Loblaw's Q3 earnings up 12.7% year-over-year to C$213M, as sales rise 1.3% to C$9.60B helped by positive impact of T&T Supermarket acquisition amid flat food sales, slight decline in drugstore sales

BRAMPTON, Ontario , November 19, 2010 (press release) – 2010 Third Quarter Summary(1)

- Basic net earnings per common share of $0.77 up 11.6%
- EBITDA(2) margin of 6.2%, an increase of 30 basis points from 5.9%
- Sales of $9,593 million, growth of 1.3%
- Same-store sales declined 0.4%

"The Company continues to make progress towards the final stages of its renewal program in a market which remains highly competitive and under deflationary pressures," said Galen G. Weston, Executive Chairman, Loblaw Companies Limited. "These factors, combined with the significant risk and cost associated with the major systems and infrastructure programs the Company is undertaking, will continue to put future sales and margins increasingly under pressure."

- Sales in the third quarter of 2010 were positively impacted by 1.7% by the acquisition of T&T Supermarket Inc. ("T&T"), which was completed at the end of the third quarter of 2009.

- In the third quarter of 2010:

- sales in food were flat;
- the Company's internal retail food price index was flat. This compared to internal retail food price inflation in the third quarter of 2009;
- sales in drugstore declined marginally, impacted by deflation due to regulatory changes in Ontario and the introduction of generic versions for certain prescription drugs;
- sales growth in apparel was strong while sales of other general merchandise declined significantly; and
- gas bar sales increased significantly as a result of higher retail gas prices and strong volume growth.

- Gross profit increased by $152 million, or 7.0%, to $2,317 million in the third quarter of 2010 compared to the third quarter of 2009. Gross profit as a percentage of sales in the third quarter of 2010 was 24.2% compared to 22.9% in the third quarter of 2009. The increase was primarily attributable to continued buying synergies, disciplined vendor management, improved control label profitability and inventory management and a stronger Canadian dollar, partially offset by increased transportation costs.

- Operating income in the third quarter of 2010 included a charge related to the effect of stock-based compensation net of equity forwards of $10 million in 2010 compared with $5 million in 2009. The effect on basic net earnings per common share was a charge of $0.04 (2009 - $0.03).

- The Company incurred an incremental cost of $46 million in the third quarter of 2010 related to its investment in information technology and supply chain, which negatively impacted basic net earnings per common share by $0.12. The Company expects associated incremental costs to range between $25 million and $30 million for the fourth quarter of 2010 and between $140 million and $145 million for the year 2010.

- In connection with the ratification of new 5-year collective agreements with certain Ontario locals of the United Food and Commercial Workers Canada union, the Company incurred a cost of approximately $17 million in the third quarter of 2010 which negatively impacted basic net earnings per common share by $0.04. With the ratification of these collective agreements, the Company expects improved operational flexibility.

- Operating income and operating margin were positively influenced by improved gross profit, partially offset by the charge related to stock-based compensation net of the equity forwards, incremental costs related to the investment in information technology and supply chain, the cost in connection with the ratification of a new collective agreement and increased labour costs.

- The Company's estimate of capital expenditures has increased to approximately $1.3 billion for the year 2010.


Management's Discussion and Analysis

The following Management's Discussion and Analysis ("MD&A") for Loblaw Companies Limited and its subsidiaries (collectively, the "Company" or "Loblaw") should be read in conjunction with the Company's third quarter 2010 unaudited interim period consolidated financial statements and the accompanying notes included in this Quarterly Report and the audited annual consolidated financial statements and the accompanying notes for the year ended January 2, 2010 and the related annual MD&A included in the Company's 2009 Annual Report - Financial Review. The Company's 2010 unaudited interim period consolidated financial statements and the accompanying notes have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP") and are reported in Canadian dollars. These interim period consolidated financial statements include the accounts of the Company and its variable interest entities ("VIEs") that the Company is required to consolidate in accordance with Accounting Guideline 15, "Consolidation of Variable Interest Entities".

A glossary of terms used throughout this Quarterly Report can be found on page 86 of the Company's 2009 Annual Report - Financial Review. In addition, this Quarterly Report includes the following terms: "rolling year net debt(1) to EBITDA(1)" which is defined as net debt(1) divided by cumulative EBITDA(1) for the latest four quarters; "rolling year return on average net assets(1)", which is defined as cumulative operating income for the latest four quarters divided by average net assets(1); "rolling year return on average shareholders' equity", which is defined as cumulative net earnings available to common shareholders for the latest four quarters divided by average total common shareholders' equity; and "operating working capital", which is defined as the sum of accounts receivable, inventories and prepaid expenses and other assets less accounts payable and accrued liabilities.

The information in this MD&A is current to November 16, 2010, unless otherwise noted.

(1) See Non-GAAP Financial Measures.

Results of Operations

Sales

Sales for the third quarter increased by 1.3%, or $120 million, to $9,593 million compared to $9,473 million in the third quarter of 2009. The following factors explain the major components of the increase:

- T&T Supermarkets Inc. ("T&T") sales positively impacted the Company's sales by 1.7%;

- same-store sales declined by 0.4%;

- sales in food were flat;

- the Company's internal retail food price index was flat. This compared to internal retail food price inflation in the third quarter of 2009. National food price inflation was 1.3% as measured by the "Consumer Price Index for Food Purchased from Stores" ("CPI"). CPI does not necessarily reflect the effect of inflation on the specific mix of goods sold in Loblaw stores;

- sales in drugstore declined marginally, impacted by deflation due to regulatory changes in Ontario and the introduction of generic versions for certain prescription drugs;

- sales growth in apparel was strong while sales of other general merchandise declined significantly due to reductions in assortment and square footage and lower discretionary consumer spending;

- gas bar sales increased significantly as a result of higher retail gas prices and strong volume growth; and

- during the third quarter of 2010, net retail square footage remained flat, as 2 stores opened and 2 stores closed. During the last four quarters, 14 stores were opened and 24 stores were closed, resulting in a net decrease of 0.1 million square feet, or 0.2%.

For the first three quarters of the year, sales increased by 1.8%, or $412 million, to $23,836 million compared to the same period in 2009. The following factors, in addition to the quarterly factors mentioned above, further explain the increase:

- T&T sales positively impacted the Company's sales by 1.8%;

- same-store sales declined by 0.3%; and

- sales and same-store sales were positively impacted by approximately 0.2% as a result of a labour disruption during the first quarter of 2009 in certain Maxi stores in Quebec. These stores reopened in the first quarter of 2009, except for two stores that were permanently closed.

Gross Profit

Gross profit increased by $152 million, or 7.0%, to $2,317 million in the third quarter of 2010 compared to $2,165 million in the third quarter of 2009. Gross profit as a percentage of sales was 24.2% in the third quarter of 2010 compared to 22.9% in the third quarter of 2009. Year-to-date gross profit increased by $362 million to $5,830 million compared to $5,468 in the comparable period of 2009. Year-to-date gross profit as a percentage of sales was 24.5% compared to 23.3% in the comparable period of 2009. In the first three quarters of 2010, the increase in gross profit and gross profit as a percentage of sales was primarily attributable to continued buying synergies, disciplined vendor management, improved control label profitability and inventory management and a stronger Canadian dollar, partially offset by increased transportation costs.

Operating Income

Operating income increased by $12 million, or 3.2%, to $390 million in the third quarter of 2010 compared to $378 million in the third quarter of 2009. Operating margin was 4.1% for the third quarter of 2010 and 4.0% for the third quarter of 2009. The increases in operating income and operating margin were primarily due to the changes in gross profit as described above, partially offset by a charge of $10 million (2009 -$5 million) related to stock-based compensation net of the equity forwards, incremental costs of $46 million related to the Company's investment in information technology and supply chain and increased labour costs. In addition, in connection with the ratification of new 5-year collective agreements with certain Ontario locals of the United Food and Commercial Workers Canada union, the Company incurred a cost of approximately $17 million in the third quarter of 2010.

EBITDA(1) increased by $34 million, or 6.1%, to $591 million in the third quarter of 2010 compared to $557 million in the third quarter of 2009. EBITDA margin(1) increased in the third quarter of 2010 to 6.2% from 5.9% in the comparable period of 2009. The increases in EBITDA(1) and EBITDA margin(1) were primarily due to the changes in operating income as described above.

Year-to-date operating income for 2010 increased by $52 million, or 5.6%, to $980 million, and resulted in an operating margin of 4.1% compared to 4.0% in the comparable period in 2009. The year-to-date increases in operating income and operating margin were primarily due to the changes in gross profit as described above, partially offset by a charge of $30 million (2009 - $17 million) related to stock-based compensation net of the equity forwards, incremental costs of $115 million related to the Company's investment in information technology and supply chain, the $17 million cost incurred in the third quarter of 2010 in connection with the ratification of new collective agreements and increased labour costs. Included in the incremental costs was $16 million of costs related to changes in the Company's distribution network in Quebec recorded in the second quarter of 2010. In addition, in connection with the distribution network changes a $26 million asset impairment charge was recorded for the closure of a distribution centre. Year-to-date operating income in 2009 included a gain of $8 million from the sale of financial investments by President's Choice Bank ("PC Bank"), a wholly owned subsidiary of the Company.

Year-to-date EBITDA(1) increased by $108 million, or 7.9% to $1,482 million compared to $1,374 million in the comparable period in 2009. EBITDA margin(1) improved to 6.2% compared to 5.9% for the same period last year. The year-to-date increases in EBITDA(1) and EBITDA margin(1) were primarily due to the changes in year-to-date operating income as described above.

(1) See Non-GAAP Financial Measures.

Interest Expense and Other Financing Charges

Interest expense and other financing charges decreased to $78 million in the third quarter of 2010 compared to $84 million in the third quarter of 2009 primarily due to an increase in interest income related to financial derivative instruments. Year-to-date interest expense and other financing charges increased to $210 million compared to $205 million in the comparable period of 2009 primarily due to an increase in interest expense on long term debt partially offset by an increase in interest income related to financial derivative instruments.

Income Taxes

The effective income tax rate in the third quarter of 2010 was 28.5% (2009 - 34.4%) and 29.4% (2009 - 31.8%) year-to-date. The quarter over quarter decrease in the effective income tax rate was primarily due to a decrease in the income tax accruals relating to certain prior year income tax matters and the change in the proportions of taxable income earned across different tax jurisdictions. The year over year decrease in the effective income tax rate was primarily due to the proportions of taxable income earned across different tax jurisdictions and a decrease in the income tax accruals relating to certain prior year income tax matters.

In March 2010, the federal budget proposed changes that impact the tax deductibility of cash-settled stock options. As at October 9, 2010, the Company has $12 million in current and future tax assets relating to outstanding employee stock options that will be expensed when the proposed changes are substantively enacted.

Net Earnings

Net earnings for the third quarter of 2010 increased by $24 million, or 12.7%, to $213 million from $189 million in the third quarter of 2009 and year-to-date increased by $39 million, or 7.9%, to $530 million from $491 million in 2009. Basic net earnings per common share for the third quarter increased by $0.08, or 11.6%, to $0.77 from $0.69 in the third quarter of 2009 and year-to-date increased by $0.12, or 6.7%, to $1.91 compared to $1.79 for the same period last year.

Basic net earnings per common share in the third quarter of 2010 included the following:

- a charge of $0.04 (2009 -$0.03) per common share for the net effect of stock-based compensation net of equity forwards.

Year-to-date basic net earnings per common share for 2010 included the following:

- a charge of $0.08 (2009 -$0.07) per common share for the net effect of stock-based compensation net of equity forwards; and

- a charge of $0.07 (2009 - nil) per common share for the distribution centre asset impairment.

Financial Condition

Financial Ratios

The Company's net debt(1) to equity(1) ratio continued to be within the Company's internal guideline of less than 1:1. The net debt(1) to equity(1) ratio was 0.36:1 at the end of the third quarter of 2010 compared to 0.42:1 at the end of the third quarter of 2009 and 0.43:1 at year end 2009. The rolling year net debt(1) to EBITDA(1) ratio was 1.3 times at the end of the third quarter of 2010 compared to 1.5 times at the end of the third quarter of 2009 and 1.6 times at year end 2009. The decreases in these ratios at the end of the third quarter of 2010 compared to year end 2009 and the third quarter of 2009 were primarily due to the decrease in net debt(1) and the increase in cumulative operating income for the latest four quarters for the respective ratios.

The interest coverage ratio was 4.3 times for the third quarter of 2010 and 4.2 times for the third quarter of 2009. This ratio increased compared to the prior year due to the improvement in year-to-date operating income which was partially offset by an increase in year-to-date interest expense.

The rolling year return on net assets(1) at the end of the third quarter of 2010 was 12.4%, compared to 12.6% at the end of the third quarter of 2009 and 12.0% at year end 2009. The increase in this ratio at the end of the third quarter of 2010 compared to year end 2009 was primarily due to the increase in cumulative operating income for the latest four quarters partially offset by the increase in net assets(1). The decrease in this ratio from the third quarter of 2009 is due to an increase in net assets partially offset by an increase in cumulative operating income. The rolling year return on shareholders' equity at the end of the third quarter of 2010 was 10.8%, compared to 11.5% at the end of the third quarter of 2009 and 10.9% at year end 2009. The decreases in this ratio were due to the increases in average shareholders' equity partially offset by the increase in cumulative net earnings over the respective latest four quarters.

(1) See Non-GAAP Financial Measures.

First Preferred Shares

1.0 million non-voting First Preferred Shares are authorized, of which none were outstanding at the end of the third quarter of 2010.

Capital Securities

12.0 million non-voting Second Preferred Shares, Series A are authorized, of which 9.0 million were outstanding at the end of the third quarter of 2010.

Common Share Capital

An unlimited number of common shares is authorized, of which 279,501,896 were outstanding at the end of the third quarter of 2010.

Further information on the Company's outstanding share capital is provided in note 13 to the unaudited interim period consolidated financial statements.

Dividends

During the third quarter of 2010, the Company's Board of Directors declared a dividend of $0.21 per common share with a payment date of October 1, 2010 and $0.37 per Second Preferred Share, Series A payable on October 31, 2010. Subsequent to the end of the third quarter of 2010, the Board declared a quarterly dividend of $0.21 per common share payable on December 30, 2010 and a quarterly dividend of $0.37 per Second Preferred Share, Series A payable on January 31, 2011.

Dividend Reinvestment Plan ("DRIP")

During the third quarter of 2010, the Company issued 2,193,185 (2009 - 2,461,769) common shares and year-to-date 3,313,638 (2009 - 2,461,769) common shares from treasury under the DRIP at a three percent (3%) discount to market resulting in net cash savings and incremental common share equity to the Company of approximately $84 million in the third quarter (2009 - $79 million) and $125 million (2009 - $79 million) year-to-date.

Liquidity and Capital Resources

Cash flows from Operating Activities

Third quarter cash flows from operating activities were $587 million in 2010 compared to $855 million in the third quarter of 2009. On a year-to-date basis, cash flows from operating activities were $991 million compared to $1,330 million in the comparable period in 2009. The decreases in cash flows from operating activities were primarily due to the change in non-cash working capital, partially offset by the increases in EBITDA(1) as described in the results of operations section of this MD&A.

Cash flows used in Investing Activities

Third quarter cash flows used in investing activities were $569 million compared to $363 million in the third quarter of 2009. The increase in cash flows used in investing activities in the third quarter was primarily due to an increase in fixed asset purchases, the change in short term investments and the increase in security deposits and other assets primarily as a result of PC Bank's accumulation of $150 million, partially offset by the acquisition of T&T which was completed at the end of the third quarter of 2009. On a year-to-date basis, cash flows used in investing activities were $696 million compared to $495 million in the comparable period in 2009. The year-to-date increase in cash flows used in investing activities was primarily due to an increase in fixed asset purchases, PC Bank's repurchase of $90 million of co-ownership interest in securitized receivables from an independent trust in the first quarter of 2010 and the increase in security deposits and other assets primarily as a result of PC Bank's accumulation of $150 million in the third quarter of 2010, partially offset by the changes in short term investments and the acquisition of T&T which was completed at the end of the third quarter of 2009. Capital investment amounted to $479 million (2009 - $284 million) for the third quarter and $863 million (2009 - $606 million) year-to-date which includes $17 million and $36 million, respectively, that was financed through capital leases. The Company's estimate of capital expenditures has increased to approximately $1.3 billion for the year 2010 due to an increase in planned retail renovations driven by better than expected performance of renovated stores.

Cash Flows (used in) from Financing Activities

Third quarter cash flows used in financing activities were $32 million in 2010 compared to $44 million in the third quarter of 2009. The decrease in cash flows used in financing activities in the third quarter was primarily due to an increase in long term debt. On a year-to-date basis, cash flows from financing activities were $12 million compared to cash flows used in financing activities of $122 million in the comparable period of 2009. The year-to-date change was primarily due to the issuance of $350 million of 5.22% Medium Term Notes in the second quarter of 2010, the cash savings associated with the DRIP during 2010, the repayment of the Company's short term debt and bank indebtedness in the second quarter of 2009 and the repayment of the $125 million, 5.75% Medium Term Note in the first quarter of 2009, partially offset by the repayment of the $300 million, 7.10% Medium Term Note in the second quarter of 2010 and the issuance of $350 million, 4.85% Medium Term Notes in the second quarter of 2009.

During the third quarter of 2010, PC Bank began accepting deposits under a new Guaranteed Investment Certificate ("GIC") program. The GICs, which are sold through an independent broker channel, are issued with fixed terms ranging from 12 to 60 months and are non-redeemable prior to maturity. Individual balances up to $100,000 are Canada Deposit Insurance Corporation (CDIC) insured. As at October 9, 2010, $7 million was recorded as long term debt on the consolidated balance sheet.

During the second quarter of 2010, the Company issued $350 million principal amount of 10 year unsecured Medium Term Notes, Series 2-B pursuant to its Medium Term Notes, Series 2 program. Interest on the notes is payable semi-annually at a fixed rate of 5.22%. The notes are unsecured obligations and are redeemable at the option of the Company. In the second quarter of 2009, the Company issued $350 million principal amount of 5 year unsecured Medium Term Notes, Series 2-A which pay a fixed rate of interest of 4.85% payable semi-annually.

During the second quarter of 2010, the $300 million, 7.10% Medium Term Note due May 11, 2010 matured and was repaid. In the first quarter of 2009, the $125 million, 5.75% Medium Term Note matured and was repaid.

Net Debt(1)

As at October 9, 2010, net debt(1) was $2,529 million compared to $2,783 million as at January 2, 2010. The decrease of $254 million was primarily due to positive cash flows from operating activities and a decrease in credit card receivables, after securitization, partially offset by fixed asset purchases.

(1) See Non-GAAP Financial Measures.

Sources of Liquidity

The Company expects that cash and cash equivalents, short term investments, future operating cash flows and the amounts available to be drawn against its credit facility will enable the Company to finance its capital investment program and fund its ongoing business requirements, including working capital, pension plan funding and financial obligations over the next twelve months. In addition, given reasonable access to capital markets, the Company does not foresee any impediments in securing financing to satisfy its long term obligations.

PC Bank participates in various securitization programs that provide the primary source of funds for the operation of its credit card business. Under these securitization programs, a portion of the total interest in the credit card receivables is sold to independent trusts pursuant to co-ownership agreements. PC Bank purchases receivables from and sells receivables to the trusts from time to time depending on PC Bank's financing requirements. In the third quarter of 2010, PC Bank accumulated $150 million of collections that will be used in the fourth quarter to repurchase a portion of its co-ownership interest in securitized receivables from two of the independent trusts. In the fourth quarter of 2010, PC Bank intends to simultaneously increase the co-ownership interest of another trust leaving the total level of securitization unchanged but rebalanced between trusts. A portion of the securitized receivables that is held by an independent trust facility was also renewed for 2 years during the third quarter of 2010. During the first quarter of 2010, PC Bank also repurchased $90 million (2009 - nil) of co-ownership interest in securitized receivables from an independent trust.

On March 17, 2011, the five-year $500 million senior notes and subordinated notes issued by Eagle Credit Card Trust will mature. Eagle Credit Card Trust has declared an accumulation commencement date of December 1, 2010 at which time collections will be accumulated until an amount sufficient to repay the notes at maturity has been accumulated. The Company is considering alternatives for refinancing these notes in the securitization market. In the absence of additional securitization of receivables, the Company would be required to use its cash and short term investments or raise alternative financing by issuing additional debt or equity instruments.

The independent trusts' recourse to PC Bank's assets is limited to PC Bank's excess collateral of $114 million as at October 9, 2010 (October 10, 2009 - $124 million; January 2, 2010 - $121 million) as well as standby letters of credit issued as at October 9, 2010 of $103 million (October 10, 2009 - $116 million; January 2, 2010 - $116 million) based on a portion of the securitized amount.

During the third quarter of 2010, the Company's Short Form Base Shelf Prospectus dated June 5, 2008 which allowed for the issuance of up to $1 billion of unsecured debt and/or preferred shares, expired. On or about November 18, 2010, the Company intends to file a Short Form Base Shelf Prospectus which will also allow for the issuance of up to $1 billion of unsecured debt and/or preferred shares over a 25-month period.

The Company has traditionally obtained its long term financing primarily through a Medium Term Notes program. The Company may refinance maturing long term debt with Medium Term Notes if market conditions are appropriate or it may consider other alternatives.

During the third quarter of 2010, Dominion Bond Rating Service reaffirmed the Company's credit ratings and trend. During the second quarter of 2010, Standard & Poor's reaffirmed the Company's credit rating and outlook. The following table sets out the current credit ratings of the Company:

The rating organizations listed above base their credit ratings on quantitative and qualitative considerations. These credit ratings are forward-looking and intended to give an indication of the risk that the Company will not fulfill its obligations in a timely manner.

The Company's and PC Bank's ability to obtain funding from external sources may be restricted by downgrades in the Company's current credit ratings should the Company's financial performance and condition deteriorate. In addition, credit and capital markets are subject to inherent global risks that may negatively affect the Company's access and ability to fund its financial and other liabilities. The Company mitigates these risks by maintaining appropriate levels of cash and cash equivalents and short term investments, committed lines of credit and diversifying its sources of funding and the maturity profile of its debt and capital obligations.

During the second quarter of 2010, Loblaw renewed its Normal Course Issuer Bid to purchase on the Toronto Stock Exchange ("TSX"), or to enter into equity derivatives to purchase, up to 13,865,435 of the Company's common shares, representing approximately 5% of the common shares outstanding. In accordance with the requirements of the TSX, any purchases must be at the then market prices of such shares. The Company did not purchase any shares under its Normal Course Issuer Bid during the first three quarters of 2010.

Independent Funding Trusts

Certain independent franchisees of the Company obtain financing through a structure involving independent funding trusts, which were created to provide loans to the independent franchisees to facilitate their purchase of inventory and fixed assets, consisting mainly of fixtures and equipment. These trusts are administered by a major Canadian chartered bank.

The gross principal amount of loans issued to the Company's independent franchisees by the independent funding trusts as at October 9, 2010 was $395 million (October 10, 2009 - $377 million; January 2, 2010 - $390 million) including $188 million (October 10, 2009 - $143 million; January 2, 2010 - $163 million) of loans payable by VIEs consolidated by the Company. The Company has agreed to provide credit enhancement of $66 million (October 10, 2009 - $66 million; January 2, 2010 - $66 million) in the form of a standby letter of credit for the benefit of the independent funding trust representing not less than 15% of the principal amount of the loans outstanding. This standby letter of credit has never been drawn upon. This credit enhancement allows the independent funding trust to provide financing to the Company's independent franchisees. As well, each independent franchisee provides security to the independent funding trust for its obligations by way of a general security agreement. In the event that an independent franchisee defaults on its loan and the Company has not, within a specified time period, assumed the loan, or the default is not otherwise remedied, the independent funding trust would assign the loan to the Company and draw upon this standby letter of credit.

During the second quarter of 2010, the $475 million, 364-day revolving committed credit facility that is the source of funding to the independent trusts was renewed. The financing structure has been reviewed and the Company has determined there were no additional VIEs to consolidate as a result of this financing.

Equity Forward Contracts

As at October 9, 2010, Glenhuron Bank Limited ("Glenhuron") had equity forward contracts to buy 1.5 million (October 10, 2009 - 3.2 million; January 2, 2010 - 1.5 million) of the Company's common shares at an average forward price of $56.27 (October 10, 2009 - $53.76; January 2, 2010 - $66.25) including $0.05 (October 10, 2009 - $9.14; January 2, 2010 - $10.03) per common share of interest expense. As at October 9, 2010, the interest and unrealized market loss of $23 million (October 10, 2009 - $71 million; January 2, 2010 - $48 million) was included in accounts payable and accrued liabilities. In the second quarter of 2009, Glenhuron paid $38 million to a counterparty to terminate a portion of the equity forwards representing 1.6 million shares, which led to the extinguishment of a corresponding portion of the associated liability.

Employee Future Benefit Contributions

During the first three quarters of 2010, the Company contributed $75 million (2009 - $75 million) to its registered funded defined benefit pension plans. The Company expects to contribute $25 million to these plans during the fourth quarter of 2010. The actual amount paid may vary from the estimate based on actuarial valuations being completed, market performance and regulatory requirements. The Company regularly monitors and assesses plan experience and the impact of changes in participant demographics, changes in capital markets and other economic factors that may impact funding requirements, employee future benefit costs and actuarial assumptions.

Quarterly Results of Operations

Under an accounting convention common in the food distribution industry the Company follows a 52-week reporting cycle which periodically necessitates a fiscal year of 53 weeks. 2008 was a 53-week fiscal year. The 52-week reporting cycle is divided into four quarters of 12 weeks each except for the third quarter, which is 16 weeks in duration. The following is a summary of selected consolidated financial information derived from the Company's unaudited interim consolidated financial statements for each of the eight most recently completed quarters. This information was prepared in accordance with Canadian GAAP.

Sales growth was positive in the third quarter of 2010 compared to the third quarter of 2009. Same-store sales decline was 0.4% in the third quarter of 2010 and 0.3% in the second quarter of 2010. Same-store sales growth in the first quarter of 2010 was 0.3%. Sales and same-store sales decreased in the third and fourth quarters of 2009 compared to 2008. Quarterly same-store sales increases were 2.1% and 2.5% for the first and second quarters of 2009 compared to 2008, respectively. Quarterly same-store sales declines were 0.6% and 7.8% for the third and fourth quarters of 2009 compared to 2008, respectively. The acquisition of T&T at the end of the third quarter of 2009 positively impacted the Company's sales by 0.2% and 1.8% for the third and fourth quarters of 2009 compared to 2008, respectively. T&T sales positively impacted the Company's sales by 1.7%, 1.9% and 2.0% in the third, second and first quarters of 2010 compared to the third, second and first quarters of 2009, respectively. The sale of the Company's food service business in the fourth quarter of 2008 negatively impacted sales in 2009 compared to 2008 by 0.5% for each of the first three quarters of 2009 and by 0.3% in the fourth quarter of 2009. The extra selling week in the fourth quarter of 2008 negatively impacted sales and same-store sales by approximately 7.0% in the fourth quarter of 2009 compared to 2008. Quarterly sales and same-store sales are also impacted by seasonality and the timing of holidays.

Internal retail food price inflation increased in the third quarter of 2010 compared to deflation in the second quarter of 2010 after it had decreased throughout each of the previous six quarters. Internal retail food price inflation was lower than national food price inflation as measured by CPI throughout each of the last eight quarters. In the fourth quarter of 2009 and the first two quarters of 2010, the Company experienced internal retail food price deflation. CPI increased to 1.3% in the third quarter of 2010 from 0.2% in the second quarter of 2010 when it had decreased from 7.4% in the second quarter of 2009. In the first quarter of 2009 it had increased to 9.0% from 8.4% in the fourth quarter of 2008. This measure of inflation does not necessarily reflect the effect of inflation on the specific mix of goods sold in Loblaw stores.

Fluctuations in quarterly net earnings reflect the underlying operations of the Company as well as the impact of a number of specific charges including the impact of stock-based compensation including the equity forwards and costs related to the incremental investment in information technology and supply chain. Since the fourth quarter of 2008, quarterly net earnings have benefited from the Company's cost reduction initiatives. Earnings in the fourth quarter of 2009 and the second quarter of 2010 were pressured by investments in pricing. Quarterly net earnings are also affected by seasonality and the timing of holidays. The impact of seasonality is greatest in the fourth quarter and least in the first quarter.

Internal Control over Financial Reporting

Management is responsible for establishing and maintaining a system of disclosure controls and procedures to provide reasonable assurance that all material information relating to the Company and its subsidiaries is gathered and reported to senior management on a timely basis so that appropriate decisions can be made regarding public disclosure.

Management is also responsible for establishing and maintaining adequate internal controls over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with Canadian GAAP.

In designing such controls, it should be recognized that due to inherent limitations, any controls, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and may not prevent or detect misstatements. Additionally, management is necessarily required to use judgement in evaluating controls and procedures.

On July 18th, 2010 the Company successfully implemented the second phase of its Enterprise Resource Planning system ("ERP"). This implementation resulted in changes to the internal controls over financial reporting during the third quarter of 2010 for the Company's corporate administration functions and general ledger. The changes in controls have materially affected the Company's internal controls over financial reporting related to these areas. Except for the preceding changes, there was no other change in the Company's internal control over financial reporting during the third quarter of 2010 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

Enterprise Risks and Risk Management

Detailed descriptions of the operating and financial risks and risk management strategies are included in the Enterprise Risks and Risk Management Section on page 19 of the MD&A as well as note 26 to the Consolidated Financial Statements included in the Company's 2009 Annual Report - Financial Review. The following is an update to those risks and risk management strategies:

Information Technology, Integrity and Reliability

To support the current and future requirements of the business in an efficient, cost-effective and well-controlled manner, the Company is reliant on information technology (IT) systems. These systems are essential in providing management with relevant, reliable and accurate information for decision making, including its key performance indicators. Any significant failure or disruption of these systems or the failure to successfully migrate from legacy systems to new systems as part of the Company's significant IT infrastructure initiatives could negatively affect the Company's reputation, ability to carry on business, revenues and financial performance. If the information provided by the information technology systems is inaccurate, the risk of disclosing inaccurate or incomplete information is increased.

The Company has under invested in its IT infrastructure in the past and its systems are in need of upgrading. An IT strategic plan was developed to guide the new systems environment that the Company requires. On July 18, 2010, the Company successfully implemented the second phase of its ERP which involved integrating its general ledger and related reporting for finance across the business and launching additional functionality including its Corporate accounts payable and marketing procurement processes and now has close to 1,000 colleagues working on its new ERP. In addition, at the beginning of September 2010, the Company's next major ERP release related to its merchandising management module began a pilot focusing on two of the Company's smaller Merchandise categories. The Company will roll-out the category management module pilot to additional categories in the fourth quarter of 2010. The Company leveraged this new ERP functionality to successfully close its third quarter reporting period.

The Company is planning for additional system implementations in 2011 to streamline merchandising and operations activities. This is one of the largest technology infrastructure programs ever implemented by the Company and is fundamental to the Company's long-term growth strategies. Completing it will require intense focus and significant investment over the next two years.

Change management risk and other associated risks will arise from the various projects which will be undertaken to upgrade existing systems and introduce new systems to effectively manage the business going forward. Failure by the Company to appropriately invest in information technology or failure to implement information technology infrastructure in a timely or effective manner may negatively impact the Company's financial performance.

Labour Relations

A majority of the Company's store level and distribution centre workforce is unionized. Renegotiating collective agreements may result in work stoppages or slowdowns, which could negatively affect the Company's financial performance, depending on their nature and duration. In 2010, 73 collective agreements affecting approximately 35,000 colleagues expire. In the third quarter of 2010, the Company was successful in negotiating the renewal of its major Ontario retail collective agreements including its single largest agreement covering approximately 13,700 colleagues. The Company continues to negotiate the 66 remaining collective agreements carried over from prior years. Although the Company attempts to mitigate work stoppages and disputes through early negotiations, work stoppages or slowdowns remain possible.

Regulatory

Beginning in the first quarter of 2010, the provincial governments of Quebec, Ontario, Alberta, Nova Scotia and British Columbia introduced amendments to the regulation of generic prescription drug prices paid by provincial governments pursuant to their respective public drug benefit plans. Under these amendments, manufacturer costs of generic drugs paid by the provincial drug plans will be reduced, and in Ontario, the current system of drug manufacturers paying professional allowances to pharmacies will be eliminated. The amendments also reduce the manufacturer costs of generic drugs purchased out-of-pocket or through private employer drug plans. The Company continues to identify opportunities to mitigate the impact of these amendments, including programs to add new services and enhance existing services to attract customers. The amendments could have a material impact on the financial results of the Company if it is not able to effectively mitigate their negative impact.

Future Accounting Standards

Business Combinations

In January 2009, the Canadian Institute of Chartered Accountants ("CICA") issued Section 1582, "Business Combinations," which will replace Section 1581 of the same title and issued Sections 1601 "Consolidated Financial Statements" and 1602 "Non-Controlling Interests". These standards will harmonize Canadian GAAP with International Financial Reporting Standards ("IFRS"). The amendments establish principles and requirements for determining how an enterprise recognizes and measures the fair value of certain assets and liabilities acquired in a business combination, including non-controlling interests, contingent consideration, and certain acquired contingencies. The amendments also require that acquisition-related transaction expenses and restructuring costs be expensed as incurred rather than capitalized as a component of the business combination. The impact of implementing these amendments is currently being assessed.

International Financial Reporting Standards

The Canadian Accounting Standards Board requires that all public companies adopt IFRS for interim and annual financial statements relating to fiscal years beginning on or after January 1, 2011. As a result, the Company's audited annual consolidated financial statements for the year ended December 31, 2011 will be the first audited annual consolidated financial statements that will be prepared in accordance with the requirements of IFRS. Starting in the first quarter of 2011 the unaudited interim period consolidated financial statements will be prepared in accordance with International Accounting Standard ("IAS") 34, "Interim Financial Reporting", including comparative figures for 2010.

Project Status

A detailed description of the Company's IFRS project structure is included in section 13.3 "International Financial Reporting Standards" on page 33 of the 2009 annual MD&A included in the Company's 2009 Annual Report - Financial Review. The following is an update on the project status.

The IFRS conversion project continues to progress. Targeted training regarding anticipated changes resulting from IFRS implementation continues to be provided to appropriate business units and finance colleagues. In addition, the Company has continued its quarterly and additional IFRS information sessions for the Board of Directors providing updates on certain transitional and 2010 quarterly IFRS adjustments and disclosures (including certain preliminary policy choices), implications of IFRS standards to the business, and their impact on the financial statement disclosure. The Company also intends to provide an information session to key external stakeholders regarding the impacts of IFRS in early 2011.

The IFRS conversion project is integrated with the Company's ERP implementation. As ERP phases have been deployed, the Company has ensured that the requirements of IFRS adoption were incorporated. For ERP phases that have not yet been deployed, the Company is ensuring that the requirements of IFRS are identified and incorporated.

The implementation of IFRS is expected to have an impact on certain financial metrics that are used in calculating the Company's financial covenants under certain of its debt agreements. These debt agreements provide for the opportunity to renegotiate the covenants to reflect the impact of the transition to IFRS. The Company has begun preliminary discussions with certain of its lenders to formalize these adjustments. To the extent that the Company and its lenders are unable to agree upon the covenant adjustments, the existing covenants will continue to apply and will be calculated on the basis of Canadian GAAP as it existed prior to the conversion to IFRS.

The Company continues to integrate IFRS into its budgeting and internal reporting processes. In accordance with the Company's transition plan, during the third quarter of 2010, the Company also completed its preliminary Q1 2011 IFRS financial statement format and draft note disclosures.

Key milestones for the remainder of the year are in line with the Company's original plan and include: completion of the opening transitional balance sheet, and compilation of the quarterly financial statements. The Company continues to progress on its IFRS transition plan as previously disclosed.

Changes to the Company's internal controls over financial reporting which include enhancement of existing controls and the design and implementation of new controls, where needed, are in process. At this time the Company expects no material change in internal controls over financial reporting resulting from the adoption and implementation of IFRS.

Changes in Accounting Policies and First-Time Adoption of IFRS

The information below is provided as an update to allow investors and others to obtain a better understanding of the possible effects on the Company's consolidated financial statements and operating performance measures. The changes identified below should not be regarded as a complete list of changes that will result from the transition to IFRS as it is intended to highlight those areas where significant progress has been made and that are believed to be most significant at this point in the project. Readers are cautioned that it may not be appropriate to use such information for any other purpose and the information is subject to change.

The International Accounting Standards Board has significant ongoing projects that could affect the ultimate differences between Canadian GAAP and IFRS and their impact on the Company's consolidated financial statements. Therefore, the Company's analysis of changes and accounting policy decisions have been made based on the accounting standards that are currently in effect. To date, the Company has determined preliminary conclusions for certain policy decisions as discussed below and included on page 33 "International Financial Reporting Standards" section of the MD&A included in the Company's 2009 Annual Report - Financial Review. These preliminary conclusions are contingent on the standards that will be effective at the time of transition.

The Company continues to assess the quantitative impact of certain of the transitional adjustments on the consolidated opening balance sheet and consolidated interim period financial statements as a result of changes in accounting policies as well as certain IFRS 1, "First Time Adoption of IFRS" ("IFRS 1") elections and exemptions. The preliminary impacts provided below represent updates to those provided in the 2009 annual MD&A pertaining to the transitional balance sheet as at January 3, 2010. The Company expects to provide additional updates in its 2010 annual MD&A.

Consolidation

IAS 27, "Consolidated and Separate Financial Statements" and Standing Interpretations Committee 12, "Consolidation - Special Purpose Entities" ("IAS 27") assess consolidation using a control model. Under IFRS, the Company will be required to consolidate Eagle Credit Card Trust, the independent trust that funds the purchase of credit card receivables from PC Bank through the issuance of notes, resulting in an increase of approximately $500 million of credit card receivables and related notes before the provision for loan losses. In addition the Company will be required to consolidate the independent funding trust through which franchisees obtain financing. The Company will no longer be required to consolidate certain independent franchisees and other entities providing warehouse and distribution service agreements that were previously consolidated under Canadian GAAP pursuant to the requirements of Accounting Guideline 15, "Consolidation of Variable Interest Entities" ("AcG 15"). Upon implementation of IFRS, the Company expects to record an increase in assets and liabilities. The Company continues to quantify the remaining impact of this standard.

Revenue

Under Canadian GAAP each franchise arrangement was evaluated under AcG 15. As a result of the Company no longer consolidating certain independent franchisees the Company was required to evaluate each franchise arrangement under IAS 18, "Revenue" ("IAS 18") at its inception. Based on the guidance in IAS 18, the Company concluded that each franchise arrangement contains separately identifiable components. As a result of this multi-element arrangement the Company was required to determine the fair value of all consideration exchanged including certain loans and receivables. The impact of applying these requirements has resulted in the Company concluding that the fair value of certain consideration was lower than its face value at inception. Furthermore, the Company has made a policy choice to allocate the consideration to each component in the multi-element arrangement, on a relative fair value basis to both the delivered and undelivered components. Upon implementation of IFRS, the Company expects to record a decrease in certain assets and deferred consideration. The Company continues to quantify the impact of this standard.

Financial Instruments

Under Canadian GAAP each franchise arrangement was evaluated under AcG 15. IFRS has no concept of a variable interest resulting in certain financial assets no longer being eliminated on consolidation. As a result the Company was required to evaluate certain financial assets relating to the franchise arrangement in accordance with IAS39, "Financial Instruments: Recognition and Measurement" ("IAS 39") which required application retrospectively to the inception of each arrangement. The Company's evaluation identified that one or more events that provided objective evidence that the cash flows associated with certain financial assets relating to certain of the franchise arrangements were impaired. Upon implementation of IFRS, the Company expects to record a decrease in certain financial assets. The Company continues to quantify the impact of the above.

IAS 39 contains criteria that are different from Canadian GAAP for the derecognition of financial assets and requires an evaluation of the extent to which an entity retains the risks and rewards of ownership. Under Canadian GAAP these financial assets qualify for sale treatment. The Company has determined that under IFRS securitized credit card receivables will not qualify for derecognition. Upon implementation of IFRS, the Company expects to record an increase in credit card receivables of approximately $1.2 billion, excluding Eagle Trust, before the provision for loan losses with a corresponding increase to liabilities.

IAS 39 requires the incorporation of credit value adjustments in the measurement of effectiveness and ineffectiveness of a hedging relationship. Cross-currency and interest rate swaps were designated as effective cash flow hedging relationships under Canadian GAAP. Certain tranches of the swaps that were part of the hedging relationship have expired in 2010 and will continue to expire up to mid-2011. The Company has concluded to not assess hedge effectiveness under IFRS which will result in de-recognition at the date of transition to IFRS. Upon implementation of IFRS, the Company expects to record a transitional adjustment of approximately $17 million from accumulated other comprehensive income to retained earnings within shareholders' equity.

Segments

IFRS 8, "Operating Segments" is substantially converged with Canadian GAAP, however with the combined impact of IAS 39, resulting in securitized credit card receivables not qualifying for derecognition and the impact of IAS 27, resulting in the consolidation of Eagle Credit Card Trust, PC Financial will now meet the quantitative threshold and become a reportable segment under IFRS.

Employee Benefits

IAS 19, "Employee Benefits", provides a policy choice regarding recognition of actuarial gains and losses for defined benefit pension plans and other defined benefit plans, permitting deferred recognition using the corridor method or immediate recognition in either other comprehensive income within shareholders' equity or through earnings. Under Canadian GAAP the Company applies the corridor method. Upon implementation of IFRS, the Company currently intends to recognize actuarial gains and losses immediately through other comprehensive income within shareholders' equity for defined benefit pension plans and other defined benefit plans and through earnings for other long term employee benefits.

In addition, IFRS 1 provides an optional election which the Company expects to apply that will result in the recognition of all cumulative actuarial gains and losses through retained earnings on transition to IFRS. The Company's choice must be applied to all defined benefit pension plans, other defined benefit plans and other long term employee benefits consistently. As a result of this election the Company has engaged its external actuaries to quantify this amount and will reclassify the unamortized net actuarial loss to retained earnings on transition to IFRS.

Share-based Payments

IFRS 2, "Share-Based Payments", requires that cash-settled stock-based compensation be measured based on fair value of the awards. Canadian GAAP requires that such compensation be measured based on the intrinsic values of the awards. This difference is expected to impact the accounting measurement of the Company's stock options, restricted share units and deferred share units. Upon implementation of IFRS, the Company expects to record a transitional adjustment to decrease shareholders' equity of approximately $10 million.

Property, Plant and Equipment

IAS 16, "Property, Plant and Equipment", provides specific guidance such that when an individual component of an item within property, plant and equipment is replaced and capitalized, the replaced component of the original asset must be de-recognized even if the replacement part was not originally componentized. In addition IFRS is more prescriptive with respect to eligible costs such as site-dismantling and restoration costs. Upon implementation of IFRS, the Company expects to record a transitional adjustment to decrease shareholders' equity of approximately $60 million.

Impairment of Assets

IAS 36, "Impairment of Assets", requires that assets be tested for impairment at the level of cash generating units ("CGU"), which are defined as the lowest level of assets that generate largely independent cash inflows. The Company has completed its analysis and concluded that the CGU will predominantly be an individual store compared to Canadian GAAP where store net cash flows are grouped together by primary market areas, where they are largely dependent on each other. The Company has completed its preliminary assessment of the events triggering potential impairments and reversal of impairments. On transition the Company expects to record a reduction in assets and a reduction in shareholders' equity. The Company continues to quantify the impact of this standard.

Leases

IAS 17, "Leases", requires the allocation of minimum lease payments between the land and building elements of a lease to be in proportion to the relative fair values of the leasehold interests in the land and building, whereas under Canadian GAAP it is based on the fair value of the land and building in aggregate. In addition, IFRS permits the immediate recognition of gains and losses on sale leaseback transactions which result in an operating lease, provided that the transaction is established at fair value. Under Canadian GAAP, gains and losses are generally deferred and amortized in proportion to the lease payments over the lease term. Upon implementation of IFRS, the Company expects to record additional finance leases on the balance sheet. The Company continues to quantify the impact of this standard.

Customer Loyalty Programs

International Financial Reporting Interpretations Committee 13, "Customer Loyalty Programs", requires the fair value of loyalty programs to be recognized as a separate component of the initial sales transaction. The Company will be required to defer a portion of the initial sales transaction in which the awards are granted. The Company has made a policy choice to defer portion of the sales transaction on the relative fair value of the awards granted. Under Canadian GAAP, the Company recognizes the net cost of the program in operating expenses. Upon implementation of IFRS, the Company expects to record a transitional adjustment to decrease shareholders' equity by approximately $15 million.

Borrowing Costs

IAS 23 "Borrowing Costs" ("IAS 23") requires the capitalization of borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. IFRS 1 provides an election to permit application of the requirements of IAS 23 prospectively from the date of transition. The Company intends to apply this election prospectively and apply IAS 23 from the date of transition. Upon implementation of IFRS, the Company expects to record a transitional adjustment to decrease shareholders' equity by approximately $200 million.

Outlook(1)

The Company continues to make progress towards the final stages of its overall renewal program. As a result of buying efficiencies related to its information technology and infrastructure initiatives and adjustments to the timing of certain phases of those initiatives, the Company now expects the impact to 2010 operating income of the incremental infrastructure and information technology costs to be between $140 million and $145 million. This is lower than the previously anticipated impact of $185 million. The costs and risks associated with these investments combined with deflationary pressures and heightened competition will continue to challenge sales and margins.

(1) To be read in conjunction with "Forward-Looking Statements".

Additional Information

Additional information about the Company has been filed electronically with various securities regulators in Canada through the System for Electronic Document Analysis and Retrieval (SEDAR) and is available online at www.sedar.com and with the Office of the Superintendent of Financial Institutions (OSFI) as the primary regulator of the Company's subsidiary, PC Bank.

Non-GAAP Financial Measures

The Company uses the following non-GAAP financial measures: EBITDA and EBITDA margin, net debt, rolling year net debt to EBITDA, net debt to equity and rolling year return on average net assets. The Company believes these non-GAAP financial measures provide useful information to both management and investors in measuring the financial performance and financial condition of the Company for the reasons outlined below. These measures do not have a standardized meaning prescribed by Canadian GAAP and therefore they may not be comparable to similarly titled measures presented by other publicly traded companies, and should not be construed as an alternative to other financial measures determined in accordance with Canadian GAAP.

EBITDA and EBITDA Margin

The following table reconciles earnings before minority interest, income taxes, interest expense, depreciation and amortization ("EBITDA") to operating income, which is reconciled to Canadian GAAP net earnings measures reported in the unaudited interim period consolidated statements of earnings for the sixteen and forty week periods ended October 9, 2010 and October 10, 2009. EBITDA is useful to management in assessing the performance of the Company's ongoing operations and its ability to generate cash flows to fund cash requirements, including the Company's capital investment program.

Net Debt

The following table reconciles net debt used in the net debt to equity and the rolling year net debt to EBITDA ratios to Canadian GAAP measures reported as at the periods ended as indicated. The Company calculates net debt as the sum of bank indebtedness, short term debt, long term debt, certain other liabilities and the fair value of financial derivatives less cash and cash equivalents, short term investments, security deposits included in other assets and the fair value of financial derivatives. The Company believes that this measure is useful in assessing the amount of financial leverage employed.

The Second Preferred Shares, Series A are classified as capital securities and are excluded from the calculation of net debt. For the purpose of calculating net debt, fair value of financial derivatives is not credit value adjusted in accordance with Emerging Issues Committee ("EIC") 173. As at October 9, 2010, the credit value adjustment was a loss of $4 million (October 10, 2009 - $5 million; January 2, 2010 - $4 million).

Net Assets

The following table reconciles net assets used in the rolling year return on average net assets ratio to Canadian GAAP measures reported as at the periods ended as indicated. The Company believes that the rolling year return on average net assets is useful in assessing the return on productive assets.

Net assets is calculated as total assets less cash and cash equivalents, short term investments, security deposits included in other assets and accounts payable and accrued liabilities.

Equity

The following table reconciles equity used in the net debt to equity ratio to Canadian GAAP measures reported as at the periods ended.

Equity is calculated as the sum of capital securities and shareholder's equity.

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