Domtar Corporation
Q2 2015 Earnings Call Transcript

Published: 30 Jul 2015

[Operator:]

Good day, ladies and gentlemen. Welcome to the Domtar Corporation’s Second Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct the question-and-answer session. [Operator Instructions] As a reminder, this call is being recorded today, July 30, 2015. 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 second quarter 2015 earnings call. Our speakers today will be John Williams, President and Chief Executive Officer; and Daniel Buron, Senior Vice President and Chief Financial Officer. He will be supported by Michael Garcia, President - Pulp and Paper Division; and Michael Fagan, President - 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 with the Securities Commissions 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 Williams:]

Thank you, Nick, and good morning, everyone. As reported this morning, we delivered a solid second quarter. In Pulp and Paper, our operating performance was strong despite the higher level of scheduled maintenance. Our Paper shipments trended better than forecast with incremental volume opportunities and good demand in certain channels. In Pulp prices were down slightly global softwood inventory levels remain lean and demand was strong with good volumes in China. In Personal Care momentum continues to build and we delivered a strong quarter. Same currency sales increased 3% year-over-year. Our EBITDA margins expanded 300 basis points to 15%. This marked improvement is driven mostly by our cost savings program and in-house production. On liquidity and capital, we generated healthy free cash flow and continue to buy back stock during the quarter. Last week, we announced the redemption of certain outstanding notes along with a new debt financing. This initiative will improve our debt maturity schedule as well as reduce our financing expenses on outstanding debt going forward. In summary, we executed well from both an operational and financial perspective reflecting the focus, commitment and hard work of our employees. With these brief remarks, let me turn the call over to Daniel for the financial review before I make additional comments on our performance and our outlook for the rest of the year. Daniel?

[Daniel Buron:]

Thank you, John and good morning everyone. Let’s start by going over the financial highlights of the quarter on slide four. We reported this morning net earnings at $0.60 per share for the second quarter compared to net earnings of $0.56 per share for the first quarter of 2015. Adjusting for items our earnings were $0.61 per share in the second quarter compared to earnings of $0.75 per share for the first quarter. EBITDA before items amounted to $158 million compared to $180 million in the first quarter. Free cash flow totaled $56 million compared to $57 million in the first quarter. Earnings of the sequential variation in earnings on slide five. Consolidated sales were at $38 million lower in the first quarter, mostly due to lower volumes and prices in our pulp and paper business. Depreciation and amortization was $1 million higher than the first quarter while and it was $1 million lower. Our second quarter of these included in impairment charge of $80 million related to the accelerated depreciation of part of a paper machine at our Ashdown facility that will be converted into a fluff pulp line in 2016. I would like to remind you that the similar charge will be recorded every quarter until Q2, 2016. Our results also included a gain on sales of property planning equipment for $14 million related to the sale of our [indiscernible] Québec lines and other access and the closure and researching charge of $1 million. Interest expense was $25 million $1 million lower than last quarter. In the quarter, we recorded a tax benefit of $1 million. The effective tax rate for the second quarter was impacted by the impairment and write-down of property, plant and equipment, which occurred in the high tax jurisdiction. The change in an active tax rate in several U.S. states, the capital gain on sale of our [indiscernible] which occurred in the low-tax jurisdiction and a reduction to our provision for uncertain tax positions. Excluding these elements our effective tax rate would have been 26%. Now, turning to the cash flow statement on slide six. Cash flow provided some operating activities amounted to $122 million. Our capital expenditures amounted to $66 million. This resulted in a free cash flow of $56 million for the second quarter. Mid-July, we announced the partial redemption of the 2016 and 2017 notes and $300 million, 10 year turmoil. The redemption and repayment of the upcoming August 2016 notes will be funded through a combination of cash on hand on to our credit facilities and proceeds from the new turmoil. A charge of approximately $42 million representing the premium paid on the redemption will be recorded in the third quarter. We refinancing we will improve debt maturities schedule as well as review our financing expenses, which would be approximately $17 million per quarter following in Q4. In the quarter, we repurchased shares for an amount of $17 million. From to January 2011 to June 2015, we returned a total of $1.2 million to our shareholders through and dividend and share buyback representing 70% of our free cash flow. At the end of the quarter, we had 63.3 million common shares outstanding. Turning to the quality [ph] on slide seven. When compared to the first quarter EBITDA before items decreased by $22 million due to higher plant maintenance cost of $22 million mostly in our pulp business. Lower selling prices for $11 million, lower productivity of $8 million mostly due to the unabsorbed fixed costs plant maintenance, higher freight costs for $2 million and unfavorable foreign exchange for $2 million. These were partially offset by lower raw material cost for $13 million with bad debt expense of $5 million that appear in the first quarter and lower SG&A in other cost $5 million. Turning to slide eight. In the pulp and paper segment sales were 3% lower when compared to the first quarter and down 4% when compared to last year. EBITDA before I think was $125 million compared to $168 million in the first quarter. Now our paper business on slide nine. Sales decreased 3% lower EBITDA before items was $9 million lower when compared to the first quarter. Manufactured paper shipping decreased 3% when compared to the first quarter and were 1% higher when compared with same period last year. Our average transaction prices for our paper grades were $7 lower than last quarter. In the quarter we took 10,000 ton or market related downtime. Our pulp business now on slide 10. EBITDA before item decreased by an estimated $24 million when compared to the first quarter. Pump shipment was sequentially lower by 1% the first quarter and up 3% when compared to the same period last year. Average pulp prices decreased by $10 per metric tons for the first quarter. Our paper inventory improved by 23000 tons compared to the last quarter while pulp inventory decreased by 15,000 metric tons. Our personal care business on slide 12. Our EBITDA before items increased by $6 million this last year and increased $4 million of this last year mostly due to manufacturing cost savings and to lower raw material costs. EBITDA before item increased 14% when compared to last year with a 300 basis point margin improvement. Same currency EBITDA increased 20% and same currency sales improved 3% year-over-year. So this concludes the financial review and with that I will turn the call back to John.

[John Williams:]

Thank you, Daniel. Our scheduled maintenance downtime [indiscernible] for the quarter with eight of our pulp and paper was impacted by annual outages. Maintenance projects were completed on time, cost from budget and most importantly our employees remain safe during one of the busiest maintenance periods of the year. The only maintenance outages, it was a selling quarter of production across the manufacturing network. Our paper shipments are trending better than forecast with year-to-date volumes outperforming the broader North American uncoated freesheet market by 2.3%. Uncoated freesheet market have shown demand stability so far in 2015 but we did take 10,000 tons of market related downtime. We also made the decision to increase inventories to better support our customers in the event that imports declining further. During the quarter the trade case weeks are significant milestone as the Department of Commerce announced preliminary countervailing duties on imports from China and Indonesia. We are pleased with their decision to support the petitioner’s claims and it’s an important step in the efforts to restore fair market conditions. We look forward to the Commerce Department’s next update on antidumping duties which is expected on August 19. As the trade case progresses, we will continue to monitor our supply with our customer demand. Overall, our paper prices are relatively unchanged but we did see erosion in some of our publishing and converting grades along with lower export prices. Raw material costs were favorable notably in energy. However flooding in the U.S. South negatively impacted some of our wood costs and supply, but production curtailments were limited. In our pulp business earnings were flat from the first quarter, some variable inventory levels remain balanced. We expect some pricing volatility by late summer as normal seasonal factors in certain markets take hold. On sustainability, our recent position has helped us remain cost competitive through a number of initiatives. For example, our decision to permanently convert four power boilers from coal to natural gas has resulted in a significant reduction in capital costs, the Boiler MACT compliance and will help us meet potential future regulatory requirements. We’ve also completed comprehensive energy audits at nine of our mills, resulting in some 500 opportunities to improve energy efficiency with approximately 100 of those projects already completed. While we are already benefiting from relatively low energy cost per say, we believe that making this commitment to efficiency improvements will service well for the longer term. Finally, we are avoiding additional operating costs by diverting materials from landfills. Although, at 70% of material that was once considered waste and landfill is now being beneficially reused. We continue to push ourselves when it comes to running our business more efficiently by reducing material inputs, lowering emissions, creating less waste, and ultimately harnessing greater value from wood fiber. On the front end of the business, the paper and packaging board, a joint partnership between the paper and paper-based packaging sectors launched a nationwide campaign in July called How Life Unfolds. Our goal is to reach out to consumers through a multiplatform campaign about the unique attributes of products we make and about the meaningful role these products play in their lives. I am confident that this initiative will help increase consumer affinity and demand for paper and paper-based packaging and educate consumers about the positive messages behind our products. Turning to personal care, we turned in a solid performance. EBITDA before items increased 14% when compared to last year with a 3% margin improvement despite continued headwinds from foreign exchange. We delivered on our cost savings program which included in-sourcing and procurement savings. We also had better manufacturing uptime resulting in stronger productivity, with both protective underwear and baby diapers achieving record output levels during the month of June. Most of our product platform in personal care performed well, with baby diapers significantly improving its sales in EBITDA when compared to last year. So I’m pleased with how we’ve reestablished ourselves in that business following some customer losses early last year. And we still have more work to do. We’re now in the process of moving one baby diaper line to Europe to capture market growth and we’ve got a good pipeline with new innovative product launches. Also in the third quarter we’ll be ramping up a new bladder control pad line in Europe. We’re making good progress with several of our top personal care target customers. We won several new bids in the second quarter with expected delivery of products in 2016. And we’re growing our share of wallet with existing accounts. So I do expect the sales and margin momentum to continue in the second half of 2015 with further year-over-year top line and EBITDA improvement. Our third quarter results will be impacted by some seasonality in southern Europe, which represents half of our revenue line in Personal Care well into the usual summer slowdown. Our focus remains in our strategic priorities including insourcing and procurement cost savings as well as growth. We are investing in our products and customer brands and in critical company capabilities. And we’re evolving the business by commercializing our product innovations and our proprietary flexible manufacturing processes. Looking back at the first six months of 2015, I’m pleased with our overall progress. In Pulp and Paper, our operations are running well. Pulp activities much improved, while our paper volumes remain strong. In Personal Care, we’ve made very good progress in building the capabilities needed to execute our strategy and we have begun to deliver directionally meaningful result so far. We’re generating good cash flow; we’re buying back stock, and managing our balance sheet to preserve financial flexibility. And we will continue to scan the horizon for value creating M&A opportunities as we target $300 million and $500 million in annualized EBITDA for growing businesses. Now, to our second half outlook. We expect our paper shipments the trend in market demand, but we should benefit from lower import volumes in North America. Pulp should benefit from lower plant maintenance costs and we expect some pricing relativity in the coming months. We anticipate inflation on input cost to be relatively flat to the second half of the year. Fiber costs will remain high in certain markets, but should not increase further, while energy costs should remain favorable. In Personal Care, we expect positive momentum to continue despite currency headwinds and a seasonal slowdown in European demand in the third quarter. And our product segments will benefit from total cost savings and continued market growth. Thank you for your time and support and I’ll turn it 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 to as many people as possible. So, [indiscernible], you can open up the lines for questions?

[Operator:]

Thank you sir. [Operating Instruction] Your first question will come from the line of James Armstrong of Vertical Research Partners. Please go ahead sir.

[James Armstrong:]

Good morning guys.

[John Williams:]

Good morning James.

[Daniel Buron:]

Good morning James.

[James Armstrong:]

My first question just on the duties, are you seeing any impact from accountability duties yet? And can you update us on any new events in the anti-dumping duties before they come out later this month - or later next month?

[John Williams:]

Yes, certainly James. So, I think we’re seeing some affects. So, there’s no doubt. A number of customers are thinking about what are they going to do about supply of some of these imports unavailable to them. A couple of - there’s a major producers seem to have already departed. So, it’s hard to quantify that effect, but I think we see it there. Obviously, the key day really now is August 19 when they are going to talk about anti-dumping duties. If those are considerable patent, then there will be a greater effect, but I still think we’re seeing a little bit of the impact now. It’s very hard to quantify though. I wouldn’t attempt to do so.

[James Armstrong:]

Okay. And then switching to Personal Care, could you dive a little bit more into that, specifically what are you seeing in terms of volume, and would you expect the seasonality in Europe to offset the cost savings and market growth into the third quarter?

[John Williams:]

Sorry, James, I’m having trouble hearing you. Could you just repeat that question?

[James Armstrong:]

Yes, of course, sorry. On personal care, what are you seeing in terms of volume and would you expect the seasonality affect in Europe to offset the cost savings and market growth?

[John Williams:]

The answer to that is, right now actually, so if I look at July it’s trending pretty much were June is or June was certainly. So actually that looks pretty solid. Obviously the issue for us is really August when southern Europeans - how will I put it, the part on mass for their holidays. And that creates a bit of a hiccup, so I don’t think that if you like underlying demand. And for the second part of your question, I actually do think our cost savings and our ability to now in source a number of these products would not offset it all, but certainly will make a huge difference to it. So, I don’t really see a kind of major impact does that make some point. Also I just would remind you, we’re also ramping up a couple of lines. Now, when we first started to do this that create a little bit of noise, it may still create some noise, but I don’t think it’s going to be that dramatic.

[James Armstrong:]

Okay. That helps. Thank you very much.

[John Williams:]

You’re very welcome.

[Operator:]

And your next question will come from the line of Mark Connelly of CLSA. Please go ahead.

[Mark Connelly:]

Thank you. Two things... Good morning.

[Mark Connelly:]

First, good morning. Can you share with us how the diaper outlook looks to you now relative to your expectations when you started the big expansion program? You, obviously, had a few things that have come in a little bit late, but I’m just curious if you still think the full benefits are out there?

[John Williams:]

Well, really the whole business, because you have so many different pieces going on.

[Mark Connelly:]

Certainly. Are you talking the business or baby diaper, adult diaper, or all of the above?

[John Williams:]

Sure. Happy to break that down for you. So, thanks for the question. My answer to that would be, yes. So we’ve had, there’s a little bit of price erosion here and there, but overall one must remind oneself particularly the adult incontinence business, which is by far the majority of our business. It has growth prospects certainly 3% to 5% well into the foreseeable future just based on demographics.

[Mark Connelly:]

Sure.

[John Williams:]

And we have, again to remind us, well over kind of 80% of our business actually is institutional business. So it’s not retail business. And in Europe, of course, it’s prescription base, i.e. the patient is remunerated by the healthcare systems. So for us where we look for the growth we see really holding our position in the institutional business and putting innovative products down that product stream, but really staying with market growth. In the retail side where we have a very small position, really in Spain we have a heavily branded position we’re actually re-launching one of our products later in the years so elsewhere we’re really looking for private label store brand partnerships with major retailers. I think we have a great story to tell. So I sit here still saying, look the potential in that business is still where we thought it was.

[Mark Connelly:]

Okay. And just one more question. Obviously, this is a very big maintenance quarter. I’m just wondering if you could help us look at the year ahead and whether we should expect any significant changes to the kind of pattern in maintenance given your portfolio keeps evolving.

[John Williams:]

No. We’re always striving to reduce costs. So we have a strategy trying to expand a little bit our share, but it’s just too early for us to be sure. I mean, we’re not - as I said, we’re not comfortable. I guess, maintenance next year should be more [indiscernible]. But I think, for this year, Bob, the shape that you normally see, there is nothing to suggest that that shape doesn’t continue.

[Mark Connelly:]

Okay. Thank you very much.

[John Williams:]

If that helps.

[Mark Connelly:]

I appreciate that.

[John Williams:]

Okay.

[Operator:]

[Operator Instructions] And our next question will come from the line of George Staphos of Bank of America. Please go ahead, sir.

[John Babcock:]

This is actually John Babcock in for George. How is everything going today?

[John Williams:]

Good.

[John Babcock:]

I just wanted to quickly ask you on Personal Care. Clearly, I think, on the last quarter, you talked about some new business would be rolling in from late last year and early this year into the next quarter. And I just want to get a sense of the impact of that. And then also how that’s going to impact the third quarter and the rest of the year?

[John Williams:]

Yeah. Certainly. So, I mean, I think, it’s hard to quantify because, of course, in the end, if you look at it, the base business is growing. I think the way you have to see this is we would expect our base business to grow at the market. And then, as we win things, that kind of gives us the growth above market, if that makes sense. So rather than give you specific numbers, because those numbers move around to such a point that I don’t think it’s terribly helpful, I think, what you should really be thinking of is that we have a base business that’s growing. We then get some wins. Now, very often between the you have got the business discussion and we’ll start shipping that business, there can be anywhere from a three- to nine-month lag depending on what we have to do on packaging, what we have to do on product spec. So sometimes there will be a win, and you’re really not going to see that impact in the sales line maybe for six to nine months. Does that help?

[John Babcock:]

Yeah. I think that helps a little bit.

[John Williams:]

Okay.

[John Babcock:]

And then, also, I mean, given - clearly, in the Pulp and Paper business, you have mills and you have maintenance expenses for that. Do you also have something similar in the Personal Care business where you end up taking downtime and you have to take maintenance on the machines? What’s a good way to think about that?

[John Williams:]

Yeah. It’s very small. So it has nothing like that impact. So, in fact, in our case, if you’re thinking about kind of what is it in that business that can create some choppiness, in our case, because we’re really in investment mode on the machine side, they can sometimes be the ramp-up. Because, obviously, as you begin to manufacture products, you’re having to test a product, you’re running that machine at very low operating rates. And so, consequently, until you’re running those machines in the 60s and the 70 operating rates, that overhead recovery doesn’t come through - i.e., you’ve got the cost of the machine and the cost of the people, but you’re not actually getting the overhead recovery. So that’s what can cause a little bit of noise. On a regular just run it basis, you don’t have anything like the maintenance shutdowns, etcetera, that you’d have in these - in our major mills. And the reason behind that - this is really a converting business. So it has a different dynamic.

[John Babcock:]

Okay. Great. Thanks.

[John Williams:]

Okay.

[John Babcock:]

Okay, great. Thanks. And last next question I just want to ask with regards to the Ashdown conversion today is that another player in the fluff pulp market plans to increase their focus there and I just want to get a sense for how that impacts your plans at all and then I just also want to get a sense for whether that will have a greater impact on the spot market or if that will have a greater impact on the contract market?

[John Williams:]

Yes. I guess one thing one has to think about is of course, they are already in this market. And have been in this market for some time. And then of course we’re going to make essentially a change in the chosen not to. I don’t think the net incremental volume that’s been out committed to is going to be that dramatic in the market to be honest. And certainly, we believe in Ashdown we’ve got, I think we’ve a number of things. One we are convinced currently the products we manufacture out of Plymouth our lighthouse brand is certainly one of the strongest fluff pulps out there in terms of how it interacts with the customer and what the customer needs. Of course what we’re intending to do is and Ashdown is largely the same type of product. So we feel pretty confident that that kind of 1 million tons that we’re going to have a fluff pulp will find his place in the market.

[John Babcock:]

Okay, great. Thanks for the color. I Appreciate it.

[Operator:]

And gentlemen, we have no further questions at this time. I’d like to hand it back over to Mr. Estrela for closing remarks.

[Nicholas Estrela:]

Thank you everyone. So as a reminder, we will release our third quarter 2015 results on Thursday, October 29, 2015. Thank you for listening and have a great day.

[Operator:]

Ladies and gentlemen, this concludes the conference call for today. We thank you for your participation. You may now disconnect your line and have a great day.