Empire Company Limited

Good afternoon, ladies and gentlemen, and welcome to the EMPIRE second quarter 2024 conference call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you need assistance, please press star zero for the operator. This call is being recorded on Thursday, December 14, 2023. I would now like to turn the conference over to Katie Brine. Please go ahead.

Thank you, Joanne. Good afternoon and thank you all for joining us for our second quarter conference call. Today we will provide summary comments on our results and then open the line for questions. This call is being recorded and the audio recording will be available on the company's website at empireco.ca. There is a short summary document outlining the points of our quarter available on our website. Joining me on the call this afternoon are Michael Medline, President and Chief Executive Officer, Matt Rundell, Chief Financial Officer, Pierre St. Laurent, Chief Operating Officer, and Doug Nathanson, Chief Development Officer and General Counsel. Today's discussion includes forward-looking statements. We caution that such statements are based on management's assumptions and beliefs and are subject to uncertainties and other factors that could cause actual results to differ materially. I refer you to our news release and MD&A for more information on these assumptions and factors. I will now turn the call over to Michael Medline.

Thanks, Katie. Good afternoon, everyone. I will start today by saying that on the surface, our Q2 results don't appear as strong as Q1. And it's true, they're not at that level. But when we unpack everything, as Matt, Pierre, and I have done over the last number of weeks, we don't think they're much worse. Let me tell you why. First, in late August, we began to see some customers retrench. We believe as a result of higher interest rates biting and overall economic uncertainty. This retrenchment wasn't major, but it did appear to occur quite suddenly. Second, Q1 fiscal 24 had easier year-over-year comparisons than Q2, resulting in a lower same-store sales this quarter. Third, we did see margins contract a little more than forecasted due to higher promotional penetration of the flyer items. Although, I must emphasize, promotional intensity at our banners did not change. with customers also purchasing more own brand products and trading down to less expensive alternatives. Fourth, we saw slightly higher shrink numbers, primarily due to rising theft. And fifth, there were a lot of puts and takes this quarter that will break down. All this said, we don't think we did anything differently or executed less sharply this quarter. And while the macro environment continues to be challenging, there's a lot of momentum in our business, which you'll see as we unpack these results. Five weeks into Q3, we are seeing increased sales momentum, higher than Q2, but not as high as Q1. And we are optimistic this trend will continue as consumers start to regain confidence. And we're in a much better position than we were last year. We're also well positioned as food inflation continues to decelerate and interest rates move past their peak. I'm going to focus on three topics today. Our Q2 results and key market trends. a brief update on our plans to help further stabilize food prices in Canada, and an update on our strategic priorities, including the progress we are making to optimize costs and enhance store and customer experience. First, our results and market trends. We were pleased to see CPI's food inflation continuous downward trend this quarter, reaching its lowest level in 22 months at 5.4% in October. Our internal inflation remains slightly below CPI in Q2, as it has been since this period of high inflation began, and it's maintained its downward trajectory. In this environment, providing value to Canadians and helping further stabilize food prices is a top priority for Empire. Earlier this month, I appeared before the Agriculture Committee to discuss food inflation, and we have been cooperative with Minister Champagne's office over the last several months, including by submitting detailed plans for how Empire will play a role in helping to further stabilize food prices. I can assure you, we are already doing a lot for our day-to-day business, and we have now taken further actions to help Canadians with the ultimate objective of narrowing the gap between CPI and food inflation. However, and as I've said before, and as I've said to our supplier partners, I've got to emphasize that all key players in the food supply chain have a role to play in stabilizing food prices, not only grocery retailers. While we are seeing inflation decelerate, we're in a unique time where we have inflation, and on top of prior periods of high inflation, and this requires a different approach. Canadian consumers cannot afford more inflation. As an industry, we need to look at every single way we can minimize price increases, and this has to be done in close collaboration with our supplier partners. While the vast majority of cost increases requested by suppliers over the past couple of years have been justifiable and fair, we are now seeing more than a few of our large supplier partners send through cost increase requests for February, and some of them are distressing. They just can't be justified. Inflationary times are not an excuse to pass every single rising cost on to grocers, and more importantly, to Canadians. This was not the way business was conducted before these inflationary times. We have instructed our national sourcing team to be even tougher on this latest round of cost increase requests. We will not take unfair cost increases and pass them on to Canadians. It's not the right thing to do. And if that results in a few holes in our shells, we believe the Canadians will more than understand. Again, this is not an indictment of all our supplier partners. I am referring to several big multinational CPGs. And as I've said many times, our federal government has a huge role to play in taking out costs that have accelerated food inflation. As a company, we will be pursuing new solutions to help mitigate inflation. One way that we can keep costs down is through our own brands portfolio, where we have greater visibility and control over prices than with national brands. As we and others have said for several quarters, private label products are in high demand and will give even more space to our own brand products if it will help us maintain lower prices on shelves. Turning to our results, I believe that our business continued to perform well in Q2, as I said. It was a bit of a messy quarter to analyze given various quarterly puts and takes regarding crumbly REIT and real estate dispositions, the strike at our Vaughan distribution facility, and the sale of our Western Fuel business in Q1. Matt will make sense of all that for you in his remarks in a couple of minutes. All in all, when I look at Q2, I felt that our execution was just as sharp as Q1, but consumer confidence affected our results a little bit. We continue to attract more customers to our stores with higher transaction counts. Our promotions are constantly improving and are attractive to our customers while still protecting our margins. And we continue to see very strong on-shelf availability consistently above the market. Moving to our financials, our sales excluding fuel grew by 2.4% this quarter, with same-store sales of 2%. Both our full service and discount banners outperformed the market in their respective channels, and voila, grew sales over 15% in the quarter. We also maintained stable gross margins, despite increased promotional penetration and supply chain challenges due to the Vaughan RSC strike. We're pleased with how we continue to protect and grow the fundamentals of the business, regardless of the macro environment, and we are optimistic that we will pick up momentum as inflation eases. Overall, we delivered an adjusted EPS of 71 cents this quarter. On to an update of our strategic priorities. When we announced our long-term goal to grow adjusted earnings per share by 8% to 11%, one of the key pillars to achieve this ambition was focused on efficiency and cost control. While Empire is out of its transformation era, we still see many areas to be more efficient, and we've begun simplifying and taking a back-to-basics approach with all of our core SG&A activities. We are doing this across several initiatives that are tried and true at Empire. We're good at this. We've done it before. While I'm not going to share with you the full extent of these efforts, we felt it would be helpful to give you some insight into where we are focusing. As we announced last quarter, we have begun making organizational changes to optimize our structure and reduce costs. A refresh of what we did in Sunrise, but on a smaller scale. Almost 70 years have passed, and we are a very different company now. We have advanced data and analytics capabilities, new strategic assets in our portfolio, and a much stronger team. Before, the focus was on fixing what was broken. Now, the focus is on supporting our go-forward strategy to drive growth in the core. This isn't just about cutting. The team is being very strategic and is also looking at what we can bring in-house to do better and more efficiently. You will see severances in our financial adjustments this quarter and through to the end of fiscal 24. These costs will be substantially completed by the end of fiscal 24 as we progress this effort. Another area where we are pursuing cost efficiencies is within goods not for resale, or as I often call it, non-merch procurement. This is an area where we had great success during Project Sunrise and are again seeing opportunity to optimize by leveraging our national buying scale and working with suppliers to simplify our assortment and reduce rates. As one example, during COVID, we saw the prices of vinyl gloves, which many of our teammates in store have to wear, rise significantly. Through this initiative, we have been all able to negotiate with suppliers to lower our rates, generating over half a million dollars of savings from this one item. We have done this in many other places too, such as with paper bags, deli bags, and product containers. In our supply chain team, we have developed new capabilities to simplify our operations and streamline our engagement with carrier partners. We are laser-focused on this simple yet effective back-to-basics approach to ensure we are getting the best costs from our suppliers so we can offer more value to our customers. There are just a few initiatives of many that we are pursuing. but are areas where we are confident we will generate savings. We've done it well before and know we can do it again. Now for an update on some of our key customer and sales driving initiatives. Regarding our space productivity program, we've successfully completed all pilots for the first phase of this project, which allows us to deploy optimized category planograms by banner and region based on our algorithms. We are very pleased with the actual results from the pilots are there as good or in some categories even better than the algorithm's predictions. Seeing the success from the pilots, we have now rapidly begun rolling out new planograms category by category across our stores, and going forward, the majority of new planograms we roll out will be based on this new technology. There are over 100 distinct grocery planograms being executed in fiscal 24 across our banners, with over 80% completed as of today. Now that the first phase is near completion, we are turning our focus to the second phase, which allows us to optimize the total non-fresh space within each store. We have conducted several in-store phase two space pilots over the last few months and are on track to start the deployment to stores with the highest returns within this fiscal year. Benefits will begin to ramp up the second half of fiscal 24 with meaningful benefits expected into fiscal 25 and fiscal 26. ScenePlus also continues to progress this quarter, outperforming our Q2 targets with strong new member growth, increasing on-card sales penetration, and significantly higher active loyalty members than we had before. Program awareness and member satisfaction have all increased significantly with Empire customers since launch. Through our partnership with Scotiabank, we have been able to drive new customers into our stores, and we have seen a 400 basis point increase and Empire's share of grocery spend on Scotiabank credit cards since launch. We continue to pursue opportunities to leverage this outstanding loyalty program and work closely with our partners to provide even more value and benefits to our customers. Lastly, we saw strong momentum from Voila this quarter, in particular CFC3, which launched in Calgary in June, has been gaining momentum week over week. Customers who were previously using curbside pickup are moving to home delivery as we anticipated, and we see strong basket sizes and net promoter scores across each CFC. So while there was a lot of noise in this quarter, we continue to experience economic headwinds. The fundamentals of our business remain strong, and we delivered solid results. We have a clear strategy to deliver against, and our team continues to execute with focus and precision. And with that, let's turn it over to Matt.

Thank you, Michael. Good afternoon, everyone. I will provide additional color on our Q2 results, our expectations going forward, and then we'll move to your questions. First, let me take some time to break down our adjusted EPS. Our quarterly results were harder to follow than normal due to the impact of our real estate transactions, both this year and last, the born distribution center strike, and the sale of our Western fuel business. Our adjusted EPS was 71 cents compared to 73 cents last year. There are three reconciling items that need to be considered which essentially offset each other. First, real estate. This year we benefited from gains on lease modifications whereas last year we benefited from unusually high income related to Crombie REITs property sales. This year gains were slightly higher than last year and as such our adjusted EPS benefited by approximately two cents. Then there were two issues that hurt our results. Firstly, we had the impact of the strike in our Vaughan DC. We've incurred some direct costs in Q2 as a result of the strike, along with a temporary loss of sales and margin in the initial first few weeks of the strike. However, through the contingency plans we have in place, the Vaughan DC is now essentially operating at normal levels so we do not expect to have a material financial impact moving forward. Secondly, we had the sale of our Western fuel business at the end of Q1. So Q2 was the first full quarter that these operations were not contributing to our results. So the combination of direct strike costs and the loss of the West fuel business hurt our adjusted EPS by approximately two cents. It's also important to note that our sales temporarily declined in the first few weeks of the strike but our operations are now fully back to normal. I will now dive into the financial performance of the quarter, which can be summarized by one word, resilience. As Michael said earlier, there was some retrenchment from consumers due to interest rates and inflation. We delivered same-store sales, excluding fuel of 2%. Due to inflation levels were sequentially lower, which also contributed to the sequential decline in same-store sales. It's also worth noting that Q2 of last year was our strongest quarter, with same-store sales of 3.1%, so we have some tougher comps to beat. Our gross margin rate, excluding fuel, grew by five basis points versus last year. The slight margin expansion reflected lower distribution costs, primarily driven by efficiency initiatives and supply chain, but partly offset by increased promotional penetration and some margin headwinds related to the Vaughan DC strike. Our gross margin expansion demonstrates the resiliency of our business. Shifting gears to SG&A, SG&A dollars were $81 million higher compared to the same quarter last year, and our rate was 22.6% in Q2, which was 74 basis points higher than last year. Consistent with prior quarters, part of the SG&A rate expansion is due to planned investments in business expansion for banners such as Voila and Farm Boy, as well as investing in new initiatives such as personalization, loyalty, and space productivity. But we also experienced inflationary cost increases in SG&A, including higher retail labor costs driven by normal wage increases plus minimum wage increases. We also had higher depreciation and amortization driven by our focused investments partially offset by some lower utility costs. Now, one way of mitigating these inflationary increases is by focusing on driving efficiency and cost effectiveness throughout our business. This is a key pillar of our financial framework. We have plans in place to manage our cost base and to deliver savings across several key areas. Michael provided details on a few of the cost initiatives we are pursuing, including non-merch procurement, supply chain, and organizational restructuring. Our non-merch procurement team is focused on driving cost efficiencies across a wide range of business areas, including goods not for resale and store services. Our supply chain initiatives will continue to generate cost savings and efficiency across transportation, processes, technology, and automation. And finally, our restructuring program is in place to optimize our organizational structure, much like we implemented in the early days of Sunrise but on a smaller scale. Beyond these areas, we continue to pursue opportunities to increase efficiencies and reduce costs, leveraging our scale, size, and our enhanced digital and analytics capabilities. Our effective tax rate was 22.3% in Q2. The Q2 tax rate was lower than the statutory rate, primarily due to capital items taxed at lower rates and the benefits of some investment tax credits. From a capital allocation perspective, our balance sheet remains solid, as our funded debt at adjusted EBITDA declined to 2.9x from 3.1x last year. In Q2, our CapEx totaled $135 million, mainly spent on investments in store innovations, construction of new stores, investments in advanced analytics, and other technology systems. Fresco stores and Western Canada, and while our CFCs also contributed to the capex. We are on track to hit our fiscal 24 goal of $775 million. And with regard to our share buybacks, we are also on track with our fiscal 24 goal of $400 million. And as of this week, we have repurchased approximately 6.7 million shares for a total consideration of $243 million. Finally, before I hand it back to questions, as in previous quarters, let me take you through the items we excluded from our adjusted results in Q2. Firstly, we excluded cyber insurance recoveries. In Q2, that amounted to $15.2 million after tax, or $0.06 of earnings per share. These are complex claims, and we continue to expect additional recoveries throughout fiscal 24. We excluded expenses associated with our continuing plans to optimize our organization. In Q2, we incurred costs of $12.4 million after-tax or $0.05 of earnings per share. We've incurred $19.5 million of after-tax costs year-to-date and anticipate additional costs throughout the remainder of fiscal 24 related to these restructuring plans. These two adjustments reconcile our reported earnings per share of 72 cents to our adjusted EPS of 71 cents. With that, I want to wish you all a safe and happy holiday. Katie, I'm going to call back to you for your questions.

Thank you, Matt. Joanne, you may open the line for questions at this time.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press the star followed by the one on your touchtone phone. You will hear a three-tone prompt acknowledging your request. If you are using a speakerphone, please lift the handset before pressing any keys. First question comes from George Dumais at Scotiabank. Please go ahead.

Yeah, good afternoon, Michael, Matt, and Pierre. I just wanted to get started on the same-source sales number. I think you called that an improvement, Q3 to date. So just wondering what's driving that. And last quarter, I think you guys were pretty happy with the basket performance. Just wondering how that's performed this quarter. Thanks.

So, actually, Matt, why don't you take it and then send it over to Pierre.

Yes, on same-store sales, we included that disclosure for a specific reason. Because when you look at trends, our Q1 was at 4.1%. Our Q2 is at 2.0. What we didn't want is anyone leaving this quarter thinking our Q3 same-store sales is going to be zero. So our same-store sales is better than Q2. It's not as good as Q1. And there's two drivers behind that. One is the cybersecurity event from last year, which will improve our Q3 same-store sales. It's not a massive number, if you remember last year. We said we had some initial loss of sales at the beginning of the cyber event, but it's not a significant number. So it's small, but it will contribute to it. What we've seen so far and what we hope for the balance of the quarter is just an improved momentum in the performance of the business.

Plus, we continue to see the same trend on transaction count, like Michael said in his script. We continue to have traffic in our store. Our promotion continues to be very efficient, relevant for customer, and with a good balance in managing well our margin. So fundamental remains very strong. I think it's just a like-to-like comparison that we give more color to everybody to understand our numbers.

Okay. And just my last question on gross margins, up five basis points, I think 10x fuel, adjusting for the strike. Matt, I think you mentioned previously an expansion of like 10 to 20 basis points. That's kind of a comfortable range that you want to get into. Should we expect that kind of for Q3 and other quarters? And maybe how long do you think we can expand margins, I guess, in the context of our competitors having some margin compression?

Yeah, look, I mean, we said, I think I said last quarter that the days of these massive increases in gross margin that we've been reporting are basically gone. And we were now at the point where We have a very stable business and some of those big opportunities have now been captured. So on an ongoing basis, 10 to 20 basis points would be a very healthy improvement in gross margin. That is what we will target. I'm not going to commit to anything moving forward. As we know, this is a very challenging environment, but we have enough tailwinds in our projects when you look at supply chain, when you look at space productivity, when you look at the work we're doing on promotions. to continue to improve that margin moving forward, and that's certainly our intention.

Okay, thanks a lot, Pastor.

Thank you. The next question comes from Tammy Chen at BMO Capital Markets. Please go ahead.

Hi, good afternoon. Thanks for the question. I wanted to go back to, Michael, your comments on competitive, sorry, promotional penetration. So I think you said that's that's still up, but the intensity you said in the quarter was stable. Just some of the other retailers recently said it sounded like they're seeing intensity go up a bit. So I just wanted to ask at this point now, are you still seeing that the general intensity is stable? Because I think we're also seeing anecdotally, like on the flyers, it just seems like that the magnitude and number of deals there has increased lately. So we'd be curious to hear a bit more of your thoughts on that area.

No, we don't see major changes in the intensity. Where we see pressure, continuous pressure, is on the penetration. Customers are hunting for deals for obvious reasons. They are buying less expensive products. and they increased their own private label purchases. So I think we can understand that. People are struggling with their budget, and they're trying to get as much as possible with their money. But in terms of intensity, we did not see major changes.

Okay, understood. And on the initiatives with respect to OPEX and the restructuring, are you at a position now to give any insights around what we should expect in terms of improvements on the SG&A once you complete these restructuring initiatives? Thank you.

Thanks, Tammy. I'll take that one. Yeah, well, I mean, we're not going to give specific details on an initiative-by-initiative basis. What I would say is As I said in my prepared notes, you can continue to see severance being recorded through Q3 and Q4. Unlike most cost reduction initiatives, when you're talking about severance, you get the immediate pickup, the immediate savings with those severances. So in our cost reduction initiatives, which are going to be critical to mitigate some of these cost increases that we have, We have a mixture of projects that generate immediate savings and some that are more of a medium-term basis. So we're nicely balanced to take costs out of the organization, but no, we're not going to provide specific numbers on the restructuring.

Okay, thank you.

Thanks, Tommy.

Thank you. The next question comes from Irene Mattel at RBC Capital Markets. Please go ahead.

Good afternoon, everyone. Really interested by your comments around the category resets. Can you give us an idea of what you're doing, the basis of some of the changes that you're making, how consumers are going to see this in store, and sort of what the mix, let's say, of sort of brands versus private label will look like once you're done?

It's a... It's a category that was... During sunrise, now we're talking more about space productivity. We're trying to optimize the sales per square foot into the planogram and in a macro environment of the store. Now we have data and algorithms helping us to maximize sales per square foot. That's what we are doing right now. Like Michael said, we did pilot with very interesting results, very encouraging results on the planogram itself. I think it More than 80% of our planogram have been completed, well integrated with tools, with new tools that the merchandising team working with, and well integrated with our planning with supplier. So when we planning activities for the year, we have to engage supplier into it. So this is well implemented right now, and now we're on deployment phase for that. So we expect same store sales grow through this initiative over time. And so that's the planogram itself. But we're also looking at optimizing the adjustment into the store, the sequencing of gathering to the store. So when we do renovation and when we have identified an opportunity in a few stores, you can see reliance in stores to optimize sales per square foot. So that's basically the project we're working on. It's slightly different than what we did through Category Reset during Sunrise. It's an update, but it's, I would say, a more powerful project with more algorithms and data that we did not have access to during Sunrise.

I'd say, for the most part, we're not disrupting the store or the customer to the degree we had to in Category Reset. Unless we're doing a major renovation or building a new store, we're not moving where customers are accustomed to find the category. So if you want crackers and cookies, you know where to go get crackers and cookies. What you will see are changes in terms of linear feed and in terms of brand sometimes and in terms of own brands where it makes sense. And we've got the algorithms and they're performing, as I said, as well or better in real life than the algorithms. in terms of they'll be boosting sales and maybe some of the other numbers. And it's probably their biggest project in terms of upside as we roll that out. But we're very confident in it, but you don't want to roll out something in the store which affects customers without some testing and piloting, and that's what we've been doing, and we're extremely happy with such testing and piloting.

That's super interesting. Thank you. Sorry, I misspoke. I meant planograms. So if the customer goes into the store, does it look meaningfully different as part of the shift in the planogram, or is it really just very subtle but to deliver the increase in square footage?

It will vary by category. Some category will have extra space. Some other category will have maybe less space to give more space to category that we have more opportunity in terms of sales. In terms of assortment, we're not expecting overall significant changes. We will just optimize what we're already having. We're not expecting less assortment for our customer. But, again, it could be very viable by category. But overall, like Michael said, not very disruptive. And no major changes in that. SKU counts in our stores. By category, that could vary, but total store, we're not expecting big changes in terms of choice for customers.

That's very helpful. Thank you. And just one other question. I was very interested in your commentary around the price increase request from the multinationals. We're hearing it from others, but yet at the same time, what we're hearing from the multinationals is that they're trying to, that they want to focus again on volume. So just trying to kind of reconcile the behavior from the rhetoric and wondering what kind of insights you might be able to provide there.

Yeah, so Pierre and I met with all of our big suppliers and medium-sized suppliers and small ones, what was it, a few weeks ago? Yeah. And we spoke, and then the rest of our team also did a good job, but we let it off by saying, by talking, and I was pretty clear that this is, and I don't want to misstate it, this is not the vast majority of our supplier partners. We have a great relationship, and I believe a lot of them are struggling, first through COVID and then through inflation. It's just very, very tough on their businesses. But what you are seeing, and I even see, I saw something last week when a supplier partner put out a press release, multi- multinational supplier put out a press release saying, hey, we keep increasing prices, we keep making more money. We did not like that. We did not like that one iota. That's not the way it should be. It's very, very bad business in the long run for supplier partners to think they have that kind of elasticity in their pricing. And it's bad practice. What I also said, I'll be perfectly frank with you, I said, before there was high inflation, you wouldn't just pass every increase on. So if you paid your people a few bucks more, you didn't pass it on to us, who you know are going to get the blame for it, and then on to the Canadian consumer. That's not right. That's not good business. That's not what happened before. I think in the short term, some of them believe they can pass this on, that it's completely elastic, will get blamed as grocers, and Canadians suffer. And so we were pretty clear that – and some of them are just ridiculous. Just ridiculous. Like every cost you have, you either should mitigate or you should eat some of it. And you know what? Every time we have a cost increase, we don't pass it on to the customer. We have to find ways to save money, and we've got to eat some of it if we have to. And that's the way you do business. And you find efficiencies in your own business. And I'm not talking about a lot, but I'm talking about some big multinational companies. And we've had discussions with them, and I guess here are some of them, some good discussions. Some, I don't know how this is going to end up, but we're not going to take, we've said all along, we'll take fair price cost increases. We will not take unfair cost increases and pass them on to Canadians. We'll fill it with other goods in our store, including our own brands.

That's very helpful. Thank you.

And if I may, on the positive side, and that's the exception. This is a real switch up here. You're going positive. In Q1, we said that we had one-third of the cost increases we had the prior year. So in Q2, we can say it's one-fifth of what we had last year at the same time. So the pressure on inflation is going down. The example that Michael gave, it's few suppliers that they need to understand that the capacity of customers to pay more is at the limit right now and we need to find different solutions. We're dealing with inflation since two years. It's not good for our industry. It's not good for their product to continue to increase prices and we'll take care of that. But again, the trend is going in the right direction. Less cost increases in numbers and in magnitude than prior year to one-fifth than we had last year in Q2.

Yeah, that's great to say. And also, we also had a discussion. We've got to put more pressure on suppliers where commodities are coming down and costs should be coming down for Canadians. It's not just that people always ask us, well, yeah, it's great. Inflation is slowing, and I think it will dramatically slow. But in cases where it rose because of global tensions or other matters, If those commodity prices are coming down, why are Canadians paying at elevated price still? That's a hard discussion for companies to have, and we're having it right now.

That's great. Thank you. Thank you. The next question comes from Michael Van Eyst from TD Securities. Please go ahead.

Hey, guys. It's Evan in for Mike. My first question is on same-store sales. If I just do the simple math of taking same-store sales, ex-fuel, and less inflation, your same-store tonnage is still negative in around, let's say, 3.5%, 4% range. And this is we're in the third year now of negative growth in that number. So given that comps are easier, Do you expect that to stabilize soon? And maybe you can elaborate a bit on the steps you're taking to stabilize that.

Hi, Evan. Well, maybe Pierre and I will tackle this together. Just first of all, for several years now, we don't talk about tonnage just because historically there's so much noise within the mix within tonnage. So we don't really talk about that. On a macro level basis, though, as we said during this whole period, is our tonnage lower? Yeah, of course, as is the whole industry. So I think that's probably just worth calling out, but is there anything you want to add?

You're exactly right. Right now, I think that the math we did in the past with tonnage, inflation, and same-store sales is no more relevant considering the magnitude of inflation we're having over the last two years, and customer behavior changed a lot, like we said. tonnage is going down in the entire industry. So this map is very difficult and irrelevant to do in my opinion. But again, so we're dealing in the same market and I think we are pleased with our overall performance when we look at every single format individually, like we said earlier. So in discount itself, we're pleased with our performance. We're growing our share into discount market. Same thing in the full service. So we're pleased with the fundamentals. It's where we remain extremely confident going forward. We're making progress. We have a strong plan, and we believe that the same-source sales will continue to improve.

Okay, great. Thanks. And then just on discount, it seems like the trend to discount is still very much there, but your discount exposure hasn't been increasing very much. Are you still planning to convert your targeted 25% of stores in the West? And what's preventing you from re-accelerating that conversion rate?

So a couple of things there. So yes, simple answer to your question is absolutely. We still have some plans to go in the West to continue that conversion. So we still have some scope to increase. Just again, I always do this, but just to clarify, when we talk about this trade down to discount, it's not necessarily trade down to a discount shop. Our customers are still in our store. We still have very strong customer numbers. In fact, they're increasing. So what that tells you is that our customers are trading down in our store. So they're looking for value in our store as opposed to a trade down to discount shop. So I would like to just clarify that. And then in terms of continued discount expansion, look, that's something that we will continue to look at strategically. So we know we've still got some scope in the West that we'll take a look. We have some scope in Ontario. But to be honest with you, we're not gonna massively expand discounts. That's not the structure of our business, but we do have some scope to continue to expand.

Yeah, it's Michael. Thanks, that was well said, Matt. Just to clarify, discount same-store sales growth across the country is falling in terms of magnitude. Numbers are coming down, just to clarify. And two, we stick to what we said. As inflation abates, and it's abating fast now, and as we reach peak and start going down in interest rates, I like full service. I like it a lot. I like where we're positioned. And I like how we've had to change full service and make it even more competitive through COVID and through inflationary times. This is not your grandmother or grandfather's full service store. And so I like where we are. I like the changes that we talked about here today. I like our strategy. And then we just, when we get a little tailwind, you'll see it.

Great, thanks. And if I can sneak one more in, just on the SG&A, If I look at it excluding depreciation, historically Q2 has typically been quite a bit below Q1 in terms of dollars, other than last year and this year. What has changed in the timing of your expenses to account for that shift?

That's a good question. When you look at SG&A, as I said in my scripts, You know, our increase in SG&A is very consistent with what we've had for many quarters now as we continue to invest in our medium term initiatives, as we continue to invest in store growth. So nothing's changed there. What has changed is some of the inflationary cost increases. So particularly when you look at store retail labor, that has had a bigger impact on our P&L than in prior quarters. Again, from wage increases, minimum wage increases, negotiated increases, etc. So this is why we've taken the time today through Michael's script and my script to really map out some of the cost optimization initiatives that we're working on. Because when you have inflationary cost increases like this, you have to take these costs, you have to take other costs out of your P&L to mitigate. So you have to have significant cost reduction initiatives in play to have that mitigation effect. So that's the reason we gave you the additional detail, because this is not empty words. These are active cost reduction initiatives that we're working on as we speak.

Thank you very much.

Your next question comes from Vishal Sridhar with National Bank. Please go ahead.

Hi, I just wanted to get your perspective on shrink, which you indicated was increasing. Is this something that is concerning? Are there initiatives in place that you can implement to reduce that? And how should we think about the impact on a year-over-year basis related to shrink?

Thank you for your question. Good question. We saw a slightly higher shrink number and some rising... theft or shoplifting but overall our margin remains strong from an eye level management shrink management is always something very challenging but the business is used to deal with that element into the shrink but yes there's a bit more pressure from theft but overall our margin remains strong all in so and the team continue to work on mitigating shoplifting and testing with action plans. So right now, the volatility is creating pressure on shrink, but as I said, the shrink number is included in our gross margin performance, and our gross performance is above our peers. So we're pleased with that.

Okay. And are some of your other initiatives potentially causing... causing or creating opportunity for shrink, such as self-checkout? And if so, how does management think about balancing that?

That's part of the initiative we're having in place already to mitigate shrink or shoplifting or type of thing like that. There's many small things that we can improve to mitigate the shoplifting in stores, and this is one example. But it's not a big one, if I may say.

Just to tack on to that, it's an interesting question, Vishal, because I guess the other example we could give you would be CFC3. So when you launch a Voila distribution sensor, in that initial ramp-up phase, your shrink is a little bit higher. I wouldn't call it acceptable shrink because we don't like any shrink, and we're fighting against that all the time. But that might be an example of where temporarily our shrink would be higher on a launcher.

Okay, thanks for that color. And just changing gears here, I was hoping to get some context on Empires, its supply chain, in particular its fleet of trucks, and if there's options or if the company is exploring freight as a service type initiatives, and if so, is that something meaningful that investors can look forward to in terms of opportunities for efficiency?

Yeah, exactly. Like we said earlier, Supply chain is one of the pillars to improve our cost, and the team is already looking at, not only looking at, but we're already seeing benefit of activities they did with the optimized routing, the utilization of equipment has changed, has improved. Our relationship with some of our carriers has changed. and we're expecting to take charge of more load to reduce cost, bring more product in our RCs versus using DSD suppliers. All of those initiatives are there to improve our supply chain, minimize our cost, improve our margin, and it's already in place, and we expect to see those benefits into this fiscal year and the next fiscal year. But everything is considered right now, including taking charge of our transportation activities more than we do right now.

Thank you.

Thanks, Michelle.

Thank you. Next question comes from Mark Petry from CIBC. Please go ahead.

Thanks. Good afternoon. I wanted to just follow up on gross margin first. Is it fair to say that the more modest expansion this quarter is mostly a reflection of normalization in what you're lapping, or were there greater pressures in costs on COGS anywhere in Q2 versus Q1?

No, it's more a stabilization. You know, when you look at the different drivers of gross margin, we benefited, like we said, through supply chain efficiency. So we had a tailwind there. But then you look at things like business unit mix and you look at the core margin of the business, it's relatively stable period on period and year on year. So, you know, in some respects, that's nice because we've got to that point where we're running a stable business. But having said that, we still are confident that we've got enough tailwind and enough fuel in the tank from our initiatives and freight as a service might be a really good one that we just talked about to continue to gradually improve that margin over time.

And if I may, in Q2, Q2 is fall. Like Michael said earlier, interest rate increase has changed again the pressure on promo penetration. The good news is it's not the first time we have to deal with customer behavior changes over the last two years, and we have been able to correct course very quickly based on new customer behavior. So into Q2, fall, back to school, interest rate increased. We saw additional pressure on promo penetration, but we have been able to correct course very quickly. So that's maybe another element into Q2 to consider.

Understood. Thank you. And that promotional penetration, Pierre, Is that any different, or that shift, is it any different in discount versus full service?

Good question. We're seeing the same appetite for deals, for sure. I cannot give you more information than that. It's a very good question. But every time we're seeing things in the news, we have to readjust our promo mix to make sure that we'll stay in control of our margin. I don't have specific differences between discount and full service. The flyer is smaller in discount. They're more lower regular price. That's difficult to say, but we're seeing same customer behavior change every time there's something happening because people are shopping multiple stores, not only discount. They're not just going to discount. They're going to full service, to discount, to They're shopping, what, four or five stores on average? So it's the same customer who's shopping in different stores. So I expect to see the same type of behavior in both full service and discount.

Yeah, okay. And I know you don't typically talk about the regional performances, but just given sort of the shifts in square footage to discount in Quebec in particular, are you seeing any changes in the competitive intensity in that market or maybe just on the topic we were just discussing in terms of promotional penetration?

Yeah, we saw a slight change in Quebec in terms of when our competitor announced many conversions from full service to discount. So, yeah, we saw more activity in the real estate side in discount in Quebec, and obviously we're not present in discount because the number of stores we have full service in Quebec. So, yeah, a bit more activity. discount activity in Quebec in terms of real estate, but many of those have been conversions. And in conversion, in some places, it could affect negatively our store, but in some other, it could affect positively in our stores. In the past, we saw that for service store conversion to discount, and it was most of the time very positive for IGE. So right now, there's appetite for discount, but again, inflation is going down. We have a bright future. We have strong stores, strong networks, strong banner in Quebec, strong franchisee. We continue to believe in our strategy.

Yeah, okay, helpful. And sorry, one just last sort of housekeeping. Is it fair to say that space productivity is not yet contributing to in the P&L, or has that contribution started now, or how material is that contribution now versus the total size of the opportunity?

I would say not material for now. Pilots are done, planograms are done, but the implementation will follow the category planning with suppliers. So, like Michael said, benefit will continue to come from now to the next six months and into the 25th fiscal year. But I would say we're just seeing the beginning.

Okay, got it. Thanks a lot for all the comments and all the best. Happy holidays.

Thank you.

Thanks, Mark.

Thank you. Your last question comes from Chris Lee from Desjardins. Please go ahead.

Oh, thanks, everyone. I think the answer is yes, but I want to just quickly confirm. So you are still seeing higher transaction counts at the conventional banner. Is that correct?

Is it correct? Yes.

Perfect. Okay. And that's, again, what gives you the confidence that as conditions start to normalize, hopefully we'll see some of the basket size to trend up again as people buy more from the conventional banners. Okay. And thank you for all the comments on the SGN expense reduction initiatives. They're very helpful. I guess my question is, you know, when you look at your SGN expense dollars, you know, they have been growing at around 4% to 5% in the last past three or so quarters. Just from a modeling perspective, do you expect a similar rate of growth for the rest of the fiscal year, or do you expect that to start to ease as some of these benefits start to be realized?

So let me take that. Again, I always like to look at this separately in terms of rate and dollars. From a dollars perspective, you should start to see that number come down. as the impact of our cost reduction initiatives start to bite. So that's not a commitment, but that's certainly what our expectation is. From a rate perspective, there's two factors driving that. And the rate was a little bit higher, A, because we didn't have as much sales leverage on the top line with a lower sales growth number. We also had the cost increases from retail labor. And the cost initiative programmers have not yet really kicked in. So as you move forward, we hope that that sales rate, SG&A rate, will start to decrease as A, we have higher sales, B, that aggravation on the retail labor line will continue, but C, the impacts of our cost reduction initiatives will start to kick in. And we'll start to see that in Q3 with the restructuring and all the work we're doing on supply chains. and good enough for resale. So, yeah, I think the expectation is that as a percent of sales, that should start to come down.

Okay, that's helpful. And my last question is maybe just on Douala. I'm just curious, more specifically in the Greater Toronto area, can you share with us how are sales trending in this market? Are they growing? And then maybe secondly, if you look at the industry overall within the GTA, what is the online penetration right now?

We'll answer our own, and we'll call you back later and guide you to where you can look to see what the penetration is in the GTA. I don't know if there is a GTA number. We'll take a look. Maybe you could just talk about our own, whether our sales are going up.

But one thing for sure, online penetration is always higher in fall and winter than it is in summer. So without looking at number, I can guarantee you we have higher sales right now because the season changes. And it will continue to grow during the winter. And like Michael said, we have strong NPS. The service continues to be highly appreciated. Voila is a double-digit growth. We're well positioned to capture that growth for sure.

Okay. So you've excluded the launch in Calgary this quarter. You're saying Voila sales would still be positive?

Yes. Yeah, I mean, don't forget, when we launch a CFC in the initial period, the cells are very small, right? So they're ramping up. They're ramping up aggressively, but from a very small base. So, yes, even if you excluded CFC3, healthy, healthy growth.

Perfect. Well, thanks very much, and, yeah, happy holidays to everyone, too. Thank you.

Yeah, have a great holidays, everyone.

Thank you. We have no further questions. I will turn the call back over to Katie Prang.

Thank you, Joanne. We appreciate your continued interest in EMPIRE. If there are any unanswered questions, please contact me by email. We look forward to having you join us for our third quarter fiscal 2024 conference call on March 14th. Talk soon.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and we ask that you please disconnect your lines.