Note: Adjusted Earnings per Share measures are defined as basic earnings per share adjusted for the impact of restructuring and other related costs.

Transcription

1 Maple Leaf Foods Inc. Management s Discussion and Analysis For the first quarter ended March 31, 2009 Financial Overview Financial and operational highlights for the first quarter include: Adjusted Earnings per Share ( Adjusted EPS ) of $0.05 compared to $0.04 last year Steady recovery in prepared meats volume; margins not yet recovered Earnings benefited from restructuring in hog production and primary processing Bakery margins improved, but short of historic levels Note: Adjusted Earnings per Share measures are defined as basic earnings per share adjusted for the impact of restructuring and other related costs. Significant focus and resources in the first quarter of 2009 were committed to selling and operational initiatives to hasten the recovery of packaged meat volume and earnings impacted by a product recall in August At the outset of the recall, Management expected that it may take at least six to 12 months to fully recover volumes to historical levels. In the first quarter, packaged meats volumes were slightly higher than the same period in the prior year, although still short of Company targets. The normalization of margin rates is expected to occur more slowly. Margins continue to be impacted by higher raw material costs as the Company s ability to pass on price increases was hindered by the recall, in addition to significant promotional and incentive investments to drive volume recovery. Sales for the first quarter increased 6.3% to $1,279.3 million compared to $1,203.3 million last year, primarily due to the benefit of price increases in the Bakery Group implemented in 2008 to offset escalating input costs. In the primary pork processing business, exchange rate movements resulted in higher sales values. Offsetting these increases was the impact of price and other promotional discounts on packaged meat products to drive volume. Earnings from operations before restructuring and other related costs and other income (expense) ( Adjusted Operating Earnings ) declined to $31.6 million for the quarter compared to $33.1 million last year. Adjusted Operating Earnings were lower in the first quarter due to higher meat input costs and significant investment in promotional activity on packaged meat products. Benefits from the restructuring of pork processing and hog production operations and the impact of price increases across the bakery business mitigated the decline in earnings. Following is a summary of Adjusted EPS: First Quarter Basic EPS $0.02 $0.00 Restructuring and other related costs (i) Adjusted EPS (ii) $0.05 $0.04 (i) Includes per share impact of restructuring and other related costs, net of tax and minority interest (ii) Not a recognized measure under Canadian GAAP. Management believes that this is the most appropriate basis on which to evaluate results, as restructuring and other related costs are not representative of continuing operations. Economic Downturn The current economic downturn has the potential to impact the Company s financial results positively or negatively depending on consumer behaviour, or the effects on commodity prices. For example, there is a risk that consumers may trade down in their purchases from higher margin specialty

2 products to lower margin staple products and the Company may experience an overall volume decline. On the other hand, there has been a recent tendency among consumers to eat less frequently away from home. This trend could benefit the Company. Although the Company has experienced some decline in the sales of specialty items in its U.K. bakery operations that can be partly attributed to the difficult economic environment, Management is currently not able to predict whether the economic downturn will have a material effect on the Company s results of operations in future periods. Business Segment Review Following is a summary of Adjusted Operating Earnings by business segment: First Quarter ($ millions) Meat Products Group $11,351 $25,013 Agribusiness Group 2,145 (2,780) Protein Group 13,496 22,233 Bakery Products Group 19,525 17,156 Non-allocated Costs (i) (1,422) (6,291) Adjusted Operating Earnings $31,599 $33,098 (i) Non-allocated costs include costs related to systems conversion and consulting fees. Management believes that not allocating these costs provides a more comparable assessment of segmented operating results. Meat Products Group (value-added processed packaged meats, chilled meal entrees and lunch kits; value-added pork, poultry and turkey products) Meat Products Group sales for the first quarter increased by 7.8% to $822.2 million compared to $762.5 million last year. The increase in sales was principally due to the positive impact of a weaker Canadian dollar on sales prices of fresh pork. Adjusted Operating Earnings in the Meat Products Group declined to $11.4 million in the first quarter of 2009 compared to $25.0 million last year. While volumes were consistent with last year, margins on packaged meat products in the quarter were compressed due to higher raw material costs, which were not passed on through normal pricing activity during the initial six months after the product recall. This impact was augmented by significant promotional costs incurred to drive post-product recall volume recovery. The benefits of restructuring and a weaker Canadian dollar resulted in an increase in pork processing earnings, despite lower industry margins in the first quarter of 2009 compared to last year. Earnings from the Company s poultry operations were consistent with last year. In the first quarter, the Company announced that due to difficult credit markets, it has suspended actively marketing its pork processing business in Burlington, Ontario. The sale process for this business is expected to resume when credit markets stabilize and an appropriate sale value can be realized. The business is profitable and contributed to cash flow and earnings for the quarter. Agribusiness Group (hog production and animal by-product recycling) Agribusiness Group sales for the first quarter decreased 23.9% to $44.6 million compared to $58.6 million last year due to the divestiture or exit of hog production operations in Ontario and Alberta. Sales of rendered by-products were consistent with last year. 2

3 Adjusted Operating Earnings for the Agribusiness Group in the first quarter of 2009 increased to $2.1 million from a loss of $2.8 million last year. Results in hog production improved significantly due to the sale or exit of non-core operations in Ontario and Alberta. Increased focus on core operations in Manitoba resulted in operational improvements such as lower cycle times, improved feed efficiency and improved hog quality. Included in earnings in 2008 is $8.4 million related to government support to compensate hog producers for losses in prior years. Despite lower volumes and higher raw material costs, results in by-product recycling were consistent with last year due to operational improvements in core rendering and higher earnings from bio-diesel production. Bakery Products Group (fresh, frozen and branded value-added bakery products, including frozen par-baked bakery products, sandwiches and specialty pasta and sauces) Bakery Products Group sales for the first quarter increased 8.0% to $412.5 million compared to $382.1 million in the same period last year. Excluding the contribution of acquisitions, sales increased by 5.3% mostly as a result of price increases taken in 2008 in response to escalating input costs. Adjusted Operating Earnings for the Bakery Products Group in the first quarter increased to $19.5 million from $17.2 million last year due to margin improvements in the North American bakery businesses. Price increases implemented in the first half of 2008 and better sales mix, were the main drivers of improved margins in the quarter. However, margins are not fully restored to historic levels as the benefit of decreasing wheat cost was offset by the weaker Canadian dollar, which increases the Canadian price of wheat. Additionally, the cost of packaging and other ingredients increased compared to last year. Adjusted Operating Earnings in the U.K. bakery business declined in the first quarter compared to last year due to sales mix as the effect of the economic recession has been more pronounced in the U.K. than in the Company s other operations. Also, increased promotional activity on bagel products reduced earnings. The bagel production line at the Company s Rotherham plant was impacted by an oven fire in the first quarter of 2008, and increased promotion and investment in the first quarter of 2009 was required to restore demand for bagels and build volumes to historical levels. In the first quarter of 2009, the Company received insurance proceeds of $1.7 million (recorded in Other Income) to cover business losses and operating impacts resulting from the oven fire. No further material insurance proceeds are anticipated in 2009 in respect of this event. Gross Margin Gross margin increased to $167.2 million from $155.9 million last year. Gross margin in the Bakery Products Group increased due to price increases taken in In the Agribusiness Group, the sale or exit of non-core hog production operations resulted in a significant improvement in gross margin. Higher meat input costs and price concessions to restore volumes compressed gross margin in the Meats Products Group. This was partly mitigated by strong operational performance and the benefits of restructuring in primary processing. Selling, General and Administrative Expenses Selling, general and administrative expenses increased by 10.4% to $135.6 million compared to $122.8 million last year. This increase is primarily related to investments in innovation and marketing of new products in the Bakery Products Group, increased selling expenses in the Meat Products Group and a $7.2 million increase in pension expense (net benefit plan expense of $5.4 million in 2009; net benefit plan income of $1.8 million in 2008). These increases were offset partly by savings from protein restructuring initiatives. 3

4 Other Income Other income for the quarter of $1.7 million (2008: nil), primarily relates to insurance proceeds for business interruption losses in the U.K. bakery business. Restructuring and Other Related Costs In the first quarter, the Company recorded $5.3 million of restructuring and other related costs (2008: $7.7 million). These costs relate principally to remaining lease payments on redundant office space in the Protein Group. Cash Flow and Financing Total debt, net of cash balances, was $1,138.6 million at the end of the first quarter, compared to $1,022.8 million as at December 31, The increase from the beginning of the year is principally due to the seasonal increase in working capital investments. Cash flow from operations for the quarter was a net use of cash of $38.8 million compared to an increase in cash of $18.4 million in The variance is largely attributable to an increase in working capital in the first quarter of The Company s strategy related to liquidity is to reduce reliance on any single source of credit, maintain sufficient undrawn credit facilities to provide liquidity and to spread debt maturities over time to reduce refinancing risk. At March 31, 2009, the Company had available undrawn committed credit of $340.0 million under the terms of its principal banking arrangements, in addition to cash available of $263.3 million. The Company s principal banking arrangements, which mature in 2011, are subject to certain covenants and other restrictions. At the end of the first quarter, the Company was in compliance with all of its lending covenants. The Company is exposed to fluctuations in the prices of raw materials, seasonal and other marketrelated price changes. Due to high sales volumes and rapid turnover of inventories, the impact of these price fluctuations is generally short term. When commodity price increases are significant, it can increase the funding required for investments in working capital. These cash flow requirements will be funded from current operating cash flow and existing credit facilities. Management is of the opinion that its operating cash flow and existing credit facilities provide the Company with sufficient resources to finance ongoing business requirements and its planned capital investment program. In the normal course of business, the Company is exposed to credit risk from its customers, substantially all of which are in the grocery and foodservice markets. The Company performs ongoing credit evaluations of new and existing customers financial condition and reviews the collectibility of its trade and other accounts receivable in order to mitigate any possible credit losses. The Company maintains an allowance for uncollectible accounts that represents its estimate of uncollectible amounts. The components of this allowance include a provision related to specific losses estimated on individually significant exposures and a provision based on historical trends of collections. Based on the above assumptions, as at March 31, 2009, the Company believes that the allowance for uncollectible accounts sufficiently covers any credit risk related to past due or impaired accounts receivable balances. Interest expense for the quarter was $21.3 million compared to $21.7 million last year, as lower shortterm interest rates were offset by slightly higher average debt balances. At March 31, 2009, 70% of indebtedness was not exposed to interest rate fluctuations, compared to 69% in the previous year. Capital expenditures on plant and equipment for the first quarter were $57.7 million compared to $45.7 million last year. Significant capital investment in the first quarter of 2009 included installation of SAP enterprise software, completion of a new food innovation centre near Toronto, Ontario, 4

5 investment to reduce costs in the Company s manufacturing distribution network and investments in bagel capacity expansion in the United States. During the quarter, the Company successfully completed the first installation of SAP software at the corporate centre. The transformation of its business systems is expected to be materially complete in Taxes The Company s income tax expense is comprised of tax on earnings from operations before restructuring and other related costs at a rate of 30.3% (2008: 38.4%) and taxes recovered on restructuring costs and other related costs at a rate of 27.4% (2008: 29.3%). Summary of Quarterly Results Following is a summary of unaudited quarterly financial information (in thousands of dollars except per share information): Sales Net earnings (loss) Earnings per share: Basic Diluted Adjusted (i) First Quarter Second Quarter Third Quarter Fourth Quarter Total 2009 $1,279,299 $1,279, ,203,263 1,355,30 1,344,33 1,339,70 5,242, $2,871 $2, (10) (9,353) (12,919) (14,575) (36,857) 2009 $0.02 $ (0.07) (0.10) (0.12) (0.29) 2009 $0.02 $ (0.07) (0.10) (0.12) (0.29) 2009 $0.05 $ (0.01) (i) Does not add due to rounding. Change in Accounting Policies Effective January 1, 2009, the Company adopted Emerging Issues Committee Abstract 173, Credit Risk and the Fair Value of Financial Assets and Financial Liabilities ( EIC 173 ). EIC 173 requires the Company to consider the Company s own credit risk and the credit risk of the counterparty in determining the fair value of financial assets and financials liabilities, including derivative instruments. The adoption of EIC 173, which was adopted on a retrospective basis without restatement of prior periods on January 1, 2009, resulted in a decrease to retained earnings of $0.2 million, net of taxes of $0.1 million and a decrease in accumulated other comprehensive loss of $0.9 million, net of taxes of $ 0.4 million. In 2008, the CICA issued Handbook Section 3064, Goodwill and Intangible Assets ( CICA 3064 ). CICA 3064, which replaces Section 3062, Goodwill and Intangible Assets, and Section 3450, Research and Development Costs, establishes standards for the recognition, measurement and disclosure of goodwill and intangible assets. The Company adopted this standard on a retrospective basis on January 1, The adoption of the new standard did not have a material impact on the Company s financial statements. 5

6 Disclosure Controls and Internal Controls over Financial Reporting The Company's disclosure controls and procedures are designed to provide reasonable assurance that material information relating to the Company, including its consolidated subsidiaries, is made known to Management in a timely manner so that information required to be disclosed by the Company under securities legislation is recorded, processed, summarized and reported within the time periods specified in applicable securities legislation. The Company's Management, under the direction and supervision of the Company s Chief Executive Officer and Chief Financial Officer, are also responsible for establishing and maintaining internal control over financial reporting. These controls are designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with Canadian GAAP. As previously disclosed, the Company had identified a material weakness in the design of disclosure controls and procedures and internal control over financial reporting for the fiscal year ended December 31, 2007 and the interim fiscal periods ended March 31, 2008, June 30, 2008 and September 30, The material weakness in design was due to the Company having an insufficient number of personnel in the taxation area with the required experience and capabilities to complete all necessary control procedures during a period in which there was an unusually high volume of activity within the taxation department, due to the sale of the Company's animal nutrition business as well as other restructuring activities. The impact of this material weakness, while limited to the taxation department, provided for the reasonable possibility that a material misstatement in the annual or interim financial statements of the Company would not be prevented or detected on a timely basis by the Company's internal controls over financial reporting or its disclosure controls and procedures. Since identifying the weakness in December 2008, the Company remediated the effect of the material weakness in design noted above by carrying out additional reviews and procedures involving senior tax department personnel. The Company is undertaking a further review of the structure and capacity of its taxation department and plans to remediate any ongoing design deficiencies identified during Other than as discussed above, there have been no changes in the Company s internal control over financial reporting during the period beginning on January 1, 2009 and ended on March 31, 2009 that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting. International Financial Reporting Standards For fiscal years beginning on or after January 1, 2011, Canadian public companies will be required to prepare their financial statements in accordance with International Financial Reporting Standards ( IFRS ). The Company will issue its financial statements in the first interim quarter in 2011 in accordance with IFRS including comparative data for In order to meet the requirement of transition to IFRS the Company has established an enterprisewide project team and formed a steering committee. The Company s transition plan is comprised of three phases: initial diagnostic assessment, design, and implementation. The Company is currently in the process of finalizing the initial assessment of the impact of the adoption of IFRS. Changes in accounting policies upon adoption of IFRS are likely and may materially impact the Company s consolidated financial statements. Other Matters On April 28, 2009 Maple Leaf Foods Inc. declared a dividend of $0.04 per share payable on June 30, 2009 to shareholders of record on June 5, Unless indicated otherwise in writing at or before the time the dividend is paid, each dividend paid by the Corporation in 2009 or a subsequent year is an eligible dividend for the purposes of the Enhanced Dividend Tax Credit System. 6

7 Forward-looking Statements This document contains, and the Company s oral and written public communications often contain, forward-looking statements that are based on current expectations, estimates, forecasts and projections about the industries in which the Company operates and beliefs and assumptions made by the Management of the Company. Such statements include, but are not limited to, statements with respect to objectives and goals, as well as statements with respect to beliefs, plans, objectives, expectations, anticipations, estimates and intentions. Specific forward looking statements in this document include, but are not limited to, statements with respect to improving business trends in 2009, expectations regarding the impact of the recession on the business, expectations regarding the timing and extent of margin recovery in the packaged meats business, expectations concerning the timing of the sale of the pork processing plant in Burlington, Ontario, expectations regarding the timing of completion of its business systems transformation, the expected use of cash balances, source of funds for ongoing business requirements and capital investments, expectations regarding sufficiency of the allowance for uncollectible accounts, the potential impact of the adoption of IFRS and expectations concerning the remediation of the Company s material weakness in design of its internal control over financial reporting and disclosure controls and procedures. Words such as expect, anticipate, intend, attempt, may, will, plan, believe, seek, estimate, and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve assumptions and risks and uncertainties that are difficult to predict. In addition, these statements and expectations concerning the performance of the Company s business in general are based on a number of factors and assumptions including, but not limited to: the condition of the Canadian, United States and United Kingdom economies; the rate of exchange of the Canadian dollar to the U.S. dollar and the Japanese yen; expected recovery of sales following the product recall; the availability and prices of raw materials, energy and supplies; product pricing; the availability of insurance; the competitive environment and related market conditions; improvement of operating efficiencies whether as a result of the protein business transformation or otherwise; continued access to capital; the cost of compliance with environmental and health standards; no adverse results from ongoing litigation; no unexpected actions of domestic and foreign governments; and the general assumption that none of the risks identified below or elsewhere in this document will materialize. All of these assumptions have been derived from information currently available to the Company including information obtained by the Company from third-party sources. These assumptions may prove to be incorrect in whole or in part. In addition, actual results may differ materially from those expressed, implied or forecasted in such forward-looking statements, which reflect the Company s expectations only as of the date hereof. Factors that could cause actual results or outcomes to differ materially from the results expressed or implied by forward-looking statements include, among other things: the risks associated with implementing and executing the protein business transformation; the risks associated with changes in the Company s shared systems and processes; the risks posed by food contamination, consumer liability and product recalls; the risks associated with the Company s outstanding indebtedness; the impact on pension expense and funding requirements of fluctuations in the market prices of fixed income and equity securities and changes in interest rates; the cyclical nature of the cost and supply of hogs and the competitive nature of the pork market generally; the risks related to the health status of livestock; the Company s exposure to currency exchange risks; the ability of the Company to hedge against the effect of commodity price changes through the use of commodity futures and options; the impact of international events on commodity prices and the free flow of goods; the risks posed by compliance with extensive government regulation; the impact of changes in consumer tastes and buying patterns; 7

8 the impact of extensive environmental regulation and potential environmental liabilities; the risks associated with a consolidating retail environment; the impact of a pandemic on the Company s operations; and the risks associated with complying with differing employment laws and practices globally and the potential for work stoppages due to non-renewal of collective agreements. The Company cautions the reader that the foregoing list of factors is not exhaustive. These factors are discussed in more detail under the heading Risk Factors in the Company s Management s Discussion and Analysis for the year ended December 31, 2008 and these factors are updated each quarter in Management s Discussion and Analysis, which are available on SEDAR at The reader should review such document in detail. The Company does not intend, and the Company disclaims any obligation to update any forward-looking statements, whether written or oral, or whether as a result of new information, future events or otherwise except as required by law. Additional information concerning the Company, including the Company s Annual Information Form, is available on SEDAR at Maple Leaf Foods Inc. ( Maple Leaf or the Company ) is a leading Canadian value-added meat, meals and bakery company committed to delivering quality food products to consumers around the world. Headquartered in Toronto, Canada, the Company employs approximately 24,000 people at its operations across Canada and in the United States, Europe and Asia. 8