Resolute Forest Products Inc.
Q3 2015 Earnings Call Transcript

Published: 30 Oct 2015

[Operator:]

Good morning, ladies and gentlemen. Welcome to the Resolute Forest Products Third Quarter 2015 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ presentation, we will conduct a question-and-answer session. [Operator Instructions] Please note that this call is being recorded today, Thursday, October 29, 2015, at 9

[Rémi Lalonde:]

Thank you, Tiffney. Good morning, everyone. Welcome to Resolute’s third quarter earnings call. Today, we’ll hear from Richard Garneau, President and Chief Executive Officer, and Jo-Ann Longworth, Senior Vice President and Chief Financial Officer. You can follow along with the slides for today’s presentation by logging onto the webcast using the link in the Presentations and Webcasts page under the Investor Relations section of our Website, or you can download the slides. We provide additional financial and statistical information, including a reconciliation of non-GAAP financial measures, in our press release and in the slides. As always, certain subjects we will cover involve forward-looking information. Our statements are based on our current assumptions, beliefs, and expectations, all of which involve a number of business risks and uncertainties and accordingly can change as conditions do. Richard?

[Richard Garneau:]

Good morning and thank you for joining us today. We generated $82 million of adjusted EBITDA in the quarter compare to $89 million in the second quarter, our growth businesses market pulp and wood product performed well considering the cyclical headwinds they faced, but our paper grades, particularly newsprint are meeting an increasingly challenging environment. By segment, we generated adjusted EBITDA of $36 million in market pulp, down by $2 million from the second quarter, $18 million in wood products, up by $13 million, $6 million in newsprint, down by $13 million, and $27 million in specialty paper, down by $9 million from the previous quarter. Overall pricing was lower across each of our four segments, especially in newsprint and market pulp and manufacturing cost rose slightly. But the impact was partially offset by the favorable effect of the weaker Canadian dollars and lower selling price at general and administrative expenses. Shipments were higher in each segment except for newsprint, Through September world demand for chemical pulp grew by 4%, compared to the same period of 2014 including an increase of 13% in China, 4% in Latin America and 1% in North America. World capacity grew by about 2% in the same period, mostly reflecting the impact of the significant expansion of Latin American hardwood capacity, year-to-date, world demand for softwood was also up by around 1%, which reflects an increase in shipments to North America and a 7% increase in shipment to China offset by a 4% decrease of shipments to Europe [ph]. In the same period the demand for hardwood was up by about 7% and shipments higher by 22% of China and 4% of western Europe, but down by 2% in North America. Through August world shipments of non-eucalyptus were up by 1 million metric tons on par with the increase in eucalyptus, but eucalyptus is gaining shares in markets like North America where shipments of northern and southern or other wood grades were down collectively by 12%. The average transaction price for market pulp was down by $19 per metric ton, compared to the second quarter, mostly as a result of customer mix, shipments improved to 360,000 metric tons up by 9,000 metric tons from the second quarter. We also continue to reduce our finish goods inventory which were up by 11,000 metric tons now down to 77,000 metric tons or tightest level of supply in years. The impact of the lower prices was partially offset by the effect of the weaker Canadian dollars and the favorable properties tax adjustment leading to an EBITDA margin of $100 per metric tons this quarter down by $8 from the previous quarter. We continue to believe in the underlying fundamentals and the growth prospects for market pulp, but our near-term outlook for pricing remained cautious, considering the uncertainty around macroeconomic factors and global commodity prices. U.S. housing starts sustained their pace of gradual improvement in the quarter with starts nearing 1.2 million on a seasonally adjusted basis, which is 13% higher in the same period of 2014. But lower North American lumber exports to China, down by 15% through August continued to have downward pressure on prices. Our average transaction price fell further $6 per thousand board feet on top of the $33 drop in the second quarter, reaching the lowest level since the first quarter of 2012. Prices bottom out in September then, started to recover in October. Likely as it became clear that the fear of a drastic increase in supply to the U.S. market failed to materialize, with the mid-October expression of the Canada-U.S. Softwood Lumber Agreement. Our lumber shipments rose incrementally in the quarter including some additional production from the Atikokan and Ignace sawmills. But we took some downtime in Quebec during the quarter due to fiber shortages. Despite the lower selling prices for lumber, our EBITDA margin improved to $43 per thousand board feet, or 14% compared to $12 in the previous quarter. As a result again of the weaker Canadian dollars, lower private costs and the recognition of additional tax credits in connection with infrastructure investments. We are also currently in the one year standstill period following the expiration of the SLA, the Softwood Lumber Agreement. We believe in free trade and that everyone benefits from open and fair market driven competition. If Canada is to renegotiate an agreement with U.S. and we believe that is must include a free trade exit ramp for provinces that have implemented market based reforms. Such an exit mechanism was included in the now expire of 2006 Softwood Lumber Agreement, but unfortunately it was never activated or enforce by either to U.S. or Canada. North American demand for newsprint dropped by 12% through September. Production was also significantly lower, down by 13% in Canada and 18% in the U.S., contributing to operating rates of 91% in North America. Global demand was down by 10% in the same period with drops in all major regions including Asia down 10%, Western Europe down 9% and Latin America down 12%. North American export remain weak down by year 16% year-to-date including a drop of 17% to Latin America and 19% to Asia. World operating rate outside of North America and Western Europe were around 80% through August. Shipments were 31,000 tons lower in the quarter, mostly due to strategic Ontario mill downtime to avoid coincidental peaks under the province electricity rules, thereby saving millions on our annual Ontario electricity bill. The average transaction price continue to slide this quarter falling another $30 per metric ton to $498. Selling price are down more of the $90 per metric ton since the same quarter of 2014. The lower prices reduce our EBITDA margin to $12 per metric ton compared to $35 per ton in the previous quarter. Consumption shows no sign of improvements. Nevertheless, we plan to run all of our newsprint machines, as we believe that our asset based gives us a competitive edge to whether the accelerate rate pace of North American and global decline and the effect of very little operating rates outside North America and Western Europe. Year-to-date demand for uncoated mechanical papers was down by 12% in North America with supercalendared grade down by 9% and standard grades, which include super-brite and hi-brites down by 13%. Overall deduction is down by a corresponding 14% leading to operating rate around 90% unchanged from 2014. Coated mechanical demand was down by 7% through September, but the shipments-to-capacity ratio was 93% as a result of the 9% reduction in capacity. Domestic shipments by North American producers dropped by 11% as Europe imports rose by 90,000 metric tons. The average transaction price in the segment down year $8 per short ton compared to the second quarter, mostly as a result of increasing pressure of European imports. Our shipments of specialty paper rose by 23,000 short tons in the quarter, reflecting a seasonal increase in demand and in shipments of our connect uncoated free sheet grade, with the connect grade, we’re moving up the value change and generating more attractive margins. The lower prices as well as higher chemical and seasonal power cost reduced EBITDA margin by $27 per short ton to $66 or 9%. Finished goods inventory fell by 12,000 short tons. The U.S. department of commerce recently announced that it would require cash deposits on estimated and project duties against Resolute in connection with the investigation of imports of SC paper from Canada. The 17.87% subsidy rate is a significant increase from the preliminary raise of 2.04% in commerce calculated in July, we believe that their possession in base on the refusal to consider all the information we made available during the investigation and an incorrect interpretation of the statue and the unreasonable application of that subsidy rate determined in an administrative review decided 1997 concerning a 1988 investigation into imports of magnesium that has nothing to do with Resolute or with SC paper. All but 0.77% of the 17.87% subsidy rate is based on two specific programs, commerce said it discover during its onsite verification of the expenses records we provided. These program relate to modest amounts received by Fibrek, which produces kraft pulp, only a very small portion of which is sold internally to have strength to SC paper of manufactured in Dolbeau and Kenogami in Quebec. We believe that it is unreasonable to conclude the two program in question represent a subsidies of any significance, if at all, for SC paper production. But for these two programs the subsidy rate applicable for Resolute what have been de minimis and Resolute would the excluded from a possible countervailing duty order. We will continue to strongly defend our possession. We’ve consistently said that our production of SC paper in Canada has receive negligible if any direct or indirect subsidies and that we should not be subjected to countervailing duties. We are considering that the facts support our case and that legal process will treat the matter fairly, but until its resolve we will be required to make cash deposit at definitive rates set by commerce on all SC paper imported to U.S. Unfortunately the situation could significantly impact the competitive possession of our Dolbeau and Kenogami mills and this just one year after the closure of our Laurentide SC mills whose competitiveness was mainly affected by the heavily subsidized restart of the Port Hawkesbury mill at the end of 2012. We have a clear strategy for the future, maximize our competitive edge to generate as much value as we can with our paper assets, continuing to grow the lumber and pulp segment, integrate our pulp asset to produce high quality tissue and towel products. Building on the integration of our Ignace and Atikokan sawmills this year, I will focus on completing the Calhoun continuous pulp digester project. This project is on track for the late December startup, once fully operational we expect that it will grow our market pulp capacity by 100,000 metric tons and that it will reduce our mill wide cost. The key advantage is that it will also provide t enough slush pulp capacity to meet all of the fiber needs for the tissue machine that we plan to startup in the first quarter of 2017. We will compete in the tissue market as one of only a few integrated producers with the benefit of the latest technology. Jo-Ann will now review our financial performance.

[Jo-Ann Longworth:]

Thank you, Richard. And good morning everyone. Today we reported third quarter net income of 14 million excluding special items or $0.15 per share. GAAP net loss was 6 million or $0.07 per share. Debt special items of 20 million in the quarter included mainly 13 million of non-operating pension and other postretirement benefit cost and a 5 million non-cash loss on the translation of Canadian dollar net monetary assets. Total sales of third quarter were 905 billion, 21 million lower than the second quarter. Shipments were 31,000 metric tons lower in newsprint but they rose in each of the other segment by 9,000 metric tons in market pulp, 3 million board feet in wood products and 23,000 short tons in specialty papers. Overall the higher shipments had a $2 million favorable impact on our results. Pricing was lower across each of the grades, $19 per metric ton in market pulp, $6 per thousand board feet in wood products, $30 per metric ton in new strength and $8 per short ton in specialty papers. The lower pricing unfavorably affected results by 25 million compared to the second quarter. This was only partly offset by the $12 million favorable impact of the weaker Canadian dollar, mostly because of the effect on our costs. Cost rose margin this quarter up by 4 million, after adjusting for the higher volume and the effective currency. The change in manufacturing costs is due to higher scheduled maintenance, increased costs for chemical and seasonally higher power costs. Partially offset by lower fiber cost, a property tax adjustment and the recognition of additional tax credit in connection with infrastructure investments. The cogeneration assets that sell power to third parties added 10 million of EBITDA in the third quarter, a $3 million reduction from the previous quarter due to the impact of schedule outages and the weaker Canadian dollar. Compared to the second quarter, market pulp’s all-in delivered cost was $9 per metric ton lower, or 2%, to 576, which reflect a property tax adjustment partly offset by higher maintenance costs and lower cogeneration contribution. The delivered cost in wood products fell by $33 per thousand board feet or 10% to 294, mostly because of the favorable effect of the weaker Canadian dollar, lower fiber costs and the recognition of additional tax credit in connection with infrastructure investment. Newsprint delivered cost was essentially unchanged by $4 per metric ton. Higher chemical and seasonal power costs attributed to a $13 per short ton or 2% increase in the delivered costs of specialty papers. Our selling, general and administrative expenses were $6 million lower in the quarter mostly as a result of expense timing and lower project costs. Cash and cash equivalents were 235 million at quarter end, down by 68 million from the second quarter. The change reflects, the repurchase of 2.3 million shares or 2.5% of outstanding for $22 million an increase in capital expenditures to $44 and a $21 million increase for pension funding to 55 million which as we described last quarter is due to the timing of contribution in both the U.S. and Canada. There was no net cash provided by operating activities in the quarter, compared to 61 million in the previous quarter and 90 million year-to-date. Most of the change was due to an increase in working capital related to non-trade receivable, the seasonal decrease of wood inventory in the second quarter as well as the timing of pension contributions. Capital expenditures were 44 million, a 13% increase from the previous quarter. As we said before, our rate of CapEx spending will increased going forward as we ramp up construction for the tissue project. We spent 22 million so far this year and we plan to spend another 28 million on the project in the fourth quarter. This is short of the $90 million we previously announced for 2015 and is due only to timing of spending. For 2016, we will spend about 190 million on the tissue project, which remains on-time and on-budget. We expect to have total CapEx including the tissue project, the continuous digester and other value creating project of approximately 240 million in 2015. Pension funding was 55 million in the quarter compared to 34 million in the second quarter and 27 million in the first quarter. As we noted in July, the interest increase reflect 15 million for the third and fourth quarter contribution to U.S. plans and an additional contribution of 14 million for machine closures under the special funding release measures in Quebec and Ontario. We expect contribution to drop back to 29 million in Q4. In total, for 2015, we continue to expect 145 million of pension contribution and 15 million of OPEB payments versus 81 million of related expense. The net pension and OPEB liability at the end of the third quarter decline by 119 million when compared to the second quarter. As a result, of the weaker Canadian dollar and our regular contributions. Finally available under our ABL credit facility at quarter end with 448 million maintaining very strong liquidity of 683 million with net debt low at only 362 million.

[Rémi Lalonde:]

Thank you, Jo-Ann. Tiffney let open the call for questions please.

[Operator:]

[Operator Instructions] Your first question comes from the line of Sean Steuart with TD Securities. Your line is open.

[Sean Steuart:]

A couple of questions. I wonder if you can quantify the Q3 property tax adjustment and the impact of the incremental tax credits. And on the tax credit side, I assume that's all in the wood products segment. And if so, what's the sustainability of that number, going forward?

[Jo-Ann Longworth:]

Hi Sean, it’s Jo-Ann. For the property taxes it was $6 million and for the tax credit it was $7 million.

[Sean Steuart:]

And was the property tax adjustment in wood products as well?

[Jo-Ann Longworth:]

No, it was partially in newsprint, partially in pulp.

[Sean Steuart:]

Okay. And sustainability of those numbers?

[Jo-Ann Longworth:]

Well those are credit for prior year, so there is some continuity on the property tax, because we lowered our tax base there, and we’ve lowered in actually many areas in Ontario, so there will be an impact going forward, but much less.

[Sean Steuart:]

Okay. And Richard, a question on North American newsprint markets. Just your sense of -- is the floor setting in with the supply response initiatives you've seen from some of your competitors? Do you have a sense that the market's balancing out here?

[Richard Garneau:]

Well, when you look at the shipment, the capacity, its 91%, so I think at this level I consider that -- well it’s certainly not a disaster, so its higher than 90%, we should not see I guess and I hope more pressure on pricing. When you look at all shipment, so Q2 versus Q3, so our shipments -- domestic shipments were down by only 19,000 tons and on the export also we were only down by 12, so I think that certainly the -- some of the capacity closure that we announced and that's going to take to be in effect basically before the end of the year of suddenly helping to bring these shipments and capacity ratio to over, maybe over 91%, so over what should maybe there would be a level where that prices could stabilize and so that’s coming down because if you look at the quarter, on the spend now we're below $500, at the $498, as I mentioned so who would have expected that a decline that significant. So I think that way probably have with at the bottom and that we should see hopefully some improvement on this side.

[Sean Steuart:]

Okay. Thanks for the context. I’ll get back in the queue.

[Operator:]

Your next question comes from line of Bill Hoffmann with RBC Capital Markets. Your line is open.

[Bill Hoffmann:]

A couple of things. Richard, you talked about the fiber shortages up in Quebec in the quarter. Could you just talk a little bit about, sort of, what your outlook is for fiber availability up there, and how it's going to affect your lumber business, if and as you continue to be able to increase shipments into the US for next year?

[Richard Garneau:]

Well, I think that its fiber shortages going to continue in Quebec, so I think that -- we’ll likely to have also outages in our sawmills, so downturn because of that fiber shortage in the fourth quarter and I think it's also likely that the situation is not going to be better in 2016. So I think that it probably worth mentioning that the selection that we have on wood, [indiscernible] it’s the new tennue system, it’s 25% of the wood that’s put to auction and planning is done by the government, but it happens quite frequently, it is difficult to have access to the cut blocks that sometime you have, if you have the wrong blocks, so you have winters blocks in summer that you can basically, that you cannot have access to so I think that's a before its completely under control, it will take time, but I expect that the shortage is going to be something that we’ve going to have to deal within in 2016 too.

[Bill Hoffmann:]

And just general thoughts, with this sort of timeframe after the expiration of the SLA, your thoughts on the market balance as you head into next year. I’m assuming demand will be up in North America. But it doesn’t look like there would be any change over to Asian shipments. So, any thoughts on market conditions for next year?

[Richard Garneau:]

Certainly when you look at the housing starts, so it’s coming up on September, it was slightly over 1.2 million, so I think that despite that next year, we should see between 1.2 million and 1.3 million and considering that there is some fiber shortage in Quebec, I don’t think that and well likely eventually in [indiscernible] fiber availability is probably going to be restrained too. So I think that’s I heard quite often this wall of wood, I don’t think that we’re going to see it. So my view and our view on the market is that supply and demand as the Chinese market that start to improve and the export comes back to last year level, I think that we, I’m optimistic to as well. Cautiously optimistic that we should see better pricing next year.

[Bill Hoffmann:]

Thank you. And then just the last question is more for Jo-Ann. Just from a pure cash standpoint, as you look into 2016 and the tissue project, and continued pension funding within the context of what you’re dealing with here, which is lower average pricing pretty much across the board in all the commodities, how do you think about your cash flows over the next year? Is ’16 going to be a cash-neutral year or cash-negative year?

[Jo-Ann Longworth:]

Well, I’ve got quite share with the bottom-line cash position will be the end of 2016. Obviously we’re only in October of this year. But certainly what we’ve said in the past CapEx will increase or stay the same level we’ve got a 190 million alone for the tissue project next year. Pension contributions, we talk about this last quarter. We are waiting for new regulation from Quebec as to its method for calculating funding. And so until we have a final regulation on that, we do know that could impact contribution, if is not next year certainly in the medium term and it will be favorable, but we don’t know by how much. And of course we have nearly 500 million of availability under the ABL and another till today $235 million of cash. So I’m not terribly concerned.

[Operator:]

[Operator Instructions] Your next question comes from the line of Paul Quinn with RBC Capital Markets. Your line is open.

[Paul Quinn:]

Yes, thanks very much and good morning. Just start on specialty papers. Just wondering what your recourse is on the Department of Commerce ruling. And mention the legal process, and what the timing of that is.

[Richard Garneau:]

Well we basically being respondents, we have only one option, it’s an administrative review. It’s likely to take a year to 18 months, and we need more than that. So, it’s a pretty long process, to have a decision. And hopefully we still believe that the one we look at how this rate was established I think that we’re still questioning and trying to see if there is a faster process basically to have the recognition that this deposit rate that has been set by commerce has no relation with the subject [indiscernible] and that rate is based on program in Ontario and also on these two program attached to Fibrek that use pulp. So, it’s and the pulp, the Fibrek pulp there is only a tiny, tiny amount that is used by Dolbeau and Kenogami. So we just don’t see the rational of this rate here. So and the rate was based on the magnesium case as we mentioned in our press release. So that’s a case that came from 1990 and the main reason it’s not related at all to SC, and certainly I feel very confident that when the administrative review that will eventually confirm that our, the SC produced in Quebec is in no way subsidized. And I think that we already closed Laurentide as you know because of the restart of Port Hawkesbury. It’s the metal that has been subsidized, certainly not our two mills.

[Paul Quinn:]

That’s a pretty fulsome answer. Maybe just moving on to newsprint, because I’m kind of confused at your answer to Sean’s question on shipment cap operating rates at 91% signaling a bottom. I mean, we’ve got North American demand going down 12%, world demand going down 10%. That just suggests that that operating rate’s going to continue to slide unless we get some capacity out. And you guys have always described yourself as a low-cost producer and yet EBITDA of $12 a metric ton, what if it’s suggesting that the average industry participant is at? Are they negative right now? Where are they most negative? Is that in the U.S.?

[Richard Garneau:]

Yes, certainly the newsprint mills that are in Canada have an advantage with the exchange rates and you are right, the U.S. mills are certainly challenged at this point, but I think that you’ve seen capacity closures in Canada and also in the U.S. I think the it’s likely to continue at this level, so I mentioned our pricing -- our selling price that is below 500, so I think that at this level, but I don't own any mills that are going to be able to continue to run and certainly U.S. mills are most challenged than the Canadian.

[Paul Quinn:]

Okay. And just lastly on the wood products side, just if you could describe how to ramp-up of Atikokan and the Ignace is going and what do you expect, additional production in 2016 from those mills?

[Richard Garneau:]

Well, we’re still working on basically the ramp-up -- production ramp-up so the challenge that we have presently that we didn’t really -- that we didn’t expect is to have enough people to run the Atikokan sawmill and even the Ignace sawmills, so two weeks ago we started a second shift at Atikokan, but just realized that we don't have enough people to run the second shift, so that's we are on a process to higher of that people and that we go job fair in other provinces, so it’s the difficulty that we presently have, that both sides have to get the scale and to get the people to run them. So I think overall when we look at the equipment, sawmill at the Atikokan is really ramping up well, that's the plan on mills that we have some difficulties with the equipment that we believe should be resolved in the fourth quarter and the Ignace sawmill that run now on the one shift, and from that two shifts, one we have the people, so I think that we should have the full complement on the labor side in 2016 working on apprenticeship program and also trying to attract people and went to western provinces for -- in oil patch that will -- that are going to come back in the northern community.

[Paul Quinn:]

Okay. And just switch back -- just lastly, just switching back to specialty again, that -- given the Department of Commerce cash deposit rate at almost 18%, and sort of your historical shipments from Canada to the US, what does that compute to, in terms of an annual cash deposit?

[Richard Garneau:]

Well it's between $20 million and $25 million a year, it is quite significant.

[Operator:]

Your next question comes from the line of Benoit Laprade with Scotiabank. Your line is open.

[Benoit Laprade:]

Thank you, good morning. Just wanted to clarify, on the CapEx side you mentioned 2016 $190 million for the tissue alone. Would you have a number for overall CapEx for 2016?

[Jo-Ann Longworth:]

Hi no, it’s Jon-Ann, we have completed our budgeting process, I don't have that number yet.

[Operator:]

There are no further questions in queue at this time. We now have a question from the line of Bill Hoffmann with RBC Capital Markets. Your line is open.

[Bill Hoffmann:]

Yes, thanks just one follow-up. As you look into 2016 with the tissue project, I mean, given sort of cash positions and some of the challenges and fundamentals here, can you slow that project down if from a cash standpoint things get tight or you start to burn into too much of your liquidity?

[Richard Garneau:]

Well, no it's a -- I think that we’re going to proceed and the converting lines should be basically ready for the fourth quarter of next year than the tissue machine is going to be ready for the first quarter of 2017, but I think that's it’s really a diversification, we had the pulp available, we’re going to complete our continuous digester project by the end of the year. So I think that it's a really important project when we look at the diversification and looking at the product that as a well study increase in demand. So and obviously with the latest technology and slush pulp available and as Jo-Ann and I have mentioned that the cost, that will be the continuous digester is going to be lower, so we want to add it on online as quickly as possible and have the segment, basically it’s going to generate EBITDA.

[Jo-Ann Longworth:]

And Bill like I said, we’ve got nearly 700 million in liquidity today, so I’m really, as I said, not overly concerned about our liquidity for next year.

[Bill Hoffmann:]

Okay. Thank you.

[Operator:]

I’ll now turn the conference back over to our presenters.

[Rémi Lalonde:]

Great thank you Tiffney. Thank you everybody for joining us today. We’ll leave it that. Thank you.

[Operator:]

This conclude today’s conference call. You may now disconnect.