SHOPPERS DRUG MART CORPORATION ANNOUNCES THIRD QUARTER RESULTS

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Nov 10, 2010, 11:44 ET

TORONTO, Nov. 10 /CNW/ - Shoppers Drug Mart Corporation (TSX: SC) today announced its financial results for the third quarter ended October 9, 2010.

Third Quarter Results (16 Weeks)

Third quarter sales increased 2.6% to $3.093 billion, with the Company continuing to experience sales growth in all regions of the country. On a same-store basis, sales increased 1.2% during the quarter.

Prescription sales increased 0.8% in the third quarter to $1.492 billion, accounting for 48.3% of the Company's sales mix compared to 49.1% of the Company's sales mix in the same quarter of the prior year. On a same-store basis, prescription sales increased 0.2% during the third quarter of 2010. A reduction in generic prescription reimbursement rates, the result of recently implemented drug system reform initiatives, principally in Ontario, combined with greater generic prescription utilization, had a negative impact on sales dollar growth in pharmacy. Prescription sales growth continues to be driven by strong growth in the number of prescriptions filled, with total pharmacy counts increasing by 4.4% during the third quarter of 2010. On a same-store basis, pharmacy counts increased by 3.4% during the quarter. Generic molecules represented 56.5% of prescriptions dispensed in the third quarter of 2010 compared to 52.8% of prescriptions dispensed in the third quarter of last year.

Front store sales increased 4.4% in the third quarter to $1.601 billion, with the Company continuing to experience sales gains in its core categories. The Company's store network development program, which has resulted in a 6.6% 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 continued investments in marketing, pricing and promotional activities. On a same-store basis, front store sales increased 2.2% during the third quarter of 2010.

Third quarter net earnings, inclusive of a 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 $159 million or 73 cents per share (diluted). Excluding the impact of this charge, the Company's adjusted net earnings for the third quarter of 2010 were $167 million, or 77 cents per share (diluted) compared to $171 million or 79 cents per share (diluted) a year ago. During the third quarter, the Company continued to deliver top-line growth and improvements in productivity and efficiency, the benefits of which were only partially offset by increased amortization and higher operating expenses at store-level associated with the Company's network growth and expansion initiatives. The year-over-year decline in third quarter operating and profit margins can be largely attributed to the impact of recently implemented drug system reform initiatives in certain jurisdictions of Canada, principally Ontario, which negatively impacted pharmacy reimbursement and margin rates.

Commenting on the results, Jürgen Schreiber, President and CEO of the Company stated, "Our results for the third quarter met our expectations as we confront the new pricing and reimbursement pressures facing all of us that are invested and engaged in the practice of community pharmacy. To that end we continue to work hard, together with our Associate-owners and their teams at store-level, to adjust our operating and service model, generate real cost savings, leverage our strengths and grow the business in a capital-efficient manner. While much hard work remains, I am confident in the capabilities of our people and believe that as a market leader, we remain well positioned to execute on our strategic priorities and initiatives and capitalize on the business opportunities that lie ahead."

Year-to-date Results (40 weeks)

Sales for the first three quarters of 2010 increased 4.3% to $7.816 billion, with prescription sales up 3.7% and front store sales up 4.8%. On a same-store basis, sales increased 2.2%, with prescription sales up 2.4% and front store sales up 2.1%. Year-to-date, total pharmacy counts increased 5.2% and were up 3.0% on a same-store basis. During the first three quarters of 2010, prescription sales accounted for 48.8% of the Company's sales mix compared to 49.0% in the same period last year.

Net earnings for the first three quarters of 2010, inclusive of the aforementioned charge, were $420 million or $1.93 per share (diluted) compared to $414 million or $1.90 per share (diluted) a year ago. Excluding the impact of this charge, the Company's adjusted net earnings for the first three quarters of 2010 increased 3.1% to $427 million or $1.96 per share (diluted).

Store Network Development

During the third quarter, 17 drug stores were opened, 11 of which were relocations, and six smaller drug stores were closed. The Company also completed eight major drug store expansions and added one Murale luxury beauty store to its network during the quarter. At quarter-end, there were 1,310 stores in the system, comprised of 1,239 drug stores (1,181 Shoppers Drug Mart/Pharmaprix stores and 58 Shoppers Simply Pharmacy/Pharmaprix Simplement Santé stores), 63 Shoppers Home Health Care stores and eight Murale stores. Retail selling space was approximately 12.6 million square feet at the end of the third quarter, an increase of 6.6% compared to a year ago.

Dividend

The Company also announced today that its Board of Directors has declared a dividend of 22.5 cents per common share, payable January 14, 2011 to shareholders of record as of the close of business on December 31, 2010.

Other Information

The Company will hold an analyst call at 3:30 p.m. (Eastern Standard Time) today to discuss its third quarter results. The call may be accessed by dialing 416-340-8530 from within the Toronto area, or 1-877-240-9772 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 November 24, 2010. The call playback can be accessed after 5:00 p.m. (Eastern Standard Time) on Wednesday, November 10, 2010 by dialing 416-695-5800 from within the Toronto area, or 1-800-408-3053 outside of Toronto. The seven-digit passcode number is 5087440.

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 1,181 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 more than 58 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 also 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, including the Management's Discussion and Analysis, (collectively, the "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 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 earlier this year in the Province of Ontario to amend the Ontario drug system and the coming into effect of the Pharmacy Services Agreement in the Province of British Columbia, along with the impact of the proposed and/or announced drug system reform initiatives in other jurisdictions of Canada, principally the provinces of Québec and Nova Scotia; 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 and for the 12 and 24 week periods ended June 19, 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

                     MANAGEMENT'S DISCUSSION AND ANALYSIS

                           As at November 5, 2010

The following is a discussion of the consolidated financial condition and results of operations of Shoppers Drug Mart Corporation (the "Company") for the periods indicated and of certain factors that the Company believes may affect its prospective financial condition, cash flows and results of operations. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements of the Company and the notes thereto for the 16 and 40 week periods ended October 9, 2010. The Company's unaudited interim period financial statements and the notes thereto have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP") and are reported in Canadian dollars. 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 for the 52 week period ended January 2, 2010.

FORWARD-LOOKING INFORMATION AND STATEMENTS

This discussion of the consolidated financial condition and results of operations of the Company 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 document includes, but is not limited to, statements with respect to the Company's future operating and financial results, its capital expenditure plans and the ability to execute on its future operating, investing and financing strategies.

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 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 and for the 12 and 24 week periods ended June 19, 2010. The forward-looking information and statements contained in this discussion of the consolidated financial condition and results of operations of the Company represent the Company's views only as of the date hereof. Forward-looking information and statements contained in this Management's Discussion and Analysis 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.

OVERVIEW

The Company is the licensor of full-service retail drug stores operating under the name Shoppers Drug Mart(R) (Pharmaprix(R) in Québec). As at October 9, 2010, there were 1,181 Shoppers Drug Mart/Pharmaprix retail drug stores owned and operated by the Company's licensees ("Associates"). An Associate is a pharmacist-owner of a corporation that is licensed to operate a retail drug store at a specific location using the Company's trademarks. The Company's licensed stores are located in prime locations in each province and two territories, making Shoppers Drug Mart/Pharmaprix stores among the most convenient retail outlets in Canada. The Company also licenses or owns 58 medical clinic pharmacies operating under the name Shoppers Simply Pharmacy(R) (Pharmaprix Simplement Santé(R) in Québec) and eight luxury beauty destinations operating as Murale(TM).

The Company has successfully leveraged its leadership position in pharmacy and its convenient store locations to capture a significant share of the market in front store merchandise. Front store merchandise categories include over-the-counter medications, health and beauty aids, cosmetics and fragrances (including prestige brands), everyday household needs and seasonal products. The Company also offers a broad range of high-quality private label products marketed under the trademarks Life Brand(R), Quo(R), Balea(R), Everyday Market(R), Bio-Life(R), Nativa(R), Simply Food(TM) and Easypix(R), among others, and value-added services such as the HealthWATCH(R) program, which offers patient counselling and advice on medications, disease management and health and wellness, and the Shoppers Optimum(R) program, one of the largest retail loyalty card programs in Canada. In fiscal 2009, the Company recorded consolidated sales of approximately $10.0 billion.

Under the licensing arrangements with Associates, the Company provides the capital and financial support to enable Associates to operate Shoppers Drug Mart(R), Pharmaprix(R), Shoppers Simply Pharmacy(R) and Pharmaprix Simplement Santé(R) stores without any initial investment. The Company also provides a package of services to facilitate the growth and profitability of each Associate's business. These services include the use of trademarks, operational support, marketing and advertising, purchasing and distribution, information technology and accounting. In return for being provided these and other services, Associates pay fees to the Company. Fixtures, leasehold improvements and equipment are purchased by the Company and leased to Associates over periods ranging from two to 15 years, with title retained by the Company. The Company also provides its Associates with assistance in meeting their working capital and long-term financing requirements through the provision of loans and loan guarantees.

Under the licensing arrangements, the Company receives a substantial share of Associate store profits. The Company's share of Associate store profits is reflective of its investment in, and commitment to, the operations of the Associates' stores.

The Company operates in Québec primarily under the Pharmaprix(R) and Pharmaprix Simplement Santé(R) trade names. Under Québec law, profits generated from the prescription area or dispensary may only be earned by a pharmacist or a corporation controlled by a pharmacist. As a result of these restrictions, the licence agreement used for Québec Associates differs from the Associate agreement used in other provinces. Pharmaprix(R) and Pharmaprix Simplement Santé(R) stores and their Associates benefit from the same infrastructure and support provided to all other Shoppers Drug Mart(R) and Shoppers Simply Pharmacy(R) stores and Associates.

The Company has determined that the individual Associate-owned stores that comprise its store network are deemed to be variable interest entities and that the Company is the primary beneficiary in accordance with the Canadian Institute of Chartered Accountants Accounting Guideline 15, "Consolidation of Variable Interest Entities" ("AcG-15"). As such, the Associate-owned stores are subject to consolidation by the Company. However, as the Associate-owned stores remain separate legal entities from the Company, consolidation of these stores has no impact on the underlying risks facing the Company. (See note 1 to the accompanying unaudited consolidated financial statements of the Company.)

The Company also owns and operates 63 Shoppers Home Health Care(R) stores. These retail stores are engaged in the sale and service of assisted-living devices, medical equipment, home-care products and durable mobility equipment to institutional and retail customers.

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.

The majority of the Company's sales are generated from the retail drug store network and the majority of the Company's assets are used in the operations of these stores. As such, the Company presents one operating segment in its consolidated financial statement disclosures. The revenue generated by Shoppers Drug Mart Specialty Health Network Inc. and by MediSystem Technologies Inc. is included with the prescription sales of the Company's retail drug stores. The revenue generated by the Shoppers Home Health Care(R) stores and the Murale(TM) stores is included with the front store sales of the Company's retail drug stores.

OVERALL FINANCIAL PERFORMANCE

Key Operating, Investing and Financial Metrics

The following provides an overview of the Company's operating performance for the 16 and 40 week periods ended October 9, 2010 compared to the 16 and 40 week periods ended October 10, 2009, as well as certain other metrics with respect to investing activities for the 16 and 40 week periods ended October 9, 2010 and financial position as at that same date.

    
    -   Third quarter sales of $3.093 billion, an increase of 2.6%.

        -  Year-to-date sales of $7.816 billion, an increase of 4.3%.

    -   Third quarter comparable store total sales growth of 1.2%, comprised
        of comparable prescription sales growth of 0.2% and comparable front
        store sales growth of 2.2%.

        -  Year-to-date comparable store total sales growth of 2.2%,
           comprised of comparable prescription sales growth of 2.4% and
           comparable front store sales growth of 2.1%.

    -   Third quarter prescription count growth of 4.4%. Comparable store
        prescription count growth of 3.4%.

        -  Year-to-date prescription count growth of 5.2%. Comparable store
           prescription count growth of 3.0%.

    -   Third quarter EBITDA(1) of $332 million. Adjusted EBITDA(2) of
        $342 million, an increase of 0.3%.

        -  Year-to-date EBITDA of $859 million. Adjusted EBITDA of
           $870 million, an increase of 4.7%.

    -   Third quarter EBITDA margin(3) of 10.73%. Adjusted EBITDA margin(4)
        of 11.06%, a decrease of 26 basis points.

        -  Year-to-date EBITDA margin of 10.99%. Adjusted EBITDA margin of
           11.13%, an increase of 5 basis points.

    -   Third quarter net earnings of $159 million or $0.73 per share
        (diluted). Adjusted net earnings(5) of $167 million or $0.77 per
        share (diluted), a decrease of 2.6%.

        -  Year-to-date net earnings of $420 million or $1.93 per share
           (diluted). Adjusted net earnings of $427 million or $1.96 per
           share (diluted), an increase of 3.1%.

    -   Third quarter capital expenditure program of $149 million compared to
        $178 million in the prior year. Opened 17 new drug stores, 11 of
        which were relocations, and added one Murale(TM) luxury beauty store.

        -  Year-to-date capital expenditure program of $359 million compared
           to $418 million in the prior year. Opened or acquired 65 new drug
           stores, 35 of which were relocations, and added two Murale(TM)
           luxury beauty stores.

        -  Year-over-year increase in retail selling square footage of 6.6%.

    -   Maintained desired capital structure and financial position.

        -  Net debt to equity ratio of 0.32:1 at October 9, 2010 compared to
           0.38:1 a year ago.

        -  Net debt to total capitalization ratio of 0.24:1 at October 9,
           2010 compared to 0.27:1 a year ago.

    (1) Earnings before interest, taxes, depreciation and amortization,
        inclusive of a $10 million (pre-tax) charge to settle a long-standing
        legal dispute related to a commercial arrangement with one of the
        Company's ancillary businesses. (See reconciliation to the most
        directly comparable GAAP measure under "Results of Operations" in
        this Management's Discussion and Analysis.)

    (2) EBITDA, excluding the impact of the charge referred to in footnote
        (1) above.

    (3) EBITDA divided by sales.

    (4) Adjusted EBITDA divided by sales.

    (5) Net earnings, excluding the after-tax impact of the charge referred
        to in footnote (1) above.

Results of Operations

The following table presents a summary of certain selected consolidated financial information for the Company for the periods indicated.

    
                             16 Weeks Ended              40 Weeks Ended
                        -------------------------   -------------------------
    ($000s, except       October 9,   October 10,    October 9,   October 10,
     per share data)          2010          2009          2010          2009
    -------------------------------------------------------------------------
                        (unaudited)   (unaudited)   (unaudited)   (unaudited)

    Sales              $ 3,092,575   $ 3,013,007   $ 7,816,213   $ 7,497,056
    Cost of goods sold
     and other
     operating
     expenses            2,760,764     2,671,789     6,956,848     6,666,361
                       ------------------------------------------------------

    EBITDA(1)              331,811       341,218       859,365       830,695
    Amortization            87,443        78,569       218,751       190,451
                       ------------------------------------------------------

    Operating income       244,368       262,649       640,614       640,244
    Interest expense        17,595        18,060        43,438        46,447
                       ------------------------------------------------------

    Earnings before
     income taxes          226,773       244,589       597,176       593,797
    Income taxes            67,465        73,695       177,659       179,949
                       ------------------------------------------------------

    Net earnings       $   159,308   $   170,894   $   419,517   $   413,848
                       ------------------------------------------------------
                       ------------------------------------------------------

    Per common share
      - Basic net
       earnings        $      0.73   $      0.79   $      1.93   $      1.90
      - Diluted net
       earnings        $      0.73   $      0.79   $      1.93   $      1.90

    (1) Earnings before interest, taxes, depreciation and amortization.

Sales

Sales represent the combination of sales of the retail drug stores owned by the Associates, sales at Murale(TM) and sales of the home health care business, Shoppers Drug Mart Specialty Health Network Inc. and MediSystem Technologies Inc. The majority of the Company's sales are generated from the retail drug store network and the majority of the Company's assets are used in the operations of these stores. As such, the Company presents one operating segment in its consolidated financial statement disclosures. Sales at Murale(TM) and sales of the home health care business are included with front store sales of the Company's retail drug stores. Sales of Shoppers Drug Mart Specialty Health Network Inc. and MediSystem Technologies Inc. are included with prescription sales of the Company's retail drug stores.

Sales in the third quarter were $3.093 billion compared to $3.013 billion in the same period last year, an increase of $80 million or 2.6%, 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 1.2% during the third quarter of 2010. Year-to-date, sales increased 4.3% to $7.816 billion. On a same-store basis, sales increased 2.2% during the first three quarters of 2010.

Prescription sales were $1.492 billion in the third quarter compared to $1.481 billion in the third quarter of 2009, an increase of $11 million or 0.8%. During the third quarter of 2010, prescription sales accounted for 48.3% of the Company's sales mix compared to 49.1% in the same period last year. On a same-store basis, prescription sales increased 0.2% during the third quarter of 2010. A reduction in generic prescription reimbursement rates, the result of recently implemented drug system reform initiatives, principally in Ontario, combined with greater generic prescription utilization, had a negative impact on sales dollar growth in pharmacy. Prescription sales growth continues to be driven by strong growth in the number of prescriptions filled, with total pharmacy counts increasing by 4.4% during the third quarter of 2010. On a same-store basis, pharmacy counts increased by 3.4% during the quarter. In the third quarter of 2010, generic molecules represented 56.5% of prescriptions dispensed compared to 52.8% of prescriptions dispensed in the third quarter of 2009. Year-to-date, prescription sales increased 3.7% to $3.813 billion and accounted for 48.8% of the Company's sales mix compared to 49.0% in the same period last year. On a same-store basis, prescription sales increased 2.4% during the first three quarters of 2010. Year-to-date, total pharmacy counts increased 5.2% and were up 3.0% on a same-store basis.

Front store sales were $1.601 billion in the third quarter of 2010 compared to $1.532 billion in the third quarter of 2009, an increase of $69 million or 4.4%, as the Company continued to experience sales gains in its core categories. The Company's store network development program, which has resulted in a 6.6% 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 continued investments in marketing, pricing and promotional activities. On a same-store basis, front store sales increased 2.2% during the third quarter of 2010. Year-to-date, front store sales increased 4.8% to $4.003 billion. On a same-store basis, front store sales increased 2.1% during the first three quarters of 2010.

Cost of Goods Sold and Other Operating Expenses

Cost of goods sold is comprised of the cost of goods sold at the retail drug stores owned by the Associates, the cost of goods sold at Murale(TM) and the cost of goods sold at the home health care business, Shoppers Drug Mart Specialty Health Network Inc. and MediSystem Technologies Inc. Other operating expenses include corporate selling, general and administrative expenses, operating expenses at the retail drug stores owned by the Associates, including Associates' earnings, operating expenses at Murale(TM) and operating expenses at the home health care business, Shoppers Drug Mart Specialty Health Network Inc. and MediSystem Technologies Inc.

Total cost of goods sold and other operating expenses, inclusive of a $10 million charge to settle a long-standing legal dispute related to a commercial arrangement with one of the Company's ancillary businesses, were $2.761 billion in the third quarter of 2010. Excluding the impact of this charge, the Company's adjusted cost of goods sold and other operating expenses were $2.751 billion compared to $2.672 billion in the same period last year, an increase of $79 million or 2.9%. Expressed as a percentage of sales, cost of goods sold declined by 121 basis points in the third quarter of 2010 versus the comparative prior year period, reflecting the benefits of improved purchasing synergies, greater generic prescription utilization and the impact of reduced generic drug costs and reimbursement levels as a result of the recently implemented drug system reform initiatives referred to above. Other operating expenses, expressed as a percentage of sales and excluding the impact of the $10 million charge referred to above, increased by 147 basis points in the third quarter of 2010 versus the comparative prior year period, due in part to top-line deflation stemming from the above referenced drug system reform initiatives and greater generic prescription utilization, along with stepped-up marketing expenditures and increased store-level expenses, primarily occupancy, Associate earnings, wages and benefits related to the growth of the store network. These increases were partially offset by additional productivity and efficiency gains in the front of the store resulting from the successful rollout and implementation of the Company's Project Infinity initiatives, along with a reduction in store opening costs due to a decrease in the number of stores opened during the third quarter of 2010 compared to the third quarter of the prior year.

Year-to-date, total cost of goods sold and other operating expenses, inclusive of the $10 million charge referred to above, increased by 4.4% to $6.957 billion. Expressed as a percentage of sales, cost of goods sold declined by 100 basis points in the first three quarters of 2010 versus the comparative prior year period, while other operating expenses, excluding the impact of the aforementioned $10 million charge, increased by 95 basis points.

Amortization

Amortization of capital assets and other intangible assets was $87 million in the third quarter of 2010 compared to $79 million in the same period last year, an increase of $8 million or 11.3%. Expressed as a percentage of sales, amortization increased 22 basis points in the third quarter of 2010 versus the comparative prior year period, an increase which can be attributed to continued investments by the Company in its store network and supporting infrastructure.

Year-to-date, amortization of capital assets and other intangible assets increased 14.9% to $219 million. Expressed as a percentage of sales, amortization increased 26 basis points in the first three quarters of 2010 versus the comparative prior year period.

Operating Income

Operating income, inclusive of the $10 million charge referred to above, was $244 million in the third quarter of 2010. Excluding the impact of this charge, the Company's adjusted operating income was $255 million in the third quarter of 2010 compared to $263 million in the same period last year, a decrease of $8 million or 3.0%. As described above, the Company continued to deliver top-line growth and improvements in productivity and efficiency during the third quarter of 2010, the benefits of which were only partially offset by increased amortization and higher operating expenses at store-level associated with the Company's growth and expansion initiatives. The year-over-year decline in the third quarter operating income and margin can be largely attributed to the impact of recently implemented drug reform initiatives in certain jurisdictions of Canada, principally Ontario, which negatively impacted pharmacy reimbursement and margin rates. In 2010, third quarter adjusted operating margin (adjusted operating income divided by sales) declined by 49 basis points to 8.23% compared to 8.72% in the third quarter of last year. The Company's EBITDA margin (EBITDA divided by sales), adjusted to exclude the impact of the charge referred to above, was 11.06% in the third quarter of 2010, a 26 basis point decline compared to the EBITDA margin of 11.32% posted in the third quarter of last year.

Year-to-date, operating income, inclusive of the $10 million charge referred to above, was $641 million. Excluding the impact of this charge, the Company's adjusted operating income increased 1.7% to $651 million and adjusted operating margin, when compared to the same period last year, declined by 21 basis points to 8.33%. During the first three quarters of 2010, adjusted EBITDA margin was 11.13%, a 5 basis point improvement over the EBITDA margin of 11.08% posted during the first three quarters of 2009.

Interest Expense

Interest expense is comprised of interest expense arising from borrowings at the Associate-owned stores and from debt obligations of the Company.

Interest expense was $18 million in the third quarter of 2010, essentially unchanged compared to the same period last year, as interest expense savings due to the Company having a lower average amount of consolidated net debt outstanding were offset by a market-driven increase in short-term interest rates on the Company's floating rate debt obligations. Year-to-date, interest expense decreased 6.5% to $43 million. (See note 5 to the accompanying unaudited consolidated financial statements of the Company.)

Income Taxes

The Company's effective income tax rate in the third quarter and first three quarters of 2010 was 29.8% compared to 30.1% and 30.3% in the same respective periods of the prior year. These year-over-year decreases in the effective income tax rate can be attributed to a reduction in statutory rates.

Net Earnings

Third quarter net earnings, inclusive of the aforementioned $10 million (pre-tax) charge, were $159 million and earnings per share (diluted) were $0.73. Excluding the impact of this charge, the Company's adjusted net earnings for the third quarter of 2010 were $167 million compared to $171 million in the same period last year, a decrease of $4 million or 2.6%. On a diluted basis, adjusted earnings per share were $0.77 in the third quarter of 2010 compared to $0.79 in the same period last year.

Capitalization and Financial Position

The following table provides a summary of certain information with respect to the Company's capitalization and consolidated financial position at the end of the periods indicated.

    
                                                     October 9,    January 2,
    ($000s)                                               2010          2010
    -------------------------------------------------------------------------

    Cash                                           $   (49,873)  $   (44,391)
    Bank indebtedness                                  278,894       270,332
    Commercial paper                                   128,726       260,386
    Long-term debt                                     946,218       946,098
                                                  ---------------------------

    Net debt                                         1,303,965     1,432,425

    Shareholders' equity                             4,100,554     3,826,110

                                                  ---------------------------

    Total capitalization                           $ 5,404,519   $ 5,258,535
                                                  ---------------------------
                                                  ---------------------------

    Net debt:Shareholders' equity                       0.32:1        0.37:1
    Net debt:Total capitalization                       0.24:1        0.27:1
    Net debt:EBITDA(1)                                  1.11:1        1.25:1
    EBITDA:Cash interest expense(1)(2)                 20.69:1       19.59:1

    (1) For purposes of calculating the ratios, EBITDA is comprised of EBITDA
        for each of the 52 week periods then ended.

    (2) Cash interest expense is comprised of interest expense for each of
        the 52 week periods then ended and excludes the amortization of
        deferred financing costs, but includes capitalized interest.

Financial Ratios and Credit Ratings

The following table provides a summary of the Company's credit ratings at October 9, 2010.

    
                                                      Standard          DBRS
                                                      & Poor's       Limited
                                                  ---------------------------
    Corporate credit rating                               BBB+             -
    Senior unsecured debt                                 BBB+        A (low)
    Commercial paper                                         -      R-1 (low)

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 confirmed the short and long-term ratings of the Company and changed the ratings trend from under review with negative implications to stable.

Outstanding Share Capital

The Company's outstanding share capital is comprised of common shares. An unlimited number of common shares are authorized and the Company had 217,452,068 common shares outstanding at November 5, 2010. As at this same date, the Company had issued options to acquire 1,149,492 of its common shares pursuant to its stock-based compensation plans, of which 797,372 were exercisable.

Liquidity and Capital Resources

Sources of Liquidity

The Company has the following sources of liquidity: (i) cash provided by operating activities; (ii) cash available from a committed $800 million revolving bank credit facility maturing June 6, 2011, less what is currently drawn and/or being utilized to support commercial paper issued and outstanding; and (iii) up to $500 million in availability under its commercial paper program, less what is currently issued. The Company's commercial paper program is rated R-1 (low) by DBRS Limited. In the event that the Company's commercial paper program is unable to maintain this rating, the program is supported by the Company's $800 million revolving bank credit facility. At October 9, 2010, $9 million of the Company's $800 million revolving bank credit facility was utilized, all of which was in respect of outstanding letters of credit, unchanged from the end of the second quarter of 2010. At January 2, 2010, $10 million of this facility was utilized, including $9 million in respect of outstanding letters of credit. At October 9, 2010, the Company had $129 million of commercial paper issued and outstanding under its commercial paper program compared to $184 million at the end of the second quarter of 2010 and $261 million at the end of 2009.

The Company has also arranged for its Associates to obtain financing to facilitate their purchase of inventory and fund their working capital requirements by providing guarantees to various Canadian chartered banks that support Associate loans. At the end of the third quarter of 2010, the Company's maximum obligation in respect of such guarantees was $520 million, unchanged from the end of the second quarter of 2010 and the end of the prior year. At October 9, 2010, an aggregate amount of $439 million in available lines of credit had been allocated to the Associates by the various banks compared to $438 million at the end of the second quarter of 2010 and $431 million at the end of the prior year. At October 9, 2010, Associates had drawn an aggregate amount of $282 million against these available lines of credit compared to $267 million at the end of the second quarter of 2010 and $254 million at the end of the prior year. Any amounts drawn by the Associates are included in bank indebtedness on the Company's consolidated balance sheets. As recourse in the event that any payments are made under the guarantees, the Company holds a first-ranking security interest on all assets of Associate-owned stores, subject to certain prior-ranking statutory claims. As the Company is involved in allocating the available lines of credit to its Associates, it estimates that the net proceeds from secured assets would exceed the amount of any payments required in respect of the guarantees.

The Company has obtained additional long-term financing from the issuance of $450 million of five-year medium-term notes maturing June 3, 2013, which bear interest at a fixed rate of 4.99% per annum (the "Series 2 Notes"), $250 million of three-year medium-term notes maturing January 20, 2012, which bear interest at a fixed rate of 4.80% per annum (the "Series 3 Notes") and $250 million of five-year medium-term notes maturing January 20, 2014, which bear interest at a fixed rate of 5.19% per annum (the "Series 4 Notes"). The Series 2 Notes were issued pursuant to a final short form base shelf prospectus dated May 22, 2008 (the "Prospectus"), as supplemented by a pricing supplement dated May 28, 2008, and filed by the Company with Canadian securities regulators in all of the provinces in Canada. The Series 3 Notes and Series 4 Notes were issued pursuant to the Prospectus, as supplemented by pricing supplements dated January 14, 2009, and filed by the Company with Canadian securities regulators in all of the provinces of Canada. At the time of issuance, the Series 2 Notes, Series 3 Notes and Series 4 Notes were assigned ratings of A (low) from DBRS Limited and BBB+ from Standard & Poor's.

On June 22, 2009, the Company filed, with the securities regulators in all of the provinces of Canada, an amendment (the "Amendment") to the Prospectus (as amended, the "Amended Prospectus"), increasing the aggregate principal amount of medium-term notes that can be issued from time to time pursuant to the Amended Prospectus to $1.5 billion from $1.0 billion. On June 22, 2010, the Amended Prospectus expired and was not renewed or extended by the Company.

Cash Flows from Operating Activities

Cash flows from operating activities were $197 million in the third quarter of 2010 compared to $239 million in the same period last year. This decrease can be primarily attributed to an increase in the amount invested in non-cash working capital balances when compared to the same period last year. The increase in the amount invested in non-cash working capital balances was driven primarily by a decrease in accounts payable and accrued liabilities, offset somewhat by a reduction in accounts receivable and by the timing of inventory purchases.

Year-to-date, the Company has generated $588 million of cash from operating activities compared to $521 million in the first three quarters of 2009.

Cash Flows Used in Investing Activities

Cash flows used in investing activities were $136 million in the third quarter of 2010 compared to $166 million in the same period last year. Of these totals, purchases of property and equipment, net of proceeds from any dispositions, amounted to $121 million in the third quarter of this year compared to $129 million in the same period last year, as the Company continues to invest in its store network and supporting infrastructure, albeit at a slower rate. The Company was not active with respect to the acquisition of drug stores and prescription files in the third quarter of 2010, as compared to investments of $31 million in the third quarter of the prior year. The Company invested an additional $15 million in the purchase and development of intangible and other assets during the third quarter of 2010, primarily computer software, compared to $12 million in the same period last year. During the third quarter of 2010, the balance of funds deposited and held in escrow in respect of outstanding offers to purchase drug stores and land was essentially unchanged compared to a decrease of $6 million in the same period last year.

Year-to-date, cash flows used in investing activities were $311 million compared to $393 million in the first three quarters of 2009. Of these totals, purchases of property and equipment, net of proceeds from any dispositions, amounted to $261 million in the first three quarters of 2010 compared to $282 million in the same period last year. Included in the net purchases of property and equipment in the first three quarters of 2010 was $51 million of proceeds resulting from dispositions, $48 million of which related to sale/leaseback transactions, compared to $25 million and $21 million, respectively, in the same period last year. (See note 4 to the accompanying unaudited consolidated financial statements of the Company.) Investments in business acquisitions and in the purchase and development of intangible and other assets were $13 million and $39 million, respectively, in the first three quarters of 2010 compared to $92 million and $24 million, respectively, in the same period last year. These investments relate primarily to acquisitions of drug stores and prescription files and while the Company will continue to pursue attractive opportunities in the marketplace, it is doing so at a somewhat slower pace than in 2009 in response to recent drug system reform initiatives in a number of jurisdictions. During the first three quarters of 2010, the balance of funds deposited and held in escrow in respect of outstanding offers to purchase drug stores and land decreased by $2 million compared to a decrease of $5 million in the same period last year.

During the third quarter of 2010, the Company opened or acquired 17 new drug stores, 11 of which were relocations, closed six smaller drug stores and completed eight major drug store expansions. The Company also added one Murale(TM) luxury beauty store to its network during the quarter. Year-to-date, 65 new drug stores have been opened or acquired, 35 of which were relocations, 10 smaller drug stores were closed and 22 major drug store expansions were completed. Two Murale(TM) stores were added to the network during the first three quarters of 2010. As a result of this activity, retail selling space increased by 6.6% compared to a year ago. At the end of the third quarter of 2010, there were 1,310 stores in the Company's retail network, comprised of 1,239 drug stores (1,181 Shoppers Drug Mart/Pharmaprix stores and 58 Shoppers Simply Pharmacy/Pharmaprix Simplement Santé stores), 63 Shoppers Home Health Care(R) stores and eight Murale(TM) stores.

Cash Flows Used in Financing Activities

Cash flows used in financing activities were $74 million in the third quarter of 2010, as cash inflows of $30 million were more than offset by cash outflows of $104 million. Cash inflows were largely comprised of a $22 million increase in the amount of bank indebtedness and a $7 million increase in the amount of Associate investment. Cash outflows were comprised of a $55 million decrease in the amount of commercial paper issued and outstanding by the Company under its commercial paper program and $49 million for the payment of dividends.

In the third quarter of 2010, the net result of the Company's operating, investing and financing activities was a decrease in cash balances of $13 million.

Year-to-date, cash flows used in financing activities were $271 million and the net result of the Company's operating, investing and financing activities was an increase in cash of $5 million.

Future Liquidity

The Company believes that its current credit facilities, commercial paper program and financing programs available to its Associates, together with cash generated from operating activities, will be sufficient to fund its operations, including the operations of its Associate-owned store network, investing activities and commitments for the foreseeable future. Historically, the Company has not experienced any major difficulty in obtaining additional short or long-term financing given its investment grade credit ratings. While the Company is committed to maintaining its investment grade credit ratings, credit ratings may be revised or withdrawn at any time by the rating agencies if, in their judgment, circumstances warrant.

NEW ACCOUNTING PRONOUNCEMENTS

Transition to International Financial Reporting Standards

In January 2006, the Accounting Standards Board (the "AcSB") announced its decision to require all publicly accountable enterprises to report under International Financial Reporting Standards ("IFRS") for years beginning on or after January 1, 2011. As a result, financial reporting by Canadian publicly accountable enterprises will change significantly from current Canadian generally accepted accounting principles ("Canadian GAAP") to IFRS.

In February 2008, the AcSB confirmed that publicly accountable enterprises will be required to use IFRS, as issued by the International Accounting Standards Board ("IASB"), unless modifications or additions to the requirements of IFRS are issued by the AcSB. IFRS must be adopted for interim and annual financial statements related to fiscal years beginning on or after January 1, 2011.

The Company launched its IFRS transition project in 2008 with a high level assessment of the key areas where conversion to IFRS may have a significant impact, or present a significant challenge. The Company has engaged an external advisor, established a working team and developed documentation and status reporting protocols. The Company has delivered its initial training program and is ensuring that the working team has an in-depth understanding of relevant IFRS as well as new developments in IFRS. General training and education of those departments outside of the Finance function that require an understanding of IFRS has commenced and will continue through the fourth quarter of 2010.

The Company's working team has substantially completed its detailed assessment of IFRS, focused on the identification and quantification of differences between the Company's current policies and those under IFRS. In this regard, a topic-specific issues list was developed, identifying the activities required for resolution and timelines for completion, including potential impacts on taxation, information technology and data systems.

The Company has developed a timeline for its 2010 deliverables under its transition plan. The Company is using this timeline to monitor progress against its transition plan and meet future quarters' disclosure requirements. Activities that the Company is undertaking in 2010 include finalization of positions on accounting issues, confirmation of changes to accounting policies, the development of the opening balance sheet, performance of the impairment test on the opening balance sheet under IFRS, conversion of 2010 interim results and development of draft 2011 financial statement and annual 2010 Management's Discussion and Analysis disclosures. The Company has developed a strategy for dual internal reporting under Canadian GAAP and IFRS during 2010. The Company expects to substantially complete these activities by the end of the fourth quarter of 2010.

The Company is in the process of completing its evaluation of existing processes and is developing new processes for accumulating information to meet new disclosure requirements, including identifying any required information system changes, by the end of the fourth quarter of 2010. To date, the Company has not identified that material changes to processes are required. The Company reports regularly to the Audit Committee of the Board of Directors on the status of its transition project. The Company expects to finalize its accounting policy and first-time adoption election recommendations and, seek approval for those recommendations from the Audit Committee, before the end of the fourth quarter of 2010.

Current developments and changes to IFRS will continue to be monitored throughout 2010 and the Company's transition plan and timelines will be adjusted as necessary to respond to these developments. The Company is currently progressing as planned against its 2010 timeline and has not experienced any significant changes from its original project plan.

The Company is focusing its primary efforts on the following standards:

IAS 27, Consolidated and Separate Financial Statements

Under Canadian GAAP, subsidiaries are consolidated based first on the variable interest model under Accounting Guideline 15, "Consolidation of Variable Interest Entities", and then based on the voting interest model under CICA Handbook Section 1590, "Subsidiaries".

Under Canadian GAAP, the Company concluded that the individual Associate-owned stores that comprise the Company's store network were deemed to be variable interest entities and, therefore, were subject to consolidation by the Company. Under IFRS, there is no variable interest concept and consolidation is based on the concept of control as described in IAS 27, "Consolidated and Separate Financial Statements" ("IAS 27").

Based on its assessment, the Company has made the preliminary determination that consolidation of the Associate-owned store network is still appropriate under IFRS. The IASB issued an exposure draft in December 2008 that will revise IAS 27. The exposure draft provides additional guidance regarding the definition and assessment of control. The exposure draft could however change prior to finalization and the Company is continuing to monitor the IASB's project on this standard. The IASB is expected to issue the revised standard in the fourth quarter of 2010.

IFRS 3, Business Combinations

The primary impacts of adopting IFRS 3, "Business Combinations" ("IFRS 3"), compared to the current requirements are:

    
    a)  the inability to capitalize acquisition costs which are currently
        considered part of the purchase price;
    b)  any adjustments to the purchase price within the twelve month period
        subsequent to an acquisition will require retroactive application and
        a restatement of prior periods;
    c)  additional limitations exist for establishing restructuring
        provisions, thereby reducing the number or amount of provisions
        recognized on acquisition; and
    d)  intangible assets (liabilities) arising from favourable
        (unfavourable) operating leases are recognized as a component of the
        leased asset (under current Canadian GAAP, these are recognized as
        separate intangible assets or liabilities).

In addition to these accounting differences, there are incremental disclosures under IFRS. The Company expects that the immediate impact will be the inability to capitalize certain acquisition costs and an adjustment to the opening IFRS balance sheet for any purchase price allocation changes made in 2010 to pre-2010 acquisitions.

IFRS 1, "First-time Adoption of International Financial Reporting Standards" ("IFRS 1"), states that a first-time adopter may elect not to apply IFRS 3 retrospectively to business combinations that occurred before the date of transition to IFRS. It is the Company's current intention to make this election and, therefore, only apply IFRS 3 to business combinations prospectively (i.e. to those that occur on or after January 3, 2010). This may result in the reversal of certain acquisition costs that are capitalized in conjunction with 2010 acquisitions.

IFRIC 13, Customer Loyalty Programmes

IFRIC 13, "Customer Loyalty Programmes" ("IFRIC 13"), addresses how companies should account for the obligation to provide free or discounted goods or services under customer loyalty programs.

IFRIC 13 is based on a view that customers are implicitly paying for the points they receive when they buy goods or services and therefore, a portion of the revenue should be deferred at the time that points are issued. IFRIC 13 requires companies to estimate the value of the points to the customer and defer this amount of revenue as a liability until they have fulfilled their obligations to supply awards. IFRIC 13 will impact the measurement and recognition of the Company's Shoppers Optimum(R) loyalty card program (the "Program"). Currently, when points are earned by Program members, the Company records an expense and establishes a liability for future redemptions by multiplying the number of points issued by the estimated cost per point. The actual cost of Program redemptions is charged against the liability account.

The Company believes that under IFRS the fair value per point should represent the retail value of the award received by the customer upon redemption, whereas under the Company's current liability measurement, the cost per point represents the cost to the Company of providing the reward on redemption. The determination of fair value and cost per point are impacted by many factors, including the historical behaviour of Program members and expected future redemption patterns. The Company is currently quantifying this measurement difference and expects to complete its quantification by the end of the fourth quarter of 2010.

IAS 16, Property, Plant and Equipment

The objective of IAS 16, "Property, Plant and Equipment" ("IAS 16"), is to prescribe the accounting treatment for property, plant, and equipment. The principal issues are the recognition of assets, the determination of their carrying amounts and the depreciation charges and impairment losses to be recognized in relation to them. The Company has investigated each class of its assets and has come to the preliminary determination that IAS 16 will not significantly impact the classification or carrying amounts of its property, plant and equipment.

It is recognized that first time adopters of IFRS may have difficulty reconstructing historical information relating to property, plant and equipment in sufficient detail to retrospectively comply in full with IAS 16. IFRS 1 offers the option for entities to use fair value as deemed-cost for the opening balance of items of property, plant and equipment. As the Company does not believe any additional componentization of its assets is required, the Company believes that the current carrying value of its assets is consistent with IFRS.

IAS 17, Leases

IAS 17, "Leases" ("IAS 17"), retains the concepts of capital (finance) leases versus operating leases. IAS 17 differs in the use of qualitative versus quantitative thresholds as exist under Canadian GAAP. Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form of the contract. A finance lease is defined as a lease that transfers substantially all of the risks and rewards incidental to ownership of the leased asset from the lessor to the lessee. Title to the asset may or may not transfer under such a lease. An operating lease is a lease other than a finance lease.

The Company has assessed its lease classification under IFRS and has determined that no change to existing lease classifications will be required.

IAS 17 also differs in its treatment of gains and losses arising from sale-leaseback transactions where the leaseback is an operating lease. Under IFRS, if the sale transaction can be demonstrated to have taken place at fair value, any gain or loss is taken into income immediately; under Canadian GAAP, gains are deferred and amortized over the term of the lease and losses are taken into income immediately. The Company has entered into several sale-leaseback transactions in the past for which gains have been deferred and amortized. The Company has assessed the gains on its historical sale-leaseback transactions (there have been no losses) and determined that the transactions were at fair value and therefore, under IFRS, the gains would have been recognized in earnings. As a result, on the adoption of IFRS, any unamortized deferred gains would be recognized in opening retained earnings.

The IASB has undertaken a long-term project with respect to leases. In August 2010, the IASB issued an exposure draft on leases. The primary objective of the project is to develop a new model for the recognition of assets and liabilities arising under lease contracts, with the expectation that all leases will be reflected on the balance sheet. This standard is not expected to be in effect prior to the adoption of IFRS in 2011.

IAS 39, Financial Instruments: Recognition and Measurement

The Company intends to continue to apply hedge accounting under IFRS to its interest rate derivative agreement and cash-settled equity forward agreements. The Company has formally identified, designated and documented all relationships between its hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. The Company has assessed the effectiveness of the hedges as at January 3, 2010 under IFRS and has concluded that the derivatives used in hedging transactions are highly effective in offsetting future changes in cash flows and market values of the hedged items.

IAS 36, Impairment of Assets

The objective of IAS 36, "Impairment of Assets" ("IAS 36") is to ensure that assets are carried at no more than their recoverable amount, through use or sale. An asset carried at more than its recoverable amount through use or sale is considered impaired and an impairment loss must be recognized immediately in income. A previously recognized impairment loss on an asset other than goodwill is reversed if there has been a change in the factors used to determine the asset's recoverable amount since the last impairment loss was recognized. An impairment loss for goodwill is not reversed.

Assets are assessed at the end of each reporting period to determine whether there is any indication of an impairment. If any such indication exists, the recoverable amount of the asset must be determined. Goodwill and intangible assets not subject to amortization must be tested at least annually for impairment, and more frequently if an indication of impairment exists.

If there is any indication that an asset may be impaired, the recoverable amount shall be estimated for the individual asset. If it is not possible to estimate the recoverable amount of the individual asset, the recoverable amount is determined for the cash-generating unit to which the asset belongs. An asset's cash-generating unit is the smallest group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. Identification of an asset's cash-generating unit involves judgment.

The requirements of IAS 36 are similar to those that exist in Canadian GAAP however there are differences in identification of cash-generating units, reversals in previously recognized impairment losses and the methodology for calculating the recoverable amount, including the use of discounting. The Company is assessing its cash generating units and is currently performing impairment testing of its assets utilizing the IFRS testing methodology.

IAS 19, Employee Benefits

IAS 19, "Employee Benefits" ("IAS 19") permits an accounting policy choice regarding actuarial gains and losses subsequent to the transition to IFRS. A reporting entity can recognize actuarial gains and losses in other comprehensive income in the period in which they occur or, actuarial gains and losses can be taken into income over time similar to existing Canadian GAAP. It is the Company's current intention to adopt a policy of recognizing actuarial gains and losses in other comprehensive income in the period in which they occur.

IFRS 1 permits a reporting entity to take all unrecognized actuarial gains and losses into retained earnings on transition to IFRS instead of restating the accrued benefit liability as if IFRS had always been applied. It is the Company's current intention to take this election.

Other Standards

In addition to the above standards, the Company is also focusing on IAS 12, "Income Taxes", and is in the process of finalizing its determinations on this standard. This list should not be regarded as a complete list of the IFRS standards that may have an impact on the Company's results of operations, financial position and disclosures. The list is intended to highlight areas the Company believes to be the most significant. Final conclusions could change as the Company progresses through its assessments. At this point, the Company is not able to reasonably quantify the expected impacts of the changes.

Further options under IFRS 1, beyond those that have been identified above, are being analyzed as the Company progresses through its detailed assessment of the individual standards. The Company will be making its recommendations on IFRS 1 elections and seeking approval for those recommendations from the Audit Committee before the end of the fourth quarter of 2010.

The impact of the transition to IFRS on other business activities, contracts and covenants, disclosure controls and procedures and internal controls over financial reporting is being assessed as the impacts of the standards as a whole are identified. Currently, the Company has not identified material changes to other business activities, contracts and covenants, disclosure controls and procedures and internal controls over financial reporting.

The IASB has significant ongoing projects, which management is monitoring, that could affect the ultimate differences between Canadian GAAP and IFRS and the impact those differences have on the Company's results of operations, financial position and disclosures.

SELECTED QUARTERLY INFORMATION

Reporting Cycle

The annual reporting cycle of the Company is divided into four quarters of 12 weeks each, except for the third quarter which is 16 weeks in duration. The fiscal year of the Company consists of a 52 or 53 week period ending on the Saturday closest to December 31. When a fiscal year consists of 53 weeks, the fourth quarter is 13 weeks in duration.

Summary of Quarterly Results

The following table provides a summary of certain selected consolidated financial information for the Company for each of the eight most recently completed fiscal quarters. This information has been prepared in accordance with Canadian generally accepted accounting principles.

    
                              Third Quarter              Second Quarter
                       --------------------------  --------------------------
    ($000s, except          2010          2009          2010          2009
     per share data
     - unaudited)        (16 Weeks)    (16 Weeks)    (12 Weeks)    (12 Weeks)
    -------------------------------------------------------------------------

    Sales              $ 3,092,575   $ 3,013,007   $ 2,402,539   $ 2,288,789

    Net earnings       $   159,308   $   170,894   $   144,576   $   136,112

    Per common share
      - Basic net
       earnings        $      0.73   $      0.79   $      0.66   $      0.63
      - Diluted net
       earnings        $      0.73   $      0.79   $      0.66   $      0.63


                              First Quarter              Fourth Quarter
                       --------------------------  --------------------------
    ($000s, except          2010          2009          2009          2008
     per share data
     - unaudited)        (12 Weeks)    (12 Weeks)    (12 Weeks)    (13 Weeks)
    -------------------------------------------------------------------------

    Sales              $ 2,321,099   $ 2,195,260   $ 2,488,544   $ 2,496,799

    Net earnings       $   115,633   $   106,842   $   171,060   $   166,536

    Per common share
      - Basic net
       earnings        $      0.53   $      0.49   $      0.79   $      0.77
      - Diluted net
       earnings        $      0.53   $      0.49   $      0.79   $      0.77

Excluding the benefit of the extra week in the fourth quarter of 2008, which accounted for $174 million of additional sales, the Company experienced growth in sales in each of the four most recent quarters when compared to the same quarter of the prior year. Net earnings in the third quarter declined when compared to the same quarter of the prior year due to the impact of recently implemented drug system reform initiatives in certain jurisdictions of Canada, principally Ontario, which negatively impacted pharmacy reimbursement and margin rates, and also due to a 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. Net earnings increased in each of the other quarters when compared to the same quarters of the prior year.

The Company's core prescription drug operations are not typically subject to seasonal fluctuations. The Company's front store operations include seasonal promotions which may have an impact on comparative quarterly results, particularly when the season, notably Easter, does not fall in the same quarter each year. Also, as the Company continues to expand its front store product and service offerings, including seasonal promotions, its results of operations may become subject to more seasonal fluctuations.

RISKS AND RISK MANAGEMENT

Industry and Regulatory Developments

The Company is exposed to a number of risks in the normal course of its business that have the potential to affect its operating and financial performance, including the risk of adverse drug system reform initiatives which may reduce the cost of prescription drug products. The Company is reliant on prescription drug sales for a significant portion of its sales and profits.

Québec

In Québec, legislation provides that the selling price for prescription drug products for the provincial drug insurance program must not be higher than the selling price granted by the manufacturer for the same drug under other provincial health programs ("Canada's best price"). As discussed under the title "Industry and Regulatory Developments" in the "Risks and Risk Management" section of the Company's Management's Discussion and Analysis for the 12 and 24 week periods ended June 19, 2010, Québec Health Minister Yves Bolduc announced on June 25, 2010 that Québec would implement pricing reductions on generic drugs consistent with the pricing reductions implemented in Ontario and indicated that the reduced prices would become effective after a consultation period with industry stakeholders. On November 5, 2010, Québec announced that the pricing reductions on generic drugs would be phased in over a three year period. Until the date of publication of the Québec List of drugs in April 2011, if Canada's best price established for a generic drug product is equal to or less than 37.5% of the price of the brand name drug in Québec, generic drug pricing in Québec may not be greater than 37.5% of the brand name drug. Generic drug pricing will be reduced to not greater than 30% of the brand name drug in Québec starting from the date of publication of the Québec List of drugs in April 2011 if Canada's best price for a generic product is equal to or less than 30% of the price of the brand name drug in Québec. Beginning on the date of publication of the Québec List of drugs in April 2012, generic drug product prices in Québec may not be higher than any selling prices granted by the manufacturer for the same drug under other provincial health programs.

Nova Scotia

On September 20, 2010, the Nova Scotia Department of Health announced its intention to gather input on its plan to achieve better prices for prescription drugs reimbursed under the Nova Scotia public drug program. As part of the process, the Nova Scotia government intends to meet with pharmacists, pharmacy owners, drug manufacturers, doctors, medical staff at district health authorities and the public for their input on the plan.

As part of the plan to achieve better prices for prescription drugs for the public drug program, the following five measures are being considered by the Nova Scotia government:

    
    Set a cap on generic drug prices - set a cap on the price of generic
    drugs based on a percentage of the price of the equivalent brand name
    drug. This cap could apply to all generic drugs or, alternatively, either
    new generic drugs or generic drugs currently covered by the public drug
    program.

    Limit pharmacy rebates - require generic drug manufacturers to report the
    financial rebates they pay to community pharmacies for stocking their
    generic drugs, and limit the amount of these rebates.

    Tender for one or more drugs - establish a competitive process in which
    the province asks manufacturers for a better price for one or more
    prescription drugs and list the drug or drugs that come in at that price
    for coverage under the public drug program.

    Establish rules around price increases - put rules in place to control
    increases in the prices of all generic drugs.

    Define the price paid to pharmacies for drugs - establish a clearly
    defined price paid by government to community pharmacists for branded
    drugs.

As an interim measure, the Nova Scotia government has issued a request for proposal for atorvastatin, the generic form of Lipitor(R), to be supplied by manufacturers at a price requested by the province.

The Nova Scotia government has also indicated that it will be working with pharmacists to better use their skills and expertise in the delivery of health care in the province. As part of this initiative, the government will be looking at how pharmacists will be compensated for providing these additional services.

Furthermore, the Nova Scotia government is in the process of establishing a Drug Management Policy Unit that will focus on reducing pricing and making efficient use of prescription drugs.

RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS

The Company is exposed to a number of risks associated with financial instruments that have the potential to affect its operating and financial performance. The Company's primary financial instrument risk exposures are interest rate risk and liquidity risk. The Company's exposures to foreign currency risk, credit risk and other price risk are not considered to be material. The Company may use derivative financial instruments to manage certain of these risks but it does not use derivative financial instruments for trading or speculative purposes.

Exposure to Interest Rate Fluctuations

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 positively or negatively 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. The Company is party to an interest rate derivative agreement converting an aggregate notional principal amount of $50 million (2009 - $100 million) of floating rate debt into fixed rate debt. The fixed rate payable by the Company under this agreement is 4.18% (2009 - two agreements with a range between 4.11% and 4.18%). This agreement contains reset terms of one month and matures in December 2010.

Furthermore, the Company may be exposed to losses should any counterparty to its derivative agreements fail to fulfil its obligations. The Company has sought to minimize counterparty risk by transacting with counterparties that are large financial institutions. There is no unrecognized exposure as at October 9, 2010, as the interest rate derivative agreement is in a liability position, unchanged from the end of the second quarter and the end of the prior year.

As at October 9, 2010, the Company had $361 million (2009 - $437 million) of unhedged floating rate debt. During the 16 and 40 week periods ended October 9, 2010, the Company's average outstanding unhedged floating rate debt was $492 million and $556 million (2009 - $574 million and $605 million), respectively. Had interest rates been higher or lower by 50 basis points during the 16 and 40 week periods ended October 9, 2010, net earnings would have decreased or increased, respectively, by approximately $0.5 million and $1.5 million (2009 - $0.6 million and $1.6 million), respectively, as a result of the Company's exposure to interest rate fluctuations on its unhedged floating rate debt.

Foreign Currency Exchange Risk

The Company conducts the vast majority of its business in Canadian dollars. The Company's foreign currency exchange risk principally relates to purchases made in U.S. dollars and this risk is tied to fluctuations in the exchange rate of the Canadian dollar, vis-à-vis the U.S. dollar. The Company monitors its foreign currency purchases in order to monitor and manage its foreign currency exchange risk. The Company does not consider its exposure to foreign currency exchange rate risk to be material.

Credit Risk

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.

Other Price Risk

The Company uses cash-settled equity forward agreements to limit its exposure to future changes in the market price of its common shares by virtue of its obligations under its Long-Term Incentive Plan ("LTIP") and Restricted Share Units Plan ("RSUP"). The income or expense arising from the use of these instruments is included in cost of goods sold and other operating expenses.

Based on market values of the equity forward agreements in place at October 9, 2010, the Company recognized a liability of $5.0 million, of which $1.8 million is presented in accounts payable and accrued liabilities and $3.2 million is presented in other long-term liabilities. Based on market values of the equity forward agreements in place at October 10, 2009, the Company recognized a liability of $2.6 million, of which $1.1 million was presented in accounts payable and accrued liabilities and $1.5 million was presented in other long-term liabilities. During the 16 and 40 week periods ended October 9, 2010 and October 10, 2009, the Company assessed that the percentages of the equity forward agreements in place related to unearned units under the LTIP and the RSUP were effective hedges for the exposure to future changes in the market price of its common shares in respect of the unearned units. Market values were determined based on information received from the Company's counterparty to these equity forward agreements.

Capital Management and Liquidity Risk

The Company's primary objectives when managing its 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 is in compliance with those covenants.

The Company monitors its capital structure principally through measuring its net debt to shareholders' equity ratio and net debt to total capitalization ratio, and ensures its ability to service its debt and meet other fixed obligations by tracking its interest and other fixed charges coverage ratios. (See discussion under "Capitalization and Financial Position" in this Management's Discussion and Analysis.)

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 credit 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.

For a complete description of the Company's sources of liquidity, see the discussions on "Sources of Liquidity" and "Future Liquidity" under "Liquidity and Capital Resources" in this Management's Discussion and Analysis.

INTERNAL CONTROLS OVER FINANCIAL REPORTING

The Chief Executive Officer and the Chief Financial Officer have designed, or caused to be designed under their supervision, internal controls over financial reporting to provide reasonable assurance regarding the reliability of financial reporting, its compliance with Canadian GAAP and the preparation of financial statements for external purposes. Internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be designed effectively can provide only reasonable assurance with respect to financial reporting and financial statement preparation.

There were no changes in internal control over financial reporting that occurred during the Company's most recent interim period that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

NON-GAAP FINANCIAL MEASURES

The Company reports its financial results in accordance with Canadian GAAP. However, the foregoing contains references to non-GAAP financial measures, such as operating margin, adjusted operating margin, EBITDA (earnings before interest, taxes, depreciation and amortization), adjusted EBITDA, EBITDA margin, adjusted EBITDA margin, adjusted net earnings, adjusted earnings per share and cash interest expense. Non-GAAP financial measures do not have standardized meanings prescribed by GAAP and, therefore, may not be comparable to similar measures presented by other reporting issuers.

These non-GAAP financial measures have been included in this Management's Discussion and Analysis as they are measures which management uses to assist in evaluating the Company's operating performance against its expectations and against other companies in the retail drug store industry. Management believes that non-GAAP financial measures assist in identifying underlying operating trends.

These non-GAAP financial measures, particularly EBITDA, adjusted EBITDA, EBITDA margin and adjusted EBITDA margin, are also common measures used by investors, financial analysts and rating agencies. These groups may use EBITDA, adjusted EBITDA, EBITDA margin, adjusted EBITDA margin and other non-GAAP financial measures to value the Company and assess the Company's ability to service its debt.

    
    SHOPPERS DRUG MART CORPORATION
    Consolidated Statements of Earnings
    (unaudited)
    (in thousands of dollars except per share amounts)
    -------------------------------------------------------------------------

                             16 Weeks Ended              40 Weeks Ended
                       --------------------------  --------------------------
                         October 9,   October 10,    October 9,   October 10,
                              2010          2009          2010          2009
    -------------------------------------------------------------------------

    Sales              $ 3,092,575   $ 3,013,007   $ 7,816,213   $ 7,497,056
    Operating expenses
      Cost of goods
       sold and other
       operating
       expenses
       (Note 2)          2,760,764     2,671,789     6,956,848     6,666,361
      Amortization          87,443        78,569       218,751       190,451
    -------------------------------------------------------------------------

    Operating income       244,368       262,649       640,614       640,244

    Interest expense
     (Note 5)               17,595        18,060        43,438        46,447
    -------------------------------------------------------------------------

    Earnings before
     income taxes          226,773       244,589       597,176       593,797
    -------------------------------------------------------------------------

    Income taxes
      Current               68,600        78,465       177,640       182,684
      Future                (1,135)       (4,770)           19        (2,735)
    -------------------------------------------------------------------------
                            67,465        73,695       177,659       179,949
    -------------------------------------------------------------------------
    Net earnings       $   159,308   $   170,894   $   419,517   $   413,848
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Net earnings per
     common share:

      Basic            $      0.73   $      0.79   $      1.93   $      1.90
      Diluted          $      0.73   $      0.79   $      1.93   $      1.90

    Weighted average
     common shares
     outstanding
      - Basic
       (millions)            217.4         217.4         217.4         217.3
      - Diluted
       (millions)            217.5         217.5         217.5         217.5
    Actual common
     shares outstanding
     (millions)              217.5         217.4         217.5         217.4



    SHOPPERS DRUG MART CORPORATION
    Consolidated Statements of Retained Earnings
    (unaudited)
    (in thousands of dollars)
    -------------------------------------------------------------------------

                                                         40 Weeks Ended
                                                  ---------------------------
                                                     October 9,   October 10,
                                                          2010          2009
    -------------------------------------------------------------------------

    Retained earnings, beginning of period         $ 2,297,091   $ 1,899,139
    Net earnings                                       419,517       413,848
    Dividends                                         (146,771)     (140,208)
    -------------------------------------------------------------------------
    Retained earnings, end of period               $ 2,569,837   $ 2,172,779
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Consolidated Statements of Comprehensive Income and Accumulated Other
    Comprehensive Loss
    (unaudited)
    (in thousands of dollars)
    -------------------------------------------------------------------------

                             16 Weeks Ended              40 Weeks Ended
                       --------------------------  --------------------------
                         October 9,   October 10,    October 9,   October 10,
                              2010          2009          2010          2009
    -------------------------------------------------------------------------
    Net earnings       $   159,308   $   170,894   $   419,517   $   413,848
    -------------------------------------------------------------------------
    Other comprehensive
     income (loss),
     net of tax
      Change in
       unrealized loss
       on interest rate
       derivatives (net
       of tax of $155
       and $438 (2009 -
       $355 and $831))         349           757           922         1,530
      Change in
       unrealized loss
       on equity forward
       derivatives (net
       of tax of $488
       and $413 (2009 -
       $214 and $22))        1,236          (519)       (1,045)          (63)
      Amount of
       previously
       unrealized loss
       recognized in
       earnings during
       the period (net
       of tax of $5 and
       $12 (2009 - $16
       and $87))                12            82            30           249
    -------------------------------------------------------------------------
    Other comprehensive
     income (loss)           1,597           320           (93)        1,716
    -------------------------------------------------------------------------
    Comprehensive
     income            $   160,905   $   171,214   $   419,424   $   415,564
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    -------------------------------------------------------------------------
    Accumulated other
     comprehensive loss,
     beginning of period                           $    (1,125)  $    (3,442)
    Other comprehensive
     (loss) income                                         (93)        1,716
    -------------------------------------------------------------------------
    Accumulated other
     comprehensive loss,
     end of period                                 $    (1,218)  $    (1,726)
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------



    SHOPPERS DRUG MART CORPORATION
    Consolidated Balance Sheets
    (unaudited)
    (in thousands of dollars)
    -------------------------------------------------------------------------

                                       October 9,   October 10,    January 2,
                                            2010          2009          2010
    -------------------------------------------------------------------------

    Assets

    Current
      Cash                           $    49,873   $    58,488   $    44,391
      Accounts receivable                442,046       459,718       471,029
      Inventory (Note 2)               1,876,693     1,797,458     1,852,441
      Income taxes recoverable            14,382        16,437             -
      Future income taxes                 85,123        87,573        86,161
      Prepaid expenses and deposits       56,508        63,078        75,573
    -------------------------------------------------------------------------
                                       2,524,625     2,482,752     2,529,595

    Property and equipment (Note 4)    1,669,412     1,461,976     1,566,024
    Goodwill (Note 3)                  2,493,075     2,484,623     2,481,353
    Intangible assets (Note 3)           255,150       244,485       258,766
    Other assets                          21,476        16,746        16,716
    -------------------------------------------------------------------------
    Total assets                     $ 6,963,738   $ 6,690,582   $ 6,852,454
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Liabilities

    Current
      Bank indebtedness (Note 6)     $   278,894   $   262,902   $   270,332
      Commercial paper                   128,726       253,283       260,386
      Accounts payable and accrued
       liabilities                       899,613       978,747       964,736
      Income taxes payable                     -             -        17,046
      Dividends payable                   48,927        46,743        46,748
    -------------------------------------------------------------------------
                                       1,356,160     1,541,675     1,559,248

    Long-term debt (Note 9)              946,218       944,375       946,098
    Other long-term liabilities
     (Note 4)                            391,819       350,593       347,951
    Future income taxes                   41,905        38,157        42,858
    -------------------------------------------------------------------------
                                       2,736,102     2,874,800     2,896,155
    -------------------------------------------------------------------------

    Associate interest                   127,082       115,194       130,189

    Shareholders' equity

    Share capital                      1,520,558     1,519,166     1,519,870
    Contributed surplus                   11,377        10,369        10,274

    Accumulated other comprehensive
     loss                                 (1,218)       (1,726)       (1,125)
    Retained earnings                  2,569,837     2,172,779     2,297,091
    -------------------------------------------------------------------------
                                       2,568,619     2,171,053     2,295,966
    -------------------------------------------------------------------------
                                       4,100,554     3,700,588     3,826,110
    -------------------------------------------------------------------------
    Total liabilities and
     shareholders' equity            $ 6,963,738   $ 6,690,582   $ 6,852,454
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------



    SHOPPERS DRUG MART CORPORATION
    Consolidated Statements of Cash Flows
    (unaudited)
    (in thousands of dollars)
    -------------------------------------------------------------------------

                             16 Weeks Ended              40 Weeks Ended
                       --------------------------  --------------------------
                         October 9,   October 10,    October 9,   October 10,
                              2010          2009          2010          2009
    -------------------------------------------------------------------------

    Operating
     activities
      Net earnings     $   159,308   $   170,894   $   419,517   $   413,848
      Items not
       affecting cash
        Amortization        87,431        77,775       216,020       188,251
        Future income
         taxes              (1,135)       (4,770)           19        (2,735)
        Loss on disposal
         of property and
         equipment             855         1,496         4,948         3,909
        Stock-based
         compensation          493           202         1,267           582
    -------------------------------------------------------------------------
                           246,952       245,597       641,771       603,855
    Net change in
     non-cash working
     capital balances      (59,402)      (20,820)      (74,721)     (118,229)
    Increase in other
     long-term
     liabilities             9,926        14,667        21,335        35,614
    -------------------------------------------------------------------------
    Cash flows from
     operating activities  197,476       239,444       588,385       521,240
    -------------------------------------------------------------------------

    Investing activities
      Purchase of property
       and equipment      (135,519)     (136,747)     (311,754)     (306,840)
      Proceeds from
       disposition of
       property and
       equipment (Note 4)   14,117         7,962        50,999        24,999
      Business
       acquisitions
       (Note 3)                (50)      (31,403)      (12,731)      (91,835)
      Deposits                 (52)        5,945         1,509         4,714
      Purchase and
       development of
       intangible assets   (12,966)       (9,352)      (34,439)      (19,157)
      Other assets          (1,841)       (2,456)       (5,047)       (4,632)
    -------------------------------------------------------------------------
    Cash flows used
     in investing
     activities           (136,311)     (166,051)     (311,463)     (392,751)
    -------------------------------------------------------------------------

    Financing activities
      Bank indebtedness,
       net (Note 6)         22,397       (14,715)        8,562        22,058
      Commercial paper,
       net                 (55,000)       13,000      (132,000)      (87,000)
      Repayment of short-
       term debt (Note 9)        -             -             -      (200,000)
      Issuance of Series 3
       notes (Note 9)            -             -             -       250,000
      Issuance of Series 4
       notes (Note 9)            -             -             -       250,000
      Revolving term debt,
       net                       -             -        (1,298)     (200,000)
      Financing costs
       incurred                  -             -             -        (2,088)
      Associate interest     7,101         6,606        (2,636)       (3,484)
      Proceeds from shares
       issued for stock
       options exercised         -           874             -         3,984
      Repayment of share
       purchase loans            -             9            33           137
      Issuance of share
       capital                 462             -           491             -
      Dividends paid       (48,922)      (46,738)     (144,592)     (140,175)
    -------------------------------------------------------------------------
    Cash flows used
     in financing
     activities            (73,962)      (40,964)     (271,440)     (106,568)
    -------------------------------------------------------------------------
    (Decrease) increase
     in cash               (12,797)       32,429         5,482        21,921
    Cash, beginning of
     period                 62,670        26,059        44,391        36,567
    -------------------------------------------------------------------------
    Cash, end of
     period            $    49,873   $    58,488   $    49,873   $    58,488
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Supplemental cash
     flow information
    Interest paid      $    15,433   $    14,880   $    44,011   $    33,361
    Income taxes paid  $    57,563   $    60,622   $   209,317   $   194,716




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

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 16 and 40 weeks ended October 9, 2010, the Company recognized cost of inventory of $1,910,725 and $4,834,045 (2009 - $1,893,190 and $4,716,421), 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 period.

During the 16 and 40 weeks ended October 9, 2010 and October 10, 2009, 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 16 and 40 weeks ended October 9, 2010, the Company recognized $10,282 in cost of goods sold and other operating expenses to settle 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 16 and 40 weeks ended October 9, 2010 of $50 and $12,731 (2009 - $31,403 and $91,835), 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 16 and 40 weeks ended October 9, 2010, the Company sold certain real estate properties for net proceeds of $7,820 and $47,854 (2009 - $6,689 and $20,783), respectively, and entered into leaseback agreements for the area used by the Associate-owned stores. The leases have been accounted for as operating leases. During the 16 and 40 weeks ended October 9, 2010, the Company realized gains on disposal of $834 and $13,832 (2009 - $3,977 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 other long-term liabilities.

5. INTEREST EXPENSE

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

    
                             16 Weeks Ended              40 Weeks Ended
                       --------------------------  --------------------------
                         October 9,   October 10,    October 9,   October 10,
                              2010          2009          2010          2009
    -------------------------------------------------------------------------

    Interest on bank
     indebtedness      $     1,889   $     1,438   $     4,142   $     4,228
    Interest on
     commercial paper        1,391         1,698         3,231         5,070
    Interest on
     short-term debt             -             -             -           504
    Interest on
     long-term debt         15,517        15,637        39,273        38,522
    -------------------------------------------------------------------------
                            18,797        18,773        46,646        48,324
    Less: interest
     capitalized             1,202           713         3,208         1,877
    -------------------------------------------------------------------------
                       $    17,595   $    18,060   $    43,438   $    46,447
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

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 October 9, 2010, the Associate-owned stores have utilized $282,431 (2009 - $283,476) of the available lines of credit.

7. EMPLOYEE FUTURE BENEFITS

The net benefit expense included in the results for the 16 and 40 weeks ended October 9, 2010 for benefits provided under pension plans was $1,667 and $4,168 (2009 - $1,442 and $3,606), respectively, and for benefits provided under other benefit plans was $179 and $448 (2009 - $31 and $77), 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 16 and 40 weeks ended October 9, 2010, the Company recognized compensation expense of $2,657 and $6,783, respectively, associated with RSUs. As at October 9, 2010, 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 16 and 40 weeks ended October 9, 2010, the Company recognized compensation expense of $369 and $921, respectively, measured at fair value on the date of the grant using the Black-Scholes option-pricing model.

9. DEBT REFINANCING

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 uses interest rate derivatives to manage this exposure and monitors market conditions and the impact of interest rate fluctuations on its fixed and floating rate debt instruments on an ongoing basis. The Company is party to an interest rate derivative agreement converting an aggregate notional principal amount of $50,000 (2009 - $100,000) of floating rate commercial paper debt into fixed rate debt. See Note 11 for further discussion of the derivative agreement.

As at October 9, 2010, the Company had $361,431 (2009 - $437,476) of unhedged floating rate debt. During the 16 and 40 weeks ended October 9, 2010, the Company's average outstanding unhedged floating rate debt was $491,938 and $556,308 (2009 - $574,006 and $605,341), respectively. Had interest rates been higher or lower by 50 basis points during the 16 and 40 weeks ended October 9, 2010, net earnings would have decreased or increased, respectively, by approximately $529 and $1,499 (2009 - $608 and $1,602), respectively, as a result of the Company's exposure to interest rate fluctuations on its unhedged floating rate debt.

Furthermore, the Company may be exposed to losses should any counterparty to its derivative agreements fail to fulfill its obligations. The Company has sought to minimize counterparty risk by transacting with counterparties that are large financial institutions. As at October 9, 2010 and October 10, 2009, there were no net exposures, as the interest rate derivative agreements were in a liability position.

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.

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 October 9, 2010, are as follows:

    
                                Payments    Payments
                                     due         due
                                 between     between
                    Payments     90 days      1 year
                      due in    and less    and less    Payments
                    the next      than a        than   due after
                     90 days        year     2 years     2 years       Total
    -------------------------------------------------------------------------
    Bank
     indebtedness $  278,894  $        -  $        -  $        -  $  278,894
    Commercial
     paper           129,000           -           -           -     129,000
    Accounts
     payable and
     accrued
     liabilities     855,865      39,661           -           -     895,526
    Dividends
     payable          48,927           -           -           -      48,927
    Medium-term
     notes                 -           -     250,000     700,000     950,000
    Other long-term
     liabilities           -           -       9,776      22,558      32,334
    -------------------------------------------------------------------------
    Total         $1,312,686  $   39,661  $  259,776  $  722,558  $2,334,681
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

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

11. FINANCIAL INSTRUMENTS

Interest Rate Derivative

As at October 9, 2010, the Company is party to an interest rate derivative agreement converting an aggregate notional principal amount of $50,000 of floating rate commercial paper debt into fixed rate debt. The agreement has a fixed rate payable of 4.18% and matures on December 16, 2010, with reset terms of one month.

Based on market values of the interest rate derivative agreement in place at October 9, 2010, the Company recognized a liability of $285 (2009 - $2,287), all of which was presented in accounts payable and accrued liabilities (2009 - $343 was presented in accounts payable and accrued liabilities and $1,944 was presented in other long-term liabilities). During the 16 and 40 weeks ended October 9, 2010 and October 10, 2009, the Company assessed that the interest rate derivatives were effective hedges for the floating interest rates on the associated commercial paper debt.

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 October 9, 2010, the Company recognized a liability of $4,978 (2009 - $2,578), of which $1,831 (2009 - $1,135) is presented in accounts payable and accrued liabilities and $3,147 (2009 - $1,443) is presented in other long-term liabilities. During the 16 and 40 weeks ended October 9, 2010 and October 10, 2009, 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 16 and 40 weeks ended October 9, 2010, amounts previously recorded in accumulated other comprehensive loss of $12 and $30 (2009 - $82 and $249), 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 October 9, 2010 and October 10, 2009 due to their short-term maturities. The fair values of long-term receivables, revolving term facility and other long-term liabilities approximate their carrying values at October 9, 2010 and October 10, 2009 due to the current market rates associated with these instruments; and the fair value of the medium-term notes at October 9, 2010 is approximately $1,008,089 compared to a carrying value of $950,000 (excluding transaction costs) due to decreases in market interest rates for similar instruments (2009 - the fair value of long-term debt approximated its carrying value).

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 is 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 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.

    
                                       October 9,   October 10,    January 2,
                                            2010          2009          2010
    -------------------------------------------------------------------------

    Cash                             $   (49,873)  $   (58,488)  $   (44,391)
    Bank indebtedness                    278,894       262,902       270,332
    Commercial paper                     128,726       253,283       260,386
    Long-term debt                       946,218       944,375       946,098
                                    -----------------------------------------

    Net debt                           1,303,965     1,402,072     1,432,425

    Shareholders' equity               4,100,554     3,700,588     3,826,110
                                    -----------------------------------------

    Total capitalization             $ 5,404,519   $ 5,102,660   $ 5,258,535
                                    -----------------------------------------
                                    -----------------------------------------

    Net debt:Shareholders' equity         0.32:1        0.38:1        0.37:1
    Net debt:Total capitalization         0.24:1        0.27:1        0.27:1
    EBITDA:Cash interest expense(1)(2)   20.69:1       18.96:1       19.59:1

    (1) For purposes of calculating the ratios, EBITDA (earnings before
        interest, taxes, depreciation and amortization) is comprised of
        EBITDA for the 52 week and 53 week periods then ended, as
        appropriate. EBITDA is a non-GAAP financial measure. Non-GAAP
        financial measures do not have standardized meanings prescribed by
        GAAP and therefore may not be comparable to similar measures
        presented by other reporting issuers.

    (2) Cash interest expense is also a non-GAAP measure and is comprised of
        interest expense for the 52 week and 53 week periods then ended, as
        appropriate. It excludes the amortization of deferred financing costs
        and includes capitalized interest.

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 October 9, 2010:

    
                                                      Standard          DBRS
                                                      & Poor's       Limited
                                                  ---------------------------
    Corporate credit rating                               BBB+             -
    Senior unsecured debt                                 BBB+        A (low)
    Commercial paper                                         -      R-1 (low)

There were no changes to the Company's credit ratings during the 16 and 40 weeks ended October 9, 2010.

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.

Earnings Coverage Exhibit to the Consolidated Financial Statements

    
    52 Weeks Ended October 9, 2010
    -------------------------------------------------------------------------
    Earnings coverage on long-term debt obligations              18.88 times
    -------------------------------------------------------------------------

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.

%SEDAR: 00016987EF

For further information: Media Contact: Lisa Gibson, Director, Communications & Corporate Affairs, (416) 490-2892, or [email protected], (416) 493-1220, ext. 5500; Investor Relations: (416) 493-1220, ext. 5678, [email protected]

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