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Edited Transcript of UFS.TO earnings conference call or presentation 1-May-19 2:00pm GMT

Q1 2019 Domtar Corp Earnings Call

FORT MILL May 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Domtar Corp earnings conference call or presentation Wednesday, May 1, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Daniel Buron

Domtar Corporation - Senior VP & CFO

* John D. Williams

Domtar Corporation - President, CEO & Director

* Nicholas Estrela

Domtar Corporation - Director of IR

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Conference Call Participants

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* Adam Jesse Josephson

KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst

* Clyde Alvin Dillon

Vertical Research Partners, LLC - Partner

* Derrick Laton

Goldman Sachs Group Inc., Research Division - Associate

* John Charles Tumazos

John Tumazos Very Independent Research, LLC - President and CEO

* John Plimpton Babcock

BofA Merrill Lynch, Research Division - Associate

* Ketan Mamtora

BMO Capital Markets Equity Research - Analyst

* Mark William Connelly

Stephens Inc., Research Division - MD & Senior Equity Research Analyst

* Paul C. Quinn

RBC Capital Markets, LLC, Research Division - Analyst

* Randy Devin Toth

Citigroup Inc, Research Division - Associate

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Presentation

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Operator [1]

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Good day, ladies and gentlemen. Welcome to the Domtar Corporation Q1 2019 Earnings Conference Call with financial analysts. (Operator Instructions) As a reminder, this call is being recorded today, Wednesday, May 1, 2019.

I would now like to turn the meeting over to Mr. Nicholas Estrela. Please go ahead.

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Nicholas Estrela, Domtar Corporation - Director of IR [2]

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Good morning, and welcome to our first quarter 2019 earnings call. Our speakers today will be John Williams, President and Chief Executive Officer; and Daniel Buron, Senior Vice President and Chief Financial Officer. They will be supported by Michael Garcia from our Pulp and Paper division; and Michael Fagan from the Personal Care division. John and Daniel will begin with their prepared remarks, after which, they will take questions.

During the call, references will be made to supporting slides, and you can find this presentation in the Investor section of the website.

As a reminder, all statements made during the call that are not based on historical facts are forward-looking statements subject to a number of risks and uncertainties, many of which are outside our control. I invite you to review Domtar's filings with the Securities Commission for a listing of those.

Finally, certain non-U. S. GAAP financial measures will be presented and discussed, and you can find a reconciliation to the closest GAAP measures in the appendix of this morning's release as well as on our website.

So with that, I'll turn it over to John.

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John D. Williams, Domtar Corporation - President, CEO & Director [3]

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Thank you, Nick, and good morning, everyone. This morning, we reported EBITDA before items of $205 million, which is a 27% improvement when compared to the same quarter last year. The improvement in our performance was driven by strong results in paper with margin expansion, accelerating price realizations and additional volume momentum. Paper prices were higher compared to the fourth quarter as we continue to implement the recently announced increases while also benefiting from a favorable sales mix. Our paper shipments increased 2% as market demand improves seasonally when compared to the fourth quarter.

We're also growing our business with our strategic customers, improving our customer mix and capitalizing on growth opportunities. Market conditions allowed us to run full out on our paper operations and several of our paper machines operated at record production levels.

Cost performance was strong, resulting in 250 basis points of margin expansion despite some challenges procuring fiber.

In pulp, our results were solid but were impacted by lower prices, while our volumes were lower than expected, mostly due to higher internal pulp shipments as a result of the wood fiber constraints. Looking forward, we remain optimistic for the long-term fundamentals of the pulp grades we supply.

Some of our energy and certain raw material costs were higher in quarter 1, which is typically a seasonally high-cost quarter. In particular, fiber costs were well above average due to the impact of record rainfall on fiber availability in the U.S. South. However, our efforts around continuous improvement initiatives and cost efficiencies led to some savings, specifically around chemical usage.

In Personal Care, we're making progress. Sales were in line with our expectations while EBITDA increased from the fourth quarter. We did well with productivity, which drove better operational efficiencies as our new customer wins ramp up. Our teams are also delivering on our margin expansion plan that's expected to show solid progress throughout the year. We will also continue to focus on winning new business and volume. Our sales pipeline remains active, with numerous opportunities to grow in both North America and Europe.

With that, let me turn the call over to Daniel for the financial review before making further comments on our first quarter performance and our outlook. Daniel?

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Daniel Buron, Domtar Corporation - Senior VP & CFO [4]

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Thank you, John, and good morning, everyone. Let's start by going over the financial highlights of the quarter on Slide 4.

We reported this morning net earnings of $1.27 per share for the first quarter compared to net earnings of $1.38 per share for the fourth quarter of 2018. Adjusting for items, our earnings were $1.44 per share for the first quarter compared to earnings of $1.63 per share for the prior quarter. EBITDA before items amounted to $205 million compared to $228 million in the fourth quarter.

Turning to sequential variation in earnings on Slide 5. Consolidated sales were $14 million lower than the fourth quarter due to lower sales in our Pulp and Personal Care businesses. The precision amortization was $2 million lower when compared to the fourth quarter, while SG&A was $23 million higher than the fourth quarter due mostly to mark-to-market of stock base of competition. In the first quarter, we recorded an income tax expense of $24 million or a tax rate of 23%, which is in line with our forecasted tax rate.

Now turning to cash flow statement on Slide 6. Cash flows from operating activities amounted to $55 million while capital expenditure amounted to $46 million. This resulted in a free cash flow of $9 million in the first quarter.

Turning to the quarterly waterfall on Slide 7. When compared to the fourth quarter, EBITDA before items decreased by $23 million due to higher SG&A cost for $23 million, higher raw material cost for $16 million and lower volume and mix for $9 million. These were partially offset by higher selling prices for $13 million, lower other costs for $11 million and a favorable foreign exchange for $1 million.

Now the review of our business segments starting on Slide 8. In the Pulp and Paper segments, sales were 1% lower when compared to fourth quarter and 4% higher when compared to the same period last year. EBITDA before items was $204 million compared to $211 million in the fourth quarter of 2008.

Our Paper business on Slide 9. Sales were 4% higher versus last quarter and were 6% higher versus the same quarter last year, while estimated EBITDA before items was $156 million or 18% margin. Manufactured paper shipments were 2% higher when compared to the fourth quarter and 4% lower versus the same period last year. Average transaction prices for all our paper grades were $30 per ton higher than the last quarter.

Let's turn to the Pulp business on Slide 10. Sales were 13% lower versus the last quarter and were 1% lower versus the same period last year. Estimated EBITDA before items was $48 million or a 16% margin. Pulp shipments were 12% lower versus the fourth quarter and down 7% when compared to same period last year. Lower shipments were in part due to higher internal shipments to our Paper business due to the wood supply shortage. Average pulp prices decreased $26 per metric ton versus the fourth quarter. Our paper inventory increased 22,000 tons when compared to the last quarter while pulp inventory increased by 24,000 metric tons.

Our Personal Care business on Slide 12. Sales decreased 3% when compared to last quarter and were 6% lower versus the same quarter last year. EBITDA before items was $22 million, $2 million higher than the fourth quarter.

Let's turn to Slide 13. As you can see, the second quarter will be our most active quarter with regards to major plant maintenance shutdown in our Pulp and Paper businesses. We expect to spend approximately $43 million more than what we spent in the first quarter, and this increase should be 60% in Pulp and 40% in paper. As usual, this increased maintenance activity in the second quarter will impact fixed cost absorption by approximately $12 million.

So this concludes my financial review. And with that, I'll turn the call back to John.

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John D. Williams, Domtar Corporation - President, CEO & Director [5]

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Thank you, Daniel. We've had a good start to 2019. In our Paper business, higher prices and a favorable sales mix underpinned a very good quarter. Total production tonnage was high. Cost performance across our paper network was strong and we expanded margins. Our average paper prices were $30 per ton higher as we're implementing our announced price increases on several paper grades. The implementation of these increases is going as planned. We expect to fully realize the $60 per ton March increase on 2 million tons in the second quarter, with a full run rate benefit by quarter 3. We continue to have a positive outlook on Paper. Our backlogs are strong, and we're experiencing favorable market conditions.

As competitors shut capacity, we're well-positioned to support the increased demand from our customers. And we remain their supplier of choice. We anticipate and are ready for opportunities to grow volume across several channels where we have unique value-added supply chain capabilities.

At our Market Pulp mills, we had a good operational performance where we continued to increase overall productivity despite some wood supply and winter-related challenges that affected our costs and volumes.

Prices were lower quarter-over-quarter. However, prices in China began to stabilize after some downward pressure in the fourth quarter and earlier this year. We continue to remain optimistic in our long-term pulp outlook. We expect softwood and fluff pulp prices to trend positively in the medium to long term supported by demand growth and a deceleration of capacity expansion.

In addition, our customers, notably in the tissue, hygiene and specialty sectors, anticipate strong growth in their markets. As I noted, some of our operations, mostly integrated paper mills, were impacted by record rainfall, flooding and poor harvesting conditions that led to fiber shortages at some of our facilities.

Outside of the cost implications that constrain wood supply, our cost performance has tracked our expectations. In the second quarter, outages are planned at several of our Pulp and Paper facilities, so we will be vigilant on both safety and execution.

In Personal Care, our actions to drive margin improvement and enhance our competitive position are beginning to generate tangible results. Margin expansion in quarter 1 was driven by better cost absorption, price increases and strong production which drove favorable unit costs.

During the quarter, we began to wind down production at our Waco facility, which will also include a workforce reduction of 148 people. The next steps include the relocation of infant and adult diaper lines to our Delaware and Greenville facilities. This is scheduled to begin in the second quarter, and the foreclosure will be completed by quarter 3. These steps will optimize infant diaper production and drive reductions in fixed costs.

Our margin improvement plan aims to increase efficiency and productivity, reduce our cost base and strengthen our long-term competitive position while focusing on growth opportunities. We'll do this through streamlining our manufacturing footprint and repositioning our assets to match our markets, optimizing our supply chain and standardizing our operational work systems, reducing complexity in our product and customer mix and undertaking pricing initiatives.

Turning to overall capital allocation, we will continue to pursue a balanced approach to the deployment of our capital. Our balance sheet's in good shape, which will allow for smart investments in our best assets while maintaining the flexibility to carry out our growth strategy and return capital to shareholders. We had a solid first quarter on the back of a strong 2018, and we will build on our commitment to deliver sustainable growth and long-term value creation for our shareholders.

Looking ahead, our paper shipments should benefit from higher demand from our customers following the announced capacity closures in the industry. Our paper prices should move higher as we continue to implement the announced increases across the majority of our grades.

We do expect softwood and fluff pulp markets to remain balanced through the year due to steady demand growth and limited new supply. We do anticipate the costs of freight labor and raw materials will marginally increase. The second quarter will be affected by seasonally higher maintenance costs in our Pulp and Paper business as we move into the planned outages at some of our major facilities.

Personal Care is expected to benefit from the continued execution of our margin improvement plan and new customer wins, partially offset by further raw material cost inflation.

2019 is shaping up to be a good year for Domtar, and we remain very focused on operational excellence to take advantage of favorable market conditions.

Thank you as ever for your time and support, and I'll turn the call back to Nick for questions.

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Nicholas Estrela, Domtar Corporation - Director of IR [6]

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Thank you, John. So both John and Daniel will be available for questions. As usual, I'd ask our participants to ask a few questions at a time and return to the queue for follow-ups as we want to get as many people as possible.

Michelle, you can open up the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question today will be from Brian Maguire with Goldman Sachs.

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Derrick Laton, Goldman Sachs Group Inc., Research Division - Associate [2]

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It's Derrick Laton for Brian. Just a quick one on Paper. It looks like the markets tightened a bit after the Georgia-Pacific mill closure. And it sounds like your increase is going through pretty well, according to your expectations. But it looks like in Pulp and Paper Week it seems like some of that commentary there was little bit more negative and it seems like maybe an increased threat from imports. Are you beginning to see that become an issue at all? And do you think there's a threat from that, that could impact this price increase?

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John D. Williams, Domtar Corporation - President, CEO & Director [3]

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That's a good question. Let me tell you what I think has happened. So I think when the increase was -- excuse me, when the closure was announced, a lot of people were thinking, well, this is 8% of industry capacity. And actually, GP was supplying some very specific customers who went out to find paper, really, I think very concerned about whether they were going to get supplied. They've found some paper but I'm not sure from what I would kind of overall sustainable supply chains over time. In addition, of course, they were producing pretty much right to the end. So if you think about sort of the average stock in the industry, some of that paper and probably still quite a lot of it actually is still in the system. So my premise at the moment is -- or our premise, I should say, is that, that will work its way through certainly by the end of the second quarter. And then particularly, in the cut-size grades, we're going to see a reasonable supply/demand situation. I don't think we're going to have, if you like, a great shortage but certainly, operating -- the operating rate opportunity for us will be considerable that we can pretty much sell everything we can make. So I think that's what's happening in the paper business at this moment in time. So it's just a little bit too early to tell as to where this will shake itself out over time. Does that give you a little bit more color on that?

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Derrick Laton, Goldman Sachs Group Inc., Research Division - Associate [4]

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Yes, yes, that's helpful. And then similarly, on the coated paper side, it seems like there's been some shift in production there, onto the uncoated freesheet side. Are you seeing that at all as a threat? And is that maybe more focused on the offset roll side relative to cut-size?

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John D. Williams, Domtar Corporation - President, CEO & Director [5]

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Well, it's definitely about offset rolls. And, of course, I think with the most recent announcement, you've seen where pretty much 8% of industry capacity on coated is coming out. That's obviously going to change things slightly in the short term.

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Derrick Laton, Goldman Sachs Group Inc., Research Division - Associate [6]

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And then just on the pulp side, you mentioned the fiber shortage was part of the reason for the volumes coming in a little bit light. Are you seeing anything improving a bit as we're looking into 2Q? Or is that going to be a little bit of a continuation of an issue there?

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John D. Williams, Domtar Corporation - President, CEO & Director [7]

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So we are -- just to be clear, on the fiber side, it's really that shortage of fiber caused us to prioritize paper over pulp, and that meant we were producing and selling less pulp tons, although we did build a bit of inventory in pulp ahead of the closures for the coming -- for maintenance in quarter 2. And it was really focused in the U.S. South just in terms of weather. Soaking wet forests are very hard to harvest from, all your costs increase. So when we put all that together, quarter 2, we think we're through that now.

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Operator [8]

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Next, we'll move to Anthony Pettinari with Citi.

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Randy Devin Toth, Citigroup Inc, Research Division - Associate [9]

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This is actually Randy Toth sitting in for Anthony. Can you touch on the potential debottlenecking that could occur as a result of this pulp optimization work? I think you're on year 2 of 4. So when all is said and done, could that increase impact meaningfully?

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John D. Williams, Domtar Corporation - President, CEO & Director [10]

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Yes, but it's in the sort of tens of thousands, at the most, 100,000 tons. It's not a massive increase. It's really across our whole system around productivity. It's also about cost reduction. So we don't see that as a kind of issue from a capacity standpoint. It's really more about efficiencies.

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Randy Devin Toth, Citigroup Inc, Research Division - Associate [11]

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Okay, that makes sense. And then just you stated that GP's closure was focused on certain subset of customers. Would it be fair to say that some of the import jump we've seen in 1Q was related to those customers attempting just to build volumes and inventory? And longer term, could we see those customers move to more domestic and reliable suppliers?

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John D. Williams, Domtar Corporation - President, CEO & Director [12]

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I think that's a very interesting question. So if you look at the imports, I think imports at their maximum level probably reached sort of 11%, 12% of total industry supply. They're not there yet. My guess would be some of those supply chains could easily be challenging, let's put it those ways. So that perhaps those customers over time will be thinking, oh right, well I solved my immediate problem, how do I now build a supply chain that's sustainable for the future and therefore, how do they think about domestic supply? As I said in my earlier answer, I think it's too early to tell how that's going to shake out. But if I look at sort of past history, that's typically what happens.

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Operator [13]

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And next, we'll hear from George Staphos from Bank of America.

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John Plimpton Babcock, BofA Merrill Lynch, Research Division - Associate [14]

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It's actually John Babcock on the line for George. I just actually wanted to tie -- tag along to Brian Maguire's question, just on uncoated freesheet pricing. I was wondering if you could talk about how implementation of this price increase is tracking relative to past increase and generally, how we should think about that?

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John D. Williams, Domtar Corporation - President, CEO & Director [15]

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Sure. I mean, I can only talk about the past. But I mean, I would say it's very much the place we would have expected from our past experience and nothing has happened so far that gives us concern around it.

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John Plimpton Babcock, BofA Merrill Lynch, Research Division - Associate [16]

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Okay. That's fair. And then moving on to wood cost, how much of a headwind was that in the quarter? Is there any way you could give us a sense for the [kind of dollar impact] for the quarter?

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Daniel Buron, Domtar Corporation - Senior VP & CFO [17]

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I think total wood cost increase was $19 million in the quarter. You normally have a little bit of seasonal. In Q1's just the winter, the snow, the ice. I would say around $12 million was probably abnormal, if you will, in the quarter and that's what we believe we'll get back in the second and third quarter. It's going to take a little bit more than a quarter for the price to go where it was before, but we believe it will go back.

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John Plimpton Babcock, BofA Merrill Lynch, Research Division - Associate [18]

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Okay. And how are you feeling about inventories in the Pulp and Paper channels right now?

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John D. Williams, Domtar Corporation - President, CEO & Director [19]

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Sure. So if you take paper, obviously, we have a model we're working to around those tons from GP not being available and therefore, a need to produce in order to supply those tones, so that's one of the reasons inventory has built a little bit. The other reason, of course, is we're taking a couple of shuts, one of which is in our largest paper mill in the second quarter, so that causes us to build stock ahead of that shut.

We dialed back actually some of our export business, so that has meant we have kind of more stock sitting available, if you like, for the domestic environment. So I would say it's as high as we'd want it to be. I wouldn't want to see it creep that much higher. But if our assumptions around kind of quarter 2, quarter 3, second half are correct, we'll work our way through that. On the pulp side, that's absolutely about really the shuts coming up and our need to supply through the shuts.

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John Plimpton Babcock, BofA Merrill Lynch, Research Division - Associate [20]

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Okay. That's fair. And then just the last question before I turn it over. I was just wondering on the pulp side of things again. If you could talk about, I mean, you mentioned fiber impact on volumes but wanted to get a sense. I mean, there was a little bit of weaker demand in China, so want to essentially understand whether or not there was some impact there from end-market weakness as well?

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John D. Williams, Domtar Corporation - President, CEO & Director [21]

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Yes, sure. I mean, I think the impact in China was largely really Chinese New Year where, essentially, nothing happens for 2 to 3 weeks. So we would imagine and are planning for the fact that our pulp volumes sort of revert back more to the norm.

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John Plimpton Babcock, BofA Merrill Lynch, Research Division - Associate [22]

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Okay. So you wouldn't say then that the impact to volumes was really much driven by end-market demand but more driven by that kind of fiber issue?

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John D. Williams, Domtar Corporation - President, CEO & Director [23]

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Yes, I think you have to -- I mean, that's a great question. I think you really have to think about the end-use markets we're supplying. So most of our pulp is going into tissue grades. It's going into Personal Care, so it's going to diapers, adult diapers, feminine hygiene. So the end-use demand and, of course, some specialty areas as well which look pretty solid. So if you look at end-use demand, I think that end-use demand has a lot of runway pretty much for as far as if you take end-use demand tissue, diaper, adult diaper over the next 20 to 30 years, it's very strong. I think what occasionally happens as we know is that inventories bump in various different directions, and therefore, buyers and sellers take different positions. But my view is over all, if you look at the softwood pulp grades, they have a very strong future. There isn't much capacity coming in. Containerboard, obviously, needs softwood, so that's another pressure on softwood and we're -- as you know, we've built our Pulp business very much around softwood grades. So we're very positive about those grades over the medium to long term.

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Operator [24]

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And next, we'll hear from Mark Connelly with Stephens Inc.

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Mark William Connelly, Stephens Inc., Research Division - MD & Senior Equity Research Analyst [25]

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John, fluff businesses have historically been moving less and slower than paper grade pulps, but it's been harder for us to see that relationship in the last year. And with the destocking, it's gotten maybe even harder recently. Do you think that the relationship between fluff prices and other paper grade prices has changed? Is China doing something different in the way they're buying that's going to make that price relationship work differently?

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John D. Williams, Domtar Corporation - President, CEO & Director [26]

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You mean between fluff and, say, southern softwood which was sort of how we all looked at it historically, Mark? Is that the question? Sorry, just to get a bit of clarity.

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Mark William Connelly, Stephens Inc., Research Division - MD & Senior Equity Research Analyst [27]

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Sure. Yes, just trying to get a sense of whether the historical pattern's different.

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John D. Williams, Domtar Corporation - President, CEO & Director [28]

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Yes I mean, that's a great question. I think the answer could be maybe, but I'm not sure -- and the only reason I think about maybe in fluff pulp, there have been a specific instance where a major customer reengineered some product to reduce usage on fluff pulp, which was kind of a one-off event which the market had to adjust to. I think that may be separated the 2 grades a little bit from where it was historically. And of course, southern softwood is a smaller market and therefore, is inherently more volatile potentially than fluff. So I think in that respect, I'm not sure you can read it that way anymore.

I also think that as people are producing fluff pulp these days, there's really less -- they need -- their costs are actually now looking very similar to when they're making ordinary softwood, which is different to history. So maybe all that has changed the dynamics a little bit. Does that help?

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Mark William Connelly, Stephens Inc., Research Division - MD & Senior Equity Research Analyst [29]

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Okay. Yes, that's very, very helpful. And just one question for Daniel. Do you have any sense of how we should think about working capital for the rest of the year? Obviously, you've explained why we had the build this quarter. But it almost sounds like some of that inventory, you may need to keep and maybe that relationship for the rest of the year is a little different?

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Daniel Buron, Domtar Corporation - Senior VP & CFO [30]

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I think there's 2 reasons why we had more inventory. I think John explained the Pulp and Paper side because of shuts. We also built a little bit of inventory in Personal Care given the Waco closure and the movement of machine as we need to be able to serve our customers while the machine that will be moved won't be producing. And so I see that going back to normal. So I see that as kind of almost cash in the bank before year-end, so I see that coming back to normal levels by year-end.

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Mark William Connelly, Stephens Inc., Research Division - MD & Senior Equity Research Analyst [31]

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But is there some component with this GP thing that you're just going to be carrying higher inventories because you're doing more business?

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Daniel Buron, Domtar Corporation - Senior VP & CFO [32]

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No, I don't think so. I think we'll be able to manage with more or less the same level we used to.

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Operator [33]

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And we'll hear from Ketan Mamtora with BMO Capital Markets.

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Ketan Mamtora, BMO Capital Markets Equity Research - Analyst [34]

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First question on Personal Care. What kind of EBITDA run rate are you targeting as you kind of sort of exit 2019? Just give us a rough sense of how your margin improvement plan is tracking versus your target.

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John D. Williams, Domtar Corporation - President, CEO & Director [35]

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Right, so Ketan, let me answer that question. So our objective in that business is sort of mid-teen EBITDA, low to mid-teen. So we'd be thinking that from a kind of year-end, looking forward into '19, that we're in -- we're at those kind of levels or moving towards those kind of levels. That's, I think, what we would consider to be success in '19 as we moved into 2020.

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Ketan Mamtora, BMO Capital Markets Equity Research - Analyst [36]

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Got it. And at this point, based on what you're seeing, you think you are kind of on track to achieve that kind of a target?

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John D. Williams, Domtar Corporation - President, CEO & Director [37]

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Yes, indeed. Because the closure -- the Waco closure really kicks in end of quarter 3, quarter 4. Our customer wins really start to benefit us as we sort of settle the volume down. Our SKU rationalization will be helping by then. So right now, we're -- actually versus where we thought we'd be, we're very slightly ahead. So, so far, so good.

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Ketan Mamtora, BMO Capital Markets Equity Research - Analyst [38]

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That's good news. And then turning to coated papers again for one more minute. I mean, some of the recent stats that we've seen on coated paper volumes, they've been down very, very sharply. So how do you think about kind of the ripple effect into kind of the uncoated -- your uncoated business with volumes down as sharply as they are?

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John D. Williams, Domtar Corporation - President, CEO & Director [39]

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Well, so I mean, obviously, coated manufacturers can take off their coat and can make uncoated freesheet and they've done that historically. I have to say that has largely been opportunistic. They haven't really built supply chains around that. And of course, you now see this closure in Maryland of 450,000 tons from Verso just been announced 60 days. It's about 8% of coated capacity as far as we can make out, which would probably bring operating rates in the coated industry up into the sort of low 90s, which suggests therefore that their need, if you like, to make uncoated freesheet will therefore be reduced.

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Operator [40]

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And next, we'll hear from Chip Dillon with Vertical Research.

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Clyde Alvin Dillon, Vertical Research Partners, LLC - Partner [41]

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First question, John, is if we go back about 5 years, when we saw the Courtland Mill shut, there was a big surprise in terms of the magnitude of the import response. And the mill in Port Hudson is -- it's basically cooled off. It's been less than 2 months since it shut down. Would you say the tariff structure that's in place today would make such a swamping of imports less likely to take place? And are there other reasons you might not see the same kind of response given that the Port Hudson shutdown is comparable to Courtland?

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John D. Williams, Domtar Corporation - President, CEO & Director [42]

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Well, so I mean, Courtland was a fair bit bigger, Chip. But I think certainly, the duties will make a difference. I also think that the customers that were being supplied by GP are a fairly specific set of customers who will look to a mix, I think over time, of also having domestic producers just to keep their supply chain reasonably balanced.

So there's no question. I think domestic suppliers have to remain competitive and we have to have a value proposition that's compelling enough for people not to build a sort of supply chain from imports.

I do also think that what's happening in the markets, so what's happening in the European market of uncoated freesheet and what's happening in other markets on uncoated freesheet, the dynamic's very different there now in terms of kind of the earnings they're getting from their domestic market. So it's not like America is this great sort of shiny spot that it used to be in terms of pricing; although still attractive, but I don't think you'd divert domestic tons here if you were thinking about defending your domestic position in Europe. So to my mind, I don't think, to your point, that it's going to happen again.

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Clyde Alvin Dillon, Vertical Research Partners, LLC - Partner [43]

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Got you. And then, just on an unrelated note, the CapEx guidance for the year, the $220 million to $240 million is unchanged since early February. And I just didn't know if you could update us on your thoughts on the timing of any kind of actual steps toward any converting activity. And does this number include any work that would anticipate something happening in 2020?

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John D. Williams, Domtar Corporation - President, CEO & Director [44]

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No, it doesn't. So as you know, we have a plan. I think we've been pretty transparent about that plan, but that plan is really driven by our view on the dynamics on uncoated freesheet. And obviously, right now, as you can hear by what we're saying and what we're experiencing, we have a pretty positive outlook on uncoated freesheet for some time.

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Clyde Alvin Dillon, Vertical Research Partners, LLC - Partner [45]

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And just quickly, you mentioned yesterday's announcement regarding a mill in Maryland. Do you see that -- was that mill actually pretty active in not coating their paper and actually, was that an influence you either were concerned about or actually were feeling that might not be there if they follow through on their plan?

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John D. Williams, Domtar Corporation - President, CEO & Director [46]

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Actually, I don't know the detail of that well enough to pass comment, but I guess I would see it on a systems basis. Patently, if you looked at that announcement carefully enough, it says very clearly that they can manufacture those grades in other parts of the network. Now, that suggests to me that if other parts of that network were doing uncoated freesheet, they'll now do the main grades. So I think that's the way it has influence as distinct from what that mill is specifically shipping.

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Operator [47]

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And next, we'll hear from Adam Josephson with KeyBanc.

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Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [48]

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John, are you able to start with 2 nitty-gritty questions if you don't mind? Can you give the...

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John D. Williams, Domtar Corporation - President, CEO & Director [49]

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Adam, your line is crackling rather badly. I don't know -- I'm having a bit of trouble hearing you.

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Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [50]

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Is this better?

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Daniel Buron, Domtar Corporation - Senior VP & CFO [51]

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No.

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John D. Williams, Domtar Corporation - President, CEO & Director [52]

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No. I don't know what we could do.

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Daniel Buron, Domtar Corporation - Senior VP & CFO [53]

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He can redial maybe?

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John D. Williams, Domtar Corporation - President, CEO & Director [54]

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We have one other question, Adam. Do you mind if we took it and you could redial and see if we could improve the line. Is that all right?

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Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [55]

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Sure. Sure.

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John D. Williams, Domtar Corporation - President, CEO & Director [56]

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Alrighty. We'll hear from you in a moment.

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Operator [57]

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We'll hear from John Tumazos with John Tumazos Very Independent Research.

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John Charles Tumazos, John Tumazos Very Independent Research, LLC - President and CEO [58]

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Concerning Personal Care, the revenues were $15 million less than a year ago, but you made reference to developing a new customer which, if it's material, let's say, 1% or 2% of revenue, would be $2.5 million or $5 million. And you made reference to price hikes, which, if they were material, should be at least 1% or 2% revenue or $2.5 million or $5 million. So it sort of gives the impression there's a $20 million or $25 million revenue decline bouncing around Personal Care, even though people keep getting older and needing the product. Does that mean that the Waco, Texas plant decreases that big an impact or some competitors making an inroad, is my question?

And then second, I understand the $10 million impairment this quarter and $7 million-or-so in December. But why do you impair in dribs and drabs rather than just writing off the whole $587 million goodwill balance? It doesn't seem -- I just don't understand why it's dribs and drabs.

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John D. Williams, Domtar Corporation - President, CEO & Director [59]

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All right, John. May I talk to the first one and Daniel will talk to the second one? Would that help you?

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John Charles Tumazos, John Tumazos Very Independent Research, LLC - President and CEO [60]

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Of course. That's wonderful.

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John D. Williams, Domtar Corporation - President, CEO & Director [61]

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Alrighty. So I think as we've talked about previously, one of our accounts took quite a chunk of business out of us a while back. So we are playing to some extent volume catch-up to make up for that. Now from a margin standpoint, that was okay business but not great business, but it creates a hole in the comparative sales line that will probably work its way out by quarter 3, I would think, this year. So that's what you're seeing. So that's what's driving that sales line issue that you discussed. So there's nothing more, I guess I would say, mysterious than that.

So basically, as we win new business, part of that business is making up for that hole that was created by one of our larger diaper accounts actually not taking all the business away but taking a substantial piece of the business away. That is also, to some extent, what drove our thinking around Waco, saying to ourselves, well, rather than living with that level of overhead, we'll actually put that business into Delaware and make certain, therefore, that we can operate productively and profitably on lower volume. So that's why we've taken some of the actions we've taken.

On the other issue, I'll defer to Daniel and he'll talk to you about that.

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Daniel Buron, Domtar Corporation - Senior VP & CFO [62]

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Let me clarify something as it is implied in your question. So the $7 million we've seen in Q4 and the $10 million we've seen in Q1 is not related to intangible asset. It's actually FAS depreciation of asset that were located, are still located at Waco that won't be used once the Waco closure is done. And you should see more or less similar amounts in Q2 and it should be done after that.

And the reason why it's not in 1 chunk, is it is FAS depreciation, accelerated depreciation. This is just responding to GAAP, the accounting principle. This is all they ask us to do that when there's a closure of an asset.

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John D. Williams, Domtar Corporation - President, CEO & Director [63]

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Does that help, John?

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John Charles Tumazos, John Tumazos Very Independent Research, LLC - President and CEO [64]

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So that's -- so Daniel, following up, if these were tangible asset charges impaired, how do you justify the large goodwill balance when the results don't seem to justify a goodwill balance? You're anticipating a year from now, the business will be turned around.

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Daniel Buron, Domtar Corporation - Senior VP & CFO [65]

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First of all, there is no more goodwill in that business. There's intangible customer relationship and all other type of intangibles. And the DCF of that business is justifying those assets one by one.

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John D. Williams, Domtar Corporation - President, CEO & Director [66]

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All right, John. So could we return to Adam?

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Operator [67]

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Yes. Next, we'll hear from Adam Josephson with KeyBanc.

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Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [68]

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John, is this better?

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John D. Williams, Domtar Corporation - President, CEO & Director [69]

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Way better.

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Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [70]

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I guess we're not -- this is from my cell. I guess we're not paying our phone bills here at KeyBanc.

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John D. Williams, Domtar Corporation - President, CEO & Director [71]

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Don't worry. At least we can hear you. Ask away.

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Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [72]

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Amen to that. Daniel, just a couple modeling ones and I'll ask John a couple big-picture ones. Can you give us, Daniel, exit -- pricing exit rates for both freesheet and pulps compared to the average prices during the quarter? And then anything on how much more pricing you might be expecting in 2Q beyond the exit rate?

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Daniel Buron, Domtar Corporation - Senior VP & CFO [73]

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Exit rate of paper was actually $10 higher than the average of Q1. And exit rate of -- exit price of pulp was $20 less than what we experienced in the quarter. Obviously, the future, we'll see. We're confident we're going to get our price increase. There is a lot of price increase in paper. And I mean, if you look at trade publication right now on pulp, U.S. is still going down, China is stable. So we'll see how that will unfold.

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Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [74]

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And just, Daniel, on the $10 a ton higher exit rate for paper, how much of the $60 does that exit rate reflect?

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Daniel Buron, Domtar Corporation - Senior VP & CFO [75]

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We're probably a bit more than half done.

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Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [76]

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With -- based on that exit rate?

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Daniel Buron, Domtar Corporation - Senior VP & CFO [77]

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Yes.

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Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [78]

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Okay. Got it. And then...

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John D. Williams, Domtar Corporation - President, CEO & Director [79]

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But Adam, just 1 note of caution. Remember that only 2 million tons are impacted by that price increase.

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Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [80]

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So we should really ignore the other 1 million tons for the purposes of that $60?

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John D. Williams, Domtar Corporation - President, CEO & Director [81]

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Yes. Yes, exactly. And obviously, that's a fair swing in the model, so I didn't want to turn you off with the wrong idea.

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Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [82]

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I appreciate your clarifying that, John. A couple others. One on pulp. You know producer inventories are quite high relative to history. Look at the Chinese, there's more data. Inventories are quite high. The European port data, inventories are quite high. So based on everything one looks at, pulp inventories are very high relative to historical levels. And obviously, the Chinese paper market is under a fair bit of pressure at the moment. What is informing your view that the pulp market has stabilized from here?

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John D. Williams, Domtar Corporation - President, CEO & Director [83]

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Well, because whether it has in the very short term, I don't know. But I think in the medium term, so looking a few months out, the inherent demand in the grades that we are supplying and the inherent demand in the end use to which they're going is growing. So -- and in that geography, obviously, baby diapers are growing; and everywhere across the globe, adult incontinence is growing; and tissue is growing pretty quickly.

So I put all that together and I just say to myself, there are going to be shocks along the way, whether that may be buyers take a position, whether there's some spot tonnage that perhaps was going into paper grades that's now trying to be sold into tissue and some of those other grades that can just sort of buy standard softwood. But overall, I'm not sitting here thinking there's any inherent demand concern. And I think stocks came down about 3.5 days if I recall, albeit, as you say quite rightly, from fairly high levels. But my view is I think that that will work its way through.

And if I look at our customers and our customer relationships, we do have the luxury that we don't sell through agents in China. We have our own people on the ground. I think that gives us pretty good visibility.

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Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [84]

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I really appreciate that. And just one last one. I know Chip was asking earlier about your CapEx plans and conversion plans and you have nothing -- there's nothing in the offing as yet. As you know as well as anyone, the global containerboard conditions have weakened quite a bit in recent months. Prices in the U.S., Europe and China are all falling. Brazilian demand is weak, too. How does what's happened in the last several months and then [Cooler Bean's] capacity announcement, how have all of these developments affected your medium- to long-term view of the attractiveness or lack thereof of the industry and consequently, your plans to potentially convert some of your machines to containerboard?

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John D. Williams, Domtar Corporation - President, CEO & Director [85]

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Yes. Well, so as we've always said, we're really driven more by uncoated freesheet prospects, I guess I would say. And as I said earlier, we see solid runway for this grade for quite some time.

I think if we see issues developing, as we've talked about before, we have the optionality around pulp as well as some of those containerboard choices.

You're exactly right; I think in the short term, having lived through containerboard cycles when I ran one of those businesses, I still think that the long-term prospects for that business are pretty strong. You can drive yourself crazy trying to time it. But if you really think about who we are, we're looking now 2 years out, 18 months out before we really have to make a choice, so let's see what happens then really.

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Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [86]

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Well, just the last question along those lines. From the time you let the market know that you were considering potentially converting some of your machines to containerboard to now, much has changed globally and in the U.S. Has everything that's changed in any way affected your view?

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John D. Williams, Domtar Corporation - President, CEO & Director [87]

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It certainly has made us think around the pulp opportunities we have in the network as carefully as the containerboard opportunities.

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Operator [88]

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And next, we'll move to Paul Quinn with RBC Capital Markets.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [89]

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Just a question, you've been partially successful on the uncoated freesheet price increase. Just wondering if we've seen, are you guys seeing any change in behavior from domestic, say, coated paper producers as well as whether you've seen certain countries increase shipments into North America on the offshore side?

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John D. Williams, Domtar Corporation - President, CEO & Director [90]

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Yes. So I mean, imports, we've seen an increase. It's been -- I mean, it's still a relatively small number but it's been sort of a large number from the delta because the delta was relatively low. And obviously, we negotiate with our customers who are aware of what else is going on in terms of the dynamics, and we've had success in moving price. So behind all that, one makes the assumption that -- of what other people are doing.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [91]

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Okay. And then just a question on capital allocation. I mean, free cash flow was kind of [needed] in this quarter, but I expect it to accelerate quite quickly with the price increases that you're getting and hopefully, a recovery in pulp markets. Has there been a change in capital allocation? Are you going to hold some back for an eventual conversion into containerboard or pulp?

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Daniel Buron, Domtar Corporation - Senior VP & CFO [92]

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I think our long-term strategy is still the same there, Paul. We're going to return the majority of our capital to shareholders. We've been delivering north of 60 -- I don't remember what, 65%, 67% since we've made that commitment. We will stay there. And if, at some point, there's cash sitting on the balance sheet, we'll revisit how we're going to deal with it. But right now, I don't think that's a problem for 2019.

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Operator [93]

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(Operator Instructions) And there are no further questions at this time. I would like to turn the call back over to Domtar for any additional or closing remarks.

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Nicholas Estrela, Domtar Corporation - Director of IR [94]

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Thank you, Michelle. So we will release our second quarter 2019 results on Thursday, August 1, 2019. Thank you for listening and have a great day.

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Operator [95]

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And that will conclude today's call. We thank you for your participation.