24 Weeks Ended June 19, 2004
TORONTO, July 30 /CNW/ -
FORWARD-LOOKING STATEMENTS
This Quarterly Report for George Weston Limited ("Weston") and its subsidiaries (collectively referred to as the "Company"), including the Management's Discussion and Analysis ("MD&A"), contains certain forward- looking statements. Such statements relate to, among other things, sales growth, the integration of operations of acquired businesses, the expansion and growth of the Company's business, future capital expenditures and the Company's business strategies. Forward-looking statements are subject to inherent uncertainties and risks including but not limited to: general industry and economic conditions, changes in the Company's relationships with its suppliers, pricing pressures and other competitive factors, the availability and cost of raw materials and ingredients, fuels and utilities, the results of the Company's ongoing efforts to improve cost effectiveness, the rates of return on the Company's pension plan assets, changes in the regulatory requirements affecting the Company's business and the availability and terms of financing. Other risks are outlined in the Operating and Financial Risks and Risk Management sections of the MD&A included in Weston's 2003 Annual Report. Consequently, actual results and events may vary significantly from those included in, contemplated or implied by such statements. In evaluating forward-looking statements, readers should specifically consider the various factors which could cause actual events or results to differ materially from such forward-looking statements.
Report to Shareholders
George Weston Limited's second quarter basic net earnings per common share was $1.04, a decrease of 26.8% compared to $1.42 in 2003. This decrease was attributed to the decline in operating results for the Weston Foods United States operations and included the negative impact of foreign currency translation. As more fully discussed in the attached MD&A, higher net stock-based compensation costs including the impact of the related equity derivatives resulted in a charge of $0.06 per common share in the current quarter's results compared to a corresponding income of $0.07 per common share in the second quarter of 2003.
Sales increased 2.9% to $7.0 billion for the quarter including the negative impact of approximately 1.3% due to foreign currency translation of the Weston Foods operating results. Sales were impacted positively by the 4.7% sales increase achieved by the Food Distribution operating segment, operated by Loblaw Companies Limited ("Loblaw"). Sales were impacted negatively by the Weston Foods sales decline of 5.3% which includes a negative impact of approximately 8% due to foreign currency translation.
Operating income declined 7.2% to $400 million for the second quarter of 2004, compared to $431 million in 2003. Consolidated operating margin for the quarter declined to 5.8% from 6.4% in 2003. The net effect of the stock-based compensation charge resulted in a decrease to reported operating income of approximately 4% when compared to the same period of 2003. In addition, the consolidated operating margin for the quarter was impacted positively by an increase in the Food Distribution operating margin to 5.9% from 5.4% in 2003 and negatively by a decrease in the Weston Foods operating margin to 4.3% from 10.9% in 2003.
Interest expense increased primarily due to higher average borrowing levels. The effective income tax rate for the second quarter increased principally as a result of the income tax impact of net stock-based compensation costs.
The outlook for the remainder of the year for Food Distribution is for continued good net earnings growth and strengthening growth in sales. Loblaw is in the process of adding substantial new retail square footage into the marketplace supporting the good progress that is being made on the rollout of the general merchandise program. Loblaw's financial position and cash flow generation is expected to continue at strong levels.
Weston Foods sales growth for the remainder of the year is expected to continue to be positive, consistent with current trends, excluding the impact of foreign currency translation. Earnings growth for the remainder of the year is expected to continue to be negative as compared to the previous year. The current consumer trend away from traditional white flour based products and the ongoing cost pressures from higher ingredient, energy and employee related costs are expected to continue to negatively impact Weston Foods earnings as the year progresses. However, price increases in key product categories are expected to have a more significant impact in the final two quarters of 2004.
While Weston Foods United States results have been impacted more than anticipated, our competitive position remains strong. In both Weston Foods and Food Distribution, appropriate strategies to ensure long term growth are in place and will continue to be implemented.
(signed)
W. Galen Weston
Chairman and President Toronto, Canada
July 29, 2004
Management's Discussion and Analysis
The following MD&A for George Weston Limited should be read in conjunction with Weston's 2004 unaudited interim period consolidated financial statements and the accompanying notes included on pages 16 to 24 of this Quarterly Report and the annual consolidated financial statements and the accompanying notes for the year ended December 31, 2003 and the related annual MD&A included in Weston's 2003 Annual Report. Weston's 2004 unaudited interim period consolidated financial statements and the accompanying notes have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP") and are reported in Canadian dollars. A glossary of terms and ratios used throughout this Quarterly Report can be found on page 94 of Weston's 2003 Annual Report. In addition, this Quarterly Report includes the following terms: rolling year return on average total assets, which is defined as operating income for the latest four quarters divided by average total assets excluding cash, cash equivalents, short term investments and the Domtar investment and rolling year return on average shareholders' equity, which is defined as net earnings available to common shareholders for the latest four quarters divided by average total common shareholders' equity. The information in this MD&A is current to July 29, 2004, unless otherwise noted.
CONSOLIDATED RESULTS OF OPERATIONS
Sales
Sales for the second quarter of 2004 increased 2.9%, or $197 million, to $7.0 billion from $6.8 billion in 2003 with year-to-date sales of $13.5 billion also 2.9% ahead of last year. The impact of foreign currency translation due to the strengthening Canadian dollar on the Weston Foods operating segment negatively impacted consolidated sales by approximately 1% for the second quarter and 2% on a year-to-date basis. The Company's consolidated sales for the second quarter were impacted by each of its reportable operating segments as follows:
- Negatively by 0.8% due to a sales decline of 5.3% at Weston Foods, due to the impact of foreign currency translation which negatively impacted Weston Foods reported sales growth by approximately 8%.
- Positively by 4.0% due to sales growth of 4.7% at Food Distribution with all regions across the country experiencing sales growth over the prior year.
- Marginally due to a sales decline of 23.5% at Fisheries which was impacted by the negative publicity directed toward the farmed salmon industry early in the first quarter.
Operating Income
Operating income for the second quarter of 2004 decreased 7.2% to $400 million compared to $431 million in 2003, including a $7 million charge (2003 - income of $12 million) for stock-based compensation net of the impact of the related equity derivatives due to the change in Weston's and Loblaw's market price per common share from the end of the first quarter. The Company's operating income for the second quarter was impacted by each of its reportable operating segments as follows:
- Negatively by 16.9% due to an operating income decline of 62.4% at Weston Foods, primarily due to lower operating margins and higher stock-based compensation cost net of the impact of the related equity derivatives.
- Positively by 10.4% due to an operating income increase of 14.3% at Food Distribution, primarily due to net improvements in operating margins partially offset by higher stock-based compensation cost net of the impact of the related equity derivatives.
- Marginally due to operating losses at Fisheries.
Operating income for 2004 year-to-date decreased 3.8%, or $29 million, to $744 million compared to $773 million last year, including a $19 million charge (2003 - income of $10 million) for stock-based compensation net of the impact of the related equity derivatives due to the change in Weston's and Loblaw's market price per common share from year end 2003.
The Company's 2004 consolidated operating margin for the second quarter declined to 5.8% from 6.4% last year with year-to-date consolidated operating margin of 5.5% in 2004 compared to 5.9% in 2003. The 2004 consolidated EBITDA (see Supplementary Financial Information beginning on page 14) margin for the second quarter declined to 7.7% from 8.3% last year with year-to-date consolidated EBITDA margin of 7.5% in 2004 compared to 7.8% in 2003. The consolidated operating margin declined in the second quarter of 2004 and on a year-to-date basis due to higher stock-based compensation cost net of the impact of the related equity derivatives and lower operating margins at Weston Foods, partially offset by improved operating margins at Food Distribution.
Interest Expense
Interest expense for the second quarter of 2004 increased $22 million, or 38.6%, to $79 million from $57 million in 2003. The increase is explained as follows:
- Net long term interest expense increased $25 million, or 41.0% to $86 million from $61 million in 2003 as a result of an increase in average long term borrowing levels and the lower net positive effect of the Company's interest rate, currency and equity derivative agreements.
- Net short term interest income of $2 million compared to interest expense of $2 million in 2003 due primarily to higher average short term investment levels.
- During the second quarter of 2004, $5 million (2003 - $6 million) of interest expense was capitalized to fixed assets.
Interest expense year-to-date increased $48 million to $158 million from $110 million in 2003 as a result of an increase in average long term borrowing levels and the lower net positive effect of the Company's interest rate, currency and equity derivative agreements.
Income Taxes
The Company's effective income tax rate for the second quarter increased to 32.7% from 29.7% in the same period in 2003 as a result of the income tax impact related to stock-based compensation and the associated equity derivatives offset somewhat by the Canadian federal statutory income tax rate decline. The year-to-date effective income tax rate decreased to 31.1% compared to 31.4% in 2003 as a result of declining Canadian federal statutory income tax rate and Loblaw's successful resolution in the first quarter of 2004 of certain income tax matters from a previous year of $14 million which were partially offset by the income tax impact related to stock-based compensation and the associated equity derivatives. The Company's effective income tax rate also varies as the taxable income by jurisdiction varies from period to period.
Net Earnings
Net earnings for the second quarter of 2004 decreased $53 million, or 27.5%, to $140 million from $193 million in 2003 and year-to-date decreased $66 million, or 20.2% to $261 million from $327 million last year. Basic net earnings per common share for the second quarter of 2004 decreased $0.38, or 26.8%, to $1.04 from $1.42 in 2003 and year-to-date decreased $0.46 or 19.3% to $1.92 from $2.38 last year. The decrease in net earnings was partially offset by the impact of lower weighted average common shares outstanding due to the purchase for cancellation of approximately 3.5 million common shares over the latest four quarters. The second quarter 2004 basic net earnings per common share included a charge of $0.06 per common share from the negative net after-tax effect of the stock-based compensation and the related equity derivatives which compared to a corresponding positive impact of $0.07 per common share in the second quarter of 2003. On a year-to-date basis, the 2004 basic net earnings per common share included a charge of $0.15 per common share compared to a corresponding income of $0.06 per common share in the comparable period of 2003 from the net after-tax effect of the stock-based compensation and the related equity derivatives.
REPORTABLE OPERATING SEGMENTS
Weston Foods
Sales
Weston Foods sales for the second quarter of $1.0 billion declined 5.3%, or $57 million compared to last year, negatively impacted by approximately 8% due to foreign currency translation. Overall volume increased by 1% for the second quarter driven by the introduction of new and expanded product offerings and increased sales with alternate format retailers. Continued changes in the product sales mix and price increases in key product categories contributed positively to sales growth for the quarter by approximately 2%. The consumer trend toward lower carbohydrate ("low-carb") products continued to negatively impact sales of traditional white flour based products during the second quarter. However, Weston Foods' sales mix has continued to benefit from strong sales growth in the whole grain and premium product categories including growth in low-carb products. Weston Foods remains well positioned to meet the consumers increasing demand for healthier and more convenient products.
For the first half of the year, sales of $2.1 billion were 6.7% behind last year, negatively impacted by approximately 9% due to foreign currency translation. Overall volume increased by 1% with changes in the product sales mix and price increases contributing positively by approximately 1% to sales growth year-to-date, consistent with the second quarter.
Operating Income
Weston Foods operating income for the second quarter of $44 million decreased 62.4% compared to last year. Operating margin declined to 4.3% from 10.9% in 2003 and EBITDA margin also declined to 7.7% from 14.1% in 2003. The negative impact of foreign currency translation combined with higher stock-based compensation costs net of the impact of the related equity derivatives negatively impacted Weston Foods operating income growth by approximately 8% during the quarter. Although operating income for the quarter was positively impacted by increased sales volume and prices, this was more than offset by the negative impact of higher ingredient, energy and employee related costs as a result of the significant inflation being experienced in these cost areas. In addition, the complexities associated with the introduction of several new and expanded product offerings during the first half of 2004, resulted in higher operating costs during the second quarter. Higher ingredient and production costs incurred as a result of the change in product sales mix as well as higher promotional and waste costs, including costs incurred to support the launch of new products, continued to negatively impact the operating margin during the quarter. The contribution from the new products introduced in 2004 is not expected to fully compensate for the declines being experienced in the traditional white flour based bakery products in the near term.
Weston Foods year-to-date operating income of $91 million was 54.5% below 2003. Operating margin declined to 4.4% from 9.1% in 2003 and EBITDA margin also declined to 7.7% from 12.3% in 2003. The negative impact of foreign currency translation combined with higher stock-based compensation costs net of the impact of the related equity derivatives negatively impacted Weston Foods operating income growth by approximately 10% on a year-to-date basis. Although operating income for the quarter was positively impacted by increased sales volume and prices, this was more than offset by higher operating costs, as noted above.
Food Distribution
Sales
Food Distribution sales for the second quarter of $6.1 billion increased 4.7% or $271 million compared to last year. All regions across the country experienced sales growth over the prior year.
The increase in sales resulted from a same-store sales growth in the quarter of 1.2% and, during the latest four quarters, an increase of 2.5 million square feet of net retail square footage related to the opening of 69 new corporate and franchised stores and the closure of 69 stores, inclusive of stores which have undergone conversions and major expansions. During the second quarter of 2004, 19 new corporate and franchised stores were opened and 14 stores were closed resulting in a net increase of .7 million square feet. National food price inflation as it impacts the Loblaw business has declined from between 1% and 2% in 2003 to a nominal amount of net deflation in 2004. Non-food retail sales growth continued to outpace that of food retail sales growth in the quarter.
For the first half of the year, sales of $11.7 billion were 5.1% ahead of last year resulting from a year-to-date same-store sales growth of 1.6% and an increase in net retail square footage during the latest four quarters as noted above. In the first two quarters, 31 new corporate and franchised stores were opened and 31 stores were closed resulting in a net increase of 1.2 million square feet or 2.8% from year end.
Operating Income
Food Distribution operating income for the second quarter of $359 million increased 14.3%, or $45 million, compared to last year, after a charge of $3 million (2003 - income of $5 million) related to the stock-based compensation net of the impact of the related equity derivatives. Operating margin for the quarter improved to 5.9% compared to 5.4% in the comparable period of 2003. EBITDA margin improved to 7.6% from 7.0% in 2003. The gross margin percentage for the quarter improved when compared to the same period in 2003 as the investment in selling prices in certain markets was offset by an improvement in product mix and buying synergies. The improvement in operating margins also resulted from efficiency improvements in supply chain together with additional leverage coming from fixed costs in stores opened during the last several years. Approximately $6 million (2003 - $1 million) of operating income in the quarter was generated from initial fees associated with the franchising of existing sites.
Consistent with the quarter, Food Distribution operating income for the first half of 2004 increased $81 million, or 13.9%, to $662 million, with an operating margin of 5.6% as compared to 5.2% in the corresponding period in 2003. EBITDA margin year-to-date improved to 7.3% from 6.8% in 2003. Improvements in operating income were partially offset by a year-to-date charge of $10 million (2003 - income of $3 million) for stock-based compensation net of the impact of the related equity derivatives due to the change in Loblaw's market price per common share from year end 2003.
Fisheries
Sales
Fisheries sales for the second quarter of $39 million decreased 23.5%, or $12 million, compared to last year and year-to-date sales of $73 million decreased 24.7% compared to last year, primarily due to lower harvest volumes and depressed demand which was impacted by the negative publicity directed toward the farmed salmon industry early in the year. Fresh salmon market average prices for the second quarter of 2004 were below the second quarter of 2003 and on a year-to-date basis were marginally below 2003.
Operating Income
Fisheries operating loss for the second quarter of $3 million compared to a break even operating income in 2003 with a year-to-date operating loss of $9 million, marginally higher than last year. The decline in operating income for the second quarter of 2004 was due to lower fresh salmon market average prices compared to last year. A return to profitability remains dependent upon price improvements.
CONSOLIDATED FINANCIAL CONDITION
Financial Ratios
The Company's net debt (excluding the Exchangeable Debentures) (see Supplementary Financial Information beginning on page 14) to equity ratio at the end of the second quarter of 2004 was 1.20:1 compared to 1.12:1 in the same period of 2003 and 1.15:1 at year end 2003. The increase in 2004 in this ratio from the comparable period in 2003 resulted in part from the decrease in shareholders' equity due to the purchase for cancellation of Weston common shares over the latest four quarters along with the impact on net debt due to increased funding requirements, primarily due to working capital requirements and the purchase for cancellation of Loblaw common shares. The interest coverage ratio for the second quarter of 2004 was 5.1 times compared to 7.6 times in the second quarter of 2003 and the 2004 year-to-date ratio was 4.7 times compared to 7.0 times last year due to lower operating income and higher interest expense.
The Company's rolling year return on average total assets (see Supplementary Financial Information beginning on page 14) at the end of the second quarter of 2004 of 11.5% was slightly lower than the return of 12.1% in the comparable period of 2003 and the year end 2003 return of 12.0%. The Company's rolling year return on average common shareholders' equity of 17.0% at the end of the second quarter of 2004 declined compared to 19.1% in the comparable period of 2003 and the year end 2003 return of 19.4%.
Dividends
On July 1, 2004, common dividends of $0.36 per common share and preferred dividends of $0.32 per preferred share, Series II were paid as declared by Weston's Board of Directors (the "Board"). On June 15, 2004, preferred dividends of $0.36 per preferred share, Series I were paid as declared by the Board. The quarterly common dividend increased by 20% over the prior year.
Outstanding Share Capital
Weston's outstanding share capital is comprised of common shares and preferred shares. An unlimited number of common shares is authorized and 128.9 million common shares were outstanding at quarter end. An unlimited number of preferred shares Series I and Series II are authorized and 9.4 million preferred shares Series I and 10.6 million preferred shares Series II were outstanding at quarter end. Further information on the Company's outstanding share capital is provided in Note 9 to the unaudited interim period consolidated financial statements.
Subsequent to quarter end, Weston entered into an agreement to acquire Boulangerie Gadoua Ltée, a bakery business which operates three bakeries in Quebec, Canada. The purchase is subject to regulatory approval and is expected to close by the end of 2004. The agreed upon purchase price includes the issuance, on closing, from treasury of 58,733 Weston common shares as partial consideration.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows from Operating Activities
Second quarter 2004 cash flows from operating activities were $415 million compared to $488 million in the comparable period of 2003. On a year-to-date basis, cash flows from operating activities were $137 million compared to $243 million in 2003. The decrease over the last year is primarily attributable to lower net earnings and the investment in non-cash working capital by Loblaw.
On an annual basis, the cash flows from operating activities are expected to fund a significant portion of the Company's funding requirements including the anticipated 2004 capital investment activity of approximately $1.6 billion.
Cash Flows used in Investing Activities
Second quarter 2004 cash flows used in investing activities were $259 million compared to $102 million in the comparable period of 2003. On a year-to-date basis, cash flows used in investing activities were $437 million compared to $258 million in 2003.
Capital investment for the second quarter of 2004 totaled $348 million (2003 - $310 million) and $589 million (2003 - $534 million) year-to-date as the Company continues its commitment to maintain and renew its asset base and invest for growth within North America.
During the second quarter of 2004, Loblaw, through its wholly owned subsidiary President's Choice Bank, securitized $72 million (2003 - $75 million) of credit card receivables, under its securitization program and $127 million (2003 - $154 million) year-to-date, yielding a minimal gain based on assumptions disclosed in Note 9 of the consolidated financial statements included in Weston's 2003 Annual Report.
Cash Flows used in/from Financing Activities
Second quarter 2004 cash flows used in financing activities were $52 million compared to $45 million in 2003. On a year-to-date basis, cash flows from financing activities were $461 million compared to $452 million in 2003. During the first quarter, Weston issued $200 million of 5.05% Medium Term Notes ("MTN") due 2014 and Loblaw issued $200 million of 6.15% MTN due 2035, both pursuant to their respective 2003 Base Shelf Prospectuses. Also during the first quarter, Weston repaid its $200 million Series A, 7.45% Debentures which matured during the first quarter.
In the first quarter of 2004, Weston renewed its Normal Course Issuer Bid ("NCIB") to purchase on the Toronto Stock Exchange or enter into equity derivatives to purchase up to 6,442,692 of its common shares, representing approximately 5% of the common shares outstanding. Weston, in accordance with the rules and by-laws of the Toronto Stock Exchange, may purchase its shares at the then market prices of such shares.
During the first quarter of 2004, Weston purchased for cancellation 587,200 of its common shares for $59 million, pursuant to its NCIB. Pursuant to its NCIB, Loblaw purchased for cancellation 132,400 of its common shares for $8 million during the first quarter and a further 443,700 of its common shares for $27 million during the second quarter.
During the second quarter of 2004, Weston entered into interest rate swap contracts with a notional value of $200 million which mature in 2014. These interest rate swaps were designated as a fair value hedge of the $200 million of 5.05% MTN due 2014. Under the terms of the interest rate swaps, Weston will receive a fixed interest rate of 4.8% and pay a floating interest rate.
QUARTERLY RESULTS OF OPERATIONS
The following is a summary of selected consolidated financial information derived from Weston's unaudited interim period consolidated financial statements for each of the eight most recently completed quarters. This information was prepared in accordance with Canadian GAAP and was reported in Canadian dollars. Each of the quarters presented were 12 weeks in duration except for the third quarter which was 16 weeks for each of 2003 and 2002 and the fourth quarter of 2003 which was 13 weeks in duration due to the 53 week fiscal year in 2003.
Quarterly Financial Information (unaudited)
($ millions
except where Second First Fourth Third
otherwise Quarter Quarter Quarter Quarter
indicated) 2004 2003 2004 2003 2003 2002 2003 2002
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Sales $6,951 $6,754 $6,583 $6,399 $7,277 $6,615 $8,768 $8,509
Net
earnings $ 140 $ 193 $ 121 $ 134 $ 252 $ 231 $ 213 $ 190
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Net
earnings
per common
share ($)
Basic $ 1.04 $ 1.42 $ .88 $ .96 $ 1.87 $ 1.70 $ 1.55 $ 1.37
Diluted $ 1.04 $ 1.42 $ .88 $ .96 $ 1.86 $ 1.70 $ 1.54 $ 1.36
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Sales growth in 2004 has been impacted by the foreign currency
translation at Weston Foods and the pricing activity at Food Distribution as
well as food price deflation in certain Canadian markets. The overall decrease
in net earnings for 2004 was impacted as follows:
- Negatively by higher stock-based compensation net of the impact of
the related equity derivatives,
- Negatively by the impact of the foreign currency translation and
higher operating costs at Weston Foods,
- Positively by the impact of the operating efficiency improvements at
Food Distribution,
- Negatively by the increase in interest expense, and
- Positively by the decline in income tax expense.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in accordance with Canadian GAAP
requires management to make estimates and assumptions that affect the reported
amounts and disclosures made in the consolidated financial statements and
accompanying notes. Management continually evaluates the estimates and
assumptions it uses. These estimates and assumptions are based on management's
historical experience, best knowledge of current events and conditions and
activities that the Company may undertake in the future. Actual results could
differ from these estimates.
The estimates and assumptions described in this section depend upon
subjective or complex judgments about matters that may be uncertain and
changes in those estimates and assumptions could materially impact the
consolidated financial statements.
Pension, Post-Retirement and Post-Employment Benefits
Certain estimates and assumptions are used in actuarially determining the
Company's defined pension and other benefit plans expense and accrued benefit
plan obligations. These estimates and assumptions include management's best
estimate of the expected long term rate of return on plan assets, salary
escalation, retirement ages, expected growth of health care costs and discount
rates. Market values are used to value benefit plan assets.
Three significant assumptions used to calculate the pension and other
benefit plans expense and the related benefit obligations are the discount
rate, the expected long term rate of return on plan assets and the expected
growth rate of health care costs. These assumptions depend on various
underlying factors such as economic conditions, investment performance,
employee demographics and mortality rates. These assumptions may change in the
future and may result in material changes in the pension and other benefit
plans expense, and in accrued benefit plan assets and liabilities and could
therefore materially affect the Company's operating income and consolidated
balance sheet. The magnitude of any immediate impact however is mitigated by
the fact that net actuarial gains and losses in excess of more than 10% of the
greater of the accrued benefit plan obligation and the market value of the
benefit plan assets are amortized on a straight-line basis over the average
remaining service period of the active employees. Changes in financial market
returns and interest rates could also result in changes in funding
requirements for the Company's defined benefit pension plans.
The discount rate is based on current market interest rates, assuming a
portfolio of Corporate AA bonds with terms to maturity that, on average, match
the terms of the obligation. The appropriate discount rate is determined at
September 30 every year. For 2004, the discount rate for pension benefit plans
and other benefit plans expense was 6.3% and 6.1% respectively and compared to
6.6% and 6.4% respectively in 2003. The expected long term rate of return on
plan assets for pension benefit plans for each of 2004 and 2003 was 8.0%. The
expected growth rate in health care costs was based on external data and the
Company's own historical trends for health care costs and was, in 2004,
consistent with that of 2003. A table illustrating the sensitivity of a 1%
change in each of these significant assumptions on the accrued benefit plan
obligations and benefit plan expense for pension and other benefit plans is
included on page 52 of the MD&A section of Weston's 2003 Annual Report.
Goodwill and Indefinite Life Intangible Assets
Goodwill is not amortized and is assessed for impairment at the reporting
unit level at least annually. Any potential goodwill impairment is identified
by comparing the fair value of a reporting unit to its carrying value. If the
fair value of the reporting unit exceeds its carrying value, goodwill is
considered not to be impaired. If the carrying value of the reporting unit
exceeds its fair value, potential goodwill impairment has been identified and
must be quantified by comparing the estimated fair value of the reporting
unit's goodwill to its carrying value. Fair value of goodwill is estimated in
the same manner as goodwill is determined at the date of acquisition in a
business acquisition, that is, the excess of the fair value of the reporting
unit over the fair value of the identifiable net assets of the reporting unit.
Any goodwill impairment will result in a reduction in the carrying value of
goodwill on the consolidated balance sheet and in the recognition of a
non-cash impairment charge in operating income.
The Company determines the fair value of its reporting units by using a
discounted cash flow model corroborated by other valuation techniques such as
market multiples. The process of determining these fair values requires
management to make estimates and assumptions of a long term nature including,
but not limited to, projected future sales, earnings and capital investment,
discount rates and terminal growth rates. Projected future sales, earnings and
capital investment are consistent with strategic plans presented to the
Company's Board of Directors. Discount rates are based on an industry weighted
average cost of capital. These estimates and assumptions may change in the
future due to uncertain competitive and economic market conditions or changes
in business strategies.
Intangible assets with indefinite lives, primarily consisting of Weston
Foods' trademarks and brand names, are assessed for impairment at least
annually. Any potential intangible asset impairment is identified by comparing
the fair value of the indefinite life intangible asset to its carrying value.
If the fair value of the intangible asset exceeds its carrying value, the
intangible asset is not considered to be impaired. If the carrying value of
the intangible asset exceeds its fair value, impairment is identified as the
difference between the fair value and the carrying value and will result in a
reduction in the carrying value of the intangible assets on the consolidated
balance sheet and in the recognition of a non-cash impairment charge in
operating income.
The Company determines the fair value of its trademarks and brand names
by using the "Relief from Royalty Method", a discounted cash flow model. The
process of determining the fair values requires management to make assumptions
of a long term nature regarding projected future sales, terminal growth rates,
royalty rates and discount rates. Projected future sales are consistent with
strategic plans presented to Weston's Board and discount rates are based on an
industry after tax cost of equity. These estimates and assumptions may change
in the future due to uncertain competitive and economic market conditions or
changes in business strategies.
During the fourth quarter of 2003, the Company performed the annual
goodwill and indefinite life intangible assets impairment tests and determined
that there was no impairment to the carrying value of the goodwill or
indefinite life intangible assets.
Income Taxes
Future income tax assets and liabilities are recognized for the future
income tax consequences attributable to temporary differences between the
financial statement carrying values of assets and liabilities and their
respective income tax bases. Future income tax assets or liabilities are
measured using enacted or substantively enacted income tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The calculation of current and future
income taxes requires management to make estimates and assumptions and to
exercise a certain amount of judgment. The financial statement carrying values
of assets and liabilities are subject to accounting estimates inherent in
those balances. The income tax bases of assets and liabilities are based upon
the interpretation of income tax legislation across various jurisdictions. The
current and future income tax assets and liabilities are also impacted by
expectations about future operating results and the timing of reversal of
temporary differences as well as possible audits of tax filings by the
regulatory authorities. Management believes it has adequately provided for
income taxes based on current available information.
On an ongoing basis, future income tax assets are reviewed to determine
if a valuation allowance is required and if it is deemed more likely than not
that the future income tax assets will not be realized based on taxable income
projections, a valuation allowance is recorded. As at December 31, 2003, total
valuation allowances amounted to $97 million.
Changes or differences in these estimates or assumptions may result in
changes to the current or future income tax balances on the consolidated
balance sheet, a charge or credit to income tax expense and may result in cash
payments or receipts.
ACCOUNTING STANDARDS IMPLEMENTED IN 2004
Effective January 1, 2004, the Company implemented the following
accounting standards issued by the Canadian Institute of Chartered
Accountants:
- Section 3063, "Impairment of Long-lived Assets", addresses the
recognition, measurement and disclosure of impairment of long-lived
assets held-for-use. Long-lived assets are reviewed for impairment
when events or circumstances indicate that their carrying value
exceeds the sum of the undiscounted cash flows expected from their
use and eventual disposal. An impairment loss is measured as the
amount by which the long-lived assets' carrying value exceeds the
fair value. Accordingly, the Company reviews long-lived assets for
impairment annually. Asset groups are reviewed for impairment at the
lowest level for which identifiable cash flows are largely
independent of cash flows of other assets and liabilities. For
purposes of annually reviewing Weston's long-lived assets for
impairment, manufacturing assets are grouped together by major
production category where cash flows are largely dependent on each
other. For purposes of annually reviewing Loblaw's store assets for
impairment, store net cash flows are grouped together by primary
market areas where cash flows are largely dependent on each other.
Primary markets refer to regional areas where Loblaw operates a
number of store formats within close proximity of each other. If an
indicator of impairment, such as sustained negative operating cash
flows exists, then an estimate of undiscounted future cash flows of
each such major production category for Weston or store for Loblaw is
prepared and compared to its carrying value. If Weston's
manufacturing assets or Loblaw's store assets are determined to be
impaired, the impairment loss is measured as the excess of the
carrying value over its fair value. In addition, the Company
evaluates the carrying value of Weston's manufacturing assets and
Loblaw's store assets whenever events or changes in circumstances
indicate that the carrying value of assets may not be recoverable.
These events or changes in circumstances include a commitment to
close, retire or transfer manufacturing assets for Weston and to
close, relocate or convert a Loblaw store where the carrying value of
the assets is greater than the expected future cash flows.
The standard was applied prospectively with no material impact on the
financial condition or results of operations.
- Accounting guideline ("AcG") 13, "Hedging Relationships", addresses
the identification, designation, documentation and effectiveness of
hedging relationships for the purposes of applying hedge accounting
and provides guidance with respect to the discontinuance of hedge
accounting. Financial derivative instruments not designated within an
AcG 13 compliant hedging relationship are measured at fair value with
changes in fair value recorded in the consolidated statement of
earnings in accordance with the Emerging Issues Committee ("EIC")
Abstract 128, "Accounting for Trading, Speculative or Non-Hedging
Derivative Financial Instruments".
Pursuant to the requirements of AcG 13, the Company has formally
identified and documented the following hedging relationships:
Weston's 3% Exchangeable Debentures as a hedge of the anticipated
disposal of the Domtar investment; cross currency basis swaps and
interest rate swaps as cash flow hedges against its exposure to
fluctuations in the foreign currency exchange rate and interest rates
on a portion of its United States dollar denominated assets,
principally cash equivalents and short term investments held by
Loblaw; Loblaw's interest rate swaps as a cash flow hedge of the
variable interest rate exposure on commercial paper; commodity
futures as a hedge of anticipated commodity purchases; and the
electricity forward contract as a cash flow hedge of price volatility
of the Company's electricity costs in Ontario, Canada. Effectiveness
tests were also performed to establish that both at inception
and prospectively the hedging relationships will be effective. The
accounting policies for hedging relationships that meet the
requirements prescribed by AcG 13, are consistent with those
described in the notes to Weston's audited annual consolidated
financial statements for the year ended December 31, 2003.
During the second quarter of 2004, Weston entered into interest rate
swaps designated as a fair value hedge of the $200 million of 5.05%
MTN due 2014.
Hedging relationships that ceased to be eligible for hedge accounting
under AcG 13 were discontinued as of January 1, 2004 except for
Weston's equity forward sale agreement based on 9.6 million Loblaw
common shares as discussed below. The financial derivative
instruments in the hedging relationships that ceased to be eligible
for hedge accounting and were previously recorded on an accrual basis
were fair valued as of January 1, 2004 and the resulting fair value
loss was deferred and is being amortized over the original hedge term
of approximately three years. The resulting impact on the financial
condition and results of operation was not material. Subsequent
changes in the fair value of these financial derivative instruments
will be recognized in interest expense prospectively.
Effective for the third quarter of 2004, hedge accounting will no
longer be permissible for Weston's equity forward sale agreement
based on 9.6 million Loblaw common shares as a result of the
amendment to EIC 56, "Exchangeable Debentures". EIC 56 has been
amended to conform with the provisions of AcG 13, which deal with
items ineligible for hedge accounting, by rescinding the ability to
use hedge accounting if an entity's investment in the underlying
shares is consolidated or is accounted for by the equity method. The
effective date to cease the hedge accounting described is the first
fiscal period commencing after July 1, 2004. As a result of this
amendment to EIC 56, effective for the third quarter of 2004, the
Company will be required to recognize on a prospective basis, the
fair value adjustments of this agreement in net earnings and may have
a significant impact on quarterly net earnings, subject to the
volatility of the market price per Loblaw common share. The fair
value adjustment is a non-cash item and will ultimately be offset by
the recognition of a gain on Weston's disposition of the 9.6 million
Loblaw common shares. At quarter end, the non-cash fair value
adjustment of $125 million has been deferred and recorded in the
balance sheet in other assets and other liabilities. According to the
transitional provisions, the non-cash fair value adjustment as of the
effective date of the amendment to EIC 56 will remain deferred and
included in other assets and other liabilities on the consolidated
balance sheet and will be recognized in net earnings at maturity or
upon termination of the forward sale agreement.
- Section 3110, "Asset Retirement Obligations", establishes standards
for the recognition, measurement and disclosure of legal obligations
associated with the cost to retire long-lived assets. A liability
associated with the retirement of long-lived assets is recorded in
the period in which the legal obligation is incurred at its estimated
fair value and a corresponding asset is capitalized as part of the
related asset and depreciated over its useful life. Subsequent to the
initial measurement of the asset retirement obligation, the
obligation is adjusted to reflect the passage of time and changes in
the estimated future costs underlying the obligation.
Accordingly, the Company has recognized a discounted liability
associated with obligations arising from specific provisions in
certain lease agreements regarding the exiting of leased properties
at the end of the respective lease terms. As well, the Company has
recognized a discounted liability associated with environmental
decommissioning and remediation as required by environmental
regulations which require that certain assets be decommissioned
and/or remediated in a specified manner. The standard was implemented
retroactively with restatement of the prior period consolidated
financial statements. The cumulative effect of implementation was a
decrease to opening retained earnings for 2003 of $9 million (net of
future income taxes recoverable of $5 million), an increase in fixed
assets of $3 million and an increase in other liabilities of
$17 million. The impact on net earnings for each of 2003 and 2004 was
not material.
OUTLOOK
The outlook for the remainder of the year for Food Distribution is for
continued good net earnings growth and strengthening growth in sales. Loblaw
is in the process of adding substantial new retail square footage into the
marketplace supporting the good progress that is being made on the rollout of
the general merchandise program. Loblaw's financial position and cash flow
generation is expected to continue at strong levels.
Weston Foods sales growth for the remainder of the year is expected to
continue to be positive, consistent with current trends, excluding the impact
of foreign currency translation. Earnings growth for the remainder of the year
is expected to continue to be negative as compared to previous year. The
current consumer trend away from traditional white flour based products and
the ongoing cost pressures from higher ingredient, energy and employee related
costs are expected to continue to negatively impact Weston Foods earnings as
the year progresses. However, price increases in key product categories are
expected to have a more significant impact in the final two quarters of 2004.
While Weston Foods United States results have been impacted more than
anticipated, our competitive position remains strong. In both Weston Foods and
Food Distribution, appropriate strategies to ensure long term growth are in
place and will continue to be implemented.
ADDITIONAL INFORMATION
Additional financial information, including Weston's Annual Information
Form, has been filed electronically through the System for Electronic Document
Analysis and Retrieval (SEDAR) and is available online at www.sedar.com.
Supplementary Financial Information
The Company reports its financial results in accordance with Canadian
GAAP. However, the Company has included certain non-GAAP financial measures
and ratios which it believes provide useful information to both management and
readers of this Quarterly Report in measuring the financial performance and
financial condition of the Company. These measures do not have a standardized
meaning prescribed by GAAP and, therefore, may not be comparable to similarly
titled measures presented by other publicly traded companies, nor should they
be construed as an alternative to other financial measures determined in
accordance with Canadian GAAP.
EBITDA
The Company believes EBITDA is useful as an indicator of its operational
performance and its ability to generate cash flows to fund its cash
requirements, including the Company's capital investment program.
The following tables reconcile EBITDA to Canadian GAAP measures reported
in the unaudited consolidated statements of earnings:
-------------------------------
12 Weeks Ended June 19, 2004 12 Weeks Ended June 14, 2003
-------------------------------------------------------------------------
Food Food
($ Weston Distri- Fish- Consol- Weston Distri- Fish- Consol-
millions) Foods bution eries idated Foods bution eries idated
-------------------------------------------------------------------------
Operating
Income $ 44 $ 359 $ (3) $ 400 $ 117 $ 314 $ 431
Depre-
ciation 35 100 2 137 35 91 $ 3 129
-------------------------------------------------------------------------
EBITDA $ 79 $ 459 $ (1) $ 537 $ 152 $ 405 $ 3 $ 560
-------------------------------------------------------------------------
-------------------------------
-------------------------------
24 Weeks Ended June 19, 2004 24 Weeks Ended June 14, 2003
-------------------------------------------------------------------------
Food Food
($ Weston Distri- Fish- Consol- Weston Distri- Fish- Consol-
millions) Foods bution eries idated Foods bution eries idated
-------------------------------------------------------------------------
Operating
Income $ 91 $ 662 $ (9) $ 744 $ 200 $ 581 $ (8)$ 773
Depre-
ciation 68 199 4 271 71 177 5 253
-------------------------------------------------------------------------
EBITDA $ 159 $ 861 $ (5) $1,015 $ 271 $ 758 $ (3)$1,026
-------------------------------------------------------------------------
-------------------------------
The following table provides additional financial information:
As at
---------------
June 19, 2004 June 14, 2003
-------------------------------------------------------------------------
Market price per common share ($) $ 92.75 $ 102.00
Actual common shares outstanding
(in millions) 128.9 132.1
Weighted average common shares
outstanding (in millions) 129.0 132.2
-------------------------------------------------------------------------
---------------
Net Debt
The Company calculates net debt as the sum of long term debt and short
term debt less cash, cash equivalents and short term investments and believes
this measure is useful in evaluating the amount of leverage employed by the
Company. The Company calculates net debt excluding exchangeable debentures as
net debt (as calculated above) less exchangeable debentures and believes this
measure is also useful in evaluating the amount of leverage employed by the
Company as the exchangeable debentures can be settled with the Company's
investment in Domtar common shares included in other assets.
The following table reconciles net debt and net debt excluding
exchangeable debentures to Canadian GAAP measures reported in the unaudited
consolidated balance sheets:
As at
---------------
($ millions) June 19, 2004 June 14, 2003
-------------------------------------------------------------------------
Bank indebtedness $ 130 $ 48
Commercial paper 1,139 916
Short term bank loans 85 50
Long term debt due within one year 307 207
Long term debt 6,026 5,686
Less:
Cash and cash equivalents 1,183 1,370
Short term investments 465 148
-------------------------------------------------------------------------
Net debt 6,039 5,389
Less: Exchangeable debentures 373 375
-------------------------------------------------------------------------
Net debt excluding exchangeable
debentures $ 5,666 $ 5,014
-------------------------------------------------------------------------
---------------
Total Assets
The Company uses the return on average total assets to measure the
performance of operating assets and therefore excludes cash, cash equivalents,
short term investments, and the Domtar investment from the total assets used
in this measure. The Company believes this results in a more accurate measure
of the performance of its operating assets.
The following table reconciles total assets used in the return on average
total assets measure to Canadian GAAP measures reported in the unaudited
consolidated balance sheets
As at
---------------
June 19, 2004 June 14, 2003
($ millions) restated (1)
-------------------------------------------------------------------------
Total assets $ 17,937 $ 17,075
Less:
Cash and cash equivalents 1,183 1,370
Short term investments 465 148
Domtar investment 366 367
-------------------------------------------------------------------------
Total assets $ 15,923 $ 15,190
-------------------------------------------------------------------------
---------------
(1) See Note 1 to the unaudited interim period consolidated financial
statements.
Consolidated Statements of Earnings
(unaudited) 12 Weeks Ended 24 Weeks Ended
-------- --------
($ millions except where June 19, June 14, June 19, June 14,
otherwise indicated) 2004 2003 2004 2003
-------------------------------------------------------------------------
Sales $ 6,951 $ 6,754 $ 13,534 $ 13,153
Operating Expenses
Cost of sales, selling and
administrative expenses 6,414 6,194 12,518 12,127
Depreciation 137 129 271 253
Restructuring and other
charges (note 2) 1
-------------------------------------------------------------------------
6,551 6,323 12,790 12,380
-------------------------------------------------------------------------
Operating Income 400 431 744 773
Interest Expense (note 3) 79 57 158 110
-------------------------------------------------------------------------
Earnings Before the Following: 321 374 586 663
Income Taxes (note 4) 105 111 182 208
-------------------------------------------------------------------------
216 263 404 455
Minority Interest 76 70 143 128
-------------------------------------------------------------------------
Net Earnings $ 140 $ 193 $ 261 $ 327
-------------------------------------------------------------------------
Net Earnings per Common Share ($)
(note 5)
Basic and diluted $ 1.04 $ 1.42 $ 1.92 $ 2.38
-------------------------------------------------------------------------
-------- --------
See accompanying notes to the unaudited interim period consolidated
financial statements.
Consolidated Statements of Retained Earnings
(unaudited) 24 Weeks Ended
----------
($ millions except where June 19, June 14,
otherwise indicated) 2004 2003
-------------------------------------------------------------------------
Retained Earnings, Beginning of Period $ 4,046 $ 3,712
Impact of implementing new accounting standard
(note 1) (9) (9)
-------------------------------------------------------------------------
Retained Earnings, Beginning of Period as Restated $ 4,037 $ 3,703
Net earnings 261 327
Premium on common shares purchased for cancellation
(note 9) (58) (16)
Dividends declared
Per common share - $.72 (2003 - $.60) (93) (79)
Per preferred share
- Series I - $.73 (2003 - $.73) (7) (7)
- Series II - $.64 (2003 - $.64) (7) (7)
-------------------------------------------------------------------------
Retained Earnings, End of Period $ 4,133 $ 3,921
-------------------------------------------------------------------------
See accompanying notes to the unaudited interim period consolidated
financial statements.
Consolidated Balance Sheets
As at
----------
June 19, 2004 Dec. 31, 2003
($ millions) (unaudited) restated (note 1)
-------------------------------------------------------------------------
ASSETS
Current Assets
Cash and cash equivalents $ 1,183 $ 965
Short term investments 465 545
Accounts receivable 982 935
Inventories 2,089 2,049
Future income taxes 161 152
Prepaid expenses and other assets 84 52
-------------------------------------------------------------------------
Total Current Assets 4,964 4,698
Fixed Assets 8,078 7,746
Goodwill and Intangible Assets (note 6) 3,665 3,542
Future Income Taxes 67 79
Other Assets 1,163 1,279
-------------------------------------------------------------------------
Total Assets $ 17,937 $ 17,344
-------------------------------------------------------------------------
LIABILITIES
Current Liabilities
Bank indebtedness $ 130 $ 108
Commercial paper 1,139 696
Accounts payable and accrued liabilities 2,724 2,971
Income taxes 72 181
Short term bank loans 85 67
Long term debt due within one year
(note 8) 307 307
-------------------------------------------------------------------------
Total Current Liabilities 4,457 4,330
Long Term Debt (note 8) 6,026 5,832
Future Income Taxes 243 228
Other Liabilities 610 689
Minority Interest 1,894 1,811
-------------------------------------------------------------------------
Total Liabilities 13,230 12,890
-------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Share Capital (notes 9 and 10) 608 608
Retained Earnings 4,133 4,037
Cumulative Foreign Currency Translation
Adjustment (note 11) (34) (191)
-------------------------------------------------------------------------
Total Shareholders' Equity 4,707 4,454
-------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $ 17,937 $ 17,344
-------------------------------------------------------------------------
----------
See accompanying notes to the unaudited interim period consolidated
financial statements.
Consolidated Cash Flow Statements
(unaudited) 12 Weeks Ended 24 Weeks Ended
-------- --------
($ millions) June 19, June 14, June 19, June 14,
2004 2003 2004 2003
-------------------------------------------------------------------------
Operating Activities
Net earnings before minority
interest $ 216 $ 263 $ 404 $ 455
Depreciation 137 129 271 253
Restructuring and other charges
(note 2) 1
Future income taxes 5 31 21 43
Change in non-cash working
capital 63 64 (584) (512)
Other (6) 1 24 4
-------------------------------------------------------------------------
Cash Flows from Operating
Activities 415 488 137 243
-------------------------------------------------------------------------
Investing Activities
Fixed asset purchases (348) (310) (589) (534)
Short term investments 91 219 105 218
Proceeds from fixed asset sales 22 14 30 21
Credit card receivables, after
securitization (5) (4) 55 77
Franchise investments and other
receivables (5) (18) (4) (35)
Other (14) (3) (34) (5)
-------------------------------------------------------------------------
Cash Flows used in Investing
Activities (259) (102) (437) (258)
-------------------------------------------------------------------------
Financing Activities
Bank indebtedness 18 (4) 20 (7)
Commercial paper 25 (72) 443 201
Short term bank loans - Issued 9 8 18 17
Long term debt
(note 8) - Issued 200 400 500
- Retired (3) (101) (203) (102)
Share capital - Retired
(note 9) (16) (59) (16)
Subsidiary share
capital - Issued 1
- Retired
(note 6) (27) (35) (41)
Dividends - To share-
holders (53) (42) (99) (81)
- To minority
share-
holders (20) (16) (20) (16)
Other (1) (2) (4) (4)
-------------------------------------------------------------------------
Cash Flows (used in) from Financing
Activities (52) (45) 461 452
-------------------------------------------------------------------------
Effect of Foreign Currency Exchange
Rate Changes on Cash and Cash
Equivalents 45 (174) 57 (224)
-------------------------------------------------------------------------
Change in Cash and Cash Equivalents 149 167 218 213
Cash and Cash Equivalents, Beginning
of Period 1,034 1,203 965 1,157
-------------------------------------------------------------------------
Cash and Cash Equivalents, End
of Period $ 1,183 $ 1,370 $ 1,183 $ 1,370
-------------------------------------------------------------------------
--------- ---------
See accompanying notes to the unaudited interim period consolidated
financial statements.
Notes to the Unaudited Interim Period Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Basis of Presentation
The unaudited interim period consolidated financial statements (the
"interim financial statements") were prepared in accordance with
Canadian generally accepted accounting principles ("GAAP") and follow
the same accounting policies and methods of application with those
used in the preparation of the audited annual consolidated financial
statements for the year ended December 31, 2003, except for the
changes described below. Under Canadian GAAP, additional disclosure
is required in annual financial statements and accordingly the
interim financial statements should be read together with the audited
annual consolidated financial statements and the accompanying notes
included in George Weston Limited's 2003 Annual Report.
Basis of Consolidation
The interim financial statements include the accounts of George
Weston Limited ("Weston") and its subsidiaries (collectively referred
to as the "Company") with provision for minority interest. Weston's
interest in the voting share capital of its subsidiaries is 100%
except for Loblaw Companies Limited ("Loblaw"), which was 61.8% at
the end of the second quarter compared to 61.7% at year end 2003.
Effective January 1, 2004, the Company implemented the following
accounting standards issued by the Canadian Institute of Chartered
Accountants:
Fixed Assets
Section 3063, "Impairment of Long-lived Assets", addresses the
recognition, measurement and disclosure of impairment of long-lived
assets held-for-use. Long-lived assets are reviewed for impairment
when events or circumstances indicate that their carrying value
exceeds the sum of the undiscounted cash flows expected from their
use and eventual disposal. An impairment loss is measured as the
amount by which the long-lived assets' carrying value exceeds the
fair value. Accordingly, the Company reviews long-lived assets for
impairment annually. Asset groups are reviewed for impairment at the
lowest level for which identifiable cash flows are largely
independent of cash flows of other assets and liabilities. For
purposes of annually reviewing Weston's long-lived assets for
impairment, manufacturing assets are grouped together by major
production category where cash flows are largely dependent on each
other. For purposes of annually reviewing Loblaw's store assets for
impairment, store net cash flows are grouped together by primary
market areas where cash flows are largely dependent on each other.
Primary markets refer to regional areas where Loblaw operates a
number of store formats within close proximity of each other. If an
indicator of impairment, such as sustained negative operating cash
flows exists, then an estimate of undiscounted future cash flows of
each such major production category for Weston or store for Loblaw is
prepared and compared to its carrying value. If Weston's
manufacturing assets or Loblaw's store assets are determined to be
impaired, the impairment loss is measured as the excess of the
carrying value over its fair value. In addition, the Company
evaluates the carrying value of Weston's manufacturing assets and
Loblaw's store assets whenever events or changes in circumstances
indicate that the carrying value of assets may not be recoverable.
These events or changes in circumstances include a commitment to
close, retire or transfer manufacturing assets for Weston and to
close, relocate or convert a Loblaw store where the carrying value of
the assets is greater than the expected future cash flows.
The standard was applied prospectively with no material impact on the
financial condition or results of operations.
Derivative Instruments
Accounting guideline ("AcG") 13, "Hedging Relationships", addresses
the identification, designation, documentation and effectiveness of
hedging relationships for the purposes of applying hedge accounting
and provides guidance with respect to the discontinuance of hedge
accounting. Financial derivative instruments not designated within an
AcG 13 compliant hedging relationship are measured at fair value with
changes in fair value recorded in the consolidated statement of
earnings in accordance with the Emerging Issues Committee ("EIC")
Abstract 128, "Accounting for Trading, Speculative or Non-Hedging
Derivative Financial Instruments".
Pursuant to the requirements of AcG 13, the Company has formally
identified and documented the following hedging relationships:
Weston's 3% Exchangeable Debentures as a hedge of the anticipated
disposal of the Domtar investment; cross currency basis swaps and
interest rate swaps as cash flow hedges against its exposure to
fluctuations in the foreign currency exchange rate and interest rates
on a portion of its United States dollar denominated assets,
principally cash equivalents and short term investments held by
Loblaw; Loblaw's interest rate swaps as a cash flow hedge of the
variable interest rate exposure on commercial paper; commodity
futures as a hedge of anticipated commodity purchases; and the
electricity forward contract as a cash flow hedge of price volatility
of the Company's electricity costs in Ontario, Canada. The
effectiveness tests were also performed to establish that both at
inception and prospectively the hedging relationships will be
effective. The accounting policies for hedging relationships that
meet the requirements prescribed by AcG 13, are consistent with those
described in the notes to Weston's audited annual consolidated
financial statements for the year ended December 31, 2003.
Hedging relationships that ceased to be eligible for hedge accounting
under AcG 13 were discontinued as of January 1, 2004 except for
Weston's equity forward sale agreement based on 9.6 million Loblaw
common shares as discussed below. The financial derivative
instruments in the hedging relationships that ceased to be eligible
for hedge accounting and were previously recorded on an accrual basis
were fair valued as of January 1, 2004 and the resulting fair value
loss was deferred and is being amortized over the original hedge term
of approximately three years. The resulting impact on the financial
condition and results of operation was not material. Subsequent
changes in the fair value of these financial derivative instruments
is being recognized in interest expense prospectively.
Effective for the third quarter of 2004, hedge accounting will no
longer be permissible for Weston's equity forward sale agreement
based on 9.6 million Loblaw common shares as a result of the
amendment to EIC 56, "Exchangeable Debentures". EIC 56 has been
amended to conform with the provisions of AcG 13, which deal with
items ineligible for hedge accounting, by rescinding the ability to
use hedge accounting if an entity's investment in the underlying
shares is consolidated or is accounted for by the equity method. The
effective date to cease the hedge accounting described is the first
fiscal period commencing after July 1, 2004. As a result of this
amendment to EIC 56, effective for the third quarter of 2004, the
Company will be required to recognize on a prospective basis, the
fair value adjustments of this agreement in net earnings and may have
a significant impact on quarterly net earnings, subject to the
volatility of the market price per Loblaw common share. The fair
value adjustment is a non-cash item and will ultimately be offset by
the recognition of a gain on Weston's disposition of the 9.6 million
Loblaw common shares. At quarter end, the non-cash fair value
adjustment of $125 million has been deferred and recorded in the
balance sheet in other assets and other liabilities. According to the
transitional provisions, the non-cash fair value adjustment as of the
effective date of the amendment to EIC 56 will remain deferred and
included in other assets and other liabilities on the consolidated
balance sheet and will be recognized in net earnings at maturity or
upon termination of the forward sale agreement.
Asset Retirement Obligations
Section 3110, "Asset Retirement Obligations", establishes standards
for the recognition, measurement and disclosure of legal obligations
associated with the cost to retire long-lived assets. A liability
associated with the retirement of long-lived assets is recorded in
the period in which the legal obligation is incurred at its estimated
fair value and a corresponding asset is capitalized as part of the
related asset and depreciated over its useful life. Subsequent to the
initial measurement of the asset retirement obligation, the
obligation is adjusted to reflect the passage of time and changes in
the estimated future costs underlying the obligation.
Accordingly, the Company has recognized a discounted liability
associated with obligations arising from specific provisions in
certain lease agreements regarding the exiting of leased properties
at the end of the respective lease terms. As well, the Company has
recognized a discounted liability associated with environmental
decommissioning and remediation as required by environmental
regulations which require that certain assets be decommissioned
and/or remediated in a specified manner. The standard was implemented
retroactively with restatement of the prior period consolidated
financial statements. The cumulative effect of implementation was a
decrease to opening retained earnings for 2003 of $9 million (net of
future income taxes recoverable of $5 million), an increase in fixed
assets of $3 million and an increase in other liabilities of
$17 million. The impact on net earnings for each of 2003 and 2004 was not
material.
Use of Estimates and Assumptions
The preparation of financial statements in accordance with Canadian
GAAP requires management to make estimates and assumptions that
affect the reported amounts and disclosures made in the consolidated
financial statements and accompanying notes. These estimates and
assumptions are based on management's historical experience, best
knowledge of current events and conditions and activities that the
Company may undertake in the future. Actual results could differ from
these estimates.
Certain estimates such as those related to pension, post-retirement
and post-employment benefits, goodwill, indefinite life intangible
assets and income taxes depend upon subjective or complex judgments
about matters that may be uncertain and changes in those estimates
could materially impact the consolidated financial statements.
Comparative Information
Certain prior period's information was reclassified to conform with
the current period's presentation and was restated due to the
implementation of Section 3110 as described above.
2. Restructuring and Other Charges
In connection with the new labour arrangement at Loblaw for The Real
Canadian Superstore in Ontario, a charge of $25 million was
recognized in operating income during the fourth quarter of 2003
relating to the voluntary early retirement offers accepted by certain
employees of Locals 1000A and 1977 of the United Food and Commercial
Workers ("UFCW") union. During the first quarter of 2004, a net
charge of $1 million was recognized in operating income, representing
an adjustment to the 2003 charge net of an additional amount
associated with the acceptance of a voluntary early retirement offer
by certain employees of Local 175 of the UFCW union. Approximately
$5 million of this accrual was paid by the end of 2003, $8 million was
paid during the first quarter of 2004 and an additional $7 million
was paid during the second quarter of 2004. The remaining accrual of
$6 million at the end of the second quarter is expected to be paid
during the remainder of 2004.
3. Interest Expense
12 Weeks Ended 24 Weeks Ended
--------- ---------
($ millions) June 19, June 14, June 19, June 14,
2004 2003 2004 2003
---------------------------------------------------------------------
Interest on long term debt $ 94 $ 89 $ 188 $ 175
Other long term interest (8) (28) (20) (52)
---------------------------------------------------------------------
Net long term interest 86 61 168 123
Net short term interest (2) 2 1
Capitalized to fixed assets (5) (6) (10) (14)
---------------------------------------------------------------------
Interest expense $ 79 $ 57 $ 158 $ 110
---------------------------------------------------------------------
--------- ---------
Net interest paid in the second quarter and year-to-date was
$116 million and $198 million (2003 - $81 million and $143 million),
respectively.
4. Income Taxes
During the first quarter of 2004, Loblaw recognized a $14 million
reduction to the income tax provision as a result of the successful
resolution of certain income tax matters from a previous year.
Net income taxes paid in the second quarter and year-to-date were
$76 million and $262 million (2003 - $86 million and $251 million),
respectively.
5. Basic and Diluted Net Earnings per Common Share
12 Weeks Ended 24 Weeks Ended
--------- ---------
($ millions except where June 19, June 14, June 19, June 14,
otherwise indicated) 2004 2003 2004 2003
---------------------------------------------------------------------
Net earnings $ 140 $ 193 $ 261 $ 327
Prescribed dividends on
preferred shares (6) (5) (13) (12)
---------------------------------------------------------------------
Net earnings available to
common shareholders $ 134 $ 188 $ 248 $ 315
---------------------------------------------------------------------
Weighted average common shares
outstanding (in millions) 128.9 132.2 129.0 132.2
Dilutive effect of stock-based
compensation (in millions)(1) .2 .4 .2 .4
---------------------------------------------------------------------
Diluted weighted average common
shares outstanding
(in millions) 129.1 132.6 129.2 132.6
---------------------------------------------------------------------
Basic and diluted net earnings
per common share ($) $ 1.04 $ 1.42 $ 1.92 $ 2.38
---------------------------------------------------------------------
--------- ---------
(1) 193,000 (2003 - 204,000) of stock options at an exercise price of
$100.00 per common share were outstanding at the end of the second
quarter but were not recognized in the computation of diluted net
earnings per common share because the options' exercise price was
greater than the average market price of the common shares for the
second quarter and year-to-date. In addition, 663,594 stock options
at an exercise price of $93.35 per common share were outstanding at
the end of the second quarter but not recognized in the computation
of diluted net earnings per common share because the options'
exercise price was greater than the average market price of the
common shares for the second quarter of 2004.
6. Goodwill and Intangible Assets
Changes in the carrying value of goodwill and intangible assets were as
follows:
As at
-----------------------------------------
June 19, Dec. 31,
2004 2003
Food
($ millions) Weston Distri-
Foods bution Fisheries Total Total
-------------------------------------------------------------------------
Goodwill, beginning
of period $ 1,269 $ 1,724 $ 9 $ 3,002 $ 3,347
Goodwill acquired
during the period 24 24 44
Adjusted purchase
price allocation (125)
Impact of foreign
currency
translation 68 68 (264)
-------------------------------------------------------------------------
Goodwill, end of
period 1,337 1,748 9 3,094 3,002
Trademarks and
brand names(1) 551 551 523
Other intangible
assets 2 2 2
Marine site
licences 18 18 15
-------------------------------------------------------------------------
Goodwill and
intangible assets $ 1,890 $ 1,748 $ 27 $ 3,665 $ 3,542
-------------------------------------------------------------------------
-----------------------------------------
(1) Includes positive impact of foreign currency translation of
$28 million (2003 - negative impact of $104 million).
When Loblaw purchases its own common shares, the Company accounts for the
purchase as a step-by-step purchase of Loblaw. During the first two
quarters of 2004, Loblaw purchased 576,100 of its common shares for
$35 million pursuant to its Normal Course Issuer Bid ("NCIB"), which
resulted in the Company recognizing $16 million of goodwill.
During the first quarter of 2004, Westfair Foods Ltd. ("Westfair"),
a subsidiary of Loblaw, redeemed its Class A shares at a price of
$350 per share for cash consideration of $8 million. The transaction
was accounted for as a step-by-step purchase of Westfair, which
resulted in Food Distribution recognizing $8 million of goodwill.
7. Pension, Post-Retirement and Post-Employment Benefits
The Company's total net benefit plan expense recognized in operating
income was $46 million and $95 million (2003 - $47 million and
$97 million) for the second quarter and year-to-date respectively. The
total net benefit plan expense included costs for the Company's defined
benefit pension and other benefit plans, defined contribution pension
plans and multi-employer pension plans.
8. Long Term Debt
During the first quarter of 2004, Weston issued $200 million of 5.05%
Medium Term Notes ("MTN") due 2014 and repaid its $200 million of
Series A, 7.45% Debentures and Loblaw issued $200 million of 6.15% MTN
due 2035.
9. Share Capital
During the first quarter of 2004, Weston purchased for cancellation
587,200 of its common shares for $59 million, pursuant to its NCIB.
10. Stock-Based Compensation
During the first half of 2004, Weston issued 5,604 (2003 - 6,812) common
shares for cash consideration of $.3 million (2003 - $.3 million) on the
exercise of stock options and paid the share appreciation value of
$7 million (2003 - $10 million) on the exercise of 151,075 (2003 -
199,136) stock options and share appreciation rights. In addition, 40,760
(2003 - 46,240) stock options and share appreciation rights were
forfeited or cancelled during the first half of 2004. Loblaw paid the
share appreciation value of $16 million (2003 - $14 million) on the
exercise of 543,267 (2003 - 439,441) stock options. In addition, 50,631
(2003 - 72,387) of Loblaw's stock options were forfeited or cancelled
during the first half of 2004.
The following table summarizes the Company's cost recognized in operating
income related to its stock-based compensation plans and related equity
derivatives:
12 Weeks Ended 24 Weeks Ended
--------- ---------
June 19, June 14, June 19, June 14,
($ millions) 2004 2003 2004 2003
-------------------------------------------------------------------------
Stock option plans/share
appreciation right plan
(income)/cost $ (9) $ 29 $ (29) $ 37
Equity derivatives loss/(gain) 16 (41) 48 (47)
-------------------------------------------------------------------------
Net stock-based compensation
cost/(income) $ 7 $ (12) $ 19 $ (10)
-------------------------------------------------------------------------
--------- ---------
At the end of the second quarter 2004, a total of 1,807,655 (2003 -
2,100,259) stock option grants and share appreciation rights were
outstanding, which represented approximately 1.4% (2003 - 1.6%) of
Weston's issued and outstanding common shares and was within the
Company's guideline of 5%.
11. Cumulative Foreign Currency Translation Adjustment
During the first two quarters of 2004, the change in the cumulative
foreign currency translation adjustment from year end 2003 increased
shareholders' equity by $157 million. This net change was due to the
positive impact of translating the Company's investment in self-
sustaining foreign operations in the United States as a result of the
weakening of the Canadian dollar relative to the United States dollar
since year end 2003.
12. Financial Instruments
During the second quarter, Weston entered into interest rate swap
contracts with a notional value of $200 million which mature in 2014.
These interest rate swaps were designated as a fair value hedge of the
$200 million of 5.05% MTN due 2014. Under the terms of the interest rate
swaps, Weston will receive a fixed interest rate of 4.8% and pay a
floating interest rate.
13. Business Acquisition
Subsequent to quarter end, Weston entered into an agreement to acquire
Boulangerie Gadoua Ltée, a bakery business which operates three bakeries
in Quebec, Canada. The purchase is subject to regulatory approval and is
expected to close by the end of 2004. The agreed upon purchase price
includes the issuance, on closing, from treasury of 58,733 Weston common
shares as partial consideration.
14. Contingencies, Commitments and Guarantees
Indemnification Provisions
Weston was recently served with a statement of claim, in the amount of
$20 million for taxes owing and alleging a breach of tax related
representations and warranties dealing with years prior to the 1998
sale of Weston's forest product business. The claim is being defended.
15. Segment Information
The Company has three reportable operating segments: Weston Foods, Food
Distribution and Fisheries. The accounting policies of the segments are
the same as those described herein and in the Company's 2003 Annual
Report. The Company measures each segment's performance based on
operating income. No segment is reliant on any single external customer.
12 Weeks Ended 24 Weeks Ended
--------- ---------
June 19, June 14, June 19, June 14,
($ millions) 2004 2003 2004 2003
-------------------------------------------------------------------------
Sales
Weston Foods $ 1,020 $ 1,077 $ 2,058 $ 2,206
Food Distribution 6,069 5,798 11,746 11,174
Fisheries 39 51 73 97
Intersegment (177) (172) (343) (324)
-------------------------------------------------------------------------
Consolidated $ 6,951 $ 6,754 $ 13,534 $ 13,153
-------------------------------------------------------------------------
Operating Income
Weston Foods $ 44 $ 117 $ 91 $ 200
Food Distribution 359 314 662 581
Fisheries (3) (9) (8)
-------------------------------------------------------------------------
Consolidated $ 400 $ 431 $ 744 $ 773
-------------------------------------------------------------------------
--------- ---------
Corporate Profile
George Weston Limited ("Weston") is a Canadian public company founded in
1882 and is one of North America's largest food processing and distribution
companies. Weston has three reportable operating segments: Weston Foods, Food
Distribution and Fisheries. The Weston Foods segment is primarily engaged in
the baking and dairy industries within North America. The Food Distribution
segment, which is operated by Loblaw Companies Limited, Canada's largest food
distributor, concentrates on food retailing and is increasing its offering of
non-food products and services. The Fisheries segment is primarily engaged in
the hatching, growing and processing of Atlantic fresh farmed salmon in North
America and Chile.
Trademarks
George Weston Limited and its subsidiaries own a number of trademarks.
These trademarks are exclusive property of Weston and its subsidiary
companies. Trademarks where used in this report are in italics.
Investor Relations
Shareholders, security analysts and investment professionals should
direct their requests to Mr. Geoffrey H. Wilson, Vice President, Industry and
Investor Relations at the Company's Executive Office or by e-mail at
investor(at)weston.ca.
Additional financial information has been filed electronically with
various securities regulators in Canada through SEDAR.
This Quarterly Report includes selected information on Loblaw Companies
Limited, a subsidiary of the Company and a public reporting company with
shares trading on the Toronto Stock Exchange.
Ce rapport est disponible en français.
This report was printed in Canada on recycled paper.
We would like to welcome you to take part in either our Conference Call
and/or Audio Webcast starting at 11:00am (EST) today.
To access via Tele-conference please dial (416) 640-4127; the playback
feature will be made available an hour after the event at (416) 640-1917,
passcode 21057405 followed by the number sign.
To access via our Audio Webcast please visit our website at www.weston.ca
(Please note that the webcast archive will not be available until the
following day). We suggest you pre-register and download any required software
in advance of the event to ensure your experience is a good one.
/For further information: Contact person: Geoff Wilson, Vice President, Industry and Investor Relations, (416) 922-8500/
