Domtar (UFS) John David Williams on Q2 2016 Results - Earnings Call Transcript

| About: Domtar Corporation (UFS)

Domtar Corp. (NYSE:UFS)

Q2 2016 Earnings Call

July 27, 2016 10:00 am ET

Executives

Nicholas Estrela - Director-Investor Relations

John David Williams - President, Chief Executive Officer & Director

Daniel Buron - Chief Financial Officer & Senior Vice President

Analysts

George Leon Staphos - Bank of America Merrill Lynch

Mark William Wilde - BMO Capital Markets (United States)

Mark Connelly - CLSA Americas LLC

Hamir Patel - CIBC World Markets, Inc.

Anthony Pettinari - Citigroup Global Markets, Inc. (Broker)

Clyde Alvin Dillon - Vertical Research Partners LLC

Gail S. Glazerman - Roe Equity Research, LLC

Stephen Atkinson - Dundee Securities Ltd.

Sean Finlay Steuart - TD Securities, Inc.

Paul Quinn - RBC Dominion Securities, Inc.

Operator

Good day, ladies and gentlemen. Welcome to the Domtar Corporation Second Quarter 2016 Financial Results Conference Call. At this time, all participants are in a listen-only mode. And following the presentation, we will conduct a question-and-answer session. As a reminder, this call is being recorded today, Wednesday, July 27th, 2016.

And I would now like to turn the meeting over to Mr. Nicholas Estrela. Please go ahead, sir.

Nicholas Estrela - Director-Investor Relations

Good morning and welcome to our second quarter 2016 earnings call. Our speakers today will be John Williams, President and Chief Executive Officer; and Daniel Buron, Senior Vice President and Chief Financial Officer. John and Daniel will begin with prepared remarks, after which they will take questions. During the call, references will be made to supporting slides. You can find this presentation in the Investors section of the website.

As a reminder, all statements made during the call that are not based on historical facts are forward-looking statements, subject to the number of risks and uncertainties, many of which are outside our control. I invite you to review Domtar's filings to the Securities Commission 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 David Williams - President, Chief Executive Officer & Director

Thank you, Nick, and good morning, everyone. This morning, we reported second quarter EBITDA before items of $152 million, on sales of $1.3 billion, a solid performance. Operationally, the quarter was one of our busiest on record. Excluding conversion-related work at Ashdown, we took 52 days of maintenance downtime on our paper machines and 59 days on pulp machines at 11 of our 13 mills. But our relentless focus on cost and execution as well as relatively-limited negative discoveries resulted in below-planned maintenance spending.

Despite the unplanned variations in quarter-to-quarter maintenance costs, our year-to-date spending is in line with plan. In addition, our mills ran exceptionally well with productivity gains across the systems. In Paper, the business continues to deliver steady results, strong cash flows and mid-teen EBITDA margins. Our prices improved with price increases implemented at the end of the quarter.

In Pulp, we executed well given the extended planned outages as well as costs related to the Ashdown conversion. Strong demand for softwood and fluff and low global stocks supported further price increases and we shipped all of our production, including 16,000 metric tons from inventories.

The conversion of the Ashdown paper machine to fluff pulp continues to progress with startup scheduled in the next few days. This is another milestone within our strategic roadmap of pursuing growth opportunities that capitalize on our existing strengths and core competencies.

In Personal Care, momentum continues to build with sales increasing 6% when compared to last year and we are on track to realize further top-line benefits through the rest of the year, resulting from the new customer wins. We also continue to invest in growth, specifically to complete our product assortment, enhance consumer and category insights, and additional innovation to win and secure sales growth.

Midway through 2016, I'm pleased to report that our company is making good year-over-year progress on achieving our growth plans, capturing the benefits of our cost savings program and building out our core capabilities. We're running our business prudently and executing well, while building on growth initiatives that are going to meaningfully improve our business going forward.

On health and safety, our total frequency rate was 0.8 for the quarter and 0.88 for the year. Our current trend is a significant improvement from where we were a few years back. So, I'm very pleased with the progress we're making. I'm also very proud to mention that eight of our facilities were recognized for safety performance excellence at this year's Pulp and Paper Safety Association Conference.

With that, let me turn the call over to Daniel for the financial review before making additional comments on our performance and outlook. Daniel?

Daniel Buron - Chief Financial Officer & Senior Vice President

Thank you, John, and good morning, everyone. Let's start by going over the financial highlights of the quarter on slide four. We reported this morning net earnings of $0.29 per share for the second quarter compared to net earnings of $0.06 per share for the first quarter of 2016. Adjusting for items, our earnings were $0.61 per share in the second quarter compared to earnings of $0.35 per share for the prior quarter. EBITDA before items amounted to $152 million compared to $130 million in the first quarter.

Turning to the sequential variation in earnings on slide five. Consolidated sales were $20 million lower than the first quarter, mostly due to lower shipment of pulp and paper, partially offset by improved pulp and paper pricing and good sales momentum in Personal Care. Cost of sales was $37 million lower than the first quarter, mostly due to lower pulp and paper production in the quarter and lower overall manufacturing costs. Depreciation and amortization was $2 million lower, while SG&A was $1 million higher.

Second quarter earnings included closure and restructuring charge of $21 million, in addition to an impairment charge of $3 million, both related to the conversion of a paper machine into a fluff pulp line at our Ashdown facility. The Ashdown project faced some minor delays and the startup of production was pushed back three weeks. This will result in approximately $5 million in additional closure and restructuring costs in the third quarter. In the second quarter, we recorded an income tax expense of $6 million or an effective tax rate of 25%, in line with our expected tax rate.

Now, turning to the cash flow statement on slide six. Cash flow provided from operating activities amounted to $118 million, while capital expenditures amounted to $119 million. This resulted in negative free cash flow of $1 million for the second quarter. Year-to-date, cash flow provided for operating activities amounted to $215 million and capital expenditure amounted to $219 million. During the quarter, we've paid a $25 million dividend and made no stock repurchases. From January 2011 to June 2016, we've returned a total of $1.3 billion to our shareholders through dividend and share buybacks, representing 75% of our free cash flow. At the end of the quarter, we had 62.6 million common shares outstanding.

Turning to the quarterly waterfall on slide seven. When compared to the first quarter, EBITDA before items increased $22 million due to higher selling prices for $10 million, lower raw material costs for $6 million, property tax refund of $5 million at one of our facility, positive working capital foreign exchange variance of $5 million, lower freight for $3 million, lower maintenance cost for $2 million and higher productivity for $2 million. These were partially offset by lower volume and mix for $7 million and an unfavorable foreign exchange rate impact of $4 million.

Now, the review of our business segment starting on slide eight. In the Pulp and Paper segment, sales were 3% lower when comparing to the first quarter and down 5% when compared to the same period last year. EBITDA before item was $131 million compared to $115 million in the first quarter of 2016.

Our Paper business on slide nine. Sales decreased 3% versus last quarter and 5% versus the same quarter last year. Estimated EBITDA before item was $5 million higher when compared to the first quarter. Manufactured paper shipments were 4% lower when compared to the last quarter and the same period last year. Our average transaction prices for all our paper grades were $10 per ton higher than last quarter as a result of previously-announced price increases. In the quarter, we took 16,000 ton of lack of order downtime to balance our production to our customer demand and to reduce finished goods inventory.

Our Pulp business on slide 10. Sales decreased 1% versus last quarter and 5% versus the same period last year. Estimated EBITDA before items increased $11 million when compared to the first quarter. Pulp shipments were sequentially lower by 2% versus the first quarter and up 4% when compared to the same period last year. Average pulp prices increased by $10 per metric ton versus the first quarter. Our paper inventory decreased by 37,000 tons when compared to last quarter, while pulp inventories decreased by 16,000 metric tons.

Our Personal Care business on slide 12. Sales increased 6% when compared to last year and last quarter as a result of new customer wins. Our EBITDA before item was $30 million, in line with the first quarter, even with additional sales and marketing investment made in the quarter such as an ad campaign to support the re-launch of Indasec in Spain.

As usual, you'll find on slide 13, our forecasted maintenance for the next two quarters. I would like to remind you that maintenance cost in the third quarter will significantly decrease when compared to the second quarter as all, except one, of our major maintenance outages for the year are behind us. We are forecasting CapEx for the entire year to be at the higher end of the range of $330 million to $350 million that we shared with you at the start of the year.

Before I end my remarks, let me make a few comments on Brexit. For the six months period ended June 30, 2016, our net sales in the UK were 2% of our consolidated net sales. As we have no asset in the UK, other than some minor finished goods, the main impact of the vote so far was limited to the volatility of the UK currency. In the long term, any impact from Brexit on our U.S. – UK sales will depend in part on the outcome of potential tariff, trade, regulatory, or other negotiation. Today, the foreign exchange impact has been negligible given the size of our sales in this country and given the hedges we currently hold.

So, this conclude my financial review. And with that, I'll turn the call back to John.

John David Williams - President, Chief Executive Officer & Director

Thank you, Daniel. We successfully completed the extensive annual maintenance outages on time and below our expected cost. In Pulp, we had a good performance on wood and energy costs due to a combination of our continuous improvement initiatives and better price and usage.

Demand for softwood has remained strong through the first half of 2016 with our Northern softwood shipments up 12% year-to-date, driven by strength in the tissue and towel sector as well as specialty pulp markets. We benefited from good price momentum and reduced our inventories by 16,000 metric tons in the second quarter. July softwood prices in China did reflect some seasonality, but we don't expect significant volatility going forward.

The conversion of the Ashdown paper machine to fluff pulp continues to progress. We did face some short delays due in part to some unexpected civil and demolition work. Production will begin in the next few days and we'll then move to the qualification of fluff pulp with our major customers.

We're very excited about the startup and we expect the machine to run 50% of its output in fluff pulp by early 2017. The new fluff line is the largest machine in the world and a low-cost asset that positions Domtar as a leading supplier to a growing market.

Our Ashdown mill has a great reputation as a manufacturing facility, and the fluff line will produce high-quality pulp that will be valued by our customers. This investment helps build on Domtar's reputation as a global player in fluff pulp and will support continued profitable growth in this business.

In Paper, we pay close attention to market fundamentals and were successful in balancing our production with our customers' demand during the quarter. We shipped at 105% of our production, while taking 16,000 tons of lack of order downtime. Paper inventories decreased by 37,000 tons as planned and we expect to see further declines as the year advances.

We continue to make progress with the announced price increases in rolls and cut sizes. These increases have been successfully negotiated and will continue to be phased over the next few months. This will translate through to our earnings in the second half of the year.

On innovation, we're focusing our efforts on becoming even more efficient in our pulp- and paper-making processes. As part of our CapEx program, we announced a $27 million investment for the installation of a second generating unit with a power output of 18 megawatts at our Windsor mill. This investment will improve the energy efficiency of the mill and reduce production cost.

The Windsor Mill self-generating capacity will reach nearly 50 megawatts, the equivalent of the annual energy consumption of nearly 13,000 homes. Domtar's self-generation of electricity has increased by 10% since 2007, making our overall mill self-sufficiency of 73% going into 2017.

Turning to Personal Care, we had our best sales quarter-to-date with our top line increasing 6% year-over-year. The main driver was strong volume growth in the baby diaper segment, up 21% when compared to last year as a result of new customer wins. The quarter was highlighted by numerous initiatives, including laying the groundwork for the adult incontinence launch of the major retailer, where we've invested in innovation and associated product development and packaging.

We also supported development and trials with leading North American healthcare chains as we bring more innovation and a new clinical value proposition to market in our Attends adult incontinence brand. We had the re-launch of our Indasec light inco brand in Spain, supported by a nationwide television campaign. This product line features new innovation based on our EAM technology.

Finally, we added the Butterfly brand to our extensive line of products. Butterfly represents a complementary addition to our portfolio brands and technologies, and further enhances our differentiated product offering. We're driving our brands in key channels and geographies, and we're changing the landscape of the private-label value proposition. Our unique partner brand strategy focuses on winning with channel leaders, and offering turnkey solutions through material and design, mechanical flexibility, and category management. Our strategy is working.

Our new customer wins were proof of the strength of our partner brand model, which offers unprecedented alignment with the needs of our customers. Operationally, Personal Care had a solid performance with procurement and operational cost savings initiatives in addition to some favorable raw material pricing. So, I do expect sales and margin momentum to continue into the second half of 2016, despite a very competitive market environment.

Turning to capital allocation, we announced a dividend increase earlier in the second quarter. This reinforces our ongoing commitment to return cash to shareholders and reflects our continued confidence in our cash flow generation. Growth through acquisitions will continue to be part of our playbook, helping to change the growth trajectory of our portfolio, while creating value. We will remain disciplined as we deploy capital with a focus on value-creating acquisitions and investments, while returning cash to shareholders through an attractive dividend and share buybacks.

Now, to our outlook for the remainder of the year. Maintenance cost will decrease with fewer scheduled outages in our mills, which will drive improved productivity. Raw material cost, notably natural gas and caustic soda, are expected to increase slightly. Our paper shipments are expected to trend with market demand. Recently announced price increases will positively impact the Paper business, while we do expect some short-term pricing volatility in Pulp in certain geographies. Personal Care results will benefit from our new customer wins, market growth and cost savings from the new manufacturing platform.

Thank you for your time and support. And I'll turn it back to Nick for questions.

Nicholas Estrela - Director-Investor Relations

Thank you, John. So, both John and Daniel will be available for questions. I'd ask our participants to ask a few questions at a time and return to the queue for follow-ups as we want to get as many people as possible. So, Angeline, you can open up the line for questions.

Question-and-Answer Session

Operator

Thank you, sir. Our first question will come from the line of George Staphos of Bank of America. Please go ahead.

George Leon Staphos - Bank of America Merrill Lynch

Thanks, operator. Hi, everyone. Good morning. Thanks for the details. Congratulations on the quarter two. Two questions.

John David Williams - President, Chief Executive Officer & Director

Good morning.

George Leon Staphos - Bank of America Merrill Lynch

Good morning. Two questions for you on maintenance. John, you spoke a little bit about what caused the more favorable maintenance experience relative to your forecast. If possible, can you provide a little bit more color there? The related question, if I look at the waterfall chart, it shows that your maintenance sequentially would have improved $2 million, if I'm interpreting it correctly, from first quarter to second quarter, yet on the deck on – the page on slide on page 13, it shows a $2 million increase in maintenance cost. I'm just trying to reconcile that.

And then, the last question is, can you talk about the lack of order downtime in the quarter on Paper? I guess, aside from the obvious, what caused it, was it purely to try to get your inventories lower? And can you provide a bit more color in terms of how you feel about your inventories into the second half? Thanks.

John David Williams - President, Chief Executive Officer & Director

All right. So, let me just have Daniel, if I may, answer the first part of that question. And then, I'll happily come back on the market question.

George Leon Staphos - Bank of America Merrill Lynch

Thank you.

Daniel Buron - Chief Financial Officer & Senior Vice President

So, George, the first – let me answer your second question, I guess the discrepancy between the maintenance cost page and the waterfall, the difference is actually FX. There's a portion of our spending, obviously maintenance, that is done in Canadian dollars. So, you have, in the waterfall slide, FX is isolated. When you look at the maintenance chart, it's all in with the current actual FX rates. So, the gap of $3 million that you see is actually all related to FX.

In terms of the lower maintenance than expected, as you know, we've moved many of our mills to an 18 months schedule. So, there's a little bit of a learning curve for us in terms of properly forecast the maintenance shut. If you look at it, I think John said it in his notes. If you look at it on a year-to-date, we're actually right on the plan, $2 million more I think spending. A lot of negative discoveries in Q1, that actually helped us, to some extent, fix stuff that we'd have fixed in Q2 or was planned to be fixed in Q2. So, you have kind of the saving, lower negative discovery, plus a little bit of the benefit of what we spend in Q1 and Q2. So, that's it in terms of how we've been able to over-perform in terms of maintenance spending in the quarter.

George Leon Staphos - Bank of America Merrill Lynch

Okay. Thank you.

John David Williams - President, Chief Executive Officer & Director

And George, just to your market point, I mean, absolutely, it was really about making sure that we balance inventories. And that's why we did what we did in terms of lack of order downtime.

George Leon Staphos - Bank of America Merrill Lynch

John, if I could, on the pricing side, of what's been reflected in the publications thus far, not making a forward view. How much would your prices have to move up additionally, if at all, to reflect the benchmark price? Thanks. And I'll turn over from there and come back.

John David Williams - President, Chief Executive Officer & Director

You mean what you're seeing in terms of price realized in publications?

George Leon Staphos - Bank of America Merrill Lynch

Yes. Correct.

John David Williams - President, Chief Executive Officer & Director

Have I understood you right? Yeah. So, I mean, you see $10 right now across the whole portfolio. So, in that $10 really is the impact of our rolls price increases, which is pretty much the headline. I mean, the next issue, although negotiated, still needing to show up in the numbers is really the cut size price increase. So, another, whatever, $10 to $20 we'd be there in terms of the publications.

George Leon Staphos - Bank of America Merrill Lynch

Okay. Thank you. I'll turn it over.

John David Williams - President, Chief Executive Officer & Director

Okay.

Operator

Thank you. And your next question will come from the line of Mark Wilde with BMO Capital Markets. Please go ahead.

Mark William Wilde - BMO Capital Markets (United States)

Yeah. I wondered, Daniel, John, turning to Ashdown and the ramp-up in the third quarter, if you can just kind of walk us through the numbers on that. And then, also how we should think about sort of the sequencing in the fourth quarter and as we move out into next year?

Daniel Buron - Chief Financial Officer & Senior Vice President

Certainly. So if you take the new machine within the second half of the year, Mark, it would make about 150,000 tons of pulp. Now, the balance of that between softwood, bales, and fluff pulp is really going to be dependent on the sort of qualification timeline of customers on fluff, because as it's a new facility, even though we've got a good reputation from Plymouth, we still have to go through the qualification period with some of our customers. Some of whom may say, well, third quarter, fourth quarter, we're too busy. Maybe we can push it a bit. The good news is, of course, is that actually the launch customer for that business is ourselves, where we'd be hoping to supply may be 80,000 tons to 100,000 tons from Ashdown into our Personal Care facilities. So, that's kind of the launch customer for that business.

Now, what you'll then see in 2017, capacity of that machine, because it's a little bit pulp-constrained as we run those two paper machines still in Ashdown, will be 430,000 tons. Of which, we would expect to be at kind of 50/50 between fluff and bales in the first half of the year, and then obviously we're highly incentivized to move as much of that to fluff as we can over the year. Does that help?

Mark William Wilde - BMO Capital Markets (United States)

Yeah, that does. I think Daniel just mentioned an extra $5 million in cost in the third quarter, so maybe you can clarify that.

John David Williams - President, Chief Executive Officer & Director

Yeah. Sure. I mean, that's really the fact – we've got a three-week delay, so that just means some of the overhead recovery we would have been expecting have we started up exactly on time won't be there. So, that's the impact of that.

Mark William Wilde - BMO Capital Markets (United States)

Okay. And, John, I wondered if we could do a little bit of the same with the ramp-up in Personal Care, because you mentioned some new business wins. You're adding Butterfly, and you've got the benefits from some of this planned equipment spending.

John David Williams - President, Chief Executive Officer & Director

Right. So, we've won really both last year and year-to-date about a – we've got about $100 million of confirmed new business to the top line, Mark, which manifested, as you saw, in that 6% sales growth year-on-year, and actually, almost 6% sales growth quarter-to-quarter. It's almost exactly the same number. So that, obviously, as new business is layered in, will come in through the year. Now, patently, there are other moving parts in our sales line that will impact that either positively or negatively.

Now, year-to-date, we're still winning solid pieces of business. So, I'd expect that momentum to continue. So, in 2017, we should see the full impact of that $100 million, again, the caveat, always the rest of the sales moves around. And we should also see layered in the beginning of the wins from 2016, because of course it probably takes six months to nine months in some from actually being given the business to supplying the business, because they have to run down all inventory. They're probably going to change the graphics. So, my view is that momentum will continue. Okay?

Mark William Wilde - BMO Capital Markets (United States)

Okay. All right. Yeah. I'll jump back in the queue. Thanks, John.

John David Williams - President, Chief Executive Officer & Director

All right. Thank you.

Operator

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

Mark Connelly - CLSA Americas LLC

Thank you. John, just two questions. The per-ton cost in your Pulp segment are down very meaningfully, and that's not the normal trend in the second quarter. So, I'm wondering if you can help us understand why those costs go down in a quarter when they typically go up and whether that's something new we should be expecting. And then second, just as a follow-up. Are the majority of your mills now on an 18 months maintenance schedule and are more going to that schedule?

John David Williams - President, Chief Executive Officer & Director

Okay. Sure. So, on pulp customer, Mark, you've got a couple of things. I mean we ran very well in terms of productivity and some of our input costs were lower, so we had lower wood cost. So, I think all those items combined show those costs coming down. We ran them well. We were efficient and some of our inputs were reduced. If you look at the 18-month schedule, that's certainly our mid-term goal is to get everything on to 18 months. I would think – I mean I'd have to look to Mike, but I would think we're probably two years away from that. But that's absolutely our goal.

Mark Connelly - CLSA Americas LLC

Are you more than halfway there?

Daniel Buron - Chief Financial Officer & Senior Vice President

Yes.

John David Williams - President, Chief Executive Officer & Director

Yeah. We are.

Daniel Buron - Chief Financial Officer & Senior Vice President

There's a couple of mill left.

John David Williams - President, Chief Executive Officer & Director

There's a couple left.

Daniel Buron - Chief Financial Officer & Senior Vice President

Yeah.

Mark Connelly - CLSA Americas LLC

Just a couple. Okay. Super. Thank you.

John David Williams - President, Chief Executive Officer & Director

Okay. You're welcome.

Operator

Your next question will come from the line of Hamir Patel of CIBC Capital Markets. Please go ahead.

Hamir Patel - CIBC World Markets, Inc.

Hi. Good morning.

John David Williams - President, Chief Executive Officer & Director

Good morning.

Hamir Patel - CIBC World Markets, Inc.

John, we've seen some more uncoated mechanical producers come out with offset grades. Just wondering if you think there's any quality or distribution issues with making white papers on those machines that would prevent them gaining some share?

John David Williams - President, Chief Executive Officer & Director

Well, it's not the first time, I guess, I would say. I mean, a number of them have been trying for quite some time. Some of them find their place. To be really competitive, they need to be relatively full, and that's a struggle, because obviously we have the largest sales organization. We have a great reputation. We have the range. So, I think our competitive offering is pretty compelling versus here's a grade I'm making, because I don't want to make my poor grade anymore, which is kind of the message, if you really think about it. So, my view at the customer base, we just have to do our basic block and tackle, keep our service position strong, make sure our representation is good. That's how we're going to compete.

Now, will they cause – will there be a nuisance in certain markets, because typically where they're going to go in is going to be sort of some of the more transactional pieces of the market? Maybe. But I think we've proven over the years that as they do come in, we're pretty strong competitors. And I don't think their product is necessarily inferior, but I mean this grade is not necessarily a slam dunk in terms of technology that people might imagine it to be. Okay?

Hamir Patel - CIBC World Markets, Inc.

Okay. Thanks. That's helpful. And the other thing I was wondering about was there was a report, I guess, in Pulp and Paper Week a week ago about the U.S. producer trade group that had brought, I guess, the original case, potentially looking at bringing another case against another producer as...

John David Williams - President, Chief Executive Officer & Director

That's right. So, one of the major producers has produced a grade specifically to get round the duties. So, a number of us have said, well – we've come back and said, we believe this is wrong and that it should not be allowed into the marketplace. But it will take six months to 12 months for preliminary determination and it might take one year to one-and-a-half year for the final determination. So, I think we're going to have to wait for a while to see if that petition has its desired effect.

Hamir Patel - CIBC World Markets, Inc.

Right. And how much volume is coming in under this? Sort of 83...

John David Williams - President, Chief Executive Officer & Director

Right now, it's really small. But I mean, I think we've named who it is. I mean, it's APP, so they'll attempt to be relatively aggressive, but it's small right now.

Hamir Patel - CIBC World Markets, Inc.

Okay. Great. That's all I had. I'll turn it over. Thanks.

John David Williams - President, Chief Executive Officer & Director

All righty. Thanks.

Operator

And we'll go ahead for our next question from Anthony Pettinari of Citi. Please go ahead.

Anthony Pettinari - Citigroup Global Markets, Inc. (Broker)

Good morning.

John David Williams - President, Chief Executive Officer & Director

Good morning, Anthony.

Anthony Pettinari - Citigroup Global Markets, Inc. (Broker)

I just had a question on 2017 CapEx and if there's an early view there. I think you flagged Ashdown as $130 million. I guess Ashdown is maybe getting pushed a little bit into 1Q in terms of the ramp-up. Any kind of early view on 2017 CapEx and maybe normalized CapEx for both Pulp and Paper and Personal Care.

John David Williams - President, Chief Executive Officer & Director

Yeah. Well, I mean – and we're a little early in the day, to be honest. I'm not trying to avoid the question, but I think typically we share that with you later in the year. So, we haven't actually done our budget process yet. So, a reasonable – and I think a reasonable assumption is to say, well, obviously, the major spend in Ashdown is over. So, kind of more steady-as-she-goes CapEx in the core business. And really in the Personal Care business, it's around machinery we may or may not need, but I'm expecting a fairly sizeable reduction in CapEx year-to-year.

Anthony Pettinari - Citigroup Global Markets, Inc. (Broker)

Okay. Okay. And then, on Personal Care, what kind of sales base can you satisfy with kind of the current asset footprint? I guess, what I'm asking is at what point would you need to make – obviously, you've made a big investment in machines. At what point would you need to make another kind of wave of investment in machinery, or what sales level do you think you can get to with the investments that you've made so far?

John David Williams - President, Chief Executive Officer & Director

Rough rule of thumb, we think about $1.4 billion to $1.5 billion on what we have today.

Anthony Pettinari - Citigroup Global Markets, Inc. (Broker)

Okay.

John David Williams - President, Chief Executive Officer & Director

A very rough rule of thumb. So, if you held it to me, I'd probably have to kill you. That's a rough guide. If you look at machinery, major machines are anywhere from $25 million to $35 million apiece, depending on the infrastructure you put in. But of course, they're supplying tens of millions dollars of sales. So, really now, as we look at the machine park, we would say, we built the machine park for our basic range. One of the issues right now in our machine part is we have some capabilities in the U.S. that we don't have in Europe and vice versa. As our businesses build, our thinking around the machine park is those two geographies should be relatively self-sufficient. And of course, we're getting growth, because remember that market's going to grow 3% to 5% a year. So, as you do that math, I think as we settle down in our footprint, we'd be thinking around sort of the machinery to get the market growth we feel we deserve and any additional growth we feel we deserve. That help?

Anthony Pettinari - Citigroup Global Markets, Inc. (Broker)

Okay. That's very helpful.

John David Williams - President, Chief Executive Officer & Director

Okay.

Anthony Pettinari - Citigroup Global Markets, Inc. (Broker)

And then maybe just one last one on fluff. I mean obviously there is a large transaction between two big competitors that still has to close. If there were to be any mill divestitures required from that from a regulatory perspective, would you be interested? And then, maybe more broadly, can you just talk about Domtar's future in fluff in terms of maybe potential conversion opportunities down the road versus...

John David Williams - President, Chief Executive Officer & Director

Sure.

Anthony Pettinari - Citigroup Global Markets, Inc. (Broker)

...brownfield expansion versus M&A?

John David Williams - President, Chief Executive Officer & Director

Right. So, I mean, let's be frank. If there is a divestment, we're interested, but it needs to be a decent asset. So, we're not going to be the guys who buy the junk that somebody else doesn't want. So, if it was a good strong competitive asset, we'd be interested.

I think on fluff pulp, if you look at the global market, it's not quite interesting. There are only three people in that marketplace who have more than one facility on fluff pulp. But we obviously are the number three with two, and you know who the other two players are. So, we're a very credible supplier right now, I think, in terms of our asset base, in terms of the quality we're producing.

Now, as we fill that asset base and we build our credibility, we have more of an opportunity with major global accounts. So, if I'm being frank, when you only have one machine, are a little bit nervous around the security of supply. So, I think that gives us more opportunity. So, my simple view is, let's really fill those machines with good-quality business, with good-quality customers. It is a growing market. And certainly, if another opportunity arose from a repurposing standpoint, we'd have a good long look. That give you a bit more clarity on it.

Anthony Pettinari - Citigroup Global Markets, Inc. (Broker)

Yeah. No, that's very helpful. I'll turn it over.

John David Williams - President, Chief Executive Officer & Director

Okay. All right. Thanks.

Operator

And your next question will come from the line of Chip Dillon of Vertical. Please go ahead.

John David Williams - President, Chief Executive Officer & Director

Sorry. I didn't catch that.

Clyde Alvin Dillon - Vertical Research Partners LLC

It's me Chip Dillon. Hi, John. How are you?

John David Williams - President, Chief Executive Officer & Director

Sorry, Chip. I didn't hear it. Very well.

Clyde Alvin Dillon - Vertical Research Partners LLC

That's okay, and good morning, Daniel, as well.

Daniel Buron - Chief Financial Officer & Senior Vice President

Good morning.

Clyde Alvin Dillon - Vertical Research Partners LLC

And congratulations on a good quarter and especially the progress on your maintenance.

John David Williams - President, Chief Executive Officer & Director

Thank you.

Clyde Alvin Dillon - Vertical Research Partners LLC

First question I have is, I noticed that in Personal Care, you are making obviously a lot of progress. But at least on – and I know it's lumpy, but the income was actually down year-over-year slightly. And I was thinking, as you think about the second half and the layering in of some of these wins, would you expect to see the EBIT go up in the second half of the year versus last year?

John David Williams - President, Chief Executive Officer & Director

Well, I mean, let's talk about the quarter particularly, and I will answer the question. So, we actually spent some marketing dollars in this quarter on the re-launch of our Indasec brand in Spain, where we are actually the market leader in light inco versus the SCAs and Procters of this world. So, we've got a good strong business and a highly-profitable business that we wanted to protect. I absolutely feel, for two reasons, that we should see momentum. One is, of course, the new wins themselves. And two, as they go on to our machine park, we're going to see our overall operating efficiency, which is the way we judge that business from a productivity standpoint, grow. And that essentially means more volume over the cost base will result in an improved EBIT. So, yeah, I expect to see that momentum.

Clyde Alvin Dillon - Vertical Research Partners LLC

Okay. Okay. And then you mentioned, I think, that we should look for a $10 to $20 increase in uncoated realizations, if we just hold where we are with the published pricing. What does it look like sequentially in Pulp? And while we've seen softwood march up during the quarter, at least paper grade, we hear that it's a little wobbly in China with the lower currency there. But how does that all take out?

John David Williams - President, Chief Executive Officer & Director

Yeah. It's interesting question. So, I mean, yeah, certainly, a little bit of a wobble in China. I mean, actually, we think prices in North America will increase/stay firm. So, as we look forward, I would say, China yet to be determined, but as the year builds, maybe that most recent small decline may reverse or at least stay where it is, and looking pretty good in North America.

Clyde Alvin Dillon - Vertical Research Partners LLC

Okay. And I guess, the last question is – and not that you would necessarily be familiar here, but my recollection is that the last full-blown pulping system that was permitted was your Marlboro Mill, when Willamette built that and announced that in the late-1980s. And yet, we have another one that's being attempted in Arkansas that would obviously enter the fluff pulp market, although there were some interesting comments by their PR person a week or so ago as they delayed that. What is your feeling about the ability to get a permit to build a pulp mill in the United States? Do you think that's going to be something that is easy to do?

John David Williams - President, Chief Executive Officer & Director

No. I think it's going to be pretty difficult. I really do. And if you look at the regulator and what's happening there, and sometimes even permitting for changes is more difficult than it used to be. I think it's going to be – I think it will be a struggle.

Clyde Alvin Dillon - Vertical Research Partners LLC

Got you. Okay. Thank you very much.

John David Williams - President, Chief Executive Officer & Director

Thank you.

Operator

Your next question will come from the line of Gail Glazerman of Roe Equity Research. Please go ahead.

Gail S. Glazerman - Roe Equity Research, LLC

Hi. Good morning.

John David Williams - President, Chief Executive Officer & Director

Hi.

Gail S. Glazerman - Roe Equity Research, LLC

Hi. You touched on this a little bit, but maybe a little – can you give a little bit more color on the initial marketing process on the off-take from Ashdown and maybe compare it to when you're first selling the tons from Plymouth? And have you seen any sense of not only having a second line, but also kind of any incremental interest given the potential deal with IP and Weyerhaeuser?

John David Williams - President, Chief Executive Officer & Director

Yeah. So, I mean, there's an awful lot of questions in that question. But let me sort of start, if I may, at the beginning. So, on Ashdown, the launch customer for fluff pulp is us. So, our Personal Care business in the geographies where it makes sense will be the launch customer. And given the momentum we have in that business and fluff pulp usage, we think that's probably roughly 80,000 tons to 100,000 tons that we'll be selling to ourselves.

Now, we're obviously – we haven't sort of sat on our hands and waited until we have pulp available to talk to customers. So there's no question that our customers – we have a very disciplined sales plan, which we've actually had now for a year or so. We've been out telling people. So, really now when we make product, it's about qualification. So, we have commitments from customers depending on the product quality, which is perfectly appropriate, because of course these are consumer products that ends up in the hands of consumers, so they have to be careful.

The transaction has meant that there are customers out there who maybe had two major suppliers, who perhaps have become one, and that has led some of them to talk to us saying, well, when we then look through the space, you are now obviously the most-credible other supplier. You have two mills, we're reassured by that, as I said in some previous remarks around security of supply. So, come talk to us about what you might be able to do for us. So, that's the sort of dynamic. Does that give you a bit of color around it?

Gail S. Glazerman - Roe Equity Research, LLC

Yeah. No, absolutely.

John David Williams - President, Chief Executive Officer & Director

Okay.

Gail S. Glazerman - Roe Equity Research, LLC

And just on the Personal Care business, can you give perspective on two things? I guess we're two years into Procter & Gamble's return into the inco market.

John David Williams - President, Chief Executive Officer & Director

Yes.

Gail S. Glazerman - Roe Equity Research, LLC

And just how you think that's shaken out? And then, just broadly speaking, whether or not you're seeing momentum and progress in private-label retailers in the U.S. getting more and more interested in kind of the European model of private label?

John David Williams - President, Chief Executive Officer & Director

Right. Certainly. So, just to remind you, of course, our position in retail is very small in the U.S., because really, historically, and even to this day, we're largely an institutional provider. So, our retail presence is quite small. So therefore, always doesn't have that much direct impact on us in terms of the business today. There are two ways, obviously, into inco. One is through feminine hygiene, as the situation becomes more serious, you move into light inco. That's really the way, always, is trying to move you into light inco. And of course, now, they have a pants line, which they hadn't got before. We're hearing that they're doing pretty well at the kind of lower end, so the lighter end of these products. But actually, they're not completely succeeding and moving that consumer into the kind of medium-end products that they have.

In Europe, obviously, TENA is very much the incumbent. So, they're fighting very hard. They've got re-launch. They've got new product innovation. So, I think SCA and Procter in that space will kind of battle away. I think the good news is, quite frankly, is it has caused retailers to look at their private-label offering to see if they've got the right technology in the product. And that really only helps us in terms of developing products for them, because of course out pitch on private label is we'll run your brand as if it was our brand. We'll give you product innovation. We'll give you a product fit for use for your type of consumer, depending on the channel. So, I think in that respect, it doesn't do us any harm, to be frank.

You had one other part of your question, which I've slightly forgotten in replying to the first one?

Gail S. Glazerman - Roe Equity Research, LLC

Just if you're seeing any kind of evolution in U.S. retailers' interests in private label (43:30) model?

John David Williams - President, Chief Executive Officer & Director

Yeah. So that's a very interesting question. That's obviously the kind of mid- to long-term strategic question. So, we are now seeing a number of retailers, actually, say to us, your story on brand partnership, as opposed to kind of national brand equivalent in a different colored bag, is very compelling. And because where that has been implemented for some time, it's been very successful. So, for example, actually, in one of the major retailers where we were the private-label supplier in a number of stores, we had double-digit growth; whereas our competitor, where they were the supplier in a number of stores, actually, had a decline. We have a European model, where we co-branded a (44:22) actually with their private label and that's had double-digit growth over for the last few years.

So, I think as the U.S. retailer is under pressure from all kinds of channels, both e-commerce and discounters, they're really looking to say, yes, I need volume, but I also need margin. Now, private label run well should be able to give them both as opposed to it's just going to be cheap as chips and that's how we're going to get the consumer. One of the issues in U.S. private label is a lot of consumers still believe that by buying private label they're somehow compromising on quality. So I think there's a lot of work to be done to make certain that they understand that's actually not the case. So, it's not just a channel decision. It's also a consumer attitude question. Does that help?

Gail S. Glazerman - Roe Equity Research, LLC

Yeah, a lot. Thanks very much.

John David Williams - President, Chief Executive Officer & Director

Thank you.

Operator

Your next question will come from the line of Stephen Atkinson of Dundee Capital Markets. Please go ahead.

Stephen Atkinson - Dundee Securities Ltd.

Thank you. Good morning.

John David Williams - President, Chief Executive Officer & Director

Stephen, good morning.

Stephen Atkinson - Dundee Securities Ltd.

In terms of Ashdown, what's left in terms of paper making? Like, can you flip as you grow the pulp market, or are you going to do it by increasing, should we say, production at other mills?

John David Williams - President, Chief Executive Officer & Director

Well, right now, we've got two paper machines still running. And if we look sort of down the pipe, Stephen, I think we're expecting to do that. Patently, if we feel – I think the way you have to look at repurposing as twofold. One, is there a market opportunity for you? Two, have you got the technology to actually supply that market opportunity? I think historically, paper industry, we were a bit kind of build it and they will come, so we can do it technically. So, let's just do it and let the market go hang. So, we think very differently around that. So, as I've said I think in my earlier remarks, if we build our fluff pulp business successfully out of Ashdown, I'm convinced we will, let's have Ashdown and Plymouth really going well, great reputation in the market. I think if we build that, we'd obviously look for other opportunities.

Stephen Atkinson - Dundee Securities Ltd.

Okay.

John David Williams - President, Chief Executive Officer & Director

That help?

Stephen Atkinson - Dundee Securities Ltd.

Yeah. No, no. That's great. And so in terms of your launch of Indasec, which I assume is comparable to the U.S. equivalent, as you say, bringing in the EAM technology, correct me if I'm wrong.

John David Williams - President, Chief Executive Officer & Director

Yeah. You're right.

Stephen Atkinson - Dundee Securities Ltd.

Okay. Thank you. And so, really the point being that I guess you're going to now bring that product into Europe? Is that basically it?

John David Williams - President, Chief Executive Officer & Director

Well, it's already in Europe – So, Indasec, of course, is a Spanish brand. But, yeah – so what we're looking for is EAM is our innovation engine on core technologies for our absorbent products portfolio. And so, it's more and more can we find great technology in EAM through what it knows how to do in terms of nonwovens, and incorporate that into product, where obviously we get a consumer benefit, we get a usage benefit, and can we then build product technology that deserves a premium. So, those are all the things we're looking at. And Indasec is the kind of first piece of that, where we've taken our brand. And so far, actually, consumer reactions have been very strong. We've seen the momentum we've been looking for in terms of sales. So, so far so good. So, that idea of having that technology engine is very powerful to us, because it enables us to build product differentiation.

Stephen Atkinson - Dundee Securities Ltd.

Okay. That's great. So that – and you've already done that in your Swedish mill or like you've already moved their product? Is that how it works?

John David Williams - President, Chief Executive Officer & Director

No. So, this would be out of our Toledo facility that would be doing this. And of course, as we move around the market and we find the right things to do with our products, all our new machinery is capable of using the EAM technology if we think it's appropriate.

Stephen Atkinson - Dundee Securities Ltd.

Okay. That's great. And I guess, in terms of Butterfly, are you going to introduce that into Europe at some point or some equivalent?

John David Williams - President, Chief Executive Officer & Director

Yeah. We may do. I mean, to be honest, we bought a business that had spent a lot of money on marketing, but have not really – I mean, we bought from the receiver, essentially, some assets that has spent a lot of money on marketing, had run out of cash because they haven't got distribution. So now, we have to manufacture the product, which we're actually doing in partnership with somebody, refill the pipeline, retell the story and re-launch it. But yeah, I mean, it's a niche product, but our approach really will be to offer that as a branded item in our portfolio to major retailers.

Stephen Atkinson - Dundee Securities Ltd.

Great. Thank you so much.

John David Williams - President, Chief Executive Officer & Director

Thank you.

Operator

Your next question will come from the line of Sean Steuart of TD Securities. Please go ahead.

Sean Finlay Steuart - TD Securities, Inc.

Thanks. Good morning.

John David Williams - President, Chief Executive Officer & Director

Sean, good morning.

Sean Finlay Steuart - TD Securities, Inc.

A couple of easy questions. Daniel, first on Ashdown. So you've treated the conversion cost as a restructuring cost item. And I think last quarter, you guys had talked about some fixed cost absorption issues that might also add to that number. Was that in the – were those sorts of issues in the adjusted EBITDA you reported in Q2 or is it all in that $21 million line item?

Daniel Buron - Chief Financial Officer & Senior Vice President

It's part of the $21 million. And as I said in my speech, because of the three weeks delay, there will be $5 million additional cost that will be separated or put as an item next quarter.

Sean Finlay Steuart - TD Securities, Inc.

Got it. Okay. And second question on the PC business. You touched on some of the issues that you expect will drive better margins, adding on to the sales growth you're anticipating. Where do you anticipate long-term EBITDA margins for that business gravitate to?

John David Williams - President, Chief Executive Officer & Director

Sure. So we've always said mid-teens, Sean, and that's where it should be. I'd be very disappointed if we didn't get there. Why would it not be the kind of margins you see in some of the bigger branded guys? I mean, that's really two things; economies of scale and the fact that, obviously, brands you can run very efficiently through a number of lines. We have to change over lines much more frequently, because we have a much more complicated SKU mix, based on the fact that we're really making a specific product for a specific retailer. So, although we don't need the marketing spend that affects the P&L of a branded guy, that margin, if you like, we use up in the complexity of what we have to do.

But that's where we ought to be. So, we went slightly the wrong way for a quarter or two, largely because of mix, particularly on baby, where baby is actually less profitable than AI. The engine of this business historically has been healthcare U.S. We're in the midst of a re-launch there, both our product and our sales approach. And as that really kicks in over the next few months and years, I would anticipate that margin moving.

Sean Finlay Steuart - TD Securities, Inc.

Great. Thanks for the context, John.

John David Williams - President, Chief Executive Officer & Director

All right. Thanks, Sean.

Operator

Your next question will come from the line of Mark Wilde of BMO Capital Markets. Please go ahead.

Mark William Wilde - BMO Capital Markets (United States)

Hey, John. I've got just a few follow-ups.

John David Williams - President, Chief Executive Officer & Director

Hi.

Mark William Wilde - BMO Capital Markets (United States)

One, just first of all, update us on sort of your paper portfolio right now. I mean, you've still got, I think, a number of smaller mills and then you've got some mills like that mill up in Pennsylvania that I think still has some small machines running. So, just kind of how you're thinking about that side of the business right now?

John David Williams - President, Chief Executive Officer & Director

Yeah. Sure. So, I mean, if you look at the mill portfolio, Mark, you've really got sort of Espanola and Port Huron as specifically technical specialty, although – and, of course, Espanola is very long on pulp, as you may know. So, what drives a lot of the earnings in Espanola is actually the pulp business. And we run those businesses actually as a small division with its own leadership, although the mill reporting system is into the main system to get real focus, because it's kind of an R&D technically-driven business, should grow around GDP, is finding life a little bit more difficult this year just because of European imports based on the currency, but is finding its way. Marlboro, now, if you think about it, is largely focused on some export on our cut size portfolio and our Appvion business, where we signed up 15-year contract, where we're getting nice volumes for Appvion, and I think we have a great partner for us and we're a good partner for them.

Johnsonburg, I think, is the mill you're referring to...

Mark William Wilde - BMO Capital Markets (United States)

Yes.

John David Williams - President, Chief Executive Officer & Director

...is actually, I think, running one machine as I see it now. Two machines, and has great leadership and is performing pretty well. And some of the specialty grades, thinking – if you call colors and things like that specialty grades, for a number of years, actually they've now been in some of our major mills. So, it's not quite as simple as saying, there are commodity mills and that's all they do these days. Some of that portfolio has moved around, so we can be competitive.

Mark William Wilde - BMO Capital Markets (United States)

Okay.

John David Williams - President, Chief Executive Officer & Director

That help a bit?

Mark William Wilde - BMO Capital Markets (United States)

Yeah. They helped a lot. All right. Second question, I think we've all watched this news around this Dollar Shave Club transaction, and I wondered are these changes in how personal care items go to the market, has that affected how you think about your strategy in this business over the last five years or six years?

John David Williams - President, Chief Executive Officer & Director

Well, I think that's a great question. So there's no doubt that you would imagine, particularly AI, is – and actually baby as well, but AI specifically, would be a strong direct-to-consumer business, right, because two reasons, if one's being honest. There's an element of embarrassment around the product and to have it delivered to home, especially if you have mobility issues, is pretty compelling. Now, interestingly, in Germany, the way that is managed is actually by the healthcare system, but then we, as a provider, do the telesales and the fulfillment.

So, actually, we already have quite a big direct-to-home model in Germany. And the debate for us is, is there something to think about in terms of a direct-to-home model in other geographies, because the kind of omni-channel approach from the retail is one thing, but can you get direct to home? And of course, you're exactly right. I think if you see Unilever to pay $1 billion for that business, it shows you that these major consumer products groups are thinking long and hard about it. And if one's being honest, one of the key attractions, of course, is there's no middleman.

Mark William Wilde - BMO Capital Markets (United States)

Yeah. Okay. The last question, John, I have is a little bit difficult, I'm sure. But can you just give us some clarification on what you're doing in Fort Mill right now versus what's up in Montreal?

John David Williams - President, Chief Executive Officer & Director

I'd be happy to, yeah. So, I sit in Fort Mill. We have a legal department in Fort Mill. The Pulp and Paper business, so Mike Garcia and his group are in Fort Mill. And then Finance, Business Development and an awful lot of services are still in Montreal. And if I'm being honest, the reason for that is, really, if we just move everything, I think all I'm going to do is incur cost. I don't think there's any particular efficiency around it. And providing everybody is happy to travel, I'm perfectly happy to keep it as it is.

Mark William Wilde - BMO Capital Markets (United States)

Okay. All right. Sounds good. Good luck in the second half.

John David Williams - President, Chief Executive Officer & Director

Thanks.

Operator

And our final question will come from the line of Paul Quinn of RBC Capital Markets. Please go ahead.

Paul Quinn - RBC Dominion Securities, Inc.

Yeah. Good morning, John and Daniel.

John David Williams - President, Chief Executive Officer & Director

Paul, good morning.

Paul Quinn - RBC Dominion Securities, Inc.

Just question on – maybe you could discuss capital allocation and your priorities here and maybe just briefly talk on M&A possibilities out there, whether that's changed over the last year or so?

John David Williams - President, Chief Executive Officer & Director

Sure. I'd be happy to. So, I mean, in the life of the policy we have today, we've given 75% of free cash flow back to shareholders. Obviously, in a world of low interest rates, it's a very strong dividend. But of course, we still have a compelling strategic issue, which is the top line of this business needs life. So, if we can find good things to do to generate growth and earnings, I think that's a key priority for us. Obviously, investing in the core paper CapEx to make certain that we run these mills as efficiently as possible. Invest in the growth in Personal Care. So, it's pretty much steady-state, Paul.

I think on the M&A pipeline, there are some interesting things that are around in the Personal Care space. Again, though, we have to make certain that we're not going to get stupid and blow our brains out. So, I'd rather walk away from things that look too expensive and overpay. I think if you overpay, it looks great at the time, but you repent at leisure. There are opportunities out there as we see it.

Paul Quinn - RBC Dominion Securities, Inc.

Fair enough. Good luck in Q3.

John David Williams - President, Chief Executive Officer & Director

All right. Thank you very much.

Operator

And it appears that there are no further questions at this time. Mr. Estrela, I'd like to turn the conference back to you for any additional or closing remarks.

Nicholas Estrela - Director-Investor Relations

Thank you, Angeline. As a reminder, we will release our third quarter 2016 results on Thursday, October 27, 2016. Thank you for listening and have a great day.

Operator

This concludes today's call. Thank you for your participation. You may now disconnect.

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