KP Tissue Inc.

consumer and retailers adjust to new price points. We anticipate shares to improve as the market adjusts to the new price points going forward. In terms of the away from home segment on slide 13, we benefited from a combination of factors, including a market recovery, share gains, price increases, and operating efficiency in our away from home facilities. This altogether posted one of our best quarters on records for that business. Volume was 12% higher in Q3, 2022 compared to the same period last year, driven by market and share gains. As a result, adjusted EBITDA for this segment was in positive territory for the quarter at $5.4 million. Keep in mind, third quarter is a seasonally strong period for this business. However, going forward, our goal is to continue to drive positive EBITDA for our AFH segment. I will now turn the call over to Mark.

Thank you, Dino, and good morning, everyone. Please turn to slide 14 for a summary of our financial performance in Q3. Dino has highlighted many of the numbers on this page. We had strong revenue growth, and while adjusted EBITDA was lower than last year, we saw a significant improvement from Q2. We had a net loss in the quarter of $38.8 million compared to $9.3 million for the same period last year. The 29.5 million decrease was due to a number of factors, lower adjusted EBITDA of 9.6 million, higher foreign exchange loss of 17.7 million, consulting costs related to operational transformation initiatives of 3.5 million, and a higher depreciation expense of 1.4 million. These items were partially offset by a lower charge in the amortized cost of the partnership unit's liability of $3.5 million. In the quarterly segmented view on slide 15, consumer revenue increased 4.1% year-over-year and 6% sequentially to $346 million. In the away-from-home segment, revenue grew 37.3% year-over-year. and 13.8% sequentially to $81 million. Consumer adjusted EBITDA totaled $25 million in Q3 compared to $39.1 million in Q3 2021, with adjusted EBITDA margin at 7.2% compared to 11.8% for the same respective period. Sequentially, consumer adjusted EBITDA was up by $10.7 million from $14.3 million in Q2. For the AFH segment, adjusted EBITDA amounted to $5.4 million in Q3 compared to $2.2 million in Q3 2021 and negative $0.5 million in Q2. Corporate and other costs were $0.3 million in Q3 compared to negative $0.9 million for the same period last year and negative $2 million for Q2. On slide 16, we review year-over-year revenue growth for Q3, which improved 35.6 million, or 9.1%. This growth can be attributed to selling price increases in both consumer and AFH, and in both Canada and the U.S., along with higher AFH sales volume and a favorable foreign exchange impact on U.S. dollar sales. These were partially offset by lower sales volume in the consumer segment and also some unfavorable sales mix. On a geographical basis, revenues in Canada rose 16.3 million, or 7% year over year, while US revenues grew 19.3 million, or 12.2%. On slide 17, we provide additional insight into the profit impact in the third quarter. Adjusted EBITDA decreased 9.6 million to 30.7 million, representing a margin of 7.2%, from 40.3 million in Q3 2021, or a margin of 10.3%. The decrease in adjusted EBITDA was primarily due to significant inflation on pulp, manufacturing costs, and freight. Memphis plant labor and productivity issues, as well as lower sales volume in the consumer segment. These factors were partially offset by selling price increases and a recovery in AFH volume. Let's turn to slide 18, where we compare revenue sequentially in Q3 to Q2. Revenue increased by $29.5 million, or 7.4% from the previous quarter. Increase was mainly due to price increases, slightly higher volume, and favorable foreign exchange impact on U.S. dollar sales. Geographically, revenue in Canada was up by 10.5 million or 4.4% sequentially, while revenue in the U.S. improved 19 million or 12%. On slide 19, adjusted EBITDA in Q3 increased sequentially by 18.9 million, or almost 160% from Q2. This significant growth was due to several factors, including the higher revenue, as previously mentioned, from price increases and slightly higher volume, along with lower freight and warehousing costs, increased productivity, and significantly reduced SG&A spend. These factors were partially offset by higher pulp and sorted office paper costs. Turning now to our balance sheet and financial position on slide 20, Our cash position stood at 82.1 million at the end of Q3, a decrease from 100.3 million at the end of Q2. Long-term debt at quarter end totaled 1.095 billion, up 55.5 million from 1.0395 billion at the end of the previous quarter. Net debt increased from $973 million to $1.0477 billion. The $74.7 million rise in net debt was primarily due to a significant FX increase on our U.S. dollar debt, the use of previously financed cash and debt for the Sherbrooke Expansion Project and the Tad Sherbrooke Project, as well as for other capital spending and working capital. Our net debt to the last 12 months adjusted EBITDA leverage ratio rose to 9.5 times in Q3 from 8.1 times in Q2. Leverage increased due to a higher level of net debt and also lower adjusted EBITDA level in the last 12 months. We expect our leverage ratio to remain relatively stable in the fourth quarter as we continue to spend on the Sherbrooke expansion project but get the benefit of improved adjusted EBITDA and lower working capital. While we're in a unique situation with our leverage at the end of Q3 2022 with ongoing strategic projects financed with debt along with currently deflated adjusted EBITDA, we anticipate that deleveraging will gradually take place as we move through 2023. As Tad Sherbrooke continues to ramp up and the adjusted EBITDA improves, as pricing catches up to inflation. At quarter end, total liquidity representing cash and cash equivalents and availability from revolving credit agreements stood at $112.4 million. In addition, $50.6 million of cash was held for the Tad Sherbrooke and Sherbrooke expansion projects. Going forward, as indicated last quarter, liquidity will be positively impacted by Kruger, Inc.' 's decision to increased its participation in the Dividend Reinvestment Plan from 50 percent to 100 percent, which was effective on July 15th. On September 15th, we completed an amendment to the Ag Credit Agreement, which covers our financing for the Tad Sherbrooke and Memphis sites, so that the starting date of the fixed charge coverage ratio covenant was changed from Q3 to Q4 of 2022, and the calculation of this ratio now uses the financial results starting as of October 1, 2022, instead of using the latest 12 months. I will conclude my section by reviewing CAPEX on slide 21. CAPEX after nine months reached $76.6 million, including $15.2 million for Tad Sherbrooke and $30.2 million for the Sherbrooke Expansion Project. We have lowered our CAPEX range to $130 to $140 million for 2022, including the Sherbrooke expansion project. This forecast represents a capex reduction of approximately $30 to $40 million from the previous quarter, based on planned reductions in discretionary projects and also some delays caused by supply chain issues on strategic projects, which are not expected to significantly impact the startup timing on these projects. Thank you for joining us this morning, and I'll now turn the call back over to Dino. Thank you, Mark.

I will conclude on slide 23. Our main goal remains to grow the business for the long term, while managing the inflationary pressure on a short-term basis. Against this backdrop, we continue to deliver solid top-line growth in the third quarter. Price increases and cost efficiencies mitigated inflationary pressure in the quarter, with a further improvement in profitability expected in Q4 2022. We're prudently investing in our brand to support price increases in the market and managing price gaps. Strong awareness and trial-building activities continue behind our Cashmere and Purex Ultra Luxe, Sponge Towels Ultra Pro, Bonterra, and White Cloud launches. Our Tad Sherbrooke facility continues to exceed its ramp-up curve, while recovery benefits from our Memphis operations are expected to progressively improve. We're very pleased with the robust away-from-home recovery across North America and aim to sustain positive adjusted EBITDA for the segment going forward. We will progressively strengthen liquidity and improve our leverage ratio, as Mark mentioned. The ratio is temporarily inflated due to large investments in strategic projects and temporarily reduced profitability caused by inflationary pressure. Finally, we will continue to invest in our organization and culture to drive future growth. Now let's turn our attention to the outlook for the fourth quarter of 2022. We believe that inflationary pressure has stabilized, price increases are in place, cost cutting programs have been implemented, discretionary spending has been restricted, and operating efficiency is gaining traction. While the market continues to be very volatile, adjusted EBIT on Q4 2022 is expected to exceed last year's fourth quarter level. With that, we'd now be happy to take your questions.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star followed by 1 on your touchtone phone. You will hear a three-tone prompt acknowledging your request, and your questions will be polled in the order they are received. Should you wish to decline from the polling process, please press star followed by 2. If you are using a speakerphone, please lift the handset before pressing any keys. Your first question comes from Hamir Patel, CIBC. Hamir, please go ahead.

Good morning. Good morning, Hamir. The sort of trade-down that the industry experienced in Q3 to private label, how much of that do you think was maybe caused by private label typically being slower to implement price increases, and how much maybe just due to households trying to maximize savings?

Yeah, it's a great question, Amir. You know, I've been in this consumer business for over 30 years, and every time there's pricing and inflation, you do see some slippage in the brands, and private label tends to be the benefactor. That eventually will recover. I think what you're seeing here is a couple of things. One is the sticker shock, as I call it, to the consumer, seeing price increases. Of course, not just tissue everywhere, but seeing price increases going up fairly significantly. And the other thing you get, Amir, when you get this type of pricing is retailers change their promotional strategy. So a lot of them may back off promoting the brand because they're not sure what the adjusted price will be in the marketplace. They may promote more of their private label during this period of time. So you get that whammy as well. That eventually corrects itself. At the end of the day, the brands are important. They're traffic drivers. Our brands are traffic drivers. And we see that situation eventually correcting itself. As far as speed of increase, I would say we have seen that everybody has generally moved within – we're all facing the same cost. So we're all moving within the same time period, give or take a few weeks.

That's helpful. Just a question for Mark. How should we think about CAPEX in 2023?

We don't have any specific guidance here on CAPEX for next year yet, but looking out in 2023, we see the Sherbrooke expansion project with the facial line converting line coming on and still spending heavily on the paper machine for that project. similar type of range I think you would see to what we have this year.

Great. Thanks, Mark. That's all I have.

Thank you. Your next question comes from Sean Stewart, TD Securities. Sean, please go ahead.

Thank you. Good morning. A couple of questions. AFH momentum, better quarter there, better than we've seen, I think, on record for EBITDA. Can you speak to, and I appreciate the factors that have led to better results there, but can you speak to the sustainability of that margin improvement as you look ahead into, I guess, not just Q4, but 2023 as well?

That's a great question, Sean. I think maybe in earlier calls a year or two ago, I always said that this business should be at least a mid-single-digit margin and maybe a low double-digit margin. And that's our goal internally to get there. And there's a few factors at play. One is obviously to continue to drive the volume curve. Part of it is market and part of it is share. I think the team is doing a great job of readjusting the portfolio and playing in segments and categories where we can win and that could be margin accretive. The team has also done a very good job at operating efficiency within our network where we make our way from home products. We're also short-term benefiting and longer-term will benefit from internal paper. We've had internal capacity available, so AFH has benefited from that. That was a penalty for them in the past. And with Phoenix coming on board, they will permanently benefit from that. And they've been very smart in announcing price increases in the market. as inflation has happened. So there's a lot of positive things going there, and I expect that business to be at least mid, if not low, double-digit margin as we look to the future. It might be a little choppy getting there, depending on what's going on in the market, but that is our long-term goal.

That's great detail. Thanks for that. And a question on the CapEx revisions for this year. You touched on some discretionary projects being taken off the budget. Can you give us a sense of what types of projects you're taking away? And we should view this as strictly a means of managing your leverage over the near to mid-term. That's the correct assumption, I suppose.

Yeah, I mean, you know, we go through this project with a fine-tooth comb. It was projects that are millions of dollars and projects that are tens of thousands. Given the year that we had, we made a decision that said unless it was urgent, unless it had to do with an environmental health and safety issue, unless it was de-risking our operations, that if we had the opportunity to delay, we would delay. I would say we generally have not canceled any projects. What we have done is push them more into next year until we feel that we're comfortable and stable with respect to our performance.

Okay. Thanks very much. I appreciate the context. That's all I have.

Thank you. Ladies and gentlemen, as a reminder, should you have a question, please press star 1 on your touchtone phone. Your next question comes from Zachary Evershed, National Bank Financial. Zachary, please go ahead.

Good morning, everyone. This is Nathan calling in for Zach this morning. Thanks for taking my question.

Morning. Hi.

So I noticed some deceleration year over year for most of your cost buckets. Can we expect similar trends going forward and If not, are there any particularly sticky inflation trends for certain materials or buckets that we should keep an eye out for?

Well, Nathan, I say my crystal ball is a little foggy right now, as I'm sure everybody else's is with the dynamics that are going on around the globe with respect to inflation and supply chain challenges. So we've learned to just be ready and to be ready to pivot. We did take pricing. We did cut costs. We continue to watch the big ones. The big ones for us are pulp. I think there was some belief that pulp would start coming down during earlier this year. It has generally not. It's starting to come down a little bit now. We won't likely see any of that benefit until next year. Freight is still high, subsiding a little bit. It's another big cost for us. Energy is still a wild card. If you're tracking what's going on with energy, it jumps around dramatically. So I just think the market is so volatile right now that our perspective, and based on industry experts and guidelines, is that we would expect to remain in a sideways inflationary period next year. I don't see dramatic deflation. I don't see dramatic inflation again. So we think it'll go sideways. Some commodities may go up, some may go down, some may stay stable. So it's probably the best I can do for you. I know it doesn't answer your question. If I knew the answer, I'd be a very smart man.

Thank you for that. I can definitely appreciate the difficulty in trying to predict where those costs go. Another question. Relative to last quarter's guidance, You included an extra price hike in October in Consumer US, I believe, on top of the January, February, and July ones. What kind of flags were raised when you decided to include that extra hike?

You cut out a little bit. What kind of – can you repeat that, Nathan? What kind of – what?

What kind of flags were raised, or what kind of internal metrics were you looking at when you decided to include that extra hike?

Yeah, so just in general on pricing, anytime we go take pricing, we don't like to take pricing, so let's be very clear. It's always difficult, and it makes it difficult for the consumer as well. So anytime we take pricing, we show our basket of costs, many of them I just talked to you about, and once we see that that basket of costs has stabilized at a high level and we're incurring those costs, we will go to our retail partners and say there's a need to increase the price by X percent based on those costs. And what we will do, and particularly what's happened in the last, let's say, 18 months, is we've had to do additional price increases in certain markets because the costs continue to rise. So the October one was no different in logic than what drove the other price increases. It was kind of a catch-up. primarily in Canada where we still had inflation after our July announcement, and some selective pricing in the U.S. where we were catching up with some particular customers that we weren't able to price earlier. So the justification is this has not been a margin grab. It's really been a price-to-recover-cost scenario for us. And unfortunately, with the lag built in, because it usually takes two to three months to get prices in the market.

All right. Thank you very much. I'll turn it over.

Thank you.

Thank you. There are no further questions at this time. Please proceed.

Okay, I want to thank you for joining us on the call today. We look forward to speaking with you again following the release of our fourth quarter results early in the new year. Thank you, and have a great day.

Thank you. Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.