Domtar Corporation
Q3 2018 Earnings Call Transcript

Published: 1 Nov 2018

[Operator:]

Good day, ladies and gentlemen. Welcome to the Domtar Corporation Q3 2018 Earnings Conference Call with Financial Analysts. At this time, all participants 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 is November 1, 2018. I would now like to turn the meeting over to Mr. Nicholas Estrela. Please go ahead, sir.

[Nicholas Estrela:]

Thank you. Good morning, and welcome to our third quarter 2018 earnings 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 Fagan 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 impressive third quarter results. EBITDA before items of $193 million was a significant year-over-year and quarter-over-quarter earnings improvement and included a $6 million unfavorable impact due to Hurricane Florence. Our strong performance was driven by solid business fundamentals and accelerating price realizations within our Pulp and Paper businesses. Operations also ran very well with productivity gains across the mill system, and we continue to generate strong cash with $70 million of cash flow from operations. In our Paper business, favorable market conditions and margin expansion underpinned the solid quarter. The recent price increases that we announced are coming in as we expected and they more than compensated for rising input costs. Our shipping volumes were strong and we continue to demonstrate that we are the partner of choice to our customers in the North American uncoated freesheet market. In Pulp, results were driven by strong global demand along with robust fluff pulp sales and favorable pricing trends. We had solid operational results, particularly in pulp productivity. The strong performance in our Pulp and Paper business more than offset a difficult quarter for Personal Care. We are seeing escalating raw material costs combined with lower prices and these are compressing margins in adult incontinence and baby diapers on both sides of the Atlantic. We have discussed the personal care industry environment at length over the past several calls. In recent quarters, I've spoken about the numerous actions we've been taking to reduce SG&A and costs, increase efficiency and productivity in manufacturing, and grow our top line. Our actions have generated tangible results, but the benefits have been offset by significantly higher raw material costs. Given prevailing market condition, we've launched a division-wide margin improvement plan to enhance profitability. Overall, we expect annual benefits of approximately $25 million to $30 million from these actions with full run rate effect by the end of 2020. This will include streamlining SG&A, cost reductions across our operations, SKU rationalization and the optimization of our manufacturing footprint. Our Waco, Texas facility, which employs 148 full-time people and supplies baby and adult incontinence products, will be permanently shut by the middle of next year. Some equipment of that facility will be relocated as part of a division-wide optimization of our manufacturing footprint. Our guiding principle is to reduce complexity to improve efficiency and productivity. We're also undertaking pricing initiatives and ways to maximize top-line contribution through our commercial means wherever conditions allow. The sum of these actions will reduce our cost base and strengthen our long-term competitive position. Challenging market conditions in Personal Care aside, we have strong momentum to finish 2018 on a high note and the confidence that our Paper and Pulp businesses will enter 2019 with the best momentum in many years. With that, let me turn the call over to Daniel for the financial review. 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 $1.57 per share for the third quarter compared to net earnings of $0.68 per share for the second quarter of 2018. Adjusting for items, our earnings were $1.46 per share in the third quarter compared to earnings of $0.65 per share for the prior quarter. EBITDA before items amounted to $193 million compared to $143 million in the second quarter. Turning to the sequential variation in earnings on slide 5. Consolidated sales were $14 million higher than the second quarter due to higher prices in our Pulp and Paper businesses, partially offset by lower paper volume and lower sales in our Personal Care business. Depreciation and amortization was $4 million lower, while SG&A was $3 million lower than the second quarter. In the third quarter, we recorded income tax expense of $3 million or 3%. This is lower than our expected tax rate due to benefits related to some pension contribution done in Q3, the deductible at last year Federal tax rate, income tax effect of the U.S. tax reform and the recognition of previously unrecognized tax benefit due to the expiration of certain statutes of limitations. Excluding these three elements, our tax rate would have been in line at 21%. Some of our operation were impacted by Hurricane Florence during the quarter. As a precaution, we proactively idle our fluff pulp mill in Plymouth, our paper mill in Marlboro, and our personal care facility in Greenville ahead of the hurricane. Even as our team managed the recovery extremely well and safely, it was nevertheless a $6 million headwind in the quarter. This estimated impact is related to advanced and preparation cost across our regional mill and converting network, less production, increased operating cost, higher regional input cost, including wood, transportation, and logistics. Now, turning to the cash flow statement on slide 6. Cash flow from operating activities amounted to $70 million, while capital expenditure amounted to $49 million. This resulted in a free cash flow of $21 million in the third quarter. Turning to the quarterly waterfall on slide 7. When compared to the second quarter, EBITDA before items increased by $50 million due to higher selling prices for $39 million, lower maintenance cost for $15 million, better productivity for $4 million, lower SG&A cost for $4 million, and lower raw material cost for $4 million. These were partially offset by lower volume and mix for $8 million, higher other cost for $4 million, higher freight cost for $3 million, and an unfavorable foreign exchange for $1 million. Now, turning to the review of our segments starting on slide 8. In the Pulp and Paper segment, sales were 2% higher when compared to the second quarter and 9% higher when compared to the same period last year. EBITDA before item was $197 million compared to $143 million in the second quarter. Our Paper business on slide 9. Sales increased 1% versus last quarter and were 7% higher versus the same quarter last year, while estimated EBITDA before item was $134 million or a 16% margin. Manufactured paper shipment were 4% lower when compared to Q2 and 1% higher versus the same period last year. Average transaction prices for all our paper grade were $40 per ton higher than the second quarter. Let's turn to our Pulp business on slide 10. Sales increased 6% versus the last quarter and were 12% higher versus the same period last year. Estimated EBITDA before item was $63 million or a 19% margin. Pulp shipment were 3% higher versus the second quarter and down 8% when compared to the same period last year. Average pulp prices increased $23 per metric ton versus the second quarter. Our Paper inventory increased 17,000 ton when compared to last quarter, while our Pulp inventory also increased by 17,000 metric ton. Our Personal Care business on slide 12. Sales decreased 4% when compared to last quarter and were 6% lower versus the same period last year. EBITDA before item was $14 million, $6 million lower than the second quarter. As John just mentioned, this morning, we announced a division-wide margin improvement plan that will lower cost and strengthen our long-term competitive position. The plan includes, among other things, the permanent closure of the Waco, Texas personal care manufacturing and distribution facility; the relocation of certain of its manufacturing asset; and a workforce reduction across the division. The Waco, Texas facility is expected to seize operation in Q3 of 2019 and will result in the reduction of 148 full-time employees, as well as certain temporary position. The aggregate pre-tax earning charge in connection with the margin improvement plan is estimated to be $57 million, which includes $29 million related to accelerated depreciation and write down and $7 million related contractual obligation of the Waco building lease. The balance of approximately $21 million, the incremental cost of this restructuring, covers severance cost, asset removal and asset relocation cost. The estimated total charge is expected to be recognized starting in the fourth quarter of 2018 through the third quarter of 2019. Let's turn to slide 14. As you can see, the fourth quarter will be a less active quarter with regards to major planned maintenance shut down in our Pulp and Paper business. We expect to spend approximately $13 million less than what we spent in the third quarter, and this decrease should largely impact our Pulp business. So, this concludes my financial review. And with that, I'd turn the call back to John. John?

[John David Williams:]

Thank you, Daniel. As indicated in previous calls, we expected top line and margin erosion in Personal Care in quarter three, but the margin compression was more severe than we anticipated. Competition remains intense, raw material costs continue to surge while pricing pressure persists. We anticipate these conditions will continue and we expect pressure on margins will remain, but we do believe that we're at the trough. We also expect some top-line improvement in quarter four as our new customers ramp up accelerates. I'm confident that the margin improvement plan that we announced today will help the business weather the storm, and will allow us to be well-positioned in the future. In our Paper business, we continue to see very positive market conditions. EBITDA before items was $134 million in the third quarter or an EBITDA margin of 16%. This is a 300-basis point margin improvement over the second quarter, so a very solid performance. On Paper prices, our recent increases are being realized with average prices $40 per ton higher when compared to quarter two. We've made meaningful progress implementing price increases this year and we expect to fully realize the recent $50 per ton September increase within the next three months. Our volume momentum continued with every channel performing well in the third quarter. Some September orders rolled over into October due to weather, but year-to-date shipments continue to be strong with our volumes up 4% versus last year. This has been driven by higher demand from our customers, new business growth in our specialty business, and we are capitalizing on every opportunity to improve mix. We're well-positioned for margin expansion over the balance of the year and we should see continued momentum as we move into 2019. We expect supply and demand to be balanced over the short to medium term. North American uncoated freesheet demand is down 1.1% year-to-date, a significant improvement over the 5% decline in 2017, and offshore imports remain at low levels. We're encouraged by what we see in the paper market and by the volume and margin improvements that we continue to drive. Our Paper price realization should further improve over the next two quarters as our recent increases take hold. In Pulp, we had one of our best performances in recent years driven by price increases and a solid operational performance. Prices were $23 per metric ton higher quarter-over-quarter. In addition, we have announced and continue to implement price increases across several softwood and fluff pulp grades. We do expect softwood prices to remain relatively stable in the fourth quarter and through 2019 supported by cyclical demand growth and a deceleration of capacity expansion. Operationally, despite some outage days of Plymouth and Marlboro in anticipation of Hurricane Florence, slush pulp productivity remains strong. Our shipments in the third quarter were impacted by weather, but also due to mills prioritizing paper over market pulp volume given strong paper markets. We're looking to further improve our customer mix and execute on growth opportunities notably with our fluff pulp customers. On the supply side, publicly reported downtime has recently started to accumulate in the market and this has increased demand for Domtar products. In addition, we believe producer and customer inventories remain at relatively low levels. During the quarter, China imposed a 5% tariff on U.S. market pulp and we are carefully monitoring trade policies, but we don't expect any near-term impact to our business. We also continue to evaluate the potential repurposing of assets. We are committed to being thoughtful and deliberate in our approach to how we leverage and repurpose assets to capitalize on market opportunities while being mindful of current market conditions. This will best position Domtar to drive both near- and long-term value for our customers and shareholders. We will provide an update on our thinking regarding asset repurposing by the fourth quarter earnings call. In conclusion, this is one of our best quarters in several years and we're pleased with our momentum going into the remainder of the year and into 2019. Turning to our fourth quarter outlook, our Paper and Pulp business is expected to benefit from higher price realizations following recently announced increases. For both Pulp and Paper, we do expect maintenance cost to be lower. Finally, in Personal Care, we expect to benefit from higher volume and cost savings, so this will be largely offset by commodity cost inflation. Thank you for your time and support, and I'll turn the call over 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. Vickie, you can open up the lines for questions.

[Operator:]

Yes. We will take our first question from Anthony Pettinari with Citi. Please go ahead.

[Anthony Pettinari:]

Good morning.

[John David Williams:]

Anthony, good morning.

[Anthony Pettinari:]

Good morning, guys. John, just following up on the mill conversion study. Is it fair to say that containerboard is still kind of the focus of the study, or are fluff or maybe other grades still in play, and the recent capacity announcements in containerboard at all change the way that you think about the opportunity?

[John David Williams:]

Yeah, so let me start with the end first, if I may, Anthony. So, I think we have to remind ourselves that whatever we choose to do, we're making a decision over a 30-year time horizon in terms of the investment. So, sort of trying to time entry into a positive market, whilst part of the judgment, is far from all of the judgment and probably a minority part of the judgment, actually. So, what's happening in terms of some of the capacity build that you see, we think about, but I wouldn't say it dramatically impacts our thinking. And of course, there are various arguments as to whether it's enough, too much and what the implications of it are. In terms of what we're thinking about, we're open to a number of options. So, it's not as if we're just thinking about containerboard. As you know, we've already taken two fluff pulp conversions, so we look very carefully are there other opportunities there. And as I said over the – certainly around the fourth quarter earnings call or before, you'll hear from us about exactly what we plan to do. So, I hope that will give you clarity at that point. Does that help?

[Anthony Pettinari:]

Yeah, no, that's very helpful. And then just maybe switching gears to the Personal Care improvement program, I guess, two questions. First, is this going to result in a net reduction of your productive capacity? And then, second, I know you guided to $25 million to $30 million of benefits run rating by the end of 2020. Any thoughts on the timing of those, how that benefits flow through? Is it linear or is it kind of more back-end loaded as you close Waco?

[John David Williams:]

Well, that's a great question. So, I would say, on the SG&A reduction piece and the Waco closure piece, we'd obviously be wanting to see that run rate post the Waco closure as the business settles down. So, I think you could see – you'd look to see the SG&A benefit in the next few months and you look to see the Waco closure benefit towards the end of 2019. And then the rest of those benefits would flow through towards the sort of end of 2019 and through to 2020. So, if you look at sort of what I would call the hard stop items, so the SG&A reduction and the Waco closure, that really ought to flow through by end of 2019, early 2020. Does that help?

[Anthony Pettinari:]

Okay. And then – definitely, and the – are you going to reduce capacity on a net basis with Waco?

[John David Williams:]

Slightly, only on baby diaper. But we would still have enough headroom for the growth we're looking for from some of our key customers. So, not on adult at all, but slightly on baby.

[Anthony Pettinari:]

Okay. That's helpful. I'll turn it over.

[John David Williams:]

Thanks.

[Operator:]

And we'll take the next question from George Staphos with Bank of America.

[George L. Staphos:]

Hi, everyone. Good morning. Thanks for all the details.

[John David Williams:]

George, good morning.

[George L. Staphos:]

Good morning, John. I wonder – to actually piggyback a little bit off of Anthony's question, if I could. So, would it be possible to delineate what the cost saves are specific to SG&A, specific to Waco or are those still somewhat preliminary? And if you'd mentioned them somewhere in the release, I apologize for having missed them.

[John David Williams:]

Don't worry, George. I'll let Daniel talk to that because we've got that for you.

[Daniel Buron:]

Yeah, George. Actually, there is a – let's call that three buckets of improvement. One is head count reduction, the second one is the Waco closure, and the third one is operational and pricing initiative. So, head count should be around $8 million. Waco closure will bring around $7 million. And other initiative that John referred to, SKU rationalization, I mean, pricing initiative, all kind of – that stuff should bring more or less $15 million over time.

[John David Williams:]

Does that help, George?

[George L. Staphos:]

I'm sorry, Daniel – yes. That was $15 million or $50 million? I assume, it's $15 million.

[Daniel Buron:]

$15 million.

[John David Williams:]

$15 million, 1-5.

[George L. Staphos:]

Okay. Thank you. And then, I guess the related question there is, certainly, Personal Care has been an opportunity that the company's been pursuing for a number of years. The performance there hasn't been necessarily where you had expected it to be. What makes you confident, John and Daniel, that this initiative is really going to set the business up to be earning above cost of capital return and what's your biggest concern about that?

[John David Williams:]

It's great question. So, I mean, you look at this and you see 2.5 points, 3.5 points of margin coming from this activity. The raw material issue, we shall see where that goes over time, but obviously we buy a lot of polyolefin-based product. So, we're a large buyer of things that are driven by polypropylene pricing and the oil price. So, we think that's going to work its way out over time. We have it once, being truthful, a little bit of a scale issue, which I think the closure of Waco helps us. We can focus productivity into the Delaware facility, focused on baby, and Greenville really very closely focused on adult incontinence. We've had a lot of cost this year. We've sort of swung out of a piece of business of one customer and had a ramp up with another customer and these are large numbers, tens of millions of dollars of sales moving about. So, I think – in fact, I still think over the long haul this is a mid-teen EBITDA business. It has got very competitive currently. You can see everybody in the space taking actions to repair margins. And you can see the large branded businesses actually moving price, which I think gives us opportunities as well. So, I still think over time we have a business that actually will make its cost of capital and give us a reasonable return. I think the challenge for us now is to really stabilize the cost position of that business, whilst we continue to make sure we have a sales line of course with the right customers at the right kind of margin. So, I don't sit here thinking we're never going to get there, but you're absolutely right, and it would be foolish to pretend otherwise. It's been a much tougher hoe to plough than we were anticipating.

[George L. Staphos:]

Understood. I guess my last and I'll turn it over. When it gets to conversions, at this juncture, if we assume mid-cycle pricing, that's really your assumption, what return would be higher, a containerboard conversion or a pulp conversion? Obviously, with containerboard, there's a lot more work that has to be done on the backend. But at this juncture, where would the returns be higher for you?

[John David Williams:]

Well, that's a great question and it's very mill specific, George, and it's very specific to the particular project and the particular grade. But undoubtedly, in the very short term if you have the opportunity, inexpensive pulp conversion at today's pulp prices in the short term versus the capital cost of doing linerboard is a pretty attractive choice.

[George L. Staphos:]

All right. Thank you, guys. I'll turn it over.

[John David Williams:]

Thank you.

[Operator:]

Our next question will come from Paul Quinn with RBC Capital Markets.

[Paul Quinn:]

Yeah, thanks very much. Good morning.

[John David Williams:]

Paul, good morning.

[Paul Quinn:]

Hey, just on the repurposing idea, you guys have been studying this for quite a while and you've involved consultants for seems like it's over a year. Just wondering why it's taking so long.

[John David Williams:]

Well, I think what one has to think about is that we had driven in our thinking, of course, by the status of paper markets, Paul, right. We're not in the containerboard business at this moment in time. And what has actually happened, if I'm being truthful, is that the paper market, we actually believe is in an inflection point. We're seeing reasonable growth as we remain clearly the market leader in the space. We're seeing a lot of price momentum. So, as you look at that and you think about – our number one duty here is to serve our customers profitably in the current space. Quite frankly when you then look at a containerboard conversion or any type of conversion, you have to see in the light of a very strong Paper business that we now have. So, that has made us think very carefully around what will we do and more importantly when would we do it.

[Paul Quinn:]

Okay, that's very helpful. And then just on the Pulp side notes that you've restated Pulp transfer at cost, I guess that was market before and just wondering why you made the change?

[Daniel Buron:]

Paul, Daniel speaking. It was a small amount of profit that was not properly presented, if you will, in the slides that we felt because of pulp price going up, the kind of a – the swing of profitability between Paper and Pulp was not reflecting the reality. So, we've made the change to be more accurate.

[Paul Quinn:]

Okay. Then, lastly, I think you outlined $6 million for Hurricane Florence impact. Do we have an idea on Michael?

[John David Williams:]

On Michael?

[Paul Quinn:]

Yes.

[John David Williams:]

Nothing.

[Daniel Buron:]

Nothing.

[John David Williams:]

Nothing of any note.

[Paul Quinn:]

Okay, that's all I had. Thanks, guys.

[John David Williams:]

All right. Well, thank you.

[Operator:]

We'll go to Hamir Patel with TIBC CIBC Capital Markets.

[Hamir Patel:]

Hi. Good morning.

[John David Williams:]

Hamir, good morning.

[Hamir Patel:]

John, you've announced additional price hikes for pulp in North America. Trade report suggests pricing is coming off in China. So, which market do you think is a better leading indicator right now?

[John David Williams:]

Well, I mean, I think they operate as two separate things, if you like the Asian and the Chinese market and the U.S. and European market. So, our judgment for the quarter is that there's probably a wash between the two of them, so there might be a little bit of softening in China, are offset by some price increase in North America. So, if you look at our mix and how we see it, we think that sort of averages out at about sort of flat pricing across the piece. Does that help?

[Hamir Patel:]

Yeah. That's very helpful.

[John David Williams:]

You're welcome.

[Hamir Patel:]

And then just turning to your Pulp contracts for 2019. Are you expecting to see a similar level of discount inflation next year as you've seen in prior years or do you think the market is tight enough that producers can actually hold the line on discount?

[John David Williams:]

That's a simple answer. No, we're not.

[Hamir Patel:]

No, you're not expecting discount inflation...

[John David Williams:]

We're not expecting discounts to open up.

[Hamir Patel:]

Okay. That's all I have. Thanks, John.

[John David Williams:]

All right. Thanks.

[Operator:]

And we'll go to Brian Maguire with Goldman Sachs.

[Derrick Laton:]

Hey, good morning. It's Derrick Laton on for Brian.

[John David Williams:]

Good morning.

[Derrick Laton:]

Good morning. Yeah, so paper prices continue to rise, and I think this market's been a little bit stronger than any of us have expected. Just curious at what point do you become concerned of the threat of imports and have you started to see this materialize at all in the market? And over the longer term, do you see this potentially upsetting any supply in the market?

[John David Williams:]

Yeah, it's a good question. So, obviously, we have the trade case with some of the Asian producers that really is stopping them being here. If you look at capacity, any capacity growth is in that geography. And if you look at the dynamics of the regional markets where potential importers into the U.S. operate, those markets actually looking pretty healthy and prices moving again in Europe pretty dramatically. Obviously, we're an exporter to Europe, so we see that. So, the answer is yes, of course, imports will be around, but we're not expecting them to have a dramatic impact in the market. Obviously, the new news there is the navigated company. But in fairness, they've been importing into the U.S. for a number of years and will continue so to do. So, I don't think we're going to see a dramatic impact from imports over the next 12 months.

[Derrick Laton:]

Got it. That's helpful. Thank you. And then just a follow-up, I think you said your transaction prices in paper were about $40 per ton higher sequentially. Just curious if you could break out or if you could quantify a little bit how much of that was just your pricing realizations and then how much of that is – as you guys continue to put forth effort to improve your mix going forward, how much maybe was impacted just from a mix effect?

[Daniel Buron:]

I think in the quarter it was largely a pricing effect. We should see a little bit of benefit of our mix in Q4. I mean, you remember that Q4 is typically our lowest mix quarter. We believe that this year it will have a small mix impact in Q4 and they get to mix impact, but way better than in prior year. So, we're very positive in how we're managing our mix.

[Derrick Laton:]

That's helpful. Thanks. I'll turn it over.

[John David Williams:]

Okay.

[Operator:]

Adam Josephson with KeyBanc is next.

[Adam Jesse Josephson:]

Thanks. Good morning, everyone. John...

[John David Williams:]

Good morning.

[Adam Jesse Josephson:]

Good morning, John. Just to try to tie together a couple of your responses to the asset repurposing issue. I think somewhat – someone said what's taking you so long and he talked about the inflection, your thoughts that uncoated freesheet may be at an inflection point for however long. Obviously was – it turned around pretty dramatically from one year to the next and I don't know precisely how long these cycles last. On the other hand, you said it's a 30-year time horizon decision. So, how exactly are you balancing the short-term factors, i.e. uncoated freesheet suddenly having gotten much better versus this being what you said is a 30-year decision?

[John David Williams:]

Sure. So, that's a great question and a relatively simple answer. So, in the end, this is an economic choice in terms of return and in terms of the capital required to get that return. And obviously, at the moment, to get a strong return on uncoated freesheet, all we need is the CapEx we have in place today and the assets we have in place today. And right now, we're full and are able to make some customer choices at the lower end of the game here and certainly drive our margins much higher on some of the kind of fill tons we used to have in quarter four. So, we put all that together. It says – actually, we've got plenty of runway here in uncoated freesheet. What does that tell us in terms of the repurposing opportunity either in containerboard or pulp or whatever it may be. And what is the appropriate timing around that based on the runway we see around coated freesheet and quite frankly, to reassure our customers that now we have the market share that we have. We are the one supplier of any size in this business who actually is driven by uncoated freesheet rather than the need to make containerboard when it comes to repurposing decisions. So, I think when we put all that together, that just says we should think long and hard about this and be very thoughtful before we decide what we're going to do next. Not necessarily in terms of the what, but certainly instead of the how and the when.

[Adam Jesse Josephson:]

Sure. And just relatedly, you made – you got into Personal Care many years ago and it obviously hasn't quite worked out as you hoped it would. In terms of your ability to forecast a market five years out, let alone 10 years, 20 years, 30 years, I mean is that part of it? To what extent is that factoring into your taking that look, you have no idea what the containerboard market or the pulp market is going to look like five years from now, let alone 10, 20, 30. So, what would give you comfort that in your ability to forecast the long-term health of those markets?

[John David Williams:]

Well, I mean, I think you're absolutely right because they move around a lot. I mean, commodity – excuse me, pulp is the classic commodity. I think, paper, one can be a bit more thoughtful about because they're all operating to some extent on a supply/demand balance as we are in our own business. So, to my mind, you just have to make some choices and make some assumptions. I mean, I think that's what strategy is all about, but are you going to be wrong at some point? The answer is, of course, you are.

[Adam Jesse Josephson:]

And Daniel, just last one on the – your freesheet exit rate pricing in 3Q versus your average pricing, just so I know, roughly how much is leftover for 4Q?

[Daniel Buron:]

I think we're a little bit shy of $20 per ton higher in September than we were on the average of the quarter.

[Adam Jesse Josephson:]

Thank you very much.

[John David Williams:]

All right. Thanks.

[Operator:]

We'll go to Mark Wilde with Bank of Montreal.

[Mark William Wilde:]

Good morning, John. Good morning, Daniel.

[John David Williams:]

Mark, good morning.

[Mark William Wilde:]

John, I wondered, just coming back to the Paper business, can you give us a sense of what your operating rates are right now in white paper and kind of compare that with the kind of industry operating rates, which appear to be in kind of the high 80s?

[John David Williams:]

Yeah, I'm confused – I mean ours is pretty simple. We sell everything we can make. And we have customers at the door who would like us to sell them more and we haven't got it. So, that's our experience, Mark. I'm a little bit – confused perhaps is the wrong word, but I'm surprised by the operating rate that's out there because when I listen to customers, they don't seem to be experiencing a supply base that suggest the operating rates in the high 80s. It suggests low to mid 90s.

[Mark William Wilde:]

Yeah, okay, all right. That's really what I was asking, John. Also, can you give us a sense on the Pulp business, where you're at in terms of your fluff proportion down at Ashdown right now?

[John David Williams:]

I think we're in the sort of 75th percentile, somewhere around there, but 75% fluff output versus softwood bales, and sort of moving forward as we go.

[Daniel Buron:]

And bale price is great right now, so...

[John David Williams:]

Right. Yeah, there's no harm in being in softwood bales currently as you know.

[Mark William Wilde:]

Yeah. Okay. The last one I have is just one more shot on this repurposing.

[John David Williams:]

Go.

[Mark William Wilde:]

I wondered if you could just give us a sense of sort of what the three biggest hurdles are for you when you kind of – when you think about that repurposing options in front of you.

[John David Williams:]

Yeah, sure. I mean – I'm not sure if hurdles is the right word, but thinking. So, number one, as I said earlier, is all around the uncoated freesheet market and the margin and volume requirement in that market to service our customers. That's certainly the first thing we're looking at, patently, because that's what drives it. Second is really how we enter the market, have we got something sensible to do, have we got a compelling value proposition depending on how we choose to enter. And of course, third is the asset base. Have we got asset that will be competitive? Now, to be frank, on the third, the answer is we absolutely know we have assets that will be competitive. I don't think that's in doubt from any of the work we've done. So, it's those other two issues that are really focusing our thinking at this point.

[Mark William Wilde:]

Okay. Would you say, John, that one of the outcomes might be some type of a joint venture?

[John David Williams:]

I mean, we'd look at all choices, Mark. We don't have our mindset on any particular choice. I think when we look at our assets, there are a number of them. So, depending on our timing and what we choose or not choose to do first or second or third or fourth or wherever, then we think about what's appropriate for us as we need to kind of have that much containerboard into the marketplace.

[Mark William Wilde:]

Okay.

[John David Williams:]

But this is a 10-year journey probably for the business, even when we decide to do it.

[Mark William Wilde:]

Okay. And then last one for me, John, just it seems like some of the coated paper producers, the uncoated groundwood producers, they're moving into kind of specialty markets that you would also be in, and I'm just curious about how much pressure that's creating in those specialty markets when you have guys like Verso and others pushing into – Verso, Sappi pushing into kind of packaging grades, other specialty grades.

[John David Williams:]

Yeah. It creates a little bit more competition. But our specialty business, if I'm being honest, is relatively small. We have a little niche out of those two mills around sort of higher technical business with small tonnage, tight run rate, relatively small machines. I think we're pretty competitive. And we have actually been able to move price on specialty this year. But yeah, there's plenty of competition around as some of those assets change hands and new owners come in, they will have new ideas. So, that creates a little bit of movement in that business that perhaps wasn't there before.

[Mark William Wilde:]

Okay. All right. I'll turn it over. Good luck in the fourth quarter and into next year.

[John David Williams:]

All right. Thanks, Mark. Thank you. Much appreciated.

[Operator:]

And we'll go to Chip Dillon with Vertical Research.

[Chip Dillon:]

Hi. Good morning. Thank you so much.

[John David Williams:]

Chip, good morning.

[Chip Dillon:]

Daniel, just to clarify, did you say the charges were total $57 million or $67 million for the margin improvement plan in Personal Care?

[Daniel Buron:]

$57 million, of which a big portion is actually write down in accelerated depreciation. The new money, if you will, to do the restructuring is around $20 million.

[Chip Dillon:]

Yeah. I got all those other numbers. That's great. And then, on the pricing just to be clear. I think you mentioned the margin at which price is now in Paper are above the third quarter average. I would imagine we would expect a little bit more based on your comments that you would get the full $50 by the year end, I guess. So, could we see the quarter-over-quarter average be $25, $30 across the mix per paper?

[Daniel Buron:]

I think we're going to see the September price increase, the portion in Q4, and the rest early in the New Year. We should have a small, as I said earlier, a small mix impact, smaller than normal. So, aiming at more than the exit price is totally right. So, $20, $25 is not a bad assumption.

[Chip Dillon:]

Okay. And then when we look at the Pulp business, I know that it's a little slushy in China, but you mentioned how good here it is selling softwood bales, and it seems like – I know you guys announced another fluff increase and it seems like that's a monthly occurrence. Could we see the pulp realizations rise in that same neighborhood or maybe a little less, I guess, I don't know, $10 to $20, fourth versus third? Is that a good place to be right now?

[Daniel Buron:]

Let's start by – our exit price was actually $5 higher than the average of the quarter. So, right there with stable pricing we should get $5 bucks more. And you're right, we are implementing price increases. I mean, don't forget that in North America it takes a little bit more time for price to actually hit our bottom line. China is little bit more direct, so I'll be careful. I mean, that's more than $5. It's probably less than $20 in Q4. But again, we will see as we're successfully implementing price increase and we'll see what China will do for the rest of the quarter.

[Chip Dillon:]

Okay. And John, just so I hear you correctly, you mentioned that you do want to give us something more tangible in terms of your – of the future with the repurposing by potentially early February. Could that – you putting yourself in a box in other words, could you tell us it's going to be this mill, but we might push it to x date because of all the factors you've pointed with how good the white paper business is. And I guess as a tie on to that, could fluff pulp be a part of that repurposing as well given how strong that market is?

[John David Williams:]

So, all I can say to both of those right now, of course, Chip, is yes and yes. So, I mean, you're going to see, our thinking is around the assets not around the timing, I guess to be absolutely precise. So, I think what we want the world to understand is this business where people think, okay, that's a declining uncoated freesheet and its options are limited. But conversation is actually going to be about we have some of the very best assets in the industry and these assets have a long-term future if we're thoughtful enough around the great opportunity, whether that great opportunity be pulp or whether it be containerboard. And that's really going to be the discussion. Does that help?

[Chip Dillon:]

That's very helpful. Thank you so much.

[John David Williams:]

All righty. Thanks.

[Operator:]

We'll go to Mark Connelly with Stephens.

[Ashish Gupta:]

Hi. Good morning, gentlemen. It's Ashish Gupta for Mark.

[John David Williams:]

Hi, Ashish.

[Ashish Gupta:]

Just wanted to follow up sort of a little bit on the paper price, maybe pulp a little bit as well, but more so on the white paper side. You've had sort of a pretty nice price increases in the last 12 months. And I'm just kind of trying to think about as we think about where we are, your comments about inflection, the absolute price in paper looks pretty good, but relative to the margins you've had in the past, if we go back several years, you still really aren't there because of all the inflationary pressures. I just wanted to get your kind of view on how you're thinking about where you are margin wise relative to where you think you could be over time certainly since you think operating rates are higher than where we actually – than the reported numbers.

[John David Williams:]

Sure. If you don't mind, I think that would be kind of speculation, which I don't think will be helpful. I think all one can think about is from a kind of opportunity basis when we see a reason and an opportunity to raise price, we'll raise price. We have opportunities certainly from a productivity standpoint. There are plenty of things we can do to try and also reduce the cost base. So, those two things combined over time, if we can, we'll sort of do everything we can. But we're operating a very strong profitable business. Patently, we look every minute of every day to find other opportunities to drive that profit. And that's what we'll continue to do.

[Ashish Gupta:]

I guess what I'm wondering.

[John David Williams:]

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[Ashish Gupta:]

Yeah, I know. I guess what I'm wondering maybe the – I should ask the question a different way is how do you think about your margins here relative to where you've been historically. Is this a reasonable rate of return or do you feel like these assets should be earning more relative to your cost of capital?

[John David Williams:]

Well, I think the question here is what momentum and runway have we got. And so, actually, if you take current performance and you think about where we could be in 2019, quite frankly, I think we've got some great momentum on margin to take into 2019.

[Ashish Gupta:]

And, no, that's helpful, John. And just in terms of the small inventory build you had on the white paper side, can you give us a sense – I mean maybe I missed this, I apologize, but did that have anything to do with transportation challenges or logistics?

[John David Williams:]

Well, certainly, it did around obviously some of the hurricane issues we had because not only we would close the mills, but we weren't shipping. So, I don't really see that 17,000 tons is neither here nor there, quite frankly. So, we have pretty much where we think the system should be on inventory levels. We haven't built unnecessarily. We're having a strong October actually in terms of sales, so I don't see it as an issue.

[Ashish Gupta:]

And then just last question, if I might, is in terms of the balance sheet and capital deployment, and I know – I think last quarter or the quarter before, you'd kind of signal that in terms of a share repurchase you were essentially on the sidelines for a while as you balance the needs for future capital for the conversion project. Is that sort of still where you are especially given the outlook for pricing and cash flows kind of getting a lot better as we look out?

[Daniel Buron:]

This is where we are. I mean, we like the flexibility that is embedded in our balance sheet. I mean, don't forget the inventory is still largely in Paper, in the declining business. So, we need to finish the transition of that business to grow businesses, and we're looking at the capital allocation on a regular basis. We have a healthy dividend. We're looking at it yearly, should we increase, should we stay flat, and we're more opportunistic in terms of buyback. So, depending on what happen in the economy and the stock market, we may emerge in buying back, but that's definitely not the first use of our cash.

[Ashish Gupta:]

Yeah, I know. I guess I was just thinking about it in terms of your multiple and sort of where the earnings are going. Just seemed like an opportunistic time, but thanks so much for all the color.

[John David Williams:]

Thank you.

[Operator:]

At this time, there is one name remaining in the roster. And we'll go back to George Staphos with Bank of America.

[George L. Staphos:]

Hi, everyone. Thanks for taking my follow-up calls, playing conference call ping pong this morning. I wanted to – yeah, I wanted to check in on your thoughts on the pulp market. John, for example, and there was last statistics for September showed somewhat from my vantage point unusual shipment patterns. We saw hardwood up significantly, we saw softwood down sharply. One month isn't a trend, but from your view, is that the premium coming in effect to softwood versus hardwood and therefore people doing where they could to use hardwood in the furnish and the recipe versus softwood? Was it timing and was that at all in any of your declines and shipments year-on-year in the third quarter versus third quarter last year? Or was it more timing or hurricane related that affected your volume in the quarter for Pulp? Thanks, and good luck in the quarter as well.

[John David Williams:]

Thank you. So, I mean, I didn't – I don't interpret it as any sort of meaningful shift. There is a view that those people who are – have that sort of hardwood, softwood choice, particularly tissue manufacturers who've done most of the engineering to do what they can to purchase more hardwood. And certainly, our shipments, although down slightly, I mean, some of that, if we're being honest, was kind of slightly storm related, transport related, it wasn't really customer related. So, let's wait and see what October shows us. But I think it's slightly proven, here we are with a price increase. I don't really think there's any great shift in the market, George, in that respect if any, quite frankly, that I can interpret from September.

[George L. Staphos:]

Okay. Thanks very much. Will turn it over.

[John David Williams:]

All right. Thank you so much.

[Operator:]

And there are no other questions, so I'll turn it back for any additional or closing remarks.

[Nicholas Estrela:]

Thank you, Vicky. We will release our fourth quarter and full-year 2018 results on Tuesday, February the 5, 2019. Thank you for listening, and have a great day.

[Operator:]

And that does conclude our conference for today. I'd like to thank everyone for your participation, and you may now disconnect.