Empire Company Limited (EMLAF) CEO Michael Medline on Q1 2020 Results – Earnings Call Transcript

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Empire Company Limited (EMLAF) CEO Michael Medline on Q1…

Empire Company Limited (OTCPK:EMLAF) Q1 2020 Earnings Conference Call September 12, 2019 1:00 PM ET

Company Participants

Katie Brine – Director, IR

Michael Medline – President and CEO

Michael Vels – CFO

Pierre St Laurent – EVP, Merchandising and Quebec

Conference Call Participants

Karen Short – Barclays Capital

Vishal Shreedhar – National Bank Financial, Inc.

Irene Nattel – RBC Capital Markets, LLC

Michael Van Aelst – TD Securities

Patricia Baker – Scotiabank Global Banking and Markets

Peter Sklar – BMO Capital Markets

Mark Petrie – CIBC World Markets

Keith Howlett – Desjardins Securities Inc

Operator

Good afternoon, ladies and gentlemen. And welcome to the Empire Company Limited First Quarter 2020 Conference Call. [Operator Instructions] This call is being recorded on Thursday, September 12, 2019.

I would now like to turn the conference over to Katie Brine, Director, Investor Relations. Please go ahead.

Katie Brine

Thank you, Joanna. Good afternoon and thank you all for joining us for our first quarter conference call. Today, we will provide summary comments on our results and give you insights on the impact of new IFRS16 leasing standard has on Empire. We will leave as much time as we can 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; Michael Vels, Chief Financial Officer; and Pierre St-Laurent, Chief Operating Officer, Full Service.

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.

Michael Medline

Thank you, Katie. And good afternoon, everyone. We are again pleased with our results this quarter. Our momentum continues. Sunrise costs are coming under the business. The team is executing more sharply. Our strategic initiatives are all progressing well. And we continue to improve EBITDA margin. Other than the IFRS accounting changes, it was a pretty clean and straightforward quarter. EPS was $0.49 this quarter, $0.12 higher than last year. And if you remove a few one time impacts of last Q1 and this Q1, it would be more than a 75% improvement. Sales rough in all regions in across all banners. It is still early days but we are pleased with the sales we are seeing from our seven FreshCo stores in the west.

Farm Boy continues to post excellent sales. Same store sales were 2.4% with customer account and basket size both up. We have lapped the healthcare reform impacts last year which rendered the impact of pharmacy same store sales immaterial this quarter. Internal inflation was approximately 3%. We saw a dip in tonnage with the slow start to summer weather-wise notably in May and that appeared to impact the whole market especially in Eastern and Western Canada. Temperatures were nowhere near seasonal norms and affected summer seasonal categories like cold beverages, ice cream, condiments and summer fruit.

While tonnage is commonly used as an indicator of market share internally, we have several different data points that we use to look at market share at more granular levels. Based on these additional data points, we held our market share at least steady this quarter even without counting our Farm Boy acquisition market share gains. So all-in-all, I thought our team did a good job on comps. And as you can see from our margins, we didn’t buy sales. In fact, we were purposefully a little less promotional this summer, as our promotions continue to become more effective that gives our customers a great experience with a more relevant offer, provides a good lift for us and reduces the amount of money we spend on promotions.

Gross margin rate was up 120 basis points from Q1 last year. Category resets continue to expand our margin as anticipated. And on top of that normal operational margin management by our merchant team was very good. This is our first quarter reporting IFRS 16; it’s created some noise that Mike will explain. I will note that our pre IFRS 16 EBITDA margin, pre IFRS increased 60 basis points over Q1 last year that’s apples to apples. We continue to close the gap on our competitors.

As we greatly improve execution and continue to unlock Empire’s cash generating potential, we believe that it is imperative to return cash to our shareholders. Last quarter, we increased our dividend and announced that we would be repurchasing shares. This quarter we repurchased about 550,000 shares for approximately $19 million and we remain committed to our $100 million target first fiscal 2020. We continue to make good progress against our major strategic initiatives. We are in the final year of our Sunrise transformation and this initiative is progressing even better than we originally anticipated.

We may remain on track to achieve a savings target of at least $550 million, $50 million more than what we originally announced over two years ago. In store execution of category resets which will drive a large portion of our total Sunrise savings is nearly complete. Our teammates and our stores have done a great job realigning our stores, tranche by tranche, ensuring our sales are stocked with the items customers want most.

All of our reporting and customer feedback to date indicates that in-store execution of resets has been very well received. We continue to expand our FreshCo banner in the West and to date have opened five stores in British Columbia including two ethnic oriented shallow FreshCo stores and another two stores in Winnipeg. We are pleased with how the stores are performing and that our customers are excited. Our marketing team has done a great job driving awareness and will continue building the FreshCo brand in the West.

Our expansion a FreshCo to the West allows us to participate in the growing discount segment by converting 25% of our poor performance to Safeway and Sobeys stores, the FreshCo stores and markets that are better suited to discount. We remain on track to open 11 additional FreshCo stores throughout the remainder of fiscal 2020. Our strategy to grow share in Ontario where we have historically had a low market share, continues to progress well. We are seeing stronger results and our existing Sobeys FreshCo and food land banners and we continue to see improved sales and customer metrics as we convert all FreshCo stores to the new FreshCo 2.0 model.

Our acquisition of Farm Boy gives us a winning format that will allow us to accelerate our growth in urban and suburban markets in Ontario. Farm Boy has been part of the Empire family for just over 10-months now and continues to build on its industry-leading operational and customer metrics. The team at Farm Boy is making progress against our plan to double the size of the business in the next five years. We currently have concrete plans to open another three Farm Boy stores in fiscal 2020, and two in the first quarter of fiscal 2021. Farm Boy’s access to our Empire real estate prowess has allowed us to accelerate development of Farm Boy in high-quality locations.

Voila, our game-changing e-commerce solution will also position us to accelerate our growth in the GTA. Voila is on track to roll out testing in soft launch in the GTA in late spring. Our second CFC in Montreal which will serve major cities in Quebec and the Ottawa area is expected to open in 2021. Winning the next generation of retail will require both extraordinary execution and smart strategic innovation. In parallel with its strategic initiatives, we have underway; we are positioning the company to innovate for the long term. Mohit Grover, our new SVP of Innovation and Strategy will join our executive team at the end of the month. Mohit will elevate the importance of data analytics and AI and drive innovation initiatives across the company.

We are focused on putting in place the lean teams, tools and culture that we need to drive innovation in our business and to win the next generation of grocery retailing. We are extremely pleased with the momentum we are seeing in our business. We are more customers oriented, more innovative and definitely more focused on execution. We are hard at work on finalizing strategy, detailed roadmap and financial goals for the three years post Sunrise to ensure this momentum continues. We see a lot of runway ahead of us. And with that over to Mike.

Michael Vels

Thank you, Michael. Good afternoon, everyone. As Michael said, we are pleased with our margin performance this quarter as margin dollars increased again due to higher sales, and more importantly an increase in margin rate of 120 basis points. The two main drivers of this margin rate expansion were category reset benefits and the inclusion of Farm Boy which has a higher margin rate than the rest of the business. If we were to normalize for mixed effects of higher sales and lower margin businesses like Quebec and wholesale the impact would be even higher.

Sales were positively impacted this quarter by the inclusion of Farm Boy and inflation. Produce specifically was a big driver of prices and sales during the quarter. Weather and increased costs increased prices that also lowered the amount of units available for sale. Excluding produce on an apples-to-apples basis comparison, tonnage was marginally positive. Consistent with last year, sales price variable SG&A expenses up mostly in store labor. SG&A as percent of sales after removing the impact of IFRS 16 was 50 basis points higher than last year.

This was due to the inclusion of Farm Boy’s higher labor cost model impact, non-recurring impairment reversals in the prior year, and closure costs associated with the announcement of 10 new FreshCo locations and conversion of two of our own stores to new Farm Boy stores. These costs amounted to $21 million before taxes related to severance, inventory and asset write-downs or about $0.06 per share after tax. These costs are in addition to the $10 million we recorded in the third quarter of fiscal 2019 aligned with our West discount expansion plan to open 10 to 15 FreshCo locations per year over the next three years.

Project Sunrise is on track. And we continue to estimate incremental savings of about $250 million in fiscal 2020 spread evenly across the year. We continue to be on track with about 25% of the incremental benefits recognized in this quarter with roughly 8% gross margin and 20% SG&A. These savings comes largely from category resets, indirect sourcing cost reductions and store improvements. Equity earnings decreased over the prior year primarily due to prior year disposable properties by Crombie that increased our share of their earnings last year by approximately $0.02 per share after-tax.

As a reminder, Crombie has announced a significant sale transaction that will occur in May that will positively impact our second quarter 2020 results. The effective income tax rate for the quarter was 26.5% and we continue to estimate that excluding the impact of any unusual transactions or differential tax rates on property sales, the effective tax rate for fiscal 2020 will be between 26% and 28%.

Free cash flow continues to be strong at $224.2 million this quarter reflective of increased earnings. The strength of our cash flows has enabled us to reinvest back into the business in a disciplined manner, positively impacting our customers in store and enabling better technology and processes in our back offices. In the first quarter, we touched over 50 stores through renovation, redevelopment or conversion. Our strong cash flows, sustainable margin improvements and improving credit metrics were a factor in the decision by DBRS to upgrade Sobeys credit rating to BBB low with a stable trend and for S&P to upgrade Sobeys outlook from stable to positive.

IFRS 16 was adopted for the first time this quarter. You’ll notice several changes in your external documents specifically you can see the impact on key metrics on pages 7and 13, 17 and 18 of the MD&A. Our documents reinforce that this is an accounting and measurement change only and it had no impact on our cash generating ability. We have provided an outline of the extent of the change on each of our key metrics on page 2 of the press release and page 7 of the MD&A.

A few key metrics to highlight are EBITDA. EBITDA margin and free cash flow. EBITDA increased by $129 million mostly due to their removal of rate expense which was replaced as depreciation expense and net financed expenses. Neither of which are captured in this metric. EBITDA margin as we report it was 6.8% for the quarter, pre IFRS 16, it would have been 4.9% an improvement of 60 basis points over the prior year.

The free cash flow definition has been updated to ensure accountability with the prior year. We will continue to show you the quarterly impact of IFRS 16 for the remainder of fiscal 2020 as we start to get used to the new metrics which will now be the new normal for the Canadian industry. Although, we will of course continue to have metric that are inconsistent with US peers who report under US GAAP. The first quarter was a solid. We’re off to a good start. The team feels confident about our packed agenda for this year that includes the completion of Sunrise. The continuation of the FreshCo expansion in the West, increasing Farm Boy’s footprint in Ontario and launching Voila by Sobeys.

And with that I’ll hand the call back to Katie for questions.

Katie Brine

Thank you, Mike. Joanna, you may open the line for questions at this time.

Question-and-Answer Session

Operator

[Operator Instructions]

And your first question is from Karen Short from Barclays. Please go ahead.

KarenShort

Thanks. I want to just ask about the cadence of tonnage throughout the quarter excluding produce. And obviously I asked because the weather had an impact. So wondering if you give a little color there. Then I had a couple other questions.

MichaelMedline

Sure. The three periods, the first was the weaker as the summer took time to get going and progressively improved through the next two months.

KarenShort

So it include — so once we got to the final month that you would have been much more positive not just marginally for the entire quarter on tonnage.

MichaelMedline

Well more positive relatively speaking. As Michael said we had a slightly lighter promotions schedule this year. So we were — if you have to pick one of the two metrics probably little more focused on margin than growing tonnage and sales.

KarenShort

Okay and then I guess just curious in terms of the competitive landscape in light of the high produce inflation because it sounds like that’s continuing into the second quarter. Has the environment changed at all in the second quarter from a competitive perspective?

MichaelMedline

We don’t anticipate a big changes except if we have some commodity seeing bigger inflation. So when the inflation is, the build it just in some commodity then we can see some change in trends, but in general I think it’s pretty stable quarter after quarter in terms of inflation and produce. So, no, we won’t anticipate big change going forward.

KarenShort

Okay and then any way you could quantify the impact of Farm Boy and also produce on growth margins.

MichaelMedline

Farm Boy is obviously positive. It just — their operating model is because of the mix in their business runs at a higher margin rate. We’ve not disclosed the exact basis points as it is competitive. But they also run in a higher SG&A percentage. All told at the bottom line their EBITDA percentage on an apples-to-apples basis would be higher than the consolidated Sobeys numbers.

KarenShort

Okay and then last question for me on data analytics. Would you be willing to just give a little color on how your approach might change going forward on the analytic front?

MichaelVels

Yes. Hi, it’s Michael. We’re — like we’re not going to get overzealous on it. We’re going to take it in stride and key on some very important big prizes especially on the merchandising side behind the scenes and personalization on the front. Any more than that I’d rather not give to you but I can tell you that we’re going to keep the team small and focused on the big prizes, not spread ourselves too thin on this.

Operator

Your next question is from Vishal Shreedhar from National Bank. Please go ahead.

VishalShreedhar

Hi, thanks for taking my questions. I’m wondering if you could provide any early color on project Sunrise 2.0, if there are any comments you can share. And if you can’t maybe you can help us on when you might share some of the details on that.

MichaelMedline

Hi, how are you doing, Vishal. It’s Michael. And we’re working through the strategy right now. Our intention this time is to share what we can with you. And as you know, we try to share as much as we can be transparent in the spring, having chosen when in the spring to share that we’re still working on it. But I can tell you that we’re not just beginning this work. We’re right in the middle of it. And we’re going to have very aggressive goals to grow our year-over-year earnings numbers as we go forward. I don’t think –I don’t want anybody think we’re going to take a holiday after Sunrise. Sunrise 2.0 and I thought what it’s going to be called will be aggressive.

VishalShreedhar

Okay. Empire has implemented a lot of change in a short period of time. And I know you have a lot more initiatives planned and you’ve given us insight into some of them. But just wondering as you look at the organization today from when you come in, would you say that the restructuring is effectively complete at this stage? And you can pull on a lever and understand how the organization will respond to you or is there still a higher degree of uncertainty associated with let’s say a company that’s running on a normal basis?

MichaelMedline

It’s night and day. And as I said in the AGM speech, which I would guess most you didn’t listen to today. I guess you got better things to do and you’re busy to hear my speech is as I said; we planned a rock solid foundation. Now this company it can execute and operate and take on more and more projects and people have accountability. The team, the structure works. We’re probably doing you know me a little bit, Vishal, we’ll do a little tweaking below the executive level make sure it works really, really well across our different functions.

We’ve got the people in place. They’re working well together. I am even a little surprised that this team is offering such a high level at this point. I would have thought probably we might be 6 or 12-months ahead of where we would have thought two and half years ago. Now that doesn’t mean that that we don’t have work to do. We do. And that people are settling into their new portfolios. Pierre is key, he keep saying that I don’t know where I’ll end up because I can’t give him much more than this without me leaving right away. But he’s a just doing a great job in terms of taking out Quebec and then merchandiser and again operation and how he works with finance and marketing and across the whole company.

So couldn’t be happier with the structure and the people and when we pull the rope it works like as you were asking.

VishalShreedhar

Okay. Thanks for that color. And just wondering from a consumer standpoint a little bit more concern out there than usual. Just wondering what you’re seeing? And if you’re seeing uncertainty macro headlines permeating to the customer.

MichaelMedline

Yes. I think I’ll start then Pierre closer to some of that than I am because of his operational and merchandising perspective. But we’re not seeing anything as of this point out in the market that would indicate consumer malaise or over-worried. Like everyone out there we are concerned about some of the things we’re seeing on the horizon. And we certainly hope that there won’t be a recession because that costs people jobs. Same time grocery performs awfully well in recessionary periods, but not as but we’d rather the economy was doing well. But we’re not seeing much and Pierre maybe you could give a little bit more color if you could.

PierreStLaurent

I think consumers looking; they’re trying to remain the same. And you are reading stuff like we do. And we need to be more relevant. The society is changing, you have less time everything so that’s the thing that these big trends continue and I think we anticipate no major changes going forward except some economic changes. But once again in difficult times it’s always an opportunity to differentiate ourself and we’re ready for it.

Operator

Your next question is from Irene Nattel from RBC Capital Markets. Please go ahead.

IreneNattel

Thanks and good afternoon, everyone. Just on the category reset just wondering as time goes on how are you seeing performance evolve or mature of some of the early categories that you did versus the later ones? And as you’ve taken all those learnings, do you think that you need to kind of go back and do any mini resets of the early categories?

MichaelVels

I think, Irene, I think the short answer is no because we went through a very rigorous and fairly identical process for all of the rollouts. And including every category that gets rolled out goes through a pilot store approach as part of its cycle. And as we got into the stores we have post got better and learned from each successive week and anything that we felt could have been improved in the early categories would already have been executed from a negotiations perspective that was done in a very compressed timeframe in a number of very tightly controlled ways.

We’re very satisfied with the outcomes and those are being executed as expected. As we move forward next year post Sunrise, I think we’ve said pretty consistently that we did a lot in a short period of time. And with a new team and now under Pierre’s leadership and more miles in the saddle, there’s clearly going to be more fine-tuning and opportunities in all of our category management. And we expect to capture that as we move forward post Sunrise. And it’s more business as usual. We’re actually very satisfied with the quality of execution.

MichaelMedline

And just maybe I’ll just add two things which is we were, I think we’ve been really pleasantly surprised that the pre work we did in terms of understanding the customer and what to do in each category and which products would resonate the most. We’ve seen our merchants pretty well nailed that very, very few changes after we put the category reset and I can’t think of one off the top of my head because there’s so few.

The second is Mike’s right that once we’re done categories that we got to go and find more optimization. And I think a lot of that will come from the data analytics and AI that Pierre is working on right now.

IreneNattel

That’s great. That’s really helpful. And I guess that brings me to my next question which is as you think about whatever you decide to call it, I know project daylight, will –what are the key elements that you see now that you really, really would like to get at in the next three-year plan?

MichaelMedline

We’re still working on it, but I think it gets clearer. You guys can do the math that we closed the SG&A gaps quite a bit on our two major competitors. And we have a long way to go and so we’ve got it. There’s a little bit to go on that not too much, but we’ll get at that. And I think that we have a large prize on cost of goods sold even now, even with all the work recording the progress we’ve had. And the third piece that we’re looking at is having more productivity in store and getting those sales per square foot up. When we look at our GAAP to being best-in-class in the country, it’s mostly going to be a combination of cogs and sales per square feet, all of — but it’s not some but it’s not without plans.

I think we can go and improve those sales per square feet against our competitors in a very smart fashion while taking out some of the cost. So we’ve got some more work to do in terms of the road map and which order we’re going to tackle it and make sure our resources are there. And we don’t overspend because we aren’t going back to the old days. So that’s what we’re doing, but the pride is there. I think it’s a matter now of prioritizing, putting our financial goals clearly in front of us. And then having a just with a road map. I’m a simple person. When something works you go back to it.

And I think that we can, why sometimes I refer to it is project Sunrise 2.0. We couldn’t do everything in a three-year period, just couldn’t do it. We had to get the infrastructure and the people in place and came into the process. Now we can go, let’s go finish the job. And I think that’s what the next three years will be.

IreneNattel

And just final question leading on from that. Do you see any need from us or a technology perspective? Do you see any need to strengthen the platform? Do any significant investments there or you’re okay for now.

MichaelVels

Rather than answer the question in absolutes, I think the short answer is maybe long answer is that our systems are stable. And they produce the answers to a large extent that you ask them to do, but it’s with some difficulty and they’re not as nimble and as focused towards robust data and analytics as you’d expect from a company of our size and complexity. So we will be investing more and for sure at higher levels than what companies you now over the last three or four years in IT. But it’s not going to be directed at changing the basic infrastructure as much as adding new capabilities such as artificial intelligence, analytics capabilities, loyalty, personalization much better data arrays. So that our merchants can rely on the data and see it on their desktops as opposed to having it put together on a periodic basis by finance people.

So it’s kind of exciting investments executed over a period of years, but it really focused on the insatiable requests and desires of our merchants and others for a better analytics and better insights.

Operator

Your next question is from Michael Van Aelst from TD Securities. Please go ahead.

MichaelVanAelst

Hi. On the Voila program that launching in the next spring. So you’re talking about a soft launch or a test launch in late spring. When would you expect a full complete rollout in the GTA?

MichaelMedline

Hi, Michael. Great question. What recent path is you get it right before you go to a large group of customers? So difficult to call or we don’t think the test and soft launch should go for too long a period of time. But we’re going to, well, if we’re not happy with how we’re progressing and we expect to be happy then we’ll slow it down kind of tiny bit and rollout but we’re going to roll it out postal code anyway. So what we put in our plans and they’ve always been there from since the very beginning, so that’s actually the work that Sarah is leading, it’s going really, really well right now is that spring test and soft launch, my experience is you go when you’re ready because you’ve got one chance to knock the cover off the ball and thrill the customer and take the eyeballs or mouthfuls in this case, and that’s what we’re going to do.

So I don’t want to commit to anything other than when we go to customers. This is going to knock their socks off, but everything is looking good so far, Michael.

MichaelVanAelst

But once you figure it out and you say, okay, the test off launch has gone exactly how you’re expecting and you’ve got it nailed. How long does it take to roll out postal code by postal code?

MichaelMedline

It will take; they will take a few months.

MichaelVanAelst

And the FreshCo in Western Canada is any way you could give us an idea of the relative performance to either the FreshCo in Eastern Canada or in Ontario story or the FreshCo in Western Canada.

MichaelVels

Sure. It’s a little different buy market as we rolled out. But our investment has been fairly significant in marketing and promotions to make sure that we set the right price in back to — in customer’s minds. This clearly been some competitive response. Having said that the sales that we’ve seen across the system are in fact higher than the Safeway stores, which they replaced pre opening. So we’ve been very pleased about that because it does mean that we’ve attracted new customers. And in addition to that the conventional stores that we have in those market areas continue to do well as well.

So we’ve clearly generated net new sales for the company which was one of our goals. From a profitability perspective, I would venture to say that it’s at this stage roughly neutral and mostly because it’s a relatively small number of stores. And we didn’t expect it obviously to be accretive in the early days. So from the Western perspective lower margins because we’re ramping up our people. We have more trading. We have more people in the stores as they get more effective and more efficient and understand how to run a discount store we will see those costs coming down.

Our promotional intensity as we start to get a little more mature with the store is starting to lessen. And we expect to see steadily increasing margins in the banner. In terms of your question on the Ontario balance, our sales continue to be very strong in our discount business very satisfied with them, the new formats, the FreshCo 2.0 continues to do well. And we don’t want to, we said, I think we’ve rolled it out to something like 45 stores to date. I’m very satisfied with the outcomes. Our franchisees are happy. So clearly two different markets, Michael, one’s a startup and one’s a mature market with some new concepts being rolled out. Obviously, the profitability in the Ontario market higher than Western at this.

MichaelVanAelst

Okay. And the roll out in Western Canada to the 65 stores or so, do you expect to have that done by the end of fiscal 2022? Is that their timing?

MichaelVels

Yes. We are saying over the next three years. So I’d say fiscal 2022 early into the next year. It’s -that’s the current plan. And so far we’ve kept to the cadence that we anticipated. We don’t see anything at this stage that should slow us down. So I think that would be a reasonable estimate.

Operator

Your next question is from Patricia Baker from Scotiabank. Please go ahead.

PatriciaBaker

Thank you very much for taking my questions. Michael in your opening remarks you reference the fact that the teams are executing more sharply and certainly that’s showing up in the numbers and you can actually see it when you go to the stores. And one area that you referenced here in discussion of the gross margin was in promotional effectiveness. I’d really like you to talk about that if you don’t mind a little bit more. So where are you in the journey of trying to drive better promotional effectiveness? When did you start? Are you looking at promotional effectiveness now more through a return lens and requiring that the promotions meet basic return hurdles? And, if so, if you are doing it that way is that a change in your approach?

And I’m assuming that the size of the prize of getting to the optimal promotional effectiveness is pretty big for you guys.

MichaelMedline

Sorry, that was, we’re now in Scotia but I don’t think we could blame the hurricane but our lines suddenly went down. It wasn’t because I was nervous about your question. I don’t think Patricia but let’s hear — sorry about that.

PatriciaBaker

Neither do I, Michael. Okay. Sorry and it’s a long one and I apologize to anybody who has to listen to it again, but you’re both. So in your opening remarks you talked about the fact that the teams are executing more sharply and you can see that in the numbers. You can see that if you walk the stores and in one area which showed up in this quarter, you’re referenced here in discussion of gross margins on promotional effectiveness. And so I would really like to talk about that a little bit more maybe talk about where you are on that journey? When did you really seriously start to get to do the work on promotional effectiveness? And additionally, are you now looking at promotional effectiveness through a return mirror and requiring that promotions actually meet some return hurdle? And if that’s the case, is that a new approach?

MichaelVels

So not a new approach. While we changed our structure and many merchants and all of their supporting teams which is just equally important ended up new categories, a large job to do through Sunrise. At the same time, we still have many very experienced and very capable merchants who are running complex categories across the country. And on an individual and collective basis they know what they’re doing. They understand the necessity to balance margin and sales. And certainly Michael’s very clear directive coming in over two years ago was margin counts.

It really counts because that’s what we put on the bottom line. And we need to get more discipline and we need to get more focused on making sure that we’re making smart decisions. And then that message has been reinforced by Pierre as he has taken over more and more responsibility and now basically controls the merchandising decisions across the entire country except for Farm Boy and discount. And so I’d say, no, it’s not new. But what’s changed now is that we are really through the Sunrise rollout. The merchants have access to better tools and analytics than they did two years ago.

We have — they’ve solidified into a new team with a strong leader. And we’re turning our eyes towards what maybe day to day category management and balancing that sales and margin equation. At the same time as we’ve referred to previously, we are investing quite heavily in new analytics and new data models to up our gain in terms of measuring. And then ultimately helping us with the execution in proportional effectiveness. So it’s, I guess ,what I’m trying to say is it has been a progression. There’s not a sudden sea change, but as Sunrise progresses matures completes, we just have — we have more material and more tools to deal with. And we’re going to get ever better on promotion. So I don’t Pierre if there’s anything you want to add to that.

PierreStLaurent

Very well said. The only other thing I would like to add is the category set exercise gave a very good knowledge of every single category to merchants. So I think they had a better ownership and understanding on every single category or SKU to handle in their proper planning. And like Michael said, our goal, we were more focused on structural change and now we’re more focused on day to day business. So with that help with good guidelines, the team is more focused and more disciplined than ever. And I think there’s still room for improvement for sure. But compared to Q1 last year, the balance between sales growth and margin expansion is a great success in only 12- months old as you compare to last year Q1 and now. I would like to congratulate the team; they pass through a big change structurally. And now they really are more focused on the day to day business.

PatriciaBaker

That’s very, very helpful, Pierre. And just on the category reset, you said that you’re almost complete, so will that be completed in Q2?

MichaelVels

Finally complete probably close to Q3 but by the time we get out of Q2, we are substantively done in terms of store roll out.

PatriciaBaker

Okay. And just Michael you mentioned the hurricanes, just curious did you have in some store closures in the Hurricane. And were able to quickly get merchandise back on the shelf because I understand there was certainly a lot of people hording product before the Saturday?

MichaelMedline

Yes. I mean, we, our stores got wiped out in the two preceding days especially in Pictou County, all up and down where the eye was going to hit. Our customers came to us because they need to get things and we were there for them. We did a really good job of pre stocking those stores; carry more water and other items that are essential in those situations. The answer is that, yes, that many of our stores were closed. Some for a short period of time; some for longer; good news is very little structural damage to the stores. So that it shouldn’t have any ongoing impact on us to restock stores that have essentially sold out in many, many categories takes some days. Although, our supply chain and operators throughout beginning, during, after have been sensational.

Although, we sold a lot at the beginning, I think it hurts you actually on the back end of it because some of the closures and try to restock all the products back in the stores. But all -in-all, I think compared to a lot of people we came through unscathed.

Operator

Your next question is from Peter Sklar from BMO Capital Markets. Please go ahead.

PeterSklar

Question on inflation. Your quarterly report it was just facilitated, you had a good 3% tailwind from inflation. Just wondering now that you’re halfway through the second quarter, I assume you’re seeing that level of inflation decelerating somewhat, is there anything you can comment about that?

MichaelVels

I’m not sure I would – it was hard to say it’s decelerating. At this point, it’s early maybe pretty consistent I would say, but turning to tell where the quarter is going to enter.

PeterSklar

And then Michael, I had a question for you. In terms of your brand positioning or brand messaging of Sobeys and Ontario, I thought I detected a subtle shift on how you’re positioning the brand. Like for example, I noticed the gone fishing advertisements that are little bit different than what Sobeys has typically done. I’m just wondering have you suddenly shifted the brand messaging and was that based on, I know you did some consumer research in terms of trying to understand who Sobeys customer is is?

MichaelMedline

Yes. I mean picked up on a great point. And I mean the brand is the brand and you make changes to it. When we did the customer research, the underlying love of a lot of Canadians for the Sobeys brand was there. And what we were trying to do is uncover it. I’d say compared to almost a brand I’ve ever seen the level of support, how they think of Sobeys as the family kind of grocery store. The place and what we weren’t doing and we’re doing now is we’re executing better and living up to some of that brand reputation.

But we’re also telling –we really own in on that message which resonates better with our customers and it’s really what Sobeys stands for. So I’d say that when you see, I think that fishing ad, I would have pointed that out is absolutely emblematic of what we’re going for and that Sandra and the marketing team working with the other executives, I think it really nailed with the brand stands for and what we’re going to stand for. Great customer feedback on all the measurements to do with that at. But and you also see much — many of the things that we’re going to do in terms of marketing and sponsorship, community activities are going to be resonate better with Sobeys.

At the same time, we’re also doing, well, actually Sandra, her team doing a lot of work on the brand messaging for takeaway and for 50s and for food land. And so I think we’re a little further ahead on the Sobeys, but not too far behind on the other banner. So that was — I’m glad to hear that you notice that.

Operator

Your next question comes from Mark Petrie from CIBC. Please go ahead.

MarkPetrie

Hey, good afternoon. I just want to ask about Farm Boy and just regarding the conversion of other banner locations. Can you talk about the size of the locations you’re comfortable putting a Farm Boy in? And how the model can adapt as you push, presumably push the store size higher over time? I understand the recent announcement was a FreshCo was presumably there are larger Sobeys locations that would be really well suited to Farm Boy concept.

MichaelVels

The answer on that part is interesting, Mark. The format has until recently been in very small footprint such as the one in the Rideau Center in Ottawa, which is been a smallest one to 28,000-30,000 feet at the top end, but we are looking at some new stores including one in Ottawa which is going to test the upper limit of that box size. And look at putting some new and innovative ideas into a little more square footage. I think the great thing about the concept is that it is very flexible. The mix stays the same but the flexibility and fixtures and the layout is such that it does fit into and is very successful in a wide range of flow plates.

So unlike I say for your Sobeys or FreshCo, we don’t have as tight a range for where how that format would work as you might think.

MichaelMedline

The only thing I’d add before anyone jumps on me, these were Jean Louis and Jeff’s idea is going to be and try different size formats which they think they can really execute upon. And but keep that fantastic brand and everything you’re trying to do there. I think that if they were on the call, J-L and Jeff would tell you that that the promise of our real estate team and some of that what we had, I mean there’s one at Yonge – Eglinton that’s going to be a Farm Boy like everyone knows that probably already. That was going to be a Sobeys. We, it’ll be a little larger than prototype Farm Boy, but they’re going to, I think it’s –that’s just situated better to be a Farm Boy store and in that area. And we’re seeing all sorts of opportunities that these are being driven by J-L and Jeff directing the work and the decision making in terms of what they’re comfortable with to make sure they can be even greater than they have been before, but working with our real estate group and our executives, it’s working real well.

MarkPetrie

Okay, thanks for that. And with regards to SG&A, could you just talk about how you sort of think about the longer term or at least through the course of fiscal 2020 sort of growth rate in SG&A? Obviously, there’s no shortage of areas where you do want to spend particularly on the brand awareness side across banners as you as you commented. And FreshCo West and Voila over time, so does that sort of require a pickup in spending or consuming a more of the Sunrise savings or do you have the ability to shift spending from other parts of the business and sort of keep on the current run rate?

MichaelVels

I don’t think I would walk away with an assumption that we have to ramp up our SG&A spend. So take out the impact of Farm Boy, the distortion of the last year one time positive we had in our numbers. And the closure costs this quarter. We, I’d say that on an ongoing basis, we’re going to continue to be very focused on cost control. And I think it would be wrong to say that we anticipate a significant ramp up is in our SG&A activity or spend to support what we want to get done. As Michael said, we still actually think we have some more opportunity and some more capability to close that SG&A gap. Not quite as much as we do in the big line on cogs and sales.

So I think you can expect us to continue to be very, very focused on becoming more efficient on that line, not less as the year progresses.

MarkPetrie

Okay and then you sort of answered this question I guess in a few different ways, but I just want to ask it specifically about sort of the regional structure and then the shift of merchandising functions in two different offices. I guess that was sort of a year and a half ago now really, but looking back on it now is there anything you would do differently and what sort of learnings have you pulled from that experience either sort of suggesting future opportunity or things that you want to kind of de-risk?

MichaelVels

I think through the gather reset exercise, we work together all format, all region together. We remain mainly we have our grocery team or inter standards they are the fresh team in Toronto, we remain the team, we keep –we kept the year the team in Quebec. And now we are more focusing on the format and so we have merchandizing people across the country to be close to customer needs which is a good thing. And but the teams are working together because they had to execute reset together, so and now reset is over but reviewing category that will be a continuous thing that it’s now our processes now and we have a national governance for all formats all region.

So we learned from, we took the best and we lost the worst. We’re working together. We are focused on regional needs and we kept the best people across the country. So honestly it’s the best of two worlds. And we leveraging the size of the company and we remain close to customers.

Operator

Your next question is from Keith Howlett from Desjardins. Please go ahead.

KeithHowlett

Yes. I wondered if you could update us on your work on private label.

MichaelVels

Do we update on private label. We reviewed the branding, the look and feel of the brand. I think we use some new look and feel the new compliment logo and everything. I think the new logo will fit better in our shelf. It would be — we have a better view on the each product in our shelf is the goal behind that. And the best thing is a true category set, we revised for every single category, a specific role for our private label in some category private label would play a specific role in another different role. And so I think it’s a bigger thing we did over the last year. And we are seeing already positive result by having I would say stronger joint business plan between our national banners our private label private label going forward specific role to play in a category.

So it’s where we are. The new image will be finished by the end of this fiscal year. So it’s a plan. It’s already started and we finish — it’s a 35 under product that we need to redesign the packaging and everything plus a couple of new products for sure.

KeithHowlett

Then I just was wondering on the square footage in terms of the doubling of Farm Boy over the next five years, how do you anticipate that will break down between conversions of existing Sobeys or FreshCo real estate versus Greenfield?

MichaelMedline

Well, I think that you’re going to — we don’t really say what percentage is which but I think it’s going to be a combination, most of the square footage will be greenfield but where we see an opportunity where a Farm Boy fits better than our current banner we’re going to make that conversion. And I think that I think that the only thing constraining us from even higher growth of Farm Boy is to make sure that they can handle that kind of growth and there are a certain number of stores in the next couple years that we wouldn’t go over because we just want them to get their feet under them. At the same time, I think that there are more opportunities should Farm Boy be ready for them to greenfield more stores maybe faster than we originally thought when we made the acquisition and there probably a few more stores that could be converted especially in the densest parts of Toronto that we’re going to go forward.

KeithHowlett

And then just on the FreshCo banner. How did, I know you may not want to speak this but how do the Chalo FreshCo work in British Columbia versus say the normal FreshCo?

MichaelMedline

The Chalo that we’ve opened, a couple we’ve opened in Western Canada are is actually one the strongest because we’ve only opened a handful of stores, but if we’re happy with the FreshCo we’re extra happy with the Chalo. I think they’re very, I think our FreshCo offering overall is differentiated and our Chalo is even more differentiated than that market. They stand out even more the would in Ontario and so in fact we we’re just talking about that today how pleased you are at the cello in Ontario. And so in fact we are just talking about that today. Hopefully the Chalo in Ontario and in the West.

End of Q&A

Operator

Thank you. There are no further questions. I will now turn the call back over to Katie Brine for closing remarks.

Katie Brine

Thank you, Joanna. Ladies and gentlemen, we appreciate your continued interest in Empire. If there any unanswered questions, please contact me by phone or email. We look forward to having you join us for our second quarter fiscal 2020 conference call on December 12. Talk soon.

Operator

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

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