Domtar Corporation
Q4 2017 Earnings Call Transcript
Published:
- Operator:
- Good day, ladies and gentlemen. And welcome to the Domtar Corporation Fourth Quarter 2017 Earnings Results 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, February 8, 2018. I would now like to turn the meeting over to Mr. Nicholas Estrela. Please go ahead, sir.
- Nicholas Estrela:
- Thank you, Cody. Good morning and welcome to our fourth quarter and full year 2017 earnings call. Our speakers today will be John Williams, President and Chief Executive Officer; and Daniel Buron, Senior Vice President and Chief Financial Officer. 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 websites. 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 could 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. Led by the strong performance of our Paper's business, higher sales of market pulp and good productivity across our mill system, we achieved solid operating results in 2017. While we reported good results for Personal Care this morning, over the past quarters, the business has become increasingly competitive with pressure in both the healthcare and retail markets and we are seeing no signs of that abating in the foreseeable future. As a result, as part of our annual goodwill impairment testing process, we were required to record a non-cash goodwill impairment charge. This charge does not, however, alter our current financial flexibility and our overall cash generating capabilities remain strong. Given this new competitive trend in Personal Care, we initiated a review of our administrative structure in the fourth quarter and this resulted in head count reductions across the division. In addition, we've embarked on a review of our operations in order to further optimize our cost structure. We will continue to work to mitigate these headwinds with a focused on continued cost savings and converting our sales pipeline into new wins. Most importantly, we continue this past year to do what Domtar does best, generate strong cash. We delivered nearly $450 million of operating cash flow and continued our track record of rewarding shareholders with a high payout ratio while maintaining financial flexibility. Our performance combined with our confidence in our future cash flow allowed us to announce this morning a 4.8% increase to our annual dividend. Our Pulp and Paper division is proving resilient year-after-year. We're managing the secular decline in white paper by adjusting our capacity to customer demand, continuous improvements to reduce costs, and annual mill investments to sustain reliability and product quality. The success of our actions is reflected in the cash generation over the past years and we have confidence that this will continue. Market dynamics support this confidence. Recently announced capacity closures, which represent nearly 10% of North American production, and lower imports are expected to result in favorable paper market conditions over the next 18 to 24 months. We're well-positioned to support customer demand and we're fully committed to remaining their partner of choice as the leading North American uncoated freesheet producer for the long-term. The global softwood pulp markets were strong in 2017 and we significantly improve results in our Pulp business. So far this year, market fundamentals for softwood grades continue to hold strong and steady, extending the trend from previous quarters. An important focus for us in 2017 was to advance our global position in market pulp. We've done that through executing our growth plans in fluff and tissue grade pulp, managing Ashdown's ramp-up in our transition to fluff, and enhancing our customer value proposition with leading absorbent hygiene and tissue manufacturers globally. We now have nearly 1.8 million tons of high quality market pulp capacity, mainly serving global softwood and fluff pulp markets. We expect year-over-year sales growth in fluff above market trends with the Ashdown mix reaching nearly 80% fluff by the end of 2018. In addition, we'll focus on cost reduction and productivity improvements across our pulp mill network to further strengthen this growth business. In Personal Care, we've built a billion dollar global business with manufacturing locations in North America and Europe and distribution to customers in some 50 countries. Sales increased 10% in 2017 as a result of the HDIS acquisition and new customer wins. And we have been focused on actions to strengthen our operations and enhance our flexibility. Winning new customers, growing sales and improving profitability have been and remain Personal Care's top priorities. Our sales growth this year has been on target and we're on the right path to build a sustainable business. With that, let me turn the call over to Daniel for the financial review, before making further comments on our fourth quarter 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 a net loss of $5.42 per share for the fourth quarter compared to net earnings of $1.11 per share for the third quarter of 2017. Adjusting for items, our earnings were $0.64 per share in the fourth quarter compared to earnings of $1.03 per share for the prior quarter. EBITDA before items amounted to $141 million, compared to $163 million in the third quarter. Turning to the sequential variation in earnings on slide 5. Consolidated sales were $45 million higher than the third quarter due to higher volume and price in our Pulp business and higher volume in our Personal Care business. Depreciation and amortization was $2 million higher than the third quarter, while SG&A was $1 million higher. The fourth quarter results included the following items
- John David Williams:
- Thank you, Daniel. Now, let's take a closer look at the fourth quarter. This morning, we reported EBITDA before items of $141 million on sales of $1.3 billion. The fourth quarter included a significant amount of planned maintenance at several of our mills, minor startup issues and an extended outage of one location at higher costs, but overall we had a good execution in cost management during the outages. Our communication paper business had the usual seasonal slowdown, but delivered strong overall shipments in the quarter as a result of increased volume of tablet paper and exports. Our average paper prices in the quarter declined on a seasonally unfavorable product and customer mix, but we did begin to implement the first round of price increases during the fourth quarter. We expect additional price momentum in the first quarter, including an improved customer and product mix. The second price increase should begin to be realized in the second quarter and beyond. In Pulp, our prices were nearly $50 per metric ton higher when compared to quarter three. We saw the full effect of our announced increases in China and the continued implementation of North American increases. We had strong shipments across all our grades which resulted in incremental sales into a strong market. They were particularly strong in fluff, with fourth quarter sales exceeding our targets as the Ashdown qualifications continued to hit their stride. Shipments of fluff pulp was 66% higher year-over-year and 45% higher than the third quarter. In the first quarter of 2018, we expect to start the shutdown process of the NC-2 line at our Plymouth mill, which also includes a workforce reduction of 100 positions. The streamlining measures will strengthen the mill's cost position in the global fluff pulp market. It will also rightsize the mill to an annualized production target of approximately 390,000 metric tons of fluff pulp or a reduction of 80,000 tons. In Personal Care, we finished the year strong with our best quarter of 2017. Our fourth quarter benefited from additional volume related to a holiday season promotional program and the seasonally strong quarter in our adult and direct-to-consumer businesses. We remain optimistic about the long-term growth trajectory of the absorbent hygiene market and we will continue to make adjustments to changing market conditions. We're well positioned to win with the business we've built. We do have the right assets and we do have the right people to drive long-term success and value. On capital allocation, we'll maintain a balance and disciplined approach by investing to fuel growth in our businesses and returning capital to shareholders. As mentioned, we announced this morning an increase of 4.8% to our dividend. This is the seventh dividend increase in the last eight years, and the pay-out will total approximately $110 million annually or $1.74 per share. Our priorities for investing in growth reflect the changing market landscape and the opportunities we have to maximize the value of our assets. Our priorities will be the following. Strengthening the competitiveness of our assets notably with our pulp mills, where we believe there are opportunities to grow and to optimize, repurposing our white paper assets as our customer demand declines in those grades. We have converted 1.5 million tons of commodity paper capacity into growing and profitable businesses over the last few years, these included fluff and tissue grade pulp and specialty paper grades. And we believe there are further opportunities for repurposing. With this in mind, I want to provide a brief update on the containerboard feasibility study we discussed during our last quarter's call. As I said in October, we retained the Jacobs Engineering Group to conduct the study and we're continuing to work closely with them to complete the analysis. The review covers multiple locations so we have a fair amount to do before we reach a conclusion, but their initial findings are very positive. We are not yet in a position to announce any next steps, but I'd like to note some of the considerations guiding our thinking thus far. As I've said, we are committed to preserving the value of our fiber lines and our work continues to confirm that we have world-class assets with a significant optionality. We are taking a disciplined measured approach to the process of repurposing our assets, with a focus on maximizing the return on the investment. We have to carefully balance the long-term need to repurpose white paper assets with mid-term supply demand considerations associated with our core operations. We are also deploying resources to make sure we better understand our opportunity in the linerboard market and how we can bring value to customers. Based on what we've seen thus far, we are excited about the value creation potential of converting some of our integrated paper mills into a competitive linerboard business. We are also pleased with the initial feedback from potential partners and customers thus far. Before I comment on the full-year outlook, I wanted to provide a brief update on January business conditions. The extreme weather we witnessed in December continued in the early part of January. As such, this has affected productivity, energy costs and fiber costs. Our teams have been very agile however and our operations are now back to normal productivity levels. We are also seeing somewhat greater than expected freight costs at certain locations as a result of constrained truck availability. Looking ahead to the 2018 outlook, costs, including freight, labor and raw materials, are expected to marginally increase. Our Paper shipments should benefit from expected industry capacity closures, while Paper prices should improve following the recently announced price increases and Pulp will benefit from volume growth in fluff. Personal Care is expected to be negatively impacted by an unfavorable tender balance, resulting in lower volume and operating margins. 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 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. So Cody, you can open up the lines for questions.
- Operator:
- Absolutely. And we'll take our first question from Brian Maguire with Goldman Sachs. Please go ahead.
- Derrick Laton:
- Hey, good morning guys. This is Derrick Laton sitting in for Brian.
- John David Williams:
- Good morning.
- Derrick Laton:
- Good morning. Just curious if you could talk a little bit about your Pulp inventories in the quarter, you ran those down about 50,000 tons. Was this mainly a function of you guys taking advantage of some stronger demand out of China? And then are you comfortable with where those inventory levels stand now? And should you continue to see that strong demand pool be able to take advantage of that opportunity?
- John David Williams:
- I mean, I guess the answer to all of those questions is, yes. So, I mean yes, we had built some inventory, we sold from it. We're pretty happy with our inventory level. So, we're really trying to think about how we – what constitutes the right inventory level across the grades because of course we got fluff growing and then we're sort of reducing some of the bailed softwood we are selling. But, I mean, no doubt if demand continues to be the way it is, we think we can take full advantage. I would say though given the fact that we sold from inventory, I'm not sure our shipments are going to be higher than quarter four in fluff pulp, they may well be a little bit lower just because we sell from inventory.
- Derrick Laton:
- Got it. That's helpful. Thanks. And then just one follow-up on the asset refurbishing study, just kind of given it looks like you're seeing a little bit more tightening in the market for white papers with some of the capacity coming out, and you guys are getting a little bit of incremental pricing there. Does that kind of change or maybe push out your thoughts in terms of just the timing for that study at all?
- John David Williams:
- Well, that's a great question. So the study continues. The way we see it, we're obviously committed to the white paper business. So I think I've said in previous remarks, it's never really been our intent to kind of get ahead of demand decline because of course, we need to supply our customers. However, when we look at our portfolio, there's obviously a part of our Paper business not generating a strong margins as other parts. So if we felt there was an opportunity there to look at that and linerboard will be more attractive, I think what you'd see us do is going to really focus on that and maybe take a little bit of the sort of poorer part of the portfolio out of the mix. Does that make sense?
- Derrick Laton:
- It does, yeah. I appreciate the color. Thanks, guys.
- John David Williams:
- Okay.
- Operator:
- Thank you. And we'll now take our next question from Mark Connelly with Stephens.
- Mark Connelly:
- Thanks, John. Shifting gears.
- John David Williams:
- Mark, I can only hear you very faintly. Are you there?
- Mark Connelly:
- Can you hear me now?
- John David Williams:
- Yeah, that's better. Thank you.
- Mark Connelly:
- I'm sorry.
- John David Williams:
- No worries. No worries.
- Mark Connelly:
- Can we talk a little bit about the mix shift in Q4. I mean we assumed it would be worse but I'm thinking I underestimated it, and I'm wondering are you now expecting a more normal or better or worse mix shift in Q1. I'm just trying to figure out what changed versus what we expected because I thought I had marked that right.
- John David Williams:
- Sure. Completely understood. So, a couple of things happened. So, a bit more export sales in quarter four versus quarter three and considerably more tablet sales, so some of the lower priced grades that we sell and sort of the downturn in seasonality hits us in terms of realized pricing. And some of the other grades that we normally sell more of, i.e. cut size, we sell lesser, which of course then throws the mix off. So those are the three major impacts, Mark, that made that happen in terms of that $17 a ton. So going forward that, to some extent, reverses itself as I said in my published – in my prepared remarks in the first quarter.
- Mark Connelly:
- Okay. So, nothing funny in Q1, nothing funny in Q1?
- John David Williams:
- No. No.
- Mark Connelly:
- Okay. So, just a second question. Most companies are telling us that costs are through the roof and everything is a disaster. Why aren't you complaining more about costs?
- John David Williams:
- Well, I mean, I guess, I always think our job is to manage it rather than complain about it. If I look at what we've been doing – for example, if you look at the trucking issue, there's undoubtedly – it's not so much a truck shortage, it's a truck driver shortage. We've had – we had our transportation people working pretty much all over Christmas and every hour God gave us to actually make sure we can get product to our customers, which we succeeded in doing. And, yeah, I think there are some costs in there that we don't like that are going to hit us a little bit, but I don't really see it as Armageddon at this point.
- Mark Connelly:
- Outstanding. Thank you, John.
- John David Williams:
- Thanks.
- Operator:
- Thank you. We'll take our next question from Anthony Pettinari with Citi.
- Randy Toth:
- Good morning. This is actually Randy Toth sitting in for Anthony.
- John David Williams:
- Hi. Good morning.
- Randy Toth:
- Just staying with – yeah, good morning. Just staying on Mark's question, freight was a $2-million hit in the quarter. If we analyze that, is that a good way to think about it for the hit for 2018 over 2017, something like $8 million?
- John David Williams:
- That's a reasonable number. I mean, I wouldn't want to be held accountable to that number. We'll obviously do everything we can to reduce it. But depending on where the leverage is, it can be a little bit higher, but that's reasonable.
- Randy Toth:
- Okay. That's fair. And then, CapEx looks like it ticked up $20 million to $40 million year-over-year. Are there any specific capital projects bringing that up or how should we think about that?
- John David Williams:
- Yeah, not really, I mean, if you look at it, most of our CapEx, particularly in our core business, we probably spend about $130 million a year in Pulp and Paper. We've now got a pretty disciplined plan in our Pulp business as to where we want to take that business in terms of its cost position. There are some elements of that additional CapEx that are focused on that and you'll see us, I think, over the next three to four years spend a little bit more money in our pure Pulp assets to really kind of drive cost and productivity, so that's really the only difference in that mix.
- Randy Toth:
- Okay. That's helpful. I'll turn it over.
- John David Williams:
- All righty.
- Operator:
- Thank you. We'll now take our next question from Gail Glazerman with Roe Equity Research.
- Gail Glazerman:
- Hey, good morning.
- John David Williams:
- Gail, good morning.
- Gail Glazerman:
- In terms of supply, demand in uncoated freesheet, can you just give me maybe a little bit more color on what you're seeing, RISI has been reporting that coated producers have all (26
- John David Williams:
- It's not in the 10% estimate, so that is specific to uncoated freesheet capacity closures that we're making on coated freesheet. I think as you say quite correctly that the coated folks are no longer kind of in the market on uncoated freesheet. So, we are seeing pretty strong demand. And certainly if we look at our capacity utilization, we are selling what we make.
- Gail Glazerman:
- Okay. And is that included in your 18 to 24 months kind of view or could it potentially be... (26
- John David Williams:
- No, I mean that's a great question, Gail. So if you think about a 3% to 5% decline, you think about 10% capacity coming out, that suggests you have 18 to 24 months of runway, and that's essentially where that number comes from. And if you look at closures, I think Georgia-Pacific had just announced Camas is closing May 1, which is a little bit perhaps earlier than we were all expecting. So, I think we see a solid marketplace over the next couple of years.
- Gail Glazerman:
- Okay. And then just on the Personal Care, can you give a little bit more color to kind of the incremental pressures that have built, is that mainly in the U.S., Europe, both? And are there kind of any near term kind of new margin assumptions, growth assumptions that you can share in light of whatever analysis you did that led to the impairment?
- John David Williams:
- Yeah, certainly. So I mean as you look at everybody who announces in that space, you see the pressure. So in – I'll split the business both geographically and by baby and in code (28
- Gail Glazerman:
- Very helpful. Yes, it does. Thanks very much.
- John David Williams:
- Thank you.
- Operator:
- Thank you. We'll take our next question from Adam Josephson with KeyBanc Capital Markets.
- Adam Jesse Josephson:
- John, Daniel, Nick, good morning.
- John David Williams:
- Good morning.
- Daniel Buron:
- Good morning.
- Adam Jesse Josephson:
- John, a couple of questions for you about the repurposing update. Obviously, on the last couple of calls you talked at length about trying to find a home for that paper, right? That's something you thought about for a while of course and it's a tricky issue as it pertains to converting any potential machine. Can you just update us on any thoughts you have now in terms of potentially finding a home for those tons compared to where you were three or six months ago in terms of that thought process?
- John David Williams:
- You're talking specific to linerboard?
- Adam Jesse Josephson:
- Exactly, yeah.
- John David Williams:
- Yeah. Have I understood you right? Sorry.
- Adam Jesse Josephson:
- Yeah.
- John David Williams:
- Well, so we've obviously started a number of discussions with potential customers and potential partners. And to my mind at this point we have a pretty open mind as to which direction we're going to go and it may be even a hybrid of that direction. But everything I'm seeing in the conversations we're having says to me we can move those tons into the market with ready customers or with ready JV partners. So my idea hasn't changed. I think my confidence level in the fact that we can move those tons has just increased.
- Adam Jesse Josephson:
- And presumably, you're confident that you won't be overly reliant on export markets if you were to make this move based on the conversations you just talked about?
- John David Williams:
- Right. I mean, that's a great question. So, exactly that, I think we can have a good size domestic position. I think export will play a part, but we're not going to be kind of the guy I'm asked to sell everything offshore or else he hasn't got an order.
- Adam Jesse Josephson:
- And do recent events such as the just announced price increase play into your decision as well?
- John David Williams:
- Well, I think you have to remember, that's – again, that's a good question. But I think one thing one (32
- Adam Jesse Josephson:
- Yes.
- John David Williams:
- ...so, sort of immediate market conditions whilst helpful the way you'd make the judgment. Of course, you're going to have to look at this thing over a cycle. I mean, yes. And if you look at the most recent piece of consolidation, it all says to me this is going to be an attractive market in the short or medium-term. And yes, that encourages us, but it's not a kind of go, no-go thinking.
- Adam Jesse Josephson:
- Sure. So, then what would be... (32
- Adam Jesse Josephson:
- No, it totally makes sense. So, what's the biggest hesitation at this point if you have one, if not, being able to find a home for those tons domestically?
- John David Williams:
- I mean there's no real hesitation. I think the real issue is we're in the middle of doing the work. The work says, at this moment in time, we probably have an attractive proposition in our hands. There are a few things that we as the management committee and the board want to question in terms of where are we going to be in cost terms, are we going to be competitive, what's the capital involved, and all that needs to be firmed out. But I mean, certainly by year-end, I think I'd be very surprised if we haven't chosen to do something and announce that we're going to do it.
- Adam Jesse Josephson:
- Okay. And have there been any surprises along this – in this journey, if you will, that you found out positives or negatives that you weren't particularly anticipating in terms of a potential conversion?
- John David Williams:
- No. I think it's been pretty much what we expected it to be.
- Adam Jesse Josephson:
- That's really helpful, John. And just one on freesheet, obviously you talked about the 10% of capacity coming out just based on all the announcements. How do you expect that to flow through over the next couple of years, because obviously the 10% is not coming out immediately, right, at all?
- John David Williams:
- No.
- Adam Jesse Josephson:
- Camas is coming out I think May 1, you said, there have been stuff that's already closed. So can you just help us what with the sequencing of that 10% reduction, if demand is declining 3% to 5% a year, what do you think capacity will be down in 2018 and 2019?
- John David Williams:
- Gosh! I'm not sure I could answer that question meaningfully. I really look at it more on the macro level. What you're inclined to see, I think, is that when a closure is announced, customers immediately start to make and think about doing other things, right? Where can I find my volume, if I'm not going to get it from that mill, can I find it from that supplier or do I have to go to another supplier? So very often, the announcement drives the beginning of a change in behavior of where can I find those tons. I think that's why very often some of these closures end up happening earlier than perhaps people imagine because the customers already kind of voted with their feet to some extent.
- Adam Jesse Josephson:
- I see, yeah.
- John David Williams:
- So my view if I look at our experience in January, I look at our volume expectations for 2018, we think it's going to have a positive impact on us and we think it's going to have a positive impact out into 2019 as well. That's about as much color as I can give you, if that's okay.
- Adam Jesse Josephson:
- No, that's perfect. And just on the Personal Care margins, you said, and... (35
- Adam Jesse Josephson:
- I'm sorry, Nick.
- Nicholas Estrela:
- (35
- Adam Jesse Josephson:
- Sorry. Sorry, Nick.
- Nicholas Estrela:
- Okay, thanks.
- Operator:
- Thank you. We'll now take our next question from Mark Wilde with BMO Capital Markets.
- Mark William Wilde:
- Good morning, John. Good morning, Daniel.
- John David Williams:
- Mark, good morning.
- Daniel Buron:
- Good morning.
- Mark William Wilde:
- I don't want to flog this thing John. But I want to just come back with a couple of other questions, first on the conversion.
- John David Williams:
- Sure.
- Mark William Wilde:
- I'm just curious, does the experience of your former employer, SCA, which now has to kind of too big just purely merchant mills that are not in the box business anymore, is that something you've looked at?
- John David Williams:
- Right. It is. It is. I think though Mark if I'm being truthful, patently that was when they sold the old business I ran to David S. Smith and signed a supply agreement. I'm not sure it's a – I'm not sure it's a parallel, but it's a similarity perhaps. You're talking about (36
- Mark William Wilde:
- Yeah, yeah, yeah. Exactly.
- John David Williams:
- Yeah. I would say, we feel there is room for a kind of non-integrated producer making a good quality product with a reasonable tonnage over the next five to seven years, I think at the macro level that's what we feel. And I think if you look at the way we have approached any repurposing, we've been very careful to think about market. We've been kind of market back rather than technical ability out because I guess you and I have been around long enough to know that the paper industry on the whole has kind of build it in (37
- John David Williams:
- So we put as much thought and effort into making certain we think there's a market and real life customers and real life potential partners as we have into those sort of technical planning of what we'd like to do. So, I'm still progressing with the level of comfort that there – there, we can sell this product to the life people and not just be sort of depending on the export market.
- Mark William Wilde:
- Yeah. I know you've been doing a lot of work – that work pretty methodically, John, because I hear about it. I'm just curious also on the conversion.
- John David Williams:
- Yes.
- Mark William Wilde:
- You've converted part of that Ashdown mill to fluff.
- John David Williams:
- Right.
- Mark William Wilde:
- Would there be any reason that that fluff portion would preclude you from maybe making containerboard at Ashdown on the other machines?
- John David Williams:
- No.
- Mark William Wilde:
- Okay.
- John David Williams:
- No.
- Mark William Wilde:
- All right. And then I wondered – I'll just tag one over to Personal Care.
- John David Williams:
- Go.
- Mark William Wilde:
- I mean I understand that this write-off is non-cash, but it's basically equivalent to a third of the capital you've put in this business over the last seven years through acquisition in CapEx. Does the kind of situation you find yourself in right now lead you to kind of rethink the strategy at all?
- John David Williams:
- That's a great question, Mark. I think – well, the first thing we've got to do is get a sense of what can we really earn from this business now under new circumstances, because the pressure has built over the last year or so, in fact, really over the last six months to nine months. Having done that and looked at it, I still believe we can get growth out of that business. But we're always focused to deliver the most value for our shareholders. So, quite frankly, I'm pretty agnostic about the path that I used to get there.
- Mark William Wilde:
- Okay. And I guess the last question, John, I had was, we had an announcement out of one of your smaller competitors the other day that they're basically going to exit the paper business and they have kind of smaller, more specialized mills. It seems to me we've got at least four or five guys in the industry looking at kind of specialty mills and where they go and whether there is some consolidation and rationalization to take place there. Could you be a player in that process with your specialty mills?
- John David Williams:
- Well – so I hit it – I always go back to what I – you may call this is a cynical description, a specialty mill is a mill that used to be competitive doing something else.
- Mark William Wilde:
- Yeah. Okay.
- John David Williams:
- So to my view, I don't think we are participating in that consolidation if that consolidation happens. And one of the reasons – we've looked at it, Mark, a lot over the years and I'll be absolutely open with you. I think one of the issues is they're often very small pieces of tonnage and there is a lot of complexity. Now, one of the things I think we've done well is where we have decent volumes of specialty business. We put that in our major mills to make sure we are extremely competitive, hence the Appvion relationship where we can be very competitive as a paper manufacturer. If those opportunities exist, I'm open to them, but just getting lots of very difficult paper grades and lots of changeovers is really not something we'd want to do.
- Mark William Wilde:
- Okay. All right. Sounds good. I'll turn it over, John.
- John David Williams:
- Thank you.
- Operator:
- Thank you. We'll take our next question from Hamir Patel with CIBC Capital Markets.
- Hamir Patel:
- Hi, good morning. John, we've seen Amazon start to do private label baby diapers again. Just curious how much of a disruption that has had on the market so far, are you concerned about any sort of future disruption from that? And are they sourcing from more than one supplier yet?
- John David Williams:
- So they're sourcing from one supplier. From a disruption standpoint, I mean obviously everything they do we watch, I mean, at the minute those volumes are fairly small. As you know this is their second try, because they came out once before and unfortunately didn't have a product that resonated much with consumers, so this is a re-launch for them. I'm actually more interested in what they announced this morning which is that Amazon Prime members can now get delivery from Whole Foods in two hours, which I think is really dramatic in terms of what that means for the grocery industry and what that means for grocery retailers. So I think that move is much more impactful than being in private label. I think their issue on private label is really to convince people that they have the kind of resonance to sell private label product. Whereas, I think a major retailer like a Walmart or a Kroger probably feels that the consumer has a more sort of intimate relationship with them. But, yeah, I mean, certainly if they build volume in what is now a declining market in baby diapers that puts pressure on everybody else.
- Hamir Patel:
- Thanks. That's helpful. And just turning to the Pulp side, could you comment on where annual discounts in 2018 have trended for both your softwood and hardwood pulp.
- John David Williams:
- Yeah. I mean I wouldn't give you specific customer details, but you could see what RISI said and I mean you could make the assumption that that's not very different to a couple of our major contract.
- Hamir Patel:
- Great. Thanks, John. That's all I had.
- John David Williams:
- All right. Thank you.
- Operator:
- Thank you. We will now take our next question from John Tumazos with John Tumazos Very Independent Research.
- John C. Tumazos:
- Thank you very much. Could you explain why...
- John David Williams:
- John, you're a little bit faint. Is there any way you could?
- John C. Tumazos:
- Is this better?
- John David Williams:
- Yeah, that's a bit better.
- John C. Tumazos:
- Thank you. Could you explain why the intangibles account was not written down when the goodwill was, and which brand would the intangible assets be?
- Daniel Buron:
- It's pure accounting mechanics. We've tested our intangible as we've tested our goodwill, and the goodwill was impaired and the intangibles was not. Intangible brands are the Indas brand, the Attends brand or name if you will, and there is also I think an intangible on the catalog that exists in Spain. So, there is a series of intangible that end up to be the un-amortizable intangible and then there is amortizable intangible that the test is totally different, and that we've also done and there was no impairments.
- John C. Tumazos:
- Thank you.
- Operator:
- Thank you. We'll now take our next question from Chip Dillon with Vertical.
- Chip Dillon:
- Yes, good morning John and Daniel.
- John David Williams:
- Chip, good morning.
- Chip Dillon:
- First question for you for Daniel. I might have missed this, but the tax rate of 17% and 19% obviously is a book tax rate. You mentioned some kind of a $20-million benefit. Is that how much the cash tax payment will be less than what you accrue? Or can you give us a way to think about how cash taxes will work over the next couple of years versus your book tax rate?
- Daniel Buron:
- I mean, it's difficult to do a relationship between tax rate and book tax rate given the source of income may differ from one year to the other. But when I'm looking at only the U.S. and again I'm making the assumption that my current result will be the same in the future, we believe that around $20 million per year less cash tax is a good assumption, and that's a simple math. It's the reduction in federal tax rate less – we're losing the difference for manufacturing. The net of that is around $20 million for us per year.
- Chip Dillon:
- Okay. So, the way to think about it is if whatever your tax expense is, assume what you pay in cash is $20 million less.
- Daniel Buron:
- It would be $20 million, yes, that it would have been otherwise.
- Chip Dillon:
- Okay, okay, got you. Now the other question I had was on the fluff marketplace and when – obviously you've seen some tremendous improvement in the – that the whole Pulp EBITDA, that's very clear. I know but it's tricky especially in fluff when we were trying to model our pricing. And I know that you have customers listening. So I just wanted to ask you, as we look at 2018, would you say a lot of what's been published and/or how it might be flowing through with discount changes at yearend renegotiations? Are you kind of caught up to where RISI was in January or would you say there was – there is more to go to reflect that just given the normal what I understand to be lags that you see in certain contracts?
- John David Williams:
- Yeah, all right. I mean I guess there are two answers to the question. So based on our product mix, a lot of our fluff goes offshore typically, particularly in Asia when you announce that price increase within a month. If you've been successful in negotiating, Chip, you've got it, right. I forgot the exact number, probably something maybe in the room would know better than I do. It may be 50% to 60% of our fluff pulp is going to Asia. Yeah, about 50%. So now on the balance of the business based on contracts that we have in the U.S., there is more of a kind of two or three-month lag before that price comes through. So for us, with 50% of our business going into Asia when we get that China announcement and you see that, we're going to get that in 30 days if we've been successful. When you see those U.S. announcements, sometimes it takes 90 days to work through. Does that help?
- Chip Dillon:
- Okay. That's very helpful. And then last question, just on Personal Care. Obviously you're talking about pressure near term, should we assume that EBITDA in – for all of 2018 should be below where it was in 2017 for that segment? Or is it too early to say, or do you think that that's too onerous?
- John David Williams:
- Well, I think you could plan that it would be a bit lower. I mean, certainly first quarter is going to be lower than fourth quarter. And if that runs through the year, I think that's a reasonable assumption at this point.
- Chip Dillon:
- Okay. Got you. Thank you.
- John David Williams:
- Okay.
- Operator:
- Thank you. We'll now move on to our next question from Kurt Yinger with D. A. Davidson.
- Kurt Yinger:
- Yeah, good morning.
- John David Williams:
- Kurt, good morning.
- Kurt Yinger:
- Just starting with Personal Care, I was wondering if you could break out what the organic sales growth rate was in 2017, sort of ex-HDIS?
- John David Williams:
- It's 4%.
- Kurt Yinger:
- 4%. All right. Great, thanks. And then as you look – think about sort of potential incremental volume in Papers from some of those closures, I'm wondering if you could talk about maybe in the past or what you would expect maybe the margin differential to be to what your current business does.
- John David Williams:
- Oh, to be honest, I couldn't answer that question. I mean I would – it depends so much on what the grades are, who they are manufactured by, which mill they are in, who the customer is. I mean, I think one would just assume we can absorb some of that business that sort of similar margins to our base business in Paper, that's the only way you could really look at that, I think, and be somewhere close to reality.
- Kurt Yinger:
- Okay. All right, thanks. And then I'm just curious, is containerboard now the only grade being contemplated as far as a repurposing or are other grades still sort of being thought about in the background or is that sort of what we should expect to be pushed forward?
- John David Williams:
- Well, I mean certainly we are focusing and we're doing a lot of work on containerboard, but I think we keep our options open. I mean if you think what we have done in the last few years essentially, we've taken really two mills to fluff pulp, and we've taken one mill into a paper grade that we think has kind of long-term future in growth. So whenever we look at it, we look across the spectrum, but certainly it would be fair to say right now, we're driving our thoughts on linerboard harder than we're driving our thoughts on other grades.
- Kurt Yinger:
- Okay, that makes sense. And then last question, not trying to get too into the weeds, but if I look at the adjusted operating income and net-off the interest expense and sort of flow that through to the adjusted net income, I get about kind of 11.5% adjusted tax rate for this year, does that sound about right, and maybe why would that go up to 18% at the midpoint next year?
- Daniel Buron:
- I think you have to look at the tax rates. I mean there's always noise in the year. For instance, there is year where we have more R&D credits that we're not including our forecasted tax rate because we just don't know at this time. So we were expecting in the past around 22% and with the new tax regime, that will move down to 2017 to 2019 (50
- Kurt Yinger:
- Okay. All right. Thank you.
- John David Williams:
- Thank you.
- Operator:
- Thank you. We'll now take our next question from Mark Wilde with BMO Markets (51
- Mark William Wilde:
- Yeah, John just a couple of follow-ons. One, I wondered if you could just update us on kind of – on the pulp market as you see it globally. It looked like maybe six or eight weeks ago, China was pretty weak and there were some reports about sort of secondary prices falling over there. At the same time, it seems like kind of North America and Europe have remained firmer.
- John David Williams:
- Yeah. So I mean I think the Chinese New Year coming will – who knows what that means, I mean right now we see stable prices in China and we see increasing prices elsewhere. So far, Mark, reading the tea leaves, there's nothing that changes our mind on that.
- Daniel Buron:
- I think if you look at the current pricing and that statement is true mostly in the U.S., but the current pricing is actually just above or just slightly above trend. So we still view the prices as not – are very far from the peak at least.
- John David Williams:
- Yeah. I think Daniel makes a good point. The real issue is although this is a ramp-up in price versus a base versus a peak price, it's not there. So we still think there's runaway.
- Mark William Wilde:
- Yeah. Well, I think, John, the further the dollar goes down, probably ...
- John David Williams:
- Right.
- Mark William Wilde:
- ...the (52
- John David Williams:
- Right. Yeah.
- Mark William Wilde:
- Could you just give us some sense of what the – you see the Latin Americans doing and the kind of market acceptance of that?
- John David Williams:
- Yeah, sure. So I mean – I mean, Suzano's claim and I mean I think this is public data, this is not a product that you're going to use on a sole basis, but probably, you can get a percentage of this into your diaper, but you're going to still need other people's fluff pulp as part of the mix. I mean, that's certainly what we've been hearing in the way they've been pitching it. Klabin, I think I'm pitching it slightly differently. But so far, I'm not sitting here thinking that they're going to take the world by storm. And certainly when we've been through qualification with customers in Ashdown, it's got a technical sell this product of course, because it's actually going into some quite technically demanding products and some quite technically demanding converting machinery. So, I think they'll find that place, but I don't really see them as a major threat.
- Mark William Wilde:
- Okay. And then just one more, I know its conversions, can you just talk to us about how you think about mitigating risk when you do a conversion, because it seems like the risky run if you are just an open market producer or a containerboard is that we hit something like 2009 and you've got really much uglier pricing...
- John David Williams:
- Right.
- Mark William Wilde:
- ...on a realized basis than RISI shows?
- John David Williams:
- Right. As in you are the person who has all the customers no one else wants.
- Mark William Wilde:
- Yeah. Yeah. Exactly.
- John David Williams:
- Clear point. Yeah so, I mean, I think that's a great question. So my personal view is we will need some major partners with whom we've signed solid mid to long-term supply agreements to make sure that that's not us and we are very conscious of that actually. In fact you've said something I said to my management team on the other day. So, and we're conscious of that. We're working on that and we will absolutely make certain, I think, that we have a lot of that volume contracted well before we're out there.
- Mark William Wilde:
- Could you, John, can see – I'm not asking you whether this is the case, but could you see, actually trying to take this relationship all the way back to the box customer rather than just go into converters or brokers or whatever?
- John David Williams:
- Yes, absolutely.
- Mark William Wilde:
- Okay. All right. That's it. Good luck in the quarter, good luck in the year.
- John David Williams:
- Thank you very much.
- Operator:
- Thank you. We'll now take our next question from Paul Quinn with RBC Capital Markets.
- Paul Quinn:
- Yeah. Thanks very much. Good morning, John. Good morning, Daniel.
- John David Williams:
- Paul, good morning.
- Daniel Buron:
- Good morning.
- Paul Quinn:
- Hey, just a question on, I guess, first on Pulp business. It seems like, if we looked at it five years ago, you've always been in long pulp and one of the – I guess strategies there was to integrate. And maybe one of the reasons why we went into Personal Care besides the growth in the business was further integration opportunities on the pulp side. Just wondering if you've changed your strategy with respect to this business, it sounds like you're more bullish on it long-term. And it looks like you're going to spend a little bit more money on the assets going forward.
- John David Williams:
- Yeah. I mean, I think the way I would characterize it Paul was maybe historically we were – I don't wish to sound cynical, a slightly reluctant pulp supplier as in this is what we did when we couldn't think of anything else to do. More recently, we think we've built two really strong assets actually in Plymouth and in Ashdown. We've now put probably one of our strongest managers in charge of that business, a guy called Steve Makris, who joined us a few years ago. And we now feel we have an opportunity to really drive that business forward. We've been incredibly successful in Asia where we actually have our own Hong Kong sales market selling into China, so we're not selling through agents into China, we are in other countries, some other countries in Asia. So we feel very much in control of that business. So really we're sitting here saying, we have great customer relationships, we think we have an opportunity there, we feel we have an opportunity to reduce our cost base. As Daniel said and I think quite rightly, the pricing is by no means of the top of the cycle. And so, providing demand continues. And if we look at the way absorbent hygiene products are adopted in Asian countries there's still tons of runway, both in tissue and personal care. We think that's a good place to be. Now, we think that's a good place to be focused on softwood and that's where we are focused. So I mean that's how we see that business today.
- Paul Quinn:
- Great. And just over on the conversion potential. Any CapEx deal for that – what that number would be, any guidance that you could give us?
- John David Williams:
- It's a bit too early, Paul.
- Paul Quinn:
- All right. That's all I had. Best of luck.
- John David Williams:
- Thank you.
- Daniel Buron:
- Thank you.
- Operator:
- Thank you. We'll now take another follow-up from Adam Josephson with KeyBanc Capital Markets.
- John David Williams:
- Adam? We lost him. (57
- Adam Jesse Josephson:
- Sorry about that. Sorry about that. John thanks for...
- John David Williams:
- No worries (58
- Adam Jesse Josephson:
- ...thanks for taking my one follow-up. I think related to what Kurt was talking about earlier. You mentioned you had converted two machines to pulp one to another paper grade over the past few years. Can you just help us with why the timing, why the conversions to pulp then and why containerboard now, and why that makes sense in your view and why not containerboard two or three years ago and pulp now? Just to better understand her thought process a bit.
- John David Williams:
- Sure. Sure. I think what you have to think about. If you took our Pulp position, so take fluff pulp for example. It might be rather a long answer, but if you look at Plymouth, we were making150,000 tons, I think, of fluff pulp in 2009. We chose to come out of paper and then we converted the rest of Plymouth if you like to fluff pulp. So there we stood with one fluff pulp mill and a reasonable market position, but nothing terribly exciting. So we always thought we like the fluff pulp market and could we create enough critical mass where we have a couple of mills, we were then a serious player, customers from a security standpoint would consider buying from us on a long-term basis. And we now find ourselves really, I think of the 33 players in the fluff pulp market, who actually have more than one mill, so we're a very solid player in that environment.
- Adam Jesse Josephson:
- Yeah.
- John David Williams:
- So that's what drove that decision and of course the wood availability, the wood basket issue on softwood, so that drove that decision very clearly. I think where we thought about linerboard, we said to ourselves well, it's now a very consolidated market. We think there is an opportunity to sell as an independent player. And as I said in my prepared remarks, I mean we are seeing it is a business, not just here we go, here is a mill, let's convert it, let's see if we can sell this stuff, we're really thinking about building the business. And certainly in Pulp, I think we've now done that and we continue to do that and we see linerboard is that next opportunity. Does that help?
- Adam Jesse Josephson:
- Yeah. Now, that's perfect. Thanks, John and best of luck in the quarter.
- John David Williams:
- Thank you very much.
- Operator:
- Thank you. And we'll take another follow-up from Chip Dillon with Vertical.
- Chip Dillon:
- Yes. Thanks very much. Just a quick one, I know it's getting late in the call. (01
- Chip Dillon:
- I noticed your net debt is now down to $1 billion. I mean it's continue to come down and I just was wondering what your thoughts are and maybe update us on your plans or your thoughts about buybacks. I'm not even sure what your authorization is and as you didn't really focus on that last year?
- Daniel Buron:
- I think we like the flexibility that our balance sheet is giving us and we're going to use a little bit of that flexibility to repurpose asset. We were delivering – we actually announced a dividend increase this morning, so actually a big portion of our cash is also used to be a good yield dividend and buyback will remain on the side line, we'll be opportunistic on the buyback. I mean we still have, I think, close to $300-million availability on the amount that was authorized, but we'll be opportunistic on buyback. So, if the stocks go down significantly or if there's shock in the market and we all know where the stock market is and the volatility, we're going to seize opportunities in the market.
- Chip Dillon:
- I'd say it just seems like you're getting – going from almost into the zone of being under levered, so I think some would say – and if this year, with all of the strength and pricing coming into it, it would seem like you guys would top last year's free cash flow with obviously not very much of an increase in CapEx. So, I just didn't know if that was something you would step up on this year. Thank you.
- John David Williams:
- Thanks.
- Nicholas Estrela:
- Okay. Thanks, Cody. So, we will release our first quarter 2018 results on Tuesday, May 1, 2018. Thank you for listening and have a great day.
- Operator:
- Thank you. And that does conclude today's conference. Thank you all for your participation.
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