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Edited Transcript of EMP.A.TO earnings conference call or presentation 12-Sep-19 5:00pm GMT

Q1 2020 Empire Company Ltd Earnings Call

STELLARTON Sep 21, 2019 (Thomson StreetEvents) -- Edited Transcript of Empire Company Ltd earnings conference call or presentation Thursday, September 12, 2019 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Katie Brine

Empire Company Limited - Director of IR

* Michael Bennett Medline

Empire Company Limited - President, CEO & Director

* Michael H. Vels

Empire Company Limited - CFO

* Pierre St-Laurent

Sobeys Inc. - Executive VP & COO - Full Service

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Conference Call Participants

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* Irene Ora Nattel

RBC Capital Markets, LLC, Research Division - MD of Global Equity Research

* Karen Fiona Short

Barclays Bank PLC, Research Division - Research Analyst

* Keith Howlett

Desjardins Securities Inc., Research Division - VP, Consumer Products & Merchandising Analyst and Retail Analyst

* Mark Robert Petrie

CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Research Analyst

* Michael Van Aelst

TD Securities Equity Research - Research Analyst

* Patricia A. Baker

Scotiabank Global Banking and Markets, Research Division - Analyst

* Peter Sklar

BMO Capital Markets Equity Research - Analyst

* Vishal Shreedhar

National Bank Financial, Inc., Research Division - Analyst

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Presentation

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Operator [1]

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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.

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Katie Brine, Empire Company Limited - Director of IR [2]

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Thank you, Joana. 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 insight on the impact the new IFRS 16 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's 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 for Sobeys.

Today's discussion include 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 new release and MD&A for more information on these assumptions and factors.

I will now turn the call over to Michael Medline.

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Michael Bennett Medline, Empire Company Limited - President, CEO & Director [3]

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Thanks, Katie and good afternoon, everyone. We are again pleased with our results this quarter. Our momentum continues. Sunrise costs are coming out of the business. The team is executing more sharply. Our strategic initiatives are all progressing well, and we continue to improve our 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 onetime impacts from last Q1 in this Q1, it would be more than a 75% improvement. Sales were up in all regions and across all banners. It is still early days, but we are pleased with the sales we're seeing from our 7 FreshCo stores in the West. Farm Boy continues to post excellent sales. Same-store sales were 2.4%, with customer count 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 a 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 did it by sales. In fact, we were purposely a little less promotional this summer as our promotions continue to become more effective. This 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 teams 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 for 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 remain on track to achieve a savings target of at least $550 million, $50 million more than what we originally announced over 2 years ago.

In-store execution of category resets, which will drive a large portion of our total Sunrise savings is nearly complete. Our teammates in our stores have done a great job relining our stores tranche by tranche, ensuring our shelves are stocked with the items customers want most. All of our reporting and customer feedback to date indicate 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 5 stores in British Columbia, including 2 ethnic-oriented Chalo FreshCo stores and another 2 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 of FreshCo to the West allows us to participate in the growing discount segment by converting 25% of our poor performing Safeway and Sobeys stores to FreshCo stores in 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're seeing strong results in our existing Sobeys, FreshCo and Foodland banners, and we continue to see improved sales in costumer 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 plans to double the size of the business in the next 5 years. We currently have concrete plans to open another 3 Farm Boy stores in fiscal 2020 and 2 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.

Voilà, our game changing e-commerce solution, will also position us to accelerate our growth in the GTA. Voilà is on track to rollout testing and soft launch in the GTA in late spring. Our second CFC in Montreal, which will serve major cities in Québec and the Ottawa area, is expected to open in 2021. In our winning the next generation of retail, we will require both extraordinary execution and smart strategic innovation. In parallel with the 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're 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're extremely pleased with the momentum we're seeing in our business. We are more customer oriented, more innovative and definitely more focused on execution. We're hard at work on finalizing strategy, retail roadmap and financial goals for the 3 years post Sunrise to ensure this momentum continues. We see a lot of runway ahead of us. And with that, over to Mike.

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Michael H. Vels, Empire Company Limited - CFO [4]

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Thank you, Michael. Good afternoon, everyone. As Michael said, we're pleased with our margin performance this quarter as margin dollars increase again due to higher sales, and more importantly, an increase in margin rate of about -- of 120 basis points. The 2 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 mix effects of higher sales and lower margin businesses like Québec in 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, but 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 force variable SG&A expenses up, mostly in-store labor. SG&A as a 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, nonrecurring impairment reversals in the prior year and closure costs associated with the announcement of 10 new FreshCo locations and conversion of 2 of our old stores to new Farm Boy stores. These costs amounted to $21 million before tax 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 3 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, split roughly 80% gross margin and 20% to SG&A. These savings come largely from category resets, indirect sourcing cost reductions and store improvements.

Equity earnings decreased over the prior year, primarily due to prior year disposal of 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 25.6% -- 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 a decision by DBRS to upgrade Sobeys' credit ratings 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 our external documents, specifically, you can see the impact on key metrics on Pages 7, 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 the removal of rent expense, which was replaced as depreciation expense and net finance expenses, neither of which are captured in this metric. EBITDA margin, as we reported, was 6.8% for the quarter. Pre-IFRS 16, it would've been 4.9%, an improvement of 60 basis points over the prior year. The free cash flow definition has been updated to ensure comparability 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 metrics that are inconsistent with U.S. peers, who report under U.S. GAAP.

The first quarter was 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 Voilà by Sobeys.

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

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Katie Brine, Empire Company Limited - Director of IR [5]

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question is from Karen Short from Barclays.

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Karen Fiona Short, Barclays Bank PLC, Research Division - Research Analyst [2]

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

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Michael H. Vels, Empire Company Limited - CFO [3]

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Sure. The 3 periods, the first was the weaker as the summer took time to get going and it progressively improved through the next 2 months.

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Karen Fiona Short, Barclays Bank PLC, Research Division - Research Analyst [4]

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So it -- so once we got to the final month, you would have been much more positive, not just marginally for the entire quarter on tonnage?

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Michael H. Vels, Empire Company Limited - CFO [5]

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Well, more positive relatively speaking. As Michael said, we had a slightly lighter promotions scheduled this year. So we were, if you had to pick 1 of the 2 metrics, probably a little more focused on margin than growing tonnage and sales.

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Karen Fiona Short, Barclays Bank PLC, Research Division - Research Analyst [6]

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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?

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Pierre St-Laurent, Sobeys Inc. - Executive VP & COO - Full Service [7]

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We don't anticipated big changes, except if we have some commodity seeing bigger inflation. So when the inflation is a little bit 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 term of inflation in produce. So no, we won't anticipate big change going forward.

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Karen Fiona Short, Barclays Bank PLC, Research Division - Research Analyst [8]

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Okay. And then, anyway you could quantify the impact of Farm Boy and also produce on gross margins?

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Michael H. Vels, Empire Company Limited - CFO [9]

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Farm Boy is -- I -- is obviously, positive. It's just their operating model is, because of the mix, their business runs at a higher margin rate. We have not disclosed the exact basis points as it is competitive. But they also are under a higher SG&A percentage. All totaled at the bottom line, their EBITDA percentage on an apples-to-apples basis would be higher than the consolidated Sobeys' numbers.

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Karen Fiona Short, Barclays Bank PLC, Research Division - Research Analyst [10]

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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?

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Michael Bennett Medline, Empire Company Limited - President, CEO & Director [11]

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It's Michael. We're -- look, 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.

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Operator [12]

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Your next question is from Vishal Shreedhar from National Bank.

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Vishal Shreedhar, National Bank Financial, Inc., Research Division - Analyst [13]

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I'm wondering if you could provide any early color on Project Sunrise 2.0, if there's any comments you can share. And if you can't, maybe you can help us on when you might share some of the details of that.

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Michael Bennett Medline, Empire Company Limited - President, CEO & Director [14]

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Vishal, it's Michael. 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, haven't 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 to think we're going to take a holiday after Sunrise, Sunrise 2.0, and that's not what it's going to be called, we'll be aggressive.

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Vishal Shreedhar, National Bank Financial, Inc., Research Division - Analyst [15]

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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?

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Michael Bennett Medline, Empire Company Limited - President, CEO & Director [16]

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It's night and day. And as I said in the AGM speech, which I would guess most of you didn't listen to today. I guess you got better things to do and you're busy than hearing my speeches. As I said, we planted a rock solid foundation. Now this company can execute and operate and take on more and more projects and be able to have accountability. The team, the structure works. We'll probably do, 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 got some people in place. They're working well together. I am even a little surprised that this team is operating at such a high level at this point. I would've thought probably we might be 6 or 12 months ahead of where we would've thought 2.5 years ago. But that doesn't mean that we don't have work to do, we do. And the people are settling into their new portfolios. Pierre is-- he keeps 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 just doing a great job in terms of taking on Québec and then merchandising and operations 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 as you were asking.

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Vishal Shreedhar, National Bank Financial, Inc., Research Division - Analyst [17]

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Okay. 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 those uncertainty macro headlines permeate into the customer.

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Michael Bennett Medline, Empire Company Limited - President, CEO & Director [18]

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Yes. I think I'll start and then Pierre's 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 worry. Like everyone out there, we're concerned about some of things we're seeing on the horizon, and we certainly hope that there won't be a recession because that can cost 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 can give a little bit more color on it if you could.

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Pierre St-Laurent, Sobeys Inc. - Executive VP & COO - Full Service [19]

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No, I think consumer looking -- they kind of remain the new same. And you're reading stuff like we do. We need to be more relevant. The society is changing, we have less time, everything. So the thing -- 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 ourselves and we're ready for it.

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Operator [20]

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Your next question is from Irene Nattel from RBC Capital Markets.

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Irene Ora Nattel, RBC Capital Markets, LLC, Research Division - MD of Global Equity Research [21]

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Just on the category resets, just wondering as time goes on, how are you seeing the performance evolve or mature in 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?

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Michael H. Vels, Empire Company Limited - CFO [22]

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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've gone into the stores, we, of course, got better and learned from each successive week. And anything that we felt could've been improved in the early categories would already have been executed. From a negotiations perspective that was done in a very compressed time frame and in a number of very tight and controlled waves. We were 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 with the 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 of management, and we expect to capture that as we move forward post Sunrise. It's more business as usual. We are actually very satisfied with the quality of execution.

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Michael Bennett Medline, Empire Company Limited - President, CEO & Director [23]

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And just maybe I'll just add 2 things which is we were -- I think we've been really pleasantly surprised with 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 seem to -- our merchants pretty well nailed that. Very, very few changes after we put the category resets and I can't even think of one off top of my head because there are so few. The second is Mike's right that once we've done the category reset, 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's working on right now.

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Irene Ora Nattel, RBC Capital Markets, LLC, Research Division - MD of Global Equity Research [24]

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That's great. That's really helpful. And I guess that sure brings me to my next question, which is, as you think about whatever you decide to call it, I don't 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 3-year plans?

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Michael Bennett Medline, Empire Company Limited - President, CEO & Director [25]

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We're still working on it but I think it's clear as you guys can do the math that we closed the SG&A gap quite a bit on our 2 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 we've put in and the progress we've had. And the third piece that we're looking at is having more productivity in-store and getting that sales per square foot up.

When we look at our gaps 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 roadmap and which order we're going to tackle it and make sure resources are there and we don't over spend because we are not going back to the old days. So that's what we're doing.

But the prize is there, I think it's the matter now of prioritizing, putting our financial goals clearly in front of us and then having a -- just a roadmap. And 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 as Projects Sunrise 2.0, we couldn't do everything in a 3-year period, just couldn't do it. We had to get the infrastructure and the people in place and the cadence and the process. Now we can go, "let's go finish the job." And I think that's what the next 3 years will be.

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Irene Ora Nattel, RBC Capital Markets, LLC, Research Division - MD of Global Equity Research [26]

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And just a final question leading on from that. Do you see any -- from a sort of technology perspective, do you see any need to strengthen the platform, do any significant investments there? Or you're okay for now?

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Michael Bennett Medline, Empire Company Limited - President, CEO & Director [27]

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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 larger extent, that you ask them to do. But it's with some difficulty and they are 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 the companies do over the last 3 or 4 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 erase 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 kind of exciting investments executed over a period of years but really focused on the insatiable requests and desires of our merchants and others for better analytics and better insights.

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Operator [28]

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Your next question is from Michael Van Aelst from TD Securities.

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Michael Van Aelst, TD Securities Equity Research - Research Analyst [29]

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On the Voilà program that's launching in 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?

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Michael Bennett Medline, Empire Company Limited - President, CEO & Director [30]

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All right, Michael. It's a great question. What recent path is, you get it right before you go to a large group of customers. So difficult to call, our -- we don't think the test and soft launch should go for too long a period of time. But we're going to -- we'll -- 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 by postal code anyway. So what we put in our plans, and they've always been there -- since the very beginning, since actually the work that Sarah is leading it's going really, really well right now is that spring, test soft launch. My experience is you go when you're ready because you got 1 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.

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Michael Van Aelst, TD Securities Equity Research - Research Analyst [31]

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

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Michael Bennett Medline, Empire Company Limited - President, CEO & Director [32]

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It will take a few months.

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Michael Van Aelst, TD Securities Equity Research - Research Analyst [33]

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And the FreshCo in Western Canada, is there any way you can give us an idea of the relative performance to either the FreshCos in Eastern Canada or in Ontario's area or the Fresh stores in Western Canada?

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Michael H. Vels, Empire Company Limited - CFO [34]

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Sure. It's a little different -- different a bit by market as we've rolled out. But our investment has been pretty significant in marketing and promotions to make sure that we set the right price impact in customer's minds. There's clearly been some competitive response. Having said that, the sales that we're seeing across the system are in fact higher than the Safeway stores, which they replaced preopening. So we've been very pleased about that because it does mean that we've attracted new customers. And in addition to that, this -- 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 bit more mature with those stores, they're 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, pretty satisfied with them. The new format, the FreshCo 2.0, it continues to do well. And I think we've rolled it out to something like 45 stores to date. Very satisfied with the outcomes, our franchisees are happy. And so clearly 2 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's higher than the West at this point.

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Michael Van Aelst, TD Securities Equity Research - Research Analyst [35]

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Okay. And the rollout in Western Canada to the 65 stores or so, do you expect to have that done by the end of fiscal '22? Is that the timing?

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Michael H. Vels, Empire Company Limited - CFO [36]

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Yes. We're saying over the next 3 years, so I'd say fiscal '22, 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.

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Operator [37]

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Your next question is from Patricia Baker from Scotiabank.

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Patricia A. Baker, Scotiabank Global Banking and Markets, Research Division - Analyst [38]

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Michael, in your opening remarks you referenced 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.

In one area that you referenced here in discussion of the gross margin was in promotional effectiveness and I'd really like you to talk about that, if you don't mind, a little bit more. Sort of where are you in the journey of trying to drive better promotional effectiveness? When did you start? Are 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 proportional -- promotional effectiveness is pretty big for you guys.

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Operator [39]

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(technical difficulty) You may now resume. Patricia you may ask the question again.

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Michael Bennett Medline, Empire Company Limited - President, CEO & Director [40]

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Sorry, that was us. We're in Nova Scotia, but I don't think we can't 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 it.

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Patricia A. Baker, Scotiabank Global Banking and Markets, Research Division - Analyst [41]

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Neither do I, Michael. Okay. So in your opening remarks you talked about the fact that 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 referenced it in discussion of gross margins on proportional 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?

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Michael H. Vels, Empire Company Limited - CFO [42]

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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 in 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 2 years ago was margin counts. It really counts because that's what we put on the bottom line. And we need to get more disciplined and we need to get more focused on making sure that we're making smart decisions.

And then that message is being 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 say no, it's not new. But what's changed now is that we are really through the Sunrise rollouts. The merchants have the access to better tools and analytics than they did 2 years ago. We have a certified a new team with a strong leader and we're turning our eyes towards more maybe day-to-day category management and balancing that sales margin equation.

At the same time, as we referred to previously, we are investing quite heavily in new analytics and new data models to up our game in terms of measuring and then ultimately helping us with the execution of promotional effectiveness.

So it's -- I guess what I'm trying to say is that 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 promotions. I don't know if, Pierre, if there's anything you want to add to that.

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Pierre St-Laurent, Sobeys Inc. - Executive VP & COO - Full Service [43]

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Very well said. The only other thing I would like to add is the category reset exercise gave a very good knowledge of every single category to merchant. So I think they have a better ownership and understanding on every single category or SKU they have to handle in their promo planning. And like Michael said a year ago, we were more focused on structural change and now we're more focused on day-to-day business. So with that help, with the 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. So if you compare it to last year Q1 and now, I would like to congratulate the team. They passed through a big change structurally, and now they're more focused on the day-to-day business.

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Patricia A. Baker, Scotiabank Global Banking and Markets, Research Division - Analyst [44]

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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?

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Pierre St-Laurent, Sobeys Inc. - Executive VP & COO - Full Service [45]

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Yes, finally complete probably close to Q3. But by the time we get out of Q2, we're substantively done in terms of the store rollout.

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Patricia A. Baker, Scotiabank Global Banking and Markets, Research Division - Analyst [46]

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

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Michael Bennett Medline, Empire Company Limited - President, CEO & Director [47]

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Yes, I mean it was -- we -- our stores got wiped down in the 2 preceding days, especially in Halifax, 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 certain situations. The answer is 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 at the back end of it because of some of the closures and trying 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.

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Operator [48]

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Your next question is from Peter Sklar from BMO Capital Markets.

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Peter Sklar, BMO Capital Markets Equity Research - Analyst [49]

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Question on inflation. Your quarter you just reported was really 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?

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Michael H. Vels, Empire Company Limited - CFO [50]

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I'm not sure, I would go so far as to say it's decelerating. At this point, it's early. Maybe pretty consistent, I would say. But turning to tailwind, the quarter is going to endure.

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Peter Sklar, BMO Capital Markets Equity Research - Analyst [51]

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

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Michael Bennett Medline, Empire Company Limited - President, CEO & Director [52]

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Yes. I think you 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 Sobey brand was there. We -- and what we were trying to do is uncover it. I'd say compared to almost any 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 at living up to some of that brand reputation. But we're also -- we're really honing 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've pointed that out as absolutely emblematic of what we're going for and that Sandra and the marketing team working with the other executives, I think, have really nailed what the brand stands for and what we're going to stand for. Great customer feedback on all the measurements to do with that ad.

As you also see, much -- many of the things that we're going to do it 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 and her team are doing a lot of work on the brand messaging for Safeway and for Thrifty's and for Foodland. 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 noticed that.

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Operator [53]

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Your next question comes from Mark Petrie from CIBC.

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Mark Robert Petrie, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Research Analyst [54]

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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, but presumably there are larger Sobeys locations that would be really well suited to a Farm Boy concept.

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Michael H. Vels, Empire Company Limited - CFO [55]

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The answer on that one is interesting, Mark. The format has until recently been in very small footprints such as the one in the Rideau Centre in Ottawa, which is the smallest one to 28,000, 30,000 feet at the top end. But we are looking at some new stores including 1 in Ottawa, which is going to test the upper limits of that box size and look at putting some new and innovative ideas into a little more square footage. The great thing about the concept is that it is very flexible. The mix stays the same, but the flexibility in the pictures and the layout is such that it does fit into and is very successful in a wide range of floor plates. So I -- unlike, say, for your Sobeys or FreshCo, we don't have that as tight a range for where -- how that format would work as you might think.

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Michael Bennett Medline, Empire Company Limited - President, CEO & Director [56]

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The only thing I'd add before anyone jumps on me. These were Jean-Louis and Jeff's ideas to go into the -- and try different size formats, which they think they can really execute upon and -- but keep that fantastic brand and everything they are trying to do there. I think that if they were on the call, J-L and Jeff would tell you that the prowess of our real estate team and some of it -- what we had, I mean there's one at [Yonge] in Edmonton, that's going to be at Farm Boy, like everyone knows that probably already. That was going to be Sobeys. We -- it'll be a larger than prototype Farm Boy, but they are going to -- I think it's -- that's just situated better to be at Farm Boy store in that area and we're seeing all sorts of opportunities. But 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 their real estate group and our executives, it's working real well.

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Mark Robert Petrie, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Research Analyst [57]

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Okay. 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 commented, and FreshCo West and Voilà overtime. So does that sort of require a pickup in spending? Or consuming 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?

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Michael H. Vels, Empire Company Limited - CFO [58]

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I don't think I would walk away with an assumption that we have to ramp up our SG&A spend. So you take out the impacts of Farm Boy, the distortion of the last year onetime 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 could be wrong to say that we anticipate a significant ramp up 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 opportunities and some more capability to close that SG&A gap, not quite as much as we do it in the big line on the COGS on sales. So I think you're going to expect us to continue to be very, very focused on becoming more efficient on that line, not less as the year progresses.

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Mark Robert Petrie, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Research Analyst [59]

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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 into different offices. I guess that was sort of 1.5 year 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 derisk?

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Pierre St-Laurent, Sobeys Inc. - Executive VP & COO - Full Service [60]

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I think through the category reset exercise, we worked together, all format, all region together. We remain -- mainly, we have our grocery team or English has it, art and the fresh team in Toronto. We remain a -- we kept the team in Québec, and now we are more focusing on format. And so we have merchandising people across the country to be close to customer needs, which is a good thing but the team is 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 is in our processes now and we have a national governance for all formats, all regions. So we learn from -- we took the best, and we lost the worst. But 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 2 worlds and we're leveraging size of the company and we remain close to customers.

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Operator [61]

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Your next question is from Keith Howlett from Desjardins.

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Keith Howlett, Desjardins Securities Inc., Research Division - VP, Consumer Products & Merchandising Analyst and Retail Analyst [62]

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I'm wondering if you could update us on your work on private label

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Michael H. Vels, Empire Company Limited - CFO [63]

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Update on private label.

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Pierre St-Laurent, Sobeys Inc. - Executive VP & COO - Full Service [64]

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We reviewed the branding, the look and feel of the brand. I think we use -- some new look and feel of the new complement logo and everything. I think the new logo will fit better in our shelf, it would be -- we have a better view and these products, in our shelf, it's going to go behind that. And the best thing is through category reset, we revised every single category, a specific role for our private label. And in some category, private label will play a specific role and in another, a different role. And so I think it's the bigger thing we did over the last year and we're seeing already positive results by adding, I would say, stronger joint business plan between our national brand and our private label. And private label have a, going forward, a specific role to play in the category. So it's where we are. The new image will be finished by the end of this fiscal year. So it's the plan. It's already started and we finished. It's 3,500 products that we need to redesign the packaging and everything, plus couple of new products for sure.

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Keith Howlett, Desjardins Securities Inc., Research Division - VP, Consumer Products & Merchandising Analyst and Retail Analyst [65]

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Then I just was wondering on the square footage. In terms of the doubling of Farm Boy over the next 5 years, how do you anticipate that'll breakdown between conversions of existing Sobeys or FreshCo real estate versus greenfield?

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Michael Bennett Medline, Empire Company Limited - President, CEO & Director [66]

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Well, I think that they're going to -- we don't want to 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 Farm Boy fits better than our current banner, we're going to make that conversion. And I think that the only thing constraining us from even higher growth at Farm Boy is to make sure that they can handle that kind of growth and there's a certain number of stores in the next couple of 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 are probably a few more stores that could be converted especially in the densest parts of Toronto that we're going to go forward with.

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Keith Howlett, Desjardins Securities Inc., Research Division - VP, Consumer Products & Merchandising Analyst and Retail Analyst [67]

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And then just on the FreshCo banner, how did the -- I don't -- you may not want to speak to this, how are the Chalo FreshCos working British Columbia versus, say, the normal FreshCos?

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Michael Bennett Medline, Empire Company Limited - President, CEO & Director [68]

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The Chalos that we've opened -- the couple we've opened in Western Canada are interestingly one of the strongest because we've only opened a hand full of stores. But if we're happy with the FreshCos, we're extra happy with the Chalos. I think they are very -- I think our FreshCo offering overall is differentiated and our Chalo is even more differentiated than that market. They standout even more than they would in Ontario. So in fact, we were just talking about that today how pleased we are with Chalo in Ontario and in the West.

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Operator [69]

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

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Katie Brine, Empire Company Limited - Director of IR [70]

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Thank you, Joana. Ladies and gentlemen, we appreciate your continued interest in Empire. If there are any unanswered questions, please contact me by phone or e-mail. We look forward to having you join us for our Second Quarter Fiscal 2020 Conference Call on December 12. Talk soon.

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Operator [71]

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