Domtar Corporation
Q1 2014 Earnings Call Transcript

Published: 24 Apr 2014

[Operator:]

Good day, ladies and gentlemen. Welcome to the Domtar Corporation First Quarter 2014 Financial Results Conference Call. [Operator Instructions] As a reminder, this call is being recorded. Today is Thursday, April 24, 2014. I would now like to turn the meeting over to Mr. Nicholas Estrela. Please go ahead, sir.

[Nicholas Estrela:]

Thank you, Tracy. Good morning, and welcome to our first quarter 2014 earnings call. Our speakers today will be John Williams, President and CEO; and Daniel Buron, Chief Financial Officer. John and Daniel will begin with prepared remarks, after which, we will take questions. During the call, references will be made to supporting slides, and you could 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 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 D. Williams:]

Thank you, Nick, and good morning, everyone. This morning, we reported first quarter EBITDA before items of $182 million on sales of $1.4 billion. Despite improved year-over-year results, our financial performance against the fourth quarter was negatively impacted by the severe weather. In particular, some of our pulp and paper operations experienced greater than normal energy and fiber costs. We estimate total weather-related cost is about $22 million, and we anticipate a return to more normal costs in the quarters to come. Compared to the fourth quarter, our paper pricing improved and our volumes outperformed the industry as we continue to offset declines with an enhanced product mix and exports. In Pulp, our profitability was weaker than the fourth quarter, mostly due to weather, which impacted volumes and costs. But we did benefit from better pulp prices. In Personal Care, we're pleased with the acquisition of Indas as it performed in line with our expectations. The acquisition represents a key milestone on our strategic journey to build a Personal Care business of sufficient critical mass. On our organic growth plans, we continue to make good progress. And since we are currently capacity constraint, we're moving fast in the deployment of new machinery to begin manufacturing product-for-sale by the end of the fourth quarter. We are bringing new production online, not only to provide the capacity, but also to improve the product mix, and the product innovation required to better serve our targeted customers. With these brief remarks, I'll turn the call over to Daniel for the financial review, and I'll come back with the outlook. Daniel?

[Daniel Buron:]

Thank you, John, and good morning, everyone. Let's start by going over the financial highlights of the quarter on Slide 4. We reported this morning net earnings of $1.20 per share for the first quarter compared to net earnings of $2 per share for the fourth quarter of 2013. Adjusting for items, our earnings were $1.29 per share in the first quarter compared to earnings of $2.09 per share in the fourth quarter. EBITDA before items amounted to $182 million compared to $190 million in the fourth quarter. Free cash flow totaled $96 million compared to $62 million in the fourth quarter. Turning to the sequential variation in earnings on Slide 5. Consolidated sales were $35 million higher than the fourth quarter, primarily due to the inclusion of the sales of Indas, our recent acquisition, and higher pulp and paper prices. This was partially offset by lower volume for both pulp and paper. SG&A was $14 million higher than Q4, mostly due to the SG&A related to our new Spanish AI business, merger and acquisition expenses in the quarter, and mark-to-market impact on some sub-based compensation. We incurred charges of $1 million to close an administrative office in our Personal Care segment related to the streamlining of our U.S. operations. Interest expense was $25 million, $3 million higher than the last quarter due to the new bond issued in late November last year to finance part of the purchase price of Indas. Finally, we reported a tax expense of $15 million or 28% in the first quarter, in line with our expected tax rate for the year. Now turning to the cash flow statement on Slide 6. Cash flows provided from operating activities amounted to $141 million in the quarter. Capital expenditures amounted to $45 million. This resulted in free cash flow of $96 million in the first quarter. Free cash flow for this quarter includes, as expected, $34 million of payment received from the Spanish government to repay past due receivables. On April 1, 2014, we announced that we will redeem all of our outstanding exchangeable shares. On the redemption date, holders of exchangeable shares will receive permanent stock of Domtar Corporation on a one-for-one basis. The exchangeable shares are included in the fully diluted share count. Therefore, the transaction will have no impact on the total number of shares outstanding. At the end of the quarter, we had 32.5 million shares outstanding including those exchangeable shares. Turning to the quarterly waterfall on Slide 7. When compared to the fourth quarter, EBITDA decreased by $8 million due to higher raw material costs of $27 million, lower volume and mix of $15 million, lower other operating income of $9 million, higher SG&A of $6 million and lower productivity of $3 million. These were partially offset by higher selling prices of $26 million, the addition of the Indas earnings of $15 million and favorable foreign exchange of $11 million. I'm now on Slide 8. In the Pulp and Paper segment, sales were down 2% when compared to the fourth quarter, and down 6% when compared to last year. This decline, when compared to the first quarter last year, is a result of the sales of our Ariva U.S. business last July, offset by higher sales in the rest of our Pulp and Paper business. EBITDA before items was $152 million compared to $166 million in the fourth quarter. Extreme weather condition on the North American East Coast cost us approximately $22 million in our Pulp and Paper business. It includes $11 million of higher energy costs, net of higher energy sales, $5 million of higher fiber costs, $4 million of pulp production slowback for either production or procurement issues, and $2 million for other services including transportation. Now turning to our Paper business on Slide 9. EBITDA before items decreased an estimated $5 million in our Paper business when compared to the fourth quarter. Manufactured paper shipments were 13,000 tons, or 1.6% lower when compared to the fourth quarter and down 24,000 tons, or 2.9% when compared to the same period last year. Our average transaction prices for all our papergrade were $23, $0.02 [ph] higher than the last quarter. In other data point, average transaction prices for all our papergrade were $8 per ton higher in March than they were in the quarter. In the first quarter, we took no significant market-related downtime. Our Paper business -- Pulp business, sorry -- on Slide 10. EBITDA before items decreased an estimated $9 million when compared to the fourth quarter. Pulp shipments were sequentially lower by 16% versus the fourth quarter and average pulp prices increased by $22 per metric ton versus the fourth quarter. Paper inventories decreased by 4,000 tons compared to last quarter, while pulp inventories increased by 13,000 metric tons. Our Personal Care business on Slide 12. Our result in the first quarter includes Indas, our newly -- new AI business since January 2. Sales in that division were up 35% when compared to the fourth quarter, and up 110% when compared to last year. EBITDA before items was $35 million compared to $21 million in the fourth quarter. Before ending my remarks, I would like to highlight that due to severe weather condition in Q1, we adjusted the timing of maintenance of certain of our facilities. So I invite you to refer to Slide 13 for the revised spending schedule. To that effect, we plan to spend, in the second quarter, approximately $26 million more than what we spent in the first quarter. For your convenience, we've also added, on Page 15 of the slide deck, a revised key financial assumption for the year in order to reflect our new Spanish business and also take into consideration currency fluctuations. So this concludes the financial review. And with that, I will turn the call back to John

[John D. Williams:]

Thank you, Daniel. As we previously mentioned, the severe weather impacted our businesses in several different ways. Nonetheless, cost pressures have now moderated. In Paper, we successfully implemented the October price increase that covered a majority of our paper product offering. Exiting the quarter, our prices were $31 higher than the fourth quarter average. In addition, prices should further improve as we implement the second increase. In Pulp, rail car supply shortages in Canada, the truckers strike at the Vancouver port and extreme weather impacted cost and volumes. However, we did benefit from better pricing in most of our grades and in most of our markets. Rounding out the segment, we announced the appointment of Michael Garcia to the position of President of our Pulp and Paper business, responsible for all aspects of our Pulp and Paper products. Mike brings over 20 years of international management experience from the paper and the steel and aluminum industries on 3 continents, and brings a wealth of strategic and operational expertise. I'm delighted to welcome Mike to the team, and I'm confident his leadership skills and global experience will bring great value to our Pulp and Paper business. In Personal Care, I'm pleased with the progress made so far in the division, even though we have faced some erosion in our baby diaper sales. The retail infant diaper business is driven by 14 significant customers in North America and can result in some sales volatility as the industry runs on a competitive bid cycle. Through the ownership transition, we lost some business of 2 of our biggest customers, but we stand firmly committed to regain this volume over time. Progress is now well underway on our planned redesign of some of our products to improve quality and offer innovations that provide a differentiated, higher value solution for our customers. Storebrand baby diapers remain a key element of our absorbent hygiene retail strategy. In the incontinence business, we're building a strong global platform. We're currently capacity constrained, and we're now bringing new production capacity online where necessary to grow and better service targeted business. By the end of the fourth quarter, we'll see this strategy manifest cost savings, additional volume and a more innovative product range. Turning to shareholder returns. We continue to believe that a balanced and disciplined approach to capital allocation is the optimal way to create value. We are committed to deploying capital to those areas that will achieve the best possible return for our shareholders. Our continued strong free cash flow allows us to invest in growth and maintain a strong and flexible financial position for operating and strategic initiatives, while still returning capital to our shareholders. We look forward to updating you further as per our usual course at our Annual Meeting on April 30. Finally on sustainability, we've begun realizing important environmental and economic benefits from our expanded sustainability agenda in our mills. While Domtar has long lead the industry in using wood supplies that are independently certified as sustainable, 2 years ago, we began a rigorous assessment of other key performance indicators in our manufacturing operations. That effort, led by our employees in the mills, has significantly reduced the amount of waste material we're sending to landfills. 58% of the solid waste generated in our mills system is now being beneficially reused. Not sending this material to landfills is both good for our bottom line and the environment. We've also continued our efficiency gains on the energy front, which benefits both our cost structure and the environment. For example, Domtar's direct greenhouse gas emissions, to produce a ton of product, are approximately half that of our Asian producers. These results are examples of what engaged employees help us deliver to shareholders and customers alike. Now turning to our outlook. Paper prices will improve from the first quarter as a result of our second price increase, while our volumes are expected to remain stable. During the second quarter, we will be affected by seasonally higher maintenance activity and input costs are expected to return to more normal levels for the remainder of the year. Finally, Personal Care will continue to benefit from the recent acquisition of Indas and with the addition of the new production lines towards the end of the year. Thank you for your time and support. And I'll turn it back to Nick for questions.

[Nicholas Estrela:]

Thank you, John. Before we start polling 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. Tracy?

[Operator:]

[Operator Instructions] And our first question comes from Mark Connelly with CLSA.

[Mark W. Connelly:]

Two things. Can you give us an idea of what your operating rates in white paper and pulp were in the quarter, and how meaningfully they were affected by the weather? And then a separate and last question. You've said earlier that you're looking for more diaper assess to reach critical mass, and you said that you're looking both at the U.S. and Europe. I'm curious if you can share with us, how different the synergies or the issues that they come into play and adding in one market versus the other are obviously very different markets?

[John D. Williams:]

Yes, you mean between the 2 geographies, Mark?

[Mark W. Connelly:]

Yes. I mean, if you said you'd be interested in both. I'm just curious what the drivers in the decision factors would be?

[John D. Williams:]

Yes, no worries. One -- and I will answer the first question. So paper, we shipped pretty much everything we manufactured. Pulp, pretty much the same. Although we had some pulp that got stuck in the supply chain, I think, Canada probably 13,000, 14,000 tons, which we -- which we'll ship this month. But -- so a little bit of an increase as you saw in some paper stocks. But we're confident they'll work their way out on the inventory side in the second quarter as we take the maintenance downtime. Did that help you on that one?

[Mark W. Connelly:]

Yes, that's fine. Thanks.

[John D. Williams:]

All right. U.S. versus Europe, certainly, the baby diaper acquisition in the U.S. is really about getting the right offering for our retail customers. If we were going to go the same route in Europe, it would have the same rationale. The difference in Europe is the private label is closer to kind of 40% of some of those key markets whereas it's a bit lower in the U.S. So the U.S. would appear to have a more compelling story if U.S. retailers and North American retailers, in general, decide to really get behind private label. Where if you look at the way Europeans do it, they typically have a kind of good, better, best offering. But very often in the U.S, it's kind of a value offering, if you take my point. But there's no doubt. I think they're going to want to drive that business in the U.S. because if you look at the profitability of European retailers on a per sales basis, it's much higher and private label's very attractive. So we think there'll be growth in private label in those key categories in the U.S.

[Operator:]

Our next question comes from Anthony Pettinari with Citi.

[Anthony Pettinari:]

Just a question on the realization of the paper price hikes. I think on the last call, you indicated you might expect a full run rate realization towards the latter half of the first half, and I'm wondering if that expectation is unchanged? And then maybe just as a follow up, we see list prices indicate that the price increase in cut size is sort of lagging or has been slower to take than the price increases in offset. I know you guys don't necessarily tie to those list prices. But I was wondering if you could -- if that's reflecting what you're seeing as well? And if you had any commentary about how the price increases are being realized by grade?

[John D. Williams:]

As you know, Anthony, we don't go into it by grade, but let me give you a bit more color because I think it might help. So if you look at that first price increase, essentially, it affected about 60% of our product range. So if you sort of did the simple math, you'd say, well, we would've had an expectation from that first price increase that we'd see $35, $36 coming through. And the reason we've given you that $31 number is to give you a sense of, well, that was the first price increase, there it is, yes? Does that help? So really now, the issue is the second price increase, how will that take. The difference in this price increase is that our specialty grade, so that's sort of 400 or 500,000 tons of specialty, also have announced a price increase. So we should see a larger overall realization from that than we saw from the first one. But, I mean, as you know, it will take a few months to work its way through. So we'd obviously give you an update on that end of second quarter, and it may well be some of that will actually turn up in quarter 3. So I think that's what will be the dynamic for pricing going forward. Does that give you a bit more color?

[Anthony Pettinari:]

Yes. That's very helpful. And then with regards to, maybe, cut size versus offset, are you seeing different speed of realization between those 2 grades? Or is there any color you can give there?

[John D. Williams:]

Probably not much color that I can give there. It does take a little bit longer from time to time. But normally, you end up in roughly the same place. It just takes you a little bit longer.

[Anthony Pettinari:]

Okay. And maybe just one final question. You referenced paper volumes being more stable in 2Q and for the rest of the year. When you say stable volumes, do you mean, maybe, consistent with sort of the 3% to 4% volume decline we've seen historically, or flat year-over-year? Or what ...

[John D. Williams:]

Yes. Good question. So we're really talking more about our volumes than the market place. And obviously, when you think about closures that have taken place, those closures were really producing product to the very last minute. That product, some of it's moving now through inventory and moving through to customers. So we have an expectation. There's some volume around that we'll probably be able to pick up, nothing too dramatic, but in the grades that suit us, which will mean that we'll probably have a flat sales line to a smaller decline, perhaps, than you've seen. I think you're seeing that actually a little bit in the first quarter, a smaller decline than you've sort of seen versus trend. Does that help?

[Operator:]

Our next question comes from George Staphos with Bank of America.

[John P. Babcock:]

This is actually John sitting in for George. I just had a quick question for you. With the rest of the weather [indiscernible], do you expect that to or much of it to swing positive in the second quarter?

[John D. Williams:]

I think some of it will, some of it won't. So we probably think, maybe 2/3 of it will come back in the second quarter. And there are couple of -- obviously, the weather changes. So we don't have sort of issues of ice in the chip lines and some of the things that lose your productivity. Gas is still relatively high. We have a little bit of an offset there because, of course, we're selling some gas. But that's tailed higher even now than usual. So that might be a bit of an offset. But I think that's a reasonable work of thumb. You do have to remember, of course, you've got the extra maintenance in quarter 2 as a potential offset as well. But we think that's going -- we think that 2/3 of that 22 will come by. Does that help?

[John P. Babcock:]

Okay. Yes, perfect. And then another question with regards to Personal Care and some of the machines that you guys are putting towards year end, how many machines, assuming you're willing to share this, how many will you have by year end?

[John D. Williams:]

If you don't mind, we're not willing to share that just for competitive reasons, I'm sorry. But let me just explain -- you've asked the question, you deserve an answer. Let me explain what we're trying to do. When we bought the business, there were a number of places where they didn't really have the product offering they needed across a range, and obviously, retailers and institutional buyers are buying a range of products, and they want to be able to buy that whole range from you and be secure that your product is appropriate across the range. That was not actually the case with the product that we were offering, actually both in Europe and the U.S. So we're investing in both the geographies to give us a kind of global product platform across all the key products in AI. And just to be clear, also, a lot of it is not that we must have new business. Quite a lot of it is actually saving several dollars per case based on the new technology. So I just wanted to give you that color so that you kind of understood. So it's not about having the chase of massive sales line, some of it -- quite a lot of it is actually about cost savings. Does that help?

[John P. Babcock:]

Yes, that's perfect. Then one last question for you with regards to the erosion of baby diapers sales, and I think you mentioned, you lost 2 customers there. What do you guys seeing as far as a competitive environment in that space?

[John D. Williams:]

Well, I think the competitors welcomed us to the market, if you understand why I'm talking about that. So we -- in the midst of the transition, the business was for sale. Did they slightly take their eye off the ball on the sales and marketing front? Maybe they did, maybe they didn't. Actually one customer we lost and we had one customer slightly reduced their sales with us. So we're still a key supplier. But they sort of took some of the sales away. I think what we're learning is that the way you have to engage with these customers is really get involved in category management, really get involved in consumer insight with them. I think, we were a bit transactional. The historical business was a bit transactional, it kind of filled out the request for quote, but didn't really engage in the interim. And as we're learning that lesson, given the buying cycle on private label, which is a year to 2 years when you give another chance, I think what is quite interesting is that since we've been telling our new story, one of those customers actually has come back to us and said, "come and talk to us again." So I see this as a temporary issue because we have the opportunities for that business again the next time if we engage properly and sort of make sure we're in a better position. Does that help?

[Operator:]

Our next question comes from Alex Ovshey with Goldman Sachs.

[Alex Ovshey:]

A couple of questions. I wanted to come back to the paper pricing discussion. So just on the first one, John, you basically said that the run rate was $31 sort of exiting the first quarter. And I think you mentioned that $35 to $36 was what you were hoping to realize on that first one. So is there a little bit more sort of to go from that $31 to $35 to $36?

[John D. Williams:]

I think, Alex, you could assume that we've got all we're going to get on the first price increase and now we're really engaged in the second.

[Alex Ovshey:]

Okay. That's helpful, John. So on the second, you said with -- on the first one, 60% of the volume was impacted. Is that essentially 100% of the volume impacted with the second price increase?

[John D. Williams:]

Probably around sort of -- I mean, there will be some that isn't -- yes, some of the filler grades may be that we wouldn't actually put a pricing. I think it's probably 90%, something like that, 80% to 90%.

[Alex Ovshey:]

90%. And then the magnitude of the second increase relative to the first, is it pretty similar? Or is it a little bit more meaningful? .

[John D. Williams:]

It's very -- it's slightly more. I think I forget the number, and Dick would know the details. Dick?

[Richard L. Thomas:]

Between $50 and $70.

[John D. Williams:]

$50 and $70, depending on the grade.

[Alex Ovshey:]

Okay. I appreciate that detail. And then just on the volume trends, can you talk about how your April volume trends in paper are shaping up? I know it's pretty difficult first quarter for the industry. Your volumes were clearly better. But any color you can give us on how April is shaping up for you?

[John D. Williams:]

I guess, it's sort of pretty much to our expectations. We have a soft week and a strong week, but it's pretty much where we thought it was going to be. Okay?

[Alex Ovshey:]

You think the industry can get back to that more normal secular 2% to 4% decline, or are we sort of still in that 5% to 7% range right now?

[John D. Williams:]

I mean, we're not seeing anything. That says that the overall decline is going to be way more than previous. I think, to be honest, the first quarter was so noisy. It's very difficult to extrapolate that out. But we're still operating under the assumption that sort of if you like that standard level of decline that we've always talked about would still hold. And it's-- there's no sign in April that that's incorrect, but we shall see.

[Operator:]

Our next question comes from Chip Dillon with Vertical Research Partners.

[Chip A. Dillon:]

On the diaper front, I'm assuming the loss volumes were in the -- were in North America. And just to be clear, there's really only one major competitor in the private label realm that you deal with, or that you compete against, is that fair?

[John D. Williams:]

Not quite. There are a couple. There's one major one, but there are a couple of others. And -- I mean, let's be very clear, it's baby diaper, it is not adult diaper. So this was a baby diaper issue specific, if you like to that business, Chip. But yes, you'll have one major competitor, but there are 1 or 2 others. And in some retailers, 1 or 2 of the branded guys actually do do some private label.

[Chip A. Dillon:]

Got you. And then on the -- and that's in baby diapers. Got you. Okay. And then on the pulp front, is this to see the shipments were barely above what the first quarter of '09 was? And I know you remember well as I do those wonderful days of early 2009. But as we look at the second quarter, I mean, it looks like, I mean, at least versus our thoughts, that you missed the number by -- or the shipments from maybe magnitude 40,000, 50,000 tons away [ph]. Could we see that come back that big in the second quarter?

[John D. Williams:]

Don't forget we took the AI line out of Kamloops, which is probably 10,000 to 12,000 a month effect on pulp. So you have to sort of take that out. Obviously, we're working, Chip, to sort of get that back through productivity, but it's not there yet. We have 15-odd-million -- excuse -- 15,000 tons that is -- we just couldn't get to pull because of the Vancouver trucker strike. So 15, 25, the general noise. So you might say well, there's sort of 20,000 where we missed the opportunity, but it's not much more than that. And obviously, our pulp productivity, interestingly, March and April has been pretty strong. So I think we're going to see that come back over time. But I wouldn't say it's as simple as -- maybe it's a 20,000 effect from quarter 1 to quarter 2, but it's not 50,000 because of what I've just explained.

[Daniel Buron:]

Quarter 4 was actually a high shipment quarter, so you should expect that. I mean, there's maintenance and there's other reason why there's volatility or seasonality in the pulp business. So you should expect 350,000 to 360,000 tons per quarter. So a little bit of inventory build in Q1, a little bit of production issue. We should come back to normal in the coming quarters.

[John D. Williams:]

Does that help, Chip?

[Alex Ovshey:]

Yes, very much. And then really quickly, it's interesting how if we take the PPC data, what they call demand, and I'm not sure what that demand is. But it's -- it was only down like 1.7% in March and 2.9% in the first quarter. And yet what the North American mills were shipping was a lot less than that, and obviously, imports were filling the void. And I didn't know if you had some thoughts on that, whether it's -- whether these imports are permanent or maybe there were some customers drawing excess inventories from overseas because it looks like things are kind of firming up now. And that maybe this was -- that this big swing will continue. I didn't know if you had any thoughts on that?

[John D. Williams:]

I mean, it's an interesting question. I mean, obviously, we've seen an increase over the last 12 months. We believe pretty strongly that sort of offshore producers use imports just to balance their supply with demand in their domestic market. So it's sort of a short-term solution for most of them. And if you look at who ships at what particular time, it kind of swings around between countries and currency, et cetera. I mean, I do actually think that the length of the supply chain is a challenge for some of them, because who can really forecast demand? So if you think what's happening at the back end of their businesses on pulp, their costs are actually increasing as we speak. So I think what we have to do as a domestic competitor, we have to leverage our supply chain and our customer insights and our ability to supply to make certain that we compete as effectively as we can. But -- I mean, there's no doubt. If you look at it right now, it's growing slightly. I'm not sure that's permanent. But certainly, if you look at that trend, it still sits there. So we just have to keep competing. I mean -- I think that's our job.

[Chip A. Dillon:]

And one quick last one. Are you still committed to returning half of the free cash flow or more through dividends and buyback this year? Or have some of the strategic moves you've made change that?

[John D. Williams:]

Well, I mean, if you look at what we've done since we made the commitment, we've returned about 80% of our free cash. And so there's no doubt. If you look our last stock buyback, we haven't done any for a while. But, I mean, certainly, it's been a long-term commitment, it's not really driven quarter-to-quarter. And we repurchased about 11 million shares, average price of $78. So we still remain very committed to a balanced approach to capital allocation and capital return policies that provide the best return. So I hope that answers the question.

[Operator:]

Our next question comes from Al Kabili with Macquarie.

[Daniel Moran:]

This is Danny Moran, on for Al. Just given where quarter 3 ship prices are, do you view coated producers as a threat to your Paper business at all?

[John D. Williams:]

Well, I mean, it depends if they sort of take the coders off and choose to launch product. I mean, quite frankly, it looks like it should've been a slamdunk. But it hasn't been, because I think customers want to make sure that these guys are in there for the long haul and they're going to be there for a good time if they try and develop business with them. So -- I mean, we're always aware of that competitive advantage. But excuse me, if that sort of competitive approach. But no, I wouldn't say it's a huge worry for us.

[Daniel Moran:]

Okay. That's helpful. And then it looks like most of the year-over-year earnings improvement in Personal Care has been primarily acquisitions. When do you expect the organic ramp up in earnings?

[John D. Williams:]

Yes. We expect that end of third, beginning of fourth quarter this year as this machinery comes on stream. So some of that machinery, we're trialing right now, but, of course, it takes a while to make certain that we have the whole range in place. So that's when we see it coming through.

[Daniel Moran:]

Okay, great. And then just one last one and a follow up on the capital allocation. With the share price up here, how are you thinking about share back -- or share buybacks versus dividends?

[John D. Williams:]

Well, now is the time of year actually we sort of engage with our board to have that conversation. So as I said in my prepared remarks, typically we're going to talk about that around the annual general meeting next week. So that's when we'd be ready to discuss that. If that helps?

[Operator:]

Our next question comes from Sean Steuart with TD Securities.

[Sean Steuart:]

A couple of questions. First, for Daniel, I guess. The $14 million sequential increase in SG&A this quarter, just trying to gauge how much of that might have been nonrecurring. And I guess, I'm thinking about M&A expense tied to the Indas acquisition and mark-to-market on the stock comp. Is $100 million more of the quarterly run rate we should be thinking about?

[Daniel Buron:]

I think the, first of all, the M&A is something that may be or may not if we have something on the table. So this quarter, there was $5 million of M&A. Actually you see that in the corporate segment, if you look at the segmented results. And that's all that is in the corporate line. So you can remove that assuming that it's not recurring. And then after that mark-to-market, it all depends on the stock price. It's a difficult one to forecast. But there was probably a $2 million to $3 million in the quarter that was due to the ramp up of the stock between the end of Q4 and the end of Q1. As I would say that, if you do that subtraction, $104 million, $105 million is probably a good run rate for the coming quarters, including the addition of Indas.

[Sean Steuart:]

Okay. The $30 million hike in your 2014 CapEx range, is that all going to Personal Care?

[Daniel Buron:]

It's largely linked to the addition of Indas actually. They have a plan. They have a new machine also that was actually part of the acquisition. It was approved before we bought the business. So yes, it's mostly linked to Personal Care.

[Sean Steuart:]

Okay. And then lastly, maybe if you can just remind us, and I'm not sure you'll disclose this are not. But Staples, how big -- how much are they of your I guess, your year-end market sales for freesheet?

[John D. Williams:]

Yes, I mean, obviously, Sean, that's not something we disclose. They are our major customer. Patently, that’s an industry where there's some consolidation going on. They are a key customer to us and remain a key customer, very solid volumes.

[Operator:]

Our next question comes from Steve Chercover with D.A. Davidson?

[Steven Chercover:]

Some of my questions have been partially addressed, and I appreciate the color you gave us on the product line. I'm just also wondering about imports because it would be terrific if the environmental footprint was a key determinant in consumer behavior. But I always thought it was the proximity of sheeters that were kind of the barrier to entry. So is that still in your view, I guess, the key determinant on how you get into the big boxes?

[John D. Williams:]

I'll hand that over to Dick. Dick, do you want to just talk to that one.

[Richard L. Thomas:]

Yes, Steve, I think you're right and John actually alluded to the supply chain. It's pretty easy to throw some tons in some of these channels and others is much more difficult. And so what we've tried to articulate and kind of prove on a everyday execution basis to our largest customers as we can help them manage their business with more efficient inventory and delivery. So I think, you're right on target. And I think right now, some of what you're seeing is people kind of trying it out and seeing how it goes, and we're pretty confident that our supply chain is far superior.

[Steven Chercover:]

So the product that would be coming in, I guess, was ordered substantially to fight the price hike, that's coming in the sheet form to the best of your knowledge?

[Richard L. Thomas:]

Yes. Yes.

[Steven Chercover:]

And that's presumably less efficient than sending rolls from a volume standpoint?

[Richard L. Thomas:]

You would have to have access to unused converting capacity in the whole market. In other words, here. So there isn't a lot of independently owned sheeters in North America. There's really only a couple.

[Steven Chercover:]

Okay. Do you have any sense in terms of the actual product quality? Is it fundable with yours for runability, for instance, through a photocopier?

[John D. Williams:]

I think, I would say here's a good place to draw a contrast to what happened with coated papers a number of years ago, where the product that was coming in was superior. And honestly, it had higher gloss and higher stiffness, and in some cases, higher printability. We don't see any of that with the uncoated coming in now. Some of it is remarkably lower quality than ours. Some of it admittedly is just as runnable as ours. But it's a bit all over the map.

[Operator:]

Our next question comes from Paul Quinn with RBC Capital Markets.

[Paul C. Quinn:]

I almost ran out of questions here. Just want an overall, just what your impression is or what you're feeling about your balance sheet, your free cash flow production going forward? And how that M&A pipeline is looking like in Personal Care? If you can just talk and [indiscernible].

[John D. Williams:]

Yes. As you saw, I mean, a strong cash flow quarter actually. I mean, something we're pretty proud of and certainly, I mean, we see that going forward. And if you look at the M&A pipeline, there's some things out there that we feel may be attractive. I mean, to be honest, one of the issues with the M&A pipeline, at 9

[Paul C. Quinn:]

Yes, that's helpful. And then just a question on just the environmental stewardship and footprint. You guys have got a pretty good track record. You think that wins out in the end of the day in terms of paper customers you have North America?

[John D. Williams:]

It certainly is compelling. I think it's a reason to buy certain grades, particularly the FSC grades, where that is very much marketed by a number of our customers. I think the real issue is going to be the consumer. So there's a channel discussion between us and our customer, and then of course, there's a consumer discussion between the consumer and, if you like, our customers. I think it matters quite a lot to a number of consumers. And if they feel that they're not able to buy appropriately, they can cut out rough. I mean, they can either cut out rough as individuals, or they can cut out rough through NGOs. And we've seen that -- as you know, we've seen that happen in this marketplace before.

[Operator:]

Our next question comes from Robert Howard with Prospector Partners.

[Robert Howard:]

Just continuing on that cash flow issue, it looks like this is your best free cash flow in the first quarter since 2011. Is that sort of a -- I guess, is there anything to kind relate that to sort of if I kind of look at the way cash flows continue on in the year off the first quarter is -- would that relationship sort of continue? Or maybe the things get shifted into Q1 that might have made that strong appearance look a little better than I should be thinking sort on a steady-state rate.

[Daniel Buron:]

Yes. I think there's one nonrecurring item in Q1 that I've explained in my prepared remarks. That's the repayment of some past due receivable in our Spanish business. That was a government-based payment plan that actually was in place when we bought the business, and payment was received actually in Q1. So that's more or less $34 million, or EUR 25 million. Apart from that, I would say Q4 this year was a little bit special. Normally, you have a lot of cash flows in Q4 and you have to rebuild a little bit of working capital in Q1. There was kind of a shift a little bit this year. So that explains also the increase as we've seen in Q1. So I would believe that the cash flow will return to normal in the quarters to come.

[Robert Howard:]

And if you were to adjust the cash flow, I mean, there would kind of be the reason to believe that this Q1 would have even been a little better if we hadn't had those weather-related items?

[Daniel Buron:]

Absolutely, because we're rebuilding inventory here and there that we were not able to do during the quarter.

[Robert Howard:]

And speaking of the weather, were there any kind of lessons learned from the experience that maybe you kind of tweak the way you do some operations to be better able to handle kind of those extremes in the future?

[Daniel Buron:]

The only thing we could have done is -- and I don't think that's why the working capital and cash flow side, would be to have a little bit more fiber closer to the mill because one of the issues we faced is we're running tight on working capital. So if you have many days where it's difficult to receive, would you may end up forcing yourself to slow down some machines. So we had to do that. It was really extreme weather. So I don't think there's a lot -- I mean, I don't think it warrants us building inventory -- wood inventory. And the lion's share of that was actually natural gas related, so transportation plus the BTU were a lot more expensive in Q1. And then there's nothing you can do actually because those lines are plugged to our system and we just buy as we consume.

[Operator:]

Our next question comes from Stephen Atkinson with Dundee Capital Markets.

[Stephen Atkinson:]

A couple of quick questions. Can you update me on the Espanola conversion to softwood?

[John D. Williams:]

Yes, certainly. So we've run some trials and we're moving forward. So we'll be, I think, ready to go if you like, Stephen, by quarter 3.

[Stephen Atkinson:]

Okay. And I guess there'd be a gradual ramp up or ...

[John D. Williams:]

Yes, indeed.

[Stephen Atkinson:]

Okay. And in terms of the Indas acquisition, are you happy or were you sort of -- when you brought it, I guess, there was sort of product development and optimization and so on. Are you running the way you want right now? Or is there still some transition?

[John D. Williams:]

Actually we're right where we wanted to be and where we're expected to be. So it's early days, 3 months in, we're very happy. And there's an investment curve there, which we knew about, which is where you see that CapEx has moved slightly. That's mostly focused around Indas. Very strong management, great management, know their market backwards, forwards and sideways. And now, really putting that together with the rest of our European business so we can sort of really build a strong presence in some of the geographies where we weren't quite so visible. I think it's just good news. So very, very happy with it at this moment in time.

[Stephen Atkinson:]

Great. So are you able to tell me what kind of machine is being installed or give me any color on that?

[John D. Williams:]

If you don't mind, for competitive reasons, Stephen, we won't do that. But again, it's a classic to build out the range, essentially make sure we've got appropriate products going forward.

[Stephen Atkinson:]

And so in terms of product development, are you able to tell us which products or is it right across the piece?

[John D. Williams:]

It's across the piece. Let me explain. Maybe it would be helpful to give you a little bit of color of why we think we have a competitive advantage here over time. Obviously, owning Plymouth is helpful because we get insight into, if you like, the chemistry of fluff pulp. We also own the EAM business, which gives us insight and real unique capabilities in terms of absorbing core technology and building absorbent cores. And of course, we have actually recruited some very strong R&D people from really blue-chip, FMCG background. So if you put all that together and you say, okay, well, we're way to use those insights to compete in the market and build products from those insights, that's kind of the engine of R&D. So even though we're a relatively small player in this marketplace, we think we can leverage some of those insights to really compete highly effectively with the major players. And in the end, over time, that's the sort of key engine in this business where we think we can generate competitive advantage rather than just kind of buying stuff and hoping for the best. Does that make sense?

[Stephen Atkinson:]

Yes. No, no. You wouldn't do it otherwise. But -- so then finally, in terms of Waco or...

[John D. Williams:]

Delaware.

[Stephen Atkinson:]

Delaware, thank you. Would you be able to make some of your products there, just maybe freight and so on?

[John D. Williams:]

Absolutely. So one of things to think about, which we're looking at very carefully, is moving production lines across that geography. One, to save freight. Two, though I think to say to our major customers, rather than being a one facility business, we have 2 facilities, so they're going to feel more secure giving us large pieces of business.

[Operator:]

[Operator Instructions] Our next question comes from George Staphos with Bank of America.

[George L. Staphos:]

I just have one more follow-up question for you. And maybe you touched upon this earlier, but with regards to the nice positive and receivables in the quarter, what exactly drove that?

[Daniel Buron:]

I would -- I don't if you recall that, when we bought the acquisition of Indas, there was abnormally high accounts receivable and that was due to a past due receivable in the reimbursed system in Spain, and there was a payment plan in Europe, in Spain. Actually there was 2 concurring events that happened in Spain. They first had a payment plan to bring back those receivables to more normal, closer to terms. And they also had a law that is in construction that will force a customer to actually buy within terms. So the big plus in the working capital is actually that payment plan, so we received the full payment of those past due receivables of Q1.

[Operator:]

Our next question comes from Alex Ovshey with Goldman Sachs.

[Alex Ovshey:]

Just a few follow up for you guys. On pulp, it seems like there's been some pulp price erosion in China on the softwood side. Do you have any visibility on sort of the supply demand fundamentals in China and what we could expect over the next couple of months there on the softwood side?

[John D. Williams:]

Yes, I mean, that's the sort of well hunger question. I mean, when you look at the kind of inventory the tissue manufacturers in China are prepared to hold, it's enormous. I mean, they're -- as far as they're concerned, the unforgivable sin, quite rightly is to run out. So they really do have a lot of inventory. But they always have a lot of inventory. We think that little price blip is actually temporary and in fact, that the softwood price in China will come back. And if you look at number of tissue machines going into China and sort of the overall growth in that market and absorbent products, we're pretty bullish, actually. The top line is going to be pretty solid for a good long while. And one should remind oneself there is actually some pricing momentum in fluff pulp. Of our pulp business, 25% or more is actually fluff. So I think you have to think about our specific grade to think about the price dynamic. If that helps?

[Alex Ovshey:]

That's very helpful, John. I just had a follow up on that. I think specifically in China, as well as on the other parts of the world, but particularly in China, the spread between softwood and hardwood has been wide for a considerable amount of time now. Have you seen any tangible evidence of your customers basically shifting out of softwood into hardwood?

[John D. Williams:]

No. No.

[Alex Ovshey:]

Given that.

[John D. Williams:]

No, we haven't. I mean, they need that softwood to get what they need in the tissue grades. If you think about fluff, specifically, they would need to reengineer a lot of product to get fluff out. They have to engineer along the kind of Procter & Gamble baby diaper dry max approach, right? So my view to all that would be that I see pretty good runway here. And that's sort of softwood hardwood mix, you would've imagined most of the substitution that people are going to do technically, they're probably done.

[Operator:]

[Operator Instructions] And there are no further questions at this time. Please continue.

[Nicholas Estrela:]

All right. Thank you, Tracy. So just as a reminder, we will hold our 2014 annual meeting of stockholders on Wednesday, April 30, 2014, at 9

[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.