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Edited Transcript of WN.TO earnings conference call or presentation 20-Nov-18 2:00pm GMT

Q3 2018 George Weston Ltd Earnings Call

Toronto Dec 26, 2018 (Thomson StreetEvents) -- Edited Transcript of George Weston Ltd earnings conference call or presentation Tuesday, November 20, 2018 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Galen G. Weston

George Weston Limited - Chairman & CEO

* Geoffrey Victor Herbert Wilson

George Weston Limited - Former SVP of IR, Business Intelligence & Communications

* Luc Mongeau

Weston Foods (Canada) Inc. - President

* Richard Dufresne

George Weston Limited - President & CFO

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Conference Call Participants

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* Irene Ora Nattel

RBC Capital Markets, LLC, Research Division - MD of Global Equity Research

* James Durran

Barclays Bank PLC, Research Division - MD, Head of Canadian Equity Research & Senior Analyst

* Mark Robert Petrie

CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Research Analyst

* Patricia A. Baker

Scotiabank Global Banking and Markets, Research Division - Analyst

* Peter Sklar

BMO Capital Markets Equity Research - Analyst

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Presentation

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Operator [1]

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Good morning. My name is Denise, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the George Weston Limited Third Quarter Results Conference Call. (Operator Instructions) Thank you. Geoff Wilson, you may begin your conference.

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Geoffrey Victor Herbert Wilson, George Weston Limited - Former SVP of IR, Business Intelligence & Communications [2]

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Thank you. Good morning, and welcome to the George Weston Limited 2018 Third 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 our 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 third 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 referred to today.

Please refer to our third quarter news release and other materials or a reconciliation of each of these measures to the most directly comparable GAAP measure. An archive of this conference call will be available on our website.

Loblaw Companies Limited released its third quarter results last week, and therefore, we'll focus this call on the performance of our Weston Foods segment.

I would now like to turn the call over to Richard.

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Richard Dufresne, George Weston Limited - President & CFO [3]

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Thank you, Geoff, and good morning, everyone. Earlier today, we released our third quarter results for George Weston Limited. On November 1, we completed the Choice Properties spin-out to George Weston Limited. We are pleased with the outcome of this transaction. The company is now much better positioned for the future with a simple structure, enhanced cash flow, strong balance sheet, and therefore, more optionality for growth.

For the third quarter, George Weston Limited reported adjusted diluted net earnings per share of $2.25 compared to $2.14 for the same period in 2017, an increase of 5.1%. In the third quarter of 2018, Weston Foods sales totaled $630 million, a decline of $38 million over the same period of 2017. Sales decreased mainly due to the impact of product rationalization and the loss of business from key customers.

Weston Foods adjusted EBITDA in the third quarter of 2018 was $72 million, a decrease of $8 million compared to the same period in 2017. Excluding the impact of a $14 million real estate gain, the decline in adjusted EBITDA was driven by the decline in sales and higher input and distribution costs, partially offset by benefits realized from the transformation program, net of costs and productivity improvements.

For the full year 2018, Weston Foods expects 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 the continued effect of product rationalization. Excluding the net gain on sale of property, 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 increases, partially offset by improvements from the transformation program and productivity.

Investment in capital expenditures will decrease to approximately $215 million for 2018 compared to $230 million as previously stated. And finally, depreciation will increase compared to last year as we continue to invest in our business.

I would now like to turn over the call to Galen.

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Galen G. Weston, George Weston Limited - Chairman & CEO [4]

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Thank you, Richard, and good morning. Before turning to Weston Foods, I'd like to comment on both the successful spin out of Choice Properties and the strong third quarter results that Loblaw released last week. Amid continued headwinds, Loblaw remained focused on its commitment to stable trading, delivering value to customers and in turn growing both traffic and basket size. We saw improvements in promotional effectiveness and further benefited from the strength of our loyalty program, PC Optimum. Loblaw's strategy continues to create momentum as data driven insights and process and efficiency initiatives allow us to make additional investments for the future. At the same time, the successful spin out of Choice Properties is another significant milestone that positions our company for the long term. Choice Properties maintains its strategic operating relationship with Loblaw, and George Weston is now a stronger company with 3 distinct and complementary pillars that provide growth and flexibilities for the future.

With the spin out complete, I'm also pleased to announce a 5.1% increase in George Weston's quarterly dividend to shareholders. At Weston Foods, we continued to underperform against our expectations. We are 1-year into an ambitious plan and it has had mixed results. Although we remain optimistic about the business' future, we have taken decisive action to slow down the transformation program and are carefully managing the pace of change so that management can focus on the top line. While the program has improved our ability to manage costs and to simplify the business, not all the benefits have flowed to the bottom line. We have fallen short on customer service that has adversely impacted our sales. Put simply, we are not yet operating at the high standard that we expect of ourselves.

Looking forward, we remain committed to our strategy and encouraged by several positive things, which are happening. Business fundamentals are improving with less waste, more productivity and a better ability to forecast our results. We are also seeing sales momentum in key growth areas, such as artisan and pre-fried doughnuts. While our recent performance continues to be disappointing, we are confident that management is focused on the right areas to position Weston Foods for the future.

I'd now like to open the call to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Irene Nattel with RBC Capital Markets.

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Irene Ora Nattel, RBC Capital Markets, LLC, Research Division - MD of Global Equity Research [2]

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Would you be able to elaborate on the ways in which you are slowing the process, how you plan on building momentum in top line and really what the implications are for the time line and the magnitude of the lift in EBITDA that you laid out when you first embarked on the transformation plan?

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Luc Mongeau, Weston Foods (Canada) Inc. - President [3]

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Yes, we're slowing the program in the areas where there is impact on customers. So basically we're doing, we are slowing down the implementation of our ERP, SAP program. We're slowing down as well -- we're reducing the number of SKUs that we are discontinuing by about 20%. And we're reducing as well the amount of CapEx that we're investing in the business to allow us to do what Galen referred to, which is really brings stabilization to the business, and significantly improve our service levels so we can return the entire business to growth.

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Richard Dufresne, George Weston Limited - President & CFO [4]

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Yes, Irene, it's Richard. In terms of the timing to -- for the business to stabilize, our focus right now is fully on the stabilization of our business, and we're focusing on minimizing the impact on customers. Focus is clearly shifting to execution in sales momentum. And as we get traction with that, we'll be able to comment further on that.

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Irene Ora Nattel, RBC Capital Markets, LLC, Research Division - MD of Global Equity Research [5]

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That's very helpful. So -- but just presumably, some of the lost volume, however, has gone to other players. How challenging do you think it's going to be essentially pull it back over to your side?

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Richard Dufresne, George Weston Limited - President & CFO [6]

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We're still having good traction and discussion with customers. So it's an area that we're focused on more, and as to some of the business we lost, like we'll have a -- we'll have to lap that business for another 4 quarters because one of the business we lost was at the beginning of Q3, so it will take us a few quarters to lap that business.

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Irene Ora Nattel, RBC Capital Markets, LLC, Research Division - MD of Global Equity Research [7]

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And what was the magnitude of the one that was lost in Q3?

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Richard Dufresne, George Weston Limited - President & CFO [8]

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Sorry, Irene, we're not going to give that number.

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Irene Ora Nattel, RBC Capital Markets, LLC, Research Division - MD of Global Equity Research [9]

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Okay. And just one final question, if I may. Now that you have simplified the structure and strengthened the cash flow, can you walk us through what the plans are for George Weston Limited or what the thinking is for George Weston Limited over the next, let's call it 2 to 5 years?

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Richard Dufresne, George Weston Limited - President & CFO [10]

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So we just closed the transaction, actually we didn't have the party yet. So joking aside, actually like -- actually that's reality. We have not really started to work on specifically what would we want to do next. But as we've mentioned earlier, we're going to be looking at businesses that have some adjacencies with the existing businesses we have. We like businesses that have organic growth. We like businesses that generate cash flow. We like businesses that are sound, and we want to maintain a strong balance sheet. So those are sort of broad criteria that we will use in sort of selecting opportunity that we want to look at. But we're really the beginning of it, and so there's nothing to report on that for the moment.

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Operator [11]

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Your next question comes from Jim Durran with Barclays.

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James Durran, Barclays Bank PLC, Research Division - MD, Head of Canadian Equity Research & Senior Analyst [12]

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Yes. Just wanted to stay on the fourth pillar. So is that a change then in terms where you're at in that process, not a change obviously in terms of strategic parameters that you're pursuing. But I was sort of under the understanding we might see something happening sooner than what you're may be suggesting in a loose fashion?

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Richard Dufresne, George Weston Limited - President & CFO [13]

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No, not really. No change. No change. Like we're -- like the first step, I guess, the first step was to complete the spin out. It's just been completed. So we wanted to make sure that was done and well done, and we're happy with the outcome as we mentioned. So now, we'll start to do the work, but it's going to require a lot of work to figure out what else -- what next we want to do.

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James Durran, Barclays Bank PLC, Research Division - MD, Head of Canadian Equity Research & Senior Analyst [14]

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And Richard, when you talk about this being sort of a George Weston component, is it possible though that Loblaws might be the recipient of that spend and that it would then have an -- you know, just by ownership have a benefit to George Weston in totality or do you see the fourth pillar as definitively residing within George Weston?

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Richard Dufresne, George Weston Limited - President & CFO [15]

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Like everything is on the table. Like we're looking at all of our businesses. We're looking at businesses that are adjacent to our existing businesses. We need to find something that works for the group, that is priced right and ultimately, that will create value for all of our shareholders.

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James Durran, Barclays Bank PLC, Research Division - MD, Head of Canadian Equity Research & Senior Analyst [16]

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Yes. And then, on the pricing front, we've heard commentary from the Canadian grocers holistically that there is a slight uptick in inflation as manufacturers have been requesting price increases to offset cost pressures. Are you seeing any of that in the bakery business at this point? And is it the same U.S. versus Canada or are some differences there?

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Richard Dufresne, George Weston Limited - President & CFO [17]

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We are definitely seeing cost increases in our input costs, as we mentioned in our comments in this quarter's results. And we're always in discussion with customers as to ways to mitigate those.

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James Durran, Barclays Bank PLC, Research Division - MD, Head of Canadian Equity Research & Senior Analyst [18]

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And so no pricing action so far?

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Richard Dufresne, George Weston Limited - President & CFO [19]

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There are no pricing actions in our outlook for the rest of 2018. No.

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Operator [20]

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Your next question comes from Patricia Baker with Scotiabank.

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Patricia A. Baker, Scotiabank Global Banking and Markets, Research Division - Analyst [21]

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Number of questions. First of all, with the decision to slow the pace of change. Am I right in assuming that, that will impact when you will achieve your targeted synergies and that puts that out a bit further?

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Richard Dufresne, George Weston Limited - President & CFO [22]

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Yes, Patricia.

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Patricia A. Baker, Scotiabank Global Banking and Markets, Research Division - Analyst [23]

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Okay. And then, secondly, with respect to slowing the SKU -- lowering the SKUs, so that you'll do 20% less than you originally intended, so does that mean -- what's the actual number of SKUs that will be taken out in 2018?

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Luc Mongeau, Weston Foods (Canada) Inc. - President [24]

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Yes, the original plan was to discontinue about 1,000 SKUs. So we'll bring this -- the 20% will bring this down to about 800. Otherwise, we're on plan to achieve our target of discontinuation.

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Patricia A. Baker, Scotiabank Global Banking and Markets, Research Division - Analyst [25]

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Okay. And then, I think it was you, Galen, you mentioned that Weston Foods fell short on customer service in Q3, and specifically, what -- how did that manifest itself? You weren't able to get the product to the customer on time or exactly where did you fall short?

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Luc Mongeau, Weston Foods (Canada) Inc. - President [26]

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Yes. The program created some disruption with customers and it's mainly, yes, as you described, service levels that prevented us to give you their quality or quantity of what our customers require to grow.

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Patricia A. Baker, Scotiabank Global Banking and Markets, Research Division - Analyst [27]

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Okay. And my final question is a bigger one. So you're 1-year into what was as you called it a very ambitious 3-year turnaround plan. When you look back after the first year, what would you have done differently?

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Luc Mongeau, Weston Foods (Canada) Inc. - President [28]

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We're inspired by the way the program is going. So on one end, the program is doing extremely very well. In the areas of productivity, reduction of waste, improvement of downtime, we're seeing very promising signal. In the areas of cost containment, we're seeing very good results as well. And as the same thing in our simplification of our business, we've got a business structure that's much simpler than it was before allowing us to take faster decision and better decision. As mentioned earlier, the program does create a disruption with customer service levels. And our aggressive SKU discontinuation unfortunately impact -- negatively impacted customers, and that's why we're taking the decision to slow down the pace of the program. Slowing down in the areas where there are direct customer impacts to allow us to return the business, the top line of the business back to growth.

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Richard Dufresne, George Weston Limited - President & CFO [29]

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The only thing I would add Patricia is, we're committed with the strategy. Like we feel, we have the right strategy, and so it's just going to take a little bit longer than we expected.

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Operator [30]

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Your next question comes from the line of Mark Petrie with CIBC.

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Mark Robert Petrie, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Research Analyst [31]

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Luc, just with regards to the slowing of the SKU rationalization. Also you guys have been closing some facilities. Can you just update us in terms of how you're thinking about the manufacturing footprint over the next couple of years?

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Luc Mongeau, Weston Foods (Canada) Inc. - President [32]

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Yes. At this point, we're really focused on stabilizing the business, improving our service level and returning the top line to growth.

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Mark Robert Petrie, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Research Analyst [33]

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Okay. And with regards to the ERP, SAP implementation, where are we with that and what's the sort of time line for sort of full effectiveness from that program?

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Luc Mongeau, Weston Foods (Canada) Inc. - President [34]

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Yes, we're still in the initial phases of the program and we've got a time horizon of about 3 years for full implementation.

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Galen G. Weston, George Weston Limited - Chairman & CEO [35]

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We're essentially going to -- it's Galen. We're essentially going to deploy the first stage of ERP in one of our businesses, specifically our artisan business and we just put that on pause. And I think the way to think about this is, we have a good plan, a good strategy. We took on too much, not any one thing caused all of this friction, it was really trying to do all of these things at the same time. And so now, we're slowing them down. We're not giving up on the full SKU reduction, we're just saying let's pause, let's make sure that we build back the business in the right places, let's pause on SAP. Even the best implementations of an ERP are disruptive, why take on that incremental disruption at the moment. And when it comes to the plant footprint, there's friction every time you change -- you shift production from one facility to another facility. And so we're just putting that on pause. Once we have the sales going in the right direction, again, and once we're delivering the quality and the customer service at the level we expect, we will ramp all of those things up. And on that basis, we still keep that financial target in our minds. It's just as Richard said, going to be pushed out somewhat.

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Mark Robert Petrie, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Research Analyst [36]

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Okay. That's helpful. And then just I guess one question just with regards to the performance in Q3 specifically, with regards to the EBITDA margin compression, wonder if you could just sort of maybe at a high level kind of help us. How much of that is just sort of deleveraging from the top line decline? How much of it is the challenge in passing the cost pressures that you're facing? And how much of it would you sort of say is the execution with regards to service levels?

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Richard Dufresne, George Weston Limited - President & CFO [37]

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Okay. So let me try to give you some guidance. Essentially, when you look at the income statement, obviously lost sales has affected the bottom line, but like more specifically, there was a loss in fresh business. And as you know, that's one of our highest margin business. So that affected gross margin. We had -- so we are experiencing more inflation year-over-year in essentially most input costs, being flour, packaging, eggs, so that's -- that is also -- that is affecting the gross margin. Actually, if you look at SG&A and if you exclude the gain on real estate, it's actually even flat with last year, so it shows that we've been able to manage our costs quite effectively. So as we gain momentum on sales again, that will help mitigate that so. But that's how to -- that's how we're sort of looking at it from a financial perspective, and that's why we feel that if you get the sales going, it will help a lot to fix our financial problems.

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Operator [38]

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

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Peter Sklar, BMO Capital Markets Equity Research - Analyst [39]

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If you look now at your broader strategy for Weston, you have really 4 assets. You have the interests in Weston, Loblaw, Choice, the bakery, plus all this cash. It sounds like over time, you're going to acquire additional businesses in adjacent categories. So my question, Richard, is like how does Weston create value through these acquisitions versus these businesses continuing to -- if you were not to acquire them and if they were to operate on their own. It sounds like, I mean, you're not going to buy another grocer and reap all the benefit from all of the associated synergies. It sounds like you're going to be buying businesses in adjacent categories where it's uncertain what the -- I mean, I'm sure, there'll be some benefits, but uncertain just to what the synergies would be. So where is the value creation coming from?

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Galen G. Weston, George Weston Limited - Chairman & CEO [40]

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It's Galen. I'll let Richard answer the question on value creation. But just a little bit of context so that you're thinking about this the same way that we are. So we're in the retail business and supermarket business in Canada, we're in the bakery business and we're in the real estate business. And we look at the potential to create value, not exclusively by adding a fourth pillar, but also looking at areas to scale up or increase investment. So Loblaw, we already kind of did that with Shoppers Drug Mart. You saw us do that with the acquisition of CREIT in the real estate business. So we're not saying that there aren't incremental opportunities over time in those areas, but it stands to reason that our priorities will be looking at, what types of opportunities there might be in the bakery business and that is conditional upon us stabilizing the existing financial performance. And the second is, are there some adjacent -- is there an adjacent third or fourth leg that we can add value to, and Richard can comment on how we see ourselves adding value. You're clearly right. There are not the obvious financial synergies that would come with the transaction like that. So we need to think carefully about how to create value.

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Richard Dufresne, George Weston Limited - President & CFO [41]

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Peter, if you look at all the strategic moves we made over the last like 5, 6 years, like I would argue that all of them have been value enhancing to the group. So that's how we're looking at things. So yes, if we look at a fully separate pillar where there are no synergies, it's going to be tougher, but like we won't contemplate doing something that's not going to be creating value long term for our shareholders. That's always how we've been looking at things. Even if you look at the spin-out, like you look at how Loblaw is trading now, like that's actually positive element of actually just reorganizing our asset. So therefore, we always have that lens that we're focused on, on whatever we do, and as Galen mentioned, like we may end up adding to what we already have. So -- but we're just keeping all options open and we don't have anything ready to announce that's in our back pocket. No, we're starting to do the work now.

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Peter Sklar, BMO Capital Markets Equity Research - Analyst [42]

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And if you do ultimately acquire the fourth leg or the fourth asset, and that acquisition is successful, could you contemplate down the road that there could be a fifth and a sixth, just what is your -- what are your long-term intentions?

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Richard Dufresne, George Weston Limited - President & CFO [43]

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Anyway, that's my opinion. I don't think there will be a fifth and a sixth. And if we have a fourth, maybe we don't stay at 4, we could be shrinking back to 3. So it's like -- we don't have a definite plan to we want 4 or 3 or 2 businesses. We want to look at opportunities, which want to create value for shareholders, that's what we care about. And I think we try to articulate it as well as we could by doing the spinoff by creating a better investment thesis in George, and we want to improve on that investment thesis. So that's how we're looking at it.

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Operator [44]

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And our next question comes from Irene Nattel with RBC Capital Markets.

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Irene Ora Nattel, RBC Capital Markets, LLC, Research Division - MD of Global Equity Research [45]

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Just continuing this conversation, thank you very much for the last statement because, I guess, if we go back part of what we're thinking is, well, this -- part of this is about addressing the asymmetric balance value at GWL, but if you create more value within say Loblaws or CREIT, that doesn't get to that objective. So should we be thinking about it -- about whatever you do next as creating value in totality or creating value in GWL, separate from CREIT and Loblaws?

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Richard Dufresne, George Weston Limited - President & CFO [46]

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Ultimately, Irene, if our businesses value go up, George Weston goes up. So that's like simple math. So that will be taking into consideration as we look at other alternatives because we can always look at what we have and that is definitely a filter that we are using when we're having those discussions.

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Galen G. Weston, George Weston Limited - Chairman & CEO [47]

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I think the message that we're trying to communicate here and I know people would love to have more information, and at the right time, obviously, we will provide that, is that, we want to be strategic and we want to be financially disciplined. And we're not pursuing strategies simply because they're historical or simply because we want balance. Our priority #1 is to buy well and well means a good trajectory to creating shareholder value. And as such, the opportunities could be anywhere across our portfolio. Having said that, we just did a big deal in the real estate business. We have a strategy that's very focused on digital organic growth at Loblaw, and so the priorities are in the 2 places that I mentioned earlier.

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Operator [48]

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And there are no further questions queued up at this time. I'll turn the call back over to presenters.

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Geoffrey Victor Herbert Wilson, George Weston Limited - Former SVP of IR, Business Intelligence & Communications [49]

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Great. Thank you very much for joining us today. Our 2018 fourth quarter release is scheduled for February 27. Thank you very much for joining us this morning. Have a good day. Bye-bye.

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Operator [50]

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