SHS
Acquisition and Bought Deal Conference Call Script
Mark
Davis
Good
morning ladies and gentlemen. Thank you for joining us on this
conference call and webcast.
Joining
me today is Vic Wells, Vice-President, Finance and Chief Financial
Officer. Vic and I will answer any questions you may have following
our remarks.
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At
the time of our IPO last year, we said our key objective was
to deliver stable cash flow and reliable and sustainable distributions.
We also said we would aggressively seek opportunities to grow
sales and earnings to increase distributions to unitholders.
We’ve
been pleased with our track record since we went public on July
18 last year. We have exceeded the IPO expectations for distributable
cash and distributions, and this has been reflected in the strong
unit price for Chemtrade and the total return enjoyed by our
unitholders, which has been well ahead of the income trust indexes.
At
the same time that we have been optimizing the returns from our
existing businesses, we’ve also been actively looking for
growth opportunities. We are very pleased that our first acquisition
is the sodium hydrosulphite, or SHS, business of Clariant International,
which fits strategically with our existing business.
As
most of you know, Chemtrade is one of the largest independent
providers of by-product removal services and a leading marketer
of these products. To-date we have focused on sulphur based products.
The two removal products that are the largest contributors to
earnings are sulphuric acid and liquid sulphur dioxide, or SO2.
We
will discuss the many strategic benefits the SHS acquisition
has for Chemtrade. Throughout this call we ask you to keep in
mind what is perhaps the most important strategic benefit. The
SHS acquisition permits Chemtrade to use the low cost SO2 we
obtain from current suppliers to produce SHS, a higher value
product for us. Further, it provides an opportunity for our current
suppliers to increase their output of SO2, which is a higher
valued sulphur product to them. SO2 is currently the highest
value/highest margin product that Chemtrade removes, so increasing
the SO2 volume will be beneficial.
Before
reviewing this acquisition, I would like to take a few moments
to restate the strategies for growth we have been pursuing, and
the criteria we look for in the various potential acquisitions
or expansions we have considered.
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Broadly,
and as stated in our IPO Prospectus and on our last conference
call, our growth strategies include:
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Expanding the group of producers to which we supply removal
services.
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Increasing the sales value of our commercial by-products by
upgrading them to higher value products.
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Expanding the products and services we supply to our end-use
customers, and
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Leveraging our core competencies in service and infrastructure.
Within
this broad strategic framework, there are a number of key criteria
we, as an income trust, look for in any opportunity.
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It must build off our existing core competencies.
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It must have stable, sustainable earnings either as a result
of contracts, the nature of the industry, or product/service
differentiation.
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It must have minimal sustenance/maintenance capital expenditure
requirements.
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Ideally, it must have further growth potential; and
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Finally, it must be accretive to existing unitholders.
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With
that background, let’s look at the Clariant transaction.
As
you have seen in the news release, we’re acquiring the
North American sodium hydrosulphite business of Clariant International
for US$62 million.
The
business we are acquiring is the largest North American producer
of SHS and one of the largest producers in the world.
SHS
is used extensively in the pulp and paper and textile industries.
Its major use in the paper industry is for bleaching mechanical
pulps and for decolorizing recycled pulp used primarily in newsprint
production.
In
the textile industry its primary use is for bleaching indigo
and vat dyes.
SHS
can be produced in both powder and liquid form which can be tailored
to meet specific customer demands. Clariant is the only producer
in North America that does both, and the only one producing powder.
The SHS business is the clear domestic market leader commanding
a 47% share of the market for SHS in North America, more than
double that of its nearest competitor. In addition, the top three
producers have an 85% share, creating a disciplined North American
SHS market.
More
than 80% of the SHS business’s sales are to the pulp and
paper industry, with the remainder to the textile industry. Although
pulp and paper prices may be volatile, production volumes are
not, generally growing slowly along with GDP. As the SHS Business
is dependent on pulp and paper volume of production, the business
has a stable and consistent demand base, very similar to the
existing Chemtrade business.
The
business has a number of competitive strengths including scale,
excellent relationships and regional manufacturing.
Let’s
start with scale. The business consists of two owned production
plants, in Leeds, South Carolina and Kalama, Washington; a long-term
tolling arrangement in Trois-Rivieres, Quebec; and two dissolving
or blending arrangements in Oshkosh, Wisconsin; and Burlington,
North Carolina. They’re top quality facilities and incorporate
state-of-the-art processes.
The
SHS business is the clear market leader with a market share over
45%. Size helps in this business. Scale allows the SHS business
to use its production capacity, broad product offering and multiple
geographic locations to meet customer needs and preferences and,
in many cases, achieve preferred supplier status.
Further,
by virtue of its size relative to competitors, the business carries
significant purchasing power enabling it to negotiate attractive
purchase prices for raw materials, solidifying its low cost position.
Next
is relationships. The business has serviced the pulp and paper
and textile industries for decades. Over that time it has developed
long term customer relationships based on the quality of its
products and an experienced, technically trained work force.
For
example, the SHS business has ongoing relationships with customers
such as Abitibi, Kruger, SP Newsprint and Georgia Pacific for
terms ranging from 15 to 25 years.
The
majority of the business’s production volume is covered
under long term agreements, with approximately 50% of volume
under contract into 2005.
The
SHS business has strategically located its facilities near its
customer base. The SHS business manufactures both powder and
liquid SHS, providing customers with choice and flexibility.
While powder can and is shipped long distances to customers with
dissolving and delivery infrastructure, liquid SHS has a limited
shelf life and is shipped ready-to-use for only short distances..
The locations of the SHS business let it readily access its customer
base and facilitates shorter order lead time and minimizes inventory
and freight costs.
We
hope that you now have at least a high level understanding of
the industry, business and its competitive strengths. Let me
now move to the strategic benefits of the acquisition.
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The
acquisition clearly diversifies our product base by adding SHS,
and it increases the number of products and services we can supply
to the pulp and paper industry which is already one of Chemtrade’s
primary customers. But, as we indicated at the beginning, this
particular acquisition does more.
As
you recall, one of our strategies for growth is to increase the
sales value of our commercial by-products by upgrading them to
higher value products. Further, our producing customers want
to increase the amount of higher value by-products they produce.
The Clariant acquisition fulfills both of these goals.
The
largest cost component, in the manufacture of SHS is liquid sulphur
dioxide, or SO2. The Clariant SHS business is the largest purchaser
of SO2 in North America, Chemtrade is the largest North American
supplier of SO2 and the SHS Business is Chemtrade’s largest
SO2 end-use customer.
SO2
is our second largest contributor to earnings , after sulphuric
acid..
Strategically
then, the acquisition will permit us to use the SO2 we obtain
from our producer customers to produce a higher value sulphur
product, namely SHS. As the SHS Business is already our largest
end-use customer today, we will have a dedicated outlet for a
large portion of our SO2.
This
significant demand base for SO2 will also be good news for our
existing principal suppliers of SO2 who would like to increase
the volumes of SO2 they produce and sell. The simple fact is
that SO2, being a higher value by-product than sulphuric acid,
provides a better margin for our producer customers, and for
Chemtrade.
In
short, the acquisition permits Chemtrade to integrate up the
value chain and provides new value Chemtrade can deliver through
its removal services to its current key suppliers of by-products.
Let
me now turn it over to Vic to describe certain financial matters.
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Vic
Wells
On
the financial side, we believe that the SHS Business acquisition
is a very positive transaction for Chemtrade and our unitholders.
The
strength of the business is obvious in the nine months ended
September 30, 2002. Revenue for this period was C$96 million,
generating EBITDA of C$15.8 million. On a historic and going
forward basis, maintenance capital has run and is expected to
be about C$3 million per year.
On
a pro forma basis the combined businesses, that is, Chemtrade
and the SHS business, would have produced EBITDA of C$36.4 million,
and distributable cash of $27.1 million, or $1.69 per unit, for
the 9 months ended September 30, 2002. Or, on a fully diluted
basis, distributable cash would have been $30.2 million, or a
$1.60 per unit for this 9 month period.
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In
terms of financing for the acquisition, it will be paid for from
the proceeds of a new issue of units, convertible debentures
and increased bank debt. The total cost of the purchase, including
costs, is estimated at $106 million. We have conservatively financed
this transaction.
As
you know, we also announced entering into a bought deal for an
aggregate of $82 million. The bought deal consists of $41 million
of Subscription Receipts and $41 million of convertible debentures
through a syndicate of underwriters led by CIBC World Markets.
The Subscription Receipts will be exchanged for units of the
Fund upon completion of the acquisition. The debentures will
carry an interest rate of 10% and be convertible into fully paid
trust units at a conversion price of $14.50 per trust unit. We
expect the acquisition and the bought deal to close concurrently.
The
balance of the purchase price, approximately $24 million will
be financed by an increase in our bank facility. This is a non-amortizing
term debt maturing on May 31, 2005.
We
continue to focus on maintaining the conservative leverage ratios
expected of an income trust. The strength of our balance sheet
continues to provide sufficient room to pursue incremental growth
opportunities.
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We
have also expanded our revolving credit line. While we are acquiring
inventory as part of the SHS transaction, we are not acquiring
the balance of the business’s working capital. Although
we do not envision an immediate draw on the line, we want to
guarantee sufficient liquidity going forward so have taken this
precaution. The line is currently undrawn.
As
I said, on a pro forma basis with the conservative leverage,
the consolidated business would have generated distributable
cash per unit of $1.69 or an accretion of over 20% for the nine
months ended September 30, 2002. Since our IPO, we have attempted
to establish a conservative, stable and sustainable distribution
policy. Accordingly, we intend to continue our policy of monthly
distributions of approximately 75% of our intended aggregate
quarterly distribution and declare quarterly supplemental payments.
Annualized,
this means that our distribution rate has increased from $1.60
to $1.76, or an accretion of 10%.
We
are pleased to announce our intention to increase the monthly
distribution from $0.10 per unit to $0.11, or a 10% increase
commencing with our January declaration. Note that the January
declaration will be payable to unitholders of record on January
31 and paid February 28.
Consistent
with our policy we expect to declare a $0.11 per unit supplemental
distribution in April following the March quarter end.
If,
as we expect, the acquired business performs in excess of this
distribution rate, and we believe the rate is sustainable, we
will again look to increase our distributions but not until that
time.
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Mark
Davis
Thanks
Vic.
To
summarize, we believe this is an excellent deal for Chemtrade.
The
acquisition fIts Chemtrade's growth strategy for a number of
reasons:
-
It is a business we know and is a clear fit with our existing
product base.
-
It increases the value of one of our key by-products, SO2,
by upgrading it to a higher value product, SHS.
-
It provides additional value for our key removal customers.
-
It expands the products and services we supply to our end-use
customers; and
-
It leverages our core competencies in service, marketing and
distribution.
Financially
it is attractive because:
-
It has sustainable earnings.
-
The business has recently been substantially repositioned and
now requires only minimal maintenance capital expenditures;
and
-
It provides Chemtrade with further growth potential as we are
supplying more products to the pulp and paper industry, a key
industry for Chemtrade.
Most
important of all, it is immediately accretive to our existing
unitholders, based on conservative leverage and payout assumptions.
Thank
you for your attention. We would now be pleased to answer any
questions you may have.
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