2016, is also on track and going well as is the integration of our newly acquired Shell operations in Denmark. While in Canada during the quarter, we successfully integrated 173 of the 278 sites from Imperial, and as I mentioned earlier, they are all now complete. Regardless of the tempo of the M&A activity, we’re committed to applying the same approach and financial discipline to the CST network once this transaction is completed.

So I’ll now turn it over to Claude to take you through the numbers in more detail. Claude?

Claude Tessier

Thank you, Brian. Ladies and gentlemen, good afternoon. For our second quarter, we report net earnings of $324 million or $0.57 per share on a diluted basis. One specific item that is described in our MD&A are factored in. Adjusted net earnings were approximately $331 million, a decrease of 11.7% compared to Q2 2016.

Adjusted diluted net earnings are at $0.58 per share compared to $0.66 per share for the corresponding quarter of 2016. This decrease is attributable to lower fuel margin in the U.S. compared with unusually high margins in the second quarter of the previous fiscal year and the impact of a higher consolidated income tax rate. These items were partially offset by the positive impact of our continued organic growth and by the contribution from our acquisitions.

As in previous quarters, we continue to accelerate depreciation of signage equipment of Statoil trade name in connection with our global brand initiative. During the second quarter, we recorded an incremental depreciation and amortization expense of $6.5 million. I will now quickly run through some of the key figures for the quarter. For more details, please refer to our MD&A which is available on our Web site.

For the second quarter, same-store merchandising sales increased by 2.3% in the U.S., by 1.2% in Canada and by 3.4% in Europe. Overall, our performance is due to our dynamic merchandising strategies, to the encouraging reaction from customers to the launch of our new global brand, to our competitive offer and to our expanded fresh food assortment which is attracting more customers into our stores.

Our merchandise and service revenues in Western Canada continued to be affected by a challenging economy while our U.S. operations were temporarily affected by the combined negative impact of floods in Louisiana, the Colonial Pipeline leak in Alabama as well as Hurricane Matthew in the Southeast which altogether affected approximately 500 of our stores.

Moreover, revenues for certain product categories in the U.S. were also negatively affected by the deflationary impact on sales prices. Excluding the net impact from currency translation, our consolidated merchandise and service gross profits grew by $58 million, a solid 7.1% increase, which is attributable to the contribution from acquisitions for approximately $27 million as well as organic growth.

The gross margin increased by 0.2% to 33.3% in the United States; by 0.7% to 41.4% in Europe; and by 0.7% to 33.6% in Canada. Overall, this performance reflects changes in our product mix towards higher margin categories, including fresh food and hot dispensed beverages, to improvement we brought to our supply terms, as well as our merchandising strategy in line with market competitiveness and the economic conditions within each market.

Total fuel volume grew by 9.8% in the second quarter through the contribution from acquisitions and organic growth. Same-store volume growth in the U.S. was 3.5% while it was 0.1% in Europe. Overall, this performance was driven by the positive response from customers to our Circle K rebranding initiatives, our fuel branding and micro-market strategies, as well as by the growing contribution from premium fuels.

In the U.S., fuel volumes were negatively impacted by disruptions caused by our fuel rebranding activities in the Southeast in addition to the negative combined impact of the floods in Louisiana, the Colonial Pipeline leak, as well as the hurricane Matthew in the Southeast region. In Canada, same-store road transportation fuel volume decreased by 0.8%, still impacted by a challenging economy in the Western part of the country.

During the second quarter of fiscal 2017, our road transportation fuel gross margin was US$19.87 per gallon in the U.S., a decrease of US$5.79 per gallon or 22.6% compared with the unusually high margins experienced in the same quarter of fiscal 2016. Fuel margin was US$9.10 per liter in Europe, a decline of US$0.52 per liter and it was CA$6.75 per liter in Canada, down CA$0.15 per liter. The decrease in Europe is mostly attributable to the impact of the lower margin in Ireland compared with our margins in Continental Europe. Excluding the results of Ireland, road transportation fuel gross margin increased in Europe.

As you know, rigorous cost control throughout the organization is part of our DNA. This has been a key focus area for several years and we intend to keep it that way. Our culture as well as the realization of additional synergies in Europe and for the Pantry stores allowed us to keep the year-over-year organic growth in expense at 1.7% during the second quarter and at 1.9% since the beginning of the fiscal year.

This is near normal inflation despite higher advertising and marketing activities in connection with our rebranding project, strong top line growth, higher average number of company-operated stores and the proportionally higher operational expense in our recently built stores due to their larger footprint.

In terms of network integration, we continue our works toward the identification and realization of cost reduction opportunities for the Pantry network. Since the acquisition, we have realized pre-tax cost reduction of $78 million still on target to meet our pre-tax cost objective of $85 million to be achievable over a 24-month period following the acquisition.

In addition to these cost reductions, we quickly achieved our merchandised and service supply cost synergies objective of $27 million. These reductions are mainly the result of economy of scale and of the negotiation of improved supply conditions. And as previously mentioned, we have completed our review of our fuel supply conditions which allows us to reach our fuel supply cost synergies objective.

Now, back to our financial results. Excluding specific items described in our MD&A, adjusted EBITDA for the second quarter of fiscal 2017 decreased by $26.4 million or 4% to $629.7 million. Our income tax rate for the second quarter of fiscal 2017 increased to 27.5% compared to the normalized income tax rate of 24.2% for the second quarter of fiscal 2016, and this is due to growing presence in the United States where our income tax rate is the highest.

Now let’s take a brief look at our financial results for the first half of fiscal 2017. Barring any foreign exchange effects, our merchandising gross profits are up by $102 million or 6.3% and fuel gross profit are up by $39.4 million or 3.3%. Excluding specific items, adjusted EBITDA increased by $40.8 million or 3.4% reaching over $1.2 billion.

Our income tax rate for the first half of the year was up 27.3% and adjusting for specific items, net earnings stood at $659 million or $1.16 per share on a diluted basis compared to $1.17 per share for the corresponding half year of 2016, a decrease of 0.9%.

As of the end of the quarter, our balance sheet and indebtedness ratio was solid compared to the industry and other retailers. Our adjusted net debt to EBITDA stands at $1.98 on a pro forma basis for the acquisition of Topaz and Imperial Oil assets in Canada, which puts us in a good position for the CST acquisition. Our return on equity remains strong at 24.8 on a pro forma basis.

As of October 9, we had $830.6 million in cash and $1.8 billion available to our revolving credit facilities providing us ample flexibility to fund future investments. And last but not least, our dividend is on the rise. We are truly happy to share our success with our shareholders by increasing the quarterly dividend by CA$1.25 per share, an increase of over 16% compared to the last quarter and of 33% compared to the dividend from Q2 2016.

Thank you for your attention. Now I’m going to turn it back to Brian.

Brian Hannasch

All right. Thank you, Claude. It’s been a very active quarter but amidst all the M&A and rebranding activity, our team members have continued to remain focus on our customers, growing basket size in traffic and delivering nice same-store growth. It’s this strong committed approach to organic growth combined with our disciplined approach to M&A that makes us who we are and brings us further along in our path to becoming the world’s preferred destination for convenience and fuel.

The second half of the fiscal year will be focused first and foremost on driving organic growth, as we work on the three pillars supporting our new Circle K brand rollout. And second, we will focus fully on integrating the newest additions to the Couche-Tard family in identifying which pieces of their business are better than ours and what we can learn from them. We’re also very much forward to completing our outstanding agreement with CST Brands and further developing our customer offer globally.

With that, I’ll turn it over to Mathieu and the operator for questions.

Question-and-Answer Session

A - Mathieu Descheneaux

Thank you, Brian. We’ll now address the questions that were submitted to us before the call.

First question comes from Patricia Baker at Scotia Capital. There has been intensive programs to encourage the use of electric vehicles in various countries. Can you discuss your view on electric vehicles and how you might see that play out over the longer term? I don’t see this as any immediate threat but do you think there is a role for Couche-Tard to play in the much longer term in this?

Brian Hannasch

Yes, we pay very close attention to how alternative fuels are developing. That will include electric, hydrogen and others. We certainly stay in touch with the major branded fuel suppliers and as recently as last quarter, we had a professor from MIT, Chuck Heywood, who's really an expert in this space come and speak to our Board and our management team about their projections and how they see alternative fuels developing, particularly in North America but also globally. There’s a reality today that this year – it was approximately one-half of 1% of the new vehicle sold in North America were electric vehicles and we’ve also seen record truck and SUV sales. When you put this in context with taking 15 years to turn the fleet over, we see a long runway for traditional fuels. And certainly the experts we talk about see a much bigger impact from the improvement of the efficiency in the traditional fleet having a much larger impact than the introduction of electric or hybrid certainly in the next 15 to 20 years. That said, we’re watching it closely. We’re actively installing charging stations in Norway, which is the one country where we’ve seen active legislation that incentivizes electric vehicles in a big way. We’re also focused on the viability of our network both – we think with a very robust fuel forecourt above average industry volumes in both the box and the store, we’re well positioned to continue to take market share as the fuel market evolves in the coming decades.

Mathieu Descheneaux

Second question; I have noted the conversion of the Esso site into Couche-Tard and it looks very good. Can you give us some early read on the consumer response?

Brian Hannasch

I think they look really good, not pretty good. It’s only been a few weeks but setting aside some supply disruptions in Ontario on the fuel side, the feedback is very encouraging. We believe the efforts inside the store are clearly leading to increased traffic in sales and look forward to reporting in more detail in the coming quarters.

Mathieu Descheneaux

Next questions are from Derek Dley with Canaccord Genuity. Can you comment on some of the initiatives that are driving the strong growth in merchandise same-store sales and gross margins across all regions?

Claude Tessier

Well, by moving to Circle K brand globally, we have put teams in place that are taking care of procurement, also the food program that we call the famous four that we have put in place. And those programs are starting to deliver results on all geographies. So in Europe, we have good growth that’s propelled by food, coffee categories. In North America, we also see positive trends in food that are helping margins and sales. In Canada also with Simply Great Coffee that Brian referred to also, we’re having good results and positive results and impact on margins also. So, overall, all the geographies are enjoying good trend in the food categories with the positive impact in terms of margins also.

Mathieu Descheneaux

Following the acquisition of the CST Brands, would you expect your tax rate to decline? And by how much given the incremental leverage you will have on the balance sheet?

Claude Tessier

So as mentioned when we disclosed a transaction, the tax rate is going to be affected between 0% and 5% and it’s going to be a decline, so somewhere between 0% and 5% we expect the tax rate to decline. So you can refer back to also the past acquisition to see the similar impact. And that’s the impact of leveraging the balance sheet. The leverage on the balance sheet is going to move to 3.5 times as also mentioned earlier, and our intent is to [leverage] [ph] the balance sheet within 18 to 24 months to 2.6 times as mentioned when we disclosed the CST transaction.

Mathieu Descheneaux

Thank you. Next questions are from Christopher Li, Bank of America Merrill Lynch. In as much details as possible, can you walk us through how RINs impact Couche-Tard’s fuel business? Second, recognizing that the outcome is uncertain at this point but in the event that these are – that there are rule changes that adversely impact the value of RIN and presumably Couche-Tard’s fuel margins as well, what measures can the company take to mitigate the impact? Importantly, would that change your view on structurally higher fuel margins over time?

Brian Hannasch

Post-CST, Couche-Tard will sell approximately 17 billion gallons of fuel. The focus that we have in on leveraging the scale to create and widen our competitive advantages on how we purchase, transport and most importantly sell fuel to our consumers. In the U.S., we buy under a variety of structures including some where we get full RIN economics and some where we get partial RIN economics. From our standpoint it’s impossible to quantify as you can never tell and I don’t think anyone can tell how much is priced in any given rack, at any given time, which is how most of the industry would purchase fuel. However, if it does go away, it goes away for everyone and the markets will adjust and we’ll focus on other ways to again establish and widen our competitive advantages on how we purchase fuel. That said, this rule cannot be changed by executive order. It does take full-blown rule making and judicial review for this rule to be changed, and from our perspective and the people we’re talking to there’s significant and very strong opposition by the American Petroleum Institute, all the major marketing groups, some of the automotive companies and the ethanol producers. So we’re watching the issue closely. Again, it’s difficult to quantify but at this point we’re not overly concerned with the RIN issue.

Mathieu Descheneaux

Recognizing that it’s a long-term risk, I would love to get your latest thoughts on hybrids and electric cars and the impact it will have on the fuel retailing industry over the long term?

Brian Hannasch

I think we covered that one, Mathieu, pretty well in the last questions.

Mathieu Descheneaux

Okay. Next questions are from Irene Nattel, RBC Capital Markets. If we [Indiscernible] merchandise revenues and margins [inaudible] all geographies – okay, we covered this one, and the next one from Irene also. So we will move to Martin Landry from GMP Securities. Now that the acquisition of the Imperial Oil sites has closed, can you give some color on the level of synergies that could be expected? Would it be possible to quantify them as a percentage of the EBITDA core?

Claude Tessier

So as we mentioned also when we disclose a transaction of Esso, we’re not disclosing synergy and we’re not going to report a number. And that’s also an asset purchase and that’s one of the reasons why we’re not disclosing any number. But there’s going to be synergies that are going to be driven by that transaction and we can give you a flavor of where we’re going to get those synergies. So distribution is one area where we’re going to do some changes in terms of providing goods to the store, so that would drive merchandising synergies also with putting our offering and our line into the stores are going to bring synergies into the equation in the acquisition. Procurement also is another big area. We have our agreements that we’re going to put in place that are going to kick in when we’re going to start operating the stores as we have done in October. The other big synergies, the combination of all that is going to obviously – and we expect an impact on sales and also putting our promotional programs in place is going to also in our mind drive sales increase on the merchandising side. So these are the areas where we see synergies coming from on the Imperial Oil sites acquisition.

Mathieu Descheneaux

And how accretive do you expect Imperial Oil to be?

Claude Tessier

So we said we were expecting positive accretion on the transaction. We think that – and we can disclose that the accretion is going to be around $0.10 on that transaction. You have to understand that also we have to put minimal CapEx also in place. It was a well-run network all over, so that’s what we can tell you at this time, so EPS accretion around $0.10.

Brian Hannasch

And that’s pre-synergy.

Mathieu Descheneaux

Next questions are from Peter Sklar at BMO Capital Markets. You reported that certain merchandised categories experienced inflation. Can you please elaborate on which categories are being impacted and how this is affecting your margins and profitability?

Claude Tessier

So there’s two important areas or three important areas where we’re being affected. There’s a lot of talk about deflation on food and most of the deflation is coming on the fresh categories which are meat and produce, which we’re not impacted a lot by. So the categories where we’re impacted are mostly dairy where there’s a deflation in the U.S. by 1.5% to 2% deflation. So we’ve been affected slightly by that. And also there’s private label that brings a deflation. So private label introducing and increasing our percentage penetration of private label is bringing our price down. So we see the impact on two fronts; one in cigarettes where we are introducing traffic and traffic brings a cheaper brand of cigarettes for the customer and with the lower price that has a positive impact on profit though, because we’re still generating more penny profit on that. Same thing on other private label products, we always bring the example of water where we’re bidding our private label proposition to the consumer and where the selling price is lower but we’re generating still more penny profit on. So that’s the area where we see impact in terms of deflation. So private label and deflation on the dairy category.

Mathieu Descheneaux

You reported year-over-year organic SG&A growth of 1.7% this quarter. Do you expect you will be able to get back to less than 1% year-over-year increase in organic SG&A? And if so, over what time period?

Claude Tessier

The growth over inflation is mainly due and we’ve explained that by first more COCO stores in Europe. So as we’re bringing on some stores on the COCO mode instead of franchisee mode there impacting and increasing our expense. And the other big factor is the conversion and the rollout of Skyfall [ph] in Europe --

Mathieu Descheneaux

Circle K brand.

Claude Tessier

Yes, Circle K brand that we do in Europe, so we’re supporting the brand as we launch it. It’s important to us to have a good success and we’re rolling out that program and we’re having that success. But that brings bit more expenses. So until we complete the rollout in Europe, we are going to incur those higher expenses.

Mathieu Descheneaux

Next questions come from Michael Van Aelst of TD Securities. Can you update us on several of your fresh food initiatives including, first, performance of the food being in test to-date and the potential timing for larger-scale rollout? Second, how many stores you have made to go in at this time and where do you see it getting to over the next two years? And third, how many North American locations you currently have Simply Great Coffee in and where do you see it getting to over the next two years?

Brian Hannasch

A long list of questions in there, Michael. I’ll start with coffee. I think I touched on it earlier. We’ve got about 400 complete on a plan of 750 for North America and we’ve fully believed that we’re on a good path there. Some parts of the U.S., as examples are Quebec, have been very strong while others in the consumers we may be a little early but we certainly think that’s where the younger consumer is headed as evidenced by the success of McDonald’s and Starbucks with their offers. So very committed to continue to roll that out and we plan to be aggressive in the context of our balance sheet in the coming year on coffee. I’m going to touch on FFI, which is the logistic solution of supplying fresh sandwiches, pastries, salads, fruit cups, things like that to our sites. We currently have 1,285 locations on as of this quarter and we’ll be adding an additional 200 before the end of our fiscal year. Bakery is an item we may not have talked a lot about but we’ve launched an initiative to get fresh bakery into a greater percentage of our network. This year we’ve added 1,120 sites bringing a producer that we’ve used in Arizona for several decades to the East Coast to assist us in this effort. We’ve currently rolled out all of Florida and we’ll be adding additional 500 sites on the East Coast in the next six months. And then finally foodvenience [ph], we’ve got around 10 sites up and operational. I would say we’ve got some sites far exceeding expectations and we’ve got some sites that are not meeting it. Since the year, it was about a year ago that we launched it, there’s certainly continued learnings and menu refinement and we’ll continue to evolve that offer and adjust the menu as appropriate. We’re excited about CST. They’ve been on the same journey with regard to foodvenience or made to go type offer. And I think they’ve got an offer that fits very well for the Southern half of the U.S., so anxious to get the experts together from both ACT and CST in the coming years as I’m confident that it can accelerate our journey in the food site.

Mathieu Descheneaux

Now that all the acquired Esso stores have been integrated into your network, can you discuss what some of the more important changes are that you are making and maybe see them conversion to Circle K or Couche-Tard? And what changes do you plan to make over the first year or two to improve operating those?

Brian Hannasch

Yes, the biggest initial change is of really a full reset and a combination of new fixtures and significantly more SKUs in the sites. You will see our signature offers added like Froster and Sloche here in the markets. In Quebec, we specifically see an opportunity on cigarettes and beer where the Esso network under indexes our legacy network significantly. Operationally, we think we can help the operators do a better job matching their labor that they bring in terms of customer service to the traffic. We’ve got some nice tools that allow for I think more accurate scheduling. And then our vendor data would show that out of stocks in an opportunity in the Esso network as well. So we’re encouraging the agents, so this is an agent model, to increase inventories and work on out of stocks as an easy way to grow sales. So those will be the big near-term changes we’ll see in those networks.

Mathieu Descheneaux

Next questions are from Keith Howlett from Desjardins Securities. What is the number of locations in the U.S. selling Circle K branded motor fuel? And what will that number be in one and two years from now including plans for CST and Cracker Barrel acquisition?

Brian Hannasch

So as of right now, we have about 1,700 sites in the U.S. selling fuel under the Circle K brand, which is about 40% of our company-operated market or network. We don’t offer that brand in any big way in our dealer channel today. The Circle K brand’s an important part of our portfolio as are Shell, Esso and BP and our other partners here in North America. And we’re working on a number of programs to bring more equity to the Circle K fuel brand including loyalty and payment projects in the coming months. And you’ll see it penetrate a high percentage of our NTIs, new-to-industry sites as we roll those out. And then finally the CST and Cracker Barrel question, until the FTC approves a transaction we really can’t have any conversations with them about go-forward strategies. But that said, Valero has been a long-term partner and certainly with the CST transaction, it becomes a very important one becoming our largest fuel supplier we have anywhere in the world. So we’re confident that that relationship will continue forward in a strong way.

Mathieu Descheneaux

What are the merchandise and fuel trends quarter-over-quarter and year-over-year in Western Canada? And is there any recent sign of improvement?

Brian Hannasch

First of all, BC has held up well. We’re actually have a good year in British Columbia. BC has really been the prairies; Alberta specifically but also if you get into Saskatchewan. Not a huge market presence for us in these markets. But that said, it’s been difficult. I think the teams’ done a great job based on Nielsen information as well as supplier information we’re performing very well, vis-à-vis competition but there’s no masking the fact that we have weak consumer demand in those markets and the trends have been fairly consistent. We don’t see a lot of upside in that market in the near term until the oil situation stabilizes and we’re prepared to wait that out. We’re very committed to the market and even though it’s a small part of our network, it’s a very strong part of our network for us. So we think we’re in good shape to compete there long term.

Mathieu Descheneaux

Next questions are from Mark Petrie of CIBC. U.S. fuel prices remain lower in the quarter though this trend has flattened or begun to [indiscernible]. Based on your experience, how significantly do fuel prices need to increase for you to see a negative impact to fuel volumes or traffic into your stores?

Brian Hannasch

It’s a difficult question to answer precisely. There’s a lot of variables; the two biggest being the pace of the increase. When we see price shocks, we see behavior impacts very quickly. If it’s a slow steady increase, we tend not to see much of an impact. Then the other big variable is the health of the consumer. Four or five years ago with higher unemployment, I think we were much more susceptible to price increases affecting consumer behavior. Today, unemployment is relatively low in most of our markets and we think it’s the consumers’ in a better place if something material did happen. So, again, today I think it would likely take a very material increase to have a significant long-lasting effect on demand or even premium fuel sales.

Mathieu Descheneaux

U.S. merchandise gross margin percentage continues to climb. Could you please provide some details on the drivers, specifically the net impact of Pantry versus last year and the impact of tobacco?

Brian Hannasch

So in Pantry, we’ve got the synergies in place fairly quickly, so Pantry is not having a significant impact on our merchandise margin percentage. It’s really a combination of mix. As Claude said, we’re seeing strong growth in higher margin categories including hot and cold beverage and food. We’ve had a good year working with suppliers as we’ve gotten bigger. And then finally promotional activity, we haven’t had the need to be as deep in terms of discounting promotional activity. So netting all that out, we’ve seen really nice margin growth across almost every business unit we have in North America and also in Europe.

Mathieu Descheneaux

Next questions are from Jim Durran, Barclays Research. I think the first one we already addressed on the Esso integration. So moving to the second question. On the tax rate, do you expect the tax rate to continue as the past two quarter run rate of approximately 27% until the CST acquisition integration begins? And so you still expect the consolidated effective tax rate upon completion of CST to drop by up to 500 basis points?

Claude Tessier

So on the first part of the question, so last quarter tax rate is in line with our expectations and what’s going to happen in the next quarter is going to be probably brought by the mix of more Canadian business put into the equation, so it may be a slight decrease. And for the CST drop, we talked about that earlier between 0% and 5% decreased after CST acquisition with the next mix of sales coming into the equation.

Mathieu Descheneaux

Next two questions are from Vishal Shreedhar from National Bank Financial. The Imperial Oil acquisition closed during the quarter with integration beginning on September 12, 2016 versus the quarter ending on October 9, how significant was the Imperial Oil acquisition to the quarter in terms of EBITDA? Did it represent the bulk of the $24 million contributed to EBITDA by acquisitions?

Claude Tessier

So as you understand when we start to rollout something like that, so we started on September 12, so the first week or two is a slower pace and then we get into full speed in terms of integration. So as of the end of the quarter, we had 173 sites that were gradually integrated and most of them closer to the end of quarter. So the contribution of Esso to the EBITDA [indiscernible] for acquisition of 24 million is on the low-single digit contribution in terms of EBITDA. So it was not significant. The most of the 24 million came from our European acquisitions, Shell and Topaz that we’ve made earlier this year.

Mathieu Descheneaux

Last quarter, [indiscernible] indicated that merchandising margins in Europe declined because of the Topaz acquisition and the impact of mix. However, in Q2 2013, the European margins increased. Can you provide additional comments on the improvement?

Brian Hannasch

So obviously the Topaz effect is still there but for the quarter, it was only outrun by solid performance across all the category, not just car wash and food but really center store. They all performed very well and ended up in again a nice increase in the entire box.

Mathieu Descheneaux

Next two questions are from Bob Summers at Macquarie Securities Group. Can you give us any sort of volume turned negative once again in Q2 2017? Are there specific factors that drove the weakness?

Brian Hannasch

I’d say the weakness was most pronounced not surprisingly in the West and also Newfoundland [ph], where we’ve had economic pressures and just seeing negative demand to some degree. The rest of the Canada has really performed pretty decent. We’re optimistic about the recently added Esso network and its opportunities.

Mathieu Descheneaux

In-store sales and margin performance was quite strong in the quarter. Can you discuss the U.S. business as several competitors posted disappointing performance? Within the U.S., was there a difference in performance based on geographies?

Brian Hannasch

Yes, for the quarter I would say as we touched on earlier, the Southeast U.S. was really hard to get a handle on. There was just so much noise from floods and hurricanes and everything else that happened down there. So it was hard to get a clear picture of how healthy that part of the geography is given the disruption. I would say Texas, Oklahoma just with the decreased economic activity, particularly in the shale regions, there’s some weakness in those markets. For the last 45 days on a macro basis, I think we’ve seen stronger trends really across all of our markets in North America. So I’m cautiously optimistic that it’s nothing systemic.

Mathieu Descheneaux

The last questions are from Tal Woolley at Dundee Capital Markets. With the cost sales you have more consolidation among the tobacco brands, for example, British American Tobacco's proposed bid for Reynolds American. How has the consolidation of the tobacco suppliers helped and/or challenged the business in the past either operationally or financially? And is there anything about this proposed deal that could impact the business positively or negatively in the future?

Brian Hannasch

With regard to that specific transaction, BAT is a global company, a very important partner for us across all of our countries and soon to be so in the U.S. with the Reynolds acquisition. We look at it as a positive in terms of it’s an opportunity to bring global experience and also different products to help us better service our tobacco and moist smokeless customers in our network here in North America but also in the rest of the world.

Mathieu Descheneaux

With the integration of the Imperial Oil assets underway and most still operated under third-party agreements, do you have a better sense of what the long-term operating model of these assets might look like? Is there a plan to convert them to company operated stores or rescind the existing commission agency agreement? Also, is there potential for any favorable change in the fuel supply agreement either now or in the future?

Brian Hannasch

So it’s only been a few weeks, as I said earlier, but I did have the opportunity to tour our Quebec market two weeks ago and I’ll be touring Ontario in two weeks. I met a lot of good operators. They’re very excited to be a part of the ACT family and as I said, they’re saying they’re ordering more and selling more. So we take that as a positive. In terms of the operating model, we operate under a number of different models here in North America including an agent model or dealer model that’s very similar to what Esso has in place. And I would also add this network is winning in the market, so it’s not broken. So any changes we make will be done very thoughtfully and we’re going to certainly learn before we make any decisions around the operating model. On the fuel agreement, again, a very large relationship with Esso. We have really two relationships; one’s our legacy network and the other is the agreement we entered into when we bought the Imperial assets just recently. So I think we’ve taken the opportunity to harmonize the agreements between the two and feel that we’ve got a very competitive cost and one of the best brands in Canada to work it, so excited about the opportunity.

Mathieu Descheneaux

This was our last question. Thank you, Claude. Thank you, Brian. This concludes today’s conference call. Thank you everyone on the line. You may now disconnect.

Brian Hannasch

All right. Thanks, everyone. Have a good day.

Claude Tessier

Thank you.

Operator

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

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