Saputo Inc.

Lino Saputo - CEO Sandy Vassiadis - IR Louis-Philippe Carriere - CFO

Irene Nattel - RBC Capital Markets Michael Van Aelst - TD Securities Mark Petrie - CIBC David Hartley - Credit Suisse Securities Peter Sklar - BMO Keith Howlett - Desjardins Securities

Thank you very much, Jennifer.

Good afternoon, everyone and thank you for joining us today. A press release detailing our 2017 second quarter results was issued earlier today and is also available as we speak on our website at www.saputo.com.

This call is being recorded and will be posted on our website for future reference. I'd like to specify that our listeners on the phone and on the Internet, as well as journalists, are on a listen-only mode.

Members of the media are invited to ask their questions by phone after this call. Before we proceed, please be reminded that some of the statements provided during this call are forward-looking.

Such statements are based on assumptions that are subject to risks and uncertainties. Refer to our cautionary statements regarding forward-looking information in our annual report and our quarterly releases and filings.

Please treat any forward-looking information with caution as our actual results could differ materially. We don't accept any obligation to update this information except as required under securities laws.

Mr. Lino A.

Saputo, Jr., our Chief Executive Officer and Vice Chairman of the Board, will begin this conference by providing his brief overview of key highlights relating to the second quarter of fiscal 2017, after which he and Mr. Louis-Philippe Carriere, our Chief Financial Officer, will proceed to answer your questions.

Thank you, Sandy and good afternoon to you all. I'm delighted with our second quarter results.

We grew adjusted EBITDA by 20.9%, net earnings by 29.1% and revenues by 1.9%. We also demonstrated our ability to tackle challenges head on while meeting customers and consumers’ needs.

Canada continued to progress with a good increase in revenues, mainly due to higher sales volumes and a favorable product mix, generating additional adjusted EBITDA. Other factors such as the inclusion of Woolwich Dairy as well as other warehousing and logistical costs also positively affected adjusted EBITDA.

In the US, we continue to generate solid results. More specifically, our revenues increased due to higher sales volumes and inclusion of Woolwich Dairy.

Our adjusted EBITDA was impacted by a favorable product mix and lower logistical costs. In the international sector, market conditions improved.

As such in Argentina, we were positively impacted by higher selling prices. In Australia, we also benefited from a realignment of raw milk costs to current market conditions and higher sales volumes.

These elements contributed favorably to adjusted EBITDA. Despite our efforts, international market prices continue to affect our export sales volumes for the entire sector.

These prices are expected to remain low throughout the third quarter of fiscal 2017. Nevertheless, looking at our results globally, I'm very pleased to the extent in which our platforms can complement each other, enabling us to deal with market headwinds and to find new ways of achieving success.

For the remainder of fiscal 2017, our outlook remains unchanged. We will continue to mitigate downward market pressures as well as focus on operational efficiencies and growth in all of our business segments.

I'm fortunate to have such a dedicated team on board who combine their hard work and passion to generate innovation ideas and expand our operations and bring new products to market. I thank them for attaining great results.

On that note, I thank you for your time and we will now proceed to answer your questions. Jennifer?

Thanks and good afternoon everyone. I'm wondering if we could just start talking a little bit about the volumes by region.

You said, Canada, volumes and mix were up. US, it looks like cheese was up, dairy foods was down.

If you just talk a little bit about which categories are up or down and maybe magnitude and a little bit of color on the demand side of the equation?

Yeah. Thank you very much for that question, Irene.

So let me start off with our Canadian platform. As you know, the industry itself at best his flat.

I think we've been outpacing the market for a couple of consistent quarters now. If I think about our cheese business in Canada, we're up 8% in terms of overall volume, when the market is up about 1% and on the fluids side, we're up about 1% overall volume when the market is down about 1%.

And this is typically true for all of the channels that we service in Canada. That would be true for our food services business.

That would be true for the retail business and that would also be true for the industrial business. So we are seeing growth in all of our channels in Canada in a very tough, difficult environment.

I commend our Canadian team for achieving that kind of success. If I move to the Saputo Cheese USA business, again there too, we can expect growth, organic growth in the US market on cheese of about 1.5% to 2% per year.

We're 6.2% ahead of last year same quarter. So again there too, we're outpacing the market.

Food service has been a little soft. We are outpacing the market there and retail has been quite strong.

So we -- with the brands that we have, the String Cheese, Cheese Heads brands and the Treasure Cave brands and the Stella brands have all been doing extremely well for us. So again we're outpacing the market on the two side in the US.

On the dairy foods side, it's been pretty soft across all channels. Traffic is down at the QSR.

We were flat year-over-year, but don't forget, we're coming off of a very, very strong year on SDF. Profitability was up, even though the volume was stagnant.

We're going into a very good season for this business, so I expect that volume will pick up in Q3 for SDF. On the international side, with the heavy rain and the floods in Argentina, overall volume is down about 13%.

But as a business, it gave us an opportunity to take the remaining milk that we had and channel them through, I guess, products and customers that were more profitable. Domestic business was very, very strong for us.

We had some great lift and great volume there. In the international side, we were able to get out of low performing products and focus mostly on products that ultimately are going to generate some great profit for us.

Australia overall, volume was up about 8% and it's not that the industry is up 8% but given the missteps of our competitors in Australia in the last quarter, we were able to take on more milk and our volume was up 8%. So that in a nutshell is the outlook of the volume perspective within all of our divisions, all of our platforms.

I think we’re outpacing the market and our teams are doing a fantastic job of just staying ahead of the curve and fighting the fight that they need to fight in order to keep the volume.

That's very impressive, Lino. Can you talk a little bit about what you think are the critical elements that are enabling you to so substantially outperform the market?

Well, there are a number of things that we've talked about over time and not everything is a question of price, because we are not price drivers. What we like to do is have a compelling argument for why we would be the ideal supplier to a customer.

We talk about service, we talk about quality, we talk about all those things, the intangibles that allow them to be better served by having us as their supplier. Things like order fill rate, when we're doing 99.8%, 99.9% order fill rates, that means 99.9% of the time, our customers have a product to sell, which isn't -- the same cannot be said for some of our competitors.

When you think about quality and consistency, and you think about our footprint on a national scope where we have infrastructure coast to coast in Canada, coast to coast in the United States, we're able to service the market quite effectively and I think that that adds some great value. I think of our diversification of our -- of our plants and how one is able to complement the other and step up when another one is perhaps stepping down.

I think about as well on the international side, between our US platform and our Australian platform and our Argentinian platform, sometimes, we have a product in a specific market that needs to be serviced by one of the three platforms and interchangeably within the three platforms. We can do that quite effectively.

So there are some very, very good compelling reasons why a customer would choose us as their supplier and that goes beyond price.

Thanks for taking my questions. Can you just clarify first off, on Australia, for the Australian volumes, you said plus 8%, was that just the domestic volumes or do that also include the drop in the export?

That’s a total combined increase in our production volume, so that production could be destined either for the domestic market and/or for the international market, but the 8% is growth in the entire platform.

Great. And then looking at Canada, so very impressive improvements there on the volume side and on the profit side.

Can you talk a little bit about the pricing environment because, if you look at cheese CPI, it’s declining in recent months, but you’ve got this 5% roughly cost increase in the raw milk, so how do we -- how are we supposed to read that?

Well, there are a lot of things that happened in the quarter. You had that initiative that was very public by the retailers of a reduction of 1.4% in terms of their ask.

You had a 2.74% increase in the cost of raw material and then of course you had competition. So all of those things happened.

I think we navigated through those waters extremely well and again I'm going back to the compelling arguments that we have when we talk to those banners, we say, look, we are the ideal supplier for you, again with our coast to coast manufacturing platform, with the strength of some of the brands that we have, the strength of what we can do in terms of market intelligence and making them even better at what they do. I think we're able to come up with a happy medium, so that we can get our fair share when it comes to raw material increases and by the same token, not have to give up too much in their margin compression.

So when we see the retail prices of cheese deflating, that's the retailers taking that hit, because I mean your margins are going up, your sales are up nicely?

Yeah. In some cases, it is and other cases, we have selective trade spending.

So it’d be a combination of both, but again our trade spending, when we think about trade spending and promotions, we're very, very, very responsible when it comes to our P&L. And so it definitely has to make sense.

But I would say and I'm not sure which banner you’re referring to specifically, but sometimes the banners themselves will also take a hit.

Okay. And then on the CETA progress, it seems like that could go ahead, has there been any final decisions on how the quarters are going to be allocated in Canada?

Not yet. So you're absolutely right.

Last Sunday Trudeau traveled to Brussels. He signed the deal.

On December 5, the Bill C-30 is expected to go through the House of Commons and it's expected to pass because the Liberal government does have a majority. And sometime in early 2017, we expect that EU will fully sign off on it.

Now, the quota allocations will not be assigned until the EU passes the agreement on CETA. So I don't suspect that the quotas will be allocated until sometime in early January 2017.

Okay. But you have no sense as to what they're going to do, what's happening there?

We really don't have a sense of course through our dairy association, DPAC and of course through the dairy farmers of Canada. We're hoping that the stakeholders in the dairy industry will have a fair share of those quotas, but at this stage, I have no read on where that will end up.

Okay. And then if you look at the volumes coming in Argentina and in Victoria, it looks like they’re both down, I guess Argentina's looking like they're going to be going down about 13% in terms of milk volumes year-to-date or raw milk supply and in Victoria, it’s down about 9% or at least forecasted to be down 9% this year.

Are your market share gains in Australia enough to offset that and are we seeing the max impact of those two trends in your numbers now or is it going to hurt more later?

So the max impact is felt in this quarter here. So you're seeing the impact of the 13% reduction and to answer the first part of your question, in terms of the reduction in Australia, we're seeing growth only because we have a large pool of dairy farmers that have indicated they want to sell us their milk coming off of some of our -- the missteps of our competitors.

So we're feeling the effects of maybe two or three years of consistent messaging to the dairy farmers in Australia and it's paying dividends now for us.

Good afternoon. Just a question on the international segment, I guess, sort of following up on some of the comments you've already made, but obviously you’ve had a lot of success in developing more profitable domestic business.

And my question I guess is, as international prices recover, does having this larger domestic business mean that you'll have less product available for export or has your access to milk and milk supply grown enough that you can capture additional upside as international prices rebound?

Thank you for the question, Mark. We can capture the upside because we're really sourcing our products from three different platforms for the international market.

Right now, the international business is sourcing less than 5% of the US production. We have an ability to increase the allotment that the US is going to be manufacturing for international.

So the beautiful thing about our set up is that we can shift things around if we need. So if we believe that there's greater value in selling into the domestic market in Argentina than there is in going into export, but the export demand is there and it's profitable, then we can source product from either the Australian platform and/or the Argentinian platform.

Now, I did talk about our last conference call, where we have upwards of about 250 million liters of milk that are waiting on the sidelines for us in Australia. Don't forget that that milk is ultimately going to be processed in our Australian platform and that cheese is going to have to find a home.

And so even if we've got increases in the domestic markets, whether it's Argentina or Australia, we believe we have enough capacity and enough milk to be able to service the growing demand in international.

Okay. That's really helpful.

And then I guess just on another topic, could you just remind us how you look at the NCIB, I mean obviously I understand you balance that against the opportunities in front of you in terms of M&A, but how do you look at NCIB, is it an opportunistic approach or how do you look at it today? Thanks.

I would say we're looking to our NCIB the same way as we look to the NCIB over the course of last six or eight years that it’s in force. Essentially, we provide through the outlook our intention to review the NCIB over the course of this actual year, we had the opportunity to repurchase shares on the market.

And certainly as we mentioned in the past, for us certainly, direction of cash as a first direction is certainly for acquisitions, dividend and CapEx and I would say the last debt reductions certainly, but the last resort potentially for excess [indiscernible] or repurchase of our shares. So it’s not different today than it used to be for last several years.

Hey, thank you very much and good afternoon. Just want to ask a little bit about Canada again.

Could you give us a little more color on how well you're doing in those -- in that market. You mentioned that you're up in all three major sub-indices, is there some kind of new programs you're working with certain partners on that are really paying dividends, any color you can provide would be helpful.

Yes. So not much more than what has already been stated.

I think that what's important for us is that we identify the leading horses in the race and when the RFPs come out, we're not going to be present in all RFPs. There's just some business that doesn't seem to be interesting for us, either because it's not profitable or it's just spot business.

And what we’d like to do is have a long-term vision, a long-term look and we like to have compelling arguments and compelling reasons for banners to stick with us for the long haul. When it comes to building relationships, we're looking at ten years, fifteen, twenty years down the road and when we do that analysis, we want to make sure that the horses we’re connected with are the ones that are leading the race.

So I think we've been successful at that. At times, we're prepared to forgo some business, ultimately to re-pick it up under better conditions in the future, but again it's not a short term gain for us.

We're really actually looking at building strong foundations for the future.

Just with regard to ERP system and some CapEx around that, can you give us an idea of where things stand there, how implementation is going on new systems?

We are actually essentially from a CapEx standpoint, the first quarter; we spent about 22 million through this extra quarter. So it’s in line essentially with what we budget at the beginning of the year, actually for which the entire, this year, we're planning about $91 million, $92 million out of the $250 million project for which we start in the fiscal ‘16 for which we spent about $48 million.

So we're all on the line from the CapEx spending and stuff like that. Essentially in term of the building of the system or essentially it’s an ongoing process actually, there is some division that essentially we’re looking to implement and starting the implementation as soon as next January, so essentially Argentina in the ground product.

So it’s all we’d see under timetable is followed and we are very satisfied with the process so far.

And final question just on the usual, could you talk a little bit about the environment for M&A globally and your goals versus opportunities and what you're seeing?

So we like to keep our balance sheet clean, we deleverage as often and as quickly as we can. So we've got quite a bit of financial flexibility to make acquisitions.

The issue for us is not so much having the financing to move forward, it's identifying those companies that actually would have a good strategic fit at the price under the right conditions. And so we are involved in a number of files on an ongoing basis, historically we've had three or four files on our table.

We currently have three or four files on our table. Again, the conditions need to be right, the price has to be right, but most importantly strategic fit needs to be right and sometimes we go down the road through a process and perhaps a company is not as strategic as we initially thought and we move on to a different file.

But again, I think the runway still is very, very long for us, if I look at defragmentation of the dairy industry globally, I think there still are some great opportunities for us to continue to grow the business and this is why we need to keep our balance sheet clean so when the right opportunity comes along that we're ready to jump on it.

So when I look at the price of your stock and I think about M&A target prices, I mean, it fair to say right now that prices have been a lot more elevated in the market and that's causing a little bit of missed opportunity, not missed opportunity but a barrier to some deals happening out there?

No, I wouldn't say that I think the multiples that we're seeing on the market now are still close to 10% to 12% which is what we've paid in the past. I mean we've paid as low as four times EBITDA, we've paid as high as 10 to 12 times EBITDA and there's a reason why we would pay four and a reason why we would pay 12.

But normally what's stopping us from a deal is not so much price, more often than not is the reason that we don't do a deal is because somewhere in due diligence we discover something that perhaps is something that we're not prepared to live with. We've built this company over 62 years and there's a 62 years of blood, sweat and tears behind us and we need to make sure that we're not going to make an acquisition for the wrong reason.

We're certainly not ego oriented, we want to continue to build this business for the next generation and make sure that our foundations remain as solid as they've ever been. Sometimes that means that for a very, very good asset we might pay a premium, we may pay beyond 12% if the justification was there.

So the issue is not that we're cheap or we're tight on money it's that we're very, very, very disciplined when it comes to buying the right assets and is perhaps what holds us back more than anything else.

Lino, starting about six months ago - six or nine months ago on these conference calls you became very bullish in your outlook on international dairy commodity prices, now the commodities have turned the corner and I'm just wondering if you're still as constructive in your outlook as you have been over the last couple of calls?

Absolutely. I think that the buyers in the markets are coming back.

If I think about the drivers of price increases like China they're back on the market. Brazil is back on the market.

Russia is always looking for products but the embargo impede some countries from selling into Russia but there are always buyers of dairy. If I think about some of the other emerging markets, the Middle East, the buyers are back in the market.

So I'm still bullish about it now. Perhaps we haven't seen the impact on our results yet because again, we're coming off the tail of some contracted volumes and prices that we had.

I think going into our fourth quarter and this is that very similar to what I said in previous conference calls, going into our fourth quarter I think we should expect to see the lift in prices.

A question on a different topic. You've talked in the past that if the right acquisition came along you would return to Europe and you’ve talked about some of the parameters I think the larger element being that you want scale.

What I was wondering though, if Saputo was to undertake a substantial acquisition in Europe, I mean, how would you - like what would your thinking be on how you would create value, I mean there is no synergies because you have no other operations there. In Australia, my sense is, it has created a lot of value by taking a lot of milk production market share, what you're thinking in Europe.

I mean how can Saputo create value through a European acquisition?

So let me start off by saying that there is no more must haves for us, I think we - the must haves have been Australia was a must have, Argentina was a must have, further development in the US was a must have, when you think about acquisitions like Land O'Lakes and Alto Dairy, those were all must haves because they really put us on the map. Now we're looking at acquisitions that are nice to haves and I would say that our European platform would be a nice one to have under the right condition.

We need size, we need scale, we need scope, we need brands and I think we can leverage that quite well not so much exclusively for the European market but perhaps to complement our international offerings. Europe is a huge exporter into the world market and you have to be cognizant of the fact of how important they are in terms of overall volume and in terms of overall product.

And so I think that it could be another tool in our belt when it comes to selling product around the world. So I think there could be perhaps not so much synergies from an operational perspective but I think synergies from a sales perspective of going into the 40, 50 different countries around the world with a new platform I think would be very interesting for us.

But it is certainly not a much have.

I’m wondering if you could speak to how the food service cheese business is doing and I’m thinking of Canada and the US, not excluding dairy food sort of business.

So, in Canada, food service continues to perform quite well, it's a very stable business. We have grown our volume in the food service sector even though the growth in food service has been modest.

So, not a whole lot of events in Canada, not a lot of things changing between food service and retail from what we've seen historically. What we have seen though in the US is a little bit of a slowdown in terms of overall food service traffic.

And so we - even though we do outpace the market, the food service business is a little softer, we've seen that over the last quarter in the US.

And just in terms of the dairy foods business, has the price of butter comes – seems to be coming down in the US. I take it that you will smooth also on the down side with your customers?

Well, yes we do have pricing protocols that do reflect the input costs which would be raw material.

Just following up on the whole question of the right kind of acquisition versus the not the right kind, would you be able to give us some examples obviously not specific names but of the kinds of things that you might find during a due diligence process that might make an asset that from the outside looks compelling far less so as you get more engaged.

So, when we, you know, typically the process the way it works is we'll get a teaser and the teaser looks actually quite good and then we'll sign on with a confidentiality agreement and then receive the full binder and the binders typically are marketed extremely well. And so you look through the binder and you say well this you know we've got great volume of milk, I got great diversification of customer profiles great brands, great products, good infrastructure because everybody says that they are state-of-the-art in terms of manufacturing and then all of a sudden we get into a letter of intent and we visit the plants and we meet the management and the book is not as compelling as the movie.

And so we recognize that sometimes if the assets are not quite as good as they thought or we thought and that would require far too much capital investment. Sometimes there are some lingering issues like environmental issues that we're not prepared to deal with or not prepared to absorb.

Sometimes, when you think about the level of profitability and we've been in this game quite a long time when you think about what they're putting down in terms of profitability and what we estimate in our pro forma the profitability to be there might be a disconnect. So for a number of different reasons we might have a bad sense or a bad feeling for what the book is telling us and what we saw in the movie and that's when we would make the assessment as a management team that is something we either want to pursue or we don't want to pursue.

For the US, you talked about market factors boosting EBITDA by $20 million but a lot of the commodity prices were similar year-over-year and a lot of those factors that you listed in your table are actually very similar year-over-year. So can you talk and give us a little bit more color as to what the key market factors were that were driving that $20 million improvement.

And again the market factor is always in comparison to the previous year. If you look at block market last year or even this year, first of all it was a wrap up from closing price at the end of first quarter to the end of the second quarter.

Certainly better realization of inventory and if you're looking to Q2 last year, it was completely reversal. So that is the main effect.

Because I was looking at the - based on the closing price that you’re showing there's 166 in Q1 and then 153 in Q2 of ’17, so not quite sure I understand your explanation.

In Q2, if you're looking to Q1 of this year essentially the block price [indiscernible] wrap up in terms of the block price.

So it’s the average pricing, right?

I’m talking about the closing price.

Maybe these are reversed in the press release.

And last year essentially it was pretty flat from 164 to 160.

I was hoping I try again some info on breakdown. Back in the day, I think you breakdown some things in food service, industrial, retail.

I was as wondering if you can give us any color where you guys sit now in the US in those businesses and I assume that retail is probably one of your more profitable ones given the brands but maybe you can kind of rank order them in terms of the margins as well?

So in the US I would say that - I would say about 60% of our volume maybe 55% of our volume would be at a food service level. I would say about - and the balance would be split between retail and ingredient, ingredient being about 10%.

So that would be pretty well the mix that we have been in the US channel of sales.

I noticed - so that’s your mix, what about the margin breakdown, how does that work?

Well, the margins in the US, it’s hard to tell on a year over year basis because it depends on where the block market is, we may be more profitable at retail versus food service when the black market is low but we're more profitable on the food service then retail when the block market is high. So it all depends on where the block market is because it's not a stable market.

So that kind of gets to the question of fixed and floating contracts for sale. Can you give us a breakdown there and how that's been trending?

Well we don't have a lot of fixed contracts on the food service side most of our contracts will be on the retail side. And the retail side what we typically do is, we’ll peg a number where we think the block market is going to be and we trade spend on or off of that.

So for instance if we think the block market is going to be at $1.50 and I'm not quoting prices here, but I'm just giving examples. If we think the block market is going to be at $1.50 we might peg our price at $1.75.

If it happens to be beyond $1.75, then ultimately we'll do less trade spending to try to come in line with profitability. If the market ends up going to a $1.25 then we got a lot more margin to trade spend and try to lift some volume there.

So it's really a floating exercise that we have and that will change from month to month and quarter to quarter.

So when you go up positive or offside on that quarter to quarter depending on how you kind of peg things does that included in your market factor kind of calculation or is that just something that you put into the regular numbers?

That comes out into our profitability numbers and you'll see that in the trade spend and promotion.

And you don't publish the trade spend and promotion right?

No, we don't do that.

Brands, I’m noticing the word brands come up a lot more with you now. Maybe it's because - nice to have is kind of what you're looking for in acquisitions now and it seems to me that the formation of the global enterprise now is going to rely more on brands, would that be kind of a fair statement?

Oh, the brands are always very good to have because you're able to control your own destiny to the market especially when it comes to retail. But if there would be an opportunity for us to make an acquisition in the commodity style business, someone who is manufacturing for private labels, someone who is cutting and wrapping for retail or food service in the private label arena that could also work well for us.

We have operational expertise and we know that we can make assets and plants and equipment run perhaps more effectively and more efficiently with the experience that we have under our belts. And so we would not shy away from a commodity oriented business, although brands will carry the day when it comes to controlling your own destiny.

I was a little confused on the Argentinean operation and the translation of profitability or revenues in Argentina back to Canadian dollars. Does the currency not go against you on that in this quarter?

Yeah, that’s why on the revenue side, we were [indiscernible].

But did it somehow help in the export market?

Yeah, there is two factors, if you're looking to Argentina, first of all in terms of the truncated version of our essentially subsidiary in Argentina, it’s all in Argentinean peso its being converted to Canadian dollars. So there is negative impact because there evaluation of the pesos.

[indiscernible] when we’re looking to international trade, we are trading essentially in US dollar and there is certainly a benefit for us trading in US dollar, when you're facing essentially or bringing back US dollar in Argentina and covering that into pesos [indiscernible] there is two difference things.

Is that helping on the volume out of Argentina or just that it's more pesos?

The US dollar is helping and we’re seeing devaluation of the pesos [indiscernible] when you’re bringing that back, certainly a good impact from a profitability standpoint.

Thank you very much Jennifer.

We thank you for taking part in this call. We hope you'll join us for the presentation of our fiscal 2017 third quarter results on February 2, have a nice day.