Sylvamo Corporation

Good morning. Thank you for standing by. Welcome to Savamo's third quarter 2022 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, you will have an opportunity to ask questions. To ask a question, please press 1 then 0 on your telephone keypad. And to withdraw from a question, please press 1 then 0. If you need assistance during the call, please press star, then zero. And as a reminder, your conference is being recorded. I would now like to turn the conference over to Hans Bjorkman, Vice President of Investor Relations. Sir, the floor is yours.

Thanks, Lois. Good morning, and thank you for joining our call today. Our speakers this morning are Jean-Michel Ribieras, Chairman and Chief Executive Officer, and John Simms, Senior Vice President and Chief Financial Officer. Slides two and three contain important information, including certain legal disclaimers. For example, during this call, we will make forward-looking statements that are subject to risks and uncertainties. We will also present certain non-U.S. GAAP financial information. Reconciliations of those figures to U.S. GAAP financial measures are available in the appendix. Our website also contains copies of the third quarter earnings press release, as well as today's presentation. I would now like to turn the call over to Jean-Michel. Thanks, Hans.

Good morning, and thank you for joining our call. I'll begin my comments on slide four. On October 1, we completed our first year as a public company. Our first year was one of significant achievements. As we built the world's paper company, we generated strong earnings per share and free cash flow, which we used to reduce debt, begin returning cash to shareholders, and reinvest in our business. We agreed to acquire the new Monomil in Sweden and divested our Russian business. Then we repaid our term loan B and achieved our target of a billion. We have also exited our transition services agreement. I'm proud of our teams and the accomplishment over the last year. More importantly, I'm pleased that we are well positioned to navigate any macroeconomic headwinds and resulting industry challenges. Slide 5 highlights our third quarter results. Our 3.3G of commercial excellence, operational excellence, and financial discipline was the foundation of our success. On a quarter-over-quarter basis, we increased adjusted EBITDA by 14% to $260 million, and we grew our margin by 160 basis points. We increased adjusted earnings per share by 24% to $2.51 per share. We generated $114 million in free cash flow and repaid $88 million of debt in the quarter. These results were above the high end of our guidance. Our continued strong performance reflects our talented teams, our iconic brands, and our low-cost meals, all of which enable us to remain the supplier of choice, for our customers. Slide six highlights our key performance metrics compared to the second quarter and to last year's third quarter. We increased net sales by 6% to $968 million. Our adjusted EBITDA of $216 million represents a margin of 22.3%, the highest margins level we have achieved. We generated $114 million in free cash flow, which was an increase due to higher earnings, less capital spending, and a reduction in working capital. These strong performances demonstrate our ability to continue to deliver on our investment thesis. Our teams performed well, creating value for all of our stakeholders. Now, John Sims will discuss our third quarter performance In more detail, John.

Thanks, Jean-Michel. Good morning, everyone. Let's turn to slide seven, please. As Jean-Michel said earlier, we earned 216 million in adjusted EBITDA in the third quarter. This is 160 basis point improvement and was driven by 60 million in price and mix improvements. as realization of price increases exceeded our outlook and we continued to drive mix optimization. Volume increased slightly by 3 million with stronger shipments in Latin America and North America. Our order backlogs were strong in all regions in the quarter. We also had a slight increase in operations and costs, which increased by 3 million. We spent 14 million less on outages than in the second quarter. and we successfully conducted the planned maintenance outage at Umojiwasu Mill. Input and transportation costs increased by 46 million, as costs for energy, fiber, and chemicals continued to increase. Let's take a look at our regional results on slide eight. Each region continues to perform very well, demonstrating the strength and resilience of our talented teams, iconic brands, and low-cost mills, as well as favorable industry conditions. Each region benefited from realizing price increases, which offset escalating costs and inflation. Our volumes remained strong in all regions, and we continued to outperform the industry shipments. We operated well in all three regions. Input costs and transportation availability remained under pressure, and we've seen some relief in truck availability in North America but obtaining adequate rail service continues to be a challenge. The appendix contains additional details on our regional performance. So let's turn to slide nine. In the third quarter, uncoded free sheet industry fundamentals remained favorable across our regions. Demand in Latin America and North America continued to rebound from pandemic levels while demand in Western Europe declined by 2%, which in part was driven by the lack of supply in Europe. Relative to 2019, 2022 year-to-date imports were about flat in Western Europe and down about 20% in each of the Americas. And as the bottom row shows, capacity is down 10 to 20% in our regions relative to pre-pandemic levels. The cost curve in Europe remains quite steep, with more than 25% of the capacity being non-integrated. The non-integrated producers are at a competitive disadvantage due to elevated market pulp and energy costs. On the other hand, our SIOP mill is integrated and generates 85% of its own energy, giving us a competitive advantage. In summary, demand is recovering, capacity and imports are down, and mill inventory levels in our regions remain below their historical averages. Moving to slide 10, not only do we operate in the most attractive regions, we continue to win with key customers. We also continue to optimize our product mix and increase our positions in high margin segments. We are growing with key customers. For example, we expect to increase our volume with a strategic retail customer in Latin America by 25%. And in all regions, we continue to focus on the evolving needs of end users. We are optimizing our mix. For example, in Europe, we will increase our brand mix to 50% in 2022 versus 30% in 2021. In North America, we're optimizing our portfolio to ensure it aligns well with our channel partners and consumer trends. Furthermore, we are updating our business practices so that we are adequately paid for the value-added services we provide, and we are segmenting our service levels. And we are growing in high-margin segments. For example, we continue to expand our e-commerce presence in North America. Our commercial efforts, our commercial excellence efforts drive higher volumes and margins, increase customer loyalty, and allow us to outperform industry demand. Now back to Jean-Michel for a discussion on our recent moves in Europe. Thanks, John.

I'm now on slide 11. First, some perspective on the recent divestiture of our Russian business. After the invasion of Ukraine, we made a principle-based decision to exit Russia. In October, we sold the business and received $390 million in net proceeds. The diversity of our Russian business allowed us to avoid a 220 million recovery boiler project, reduced our exposure to the most cyclical market bulk segment by 30%, and significantly decreased our geopolitical risk and uncertainty. Completing this deal also eliminated a major distraction for our management team, which is now focused on our core business. Let's move to slide 12. We are taking advantage of the opportunity to acquire the Numero mill in Sweden at an attractive price. These 500,000 tons of uncoated free sheet mills fits well with our strategy. It would strengthen our position in uncoated free sheet and enable us to better serve our customers in Europe and around the world. We agreed to pay 150 million euros for this mill, which would benefit from a $40 million bulk mill upgrade that would be mostly completed before we take ownership of the mills. As you might imagine, we're excited to add this mill to our urban business in the first quarter. Slide 13, please. The New Mona Mill is one of the largest integrated unconstituted mills in Europe. It is 85% energy self-sufficient and has strong environmental practices. The mill produces multiple grades for cut size, business forms, digital papers, and offset papers. It produces iconic brands that fit well with our strategy. Let's move to slide 14. The Numola mill is an excellent fit with our three-pronged strategy of commercial excellence, operational excellence, and financial discipline. In addition to the complementary uncoated fruit sheet product mix, and iconic brands, the mills maintain strategic channel partnerships and a complementary geographical mix. It also has a customer-focused culture and shares values with our company. The mill is low-cost and in an attractive location. It fits well within our portfolio and strategy. This purchase price represents an attractive price, and we expect more than $20 million in synergies and an internal rate of return greater than 25%. The deal will be immediately accredited to our earnings per share and free cash flow. Let's turn to slide 15. Using the last 12 months of adjusted EBITDA as of the end of June, the transaction multiple is two and a half times. and is expected to be below two times after $20 million in synergies, including the pulp mill project previously mentioned. We estimate $15 million one-time cost and capital to achieve the synergies, and $14 million in information technology, transition services, and other integration costs. We look forward to closing as soon as we receive the required regulatory approvals and to welcoming new colleagues to Sylvamo's as soon as possible. Now back to John for a discussion on our four-square outlook and revised investment thesis.

Thanks, Jean-Michel. I'm now on slide 16. In the fourth quarter, we project price and mix to improve by 30 to 35 million as we continue to realize prior price increases in all three regions. We expect volume to be flat to decreasing by 0 to 5 million with seasonally weaker volume in Europe and North America. We project operations and costs to increase by 35 to 40 million, driven by seasonally higher costs in Europe and North America, foreign exchange impacts in Brazil, and an increase in incentive compensation accruals. We expect input and transportation costs to be flat to increasing by zero to 5 million, largely due to higher energy and input cost inflation. Maintenance outage expenses are projected to increase by 21 million as we conduct two planned maintenance outages. This will be our heaviest planned maintenance outage quarter of the year. All in, we expect to deliver fourth quarter adjusted EBITDA of 180 to 190 million, which would put us slightly below or at the low end of our full year guidance of 740 to 780 million. This change is largely driven by the increase in foreign exchange impact on our Brazilian earnings and compensation accruals, which were not included in our previous guidance. We expect fourth quarter earnings per share of $2.05 to $2.25, and we expect free cash flow of more than $25 million for the quarter, which increases our four-year outlook to greater than $210 million. The appendix contains additional information on fourth quarter outlook. Also, appendix slide 37 shows that we have reduced our outlook for 2022 capital expenses by 20 million to 155 million. We will be unable to complete certain projects in 2022 due to supply chain constraints and contractor delays. We project spending this 20 million in 2023. Slide 17 shows the three pillars of our capital allocation framework. This is how we think about allocating cash to create shareowner value. At the time of the spinoff, we prioritized debt reduction and returning capital spending to the levels necessary to maintain our mills. Now that we've reached our $1 billion growth debt target, we are putting greater emphasis on returning cash to shareholders. We remain a cash flow story. we will leverage our strength to drive high returns on invested capital and generate free cash flow. And we'll use that cash to increase shareholder value by maintaining a strong financial position, returning more cash to shareholders, and reinvesting in high returns projects in our business. Let's move to slide 18 to review our four to five financial positions. Since the spinoff, we've reduced debt by more than $560 million. We repaid the initial amount drawn from the revolving credit facility and have entirely repaid our term loan B. Also, we renegotiated our credit agreement to raise the limits on restricted payments prior to the final settlement of the Brazil tax dispute so that they now match the terms of our bond agreement. Under the revised agreement, our annual restricted payment limit was increased to $90 million from $75 million, as long as our gross debt is less than two times our adjusted EBITDA. Currently, that ratio is less than one and a half times. Appendix slide 35 provides more details. As a result of reducing our debt, our annualized interest expense will decline more by more than $20 million at the current interest rates. Note also that our pension fund remains well funded at more than 95%. So as you can see, we head into the second year with a strong financial position. Back to you, Jean-Michel. Thanks, John.

Slide 19, please. We are well positioned to create value for shareholders. We have reduced total debt significantly and $128 million in 2022 spin-off related payments will not recur next year. Returning cash to shareholders is a core component of our investment thesis. We started by paying $10 million in dividends this year and by establishing the authorization to repurchase up to $150 million of shares. I'm pleased that today our board has approved an increase that more than doubles our quarterly dividends to 25 cents per share, effective in the first quarter of 2023. As John discussed, we'll continue to invest in our business to increase returns on capital and generate free cash flow. This includes our investment in the new motor mill and high-return capital projects. We're investing in our business to increase our cost competitiveness and to remain the supplier of choice. I'm grateful for our talented and engaged colleagues and their dedication to working safely, delivering on our promises to customers, and for creating value for shareholders. We remain committed to creating value for all of our stakeholders and are confident in our ability to achieve our vision of being the employer, supplier, and investment of choice. With that, I'll turn the call back over to Hans.

Thanks, Jean-Michel, and thank you, John. Okay, Lois, we're now ready to take any questions.

Thank you. If you would like to ask a question, press 1 then 0 on your telephone keypad. If you would like to withdraw a question, please press 1 then 0. We would like you to limit your question to one question and one follow-up. Thank you. Again, that is 1 then 0 for a question. And we have a question from Ed Brucker from Barclays. Please go ahead.

Thanks for taking the call and congrats on the new quarter. Just had a couple... First one, just on the guidance. It seems like it's going to come in. It's been on the lower end of the original guidance, but the quarter was strong, and it seems like even the fourth quarter might be strong, too. I was just wondering if you're thinking a little... conservatively, given the environment right now, and I guess on top of that, how do you expect, kind of given the uncertainty, how do you expect, you know, the go-forward outlook for your market and the uncoded precision market?

Yeah, this is John Sims. Yes, as we mentioned earlier, Our guidance puts us on the lower end of our four-year guidance, but that's really driven by the FX impact we're seeing as the REI strengthens. And so that's kind of questionable where that ends up. But also, it also reflects the fact that we've had to take an additional accrual on our incentive plan. Just to remind everybody on the call, we really target our incentive plans to match up with our The interest of our shareholders is driven by EBITDA margins and free cash flow. And the increase in the incentive compensation is the fact that a strong cash flow that we're generating this year. And I think that's testament to the focus that we have on free cash flow. But in terms of being conservative, everything else essentially continues, you know, as we had thought in the fourth quarter. That meaning that the price increases that we've been able to realize from our prior price announcements have come in. Those are more than compensating in the input cost. And in fact, we're seeing input costs kind of flatten out across all the regions. So certainly at an elevated level and a high level, but we feel going in, it's hard to predict what 2023 is going to be. I mean, given... some of the uncertainties we have that everybody, you know, I think can read about. But one of the things we feel very good about is our exit rate and how well positioned we are from a balance sheet perspective, you know, being at $1 billion of debt, and also from where we are from the margins, earnings, and, you know, order backlog and the strength that we have with our customers and our positions in all our markets.

Yeah, it's helpful. Yeah, I mean, it's a testament to how well you've done with the balance sheet. And I guess my next question is about that. Just if you are thinking about a potential leverage target through the cycle, or if you I guess the max leverage you'd be willing to take it up given your capital allocation priorities have shifted a bit given that you have paid down so much debt. I just want to get your thoughts on where leverage kind of fits in there.

Well, we set the $1 billion target because we felt that that would allow us to continue to invest through the cycle of and high return projects into the business and continue to improve our business and also, you know, return cash back to our shareholders. Now, we'll continue to have to pay down some debt because we have amortization requirements, you know, for the term loan Fs that we do. So in terms of your question is what's the max that we go, I think we're comfortable in stating where we want to be is at that $1 billion or slightly less. And we think that's that's a very good position for us to be in to be able to execute the rest of our strategy. Great, thanks for the time.

Thank you, and once again, if you do have a question, please press 1 then 0, and we'll move to the line of Ron Guthlisch from Elm Ridge. Please go ahead.

Yes, thank you. Last year on your fourth quarter, going into the fourth quarter, you expected operations to hit $15 million because of normal seasonality. So could I assume that I realize energy expenses are up from last year, that of your guys, 35 to 40 more in the fourth quarter, about half is normal seasonality and half is the incentive accrual.

Ron, this is John. Yes. The incentive, you're right, but it's also the FX. So add the FX with the incentive accrual and you're close to that 50% of that cost is driven by those two items.

So going to the next quarter, whatever is the incentive accrual, let's assume, are they roughly equal? Because Whatever the incentive accrual ought to go back to some normal level, I realize you were underbooking earlier in the year, but the extra incentive accrual ought to go back, and I guess the FX you would just hope to be flat. But roughly the incentive accrual, would it be in the $10 million range?

Yes, $10 million is correct and about $5 million or so for the FX range.

And secondly, you're going to be way, way under the leverage that you're looking at by the end of next year. I realize you have $150 million going out the door, but you're generating so much free cash. Is there thought to renegotiating the terms on the agreement, or really what you're going to do is deploy it and see if you can get more? I'm going to pronounce this wrong. I'm all this.

Ron, I guess we're looking at the options in terms of what we can do from the bond perspective to get more room on the restricted payment terms. But we're analyzing that right now. And let me just add another to your comment. The acquisition is not core to our strategy. We said that previously. We also said that we will opportunistically look at acquisitions that make strategic fit with us. And that certainly was the case in the NUMOLA perspective.

Maybe I can add a point to Jean-Michel here, Ron. Know that we've reached our $1 billion debt target. And as John mentioned, NUMOLA was probably a very unique opportunity which is not core to Australia, but what is core to Australia is the returning cash to shareholders, and it has become even a higher priority for capital allocation. So that's why we increased dividend. We more than doubled. And at current share price, repurchasing share is very attractive. So maybe you might ask why we haven't done it before. As you might understand, in third quarter, we had blacked out due to material nonpublic information. We had Russia, we had the Mueller, the third quarter earnings. So, really, we're back to this returning cash to shareholders is really a high priority right now. That's what I would put in front of.

Can I follow up one quick one on that? So, the 90 million you haven't done any this year, Could you sort of reach forward in the fourth quarter because the $90 million starts again for 2023?

We've done $10 million in dividends out of the $90 for this year, and then it starts again $90 million January 1st.

So you have lots of room to do it in the fourth quarter this year. We do. Okay. Thank you.

You're welcome.

The next question is from Paul Quinn from RBC Capital Markets. Please go ahead.

Yeah, thanks very much. Morning, guys. Just on the increased brands in Europe from 30% to 50%, what's the margin impact on that? And then what happens with the addition of the Sweden mill?

Well, we don't... This is John. We don't want to get specifics on the... the margin difference between the brands. There is a margin increase, and there is a premium that's what drives it, but there's also other benefits as well. And mostly you can think about it in terms of brands being more sticky with customers, barriers to both imports and also to competition. And so there's also other values in terms of increasing our brands that we were able to realize across all the regions.

And concerning Numola, they have also a strong brand, which is called Multicopy. So on the cut-size side of the business, it's going to continue to be a Sylvamo strong brands approach.

And the other thing that Numola brings to us that we didn't really have with the Sayat mill is strong brands in the commercial printing and forms business. So that's actually an increased market segment for us, an opportunity for us to really leverage that.

Okay. And then just maybe you could give us a little bit more color on this $40 million pulp mill upgrade at Manuela as well as when are you taking maintenance at Salliet?

I'll answer your second question. SIAD is only 18 months, so we won't have any maintenance. But we want to have an annual outage this year, so it'll be next year, around April timeframe, I believe. And in terms of the new mill modernization project, this is being actually completed, mostly completed. by store this year, so all the benefits will begin to accrue to us next year when we finally do take ownership of the mill. And what they've done is they've upgraded the back end of the mill, specifically two areas is a new digesters with increasing the ability to produce softwood pulp, and so that'll expand the capacity there. and also an O2 delignification, which will reduce cost. So just the mill has somewhat a different pulping process than our other mills. It's a sulfite process, so increasing softwood pulp consumption and production is a positive for that mill, and that's what this mill upgrade does.

Okay, so just lastly, does that upgrade affect the production or capacity of the mill at 500,000 tons?

No. What it does increase is the pulping capacity. And so you have to buy less open market. It's not open market tons. Or pulp, rather. I'm sorry.

Okay, so that just begs the question, how much are you buying, how much is that milk purchasing on the open market right now, and how much, well, what's the self-sufficiency on the pulp side, you know, pre- and post-pulp mill grade?

It is, it buys... It doesn't buy a lot of market pulp. It buys hardwood pulp for the product grade. And this upgrade now allows us to substitute that with software that we can source the fiber in Sweden. All right. Thanks very much. Best of luck.

Thank you. The next question is from Adam Ritzer. He's a private investor. Please go ahead.

Hi, thanks for taking my call. I just had one quick question. You guys gave kind of a pro forma debt number after the Russia sale of, what, 957, I think it is. How much cash are you going to have on a pro forma basis after the sale?

After the sale... I'd have to think about, maybe we ought to get back to you. We'll probably be in about $100 million range. Let us get back to you on that.

So if you had $390 in proceeds from the sale and you paid down about $270 of debt, couldn't that difference add to the cash you had at the end of Q3? Is that the right way to look at it?

That's the right way to look at it.

Okay, we can talk about it later. Okay, that's all I wanted to ask. Thanks very much.

We're using cash to pay for the Nomola mill.

Right, but that's not going to be until Q1, right?

Right. Yeah, and the number I gave you, I was subtracting the paying for the Nomola mill out of that cash, because we're expecting to hopefully close that early in the first quarter.

Right, okay, right. So you take that cash minus the 150, assuming that, plus whatever free cash you generate in Q4. Okay, understood. Thanks very much.

Thank you. I'll now turn the call back over to Hans Bjorkman for closing comments.

Thank you, everyone, for joining our call today. We appreciate your interest in Silvamo, and we look forward to continued conversations in the coming days weeks and months ahead. Have a great rest of your day and a great week.

Once again, we would like to thank you for participating in Silvano's third quarter 2022 earnings call. You may now disconnect.