Q1 2005 Results Conference Call
Mark Davis
Good morning, ladies and gentlemen. Thank you for joining us for our conference call and webcast this morning.
As usual, joining me today is Vic Wells, Vice-President, Finance and Chief Financial Officer. Vic and I will review the first quarter results and I will have a few comments on the acquisition we announced earlier this week. We’ll then answer any questions you may have.
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I’m pleased to report good results for our first quarter, although, as anticipated, results were lower than last year. Our Pulp Chemicals and International segments achieved results similar to last year, but our SPPC segment reported lower earnings than 2004.
We generated distributable cash for the quarter of $11.3 million, or 48 cents per unit. Distributions declared were $10.6 million, or 45 cents per unit.
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As you know, the specific product that has faced the toughest challenges over the past year has been SHS. SHS has faced increasing raw material costs and, with respect to powder SHS, also the competitive threat of Chinese material.
On our last call, and in the annual report, we explained the initiatives we were taking to combat these pressures, primarily securing our customer base and reducing costs. The contractual arrangements we now have for the bulk of our powder SHS sales and the excellent job our team did with controlling manufacturing costs were instrumental in delivering our first quarter results.
In fact, our first quarter 2005 powder sales volumes were ahead of the first quarter last year. However, as we noted previously, we did suffer some margin compression primarily due to raw material cost increases, particularly caustic soda.
The competitive pressure from Chinese product appears to have lessened although we do not think it has disappeared. We believe the reasons include our success in securing most of our powder customers with longer term sales contracts, a customer preference for a shorter supply chain and superior service offering, and increasing costs faced by the Chinese in both production and transportation costs.
The larger issue continues to be the higher prices for caustic soda, a major input for SHS manufacture. Caustic costs were again higher in the first quarter, and we expect further increases, albeit smaller ones, in the second and third quarters before leveling out later in the year. These costs, as we noted in our last call, will have an impact on our SHS business this year, but we continue to pursue initiatives to mitigate the impact.
You will recall that one initiative was to have some of our customers ship caustic to us and pay the supplier directly. Approximately 10% of our needs are now supplied in that manner. Further, we have improved the efficiency in most of our operations to more effectively use caustic, thus reducing the amount we need to purchase. These and other efforts continue.
Demand for sulphur products, particularly acid, remained strong. While we benefited from increasing acid pricing this was partially offset by increased product cost and a reduction of the sulphuric acid volume we could have sold had we not had to build sulphuric acid inventory in preparation for the Inco maintenance shutdown later this month. The inventory will enable us to maintain supply to our customers during the three-week turnaround but since Inco did not take a similar shutdown last year, reduced the amount of product we had available for sale in 2005 when compared to 2004.
Overall, SPPC performed well but the results were below last year. Our team continues to take decisive steps to deal with both the cost and competitive issues facing SHS. Although raw material cost increases are compressing margins, when they return to normal levels we will be well positioned with a solid customer base, secure customer contracts and a more efficient manufacturing operation.
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Pulp Chemicals’ results for the first quarter were essentially level with the first quarter last year. We had hoped for additional third party sales in the first quarter that did not materialize. However, we are pleased to announce that we have now secured a new long-term customer. This customer contract should result in Pulp Chemicals being able to run at full capacity for the remainder of the year and for a number of years forward.
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Finally, BCT Chemtrade had another solid quarter, producing results level with the same period last year. Sulphuric acid markets appear to be well balanced at the moment and we expect this to continue for the mid-term.
I’ll have a few comments to make about the acquisition we completed on May 1 that is now part of the International group, but first Vic will review the financial results for the quarter.
Vic Wells
Thank you, Mark and good morning ladies and gentlemen.
Before reviewing the results, I would like to point out that the per unit amounts for distributable cash for the latest quarter and the first quarter last year are calculated using the weighted average number of units outstanding during those periods. The relevant weighted average numbers of units outstanding during the periods are detailed in the news release.
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For the three months ended March 31, 2005, cash available for distribution was $11.3 million, or 48 cents per unit, generated from revenue of $80.9 million and EBITDA of $13.4 million. In the first quarter last year, distributable cash was $12.3 million, or 54 cents per unit, revenue was $80.9 million, and EBITDA was $15.1 million.
Net earnings for the first quarter this year were $4.2 million compared with $6.2 million last year.
The principal reasons for the decrease over last year are raw material cost increases at Performance Chemicals, higher product costs and inventory build at Sulphur Products, and foreign exchange.
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Looking at the segmented results, SPPC generated EBITDA of $9.5 million in the first quarter compared with $11.6 million last year. The major reasons for the decline were increased raw material and product costs, and the acid inventory build in preparation of Inco’s maintenance shutdown. SPPC’s decrease in revenue is primarily a result of foreign exchange and the holding of the additional acid inventory. Recall that our hedging policy, which I will discuss in a minute, hedges cross border cash flow not U.S. dollar revenue. Accordingly, the increased value of the Canadian dollar in 2005 vs. 2004 adversely affected the revenue line and SPPC EBITDA.
Pulp Chemicals reported EBITDA of $5.1 million for the quarter, which was unchanged from last year. Although revenue was lower than last year, due largely to lower sales to third parties, margins were improved, resulting in EBITDA in line with 2004. With the new third party sales contract now in place, we expect volumes for the remainder of this year to exceed 2004 volume.
BCT Chemtrade’s results were level with last year, reporting EBITDA of $1.4 million. Once again revenue was significantly higher than last year, but because BCT Chemtrade matches contracts for buyers and sellers, the margins remain relatively constant.
Corporate costs for the first quarter improved to $2.6 million compared with $3 million last year.
The demand for our products remains strong. We expect to continue experiencing increases in raw materials pricing, particularly caustic soda for the next three to six months. In the second quarter we will incur our annual maintenance shutdowns in Pulp Chemicals and Performance Chemicals. Additionally, our major sulphur products supplier will take its scheduled three-week maintenance shutdown. These shutdowns will reduce our supply of products to the market in the second quarter. However, we should continue to benefit from higher acid prices, better Pulp Chemicals volumes and the RS acquisition Mark will be describing.
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Finally, a comment on foreign exchange.
At the Fund’s expected exchange rates in 2005, we estimate approximately 40% of both EBITDA and distributable cash will be generated in US dollars. To manage the predictability of our cash flows, we have entered into a series of foreign exchange contracts that hedge that portion of Chemtrade’s U.S. dollar based cash flow that is expected to be converted into Canadian dollars. As of April 30, 2005, approximately 85% of planned transfers for the remainder of 2005 and 21% of 2006 planned transfers have been effectively hedged.
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I’ll now hand the call back to Mark.
Mark Davis
Thank you, Vic.
We were pleased with our Team’s efforts to deliver the first quarter results. However, as you have heard, there remain a number of external challenges that will continue to have an impact on the business this year. The biggest challenge continues to be increasing caustic soda prices. While the pace of the increases is expected to slow over the next two quarters and stabilize later in the year, any increases will affect us. However, we should continue to benefit from higher acid prices, increased Pulp Chemicals volumes and increased operational efficiencies.
Looking beyond this year, there are some encouraging signs. Two new chlor-alkali plants that will add capacity are under development, with one of them expected to start up in early 2006. The experts continue to predict lower prices in 2006 and still lower in 2007. In the meantime we are working to strengthen our businesses.
We are continuing to look at ways to mitigate the impact of caustic prices, and at the same time aggressively manage other costs. As I said earlier, the Chemtrade Team has done an outstanding job in this regard and will continue seeking ways to improve efficiencies.
Our drive to lower costs is being applied in all our operations and we’re pleased with what we have been able to achieve.
We also remind you, that in 2006, we expect higher volumes of sulphur products as our main supplier meets more stringent environmental regulations, Pulp Chemicals should operate at capacity for the full year possibly at higher chlorate pricing as there are signs that the chlorate market continues to tighten, and we have improved our international business.
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As we have said since our IPO, we continue to grow our businesses.
The acquisition of Ruhr Schwefelsäure GmbH and its subsidiary Ruhr Transport GmbH that we announced on Monday are a great addition to our International business. I would like to take a few minutes now to expand on what we have said to date.
RS is the leading sulphur removal company in Germany and, like our other acquisitions, it meets our objective of broadening our sources of earnings and distributable cash.
Although BCT Chemtrade is based in Europe, it operates primarily in global markets. Its products, sulphur and sulphuric acid, are obtained through removal services contracts with customers in Europe and South America, but for the most part are then exported to non-European end-use customers throughout the world, particularly in South America.
For some time, we have been looking for a complementary European business, and RS is an excellent fit. The majority of RS’s earnings are derived from the removal and sale of liquid sulphur from various oil and gas industry desulphurization plants in western and central Europe. RS has a 20% share of this total market. In Germany, which accounts for a bit less than one-third of the total European market, RS has a 36% share, making it the leading removal services company by a comfortable margin.
The balance of RS earnings are derived from the removal and sale of sulphuric acid, primarily in Germany, where the company has an estimated 18% share of the market. Of the total volume of sulphuric acid handled by RS, about half is from involuntary production such as copper and zinc smelters, and the balance from merchant producers and sulphur conversions.
The company has an impressive customer list, with sulphur removal customers including oil refiners such as BP, Shell and Exxon. It has long-term intake contracts with these customers, including one accounting for 35% of its volume that is in effect until 2017.
On the sales side, customers include Bayer, Degussa and BASF.
The combination of our existing business and RS will create the largest European operator in the industry, but more importantly, it provides us with a more diversified and balanced portfolio in Europe. As part of Chemtrade, RS will have improved access to international markets for sulphur and sulphuric acid, and the combined logistics operations of their trucks and trailers and our storage facility at Rotterdam, should produce cost savings for the group.
We’re pleased with the acquisition of RS. It will be immediately accretive for unitholders, and provides an excellent base for pursuing additional opportunities to increase earnings and distributable cash from our international operations.
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Thank you. Vic and I would now be pleased to answer any questions you may have.
MARK DAVIS (President and Chief Executive Officer): Operator, Vic and I will now be pleased to answer any questions.
OPERATOR: Thank you. One moment, please. Ladies and gentlemen, we will now conduct the question-and-answer session. If you have a question, please press the * followed by the 1 on your touchtone phone. You will hear a tone acknowledging your request. Your questions will be polled in the order they are received. Please ensure you lift the handset, if you are using a speakerphone, before pressing any keys. One moment, please, for your first question.
Your first question comes from Horst Hueniken from Westwind Partners. Please go ahead.
HORST HUENIKEN: Good morning gentlemen.
MARK DAVIS: Horst.
HORST HUENIKEN: I have three questions. The first one relates to caustic prices, could you tell us what you’re budgeting for 2005 and 2006 by quarter?
MARK DAVIS: I don’t recall to be honest. We had anticipated pricing was going to go up in the first and second quarters, and then level off for the balance of the year.
HORST HUENIKEN: Okay.
MARK DAVIS: And we expect it to start coming down in ’06, but not aggressively, right?
HORST HUENIKEN: Okay. All right, I’ll work with that. Second question, another raw material we understand is important to follow is sodium formate; are there any issues with regards to rising costs there, given limited suppliers?
MARK DAVIS: No, in fact, probably the contrary, but the way it works is that sodium formate is a byproduct of a process that makes something called pentaerythritol, which means that the producers of pentaerythritol need to have and market sodium formate.
HORST HUENIKEN: Umm, okay.
MARK DAVIS: And we are a large buyer of sodium formate.
HORST HUENIKEN: Okay. So, there’s not another cost squeeze there obviously. Third question, we’ve heard rumours in the pulp and paper industry from (?), for example, that they’re starting to look offshore for pulp supplies as costs are getting higher in North America, is that influencing your strategic direction for your firm?
MARK DAVIS: It’s something that we watch, and it depends on what they’re looking for. I think we’ve talked about this before, people have the tendency to lump the pulp and paper industry into one big block, and you have to take a look at what you’re talking about.
I don’t think that anyone anticipates another pulp mill ever being constructed in North America, but I don’t think anyone actually is targeting a great reduction in pulp throughput in North America either. Having said that, for our current pulp chemicals business most of our product isn’t directed towards paper, but is directed towards pulp.
HORST HUENIKEN: Okay, alright. Okay, that’s all for me. It was good to see the numbers come in as expected. Thanks.
MARK DAVIS: Thank you.
OPERATOR: Your next question comes from Chris Blake from Scotia Capital. Please go ahead.
CHRIS BLAKE: Good morning guys.
MARK DAVIS: Hi Chris.
VICTOR WELLS (Vice President, Finance and Chief Financial Officer): Good morning Chris.
CHRIS BLAKE: A couple questions, first of with the acquisition of RS, could you comment on the revenues and EBITDA contribution?
VICTOR WELLS: Revenues will be, give or take 40 million euro range, and, frankly, for some competitive reasons, we haven’t really disclosed what the EBITDA basis is. What we have actually said is that we bought the Performance Chemicals business at about 5 times EBITDA, the Pulp Chemicals business at about 6 times EBITDA, and we bought this business on an EBITDA basis at a better rate than either of those.
CHRIS BLAKE: Okay, that’s great. Now, with respect to the cash flows from this acquisition, are they hedged at all, are you planning on hedging the currency effect?
VICTOR WELLS: We will, but as of now they’re not.
MARK DAVIS: That’s right.
CHRIS BLAKE: Okay. And, back to the caustic soda, could you comment on, do you believe the caustic prices, in your crystal ball going forward, are price increases that you expect are ahead of the expectations from say maybe the beginning of this year or last?
MARK DAVIS: I think they’re pretty much bang-on, as we’ve been saying, as you know, for months now, or quarters now, that we expected it to keep on increasing through the year, and we’ve been tracking pretty well where we thought we would be.
CHRIS BLAKE: So, you don’t see any impact of lower energy prices flowing through the caustic side at all?
MARK DAVIS: Not yet, cause I’m not sure that natural gas has taken a big downturn, and you know, well, we’ve explained here, in our view anyway caustic price is being driven by not just natural gas, but by some capacity curtailment this year, and a hot US economy. So, you know, you put those three combinations in, and that’s what’s driving price. So, even if natural gas came down short-term, I don’t think you’re going to see breaks from the caustic guys short-term. I think it’ll take a while.
CHRIS BLAKE: Okay. Now, some users of caustics have indicated that they may, if they can, switch over to soda ash as an alternative, is that a possibility for Chemtrade?
MARK DAVIS: It is something we’ve looked at. It is feasible, but not economically feasible for us to do that in the short-term. If we had a belief that caustic price was going to continue to rise and stay at an elevated level for a long period of time, that is something that we know how to do; even right now it doesn’t make economic sense unless you think prices are going to continue going up for years.
CHRIS BLAKE: Okay. That’s it for me. Thanks.
MARK DAVIS: Okay.
OPERATOR: Your next question comes from Petro Panarites from CIBC World Markets. Please go ahead.
PETRO PANARITES: Good morning. Just a couple of questions, first, how many tonnes of caustic soda did you procure during the first quarter?
MARK DAVIS: Well, we buy about 20, 22, say we buy 22,000 for the year, our second quarter is our, would be our lowest purchases, cause we take our big shutdown then. Our third quarter is when we run highest, so it would be the most then, right?
PETRO PANARITES: So, about average then in Q1?
MARK DAVIS: Yeah, I would say that; probably average.
PETRO PANARITES: Okay. And the second question, given that you do expect turnarounds coming up here in the second quarter, how would you essentially, you know, sort of proportionally speaking distribute annual cash flow between the four quarters?
MARK DAVIS: Well, I think if you look at what we’ve done, our second quarter has always been our lowest quarter of distributable cash flow. Our second quarter has always been our lowest quarter. So, again, percentage wise is, frankly, I haven’t looked at it that way. Last year, you know, the first half of the year and second half of the year were relatively equivalent, right?
PETRO PANARITES: Okay. Relatively equal in first half and second half?
MARK DAVIS: Yeah.
PETRO PANARITES: Great. Thank you.
OPERATOR: Your next question comes from Damir Gunja from TD Newcrest. Please go ahead.
DAMIR GUNJA: Good morning. On the Pulp Chemicals, how much capacity did that new contract sort of fill out, and I guess, what were you running at before, just trying to get a sense of the lift?
MARK DAVIS: And, frankly, it’ll be hard to do that because what it really does is, is it takes any operating variability that Canfor, I shouldn’t say any, it takes most operating variability Canfor has and fills it up, so we were already operating at, I don’t know, call it 95 percent capacity utilization, so this is the extra 5, but you won’t actually get all of the extra 5, because it’s not, you know, you can’t do this stuff instantaneously. So this is worth good money to us, in the, you know, hundreds of thousands of dollars, but it’s not going to be another million, right?
DAMIR GUNJA: Okay, thanks.
OPERATOR: Your next question comes from Lorraine Gloster from McFarlane Gordon. Please go ahead.
LORRAINE GLOSTER: Yes, I wondered if you can just comment a little bit more on that caustic soda; you had said that you were getting some of your customers that were delivering caustic soda to you, I was wondering, what is the advantage for them to do that, do you give them, do they have a better, I don’t know, a bigger maybe purchase of caustic soda than you would have that gives them a better price, or what would be the, what would be the driver for them to do that?
MARK DAVIS: Yeah, that’s right. It is, I mean, we buy, you know, 20 to 22,000 tonnes of caustic soda, which is a nice size buy. Having said that, an average pulp mill will, a single pulp mill will buy that much, or a pulp and paper mill. So, you know, if a customer buys infinitely more than we do, we believe, and he believes, he can buy it better, so we let him buy it, deliver it to us, and adjust the pricing accordingly.
LORRAINE GLOSTER: Have you gotten others to, or do you think you’ll get others to follow suit, and the ones that you have the 10 percent, is that, is that just for a short-term, or is, are those now kind of locked in for the next year or two in which they’re going to go with that arrangement?
MARK DAVIS: I’m not sure if we’re going to get more, cause we took a pretty good kick at it, but it’s not a short-term thing. It’s at least a couple years.
LORRAINE GLOSTER: Okay, so those ones that have gone that route will be that way?
MARK DAVIS: For at least a couple years.
LORRAINE GLOSTER: Okay. And then on RS, what is the main, like annual maintenance Capex for that operation; just the maintenance part of it?
MARK DAVIS: Yeah, they maintain a bunch of trucks. It’s probably, you know, call it 300,000 euros.
LORRAINE GLOSTER: 300, okay. And then, just lastly, on that new contract with Pulp Chemicals, when does that take effect, was that signed in Q1, or was it signed in Q2?
MARK DAVIS: You would have seen no effect from that in Q1, and it’ll come in during Q2, so we don’t get the full benefit from all of Q2, but by the end of Q2 we’ll get it.
LORRAINE GLOSTER: Okay, that’s it for me. Thanks.
MARK DAVIS: Okay.
OPERATOR: Your next question comes from Gerry Hannochko from National Bank Financial. Please go ahead.
GERRY HANNOCHKO: Oh, hi guys. Just a quick question, maybe if you can quantify some of the cost savings that you’ve been able to achieve in your network with regards to trying to squeeze some costs out of it and improve your margins?
MARK DAVIS: I won’t quantify them for you, but I’ll tell you what some of them were.
GERRY HANNOCHKO: Okay.
MARK DAVIS: We’ve had a headcount reduction in our SHS business. We’ve improved the efficiencies of some of our operations thereby using less chemical inputs. We have negotiated a reduction in prices of certain raw material inputs, obviously not caustics, but certain other ones, and those would be the big hitters.
GERRY HANNOCHKO: Okay, thank you.
OPERATOR: Ladies and gentlemen, if there are any additional questions at this time, please press the * followed by the 1. As a reminder, if you're using a speakerphone, please lift the handset before pressing the keys.
Your next question is a follow-up from Damir Gunja from TD Newcrest. Please go ahead.
DAMIR GUNJA: Oh, hi. Just looking out to ’06, in terms of the potential increased volumes of, of sulfur, do you care to kind of give a range of magnitude there?
MARK DAVIS: We think it’ll likely be about 60,000 tonnes; that is, by January 1, 2007. They have to capture enough extra gas to produce about 90,000 tonnes, so they ought to be actually working towards that in the latter half of ’06. So, whether or not it’s, you know, 50, 60, or more will depend on their comfort level of being able to throw the switch Jan. 1, so we think it’s probably about 60,000.
DAMIR GUNJA: Thanks.
OPERATOR: Mr. Davis, Mr. Wells, there are no further questions at this time. Please continue.
MARK DAVIS: As usual, thank you all for your interest, and we look forward to talking to you either next quarter or at the end of our annual meeting. Thank you.
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