Empire Company Ltd
TSX:EMP.A
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Empire Company Ltd
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Good afternoon, ladies and gentlemen, and welcome to the Empire Company Limited First Quarter 2019 Results Conference Call. [Operator Instructions] This call is being recorded on Thursday, September 13, 2018. I would now like to turn the conference over to Katie Brine, Director Investor Relations. Please go ahead.
Thank you, Leonie. Good afternoon, and thank you all for joining us for our first quarter conference call. We will provide some short summary comments on our results and 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 www.empireco.ca. As well, there will be 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; Lyne Castonguay, Executive Vice President, Store Experience; and Pierre St-Laurent, Executive Vice President Merchandising and Quebec. Today's discussion includes forward-looking statements. We caution that such statements are based on management's assumptions and beliefs and are subject to uncertainties and other factors that could cause actual results to differ materially. I refer you to our news release and MD&A for more information on these assumptions and factors. I will now turn the call over to Michael Medline.
Thanks, Katie. Good afternoon, everyone. Empire Company continues to make progress. The Sunrise costs are coming out of business. We're seeing stronger tonnage. The team is executing more sharply. We are increasingly optimistic about our future. Retail is after all a simple business, sales, margins, costs, capital allocation. We're optimistic on all of these 4 fronts. The business is simple. The execution is hard and complex, and we're getting there. EPS was $0.37 this quarter. Could we have done better? Yes. We left some money on the table, but we are still going through a transition. In addition, our performance was better than it looked. We had some onetime expenses, which hit our bottom line and some noise in our margins that Mike will take you through in more detail.As we have been saying, our merchants had a lot on their plates. Ultimately, we want them to have a singular sharp focus on the business fundamentals. But right now, we also have been working hard on critical category resets as a part of Sunrise. We were a little slow on the trigger to pass on some of the increased costs that're accumulating in our business. We expect that the significant cost incurred by us and the industry such as rising freight charges, minimum wage increases and the impact of the new tariffs should begin to normalize in the market. We'll do everything we can to stave off these increasing costs, but we see that we will now inevitably need to pass some through to remain competitive. This quarter we began to see strong same-store sales growth and best of all we have seen sales momentum continue into the first half of Q2. Sales momentum can largely be attributed to a combination of our increasing promotional sharpness, strong long weekends and better operational effectiveness. Same-store sales were 1.3% and excluding our pharmacy numbers, food same-store sales were 1.8%. We were able to put up these comps in a pretty competitive environment and with 0 internal inflation. We saw increases in both basket size and customer count, and tonnage growth was the best we've had in 6 years.We were pleased to see strong sales across the entire country, particularly in Quebec, where we gained market share and posted strong results. Strong summer-friendly products sales such as beer, wine and tobacco were great for our topline, although, they did have the effect of reducing the overall margin percentage. Also the change in the ratio of Quebec corporate stores impacted our average margin rates. Our conventional business margins outside of Quebec held steady. We continue to stabilize our margins. Our Sunrise work including category resets is important and progressing exactly as we had anticipated. Our merchants are doing a good job on this key initiative. Category resets involve an assessment of our categories nationally to ensure we have the optimal assortment at the lowest underlying cost base. Not only will category resets drive a large portion of our Sunrise savings, they will also position us to win in our stores by ensuring we carry the items that customers want most.We are looking forward to seeing the very beginnings of category reset changes in our stores beginning in the third quarter. We're making good progress overall, but it's not enough for us to just execute on Project Sunrise and stabilize their business. We do not have that luxury. Our old world and new world competitors aren't standing still. So we will do 2 things at once, run our business in the best way possible, while setting ourselves up for long-term growth.One of the key decisions we made to positon our company to win in the long term was the expansion of our FreshCo banner to the west. We will open our first 2 FreshCo stores in Winnipeg, Manitoba in spring 2019. We also settled our labor issues in Manitou in Saskatchewan. We continue to work with our BC unions to reach a mutually beneficial agreement.Once an agreement is in place, which we hope will be soon, we will work toward the opening of our FreshCo stores in British Columbia in 2019. Our western FreshCos will have evolved branding that more strongly signals discounted value, which we piloted in 4 of our London stores. Our results from the customer feedback have been exceedingly positive in those 4 stores. So positive, in fact, that you will see us refresh the bulk of our Ontario stores with the new branding over the next few years.Winning in key urban markets like the GTA, where our market share is low is another one of our key priorities for growth. We are taking an omnichannel approach. In our bricks-and-mortar stores, we're investing capital to revitalize our stores with discount and conventional, and we're putting up a few key greenfield stores. We also invested in a game-changing Ocado engine e-commerce solution that positions us well to expand our presence in urban markets with the launch of our e-commerce solution in the GTA in spring of 2020. These priorities are part of our offensive playbook and will help to position our companies to thrive in the future. The work to fix the fundamentals of our business while setting it on the track to compete and win in the long term will continue to Q2 and beyond. We believe we have only begun to scratch the surface of our company's potential. With that, over to Mike.
Thanks, Michael. Good afternoon, everyone. As Michael said, although, we believe our numbers could have been even stronger with some inflation to pass on cost pressures and before taking account of restructuring-related expenses that are in our SG&A. We are satisfied with our sales margin and cost performance for the quarter. Before we go to questions, I'll provide some more color on a few items including gross margin, SG&A, real estate and our cash flows.Gross margin for the quarter was lower by about $19 million, and the gross margin percentage was about 120 basis points lower than last year. There are a number of factors that contributed to this performance.Firstly, a lower gross profit dollars, even in the face of higher sales overall, it's due to 3 principal factors. Firstly, we closed 10 underperforming stores in British Columbia this quarter, and the loss of the gross margin from these stores impacted the result.Secondly, pharmacy gross margin was lower due to health care reform and the Alberta AIR MILES inducement ban.Otherwise, the remainder of our business recorded higher margin dollars. And finally, both our margin rate and dollars were somewhat affected by increased costs predominantly transportation that have not yet been fully passed on in pricing.The gross margin rate, on the other hand, was mostly impacted by our mix of sales. The largest impact was a higher proportion of fuel sales, which carry a lower margin, and also the actual margin on fuel sales was somewhat lower than last year.Our Quebec business, although recording a strong quarter experienced a margin rate decline due to higher sales of lower margin products such as beer, wine and tobacco. Excluding these and some other mix impacting in Quebec, our grocery margins were stable and consistent with last year.Regarding SG&A, Project Sunrise, as Michael said, is on track, and we continue to see the positive impact in our SG&A costs. As we mentioned last quarter, we estimate up to a further 30% of our $500 million target can be achieved during fiscal 2019, with the majority of this in the second half of our fiscal year. As we begin to generate benefits related to our category resets, we expect these to be reflected in improved sales as well as gross margin.The adjusted selling and administrative expenses as a percent of sales was 21.2% this quarter, an 80 basis points improvement.As I said, we achieved our Sunrise target for the quarter, which is reflected in the improved rate. It was also some other noise in our costs this quarter, both positive and negative, that impacted SG&A as a percent of sales.Firstly, our improved results over the past year resulted in several stores returning to consistent profitability. And as a result, we were required to reverse some of the impairments that the company had previously recorded related to underperforming stores, primarily in Western Canada.However, partly offsetting these positive impacts were some restructuring-related costs and the effect of minimum wage increases, principally in the conventional and the discount business.In real estate this quarter, our share of earnings from investments increased due to Crombie REIT's activity. Crombie REIT entered into a co-ownership agreement during the quarter that resulted in the disposition of 50% interest in a portfolio of 9 of their properties. This gain was partially offset by an impairment charge that they took on 2 properties during the quarter.These results were reflected in our improved equity earnings, but however, will not be representative of ongoing contributions every quarter from Crombie going forward. We also sold a property to Crombie REIT and recognized the previously deferred gain this quarter. Lastly, cash flow. The increase in proceeds on the property sale to Crombie along with some -- our lower capital spending resulted in increased cash flows for the quarter. The increase was partially offset by decreased operating cash flow as a result of the aforementioned decrease in gross margin, drawdown of restructuring provisions due to Project Sunrise as we paid out the costs of our restructuring last year and the closure of stores in Western Canada.We're very satisfied with our consistent performance in cash flow generation over the last 6 quarters, increasing our confidence that our sustainable cash flow improvements will return the company to its investment grade rating in the near future.During the quarter, we finalized the previously disclosed purchase of a majority interest in Kim Phat, a small ethnic retailer in Montréal with 3 stores, and welcome that business and their management and employees to the company. As Michael noticed, we're balancing and fixing the foundations of our business while setting the company up for long-term success.Overall, we feel this was a good start to the year, but we know we have a significant amount of work in front of us, as we return the company to its full earnings potential. And with that, I'll hand over to Katie for questions.
Thank you, Mike. Leonie, you may open the line for questions at this time.
[Operator Instructions] Irene Nattel from RBC Capital Markets.
Starting with same-store sales, which seems to be the topic of the day. Obviously, you had a really nice same-store sales trend. Can you talk about where you saw the biggest gains? What, in your factors, were the key drivers of those gains? And really how you see that playing out over the coming quarters?
It's Michael. Great question. It's -- I don't want to be too boring, but we saw a really positive same-store sales and relatively consistent across the whole country, and across I wouldn't say every category, but most places. I would call it that we're seeing particular strength in Quebec and in our FreshCo banner. I'd say that if there's a few things that made a difference this quarter. And the first was the flyer. I thought we did a much better job in the flyer, and most people think that, that means you guys get way more promotional, but I -- we did a better job of being able to balance the flyer and have attractive deals. I think that we started to put product in the store that was more friendly to families, larger packs and around part of the countries things like that. Our discount banner in Ontario is just far sharper in-store on the flyer than we've seen before. And some of it, and I keep saying it, although, it's boring to everyone, it's block -- better blocking and tackling in the store on replenishment and in terms of our marketing and merchandise. But it was very consistent across the board. And because our margins are down, I hope Mike's a good CFO, I think he explained it pretty well. We do not believe we bought those sales, and we don't like empty calories. I do think though that we are sharper and that although, we didn't go too far, we were far more competitive on the long weekends, where -- which is such a big deal for us, especially conventional, especially with families. And so I'm really proud of the team. They really did a much better job than they'd done over the past 1.5 year in terms of winning long weekends without giving away the store.
That's really helpful. As you look at -- when you talk about being more effective in the flyer, what are the key -- is it really just the merchants being more focused, or are you approaching the flyer a little bit differently?
I want Pierre to say a few words.
I think it's more about the relevancy of the offer. So we know more than ever what our customer looking for, what is important for them in term of SKUs and price. So consumer knows quite well pricing and more specific product, which are important for them. And I think our merchant are more tripe on these items, that's it.
And I think it's fair to say that our merchants have been -- we've overwhelmed them, I would say. They've a lot on their plates as I said in the script. And I was proud of actually how well they did on the day-to-day, although, I do think we left some money on the table that we'll pick up as we become sharper and more focused. Fair enough here?
That's really helpful. And just one other question, if I might. We heard from Loblaws, we heard from Metro around the need to raise prices. Are you seeing any movement on pricing in the market? And if so, what are you seeing in terms of consumer reaction?
It's -- we're seeing -- I'll back it up, and I'll say that we're -- up where, we're getting, how many letters do you think we get a week now from suppliers who want to pass on tariff-related increases. We are seeing a little bit of that starting in the market. And it's too early to speculate what the customer reaction is going to be. But it's clear with what's going on in terms of transportation cost and tariff-related cost that our expectation, although we're not economists, is that there will be some inflation.
Your next question is from Vishal Shreedhar from National Bank.
Just on the balance sheet. Obviously, continued strong improvement there over the last little while. And I know this is not a kind of a next quarter or next 2 quarter question, but Michael, I think in your prior life, you used share repurchases really well. Your peers tend to use that as well. Just wondering, if that's a thought that something you guys are thinking about down the line for the investor value proposition.
There's a not that many ways to use cash. There's -- I've only come up with 5 in my career, if you have a sixth, call me. And I think at different points and at different points in your company and different points in the cycle, you have to be open to all 5. At this point, I don't want to stir the water and say, we're about to do a share buyback. It certainly should be in our arsenal as we go forward. Right now, we're concentrating on investing smartly in our business, making our way over time back to investment grade rating and in making smart, smart investments. We -- you saw us continue to raise our dividend as we did in last quarter, and I'm not saying anything, because I don't like to do it. But companies should be open to share buybacks at the appropriate time, and this company is open to share buybacks at the appropriate time.
Okay. And just switching gears here. On the Sunrise benefits recorded in the quarter, I can't speak for the other guys, but I have a little bit of a tough time trying to figure out how much is in each quarter for modeling purposes. So I'm wondering if you could help us out with the benefits recorded this quarter.
I think the easiest way to think about it, Vishal, is that we had some improvement in our SG&A related to Sunrise costs consecutively year-over-year, and it's in our SG&A. As I mentioned, we do have some other items in there that are creating some noise in our SG&A costs in total. We had the impairment reversal we talked about. We have some restructuring-related costs that are in those numbers that probably be enough with the sort of outcome or roughly even with that. And of course, we had pressures related to the labor cost increases related to minimum wage, and of course, our sales were up. And as a result, our labor in the stores has increased slightly. In terms of how much and what you should expect this year, we've consistently said that, while we expect to get relatively modest improvements for the first 2 quarters related to Sunrise, mostly initiatives that we completed last year. The bulk of our improvement and most of the benefit will be in the second half of the year, as we begin to bank some of the benefits related to our category resets. So we're not disclosing at this point specific numbers, but I, sort of, refer you to the second half of the year in terms of our expectations for material improvement.
Okay. And maybe this is an offline question. But Mike, maybe you could just help me on the cadence of the annualizing, which is -- which I thought would have been bigger numbers in H1, because I -- because last year, I think in H1, you didn't record a ton of benefits. But maybe that's an offline question.
Sure. We have to have a conversation about that.
Your next question is from Jim Durran from Barclays.
Just wanted to go back to FreshCo for a second. Mike, can you sort of give us some articulation as to why you think FreshCo in Ontario's doing so much better than it was before?
It's -- I think the team's doing a great job. I think they've gotten a better -- how I think that retail's not the most complex business. It's hard to execute like I said at the beginning. I think they've just gotten -- 2 things have happened. One much better balance on the sales and margin, which you look for in merchants and in leaders, very pleased with that kind of balance. So they're not giving away the store, but they're seeing really healthy sales increases the right way. I also think that the -- that their store practices and the operations are working very, very well. We did see some real improvement too -- although, it's only 4 of the stores. Those London stores performed extremely well and that's the reason we're going to roll out those refreshes. But I touched on -- much more emphasis on value. And I thought that, that's one thing at FreshCo that we -- because we call it FreshCo, because we have the freshest products, sometimes people don't obviously realize that it's a discount shop and a competitive discount shop. And I think much more value everywhere including the [ 48 planned ] stores and much more pushing on the fresh and specialty produce. So not a magic bullet, but surprisingly, just tweaking some of those things has had a material -- it's made a material difference in our business.
Okay. That's helpful. On your tonnage performance in the quarter as you alluded to as one of the strongest outcomes you've seen in quite a while. Would you then believe that if I was looking at like Nielsen data or something that you gained share through the quarter?
Yes. We think we gain share in pretty well every market or almost every market in the country in the quarter.
That's helpful. And last question. On your IT platform, as a merchant, am I getting close to a point, where I only have to look at 1 screen and 1 system?
I love your questions, because there's never a way to answer them in a short couple of words. We've built some systems to enable our merchants to walk through the inevitable difficulties that come. We're still owning 4 systems. So we've put some development and some work in to make their lives somewhat easier. But if you had to ask anyone of our merchants, like one of them sitting next to me, he would say -- I think they would say that we have a long way to go. And that's going to be an initiative that's likely going to continue over the next 12 to 24 months. So we've done what we can today. We continue to do more. But ultimately, there is some level of rework that we have to put in place and some tools that[Audio Gap]a 5-year initiative. But that's not going to happen in the next few quarters.
And do you see that moment in time down the road as being a driver to incremental upside? Like is -- how much of a constraint do you think it is today? And how much of a benefit you think it'll be, once it's fully in place?
Personally, I -- my view on great systems, and I put a few in, is that when you get them right, they add value every year. So I think the obvious answer to your question is, yes. The more tools that we can provide, the more data, the more analysis, the more individualization, understanding of what the consumers are actually doing in our stores, starting to move towards some closer tracking of forecasting consumption, how to -- effectiveness and promotions, et cetera, et cetera. I know it will be better. Right now, however, we have a merchant group that is getting to know their new categories, and as Michael said, they're starting to have better traction. And I actually think ex the systems, we have a lot of opportunity, and we have great leadership and some good team. So I think we're going to see benefits coming from both existing efforts and new systems in the future consecutively year-over-year.
I agree with that. I think, I mean, if you look at it, only 2 Saturdays ago, for the first time in our recent -- modern company history, we have cost harmonization across the country. And so you go, wow, that sounds simple. It isn’t simple, and it's important and everyone should have it. We now have it, and that's allowing -- that's going to allow us over the next year and onward to really run our business in a better way. We couldn't do the category resets. There's so much you need as a merchant or as an operator, so without things like that. I know it's using one example, so I'd like to separated it into sort of running the business better and then the discipline and the processes. And then the systems that we're going to need to put in place, which are in our capital budget, so over the next 2 years to allow our merchants to do the best job to their capabilities. And right now, they're doing a great job, and we're in better shape than we were, but we have a long way to go to give them the tools they need to be great.
Your next question is from Michael Van Aelst from TD Securities.
It's Evan in for Mike. In your press release, you mentioned that you expect to begin to recover the cost pressures that were incurred. Do you expect to recover the full 100 basis points on your gross margin? And how long is that going to take?
We've got no way of entering that really because as Michael said, we're not -- we don't have the crystal ball that's going to allow us to understand to what extent and how fast these prices will be recovered across a wider market. There are number of price makers in those markets, we're not the only one. So I'm not sure that there's a good way to provide an assessment of that. Our view is that inflation is likely -- more than likely to increase going forward, we can't tell you by how much.
Our goal is to get that back, over what time period that takes because it's starting to fluster the system, and you still have to be competitive, and we'll see how the market reacts. It doesn't happen overnight, but that is the goal.
Okay. And just looking at tariffs and transportation-related cost of goods inflation, I know you touched on it earlier, but could you give us an indication as to how much selling prices would have to go up to offset it -- offset what you've been seeing so far?
No.
Okay. And then turning to the other income. I noticed that lease revenue has come down. It was almost $7 million a year ago, down to $4 million this year. Is that related to the selling of properties? And if so, how much longer can we expect to see gains on asset sales?
Yes. I imagine that the difference in the lease revenue is probably that. But I reserve the right to call you back if I'm wrong, but your bigger question, I think, is asset sales. Those are not really -- as you've noted, over the past several periods, they're not predictable. We do have an ongoing discussion and relationship with Crombie REIT. And from time to time, we identify opportunities that make sense for both of us. So I think you'll see transactions like that in our results for some years to come. It's just not every quarter and not particularly predictable.
[Operator Instructions] Your next question is from Mark Petrie from CIBC.
Just following up on a couple of the topics that you've already touched on. Just with regards to the expectations for gross margin to improve, is inflation the prime -- or recovery of some costs inflation, is price inflation the only driver of that? And then maybe secondarily, the category resets, or what other drivers are there to be able to recover the gross margin?
It's a good question. The biggest is if you just look at the margin dollar effect for the quarter, the biggest impact was closing 10 stores in Western Canada. So that's obviously behind us, and we're moving on. And then as we move forward in Western Canada, the reopening of those stores as discount is clearly going to be helpful, and they'll be more profitable than those stores were before. So that's relatively small, but it will be a growing impact. But yes, on the remainder, becoming sharper on moving cost like tariff cost into the market, making sure that we're not compressing our margins in the long term for those types of cost increases is important. Eclipsing that though, all the benefits, both sales and margins that we expect to get from this complete refresh and renegotiation of all of our categories on a national basis across the country, that's where a significant amount of the action is going to be -- at margins going forward, and that's part of our Sunrise estimate. But at the same time, as Michael mentioned, and I think as Pierre said as well, we're becoming better at execution in the stores. And Lyne's already taken hold of number of issues there such as shrink, execution, training, existing great every day, and then the merchandisers as Pierre said are also getting much better and sharper in terms of understanding what customers want. So you know what, that's the boring bit that Michael talked about, but that execution is something that we still need to be better at. We're getting better but there's a lot of runway just left on basic blocking and tackling execution as well. Those have been the 3 things I'd point out.
That's helpful. I think the comment before was the merchants being more dialed into consumer needs. And I guess, I'm just curious, is that just a reflection of sort of simplification of the merchandising systems that they're dealing with? Or what would you say is the driver of that?
Could you repeat it?
Sure I'll repeat the question. So the question is, your comment that you made previously about our merchants becoming more dialed into consumers and much more focused and better on the flyer. Is that because we now have cost harmonization or better systems or is it the dynamics around the merchant group that are changing?
I think better use of data, it's one of the key elements. And in some region, it's not equal but we see big improvement in some region, and we need to share these learnings across the country. And as the power of being 1 company [ by design ], so we see really impressing initiative in merchandising based on data, based on learnings. And we're more relevant I'd say so, and the other thing is people are more comfortable with their category. So it's helpful to take better decision. so better to come. It's very positive and encouraging for future. But once again, structurally, we need to continue to improve, do continuous improvement with systems. So we did important -- the important realization, I would say, as Michael said, [ custom ] is a big things. So it's more simpler for CM. So CM needs to spend less time with complexity and stream and spending more time seeing the business and spending time with the supplier/vendor and be relevant for consumer.
Okay, and then I guess just last and again sort of related to that topic. It seems like there's been a greater push towards coordination of promotional efforts across regions and across banners. Or I guess mostly across regions. How have you adjusted sort of the team and the processes to manage that? And to also manage the need to remain dynamic and sort of reflect regional tastes or preferences?
Well, Pierre has talked about the national merchandising efforts and understanding the dynamics of the flyer. But at the same time, it's executed on the ground. Local intel is really important. That to a large extent is the responsibility of Lyne and her team so I don't know, Lyne, if you want to just talk about how you account for regional differences.
Yes. So I would say 2 things. One, obviously working very, very closely with the field merchandising team, which is really the team that helps do the liaison between merchandising and operations. And help us ensure that we remain very focused on local. We've done a slew of local initiatives with that team in the past quarter, and we've measured them. And we've seen some great results and great successes and I think that, that's very important. And we have such -- the second point I would make is, we have such a better working relationships between merchandising and operations as well. We collaborate on doing ads together weekly and just the collaboration on assortments and what's going on in our business based on the resets that we're working on anything else, I mean we're connected at the hip. And we're seeing the benefits of that. And so that's the result of the -- a direct result of the restructuring that we've done. So very, very pleased with the progress we're making.
Your next question is from Keith Howlett from Desjardins.
I wanted to ask about the 30% of the $500 million Sunrise savings that may be achieved in current year. I think you're asked this on the last call, but it sounds like most of it will be through the category resets. So does that imply that it's mostly going to show up in the gross margin line? Or is there -- what do you think that balance might be?
No. I think that's fair, Keith. We do have, obviously, other initiatives that are flowing through. But the -- by far the largest impact this year is going to be on those resets. And there's some -- and without getting into too much detail, the benefits there clearly come from cost reduction, because we are negotiating on a national basis now, and it's very clear to us that there were inefficiencies in our system that we're fixing up. But also at the same time, these refreshes that are very supported by a ton of work that we've been doing as Pierre and Lyne said on cost harmonization, all the data packs that we've put together are also changing the efficiency -- will change the efficiency of the category from an assortment perspective. So we expect it to show up both in the top line as the categories perform better. But the clearly, also very significantly materially in the cost of goods. So all of that is going to translate to our margin dollars and some expansion in our margin rates.
And then in terms of the discount rollout in Western Canada, there will be the 2 stores in Manitoba by the spring. If the labor agreement -- when could it be concluded for you to get additional stores open in fiscal '19? Or are the further openings likely now into fiscal '20?
The -- I mean just to be transparent, we're turning to the end of this -- these talks with our labor union out there. And I think that'll be settled relatively soon, but it has pushed off some of the openings that we would have hoped to open in BC. Now over the whole scale of history of these stores, I'm not concerned, but I'd like to get these stores opened, because there -- in these market, with these stores, we're going to do much better than we will with the conventional stores we have right now.
And I'm just wondering if -- and I know that none of the companies like to talk regional markets. But clearly, Western Canada was the source of greatest challenge at Empire and Quebec was well performing market before and Ontario wasn't bad. So I'm sort of wondering how you feel you're doing in progress in Western Canada independent of the planned conversions of 5 stores to FreshCo?
Yes. I think -- it's still the market which we need to do the most working, because we're the furthest behind as you pointed out. We have seen palpable improvement over the last 18 months and into the Q1. And I'm not going to pull out the provinces, but I was pleased with -- in terms of progress we're making, and that's because our merchants are -- and our operators and a little bit at the marketing too. I'd say that what I think about -- one of the things to give you a little bit of comfort because not just Mike or I talking is that we had to reverse some impairments this quarter in the west. Usually impairments mean those stores aren't going to be coming back and be as profitable as they were supposed to be and we have to take impairments, which is always a tough thing to do. You don't hear about reversals of impairments very often in retail. And we reversed those impairments as you could see in our disclosure, and that is tangible evidence of some improvement in the west. But you're never going to get me to tell you that I am pleased with the results or we're anywhere near where we need to be. We had, in the past, let down the customers. I'm not going to reiterate that, I'm sick of it. And it's time to get them back, and we're making good progress, albeit, I think we can accelerate that going forward.
And is the 10-store closures in British Columbia out of -- I think there were 66, I can -- maybe, I'm wrong there. But is that representative in any way of what you might need to do in Manitoba, Saskatchewan, Alberta, or is it -- was it a unique situation to BC?
I think to be clear, when we have the -- we're going to -- but it's 60 or very close, 65 stores, we're going to convert is on our current plan. That we -- when we closed those 10 down, we said 5 were closed forever, 5 could reopen as FreshCos, should we have the labor agreement we want. Our -- right now, we're pleased with our portfolio, especially, as we look to convert stores that were underperforming and that are in markets, it would be better served for the discount format. So -- but we should and will continue to look for stores that should be closed if we -- if they don't make the cut on either of those, but right now, we'd tell you if there were some and we'd disclose it. But right now, we think we can improve our conventional stores, and we can convert some that are well suited to discount. So I like the strategy, it's a multipronged strategy. But I think it's the right strategy at this time. If we see some stores that we don't think are worth our investments in, and they're not going to be as strong as we want our stores to be, we'll close them.
Then just 1 last question, if I could on the future arrangement with Ocado and the focus on the GTA market. When -- you've got a lot of FreshCo stores in Ontario. And I'm just wondering, is the Ocado relationship really targeted, I'm assuming at the Sobeys banner and Foodland banner stores? Or is FreshCo a possible banner to be associated in the [indiscernible] effort?
Two things. One is Ocado will be its own banner first of all. And by the way we've got to stop calling it Ocado, we have to have a name for it soon, so we can stop calling it Ocado, as much as I respect them. And but no, it's not going to be -- it's going to have good value, but it's not a discount offering.
But it won't be like Sobeys online?
Well, we haven't unveiled yet, what the name is going to be. And there will be obviously be large overlap between the Sobeys, SKUs and some of the Ocado. But Ocado, because of the way it's designed, has the ability to go far and beyond the numbers of SKUs that we could possibly have or anyone could possibly have in a grocery store. So it gives us a lot -- that's why I say, you'll be able to have a great shop with value, and get the products you want and it's going to be -- just because of the nature of it, it's going to be highly exciting in terms of other products we'll be able to offer.
Your next question is from Patricia Baker from Scotiabank.
Michael, when you are reviewing this quarter, let's say with your team. I'll be very curious for you to share with us what you're saying to them about, okay, people, I'm really pleased about this particular element and then basically, what are you telling them your disappointed in and what do you want them to work harder at? And then if you could take that same approach and talk to me about you're reviewing the progress. You're a 1.25 year into the turnaround. What are you saying with respect to the -- what you're most proud of and what you're most worried about with the team as you review so far in the turnaround?
Interesting question. Probably, the team could tell you what I think the most, if I miss anything, they can correct me. But I can be -- and we can be very demanding of ourselves, and we should be. We owe it to our 120,000 employees and especially to our shareholders. I'd say that this quarter -- every quarter, almost every week, I'm more confident in Sobeys, and we keep saying look at this price, let's go get this price. And then -- but you got to be a little bit patient and realize where we started from. You have to realize that the -- that we're trying a lot of merchants all at once, and we're asking people to have new jobs, a national structure and please go out and cost harmonize and category reset, and then we expect them to do it all and they're doing it. So you can select -- I'm not upset in any way. I'd say I'm extremely proud of the traction in tonnage. And that, well they can tell you, they get a lot of conversations and texts and e-mail about we got to be able to keep that margins strong, and I was proud that in rest of Canada in our conventional banners, the margin was stabilized. But it should've been even a little bit stronger. So I'd say in our -- on our costs and the work we're doing at Project Sunrise, I am -- I guess, it's a [indiscernible] I ever would be. It's right now, it's whatever is off, and it's a balancing act like I said at the beginning of my script. So right now we want higher margins. And I realize that can't be all the time and that we're balancing a lot of things, but I also want to make sure that you can go for margins, and you can lose market share for too long, and I don't want to chase market share. That's not what I'm thinking, so I'd say most of our conversation right now, team, are on what's going on in terms of the cost that are hitting us and passing those along how fast can we get at those category resets later in the year and make some real changes to our merchant, and they're systemic from doing a better job. So it's a bit -- it's good and it's not all the time and you're always trying to balance that because the team is working very, very hard. The team did you want to add anything there? They're kind of smiling, so I guess -- I don't know what that means.
Whatever you said, boss.
Yes, sir.
I think Karin's going, I don't remember the nice part of that. I remember that -- so but no, it's a great question, did that answer it for you, Patricia?
No. That's very helpful, and if I took one word away from what you said, it sounds like the major focus in where you want everybody to work harder is on balance, right?
Yes and balance, and I think part of our job -- and we don't talk about it a lot, but part of my job and Mike's job is to not get the merchants and operators give -- not give them more stuff to do to keep them separate from all of the other sort of things, like they don't have to get involved with the discount expansion. For the most part right now in the busiest time for the merchants, they don't have a lot of work to do in Ocado. And I -- we have to be really focused in each of the businesses and not try to have Pierre and Lyne and Mike and Vivek always having to do everything together, and that's because they only have so much time and effort they can put in, be very, very focused.
Okay, fair enough. Maybe if I could -- my next question is on the categories resets and you said that they're going to begin in the third quarter. So just curious how long is -- how long will do you envision it will take to complete the category resets at the store level, and how many category resets will we see completed by the end of fiscal '19?
Michael won't give the answer on that, because our merchants and our operators are still working through category by category and region by region as to how they're going to actually execute that in the store. So but what I can maybe give you some color on is that we've only started in on the first sort of wave, if you want to call it that of all of our categories. There's still another one coming after that. And likely another one after that, which would then all be executed in-store in the next fiscal year. So this is something that is a pretty significant rework of everything that we sell. It's clearly because we have identified the aggressive targets for the second half. It's a fairly high number of categories that we're dealing with here for the -- just for the second half of our fiscal year. And we are still very confident that between our supplier negotiations and getting them right in the store that we're going to do well and hit our targets. But really you should expect through the next fiscal year a material amount of work on the remainder of the categories. So as we said when we started this is a 3-year progress. We generally had said that our fiscal 2020 year was really the category year. We're getting at some of them in this year, and yes, well, and towards the end of the year. So I'm did not exactly answer -- I'm actually elaborating on your question just to make it clear that this is not a onetime thing. We're working on all the categories right now. There's going to be more work next year and that why only started annualizing the 500 by the end of 2020. So but your specific question, we are going to execute in-store in a way that doesn't make for a negative experience for our customer or interfere with one of our peak selling seasons, which comes up in Christmas. So we are doing a lot of logistical planning around that season and making sure we get it right. It's better to get it right then to get it early.
Fair enough. And Mike, presumably when you've done some of these, I as a customer walking into the store should notice a different?
Yes, you should.
Okay. Then just if I -- was interesting to hear that you were going to take FreshCo 2.0 as you call it sometimes to Ontario and you said that will be done over the next few years. So Michael, is the expectation there that you'll do that for the entire Ontario network? And are you doing it in the capital-light manner?
Yes. It's -- it will go across the whole province over the next 2.5 or so years. And it is -- it's quite capital light, and we can fit it in our stores now. I mean these things, they move around a lot, but our current learning is that it would be about between $300,000 and $400,000 a store depending on the store.
Okay. And my last -- it's not actually a question, more of a comment. So the 10-store closures, it's easy to understand how that impacted both of your sales and gross margin dollars in second quarter. But presumably, the closure were actually accretive to your gross margin rate, is that correct?
At the margin, that's probably right. But probably a [indiscernible] by the time you get to have it to our -- there would be -- that would be positive, because you're taking out some inefficient labor as well but...
[Operator Instructions] Your next question is from Peter Sklar from BMO Capital Markets.
Michael Vels, in your commentary, you said one of the reasons why you expect gross margin rate to improve is that the 10 store closures are behind you. But just listening to the comments of management on the call today, there's going to be a lot more either closures or conversions, so this is going to be a bit of an ongoing process. So I'm just wondering how should we think about that.
Yes. And I didn't mean to necessarily try and link the -- 10 stores, as Michael said, was party closures of underperforming stores that we really didn't believe were going to -- we're in -- either in the wrong place or we didn't see we were going to improve and half of them are stores that we will convert. As we move forward, I think you're right, there will be some incremental cost in our numbers as we move forward as we close, renovate and then reopen a discount store. But I don't think it would necessarily be to the same extent. It will likely be a little more store by store as to necessarily in large groups, and it'll be more akin to what retailers, I think do over a greater time, we just close, refurbish and open stores. There may be times over the next couple of years when we decide maybe to do several at the same time, and that may have an impact. But at this stage, I don't think that you will see the same -- well, at least we don't foresee the same situation where we will close 10 stores all at the same time.
Okay, so when you close a store and convert it to a discount banner. Are there capital costs and operating costs that we'll see on the financial statements? And what are the magnitude of those costs? And does it include the labor buyout how is that being treated?
So in the closure and conversion of the store would entail capital of course, and we've talked about it before. And again, store specific, it is a refurb, not a complete greenfield obviously, so it's relatively speaking capital light. There are some severance costs and inefficiencies that do end up in our numbers. But again, they are -- they're not that significant. And I think, we'll call it out if it was material, but I don't see it as being a significant drag on major impact to the earnings going forward. And I must apologize, we are in Stellarton today and there's a railroad track next to our head office, which occasionally creates a bit of noise [indiscernible].
And last -- my last question on a different topic. As I listen to both of you speak, there seems to be a pretty high level of conviction that these cost pressures that you're seeing are going to be passed through and you're going to see some retail food inflation in the second half of the year. So I'm just wondering like why you're so confident it's going to unfold that way. I would think it only takes one stubborn competitor, who's not prepared to pass through those costs and that could hold back everyone.
Let me answer that one, which is I can't speak for anyone else. We'll assess our cost increases, and we'll decide what we should do to be smart and be competitive, and then we'll continue to reassess that judgment. So I think you asked a good question, but that's the way we look at it.
There are no further questions at this time. Please proceed, Katie.
Thank you, Leonie. Ladies and gentlemen, we appreciate your continued interest in Empire. If there are any unanswered questions, please contact me at my phone or e-mail. We look forward to having you join us for our Second Quarter Fiscal 2019 Conference Call on December 13. Goodbye.
Ladies and gentlemen, this concludes your conference call today. We thank you for participating, and I ask that you please disconnect your lines.