Fortress Paper Ltd. (OTC:FTPLF) Q2 2016 Earnings Conference Call August 9, 2016 12:00 PM ET
Yvon Pelletier - CEO
Kurt Loewen - CFO
Chad Wasilenkoff - Executive Chairman
Axel Wappler - CEO of Landqart
Bryan Fast - Raymond James
David Shapiro - Venture
Andrew Shapiro - Lawndale Capital Management
Tom Bernard - Private Investor
Dave Gibbons - Private Investor
Good morning, ladies and gentlemen. Welcome to Fortress Paper Limited’s Quarter Two 2016 Earnings Conference Call.
I’d like to introduce Kurt Loewen, Chief Financial Officer. Please go ahead.
Thank you, operator and welcome to Fortress’ second quarter 2016 conference call. With me today are Yvon Pelletier, our Chief Executive Officer, Chad Wasilenkoff, our Executive Chairman and Axel Wappler, our CEO of Landqart.
Yvon will provide an overview of our operating highlights and discuss both the Dissolving Pulp segment followed by an update on the Security Paper product segment by Axel. I will then present a brief summary of our financial results and balance sheet. Yvon will finish followed by questions from the floor.
Throughout the call, reference may be made to slides of the presentation, which has been made available for reference through our website at www.fortresspaper.com in the Investor Relations tab. During the call, management may make certain forward-looking statements that reflect the current views and/or expectations of Fortress with respect to its performance, business and future events. The forward-looking cautionary note contained in the MD&A is applicable for today’s call.
During this conference call, management will make reference to operating EBITDA and adjusted net income or loss. For a definition of operating EBITDA, reconciliation of net income to operating EBITDA and calculation of adjusted net income or loss, please see the management’s discussion and analysis available on SEDAR at www.sedar.com.
Yvon, over to you.
Thanks Kurt and good morning, everyone. Overall results are much improved over to prior quarter and prior year. Although the second quarter results of Thurso were below management expectations, the trend is positive and encouraging.
Despite the decline in average realized U.S. dissolving pulp price due to market fluctuation and unfavorable U.S. exchange rate in the second quarter compared to first quarter, operating cost contributed to much improved results.
Production cost were in the low $800 range for June. The third quarter has started well with July production cost also in the lower $800 range and co-generation revenue back on tract.
We look for continued improvement at the mill from our lean Six Sigma project team, which are already improving cost and reliability at the Thurso operations.
At our Landqart mill overall performance continues to meet management’s expectation. The Landqart sales lease back of land and building combined with the LSQ sales have provided for improved balance sheet flexibility to manage obligation and seek organic and/or strategic growth opportunities.
Looking more closely on our consolidated results on Slide 3, you will see that Fortress Paper reported 2016 second quarter operating EBTIDA of $6.3 million a $5.2 million improvement over the prior quarter.
The Dissolving Pulp Segment generated operating EBITDA of $3.2 million and the Security Paper product segment generated operating EBITDA of $4.7 million. Corporate cost included in operating EBITDA were $1.6 million.
Moving to Dissolving Pulp Segment results on Slide 4, the result of the second quarter 2016 were favorably impacted by increased production and sales.
In the second quarter of 2016 the FSC mill production cost including amortization of some of the shutdown cost and the positive impact of cogeneration facility averaged $878 per air dried metric ton of dissolving pulp produced, excluding the cost of the plan two-day shutdown.
On Slide 5, you will see the company sold 39,931 air dried metric ton of dissolving pulp in the second quarter of 2016 compared to 31,762 in the first quarter of 2016.
FSC mills held finished goods inventory consisting of 1,487 air dried metric ton of dissolving pulp at the end of the first quarter, slightly below the 3,254 air dried metric ton at the end of quarter one.
Dissolving pulp price has been improving since May 2016, although results continue to be impacted by the current dissolving market, management believes that improving market conditions, a relatively favorable foreign exchange rate to the U.S dollar and anticipated improvement in production cost will positively impact results at the FSC mill.
On Slide 6, the broader industry trends are mainly positive. Viscose staple fibre and rayon filament markets, which are key drivers in dissolving pulp demand have experienced improved supply-demand balance and improved pricing since bottoming in 2015.
Rayon filament has maintained consistent pricing in 2016, which is 7% above 2015 low. Viscose staple fibre price in July 2016 are higher by approximately 19% over the prior year and approximately 29% from the 2016 low in January.
We expect improved viscose staple fibre and dissolving pulp pricing through the third quarter of 2016 in part due to increasing demand in yarn and textile market. Dissolving pulp and viscose staple fibre price have increased by $40 per ton and $535 per ton respectively from their lows in early 2016.
Pulp price improvement continue to put upward pressure on all fibre pricing. Also during the quarter, our collective agreement with the unionized employee at the FSC mill that expired late April was renegotiated and the union membership has voted in favor of the new collective agreements. So we put this element behind us also.
On Slide 14, there are further detail on the transaction for the sales of Fortress Global Cellulose mill asset for the aggregate purchase price of $15.4 million that completed on July 27.
Axel, will now comment on the Security Paper product segment.
Thank you, Yvon and good morning, to everyone. On Slide 7 the Security Product segment had operating EBITDA of $4.7 million compared to $1.8 million in the previous quarter due primarily to product mix.
Results at the Landqart mill year-to-date were consistent with management expectations. A new piece of equipment for the finishing line has been ordered to eliminate the main bottleneck at the mill in order to increase finished product capacity by up to 15% depending on product mix by the third quarter of 2017.
Capital expenditure for the project is estimated at $4 million Swiss Francs of which the majority is finance. Sales tonnage of 2,714 for the quarter was a slight improvement over the previous quarter. Security Paper production include bank notes, which result in varying degrees of cost to margins depending on the complexity of the security features included.
On Slide 13, there are further details on the sale of these types of land and building at the Landqart mill by the aggregate purchase price of Swiss Francs $44.5 million.
Kurt, will now provide financial review.
Thanks, Axel. On Slide 9 you can see that sales are higher in both the first quarter of 2016 and the prior year comparative quarter. Sales orders in the order backlog in both segments continue to show strength. Also on Slide 9 and 11, our available cash balance decreased from the prior quarter.
The main uses of cash were debenture interest and debenture repurchases, CapEx and a $3 million net increase in non-cash working capital.
By June 30, 2016, the company had repurchased $2.4 million face value of our debenture due December 31, 2016. Subsequent to the quarter end the company continued to purchase this debenture and has now fulfilled the $4 million maximum committed under the normal course issuer bid.
Working capital increased by $17.4 million from the first quarter because both the sale lease back and LSQ sale closed subsequent to the quarter end, we had to classify associated assets and liabilities has held for sale.
The net impact on working capital was an increase of close to $40 million for that somewhat offsetting this was the inclusion of $27.6 million primarily represented by our $25 million debenture due mid 2017 moving from long term debt to short term.
The remaining movement is explained by the net decrease in inventory increase accounts receivable and decrease in accounts payable.
Moving to Slide 10, to present an overview of SG&A expenses which were $11.6 million in the second quarter of 2016. SG&A expenses were lower during the quarter due to the capitalization of transaction cost related to the deals closed subsequent to the quarter end.
Included in SG&A for the second quarter was 372,000 related to ongoing maintenance and other cost incurred at Fortress Global Cellulose which has been sold subsequent to the quarter end. We expect to track around the $12 million quarterly on an ongoing basis.
On Slide 12 we have a schedule of our upcoming principle repayments as of June 30 based on our anticipated EBITDA growth, current cash proceeds from the sale and lease back transactions at the Landqart mill, free cash flow conversion, working capital requirements and other cash generating initiatives, we believe we are well positioned to service our debt, reduce our leverage and enhance our balance sheet metrics over the remainder of the year and beyond.
Yvon now back to you.
Thanks Kurt. Looking ahead we anticipated to continue to build on the positive development and focus on two key areas. First continued to improve the productivity operational efficiency and cost reduction at our Thurso mill by continued implementation of the lean Six Sigma management protocol which has already delivered proven result at our Landqart mill in his consistent with the execution of our strategic plans.
Second managing a much improved balance sheet in a strategic manner to announce, shareholder value, while preserving our financial flexibility to pursue value enhancing opportunities. In summary although overall result are lowered in our expectation that trend is positive and we fully expect this to continue.
Thank you for your time. The financial result and management discussion analysis are available on SEDAR at www.sedar.com.
I will now ask the operator to open the call to your questions.
[Operator Instructions] So the first question comes from Bryan Fast from Raymond James. Go ahead.
Hey guys. Just to start off here, what can we expect from maintenance downtime in the coming quarters and secondly, I know it’s still few months away but any indication of what -- we're seeing 2017 CapEx trending?
Yvon here, I’ll answer the first question and I’ll ask Kurt to review the CapEx. This quarter there is no planned shutdown. The next planned outage is in Q4. We have eight-day annual maintenance outage.
And sure, I'll touch on CapEx, for maintenance CapEx, we typically have been trending and tracking to approximately $8 million as a group for the mills per year. So that’s mandatory spend that will have each year, typically it’s been about $5 million at Thurso and $3 at Landqart. So, that’s again expected in 2017.
Aside from that, there will be other projects that we'll assess that we'll have -- we'll be looking at paybacks and looking at various sources of funding for these projects, but have a good return.
To quantify it now might be premature, but certainly we'll provide further guidance as we progress on some of these projects that I think Yvon may touch on during the call here.
And having said that, when you look at our history like 2015, 2016 typically, CapEx when you look at maintenance CapEx and project CapEx, we're around the $15 million, $16 million mark. So that combined CapEx is probably a good figure to try to forecast with at this moment. Does that help?
So the second question comes from David Shapiro from Venture. Please go ahead.
Hello. Just had a question, two questions, one regarding your thoughts surrounding your 2019 bond activity and if there is any opportunity to further go down the line on that given the large cash infusion and having some foresight probably into retiring the 2016 and 2017 issues?
And then the next question would revolve around what capacity you're seeing coming back on to the global dissolving pulp markets or if you're seeing any anticipated significant capacity coming in the next year or two in response to the improvement in price outlook?
I'll take the first part of the question there, the one tied to the debentures in 2019. We do have a normal course issuer bid that does permit us to buy up to 10%. So needless to say we will be looking at opportunities and assessing the best return for multiple projects and one of those returns would be looking at where that's trading and if there is opportunity to repurchase up to 10% we will look to do so.
Having said that, we will continue to monitor how those are performing and what sort of returns there could be beyond this year as well. So, there may be opportunities in 2017 to look to purchase into '19 as well. So I'll pass the second question to Yvon.
Thanks David. From a capacity standpoint as you know, we had a few mill -- swing mills that were in the market over the last couple of years that came converted, but some of them didn’t produce very much dissolving pulp.
As of today, our understanding is that most of that capacity is now in the market and serving the demand for dissolving pulp market.
As far as we can see, as far as we know and what we can see there is no new capacity that has been announced really until sometime in 2018 and those that have been announced are still going through experimental permitting process and apparently have challenges on that aspect.
So right now looks like 2017 and early 2018 not much capacity will be coming in and most of the current capacity will be servicing the improving demand for the market. So that is why we are getting fairly both positive about the market.
Thank you so much. I will jump back into queue.
All right. So the next question comes from Andrew Shapiro from Lawndale Capital Management. Please go ahead.
Hi I was wondering if you had some insights or some industry feedback on the timing or visibility for modification of the MOFCOM tariffs and dissolving pulp or if you can update us on the Canadian government efforts or progress to get repeal the tariffs and anything going on at the WTO compliant on the China tariffs?
The WTO process it was announced by the Canadian government is proceeding, it is proceeding as per their plan but we are not expecting anything coming out of that process until 2017.
As far as MOFCOM is concerned on the ground, we haven’t heard anything really or discussion or anything from China regarding tariff to our business for since last year. So there hasn’t been any pretty thing out there right now.
Okay. Great. Nothing else. Thank you.
Thanks. Since we don’t have any more questions, actually one just came in, it comes from Tom Bernard from Private -- he is a Private Investor. Please go ahead.
I have a couple of questions, number one the digester problems that we've had at Thurso that is Yvon you indicated that that is a priority going forward and I'm just wondering how that is performing and what your specific intentions are for improvement and how confident are you that that will perform when weather gets cold?
There is three level of actions in that area, we've had as you recall the blockage issue, which has been a repetitive issue since the start of the mill and following the action that we implemented in Q1 the blockage issue has not been an issue at all. So we basically believe an indication of this one is behind us.
As far as the winter slowdown in productivity, we have now also developed an action item that is being put in place as we speak to improve significantly the productivity during the winter time.
So we expect that problem to be improved significantly maybe not to the full potential but significantly this coming winter and the third aspect of which we're working on is basically the addition of a new digester.
This project has two objectives, one is to improve to give us more flexibility in our production department, production department and secondly to utilize underutilized species from our wood basket, there is some issue with some wood that because of the limited capacity today, we're not able to consume and that wood is available and the governments, the different governments are working with us right now to develop a project to have possibly in this project and allow the utilization of those species.
So we are working right now with the government to on the program to help put in place the new digester and we will know that answer by basically end of Q3 or early Q1. And this digester when the project is decided internally would not be running until late 2017, so the late 2017 start up timetable.
How much will the cost?
Well the cost is -- the cost from a dollar standpoint is $15 million to $20 million but right now there is already a program in Quebec that is available for that would take care of 40% of the cost and we're working to finalize with the industry transformation program at the Federal level that could also bring significant capital for that project.
So the cost will be finalized when we have all the answer the net cost Fortress will be finalizing when we have all those answer between now and Q3, early Q4.
And in terms of tons, what kind of capacity do you think that would add at Thurso?
Like just by the digester capacity itself would be an additional 25 plus percent but from an overall mill standpoint, it would more likely materialize in more of a 10% short medium term 10% and would give us the possible to continue to develop and above other areas.
And what do you getting paid for dissolving pulp today, what is the price?
The transaction price, the published price is ADT as of today, it is up $50 from the low point in 2016 which was 830. If you compare our transaction price right now, it is about $10 below the published price.
Okay. So $860 and then moving over to Landqart the mix improved dramatically this quarter and for the second quarter and I presume that is more Durasafe, how does the mix look in the current quarter?
Axel, do you want to take that?
You mean the current quarter?
I would say that the mix structure is not very transparent to us because it depends sometimes from delivery terms with customers, they can sometimes switch between one way or the other, so we look only for the whole year and at the end of the year and for that reason we are -- the visibility for that part for us is good and we think that at the end of the year, we can meet expectation from the market.
Okay. Last question, given the cash, sitting in the bank wouldn’t it be prudent to go after the 2019's more aggressively in the open market to eliminate that or cut in to that big at the end of 2019 and still require the securities at reasonable discount?
Yes as mentioned within our normal course issuer bid, we can repurchase up to 10% and depending on where that bond is trading will determine how active we will be.
What about the tender?
Probably the consideration, but at this stage we will be working within our insight, at the end we can assess that as we progress the business.
What is the negative area quarter to just have that cash on the balance sheet while you are paying 7% on the converted?
I mean it is negative carry for sure but it is also competing uses and good positive returns for different projects out there that we have to assess and analyze internally to get the best return on that cash.
We have two additional questions the first one comes from David Shapiro from Venture. You can go ahead.
Thank you. Just a point of clarification and follow up to your previous comments, excluding the possibility of installing the new digester, where do you see the mill capable of producing as you implement more efficiencies, but assuming you do not go ahead with a new digester is the low 800s about as good as can be expected from the mill without a new digester, and only producing maybe one 160,000 tons or do you expect that can even be further approved -- improved upon?
Where without the additional digester, the mill will continue to progress into the I mean stabilizing the low-80s and slowly get up mid-80s, but to get beyond that we’ll need the new digester.
And the cost associated with it will get more stable in the 800s at the mill level and with slowly grinding down with other projects here and there to reduce costs especially in the energy side.
Okay. And then a quick clerical follow-up on your slide with the debt amortization as of the end of June, does this include the impact of the deferment and the elimination of certain debt payments associated with the recent transaction or is that table not reflective of the IQ loan deferments and repayments?
Which table are you looking at, I just scrolling it?
Let's see the table on page 12.
Right, I know that is not incorporate those changes yet.
Okay, thank you gentleman.
The next question comes from Dave Gibbons, he is a private investor. You can go ahead.
Yes, thanks. Yvon you spoke about that the digester gave visibility on that, I had one other question around this new equipment on the Landqart side that could increase capacity price up to 15% could you speak to that as well.
I’ll ask Axel to comment.
Yes, thank you. About 15% what we have and -- 15% is more or less because it really gives increased operational flexibility and improved quality efficiency and reliability, this is the main reason why we’re you doing this. And we expect that this will help us in our total performance of the mill if the main aspect.
So if in most recent quarter where you shipped 2.7 million tons with that?
So you can move that up to upwards of three million if you were running at full capacity?
We have to be -- we have to consider that depending on product what you have. It has a different need of the finishing capacity, you have some products in some more income life and that's why it's related to product mix.
You cannot just make a relation from one to one to say we have an increase of that it really depends on the product we expect makes a little bit complicated.
Okay. Okay. The other question just more around kind of competitive insight with dollar rule bidding U.K. based, I mean are you seeing any impact into them in the market that can’t be in the value from late June onwards are they bidding low at a capture more market share to kind of maintain a product mix, margin mix?
No from our side we do not see that it's going to be a big change due to the Brexit situation and because the market or the market partners are still behaving the same way.
So I think at the moment it's too early to say what kind of policy and really see out of the financial politics that we will have, and what impact is going to be on the market, at least we can say today based on what we have seen there were no significant impact on the market.
Okay. Thanks. That’s all I had.
Perfect. We do not have any more questions. [Operator Instructions] Thank you.
All right. No more questions.
Thank you for your question and continued support. We look forward to updating you on our result in the near future. Good day everyone.
Ladies and gentlemen this concludes Fortress Paper Limited’s quarter two 2016 earnings call. Thank you for your participation. And have a nice day.
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