Shoppers drug mart corporation announces fourth quarter results

Feb. 10, 2011 (Canada NewsWire Group) --

-     STRONG SALES GROWTH

-     ANNUAL DIVIDEND INCREASED BY 11.1% TO $1.00 PER SHARE

-     ESTABLISHES SHARE REPURCHASE PROGRAM

TORONTO, Feb. 10 /CNW/ - Shoppers Drug Mart Corporation (TSX: SC) today announced its unaudited financial results for the fourth quarter and fiscal year ended January 1, 2011.  The Company also announced that its Board of Directors has declared a dividend of 25 cents per common share, payable April 15, 2011 to shareholders of record as of the close of business on March 31, 2011.  This represents an increase in the Company's quarterly dividend payments of 11.1%, resulting in an annualized dividend of $1.00 per common share.

The Company also announced today that its Board of Directors has authorized the purchase of up to 8,700,000 of its common shares, representing approximately 4.0% of the 217,468,192 common shares currently outstanding, by way of normal course purchases effected through the facilities of the Toronto Stock Exchange (the "TSX"). Subject to approval of the TSX, it is anticipated that purchases may commence on February 15, 2011 and will terminate on February 14, 2012, or on such earlier date as the Company may complete its purchases pursuant to a Notice of Intention to be filed with the TSX.  Purchases will be made by the Company in accordance with the requirements of the TSX and the price which the Company will pay for any such common shares will be the market price of any such common shares at the time of acquisition, or such other price as may be permitted by the TSX.  For purposes of the TSX rules, a maximum of 170,759 common shares may be purchased by the Company on any one day under the bid, except where purchases are made in accordance with the "block purchase exception" of the TSX rules. Common shares purchased by the Company will be cancelled.

Fourth Quarter Results (12 Weeks)

Driven by strong results in the front of the store, fourth quarter sales increased 2.9% to $2.560 billion, with the Company continuing to experience sales growth in all regions of the country, led by strong gains in Alberta and Québec.  On a same-store basis, sales increased 1.7% during the quarter.

Prescription sales decreased by 0.2% in the fourth quarter to $1.146 billion, as strong growth in the number of prescriptions filled served to essentially offset a reduction in average prescription value.  On a same- store basis, prescription sales decreased 0.5% during the fourth quarter of 2010.  The decrease in average prescription value can be largely attributed to a reduction in generic prescription reimbursement rates, the result of recently implemented drug system reform initiatives, principally in Ontario, combined with increasing generic prescription utilization rates.  Total prescription counts increased 3.2% during the fourth quarter of 2010.  On a same-store basis, prescription counts increased 2.9% during the quarter.  Generic
molecules represented 56.7% of prescriptions dispensed in the fourth quarter of 2010 compared to 53.7% of prescriptions dispensed in the fourth quarter of last year.  During the fourth quarter of 2010, prescription sales accounted for 44.8% of the Company's sales mix compared to 46.1% of the Company's sales mix in the same quarter of the prior year.

Front store sales increased 5.5% in the fourth quarter to $1.414 billion, with the Company experiencing particularly strong sales gains in the beauty, confection and convenient food and beverage categories.  The Company's store network development program, which has resulted in a 6.4% increase in selling space compared to a year ago, continues to have a positive impact on sales growth, particularly in the front of the store.  Front store sales growth was also aided by effective marketing campaigns and impactful promotions, strong seasonal programs and solid execution at store-level.  On a same-store basis, front store sales increased 3.7% during the fourth quarter of 2010.

Fourth quarter net earnings, at $171 million or 79 cents per share (diluted), were essentially flat when compared to the fourth quarter of the prior year, a strong result considering the fact that recently implemented drug system reform initiatives in certain jurisdictions of Canada had a negative impact on
pharmacy reimbursement and margin rates.  Downward pressure on sales and margins in the dispensary was offset by strong performance in the front of the store, improved purchasing synergies and continued gains in productivity and efficiency across the store network and supporting infrastructure.

Commenting on the results, David Williams, Chair of the Company's Board of Directors stated, "Given that fiscal 2010 was a particularly challenging year on a number of fronts, we are encouraged by our performance in the fourth quarter and the momentum it provides as we prepare to confront the challenges and capitalize on the opportunities that lie ahead in 2011 and beyond.  These operating and financial results speak not only to the strength of our brand and the power of our value proposition with patients and customers, but also to the leadership of our Associate-owners and the capabilities of their teams at store level.  On behalf of our shareholders, the Board of Directors and our corporate and regional office employees, I would like to thank all of our Associates and their teams for their efforts, dedication, commitment and contributions to our collective success this past year."  Mr. Williams went on to say that, "I would also like to take this opportunity to thank Jürgen Schreiber, who will be resigning as a Director
and as the Company's President and Chief Executive Officer effective February 15, 2011, for his contributions to the Company's continued success under his leadership.  As previously announced, Mr. Schreiber is leaving the Company to pursue a private equity opportunity outside of North America.  We wish him well in his future endeavours."

Commenting on the dividend increase and the establishment of a share repurchase program, Brad Lukow, Executive Vice-President and Chief Financial Officer stated, "The Board's decisions in respect of these matters is a testament to the financial strength and solid operating performance of the Company.  It also speaks to our confidence in the future with respect to the cash flow generation potential of the business.  While we remain committed to utilizing free cash flow to invest in opportunities that will generate attractive rates of return on that capital, the Company also expects that from time to time, it will have cash or debt capacity in excess of its operating, financing and capital investment requirements.  Therefore, in addition to maintaining a sector-leading dividend payout ratio, it is the Company's belief that the establishment of a share repurchase program provides it with a flexible alternative to enhance total shareholder returns through value-enhancing share repurchases."

Fiscal 2010 Results (52 Weeks)

Sales in 2010 were $10.376 billion compared to $9.986 billion in 2009, an increase of $390 million or 3.9%.  During 2010, the Company continued to experience sales growth in all regions of the country, led by strong gains in Western Canada and Québec.  The Company's capital investment and store development program, which resulted in a year-over-year increase in selling space of 6.4%, continues to have a positive impact on sales growth.  On a same-store basis, sales increased 2.1% in 2010.

Prescription sales were $4.959 billion in 2010 compared to $4.824 billion in 2009, an increase of $135 million or 2.8%.  On a same-store basis, prescription sales increased 1.7% during the year.  A reduction in generic prescription reimbursement rates, the result of drug system reform initiatives implemented in the second half of 2010, principally in Ontario, combined with greater generic prescription utilization rates, had a negative impact on sales dollar growth in pharmacy.  Prescription sales growth was driven by strong growth in the number of prescriptions filled, with total prescription counts increasing by 4.7% during 2010.  On a same-store basis, prescription counts increased 3.0% during the year.  Generic molecules represented
55.5% of prescriptions dispensed in 2010 compared to 53.0% of prescriptions dispensed in the prior year. In 2010, prescription sales accounted for 47.8% of the Company's sales mix compared to 48.3% in the prior year.

Front store sales were $5.417 billion in 2010 compared to $5.162 billion in 2009, an increase of $255 million or 4.9%, with the Company posting sales gains in all core categories, led by food and confection, cosmetics and beverage.  Sales gains in over-the-counter medications were also strong, a particularly  impressive result given that this category also performed well in the prior year during which time sales benefitted from customer and patient awareness of the H1N1 virus.  On a same-store basis, front store sales increased 2.5% in 2010.  In addition to square footage growth, the Company's investments in marketing, pricing and promotional activities throughout the year drove sales and market share gains in the front of
the store.

Net earnings in 2010, inclusive of a third quarter charge of $10 million (pre-tax) to settle a long-standing legal dispute related to a commercial arrangement with one of the Company's ancillary businesses, were $591 million or $2.72 per share (diluted).  Excluding the impact of this charge, the Company's adjusted net earnings were $598 million in 2010 compared to $585 million in 2009, an increase of $13 million or 2.2%.  On a diluted basis, adjusted earnings per share were $2.75 in 2010 compared to $2.69 in 2009.  During 2010, the Company continued to deliver top-line growth, improved purchasing synergies and further gains in productivity and efficiency, the benefits of which were largely offset by increased amortization and
higher operating expenses at store-level associated with the Company's network growth and expansion initiatives.  Net earnings growth in 2010 also benefitted from a modest reduction in interest expense and from a decline in the Company's effective income tax rate.

Store Network Development

During the fourth quarter, 10 drug stores were opened, eight of which were relocations, and the Company completed five major drug store expansions.  For the fiscal year ended January 1, 2011, the Company opened or acquired 75 drug stores, 43 of which were relocations, and consolidated or closed 10 smaller drug stores and three home health care stores.  The Company also completed 27 major drug store expansions and opened two Murale stores in 2010.  At the end of 2010, there were 1,312 stores in the system, comprised of 1,241 drug stores (1,182 Shoppers Drug Mart/Pharmaprix stores and 59 Shoppers Simply Pharmacy/Pharmaprix Simplement Santé stores), 63 Shoppers Home Health Care stores and eight
Murale stores.  During 2010, the selling square footage of the retail store network increased by 6.4%, to in excess of 12.7 million square feet at year end.

Fiscal 2011 Outlook (52 Weeks Ending December 31, 2011)

The Company expects total sales to increase by between 2.0% and 3.0% in 2011.  This expectation is underpinned by anticipated same-store sales growth of between 2.0% to 3.0% in the front of the store and flat same-store sales growth in pharmacy.  In pharmacy, it is expected that strong growth in the number of prescriptions filled will be largely offset by a continued reduction in average prescription value, with the decline in average value being mostly attributable to further reductions in generic prescription reimbursement rates as a result of recently implemented drug system reform initiatives in a number of provincial jurisdictions.  Furthermore, it is anticipated that increasing generic prescription utilization rates will also serve as a contributing factor to the decline in average prescription value.

In fiscal 2011, the Company plans to allocate $360 million to capital expenditures, with approximately 75% of this amount to be invested in the store network, including any related investments to acquire drug stores, prescription files and land.  This should result in an increase in retail selling square footage of approximately 4.5%.  This will be accomplished through the addition of between 50 and 55 new drug stores, approximately 35 of which will be relocations, and through the completion of between 25 and 30 major drug store expansions.  The Company also plans to remodel up to 40 existing drug stores, converting these stores to smaller prototype formats consistent with the brand identification, product offering and consumer proposition offered by the Company's large-format drug stores.

Based on the above assumptions, the Company expects fiscal 2011 EBITDA (earnings before interest, taxes, depreciation and amortization) to be within the range of $1.220 billion to $1.250 billion.  It is further assumed that the year-over-year rate of increase in the Company's amortization expense will decrease to approximately 12% in 2011, resulting in estimated earnings per share (diluted) of between $2.80 and $2.90, with the momentum in earnings growth expected to pick-up in the second half of the year.

Commensurate with the Company's expected growth in sales and net earnings, along with the year-over-year reduction in its capital expenditure and investment program, it is anticipated that cash flows from operating activities will continue to increase and will be more than sufficient to fund the Company's investments and dividend payments, with the remaining balance available for share repurchases and/or the repayment of debt.

2010 Annual Report

The Company's audited consolidated financial statements for the year ended January 1, 2011 will be available on or before March 31, 2011.  Management's Discussion and Analysis for the year ended January 1, 2011, including further discussion and analysis of fourth quarter events or items that affected results of operations, financial position and cash flows, will also be available on or before March 31, 2011.  Both documents will be contained in the Company's 2010 Annual Report and will be available in the Investor Relations section of the Company's website at www.shoppersdrugmart.ca, or on the Canadian Securities Administrators' website at www.sedar.com.

Other Information

The Company will hold an analyst call at 3:30 p.m. (Eastern Standard Time) today to discuss its fourth quarter results and its outlook for fiscal 2011.  The call may be accessed by dialing 416-340-2217 from within the Toronto area, or 1-866-696-5910 outside of Toronto.  The call will also be simulcast on the Company's website for all interested parties.  The webcast can be accessed via the Investor Relations section of the Shoppers Drug Mart website at www.shoppersdrugmart.ca.  The conference call will be archived in the Investor Relations section of the Shoppers Drug Mart website until the Company's next analyst call.  A playback of the call will also be available by telephone until 11:59 p.m. (Eastern Standard Time) on February 24, 2011.  The call playback can be accessed after 5:00 p.m. (Eastern Standard Time) on Thursday, February 10, 2011 by dialing 905-694-9451 from within the Toronto area, or 1-800-408-3053 outside of Toronto.  The seven-digit pass code number is 3256747.

About Shoppers Drug Mart Corporation

Shoppers Drug Mart Corporation is one of the most recognized and trusted names in Canadian retailing.  The Company is the licensor of full-service retail drug stores operating under the name Shoppers Drug Mart (Pharmaprix in Québec).  With more than 1,182 Shoppers Drug Mart and Pharmaprix stores operating in prime locations in each province and two territories, the Company is one of the most convenient retailers in Canada.  The Company also licenses or owns 59 medical clinic pharmacies operating under the name Shoppers Simply Pharmacy (Pharmaprix Simplement Santé in Québec) and eight luxury beauty destinations operating as Murale.  As well, the Company owns and operates 63 Shoppers Home Health Care stores, making it the largest Canadian retailer of home health care products and services.  In addition to its retail store network, the Company owns Shoppers Drug Mart Specialty Health Network Inc., a provider of specialty drug distribution, pharmacy and comprehensive patient support services, and MediSystem Technologies Inc., a provider of pharmaceutical products and services to long-term care facilities in Ontario and Alberta.

For more information, visit www.shoppersdrugmart.ca.

Forward-looking Information and Statements

This news release contains forward-looking information and statements which constitute "forward-looking information" under Canadian securities law and which may be material, regarding, among other things, the Company's beliefs, plans, objectives, estimates, intentions and expectations.  Forward-looking information and statements are typically identified by words such as "anticipate", "believe", "expect", "estimate", "forecast", "goal", "intend", "plan", "will", "may", "should", "could" and similar expressions.  Specific forward-looking information in this News Release includes, but is not limited to, statements with respect to the Company's future operating and financial results, its capital expenditure plans, dividend and shareholder distribution policies and the ability to execute on its future operating, investing and financing strategies.

The forward-looking information and statements contained herein are based on certain factors and assumptions, certain of which appear proximate to the applicable forward-looking information and statements contained herein.  Inherent in the forward-looking information and statements are known and
unknown risks, uncertainties and other factors beyond the Company's ability to control or predict, which give rise to the possibility that the Company's predictions, forecasts, expectations or conclusions will not prove to be accurate, that its assumptions may not be correct and that the Company's plans, objectives and statements will not be achieved.  Actual results or developments may differ materially from those contemplated by the forward-looking information and statements.

The material risk factors that could cause actual results to differ materially from the forward-looking information and statements contained herein include, without limitation:  the risk of adverse changes to laws and regulations relating to prescription drugs and their sale, including pharmacy reimbursement programs and the availability of manufacturer allowances, or changes to such laws and regulations that increase compliance costs; the risk that the Company will be unable to implement successful strategies to manage the impact of the regulations enacted in 2010 in the Province of Ontario to amend the Ontario drug system,  along with the impact of the new Pharmacy Services Agreement that came into effect in 2010 in the Province of British Columbia, as well as the impact of the proposed and/or announced drug system reform initiatives in these and other jurisdictions of Canada, principally the provinces of Alberta, Québec, Nova Scotia and Newfoundland and Labrador; the risk of adverse changes in economic and financial conditions in Canada and globally; the risk of increased competition from other retailers; the risk of an inability of the Company to manage growth and maintain its profitability; the risk of exposure to fluctuations in interest rates; the risk of material adverse changes in foreign currency exchange rates; the risk of an inability to attract and retain pharmacists and key employees; the risk of an inability of the Company's information technology systems to support the requirements of the Company's business; the risk of changes to estimated contributions of the Company in respect of its pension plans or post-employment benefit plans which may adversely impact the Company's financial performance; the risk of changes to the relationships of the Company with third-party service providers; the risk that the Company will not be able to lease or obtain suitable store locations on economically favourable terms; the risk of adverse changes to the Company's results of operations due to seasonal fluctuations; risks associated with alternative arrangements for sourcing generic drug products, including intellectual property and product liability risks; the risk that new, or changes to current, federal and provincial laws, rules and regulations, including environmental and privacy laws, rules and regulations, may adversely impact the Company's business and operations; the risk that violations of law, breaches of Company policies or unethical behaviour may adversely impact the Company's financial performance; property and casualty risks; the risk of injuries at the workplace or health issues; the risk that changes in tax law, or changes in the way that tax law is expected to be interpreted, may adversely impact the Company's business and operations; the risk that new, or changes to existing, accounting pronouncements may adversely impact the Company; the risks associated with the performance of the Associate-owned store network; and the risk of damage to the reputation of brands promoted by the Company, or to the reputation of any supplier or manufacturer of these brands.

This is not an exhaustive list of the factors that may affect any of the Company's forward-looking information and statements.  Investors and others should carefully consider these and other risk factors and not place undue reliance on the forward-looking information and statements.  Further information regarding these and other risk factors is included in the Company's public filings with provincial securities regulatory authorities including, without limitation, the sections entitled "Risks and Risk Management" and "Risks Associated with Financial Instruments" in the Company's Management's Discussion and Analysis for the 52 week period ended January 2, 2010, for the 12 week period ended March 27, 2010, for the 12 and 24 week periods ended June 19, 2010 and for the 16 and 40 week periods ended October 9, 2010.  The forward-looking information and statements contained in this news release represent the Company's views only as of the date of this news release.  Forward-looking information and statements contained in this news release about prospective results of operations, financial position or cash flows that are based upon assumptions about future economic conditions and courses of action are presented for the purpose of assisting the Company's shareholders in understanding management's current views regarding those future outcomes and may not be appropriate for other purposes.  While the Company anticipates that subsequent events and developments may cause the Company's views to change, the Company does not undertake to update any forward-looking information and statements, except to the extent required by applicable securities laws.

Additional information about the Company, including the Annual Information Form, can be found at www.sedar.com.

SHOPPERS DRUG MART CORPORATION
Notes to the Consolidated Financial Statements
(unaudited)
(in thousands of dollars except per share amounts)

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1. BASIS OF PRESENTATION

The unaudited interim consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP") and follow the same accounting policies and methods of application with those used in the preparation of the audited annual consolidated financial statements for the 52 week period ended January 2, 2010.  These financial statements do not contain all disclosures required by Canadian GAAP for annual financial statements and, accordingly, should be read in conjunction with the most recently prepared annual consolidated financial statements and the accompanying notes included in the Company's 2009 Annual Report.

Under the Canadian Institute of Chartered Accountants ("CICA") Accounting Guideline 15, "Consolidation of Variable Interest Entities", the Company consolidates the Associate-owned stores.  The individual Associate-owned stores that comprise the Company's store network are variable interest entities ("VIE") and the Company is the primary beneficiary.  The Associate-owned stores remain separate legal entities and consolidation of the Associate-owned stores has no impact on the underlying risks facing the Company.

The consolidated financial statements of the Company include the accounts of Shoppers Drug Mart Corporation, its subsidiaries and the Associate-owned stores that comprise the majority of the Company's store network.  All intercompany balances and transactions are eliminated on consolidation.

2. COST OF GOODS SOLD AND OTHER OPERATING EXPENSES

Inventory

During the 12 and 52 weeks ended January 1, 2011, the Company recognized cost of inventory of $1,538,314 and $6,372,359 (2009 - $1,521,818 and $6,238,239), respectively, as an expense.  This expense is included in cost of goods sold and other operating expenses in the consolidated statements of earnings for the periods. 

During the 12 and 52 weeks ended January 1, 2011 and January 2, 2010, there were no significant write-downs of inventory as a result of net realizable value being lower than cost and no inventory write-downs recognized in previous periods were reversed.

Other Operating Expenses

In the 12 and 52 weeks ended January 1, 2011, the Company recognized an expense of $nil and $10,282 in cost of goods sold and other operating expenses related to the settlement of a long-standing legal dispute related to a commercial arrangement with one of the Company's ancillary businesses.

3. ACQUISITIONS

In the normal course of business, the Company acquires the assets or shares of pharmacies.  The total cost of acquisitions during the 12 and 52 weeks ended January 1, 2011 of $259 and $12,990 (2009 - $5,265 and $97,100), respectively, including costs incurred in connection with the acquisitions, is allocated primarily to goodwill and intangible assets based on their fair values.  Purchase price allocations are preliminary when initially recognized and may change pending finalization of the valuations of the assets acquired.  The operations of the acquired pharmacies have been included in the Company's results of operations from the date of acquisition.

4. SALE-LEASEBACK TRANSACTIONS

During the 12 and 52 weeks ended January 1, 2011, the Company sold certain real estate properties for net proceeds of $9,453 and $57,307 (2009 - $nil and $20,783), respectively, and entered into leaseback agreements for the area used by the Associate-owned stores.  The leases have been assessed as capital or operating in nature and have been accounted for accordingly.  During the 12 and 52 weeks ended January 1, 2011, the Company realized gains on disposal of $350 and $14,182 (2009 - $nil and $8,012), respectively.  The gains have been deferred and are being amortized over the lease terms of 10 to 20 years (2009 - 15 to 20 years).  The deferred gains are presented in accounts payable and accrued liabilities and other long-term liabilities.

5. INTEREST EXPENSE

The components of the Company's interest expense are as follows:

6. BANK INDEBTEDNESS

The Associate-owned stores borrow under their bank line of credit agreements, which are guaranteed by the Company.  The Company has entered into agreements with banks to guarantee a total of $520,000 (2009 - $520,000) of lines of credit.  As at January 1, 2011, the Associate-owned stores have utilized $176,410 (2009 - $254,332) of the available lines of credit.

7. EMPLOYEE FUTURE BENEFITS

The net benefit expense included in the results for the 12 and 52 weeks ended January 1, 2011 for benefits provided under pension plans was $1,250 and $5,418 (2009 - $1,082 and $4,688), respectively, and for benefits provided under other benefit plans was $134 and $582 (2009 - $1,012 and $1,089), respectively.

8. STOCK-BASED COMPENSATION

Long-term Incentive Compensation Awards

The Company maintains a Long-Term Incentive Plan ("LTIP") pursuant to which certain employees are eligible to receive an award of share units equivalent in value to common shares of the Company ("Share Units").  Awards of Share Units under the LTIP are made in February of the fiscal year immediately following the year in respect of which the award is earned.  There were no awards made under the LTIP in respect of the 2009 fiscal year.  For a description of the awards, see Note 14 to the consolidated financial statements in the Company's 2009 Annual Report. 

In February 2010, the Company made grants of restricted share units ("RSUs"), in respect of the 2009 fiscal year, under the Company's Restricted Share Unit Plan (the "RSU Plan") and for certain senior management, grants of RSUs, combined with grants of stock options under the Company's Share Incentive Plan (the "Share Plan"). 

On February 23, 2010, the Company awarded 350,384 RSUs at a grant-date fair value of $44.09, which vest 100% after three years.  Full vesting of RSUs will be phased in for employees who received an award under the LTIP in respect of a fiscal year prior to the 2009 fiscal year. During the 12 and 52 weeks ended January 1, 2011, the Company recognized compensation expense of $2,021 and $8,804, respectively, associated with RSUs.  As at January 1, 2011, there were 326,117 RSUs outstanding.

On February 23, 2010, the Company awarded 282,120 stock options under the Share Plan at a grant-date fair value of $6.94, which vest one-third each year.  The exercise price of the stock options granted was $44.09 and upon vesting, the stock options may be exercised over a period not exceeding seven years.  During the 12 and 52 weeks ended January 1, 2011, the Company recognized compensation expense of $276 and $1,197, respectively, measured at fair value on the date of the grant using the Black-Scholes option-pricing model.

9. DEBT REFINANCING

2010 Debt Refinancing Transactions

On December 10, 2010, the Company entered into a $750,000 revolving term credit facility.  This new credit facility, which matures on December 10, 2014, replaces the Company's previously existing $800,000 revolving term credit facility that was to mature on June 6, 2011.  The new credit facility, as was the case with the credit facility it replaces, is available for general corporate purposes, including backstopping the Company's $500,000 commercial paper program.  The Company recognized financing costs related to the new credit facility of $3,281, which are netted against the long-term debt balance on the consolidated balance sheet.

2009 Debt Refinancing Transactions

On January 20, 2009, the Company issued $250,000 of three-year medium-term notes maturing January 20, 2012, which bear interest at a fixed rate of 4.80% (the "Series 3 notes") and $250,000 of five-year medium-term notes maturing January 20, 2014, which bear interest at a fixed rate of 5.19% (the "Series 4 notes").  The Series 3 notes and the Series 4 notes were issued pursuant to the Company's shelf prospectus, as supplemented by pricing supplements dated January 14, 2009.

The net proceeds from the issuance of the Series 3 notes and the Series 4 notes were used to refinance existing indebtedness, including repayment of all amounts outstanding under the Company's senior unsecured 364-day bank credit facility ("short-term debt").  The Company's senior unsecured 364-day bank credit facility was terminated on January 20, 2009.

On June 22, 2009, the Company filed with the securities regulators in all of the provinces of Canada an amendment to its short form base shelf prospectus dated May 22, 2008 (the "Amended Prospectus") to increase the aggregate principal amount of medium-term notes to be issued from $1,000,000 to $1,500,000.  On June 22, 2010, the Amended Prospectus expired and was not renewed or extended by the Company.

10. FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES RELATED TO FINANCIAL INSTRUMENTS

In the normal course of business, the Company is exposed to financial risks that have the potential to negatively impact its financial performance but it may use derivative financial instruments to manage certain of these risks.  The Company does not use derivative financial instruments for trading or speculative purposes.  These risks are discussed in more detail below:

Interest Rate Risk

Interest rate risk is the risk that fair value or future cash flows associated with the Company's financial assets or liabilities will fluctuate due to changes in market interest rates.

The Company, including its Associate-owned store network, is exposed to fluctuations in interest rates by virtue of its borrowings under its bank credit facilities, commercial paper program and financing programs available to its Associates.  Increases or decreases in interest rates will negatively or positively impact the financial performance of the Company.

The Company monitors market conditions and the impact of interest rate fluctuations on its fixed and floating rate debt instruments on an ongoing basis and may use interest rate derivatives to manage this exposure.  Until December 2010, the Company used interest rate derivative agreements to manage a portion of the interest rate risk on its commercial paper.  The Company was party to an agreement converting an aggregate notional principal amount of $50,000 of floating rate commercial paper debt into fixed rate debt at a rate of 4.18% which expired in December 2010.  The Company had an additional agreement in 2009 converting an aggregate notional principal amount of $50,000 of floating rate commercial paper debt into fixed rate debt at a rate of 4.11%, which expired in December 2009.  As at January 1, 2011, the Company no longer had any interest rate swap agreements to convert its floating rate debt into fixed rate debt.  See Note 11 for further discussion of the derivative agreements.

As at January 1, 2011, the Company had $304,410 (2009 - $466,630) of unhedged floating rate debt.  During the 12 and 52 weeks ended January 1, 2011, the Company's average outstanding unhedged floating rate debt was $478,026 and $538,243 (2009 - $584,631 and $600,562), respectively.  Had interest rates been higher or lower by 50 basis points during the 12 and 52 weeks ended January 1, 2011, net earnings would have decreased or increased, respectively, by approximately $386 and $1,885 (2009 - $464 and $2,066), respectively, as a result of the Company's exposure to interest rate fluctuations on its unhedged floating rate debt.

Credit Risk

Credit risk is the risk that the Company's counterparties will fail to meet their financial obligations to the Company, causing a financial loss.

Accounts receivable arise primarily in respect of prescription sales billed to governments and third-party drug plans and, as a result, collection risk is low.  There is no concentration of balances with debtors in the remaining accounts receivable.  The Company does not consider its exposure to credit risk to be material.

Liquidity Risk

Liquidity risk is the risk that the Company will be unable to meet its obligations relating to its financial liabilities.

The Company prepares cash flow budgets and forecasts to ensure that it has sufficient funds through operations, access to bank facilities and access to debt and capital markets to meet its financial obligations, capital investment program and fund new investment opportunities or other unanticipated requirements as they arise.  The Company manages its liquidity risk as it relates to financial liabilities by monitoring its cash flow from operating activities to meet its short-term financial liability obligations and planning for the repayment of its long-term financial liability obligations through cash flow from operating activities and/or the issuance of new debt.

The contractual maturities of the Company's financial liabilities as at January 1, 2011 are as follows:

There is no difference between the carrying value of bank indebtedness and the amount the Company is required to pay.  The accounts payable and accrued liabilities and other long-term liabilities amounts exclude certain liabilities that are not considered financial liabilities.  The medium-term notes amounts include principal and interest liabilities.

11. FINANCIAL INSTRUMENTS

Interest Rate Derivative

Until December 2010, the Company used interest rate derivatives to manage a portion of the interest rate risk on its commercial paper.  The Company was party to an agreement converting an aggregate notional principal amount of $50,000 of floating rate commercial paper debt into fixed rate debt at a rate of 4.18% which expired in December 2010.  The Company had an additional agreement in 2009 converting an aggregate notional principal amount of $50,000 of floating rate commercial paper debt into fixed rate debt at a rate of 4.11%, which expired in December 2009.  The Company recorded a net loss of $3,766 (2009 - $1,811) over the life of the agreement that expired in 2010 as interest expense on commercial paper.  As at January 1, 2011, the Company no longer had any interest rate derivative agreements to convert its floating rate debt into fixed rate debt. 

Based on market values of the interest rate derivative agreement in place at January 2, 2010, the Company recognized a liability of $1,645, all of which was presented in accounts payable and accrued liabilities.  During the 12 and 52 weeks ended January 1, 2011 and January 2, 2010, the Company assessed that the interest rate derivatives were effective hedges for the floating interest rates on the associated commercial paper debt.

During the 12 and 52 weeks ended January 1, 2011 and January 2, 2010, no amounts previously recorded in accumulated other comprehensive income were recognized as income in earnings.

Equity Forward Derivatives

The Company uses cash-settled equity forward agreements to limit its exposure to future price changes in the Company's share price for share unit awards under the Company's LTIP and RSU Plan.  The income or expense arising from the use of these instruments is included in cost of goods sold and other operating expenses for the period.

Based on market values of the equity forward agreements in place at January 1, 2011, the Company recognized a liability of $2,257, of which $674 is presented in accounts payable and accrued liabilities and $1,583 was presented in other long-term liabilities.  Based on market values of the equity forward agreements in place at January 2, 2010, the Company recognized a net liability of $910, of which $286 was presented in other assets and $1,196 was presented in accounts payable and accrued liabilities. During the 12 and 52 weeks ended January 1, 2011 and January 2, 2010, the Company assessed that the percentages of the equity forward derivatives in place related to unearned units under the LTIP and RSU Plan were effective hedges for its exposure to future changes in the market price of its common shares in respect of the unearned units.

During the 12 and 52 weeks ended January 1, 2011, amounts previously recorded in accumulated other comprehensive loss of $3 and $33 (2009 - $45 and $294), respectively, were recognized in net earnings.

Fair Value of Financial Instruments

The fair value of a financial instrument is the estimated amount that the Company would receive or pay to settle the financial assets and financial liabilities as at the reporting date.

The fair values of cash, accounts receivable, deposits, bank indebtedness, commercial paper, accounts payable and accrued liabilities and dividends payable approximate their carrying values at January 1, 2011 and January 2, 2010 due to their short-term maturities.  The fair values of long-term receivables, the revolving term facility and other long-term liabilities approximate their carrying values at January 1, 2011 and January 2, 2010 due to the current market rates associated with these instruments.  The fair value of the medium-term notes at January 1, 2011 is approximately $997,345 (2009 - $1,007,522) compared to a carrying value of $950,000 (2009 - $950,000) (excluding transaction costs) due to decreases in market interest rates for similar instruments.

The interest rate and equity forward derivatives are recognized at fair value, which is determined based on current market rates and on information received from the Company's counterparties to these agreements.  The interest rate derivative was valued using the one-month Reuters Canadian Dealer Offered Rate Index.  The primary valuation input for the equity forward derivatives is the Company's common share price.

12. CAPITAL MANAGEMENT

The Company's primary objectives when managing capital are to profitably grow its business while maintaining adequate financing flexibility to fund attractive new investment opportunities and other unanticipated requirements or opportunities that may arise. Profitable growth is defined as earnings growth commensurate with the additional capital being invested in the business in order that the Company earns an attractive rate of return on that capital. The primary investments undertaken by the Company to drive profitable growth include additions to the selling square footage of its store network via the construction of new, relocated and expanded stores, including related leasehold improvements and fixtures, the acquisition of sites as part of a land bank program, as well as through the acquisition of independent drug stores or their prescription files. In addition, the Company makes capital investments in information technology and its distribution capabilities to support an expanding store network. The Company also provides working capital to its Associates via loans and/or loan guarantees. The Company largely relies on its cash flow from operations to fund its capital investment program and dividend distributions to its shareholders. This cash flow is supplemented, when necessary, through the borrowing of additional debt. No changes were made to these objectives during the period.

The Company considers its total capitalization to be bank indebtedness, commercial paper, short-term debt, long-term debt (including the current portion thereof) and shareholders' equity, net of cash. The Company also gives consideration to its obligations under operating leases when assessing its total capitalization. The Company manages its capital structure with a view to maintaining investment grade credit ratings from two credit rating agencies. In order to maintain its desired capital structure, the Company may adjust the level of dividends paid to shareholders, issue additional equity, repurchase shares for cancellation or issue or repay indebtedness.  The Company has certain debt covenants and was in compliance with those covenants as at January 1, 2011 and January 2, 2010.

The Company monitors its capital structure principally through measuring its net debt to shareholders' equity and net debt to total capitalization ratios, and ensures its ability to service its debt and meet other fixed obligations by tracking its interest and other fixed charges coverage ratios.

The following table provides a summary of certain information with respect to the Company's capital structure and financial position as at the dates indicated.

As measured by the ratios set out above, the Company maintained its desired capital structure and financial position during the period.

The following table provides a summary of the Company's credit ratings at January 1, 2011:

There were no changes to the Company's credit ratings during the 12 and 52 weeks ended January 1, 2011.

On April 8, 2010, DBRS Limited placed the short and long-term ratings of the Company under review with negative implications.  The rating action was in response to the Ontario Ministry of Health and Long-Term Care's April 7, 2010 announcement with respect to further drug reform in the province.  On July 30, 2010, DBRS Limited confirmed the short and long-term ratings of the Company and changed the ratings trend from under review with negative implications to stable.

13. CONTINGENCIES, COMMITMENTS AND GUARANTEES

Litigation

The Company has been served with a Statement of Claim in a proposed class proceeding that has been filed in the Ontario Superior Court of Justice by two of its licensed Associate-owners, claiming various declarations and damages of $1,000,000 on behalf of a proposed class comprised of all of its current and former licensed Associate-owners resident in Canada, other than in Québec. The claim alleges, among other things, that Shoppers Drug Mart and two of its affiliates breached contractual and other duties to its Associate-owners by collecting, receiving and/or retaining funds and/or benefits that are in excess of those permitted to be collected, received and/or retained by the applicable agreements. The Company believes that the claim is without merit and will vigorously defend the claim.  However, there can be no assurance that the outcome of this claim will be favourable to the Company or that it will not have a material adverse impact on the Company's financial position.  The amount payable, if any, is not reasonably determinable at this time.

In addition, the Company is involved in certain legal claims arising in the normal course of business.  In the opinion of the Company's management, the eventual settlement of such claims will not have a significant effect on the Company's financial position or results of operations.  Management has recorded a provision for these claims based on its best estimate of the final settlements.

SHOPPERS DRUG MART CORPORATION
Exhibit to the Consolidated Financial Statements
(unaudited)

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Earnings Coverage Exhibit to the Consolidated Financial Statements

The earnings coverage ratio on long-term debt (including any current portion) is equal to earnings (before interest and income taxes) divided by interest expense on long-term debt (including any current portion).  Interest expense excludes any amounts in respect of amortization and includes amounts capitalized to property and equipment that were included in and excluded from, respectively, interest expense as shown in the consolidated statement of earnings of the Company for the period.