Canadian Tire Corporation Ltd

TSX:CTC.A

Earnings Call Transcript 2019-Q2

[Operator]

Good morning. My name is Louise, and I will be your conferencing operator today. At this time, I would like welcome everyone to the Canadian Tire Corporation Limited second quarter conference call. [Operator Instructions]This morning, Canadian Tire Corporation Limited released their financial results for the second quarter of 2019. A copy of the earnings disclosure is available on their website and includes cautionary language about forward-looking statements, risks and uncertainties, which will also apply to the discussion during today's conference call.I will now turn this call over to Stephen Wetmore, President and CEO. Stephen, please go ahead.

[Stephen G. Wetmore, CEO, President & Non]

Thank you and good morning, everyone. As the operator just informed you, we announced our quarterly results earlier this morning and the details of our acquisition of Party City. In the interests of time, I'll keep my remarks short to leave time for your questions and for Allan and Dean to provide more detail.From a financial performance perspective, this quarter our Financial Services business delivered strong results, with GAAR growth of 8.4%, while maintaining a risk profile that is well within our operating parameters.In Retail, despite some weather volatility in the quarter a very strong June allowed us to achieve respectable comp growth of 2.2% and year-to-date comp growth of 3.8%. Our Retail revenue rebounded to 7.9% in the quarter which overcame the imbalance we saw in the first quarter.As I mentioned briefly at our first quarter and at our AGM, our company's strength is in execution. Our digital performance metrics continue to exceed our expectations for web and app traffic and our e-commerce sales are generating industry-leading growth in Canada across all banners. We recently appointed John Koryl as President of CTC Digital to further accelerate the development and execution of our digital capabilities and strategies across the company.Mark's and SportChek's rebranding has been a huge success. Our consumer brand strategy is driving impressive growth and will be strengthened by the announcements this quarter.Triangle Rewards is allowing us to build a connected marketplace, driving loyalty and increased share of wallet.And Helly Hansen is meeting our aggressive growth plans both here in Canada and throughout their international markets.All our strategic initiatives are on schedule, which brings me to our operational efficiency program. We divide our program into 2 parts, one focused on top line and margin growth, which has been successfully underway for a number of years and is continuing; and part 2 is our current primary focus, to reduce our supply chain, technology and all our operating expenses in order to achieve our stated aspirations for earnings and ROIC growth.Last year we asked Iain Kennedy to entrench himself in key processes across our organization, including supply chain and information technology. He has provided the blueprints to our organization's processes, allowing us to move our program to a new level to the point where we can start executing. So we have reached the stage where we can hand the complete enterprise program off to operations.With that, I am very pleased to announce that Greg Hicks has agreed to lead our operational efficiency program going forward. If you want something done give it to a busy person is our motto here. And the same holds true for Greg Craig, who has agreed to drive the financial analysis which is critical for success. We've also engaged world-class talent to work with our teams and I have every confidence that we will again, as always, execute flawlessly over the coming many months. This phase of our program is a significant companywide transformational effort that we officially launched internally last week and it's our intent to keep you apprised of our progress over the coming quarters.Allan and Dean are going to expand further on our Party City investment and comment on Helly Hansen progress, so just let me say one more thing before I hand off to Allan. I would like to officially welcome John Pershing as our new Chief Human Resources Officer. John is a seasoned leader who has assembled high-performing teams and led global companies through retail disruption. We're excited to have John join the team and also guide the people and structure components of our operational efficiency program.So with that, I'll hand off to Allan.

[Allan Angus MacDonald, Executive Vice]

Thanks, Stephen. Good morning, everyone.Well, let me first start by saying how pleased I am to welcome Party City to the Canadian Tire family. It's a great addition to our Triangle marketplace. As I've said in the past, we've set aggressive targets to continue to grow in Canada by building or acquiring to capture opportunities in adjacent categories, or with high-value customer segments like younger Canadians and families.With this acquisition, we're doing exactly that. We've been looking at the party supply category for a while now and we've been putting our data to work. We've been examining every aspect of the category and consumer engagement. For example, I can tell you Party City customers skew younger and spend 60% more at Canadian Tire than our average Triangle Rewards member each year. It's a natural extension for us and has a lot of room to grow. The category is almost $2 billion in Canada today and it's actually quite fragmented. By combining Party City and Canadian Tire, we'll consolidate 2 significant players and immediately become the #1 party supply retailer in Canada.So in terms of our plan, we have 4 important initiatives to execute. First, we'll be rolling out a subset of the 45,000-SKU Party City assortment to Canadian Tire Stores across the country. The formats will vary from shop-in-shops to dedicated Party City aisles, depending on the store. Second, Party City's assortment will be available on canadiantire.ca to the 300 million visitors to our website each and every year. Third, Party City will become the newest member of the Triangle Rewards program, with earn-and-burn privileges at Party Stores. And fourth, we'll be looking at opportunities to expand the Party City store network to new markets.We're going to bring Party City's innovation and unique specialty assortment to Canadians across the country and drive more trips and bigger baskets by becoming Canada's celebration store. With our One Company, One Customer strategy we have been advocates of building a marketplace of strong brands and retail destinations. Combining those assets with an iconic loyalty program and credit card creates a world of opportunity to introduce our customers to new products, categories and brand. This announcement today is a perfect example of the power of our marketplace to create new opportunities for growth.With that, let me make a few comments about the quarter. Party City is just the latest and big example of our continued momentum in expanding our consumer brands portfolio in Canada and abroad. Consumer brands in Canada were -- in terms of sales were up 7% in the quarter and our penetration rate has now reached 36%, up almost 200 basis points from last year. So we're pleased to tell you we're on track with our plans for these assets. Today we have more than 15 consumer brands, each with annual revenue over $100 million and growing.And just like Party City, we said we will continue to build or acquire brands to strengthen our position in key categories or create new opportunities for growth. That's why we're also announcing the acquisition of 4 new cycling brands, including Raleigh, Diamondback, Redline and IZIP. In 2018 we sold over 600,000 bicycles, so who better to own iconic brands like Raleigh and Diamondback than Canada's bicycle store? The opportunities with these brands are quite obvious. They solidify the brand structure within our assortment. They provide a nice coverage at the best and performance ends of the spectrum. And they give us a great opportunity to introduce new accessories in the store and online.After a couple of years into our consumer brand strategy, I'd offer a few observations. We've learned a lot. We've got a good feel for where we have opportunities to shore up some categories with iconic brands and where we have some opportunities to drive growth. We've created a playbook that works. Before any decision is made we build a plan for these brands that includes everything from strategies for our stores and online to product design, marketing and assortment planning.Probably the best example of this playbook in action is Helly Hansen in Canada, our biggest project to date. So far we're on track with our plans for bringing Helly Hansen to life across Canada with expanded assortments online and in stores. And it's working. Helly Hansen sales in Canada year-to-date June were $39 million, up 63% in Q2 alone. I'm very proud of the partnership with the Helly Hansen team and together we've strengthened the Canadian Tire marketplace. I'm looking forward to more opportunities like this in the future.Now let me quickly run through the highlights of the quarter. At CTR we were up just shy of 2% comp sales growth with decent results at the end of May which culminated in a record June when retail sales exceeded $1 billion. We had strong revenue performance in the quarter and while we were left with some excess inventory versus last year, the vast majority of that has been shipped to dealers in Q3.Our growth in the quarter was driven by our 2 largest businesses, Living and Automotive. Auto service was up 3 1/2% in the quarter, as CTR has been significantly strengthened by combining new data capabilities with targeted offers for auto service and tires customers.SportChek had a strong Q2, which was the fourth consecutive quarter of growth for the banner, up 3.7%. Our Consumer Brands performance was a highlight at SportChek, increasing an impressive 47% versus last year and now representing nearly 11% of sales.Helly Hansen is the second largest of our Consumer Brands at SportChek and is playing an increasingly larger role in making SportChek a destination for categories like rainwear. You'll see the full spectrum of Helly's assortment in stores for the first time in Q4.Mark's also had a good quarter with comp growth of 2.6% despite a cool and wet spring.There are many things to highlight here, but in the interests of time, I'm going to hand things over to Dean to walk through the financials.

[Dean Charles McCann, Executive VP & CFO]

Thanks, Allan. I'll follow suit and start by addressing our newest acquisition announcement.As Stephen and Allan said, adding Party City Canada to our family of companies provides us with another great platform for growth. With the purchase of $174 million, which includes $40 million of inventory, we get all the assets of the Canadian operations, including a network of 65 stores across 7 provinces as well as their e-commerce business which has generated strong financial performance in recent years.Party City Canada's past 3-year CAGR for revenue is 10-plus-percent, while EBITDA category has been 40%. Greg Hicks and team have ambitious targets to double Party City's Canadian business by 2021 and plan to continue growing strong EBITDA growth, building on Party City Canada's existing momentum. This expected growth makes this acquisition extremely attractive for us at a forward 2021 expected EBITDA multiple in the mid- to low single digits. These valuations don't reflect the past. They reflect what CTC can bring to this business.The same impact is true for Helly Hansen and now 1 year later based on our latest forecast we are right on track with our original business case that will put Helly Hansen '21 forward multiple in the mid-single digits as well.Moving to Q2, I want to remind you that we have, as Stephen mentioned, launched the latest operational -- latest phase of our operational efficiency program and have isolated approximately $8 million for the quarter related to both execution costs of the program and impacts related to permanent removal of costs.To explain our performance in the quarter, I've broken out the impacts into 2 categories -- first factors that impacted us positively and second, factors that didn't go our way in the quarter.Starting with the first category, I'll highlight what went well. First, our retail sales and revenue were strong and all banners contributed positively to our performance. Retail comp sales grew 2.2% year-over-year and retail revenue increased 5.7%, 4 1/2% excluding Helly and Petroleum.Second, our Financial Services business experienced continued momentum with strong IBT growth and gross average receivables, GAAR, which increased 8.3%. GAAR growth was driven by both a higher number of accounts, up 4.3%, and an increase in the average balance, up 3.8%. This reflects our shift in focus towards growing customer engagement which we talked to you about last time we were on our call. Credit metrics are performing extremely well and we continue to monitor the health of the Canadian economic conditions on our portfolio. An important risk measure, which we call the PD2+, referring to accounts that are 2 periods past due, was essentially flat the last year, an indication that there were no concerning trends in our customers' payment behavior.Third, Helly Hansen's earnings performed as expected in Q2 and year-to-date. I'd like to remind you that Q2 is the lowest revenue and earnings quarter for Helly Hansen and as I mentioned earlier this business is tracking very well against our expectations at the time of the purchase.And fourth, a planned real estate gain of $16 million was recorded for the sale of the gas bar property in Toronto, a positive on our earnings.And finally, one more impact, call it, is related to tax. A settlement with the Ontario Ministry related to prior years resulted in a pretax interest income pickup and an income tax recovery of about $7 million and $3 million, respectively.Now switching gears to the second category, the list of items which didn't go our way in the quarter. First on that list is that the Retail segment margin rate was not as strong as we would have liked. Excluding Petroleum, our gross margin rate declined 120 basis points. The better part of this decline, approximately 100 basis points, came from CTR and was driven by 2 key impacts. One, we recorded a lower benefit than last year from a true-up related to the margin sharing arrangements with dealers. And, two, our shipment mix was dominated by lower-margin Living products which were flying off the shelves while our more profitable Seasonal business took a back seat, impacted by the cooler start to spring.The balance of the decline was due to investments and promotions to offset softness in performance driven by weather, mostly at Mark's -- it's hard to sell shorts when the weather's that poor -- and higher freight costs, particularly at Chek, related to our strong e-commerce sales growth.Second is the tougher environment for the Petroleum business. Consistent with other industry players, our gross margin was hurt and it was down over $7 million in the quarter from an increasingly more competitive marketplace and the newly introduced carbon tax.Third, higher interest costs related to deployment of the capital to buy the Helly Hansen business increased interest expense by another $7 million versus last year.And in Q2 our EPS was lower by $0.08 due to the sell-down in Q3 of '18 of a portion of our interest in the REIT.Moving to inventory, corporate inventory is in a very good condition but it is up about $370 million at the end of the quarter. About 1/2 of that is Helly Hansen. The balance of the increase came mostly from CTR in the Seasonal and gardening businesses which, as mentioned earlier, didn't perform to their full potential due to the cold start of the season, particularly May. And as we sit today I'm very pleased to say that in July alone the team has worked through well over 1/2 of that inventory surplus. So we're in very good shape.We also had the deliberate increases at SportChek we commented on before, as T.J. and team stocked up in the quarter to better meet customer demand.Stephen talked earlier about our focus on improving our operational efficiency which combined with our focus on high-quality investments will contribute to growth in the business and help us achieve our financial aspirations. In the quarter our OpEx performance reflects a more muted trend in our spend. And when we strip out the noise related to IFRS 16 and include Helly Hansen our consolidated in Retail OpEx versus last year has increased minimally on a year-over-year basis. And while it may not be obvious in our financials, the normalized Retail OpEx ratio, excluding Petroleum, IFRS 16 and Helly Hansen, has actually improved by 23 basis on a year-to-date basis and 42 basis points in Q2.Retail ROIC has increased to 9.2% in the quarter and while I'm pleased with this result its trajectory to our 10% target isn't going to be a straight line as our invested capital will start reflecting the full year effect of Helly Hansen's acquisition as of Q3.Another note. This quarter we also launched a new US$1 billion U.S. kind of commercial paper program that reduces our short-term borrowing costs. This program is an additional source of funding and our first from the U.S.And lastly, with respect to the balance of the year I want to remind you all that in looking forward to Q3 we did highlight 2 notable unusual items which impacted the Financial Services performance positively for Q3 '18, which we will not have this year. They were an allowance benefit of $15 million and a pickup of $20 million for the change in methodology to record recoveries.And with that, I'll hand it over to the operator for the Q &A.

[Operator]

[Operator Instructions] Our first question is from Patricia Baker, Scotiabank.

[Patricia A. Baker, Analyst]

My first question I guess is for you, Allan, on Party City. And judging from the slide deck that you put out you've got a lot of detail in here on the Party City customer and the overlap with the Canadian Tire customer. So it seems to me that the Triangle -- the whole Triangle data and the Triangle program was very instrumental in helping you make the decision to acquire Party City. Do you think -- is this the first big strategic move you've made where the Triangle has played such a large role? And do you envision Triangle kind of being a guide or a lens for you in kind of future strategic activity?

[Allan Angus MacDonald, Executive Vice]

You've caught us. In terms of first, I'd say it's probably the first most material. In Stephen's comments at the AGM, he said that creating the Triangle marketplace was probably the most strategic thing we've done in his tenure as CEO. And that was at the time I think for the most part interpreted as a rebranding exercise of the Canadian Tire Money program and really just an extension of the loyalty program. And in fact what we were trying to do was create an umbrella brand that sort of created a marketplace for us that allowed all of our individual banners and our consumer brands to maintain their unique identity. But the sum of the parts is greater than the whole. And it created a vessel for us to start -- expand the business and include other assets that could take advantage of this captive marketplace.The most important thing here is it becomes a self-fulfilling prophecy. The marketplace is stronger because of the assets in it and the assets in it are stronger because they're part of the marketplace. So Party City is going to make Triangle Rewards more attractive to customer segments that are frankly very interesting to us like young families, millennials. And Party City is going to benefit hugely. I mean if you were the President of Party City today you go, "Well, tomorrow virtually, I'm going to be in 500 Canadian Tire stores and be on the Canadian Tire flyer and be part of the Triangle Rewards and credit card program. That's a huge lift."So we're trying to make this one of the most coveted marketplaces in Canada. And I think today what you're seeing is our strategy -- the first probably most material announcement we've made in bringing that strategy to life. At least that would be my perspective. I don't know, Stephen, if you would anything.

[Stephen G. Wetmore, CEO, President & Non]

No, all set.

[Allan Angus MacDonald, Executive Vice]

So thanks for the question. It's a big day for us.

[Patricia A. Baker, Analyst]

Okay. I'll follow up if I may. I'm just looking at -- apart from Party City, but looking at the Canadian Tire business and specifically looking at SportChek in the quarter. You mentioned in the release that you had significant growth in e-commerce sales at the SportChek and that that impacted the margin in the quarter because of higher freight costs, which everybody can understand. It would be really helpful if you could share with us any data that you can on where you are in SportChek with regard to your e-commerce. You gave us some good numbers today on penetration of owned brands at Sport and at Canadian Tire. Can you give us maybe even just directionally or ballpark of where you might be on e-commerce penetration at your various banners but in particular at SportChek because I believe that's probably where you have the highest e-commerce penetration?

[Allan Angus MacDonald, Executive Vice]

Yes. Well, it's funny because we debate the right way to think and communicate about our progress in e-commerce. And our strategy as we've said a number of times is to remain competitive, vigorously protect our share, but not cause disruption within the market unnecessarily by overreacting. And I feel like we've stuck to that and have been very, very diligent in being prepared to be competitive and defend our share. That's a really hard thing to communicate, though, when there are sort of nebulous facts floating around, like how much is online and how under attack we are. And so that's always been a challenge for us.I can tell you that every quarter we review in great detail a lot of data that talks about the transformation or the impact that e-commerce is having in our businesses in every one of our categories. And when you have a business like SportChek it's a little easier because there's comparators. When you have a business like Canadian Tire, Canadian Tire is effectively in itself a marketplace. So you're dealing with the tire business or the kitchen business. You're dealing with large cube items in bulk and so on. So it's a little more difficult.To your question, though, this quarter I can tell you that in terms of SportChek we've used that business as our leading banner in terms of understanding and aggressively competing in the e-commerce space. And it's worked really well for us. We've had some missteps over the course of the last couple of years. There's no question. But for us, it's been our sort of bellwether in terms of our capability for e-commerce.I think it would be surprising if people looked under the covers to see that if you take a SportChek -- if you take SportChek's performance and compared it to the performance of sporting good apparel and footwear retailers in the States, we're neck and neck in terms of same-store sales growth. Actually, in a lot of cases, we're ahead. And quite honestly, our e-commerce penetration would be right in the average of where the likes of the big U.S. retailers are around the sort of 13% to 15% range of e-commerce penetration of sport wear -- sporting-goods apparel and footwear retailers in the States, which I think would surprise most people because it's not something that we spend a lot of time talking about. But that category has had aggressive online sort of migration and SportChek has been right there defending it. But at the same time, all the work we've been doing at SportChek has been paying off because our bricks and mortar is equally performing really well. So I think T.J. and the team [ Koryl ] have done a really nice job creating a competitive offering. We're no slouch; we can hold our own when it comes to e-commerce. But that's not our source of growth either. We're just as focused on our stores and getting the assortment right as we've ever been.So when it comes to the rest of the banners you can use the same philosophy. We're going to be competitive and vigorously defend our share. And you can rest assured that's what's happening with the other banners, too. Sorry for a long answer, Patricia.

[Operator]

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

[Peter Sklar, Analyst]

On the operational efficiency program -- this is something you've mentioned a few times on the call now. You also mentioned that it's really taking effect this quarter. Can you provide us some -- it's all a little vague to me. Can you provide some examples of maybe what are the biggest elements of it, provide some more specificity just so we can get our hands wrapped around what this really means?

[Stephen G. Wetmore, CEO, President & Non]

Yes. It's Stephen. If you look at the organization, Peter, you obviously -- you go where the big numbers are. And so from that aspect of it what we've had underway for the last probably 4 years I guess, well the huge focus has been on cost of sales and top line and promo and pricing and efficiency at that level, which over that period of time has taken -- or put hundreds of millions of dollars under the margin line, which combated a whole bunch of headwinds that we had at the time. Those programs continue and I think the primary driver of those is CTR, only because of the size of the numbers. But those programs have now been implemented within Mark's and is on T.J.'s kind of top strategic priority list as well. So they will continue and you're never going to get yourself to greatness here by not -- by taking the focus off the top line. So we're very, very much still concentrating on cost of goods.When you come down below that and the portions of it -- your big buckets are supply chain. Your big buckets are information technology, the efficiency of marketing. And after that it gets into the corporate world and their individual HR, finance, et cetera. So your programs have to concentrate initially on the big processes that drive your costs. And they drive costs through supply chain and technology. So when I reference the supply chain technology that Iain Kennedy has worked on through the past year, we have our focus within those. We know the processes we'd like to change at this stage of the game. More work to be done. Not saying that. But we have rough numbers in about 8, 10 categories that we know we're going after. And so on a very logical, prioritized basis along with assistance of some folks that we've hired to assist us, Greg Hicks and team, along with the enormous requirement for tracking of this that Greg Craig will be focused on. We'll dive into the processes, dive into where we're spending our money, how we can change, how we can transform, inject technology in and simply reduce our costs through those big cost buckets. And they'll be prioritized. Some of them will be a little bit of low-hanging fruit initially, I think, like the $7 million or $8 million, for example, that Dean would have referenced in the quarter is really low-hanging fruit, and we'll get some of that that we want to get in before we start the 2020 fiscal year.So I think over the coming months, if we have -- if we get fairly confident with some of the numbers that we're driving towards, I don't have a problem in probably discussing them with you. But it's early days at the moment. And if you -- if I tell you we're after $200 million or we're after $800 million, then I'm going to have to report on it every quarter. And so I'm just kind of shying away from that at the moment. But this is a monster program for us that affects every piece of our business, which is why we had quite a substantial kind of internal launch and will for the next month or so.So stay tuned. We'll try to tell you as much as absolutely possible as the quarters go along and I think as Greg Hicks and his team become even more comfortable with what's ahead for the next 12 and 24 months.

[Peter Sklar, Analyst]

Okay. And then just my last question. Switching gears to the SportChek comp, I'd just be curious to hear, was management satisfied with the SportChek comp given the tailwind you would have had from all the -- with what went on with the Raptors and the associated merchandise and apparel?

[Stephen G. Wetmore, CEO, President & Non]

Well, look, what happened with the Raptors was absolutely fantastic. We're all really, really pleased. I think there's a lot of optimism in terms of the size of the Canadian jersey market though. T.J., do you want to offer a comment too?

[Thomas J. Flood, President of FGL Sports]

Yes. I think, Peter, it's a good point. We did have some tailwind, but I think if you think about the materiality of that tailwind relative to the size of our business, we felt very good about the other areas of our business in terms of its growth. And obviously, it was a great brand builder for us. We did a lot of things in the City of Toronto, both SportChek and Canadian Tire, in terms of refurbishing basketball courts, and we had a lot of excitement at our Maple Leaf Square store.But the -- certainly the growth we achieved in Q2 wasn't just on the backs of the Raptors. A little bit of tailwind there, but we're actually excited about other categories we're able to grow like footwear and apparel, accessories. So we had a pretty strong quarter, and we're excited about the growth prospects as we head into the back half of the year.

[Peter Sklar, Analyst]

Okay. Like maybe you misunderstood my question. Like I found the quarter a little bit weak given the tailwinds you would have had from the Raptors. Did you not find it that way?

[Thomas J. Flood, President of FGL Sports]

No, I don't think so. I think the materiality of the license business, which is where we got the predominant amount of growth from Raptors, was very strong. But relative to the size of our overall SportChek business, we felt very good about the performance of the quarter.

[Peter Sklar, Analyst]

Okay. I understand what you're saying now.

[Operator]

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

[Irene Ora Nattel, Managing Director of Global Equity Research]

Just extending the whole Party City conversation. So as we think about Canadian Tire and Triangle on a go-forward basis, should we be expecting ongoing potential acquisitions of whether it be in addition to specific brands, other retail offerings that could conceivably appeal to your core customer? And I guess, related is if the answer is yes, at what point do you start getting concerned about complexity of the number of retail banners that you're operating?

[Stephen G. Wetmore, CEO, President & Non]

Irene, it's Stephen. I -- well, we've been acquiring here at various levels for a while now, so it's an ongoing strategy of our Consumer Brands side. There's absolutely no doubt about that. This is the -- I'll rattle it off here. I think I'm right. This is the first kind of -- or brand acquisition that is nonspecific, if you will, to a product category. So we tend to -- if you're doing a little bit of Golfgreen or you're doing Paderno, et cetera, and building those brands have been product-specific. I think where this one is wandering off a bit, and it's not -- and it is different because the brand itself represents a complete assortment and in this case obviously has stores that run with it and enables us to really play the Triangle Rewards card from an earn-and-burn perspective. If we -- but we start this by looking at categories that we're interested in growing -- this culmination that we announced today in terms of the transaction, if you go back 8 months or 9 months ago, Greg Hicks was talking to Party City because he wanted a supply agreement. And the supply agreement led to an ongoing discussion which has led to today.So its origin is always in product categories that we feel we're weak. We want to extend our consumer. There was a position for it in the good/better/best category, attracting the customer segments that we want, et cetera, et cetera. So it has to meet all the criteria. This one is unique. But if there was another one that is as good as this one, then we'd grab it providing it fits into the strategy of what Greg and T.J. and P.J. want to execute for Allan. So that's kind of how we look at it, if that helps you.

[Irene Ora Nattel, Managing Director of Global Equity Research]

Yes. No -- and actually, that's quite helpful. So as you look at your categories, do you see any other areas that you really think could or should be strengthened in order to enhance the competitive positioning?

[Stephen G. Wetmore, CEO, President & Non]

Yes. You want me to tell you what we're going to buy next; I'm not going to tell you, but absolutely we do. And there's -- like I said, though, it goes back to those criteria, okay? So really if the customer segment is what we need for the experience overall, strengthen the -- the marketplace within CTR, as Allan referenced earlier, is a complex marketplace. So you have to really break out all the different segments of it down to identify the areas that we're focusing on. But the -- we see a lot of opportunity in doing this, and Consumer Brands is continuing to develop our brands and our products that we want to launch within the store. So yes. And look at the contribution that -- when we announced the Consumer Brands in the fall of -- '16, was it?

[Allan Angus MacDonald, Executive Vice]

'16.

[Stephen G. Wetmore, CEO, President & Non]

The idea was to generate an expertise in here that would allow us to generate our own, come up with the playbook that is necessary. And I would say that it's most likely taken us from then -- oh, probably taken us the last 2 years for Allan and team to come up with a playbook, if you will, for developing products, acquiring products and acquiring brands that we know how to actually launch. Obviously, Helly Hansen finished the playbook, if you will, in terms of having all the chapters written on how to do it. But -- so this is going to continue to be an enormous focus for us as it extends our marketplace tremendously.

[Irene Ora Nattel, Managing Director of Global Equity Research]

That's very helpful. And then just looking at the quarter, so the gross margin pressure, certainly understand, well, given the lower sales of seasonal products. As we move forward, putting aside the Petroleum business, would you expect to see strengthening in the gross margin percentage assuming sort of a more normal flow-through of seasonal sales?

[Dean Charles McCann, Executive VP & CFO]

So just on -- I mean, I'd just make one comment. Maybe Greg and Allan want to chip in. But with respect to a significant portion of that impact in the quarter, the 120 basis points if you just look at pure Retail, a high proportion of that was related to CTR, right? You can isolate the CTR, about 100 of that 120, I would say. And about half of that, a little more than half of that, is related clearly just to the year-over-year impact of the MSA, right, which we talked about in the first quarter and is an event, if you will, just a function of the forecasting of that and truing it up in the quarter. So on a go-forward basis that should be parked, right? We shouldn't see that on a go-forward basis and work on getting our estimates a little truer, right, as we go into the back half of the year. So I would leave it there.With respect to the mix, maybe I'll turn that over to the guys, right, to talk about it in terms of the back half because really, it was just -- they got good -- as I say, they got good revenue growth, but they sold some different stuff than we would have expected or liked to in the quarter simply because, as I have said many times, I played -- I went and had breakfast at the golf club more times in April and May than I played golf. So...

[Gregory Huber Hicks, President of Canadian Tire Retail]

Irene, it's Greg. So I think -- I mean, Dean did a good job just kind of articulating what happened with respect to how the season came to us from a sales standpoint and its impact on replenishment in the quarter. Lack of seasonal replenishment led to nonseasonal kind of really being a more predominant part of the mix, which is at a lower margin profile.But I guess from a contact standpoint, I'd say we continue to be pleased with the team's management of our product gross margins. It's really only been the last 2 quarters where we've experienced some margin rate softening, and a good portion of that in both quarters was the MSA issue that Dean talked to.I'm not sure we would have managed the quarter any differently if we had to do it again. We managed to deliver the best June sales performance we've ever had. And you all might laugh at this, but with later season breaks, this traditional quarterly report thing is becoming a little bit more difficult to manage our disclosure with you. The season was really just getting going, and then the quarter ended and we're here having to talk about it. So I know we're not going to figure that one out, but I guess I would summarize by saying we're confident in the underlying health of the business. We think that the performance of our nonseasonal businesses demonstrates this, and we're always there when Mother Nature eventually calls. So all this to say I'm happy where we ended, and as I look forward, I feel very strongly about our margin fundamentals.

[Operator]

Our next question is from Mark Petrie from CIBC World Markets.

[Mark Robert Petrie]

Actually, I just wanted to follow up on that last topic with regard to mix and then I guess the sell-through of your seasonal inventory in Q3. I mean should we just interpret that as a tailwind for margins given that those products, as you highlighted, are higher-margin in general? Or would that be happening at sort of lower margins because of a greater promo or clearance penetration?

[Gregory Huber Hicks, President of Canadian Tire Retail]

Yes. We don't anticipate the need -- I think Dean tipped his hat with respect to, I think, what's happening with the inventory relieving from the balance sheet. Given that's happened over the last number of weeks, we don't anticipate the need to aggressively discount that would be any different on a year-over-year basis.The only thing I'd add, and Dean touched on it in his commentary, is we're really having some great health in our nonseasonal business, which does have a lower gross margin. We would expect that to continue into Q3 and Q4. I mean the Living business, which is our single biggest division, posted an 8 comp on top of a 9 comp in Q1 and a really strong comp performance in Q4 last year. So as long as that continues, we'll have a little bit of pressure to manage on our overall rate but feel pretty strong that we'll be able to deliver the dollars. I just think that now the seasonal replenishment kicked in, we'll be able to balance that market a little bit more effectively than we could in Q2 when there was virtually no seasonal replenishment whatsoever. I mean nonseasonal revenue was driven -- over 80% of it was driven by -- or, sorry, revenue in the quarter was driven by nonseasonal businesses, over 80% of it. So that kind of just pulled down the overall margin. So hopefully, that gives you a little bit of color in terms of how we're thinking about it in Q3.

[Mark Robert Petrie]

Yes. That's helpful. Just on Party City, I think one of the pillars of their sort of overall total business is the vertical integration. I think you -- I know you mentioned you have a 10-year sourcing agreement. But could you just talk about how that works, how you're going to sort of manage assortment and what your longer-term strategy would be in terms of developing your own sourcing?

[Gregory Huber Hicks, President of Canadian Tire Retail]

Yes. So we're really excited about the fact that as part of this deal, Mark, we've signed on a long-term supply agreement. As you point out, Party City has tremendous scale and is a vertically integrated operator, maybe the world's kind of largest wholesale supplier of party supplies. They have tremendous scale -- 10 manufacturing facilities. They've got relationship with over 1,200 suppliers. So it was extremely important for us to establish this multiyear relationship with Party City as part of the deal. We've been very impressed with their sourcing teams. They have very tight relationships with the movie houses. We're going to get all sorts of kind of exclusivity around licensing and direct-to-retail relationships with brands like Disney and Marvel and all the things that kind of make the business tick, especially around the Halloween timeframe. And we're going to work with them very closely, our style and design and our sourcing teams and their customization and design teams, to really develop an assortment that's unique and differentiated for Canadian Tire going forward. So it's really kind of a back-end partnership for procurement with what we believe to be the world's best authority in this business.

[Mark Robert Petrie]

Okay. And then just one other one on Party City. I think this category's been pretty significantly shifting to online. Looks like Party City's been pretty active and that's been a big focus of their strategy. How has that evolved in Canada? And how will that actually be executed at Canadian Tire? Is that going to happen sort of through your existing supply chain? I think they fulfill right now from the U.S. What's your plan in terms of building the online business?

[Gregory Huber Hicks, President of Canadian Tire Retail]

Well, I'd start by saying, Mark, we absolutely view this business as a multichannel business. The category has economic characteristics that generally lean towards more bricks than clicks, things like low dollar profit per unit, seasonal churn. It's got a really long turn -- a really long tail, sorry, from an inventory standpoint. There's a real trip assurance requirement for celebrations -- you really can't afford to have your package be delivered a day late for your child's first birthday and the fact that balloons can't be shipped online, to name a few. But from a customer standpoint, preplanning for parties and celebrations and a younger demographic certainly lend the model well to online.So we would intend to be very active with both channels and believe that Party City's current online business will benefit very significantly from the traffic that we have at our website. You're right. The business today is delivered exclusively from the U.S. It's not a material portion of the Canadian business right now. And we're going to be working from a sourcing standpoint. There's a small number of SKUs -- about 7,000 SKUs represent 80% of the business. So we're going to be looking to stock those in our central distribution centers over time. We'll probably start with 2,500 to 3,000, which will be a real good first phase. And we'll grow it from there. And we've got work to do between now and probably the early part of 2020 to really figure out our strategy for e-commerce. But between now and then we're going to continue to utilize the U.S. relationship that's a part of the deal. They'll continue to ship direct out of the U.S. direct to customer's home while we figure out what the best strategy is. And it will be a combination of click and clack and ship-to-home, just like it is in CTR.

[Operator]

Our next question is from Vishal Shreedhar from National Bank Financial.

[Vishal Shreedhar, Analyst]

On Party City the EBITDA numbers provided, in particular the future-looking ones at $50 million, do you have that number in IFRS 16 terms or is it in IFRS 16 already?

[Dean Charles McCann, Executive VP & CFO]

It is IFRS 16 already, Vishal.

[Vishal Shreedhar, Analyst]

Okay. So that -- the $18 million and the $50 million are both IFRS 16?

[Dean Charles McCann, Executive VP & CFO]

Well, $18 million didn't have IFRS 16, so -- the $18 million is the real number for them and the $50 million is the real number for us on the future.

[Vishal Shreedhar, Analyst]

So some of the growth in that presentation that you're showing that would be just due to the true-up related to IFRS 16 and EBITDA?

[Dean Charles McCann, Executive VP & CFO]

It wouldn't be -- I mean it wouldn't be significant, Vishal.

[Vishal Shreedhar, Analyst]

Okay. In terms of the competitors, who would you deem are the largest competitors for Party City?

[Gregory Huber Hicks, President of Canadian Tire Retail]

Vishal, it's Greg. We like the market characteristics of this business. It's a very -- I think Allan may have mentioned this -- this is very fragmented. Party City is the largest -- would have the largest share and they would be under 10%. So independent party stores across the land have a 50%-plus market share. These are kind of 1- to maybe 2- or 3-store operators and obviously a very large and growing market. So when you put those 3 things together, that's a big part of the attraction for us.

[Stephen G. Wetmore, CEO, President & Non]

Frankly, just to add to what Greg said, it's an underserved market too because there's a lot of communities in Canada where party supply just isn't available other than through online channels. So when you look at the size of the market in terms of its captured revenue versus its potential we think there's opportunity.

[Vishal Shreedhar, Analyst]

Okay. Regarding some of the strategies that you've indicated to grow Party City's [ system ]. I think was store-in-stores at CTR. You can correct me if I'm wrong, but I think you've tried that in the past at Mark's Work Wearhouse or Mark's Work Wearhouse at the time and it -- I don't think that strategy is in effect as much as it was once talked about. So if that's the case, the shop-in-shop, why do you think that would be a different kind of approach related to the Mark's strategy?

[Gregory Huber Hicks, President of Canadian Tire Retail]

Yes. It wouldn't be akin to the Mark's store-in-store, Vishal. Mark's store-in-store has walls separating one store from the other, different checkout experiences, et cetera. It's a completely -- it's a standalone experience for all intents and purposes.And what we're envisioning here is a very integrated experience. This is just another category of the 200 categories that we have in Canadian Tire. And over the course of the last 3 or 4 years we've been deploying a pile of category store-within-a-stores, whether it's kids' fun, whether it's PHL deployed into 30 or 40 stores, different kind of departmental refreshes, et cetera. And those have been extremely successful. So this is leveraging kind of the traffic flow. It's allowing the customer to kind of move around with a shopping basket from category to category. The customer experience is fully integrated. It's single checkout. Again, extremely different than what you would experience in the Mark's Work Wearhouse combo store. So that gives us a lot of faith and confidence in our ability to -- for a store-within-a-store to be a big driver of our growth potential.

[Vishal Shreedhar, Analyst]

Okay. And maybe just taking a few steps back, kind of looking at the broader picture, in this quarter there was some transient elements which off the top, as you noted, kind of helped a little bit on the EPS line. And if you look over the last several quarter earnings have been seemingly, at least to me, pretty volatile relative to consensus expectations. Wondering if management considers the predictability of the business, if that's a consideration for it to manage more effectively and if this seeming increasing volatility is a concern to management.

[Stephen G. Wetmore, CEO, President & Non]

Yes. I mean I'll make a couple comments on it. One of the volatilities I think is what Greg actually referenced is that it's difficult to cut our seasons off based on calendar quarters. That always has a big effect on us. Volatility can also be caused by when you look at the last 3 weeks of December and its impact both on the fourth quarter results, impact on our shipments to our dealers at CTR, and then its impact on the first quarter. The first quarter, as you know, is really a Financial Services quarter. It's not a Retail quarter.And so now we though inside have commented about the volatility. I wouldn't classify it as volatility, but I'd classify it as our requirements to normalize our results for you. And that is caused by a lot of factors now, not the least of which -- I'll start with IFRS. And so when you go back and start taking a look at IFRS 9 and IFRS 16 and then we have to classify things differently, et cetera, et cetera, and we're coming into a third quarter that have some of that from last year. We're going to have to normalize again for you and all these sort of things, which is causing some of the issues that I think that you're referencing. First and second quarters as well this year were impacted by the margin sharing agreement that Dean and Greg referenced which in the first quarter has to have a volatile effect because it's such a small retailing quarter and impacted negatively on our second quarter.I don't believe -- the business is not volatile other than the volatility -- from a Retail point of view other than the volatility related to weather transactions and year-over-year comparisons. And the stability of Greg Craig's business in Financial Services is quite extraordinary actually when you look at it on a year-over-basis. It's just been a continual constant growth engine for us. Again, though, impacted volatility-wise by IFRS. So we feel very confident in the business and I think that's why Greg Hicks as well answered earlier as far as his outlook for margin performance and things like that the business is performing extremely well.So yes, from our end we feel the pain that you're feeling too on a normalization basis. And we're trying to go to every effort possible on our disclosures to help you out.

[Vishal Shreedhar, Analyst]

Okay. The efficiency initiatives that you're talking about, I understand you're not prepared to quantify them at this point. But should we anticipate them offsetting the investment pressures in the business such that we can see the profitability in the Retail business growing like some of the historical numbers that investors have become accustomed to?

[Stephen G. Wetmore, CEO, President & Non]

Yes. I mean that's the impact of -- we put our aspirations out, 3 years ago I guess it was, for performance and bottom line and ROIC performance. It's extremely important we hit those numbers. But it was more important in our operational efficiency program overall that we drove what's necessary for our customer experience. That, bar none, had to be the #1 priority both from a digital point of view and from our ability to collect data and analyze it and use it in the proper way. And we had to launch Triangle Rewards. We had to launch our direct-to-home. So while I wasn't going to -- none of us were going to jeopardize any of that. But you couldn't do that and also go after the operational efficiency that I referenced earlier today at the same time because it's absolutely impossible to do it.So now is the time. We've got things up and running. We feel quite confident and so now is the time to push it. But we have to hit those numbers. It's what we published and it's what we expect ourselves to -- how we expect ourselves to perform.

[Operator]

Our next question is from Keith Howlett from Desjardins Securities.

[Keith Howlett]

I wanted to ask about the exclusivity with Party City. Can they continue to ship products from the U. S. into Canada, either online, direct to consumer? And can they continue to seek other wholesale customers in Canada?

[Gregory Huber Hicks, President of Canadian Tire Retail]

Keith, it's Greg. We will be their exclusive B2C relationship in the Canadian marketplace. And their wholesale relation -- their wholesale business in Canada isn't material for them right now. But yes, they can still supply on a wholesale B2B basis.

[Keith Howlett]

And then I just had a question on the endless aisle, so to speak. Canadian Tire, as I understand it, currently only ships to consumers what's in the stores. And I'm not sure what the situation is at Mark's or at SportChek, but it sounds like Party City will ship eventually up to 45,000 SKUs, if I understand it correctly, more than in any one store. So I'm just trying to get generally what your view is on the endless aisle across the banners.

[Gregory Huber Hicks, President of Canadian Tire Retail]

Want me to...

[Stephen G. Wetmore, CEO, President & Non]

Yes, take it.

[Gregory Huber Hicks, President of Canadian Tire Retail]

So yes, from a Canadian Tire standpoint, this is a capability that you're correct, Keith, that we don't have today, the ability to kind of extend the aisle, ship direct to a customer's home. We do have quite a growing and high-performing endless aisle that's pick up in store. And that's just a capability that we need to build. There's nothing kind of impeding us from delivering that. It's just kind of getting on with it. So you could expect us to be shipping to a customer's home from an endless aisle standpoint for core Canadian Tire merchandise. And that would include Party City going forward. It's on our kind of investment radar screen as we speak.

[Allan Angus MacDonald, Executive Vice]

The only thing I'd add to that is from a -- if I sort of weave together Stephen's comments and Greg's, when you look at our priorities over the last few years, we knew that establishing -- in order to get our aspiration, I mean there's top line aspirations there, too. We knew that establishing the next generation of Canadian Tire Corporation in Canada was of paramount importance and that was going to take the longest. That's about getting the assortment right, getting the banners where we need them to be, creating the Triangle Rewards program, relaunching the credit card, building this marketplace and things like the announcement of Party City.At the same time, we wanted to get our e-commerce expertise to be competitive and in anticipation of the disruption that we knew was coming into the market. So as we sit here today we've got a SportChek that's performing as good as American retailers in a much more disrupted industry. We've got the Triangle marketplace which we just talked about and this opportunity in front of us.You can't -- you have to take these things in order. So endless aisle is going to be incredibly important, especially when you look at a SportChek in terms of how they're looking at their reinvention or a Canadian Tire in terms of its own marketplace, et cetera. And there's a logical time to move through that. But we had to get to the point where our business structurally was on a path to this reinvention that we're talking about here today effectively. And it's just a matter of time and a matter of course, but it's incredibly important for us. And it's really one of the reasons that we created the marketplace that we have today.

[Operator]

Thank you. This will now conclude today's call. A webcast of the conference call will be archived on Canadian Tire Corporation Limited's Investor Relations website for 12 months. Please contact any member of the IR team if there any follow-up questions regarding today's call or the materials provided. You may now disconnect.