Good morning, and thank you for standing by. Welcome to Sylvamo's Q1 2022 earnings call. All lines have been placed on mute to prevent background noise. After the speaker's remarks, you will have an opportunity to ask questions. To ask a question, press star one on your telephone keypad. To withdraw a question, press the pound key. I'd now like to turn today's conference over to Hans Bjorkman, Vice President, Investor Relations.
Thanks, Faith. Good morning, and thank you for joining our call today. Our speakers this morning are Jean-Michel Ribiéras, Chairman and Chief Executive Officer, and John Sims, Senior Vice President and Chief Financial Officer. Slides two and three contain important information, including certain legal disclaimers. For example, during this call, we will make forward-looking statements that are subject to risks and uncertainties. It is important to note that all earnings and figures include our Svetogorsk mill and Russian business, unless otherwise noted. We will also present certain non-GAAP financial information. Reconciliations of those figures to US GAAP financial measures are also available in the appendix. Our website contains copies of the Q1 2022 earnings press release, as well as today's presentation. With that, I will now turn the call over to Jean-Michel.
Thanks, Hans. Good morning, and thank you for joining our call. I'll begin my comments on slide four. Before we discuss our Q1 results, allow me to share some thoughts on 2022. We are well positioned to continue to create value this year. Given all the moving parts in our business, I want to share guidance on our full year 2022 key metrics. We expect to generate strong results despite input cost inflation, supply chain challenges, and the impacts of Russia's invasion of Ukraine. In fact, we're on the path to achieve pre-pandemic EBITDA levels in 2022, even if we exclude our Russian business for the full year.
We expect to generate $725 million-$775 million in adjusted EBITDA and $160 million-$180 million in free cash flow this year if we exclude our Russian business for the full year. Slide five provides an update on Russian business. Our path forward in Russia is driven by our primary value to always do the right things in the right ways for the right reasons. We will not operate in an environment that is inconsistent with our values. We have made the decision to exit Russia, and we'll do so in an orderly manner. That said, we are not implementing a full suspension of operations, primarily because we want to maintain full control of our assets as we work to exit Russia.
We are conducting a process to sell our Russian business and have received a significant numbers of non-binding offers. We are working to reach an agreement and plan to complete this process promptly, including obtaining approval from our board, as well as the required government approvals to execute the transaction. Please keep in mind that the situation in Russia changes frequently, and we will provide public updates as appropriate. In the meantime, we continue to comply with all regulations and sanctions. Now on slide six. We continue to execute our three-pronged strategy of commercial excellence, operational excellence, and financial discipline, which resulted in a 19.1% adjusted EBITDA margin in the Q1 . Global demand for uncoated freesheet continued to strengthen in Latin America and North America as schools and offices reopened. Our volumes remain strong, and we run at full capacity in all three regions.
We also continue to realize the benefit of prior price increases, resulting in price and mix outpacing input cost inflation. We operated well in a challenging supply chain environment. I'm proud of how our teams navigated through continued input costs and transportation challenges and worked to take care of each other as well as our customers. Implementing the strategy generated free cash flow of $73 million, enabling us to pay down $33 million in debt and to increase our cash balance by $49 million. All in all, another strong performance by our team in dynamic industry conditions. Slide seven highlights our key performance metrics for the quarter. Q1 net sales were $977 million, reflecting seasonally slow volume in Eastern Europe and Latin America. We generated an adjusted EBITDA of $187 million.
As usual, our Q1 was a light maintenance outage quarter. If we had normalized maintenance outage expenses, our adjusted EBITDA margin would have been 18% for the quarter. We generated $73 million in free cash flow and adjusted operating earnings of $1.97 per share. Okay, John, would you discuss our Q1 performance in more detail?
Thanks, Jean-Michel. Good morning, everyone. Let's turn to slide eight. In the Q1 we generated $187 million in adjusted EBITDA.
This amount includes our Russian business, which contributed $34 million of adjusted EBITDA. We improved price and mix by $53 million, as price increase realizations in Europe and North America exceeded our forecast. As expected, volume decreased by $17 million due to slower seasonal demand in Eastern Europe and Latin America. Our order backlogs remain strong everywhere outside of Russia. Operations and costs increased by $22 million. These higher costs reflect the absence of a favorable fourth quarter LIFO adjustment in North America, and an unfavorable foreign exchange charge in Latin America. However, overall, our operations ran well.
As Jean-Michel Ribiéras mentioned, we successfully conducted planned maintenance outages at our Eastover and Três Lagoas mills, and spent $26 million less on outages than in the Q4 . Input and transportation costs increased by $24 million, with rising costs for chemicals due to energy impacts, along with higher fiber and distribution costs.
You know, I wanna recognize and thank our regional teams who worked hard to offset the impact of input cost inflation, especially our Saillat mill team for acting quickly to reduce the impact of record high European natural gas prices. Let's look at our regional results on slide nine. Each region performed well, demonstrating the strength of our talented teams, low-cost mills, and iconic brands. Our commercial teams deserve credit for their contributions to these results. They remain focused on strengthening our customer value propositions and ensuring that we remain the supplier of choice. Strong regional performances reflect continued price increase realization. Our volumes remain strong in all regions, and we continue to outperform industry shipments. Operations were good in all regions, and we started to see some improvement in supply chain bottlenecks.
Our Latin America margin was negatively impacted by about 400 basis points due to FX headwinds in the quarter, as well as a seasonally lower volume. The appendix contains additional details on our regional performance. Let's turn to slide 10 to discuss uncoated freesheet industry conditions in the markets we serve. Supply and demand balances are favorable in all our regions, and operating rates remain strong. North American industry demand is now forecasted to grow at 1.1% this year versus the prior forecast of a 4.4% decline. Latin American industry demand is projected to improve by 2.6%, which is in line with prior projections. European industry demand is down in 2022, but the shutdown of high-cost capacity has resulted in favorable supply and demand balances.
Selling prices remain favorable, and we expect to continue to realize prior increases throughout the Q2 . Our price and mix improvements continue to more than offset input and transportation cost increases. Let's move to slide 11 and look at the results of some of our commercial excellence efforts. Commercial excellence is a key driver of our earnings, and we continue to make progress. In Europe, our non-price initiatives are improving earnings. We have increased our mix of branded products and are developing relationships with new customers. For example, we gained premium notebooks business and expect more than 10,000 tons of this new volume. In Latin America, our commercial excellence initiatives have led to more than 20 new customers, and we're improving our domestic cut size mix. We also have landed new publishing business that benefited from strong offset sales. In North America, we continue to outperform industry shipments.
We also continue to simplify our product offerings and have realized improved margins from our value-added services. I'm now on slide 12. In light of the current challenges in Europe, I wanna emphasize that we remain confident in our ability to succeed in Europe. Our 2022 earnings outlook reflects the increasing profitability of our Saillat mill. We expect our European earnings to improve each quarter this year. High market pulp prices and elevated energy costs have put tremendous pressure on non-integrated producers, which represents about 25% of the total uncoated freesheet supply in Europe. These cost increases have resulted in a significant steepening of the uncoated freesheet cost curve there, which works in our favor. Our Saillat mill produces its own pulp, benefits from a favorable energy position, and generates excess carbon credits. We also maintain strong channel partnerships across Europe.
I also note that we serve European customers from Saillat as well as our low-cost Brazilian mills. Let's move to slide 13 and review our Q2 outlook. Given our intent to exit Russia, we are providing Q2 guidance including and excluding our Russian business. I will limit my comments, though, to the guidance that excludes Russia. In the Q2 , we expect to deliver an adjusted EBITDA of $170 million-$180 million. We project price and mix to improve by $50 million-$55 million as we continue to realize price increases already communicated to our customers in all regions. We expect volume to be relatively flat, with seasonally stronger Latin America volume offsetting more maintenance outages in North America. We expect operations and costs to increase by $5 million-$10 million.
We expect input and transportation costs to increase by $10 million-$15 million, largely due to the higher cost of natural gas in North America and increasing diesel costs affecting the delivery of fiber in Latin America. We project maintenance outage expenses to increase by $15 million as we conduct more planned maintenance outages. To be clear, we continue to own and operate our Russian business while we pursue a sale. We are showing our EBITDA including and excluding Russia, so you can understand how we expect to perform in either scenario. Once a sale has been approved by our board, we would report our Russian business as discontinued operations for the entire year. Let's turn to slide 14. As Jean-Michel and I discussed, industry fundamentals remain favorable. Our competitive advantages position us to benefit from the industry conditions shown on this slide.
Our key advantages include low-cost mills in attractive regions, the world's strongest paper brands, committed channel partnerships, and our talented teams. These unique strengths, combined with our focused three-prong strategy and our strong regional positions, are driving the growth in our earnings and cash. Let's turn to slide 15 to discuss free cash flow and how we allocate cash with discipline. We remain focused on generating cash. As Jean-Michel mentioned, we generated strong free cash flow in the Q4 , $73 million, even after we paid $36 million to International Paper for the day one Riverdale inventory. You may recall that our Q4 cash flow reflected the benefit of extended payment terms to IP for the day one inventories at both the Georgetown and Riverdale mills. We'll use our cash to fund $175 million of capital spending in 2022.
Since we will not spend capital on Svetogorsk recovery boiler, we will increase spending on other high-return projects outside of Russia to further improve our business. We will pay IP the final incremental $41 million of the day one Georgetown inventory in the Q2 . Additionally, we'll pay $57 million of one-time and transition service costs. This amount, though, is $15 million less than our last estimate of $72 million, as we've been successful in reducing one-time spin-off expenses. We expect to see a step change in free cash flow starting in the Q4 after all day one inventory, one-time spin-off, and transition service costs have been completed. We also intend to continue debt reduction, which I'm going to further discuss on the next slide. Let's go to slide 16 to review how we would judiciously allocate cash in 2022.
As I mentioned, we are generating sufficient cash this year to fund more than $300 million in capital spending, inventory payments, and one-time spin-off costs. With all this going on and the increasing uncertainty of the macro environment, we will continue to prioritize debt reduction. We have set a targeted gross debt level of $1 billion. This will reduce risk, increase our flexibility, improve free cash flow generation, and should increase our equity value. In addition to the $33 million we repaid in the Q1 , we repaid $15 million in April, resulting in long-term debt of just under $1.35 billion. Our 2022 capital spending plan includes $20 million for high-return cost reduction and strategic projects with internal weighted returns of greater than 25%. In fact, some of these projects have IRRs over 50%.
Since we will not proceed with the $222 million Svetogorsk recovery boiler project, we're advancing high-return projects outside of Russia to be included in our strategic plans going forward. Importantly, we are conducting board-level discussions about returning cash to shareholders, and we'll continue that dialogue with them. Let's turn to slide 17 for a brief update of the Brazilian goodwill tax dispute. You know, during our last call, we told you that we did not expect a tax amnesty legislation to be enacted during the presidential election year in Brazil this year. However, on May 3, the Brazilian Internal Revenue Service issued a specific rule that will allow companies to settle goodwill tax disputes. Keep in mind, though, that the ball is in International Paper's court. They have the sole right to decide whether or not to apply for a settlement.
Also, as a reminder, our maximum liability is $120 million. I'll now turn the call back over to Jean-Michel.
Thanks, John. I conclude our remarks on slide 18.
We are well positioned to continue to create value in 2022. We remain committed to generating strong earnings and cash flow and confident in our ability to achieve pre-pandemic earnings levels in 2022, even if we exclude our Russian business for the full year. We made a principle-based decision to exit Russia, but we remain committed to increasing our earnings and free cash flow. Our strategy has not changed, although we are now targeting a gross debt level of $1 billion and we're accelerating other high return projects. Even excluding Russia for the full year, we are on a path to generate $725 million-$775 million in adjusted EBITDA for the full year, and we project $160 million-$180 million in free cash flow.
Our success is made possible by our employees who worked through the global pandemic, had to plan and execute the spin-off, and continue to navigate through input cost inflation, supply chain challenges, and impact from the war in Ukraine. We appreciate their working safely and serving our customers. We remain confident in our ability to achieve our vision of being the employer, supplier, and investment of choice. With that, I'll turn the call back over to Hans.
Thank you, Jean-Michel, and thank you, John. Okay, Faith. We're now ready to take the questions.
As a reminder, to ask a question, press star one. To withdraw a question, press the pound key. Again, that's star one to ask a question. Thank you. We will pause a moment to compile the Q&A roster. Our first question comes from the line of George Staphos from Bank of America. Your line is open.
Thanks very much. Hi, everybody. Good morning. Thanks for all the details. Congratulations on the progress so far, obviously in a very challenging environment. I wanted to ask, to start more of a nitty-gritty question, and trying to bridge from adjusted EBITDA to cash from operations and using kind of the midpoint of guidance. If I remember correctly, you have a midpoint of about $750 million you're targeting ex-Russia. Tax, I think you said, is roughly about $128. Interest is about $67. Recognizing, I think those are the book numbers, we'll use them as tax. You mentioned that Georgetown, Riverdale, and the one-time transition costs are another $135. That would get you to basically, like, $420 million, and we have to get to cash from operations of $345.
Should we assume the rest is just working capital or is there something else that I'm missing either in the gap or in my calculations to begin? I had a couple of follow-ons. Thanks, guys.
Yeah, George, you guys take into account the capital spending?
Well, I'm going to cash from operations, so I'm not.
Yeah.
I don't need the cap. Yeah.
Yeah. It's working capital.
Okay. Very good. The next thing I wanted to check in on, you said Saillat did a great job of, you know, this is me paraphrasing, this isn't your wording, but, avoiding as best as possible the energy cost increases. Can you talk to, you know, without sharing anything that's proprietary, what you did, what they did to accomplish that?
Yeah.
What coverage it gives you know, the rest of this year.
A couple of things I wanna, you know, draw your attention to around Saillat. It's an integrated mill, and for the most part.
Yeah.
You know, we produce our own energy from biofuels. We don't use a lot of gas, but it's about 15% or so that we do consume, you know, of gas. You know, there were significant increases in Europe due to, of course, the Russian situation, the Ukrainian situation. What the Saillat team did is they developed a sophisticated model so that they could adjust, you know, different energy supplies as well as consumption and to mitigate how much gas they actually burned in their operations. That's caused a significant savings.
The other thing that I wanna point out about Saillat, we kinda alluded to it in our comments, is you know, one of the significant increases that we're seeing in Europe is carbon tax that the EU has. You know, it's been ranging from EUR 60-EUR 80. Our Saillat mill is actually a net seller of credit, so we actually have credits, and so we were able to use that to offset some of the energy costs.
On that. That's great, John, but that's not a new development, or were you able to generate more credits this quarter, which then also helped to offset the pressure?
Yeah, George, that's not a new development.
Okay.
It's more of the model that they used and implemented in the Q1 in terms of flexing their gas consumption and also knowing where to conserve their energy consumption.
Okay. Last one for me, and I'll turn it over. One, you mentioned that the bottlenecks are starting to improve on transportation. Can you comment on that? In relation to, I think you said you expect higher earnings in Europe over the rest of the year in each quarter. Do you expect sequentially improving earnings each quarter or year-on-year earnings to improve in Europe in each of the quarters? Thanks, guys.
Hi, George Staphos. Jean-Michel Ribiéras. Thanks for joining the call. Yes, we have seen in the US especially some improvement in the truck business. Not in the input cost, but we're seeing quite some improvement in terms of availability of truck. We haven't seen it yet on rail, but it is significant even in trucks. We really. It's more fluid. Considering our earnings of Saillat, I would say we expect both year-over-year improvements, and we expect every quarter this year to get better.
That's great, Jean-Michel. Thank you. I'll turn it over.
Thank you.
Our next question comes from Paul Quinn of RBC Capital Markets. Your line is open.
Yeah, thanks so much. Morning, guys. Just given the positive demand environment right now and the significant cost pressure, are you or anybody else in the industry anticipating a further price increase in 2022?
We don't comment on future prices. Good morning, first. I'm sorry for that. We can't make comments on future prices. We are realizing in Q2 price increase that we've announced, all around the globe, with the exception of Russia. We still have more realization in the Q2 , as you can see in our outlook, to come.
Okay, nobody else has announced a price increase in, say, Latin America or Europe that we don't have great exposure to, right?
I cannot comment on our competitor's IR approach.
The process to sell the mill in Russia, do you expect that to be, you know, done in Q2?
There's two parts of the process. One is to find an agreement with a potential buyer, and that we think could happen in Q2. You have the process to get it authorized through the Russian government, and that's a more complex process which the timing could be longer than that.
Okay. Just lastly, on the transition services agreement with IP, what is the ongoing cost of that after the, I guess, $57 million one-time and transition services? What do we expect after that's paid? What's the ongoing amount?
Well, the TSA agreement should end in October. That's what the target date is for us to exit that, and it's about $8 million a quarter.
That's all I had. Best of luck, guys. Thanks.
Thank you.
Again, to ask a question, please press star one on your telephone keypad. We do have a follow-up question from George Staphos from Bank of America. Your line is open.
Thanks very much. Two from me. Can you talk a bit more about what you're doing on commercial excellence? How much is left in the tank, so to speak? Use whatever cliché or metaphor you wanna use, you know, third inning, eighth inning, half full, half empty. Particularly as regards to Europe, and are you finding your bottom slicing at all in terms of your customers and SKUs, given how tight the market is? Or is it truly around some of the products that you said you're rolling out, you know, new premium. Well, you're not rolling them out. You own, you know, new premium notebook pads and things like that. If you could give us some color there, that'd be great.
It's all in the above, if I may say, George. We are seeing a lot of improvement, but we still have a lot of opportunities. We're seeing it in different categories. You mentioned SKUs rationalization, that's one of them. We're seeing it in product mix. We're seeing in new products innovation. We're also seeing in terms of business rules with the customers. We've got a large range of initiatives, which we've started to implement and we're continuing. I would say we probably have done 40% of the potential. Still, quite some to come.
Okay. Thanks for that percentage there. Just a quick one. Back to what Saillat was doing, you know, what was the benefit from the model in the Q1 ? If you can talk to how it helped you sort of avoid some of these costs, if you can share it, and you might choose not to, I understand. Then can you talk a little bit about, you know, you expect, if I read your release and heard you correctly, to grow 10% better than the industry in North America. Did I hear you correctly or see that correctly? How are you developing your benchmark, which I think you said is up 1.6% for the industry? Again, correct anything that I misphrased there. Thanks, guys.
On the Saillat mill, I can give you an idea. Our normal gas consumption was about 15%, and we've gone down to 10%, about 9%. Exactly. As you can see, this metrics is significant. In North America, our improvement was 10% versus the market in Q1. We are winning with the, I would call the winning customers and well-aligned.
Okay. Go ahead. I'm sorry about that.
I want to recall the industry number. I've got it, if you give me a few seconds. In North America, it was 2% for first quarter. If you take all the total regions, it was 1.5%. I'm talking about our regions.
Understood. Thanks, Jean-Michel. I'll turn it over.
Our next question comes from Jonathan Love from Eagle Capital Partners. Your line is open.
Hey guys. Thanks for taking my question and great results. The first question I'd love to ask you guys is, you know, with some of the new products, particularly in Latin America and you know, some of the notebook and stuff. Can you talk about, you know, why you're winning that business? Are people shutting down capacity, or do you have a better product? Like, what's happening there?
Good morning, Jonathan. Thanks for joining the call. I would say it's a mix of what you said. I mean, some people are exiting, and we're taking the opportunity to develop new product and replace this exit. The other ones is segments where we were not present up to now, and we've developed the products to fit those segments. Also, I will say, we've been managing not perfectly because nobody can manage perfectly what's going on with supply chain and everything. We've maintained a level of services, you were talking specifically in Latin America. Importantly to our customers, we try to be reliable, and I think our customers see we are long-term going to be the world paper company. I think our customers like to be aligned with a long-term player in this area.
I think all those things make the difference why we're winning some new contracts or new businesses.
That's terrific. You know, given your comments, you know, about the cost advantage you mentioned in Europe, can you maybe talk about what you're seeing in capacity in both North America and in Europe? Are people adding capacity given the profitability, or are people taking some capacity out? What are you seeing there?
Recently, we've seen in both, in the last two years in North America and in Europe, quite a lot of capacity sometimes shut down, but a lot also, moved to packaging. From uncoated freesheet to packaging, we have seen no new capacity of uncoated freesheet just downtime. We started one paper machine this year, but net-net still a decrease, both in North America and Europe, quite a lot.
Jonathan, this is John. We've said this before, but we're also seeing very tight markets in other paper markets. Particularly like in the coated freesheet, which has caused you know customers to move to uncoated freesheet because of the lack of supply of coated freesheet, which has increased demand for our products. It's not only has uncoated freesheet been shut down or converted, but also coated freesheet in other paper markets that's having an impact, and we're seeing that across all our regions.
Okay. That's good to know.
I guess another impact too, Jonathan, to point out is that the Russian situation. Russia did export. We did. We exported out of Russia into Europe, but then of course that's all stopped. There's that supply went away because of the Russian situation.
Okay. Gotcha. Just one last question from me, which is, can you maybe talk about inventories and your situation? I mean, given your growth relative to the industry, are you building inventories or where are inventories relative to historical norms?
Our inventories are between normal to low, depending on the regions.
Okay.
Certainly not building.
Yeah. All right. Well, great results, and I'll turn it over. Thank you so much.
Thank you.
Again, to ask a question, press star one on your telephone keypad. We have a follow-up question from George Staphos from Bank of America. Your line is open.
Hi. Thanks, guys. Last couple from me. Recognizing again, you might not be able to share too much here, nonetheless, we wanted to ask. First, Jean-Michel, can you talk to the type of interested party in the Svetogorsk mill? Are you finding interest more from local market purchasers, or local investors in the business? Or is it really dispersed between, you know, Russian and non-Russian potential buyers? Then this last question I had for you is can you talk at all about how the value return discussions, you know, the priorities, may have changed? Can you remind us again how you would think about value return, as you know, obviously de-lever and what your preference is for, you know, increasing buyback versus dividend over time?
Thanks, guys, and good luck in the quarter.
George, to make sure I answer correctly, we are in the middle of the process. The process in Russia is a bit complex, so being in the middle of the process, you will understand, I don't want to comment on that. We will update.
Understood.
As soon as we can. Our priorities have not changed. We have the same strategy long-term, which is to de-leverage. I mean, we think we can with the uncertainty, everybody getting a little bit nervous with what might happen with the economy. We wanna accelerate a little bit and continue our debt reduction. That's our priority number one. Once we've done that, we wanna invest and continue to invest in our high return projects. We have some high return projects we've mentioned before. We're seeing those really high return short-term, so everything especially around cost saving. We actually probably would like to be able to do more than we can because it takes time to do all of these projects.
We are talking and have started the discussion to talk with our board about returning cash to shareholders through buybacks or dividends. That has not been decided yet, but that's the next step. Priority to debt repayment, high return projects, and looking at options and talking with our board for the next steps in buyback or dividend.
Thank you very much.
Thank you. I'll now turn the call back over to Hans Bjorkman for closing comments.
Thanks again everyone for joining us today. We truly appreciate your interest in Sylvamo, and we look forward to continued conversations in the coming days, weeks, and months ahead. Have a great day and a great week.
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