High Liner Foods Inc

TSX:HLF

Earnings Call Transcript

[Operator]

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the High Liner Foods Incorporated conference call for results of the fourth quarter and fiscal 2017. [Operator Instructions] This conference call is being recorded today, Wednesday, February 21, 2018, at 2:00 p.m. Eastern Time, for replay purposes.I would now like to turn the call over to Heather Keeler-Hurshman, Vice President of Investor Relations for High Liner Foods. Ms. Keeler-Hurshman, please go ahead.

[Heather Keeler-Hurshman]

Thank you, and good afternoon, everyone. Thank you for joining High Liner Foods' conference call to discuss our financial results for the fourth quarter and fiscal 2017. On the call today from High Liner Foods are Henry Demone, Chairman and Chief Executive Officer; and Paul Jewer, Executive Vice President and Chief Financial Officer.Today's call will start with Paul reviewing the company's financial performance for the fourth quarter of 2017; followed by Henry, who will discuss key developments in the business and provide an update on objectives for 2018 before opening the call up for questions.Before turning the call over to management, listeners are reminded that certain statements made in today's call may be forward-looking statements that are subject to risks and uncertainties. Management may use forward-looking statements as they discuss the company's strategy and business in the future. Actual operating or financial results could differ materially from those anticipated in this forward-looking statement.High Liner Foods included a thorough discussion of the risk factors that can cause its anticipated outcomes to differ from actual outcomes in its publicly available disclosure documents, particularly in its annual report and annual information form. Please note that High Liner Foods is under no obligation to update any forward-looking statements discussed today.Earlier today, High Liner Foods reported its financial results for the fourth quarter and fiscal year ended December 30, 2017. That news release, along with the company's MD&A and audited consolidated financial statements for fiscal 2017, have been filed on SEDAR and can also be found in the Investor Information section of High Liner Foods' website. If you'd like to receive our news releases in the future, please visit the company's website to register.Lastly, please note that the company reports its financial information in U.S. dollars, and the results to be discussed today are stated in U.S. dollars unless otherwise noted. High Liner Foods' common shares trade on the Toronto Stock Exchange and are quoted in Canadian dollars.I will now turn the call over to Paul. Paul, please go ahead.

[Paul A. Jewer, Executive VP & CFO]

Thank you, Heather, and good afternoon, everyone. Before beginning my financial review, I'd like to remind listeners that we use certain non-IFRS measures and ratios when discussing our results as we believe these are useful in assessing the company's financial performance. These measures are fully described and reconciled to IFRS measures in our MD&A. Please note that all comparisons provided during my financial review of the fourth quarter of 2017 are relative to the fourth quarter of 2016, and any comparisons made to fiscal 2017 are relative to fiscal 2016.To assist listeners with assessing the company's year-over-year performance, there are 3 items to be aware of when comparing these results to the same period last year. The first item is the acquisition of Rubicon on May 30, 2017. Rubicon contributed 9.1 million pounds of sales volume, $50.1 million of net sales and $6.1 million of gross profit and $1.9 million of adjusted EBITDA in the fourth quarter of 2017.The second item relates to the company's product recall that was initiated in the second quarter of 2017. In the fourth quarter, we recognized an additional $1.5 million in losses associated with the recall, increasing the total losses recognized in 2017 to $13.5 million. We continue to expect to recover substantially all of the losses associated with the recall from the ingredient supplier and will record these recoveries in the period in which they occur or are virtually certain to occur in accordance with IFRS. No recoveries were recorded in 2017.The third item relates to a noncash income tax recovery of $11.2 million recognized in the fourth quarter of 2017 associated with the Tax Cuts and Jobs Act or U.S. Tax Reform enacted on December 22, 2017, which reduced the U.S. federal corporate income tax rate from 35% to 21% effective January 1, 2018. This income tax recovery reflects the provisional revaluation of the company's existing U.S. deferred income tax liability and was not the result of any operational or market-driven event. As such, the $11.2 million income tax recovery has been excluded from adjusted net income and adjusted diluted earnings per share for the fourth quarter and fiscal 2017.Sales volume increased in the fourth quarter by 9.2 million pounds to 71.6 million pounds, reflecting the additional volume from Rubicon. Excluding Rubicon, sales volume for the fourth quarter increased by 100,000 pounds, reflecting higher sales volume in our Canadian and U.S. foodservice businesses, partially offset by lower sales volume in our U.S. retail business.Sales in U.S. dollars increased in the fourth quarter by $54.2 million to $263 million, reflecting $50.1 million in sales from Rubicon, a $400,000 decrease in sales related to product recall returns and a $3.1 million increase in sales related to a stronger Canadian dollar on the translation of U.S. dollar sales from the company's Canadian dollar-denominated operations. Excluding these items, sales increased by $1.4 million due mainly to price increases and changes in product mix.Gross profit increased in the fourth quarter by $900,000 to $44.5 million, reflecting higher sales volume, partially offset by a decrease in gross profit as a percentage of sales to 16.9% compared to 20.9%. Gross profit reflects $6.1 million from Rubicon, partially offset by $1.5 million in further losses associated with the product recall. Excluding these items, gross profit decreased in the fourth quarter by $3.7 million to $39.9 million and was 18.7% of sales compared to 20.9%, reflecting unfavorable changes to product mix and higher raw material costs, partially offset by some improvement in the efficiency of our plants compared to the fourth quarter of 2016.In addition, the stronger Canadian dollar had the effect of increasing the value of U.S. dollar gross profit from our Canadian operations in 2017 by approximately $600,000 relative to the conversion impact last year.Adjusted EBITDA decreased in the fourth quarter by $3 million to $13.1 million. Excluding the impact of converting our Canadian dollar-denominated operations and corporate activities to our U.S. dollar presentation currency, adjusted EBITDA decreased by $4.6 million, reflecting increased distribution and SG&A expenses, offset by the higher gross profit mentioned previously that is further increased by $1.5 million in losses related to the product recall, which we have added back for the purpose of computing adjusted EBITDA as they relate to destroyed product and direct incremental costs incurred as a result of the recall. Adjusted EBITDA in the fourth quarter was positively affected by the acquisition of Rubicon, which contributed $1.9 million to adjusted EBITDA.Reported net income increased in the fourth quarter of 2017 by $7.5 million to $14.2 million, with diluted earnings per share of $0.43. This increase reflects the $11.2 million noncash income tax recovery associated with the U.S. Tax Reform that I highlighted earlier. The impact of this tax benefit was partially offset by the decrease in adjusted EBITDA mentioned previously and increased depreciation expense and finance costs.Excluding the impact of certain nonroutine and noncash items, which are explained in our MD&A, and the impact of the U.S. Tax Reform, adjusted net income decreased in the fourth quarter by $2.2 million to $4.8 million, and correspondingly, adjusted diluted earnings per share decreased by $0.07 to $0.15.Turning now to the balance sheet. Including 12-month adjusted EBITDA from Rubicon, net interest-bearing debt to rolling 12-month adjusted EBITDA was 5.6x at December 30, 2017 compared to 3.4x at the end of 2016, reflecting a $15.3 million decrease in adjusted EBITDA and a $135.8 million increase in net interest-bearing debt. Net interest-bearing debt was $387.9 million at the end of fiscal 2017 compared to $252.1 million at the end of fiscal 2016, reflecting the acquisition of Rubicon, lower cash flow from operating activities and higher capital expenditures.Net cash flows from operating activities decreased by $101.5 million to an outflow of $21.5 million in fiscal 2017 compared to an inflow of $80 million in fiscal 2016, primarily reflecting less favorable results from operations and the increase in net noncash working capital requirements. Net noncash working capital requirements increased by $48.3 million to $239.1 million at the end of fiscal 2017 compared to $190.8 million at the end of fiscal 2016, primarily reflecting increased accounts receivable and inventory, partially offset by higher accounts payable and accrued liabilities largely due to the acquisition of Rubicon and the timing of working capital requirements.Gross capital expenditures were $27.8 million in fiscal 2017 compared to $17.7 million in fiscal 2016 due to capital expenditures related to efficiency improvements in our manufacturing facilities, leasehold improvements and investment in the company's enterprise-wide business management system.Before turning the call over to Henry, I want to take a minute to discuss Rubicon. Its contribution to adjusted EBITDA in 2017 was significantly below the annual pro forma adjusted EBITDA expected from this business when it was purchased. It has experienced raw material cost increases that have not been fully passed on to customers, and volume has been lower than expected, particularly in the fourth quarter. While we expect Rubicon's product margins to improve in 2018, we anticipate sales volume declines will continue as one of its major customers continues to procure certain products directly from shrimp producers. We are focused on replacing this lost volume and leveraging Rubicon's capabilities in shrimp to grow shrimp sales across the rest of High Liner's business. However, adjusted EBITDA performance from Rubicon is expected to be similar in 2018 as compared to the level experienced in 2017, except that 2018 will reflect a full year of contribution from this business versus only 7 months in 2017.That concludes my financial review, and I will now turn the call over to Henry.

[Henry E. Demone, Chairman & CEO]

Thank you, Paul, and good afternoon, everyone. The fourth quarter of 2017 was the third consecutive quarter that sales volume improved on a year-over-year basis. This is before considering the additional volume from Rubicon. In the fourth quarter, we also experienced improvement in the overall efficiency of our plants, in particular, at our Lunenburg facility. Improving plant efficiency will continue to be a key focus area in 2018, along with improving our pricing methodologies, lowering our fixed costs, increasing the effectiveness of our overall supply chain as well as product innovation and simplifying our business. We are making progress in these areas and believe that these actions will contribute to year-over-year improvements in adjusted EBITDA in 2018.Improved adjusted EBITDA, combined with debt repayment and in the absence of any major acquisitions or strategic initiatives requiring capital, is expected to improve our net interest-bearing debt to rolling 12-month adjusted EBITDA ratio to 4.5x by the end of 2018.Paul discussed the current challenges being experienced by our Rubicon business, but I remain confident that growing High Liner's product offerings of key aquaculture species like shrimp and Atlantic salmon represent an important avenue for growth. Rubicon provides capabilities in shrimp such as shrimp procurement and value-adding expertise that will be leveraged across the rest of our business to grow overall sales from shrimp products. In the longer term, I see Rubicon expanding into an aquaculture platform for High Liner as we further develop our procurement, product development, marketing and sales expertise with the key aquaculture species.Before opening the call for questions, I'd like to share with you that earlier today, the company's Board of Directors approved a quarterly dividend of CAD 0.145 per share on the company's common shares payable on March 15, 2018 to shareholders of record on March 1.Operator, I'd like to now open the call for questions. Thank you.

[Operator]

[Operator Instructions] Your first question comes from the line of Saba Khan with RBC Capital Markets.

[Sabahat Khan, Analyst]

Just on the, I guess, the losses related to the recall in Q4. Was that something that was expected later in the year? Or was that something that just came up as you worked through Q4?

[Paul A. Jewer, Executive VP & CFO]

No, it was -- wasn't I would say, expected. We did know that there were a number of customers that we were still waiting to hear from in terms of costs that they are able to pass on to us as a result of our arrangements with them, and those did flow through in the fourth quarter of 2017, so that's the bulk of that amount. And as I said in my prepared remarks, we expect that we'll recover that from the ingredient supplier, similar to the costs that we incurred in that regard in the second and third quarter.

[Sabahat Khan, Analyst]

And then just on the recovery, is that claim still kind of in process? Or is there a time line around when you think that will flow back?

[Paul A. Jewer, Executive VP & CFO]

Certainly, it's still in process. No specific time line in terms of when we expect it to be fully recovered. We are working closely with the ingredient supplier and their insurers, and we'll continue to do that and have done what we can to mitigate any cash flow implications associated with those costs in working with that supplier as well.

[Sabahat Khan, Analyst]

All right. And on the Rubicon, you said expect to improve margins as you head into 2018. Have you been able to take some more pricing? Or is that just through the input cost maybe flattening year-over-year?

[Paul A. Jewer, Executive VP & CFO]

I think it's both sides of the equation. So the input cost pressure did relieve a little, and we were able to move on price with a couple of key customers, where that was deferred in 2017.

[Sabahat Khan, Analyst]

Okay. And then just one last one for me. Just on the overall gross profit margin this quarter, it was down quite a bit versus prior year. Would you attribute most of that to the weakness at Rubicon? Or how should we think about this quarter and then as we head into 2018 for your overall gross margin profile?

[Paul A. Jewer, Executive VP & CFO]

Yes. So I'd say there's a few factors to consider there. One, you're right. It's absolutely Rubicon because their gross margin profile is lower than ours given the nature of their business. But even when you exclude Rubicon, as I mentioned in my remarks, our gross margin percentage is down. That is primarily driven by mix in the business, unfortunately. So we continue to see some declines in our higher-margin value-added business and some increases in our lower-margin procured business, and so that has the impact on the margin mix. The other piece, I mentioned in our remarks that plant performance was improving, but it's still not back to where we believe it needs to be. And obviously, that has an impact on cost of goods and, therefore, an impact on margins. And also, raw material prices have started to come up, so we see some of that reflected in the mix. And in our Canadian business, in particular, we've had some challenges being able to fully get that passed through into the marketplace, and we're continuing to work on that challenge as we move into 2018. So the focus, as Henry said, in 2018 to improve that is work on that mix, continue to improve plant performance and look at opportunities for reduced cost and opportunities for any SKU rationalization and simplification necessary on some of those lower-margin product lines, in particular.

[Sabahat Khan, Analyst]

Okay. Sorry, if I could just get one more follow-up there. What is the kind of the outlook for mix? What are you seeing in the trends for the value-added stuff versus some of the decrease that you've seen over the last couple of years?

[Paul A. Jewer, Executive VP & CFO]

Yes, I would say that decreases aren't as acute as you've seen in our volume performance, but there still is some decrease in the value-added side of the business. And there is some increase in the procured side of the business, which is really driving that margin mix issue. We don't expect that to abate. What we're working on, as we've talked about before, is finding new areas for product innovation in our value-added business to allow us to offset some of those declines in the traditional breaded and battered category.

[Operator]

Your next question comes from George Doumet with Scotiabank.

[George Doumet, Analyst]

I'd just like to follow up on a little bit of the previous questions that were asked about the gross margin. You pointed to the unfavorable mix shift that's been going on for a while. Is there anything going on maybe in the category of discounting? Are we doing more of that to push product than we were in the past? Just maybe a little bit more color on that kind of mix shift and how long you expect it to continue.

[Paul A. Jewer, Executive VP & CFO]

Yes. I would say it's less about increase in promotional activity or discounting. It does reflect, though, some challenges in being able to pass on costs in the business. As an example, as our costs related to manufacturing have gone up because of our challenges on the supply chain, difficult to pass those on in the current environment with our customers. So we know we need to work on continuing to reduce those costs to improve margins going forward. And the category has been a category that has experienced declines. In fact, if anything, we're holding or improving share in the category, but the category is declining more rapidly than us. And it's difficult to achieve margin growth in a declining category, so that's one of the headwinds that we're facing. And we're spending a lot of time working on the architecture of the category, the pricing in the category and the promotional activity in the category to try to improve that performance.

[George Doumet, Analyst]

Okay, great. And I guess looking at the input costs side of the equation, cod and haddock, as you're [indiscernible] into the procurement cycle going forward, the lag time there, do we expect cost per pound in those 2 to be higher in Q1 and Q2 than they were in Q4? And can you maybe give us --- if so, can you maybe give us a sense of a ballpark magnitude there?

[Henry E. Demone, Chairman & CEO]

Yes. We expect them to increase, George. We always have a good pipeline of raw materials. So it's not a shock when it happens. It's very predictable. But we would expect costs for cod and haddock to increase, certainly, in Q1 and Q2. I mean, we usually have pretty good visibility for 6 months. Q3 is a little bit early to say yet, but certainly, for Q1 and Q2, we would expect increasing cod and haddock costs. And we have increased prices in December, effective January, to look after, I would say, the increase that's facing us in Q1 and Q2.

[George Doumet, Analyst]

And can you maybe give us a sense of how big that price increase was?

[Henry E. Demone, Chairman & CEO]

Yes. It was, depending on the channel, between $0.15 and $0.25 a pound.

[George Doumet, Analyst]

Okay. I guess just -- I think you had mentioned in the past about moving some of the products towards pollock. Is that something that we're still looking to do? And will it take quite a bit of time to implement?

[Henry E. Demone, Chairman & CEO]

Yes. Things which are sold as cod and sold as haddock, very difficult to do that, but we do have certain lines in retail where there's more flexibility on the raw material. So that's a possibility there. But it may make certain product lines more profitable, but I don't think the delta is material for the corporation overall, George.

[George Doumet, Analyst]

All right. That's helpful. And just one last one, if I may. I guess in the outlook, you guys mentioned to improve the supply chain and removing costs. We've done a pretty extensive exercise in that area lately. I'm just wondering, how much more room do we go -- do we have to go there going forward?

[Henry E. Demone, Chairman & CEO]

Well, if you look at what happened last year, right, I mean, we did have a slip-up in our planning in Q1 last year. And then just as we were solving those issues, we got hit by this massive recall. So the plants are really starting to recover from that. I mentioned in my remarks that the Lunenburg plant has largely recovered, and still room for improvement, but it's no longer a worry in terms of nonperformance. Our Portsmouth, New Hampshire plant is operating well. Where there's still a significant room for improvement would be in our Virgina plant, in Newport News, where they have still not fully recovered from the challenges of last summer.

[Paul A. Jewer, Executive VP & CFO]

And George, you may be thinking back to the supply chain optimization initiatives a number of years ago. This is different than that. This is about getting back to the operational execution in those plants that we had demonstrated in the past and, therefore, being able to get lower costs as a result of achieving that.

[Operator]

Your next question comes from Bob Gibson with PI Financial.

[Robert Gibson, MD, Head of Research & Consumer Products Analyst]

Just to touch on price increases a little bit. Yearly, historically, after lent, you increased prices if you feel it's necessary, especially on the retail side. What are you thinking for this year?

[Henry E. Demone, Chairman & CEO]

I think we're going to have to stay in line with raw material increases on those 2 important raw materials that were brought up in a previous question. I would not see retail prices immediately after lent per se. Retail price increases are typically a once-a-year, maybe twice at maximum, phenomenon. Foodservice is a lot more dynamic when it comes to pricing, and the foodservice market allows price increases on a monthly basis, if necessary. But on retail, you've got, as I mentioned, 1 maybe 2 opportunities, and I don't see us moving after lent on retail.

[Paul A. Jewer, Executive VP & CFO]

And Bob, part of the way -- in a retail environment, where it's harder to pass on those cost increases, part of the way you go after it is looking at promotional and trade spending in the face of higher costs and also things like package size and SKU optimization, which I mentioned earlier. Those become more critical in a rising cost environment.

[Robert Gibson, MD, Head of Research & Consumer Products Analyst]

Okay, great. Were there any significant severance costs in the quarter?

[Paul A. Jewer, Executive VP & CFO]

There were some severance costs booked in the fourth quarter, yes, but we included those because there was a restructuring. Those were adjusted out as part of the adjusted EBITDA numbers. So the adjusted EBITDA number that you see does not include any significant severance cost.

[Robert Gibson, MD, Head of Research & Consumer Products Analyst]

Okay, great. And you talked before about rolling out CAN'T MESS IT UP into the states, and just wondering how that's going and if there's any new innovations coming down the pipe.

[Henry E. Demone, Chairman & CEO]

We have done a limited launch of CAN'T MESS IT UP in the U.S. market. It's a bit early, frankly, because we just did it in the last -- since the New Year, frankly. So it's a bit early to say how that's going, but we have launched with a limited number of customers that have demographics that we think are well suited for the product.

[Robert Gibson, MD, Head of Research & Consumer Products Analyst]

Okay, great. And then lastly, despite the sort of the financial situation, your balance sheet, what are you thinking vis-à-vis M&A? And what are the prices on things that are out there?

[Henry E. Demone, Chairman & CEO]

Bob, we're really focused on fixing our operations and running the business we have today better. So with our balance sheet, it's not sensible for us to be looking at acquisition targets today. So I can't comment on valuations. Typically, with the credit markets being quite liquid, I suspect acquisitions are going at a premium, but we're not in that mindset in 2018. It's running the business that we own today better.

[Operator]

There are no further questions at this time. I will now turn the call back over to the presenters.

[Henry E. Demone, Chairman & CEO]

Okay. I'd like to thank everyone for calling in today, and we look forward to updating you in May, after our first quarter. Thank you very much.