KP Tissue Inc.

Mike Baldesarra - IR Mario Gosselin - CEO Mark Holbrook - CFO

Sean Steuart - TD Securities Paul Quinn - RBC Capital Markets Keith Howlett - Desjardins Securities Leon Aghazarian - National Bank Financial

Thank you, operator and good morning, ladies and gentlemen. My name is Mike Baldesarra.

I am the Director of Investor Relations at KP Tissue Inc. The purpose of the conference call is to review the financial results of the second quarter of 2017 for Kruger Products, which we'll refer to as KPLP going forward.

With me this morning is Mario Gosselin, the Chief Executive Officer of KP Tissue and Kruger Products LP; and Mark Holbrook, the Chief Financial Officer of KP Tissue and Kruger Products LP. Following a discussion, we'll respond to questions containing forward-looking statements concerning the company's activities.

Forward-looking statements involve known and unknown risks and uncertainties, which could cause the company's actual results to differ materially from those in the forward-looking statements. Investors are cautioned not to rely on these forward-looking statements.

The company does not undertake to update these forward-looking statements except if required by applicable laws. There is a page at the beginning of the written presentation, which contains the usual legal cautions including as to forward-looking information, which you should be aware of.

I'd like to point out that the figures expressed in today's call are in Canadian dollars unless otherwise stated. The press release reporting our Q2 2017 results were published this morning and will be accessible from our website at kptissueinc.com.

Please be aware that our MD&A will be posted on our website and will also be available on Cedar. Final I'd like to ask that during the call your refer to the presentation we've prepared to accompany these discussions, which is also available on our website.

We also appreciate that during the Q&A, the question-and-answer period, that you limit your questions to two. Thank you for your cooperation.

Ladies and gentlemen, I'll now turn the call over to Mario Gosselin our CEO. Mario?

Thank you, Mike and good morning, everyone and thanks once again for joining us on our conference call today. To begin let me provide you with key financial and operational highlights of our second quarter of 2017.

We'll now ask you to please refer to Slide Number 4 of the presentation that we have provided in support of this conference call. For the second quarter, I'm very pleased to report that our revenue reached $314 million, a 6.2% increase over 2016.

The increase was primarily driven by higher sales volume and favorable FX on our U.S. sales.

Revenue increase in both Canada and the U.S. Adjusted EBITDA continue to display growth with a 3.9% increase to $37.3 million.

This increase was primarily due to higher sales volume, cost reduction initiative and benefits from capital project, partially offset by higher pulp and commodity costs in Canadian dollars. TV product continue to meet our sales and profit goals, support by higher manufacturing efficiency and new customers.

As I mentioned last quarter, we now have TAD products fully integrated into our business and I am very proud of the result we have achieved so far. Also, away from home we had a solid performance with an increase in adjusted EBITDA of $0.5 million or plus 28% supported by the benefits of the new production line in Trenton.

Overall, net income was $9.9 million and Mark will provide further detail on this later on. I will now turn to Slide 5 and 6, which present the most recent dollar market share statistics from Nielsen for the 52 weeks period ended June 24, 2017.

Our industry-leading market share in bathroom tissue categories stood at 36.7% for the last 52 weeks period ending June 24, 2017 in line with the same period last year. As indicated in the past, bathroom tissue is by far the largest category and accounts for close to 60% of the overall tissue market.

In the facial tissue category, our market share was 31.8% in the latest 52 weeks, similar to the same period last year. We remain the uncontested market leader in this segment.

In the paper towel category, our market share slightly decreased to 23.5% from 23.7% and we continue to have a strong market position in that category. Overall, despite a very competitive environment, we continue to be that care industry leader with an overall market share of 33%.

Slide 7 of the presentation graphically represent pulp price in U.S. in Canadian dollars.

As you can see, the NBSK market price in Canadian dollars has moved up sharply since the end of 2016. When compared with last year, we characterize this price as been quickly rising also.

Pulp price in Canadian dollar are now at historical high. As a result, overall higher pulp price will have a further impact in 2017 results.

Based on industry information, we expect pulp price in U.S. dollar to remain in the same high range in the near term.

The volatile Canadian dollar will also create further fluctuation in pulp and input costs during 2017. I will now turn the call over to Mark who will review the quarterly financial in more detail.

Mark?

Thank you, Mario and good morning, ladies and gentlemen. I'll now ask you to refer to the chart on Slide 8, which summarizes our financial performance for the second quarter.

We continued to post another solid performance this quarter with a 6.3% increase in revenue and a 3.9% increase in adjusted EBITDA year-over-year. From a margin perspective, adjusted EBITDA was 11.9% down slightly from last year at 12.1%, but up sequentially compared to Q1 at 11.7%.

Our net income in the second quarter we recorded $9.9 million compared to $12 million last year. The decrease was primarily due to three factors; an increase in the change in the amortized cost of partnership units liability, an increase in tax expense and also higher depreciation expense.

These were partially offset by higher adjusted EBITDA. In the quarterly segmented view on Slide 9, consumer revenue increased 8.8% year-over-year to reach $252.2 million, while our away from home revenue increased 1.4% to $59.9 million.

Adjusted EBITDA increased by $1.2 million or 3.6% to $34.9 million for the consumer segment and by $0.5 million or 27.8% to $2.3 million for the AFH segment. Margins increased year-over-year in the AFH segment, while decreasing slightly in the consumer segment.

On Slide 10, we review Q2 2017 revenue over Q2 2016, which was up by 18.6% -- sorry, $18.6 million. This was driven by the consumer segment as a result of higher sales volume in both Canada and the U.S.

and favorable FX on U.S. sales.

Looking at this regionally, sales in the U.S. increased by $12.3 million or 12%.

In Canada sales increased by 7.5% or 4.2%. On Slide 11 we provide some insight into our Q2 2017 adjusted EBITDA, which increased by $1.4 million over last year to $37.3 million.

The increase was driven by the combination of higher sales volume in the consumer segment, improved contribution from AFH, cost reduction initiatives and the benefits of capital projects. These were somewhat offset by a net negative FX impact, higher commodity costs for pulp sorted office waste and natural gas as well as higher freight warehousing and SG&A cost.

Q2 2017 gross margin decreased from 15.5% to 15%, primarily due to the same offsetting cost factors. On Slide 12, we compare Q2 2017 and Q1 2017 revenue, which increased by $25.1 million or 8.7% mainly due to six more sales days in Q2 2017, generated higher consumer revenue and we also had the benefit seasonally higher sales volumes in the AFH segment.

By region, revenue in Canada increased by $13.9 million or 8%, while revenue in the U.S. increased by $10.3 million or 9.8%.

On Slide 13, we compare Q2 2017 and Q1 2017 adjusted EBITDA. Q2 adjusted EBITDA increased by $3.5 million sequentially, due primarily to the higher volume from six more sales days in Q2 along with lower advertising and promotion spending, partially offset by higher pulp prices and an increase in SG&A costs.

Gross margin in Q2 decreased from 15.6% to 15%. This impact was primarily driven by higher pulp prices.

Finally, I'll now ask you to refer to Slide 14, which sets out our balance sheet. Our cash position including bank indebtedness stood at $24.6 million as at the end of Q2 2017, down from $34.8 million at the end of Q1 2017.

Overall, net debt at the end of Q2 stood at $425.4 million up from $417.5 million at the end of Q1. The increase in net debt primarily reflects the increase in our CapEx program during Q2.

Our net debt to latest 12-month adjusted EBITDA ratio is at 2.7 times compared to 2.6 times at the end of Q1. Thank you for your attention.

And I'll now turn the call back over to Mario.

Thank you, Mark. Turning now to CapEx on Slide 15; Q2 2017 CapEx of $25.5 million was up slightly from $22.5 million in Q2 2016.

This year's spending is mostly due to PM8 project in Crabtree, which I will discuss further in the next slide. For fiscal 2017 our expected CapEx range remain between $75 million and $85 million.

We'll continue to focus on high return project from which we are starting to see positive contribution on our result. On Slide 16, we present our largest single capital expenditure project this year.

Our paper machine number eight in Crabtree. As we indicate in the past, this project is mostly dedicated to the away from home market.

Total CapEx for this project is estimated at $55 million with approximately $12 million of CapEx remaining at the end of Q2 2017. I'm pleased to see that the PMA project is on time and on budget.

The commissioning process for PM8 will commence in Q3 2017 and we expect to incur some start-up cost in that period. By the fourth quarter, we expect a neutral contribution and we continue to anticipate a positive contribution from this project in Q1 2018.

I will now direct your attention to Slide 17 and 18 where we provide you with a look at some of our principal initiative and objective for the remainder of 2017 and going forward. Our objectivity in Canadian consumer brand business is to continue to maintain our market-leading share.

To somewhat offset the continued rise of raw material price in Canadian dollar, we announced the price increase Canadian retailers in late July 2017, which will take effect in the fourth quarter. Should be noted that NBSK pulp market list price have risen since our IPO by more than 70% over the past five years in Canadian dollars with a significant increase in 2017.

Our cost-reduction program in capital project are delivering according to plan and are having a favorable impact on our cost of sales. In the U.S.

we're pursuing our white cloud customer diversification strategy and continue to expand our private label and TAD product offerings. In the away-from-home segment, new production line projects have already started to improve our manufacturing cost.

As discussed before the Crabtree paper machine will start commissioning in Q3 2017 and incur startup cost and will have a positive contribution in Q1 2018. In term of CapEx for fiscal 2017, we'll continue to aggressively invest in project that will improve profitability and manufacturing efficiency both in the consumers and away-from-home segments.

The benefit of adjusted EBITDA will start primarily in fiscal 2018. Finally adjusted EBITDA for Q3 2017 is expected to decrease over Q3 2016 due to higher pulp price, but increase sequentially over Q2 2017 due to seasonally higher promotional activities in Q3.

Thank you for your time and attention. At this point, Mark and I will be pleased to answer any question you may have.

Hi. Good morning.

Good morning, Samir.

Could you speak to maybe what the percentage price hike you're seeking in the Canadian retail market and have other producers joined yet in this initiative?

It's a tough question. First of all, we're not announcing the rate where to put price increase in the marketplace.

It's private information and regarding my computers I will assume that there has much affect as I am with pulp price which is at the peak. So anyway, while I'm leading -- I am putting the price increase because we really need it in the Canadian marketplace and I will assume that the other guy will do the same because everybody is suffering and for us it's just to offset cost that we're doing that.

Fair enough. And Mario, can you comment on TAD2 where things stand with the project in terms of site selection and potential timing?

Site selection is almost completing. We're discussing with different government persons starting financing.

So, I mean that we're starting discussion and we're progressing in the engineering side and we should be ready to announce something this year.

Thanks Mario. That's all I had.

I'll turn it over.

Thanks. Good morning.

Good morning, Sean.

A couple questions. The startup costs for Crabtree that you referenced for third quarter, can you quantify how much you're expecting there?

It's a couple of million maximum. It will not be huge, but it's still impacting the order, but the machine has -- I did not get into the detail in the presentation, but commissioning is pretty well advanced and we're starting to make papers.

So, we're in pretty good condition down there. Capital cost is right and we're right on our budget.

Timing is a bit before. So, we really happy with these projects and for sure that we've got a lot of focus on these projects.

So that's why TAD2 was a bit -- we slowed down a bit on that because we would like to complete these project in quick time. It's kind of a 12-month projection since the date we bought the machine and everything is under -- over our expectation from my point of view.

We're quite happy with the project so far.

Okay. And you didn't provide detail on the magnitude of the Canadian retail hike, but it starts in Q4 correct and can you give an idea of expected implementation timelines.

How long it will take to secure the full hike?

We announced in July and technically depending of the retailers, we can -- you can assume at least 12 to 16 months -- week's window before it will be implemented. So, in 2017, you will not have a big impact.

So, the impact will be in 2018. So, you will see some in the last month.

Okay. That's all I had.

Thanks very much.

Thanks Sean.

Yeah. Thanks very much.

Good morning. Question just on your away-from-home margins, they're significantly lower than what you're seeing in consumer product.

Just wondering where you think those margins will get to over time once you've got Crabtree fully out, so if we went out till 2019, are those margins close to consumer at the point?

Hi Paul, it's Mark. I would say that we'll be targeting high single digits in the first stage here before we get to the level that we had in our consumer business, but certainly much higher than where we're at today.

Okay. And then in terms of the price hike, I suspect that's only in Canadian product and this is only in the consumer segment or is it also on the away-from-home?

It's the one that I'm talking about July where in the consumers, but as you know, we've announced one in the away-from-home a month before.

Right. Okay.

All right. That's all I had.

Best of luck, thanks.

Thanks Paul.

Yes, I am wondering, is the commissioning cost included in adjusted EBITDA?

Yes, it would be Keith.

So, you don't adjust for it anyway?

Anything related to large projects startup costs would all go through our adjusted EBITDA yes. We don't adjust.

Okay. Thanks.

And just in terms of the Crabtree plant, what is the ramp-up curve, would you be fully ramped up in 12 months or is it 24 months or six months or…

It should be pretty quick to be honest because we know the technology pretty well. It's a bit in the conventional technology and we got very capable people in our Crabtree facilities.

So, I am expecting a pretty quick startup, but you never know, but so far, it's doing extremely well. And we know this technology and we have put the best modification in the paper machine to have a successful startup.

So, I'm not concerned at this stage of the startup and the ramp-up should be pretty quick.

And then just in terms of the TAD machine, I might conclude that you will no longer be disclosing the EBITDA number from the TAD machine?

Yes, as we reported last quarter we had already achieved the run rate target that we had set for the TAD project. So, while we're no longer being specific with the TAD performance numbers, I would say that TAD products continue to perform very well and it's a highly sought-after product in the market.

And we saw further improvement in Q2 versus Q1. So, we're right on our plan.

And then finally on the AFH business, do you notice the impact of the rainy weather in the material Québec in the Northeast on your AFH business or not really?

Well, it's not really significant for us for sure. We've got in the summer period, there is a kind of the winter has small impact, but so far, we didn't see any major impact in the restaurant and hotel and any major drop to be honest.

It's a quite -- our volume is quite stable.

Thank you.

Thanks Keith.

Hi. Good morning, guys.

Good morning, Leon.

My first question is just on FX, we're seeing obviously some fluctuations with the CAD versus USD. I realize it was a pretty big headwind in 2016.

Just want to get an update on the sensitivity for you guys as it relates to the FX?

Early on, yes about, it was about $600,000 for each cent movement, that would be a good benchmark on a consolidated basis for us as an effect on adjusted EBITDA.

But the problem now is it's only an inventory issue. We do not see any impact before two months, at least two months any positive impact.

Yeah there is always a two-month lag there, but certainly if it stays down where it is now, that would certainly be a benefit going forward.

Okay. Appreciate the color there.

And just one quick one for me on the CapEx, I realize obviously Crabtree is part of the main component of the CapEx spend for this year. Once that starts to tailing off, what kind of CapEx run rate would you be expecting going forward?

The regular CapEx we're still in our targeted $40 million for sure this machine will change a bit our capital behavior, but we're still targeting to have in the long-term excluding major project of $40 million which is $25 million from maintenance and $15 million for high return projects.

And those projects typically would have a three to four-year payback on the high return one and really to modify our converting line and to improve speed up machine, these kind of project, but it's always excluding project like a new paper machine.

Yes. So, excluding any type of large projects you expect to your CapEx run rate for example in 2018 to be in the $40 million range, is that fair to say?

Yes, that's right, yes.

Okay. Thank you very much.

Yes, I just wanted to clarify, on the sensitivity on the exchange rate, is that the dollar going from $0.75 to $0.76 or is it the other way?

Yes, we're unfavorable. So, our purchases are higher than our revenues in U.S.

dollars. So that would -- as the dollar comes down from say $1.27 to $1.26, that will be a benefit for us.

And similar to the other way, it would be a negative.

But the $600,000 is based on the $1.27 to $1.20 on that for each cent.

That's right. For each cent, yes.

On that basis, yes.

And then just had a question on capacity in the market, would you be interested in purchasing capacity from anybody who might be struggling in the market or do you prefer to build.

But our preference is to build, but we're always trading in the market, but in small volumes. So, we're not a big trader, but sometimes we're buying paper or we're selling paper just to be in balance, but our strategy is to be self-sufficient from a paper point of view.

And in terms of purchasing a company's plant and equipment, would you look at buying versus build or…

It's always something at all the potential opportunities, but right now, it doesn't have anything as serious in our radar, but when we got something up in the marketplace, we're always willing to look at opportunities to continue to grow in North America.

Okay. Thank you.

Thank you for joining us on this conference call this morning. We really look forward to speaking with you again in November 2017, following the release of our third quarter results.

Thank you very much everybody.

Thank you.