Q3 2007 Results Conference Call
Mark Davis
Good morning, ladies and gentlemen. Thank you for joining us for our conference call and webcast this morning.
Joining me today is Rohit Bhardwaj, our Chief Financial Officer. We want to review several things today. We will review the third quarter results, update you on the strength of our foreign exchange and bank loan positions, and finally, summarize the findings of our strategic review. After these reviews we’ll answer any questions you may have.
Before I commence the review, I would remind you that our presentation contains forward-looking statements that are based on current expectations, and are subject to a number of uncertainties and risks, and actual results may differ materially. Further information identifying risks, uncertainties and assumptions can be found in the disclosure documents filed by the Fund with the securities regulatory authorities, available at www.sedar.com.
I’ll start with our third quarter results. We had good overall results in the quarter with very strong results in the operating segments. Distributable cash after maintenance capital expenditures was 42 cents per unit. As you know, we paid out 30 cents during the quarter. The results show the strength of our operating performance since the 42 cents was earned even after incurring almost 4 cents per unit of corporate costs relating to our senior management change and the strategic alternatives review. Rohit will describe these costs later.
Overall, our operating groups generated EBITDA that was $4.1 million higher than the third quarter last year. The Sulphur Products & Performance Chemicals segment was the key driver for our strong third quarter results. Our other business segments also performed well, although Pulp Chemicals was again impacted by higher input costs, particularly salt, which we have discussed before.
Regarding SPPC, there are two things I’d like to discuss. First, the reasons for the significant financial improvement in this segment; and second, the successful repositioning of our SHS products.
The financial results were driven by increased volume but more importantly a significant increase in pricing for all of the group’s acid products – merchant, regen and ultra pure. Supply demand characteristics for all our acid products are very strong. Further, as you know, we have been spending additional capital on our Beaumont and Shreveport facilities to enhance operating reliability. The plants operated well this quarter, which gave us the opportunity to respond effectively to the increased demand for product.
The further good news is that we anticipate that demand for merchant, regen and ultra pure acid will remain strong for the balance of this year, and throughout 2008.
Secondly, I want to mention the results of the various initiatives we took to reposition our SHS business, including the closing of our Leeds powder facility, entering into the long-term agreement with ZhongCheng, and the acquisition in May of the Olin assets. These actions have greatly stabilized both our business and the industry. The financial results will become more evident as time passes. But for the significant increase in net zinc costs this quarter versus the same period last year, the improvement in financial performance would have been material. It has been a difficult process to get to this point, but we are confident we have taken the right steps to optimize the returns from this business.
Pulp Chemicals also operated well and selling prices for sodium chlorate continued to move higher, although input costs were higher than last year, primarily because of increased salt costs. Improving selling prices in the market benefits our non-Canfor sales, however, so far the increased pricing has not been sufficient to wholly offset the higher salt costs.
Overall, we were pleased with the third quarter results and, looking forward, the position of our businesses. The businesses are performing well, which is a credit to all our people who have been focusing on improving efficiency and reliability, acting on market opportunities and maintaining our customer relationships. We will continue to make these areas a central part of our strategy as we maximize the benefits we can derive from the buoyant demand and increasing prices for our products.
Rohit will now review the financial results, after which I will have some remarks on our outlook and the conclusions reached by our review of strategic alternatives.
Rohit Bhardwaj
Thank you, Mark and good morning everyone.
You will notice some wording and term changes in our MD&A, press release and this call. These changes are due to National Policy 41-201 which was amended by the Canadian Securities Administrators in July 2007. In our MD&A we have presented a new cash flow statement that includes a few new non-GAAP measures relating to cash flow. The new metric that is most closely aligned with our key previous metric, Distributable Cash is now distributable cash after maintenance capital expenditures. We think that the enhanced disclosure will assist users in understanding our results.
For the three months ended September 30, 2007, distributable cash after maintenance capital expenditures was $14.3 million, or 42 cents per unit compared with $13.3 million, or 40 cents per unit in 2006.
EBITDA for the third quarter was $19.4 million compared with $16.7 million in 2006 generated from revenues of $143.2 million and $148.7 million respectively. As Mark said, these results reflect strong performances by the operating businesses, particularly by SPPC, offset by increased corporate costs. The corporate cost increases compared to last year were mainly due to a senior management change and to activities connected with the review of strategic alternatives. Together these costs amounted to $1.4 million and negatively affected third quarter distributable cash by about 4 cents per unit.
Net earnings for the quarter were $7.1 million compared favourably with a loss of $10.2 million in 2006. Last year’s result included the non-cash charge of $15.6 million related to the impairment in net book value of the Leeds powder SHS plant.
As with the second quarter, the principal reason for the decline in aggregate third quarter revenue over last year was the adoption of the new CICA Handbook section on Financial Instruments. This required us to record certain sales transactions in the International segment on a net margin basis. Revenues in SPPC and Pulp were higher than last year, but these were more than offset by the effect of the accounting change.
Turning to the segmented results, SPPC generated revenue of $84.6 million, $11.3 million above last year. EBITDA of $16.8 million was $4.5 million higher than the same period last year. As already noted, increased demand, pricing and volume for acid were the major contributors to the improved results. Some of the improvements we had expected from our repositioned SHS products were offset by higher zinc costs.
Pulp Chemicals reported third quarter revenue of $14.8 million compared with $13.4 million in 2006, reflecting higher selling prices for sodium chlorate. EBITDA was $5.0 million compared with $5.7 million. Higher input costs, particularly for salt, more than offset the revenue gains. The costs for salt are in line with the expectations we had for this year following the change in supplier at the end of last year, and we continue to look for ways to mitigate the impact. Chlorate demand remains strong and further price increases have been announced in the market.
International reported revenue of $43.8 million for the third quarter, which was $18.3 million lower than the third quarter of 2006. As I just mentioned, the decrease is due to the adoption of Section 3855 of the CICA Handbook. EBITDA was $2.3 million compared with $2.0 million last year.
Corporate costs for the third quarter were $4.7 million compared with $3.3 million last year. Corporate costs include costs of $900,000 related to the senior management change, and costs for the review of strategic alternatives amounting to $500,000. With respect to the latter, there may be some small additional future costs, but they are substantially accounted for with the third quarter expense.
As mentioned on previous calls, the gains and losses on our currency hedging program are included in corporate costs. During the third quarter of 2007, a net foreign exchange gain of $0.7 million was recorded, whereas during the same quarter of 2006, there was a net foreign exchange gain of $0.1 million. These foreign exchange amounts for the third quarter of 2007 and 2006 include an unrealized gain of $0.3 million and an unrealized loss of $0.4 million, respectively.
Total capital expenditures for the third quarter were $1.4 million in 2007 and $0.8 million in 2006. Of the spending in the third quarter this year, $1.1 million was for maintenance capital requirements.
Maintenance capital expenditure for the first nine months of 2007 was $4.1 million. As we have noted on previous occasions, we have estimated our annual maintenance capital spend at $7.5 million and that remains the case for this year. We expect, therefore, to spend the balance in the fourth quarter. Just as a reminder, our capex spend in the fourth quarter of 2006 was $3.3 million, so our expected spend this year is similar to the amount we spent in this time frame last year.
Looking ahead, we expect that our annual maintenance capex spending will be higher than the rate of $7.5 million we had previously indicated. The costs for all projects appear to be 25-30% higher than even last year as the high demand for skilled labour and materials has led to increased costs for most capital projects. Once the construction and materials markets cool somewhat we expect that our maintenance capital plan will return to about $8 million per year.
In view of all the attention being given to the credit markets these days, it may be appropriate to comment briefly on Chemtrade’s situation. In a nutshell, we are in good shape. We are fortunate that during the current period of tightness in the credit market we have no need to access further credit at this time. We have no debt due to mature until August 2009 and sufficient liquidity and credit lines to manage our business appropriately. We also have interest rate swap agreements that result in our having an effective interest rate on our U.S. term debt at 5.85% and on our Canadian term debt at 5.22%.
Finally, an update on foreign exchange. As we all know, the Canadian dollar has surpassed parity with the U.S dollar. Despite that we are in quite good shape. To manage the predictability of our cash flows, we 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 September 30, 2007, substantially all planned transfers for the remainder of 2007 and all 2008 have been effectively hedged at approximately 83 cents.
Also, our sensitivity to changes in the exchange rate has changed as we made changes in our business. We are much less sensitive now to changes in the U.S./Canadian exchange rate than we used to be. We now estimate that a one-cent change in the Canadian/U.S. dollar exchange rate impacts distributable cash after maintenance capital expenditures by less than $200,000 annually. Again, this is not an issue for us in 2008 as we are completely hedged, but affects our unhedged position post 2008.
I’ll now hand the call back to Mark.
Mark Davis
Thank you, Rohit.
In the third quarter we started to see the real potential of Chemtrade’s businesses to generate cash. Even including the extra corporate costs incurred in the quarter we generated distributable cash after maintenance capital expenditures of 42 cents per unit, which more than covers our 30 cent per quarter distribution rate. Although the costs of a few of our inputs and our capex projects provide some challenges, the supply/demand characteristics for our main products allow us to remain comfortable in our belief that we will continue to generate more than sufficient cash to maintain distributions. Further, the base foundation of these earnings is stronger as we have repositioned the SHS business and improved our plants’ operating performance.
Turning now to our strategic alternatives review. The review was initiated largely in response to the Government’s proposal to tax income trusts and the possible restriction to growth that the changes in tax laws may impose on trusts.
Of key importance to us was ensuring that Chemtrade retained the ability to continue adding scope and scale to its businesses.
The review is now complete. In summary, we believe that maintaining our current income trust structure best maximizes value for our unitholders. Further we believe that our structure currently minimizes taxes while not unduly impeding our ability to access the capital necessary to grow and improve our business.
Our portfolio of businesses is now well positioned and can be further improved. Growth of size and scale continues to be a key element of our strategy and our businesses form an excellent foundation from which to build. The new tax on income trusts that becomes effective in 2011 will not have a significant negative impact on Chemtrade. Since a large portion of the Fund’s earnings are non-Canadian source or are received as dividends, the majority of our earnings will not be subject to the new 2011 tax. Despite the introduction of an approximately 30% tax rate on the Fund’s earnings, we believe that the Fund’s effective tax rate in 2011 should be no more than 10%. We believe that this tax burden can be borne by our business without affecting our initiatives.
Other conclusions from the review are set out in our news release.
We are focused on building from the strong base we have created for the business and taking advantage of the more favourable market conditions we see for the near future. Looking forward we continue to expect to generate more distributable cash after maintenance expenditures over the next 12 months than the 12 months just passed.
Thank you for your attention. Rohit and I would now be pleased to answer questions.
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