Welcome to KP Tissue's first quarter 2018 results conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. If anyone has any difficulties hearing the conference, please press star followed by zero for operator assistance at any time. Before turning the meeting over to management, I would like to remind everyone that this conference call is being recorded on Thursday, May 10th, 2018. I will now turn the conference over to Mike Baldesarra, Director of Investor Relations. Please go ahead, sir.
Thank you, operator, and good morning, ladies and gentlemen. My name is Mike Baldesarra. I'm the Director of Investor Relations at KP Tissue. The purpose of this conference call is to review the financial results of the first quarter of 2018 for Kruger Products LP, which I'll refer to as KPLP going forward. With me this morning is Dino Bianco, the Chief Executive Officer of KP Tissue and Kruger Products LP, and Mark Holbrook, the Chief Financial Officer of KP Tissue and Kruger Products LP. The following discussions and responses to questions contain forward-looking statements concerning the company's activities. Forward-looking statements involve known and unknown risks and uncertainties, which could cause the company's actual results to differ materially from those in the forward-looking statements. Investors are cautioned not to rely on these forward-looking statements.
The company does not undertake to update these forward-looking statements, except if required by applicable laws. There's a page at the beginning of the written presentation which contains the usual legal cautions, including as to forward-looking information, which you should be aware of. I'd like to point out that all figures expressed in today's call are in Canadian dollars, unless otherwise stated. The press release reporting our Q1 2018 results were published this morning and will be accessible from our webpage or website on kptissueinc.com. Please be aware that our MD&A will be posted on the website and will also be available on SEDAR. Finally, I would like to ask you during the call to refer to the presentation we have prepared to accompany these discussions, which is also available on our website. We'd also appreciate that during the Q&A period for you to limit your questions to two.
Thank you for your collaboration. Ladies and gentlemen, I'll now turn the call over to our CEO, Dino Bianco. Dino.
Thank you, Mike. Good morning, everyone, and thank you for joining us on our conference call today. I'm very pleased to address you for the first time as CEO of Kruger Products and KP Tissue. In taking over this position of CEO, my role is to lead the company to the next phase of growth, leveraging the great work done by Mario Gosselin and the team, and taking the company in the forward direction, in the years to come. I'm very excited by this opportunity ahead. To summarize our performance in Q1, we continue to show revenue growth, driven by our leadership position in Canada, our focused growth in the U.S., and the benefit of last year's selling price increase in Canada. Despite the strong revenue growth, we faced sustained market headwinds from rising pulp and freight costs.
Let's turn to slide five of the presentation for first quarter highlights. In Q1 2018, revenue increased by 11.9% to $323.7 million dollars. Sales volume was higher in all segments and in all geographic regions. Adjusted EBITDA totaled CAD 27 million, which was down by CAD 6.8 million or 20.1% over last year. This decrease primarily reflects the continued negative impact of rising pulp prices and increased freight costs. We are taking action to mitigate these cost increases, which I will talk about in the upcoming slides. Let's turn to slide 6 of the presentation, which presents the market pulp prices in U.S. and Canadian dollars.
As mentioned in previous quarters, the NBSK pulp market prices in Canadian dollars and BEK or eucalyptus pulp prices rose sharply since the end of 2016. Q1 pulp prices also rose sequentially compared to Q4 and year-over-year in both US dollars and Canadian dollars. Pulp prices in Canadian dollars continued to be at historical highs. As a result, overall higher pulp prices had an impact on our Q1 results and will continue to have an impact for the remainder of 2018. Based on industry sources, we expect pulp prices in US dollars to remain high for the balance of 2018, and the volatile Canadian dollar will also create further fluctuations in pulp input costs during the year.
We also added slide seven this quarter, which summarizes the situation we are experiencing with freight costs. As you can observe, these costs peaked in the fourth quarter of 2017 and remain near all-time highs in the first quarter of 2018. We also expect these costs to remain high for the balance of 2018. As you can see on slide eight, we've been proactively managing higher input costs by initiating a price increase in Q4 2017, which started to have an impact in Q1 of this year. According to data from Nielsen, the latest price increase has seen good traction in Q1, as the dollar value of paper tissue categories has increased between 3%-5% greater than volume increases. Also, promotional activities are starting to return to more normal levels as we exit Q1.
However, this increase had a partial relief effect on our bottom line, which is why we also implemented an escalated company-wide value creation program. This smart cost reduction program is much larger in scope and size compared to our previous programs. We are essentially doubling the size of expected savings compared to past years. The program is aimed at content reduction, procurement savings, reducing fixed costs, and North American logistics optimization. The value creation program is designed to have no impact on the quality of our products, on our people, or on our long-term strategy. We believe that these measures will help to mitigate current market conditions, which are expected to be short to mid-term in nature. I will now turn the call over to Mark, who will review the quarterly financials in more detail.
Thank you, Dino, and good morning, ladies and gentlemen. I'll now ask you to refer to slide nine, which summarizes our financial performance for the first quarter. Our revenues reached CAD 323.7 million, an 11.9% increase compared to last year, including six more sales days in the quarter. However, Adjusted EBITDA decreased from CAD 33.8 million in Q1 last year to CAD 27 million in Q1 of 2018. From a margin perspective, Adjusted EBITDA decreased to 8.3% from 11.7% last year, and sequentially, 9.9% in Q4 2017. As Dino mentioned, the rapid escalation in pulp prices and freight costs had a significant impact on our results. This was only partially offset by the Q4 2017 increase in Canadian consumer selling prices.
Our net income was CAD 1.6 million in the first quarter, compared to CAD 6.9 million last year. The decrease was primarily due to lower Adjusted EBITDA and also higher depreciation expense and an increase in interest expense, which were partially offset primarily by a decrease in tax expense. In the quarterly segmented view on slide 10, consumer revenue increased by 12.1% year-over-year to reach CAD 267.7 million, while away from home revenue increased 9.9% to CAD 53.5 million. Adjusted EBITDA decreased by CAD 3.1 million to CAD 29.9 million for the consumer segment and decreased by CAD 1 million to negative CAD 0.3 million for the Away-F rom- Home segment.
Similarly, margins decreased year-over-year in the consumer segment from 13.8%- 11.2%, and decreased in the away from home segment from 1.4% to -0.6%. On slide 11, we review Q1 2018 revenue over Q1 2017, which was up by CAD 34.4 million or 11.9%. The increase was due to several factors, namely six additional days of sales in Q1 2018, or 7.1% more days than Q1 last year. Increased sales volumes and the selling price increase implemented in Canada in Q4 2017, which were all partially offset by unfavorable impact of foreign exchange fluctuations on US sales.
Looking at this regionally, sales increased by 14.8% or 8.5% in Canada, and by $10.9 million or 10.4% in the U.S., and sales also increased in Mexico. On slide 12, we provide some insight into our Q4 sorry, Q1 2018 Adjusted EBITDA, which decreased by 20.1% to CAD 27 million. This decrease was due to a significant increase in pulp costs and also increased freight costs, partially offset by increased sales volume, the Canadian selling price increase, the net favorable impact of foreign exchange, and also the benefits from cost reduction initiatives and capital projects. Q1 gross margin decreased from 15.6%- 11.2%, primarily due to the increase in costs I just mentioned and also sales mix.
On slide 13, we compare Q1 2018 and Q4 2017 revenue, which decreased by CAD 16.3 million or 4.8%. Q1 consisted of seven less sales days than Q4 2017, or 7.1%, and is usually also a lower seasonal quarter, particularly for AFH. The Canadian consumer selling price increase also created some market uncertainty, which affected volume in certain product categories in the quarter. By region, revenue decreased in Canada by CAD 14.9 million or 7.3%, and in the U.S. by CAD 4.6 million or 3.8%. On slide 14, we compare Q1 2018 and Q4 2017 Adjusted EBITDA.
Q1 Adjusted EBITDA decreased by CAD 6.7 million due to the seven less days of sales, the impact of higher pulp costs and increased freight costs. Gross margin in Q1 decreased from 12.9%- 11.2%, primarily due to the same cost factors. I'll now ask you to refer to slide 15, which sets out our balance sheet. Our cash position, including bank indebtedness, was CAD 1.3 million as at the end of Q1, 2018. Overall, net debt at the end of Q1 stood at CAD 459.2 million, up CAD 42.7 million from CAD 416.5 million at the end of Q4, 2017. The increase in net debt primarily reflects higher working capital requirements, most of which is typical in Q1.
As at the end of Q1, we had CAD 198.2 million in the current portion of long-term debt, relating primarily to our KTG subsidiary, and we are in advanced discussions to refinance this portion of the debt maturing in August of this year. We also changed our long-term debt structure on April 24, 2018, through the issuance of CAD 125 million of senior unsecured notes for a seven-year term at 6%, repaying part of the balance on the revolving bank credit facility with the net proceeds. Our net debt to latest 12 month Adjusted EBITDA ratio is at 3.3x , up compared to 2.9x at the end of Q4.
Finally, as we can see on slide 16, CapEx increased to CAD 15.7 million in Q1 2018, from CAD 12.7 million a year ago, due to project timing. Our expected CapEx for fiscal 2018 is approximately CAD 50 million-CAD 60 million as we return to more normal levels after two years of increased investments. We'll continue to focus on high return cost reduction and growth projects, which generally have 3- 4-year paybacks. Thank you for your attention, and I'll now turn the call back over to Dino.
Thank you, Mark. On slide 17 and 18, we present two strategic initiatives relating to TAD2 and our Away-From-Home business. TAD2 is part of our long-term strategy to increase premium paper capacity, which we would use for the growing Canadian and U.S. markets. We are currently studying the potential for a TAD2 paper machine with state-of-the-art converting capability. A decision to proceed with the project would be taken once we have selected the site and obtained financing on satisfactory terms. Following board approval, we expect the construction would take approximately two years, followed by a ramp-up period for production and sales. We believe that in-house expertise developed with the first TAD project and our capacity to deliver the first project on time and on budget, will provide a solid foundation for TAD2.
As for the Away-From-Home segment on slide 18, we are progressing to reset our strategy to create a more efficient and focused manufacturing footprint. We are currently in progress with a CapEx program to improve AFH manufacturing costs, logistics, and flexibility. Higher pulp and freight costs have also impacted the AFH business and offset the benefits of our recent CapEx investments. We also made a strategic decision to partly use the Crabtree PM8 paper machine for the consumer segment to meet increasing demand. This has reduced the beneficial impacts for AFH. Overall, we believe that the reset will allow the Away-From-Home business to become more competitive and profitable in the future. Turning now to slides 19 and 20.
Despite the short-term input cost challenges, the industry remains strong, with stable, growing demand in both Canada and in the U.S., supported by overall population growth and higher rates of household penetration. On slides 21 and 22, we provide a summary of our competitive position. Despite a tough Q1, our business remains healthy as we continue to be number one in the Canadian market. As you can see, we are the overall leading tissue company in Canada. We are share leader in bathroom tissue and facial tissue, and a strong number two share in paper towels. Also, we were able to increase our market share for all three product categories since 2011. The price increase taken in Q4 has slightly hurt us on market share, and we plan to recover this share through strong consumer and customer support throughout the year.
On slide 23, we present the four pillars of our strategy focused on building great brands and products. First, we want to expand our consumer and brand leadership in Canada. Second, we will pursue our growth strategy in the U.S., which accounted for approximately 35% of our total revenue in 2017. Third, we need to create a more efficient North American supply chain. Lastly, we want to drive sustainability with ambitious goals to reduce energy, water consumption, and greenhouse gas emissions, along with improving quality and employee safety. Finally, I would like to conclude the call with slide 24, that summarizes our objectives and the steps we have taken and will pursue for fiscal 2018. Our main objectives are to build revenue, maintain market share leadership, secure our private label activities, and focus on opportunistic growth for our Away-From-Home segment.
In order to mitigate continuous pulp and freight price increases, we have taken appropriate measures, which includes a price increase in Canada and an escalated value creation program that is much larger in scope and size compared to past programs. In terms of CapEx for fiscal 2018, we will return to more normal levels after two years of increased investments. Our product portfolio will continue to leverage our TAD products market potential as we continue to study the need for a second TAD machine. In the Away-From-Home segment, we are resetting the AFH business to create a more efficient manufacturing footprint. In the U.S., we will continue to build the premium private label business and pursue our White Cloud customer diversification strategy. Looking forward, KPLP continues to have strong long-term business fundamentals.
However, Adjusted EBITDA is expected to decrease in Q2 2018 due to significantly higher pulp and freight costs. Thank you for your time and attention, and at this point, Mark and I will be pleased to answer any questions you may have.
At this time, if you would like to ask a question, please press star, followed by the number one on your telephone keypad. If you are using a speakerphone, please lift your receiver before pressing any key. Your first question comes from the line of Hamir Patel from CIBC. Please go ahead.
Hi, good morning. Dino, some of your U.S. peers have indicated that there's been some de-sheeting by the brands in the U.S., and even some talk of price hikes having been announced by some of the U.S. private label players. What, you know, what are you seeing in that market, and do you have any pricing or de-sheeting initiatives planned for White Cloud?
Hamir, it's Dino here. I would say that the pricing in the marketplace in Canada was through a price increase. In the U.S., it's primarily been through a sheet count reduction led by the major competitors in that marketplace. And as a result, as you know, our private label business in the U.S., we are working with them and looking at sheet count reduction opportunities in that market. We are also selectively looking at sheet count reduction opportunities in Canada, where we think it's appropriate. But that strategy is much more prevalent with our U.S. business. As it relates to White Cloud, we will opportunistically adjust those sheet counts to make sure that that product continues to remain competitive relative to the market set in the U.S.
Okay, thanks. Thanks, Dino. That's helpful. And, you know, you mentioned TAD2. We've seen a couple distressed tissue producers out there in the U.S. with, you know, NTT machines that have recently started up. Any thoughts about, you know, whether you can perhaps achieve your premium tissue sale goals through acquisition instead of going forward with a TAD2?
Yeah, Hamir, a good question, and not unexpected, I guess, given what's going on in the market. I would tell you that, you know, our M&A strategy, first of all, we are a grower in the market, so our intention is to continue to grow, ideally, organically or through some combination thereof. We look at everything. We talk about nothing, until we're ready to talk about something. I would tell you, though, the framework and the lens that we use when looking at M&A is we want to make sure there's a strategic fit to our business. We want to make sure that there's value. We want to make sure there's synergy opportunities, either through cost or revenue.
We want to make sure that there's asset quality, and we want to make sure that there's a complementary, geographic footprint. So that would be the lens that we would use and when we look at any any potential acquisition target.
Great. Thanks, Dino. That's helpful. That's actually all I had. I'll, I'll get back in the queue. Thanks.
Thanks, Hamir. Thank you.
Your next question comes from the line of Kasia Kopytek from TD Securities. Please go ahead.
Hi, good morning, everyone. This is Kasia-
Good morning, Kasia.
Hi, Dino. Just a few questions on the quarter. The Canadian price hikes, are those fully in by now?
Yeah, so we took the price increase at the end of last year. And then it normally takes a quarter to work its way through the market to the consumer. And as I quoted to you earlier, based on Nielsen data, and this is total market, this is not our data, you're seeing 3 - 4, 5 points of increase in selling price increases versus cases or units increases. So that would tell me that pricing is moving through the market.
Okay, so just a little bit more follow-on in Q2, then. That's something. That's a, that's a reasonable expectation, then?
I'm sorry, I missed the first part of your question.
Oh, just wondering if we should expect to see a bit more follow-on from the price hikes in Q2, then?
Well, I would say that the market is generally adjusted now. Consumer prices have generally adjusted. Promotional activity is generally adjusted. So I, I would say, as we look to Q2 and beyond, that there's more stability than there was in Q1, and I think the, the pricing is being reflected in the market.
Okay, got it. And then just in terms of volumes, then, are you guys seeing more normalized volumes in Q2, or is there ongoing pressure? I think before you had mentioned that you had expected volumes to kind of settle by Q2.
Yes, and that's what we're seeing. It's early on, and what our projections are as we look at activity in the marketplace and working with our sales and customer teams, both in the U.S. and in Canada. I would say that we're seeing a return to more stable growth-oriented activity in Q2.
Okay, that's helpful. Thanks. The pressure in the EBITDA results in the other segment, can you just give a bit of context on what was driving that?
Hi, Kasia. Yes, in the other segment, it's primarily related to our parent roll business, where we had, again, pressure due to the cost of pulp and freight, and as well, included in that segment is a one-time cost from corporate expenses that are also in there. So that's the main two drivers in the quarter.
Okay, and would you be able to quantify that, the magnitude of that one-time cost?
We typically don't split that out when we're talking segment EBITDA.
Okay. And just back to the Crabtree PM, did that machine contribute positively, as guided to previously in Q1?
Yeah, I would say, and as we've talked about before, the startup of that machine, the efficiency we're getting out of that machine is as we expected. The one difference, and I noted in my commentary, we made a strategic choice just based on increasing consumer demand and, quite frankly, a better margin structure to move some of that capacity and output to our consumer business, which unfortunately hurt the Away-From-Home P&L, but was a better decision for the company as a whole.
Got it. Okay. Yeah, that makes sense, because the Away-From-Home results were a bit weaker than expected, but I guess if the results are being filtered through to the consumer segment, that makes sense. Just a few quick ones. The guidance for lower EBITDA was that meant to be on a year-over-year or quarter-over-quarter basis?
That's a year-over-year number.
Year over year. Okay. And just your promotional and marketing expenses in Q2, is that relatively flat in Q1, or are you guys expecting an increase there?
We are holding, you know, despite cost cutting, we're obviously making smart decisions, nothing that's gonna hurt our business, and that applies to our advertising and promotional spending. We continue to support our brands through the year. We recognize it's a long-term investment to build our brands, so there's been no major change in that area.
Okay, great. Thanks very much. Appreciate the answers. That's all for me.
Thanks, Kasia.
If there are any additional questions at this time, please press star followed by the number one on your telephone keypad. Your next question comes from the line of Sharan Sanghera from RBC Capital. Please go ahead.
Hi, good morning, guys. Just a quick-
Good morning.
Most of the questions have been answered. Just a quick follow-up on that, the move of the volume from Crabtree to AFH to consumer, is that, you know, something that you see going, you know, forward for the next few quarters? Or is it just a, you know, a opportunistic Q1 type of thing?
I would say that the move to, of that capacity satisfy consumer will probably be higher than we expected coming into the year. I can't answer whether it'll be equal to or more than Q1 at this point. It depends, obviously, on our demand curve, the types of products that are growing and how we produce those products, from what facilities. So however, our outlook would say that it's gonna be higher than we would have expected coming into the year.
Okay. And, can you give us, like, maybe like the percentage of capacity that you moved in, or, or you don't want to talk about that?
Yeah, we don't want to talk about that. Thank you.
No worries. Just maybe bigger picture on the Canadian price increase. Yeah, you mentioned that you lost some volume, and I think overall, branded tissue players in North America have done a good job at fighting off private label. But in the sense of the, you know, the volume loss, do you get a sense of that went to other branded players or went to, you know, private label picked up some share in Canada?
A little bit of both. So let me just clarify. You know, when there's pricing in the marketplace, especially a price increase, generally the market kind of stands back a little bit from activity because they see that, you know, they don't, nobody wants to be the first one out there with the higher prices. So generally, there's a bit of a withdrawal from the category, a promotional activity. When that withdrawal happens, if you're the market leader, and you've generally been getting most of that activity, you end up disproportionately hurting, which is what happened during Q4, and it's a bit of the burden of being a price leader in the marketplace. You incur a bit of that transitional dislocation.
That starts to come back, and we're starting to see it come back now as we're going, you know, through Q2 and beyond the year. As far as the share loss, generally, I would say that it was a combination of private label and some other competitors in each of the categories. Each category played out a little differently.
All right. Thanks. That's, that's all for me.
Okay. Thanks, Sharan.
There are no further questions at this time. I turn the call back over to Mr. Baldesarra.
I'll take it. Thank you, Operator. Thank you for your questions. Thank you for your time this morning, and thank you for joining us on the conference call. This afternoon, we will be hosting our annual meeting of shareholders in Toronto at 3:00 P.M. at the Gallery Room of the TMX Broadcast Centre. We look forward to speaking with you again in August following the release of our second quarter results. Thank you, and have a great day.
This concludes today's conference call. You may now disconnect.