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

Q2 2019 Domtar Corp Earnings Call

FORT MILL Aug 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Domtar Corp earnings conference call or presentation Thursday, August 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

* Michael Dennis Garcia

Domtar Corporation - President of Pulp & Paper Division

* 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

* Brian P. Maguire

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Clyde Alvin Dillon

Vertical Research Partners, LLC - Partner

* John Charles Tumazos

John Tumazos Very Independent Research, LLC - President and CEO

* John Plimpton Babcock

BofA Merrill Lynch, Research Division - Associate

* Mark William Wilde

BMO Capital Markets Equity Research - Senior Analyst

* Paul C. Quinn

RBC Capital Markets, LLC, Research Division - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen. Welcome to the Domtar's Second Quarter 2019 Earnings Conference Call with Financial Analysts. (Operator Instructions) As a reminder, this call is being recorded. Today is Thursday, August 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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Thank you. Good morning and welcome to our second 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 we supported by Michael Garcia from our Pulp and Paper division; and Michael Fagan from the Personal Care division. John and Daniel will begin with 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's 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 to the Securities Commissions for a listing of those.

Finally, certain non-U. S. GAAP financial measures will be presented and discussed, and you can find the 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 $133 million. Our results in the Paper business fell short of our expectations. This is reflected in lower volumes and the market-related downtime we took in our system. We do believe the current softness in the uncoated freesheet market is short term in nature and driven mainly by a buildup of inventory in the supply chain, ahead of announced capacity closures and also imports.

Looking past quarter 2, we expect channel inventory to adjust over the next few months, and we anticipate our shipments to pick up as the year progresses. Despite significant market-related downtime, our paper machines ran well with record productivity at some of our facilities. We also made progress with announced price increases across several uncoated freesheet grades.

In Pulp, the current cycle in global markets led to downward price adjustments in most regions. Quarter 2 was also our peak outage quarter this year. In total, we took maintenance downtime at 8 of our 13 mills, with maintenance spending $44 million higher versus the first quarter, which was in line with our plan. Although maintenance costs were in line with our guidance, the elevated level of outages led to the usual productivity impact.

In Personal Care, we had a good performance considering the lower production volumes related to the permanent closure of the Waco, Texas facility in May. This was partially offset by favorable input costs and margin improvement initiatives coming in as planned.

On a consolidated basis, we generated $119 million of operating cash flow in the quarter and $174 million year-to-date. So we continue to trend well.

To sum up, although we're operating in a challenging environment, we do expect market conditions to improve in the short to medium term in all of our businesses, and we continue to generate strong operating cash flow and are maintaining our solid balance sheet.

With that, let me turn the call over to Daniel for the financial review, before making further comments on our second quarter performance and our second half 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 $0.28 per share for the second quarter compared to net earnings of $1.27 per share for the first quarter of 2019. Adjusting for items, our earnings were $0.57 per share in the second quarter compared to earnings of $1.44 per share for the prior quarter.

EBITDA before items amounted to $133 million compared to $205 million in the first quarter.

Turning to the sequential variation in earnings on Slide 5. Consolidated sales were $59 million lower than the first quarter, due mostly to lower sales in our Pulp and Paper businesses.

Depreciation and amortization was $1 million higher when compared to the first quarter, while SG&A was $18 million lower than the first quarter, due mostly to mark-to-market of stock-based compensation.

In the second quarter, we recorded an income tax expense of $5 million, resulting in an effective tax rate of 22%.

Now turning to the cash flow statement on Slide 6. Cash flows from operating activities amounted to $119 million, while capital expenditures amounted to $55 million. This resulted in a free cash flow of $64 million in the second quarter.

During the quarter, we've paid $28 million in dividends and we've repurchased approximately 194,000 shares.

Turning to the quarterly waterfall on Slide 7. When compared to the first quarter, EBITDA before items decreased by $72 million due to higher maintenance costs for $44 million, lower productivity for $19 million, lower volume and mix for $12 million, higher audit costs were $11 million, higher raw material costs were $2 million and higher freight costs for $2 million. These were partially offset by lower SG&A costs for $18 million.

Now the review of our business segments starting on Slide 8. In the Pulp and Paper segment, sales were 4% lower when compared to the first quarter and 2% lower when compared to the same period last year.

EBITDA before items was $123 million compared to $204 million in the first quarter of 2019.

Our Paper business on Slide 9. Sales were 6% lower versus the last quarter and were 1% lower versus the same quarter last year, while estimated EBITDA before items was $115 million or 14% margin.

Manufactured paper shipments were 7% lower when compared to the first quarter and 10% lower versus the same period last year.

Average transaction prices for all our paper grades were $22 per ton higher than the last quarter. Our July average price -- paper prices were unchanged compared to the average of the second quarter.

Let's turn to the Pulp business on Slide 10. Sales were 1% lower versus last quarter and were 6% lower versus the same period last year.

Estimated EBITDA before items was $8 million.

Pulp shipment were 6% higher versus the first quarter and down 2% when compared to the same period last year. Average Pulp prices decreased $45 per metric ton versus the first quarter. Our July average Pulp prices were $80 per metric ton lower than the average of the second quarter.

Our Paper inventory increased by 15,000 tons when compared to the last quarter, while Pulp inventory decreased by 2,000 metric tons.

Our Personal Care business on Slide 12. Sales decreased 4% when compared to last quarter and were 4% lower versus the same period last year, largely due to planned exit of unprofitable customers.

EBITDA before items was $21 million, $1 million lower than the first quarter.

Let's turn to Slide 13. In the quarter, our Espanola mill underwent an extensive audit and inspection of major components during their planned outage. John will talk through the details in his prepared remarks, but in the current market context, we've decided to extend the outage and take the opportunity to do some of the work that will prepare the mill for its revitalization plan.

We currently estimate that the outage will be extended until the end of August, and we will proceed with the second shut in November to finalize the work. As such, additional maintenance downtime will reduce our Pulp production by approximately 60,000 tons and will have a fixed cost absorption impact of approximately $13 million. As a result of the additional work, our total maintenance expense for this year will increase by approximately $36 million. We will continue to operate the mill's paper machine over this period.

As usual, you'll find on this slide the updated maintenance schedule, including the additional work at Espanola.

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. Despite overall domestic paper shipments being lower than expected for the quarter, underlying consumptions not as affected as shipments would suggest. In fact, uncoated freesheet demand remains in line with secular trends. Our customer demand should improve in the second half due to return to normal inventory levels and some new business ramping up. Furthermore, we continue to have a positive outlook and still expect some upward momentum over the next 12 to 18 months, driven by announced capacity closures.

We've been proactive in responding to prevailing market conditions by matching our production to our customers' demand. We took a total of 73,000 tons of market-related downtime in our paper business in the second quarter, and in July, we took an additional 40,000 tons of downtime. We will continue to closely monitor our inventory levels and address imbalances as required.

As Daniel mentioned, our Espanola pulp and specialty mill underwent an extensive audit and inspection of major components during their annual outage. The inspection was an initial step and a path towards the mill's long-term revitalization plan, which I'll discuss shortly.

Following the inspection and given cyclically low pulp prices, we made the decision to fast track some maintenance work that was originally planned for next year. This was addressed during an extended outage in June and currently ongoing, and we'll also do some additional work on the assets in November.

The long-term revitalization plan in Espanola includes a CAD 58 million investment spread over the next couple of years. Most of the work will include streamlining the mill to one bleach plant and installing new equipment to support the continued product development with a focus on alternatives to single-use plastics. This will further strengthen the mill's competitive cost position in the global market, reduce waste from production, improve environmental performance and help secure good jobs for the community.

Approximately, half of the investment is supported by the Canadian government from part of their Strategic Innovation Fund. The work at Espanola is part of a broader investment plan, which includes high-return initiatives to optimize production and increase efficiencies across our market pulp mills, with the objective of driving performance.

In our Pulp business, average pulp prices were down $45 per metric ton quarter-over-quarter, while our volumes were actually higher quarter-over-quarter. Although, our visibility remains limited in the current pulp environment, we do believe that the market is expected to improve cyclically and seasonally in the second half.

We did see a rebound in volume in China with demand picking up in July, and we believe that customer inventories are now reducing. Beyond 2019, we still expect improved market conditions, supported by a favorable supply/demand outlook for the softwood grades over the long term.

In summary, in both Paper and Pulp, we managed costs well and leveraged the strength and flexibility of our mill system in a quarter with high downtime. As we go forward, we'll continue to focus on the things we can control, maintaining our position as the supplier of choice with winning customers, managing our costs, generating strong free cash flow and operating our mills as efficiently as possible.

Doing so allows us to achieve the best possible business results in every market environment.

In Personal Care, we had a good performance driven by improved input costs and steady progress in our margin improvement plan, which is delivering as expected. Our Waco facility ceased production in May and shipped all remaining inventory in June.

Waco employees have made commendable efforts over the years to keep their facility operating efficiently, and I want to thank all affected employees for their hard work and dedication over the years.

We're now focused on the installation phase of the equipment at the other plants and ramp-up activities. These initial steps will optimize production and reduce costs.

Looking ahead, we expect to see further momentum in Personal Care in the back half of the year. We anticipate a strong order book, while input costs should be favorable.

Commercial initiatives are now benefiting us, and we'll see continued cost savings from the execution of our margin improvement plan.

Turning to capital allocation for the group. We increased our quarterly dividend by 5% during the quarter, which is our eighth increase over the last 9 years. We also resumed our share repurchases, buying back $8 million of shares during the quarter and an additional $13 million in July. These initiatives reinforced our ongoing commitment to return cash to shareholders, and reflect our continued confidence in our cash flow generation. We will remain disciplined as we deploy capital with a focus on value-creating investments, while returning cash to shareholders through an attractive dividend and share buybacks.

Moving now to our outlook for the remainder of the year. We believe that paper markets will firm up in the next few months and expect our paper shipments to trend with the market, while our paper prices should remain relatively stable. We'll continue to monitor our inventory levels and balance our production to our customer demand accordingly. We anticipate volatility in softwood and fluff pulp markets, but market conditions should improve in the back end of the year. Maintenance costs should be relatively flat versus the first half due to the additional outage at our Espanola mill.

Personal Care is expected to benefit from our margin improvement plan and increased sales, driven by a stronger order book.

Finally, we do expect moderate inflation in our costs for the second half of the year.

So thank you for your time and your 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. (Operator Instructions) Valerie, you can open the lines for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will take our first question from the line of George Staphos of Bank of America.

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John Plimpton Babcock, BofA Merrill Lynch, Research Division - Associate [2]

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John Babcock on the line for George. Just wanted to start out on the Paper business. I was wondering if you could talk a little bit about what you think it's going to take for the market to balance there? And also, imports have clearly been a bit of a weight on the paper market and want to get a sense for ultimately which countries you're seeing the greatest imports from?

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

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Yes. Sure, so let me talk to that. So I'll go back, I think, to the announced closure, when -- if 8% of market capacity comes out, I think the customer is concerned, are they actually going to be able to get paper? So as a consequence, a lot of orders were placed, actually both from domestic producers and the importers and of course, GP, who continue to produce and sell right up to closure. So that led, we think, to an inventory bubble. In fact, that's what we can see.

But actually, underlying demand is staying around that sort of 3%, 3.5% decline, which we've seen for a number of years. So our premise is that, that actually will work its way out over time. And then, if you like, our shipments will more likely reflect that market than they currently reflect the inventory correction. So that's what we're engaging at this moment in time. I think that's partly vindicated by the fact that our prices have remained stable July to June. So what we've then seen is really the paper comes from just about anywhere other than those people where the duties are too high to make it economic for them. So that's what we've seen happening.

Now I think, if we look back to the Cornwall closure, what you saw there was the same thing happen, and then everybody kind of found their level. And those imports disappeared because actually, from a supply chain standpoint, they're not sustainable. And also, the people who placed those orders may very likely be losing money on the tons as they try and move them into the market. So I hope that gives you a bit of color, but that's what we're anticipating.

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John Plimpton Babcock, BofA Merrill Lynch, Research Division - Associate [4]

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Yes. That's helpful. I guess in the next question, I mean, when we look at the inventory levels that you have and going back historically, I mean, clearly, they are elevated. I mean how long do you think it might take for those to return to a more normalized level?

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

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Well, we're working on that now. We -- as you saw the downtime that we took in the month of July. So we would think 3 to 6 months by year-end we'll have worked them out.

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John Plimpton Babcock, BofA Merrill Lynch, Research Division - Associate [6]

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Okay. That's helpful. And then just to clarify, it sounds like most increase in maintenance in the second half is related to Espanola, is there any -- are there any other changes in the maintenance schedule? Or is that really the biggest adjustment there?

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

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That's it.

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John Plimpton Babcock, BofA Merrill Lynch, Research Division - Associate [8]

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Okay. And then lastly, before I turn it over. PPW has published a number of kind of price decreases in paper, and just want to get a reminder as to how we should think about the roll through of that?

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John D. Williams, Domtar Corporation - President, CEO & Director [9]

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Yes. Sure. So we're not seeing that at the moment. I mean there is definitely some deals are being done here and there. But as far as we can see, with our customer base, that's all we have visibility to. Prices are remaining fairly stable. So -- and if our premise is right, with obviously the next closure coming in the not-too-distant future from one of our competitors, I think we'd see a world where we can sustain our pricing.

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Operator [10]

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(Operator Instructions) We'll move to our next question from the line of Chip Dillon of Vertical Resource Partners (sic) [Vertical Research Partners].

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Clyde Alvin Dillon, Vertical Research Partners, LLC - Partner [11]

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You look at the increase in the maintenance schedule to $516 million, 5-1-6. What should we expect that to be in 2020 and beyond? In other words, it seems -- and also, as you talk about that maintenance because of the Espanola mill, is that project that you're pursuing, is that something that you anticipated when you were talking about your pulp improvement program a couple years ago?

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

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Yes, it is. But can I -- I'd like to refer this to Mike Garcia, if I might, Chip, who's got a bit more color on it for you. So Mike, do you want to talk to that?

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Michael Dennis Garcia, Domtar Corporation - President of Pulp & Paper Division [13]

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Thanks, John. Yes. Chip, at Espanola, we've put together a long-range plan to really put that mill on another level of competitiveness. And it's really 2 main components of this $58 million investment project, simplifying the mill from 2 pulp lines down to a single line and upgrading the paper machine equipment to include installation of our stealth fiber technology. And so this stealth fiber technology allows us to reach different levels of strength, formation, density and better barrier performance in the paper that we make. And that are -- those -- all four of those characteristics are really important to different sectors that are going after the displacement of single-use plastics. And we've gotten a lot of traction with retailers and packagers -- packaging companies as they really try to do more with paper to take advantage of the pull that's being created in the market. So we've got a lot of optimism around the Espanola location. We've got to do some work to address the issues that we found that will require maintenance and that's continuing. But the mill sits in a great fiber basket, it's got machines that are quite capable of making unique and competitive grades of paper that there's actually a pull for as well as it's a very good pulp location as well. So got a lot of work to do there. But we're pretty optimistic about the future of that mill.

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John D. Williams, Domtar Corporation - President, CEO & Director [14]

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And Chip, to your other point of your question, we see maintenance next year reverting to, I guess, what one would call, normal levels. And obviously...

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Clyde Alvin Dillon, Vertical Research Partners, LLC - Partner [15]

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Okay. So something below $500 million?

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John D. Williams, Domtar Corporation - President, CEO & Director [16]

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Yes. So typically, I think if I recall, we give you that number tail end of the year when we've done our budgeting. So you could expect us to do that in that sort of quarter 4 call in January. Okay?

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Clyde Alvin Dillon, Vertical Research Partners, LLC - Partner [17]

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Okay. And then just a quick follow-up. When you look at Personal Care, I know you've talked a bit about how we should see that really inflect up later in the year. And just want to know how that, and next year, based on some of your customer activity, et cetera, how is that proceeding? And how do you think about -- I know it's early days, but next year compared to, say, this year?

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John D. Williams, Domtar Corporation - President, CEO & Director [18]

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Sure. So we think we've got considerable momentum now. So if I recall, I think, quarter 4 -- sorry, excuse me, quarter 3 last year, we made $14 million of EBITDA. We expect to comfortably beat that in quarter 3 of this year. We then see some major activity in terms of our customer wins coming in in the fourth quarter. So we would be expecting, as we exit this year, to show real momentum, I mean to show -- I mean the specific number I can't really give you, but I would say, we'd hope to be running sort of the equivalent of $100 million of EBITDA by year-end, looking forward into 2020. Does that help?

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Clyde Alvin Dillon, Vertical Research Partners, LLC - Partner [19]

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Okay. Helpful. And one more quick one, if I can, if I'm still on is, when you think about CapEx, could you update us to where we sit this year? And I seem to recall that in recent months, you're kind of put -- converting -- conversion decisions kind of on the back-burner, until say, at least the middle of next year. So should we expect -- first of all confirm that. And should we expect, therefore, what kind of range could we see CapEx, and you can be quite broad, look like not only for this year but next year?

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Daniel Buron, Domtar Corporation - Senior VP & CFO [20]

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This year, we're still expecting to be between $220 million and $240 million. Next year, we're going to enter the budget season soon. So that's a number that we'll be more than pleased to share as soon as it's available.

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

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But you're right on the conversion point.

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Clyde Alvin Dillon, Vertical Research Partners, LLC - Partner [22]

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[But would it actually be different at all]?

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Daniel Buron, Domtar Corporation - Senior VP & CFO [23]

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I think it's very tough, Chip, to say. I don't expect something quite different than this year. But we'll see what type of project we have, what type of return and it may be a bit lower, may be a bit higher.

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Operator [24]

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And we'll move to our next question from the line of Brian Maguire of Goldman Sachs.

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Brian P. Maguire, Goldman Sachs Group Inc., Research Division - Equity Analyst [25]

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Daniel, did I hear you right? You said on pulp prices, July is $80 a ton below the second quarter average, just confirm that. And then given the low amount of EBITDA in pulp in 2Q sort of implies running negative at these levels, understanding and there is maybe a little bit of elevated maintenance, but with elevated maintenance in the back half of the year. Obviously, it seems like it'll be negative again. Just wondering, how much longer you think you or the industry in general can kind of sustain production at these price levels? Would you kind of characterize them as being sort of at or below your cash costs? And just thinking about if we don't see the sort of cyclical and seasonal improvement you're talking about in the back half of the year. Have you guys started to entertain the thought about more permanent mill closures then just the temporary maintenance at Espanola?

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Daniel Buron, Domtar Corporation - Senior VP & CFO [26]

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Well let's answer the first question first. So yes, you are right, you've heard it well that our price in July are $80 per metric ton lower than what they were on average in the second quarter. So your math is right. If you do the math quickly, our Pulp EBITDA should be close to 0 or a slight negative in the second quarter. And that's why, actually, we're -- that's part of the reason why we're advancing a little bit of the maintenance in Espanola because we believe this is better to do that in a low price environment. We're actually removing 60,000 tons from the market by doing that. And we'll manage our supply, and we'll look at our costs. And if we have to, at some point, to take market downtime in the Pulp business, we'll do. But I want to remind you that EBITDA is one thing, but it's actually real cash cost that you're looking at. And we're still positive from a real cash cost point of view.

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John D. Williams, Domtar Corporation - President, CEO & Director [27]

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But to answer your question, I don't see permanent closure here. Because obviously, we're in a cyclical market. The market shifts, it's come down very fast. When will the bounce back happen, that's to be determined, but overall, softwood demand is pretty good. We like the medium to long-term view on softwood from a macro standpoint. So there may be some downtime, but I fail to see at this point anything that looks like permanent closure.

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Brian P. Maguire, Goldman Sachs Group Inc., Research Division - Equity Analyst [28]

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Just another one.

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Daniel Buron, Domtar Corporation - Senior VP & CFO [29]

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If we look at where we sit at on the cost curve...

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Brian P. Maguire, Goldman Sachs Group Inc., Research Division - Equity Analyst [30]

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Sorry about that.

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Daniel Buron, Domtar Corporation - Senior VP & CFO [31]

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If we look at where we -- our asset sits on the cost curve, I don't think we have candidate for permanent shuts.

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Brian P. Maguire, Goldman Sachs Group Inc., Research Division - Equity Analyst [32]

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Okay. And then just following up on your comments on demand, John. You mentioned that demand remained strong, but why would you kind of -- what -- to what do you sort of attribute the weakness that we've seen over the last 9 months or so? It seems like it's more than just destocking and the channel and inventories still remain high...

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John D. Williams, Domtar Corporation - President, CEO & Director [33]

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Yes. That's a great question. So I think, hindsight, it's not necessarily 2020 vision, but it's probably better. I would say the grades that we sell typically we're selling to people making personal care products and people who are making tissue products. And if you take fluff pulp in particular, about 1.5 million tons of fluff pulp, as you know, can swing between fluff and southern softwood. Now there was a while there southern softwood was pretty attractive. It's far less attractive. Fluff pulp now looks more attractive. So therefore, people are moving into fluff and there's challenges therefore around that.

And of course, the kind of printing and writing grades in China, where they are nonintegrated, got very quiet. So there was a lot of pulp looking for a home. Some of it have been speculatively bought at quite high prices. The minute prices erode that inventory starts to work its way out from kind of dealers and traders. And I think that's what began this decline. And then it's just about the buyers and the sellers and who can hold the line. So we don't see anything that's dramatically changed, if you like, the demand of the products into which our grades are going. And in fact, we have a very nice broad range, some of which is specialty, where we still actually see demand looking pretty solid. So if I take our shipments in July, for example, they've been strong.

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Operator [34]

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And we'll move to our next question from the line of Mark Wilde of Bank of Montreal.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [35]

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John, I wondered, I'm just coming back to Brian's question on pulp. I'm just curious about your situation at Kamloops. We're seeing a lot of sawmill closures, a lot of the wood fiber for western mills usually comes from sawmill residuals. Can you just update us on what the situation would be out there for you?

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John D. Williams, Domtar Corporation - President, CEO & Director [36]

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Yes, I can't -- certainly. I can't give you the detail, Mark, but actually, at the moment, we're in very good shape and we think we're going to be in good shape for the medium and the long term. So we haven't really been impacted.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [37]

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So what's it done for the cost of fiber for that mill in B.C.?

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John D. Williams, Domtar Corporation - President, CEO & Director [38]

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Pretty much nothing at this point. It stayed pretty stable.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [39]

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Okay. All right. Well, I hope it stays that way.

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John D. Williams, Domtar Corporation - President, CEO & Director [40]

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Yes. Me too, me too.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [41]

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I wanted to move over to this notion of paper pricing remaining sticky. I mean If you just look at the backdrop, it seems like, globally, Pulp costs are down for a lot of paper mills. We know a lot of the mills outside of North America are not integrated, so they buy pulp, so their costs went up. We've also got a very strong dollar, and we've got U.S. paper prices are relatively healthy. So just against that backdrop, it's kind of hard to see why the import pressure is going to ease?

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

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Well, it did the last time. I actually think, those supply chains in moments of tightness, people will use them, they'll buy their 20,000, their 30,000 tons. On the whole though, I think over the years, they've never really built a, what I would call completely dependable supply chain. Some have and we know who they are, but most have not. And I think some people's experience of buying those grades has not been happy, either in terms of quality, in terms of supply, in terms of reliability, in terms of shipment. So I think major customers, whilst they may use some of those products from time to time, are not really sitting there thinking I'm going to build my supply chain based on imports.

So the major -- I mean our experience, anyway I can only speak for ourselves, has been very much that they may come, they come and they go. They cause pressure when they arrive, as they're causing some pressure now. And our assumption here is that as inventory works its way through, as people do some of these deals to move some of this stuff, there's not enough of it to really erode total market pricing. And one must, I think, remember that everything one hears about pricing is often anecdotal between buyers and sellers and is not always reflected in the absolute numbers. So in our view, I think if we're right in terms of our assumption of how this inventory works through, there's no particular reason why we should see erosion in the short term.

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Michael Dennis Garcia, Domtar Corporation - President of Pulp & Paper Division [43]

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John, if I could just add. This is Mike. A large portion of that imported volume came in under, what I would call, kind of a speculative nature. So it gets to the shore, but it doesn't have a final customer yet. And it kind of sits in the market, and it looks to get placed and that could put a little temporary pressure on pricing. But it didn't come in as part of a reconfigured supply chain that's going to go forward into the future as John was saying.

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

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All right, Mark?

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [45]

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All right. That's clear. John, I wondered, also is it possible to get a little more color on what these new products would be up at Espanola? Just curious about what exactly you're doing?

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

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Yes. So -- I mean I can give it to you on the macro. So the Canadian government and ourselves, the Canadian government really wants to work very hard to drive plastic out of the supply chain. So particularly in a packaging environment obviously from a recyclability standpoint, it's got huge challenges. So they and ourselves are saying, all right, we're going to build a series of products, we've got some -- I don't want to go into the detail, if you don't mind. We've got a lot of R&D going on to say, can we use paper as a substitute for plastic in some of these decent-sized, I would say, both packaging applications and other types of applications across this space. So that's where the work is. I wouldn't say, we're 5 minutes away from launching product, Mark. But we've got some pretty strong ideas, and we've got some good partnerships with retailers who are wanting to drive this. So I think with that combination over time, I think we'll be in good shape. I'm happy to make the commitment that when we've got a bit more color, we'd happily give it to you all.

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Mark William Wilde, BMO Capital Markets Equity Research - Senior Analyst [47]

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All right. That's fair enough. Finally, John, just any update in terms of what you're seeing in the Personal Care markets? I think particularly in Europe, it sounds like pricing around a lot of these government contracts had been really rough. Is there any change there? Are your gains going to have to just be self-generated?

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John D. Williams, Domtar Corporation - President, CEO & Director [48]

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Well, that's a great question. So our -- we do very well in government contracts, particularly in Iberia. And obviously, a number of them have come up for bid recently. There's been a little bit of a shift in terms of product usage in those channels, which has helped us. So it's sort of moved to a more modern product. And that's helped us to sell a little bit more added value. And we continue to win those bids where we participate, not at prices that embarrass us. So we find that helpful. I think if you look at U.S. and you look at baby, we're very much a private label supplier. So a private label is gaining versus brand in pretty much every category in FMCG globally, but particularly, in the U.S., where it's less developed. So our view is, keep winning with those winning customers and showing them value in baby where we have a decent position.

In our [inco] business, we've launched an added value product, which we feel has got some good traction. And in our [pull-up] business, we're growing like topsy. So there is one major account that we just didn't like the profitability on that we chose to resign, which was European. I'm so glad we did. And you're going to see that sales momentum coming through, I think in the sort of first half of next year, which is actually going to be potentially quite dramatic. So I feel very much on track with that business in terms of the recovery that we promised ourselves.

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Operator [49]

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We'll move to our next question from the line of Paul Quinn from RBC Capital Markets.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [50]

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Just a couple of easy questions. One on the Pulp side. In your outlook, you quoted that you expect markets should recover in the back half of the year, just wondering what gives you the confidence given where global inventories are and a lack of monthly data out of the PPPC?

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John D. Williams, Domtar Corporation - President, CEO & Director [51]

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Right. So we're seeing signs already that some of the pricing in China from the sort of reseller pricing to the direct pricing that reseller pricing is moving up. That suggests that at the customer level, some of those inventories have been worked out. I mean I can't speak for hardwood grades, obviously, Paul, because we're not really in them. And certainly, end-use product demand is pretty strong. So one gets a feeling that, that's going to come off the bottom some time before the end of the year. And I think as that happens, that starts to drive the rest of the market a bit. So that's our assumption. Now patently, I think everyone has been taken by surprise by the speed of what's happened in the Pulp business, but that also suggests that recovery will bounce pretty quickly too.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [52]

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Okay. And then if I just shift over to paper. I mean I understand the inventory bubble and the effects of that, but I was expecting with GP coming out that markets would certainly tighten towards the end of June and definitely in July that looks like you're taking more downtime in July. So just I wonder if that moves up your conversion opportunity announcements from mid-2020 up to the end of the year?

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John D. Williams, Domtar Corporation - President, CEO & Director [53]

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Actually, at the moment, we obviously always look really carefully. But at the moment, the answer to that is no.

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Operator [54]

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And we'll move to our next question from the line of Adam Josephson of KeyBanc.

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

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John, just to start, on the last call you talked about 18 to 24 months of runway in freesheet before you'd have to make some sort of decision regarding a conversion or shut down. Obviously, fast-forward 3 months you're having to take indefinite market-related downtime. Can you just, again, at a high level, what changed so seemingly dramatically compared to what you were thinking 3 months ago? And what gives you this confidence that freesheet conditions will improve in the short term, given what's happened over the past 3 months?

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

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Right. So -- that's a great question. It's the question really. I mean, I think 2 things. Underlying demand, if you think about what happened, right? 8% of industry capacity came out. Underlying demand, i.e. the demand from the customer to their customer, not shipments, is running at about the usual level, right? So the 3%, 3.5% decline. So the math still holds. Some imports were bought in pretty aggressively, which still sit in inventory, and they will work their way out. So to my mind, if you put all that together, you say to yourself, this is a temporary experience. It may last a little bit longer than any of us are comfortable with, but this is not the future. And of course, you sit there knowing that there is further industry closure announced in the not-too-distant future. So I put all that together, it says to me, I still think we have that runway. But this is a temporary challenge that we have to work our way through.

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Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [57]

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Okay. One on Pulp. You had some bullish thoughts about July and thereafter. I mean correct me if I'm wrong, but futures prices in China have fallen right back to their lows. Again, we don't know what the June data is given the delay from Brazil. But have you seen a decline in inventories or rising prices in China or anywhere for that matter?

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John D. Williams, Domtar Corporation - President, CEO & Director [58]

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No. So what we've seen is an ability to move volume that was, if you like, softer in previous months. So that suggests to us that the customer actually is now thinking about buying as opposed to not buying at all. And we've seen some of those reseller prices tick up, which suggest that they too have not got the kind of inventory levels that they used to have. So maybe there's some light in this over the next 3 to 4 months out. But it's early days, to be honest with you, Adam.

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Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [59]

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Sure, John. And just on the conversion topic. Given what's happened with containerboard and pulp market conditions in the last several months, I mean are you -- you had previously said you have 18 to 24 months of runway. I don't know if you still think that. But what do you think -- regardless of what the runway actually is now, what do you think of the -- I mean we know what's happening with pulp. And then containerboard I think -- I imagine you'd agree that the market is more than adequate -- adequately supplied. I know you said this is a 30-year decision, but you obviously have to be mindful of what's happening not only now, but what's likely to happen over the next year or 2. And it's not looking so rosy along those lines. So regardless of if and when you do a conversion, have those options changed for the worse in your mind given everything we've seen in both markets in the last several months?

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John D. Williams, Domtar Corporation - President, CEO & Director [60]

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Well, I think let's talk pulp, first. Pulp, everybody knows is a cyclical business. So as a consequence, when you're in a tough part of the cycle, it seems to me the work is to make sure you can squeeze as much money out of it as you can. Make sure you're not doing anything stupid, keep your costs tight. And over time, these markets tighten up again. So on the Pulp side, if a conversion opportunity comes along, which says we could do more in Pulp, I have no embarrassment in making that decision or we and the Board, to be precise, have no embarrassment in making that decision. It's a cyclical business. And right now, we're in a weak part of the cycle, that will come back. I think our containerboard, the jury, is out on how long this lasts. It's still a very strong business. I mean look at the numbers that are coming out from the containerboard producers. So I'm still pretty confident that over time, containerboard's attractive for us.

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Adam Jesse Josephson, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [61]

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Got it. And just on capital allocation, aside from the growing dividend, can you just remind us of your plans, before any conversion takes place?

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

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We've -- as we've said, we've bought back $8 million of stock in the second quarter, an additional $13 million in July. We still have around $300 million in our plan. So we'll continue to look at the market and act when we believe it's appropriate for us to act.

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Operator [63]

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(Operator Instructions) We'll move to our next question from the line of John Tumazos of John Tumazos Very Independent Research.

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

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Looking back at the first quarter dynamic where the competitors shut down, it looks like the customers double ordered or inventoried, the price got raised and then the imports flooded in. Where we sit now on August 1, what is the best remedy to simply have a lower selling price and let the customers feel secure?

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John D. Williams, Domtar Corporation - President, CEO & Director [65]

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Sorry, John -- I mean our view is that within the market dynamic, our job is to offer value to our customers. We believe we continue to do that, particularly the major accounts, where the major accounts need our network, they need our quality and quite frankly, they need our tonnage because there aren't other people who are capable, even from an import standpoint, to ship anything like the tons we ship into the market. So I'm -- in hindsight, I still think it was right for us to take a price increase. That price increase actually has held for quite some time. Imports do come in, in this world. But I think they'll work their way through as they usually do. So I'm not sitting here thinking we should do anything, nor would I quite frankly speculate over a phone call about what our strategy should be on that front.

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John Charles Tumazos, John Tumazos Very Independent Research, LLC - President and CEO [66]

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When the orders came in, in the first quarter, did you think that they were orders for consumption? Did you have any suspicion that there was an inventory bubble building up?

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John D. Williams, Domtar Corporation - President, CEO & Director [67]

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We knew there was an inventory bubble building up based on the fact that the competitor who closed kept producing. And that it made sense, therefore, that there will be a bit of an industry bubble -- excuse me inventory bubble.

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Operator [68]

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It appears there are no further questions at this time. Mr. Estrela, I'd like to turn the conference back to you for any additional or closing remarks.

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Nicholas Estrela, Domtar Corporation - Director of IR [69]

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Thank you, Valerie. So we will release our third quarter 2019 results on Thursday, October 31, 2019. Thank you for listening, and have a great day.

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Operator [70]

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This concludes today's call. Thank you for your participation. You may now disconnect.