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Operator: Good morning. My name is, Simon, and I will be your conference operator today. At this time, I would like to welcome everyone to the Loblaw Companies Limited Third Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.
Ms. Janet Craig, you may begin your conference.
Janet Craig: Thanks, Simon, and good morning. Welcome to the Loblaw Companies Limited third quarter 2013 conference call. This call is also being webcast simultaneously on our website at loblaw.ca. I'm joined here this morning by Galen G. Weston, Executive Chairman; Vicente Trius, President, and Sarah Davis, Chief Financial Officer.
Before we begin today's call, I want to remind you that the discussion will include forward-looking statements, such as the company's beliefs and expectations regarding certain aspects of its financial performance in 2013 and future years and the company's plans and projections with respect to Shoppers Drug Mart Corporation, which the Company recently entered into an agreement to acquire.
These statements are based on certain assumptions and reflect management's current expectations and they are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations. These risks and uncertainties are discussed in the company's materials filed with the Canadian securities regulators from time-to-time, including the company's Annual Report.
Any forward-looking statements speak only as of the date they are made. The company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise other than as required by law.
Certain non-GAAP financial measures may be discussed or referred to today. Please refer to our annual report and other materials filed with the Canadian Securities Regulators from time-to-time for a reconciliation of each of these measures to the most directly comparable GAAP financial measures. An archive of this conference call will be available on our website.
With that, I will turn the call over to Galen.
Galen G. Weston: Good morning, everyone. Over the past year, we continue to execute on our strategy of improving our customer composition while at the same time creating a more responsive and lean organization. This strategy has increased our competitiveness and yielded measurable results, including three quarters of basket, traffic and same-store sales growth. As expected, in the third quarter, the competitive environment intensified significantly. Increases in square footage from incumbents and new entrants reached critical mass. This combined with a shift in consumer expectations put significant pressure on our business.
Balancing sales and margin in such a dynamic market is not easy. In the third quarter, we made significant incremental investments in the customer proposition. In most areas of our business this drove sales and tonnage, however sub-targeted investments in our conventional business did not. We have rebalanced and brought the business back in line without compromising our market position. However, the combination of the incremental margin investment in Q3 and some continued margin pressure in Q4 results in us lowering our expectations for earnings growth this year.
Despite this disappoint, as we move into 2014, we remain dedicated to our strategy. We will carefully balance our commitment to competitiveness and earnings performance while maintaining the flexibility to respond in this volatile market. In addition to the strives we have made in our customer propositions here, we have accomplished much that positions us extremely well for the future. We have continued to gain efficiencies in our business and over the last 12 months taken out over $100 million of annual expense and see the opportunity to continue this trend. Albeit slower than we anticipated, we have carefully managed our SAP rollout to successfully scale up at store level. We are positioned to deliver an accelerated rollout in 2014.
The launch of Choice Properties REIT unlocked the value of our property while at the same time creating an additional growth channel within the Loblaw portfolio and the announcement of Shoppers Drug Mart, the acquisition which will drive synergies in both, the top and bottom line as well as position us as the leader in the two most compelling trends in retail, health and urbanization.
Looking forward, our company will be more powerfully positioned than ever before to meet the evolving needs of the Canadian consumers with the right infrastructure, cost structure, asset mix and formats to deliver long-term earnings growth.
I will turn the call over to Sarah.
Sarah Davis: Thank you, Galen, and good morning everyone. Before I turn to the discussion of our third quarter results, I would like to highlight that we will be presenting adjusted numbers along with our quarterly financials going forward.
Prior to this quarter, we chose to highlight certain notable items on a quarterly basis that helps to explain changes in our financial performance. However, as a result of the creation and consolidation of Choice Properties, the pending Shoppers Drug Mart acquisition and certain other items, there is more volatility in our earnings.
By presenting adjusted numbers, we hope to make it easier for investors to obtain a view of our underlying operating performance. I should highlight that as part of the adjusted amount, we will only be adjusting for the SG&A cost related to Choice Properties until Q3 of 2014, but we will have comparable results. In addition, when the Shoppers Drug Mart acquisition closes, we will adjust for intangible amortization at other purchase price valuations.
Now, let's go to the quarter. As we continue to execute against our strategy, we have two primary levers we are balancing to drive performance. The first lever is our customer proposition investment. These are investments in price, service and assortment and they are aimed driving the top line, specifically, it is our goal to drive same-store at a rate greater than our internal rate of inflation. We have succeeded at doing that for the first three quarters of this year.
The second lever is efficiencies. We need efficiencies to offset our investments, increase margin and service as well as to drive long-term earnings performance. We have delivered our efficiencies at a few areas. We have taken over $100 million expense out of the business since Q4 of last year and we will continue to drive further efficiencies in 2014.
In Q3, we hit our targets on sales and efficiencies but accomplished more than we projected in margin. Let's look at the sales in our retail business. same-store grew 0.04% in Q3, or 1.01% excluding the gas bar. While we have the same number of shopping days year-over-year, Q3 of 2013 lost one week of pre-thanksgiving shopping that we estimated impacted our comps by approximately 15 basis points to 17 basis points, so we are looking at an adjusted comp number of approximately one percentage point just using the midpoint. We are happy with that result given the intensity of the environment and the fact that our internal food basket continue to deflate in the quarter.
Same-store sales were driven by continued positive comp in Fresh, a differentiator and an area we continue to focus on. Most of the deflation in the quarter was driven by growth rates, which is the factor of competitive intensity. Drug store sales declined marginally as a result of reform induced deflationary pressures.
Apparel comp sales were soft driven by both, by Canadian retail and U.S. wholesale businesses. Excluding apparel, sales in our general merchandise business declined marginally versus Q3 of last year. Declines were primarily related to categories we are exiting or downsizing such as electronics and leisure.
Now turning to gross profit. Gross profit in Q3 was $2.1 billion, flat from last year, while gross margin was down 40 basis points to 21.5% from last year of 21.9%. Consistent with our strategy, in Q3, we continued to make investments in our customer proposition.
During the quarter, we decided to accelerate our planned investment by $25 million across select categories within our industrial business based on the opportunities we saw in the market. While the investments translated into sales and packaged, they did not result in the volume we had targeted. By the end Q3, we have retracted to our base investment plans and we will continue to execute on vast trajectory as we move forward.
We also benefitted from improved strength during the quarter which was the result of lapping some of the investments we made last year as well as improved practices on the part of the business. We had targeted areas such as dry shrink for focused improvement going forward.
Higher margins in our general merchandise and apparel businesses provided a partial offset to the gross margin decline during the quarter. We maintained interest cost control in the quarter. On an adjusted basis, retail operating expenses as a percent of sales were 17.9% roughly flat with the third quarter of last year, excluding depreciation and amortization operating expenses were 15% a 10 basis point improvement over last year.
The higher depreciation year-over-year was primarily limited to our IT investment. Gross profit dollars were flat adjusted operating declined driven primarily by lower foreign exchange gains reported in SG&A, higher depreciation and amortization and changes in the value of our investments in our franchise business.
Supply chain and labor efficiencies provided partial offset to the decline. On the financial services side, revenue grew about 11%, driven by higher interest and interchange income from increased receivable balances and in our PC classified business as well as higher revenue from the growth of our Mobile Shop business.
PC financial earnings before tax grew by $8 million or 42.1% year-over-year. Q3 marks the first quarter where the results of Choice Properties REIT has been included in our consolidated financials. Revenue of Choice Properties was $154 million for the quarter of which $107 million of rental revenue and $32 million of cost recovery came from Loblaw's Retail segment.
Net operating income for Choice Properties was $108 million, in line with our IPO forecast. In addition, the presentation of our results this quarter matches closely to what we shared with you as a part of REIT accounting we did last June.
As a result of the consolidation of Choice Properties, consolidated revenue in the quarter increased by approximately $15 million, SG&A increased by roughly $21 million, a $15 million increase in revenue as well as $15 million of the $21 million increase in SG&A represents a reclassification of base rent operating cost and property tax recoveries on an properties, which were previously netted out of SG&A. There remaining $6 million increase in SG&A is related to $3 million in startup cost and $3 million in net Choice Properties' SG&A.
Turning back to our consolidated results, adjusted, basic net earnings per share of $0.58 were 3.07% lower in Q3 compared to the prior year. The impact of competitive environment in Q3 put pressure on our gross margin as we continue to invest.
I am disappointed based on our performance in Q3 and the environment we foresee for the remainder of the year, we will not be able to deliver on the expectation we set last quarter for full year operating income growth. While we raised our outlook in Q2, we foresaw a competitive back half, however the actual intensity we experienced in Q3 was greater than projected and caused actual performance to be for lower expectations.
We anticipate that Q4 will be comparable to Q3 from a competitive standpoint and we plan to continue to invest in the food margin. We have adjusted our full year expectations to call for flat adjusted operating income and flat operating income growth for the full year.
Before I close, I would like to turn to SAP. We continue to take a measured approach to our SAP rollout. We have not reached as many [stores] as we had expected to this year, but it's critical that we get it right. Our confidence from an operational perspective increases everyday as our colleagues in the stores work with the systems. We now have stores live and every partner has accepted that. We have successfully rolled out 10 stores in the weekend. We still need to optimize the model trying to scaling up at a more rapid pace.
As we continue our rollout, we expect to see lower IT spending. We still project that our total IT and supply chain expense that standalone Loblaw will be 60 basis points lower than the peak of approximately 1.8% of revenue in 2012. We expect capital expenditures on IT to be 50% lower in 2014, compared to 2012 and we see cash cost continuing to decline.
Over time, as we optimize our wide locations and continue to rollout, we expect to see benefits in areas such as productivity, inventory management, pricing and strength. As we continue to drive efficiencies in our business to become a more agile organization, we implemented a restructuring in October. This restructuring was the result of detailed work by colleagues across the business to improve our processes. We expect this measure will save us roughly $30 million on an annualized basis, which is approximately equal to the restructuring charge we will take in Q4. We will continue to use these savings to invest in the business and drive competitive advantage.
With that I will pass the call over to Vicente.
Vicente Trius: Thank you, Sarah, and good morning everyone. While I am disappointed with our earnings growth for the year will not come in where we expected, I am pleased with the same-store sales results we drove in the quarter where our internal food price index continues to deflate. This is growth is a result of our continued focus on the customer proposition. We are focused on how we trend to the customer house banners (Inaudible) and regions.
I firmly believe that we are following the correct strategy to position our business to deliver long-term earnings growth. The current competitive is intense, but certainly not unprecedented. We are investing in our customer proposition to drive the top line while consistently driving efficiencies. We expect the combination of these strategic initiatives to result in earnings growth over the long-term.
In Q3, results were led by Fresh. Fresh is a competitive differentiator and drives traffic. We continue to work in the Fresh and that is key to delivering on our customer proposition. During the quarter, both traffic and basket were up and we performed better than the market on tonnage. We continue to work through our category strategies during Q3.
We are happy with the assortments we have rolled out. Our competitiveness as well as the tonnage trends we are seeing the categories we have reset. This is a dynamic process. We have 50 to 60 categories across our network, and by the end of 2013, we expect to have implemented approximately half of our targeted category tons. This initiative is about giving our customers more of what they are looking in each category, optimizing assortment, getting the price right and looking at [brand] as well as other areas such as ethnic and natural value within the context of each category.
We expect to be complete over the next year to year-and-a-half, at which point we will enter a regular cycle of updates. As a company, we have made completed efforts to ensure our banners are positioned correctly from a price and experience standpoint, but there is more work to do.
In our discount division, our target is to be the lowest cost operator delivering the lowest prices in the market in differentiating refresh. Most of the adjustments we have made in the discount are of the business over the business over the past two years have been around price while also improving our fresh sourcing and narrowing assortment. We are happy with our results in this division with solid performance on the metrics we are targeting, sales, share and tonnage.
On the conventional side of the business, our strategy is to lead in Fresh with a right assortment. We are focused on providing a consistent theme, store experience as well as sustainable and competitive pricing for our customers. Last year, we made a number of target investments in labor to ensure service standards were higher. We also invested in shrink to broaden our assortment and offer the customer a better selection of high quality fresh food. We are getting the formula right and are gaining traction, but there is room for conventional to be a larger contributor to our business as we continue to optimize the offering.
Across our business, we have driven solid performance over the past three quarters and we still have room to grow. One of the leading indicators of sales, we track is the net promoter score. The net promoter score is the third-party survey that tells us what proportion of our customer base will go out of their way to not only shop in our score, but to be recommended to others. Both divisions have shown an improvement since the beginning of the year. Our conventional division has made particularly impressive strides and is now in a zone where we would expect to see this score translate into further improvements in operating performance.
As the market environment intensifies, our goal is to continue to execute our strategy of investing in our customer proposition to drive the top line while consistently levering efficiencies to largely offset this investment. We are targeting slight adjusted operating income and operating income growth for 2014 for standalone Loblaw. We need to retain the flexibility to respond to the market as it evolves, but our goal is to balance the speed at which we deliver the strategy.
We took further steps to drive efficiencies in October, and we will remain focused on the opportunities we see to get more competitive going forward. Beyond our recent restructuring, we also expect to continue to drive efficiencies in supply chain, in-store productivity and shrink. A strong driver of our business going forward is our loyalty program, PC Plus, which is looking to be a real game changer.
PC plus is performing beyond our expectations, if placed right the trends we are targeting, interacting with the customers across multiple channels. Talking to them one-on-one in a personalized way and learning their technology they carry with them every day to do that. In fact, based on the experience we have had with over 300,000 for registered members to this point, we see PC Plus having the potential to be a meaningful, positive additional to our sales line at a national level.
In our 44 Loblaw's [stores], customers have demonstrated a high level of engagement. Over third all sales in the banner and now accompanied by the scan of a PC Plus card. Customers that are engaged with PC Plus make more trips to our stores, shop a largest average basket and they also shop more categories. We believe PC plus has driven a low-single digit sales lift in our Loblaw's banner in Ontario since we launched (Inaudible). We are launching nationally over the next few days.
During the quarter, we did a soft e-commerce launch with Joe Fresh brand, reaching out to our core customers to build the base and scale our operations. So far we are happy with sales and margins and we have seen a higher average ticket than we had projected. PC Plus and e-commerce are part of a broader omni channel strategy. It is all about meeting the evolving needs of our customers who are more digitally connected than ever with new digital channels where they can be served.
Before closing, I wanted to touch on Shoppers Drug Mart transaction. As we work together, my confidence increases about the opportunities that this will drive. Following the completion of the transaction, Mark Butler, a seasoned Loblaw executive will be charged with delivering the $300 million in synergies we have outlined to you. We plan to realize those synergies over three-year period and intend to be transparent about our progress and results.
The office that has been setup to accomplish these tasks has been staffed with some of the best and brightest talent from both, Loblaw and Shoppers Drug Mart. These individual are extremely busy planning for the start on day as well as taking care of the planning necessary to achieve our short and long-term business objectives. We continue to believe the transaction will close by the end of the first quarter of 2014.
In conclusion, what is important is to be focused on our strategy. We remain focused on the initiatives that will drive the critical strategic pillars in our business, best-in-food experience, driving efficiencies and driving growth.
We'll now pass the call back to Janet for questions and answers.
Janet Craig: Thanks, Vicente. Before I turn the call over for the questions, I would request that you limit your questions to two. After your second question you will be placed on mute. We appreciate your cooperation.
Now, I'll turn the call over to questions. Simon?
