Empire Company Ltd
TSX:EMP.A
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Empire Company Ltd
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Good morning. My name is Sharon, and I will be your conference operator today. At this time, I would like to welcome everyone to the Empire Company Limited Third Quarter 2018 Results Conference Call. [Operator Instructions] Katie Brine, Director of Investor Relations, you may begin your conference.
Thank you, Sharon. Good morning, and thank you all for joining us on our Third 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 is a short summary document outlining the points of our quarter available on our website.Joining me on the call this morning are Michael Medline, President and Chief Executive Officer; Michael Vels, Chief Financial Officer; Lyne Castonguay, Executive Vice President, Merchandising; Jason Potter, Executive Vice President, Operations; and Pierre St-Laurent, Executive Vice President, Québec.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 who will discuss operations. Mike Vels will then provide a review on our financial results.
Thanks, Katie. Good morning, everyone. We continue to see improved results this quarter. In Q3, our adjusted EPS was $0.33, up 150% from last year. Against the backdrop of restructuring the company, we have generated 77% more adjusted EPS in the first 3 quarters this year than the same period last year. We are committed to doing everything it takes to make our company successful. We will make the tough decisions. We announced the closure of 10 underperforming stores in BC, cut CapEx this year to $350 million and had to let go a lot of good people in our offices in order to be efficient. We announced the decision to expand discount to the West. We invested in a partnership with Ocado to build the best e-commerce solution in Canada.In the quarter, same-store sales grew 1.1%. The last time we saw comps greater than 1% was 10 quarters ago. Inflation helped, so did execution. I want to explain something. We are far more interested in stabilizing our margins right now than chasing empty calorie comps. We witnessed a fairly aggressive industry promotional environment in Q3, and that has continued into Q4, especially in Ontario discount. We're expecting to see increased pressure on sales in Q4 as those curious gift cards from our competitor begin to -- began to continue to hit the market. But we're more interested right now in margin and basket size than simplistically pursuing tonnage and inflating same-store sales. We need to earn comps through execution and our strategic initiatives. Having said that, we had good comps this quarter, as we benefited from inflation and better execution through better blocking and tackling. We had a solid holiday period, better service levels from our warehouses to our stores, improved store execution, creative merchandising and our ad campaign are worth calling out here.This quarter, we continue to stabilize our margins. We previously mentioned that Q3 and Q4 would be the riskiest time period of our transformation and we may see volatility. However, in Q3, margin was actually up 30 basis points over the prior year, even the Sunrise distractions. Of course, we're not out of the woods yet. We're still in the riskiest phase of transformation. But the long-term gain we're looking for is well worth any short-term bumpiness.And with that, I will organize a few additional comments around the 4 key priorities that I set out a year ago. First, reorganizing our organizational structure and our people. At this point I am happy to report that we have completed the organizational restructuring. We have some merchants still transitioning, but for all intents and purposes, we are complete. Second, we remain on track with our Sunrise program. With a strong foundation laid in the first year, we are pleased to see benefits reflected this quarter that aligned with our expectations. However, it is still early days, and the quarterly results only reflect slightly less than 5% of our full target of $500 million with benefits expected to ramp up over the next 2 years. Third, we are seeing improvements on executing on our brand promise, but as I always say, this is the piece that is going to take the longest. We've made great strides in understanding our customers and are in the process of finalizing our customer brand strategy. I'm actually a little surprised we have already 3 positive comp quarters after the free fall we were in.Brand strategy, of course, is not just determining the look and feel of ad campaigns. Brand is the sum of everything we do, it touches the customer, the net impression of who we are and what we offer.A game-changing e-commerce offer is part of bolstering our brand, and that is exactly what we announced this quarter. Our exclusive Canadian partnership with global e-commerce leader, Ocado, will give us the best strategic and sustainably profitable e-commerce infrastructure in Canada, positioning us to thrill our customers and take customers from our competition. Leveraging Ocado's state-of-the-art robotics and end-to-end proprietary systems, we plan on rolling out home delivery to customers in the GTA in the spring of calendar 2020. We've secured a location for the first customer fulfillment center, and it's in Vaughan, a few hundred meters from our existing automated distribution center.Now on to our fourth priority, fixing the West. The progress we've made has been encouraging, in this early going, we are seeing positive same-store sales and improvements in our margins. We are making the difficult decisions necessary to turn around our business in the West. We closed stores, we're negotiating many provincial labor union agreements, we're converting stores to discount, we're improving BC's service levels and store standards.Recently, we reached a settlement in Saskatchewan with our labor union that keeps us competitive while allowing us the flexibility to run our business.Now we are in the hardest point in negotiations with our Manitoba Union. We hope to reach a mutually beneficial agreement, but we need to be competitive in the market.So to summarize, only 9 months into a 3-year transformation. I am very pleased with the progress we've made on our journey to turn around our company. Again, we will make every tough decision we need to in order to win. We're changing the culture at Sobeys. Our leaders are expected to deliver Sunrise results and strengthen our company to win in the future. No excuses.With that, over to Mike.
Thank you, Michael. Good morning, everyone. As Michael said, same-store sales from the quarter, excluding the impact of fuel sales, increased by 1.1% from the same period last year and an internal inflation number of 1.6%. The gross margin of 24% improved 30 basis points compared to the prior year, reflecting a continued focus on margins and improved promotional strategies, as stable margins continues to be our priority.Selling and administrative expenses as a percent of sales was 23% for the quarter, but excluding one-time expenses is 22.3%, a 70 basis point improvement, in part, reflecting early benefits of Sunrise although partly offset by increased incentive compensation costs.In January, we announced the closure of 10 underperforming stores in British Columbia and recorded $20.9 million in expenses related to the closures, including asset and inventory writeoffs and severance.Last quarter, we finalized our estimate of one-time Sunrise-related costs, comprising severance, relocation, consulting and minor system developments, noting it will not exceed $240 million. We have expensed $16.3 million this quarter, mostly comprised of severance and consulting costs.The real estate operation contributions for the quarter increased significantly due to a higher level activity this quarter in the Genstar partnerships, which contributed $20 million compared with $10.9 million last year.Lot sales in Western Canada and a bulk sale in the United States accounted for the elevated contribution this quarter. As I've mentioned before, timing plays an important element in these sales, and this quarterly result is not necessarily indicative of an increasing, continuing trend.The effective income tax rate for the quarter of 28.1% is at the top end of our indicated range of 26% to 28%. Free cash flow for the quarter was $269.4 million, a strong increase, up $241 million from last year due to stronger earnings and lower capital investments. We continue to expect that capital expenditures for this year will be at or slightly less than $350 million.Since the beginning of the transformation, the company's balance sheet has strengthened considerably, driven by consistent operating cash flow improvements and cash and investment controls. Liquidity continues to improve, and all of the company's significant credit metrics are moving in the right direction. For example, debt to adjusted EBITDA improved to 1.8x compared to 2.2x a year ago, and adjusted interest coverage has grown from 2.9x to 6.5x over the past year. This supports our continued expectation of reestablishing the company's investment-grade credit rating over time.As Michael said, Project Sunrise is on track, and we continue to anticipate that the transformation will yield at least $500 million in cost reductions on an annualized basis by the end of fiscal 2020. The transition of our merchandising staff will occur over the next 6 months, and the speed of this transition will determine the rate of benefits realization for the next and the following year.As Michael said, we did realize benefits in the quarter, mostly reflected in SG&A. But as he said, it's still early days, and only slightly less than 5% of our total target is included in results this period.At the end of our fourth quarter, we expect to be in a better position to provide expectations of the rate of realization of benefits over the next 2 years and the impact on our EBITDA margins.The 3-year plan, as we said before, can be divided into 3 phases: the first, organizational redesign from a regional to a national structure, is complete; the second, operational benefits, is gaining traction. Activity related to improving store operations, labor standards and other operational processes is progressing well and is an important element in our efforts to offset minimum wage increases. The third and largest, cost of goods sold, will take the longest to recognized -- to be recognized and will mostly be realized by Year 3. Our current structure systems and processes are fragmented and cause confusion between us and our supply of partners. Discussions are ongoing with our partners, and we're making necessary improvements in our systems to harmonize information across our company and with our supplier partners.Healthcare reform and minimum wage continue to be hot topics in the industry today. On January 29, additional healthcare reform was introduced that will come into effect on April 1, 2018. We estimate the impact of these changes prior to any mitigation may need to reduce our income before taxes by up to $40 million.This quarter, we had our first month that was impacted by the new minimum wage increases, most of which, I'm pleased to say, we were able to mitigate through Sunrise and other initiatives. At this time, we continue to be cautiously confident that we can offset the full year fiscal 2018 impact of $25 million. We continue to develop plans to mitigate the full year impact of minimum wage and Bill 148 increases that will arise in fiscal 2019, but there is risk that the company may not be able to fully offset the result -- the effect on earnings, considering the short transition period.In summary, we're pleased with our results to date and the early traction on Sunrise benefits, although we have a significant amount of work in front of us as we return the company to its full earnings potential.With that, Katie, over to you for questions.
[Operator Instructions] Your first question comes from Mark Petrie from CIBC.
Just wanted to ask, I guess, first, with regards to the competitive environment, and Michael, you mentioned that Ontario discount seem to be particularly intense in terms of the promotions, but maybe you could just comment, broadly by geography, what you've seen from a competitive perspective?
Yes, I mean I don't want to overplay it. It's not intense. But we've seen more promotional activity from our largest competitors in Ontario and in the West than we've seen in the previous 12 months. So we're dealing with that. You can see that we were able to deal with it in Q3. And as I said before, we'll stabilize margins and -- but we will remain competitive.
Okay. And then just in terms of your own same-store sales performance, I think, last quarter, you kind of said that Québec was the, sort of, the weakest region, and the rest of the regions were performing quite well. Has that trend continued? Or how would you describe Q3?
Q3 was strong across the board. Québec was mad at me for saying that last quarter, and they responded very well.
Okay. And then just last, I guess, you talked about the minimum wage increases and offsetting it through Sunrise and other initiatives, but how would you characterize the reaction in the competitive environment so far in 2018? Have you seen people, sort of, begin to react to those -- to the increases and the market's most affected?
Mark, it's Mike. The -- our observation, while imperfect, across the market would seem to indicate the initial actions by most of our competitors would be to reduce costs and do their best to mitigate prior to increasing any prices. So I think that's been the primary activity at this point in time. From our perspective, we had a lot of cost to take out. That's clearly a benefit for us, and we did benefit from that in the first month. We are working hard on our labor standards and have made some adjustments in store hours and other actions within our stores. So that, I think, given that it's really just the first month or so that it's been impacted, it probably makes sense that people would look to cost [indiscernible].
Your next question comes from Kenric Tyghe from Raymond James.
Can you just touch on the gross margin discussion and specifically the expansion? You highlighted improved execution, promotional strategy. Is there any positive mix impact you could speak of on, sort of, share recovery and select categories? I'm just trying to understand if there's sort of a second leg to the story here that we should be thinking about.
No, I don't think so. As Michael said, we're focused very much on making sure that our strategies are rational from a promotional perspective. We're putting a high premium on keeping our margins in a range while remaining competitive in the marketplace. And at this time, that's the priority for us as opposed to chasing after sales that are potentially transitory. We have a lot of work to do, as Michael said, on improving our stores, execution, delighting our customers, improving our marketing. And over time that will have impact on sustainable topline growth. At this time, that's not as much of our focus.
Sure. Michael, if I could just switch gears quickly then to the scores closures in quarter. Were there any surprises in either the number or were these stores, sort of, the perennial underperformers that were flagged for closure early on in your review process?
I'm not sure what you mean by surprises. We felt -- as Michael said, as we fix the West, in addition, link to our expansion of discount, there are -- there's number of stores we felt would be better closed and would have a positive impact on our Western results. But having said that, certainly, the number that was closed is to some extent related to the fact that we do believe that those stores may, at some point, be able to reopen, assuming we have appropriate labor agreements as discount formats. But it is a part of the scan and the review of our operations and specifically related to fixing the result in our Western unit.
Your next question comes from Jim Durran from Barclays.
Just wanted to go back to tonnage. So with respect to tonnage, and while I know it's not a focus, it's, obviously, an important metric over the long term. Right now, you're just saying that there've been previous promotion practices, I guess, that were not less than ideal in terms of their payback and so you're not chasing that business any longer. Is there any other factors that are impeding your ability to get back to even modest traffic growth -- traffic and tonnage growth?
Well, traffic. We're not -- we're seeing better traffic; we're seeing better basket size. I -- at this point, I look for how's our margin doing and organic comp. And I think we are helped by inflation, we're helped by some better execution. I think it's not right to expect us to be vastly growing market share until we put into place more of our strategic initiatives. So although we've improved our store standards, although we've improved service levels, and our branding and advertising is better than it was, I do not want the team chasing market share at the expense of -- being strong, getting Sunrise savings and being strong in the long term. Obviously, as we execute our conventional strategy, get discount up and running, open our e-commerce, improve our stores and our service, we are going to grab back our market share. That's inevitable. I just do not -- and I've been clear since I started, I do not want to get this out of order, because it will not help us to do so.
That's helpful. And within the context of your inflation number, like, what are the primary drivers to that recovery and inflation? I think by category, or how much of it's really just you not being as aggressive on price promotion?
Hard for me to give you an exact [ quantity on ] that or any real useful color. I just -- it's really a combination of both. We are clearly different this year from last year in terms of how we're pricing and our strategy in the market. At the same time, we have seen some element of increases across some of our categories. So hard for me to give you a split, it would be a combination of the two.
I think a lot of it's just doing things smarter. I think our flyers are more exciting for the customer at the same time as we're seeing slightly better margin growth. I think we're just -- I think we're pricing competitively. Our promotions are hawk and focused. And I think we're just doing some things, we're just executing on that better. And that's what we should do. But the big gain in margin will come, as we get -- as Lyne and the team get at that cost of goods sold.
Okay. And for the cost savings in the quarter, just want to be clear, so the 5% of the $500 million or $25 million, was that a run rate established towards the end of the quarter? Or was that a fully realized number in the quarter? And what was the potential dollar value of the compensation increase offsetting some of the benefit of those saving?
So to your first question, the amount would've been fully realized in the quarter. We're going to avoid talking run rates, because it's confusing. And the competition increase would've been a relatively small percentage of that, but not a number that I have right at the tip of my fingers.
Your next question comes from Irene Nattel from RBC Capital Markets.
Noticing that here in Québec, you've stepped up the communications with the -- with consumers around e-commerce. Could you just talk a little bit about that? And also, could you walk us through, once you get your first -- I guess, once you get up and running in 2020 with e-commerce, how you expect to get back some of revenue you may have lost between now and then as your competitors kind of ramp up their initiatives in the GTA?
So Pierre will say a couple of sentences on Québec e-commerce, and I will [take] that up, and then I'll speak on the second question.
On e-commerce, the news with Ocado is really interesting for dealers because we have a quite good result with e-commerce in Québec. So by implementing Ocado in Québec will improve our cost in stores, because we move from store pick to central fulfillment. So our dealer expecting that as soon as possible in the province to be more efficient and to get savings from that.
And generally, on e-commerce, I see this as a marathon, and we're in the first 100 meters. I say that often internally. We're -- we made a strategic decision to have the best arsenal at our disposal and the best assets and systems and store pick, although, really, the best that's available in Canada right now, and we did, I think, the best job in Québec and out in BC with our Thrifty. If not, in the end, in the next 5 to 7 years, sustainable, profitable or the best way to serve your customers. And so we made the decision to go for the win rather than a short-term answer. So I'm -- look, I'd rather be up and running with our system today, but I don't want to put a mediocre systems across the country when there's much more modern ways to win over the customer.
And just to be clear, when do you expect to have the Ocado system available here in Québec?
Well, we're -- right now, we said that we are concentrating on the GTA and getting that up and running, because that's a market we need to and will win. And there are 3 or other 4 other markets in the country that we need to look at. If you look at it, a handful of market covers over 3/4 of the customers in the country, I think it's quite clear which markets I'm referring to and that the question then is just timing over a period of times because we've got to watch our capital expenses overall in the company, and we're very, I think, getting very good in terms of capital allocation. And we need to time when the CFCs open. But our main priority for the next one will be the GTA, and then we'll look at, as Pierre said, we're talking to our dealers about what the correct timing could be in Montréal or in other regions across the country.
That's certainly understandable and helpful. Just sort of conceptually, would it be sort of 1 a year? Would it be sooner than that? Less than that? Longer than that?
Well, because -- I'm not going to commit to 1 a year or 1 every 2 years or whatever. I'm not going to commit to that because right now we're working through the GTA. Having said that, because of the lead time of 2 years to open up, you've got to factor that in. As we're working through even further with Ocado, and we've been meeting with them constantly since we announced the deal, and as we look at the market, we're more and more confident this is a good strategy. But we will put it in, and we'll allocate capital in the correct manner, we'll phase this, and we will not be announcing a bunch of CFCs at the same time. This will be in a measured, focused way. And right now the big prize we're going to capture is the GTA.
That's great. And just one other question, if I might, please. You did call out, from a competitive perspective, the discount side of things. But what are you seeing in, I guess, the sort of conventional segment? And also what are you seeing from the smaller ethnic banners?
I think it's -- I called out the discount because I think we've seen much more promotional behavior from our discount competitors, especially in Ontario over the last couple of months -- few months. And we're -- we have -- it's always competitive, so I hate to whine about competition. And I was just hearing stories in the United States, you want to see competition. So I don't like to whine about it. I would say that in the face of the -- some competitors, especially on the ethnic side that we continue to grow our comps. So we will respond -- we have so much upside to be able to grow our comps. We can do that in the face of competition. I expect more competition.
Your next question comes from Michael Van Aelst from TD Securities.
I just wanted to touch on a few things. Just wanted to start out by clarifying, again, on the cost savings for project centers. So that $25 million, give or take, was actually saved in the quarter? It's not an annualized rate?
That's right, Michael.
Great. And then if we look at the same-store tonnage trends, I know it's not your immediate focus, but you started to show some improvement and then it slipped a little bit the last couple of quarters. At the same time, the gross margin is up year-over-year, but it's about 50 basis points and lower than it was in the last 3 quarters. So you've seen some slippage there. I'd assume, it's still within a band that you're comfortable with. But can you describe, kind of, what happened in the quarter with respect to gross margin? Did you -- was that a reflection of investing a little bit to try and protect the market share? Or was there some other factors?
It's -- I wouldn't point to any particular factor, Michael. It's within a range that we were comfortable with. We're going -- it's not going to be dead flat, obviously. There are, also, some seasonal impacts. As Michael said, we had a good Christmas holiday outcome and we certainly drove higher sales through that. On average, those tend to come at slightly lower margins but still accretive. So there's a mix impact. So I wouldn't look at any particular factor or any systemic change or anything we're doing differently. It's within a range that we're comfortable with.
Okay. And with respect to the headwinds from minimum wage and healthcare reform. In the past, I think you've said that you -- the -- you'll try to mitigate the fiscal '18 $25 million amount for minimum wage without dipping into the Project Sunrise savings. When you look at the numbers into fiscal '19, are you expecting to have to dip into those -- that $500 million of savings to offset it? Or do you think you can do it over and above?
I think, realistically, particularly when you layer on the wage parity and other impacts, Michael, I think what we've said is, we're lucky that we have -- lucky -- fortunate, I guess, that we have an ability to reduce costs at a higher rate than our competitors. So yes. To fully offset it in the absence of increased prices in the market, Sunrise is going to be a partial offset for those minimum wage increases.
Okay. And you did talk about some new labor deals with Saskatchewan and then negotiations with Manitoba. I see labor union in BC with respect to those 10 store closures has been in the press lately. What's your progress in negotiations with Western Canada unions for -- or BC unions, I guess, for the FreshCo banner?
So we're -- it's Michael. Great question. We're in talks with BC right now, and we're moving along. And it's about on the pace that I -- head of our labor relations in HR, Simon Gagné, would've said. Would love to move it faster. But as we said, we will be opening our first stores in about 9 months. We're on pace to do that. We haven't said they're going to be in BC. We haven't said where they're going to be in the West, and I don't see foresee an issue. We're also working on the real estate portions of it as well, getting the permitting done as we talk this through with the unions.
Your next question comes from Chris Li from Macquarie.
I just have maybe a few questions on the Ocado partnership. Maybe, Michael, first, in order for the company to earn a good return on investment, can you maybe share with us on a high-level basis what are your long-term assumptions on things like online market penetration as well market share for Empire when this is up and running in the GTA?
We haven't said anything publicly that it's ought to be careful here. But I'd say that if you -- our assumptions are that we assumed that we would follow the -- where the U.S. market is growing. And actually we even paired that back to be even a bit more conservative. Our assumptions are -- I'm not going to give a number, because I'll just -- I haven't said anything publicly, but we will have a very high market share in the GTA. But when we ran it, we do very well financially, even if we don't hit the number that we have in mind of hitting. So we -- this is a -- we expect a -- I mean, I think, if you don't believe in growth or e-commerce, this is not the deal for you. But we believe that e-commerce will grow. It'll grow in a percentage terms, fast, off of small base. And then next 5 years, it's going to grow quite a bit. The issue for e-commerce in this country, in Canada, is that no one has given the customers a fantastic option. And you can see in the U.K. where they were given a great option that the growth in e-commerce took off faster than it otherwise would have. So even with the growth as it is on the current trajectory, it makes sense for us by offering customers something that they just never have seen before. We will -- we'll have the highest market share of any grocer, and we'll be competing with you know who. So that's what we're looking at.
Okay, that's great. And on the flip side, I know you guys have done a lot of due diligence on this before signing the deal. I mean, what are some of the key risks do you think that would cause this partnership to not be a good win for them? Are there anything that particularly was concerning as you were doing the due diligence?
No, none at all. I mean, honestly, the thing you look for is in any of your deals, and I know you guys think it's soft, but it's the most important thing, but can you work culturally together? And I think this is going to be a super cultural fit.
Okay. And maybe just couple ones, for Mike. This -- with respect to the $70 million of investment that the company is making over the next 2 years for the e-commerce customer fulfillment center, will most of that be treated like CapEx, kind of, flowing through the cash flow statement with some depreciation expense flowing through the income statement? Or will there be an SG&A expense component associated with it? Essentially, I want to make sure that I'm, kind of, capturing the numbers correctly in the earnings forecast over the next couple of years.
Yes. The $70 million that we've referred to on capital is the expenditure that we're making both to purchase the software effectively and build the distribution center, which, as Michael said, we've now located and is actually under construction, as we speak. Those amounts will be capitalized, as per usual, on our balance sheet as fixed assets and depreciated over the useful life.
Okay. And then I think in the past you've mentioned this will be marginally dilutive to earnings in the beginning. Is that still the case?
Well, it just makes sense that it would be because when you start up a completely new warehouse with very little volume, by definition, you're not going to make profits on -- in Year 1 and then it will improve. And as we've said at scale, this -- these warehouses, CFCs, are profitable because of their efficient costs and the very high-quality website and promotional approaches that we have towards the -- on the customer end, so. So yes as you ramp it up, just by its very nature, it's not going to make money on Day 1.
Okay. My last question is just on the 10 store closures, can you give us a sense of what the sales and earnings impact would be from those 10 store closures?
No. We're not going to disclose those numbers.
Your next question comes from Vishal Shreedhar from National Bank.
In terms of Project Sunrise, I think management said it's on track, yet in the disclosure materials, management now says it's looking like it could be equal to or above $500 million. Just wondering if you can give me some color on why management feels that it could be above $500 million now?
Well, we've said at least $500 million. So I guess we're -- we've always been positive about our ability to achieve $500 million. I think Michael's said, and myself have said, that we're a competitive team. We're going to -- as we go along, we anticipate and expect, as we put improved systems, talent and people into our system, into our company, rather, that there's probably other opportunity. But at this point, we're holding firm to our $500 million number, and we feel more confident about that as our progress continues.
Okay. So does management still anticipate that of that $500 million there will be a portion reinvested?
Yes, we've said that a majority will go to bottom line and some proportion will be reinvested in company. But we've also said that if we reinvest in the company, it better have -- better be accretive. And so if we see opportunities to invest a little bit of the money and make the company stronger, we'll do so.
Okay. The company, obviously, has a lot on the go right now, many initiatives. Is it reasonable, as we model -- I'm not sure how much color you guys will give me, but as Empire grows the discount banner and as Ocado starts to ramp up, as we look a little longer term, that might be dilutive to margin percentage although accretive to dollars. Is that a reasonable framework to think about it in?
Well, I think that's -- I'm just trying to figure out how to exactly answer that. So depending on which year you're looking at, as I mentioned to Chris, in the early days, the online -- the e-commerce online offering will not be immediately profitable. So that would have a -- an impact, for sure, on our average mansions, just as you factor it in. But having said that, I think you need remember that it's still a very small percentage of our ongoing business. It's very important, because, from a market share perspective and participating in what we anticipate to be a growing and vibrant channel for grocery. But still a relatively small impact if you look at the size of the company. On discount, as we drive more through discount channel, from a averaging perspective, I think you'll see high end growth rates because we'd be participating in a channel that has a higher growth rate on the top line. But on average, those margins are slightly lower than conventional.
Okay. Just in terms of what you said, it's going to be a small percentage, I think you were referring to the Ocado partnership.
That's right.
What is the reason in the next few years, what is the capacity of one of those DCs in sales dollars?
Well, the only public information that's out there and that we've -- that people have picked up, I guess, is that Ocado records their new facility, which is not entirely dissimilar to the size of the one we're putting into Toronto, as having a capacity, if you translate the dollars to roughly about half -- about $500 million. That doesn't mean that we anticipate that to be our sales number, our sales target. But that will give you a sense for the capacity of the facilities that Ocado is putting into U.K.
Okay. And just going back to a comment you made earlier. So regarding the minimum wage and the drug reforms, should investors anticipate that those challenges will be met, in part, from Project Sunrise? And I might have gotten this wrong, but my earlier understanding was the minimum wage would've -- the initiative to offset that were independent of Sunrise.
So on minimum wage, the first year, we felt that we had enough flexibility and opportunity in our systems across the country to offset it. And obviously Sunrise is also a potential to offset the larger and increasing cost of that as we get into the second year. So yes, for fiscal '19, we anticipate, as I said, without any increases in prices in the market or any recovery of those in the industry, we will likely require an element of our Sunrise savings to offset it.
Okay. And that goes for drug reform and [indiscernible]?
Well, drug reform, I think, we've been pretty clear, is going to impact our earnings. And we're approaching it in a way that it's not going to impact our earnings close to the amount that would impact our competitors as we're not as penetrated in that areas as our competitors are. But yes, that is a -- an impact in our earnings, and we anticipate that to occur.
And when drug reforms kick in, isn't it even cadence from that April date that we just assume for the impact?
Yes, pretty well.
Your next question comes from Peter Sklar from BMO Capital Markets.
Question for Pierre. Pierre, you were talking about that the -- your IGA franchisees seem open to the Ocado online distribution model in Québec. And like how -- what will happen to the click and collect business in Québec? Will you discontinue that? And are your franchisees like -- are they not unhappy that they're going to be losing that business or that Empire at least -- at the least will be competing with that business through the centralized opportunity?
Well, first of all, the business in Québec is a bit different. I mean, it's a partnership with dealers in Québec, so we own the wholesale business and they own the retail business, in general. So it's our job to build the same partnership model with them for e-commerce business. So it's what we're looking for. So there's no danger for them. As a good partner they were with us in the last, I would say, 60 years. So there's no reason that it won't work for e-commerce. It's where we are now. And as we mentioned, it's growing quickly. And this put pressure on store cost and everything. So they are more than open to find solutions, win-win solution between us and them to run their business in the future.
And by definition, there's no store retail -- like bricks and mortar store retailing. How do the -- how do your IGA partners participate in the Ocado model?
It's not defined yet. It's a work in progress that we're working with them.
Okay. And then just I have one question for Michael. Is like -- you've talked, like, earlier in your comments, you talked about the competitive backdrop. I believe you said that in Q3 and carrying into Q4, it was a little more promotional, particularly in discount in Ontario, and I'm just wondering how you reconcile that statement with the fact that both yourself and the entire industry is reporting pretty decent inflation numbers. I think, Michael, you said your internal inflation was positive 1.6%?
No, we -- our internally at 1.6%. So your question is, how are we saying it's more promotional and we're seeing inflation. Well, we're seeing some of the costs going up. But we're seeing our competitors in the flyers becoming -- and I think if you've looked at some of the flyers in Ontario in the last few weeks of the competitors, you'd see a much more promotional you would at any time over the previous year. So we haven't gone out and reconciled all those kinds of numbers.
[Operator Instructions] Your next question comes from Patricia Baker from Scotiabank.
I have two questions. Michael and Mike, you both referenced in your opening remarks the fact that with respect to the organizational restructuring that you still have the merchandising piece to complete. And Mike, I think you said that depending on how quickly that gets done, it will impact the pace of some of the achievement of the benefits of Project Sunrise. So I'm just curious about what exactly is left to do? What are the particular challenges associated with restructuring the merchandising? And is there any specific risks associated with the how that's perceived? And just broadly, when do you think you will complete it?
So I'll have Lyne provide some color commentary on this, but the point that we're making, Patricia, is that the organizational restructuring is now done. Everybody's in their new seats. Everybody has their new jobs, they know what their task is. And they know they're accountable for a significant amount of benefit related to Sunrise, which is mostly going to come from improved cost of goods sold and better category management. So we having now completed first phase, that category group is now working through the rate and the pace at which they can accomplish these benefits. So Lyne if want to give a little bit of color to what that looks like, how you feel about it, that would be great.
Yes, Patricia, this is Lyne. It's obviously a really big transformation and impacts the entire company. So our category in merchants have been now announced since the end of November. We transitioned to their new position a few weeks ago. So we now have transitioned officially through our national merchandising team. They've been through extensive training and they've been able to hit the ground running now with the transition. So they're working right now on our merchandising, transformation to harmonize our supplier price file. And to begin to rationalize our categories across the company, and to reduce the cost of goods sold, obviously. We're pleased with -- we're very pleased with the team's progress. We have seized of a national buy and some good opportunity buy that has helped us with some of the margins that you're seeing. And so it's a complex time for the team, obviously. But because we're simplifying the structure, it's actually making things progress well, and our supplier partners are starting to see that simplification in our structures and the number of people that they deal with. And this will continue to improve. So we're pleased with the progress that were making in that area.
I just got -- sorry, I just have one thing -- So I just want to say something, I'm ruminating on Peter's question a little bit more as I'm apt to do. Just three quick -- three quick things, Peter, on your question in terms of discount in margins. I mean, there's a lot more going on in margin as you know than just the promotion, but -- and I referred specifically to discount Ontario and a little bit of discounting in the West. And two, or three is -- we're seeing now -- if you don't think that people giving away some free groceries for whatever reason with gift cards impact everybody in the market, that's -- it does. To what extent is you can't measure it. But theoretically, it make sense. So those -- there's a little bit of noise right now. But I don't -- I think what you're implying to is, look, it's always promotions, always some competitiveness. I was saying for 3 quarters that I didn't see a lot of promotional intensity, we're trying to see a little bit of promotional intensity. Sorry, Patricia?
Okay, Michael. I have a question for you then, Michael. I'm just curious, the location of the CFC in Vaughan, is there -- there may or may not be anything here, but is there any advantage for you having it located in Vaughan?
Yes. There's a big advantage, especially, in the start-up phase where you can bring over some products from our automated DC in Vaughan over. I think when we're up and running at any sort of capacity, it's -- you don't really -- you won't be using the Vaughan facility, per se, unless there was some sort of urgent need to do so, which we wouldn't foresee. The beauty of that site wasn't so much that it was near the Vaughn, DC, the beauty was, we're looking at 13 sites, this one was #1 by a mile. And the reason being it was perfect size it had been zoned and permitted already and the walls were already up, but they weren't so far along the building that we couldn't retrofit for the technology that we're putting in place. So it was -- we have a landlord there, we were very pleased to be able to make that deal.
[Operator Instructions] We do not have any questions over the phone. At this time, I will turn the call over to the presenters.
Thank you, Sharon. Ladies and gentlemen, we appreciate your continued interest in Empire. Is there are any unanswered questions, please contact me by phone or email. We look forward to having you join us for our Fourth Quarter Fiscal 2018 Conference Call on June 28. Goodbye.
This concludes today's conference call. You may now disconnect.