Marlene Robillard - Investor Relations Lino Saputo - President and Chief Executive Officer Maxime Therrien - Chief Financial Officer

Irene Nattel - RBC Capital Markets Peter Sklar - BMO Michael Van Aelst - TD Securities Mark Petrie - CIBC Vishal Shreedhar - National Bank Financial Keith Howlett - Desjardins Securities

Ladies and gentlemen, thank you for standing by and welcome to the Saputo Fiscal 2019 First Quarter Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded on Tuesday, August 7, 2018. I would now like to turn the conference over to Mr. Lino Saputo, Jr. Please go ahead.

Thank you very much, Frank.

Good afternoon, everyone and thank you for joining us today. A press release detailing our 2019 first 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 would 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 and are subject to risks and uncertainties. Refer to our cautionary statements regarding forward-looking information in our annual reports and our quarterly releases and filings. Please treat any forward-looking information with caution as our actual results could differ materially. We do not accept any obligation to update this information, except as required under securities laws. Mr. Lino A. Saputo, Jr., our Chairman of the Board and Chief Executive Officer will begin this conference by providing a brief overview of key highlights relating to the first quarter of fiscal 2019 after which he along with Mr. Maxime Therrien, our Chief Financial Officer, will proceed to answer your questions.

Thank you, Marlene and good afternoon to you all. Our fiscal 2019 first quarter results were released this morning and as we expected, this was a challenging quarter. Consolidated revenues grew by 13% compared to the corresponding quarter last fiscal year mainly related to additional sales volumes stemming from recent acquisitions. Conversely, our adjusted EBITDA amounted to $307.5 million, a decrease of 13.4% and adjusted net earnings declined by 20%. As we have previously highlighted, we anticipated the headwinds. Indeed, we faced a huge competitiveness lower international selling prices of dairy ingredients, higher administrative expenses related to the ERP initiatives and increased warehousing and logistical costs. Notwithstanding, our efforts have been geared towards numerous initiatives aimed at mitigating market conditions and laying solid foundations for a bigger, better and stronger business. We have undertaken capital projects to maintain our leadership position and we will explore additional opportunities to mitigate pressure on margins, growth and competitive market conditions. We will carry out the integration of recent acquisitions, including Shepherd Gourmet and Montchevre, as we further increased our presence in the specialty cheese and yogurt space. We will continue to rollout the ERP system, which has already been successfully executed in both Australia and Argentina. In Australia more specifically, we are committed to building solid relationships with farmer suppliers and growing milk intake. Over the course of the last 2 months, our management team has had an active presence on the ground in Australia. And since May 1, we have focused our efforts on meeting stakeholders, stabilizing activities and reviewing operations to maximize our network. The integration of both the WCB and MG businesses is going extremely well and colleagues are starting to operate under a combined Saputo Dairy Australia umbrella. We also recently announced having entered into an agreement to sell our Koroit plant. This transaction is subject to the approval of the Australian Competition and Consumer Commission and is expected to close in the second quarter of the fiscal year. Across all our operations, we will not deviate from focusing on constantly bettering our activity and enhancing operational efficiencies to reduce the effects of the ongoing volatility in dairy markets. We will benefit from our global complementary platforms, solid balance sheet and high levels of cash generated by operations. We hold steadfast to our long-term growth strategy and strive to expand our global footprint by seizing the right opportunity at the right time. On that note, I thank you for joining our call and we will now proceed to answer your questions. Frank?

Thank you. [Operator Instructions] Our first question comes from the line of Irene Nattel with RBC Capital Markets. Please proceed.

Thanks and good afternoon. Just reading through the release, the tone of the outlook section seemed more cautious than the Q4 release. And I mean clearly as there is the commodity prices that you have mentioned a couple of times, the competitive dynamics, can you walk us through what you are seeing and just sort of what may have changed in the last little bit?

Well, Irene, not much has changed since the last conference call we had. We had highlighted that there is an overhang of inventory stocks in the industry. Europe is sitting on over 250,000 metric tons of powder that they still have to flush out of the systems. I saw a report on CNBC last week as they are talking about 1.4 billion pounds stockpile in the U.S. There has not been the effect of a reduced production platform relative to consumption in the world markets yet. And on top of that of course, what we are seeing is because of the number of solids available in the industry, a lot of competition in the different platforms, namely the Canadian platform and the U.S. platform where there is some, what I would perceive to be unreasonable competition that’s going on. We highlighted this last quarter. I think moving forward there might be perhaps another one or two quarters ahead of us with similar market conditions and that might be the cautious tone in the outlook. But I will say on the flipside, as I also indicated in the last conference call, I think it presents a lot of opportunities for us to capitalize on other competitors’ weaknesses where our balance sheet remains very, very strong our cash flows are very healthy our ability to take on more debt is very real. And quite frankly, we have the ability to be able to make selections on what we think the right platforms are for us as we move forward from my M&A activity perspective. So yes, cautious from an economic standpoint within the industry, but I would say very optimistic from ability for us to build solid foundations for an even bigger, better, stronger platform going forward.

Couple of follow-up questions if I may. First of all, just in terms of the competitive intensity, are you seeing competitors acting irrationally? That’s one question. And then my second question is of course around M&A and what you are seeing?

Yes. So in terms of the competitive landscape, yes, I have to say that it is irrational. We are seeing things that are going on in our industry that we quite frankly haven’t seen before and we had seen some pretty intense competition in the past. So yes, we are seeing some of that in our markets. And our focus is really not volume driven we are not overly concerned about waving the flags about being number one in certain categories or products. We know we need to be profitable. We know our balance sheet needs to remain healthy. And I think that, that is the right recipe for a long-term perspective as a strong viable player in the dairy space and I am not at all concerned about that, but there is going to be some effect of that irrational behavior on our quarter-to-quarter results as long as that happens. From an M&A perspective, we are seeing that the economics in the dairy space is taking its toll on some of our competitors. There are a lot of assets available for sale. What we need to do is make sure that we choose the right platforms that give us the best potential to further strengthen our platforms. And quite frankly, there are some files we put on the back burner because more interesting files have presented themselves. So I enjoy the position we are in now. I like to be in a position where our balance sheet is clean, where we have the ability to raise anywhere from $3 billion – maybe even $3.2 billion or $3.3 billion either for one or for multiple acquisitions. I think we really are in the driver seat here.

That’s great. Thank you. Well, it’s not great, but at least there is a silver lining. Thanks doing that.

Well, I think there is a silver lining there and I am quite optimistic about the future of our business.

Absolutely.

Our next question comes from the line of Michael Van Aelst with TD Securities. Please proceed.

Thank you. I would just like to follow-up on the M&A comments that you have made, can you give us some color as to the geographies that you are looking at, where the opportunities are greatest right now?

Yes. So we see that there are files that are open in the United States. There are files that are open in Argentina. There is quite a bit of turmoil going on there. Files that potentially could open up in Europe, there is perhaps other developments in Australia and perhaps you may have seen in New Zealand now there is a new file that has just opened up. And I would say, in addition to that I would not exclude a potential opportunity for other tuck-in businesses in Canada. So if you look at the main dairy producing countries around the world, we have an ability to be part of a process in every single one of those markets, if we choose.

And do you have the resources, like the personnel resources to integrate in all these different areas or can you do one per geography, can you do two or three max at a time, what’s your capacity?

So the first resource we think about is the financial resource and we do have quite a bit of financial flexibility. So that’s not what’s going to stop us. But you are very right in saying there is a human element here. And we need to make sure that if we are going to materialize an acquisition that we are able to integrate it effectively and efficiently and that’s perhaps where our limitations would be. And this goes back to my original point that I have made in Irene’s question is that we are going to have to be choosy. We can’t do it all. So we are going to be identifying and selecting those opportunities that will have the best return for us. Financial return and return as well from a perspective of building solid foundation, making us more diverse and perhaps have mitigating factors to future headwinds. So we look at all of those elements. And then we shipped through the files and we determine what would be Tier 1, what would be Tier 2 and what would be Tier 3. But I will tell you that there are files in all of those tiers open to us.

And the size of those files range from…?

I would tell you that there would be small and what I am thinking about small businesses would be somewhere within the $150 million to $200 million sales range, all the way up to the $1 billion range.

Alright. And then you touched on the competitive market in the U.S., I mean we have seen the irrational activity in Canada in the past, in the U.S., it doesn’t seem to happen quite as often, but can you talk a little bit more about what’s happening there?

Yes. Well, I think what happened was in the initial tariff war there was a shock. And I think in the U.S., some processors started to panic and perhaps may have thought that some markets would have been close to them. When you think about in the U.S., where they are exporting anywhere from 15% to 17% of total production, some of our competitors started to think about placing their solids domestically. So there was a little bit of the initial tariff war shock that happened. There was then the run-up of international markets that were rushing to buy before the tariffs would be in place. And then once that was done, the pipeline was full. And this is probably where you are seeing in the U.S. the stockpiles grow to about 1.4 billion pounds of inventory. And so there is an overhang in the U.S. as well, which creates a competitive environment, different from that in Canada, but still a very, very competitive environment. Now as we look at that, we look at our customer profile, then we look at the relationships that we have with some of our longstanding customers. And we will then determine whether we want to play in that game or not. And in some cases, where we are the incumbent and where it is a market that we want to protect, we will have to fight a good fight. And then in other markets we may decide that perhaps there is less loyal customers and less valuable products, where we will just cut those products loose. So we can engage in any war, we can fight against any of our competitors, our balance sheet is clean. So that – what might happen is it takes of our EBITDA percentages from 12% or 13% down to maybe 9% or 10%. Those are the casualties of war. But if you look at some of our competitors, they lost a couple of points on EBITDA percentage as well, but they are starting from a much lower standpoint. So we have got deep enough pockets that we can fight a good fight anywhere we go. Sometimes we choose to fight it, sometimes we choose to walk away depending on the importance of the customer and the importance of the diversification of the product portfolio.

Thank you. And then just one last question for now, the dairy – the $33 million year-over-year hit from dairy ingredients is self-explanatory, but the – when you look at the $29 million tied to warehousing, logistics and your ERP systems, can you kind of break it out between the costs that are going to be sticking around and the costs that are temporary due to like the warehousing maybe explain the warehousing costs a little bit more?

The $5 million relative to ERP is a cost that’s going to be there and it’s planned for and we don’t expect that cost to really to go down from a quarter-to-quarter perspective. On the warehousing side, there are some additional costs that we are having today relative to additional external warehouse that we will be working towards reducing those warehouses and therefore reduce the cost structure. Mind you, these costs are not going to disappear from now to Q2 and likely Q3 is going to be a much longer period. And that’s also – that cost of warehouse, logistics and handling also includes the incremental costs relative to the situation on the delivery side with a shortage of driver and the new electronic devices that they have to log on and that costs that have been going up recently, the last few quarters. We don’t expect that costs to come down to the historical level.

I am assuming there is no capacity at this point, given the competitive situation to pass-through on higher prices?

That’s part of the issue Michael, both in the U.S. and Canada with the irrational behavior that’s going on. Even the last milk price increase that we had was very, very challenging to pass on. Unfortunate, but we had to absorb some of that. And then of course, even on the warehouse and logistics side in the U.S., very, very tough when your competitors aren’t passing those costs on, to be the only guy in the game trying to pass them on. We are looking at ways where we can mitigate some of that. But we can’t go beyond what the trends are in the market otherwise we isolate ourselves with our competitors – with our customers, rather.

Thank you very much.

Our next question comes from the line of Mark Petrie with CIBC. Please proceed.

Hey, good afternoon, just wanted to actually follow-up again on the competitive dynamics, specifically in Canada and I am wondering if you could just provide a little bit more detail, particularly in the context of volume growth in the quarter and so what channels are you seeing the most pressure and has that ratcheted up in the last couple of months or just a little bit more color, please?

Yes. So the competitive pressure that we are seeing in Canada is mostly on the fluid side. As you know, Class 1 milk is on-demand and milk that is on-demand is an easy target for some of our competitors to use to fill up their plants that they are running at below capacity utilization. So, that’s where we are seeing a lot of the fighting in the industry. Then of course, there might be some key areas here and there where there might be some cheese volumes that could be impacted, but I will tell you when I talked about fighting the good fight, we are going to fight the good fight on cheese, especially on value-added cheese and products that we know how to make more effectively and more efficiently than our competitors. I will tell you that in the last quarter, our volume has not been impacted. Our margins mostly had been impacted, but moving forward, I would suspect that maybe some of that volume might go down, because if this price war continues, we might cut some of those categories loose. And I would say fluid milk for us already at the margins that we are at is exchanging four quarters for $1. And to be honest with you, there is way too much risk in operation and in processing to satisfy ourselves with four quarters for $1.

Okay, thanks. Sticking with Canada, but a different topic, Lino obviously, you have been open with your views regarding our dairy trade issues over the course of time. Open to hearing any update on those views, but specifically, I guess my question is around Class 7 milk and appreciating that Saputo will always leverage its full supply chain to source competitively priced product and maintain profitability as best as you can. What do you expect the impact, if Class 7 were to go away, the impact would be on Saputo, specifically either in terms of volumes or profitability?

Yes. Mark and I am glad you asked the question, because I think some of my comments in the past by media have been taken out of context. I am not against the milk supply managed system in Canada. The milk supply managed system in Canada has been around for 40 years, perhaps even 45 years and it’s working well for Canada. And if dairy farmers want the milk supply managed system, I am not going to argue with that. I think it makes for a much more stable business here than we have in any other platforms. What I am opposed to is the Class 7 and the Class 7 has only been in effect for the last 2 years. And the Class 7 is competing against solids that were coming in from the U.S. prior to Class 7 existing. Class 7 also as a compound effect has excess solids beyond the solids that were coming in from the U.S. that will go into powders and then be sold into the international market. So, Canada cannot have a two-tiered system, which is what they have right now with the Class 7. That’s not fair trade. So, I agree with the suppliers in the states. I agree with the suppliers around the world that are saying that Canada does not have an equitable system. We don’t and I will be very clear about it. And not many leaders in the dairy industry are calling it out, I will. I have discussions with dairy farmers in the U.S. and I have discussions with dairy farmers around the world, including New Zealand and in Australia. Class 7 is unfair. So, I believe that something has to get in the dairy file relative to NAFTA, if we want NAFTA to go through. All I am pointing to is this is the solution to close a dairy file and have governments think about the other industries by which they have to come to an agreement with the U.S. and Mexico in order to have NAFTA move on. It’s not rocket science. It’s not that complicated. Class 7 will solve the issue. Now your question Mark is what happens if Class 7 no longer exists. Well, it’s quite possible that we will buy solids from around the world like we have done before Class 7 and be able to standardize our ingredients and our production for high-quality products and we will go back to reverting to the practices that we had before Class 7 existed. I don’t think Class 7 is a fair system, but I do support the milk supply managed industry here in Canada.

Okay, thanks for all that. And I guess just last on the international side profitability was actually relatively strong compared to or particularly considering no earnings contribution from MG and I guess dilutive on the margin side. So overall, just what’s your outlook for international and how should investors expect MG to progress from here over the next year or so?

Well, we had the benefit in the international platforms of increased milk intake. So, we had – over the course of the quarters we had milk intake increase in WCB, but we had substantial milk intake increase in Argentina. Added to that, we had a very positive foreign exchange environment for us as we are selling product into the international markets in U.S. dollars and we are paying our milk in pesos. That was a very favorable situation for us. Moving forward, I think that as the milk that we are collecting is sustainable, I think that the production that we have both in Australia and Argentina will continue and perhaps might even rise from this point going forward. Foreign exchange is really dependent upon the depreciation of the peso and perhaps depreciation of the Argentinian – rather the Australian dollar relative to the U.S. dollar. That’s always helpful for international trade, but we do have a solid platform. The prices on the international market don’t seem to be declining as rapidly as they did in the past. In fact, if I look at the world dairy production numbers coming out of New Zealand and coming out of Europe, there are some very encouraging signs there. There is New Zealand because of regulatory issues and because of some climate issues, doesn’t look like production is going to be exceeding 1% to 1.5% growth year-over-year. Europe as well, because of economic issues and because of I would say quite frankly strong leadership from some of the co-ops in Europe it looks like they will temper their growth somewhere within 2% per year. That bodes really, really well for the international markets, especially if you consider Europe and New Zealand accounting for 54% of international trade. Already there is a better balance between supply and demand just by virtue of what’s coming off the farm. So I believe again, I will reiterate, I think that there still will be some headwinds over the next two quarters because the stockpiles have to decline. But beyond those two quarters, I am quite optimistic that there is going to be a better balance within our industry. The only caution I have after that is that once the economics get better in our industry, I am hopeful that there will be the same amount of discipline in our industry to balance right-size supply and demand so that we don’t have this pendulum go the other way again.

Okay. Appreciate all the comments, Lino. Thank you.

Thank you, Mark.

Our next question comes from the line of Peter Sklar with BMO. Please proceed.

Lino, this argument you are making that Canada should do away with the Class 7, but isn’t – are we going to have a big issue that we are going to be totally flooded with skim in Canada, because with the Class 7 we have been able to get rid of our skim. Now we are not going to be able to get rid of it. So, won’t milk production that Canada have to be cutback pretty dramatically in order to bring the Canadian milk markets back into balance?

Absolutely, yes. Peter, so if you look at the production numbers in Canada for the first time in 40 years, Canada’s milk production has gone up from 8 billion liters of milk to 9.5 billion liters of milk, that’s all that surplus. That’s all that skim that’s flooding the markets absolutely. So what I am saying is that if Canada wants to have a milk supply managed system, you have got to manage your supply to domestic consumption, which is what the milk supply manage system is all about. So yes, that means perhaps maybe 1.5 billion liters of milk has to come off the table from Canada. But 2 years ago that 1.5 billion liters of milk wasn’t even there. That is exactly, that is precisely my argument, Peter.

I know, but you have enjoyed the benefit of that because there has been more butter fat, which is what you need and then all that butter fat is going to be eliminated, so won’t you have to retrench your operations in Canada?

Well, yes, that is exactly what’s going to happen. And if Canada needs to import butter, they should import the butter. If consumers are asking for butter and we can’t produce it domestically then let’s import it, but yes, it’s true. Maybe we will have less skim or powder to produce and we will have less butter to produce. That’s exactly what the milk supply manage system is all about and then we would import the butter for consumers.

And then the other thing, like since this whole Class 7 thing rose, I think that some of your competitors I think there has been two or three drying facilities that have come on-stream in Canada, I don’t think Saputo has brought one on to deal with all the skim, so politically aren’t they – like aren’t your competitors going to fight hard, take the opposite position of you because they need the Class 7 for these facilities they brought on?

You are absolutely right. There is more infrastructure in the system to accommodate the Class 7. But the reality is Class 7 didn’t exist 2 years ago and so yes, there might be some idle assets in Canada. But you can’t have a system where you have your cake and you want to eat it too. To me, it’s illogical that this system exists and I will side with the U.S. suppliers and I will side with the suppliers around world that Canada’s system does not make sense. And I will tell you this Peter, that if we think that there is going to be a NAFTA deal signed and there is going to be no change to the dairy industry, then I think we are all crazy. That’s not going to happen. There is no way in hell. NAFTA is going to get signed with no change to the dairy industry. Now, I would prefer to see Class 7 go away then have incremental import licenses be granted to the U.S. That will be crazier. That’s not good for the industry.

Okay. On another subject, so this recent announcement that the milk prices are going up 4%, I think effective pretty shortly, I believe the processors like kind of agreed to the shorter time line for the price increase, I am just wondering if that’s true and if you agreed with that and also like how do you think that’s going to play out in the industry, like as I recall like price increases are typically 1%, about 1% a year, this is dramatically higher and so how the dairy processors are going to cope with this?

Okay. So you are asking if the processors had a voice at the table when it came to the Canadian Dairy Commission deciding on the 4%, I will tell you they don’t really care what processors think. They are more concerned with the profitability at the farm level, which I am completely in favor of. If the costs are going up at the farm level and the Canadian Dairy Commission says that we need a 4% milk increase, that’s just the way it is. This is our milk supply manage system. So we are not opposed to it. Now, what I am hoping is that a 4% is going to be substantial. It’s very difficult for anybody because as you know, the cost of milk, our raw materials represent 85% of our cost of goods, 85%. When you got 4% increase on your most important cost element, you have got to pass that on. So I am hoping again there too that there will be discipline in the industry to pass that on, because it’s a direct impact on our cost of goods sold. Now not to beat a dead horse here, but the suppliers are complaining about lower revenues. Well, Class 7 has contributed to lower revenues at the farm level because Class 7 has sold at international prices and the suppliers are getting a blended price. So of course, the economics at the farm level aren’t making sense, but Class 7 is a culprit there. So all of what we are trying to do to fix the industry is actually making it more fragile.

Okay. Lastly, I have a question for Maxime, if I may?

Yes. Go ahead.

Maxime, just wondering the accounting for the Koroit plant, the plant you sold, was that – like, is that in the EBITDA or is that classified as a discontinued operation…?

No. We have classified that asset on the balance sheet as an asset held for sale. That the accounting of the disposal will be executed once the transaction gets complete in Q2, likely in a couple of weeks.

So the EBITDA you reported for Q1, the adjusted EBITDA that excludes the EBITDA from that plant then?

No. The operation of Koroit our own business till we sell the plant. So we do have Koroit’s results embedded in our Murray Goulburn EBITDA part of international.

Right. So it would have been two months of EBITDA, can you give us some guidance as to what that amounted to?

Well, I will say shy about giving too much indication. Obviously, all the milk step-up has been passed on as per the agreement – what we have intended to do with our farmers. And in Q1, the result was positive impact on our EBITDA and I will leave it at that for now.

Okay. Thank you.

Thanks.

Our next question comes from the line of Vishal Shreedhar with National Bank Financial. Please proceed.

Hi. Thanks for taking my questions. Just on the fluid business, earlier in the call Lino, you said that you are thinking about reevaluating that business if the profitability doesn’t improve there, just for the analysts, investors, wondering if you could help us understand the size of that business in terms of revs?

Yes. So what we are looking at here Vishal, when I say rightsizing the business of fluid is we are looking at more value added products rather than commodity products. We are not going to go chase the 30 million, 40 million, 50 million liter contracts just because we want to pass volume to our plants. To us, that doesn’t make sense. But there still is a very good solid business in fluid. When you think about the single serve flavored milks, when you think about the value added let’s go, sport type of categories, when you think about the lactose free and more organic milk categories, the more value added, the margins are still very healthy and we are going to compete at those levels and we are going to maintain our volume and our market share there. When we get to the traditional white commodity milk, 4 liter bag, 2 liter jug kind of contracts that are up for renewal and competitors are telling their retailers name your price, that’s something at a point where we are saying, well, that’s not the way we play the game.

Okay. So when you are saying reevaluate, you are talking a portion of the business that’s specific to the traditional milk?

Correct.

Okay, got it. And do you have the revenues for that business or is that something you are not disclosing?

We don’t disclose that, we don’t break that out. And you can understand Vishal, for competitive reasons.

Understood. Thank you. Turning to MG in Australia, so you said that it wasn’t – it didn’t contribute on the earnings level, wondering if it did contribute consolidated on the EBITDA level and how we should expect that?

It did contribute, that is positive. Yes, it is positive in this quarter since we have been operating since May on the EBITDA level.

And then how should we expect the synergies to – sorry, go on?

Yes. Vishal just to clarify, the positive contribution is at the EBITDA level. When you look at items referring to stamp duties that we have to pay, those acquisition costs for the period from a net standpoint, it was not positive, but it was positive on the EBITDA side.

Okay. And how should we expect the synergies to unfold in relation to all your strategies, even when we think about your strategies to gain more milk, should we expect EBITDA to – the margin to improve rapidly at that business or will it take time?

Yes. But you hit the nail right on the head there Vishal. We have got to bring more milk into the platform. Right now if I look at the WCB platform, we are running close to 97%, 98% capacity utilization. On the MG side, we are running somewhere around maybe 58% capacity utilization. So one of the easiest ways to drive synergies and drive profitability is getting more milk through the plant, but of course it’s got to go into profitable products that we can sell either domestically or internationally. On the positive side, I would say that we do have customers in the emerging markets that are looking for more product from us. So, as we ramp up the capability of processing in MG we will have a home for that for the finished goods. And then beyond that, of course, we have got the two teams of MG and Warrnambool coming together. There has been since May 1 a headcount reduction. We are running that platform internally at the corporate level as one entity. Now we have got to start tripling out some of the synergies operationally and I will point to some examples where we are thinking about milk collection and transportation. We still have that the fleet of MG trucks and the fleet of Warrnambool trucks that seem to cross each other on the same road. Well, there is opportunity for us to synergize some of those things. There is opportunity for us to consider in production perhaps moving some production from say a MG plant over to Warrnambool or some of the production from Warrnambool to an MG plant to streamline production and have longer runs of similar type of products. So, there is all of that that still needs to be rolled out. Our engineering teams, both corporate and locally, are looking at those opportunities where we can take cost out of the system. I think in the case of this acquisition before we get the milk back before we realigned our contracts with our suppliers, before we think about some technology that we want to employ ordering equipment and starting them up, it might take anywhere between 24 to 36 months. But our projections in terms of the respectable levels of profitability for the combined Australian platform, we believe that we will be there within year 3.

Thanks for that. And just moving on to the incremental costs in the quarter and for the last few quarters that have depressed EBITDA relative to what this business otherwise could have earned. You talked about the warehousing, the logistics costs and ERP. So when should we expect those to reduce on a year-over-year basis? Are we talking – I know earlier in the call, the future quarters were indicated to be negatively impacted by those costs as well, but are we looking at 1 year out, three quarters, is there any help you can give us there?

Well, we have seen these costs increase the last few quarters. Obviously, over the next couple of quarters, we don’t see these costs going down. I would not be comment – putting any comments as to 1-year period, but certainly for the next few quarters, we don’t expect significant decline of these costs.

Vishal, I will add one other thing though. When we think about some of the incremental expenses over the course of this last quarter, unfortunately, we were – on the plant efficiency side, we were negatively impacted by two power outages in some of our largest facilities in the U.S. that took our plants down anywhere from 1.5 to 3 days. So, that did impact us in this quarter here. Hopefully, those kinds of things won’t repeat themselves. And one other thing that we are seeing in terms of our lack of plant efficiency with the low unemployment levels is that it’s getting harder and harder for us to find talent that wants to work in a plant environment. And so as we have got the milk coming into our milk receiving base, we have got to process it. And typically, our plants are running 6.5 days a week. We have had a higher than normal level of over time because of the labor shortage in our facilities. We are hoping that there will be more people in the labor force that we can tap into to try to reduce overhead, but right now, we don’t see a lot of relief in site with the labor shortages that we are seeing in the U.S. specifically. So, when you think about just some of the incremental costs in this quarter, yes, that was warehouse and delivery, but there was also some plant inefficiencies that were related to the power outages and over time on the labor side.

Okay. And one last one if I can try to get some color here. You are very helpful in quantifying some of these costs like warehousing FX and ERP was in there as well, I was wondering if you could give us a sense maybe not the exact number, but just a sense of magnitude of to what extent the competitive conditions are compressing margins and that’s the factor in the quarter, is there any color you could give us there?

Well, the competitive market condition when we talk about pricing to customer, cost of living adjustment that we are trying to pass on to customers, we are affecting – it affects all of our three sectors, certainly Canada and the U.S. On the international front, it’s more relative to the incremental cost of milk, mainly in Australia. To quantify those, it’s pretty subject to some – I would like to share not too much share that number, prefer to keep that inside us. It’s these incremental costs that we are not able to pass on to customer could be absorbed, should we be successful passing on these price increases.

And maybe to give you a little bit of help on calculating the numbers Vishal is what the upside of the market factors related to spread, which was favorable, our milk premiums were favorable and cheese was no decline, although that favorability was really offset by some of the price margin initiatives. So it was unfortunately, we didn’t reap the benefit of some of the positives that came in, in the market this last quarter.

Thanks for the color. I appreciate it.

Okay.

Our next question comes from the line of Keith Howlett with Desjardins Securities. Please proceed.

Yes. I just want to get a little bit more detail on the dairy ingredients market, as I understand you don’t sell too much whole milk powder or skim milk powder, so can you just give us some broad brush on what are the key components of your dairy ingredients business?

Yes. The major one that affected us in this quarter here was our WPC 80%. So as you think about WPC 80 in its heyday, when we first invested in WPC 80 back in 2006, ‘07, we were selling WPC upwards of $3.80 a pound, even sometimes in excess of $4 a pound. In this last quarter, WPC 80 markets were somewhere in the $2 range. And we also had and I think I explained this on the last conference call that we had – we were accumulating inventories of WPC 80 that in fact at any price there wasn’t any market for it. So those inventories got a little older and we were able to flush those powders out of our system in this quarter here, well below $2 a pound. So that was all impacting us in this quarter here. So if you think about the margins that you are seeing in the U.S., think about WPC 80% being a portion of the inventory being flushed out below our cost. That’s where the some of the margin went as well.

And when it comes to Australia, Argentina and international markets, is the WPC 80 much less of a factor in your sales mix or is it similar?

It is much less of a sales factor. We do have WPC of other percentages, like 35% or 65% which wasn’t as impacted as WPC 80. But don’t forget, in Australia we also have value added product that we give to the offshoot of WPC, which is our GOS product. It’s our joint venture with FrieslandCampina that is value added. And then on top of that, we also have a value added product, which is called lactoferrin, which the market has really come back on that. So we have some offsetting other ingredients that will help mitigate maybe some of the losses of WPC. But we do sell – but I also want to be clear Keith on this. In Canada because of Class 7, we are making powders, skim milk powders that ultimately because of the cost of the milk, we are able to sell into the international market. So we are somewhat impacted by the skim powder as well.

And then so the lactoferrin market is improving, is that…?

It’s absolutely improving, yes.

And then just on the company wide inventory that’s higher than it was, is that part of the reflected logistics that you just need place to store these products till market improves or…?

Yes. So the warehouse costs that we are talking about has a little bit to do with increased powders that we are holding because the markets are soft. But also and probably majority of it has to do with the ERP rollout. So let me just give you a bit of color if I could there, Keith. If you recall going back to our rollout of the Montreal DC, we had ERP program called Manhattan. Manhattan was a mini disaster for us. It took us a while to get our staff educated on the restrictive nature of that kind of ERP program. That was not very flexible. And so there was a huge learning curve for us there. In order not to replicate the same kinds of disasters as in the SAP rollout, some of our teams have duplicated their infrastructure in warehousing to make sure that we don’t disrupt service to our customers like we did under the Manhattan system and like it could have happened under the rollout of the first DC in the dairy foods platform. So we are actually operating five incremental warehouses more than what we actually need because of ERP. Then there is a couple of other warehouses we have for the incremental inventories, but the majority of our warehouse incremental expenses are coming from the ERP rollout, which once we get SAP systems throughout the organization, once we get everybody familiar with the rigidity of that system and how to enter data and how to release products, then those five warehouses probably in the next 1 year or 2 years will come out of our system. The third-party warehouses that we are renting right now are not owned by the organization and those are costs that are going to come out of our system once we got ERP rolling effectively and efficiently.

And once your organization is familiar with doing that with Saputo dairy foods, can you do the cheese division without additional inventory space or probably you would put it in there also?

To be safe, we will certainly be prepared to add all the necessary space that we need in order to make sure we don’t short supply the market. And we are in that phase of getting ready to deploy in the Christmas time in our Cheese Division U.S. And we are in the analysis phase relative to that part right now.

So we are about that 2.5 years into this 5-year journey. And I would say that we have implemented ERP in Argentina and Australia successfully. We are close to probably three quarters implementation in SDS. And throughout all of those implementations, of course there have been some bumps on the road, but there has been no paralysis of our systems. And no paralysis of us being able to get product to our customers. Again, bumps along the way, but not to degree that we experienced with Manhattan. So we believe that this investment and these incremental costs are the right decision for the organization. But they will be short lived once we have got the ERP fully entrenched in our system.

Great. Thank you. And just to switch topics dramatically, when you speak about diversification of your business through acquisitions, does that refer to product lines or geographies or…?

All of the above, yes. So with the geographies, we have talked about eventually now that we have got a very strong management team in Australia, eventually having a platform in New Zealand if the right opportunity comes along. And you may have seen that one of those opportunities have presented themselves. So I think we will be quite active on assets that become available in those geographies that we are interested in. We are talking about diversification as well in terms of product categories in the dairy space. In those categories that we believe we are experts in and where we can generate value. And I say that because when you think about outside of the platforms that we are in, I don’t think that fluid milk is a winning category. Number one consumption is going down and number two, it’s a very competitive area. So, that’s something whether it’s the U.S. or some other platform, Europe or something else, we would prefer not to get into fluid milk. We talked about yogurt not really being in our wheelhouse unless it’s really value-added specialty over like we did with Shepherds Gourmet and ice cream is not something that we are in outside of the say the ice cream mixes that we are making for some of our foodservice customers. So we are very, very focused on the dairy processing spaces that we are very good at. We are very focused on the geographies that make sense to us, 5 largest dairy producing countries is where we want to be. And I think within even that narrow focus there still are some really great opportunities that could catapult our company again to become bigger, better, and stronger.

Thank you.

Thank you very much.

Our next question comes from the line of Irene Nattel with RBC Capital Markets. Please proceed.

Thanks. Just one final question. Following up on that last comment, Lino, can you please remind us within Europe, what the criteria would be for you to get back into that market given what you learned the last time?

Yes. So Europe is still on our radar screen. If you recall, when we were in Europe, I would characterize us as being a one-trick pony. We were a mozzarella manufacturer, where we were producing mozzarella for retail and for foodservice. And mozzarella in Europe is not really viewed as a specialty category or specialty items. In fact, most processors that had diverse platforms would put their excess milk into mozzarella and just dump the mozzarella in the market and even as a high-quality, low cost processor, it was tough to compete. So, as we look at Europe, we have got to look at those countries number one, where we have got milk, where milk is available. Number two, where there could be a platform that has diversification in their product portfolio, where the platform is sizable and where the brands are strong. When you think about the strength of the retailers in Europe, you need to have a brand that can carry the day. So, that’s the criteria that we are looking at in Europe. If we can find a platform that would check all of those boxes, where we got size and scope, where you have got diversification of products, where you got value-added categories and on top of that, you have got a brand that can carry the day, that’s the kind of acquisition we are looking for.

So presumably, you found some?

Presumably, we have some targets. Let’s put it that way.

That’s great. Thank you.

Thank you very much, Irene.

Mr. Saputo, Jr., there are no further questions at this time. Please continue with your presentation or closing remarks.

Thank you very much, Frank.

We thank you for taking part in this conference call. We hope you will join us for the presentation of our fiscal 2019 second quarter results on November 3. Have a nice day.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Have a great day everyone.