Q2 2004 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. However, Vic is joining us by conference call today, so I will review the quarter but Vic will also be available to answer questions following the review.
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I’m pleased to report that our results for the second quarter slightly exceeded our expectations. As we noted in our first quarter conference call and report, the second quarter maintenance shutdowns at our plants in Leeds and Prince George impacted the quarter’s results. The aggregate results came in slightly higher than we anticipated.
On a per unit basis the 41 cents per unit of distributable cash generated for the quarter met our expectation despite a larger number of convertible debentures being converted into units during the quarter than we had anticipated.
For the first six months of this year, we generated 96 cents per unit of distributable cash, which adequately supports our total distributions for this period of 90 cents per unit.
Before going over the numbers in more detail let me briefly review our operations.
Sulphur Products & Performance Chemicals exceeded expectations for the quarter. Similar to the first quarter, sulphuric acid volumes and favourable product cost continued to be the main driver of sulphur-based products’ performance, which was ahead of plan for the quarter.
Our sodium hydrosulphite products were slightly behind our expectations, but were ahead of last year. Sales of liquid sodium hydrosulphite were strong, but we are experiencing increased competition from overseas imports in the powder segment. While we expect this new competition to continue, we are pursuing a number of initiatives to improve the cost competitiveness of our business and to protect our customer base.
The 3-week April maintenance shutdown at the Leeds plant went smoothly, and the organizational changes at SPPC that we referred to on our last call are beginning to have some early positive effects.
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Pulp Chemicals came in below expectations in the second quarter due to lower than anticipated sales to Canfor and other third parties. Canfor’s mills continued to have some operating problems, and this is reflected in the lower than expected level of sales. These issues now seem to be resolved and we expect Canfor to return to expected levels of sales for the balance of the year. The crude tall oil operations came in on plan for the quarter.
The maintenance shutdown in May also had an impact on results for the quarter.
It’s now almost a year since we acquired Pulp Chemicals and overall we’re pleased with the business and the improvements we’ve made.
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Finally, BCT Chemtrade posted results that were ahead of plan and consistent with the second quarter last year.
Conditions in the international market are essentially unchanged from earlier this year with supply tight and spot volumes difficult to obtain.
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Overall, the results for the quarter came in essentially where we expected. We believe that our businesses continue to perform well and that our increased scale and diversity of operations supports our distributions.
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Let me turn now to the financial results. Before reviewing the results, note that the per unit amounts for distributable cash for all periods mentioned are calculated using the weighted average number of units outstanding during those periods. A total of 5,860,000 units were issued in August 2003 in connection with the financing of the Pulp Chemicals acquisition. The relevant weighted average numbers of units outstanding during the periods are detailed in the news release.
The Pulp Chemicals acquisition also means the consolidated results are not comparable with the second quarter and first half of 2003.
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For the three months ended June 30, 2004, cash available for distribution was $9.6 million, or 41 cents per unit, generated from revenue of $90 million and EBITDA of $12.7 million. In the second quarter last year, distributable cash was $6.5 million, or 40 cents per unit, revenue was $68 million, and EBITDA was $9.2 million.
Net earnings for the second quarter this year were $4.1 million compared with $3.3 million last year.
For the first half of this year, distributable cash was $21.9 million, or 96 cents per unit compared with $14.1 million, or 87 cents per unit last year
The principal reason for the increase over last year is the acquisition of Pulp Chemicals at the end of August 2003.
In total, consolidated financial results for the second quarter of 2004 met expectations. Results were affected by the planned maintenance shutdowns at our SHS plant in Leeds, South Carolina, and at the Pulp Chemicals plant in Prince George, British Columbia. Capital expenditures, which were lower than expected in the first quarter, returned to expected rates in the second quarter.
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During the second quarter we continued paying our monthly distributions of 11 cents per unit. Including the 12 cents per unit supplemental distribution that was declared yesterday, total distributions attributable to the second quarter were 45 cents per unit.
Cash distributions attributable to the first half, therefore, were 90 cents per unit. As I mentioned, distributable cash per unit for the first half was 96 cents per unit. This represents a payout ratio of 95% for the first half of the year despite this period including the time of our major maintenance shutdowns.
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Looking at the segmented results for the second quarter, SPPC generated EBITDA of $9.8 million. These results are slightly ahead of last year. As I mentioned earlier, the results from our powder SHS products were lower than we had expected, but the balance of the product portfolio offset this weakness.
Pulp Chemicals reported EBITDA of $4.4 million, which was below expectations, reflecting lower than anticipated sales of sodium chlorate. Sales to Canfor, our primary customer, did not meet expectations for the quarter. There is no comparison with last year, of course, but the difference between this quarter’s results and those of the first quarter are attributable to the shutdown and associated capital spending. We continue to be pleased with the performance of the business, which is now fully integrated into Chemtrade.
BCT Chemtrade, our international business, reported EBITDA of $1.5 million for the second quarter, essentially level with last year’s $1.6 million.
Corporate Services, the non-operating segment we added this year, reported costs of $3 million for the second quarter, which was steady with the first quarter this year.
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In summary, the first half of 2004 met our expectations. The strength of our businesses and the increased diversity and scope of Chemtrade this year has had a positive effect on our results despite the higher Canadian dollar for the first half on this year when compared to 2003.
As we said on our last call, we expected the second quarter to be our weakest this year for distributable cash, and we believe that is still the case. The outlook for the balance of 2004 looks consistent with the first half results.
Pulp Chemicals should benefit from stronger sodium chlorate volumes, offsetting SPPC results that are expected to be somewhat softer than realized in the first half of 2004.
The acid market both internationally and in North America remains tight and the SO2 market appears to have stabilized.
Our liquid SHS products are expected to continue performing well. However, excess capacity in China is resulting in our powder SHS facing competitive pressures from Chinese products in both North American and the export markets.
We are taking steps to improve our competitive position and defend our customer base, however we expect contribution from this product to be negatively impacted for the balance of 2004.
Results from the International business are expected to remain stable.
Chemtrade believes that cash generated from operating activities will be sufficient to meet all of its ongoing cash requirements including its indicated distribution target of $1.80 for the 2004 year.
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Thank you. Vic and I would now be pleased to answer any questions you may have.
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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 star followed by the 1 on your touchtone phone. You will hear a three-tone prompt acknowledging your request and your question will be polled in the order they are received. Please ensure, you lift the handset if you are using a speakerphone before pressing the keys. One moment please, for your first question. Your first question comes from Damir Gunja from TD Newcrest. Please go ahead.
DAMIR GUNJA: Good morning. Just wanted to dig into the SHS powder a little bit more. I recall it represents about half of the SHS business on the powder side. I’m just trying to get an idea for what sort of an EBITDA run rate that would represent, $6 million to $7 million roughly?
MARK DAVIS: You’re right. It’s about half and that’s probably a good number, Damir.
DAMIR GUNJA: Great, and just a follow-up on the FX side. You plan to do some more hedging out into 2005? Maybe a question for Vic?
VICTOR WELLS: Damir, yes we do. We started into 2005 and did a little bit in the first quarter and we will continue each quarter increasing that. Our policy, Damir, means we go out over 18 months -- 6 quarters.
DAMIR GUNJA: Great, thanks very much.
OPERATOR: Your next question comes from Barbara Gray from First Associates. Please go ahead.
BARBARA GRAY: Good morning guys.
MARK DAVIS: Good morning, Barbara.
BARBARA GRAY: I have a few questions here. On the international side, your revenues where quite a bit higher than what we expected. Can you expand on what the actual trading was, and it looks like it’s quite a low margin business.
MARK DAVIS: If you remember, that business is essentially conducted on what we have always called matched contract whereby we usually don’t agree to pay the supplier of the product a price until you know what price you’re going to get in the end market. So it’s very much a low-margin, commission-type business done on matched contracts. But what happens is when the price you can get from the end customer goes up or down, the product cost goes up or down. So that what we have always said is that judging results on that business based on revenues is really distorting because your product costs will move in tandem with your revenue line.
BARBARA GRAY: So the price was up quite substantially then.
MARK DAVIS: Yes it was, which is again consistent with what we have been saying about the tightness of the international acid market. There’s just not a lot of acid product available, so those people that need it are willing to pay much more this year than they have in previous years, but again that gets passed through primarily to the smelters who produced the product.
BARBARA GRAY: Okay and going forward, can we use that as a run rate level or what should we use as our revenue run rate?
MARK DAVIS: What I normally have said is that I have been absolutely wrong guessing sulphuric acid prices since the time Chemtrade became public, but we believe that the acid market internationally will remain tight for the next 2 to 3 years, so it’s probably not a bad estimate.
BARBARA GRAY: Okay, and on the pulp side - your pulp margin was down to 36.8% in the quarter. That’s down from the 40% level you have been running at in the last two quarters. Should we use 40% going forward when the operational problems at Canfor are resolved?
MARK DAVIS: Yes, I would say that this quarter is not an indicative rate for two reasons; one is lack of Canfor and third party sales, and second of course, is we took our shutdowns, so there’s less throughput which affects your fixed cost absorption.
BARBARA GRAY: Right. Okay, and on the SPPC business, at Inco you were impacted last year by a one-month strike, and yet it doesn’t look like there’s been any improvement really in your revenue or in your EBITDA, and I know Inco is quite a substantial contributor to that. Can you elaborate?
MARK DAVIS: Yes, sure. If you remember what we said at the time of the Inco strike, and in the quarters following it, we said we were affected operationally by shortage of product but not financially, as we obtained other products. So that, you don’t see. This is what we said at the time -- that there really was no financial impact to us of the Inco strike, so it’s hard to actually see any difference last year over this year because we weren’t hurt last year.
BARBARA GRAY: Okay, and on the maintenance capital, you’re still counting on $3.5 million for the year?
MARK DAVIS: It might be slightly less than that but that’s about our run rate number.
BARBARA GRAY: Okay. Because it was my understanding that Q2 is when you usually spend I guess a greater portion of your capex.
MARK DAVIS: Yes
BARBARA GRAY: And it didn’t seem to be.
MARK DAVIS: If you go back to our first quarter call, we actually said we under spent capex in the first quarter. I just said second quarter was as planned. We will probably pick up some of the capex that wasn’t spent in the first quarter in third and fourth quarters. This was just a timing thing, so the overall numbers are probably still pretty good.
BARBARA GRAY: Okay, but going forward, I guess next year Q2 should it be even with the other quarters, or should it be usually higher?
MARK DAVIS: Q2 should be our highest quarter in a normal year.
BARBARA GRAY: And why wasn’t it higher this quarter?
MARK DAVIS: Well, if we had spent what we thought we were going to spent in the first quarter, the third and fourth quarters would be lower and second quarter would be the highest quarter.
BARBARA GRAY: Okay, and on the acquisition front, are you seeing any opportunities from conglomerates spinning off parts of their business, or what you think the potential is for that?
MARK DAVIS: We think there is lots of movement these days in the chemical industry, and you could actually see a bunch of people that have bought something and announced that, so we are always looking and we’ll always continue to look and having said that we’ll try and make sure that the only thing that we buy also fits the business model we have. I have always believed and have always said that there are plenty of opportunities out there for Chemtrade to continue growing, and I still believe that.
BARBARA GRAY: Okay, and the last few acquisitions you made have been at quite reasonable EBITDA multiples, five times and 6.3 times. You think you can do that going forward, or has the market improved or valuations of companies gone up?
MARK DAVIS: I think that is a difficult question to answer. I think it depends on a specific seller and a specific market and specific products.
BARBARA GRAY: Okay, and just a last question with respect to the risk from the Chinese imports on the powder SHS side. How significant a risk factor is this, and has your outlook or your concerns changed since the last quarter?
MARK DAVIS: The Chinese threat is one that believe we’ll deal with adequately. What we will likely see in the last half of this year is a reduction in our revenue line on our powder products as we ensure that we maintain our customer base, and then to ensure that we maintain our margins long run, we have to figure out how to reduce our cost base. So we think it’s an issue, but we think we have a number of things in place that will deal with that.
BARBARA GRAY: Okay, but has the risk level increased since last quarter or since a year ago?
MARK DAVIS: I think it’s increased since a year ago. I don’t know if it’s increased since last quarter, but it’s increased, I think, since a year ago because there has been more capacity built in China over the last year.
BARBARA GRAY: Do you have any numbers to attest to that?
MARK DAVIS: Not at the top of my head to be honest, but I think they probably have excess capacity equal to our capacity in North America and China.
BARBARA GRAY: Okay, great. Thanks very much.
MARK DAVIS: Thank you.
OPERATOR: Your next question comes from Chris Blake from Scotia Capital. Please go ahead.
CHRIS BLAKE: Thank you. Good morning gentleman.
MARK DAVIS: Hi, Chris.
CHRIS BLAKE: Just wanted to follow up with the strategic initiatives you are undertaking to maintain your market share with respect to SHS. Could your elaborate further on the type of price discounting that you are seeing here?
MARK DAVIS: I’d actually rather not, because what we are going through right now, obviously, is we’re talking to our customers and we’re combating a Chinese threat and I’d rather actually not give anyone specific targets, not for lack of initiative, but for my competition to know what to aim at. I know what you are trying to do is to improve your understanding of the business. My problem is that to the extent I help you, I help my competition hurt my business.
CHRIS BLAKE: Okay, how many customers or how much volume decline have you seen over the last quarter?
MARK DAVIS: Well that’s the issue - we actually haven’t lost that much volume. The Chinese have not made great volume inroads into North America, and we don’t expect them to because we expect to maintain our customer base, and over a requisite period of time restore margins to where they were, although pricing might be down. So there is a bunch of things that we’re looking at doing and again I’d really rather not list them now.
CHRIS BLAKE: Okay, and how much of your SHS volumes are currently under contract?
MARK DAVIS: All, virtually all of it is sold on contract. This is a very, very small spot business, right? But virtually all of this is sold on a minimal annual contract. There is a bunch of it that’s sold on three-year contract basis.
CHRIS BLAKE: And when do they expire?
MARK DAVIS: Well a variety of different times, Chris. Depends on who the customer is. Right?
CHRIS BLAKE: Okay, you don’t have any major customers’ expiration?
MARK DAVIS: Not this year.
CHRIS BLAKE: How about next year?
MARK DAVIS: There is at least one major customer that will expire next year, probably more than that to be honest because these things roll. Although there’s a percentage of our business that will expire under contract next year, unless what we do is what we did this year, which is renew it beforehand. That’s why we really don’t have any major guys expiring at the end of this year.
CHRIS BLAKE: Okay, that’s good. That’s it for me.
MARK DAVIS: Okay thanks.
OPERATOR: Your next question comes from Lorraine Gloster from McFarlane Gordon. Please go ahead.
LORRAINE GLOSTER: Yes, for China, as they were creating all this capacity on powder SHS, I assume that was to sell from demand over there. Is it that demand hasn’t really met their expectation, or have they just, as you believe, overbuilt?
MARK DAVIS: Both. They built capacity in anticipation of the textile market moving to China, or Asia, which it has, but I think they miscalculated the demand base and therefore built too much. And whether or not actually they have miscalculated two years from now, that I don’t know and that they don’t know. I don’t know if that’s an answer to your question, but I think that’s what happened.
LORRAINE GLOSTER: Okay, and just in the quarter, if you were to look through it or, I guess, year to date, what would have been the trend there? Was it worse towards the last couple of months, or has it been kind of the same since the beginning of the year? How do you describe the trend on the exports here?
MARK DAVIS: Well, I don’t think it’s gotten any worse as the year has gone on. What we plan to do in the rest of the year is proactively ensure that we maintain our customer base. So some of the weakness I allude to will be self-induced to ensure that we maintain our customer base.
LORRAINE GLOSTER: Okay, that’s great. Thank you.
MARK DAVIS: Thank you.
OPERATOR: You have a follow-up question from the Damir Gunja from TD Newcrest. Please go ahead.
DAMIR GUNJA: Thanks, just one final one on the SHS powder. I realize a good deal of it is under contract, but can you give us a sense of a swing factor, like what would a worst-case scenario be? Are we talking 5% or 10% or something?
MARK DAVIS: For the balance of this year you are talking, Damir, or when?
DAMIR GUNJA: Or a run rate basis.
MARK DAVIS: I don’t think the run rate for the balance of the year should be any different than we experienced in the second quarter.
DAMIR GUNJA: Okay, just a couple of follow-ups and then that’s it for me. The trucking accident earlier this year - there are no issues related to that?
MARK DAVIS: No, we have a copy of the police report which seemingly indicates -- I am trying to be careful with my words now because this could be obviously a litigious event -- the police report seems to indicate that the Cadillac driver was fully at fault for the accident. Though we think, again, that the financial exposure to Chemtrade is minimal, if any.
DAMIR GUNJA: Okay, and a final question. Are you seeing anything on the logistics cost side, trucking or otherwise, rail?
MARK DAVIS: Nothing that we’ve seen that would be significant, no.
DAMIR GUNJA: Okay. Thanks very much.
OPERATOR: Your next question comes from Paul Holden from CIBC World Markets. Please go ahead.
PAUL HOLDEN: Good morning, gentlemen.
MARK DAVIS: Hi, Paul.
PAUL HOLDEN: Is your anode replacement program at your Pulp Chemicals facility complete at this point?
MARK DAVIS: No, it isn’t. It will be completed by the end of the calendar year.
PAUL HOLDEN: By end of the year. About how much in additional capex do you expect to expend on it this year?
MARK DAVIS: It’s about a couple of hundred thousand dollars more, and I don’t have those numbers at hand for referring, but that’s about right. You remember we pre-funded that when we raised money for doing the acquisition.
PAUL HOLDEN: Right. You gave an explanation why current taxes are a little bit higher this year as opposed to 2003. Do you expect that to continue through the second half of the year?
VICTOR WELLS: Paul, yes. That’s a reasonable run rate for the balance of the year.
PAUL HOLDEN: Yep, and have you heard anything from pulp mills, excluding Canfor, regarding demand for sodium chlorate.
MARK DAVIS: Sure, I mean anecdotally, actually these guys are running hard right now, as there is a bunch of mills -- Canfor is so big, so of course we talk about them a lot -- but there is a bunch of Western Canadian mills that had a bunch of hiccups in the first half of the year as far as operating rates go and they all want to be running really hard right now, because there’s a good pulp market.
PAUL HOLDEN: Right, the mill rate should be up.
MARK DAVIS: Mill rate should be up.
PAUL HOLDEN: Can you speak a little about your sulphur dioxide performance during Q2?
MARK DAVIS: Yes, it came in fine. I think as we’ve said a couple of times the SO2 market was under some pressure. I think we said that last year and the year before, and starting this year we started to say that we think the SO2 market has stabilized. I don’t think we believe it’s actually going to turn off. We think it’s a nice stable market for us and results came in as expected.
PAUL HOLDEN: Now, when you say stable, you mean prices are flat, sort of, year-over-year, and volume as well.
MARK DAVIS: That’s right.
PAUL HOLDEN: You implemented a 5% price increase on your liquid SHS product effective January 1, I believe?
MARK DAVIS: Right.
PAUL HOLDEN: Has that price increase stuck?
MARK DAVIS: Most of it has. The liquid product is doing very well. Powder product is suffering from difficulties.
PAUL HOLDEN: Okay, that’s all the questions I had for you gentleman today.
MARK DAVIS: Thank you, Paul.
OPERATOR: Gentlemen, there are no further questions at this time. Please continue.
MARK DAVIS: I would like to thank you all for your continued interest in Chemtrade and your increasingly penetrating questions. Thank you all and we’ll see you all in the next quarter.
OPERATOR: Ladies and gentlemen, this concludes your conference call for today. Thank you for participating and please disconnect your lines.
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