Empire F2Q08 (Qtr End 11/03/07) Earnings Call Transcript

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Empire Company Ltd. (EMP.A) F2Q08 (Qtr End 11/03/07) Earnings Call December 13, 2007 3:00 PM ET

Executives

Paul Beesley - EVP and CFO

Paul Sobey - President and CEO

Stewart Mahoney - VP of IR andTreasury

Frank Sobey - VP of Real Estate

Bill McEwan - President and CEOof Sobeys Inc.

Francois Vimard - CFO of SobeysInc.

Analysts

Jim Durran - National BankFinancial

Ryan Balgopal - Scotia Capital

David Hartley - BMO CapitalMarkets

Keith Howlett - DesjardinSecurities

Operator

Welcome to the Empire CompanyLimited second quarter results conference call. (Operator Instructions)

I will now turn the conferenceover to Mr. Paul Beesley, Executive Vice President and Chief Financial Officer.Please go ahead, sir.

Paul Beesley

Thank you very much, Gloria. Goodafternoon, and welcome to the Empire Company Limited fiscal 2008 second quarterconference call.

Our comments today will focusprimarily on the financial results for the second quarter ended November 3, 2007. This callis being recorded in live audio, and it will be available on our website atwww.empireco.ca.

Today's discussion includesforward-looking statements. We want to caution you that such statements arebased on management's assumptions and beliefs. These forward-looking statementsare subject to uncertainties and other factors that could cause actual resultsto differ materially from such statements.

Joining me on the call thisafternoon are, from Empire Company Limited, Paul Sobey, President and ChiefExecutive Officer; and Stewart Mahoney, Vice President, Investor Relations andTreasury; and Frank Sobey, Vice President, Real Estate.

From Sobeys, Bill McEwan,President and Chief Executive Officer; Francois Vimard, Chief FinancialOfficer; and Paul Jewer, Senior Vice President, Finance and Treasurer.

As previously communicated, weannounced the completion of Sobeys privatization in our first quarter on June 15, 2007. Thistransaction saw Empire acquire all of the outstanding common shares of Sobeysthat it did not already own. As a result of this transaction, Empire's secondquarter fiscal 2008 financial results reflect 100% ownership of Sobeys ascompared to a 72% ownership interest in the second quarter last year.

This morning we released Empire'sfinancial results for our second quarter ended November 3, 2007. Revenue for the secondquarter equaled $3.48 billion compared to $3.35 billion previous year, a 3.9%increase. There are two items that impact revenue comparability in thisquarter.

First, Sobeys sales were positivelyimproved by the acquisition of Thrifty Foods on September 11, 2007 and by ADL acquired on August 27, 2006. Theseacquisitions collectively increased the second quarter fiscal 2008 sales by$103.5 million over the same period last year.

Second, late in the secondquarter of fiscal 2007, a major Canadian tobacco supplier began to sell anddistribute directly to certain Sobeys' customers. This reduced second quarterfiscal 2008 revenues by $30.1 million relative to the second quarter last year.Adjusting for these items, Empire's consolidated sales growth would have been1.7%.

Consolidated operating incometotaled $118.2 million compared to $113 million in the second quarter lastyear, an increase of $5.2 million or 4.6%. The increase was the result of an$11.1 million or 13.9% increase in operating income contribution from the fooddivision; an increase in investment and other operations' operating income, netof corporate expenses of $1.6 million, partially offset by $7.5 million declinein operating income from the real estate division.

The decline in real estateoperating income was anticipated largely as a result of completion of a major condominiumproject in Q2 last year due to slower residential lot sales.

Second quarter operatingearnings, that is earnings before net capital gains and other items equaled$59.9 million or $0.91 per share compared to $49.8 million or $0.76 per sharein the second quarter last year, a 20% increase.

Net earnings in the secondquarter amount to $58.4 million or $0.89 per share compared to $55.8 million or$0.85 per share in the second quarter last year. Company incurred capitallosses and other items, net of tax, of $1.5 million during the second quarterof fiscal 2008 largely as a result of a 10% fair value adjustment recorded bySobeys on $30 million of asset-backed commercial paper withheld at the end ofthe quarter.

Capital gains and other items,net of tax, of $6 million were recorded in the second quarter last yearprimarily from the sale of liquid portfolio investments.

The ratio of consolidated fundeddebt to capital at the end of the second quarter equaled 45% versus 34% at theend of the second quarter last year and 43% two years ago. After deducting cashand cash equivalents of $133.1 million, Empire's net debt to capital at the endof the second quarter equaled 43%.

The increase in debt to totalcapital ratio from last year reflects increased debt levels as a result of theSobeys privatization as well as the additional debt used to fund theacquisition of Thrifty Foods. At the end of Q2, there was $237 million onunutilized bank lines. Interest coverage for the second quarter remainedhealthy at 4.3 times.

Finally, senior management ofboth Empire and Sobeys want to reinforce that we are committed to not onlybuilding long-term shareholder value, but also strengthening our financialcondition. Before we recognize, this is most likely to be achieved through acombination of debt reduction and ongoing sales and margin expansion.

I'll now turn the call over toPaul Sobey.

Paul Sobey

Thanks very much, Paul, and goodafternoon, everyone. We are pleased with the progress to date in fiscal '08.Our operating earnings for the second quarter and the first half of the yearare both at record levels compared to the same period last year.

Operating earnings have grown by20% in Q2 and by 17% fiscal year-to-date. Our growth in the Q2 earnings beforecapital gains and other items is largely the result of having a 100% ownershipof Sobeys, following the privatization completed last June.

In the second quarter, Sobeyscontinue to generate solid same-stores sales growth and operating incomeresulting from consistently competitive pricing and programs innovation, costmanagement initiatives and improving day-to-day execution that Bill willprovide in his comments little later.

We're also pleased to have closedthe acquisition of Thrifty Foods in the quarter. The assets acquired include 20full-services supermarkets, a main distribution center and a wholesale divisionon Vancouver Island and the lower mainland of British Columbia. Theacquisition was accounted for using the purchasing effort with the results ofThrifty Foods being consolidated as of the acquisition date September 12, 2007.

I will now provide a few commentson our real estate division's performance. Second quarter real estate divisionrevenues, net of intercompany amounts equaled $28 million versus $66 millionlast year. Revenues from commercial properties increased $1 million whilerevenues from residential operations declined $39 million.

Residential sales decline wasanticipated reflecting primarily the completion of the Martello condominiumproject in Halifaxlast year which accounted for approximately $34 million of this decline.

The real estate operating incomein the quarter totaled $21.5 million, a $7.5 million decrease over last year.Operating income for commercial properties increased approximately $400,000,while operating income from residential operations decreased by $7.9 million.The decrease in residential operating income was a result of the completion ofthe Martello project last year and lower quarterly residential lot salesactivity in western Canada,primarily western Canada.

The focus of Empire's real estateactivity is clearly on the development and sales of food-anchored retailcenters, rather than managing of our portfolio as this activity is previouslymentioned, is now undertaken by Crombie REIT.

We continue to work closely withSobeys to more fully exploit property development pipeline and Empire's 100%ownership of Sobeys solidifies this relationship. As properties are developed,they will be first offered for sale to Crombie and the capital generated willbe redeployed into further property developments.

With respect to our investmentand other operations, at the end of the second quarter, Empire's investmentsconsisted largely of its equity accounted investment in Wajax Income Fund andin Crombie REIT. The market value of the investments at the end of the secondquarter equals to $410 million on a carrying value of $140 million resulting inan unrealized gain of approximately $270 million.

Revenue from investments andother operations totaled $50 million in the second quarter as compared to $35million last year. Empire theaters recorded significantly higher revenues as aresult of improved product quality and also the change in its fiscal year-endto December 31, which resulted in the typically strong months of July beingincluded in the second quarter of fiscal 2008 results.

Investment income generated bythe portfolio in the second quarter equaled $5.5 million, compared to $7.5million last year. The dividend income decline of approximately $2.5 millionwas as expected given the sale of our investment portfolio by the end of thefirst quarter of this year.

Equity earnings from Wajax IncomeFund grew by approximately $400,000.

I'll now turn the conversationover to Bill McEwan for his comment on Empire's food division, Sobeys.

Bill McEwan

Thank you, Paul. Sobeys' salesfor the second quarter increased 4.8% to $3.41 billion compared to $3.25billion last year, an increase of a $155 million. Same-store sales grew by 2.3%for the second quarter.

Our sales growth was driven bythe continued implementation of selling and merchandising initiatives acrossthe country, coupled with an increased retail selling square footage from thedevelopment of new stores, and an ongoing program to enlarge and renovateexisting store assets. Sales were also driven by the acquisition of ADL and ThriftyFoods, as Paul mentioned earlier.

As communicated in priorquarters, a major Canadian tobacco supplier began to sell and distributedirectly to some of our customers, resulting in a decline in tobacco sales.This change in distribution, along with lower market demand for tobaccooverall, reduced sales by $30.1 million during the second quarter of thisfiscal year.

Margins on tobacco sales aresignificantly lower than other products, therefore the loss of these sales doesnot have a material impact on earnings. After adjusting for the impact of thedecline in wholesale tobacco sales and the ADL and Thrifty's acquisitions,second quarter sales growth would have been 2.5%.

Sobeys' operating incomecontribution to Empire increased $11.1 million, or 13.9%, a $90.8 million.Operating income margin equaled 2.67% compared to 2.45% in the second quarterlast year. Included in the second quarter of fiscal 2008, operating income wasa $7.2 million increase in depreciation and amortization expense, reflecting continuedcapital investments.

Also included in Q2 operatingincome was $4.8 million of pre-tax costs related to our business process andsystem initiatives, as compared to $11.1 million of costs in the second quarterlast year.

EBITDA for the second quarter offiscal 2008 increased $19.3 million, or 13.8%, to $159.5 million from $140.2million reported last year. EBITDA as a percent of sales increased from 4.31%to 4.68% in the second quarter of fiscal 2008.

Sobeys invested $114.9 million inproperty and equipment purchases in the second quarter of fiscal 2008, anincrease of $20.1 million from last year.

During the quarter, 26 corporateand franchise stores were opened, acquired, or relocated compared to 40corporate or franchise stores opened or relocated during the second quarter oflast year. And additional six stores were expanded during the quarter comparedto four stores expanded during the second quarter of fiscal 2007. 19 storeswere closed during the second quarter of this year compared to nine in thesecond quarter last year. There were 13 stores rebannered in the second quarterof this year compared to 15 stores in the second quarter last year.

As previously announced duringthe first quarter, and as Paul mentioned, we completed the purchase of Thrifty,a very well respected British Columbia food retailer. The similarities betweenSobeys and Thrifty Foods were clear to us, as we were looking at theacquisition: unwavering focus on food, dedicated employees, a great serviceculture and very strong values, including a strong commitment to theirindividual communities.

This acquisition provides Sobeyswith a presence in the expanding BC market and a base for continued growth inthat province. I had an opportunity to visit the Thrifty's operations on anumber of occasions before and since the acquisition, and I am pleased toreport the transition is right on track.

I would like to conclude myremarks with acknowledgment that competition coast-to-coast, but particularlyin Ontario,is intense. Our sales and earnings results have been and will continue to beimpacted by our unwavering commitment to sustaining the harder end pricecompetitive position that we invest in to achieve over the past three or fouryears and our ability to consistently improve our offering, service,productivity and execution store-by-store.

In spite of some persistentchallenges and in spite of some rather radical competitive activity, wecontinue to make progress as we've already said we would to build a healthy andsustainable retail food business and infrastructure in the long term.

We'll now conclude with PaulSobey's remarks.

Paul Sobey

Thanks, Bill. So, second quarteris off to a good start and for the first half of the fiscal '08 with improvedearnings performance to plan and last year. Going forward with respect to ourfood division, Sobeys, we remain very supportive of Sobeys food-focusedstrategy and their intention to continue to invest in infrastructure andproductivity improvements necessary to build a healthy and sustainable retailbusiness for the long term.

With respect to real estate, themanagement group intends to continue with policy of maximizing and prudentlyreinvesting its cash flow to further strengthen and develop its portfolio ofresidential and commercial properties.

And in summary, Empire'smanagement remains committed to executing operationally and capital allocationdecisions that will grow the company's earnings, cash flow and net asset valuesin each of our businesses over the long term.

In closing, I would like to thankour dedicated and outstanding employees, franchisees and affiliates of the EmpireGroup of Companies who have stayed focus on our plan and have deliveredresults. It's their continuing dedication and ongoing commitment to serving ourcustomers day-in and day-out more than anything else that will sustain oursuccess.

Now, we'll have to respond yourquestions.

Paul Beesley

We will be happy to takequestions at this point. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions). Thefirst question comes from Jim Durran from National Bank Financial. Please goahead.

Jim Durran - National Bank Financial

Yes, a question for Bill. Justwondering: if you could give us some idea of what kind of changes you've seenin the pricing environment across the country?

Bill McEwan

Well, they haven't beeninsignificant, but I would start by saying that the changes in the pricingenvironment have been significantly more on the promotional side than they haveon the base pricing side, and that goes pretty much coast-to-coast. There hasbeen very, very different and aggressive promotional activity and some of whichwe haven't seen for many years, including what we have chosen to do to buildour own sales base proactively rather than react to what's going on in themarket promotionally.

From the base pricingperspective, clearly, and I think you remember, we took initiatives a couple ofyears ago and as recently as last May in Ontario to significantly improve ourfood pricing position, and perhaps that had some impact on the marketplace aswell.

So, we have taken our ownproactive approach to the pricing and we've, as necessary as individual pricezones have dictated, made adjustments to key staple items and sensitive items,just as we have all the way along.

But I would emphasize that wehaven't seen dramatic regular retail price reductions, because we are takingtwo to three years to get to a position that we thought was more thancompetitive, particularly in our fresh stores. But on the promotional side,there is no question, there has been deflation associated with dramaticincreases in promotional activity coast-to-coast.

Jim Durran - National Bank Financial

And, just based on the commentaryfrom last quarter, I mean: you were suggesting that Ontario was predominantly sort of in thediscount segment competitively. Have you seen any shift in the conventionalsegment this quarter?

And in the West, I know you hadproactively moved earlier on pricing in the West in anticipation of someincreased competitive activity. Have you seen the competitors come into themarket now and respond in the West?

Bill McEwan

I can't even begin to imagine ifthey have responded to us or not, but there clearly has been more promotionalactivity in the West than there was when we last talked a quarter ago. Thatwould be the same for Ontarioin both, what we call: “the fresh channels” and “the discount channels”.

And in Atlantic Canada, there isno question about it. There's been additional intense activity. Much of that weanticipated, some we did not, but our numbers reflect the net result of what weplan to do and what we needed to do to see competitively keep the momentum up.

James Durran - National Bank Financial

And with respect to your same-storesales, when I look at the 2.3% this quarter versus your number last quarter, isthe contraction mostly a reduction in inflation rate in the industry or isthere a traffic change?

Bill McEwan

No. It's mostly the reduction ofthe inflation rate. Quiet frankly, the 1% that we quoted in our press releaserelates to base price inflation based on cost of goods. In net terms, allthings considered, even with the change in the Canadian dollar, there has beendeflation across the board.

James Durran - National Bank Financial

Okay, and then my last questionand then let's somebody else take over. Both of the competitors have talkedabout significant deflation on produce mostly driven by the Canadian dollar.What kind of impact might have that had on your comp-store sales number for thequarter?

Bill McEwan

It had a negative impact oncomp-store sales as a result, but frankly, because in two of our threeoperating regions, we had already enacted a competitive pricing program thatwould have benefited from the strength of the Canadian dollar. I don't think ithad a negative impact on us. We already took the hit in prior quarters, becausewe took the prices down at the beginning of the year.

James Durran - National Bank Financial

Great. Thanks, Bill.

Bill McEwan

Okay.

Operator

The next question comes from RyanBalgopal from Scotia Capital. Please go ahead.

Ryan Balgopal - Scotia Capital

Hello. Thanks. Good afternoon. Iwas wondering that your EBITDA margins were up roughly 30 basis points. Frank,if you can just talk about: how much of that came from SG&A savings fromall the business process initiatives that you have done? And: what's going onin gross margins? Sounds like they're probably down, but: can you give us somemore color on that?

Frank Sobey

I won't quantify the specificareas, but I will tell you that our SG&A is down as planned, that ourEBITDA margins have benefited from improved mix associated with merchandisingactivity. It is also benefited from the improved mix as a result of lower percentageof tobacco in wholesale sales, as wholesale street sales begin to decline, thatwas lower margin business.

So, the arithmetic just pushesthe EBITDA margins up. But on top of that, it's the sum total of everythingwe've said we would do. Cost reduction, SG&A, margin improvements throughmix, the wholesale mix adjustments and I think there was one other component,that I'm missing but, it's the sum total there and we've talked about it allthe way along.

Ryan Balgopal - Scotia Capital

So, on the gross margin with thesum total still be positive then?

Frank Sobey

On the gross margin with the sumtotal still to be positive, versus what?

Ryan Balgopal - Scotia Capital

Well, I was just looking at,promotional activity as it makes it a tough comparison, but you're gettingmixed benefits et cetera.

Frank Sobey

The only thing that I would backthat you have to say is arithmetic, or extraordinary would be the wholesalemix. Thus the wholesale mix, if you just take a low margin business and itdeclines or is eliminated, your numbers adjust accordingly. But net of thatadjustment, our margins were up across the board.

Ryan Balgopal - Scotia Capital

Okay. Now, is that tobaccoimpacts -- is that the last quarter we should see impact from Imperial tobacco?

Frank Sobey

It's the last quarter we intendto talk about it.

Ryan Balgopal - Scotia Capital

Okay. I was wondering if you canupdate us on your plans for Quebecand putting SAP in there. I think at the beginning of the year, you weretalking about business process costs of sort $27 million to $32 million. Halfway through the year, we are at about $10 million, and I know Quebec was sort of put on a hold. I amwondering: if you can give us an update there?

Bill McEwan

That wasn't really put on hold.Let me explain what we've done. It's a good question. Our EBITDA reflects lowerspending in transformation cost as well, slightly lower spending, but about thesame as last quarter.

What we chose to do through thecourse of the last two quarters is reflect on the successful implementations,and I underlined that we are successful, first of all, in Atlantic years ago,but recently in Ontario, and most recently in the West. And we chose to saybefore we raise on to complete the execution in Quebec, let's at least reflect on thecontinuous improvements, the changed management makes sure the process isworking.

So, we diverted our efforts toour current installations, make sure that we don't just think we've installedit and off we go. You got to work the system as the change management fails inthese transformations and we recognized that. So, we are reflecting how muchmore of that we need do before we make a final determination on the pace atwhich we'll go forward in Quebecand I think we'll be in a much better position to finalize that with you bynext quarter.

Ryan Balgopal - Scotia Capital

Okay. So, we can't really get asense of what the full annual cost will be?

Paul Beesley

I would suggest you that our fullannual cost well for the back half will approximate the first half.

Ryan Balgopal - Scotia Capital

Okay. Maybe more on the Empirelevel, wondering there is no mentioned in the press release about Sobey LeasedProperties. Last quarter you had talked about potentially vending that into Crombie.I thought there was nothing there and I noticed that Sobeys took on another$100 million in debt. Just wondering, sort of: how you plan on repaying thedebt that you talked about?

Paul Sobey

Are you referring to the extradebt associated with the Thrifty acquisition?

Ryan Balgopal - Scotia Capital

Yeah, I guess, that's part of it.

Paul Sobey

Okay, all right. With respect tothe Sobey Leased Properties, I think, the last time when we talked on thephone, I said we'll provide you with an update as things developed. And wecontinue to say that we're going to do that, certainly we're having thediscussions and they are ongoing and we'll be in a position to provide moreinformation when it becomes earn.

Ryan Balgopal - Scotia Capital

Okay.

Paul Sobey

That's a quick way of saying:“not yet”.

Ryan Balgopal - Scotia Capital

Okay. Fair enough. And maybe, I'msorry, I missed it Bill. Just: what was the actual rate of inflation in thequarter?

Bill McEwan

We said that the base pricinginflation was approximately 1%, but please understand there was net deflation,net of all promotional activity across the country.

Ryan Balgopal - Scotia Capital

Okay. Can you give us some sortof sense of how deflationary it was?

Bill McEwan

No, it's just negative.

Ryan Balgopal - Scotia Capital

Okay. All right. Thanks.

Operator

The next question comes fromDavid Hartley from BMO Capital Markets. Please go ahead.

David Hartley - BMO Capital Markets

Good afternoon, everyone. Firstof all, I have been in your IGA stores in Quebec and they are fantastic stores. I'mjust curious about: the level of profitability that these stores generate atthis point in time? And: maybe you can give me some kind of general coloroutlook as to what you see them doing over time?

Bill McEwan

Well, I'd say this we don'tsegment divisional or regional results, either by banner or by piece ofgeography. But thank you for your comments on the IGA stores. They run verygood stores and, on behalf of the franchisees, they run them and the team thatsupport them, we appreciate that comment. But we are satisfied with ourbusiness in Quebec.For part of our business in Quebec,we think we operate superior food stores at solid profitability both for ourcompany and our franchise affiliates.

David Hartley - BMO Capital Markets

Okay. And could you talk to me alittle bit, you made a comment about margins being up, net of the tobacco: areyou talking about EBITDA margin or gross profit margin?

Bill McEwan

Well, gross margins, both benefitfrom the change in the mix, yes. And when you've got a low margin business liketobacco and it's not just tobacco because we've rationalized some low profitwholesale business. So, between the wholesale street business, that we nolonger have, that we've rationalized and the low margin tobacco business thathas eroded, that has a positive impact on margins and EBITDA.

David Hartley - BMO Capital Markets

But, if you take that positiveimpact out: were both gross profit and EBITDA margins up in the quarter?

Bill McEwan

Yes.

David Hartley - BMO Capital Markets

Okay. And in terms of yourrevenue lift, you talked about your exposure to some of the promotional andbase pricing in the country. Are you talking about it more in relation to howyou are exposed? Meaning that: you'll have a higher percentage of your salescoming out of conventional or fresh stores relative to some of yourcompetition? Does that kind of skew your numbers a little bit?

Bill McEwan

No, that's not the way it works.I don't think I used the word: “exposure”. I was asked the question aboutcompetitive activity across the country. And we intend to say competitive onbase pricing and promotional activity, but we need to continue to draw ourcustomers into our stores with competitive promotional activity and to theextent that others hiding their promotional activity or increase thepromotional weights, we found it necessary to look at our plans and on ourterms with our strategy, going forward with some additional weight in ourpromotional programs as well.

So it's not about impact fromothers. It's about the general environment and: how we compete? And: what wechoose to do? And: how we choose to invest? So the second part of your questionis: there isn't that kind of channel switching associated with where promotionsare going on a week-to-week basis. I won't say there is none, but there hasbeen aggressive activity in both the discount channel where it exists and thefresh channel across the country.

David Hartley - BMO Capital Markets

Okay. And in terms of your basepricing: have you seen it come down in discount and up in conventional in thequarter?

Bill McEwan

Absolutely not.

David Hartley - BMO Capital Markets

Could you characterize your basepricing and your promotional investments in the two channels in the quarter?

Bill McEwan

I'll tell you what they are? Weare competitive on price, in fact on base price and promotional activity in thediscount channel, and we have been more than competitive across the board wherewe compete with our fresh format stores. And that isn't a recent phenomenon.That's what I tried to refer to in my remarks on the call.

We worked hard to get into aposition, anticipating what has happened in terms of aggressive retail pricingactivity promotionally and on the base pricing side. So we've put ourselves inplay proactively for the situation that has unfolded.

Has there been some modificationsince? Yes, there has. We've had to modify some prices in some areas across thecountry. But I think it would be misleading to suggest and inaccurate tosuggest that we've had a cascading of retail prices in the past quarter or two.

David Hartley - BMO Capital Markets

Okay. And going forward: was Loblaw'sannouncement that they are going to take down pricing in conventional? Have youanticipated that already?

Bill McEwan

Our job is to anticipate. So,irrespective of what their strategy is, we have ours, and we will price ourproduct and our services fairly in a way that attracts and can sustain ourloyalty with our customers.

David Hartley - BMO Capital Markets

Okay. Just in terms of Thrifty,where do you think over time you'll get the greatest lift from this operationin terms of the return on investment you've made here? How much opportunity doyou see in terms of putting this business together on the distribution orprocurement side relative to, say, on the sales side?

Bill McEwan

Well, these are obviously not thesame kind of synergies if Thrifty's were in a continuous piece of geographywith one of our operating regions. That, in fact, what makes it special, makesit successful. They operate very good stores. They're productive stores with avery low customer base on Vancouver Island andimproving performance on the mainland stores.

So, I'm not sure what you aresaying. We intend to continue to develop inside the four walls of those stores,continue to develop in emerging market on the island and look at otheropportunities in the lower mainland. And our net effort will be to investwisely for a solid return on capital.

David Hartley - BMO Capital Markets

I guess what I am asking is, isthere opportunity here to merge some distribution centers together, get someprocurement savings, and have you identified these numbers and are you willingto share anything like that over time with us?

Bill McEwan

No. We are looking atdistribution in the 50s of itself. We do not see any significant operationaldistribution synergies across the Rocky's. And we don't have any distributionfacilities west of the Rocky's and it is a very solid physical barrier fordistribution. So, there isn't a lot of overlap to our network today. So, thereis not a lot of synergies there.

David Hartley - BMO Capital Markets

Okay. That's good. And if I mayask a last question here, in terms of your real estate business overall: isthere any outlook you can provide and what you are seeing in the marketplacetoday, both from a residential and commercial perspective in terms of thegrowth that you might expect to see? And: what's happening around you in theenvironment there?

Frank Sobey

Frank Sobey, answering.

David Hartley - BMO Capital Markets

Okay.

Frank Sobey

What we have notice is, there hasbeen a bit of a beginning of a slowdown particularly in the West not so much inOntario. Thereason that takes a bit of a slow down, we have not experienced the rate ofgrowth that the USdid or the lending [excesses]. So, we've noticed the rate of growth has sloweddown as opposed to something else.

David Hartley - BMO Capital Markets

Okay. And so, when we think aboutmodeling out your real estate business, it tends to be very lumpy. Can youmaybe characterize the lumpiness, and the type of growth you would expect tosee in the back half of the year?

Frank Sobey

We have historically not donethat. You guys are on your feet, I guess, I don't know.

Paul Beesley

It's pretty hard to predictcertainly on the residential side. We certainly have our own internal thoughtson that. But we've said that the residential area, is an area we have beenrolling for the last five years. So that it can't continue at that same pace.Year-to-date, we had outstanding results in the residential. I think the lastpart of the year should be, let's say, very solid, but certainly not at thepace that we've experienced in the past.

On the commercial side,commercial properties are really basically, the Sobey Leased Properties side ofthe equation, which should be very stable, given the nature of that type ofinvestments at this point in time. And the development side is lumpy. It's justthe nature of the development activity and it depends on permits, it depends ona whole bunch of actors. So, it will be lumpy.

But we are shifting ouroperations in our real estate side equation outside of Genstar. They are beingshifted more to the development side of the equation. And what we are doing is,is really developing real estate, but for our own use quite frankly, as theretailer side of the equation. And we are providing that opportunity topurchase those assets through Crombie REIT. So, the nature of our real estateholdings is changing and will continue to change over time consistent with whatwe have said our objective is.

David Hartley - BMO Capital Markets

So: you are making a bet that youactually will be more right in the next five years?

Paul Beesley

I don't understand the question.

David Hartley - BMO Capital Markets

I'm just joking with you. Ididn't mean it. How about I'll leave it at that, and thank you very much.

Paul Beesley

Okay. Thank you, David.

Operator

Your next question comes fromKeith Howlett from Desjardin Securities. Please go ahead.

Keith Howlett - Desjardin Securities

Yes. I wondered: if you couldupdate us on the compliments program and especially heading into the holidays?Where are you right on that program?

Bill McEwan

We're very pleased with thedevelopment of our Compliments program. This year, we have introduced just over200 additional SKUs. I am very proud of our Inspired program which is thecommunication around the holiday season. We have three Inspired magazines peryear. We are satisfied with the growth category-by-category, not in every case,but the vast majority of the Compliments.

The extended line programs of Devon and the Organic and Disney Junior which we launchedin September are exciting real innovations that have done well, and they justcontinues to build. So, if I look back over the last three years, I quitefrankly not sure, I would have anticipated being as solid as we are with thatprogram and as well develop as we are. So, we are very pleased with where it'sheaded and the consumer reaction.

Keith Howlett - Desjardins Securities

And then, I had a question on theRachelle-Bery boutiques, you have in Quebec.I was just wondering: how far you will go with that, that something you willbring to other geographies?

Bill McEwan

I don't know, we are learning,we've got a great innovative team there that has done some great work with Rachelle-Beryand the Natriga concept inside the four walls of our IGA Extra stores, which isa small unit bolted on to our IGA Extra stores. We relocated a Rachelle-Bery[seller on street] that we're very satisfied with the early results. And itslaboratory, we think we're ahead of the curve, we think it's a trend, aconsumer trend that we can learn from in Quebecand should there be applications elsewhere or elsewhere in Quebec or elsewhere in the country, we'vegot something pretty much ready to go. But it's too early to give you anyindication where that might be because we continue to learn.

Keith Howlett - Desjardins Securities

And just on the Sobeys express, Iknow it's a very tiny part of the business, but what are your thoughts thereon: how that might unfold?

Bill McEwan

We will continue to look foropportunities to serve customers in any part of this country and to the extentthat as an example urban Toronto,where you know that we have a number of urban express already, and we don'tintent to stop where opportunity avails itself. We'll go one at a time, onelocation at a time and we see a future for it.

Keith Howlett - Desjardins Securities

And just had a question, I guess,on the Price Chopper banner you've got quite a lot, I guess, of the mainAtlantic Canada. I'm wondering: so what your thoughts are going forward inAtlantic Canada on the Price Chopper banner?

Bill McEwan

We don't have any specific plansto dramatically expand the Price Chopper banner in Atlantic Canada.

Keith Howlett - Desjardins Securities

And in terms of Ontario, I noticed a few closures of PriceChopper. Is the fleet of stores that you currently have above what you want tohave going forward, or how looks the outlook on Ontario for the Price Chopper?

Bill McEwan

I want to put that in context.Over the last five or six years, we have approximately the same number ofstores today that we had six years ago. We closed about 50 stores to 60 storesa year, it's an ongoing process of renewal of the network. So, I would cautionanybody coming to conclusion as a result of any recent closures of PriceChopper or any other banner that there has been some significant increase inour willingness to close stores. We've done it. We've always done it. We'llcontinue to do it.

The two Price Chopper stores thatyou talk about, actually there were four in the last four months, the two PriceChopper stores you talk about, we've had in our books to close for the last twoto three years. So it's been a plan full network renewal process.

In terms of the Price Chopper,Price Chopper has a consumer following the price, discount segment has aconsumer following and our job is just continue to offer a better and betterstores, improve our execution and put that asset, that price discount store hasthe best chance of success. It's one location at a time, there are discountmarkets and there are full service fresh markets and we have a portfolioformats to satisfy individual occasion and that's the only way I can answerthat for you Keith.

Keith Howlett - Desjardins Securities

And just one last question on,your IGA stores in Quebec seem to have an extremely good refrigerated servehome meal replacement or frozen home meal replacement and sort of prepared homemeal replacement. I am just wondering: why that can't be more developed in Ontario? Or maybe I ammisinterpreting it, but: is there much room in Ontario to sort of go that way?

Paul Sobey

Yes, there is. It has to do withthe type of production facilities and the capacities of a variety of differentproducts that are available in Quebecthat aren't just developed in other parts of the country. But stay tuned. Youcan look forward to additional development of that type of product across ournetwork in the country outside Quebec.

Keith Howlett - Desjardins Securities

Thanks very much.

Operator

(Operator Instructions). Next isa follow-up question from Jim Durran from National Bank Financial. Please goahead.

Jim Durran - National Bank Financial

Yes, I am just wondering on your squarefootage growth: can you tell us what your square footage growth was excludingthe Thrifty's business addition?

Bill McEwan

1.1%.

Jim Durran - National Bank Financial

And: how does that line up withwhat your plans are for the balance of the year?

Bill McEwan

The plans for the balance of theyear for square footage growth, Jim, I don't have that number in my head, but Ithink it'll be approximately at the same pace of increase and rationalization.

Jim Durran - National Bank Financial

So: is there any change to yourplanned CapEx spend?

Paul Sobey

We've reduced our CapEx modestly.Francois, why don't you --?

Francois Vimard

Yes, what we've said is that theplanned CapEx what you'll see are going to be on the balance sheet around $500million, which is about the same pace we had the previous years, a bit morethan we had in the previous year, but a bit little lower than our overallforecast for this year.

Jim Durran - National Bank Financial

Right. And would that 1.1% belower than what you might have been planning going into the year, I think thatseems in my recall?

Francois Vimard

Some of that is planning forsure, but the reduction of the [capital], so realign some of that capital whereit needs.

Jim Durran - National Bank Financial

Okay. And the $500 million, thatincludes the acquisition of Thrifty's?

Francois Vimard

No.

Jim Durran - National Bank Financial

Okay.

Paul Sobey

It's separate from Thrifty.

Jim Durran - National Bank Financial

Okay. On your SG&A,wondering: when you talk about you're down year-over-year on SG&A? Are youexcluding the business initiative costs or is that including it?

Paul Beesley

Excluding the business initiativecosts, we'd be down, because our business initiative costs are down and theirSG&A ex-business initiative costs are down.

Paul Sobey

Yes.

Jim Durran - National Bank Financial

Okay. Thanks a lot now.

(Multiple Speakers)

Jim Durran - National Bank Financial

And last question just you weretalking about some of the things that are contributing to margin improvement.This one of the ones that maybe was missed out was that Thrifty's has a highermargin than some of your business?

Bill McEwan

Perhaps modestly, but it wasn'tfor the full quarter. And it's a significant business, a special business, butit wouldn't have a material impact on the margin mix.

Jim Durran - National Bank Financial

Okay. Thanks, Bill.

Bill McEwan

Okay.

Operator

The next question comes from RyanBalgopal from Scotia Capital. Please go ahead.

Ryan Balgopal - Scotia Capital

Yes, I just wanted to follow upon the CapEx spend. The $500 million I am assuming is just Sobeys. I amwondering: what the total Empire on balance sheet CapEx program would be forthe year?

Stewart Mahoney

Ryan, its Stewart here. We wouldadd some dollars for Empire Theatres and some for real estate, but it wouldn'tbe material. We don't disclose on the theatre side specifically. But realestate, we did build in a budgeted amount there for land acquisitions.

Paul Sobey

Some older assets that we have aswell, Ryan. I mean there is a going to be churn in those numbers of the Empirelevel now.

Stewart Mahoney

That's modest.

Paul Sobey

That'll be modest.

Ryan Balgopal - Scotia Capital

I guess I thought if you weredoing lot of development, there would be some significant capital there.

Paul Sobey

Yes, we've already spent somecapital at the Empire level, but we are also selling assets at the same time.So, I mean, it's in and it's out.

Ryan Balgopal - Scotia Capital

Okay.

Paul Sobey

Year-to-date is $40 million, Imean if you were to pick a number that props the same rate. I think that'sprobably a safe assumption.

Ryan Balgopal - Scotia Capital

Okay. Thank you, Paul.

Operator

The next question comes fromDavid Hartley from BMO Capital Markets. Please go ahead.

David Hartley - BMO Capital Markets

Hi. Just one last question on theCapEx: is that your CapEx at the Sobey level or does that include thefranchisees?

Bill McEwan

I recall I talked about ourbalance sheet.

David Hartley - BMO Capital Markets

Your balance sheet, okay. Just onthe inventories, just a slight increase in inventories, as a percentage ofsales: anything to read into that? Are you seeing anything changed at thatlevel?

Bill McEwan

Well, the big piece is Thrifty,David.

David Hartley - BMO Capital Markets

Okay. Alright. And: what's yoursquare footage overall right now?

Bill McEwan

27 -- we will just look it up, weare not going to go. Okay. We are running at a 25, 26 level with (inaudible)net of closures. Sorry, David, I'll get back tomorrow.

David Hartley - BMO Capital Markets

Thank you all. I'll sign off.That's my question.

Bill McEwan

We'll get it to you.

Frank Sobey

Its 27.1 million square feet.

David Hartley - BMO Capital Markets

27 point, sorry?

Frank Sobey

Thank you.

David Hartley - BMO Capital Markets

Okay. Thank you. That's it forme.

Operator

Your next question comes from JimDurran from National Bank Financial. Please go ahead.

Jim Durran - National Bank Financial

I was actually going to giveDavid the number out of the press release.

Paul Sobey

We will refer it with you too,yeah.

Jim Durran - National Bank Financial

Sorry, David. Bill, I guess,we're into the all important fourth quarter now, and I know you don't provideforward commentary, but do you see any significant increase in competitiveactivity in fourth quarter compared to what you saw in third quarter?

Bill McEwan

Well, yeah, first of all, I knowyou're talking about calendar fourth quarter, we're in our third quarter.

Jim Durran - National Bank Financial

Yeah, sorry.

Bill McEwan

That's okay. But, yeah there hasbeen some significant increase in competitive activity continue at evenincreased levels through this quarter. Yes is the answer.

Jim Durran - National Bank Financial

And I know you have changed theadjective you are using to describe the pricing activity out there. I thinkwe've gone from irrational to radical. I'm trying to understand: is there acertain type of promotional structure that's in place that you feel has gonefurther or is it just the present discount? What is it that's going on outthere in your mind?

Bill McEwan

I would just call it unusual andunfamiliar. And I don't really want to comment on other competitors. It is verydifferent from what we've seen in prior years and it's quite deep in itsnature. It's radical in its approach and that's all I'm really prepared to say.

Jim Durran - National Bank Financial

Sure. I know you don't talk aboutcompetitors. But within this equation: how much of a factor are the supercentersfrom Wal-Mart?

Bill McEwan

They have more square footage,they are factored. But I won't comment specifically on what impact I think theydo or don't have. But fairly more square footage of any kind and prices thatare competitive is the factor.

Jim Durran - National Bank Financial

Okay. Thank you.

Operator

Mr. Beesley,there are no further questions at this time. Please continue.

Paul Beesley

Thank you very much, Gloria.Ladies and gentlemen, we appreciate your continued interest in Empire and lookforward to having you join us on our third quarter call scheduled for March,11. Bye-bye.

Operator

Ladies and gentlemen, this concludesthe conference call for today. Thank you for participating. Please disconnectyour lines.

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