KP Tissue Inc.

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

I'm the Director of Investor Relations for KP Tissue, Inc. The purpose of this conference call is to review the financial results for the fourth quarter for 2022 for Kruger Products.

With me this morning Dino Bianco, Chief Executive Officer of KP Tissue and Kruger Products L.P.; and Mark Holbrook, the Chief Financial Officer of KP Tissue and Kruger Products. The following discussions and responses to questions contain 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 as required by applicable laws. There's a page of 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 in today's call are going to be in Canadian dollars, unless otherwise stated. The press release reporting our Q4 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 would ask that during the call you'd refer to the presentation we prepared to accompany these discussions, which is also available on our website.

We'd also appreciate during the Q&A period that you limit your questions to 2. Thank you for your collaboration.

Ladies and gentlemen. I'll now hand the call over to Dino Bianco, our CEO.

Thank you, Mike. Good morning, everyone, and thank you for joining us for our fourth quarter and full year 2022 earnings call.

We are highly encouraged by the ongoing recovery of our financial results in 2022, despite uncertain market conditions and persistent inflationary pressure. The actions we undertook earlier in the year on pricing, cost management, and our Memphis operations turnaround are driving improved financial performance.

We took these actions while continuing to invest in the business long term. Looking ahead to 2023, we intend to deliver continued top line growth and improved profitability, while keeping a close watch on input costs and a fluctuating Canadian dollar.

Now let's take a look at our quarterly numbers on Slide 5. Our revenue growth of 8% in the fourth quarter of 2022 can mainly be attributed to selling price increases across the board and a favorable foreign exchange impact on our U.S.

dollar sales. These factors were partially offset by lower sales volume in our Consumer segment as some shoppers traded down on purchases due to the higher market pricing.

Canadian revenues increased by 7% in the fourth quarter, while the U.S. improved by 9.5%.

Adjusted EBITDA was up 15.8% year over year to $44.4 million, primarily due to higher selling prices and lower SG&A expenses. These factors were partially offset by inflationary pressure on pulp, manufacturing costs and freight, lower sales volume, and unfavorable foreign exchange impact.

Now turning to full year financial results on Slide 6. Revenue of $1.7 billion improved 15% year over year, while adjusted EBITDA of $116 million was lower than 2021, driven by high inflation and our Memphis operational issues, partially offset by pricing, volume, and cost cutting.

I am also pleased with the performance of our AFH business, our Away-From-Home business, in 2022, which was driven by pricing, strong volume, and operational efficiencies. AFH revenue increased 40% year over year on the strength of pricing actions, a portfolio approach to targeting higher-margin segments, and aggressive expansion in the U.S.

As a result, a AFH adjusted EBITDA finished in positive territory at $7.4 million in 2022. Through these actions, our AFH business is moving to a sustainable profit model, and I'll speak more about that in a few pages.

On slide 7, pulp average prices in Canadian dollars increased 1% in the fourth quarter of '22 from the previous quarter, while year-over-year prices rose significantly. Both NBSK and BEK average prices climbed 26% and 37% in Q4 '22.

Based on industry forecasts for '23, pulp prices and the Canadian dollar will continue to remain volatile. As a result, pricing management and cost management will be critical in 2023 as well.

Turning to Slide 8. Our pulp or our fiber costs as a whole accelerated in the fourth quarter of '22, while growth for other input costs continued to grow but at a slower pace.

Fiber remained elevated with an 18% to 27% increase in U.S. dollars in the fourth quarter compared to the same period in 2021.

Freight and packaging costs rose 10% and 8% year over year, while natural gas prices were up 25%. Finally, our labor expenses increased approximately 4% in the fourth quarter.

All combined, we estimate that inflationary pressure raised our cost base by an additional $40 million in the fourth quarter and $180 million for the year. To counter this inflationary pressure, we implemented pricing actions and cost management initiatives in '22 that we previously communicated as shown on Slide 9.

Altogether the prices for our products increased on average by 14% in Q4 '22 compared to the same period last year. Moving on to our network modernization slide on Page 10.

Production capacity at TAD Sherbrooke continues to exceed ramp-up plans. We continue to invest and roll out our artificial intelligence with the implementation of Data Historian software and visualization tools at the site to maximize reliability and uptime.

Our digital twin tools have also been expanded to include our TAD paper machine. In terms of our Sherbrooke expansion project, we anticipate it will become a key long-term catalyst with two new lines starting up in 2023.

The bath line in Q1 and the facial line in Q4. Turning to Slide 11.

We enhanced operating efficiency at our Memphis plant in early January 2023 by permanently shutting down older assets, including a paper machine and 6 converting lines. Although this was a difficult decision, we closed these assets because we saw no clear path to profitability in this highly competitive segment.

I wish to thank the employees and leadership at Memphis for undertaking this difficult decision with professionalism and compassion. The impact on our U.S.

customers will be negligible as we refocus production capacity on our TAD and facial tissue products. Improved operating efficiency from this shutdown will lead to a more efficient and profitable Memphis plant that will become a very competitive operation for us long term.

Meanwhile, the facial tissue line rolled out last July continues to exceed expectation. New operators have been hired, the equipment is at base operating condition, and as a result, we anticipate continued growth from this asset which will allow us to grow our business in the facial category.

Now let's pivot to brand support on Slide 12. Despite high inflation, we continued to invest to support our brands.

We obtained strong results from our Kruger Shopper Big Assist program in the fourth quarter to drive in-store sales and mitigate price increases. If you recall, this marketing initiative was implemented with a Shopping Assist incentive to drive sales.

When consumers spent $25 on participating tissue products, they receive a $10 gift card. We also continued to develop awareness and trial building activities behind our new innovations.

Cashmere and Purex UltraLuxe, SpongeTowels Ultra Pro, Bonterra, and White Cloud brands. Given an inflationary environment, it's critical that we continue to support our brands.

Of note, our 19th Annual Cashmere Collection returned to a live audience with significantly increased participation. Clothing was fashioned entirely with our new and improved Cashmere UltraLuxe bathroom tissue.

That product is produced at our Sherbrooke facility. Moving to Slide 13.

The data presented is taken from Nielsen. It shows market share performance over a 52-week period ended December 31, '22.

The data reflects that branded share, particularly bathroom tissue and paper towels, have been affected by industry-wide price increases when sub consumers are trading down. This usually occurs during high inflationary periods and these shares tend to normalize once pricing stabilizes.

In the meantime, Kruger Products maintains a leadership position in the bathroom and facial tissue markets, and we are well entrenched in a number two position on paper towels. We will continue our efforts to support our brands and rebuild our share over time.

Looking at Away-From-Home on Slide 14. This segment delivered a third consecutive quarter of adjusted EBITDA growth in Q4 '22 based on increased sales volume and selling price increases.

Volume in Q4 was up 4% year over year as the market recovered in Canada and the U.S. AFH pricing actions have been implemented to offset costs, and as mentioned earlier, our AFH business is moving towards sustainable profit model, although we are watching Q1 carefully as we continue to monitor the impact of slow economy and normal seasonal softness in Q1 2023.

I will now turn the call over to Mark. Mark?

Thank you, Dino, and good morning, everyone. Please turn to Slide 15 for a summary of our financial performance in Q4 2022.

As Dino mentioned earlier, we delivered strong revenue and adjusted EBITDA growth in the fourth quarter as price increases and cost management initiatives increasingly gain traction. Net income totaled $16 million in Q4 2022 compared to $42.3 million for the same period last year.

The decrease was mainly due to the comparison against the significant income tax recovery in Q4 2021, along with higher depreciation and restructuring expenses. These factors were partially offset by the higher adjusted EBITDA, a greater change in the amortized cost of the partnership units liability, a higher foreign exchange gain, as well as reduced interest expense.

In the quarterly segmented view on Slide 16, Consumer revenue increased 4.1% year over year and 9.5% sequentially to $378.8 million in the fourth quarter of 2022. In the Away-From-Home segment, revenue grew 31.9% year over year to $79.3 million, but decreased 2.1% sequentially.

Consumer adjusted EBITDA totaled $42.7 million in Q4 compared to $43.7 million in Q4 2021, with an adjusted EBITDA margin of 11.3% versus 12% for the same respective period. Sequentially, Consumer adjusted EBITDA was up by $17.7 million from $25 million in Q3.

For the Away-From-Home segment, adjusted EBITDA amounted to $5.7 million in Q4 compared to negative $1.7 million in Q4 2021 with an improved margin of 7.2%. Sequentially, AFH adjusted EBITDA was up $0.3 million from $5.4 million in Q3.

On Slide 17, we review year-over-year revenue growth for Q4, which improved by $34 million, or 8%. This growth can be attributed to selling price increases across all segments and regions, as well as a positive foreign exchange impact on U.S.

dollar sales. These factors were partially offset by lower sales volume in the Consumer segment and unfavorable sales mix.

On a geographical basis, revenues in Canada rose $17.2 million, or 7% year over year, while U.S. revenues grew by $16.9 million, or 9.5%.

On Slide 18, we provide additional insight into profitability in the fourth quarter. Adjusted EBITDA increased $6.1 million to $44.4 million, representing a margin of 9.7% from $38.3 million in Q4 2021, or a margin of 9%.

The increase in adjusted EBITDA was primarily due to higher selling prices combined with lower SG&A expenses. These items were partially offset by a significant inflation on pulp, manufacturing costs and freight, lower sales volume, and also unfavorable impact of foreign exchange fluctuations.

Now let's turn to Slide 19 where we compare revenue sequentially from Q4 to Q3. Revenue increased by $31.1 million, or 7.3% from the previous quarter.

Revenue growth was primarily driven by price increases in Consumer Canada and the U.S. and improved volume for the Consumer segment across both regions, mostly offset by seasonally lower volume in the Away-From-Home segment.

In addition, a positive foreign exchange gain on U.S. dollar sales contributed to sequential revenue growth.

Geographically, revenue in Canada was up by $12.5 million, or 5%, sequentially, while revenue in the U.S. improved $18.6 million, or 10.5%.

On Slide 20, adjusted EBITDA in Q4 increased sequentially by $13.7 million, or 44.6%, from Q3. This significant growth was due to several factors, including higher selling prices, lower freight costs, increased productivity, and reduced SG&A spending.

These factors were partially offset by increased warehousing costs and an unfavorable foreign exchange impact. Turning now to our balance sheet and financial position on Slide 21.

Our cash position stood at $78.4 million at the end of Q4, a slight decrease from $82.1 million at the end of Q3. Long-term debt at quarter end totaled $1.077 billion, down $17.7 million from the end of the previous quarter.

Net debt decreased $14.4 million from Q3 to remain relatively stable at $1.033 billion. Our net debt to last 12 months adjusted EBITDA ratio improved to 8.9x in Q4 from 9.5x in Q3.

Leverage decreased due to a slightly lower level of net debt coupled with a higher adjusted EBITDA in the last 12 months. Looking at 2023, even with ongoing capital investments in our Sherbrooke expansion project, we expect deleveraging will progress steadily in 2023 as adjusted EBITDA improves and TAD Sherbrooke continues to ramp up.

At quarter end, total liquidity representing cash and cash equivalents and availability from revolving credit agreements stood at $137.5 million. In addition, $29.6 million of cash was held for the TAD Sherbrooke and Sherbrooke expansion projects.

I will conclude my section by reviewing capital expenditures on Slide 22. Total CapEx for 2022 was $115.6 million, including $20.7 million for TAD Sherbrooke and $53.4 million for the Sherbrooke expansion project.

Annual capital spending was lower than initially forecasted due to reductions in discretionary projects and delays related to supply chain issues on strategic projects. As a result, we are projecting CapEx between $200 million and $230 million for 2023, including spending related to the Sherbrooke expansion project.

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

Thank you, Mark. I will conclude on Slide 24.

We are steadily progressing along a recovery curve to drive long term shareholder value. As such, we continue to deliver solid top line growth in the fourth quarter and improved profitability.

Price increases have been fully implemented across all our segments and regions to offset inflation. Given this inflationary environment, we are prudently investing in our brands to support price increases and innovations.

Our TAD Sherbrooke production capacity continues to be ahead of ramp-up plans, with the Sherbrooke expansion assets coming on stream in 2023. We refocused our Memphis operations to drive efficiency on TAD and facial products which should improve profitability ongoing.

Away-From-Home is moving towards a sustainable profit model as we are undertaking long-term actions to improve that business. Our leverage ratio should progressively improve as adjusted EBITDA accelerates and our TAD Sherbrooke facility continues to ramp up.

And finally, we will keep investing in our organization and culture to drive future growth. In fact, on that note, 2022 was a difficult and challenging year for our industry and our company.

I wish to thank the 2,700 employees of Kruger Products across North America for meeting the challenges of '22 while continuing to get us ready for '23 and beyond. Their efforts are beginning to take hold, and I'm optimistic about our future.

To each of you, thank you. Now let's turn our attention to the outlook for the first quarter of 2023.

Price increases are in place, and we believe inflationary pressure has stabilized while our operating efficiency continues to gain traction, and we tightly manage discretionary spending. As a result, we expect adjusted EBITDA in Q1 '23 to be similar to Q4 '22 and significantly ahead of Q1 2022.

We will now be happy to take your questions.

Good morning. Dino, with respect to the market share data that you present, have you seen any signs in early 2023 of share starting to stabilize as the pricing has already been felt in market?

It's too early to see the share stabilizing, but I would say the actions that will help us drive share our evidenced. A couple things happened last year, and this is normal during inflationary times and quite frankly for most CPG categories, is as prices go up, it creates instability in the market.

Consumers don't know what to expect as prices start to change fairly quickly. And generally what happens is retailers will slow down on their promotions or support their private label because that one they can control, whereas the brands the prices are still moving around.

So we did see less promotions on branded tissue products in '22 through the price increases. We also saw some price gap expansion during that period of time as new pricing went in for trademark.

As we started exiting the year and early into this year, we're seeing a more of a return to normal for promotion of brands. The brands drive traffic for the retailers, so there's an encouragement to want to promote the brands and tissue, and we're seeing a more stable price gap returning back to normal.

So I think those factors, more promotions, better price gap management, consumers becoming more unhappy but more aware that the prices are here to stay and, of course, the marketing work that we're doing in supporting innovations, I expect to see our share start to return to a more normalized level over time.

Okay, great. Thanks Dino, that's helpful.

And just wanted to turn to the TAD. We've seen a lot of capital project inflation across the industry.

Do you have a sense as to if you were to be in the market for a new TAD today, what the capital cost would be for anybody trying to build a TAD in North America?

I don't. But I'd probably -- if you would ask me in an elevator, I would say to you, I'd probably add 20% to what we -- at least 20% to what we just paid recently.

And we paid $575 million for that facility. So I'd probably say it's 20%, 25% just based on not just the input costs, but obviously, transportation costs, construction costs, everything in that supply chain has gone up.

Okay, makes sense. Okay, that's all I had.

I'll turn it over. Thanks Dino.

Thanks Hamir.

Thanks. Good morning, everyone.

Dino, can you remind us of your fiber mix between hardwood and softwood pulp across the full operations and any ability to flex that recipe a little bit at the margin? I'm just trying to dial in our cost assumptions next year, assuming different spreads between hardwood and software pulp.

Yes. That's a great question.

But I'm going to start at the other end of that question, which is our quality is first and foremost. We need to maintain the quality of our products.

So we will adjust fiber baskets accordingly if we have the opportunity to do so. Obviously, when you change the fiber basket, it has impacts on softness and strength and absorbency.

So we stay within a very tight range to make sure that we're delivering the quality that we promise to our customers and to our consumers. Having said that, we do have some ability to flex and still deliver that output quality, but it's not dramatic, Sean.

And I will -- I think I've said this before, we're usually in the 60-40 range. This is not an 80-20 or 90-10.

It's a pretty tight range and it depends on whether you're talking about towel or bath, and obviously, our better-quality towels or baths or more of our mainstream. So we do all that.

I'm not going to get into the specifics here. That's part of a lot of actions we undertook last year to see if we can continue to tweak our fiber basket given the arbitrage that existed and we do that.

But first and foremost is maintaining our quality.

Okay. That's great context.

And Dino, just so I'm clear on it, all of the price increase efforts that have rolled out across Consumer and Away-From-Home. Are those fully baked into price realizations now?

Is there any follow-through we can expect through the first half of this year? Or is it all baked in already?

Yes, Sean, it's a great question. I would say the answer is, yes.

When you look at the total fiber basket and in Canadian dollars, because you have to understand the piece that worries me right now is the Canadian dollar starting to deteriorate. And obviously, most of our commodities are bought on U.S.

dollars. So that's one we're really watching carefully.

But I would say, generally, we are priced into market. We had some minor pricing -- I wouldn't call it minor, but we had contractual pricing in January, both in the U.S.

Consumer business and our Away-From-Home business did a small price increase announcement. Other than that, though, I would say that we are balanced with the cost basket that we're seeing today.

Of course, last year, what hurt us was the lag because costs come up fairly quickly, and then there's always a 12- to 16-week lag before you can get pricing. We feel now that's behind us and more in line on an ongoing margin structure.

Okay, that's useful. Thanks very much, guys.

That’s all I have.

Thanks Sean.

Good morning, everyone. Congrats on the quarter.

Good morning. Thank you.

So a couple of questions for you on the CapEx projects for 2023. When you're talking about the discretionary projects that were delayed, how much of that is going to be caught up later and how much of that was actually just fully discretionary and can be discarded?

When we look at our discretionary spending, it's relatively low compared to what we're spending on our strategic projects. So those were just prudent in reductions because of the cash relative experience that we had in 2022.

Looking at 2023, we plan to maintain that same level because we are spending significant amounts on our Sherbrooke expansion project. So we plan to maintain that level of discretionary spending on projects that are unrelated to the strategic project.

Understood. And great segue there.

Given your total liquidity position versus the CapEx budget plan in 2023, what's your confidence level in your free cash flow generation this year?

When we look at our free cash flow, and certainly, it brings us into the leverage conversation as well, but we definitely have expectations for improved EBITDA as we look out into 2023, which will allow us to improve our cash flow. We do have our strategic project in Sherbrooke fully financed.

So that is going to allow us to use our operational cash flow and improve this year. And certainly, that's all based on an improved EBITDA outlook in the business overall.

If I can add to Mark's point, we're pleased with the recovery. Obviously, we feel good about how we delivered in Q4 and where we're looking at Q1.

But 2023 will continue to be a volatile year. We're not out of the woods.

I think there continues to be a lot of movement and uncertainty in the marketplace. So we will manage '23 similar to what we did '22, which is watch our capital very carefully, watch our investments very carefully, hold back any discretionary spending until we see how the year plays out, have contingency planning in place, be very cognizant of what's going on, on the cost side, so that we're able to react quickly.

So a lot of the actions that we had to take in '22, given where the marketplace was going, I think we're going to operate in the same way in '23 to make sure that we can deliver the results we need to deliver.

Great color. Thanks.

I'll turn it over.

Thanks Zachary.

Thanks guys. Good morning.

Solid results.

Thank you, Paul. Good morning.

You did a great job outlining the cost increase, up $40 million in Q4 year-over-year and $180 million in 2022. Just that 14% price increase year-over-year, what does that translate to in dollars?

Is that over the $40 million year-over-year in Q4?

Well, there's a lag in there, Paul. So I would say those numbers are pre-price and post-price after the price increase.

They don't represent necessarily the annual financial impact because there's a lag built into that, which I talked about earlier. And that lag, unfortunately, is, as I said, engineered into the way that pricing gets done in the grocery segment, and we were not able to overcome that lag, and that hit us.

But as I said, we're back now on a flight path that I think our margin is balanced.

Okay. So still not sure, did the pricing in 2022 offset the costs or it will once fully implemented in '23?

No, it did not. It did not because of the lag.

Inflation started hitting us as we entered the year and then you don't -- you price in steps. So we had a lot of inflation in Q1 and Q2 of the year as we got pricing out in mid-year for the Canadian business.

U.S. was a little more flexible because there we have some contracts where they come due, the same with Away-From-Home.

So it depends on the business, but generally, we lag, as essentially anybody who went through '22 did, because inflation came so fast and so broad and so steep that the lag really was what hurt us. So our pricing did not cover costs in '22.

But the pricing I put in place now on a run rate basis will cover costs.

Okay. That's helpful.

And then just trying to understand the CapEx. Initially, in '22, you guided for $160 million to $180 million and then dial it back to $130 million to $140 million and then actually spent just under $115 million.

This you're almost doubling it in '23. Is this a lot of catch-up?

Or did you actually delay a lot of the projects just because of concerns over leverage?

Paul, we really did have a reduction in our discretionary spending, but we also had delays due to the supply chain issues on the strategic projects for the Sherbrooke's expansion in particular. But that doesn't actually affect the project itself in terms of the implementation timing.

It's just really a shift in the CapEx that we're going to see into 2023 and probably more so in the back-half of '23 where a big chunk of the spending will occur. So overall, just a shift, I would say, year-to-year.

Okay. And then just overall, it sounds like the implementation of price increases in '23 will offset this cost headwind that you got in '22.

Is that going to bring you to the level of profitability that is what you're targeting in the business? Or are you considering more price increases in '23?

I would say at this point, Paul, we're not considering pricing in '23, other than the ones that I just talked about with Sean's question that we took. We do have some contractual customers that just come on cycle, but that's relatively minor relative to our whole base.

To answer your question, if we deliver the margins that we now have on a run rate basis, if we can deliver the volume that we have, including TAD Sherbrooke coming onboard and then some of the Sherbrooke expansion that's going to come onboard, and if we can get our operational efficiencies at Memphis where we expect it to be, that will be the model that will drive sustainable profit growth at the level that we expect.

Okay. Fair enough.

Best of luck.

Thank you.

Great. Thank you.

I want to thank you all for joining us on this call today. We look forward to speaking with you again following the release of our first quarter results.

I personally -- even though we had a really good Q4, I'm glad to see '22 from a business point of view behind us and happy to talk about a new year. We'll do that when we report our first quarter results for '23 in a few months.

So thank you all and have a great day.