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Executives

Galen Weston - Executive Chairman

Pavi Binning - President

Richard Dufresne - Chief Financial Officer

Allison Doner - Controller

Analysts

David Hartley - Credit Suisse

Irene Nattel - RBC Capital Markets

Peter Sklar - BMO Capital Markets

Perry Caicco - CIBC World Markets

George Weston Limited (OTCPK:WNGRF) Q2 2014 Results Earnings Conference Call July 29, 2014 11:00 AM ET

Operator

Good morning. My name is Jay, and I will be your conference operator today. At this time I would like to welcome everyone to the George Weston Limited, Second Quarter Results Conference Call.

All lines have been placed on mute to prevent any background noise. After the speaker’s remarks there will be a question-and-answer session. (Operator Instructions). Thank you.

I would now like to hand the call over to Mr. Geoff Wilson.

Geoff Wilson

Good morning and thank you for joining us. I’m joined here this morning by W. Galen Weston, Executive Chairman; Pavi Binning, President; Richard Dufresne, CFO; and Allison Doner, Controller.

Before we begin today’s call, I want to remind you that the discussion will include forward-looking statements, such as the company’s beliefs and expectations regarding certain aspects of its financial performance in 2014 and future years.

These statements are based on certain assumptions and reflect management’s current expectations and they are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations. These risks and uncertainties are discussed in the company’s materials filed with the Canadian Securities Regulators from time to time, including the company’s Annual Report and second quarter 2014 news release.

Any forward-looking statements speak only as of the date they are made. The company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Other than as required by law, certain non-GAAP financial measures may be discussed and are referred to today. Please refer to our second quarter news release and other materials filed with the Canadian Securities Regulators from time to time for a reconciliation of each of these measures to the most directly comparable GAAP financial measure.

An archive of this conference call will be available on our website. Loblaw Companies Limited released its second quarter results last week and therefore we will focus on the performance of our Weston Foods segment.

I would now like to introduce our Executive Chairman, Galen Weston.

Galen Weston

Good morning ladies and gentlemen. Good news today. The country’s number one grocery retailer and now number one pharmacy and beauty retailer were brought together in the second quarter through the successful completion of Loblaw’s acquisition of Shoppers Drug Mart.

The increased scale and competitive positioning with the Canadian consumer, as well as the opportunities to realize significant synergies to meet both the changes, need of the market and create long term value for shareholders.

A number of executive changes were announced last week at Loblaw, including my son Galen taking on additional responsibility as President of the company. These changes demonstrate not only the depth of management strength, but also the start of a very exciting new era for the company.

I would now like to turn over to Pavi Binning.

Pavi Binning

Thank you, Galen. Good morning everyone and thank you for joining us today. The second quarter results came in as we expected for Loblaw and Shoppers Drug Mart, with strong same-store sales growth in a competitive retail environment.

Weston Foods operating results in the second quarter were disappointing and more challenging than we had previously forecast. The quarter two results were driven by three main factors that all came in a little worse than we had expected. These were higher commodity costs, higher start-up costs with our new fresh plant in Toronto, and softer volumes in our fresh business, driven in part by the additional retail square footage in the market.

We are working hard to address the decline in fresh volumes and the additional costs at our new fresh facility. Commodity costs were a challenge this year as we have not been able to pass the increases onto our customers.

In terms of outlook, we expect a decline in adjusted operating income in the third quarter. However, the results for the balance of the year should begin to moderate as some of our initiatives kick-in and commodity costs improve year-over-year.

Let me now turn the call over to Richard, who will take you through the financials.

Richard Dufresne

Thank you Pavi and good morning everyone. For the second quarter of 2014, George Weston Limited reported adjusted net earnings per share of $1.26 compared to $1.08 in the same period in 2013, an increase of 16.7%.

Adjusted earnings per share were normalized to take into account key items disclosed in Loblaw’s results last week, namely the recognition of fair value increment on the acquired Shoppers Drug Mart inventory of $622 million, the amortization of the acquired Shoppers Drug Mart intangible assets of $125 million, and a $190 million charge related to inventory measurement from retail inventory method to perpetual inventory.

In the second quarter of 2014, Weston Foods sales increased by 4.4% to $431 million from $413 million in the same period of 2013. Foreign currency translation positively impacted sales by approximately 3.2%. Excluding the impact of foreign currency translation, sales increased 1.2%, primarily due to an increase in volume.

Weston Foods adjusted operating income in the second quarter of 2014 was $51 million compared to $64 million in 2013, a decrease of $13 million. Adjusted operating margin decreased to 11.8% from 15.5% in the same period in 2013.

Adjusted operating income in the second quarter of 2014 were negatively impacted by higher commodity costs in areas where we were not hedged and other input costs, including the negative impact of foreign exchange, plant start-up costs, lower fresh bakery sales volumes and the cost impact of continued investments.

For the remainder of 2014, Weston Foods expects modest sales growth, driven primarily by volumes. Fresh volumes are expected to remain soft.

Weston Foods expects a decline in adjusted operating income in the third quarter of 2013 when compared to the same period in 2013. Despite this anticipated decline, efforts to grow sales volume and easing pressures on commodity and other input costs are expected to improve adjusted operating income increasingly over the second half of 2014 when compared to the first half.

From a balance sheet perspective, I just want to mention that we repaid $350 million of debt on a consolidated basis since the closing of the Shoppers Drug Mart transaction, and we’ve also re-priced the term loan associated with this acquisition last week, which reduced our pricing by 30 basis points.

So that concludes our comments, and we’d now be pleased to take your questions.

Geoff Wilson

Operator.

Question-and-Answer Session

Operator

Our first question comes from David Hartley with Credit Suisse. Your line is open.

David Hartley - Credit Suisse

Thank you. Good morning. A question on individual products. Could you talk a little bit how they’ve been progressing, so gluten-free, some of the other new products and where you’re seeing tradeoffs in the portfolio?

Pavi Binning

Yes, David. Clearly, we talked in this morning’s announcement about the softness in our fresh volumes. What we are trying to do is obviously offset that by focusing on categories like gluten-free and also other segments that are growing. Like for example ACE Cookies, sweet goods, both cake and doughnuts and pies. So, there are different trends at play in the various other products and clearly our focus is to make sure that we invest behind and grow the categories that are moving ahead and protect the businesses that are a little bit soft at the moment.

David Hartley - Credit Suisse

Is there anything incremental or has the softness in fresh fallen off a bit, meaning it’s improved? Could you talk a little bit about the environment around that?

Pavi Binning

Yes. I think, I mean in terms of fresh, just to give you some facts, fresh for us was down about 3% in a market that continues to be soft and our decline was a little bit higher than the market.

As I mentioned in my opening comments, there’s a number of factors at play here, but one of them is certainly the amount of square footage that’s gone into the retail space and as you know, we are underrepresented in the retailers who’ve added significant square footage, and so that’s had an impact. We continue to build relationships with these retailers.

And our plan for the sort of second half is to put in place programs to try and address this decline, so that’s what we are focusing on.

David Hartley - Credit Suisse

Okay. So that makes sense that the second half will look incrementally better, perhaps from a volume perspective. Would that be fair enough to say?

Pavi Binning

That’s what I want to see.

David Hartley - Credit Suisse

And you’re also expecting some improvements. I guess you’re mark-to-marketing on your commodity costs. So you’ve kind of got two things that potentially will be a little more positive for you going forward, but I think you noted in your release today that you still see a decline, an impact. Is it just the challenges are becoming less, but still challenges nonetheless? And when would you see that tipping point when you could actually see perhaps your EBIT margins or EBITs going positive?

Pavi Binning

Quarter four.

David Hartley - Credit Suisse

Q4, okay. The second question, just around the economic environment and what you’re seeing, if anything’s changed from a demand perspective in general from consumers. What are you seeing?

Pavi Binning

No, no change David. It’s still pretty much the same.

David Hartley - Credit Suisse

Okay, great. Thank you very much.

Pavi Binning

Thanks.

Operator

(Operator instructions) The next question comes from Irene Nattel with RBC Capital Markets. Your line is open.

Irene Nattel - RBC Capital Markets

Thanks and good morning everyone. It’s I guess a couple of months now since the acquisition of Canada Bread. I think that has closed. I was just wondering whether you’ve seen any early indications or perhaps any change in competitive stance or competitive behavior from your major competitor.

Pavi Binning

Good morning, Irene. Irene, we haven’t seen any change. There’s relative stability in the marketplace, so nothing as yet certainly.

Irene Nattel - RBC Capital Markets

That’s good to hear, thank you. And just thinking about your volume declines, if you kind of make the adjustments for the differential in incremental square footage, do you feel as though you’re losing any ground fundamentally or really it’s just a question of who’s represented where?

Pavi Binning

It’s who’s represented where, but I would sort of say the volume’s a little bit softer than I would have liked, and that’s why we need to sort of address that.

Irene Nattel - RBC Capital Markets

Okay. And do you think Pavi it’s a question of really just getting a little bit sharper on the pricing or the marketing support or is it kind of maybe new product innovation? What are the different tools that you’re really looking at to address some of that?

Pavi Binning

Yes, I think it’s actually a combination of both things. I think what we have to do is put in place programs in the balance of the year, that are as you say sort of sharper. But also, innovation is critical in this business, because as you’ve heard me say in the past, the sort of all tools that were used to drive value of pricing and productivity are now much harder to achieve.

So I think growth is critical and we are investing in the business, both in terms of marketing, in terms of capabilities, in terms of innovation and new products are obviously fundamental to that. Gluten-free is a great example, but in the areas of ACE, Mrs. Fields, and sort of some of the sort of bread products that we have as well. There are innovations that we’ve brought into the market in the first half, and we’ll continue to do that in the second half.

Irene Nattel - RBC Capital Markets

That’s great, thank you. Much appreciated. And then, could you give us just an outlook on your other status that you’re hedging at this point?

Richard Dufresne

Still, our policy has not changed Irene. Like we’re hedged minimum six, maximum 12 and right now we’re sort of in the middle of this time periods.

Irene Nattel - RBC Capital Markets

That’s great, thank you, and then just one final question if I might. Could you give us a little bit more color on the start-up costs associated with the new plant and what’s going on there and how we should expect it to evolve?

Pavi Binning

Yes, Irene. In the first quarter we opened a new fresh bakery in Toronto to serve the GTA market with breads and rolls. The facility has brand new equipment in it and also new employees working there. And what I would sort of say to you is normally it takes up to 12 months to get a new plant of this scale fully operational, and the incremental costs are in the areas that you would expect like labor and wastage downtime as we get the plant fully operational. So, we continue to work hard. Things are improving month-to-month, but it normally does take up to a year to get something like this fully tuned and operational.

Irene Nattel - RBC Capital Markets

That’s great. Thank you.

Operator

Your next question comes from Peter Sklar with BMO Capital Markets. Your line is open.

Peter Sklar - BMO Capital Markets

As a result of the Shoppers transaction, I believe that your interest in Loblaw is now at 46%. Just wondering if you could talk a little bit how you feel about having your interest below 50% and I would suspect your intention is to get back to 50% through the DRIP and it’s an end when Loblaw ultimately starts buying back stock again. Can you talk a little bit about that?

Pavi Binning

Peter, in terms of the 46%, clearly we knew that we would be at 46% as we did the transaction. As you all know, George Weston Limited did invest $500 million in the transaction to achieve that 46% position. We’re very comfortable with that. And as you sort of say, as Loblaw begin to buy shares back, we expect to get back to 50%.

Peter Sklar - BMO Capital Markets

Okay. On another question, your customers, the grocers are under a lot of pressure in terms of cost of grocery because of this weakness we’ve had in the Canadian dollar, the rising prices of produce and proteins. I’m just wondering if you’ve noticed that the dynamics between yourself and your grocery customers has changed at all because of the pressures that they are under.

Pavi Binning

Well, certainly the retailers are under pressure and it isn’t just Loblaw; it’s the retail industry, certainly in Canada and even in the United States. That is one of the reasons we haven’t been able to get price increases, despite the commodity cost increases and the FX impact on commodities. But the environment has been tough for some time now and continues to be tough as we move forward.

Peter Sklar - BMO Capital Markets

Okay. Thank you for your comments.

Operator

(Operator instructions). The next question comes from Perry Caicco with CIBC World Markets. Your line is open.

Perry Caicco - CIBC World Markets

Yes, thanks. Pavi, can you remind us where we are in the pricing cycle? I know it’s been a while since you took an increase and kind of what do you see in terms of the opportunities to take pricing in the next six to eight months?

Pavi Binning

Yes. The last price increase Perry was at the beginning of 2013, so we haven’t had a price increase now for coming up to 18 months and I just expect the pricing environment to remain challenging as we move forward for the very reasons that Peter outlined in his question.

Perry Caicco - CIBC World Markets

And can you remind me, in terms of product innovation on the fresh side in Canada, where you are in terms of developing product or aiming product at the more ethnic or diverse grocers in the country?

Pavi Binning

Yes. I think what we are doing is, I mean ethnic is one of the areas. The fresh sort of innovation – I don’t really want to talk about products that are coming into the market, because obviously that would be competitive. But what I can tell you is, what we are doing is we’ve been investing in our main brand, the Wonder brand. We’re also investing in D’Italiano and Gadoua as well, and we’re also thinking very carefully about the ethnic market.

Perry Caicco - CIBC World Markets

And I guess in May you bought a small U.S. bakery, I think in Chicago. Can you tell us a little bit about strategically how we should look at your U.S. business over the next say three to five years?

Pavi Binning

Our U.S. business, we bought a company called Rubschlager, a small sort of bakery in the right product area. We didn’t have a rye offering and so that was important for a portfolio expansion perspective. What I would sort of say is, in the U.S. we have a number of businesses, primarily doughnut, cake and cookies and all of those businesses are in categories that are growing at the moment and so we feel good about those particular businesses.

Perry Caicco - CIBC World Markets

Thank you.

Operator

There are no additional questions at this time. I’ll turn the call back to Mr. Wilson for closing comments.

Geoff Wilson

Well, thank you very much for joining us today. Our third quarter conference call is scheduled currently for November 18, 2014. Have a good day.

Operator

This concludes today’s conference call. You may now disconnect.

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Source: George Weston (WNGRF) Q2 2014 Results - Earnings Call Transcript

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