KP Tissue Inc.

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

I'm the Director of Investor Relations at KP Tissue Inc. The purpose of the conference call is to review the financial results for the first quarter of 2022 for Kruger Products, which I'll refer to as KPLP going forward.

With me this morning is Dino Bianco, the Chief Executive Officer of KP Tissue and Kruger Products L.P.; and Mark Holbrook, the Chief Financial Officer of KP Tissue and Kruger Products L.P. The following discussions and responses to questions contain forward-looking statement 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 all figures expressed today in the call are in Canadian dollars, unless otherwise stated. The press release reporting our Q1 2022 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 the website and will also be available on SEDAR. Finally, I'd like to ask that during the call, you refer to our presentation we prepared to accompany these discussions, which is also available on the website.

We'd also appreciate that during the Q&A period, that you limit your questions to two. Thank you for your collaboration, ladies and gentlemen.

I will now turn the call over to Dino Bianco, our CEO. Dino?

Thank you, Mike. Good morning, everyone, and thank you for joining us for our first quarter earnings call.

We continue to deliver strong sales growth in the first quarter of 2022, driven by ongoing market recovery, new Sherbrooke capacity and price increases affecting all our businesses and regions. Robust top line growth was tempered by escalating inflation across many parts of our business, which significantly impacted adjusted EBITDA in the first quarter.

To counter inflationary pressure, we have adopted a multifaceted strategy, which I will outline a little later in my prepared remarks. Now let's take a look at our financial performance on Slide 5.

Revenue growth of 28.5% in the first quarter of 2022, mainly reflects the Q3 2021 selling price increase in Consumer Canada and pricing in Consumer U.S. and AFH, along with higher sales volume in the Consumer segment compared to a relatively soft quarter in 2021.

The AFH segment also benefited from higher sales volume in the first quarter of 2022 versus Q1 2021 as the business continues to recover from the impact of COVID-19. From a geographic perspective, revenue in Canada increased 24.8% year-over-year, while the U.S.

surged 34.6%. In terms of profitability, adjusted EBITDA decreased to $29.1 million in the first quarter of 2022, mainly due to unfavorable effect of sales mix and overhead absorption, higher fiber prices and other inflationary pressure along with some operational issues in our Memphis facility.

These factors were partially offset by the higher sales volume and the selling price increases. Pulp and BEK average prices in Canadian dollars continue to increase.

I will go off script here to say, you can look at the chart, we are in uncharted territory as we look at pulp pricing and the impact that has had both on BEK and NBSK. Pulp or fiber as a whole is not the only cost item being impacted by inflationary pressure, as shown on Slide 7.

Freight and natural gas prices soared more than 35% and 50%, respectively in the first quarter of '22 compared to the same period in '21. Packaging costs newer increased more than 15% year-over-year, while labor costs climbed roughly 5% in the first quarter.

To counter such inflationary pressure, we’ve adopted a multifaceted strategy, including additional price increases across all our segments, SG&A cuts, incremental productivity programs, reductions in working capital and deferring discretionary capital spending. We believe that price increases, combined with cost-saving initiatives should begin mitigating inflation in the second half of the year.

Moving on to our network modernization slides on Page 8 and 9. TAD Sherbrooke continues to exceed ramp up expectations.

In terms of our Sherbrooke expansion project, we now anticipate that the bathroom tissue line will start up in Q1 2023, while other assets are on track for later in 2023 and 2024. Turning to our network in Memphis.

Sell-in has been very strong for our new facial tissue line, but the start-up has been pushed out to the third quarter due to global supply chain issues affecting our ability to secure equipment. We have committed more than US$20 million to this new facial line, which will provide future growth opportunities in the U.S.

market. In terms of our Memphis operations, we anticipate labor challenges will continue affecting productivity in the first half of 2022.

Staff availability is improving, but it takes time to train new employees on this equipment. We have also endured some equipment challenges, which has delayed our turnaround.

In response, we're increasing maintenance spend on our assets, ramping up employee training and leveraging more resources from our other facilities. And as demand remains strong, we are utilizing our other plants within our network to offset any production shortfall.

In light of price increases in the marketplace, we believe it's vital to continue supporting our brands through targeted innovation and marketing. Accordingly, we are seeing strong distribution across our customer base for newly launched Bonterra, our sustainable product family.

Speed to shelf has been very quick for this new brand. Our recently upgraded Purex and Cashmere UltraLuxe TAD products are also tracking well against expectations, while second year SpongeTowels UltraPro continues to drive share with consumers.

More recently, we expanded the distribution and support of our newly relaunched White Cloud portfolio in the U.S. And finally, on the heels of more than 80% growth for our e-commerce channels in 2021, our internal estimates indicate that we continue to increase share in this channel, reflecting a two-point share increase in e-com.

The data presented on Slide 11 is from Nielsen. It shows solid market share performance over a 52-week period ending on March 23, 2022.

Amidst the market recovery, we continue expanding in the facial tissue and paper towel categories, with shares of 36.2% and 24.1%, respectively. As for bathroom tissue, we’ve maintained our share above 34% as we had some competitor recapture post-COVID.

On Slide 12, the Away-From-Home market in Canada continued to pick up in Q1 2022, while the U.S. market has fully recovered from the COVID-19 pandemic.

We estimate volume was approximately 30% better in the first quarter of 2022 than Q1 2021 levels. Rising inflation for raw materials, transportation and labor negatively affected AFH profitability in Q1 2022 as price increases lag cost inflation.

Further price increases in AFH became effective in May, allowing us to create a better EBITDA profile for this segment in the second half of the year. With that, I will now turn the call over to Mark.

Thank you, Dino, and good morning, everyone. Please turn to Slide 13 for a summary of our financial performance in Q1 2022.

Revenue increased 28.5% to $398.7 million in the first quarter of 2022 and from $310.4 million in the first quarter of 2021. On a sequential basis, revenue was down 6% from $424.1 million.

Adjusted EBITDA was $29.1 million in Q1 2022, lower by $8.4 million from $37.5 million in the same period last year and down $9.2 million sequentially from $38.3 million in Q4 2021. From a margin perspective, adjusted EBITDA amounted to 7.3% in Q1 2022 compared to 12.1% in Q1 last year and 9% in Q4 2021.

In the first quarter of 2022, net income totaled $1.4 million compared to $6.8 million for the same period last year. The $5.4 million decrease was primarily due to lower adjusted EBITDA, higher interest expense and other finance costs and higher depreciation and amortization partly offset by higher income tax recovery and higher other income.

In the quarterly segmented view on Slide 14, consumer revenue increased 26.3% year-over-year, but decreased 5.8% sequentially to $342.8 million in the first quarter of 2022. In the Away-From-Home segment, revenue grew 43.3% year-over-year, while posting a 7% sequential decrease to $55.9 million.

Consumer adjusted EBITDA amounted to $35.4 million in the first quarter of 2022 compared to $44.1 million in Q1 2021, while adjusted EBITDA margin was 10.3% and 16.2% for the same period respectively. Sequentially, consumer adjusted EBITDA was down by $8.3 million, while the margin reduction was limited to 1.7 margin points.

For the AFH segment, adjusted EBITDA amounted to minus $3.2 million in the first quarter of 2022 compared to minus $4.8 million in the first quarter of 2021 and minus $1.7 million in Q4 2021. Corporate and other costs were minus $3.1 million in Q1 2022 compared to minus $1.8 million for the same period last year and minus $3.7 million for Q4 2021.

On Slide 15, we review the year-over-year revenue growth for Q1 2022, which amounted to $88.3 million or 28.5%. This increase can be attributed to selling price increases in all segments and regions, higher consumer sales volume as well as an increase in Away-From-Home sales volume.

On a geographical basis, revenues in Canada improved $48.3 million or 24.8% year-over-year, while U.S. revenues grew by $40 million or 34.6%.

On Slide 16, we provide additional insight into our Q1 2022 adjusted EBITDA which decreased year-over-year by $8.4 million or 22.4% to $29.1 million. The adjusted EBITDA margin was 7.3% in Q1 2022 compared to 12.1% in Q1 2021.

The decrease in adjusted EBITDA dollars was primarily due to higher pulp prices and overall inflation which also resulted in higher freight rates, unfavorable impacts from overhead absorption and labor shortages at our Memphis manufacturing operations. These factors were partially offset by a higher sales volume and selling price increases.

Now let's turn to Slide 17, where we compare revenue in Q1 2022 to Q4 2022. Revenue decreased by $25.4 million or 6% sequentially.

This decline was mainly due to lower seasonal Q1 volume in both consumer and Away-From-Home segments. In terms of geography, revenue in Canada decreased by $2.3 million or 0.9% while revenue in the U.S.

declined by $23.1 million or 12.9%. On Slide 18, Q1 2022 adjusted EBITDA decreased sequentially by $9.2 million or 24.2% from Q4 of 2021.

This was due to the lower sales volume, higher pulp prices and inflation, increased freight costs, labor challenges in Memphis increased overhead absorption and a loss on foreign exchange which was partially offset by a reduction in advertising expenses as well as selling price increases in consumer U.S. and Away-From-Home.

The adjusted EBITDA margin was 7.3% in Q1 2022 compared to 9% in the previous quarter. Let's turn now to our balance sheet and financial position on Slide 19.

Our cash position stood at $113.7 million at the end of Q1 2022, a decrease from $151 million at the end of Q4 2021. The reduction in cash mainly reflects a $46.5 million increase in working capital during the quarter.

Overall, total debt at quarter end stood at $985.5 million, up $16.6 million from $968.9 million at the end of Q4. Variation is primarily attributable to the aforementioned increase in working capital.

Our net debt to last 12 months adjusted EBITDA leverage ratio increased to 6x in Q1 2022 from 5.3x in Q4 2021. Leverage increased due to the higher level of net debt from a lower cash position and lower last 12 months adjusted EBITDA.

At quarter end, total liquidity representing cash and cash equivalents and availability from revolving credit agreements stood at $206.9 million. In addition, $76.4 million of cash was held for the TAD Sherbrooke and Sherbrooke expansion projects.

I will conclude my section by reviewing CapEx on Slide 20. CapEx amounted to $16.3 million in Q1 2022, including $5.3 million for TAD Sherbrooke and $6 million for the Sherbrooke expansion project.

We now expect CapEx to range between $160 million and $180 million in 2022, including incremental investments announced for the Sherbrooke expansion project. These figures represent a $30 million reduction from our previous range, attributable to both deferrals and schedule revisions for certain capital investments.

Thank you for joining us this morning, and I'll now turn the call back over to Dino.

Thank you, Mark. On Slide 21, just a brief word about our ESG efforts.

Reimagine 2030 reflects our commitment to creating a sustainable environment, but we're also focused on social and governance issues. All three elements are [indiscernible] linked with our strategic plan to create long-term value for our shareholders, our stakeholders and our employees.

And we will continue to build our actions against this framework. I will conclude on Slide 22.

Our main goal is to grow the business for the long-term, while managing current inflationary pressure. In that context, we continue to deliver strong top line growth despite a challenging environment.

We expect our price increases and cost efficiencies to be offsetting inflation pressure in the second half of 2022. In terms of marketing, newly launched Bonterra and the UltraLuxe upgrade are tracking well above expectations.

We also expanded the distribution of a relaunched White Cloud portfolio in the U.S., and we are supporting these latest initiatives by investing in our brands and innovation to drive growth. For our network modernization, the TAD Sherbrooke facility continues to ramp up ahead of expectations, while the Memphis turnaround plan is expected to yield benefits in the second half of the year.

Our Away-From-Home segment is gradually recovering in Canada and will benefit from price increases in the second half of the year, while continuing to grow in the U.S. And finally, we continue to invest in our organization and culture to drive growth for the future.

Now turning our attention to the outlook for the second quarter of 2022. We anticipate continued sales momentum in Q2 2022 for both our Consumer and AFH segments.

However, ongoing and rapid cost inflation and supply chain issues are expected to negatively impact our profit. As a result, adjusted EBITDA for the second quarter of 2022 is expected to be well below the Q1 2022 level with pricing and cost savings initiatives, improving our overall outlook in the second half of the year.

We will now be happy to take your questions.

Hi. Good morning.

Good morning, Hamir.

Dino, did you speak to the timing of the various price initiatives that you have in the market across categories and geographies and any scale you could provide on those?

Yes. Hamir, it's a great question.

Obviously, with the level of inflation, I guess the speed, the breadth and the magnitude of the inflation, pricing is a necessary offset to that as well as the cost cuts that I talked about. We did do pricing last year in Canada, Consumer Canada, I mentioned that it was mid to high single digits.

That took effect last July. We did some contractual pricing in the U.S.

and AFH in the back half of last year. And then in this -- in 2022, we’ve recently announced a new price increase in Canada to catch up to all the additional inflation, high single-digit.

That will take effect beginning in July. U.S., we've announced a couple of price increases depending on the customer contracts that are probably in the mid to low single -- mid-single-digits, let's say, a couple of points behind the Canadian one, just different market dynamics there.

And then AFH has also announced two separate price increases this year in the mid to high single digits also affecting the back half. Most of those -- some will come in April, a little more in May and then really July is when they start to hit just given the structural way that pricing flows through the North American market for our business.

Okay, great. Thank you.

That's really helpful. And I just want to get your perspective on the U.S.

supply situation. It does seem like operating rates are probably suboptimal right now across a lot of the private label market.

Are you expecting more supply rationalization later this year? I know there's at least one mill [ph] that's for sale.

Yes. That's a great -- it's a great question.

I’ve read all the reports. And there's obviously at the macro level, there seems to be more capacity than demand.

I will tell you that's not the case for our business. Our business is very strong.

In fact, we are ramping everything up despite Memphis being behind our plan. We are ramping up to continue to satisfy the marketplace.

So it's hard for me to comment on long-term supply/demand. I think ultimately, will balance.

You've heard of one mill [ph] for sale. There's -- I think that may not just be a capacity issue, maybe just the cost structure issues, inflation, I think, affecting a lot of companies differently.

And so I think companies will have to make their own decision as it relates to either new capacity or existing capacity. In my mind, Hamir, I continue to see robust growth in this category continue to see it in Canada, in the U.S.

and in AFH. So all three segments that we play in.

I think the U.S. market-- recently, private label has been a little stronger.

So we are watching that. And of course, we participate in that growth.

In Canada, our brands continue to be strong in this marketplace. I think a testament to the investments we've made in our brands and the quality over the time.

So, I feel good about the demand curve. For me, it's the cost curve that’s been the biggest challenge.

And we are dealing with a lag. We will catch up what we are dealing with the lag right now which is affecting the first half of this year.

Okay. Fair enough.

And just last question I had is on the White Cloud relaunch. It looks like you're now in [indiscernible].

Is that the only major U.S. grocer customer at the moment?

And maybe if you could speak to the plans for distribution there.

Hamir, I wish I could talk a lot more about White Cloud. We are really proud of what we are doing, but I also recognize that our competition listens to these calls.

So I think I just want to say that it's a brand we believe in. We’ve restaged the brand.

We’ve upped the quality. We are investing to support it.

We think there's a sweet spot for that brand in parts of the U.S. market.

We have and are increasing distribution at some key accounts with that business. So just stay tuned and keep watching it.

Okay. Fair enough.

Thanks, Dino. That’s all I had.

I will turn it over.

Thank you.

Hi, good morning, everyone.

Good morning.

First question just back to -- good morning -- back to Hamir's question on price. Price you’ve [indiscernible].

I think I read in your disclosures that you expect those pricing initiatives to restore margins. If you could maybe speak to what level you expect those margins to be restored to and I appreciate you will be reluctant to give us an actual number, but maybe if you could just speak to it qualitatively, that would be helpful as well.

Kasia, you were cutting in and out. So I’m not sure I totally understood the question, but let me answer what I think you asked, which is how does pricing affect our margin structure and what are we looking at from a margin point of view?

I would say that, as I mentioned with the last question from Hamir, what you're seeing here over the last 12, 18 months is a rapid, broad and significant increase in inflation. And even though we, like many companies have tried to catch up to it either through pricing and/or cost cutting, you just can't catch up to that speed.

So you're seeing a lagged effect and that's affecting our margin structure of our products, but we are affecting pricing that will take -- we think inflation is peaking, although it's hard to predict anything in this day and age, but we think what we are seeing is a lot of the inflation is peaking pulp and fiber continue to be a bit of a wildcard, but we think things like freight and packaging are peaking energy. It's hard to tell [indiscernible], but that has less of an impact on our total business.

So we're watching them closely. We think we have price to restore our historical margins.

We are not really doing this to go beyond and above that. We don't think the market will allow us to.

We made some portfolio adjustments just for brands that were perhaps maybe not at the level we wanted to. So we made some tweaking along our portfolio, both in U.S.

and Canada around margin structure. But we expect after this pricing and assuming inflation is peaking and stabilizing that we should be in a position to restore margins.

Okay. Thanks for that, Dino.

Sorry about the [technical difficulty], but one more question maybe for Mark. I know CapEx has been lowered and you said that's both a deferral and just a reduction in planned spending.

Any additional context you can provide as to where those reductions are coming from which projects and I think the Sherbrooke expansion is still the $350 million that was originally guided to, right?

Yes. That's correct, Kasia.

So Sherbrooke expansion, we haven't really changed that at all. As you know, that project goes out through 2024.

So it's progressing well and on time, on budget. We are not changing anything there.

We are seeing some inflationary effect on that project, but we still feel it can be within the total bundle that we’ve set out for everyone. On the rest of our CapEx or our regular CapEx that we’ve decided to defer some of that CapEx going forward, and so that will be pushed into 2023, and that’s what you're seeing there.

So majority of that, we had a fairly substantial list of projects this year, and we are just pushing them out.

Okay, great. Thanks, Mark.

I appreciate the context. I will get back in the queue.

Thank you.

Good morning, everyone. It's actually Nathan calling in for Zach.

Good morning.

Good morning, Nathan.

So my first question is, with pulp soring off like a rocket, do you think it will remain elevated once freight [indiscernible]?

Well, I put my crystal ball away a few months ago, Nathan and I've given up trying to project these where these things are going. I mean people love smarter than me and closer to this market, they're having difficulty predicting it.

So our approach has been we need to be agile. We need to be flexible.

We need to be ready, both on the pricing front and the cost cutting front to be able to adapt as it moves. I believe it's peaking.

I believe you've got some supply -- you've got supply chain challenges happening. There is probably a knock-on effect of the war in Russia.

I believe you've got cost of production going up. And I believe you've got just the general inflation, fiber costs relative to what's going on in every other commodity in the marketplace.

Ultimately, supply and demand will determine the real -- where the real cost settles out. I know we've got some new capacity coming on board.

So that may be more of a bearish sign in the back half. But at this point, all I can tell you is, we are projecting it at fairly high levels, both NBSK and BEK and then the other one I didn't really talk about because it is a core ingredient for us is sorted office paper, also significant cost increases on that one even more on a magnitude basis than what we are seeing on pulp.

All right. Thanks.

And for -- in terms of this inflationary environment, are you concerned about customers swapping to private-label tissue?

Yes. I mean that's always a watch out for sure.

In the U.S., where we are more of a private-label supplier, I think that will benefit us, and we've seen a little more escalation there. The Canadian market is generally overdeveloped versus the U.S.

on private-label already. So we haven't seen a dramatic shift there.

Bathroom tissue, we did. But I think a lot of that was driven by just post-COVID recovery of some of those competitors, including private-label.

We watch it. We watch our price gaps.

We have a portfolio of products that span different quality series and different sizes. So we can manage our price points accordingly for consumers.

We got to make sure that our price gaps stay in line, and we got to make sure we continue to invest to support our brands. We are not taking an approach where we are going to be cutting our marketing spend significantly at a time, we are doing price increases.

We want to make sure we are continuing to invest in making our brands relevant. So, some will continue to watch very closely, particularly around the price gap moving and the promotional strategies that are going on in the marketplace.

And then, of course, you also got channel mixing, I think a lot of the retailers talk about this in terms of consumer growth moving to different channels, whether it be a discount or master club and just [indiscernible] relevant in those channels where the consumer is going.

All right. Thank you for the context.

I will turn it over.

Thank you, and thank you all for joining us on this call today. We look forward to speaking with you again following the release of our second quarter results.

Thank you. Have a great day.