Domtar Corporation
Q2 2017 Earnings Call Transcript

Published: 29 Jul 2017

[Operator:]

Good day, ladies and gentlemen. Welcome to the Domtar Corporation's Second Quarter 2017 Financial Results Conference Call. At this time all participates are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. As a reminder, this call is being recorded today, July the 28, 2017. And I would not like to turn the meeting over to Mr. Nicholas Estrela. Please go ahead, sir.

[Nicholas Estrela:]

Thank you. Good morning. And welcome to our Second Quarter 2017 Earning Call. Our speakers today will be John Williams, President and Chief Executive Officer; and Daniel Buron, Senior Vice President and Chief Financial Officer. They will be supported by Michael Garcia from our Pulp and Paper division, and Michael Fagen from the Personal Care division. John and Daniel will begin with prepared remarks after which they will take questions. During the call references will be made to supporting slides, and you can find this presentation in the Investors section of the website. As a reminder, all statements made during the call that are not based on historical facts are forward-looking statements, subject to a number of risks and uncertainties, many of which are outside our control. I invite you to review Domtar's filings to the Securities Commission for a listing of those. Finally, certain non-U.S. GAAP financial measures will be presented and discussed, and you can find the reconciliation to the closest GAAP measures in the Appendix of this morning's release, as well as on our website. So with that, I'll turn it over to John.

[John David Williams:]

Thank you, Nick. And good morning, everyone. This morning we reported EBITDA before items of $143 million and sales of $1.2 billion. Our Pulp and Paper mills ran well and productivity was strong, resulting in a good cost performance across our network. Our teams also demonstrated solid execution by managing through several days of planned maintenance downtime. Maintenance costs were under budget, with relatively few discoveries or delays. In the Pulp business, results improved from the first quarter. Notably Ashdown had an excellent quarter with daily production of over 2,000 metric tons of slush pulp, while fluff pulp volume production continues to increase. Momentum continued in both volume and price. Year-to-date our pulp shipments are 15% higher when compared to last year. We announced several new price increases in the quarter, supported by steady demand and tight supply of softwood pulp. In Paper, demand is down nearly 5% year-to-date, but our system is relatively balanced and we do see volume rebounding in certain channels after a slow start to the year. Our Personal Care business delivered a good performance in a competitive market environment. We continue to show year-over-year volume growth across most of our channels, while our cost savings and efficiency improvement projects partially offset price erosion. We are continuing to invest in innovation and marketing and targeted growth initiatives that capture the opportunities in our categories and geographies. We generated strong cash flow in the quarter. Our year-to-date free cash flow has already surpassed full year 2016 levels, which provide us with further flexibility to make strategic acquisitions and for re-purposing opportunities. Our ability to generate strong cash ensures we're a sustainable company. Caring about our environment, our communities and our people also helps us better meet our business objectives. The sustainability report we issued this month shows we've achieved a 33% reduction in the amount of waste sent to landfills, a 13% reduction in greenhouse gas emissions since 2010, significant efficiency improvements in our use of water, and a doubling of hours that Domtar employees volunteer at company-sponsored events to improve the communities where we live. By working smart for the long term, Domtar is enhancing its reputation for ethical, sustainable business practices. This differentiates us with customers who care about the integrity of their supply chains, and provides us with a distinct advantage in recruiting the next generation of talent. With that, let me turn the call over to Daniel for the financial review, before making further comments on our performance and our outlook. Daniel?

[Daniel Buron:]

Thank you, John. And good morning, everyone. Let's start by going over the financial highlights of the quarter on Slide 4. We reported this morning net earnings of $0.61 per share for the second quarter, compared to net earnings of $0.32 per share for the first quarter of 2017. EBITDA amounted to $143 million compared to $122 million in the first quarter. Earnings – the sequential variation in the earnings on Slide 5. Consolidated sales were $80 million lower than the first quarter mostly due to lower pulp and paper volume. Depreciation and amortization was $1 million lower than the first quarter, while SG&A was at $3 million higher than the first quarter. In the second quarter, we recorded an income tax expense of $9 million or an effective tax rate of 19%. The tax expense in Q2 includes a $2 million benefit from changes in inactivate (05

[John David Williams:]

Thank you, Daniel. Our financial results improved in the second quarter versus the first quarter. Productivity was strong, resulting in a solid cost performance. We're making good headway with our continuous improvement initiatives. They're yielding encouraging results, specifically with chemical usage, where we're tracking over $5 million in year-to-date savings. In addition, the rollout of our management operating system, or MOS, across seven of our mills is driving the focus on effective planning and problem solving. MOS involves establishing and closely tracking key performance indicators for each area of mill operations. We will further pursue permanent cross reductions through savings projects, supply chain optimization, and investment in high return improvement opportunities in order to drive sustainable results. Moving to my business review, pulp prices were higher following the recently announced price increases. And we expect some additional price momentum in the third quarter, as we implement those increases. We're seeing our pricing on NBSK in China holding steady for August versus July. Good news for the seasonally slower summer periods. Our fluff pulp shipments continued to grow. In addition, the A1 fluff pulp line at Ashdown had the best performance to date on cost and productions, with shipments of nearly 25,000 tons of fluff pulp in the quarter. We made progress on several internal and external customer qualification trials and are on track to ramp up to approximately 50% fluff pulp sales by year-end at Ashdown. Kamloops and Dryden also ran well with both mills operating above plan. At Kamloops, the turbine generator rebuild took place in the second quarter. We successfully completed the installation with start-up occurring earlier this month. With regards to the wildfires in British Columbia, weather conditions have improved recently with cooler temperatures and some rain, which has helped contain some of the major fires in the area. In Paper, we took 12,000 tons of lack-of-order downtime in order to balance our supply with customer demand while prices were higher due mostly to an improved mix. We completed the installation of a second turbine generator at our Windsor Mill. The turbine will add more than 15 megawatts of output, and will start up in the third quarter. This investment will improve the energy efficiency of the mill and reduce production costs. Windsor's self-generating capacity will reach nearly 50 megawatts of green energy, the equivalent of the annual electricity consumption of nearly 45,000 thousand homes. Domtar's self-generation of electricity has increased by 16% since 2007, bringing our overall mill self-sufficiency to 72% in 2017. In Personal Care, we continue to perform well in a challenging environment. Price pressure in retail and institutional healthcare persists, while promotional and discounting efforts have increased in branded products. Rising input costs are expected to remain a headwind for the balance of the year, but we believe that our cost savings programs will largely offset this. In the second quarter, sales increased 6%. Several key customers grew their store brand programs in the quarter, and we gained distribution at additional points of sale. Our top line was partly impacted by less shipping days in the quarter and inventory draw-downs with some of our distributors. In our North American Infant business, year-over-year volumes increase 8%, a good performance despite continued slow market growth. Some perspective demand for infant diapers in the U.S. is actually down 4% year to date In Europe, we're launching a new lineup of protective underwear and bladder control pants, so we expect a strong performance from our AI business in the second half. Our sales pipeline also remains strong with a number of bid submissions in both North American and Europe in the quarter. Our partner brand model continues to resonate driven by our superior consumer insights and customized innovation, two key value drivers for our customers. And we are focusing on the fundamentals that differentiate our business and stepping up our growth plans. We continue down a well-defined path in both Pulp and Paper and Personal Care to build a solid foundation for long-term success. We remain on the lookout for M&A and repurposing opportunities that will accelerate Domtar's transition towards growth markets, while capitalizing on our existing strengths and core competencies. Before we open the line for questions, it's with heavy heart that I have to report we had a fatality at our Kamloops Mill in late June. The employee involved was a 36-year member of the Domtar family, and he will be greatly missed. On behalf of all Domtar employees, we offer our thoughts and our prayers to his family. I wanted to take this opportunity to reaffirm that the safety and well-being of the people working in our facilities is of the highest priority to all us here at Domtar. Our year-to-date incident rate of .75 is a significant improvement since 2011, but this tragedy deepens our resolve to continuously improve our safety culture, our processes and our behaviors, as we strive to achieve and injury-free workplace. Now to our outlook. For the remainder of the year, we expect our Paper shipments to be in line with market demand. Pulp shipments should be growing, due to the ramp up of the Ashdown fluff pulp line while mix should continue to improve as we qualify more customers to fluff pulp. In Personal Care, investments in advertising and promotion, in addition to new customer wins, will drive higher sales, while raw materials costs are expected to increase marginally. Thank you for your time and support, and I'll turn the call back to Nick for questions.

[Nicholas Estrela:]

Thank you, John. So, both John and Daniel will be available for questions. I'd ask all of our participants to ask a few questions at a time and return to the queue for follow-ups as we want to get as many people as possible. Angel, you can open the lines up for questions.

[Operator:]

We'll go ahead with our first question from Anthony Pettinari of Citi. Please go ahead.

[Anthony Pettinari:]

Good morning.

[John David Williams:]

Good morning.

[Anthony Pettinari:]

John, in prepared remarks, you talked about maybe a more competitive environment in institutional and retail and some price erosion in Personal Care. I was just wondering if you could share any thoughts on what's driving that. Is that transitory or something that could be more long lived and any kind of thoughts on what margins might look like in the second half of the year?

[John David Williams:]

Yes. Certainly. Let me talk to the first part in some detail. So, what you've certainly got in the baby diaper business, you have the major brand. It's Pampers, we all know who it is, really fighting to try and regain position. And you have private label responding to that with lower prices and promotion. Now what that's actually meant for us is because of the customers we have is we've done out of that, in volumes terms, as those customers we're with and the fact that we've won a new major customer in Europe, so we're seeing growth in the market. If you take the last 12 weeks, it's actually some considerable decline. So, I think over time that price pressure will erode because the major brands are not going to be able to afford to sustain that price position, and they're going to have to think about sort of building customer loyalty through advertising as distinct from just promotion. So, that's the infant diaper piece. On the AI piece, of course, what is happening is both in the prescription business in Europe and in the reimburse business in the U.S., you're seeing pressure because, you know, all healthcare systems are under pressure in all kinds of different ways depending on the geography. So, this is pushing the consumer home. As that consumer goes homes, there is quite a battle going on for how you generate loyalty with that consumer; how you generate business with that consumer. That really is why we purchased the HDIS business, because we believe, over time, as that consumer gets home, if we can build a really strong personal direct relationship with that consumer and ship product to him or her, effectively, we're actually going to have a strong branded business opportunity, which we hadn't got before. So, what that means, certainly in the short term I think is there is margin pressure around. I think if I look just at sort of the second half, I don't see further erosion from where we are today. If we win new business and we win the drop through of that new business through our machine park, and we work hard, I think, to offset some of the cost issues, I mean I don't see it getting worse than where it is today. I still believe pretty strongly as those markets settle that opportunity for kind of mid-teens margin over time still is there. I have not lost sight of that, nor hope on that. But certainly at the moment, it's a very competitive marketplace. Does that answer the question?

[Anthony Pettinari:]

No. That's extremely helpful. And then, maybe just one more. You know you referenced the potential repurposing opportunities. When you look at the footprint, is it safe to say that fluff might be the most logical target for repurposing or could there potentially be opportunities in tissue or even containerboard? And understanding that you don't have a box plant system, would it make sense potentially to sell a mill to be converted by maybe another containerboard producer? Any kind of thoughts you can give around that?

[John David Williams:]

Certainly. So, let's just talk briefly about how we look at conversion. So really the first thing we look at is the marketplace. So, is there a compelling reason to be in the market? What are the dynamics of the market? I think what we've done so far – we've done the Marlboro conversion, you know, to really line up in terms of lightweights behind our key customer Appvion. We've done Plymouth. We've done Ashdown. So first of all, is there a market? Is there a dynamic? Is there an opportunity? So certainly, fluff, we continue to believe there's a strong opportunity. Historically, you mentioned containerboard – historically, I've always wondered, you know, well would we actually have to go and buy box plants. If I look at it now – if I look at the independent box plants, the amount of containerboard they're buying and how they're having to now buy that from a very consolidated supply group in containerboard who we're also competing with among the box plant front, you know we're thinking long and hard actually about whether there's not an opportunity there without the need to actually purchase box plants if we took one or two mills into containerboard over the next three years to five years. But it's very much early days. I'm not saying for one minute we're going to do it. But I think that's become more interesting as that containerboard and corrugated world has consolidated and continues to consolidate so dramatically. So, I hope that answers your question.

[Anthony Pettinari:]

Yes. No, that's very helpful and very interesting. I'll turn it over.

[John David Williams:]

Ok. Thank you.

[Operator:]

We'll go ahead with our next question from George Staphos from Bank of America. Please go ahead.

[John David Williams:]

George.

[George Leon Staphos:]

Thanks, everyone. Good morning. I wanted to come back to Personal Care. John, I thought I heard you say there was some destocking that occurred in one of your channels. If I heard correctly, could you confirm then, provide a little bit more color around that?

[John David Williams:]

Yes, certainly.

[George Leon Staphos:]

And then I guess you expressed your confidence in terms of the margin target of mid-teens down the road. And obviously we appreciate that. But given the performance over the last few years and the need to continue to meet pricing and promotional activity from your peers and perhaps they'd say that you're also creating some of that, why do you have any more confidence about that mid-teens? Why should we, based on that track record?

[John David Williams:]

Right. Let me talk that one through because I think that's a key question. So two things you have to remember about us I think. We've bought six businesses, all of which were relatively small, subscale businesses and we've turned them into a business. That has certainly done two things. We've incurred cost just to have that kind of network organizing itself properly. And we've incurred capital to really rebuild a platform that's appropriate for a business of that size. To this day, we're seeing about $1 billion in sales in a network that we're pretty confident can do $1.3 billion to $1.5 billion worth of sales without any great addition of CapEx. As that volume drops through this network, two things I think start to happen, George. One is, we don't need the SG&A intensity for those additional sales that we have already. And of course we get far more efficiencies on our lines as we settle down the production. I'm convinced in there is 2 points to 3 points of margin that I don't currently have that over time I'm going to see come through. And as I see that come through, to my mind, I'm going to see those mid-teen margins. Now the timing of that becomes more of a challenge, to your point, as you see a very competitive market. But to my mind, that lasts as long as it lasts. We have to keep our position or even gain our position, but I'm certainly not losing sight, but I think those margins are available to us. That answer your question?

[George Leon Staphos:]

It does, John. I mean, again, obviously, there's so many unknowables, and no one's going to hold you to a guarantee on any of this. But to get that dropdown which requires the revenue, I guess I'd appreciate a little bit more color in terms why you don't think it takes more price compression or net margin compression through promotion to get that incremental revenue and so we're on this...

[John David Williams:]

Yeah.

[George Leon Staphos:]

Or you're on this treadmill that never really ends.

[John David Williams:]

Right. Okay. So I think two reasons. One is – I mean in the private label space as the customer makes their choices in the marketplace, they're not really asking you directly to subsidize that. You have a price to them, that price is the price during the contract period. And as they make whatever market moves they need to make, it's not as if it's your brand and they're asking you for a specific advertising and promotion support.

[George Leon Staphos:]

Right.

[John David Williams:]

Occasionally they do, but you're not subsidizing it in the way that a brand would need to subsidize it. So you're getting that volume opportunity and that volume pull-through at your current price. So that's I think one dynamic that's slightly different. I think, two, as we build our direct-to-home model in healthcare in the U.S. and as we do the same thing in Europe, we get two benefits. We're not just making the distributor margin, but we're also making the manufacturing margin as we manufacture these products. I think all that combined, I still believe over time that we can see that margin come through.

[George Leon Staphos:]

Okay. Two quick ones and I'll turn it over. One, I think you said something about de-stocking, if you can just confirm that and provide color.

[John David Williams:]

Yes, sure. We had one major account who de-stocked – decided to take their stock down by a number of days and that impacted us.

[George Leon Staphos:]

Okay.

[John David Williams:]

But I mean, a temporary measure.

[George Leon Staphos:]

You know what? All right, I will turn it over and I'll be back. Thank you.

[John David Williams:]

Thank you.

[Operator:]

Your next question comes from the line of Mark Wilde of BMO Capital Markets. Please, go ahead.

[Mark William Wilde:]

Good morning, John. Good morning, Daniel.

[John David Williams:]

Mark, morning.

[Daniel Buron:]

Morning.

[Mark William Wilde:]

Starting out, I wonder, John, if you can just talk a little bit about kind of the supply/demand balance in the paper market and how you see that playing. From the outside it looks like we're kind of running somewhere in the high 80s%, but we're also losing four points or five points a year just from kind of the shrinkage in the market. And historically, this market needs something in the low-to-mid 90s% to really be healthy.

[John David Williams:]

Yes, I mean I can only really talk about us, Mark.

[Mark William Wilde:]

Yes.

[John David Williams:]

I mean, so, the way, as you know, we look at it says, what's happening in our own supply-demand balance? What's happening in our own network? Can we flex export, for example, a little bit more aggressively now that currency is coming back to sort of keep the runway going a little bit longer? The minute we feel, within our own network, that we are operating at levels that are a challenge to us, I think we've proven over the years that we'll do what we need to do to change that dynamic. That remains very much the case. So we're never going to be out there, I think, chasing volume for volume's sake. I think where we feel there's a volume opportunity to us that's a decent margin and contributes towards the network, we'll be aggressive. I mean, we're not going to roll up the shop in terms of making sure we maintain our market share. But I do think that as we keep going forward, if we feel there's a need for another shut at some point within our own network, we'll take it. I mean there's no hesitation in that regard from us.

[Mark William Wilde:]

Okay. And then I wondered, just toggling over to the Pulp business, it seems like we are seeing some signs of weakness in softwood pulp, softwood paper grade pulp. And I just wondered how you see that sort of dynamic playing vis-à-vis your fluff pulp sales? The fluff pulp I can...

[John David Williams:]

Well, I mean...

[Mark William Wilde:]

It feels healthier right now.

[John David Williams:]

What? Fluff than softwood?

[Mark William Wilde:]

Yes.

[John David Williams:]

Yes. Well, interesting. So obviously we're – if I look at our softwood business, we've got some sort of – if I take it mill by mill, I mean, Kamloops, we got some specialty grades with sort of good dynamics. We're very much involved in the Chinese and Asian markets. That still looks pretty healthy. There was a price adjustment in July, but as I said in my prepared remarks, that stabilized into August. So this is sort of a strange period in those markets. So if that momentum carries through to the end of the year, I think we see sort of stable July prices in softwood in some of our key markets. Dryden very much domestic northern softwood. Demand looks pretty solid. Customers look contracted. So, I think we're in pretty good shape there. And then of course you know the rest of what we do, or largely the rest of what we do is fluff pulp. So, we're not really seeing major erosion. We're going to see a little bit of price momentum come through from the announced price increases. We saw that come through July/August. But I think for quarter three, I'm not expecting anything sort of dramatic to happen. As you rightly point out, I mean, there's some new capacity coming in. we'll have to see how that finds its place. But, I do, to your point, see fluff dynamics as more positive. So, I don't see softwood as sort of majorly negative. I think on fluff, to your point, I think particularly for us well enough I find it very positive because undoubtedly, the market consolidation that has taken place due to the transaction that IP did with Weyerhaeuser has been some customers now saying, look, that means we're uncomfortable here. We'd like to see a sensible third-party come in as a potential supplier. So that's actually given us some opportunities.

[Mark William Wilde:]

Okay. All right.

[John David Williams:]

That help?

[Mark William Wilde:]

Yes, that helps quite a lot.

[John David Williams:]

Ok.

[Mark William Wilde:]

And then just back to this kind of re-purposing of capacity, because I think we're all sensitive of the fact you've got some great assets in the white paper business...

[John David Williams:]

Right.

[Mark William Wilde:]

...with pretty valuable kind of infrastructure, and licenses and the right to operate. What besides containerboard and fluff pulp, what do the other options look like to you? And how would you kind of weigh them against each other?

[John David Williams:]

Well, I think those are sort of two of the most compelling ones, to be honest. I mean, there's obviously one of the things that we did in Marlboro was really takes someone who was making their own paper and then coating it and say, let us make the paper for you because we're going to be much more competitive than you are. And they then took out their paper capacity. So whether there are other choices like that to be made by people remains to be seen. But I think there's that opportunity. I think for us, fluff and pulp, generally, is still an attractive market. It's large, it's growing, and we think we can be very competitive. As you say on containerboard. I think that's really all about, one, can you be competitive, and two, is there a market for you in this very consolidated world of containerboard, but not quite such a consolidated world in terms of converting? So, would that independent converter come your way because you're seen as somebody who's not competing with them? I think we could think about that. And yes, there are models in Europe where that's the case. If you take SCA, of course now, the new SCA, the forest products business, they've got two very large kraftliner mills and they haven't got a single box plant. But they still have a great business, so is there a model there for us I think we could think about. Did that help?

[Mark William Wilde:]

Okay. So last thing – yes, that does help. Just any thoughts on your Specialty Paper business, and how that's functioning? We don't usually talk about that too much.

[John David Williams:]

Yes. I mean, as we've said, we've seen a little bit of volume loss with a couple key grades. We lost a piece of business. Someone decided to go from white to brown, so we lost some business in the bag business. It had a lot of competition when the euro really weakened. There are a lot of Europeans over here. That's obviously reduced now as the euro has strengthened. We would like to run that business, seeing it grow by kind of 1% or 2% a year as it gets GDP growth. It's very much more R&D driven I suppose than the core business, and very much more small-order driven. One of the things it does do for us, though, if we can find sufficient volumes in that specialty business, we can actually move some of those tons to our larger mills. So, if you now look at what we define as specialty products, actually we've got some of them in Hawesville now where we can get an attractive cost per ton reduction by running them through those. So, we like it as the front end, and I'd like to get it back to growth, which we've had our struggles with over the last year or so.

[Mark William Wilde:]

Okay. All right. Great. John, I'll turn it over.

[John David Williams:]

All right. Thanks, Mark.

[Operator:]

We'll go ahead with our next question from Adam Josephson of KeyBanc. Please go ahead.

[Adam Jesse Josephson:]

John, Daniel, Nick, thank you very much. Good morning.

[John David Williams:]

Adam, good morning.

[Adam Jesse Josephson:]

John, just one more on that conversion question that Mark and I think Anthony were asking about. Appreciating that you've already converted the machine at Ashdown to fluff, and given how important the fiber basket is, right...

[John David Williams:]

Yes.

[Adam Jesse Josephson:]

...how many – are you able to opine on how many of your mills are potential candidates to be converted to liner? And as well as any sense for how expensive and time-consuming such a conversion would be?

[John David Williams:]

Certainly. So I can't talk to the first one, but I can give you a sort of rough guide on the second one. So probably a conversion from the sort of day the board says okay to when you're actually making products, probably about 18 months. Depending on the mill and the complexity of what you're doing, it might be $200 million, you know, $50 million on either side depending on some of the challenges. So, it's – when you actually look at what converting does for you based on the sunk costs in these businesses, these are very attractive returns, of course. So, we're always thinking very carefully around what we might do in terms of conversion, because from a monetary standpoint, it's a very compelling story.

[Adam Jesse Josephson:]

And so, it sounds like the cost to convert to liner would be reasonably comparable to the cost that you incurred to convert Ashdown to fluff, is that about right?

[John David Williams:]

Yes. That sounds about right. Yes, you just, I mean, you couldn't hold me to it, because you don't...

[Adam Jesse Josephson:]

Sure.

[John David Williams:]

It's really very dependent on the mill and it's sort of dependent on the wood basket. But somewhere around there is about the right number.

[Adam Jesse Josephson:]

Terrific. And just one on the – John, I think you mentioned you expect some additional pulp price realization sequentially just based on the price increases that you've implemented. Can you give us any references to – so you had $45 incremental 1Q, 2Q – can you give us any sense of a rough ball park how much more you're expecting 2Q to 3Q?

[John David Williams:]

I mean, it's hard to tell because who knows. I mean, $5 to $10 at the most I would say. No more than that.

[Adam Jesse Josephson:]

Okay. And just one related question. You talk about softwood, I think China having stabilized in July or August, can you just again repeat what you said about what might have happened in July and what happened in August?

[John David Williams:]

Yes. So, the price in China came off about $30.

[Adam Jesse Josephson:]

Right.

[John David Williams:]

And then the price in August stayed where it was at that $30 reduction level. But, in fact, the Russians who'd gone up a little bit further than $30 came up $10 bucks, so that sort of helped the momentum.

[Adam Jesse Josephson:]

And that would be – even with that you still think you'd be up $5 to $10 in terms of pulp prices sequentially?

[John David Williams:]

Yes.

[Adam Jesse Josephson:]

Ok.

[John David Williams:]

Because of our balance and what's happening in fluff and what's happening in softwood in the U.S.

[Adam Jesse Josephson:]

O Terrific, thanks a lot John. Appreciate it.

[John David Williams:]

Thank you.

[Operator:]

Your next question comes from Brian Maguire of Goldman Sachs. Please go ahead.

[Brian Maguire:]

Hey. Good morning guys. I just wanted to follow up on some of the comments on Personal Care and the markets, recognize there was a little bit of choppiness in the quarter, but just as you're looking out ahead, we've seen some developments with the Amazon bid for Whole Foods and Little (36

[John David Williams:]

Well, it's a great question. So, if you look at your – and you look at private label penetration in some of the key product areas, it's very often much, much higher than it is in the U.S. And there are a couple of reasons behind that. I mean, some of it's about grocery formats. Some of it's about, sort of the quality of the product you see in private label. I think historically the American consumer has said private label is a tradeoff between price and quality. So, if I'm going to buy private label, I'm going to buy cheap, but it probably isn't as good as, if you like, the branded offering. That's absolutely not the case in Europe. And certainly it's not the case in the categories where we operate. So, the product we make for customers in terms of private label diaper for baby and adult incontinence are absolutely first rate, high-quality products that are very much fit for use. If they weren't, our major partners in retail wouldn't even buy them from us. So, I think post the emergence from the Great Recession, as I guess we might call it, the American consumer is actually much more motivated around private label, realizing having bought these products to some extent under duress in the recession that these are good quality products and fit for purpose. So, I think my view is you're going to see major retailers really market their private label offering to their consumers as something much more compelling than just something you have to buy because you can't afford the brand. And as they do that, you're going to see a better- quality product. And you're going to see market share for private label. That's the way we see it, anyway. And what's interesting is that baby diaper customer is so critical to these channels in terms of the way the mother purchases and the kind of products she's going to purchase, that I think you're going to see a lot of thought put into that from our customers. And our story of giving you real consumer insights, Mr. Customer, around your consumer in these categories, I think therefore is very powerful and will resonate very strongly in that marketplace. Sorry. It's a very long-winded answer, but I think it's important for you to get that perspective.

[Brian Maguire:]

And I appreciate the color there. And do you see that translating into any new commercial wins in the back half of the year? And can you just kind of comment on the pipeline there and how that's looking?

[John David Williams:]

Yes. Sure. Yes. So, I mean the answer to that question is absolutely yes. So, there's a number of people we're talking to who I think we're going to win business from. In addition, in our direct-to-consumer business – the HDIS business – we are upping the advertising intensity pretty strongly to drive business through that channel as well where we're in complete control. We have a brand and we manufacture it for ourselves. So, yes. I mean, I'm looking for two things to happen really

[Brian Maguire:]

Okay. And so, the 6% growth that was impacted by the destocking. And so you sort of expect to accelerate off of that in the back half? Is that...

[John David Williams:]

I mean I would love to. But, again, I think at the unit level of course it's much more dramatic than that, but there is some price pressure, so that makes that more difficult. I mean, if you look at some of our competitors have announced, they're really saying the market's flat and we're trying to grow by a percent or two. We're $1 billion in a gargantuan market, so I think we can do better than that. But growth's going to be a bit of a challenge I think for a while, but I'm still looking for it.

[Brian Maguire:]

Okay. Thanks very much.

[John David Williams:]

All right. Thank you.

[Operator:]

We'll go ahead with our next question from Steven Chercover of D. A. Davidson. Please go ahead.

[Steven Pierre Chercover:]

Good morning. Thanks for taking my call.

[John David Williams:]

Steven.

[Steven Pierre Chercover:]

First question, one of your smaller competitors is closing an 80,000-ton paper machine in Ohio and I'm just wondering is there any intersect with your product offerings, or they call it specialties so I don't know if there's any impact for you?

[John David Williams:]

Well, one man's specialty is another man's commodity, Steve. Should we just leave it at that? So the answer is yes. There's a lot of crossover between the kind of products we manufacture and the products they manufacture. So I mean, who knows what impact that will have. And I think if you, sort of, read carefully between the lines, they probably have an expectation they can get that on the other six machines they still have. But we'll see.

[Steven Pierre Chercover:]

Yes. Probably not a needle mover for the industry as a whole though? Okay.

[John David Williams:]

I mean it's okay but I don't think it's going to move the world.

[Steven Pierre Chercover:]

Got it. And the second one's almost like a business school question, but philosophically, is it easy for a company to reverse course and get back into a business that was exited, lumber or containerboard in your case? And I recognize this wasn't necessarily done under your watch, but it's almost like admitting you were wrong.

[John David Williams:]

Well, I'm not sure – okay. Well, thank you for that input. I think the way we have to think about it, the world changes. Were we ever going to be a massive consolidator in that market? No. We chose the market we were going to consolidate in and we did it, I think. But there's also, obviously, in a declining world, an asset-based strategy as well as the purity, if you like, of the grade strategy. And I mean I'm not saying we're going to do it, but there's definitely now – as you look at that marketplace, is there now beginning to be an opportunity for somebody with a very attractive mill network and a good fiber basket to actually do something slightly different.

[Steven Pierre Chercover:]

Yes. I mean there's no question your assets are good. Well, I guess once Apple had a Newton and then they had an iPhone so, all the best.

[John David Williams:]

Thank you, Steve.

[Operator:]

And your next question will come from the line of Gail Glazerman of Roe Equity Research. Please go ahead.

[Gail S. Glazerman:]

Hi. Good morning.

[John David Williams:]

Good morning.

[Gail S. Glazerman:]

And I apologize for beating a dead horse...

[John David Williams:]

Beat away.

[Gail S. Glazerman:]

... but if you think about converting to containerboard, would you be comfortable having to rely on the export market? Because, of course, well, there's consolidation on the mill side. There's new integration in the shrinking pool of independents. And I would note when you got – and in terms of the FDA situation, the European market is actually structurally short kraftliners, so it's a little bit different, I would think.

[John David Williams:]

Right. But I think – but remember, you're quite right, but there's a huge export of kraftliner, of course, a lot of it going into Europe. So I think – I mean it's very early days. And I'm not for one minute suggesting this is something we're going to do. I just sit here and say to myself, you know what? That dynamic has changed quite dramatically. Is there now an opportunity that wasn't there before? Patently you'd have to think about export and you'd have think about building strong relationships with those independent converters. And some of them may or may not come your way. And you really have to think that through very carefully before you decide whether to do it or not. But I just have – I think we just have more of an open mind to it than we did before because for a mill or two, it may well be that needing those box plants is now not the case. Does that help?

[Gail S. Glazerman:]

Okay. Yeah, no, it does. It's just in the context someone mentioned yesterday they think the independent market is down to 5%. I think you'd mentioned that there was....

[John David Williams:]

Well, we think – well, I'll give you a number. We think the independents are still buying about 5 million tons of containerboard. That doesn't suggest there's nothing there.

[Gail S. Glazerman:]

No, no, that's interesting. I think in your prepared comments you mentioned that certain channels within uncoated freesheet were kind of showing maybe a bit of a turn in improvement. Can you give a little bit more color what's going on there?

[John David Williams:]

Yes. Sure, Gail. So I mean that's really about a couple of customers in a couple of grades who had a little bit of a difficult first half, who we have sort of agreed volumes with them. So it's really about them promoting more heavily in the second half. I don't want to give you the detail, if you don't mind because it's customer specific. But that's really what that's about.

[Gail S. Glazerman:]

No problem. And just a couple quick ones. Do I remember correctly, can you just remind me what the seasonality is in HDIS? I know there were certain times of year where you're investing more.

[John David Williams:]

Yes. So it's very much back half weighted in terms of EBITDA. So you're going to see most of the EBITDA come in the second half or even actually in the fourth quarter. It's not a gigantic number. But, it's a number.

[Gail S. Glazerman:]

Okay. Okay. And then just one last one. I think it was touched on in the formal comments, but the recovery from the operating issues at Kamloops, did that cost about $6 million as expected in the quarter? And is that something that should be gone now as we enter – as we're in the third quarter?

[Daniel Buron:]

Yes. I think, Gail, it should – there is no impact actually in Q2. We had some payment from our insurance company that made the sum of our costs to zero. And that should be gone. I mean there's probably another $1 million in the third quarter, but not more than that.

[Gail S. Glazerman:]

Okay. Great. Thank you.

[John David Williams:]

Thanks, Gail.

[Operator:]

We'll go ahead with our next question from Chip Dillon of Vertical. Please go ahead.

[Chip Dillon:]

Yes. Good morning, John and Daniel.

[John David Williams:]

Chip, good morning.

[Chip Dillon:]

Yes, the first question is, I notice you all had mentioned that your Pulp inventories I think were up 33,000 metric tons from the first quarter. And given your system, I know it's getting bigger, but that seemed like a fairly sizeable number. But am I – is that fair, or is it more of seasonal increase?

[John David Williams:]

Well, it's a couple of things. Obviously, we've made fluff pulp ahead of some qualifications with certain customers, so that's sort of – that's just going to kind of work its way out, Chip, as we qualify. So we got two or three of them now, actually that we're qualifying with. But as we qualify, we're going to have to kind of move some of that product through. So I'm pretty confident that will work its way out. I mean I think the way you have to look at our pulp business is, when all things are as they should be, it's about a 450,000 ton a quarter – 425,000 ton, 450,000 ton a quarter business. Now that's a good way to look at it. I mean there will be puts and takes on that, depending on how we qualify, what's happening to the geography, has the ship left. But I think that's the most useful way to look at our Pulp business.

[Chip Dillon:]

Okay. And speaking of the fluff you mentioned you'll be at about 50% of the – on a fluff basis on the Ashdown conversion which I think would mean you're probably pushing 50,000 tons to 60,000 tons a month as you hit – year, not month – quarters you hit year-end? Is that about right?

[John David Williams:]

Right. That's exactly right. That's exactly right.

[Chip Dillon:]

Okay. And then, I guess, you had given some details on the potential to convert- again, I know it's early days for containerboard, but – and you mentioned mills. Now, I would imagine you're really talking probably individual machines as opposed to the entire mill when you talk about $200 million. Is that fair? And we're probably talking in the ballpark of 300,000 tons to 500,000 tons? Is that about right?

[John David Williams:]

It's too early to tell, to be honest with you, Chip, because to be frank, we're a long way from getting to that level of detail.

[Chip Dillon:]

Yes. My last question...

[John David Williams:]

Yes, if I look – I mean if – go on, please.

[Chip Dillon:]

Oh, no. Go ahead.

[John David Williams:]

Well, I mean, if you look at what we did at Ashdown, that really wasn't the entire mill because it was really one large machine, but the impact was all over the mill. Yes, it seems to be a reasonable proxy for a major conversion. That kind of – that sort of $200 million number.

[Chip Dillon:]

Got you. And then, I guess the other thing is, I mean, as I look at it, there's a little bit of a cat-and-mouse game here. I'm not sure of the 5 million tons and that might include medium and recycle and other things. But there's a question that you guys are sitting on, somewhat of a golden goose and why should your shareholders just sort of give away those assets at a low price and let someone else get those returns, I totally see that. And in that regard, is there kind of a potential that maybe there's a middle way where you involve some kind of a partnership so that you mitigate some of the open market risk and the pricing dynamics that involves while also achieving good returns for your shareholders?

[John David Williams:]

Well, I mean, we'd look at any construct. I don't want to negotiate with anybody who's listening over the phone, Chip, obviously, but I mean I think we'd look at any construct where – you know what are we motivated by? We're motivated by the fact we have, we think, great assets. Those great assets have a certain cost. Converting those assets to doing something meaningful for the next 30 years to 40 years is about the best financial decision we can make as a management team. So, anything that helps us do that, we're very open minded about. And I think – if you think what we've done so far, we've taken the Marlboro Mill, we've turned it to lightweight; we've taken Plymouth, we've turned it to fluff; we've taken Ashdown, we've turned it to fluff and paper. Obviously we do our best to say – to stay, what I would call it, strategically pure. But there's no doubt the asset out aspect of this, and the kind of returns we think we can earn from being more imaginative around re-purposing are very compelling. So, to your point, we'd look at any construct. Did that help?

[Chip Dillon:]

And then, last question, quickly is, you know, John, a lot of people we talk to have this perception of Domtar being in a state of decline, which of course your sales really haven't been because of the re-purposing...

[John David Williams:]

Right.

[Chip Dillon:]

...and it's ironic that versus the industry that we're talking about on this call, you all have the best dividend increase record of any of them – I think it's seven years in a row. Would it be disappointing to you to not keep that streak going in 2017?

[John David Williams:]

An interesting way of asking the question. I mean I think the way I look at this, is if you look at where we are, our yield as it sits today, as you say quite rightly, Chip, I think it's very strong, we want to maintain it to be very strong. I'm not sure in the short-term that really is kind of compelling to actually do something about it in 2017. I think, more importantly, for us is to continue to focus on the kind of transformation of the overall business into sort of more compelling growth stories.

[Chip Dillon:]

Got you. Thank you.

[John David Williams:]

Thank you.

[Operator:]

We'll go ahead with our next question from Charan Sanghera, RBC Capital Markets. Please go ahead.

[Charan Sanghera:]

Hi, guys. Thanks for taking my question. Just building a little bit maybe on Chip's question, you know, maybe a little bit hesitant on the dividend increase, we've also seen buybacks be a little bit lower than usual for the past 18 months or so. Can we read into this in terms of the M&A pipeline or – and maybe provide some color on your order of preference for the Personal Care M&A potential?

[John David Williams:]

Sure. So, I mean I think from a return standpoint and building a business for the future, and really from a shareholder standpoint to make sure that we build something that really – we've been in business since 1848 and I'd like us to be in business for another 100 years. I still think spending our money to build that business out, even if it's a little bit choppy currently, is a great thing to do. I also think, you know, saving our fire power to really think carefully around repurposing some of these great assets is another way, you know, and in fact it's a $200 million spend or whatever it maybe you look at what it costs us to do Ashdown last year and what that meant to us in cash flow, I think we have to be circumspect around making sure that we've got the cash available to do that. And since 2011, we have returned about 72% of free cash flow, about $1.4 billion to shareholders. So, I think the timing is right when the timing is right.

[Charan Sanghera:]

Okay. Thanks. Maybe shifting gears just a little bit do quick one on pricing realization. Looks like Domtar had performance on pricing realization versus peers. Is this may be due to the lag effect at peers? Or do you think it's to do with fluff mix and less discounting in the fluff market? Maybe some color on that.

[John David Williams:]

You talking specifically in Pulp, Charan?

[Charan Sanghera:]

Yes.

[John David Williams:]

You're talking about Pulp. Okay.

[Charan Sanghera:]

Yes.

[John David Williams:]

Well, I guess – I think it's a little bit of mix, definitely, little bit of timing, little bit around the way we've got customer arrangements. You know, if you're a pulp business and you're with the very, very biggest, a lot of those structures of those particular contracts have a huge lag in them versus price announcement. You know, we've got a bigger Chinese business probably in comparison to the rest of our business than others that's going to move around faster. You know, when you negotiate in China, you get the price you've gone. So that's probably what it is. I don't think for one minute that it's – we're cleverer than the other guys, let's be clear about that. It's just really customer mix over the geography.

[Charan Sanghera:]

All right. Thanks. That's it for me.

[John David Williams:]

All right. Thank you.

[Operator:]

Your next question comes from the line of George Staphos of Bank of America, please go ahead.

[George Leon Staphos:]

Hi, guys.

[John David Williams:]

Sure.

[George Leon Staphos:]

One last one that hasn't already been asked, thanks for taking it.

[John David Williams:]

You're welcome.

[George Leon Staphos:]

So, if we think about the – adjusting your production stance in uncoated freesheet potentially, over time, and maybe even looking at conversions whatever form they might take, do you need to synchronize those two in your view? I know it'd be the better alternative, but if you come to a decision that the market doesn't need another sheet of uncoated freesheet at the present time and you need to look at your own profile, do you then also need to do the work or have the work done on what's the alternative use for that machine might be? Or you'd feel comfortable tabling the production for a time being until you figure out what you might do with that asset down the road? Thank you, guys. And good luck on the quarter.

[John David Williams:]

Well that's a great question. I think, to be honest, George, it's what I think about every day. So, you're always looking across the asset base, so what are the other alternatives. You're always looking around that sales decline to say, okay, well can we do grades X, Y, and Z in mill A, B, C? And if could do that, can we rearrange our network in some way that would allow us to convert mill D, because then for mill D we're not running so full. I mean, that's really the way we look at these things. And we look at it all the time. So, we're rarely sitting there going, oh my God, sales are declining, what are we going to do next? In fact, we're never sitting there doing that, we're always saying, okay, sales are declining, what's our plan, what are our opportunities?

[George Leon Staphos:]

Okay. One last one. How many tons of corrugated do you buy a year for the Personal Care business?

[John David Williams:]

First of all, actually, for the Paper business is much the bigger buy of corrugated than the Personal Care business.

[George Leon Staphos:]

Okay, fair enough.

[John David Williams:]

In total, we buy about 40,000 tons. About 10,000 tons in Personal Care in U.S. and about 30,000 tons in the – for the paper base.

[George Leon Staphos:]

All right. Thank you, John. Good luck.

[John David Williams:]

Thanks. Thank you.

[Operator:]

Our next question comes from Adam Josephson of KeyBanc. Please go ahead.

[Adam Jesse Josephson:]

Thanks, John, thanks for taking just one last question, another one on the containerboard conversion discussion.

[John David Williams:]

Sure.

[Adam Jesse Josephson:]

Just a couple related questions. You're trading at call it six times EBITDA; the containerboard guys are closer to nine times, in some cases even higher than that. Has that played into your thinking at all? And relatedly, there's been substantial inflation in recycled fiber prices off late while wood fiber costs it's the opposite, as though the pulp – the virgin mill obviously have a huge advantage right now. Has that played into your thinking as well along these lines?

[John David Williams:]

The first has not, to be honest with you, but the second has, because I think...

[Adam Jesse Josephson:]

Can you elaborate on that?

[John David Williams:]

I think – well I mean, obviously the issue is can you do this and be competitive? And my view is that whole balance between what I call test liner and kraftliner, how that plays out, what are the dynamics going forward, all that – we've got a lot of work to do before we go anywhere near this, but at the minute, some of the signals suggest there may be an opportunity. I don't think I'd go further than that, to be honest with you.

[Adam Jesse Josephson:]

Sure, now, thank you very much.

[John David Williams:]

All right. Thank you. Thanks, Adam.

[Operator:]

And there are no further questions at this time. Mr. Estrela, I will hand it over to you for closing remarks.

[Nicholas Estrela:]

Thank you, Angel. So as a reminder, we will release our third quarter 2017 results on Friday October 27, 2017. Thank you for listening, and have a great day.

[Operator:]

This concludes today's call. Thank you for your participation. You may now disconnect your lines.