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Good morning, my name is Casey, 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. [Operator Instructions] Thank you. Mr. Geoff Wilson, you may begin your conference.
Good morning, and welcome to the George Weston Limited 2018 Second Quarter Conference Call. I'm joined here this morning by Galen Weston, Chairman and CEO; Richard Dufresne, President and CFO; and Luc Mongeau, President of Weston Foods.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 2018 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, including the company's second quarter 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 for a reconciliation of each of these measures to the most directly comparable GAAP financial measures. 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 this call on the performance of our Weston Foods segment.I would now like to introduce Richard.
Thank you, Geoff. Good morning, everyone. Earlier today, we released our second quarter results for George Weston Limited. For the second quarter, George Weston Limited reported adjusted diluted net earnings per share of $1.63 compared to $1.67 for the same period in 2017, a decrease of 2.4%. Normalized for the disposition of Loblaw's gas bar operations, adjusted EPS increased by $0.01 per share.In the second quarter of 2018, Weston Foods sales totaled $468 million, a decline of $41 million over the same period of 2017.Sales included the unfavorable impact of foreign currency translation of approximately 2.4%. Excluding this impact, sales decreased by 5.7% mainly due to the impact of product rationalization and the negative impact of changes in sales mix.Weston Foods adjusted EBITDA in the second quarter of 2018 was $48 million, a decrease of $6 million compared to the same period in 2017. Adjusted EBITDA margin was 10.3% compared to 10.6% in the same period in 2017. The decline in adjusted EBITDA was driven by the decline in sales and higher input and distribution costs, partly offset by productivity improvements and benefits realized from the transformation program net of costs.Capital for the quarter was $38 million, and for the year, investments continue to be estimated at around $230 million.In the second half of 2018, Weston Foods expect sales to trend in a similar fashion to the first half of 2018 when compared to last year. Sales are expected to be negatively impacted by volume declines, including the loss of sales from key customers and continued product rationalization.Adjusted EBITDA will trend in a similar fashion to the first half of 2018. Adjusted EBITDA will be impacted by sales trends, headwinds from higher input and distribution costs in an inflationary environment. And minimum wage increase, partially offset improvements from the transformation program and productivity. Depreciation will increase. I'd like to provide a bit more color behind our revision to the outlook. After excluding the significant impact of FX, the largest contributor to the sales decline in the second quarter has been the SKU rationalization as part of our transformation program. This is having a positive impact to cost and complexity, ultimately, freeing up capacity for more profitable business. However, it's also having a negative effect on sales performance as we see the slow ramp up of the replacement volume. We're in the midst of key aspects of the transformation plan, and while we are seeing benefits, there are also pressure points occurring throughout the business. I would now like to turn the call over to Luc, who will give some highlights of the transformation program.
Thank you, Richard. Despite challenging business results, I am pleased with the progress we are making on our transformation program. Programs are starting to generate benefits to the organization, and I will provide highlights on few areas of focus. We are pleased with the progress on organizational changes and are saying -- seeing the costs savings. It is important to note that this exercise is not just about cost reduction. We now have a leaner workforce, but we have added talent in targeted areas. For example, we added resources in consuming sites to better understand key trends, and this combined would increase investment in food R&D capabilities. It's allowing us to respond faster through emerging trends and win in the marketplace.We have also enhanced our sales strategy team to build stronger relationship with our key customers. Further, the implementation of key operational processes and the centralization of our supply chain team has allowed to markedly improve our customer service levels since the start of our transformation journey. We continue to make progress in our simplification efforts.Our SKU rationalization efforts have addressed 60% of our targeted SKUs. Some of the benefits: we see a reduction in sourcing of unique ingredients and the removal of low-volume SKUs, which disrupt our bakeries efficiency. Eliminating these SKUs enables the business to our customers to have a focused and simplified portfolio of relevant products for the consumer. I remain confident that our team will achieve the target efficiencies by the end of 2020.I would now like to turn the call over to Galen.
Thank you, Luc. Good morning. For the last 5 years, our strategic focus as a group has been on Loblaw. During that time through the creation of Choice Properties, the acquisition of Shoppers Drug Mart, the successful implementation of SAP, the company has been fundamentally reshaped and positioned to prosper in the dynamic and competitive retail market of the future. The recent acquisition of CREIT by Choice Properties has set our real estate division up to pursue a diversified strategy for growth in a manner that is both complimentary to and independent of the retail business.Over the last 12 months, we've also turned our minds to a similar ambition for George Weston. The transformation that Luc and his team have undertaken is the first step on that journey. It is an ambitious plan. And while recent performance has been disappointing, we are confident that once completed, it will position Weston Foods well for the future. And as always, we will continue to look at investment opportunities at George Weston that support long-term value creation.
Operator, we'd now like to open the call to questions, please.
[Operator Instructions] And your first question comes from Irene Nattel with RBC Capital Markets.
I'm wondering if you could just walk us through a little bit of how you're expecting the back half of the year to evolve, a little more color for Weston Foods? And then really -- how -- what 2019 and 2020 look like in order to get you to the EBITDA target, which is in, I'm assuming, the $350 million-ish range?
Good morning, Irene. As we said in our outlook for 2018, like, we essentially expect to see a similar trend on sales and on EBITDA as we experienced in the first half. So we -- there's been a few delisting that had happened that are affecting our business. So therefore, we expect the trend to be as outlined. For 2019 and 2020, like, we're just starting to build our budget and plans for those years, but big picture, I think the plan remains the same in that. When we announced the benefits of our transformation plan, we said that would amount to $100 million. We remain confident in that number. And in terms of the total number, because of our recent setback, it may delay the actual number by, I don't know, 6 to 12 months following that. So that's what [ the eyes are on ].
So -- sorry, just want to make sure that I understand, Richard. So you're saying that you should still get to that $350 million to $400 million-ish level, it may be close to more like 2021 than 2020, but you're confident that you're going to get there?
We're confident we're going to get there, and we haven't said that exact number. But like, your number is probably in the range, yes.
Okay. That's very helpful. And just as we think about the SKU rationalization and sort of the longer than expected to rebuild the volume, are you getting -- is the issue that you're getting pushback from some of the clients who were quite happy with each of these 16 blueberry pie recipes? Or is it that, that they're finding someone else to do it for them? Can you kind of walk us through what you're finding in terms of your customer reaction?
The issue as to SKU rationalization is actually quite complex, because the way we go about is, first of all, we have contracts with these customers. And when you're also to manage the full customer relationships, so we're careful as to the timing of which we implement those. But the moment we implement them, like, we lose the sales immediately. So we have plans in place to start to rebuild. But like it's -- you lose the sales immediately and you hope that you are going to have new sales coming online. It's not coming as fast as we expected. But what we like is that we're seeing the complexity exit the business. If you actually look at our SG&A line in the second quarter, you're starting to see those benefits and we expect those benefits to continue as the year progresses. So that gives us the confidence to continue and push forward.
And your next question comes from the line of Jim Durran with Barclays.
So in the context of the change and expectation for this year, right, how much of a contributor on a proportionate basis was the loss of some of the business at Walmart versus the slower ramp-up in the volume gains as you free up capacity?
I guess, the way I can answer that question, Jim, is essentially, like, we said that we are going to have the same trend in the second half as the first half. But in addition to the first half, now we have the delist that you just talked about. And we're not saying it's going to get worse. So that means, on a combined basis, it's somewhat getting a bit better on an overall basis. So I'll leave it at that because I don't want to comment on...
That's helpful. And you indicated that you're about 60% of the way through the SKU rationalization. Is that by SKU count or by tonnage? And when do you expect the SKU rationalization to be largely completed by?
Good question, Jim. Like it's more in SKU numbers. In dollars, we're probably closer to $50. And I expect it to be completed in 2019. So you're going to hear us talking about this for another 6 to 12 months.
No, it's been a long, painful process, I know, for everybody. With respect to the categories that you've been pursuing using the increased capacity you added last year, and I assume, incrementally, the freed up capacity. Are those categories still doing well? And are they still the primary focus for what you're trying to gain increased market share in?
Well, we are -- like, we're clearly seeing growth in artisan. We're seeing growth in doughnuts. We have work to do in our cake business and in our pie business, but we're on it. And those are areas where we expect to reasonably grow as the year progresses.
And then my last question just on pricing. What is the outlook for price increase opportunities in the marketplace? And on an implied basis, it looks like pricing and mix were down in the quarter, like, how much of that is a function of the SKU rationalization versus price compression in the marketplace?
Well, I don't want to talk about pricing. But like, yes, we are feeling cost pressures throughout the business, so I'll leave it at that.
Your next question comes from the line of Mark Petrie with CIBC.
I just want to follow up on the comment and the questioning earlier around the replacement volume ramping up more slowly. Is that simply a matter of the retailers or your other customers not sort of taking up the new SKUs? Or are you seeing it at the sort of actual consumer level?
No, it's more us developing programs to fill these volumes. It's not -- like, Luc and his team have a bunch of new ideas and new initiatives that they are pushing forward. But they need to convince the retailers to buy up the idea. So that's what's happening.
Okay. And then I wanted to follow up on the comments earlier around sort of future investment opportunities for -- at the George Weston level. I just wonder if you could expand on what that means. And sort of how do you think about that?
Yes, listen, as you'd expect, we don't comment on these things. So if we do have something to say and when we have something to say then we'll certainly update you and the rest of the market. So really nothing to comment on beyond that.
Your next question comes from Patricia Baker with Scotiabank.
Actually, my question was very similar to Mark's question. And I know you have no comment, but I'm going to ask it anyway and I'm going to ask it slightly differently. In the past, Galen, when you talked about investment opportunities at Weston, it was always about bakery bolt-on acquisitions. And there's a lot of chatter in the marketplace currently that there's been a bit of pivoting strategy at Weston with respect to M&A and that you're looking at opportunities outside of baking and probably outside of food and drug. Can you comment on that?
Not really. Suffice to say, we believe we have a set of competencies as the George Weston group. And so there's no reason to imagine that we would be exploring things wildly outside of the range of those competencies. But as I said, we have nothing to comment on at this point. And as soon as we do, if and when we do, then we'll make sure that we update the market appropriately.
Okay, fair enough. Can I just ask whether or not the -- where you would be looking would be in the context of North America?
I can't comment beyond that.
Your next question comes from Keith Howlett with Desjardins Securities.
So I wanted to ask about your corporate development team. You assembled quite a large team, as I recall, before the decision to support the Shoppers Drug Mart acquisition at Loblaw's. I'm just wondering if you can speak to how large is your corporate development team at this time?
Sure. So we do have a corporate development team. It sits at the George Weston level. The way to think about that team at somewhere between 10 and 15 people is that they provide strategic support. They provide a small M&A support to all of the operating businesses, whether it's Shoppers Drug Mart, Loblaw, Choice Properties or Weston Foods. And then if we are working on something substantial, like the acquisition of CREIT or the acquisition of Shoppers Drug Mart, they would be firmly deployed against those large M&A deals as well. So we would consider them as a small, highly competent team that's extremely well leveraged across the entire group of companies in Weston/Loblaw Group.
And maybe just to go back in history. When you sold the fresh baking business in the U.S., was that a decision based on it was a very favorable evaluation? Or was that based on some longer-term assessment of that business?
No, it was based on favorable evaluation, it was based on the circumstances and the context of the time, and that's a decision that we're quite happy with.
[Operator Instructions] Your next question comes from Jim Durran with Barclays.
Yes, I was just wondering if you can give us an update on how you see wheat prices playing out over the next year. How forward you are in terms of that buy? And lastly, I'm not aware of anything specific, but tariffs, like, is there any tariff impact that could be coming into play?
So on commodity prices, in general, Jim, what we do is we have a hedging policy, minimum 6 months up to a year or 1.5 years. So we're always within those bands based on our view as to where each commodity is going. As for tariffs or FX, because those things we look at together, it's not a big factor in Weston Foods in that, like, most of our operations are in the country in which we do sell. There is a bit of cross border, but it's not that significant.
So on wheat prices, is it accurate to believe that, directionally, they should be coming down year-over-year sometime in the next 6 to 12 months?
Not to my knowledge.
And there are no further questions at this time. I would turn the call back over to Geoff Wilson for closing remarks.
Thank you very much for joining us today. Our third quarter conference call is scheduled for November 20. We look forward to talking to you then. Thank you very much for joining us this morning. Good bye.
And ladies and gentlemen, this concludes today's conference call. You may now disconnect.