KP Tissue Inc

TSX:KPT

Earnings Call Transcript

[Operator]

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to KP Tissue First Quarter 2019 Results Conference Call. [Operator Instructions] Before turning the meeting over to management, I would like to remind everyone that this conference is being recorded on Friday May 10, 2019. I will now turn the call over to Mr. Mike Baldesarra, Director of Investor Relations. Please go ahead.

[Mike Baldesarra, Director of Investor Relations]

Thank you, operator, and good morning, ladies and gentlemen. My name is Mike Baldesarra, I'm the Director of Investor Relations at KP Tissue Inc.The purpose of the conference call today is to review the financial results of the first quarter of 2019 for Kruger Products L.P., which I'll refer to as KPLP going forward. With me this morning is Dino Bianco, the Chief Executive Officer of KP tissue and Kruger Products L.P.; and Mark Holbrook, the Chief Financial Officer of KP Tissue and Kruger Products L.P.The following discussions and responses to questions contain forward-looking statements concerning the company's activities. Forward-looking statements involve known and unknown risks and uncertainties, which could cause the company's actual results to differ materially from those in the forward-looking statements. Investors are cautioned not to rely on these forward-looking statements.The company does not undertake to update these forward-looking statements except as required by applicable laws. There is a page at the beginning of the written presentation, which contains the usual legal cautions, including as to forward-looking statements, which you should be aware of. I'd like to point out that all figures expressed in today's call are in Canadian dollars unless otherwise stated. The press release reporting our Q1 2019 results were published this morning and will be accessible from our website at kptissueinc.com.Please be aware that our MD&A will be posted on our website and will also be available on SEDAR.Finally, I would ask that during the call to refer to the presentation we presented to accompany these discussions, which is also available on the website. We'd appreciate that during the Q&A period, you limit your questions to 2.Thank you for your collaboration. Ladies and gentlemen, now I'll turn the call over to Dino Bianco, our CEO. Dino?

[Dino J. Bianco, Chief Executive Officer]

Thank you, Mike. Good morning, everyone, and thank you for joining us on our conference call today. Let's start with our first quarter highlights on Slide 5. In the first quarter, we posted solid revenue growth of 8.4%, driven by both higher volume and the benefit from our recent price increases. Revenue increased in all geographic regions. Adjusted EBITDA totaled $23.6 million, a decrease of 23.2% over last year. While the adjusted EBITDA contribution to the Consumer segment remained relatively stable year-over-year sequentially, our Away-From-Home or AFH business reported a negative adjusted EBITDA of $6.6 million. Although the drivers of this loss are understood, we are disappointed in these results. I will discuss the AFH EBITDA drivers and action plans later in the presentation. On Slide 6, you see the market pulp prices in U.S. and Canadian dollars. The picture is somewhat similar to previous quarters with NBSK pulp prices in Canadian dollars and BEK or eucalyptus pulp prices on an upward trend since the end of 2016. However, more recently prices have fallen from their peak. Q1 pulp prices declined sequentially compared to Q4 and increased year-over-year in both in U.S. dollars and Canadian dollars and pulp prices in Canadian dollars continue to be near historical highs. Pulp prices in U.S. dollars have moderated in Q1 2019 and based on industry forecast, we expect that they'll remain in a similar range throughout the year.Let's turn to Slide 7, which summarizes the market situation regarding freight costs. As you can see these costs are also at new all-time highs, which will reach in October but have declined since then. We expect freight costs remain near current levels for the remainder of 2019.On Slide 8 are details of our price increases that we have recently implemented. We did see a benefit from the Canadian consumer price increase in Q1, and we should see benefits from our US consumer price increase starting in Q2 as that pricing has lagged our Canadian pricing. We also recently announced a price increase in our AFH business in Canada and the U.S., which took effect on May 1, 2019. And considering the competitive pressures, this increase should partially offset the higher pulp and freight costs that are impacting that business.Let's turn to Slide 9, which provide details of our recently announced operational excellence program. As mentioned on the last earnings call, we have engaged a third party consulting firm to help us drive savings across our manufacturing network. The work started in February of this year and the initial focus is on 2 of our lead facilities. The focus of this work is to implement lean manufacturing practices to help us increase capacity through operating efficiency improvements and to reduce waste. The work is in the early stages, but we already started to see some benefits in reduced machine downtime, waste reduction and increased machine speed. In addition to this initiative, we also engaged a third party firm to focus on improving our transportation and warehouse cost structure. This work is just underway and is also in the early stages. The financial benefits from these 2 initiatives will continue to build over time and as indicated before, we are expecting cost savings of $15 million to $20 million on a run-rate basis by the end of 2020. It's also important to note that these plans are not CapEx dependent and focused primarily on process standardization and improvement.We believe that these initiatives will allow us to expand our existing capacity and reduce costs across the network, in advance of TAD Sherbrooke project.On Slide 10, I want to write an update of our TAD2 project, which we will now refer to as the TAD Sherbrooke project. As you know, this project is central to our long-term North American growth strategy in the ultra-premium paper tissue segment. This project is on time and on budget, and we are progressing against our execution plan. We recently started the excavation at the site and have also purchased or contracted for most of the assets required for this new plant. Startup is still expected for early 2021. I will now turn the call over to Mark, who'll review our quarterly results.

[Mark Holbrook, Chief Financial Officer]

Thank you, Dino, and good morning, ladies and gentlemen.Before reviewing our first quarter results, let me mention that effective January 1, 2019, KPLP adapted IFRS 16 leases and new accounting standard covering lease accounting, using the full retrospective reproach. Under this approach, all comparative period information has been restated to reflect the adoption of IFRS 16. We provided you, in the appendix on Slide 28, Restated Annual Segmented Results. Note that IFRS 16 lease accounting had no effect on revenue or net income. For adjusted EBITDA, IFRS 16 had a full year positive impact of $16 million for 2018 and for Q1 2018, the positive impact was $3.7 million. Now please turn to Slide 11, which reviews our financial performance for the first quarter. Our revenues for the quarter were up 8.4% to $351 million compared to $323.7 million for the same period last year. Adjusted EBITDA, however, declined to $23.6 million in Q1 of 2019 from $30.7 million in Q1 last year. From a margin perspective, adjusted EBITDA decreased to 6.7% from 9.5% last year but remained relatively at the same level as Q4 2018. As Dino mentioned, higher pulp cost continue to have a significant impact on our results year-over-year.In the first quarter of 2019, we recorded a net loss of $3.2 million compared to net income of $1.6 million last year. This was primarily due to lower adjusted EBITDA and the lower income tax recovery in Q1 2019 compared to the same period last year partially offset by a positive change in the amortized cost of the partnership units' liability, a decrease in interest expense and lower depreciation expense. In the quarterly segmented view on Slide 12, Consumer revenue increased by 9.6% year-over-year to reach $296.2 million. Regarding the Away-From-Home segment revenue rose by 2.4% to $54.8 million. Adjusted EBITDA decreased by $1 million to $30.1 million for the Consumer segment and margin declined from 11.5% to 10.2%. For the Away-From-Home segment, adjusted EBITDA decreased by $6.9 million to a loss of $6.6 million and margins stood at a negative 12% compared to 0.5% in Q1 of last year.On Slide 13, we review Q1 2019 revenue over Q1 2018, which was up by $27.3 million or 8.4%. The increase is attributable to high -- higher sales volume, the Canadian consumer selling price increase implemented in Q4 2018 and the favorable effect of foreign exchange fluctuations on U.S. sales. By geography, Canadian sales increased by $8.8 million or 4.6%. Within the U.S. sales grew by $12 million or 10.4%. Mexican operations also saw their sales increase significantly, although it is a low contribution business. On Slide 14, we've provide further insight into our Q1 adjusted EBITDA, which decreased by $7.1 million or 23.2% to $22.6 million. Gross margin in the quarter also decreased from 11.6% to 8.8%. As mentioned earlier, the decrease in adjusted EBITDA was primarily driven by significantly higher fibre costs, increased warehousing cost and other contributing factors were capacity-driven cost challenges, unfavorable sales mix and FX. These are partially offset by the Canadian consumer selling price increase in Q4, increased sales volume and a decrease in SG&A expenses. For a sequential perspective, let's turn to Slide 15 where we compare Q1 2019 to Q4 2018 revenue. Quarter-over-quarter revenues decreased by $8.5 million or 2.4%. The Consumer segment decreased 1.6%, whereas Away-From-Home decreased by 6.5%. Q1 is typically a lower quarter on a seasonal basis than Q4. By region, revenue decreased in Canada by $9.5 million or 4.6% and in U.S. by $0.8 million or 0.6%. Revenue increased $1.8 million or 7.3% in Mexico. On Slide 16, Q1 adjusted EBITDA decreased by $0.9 million compared to Q4 or 3.7%. Gross margin, however, improved from 7.8% to 8.8%. The decrease in adjusted EBITDA is mainly due to lower sales volume typical of Q1 compared Q4, the cost of outsourced manufacturing and the unfavorable net impact of foreign exchange fluctuations. These are partially offset by slightly lower pulp cost.Now I'll turn to our Liquidity and Financial Position on Slide 17. Our cash position was $142.1 million as at the end of Q1 2019, down from $169.9 million at the end of Q4. The Q1 cash balance includes the TAD Sherbrooke project, initial financing proceeds less spending to date, or a net $119.5 million of TAD Sherbrooke cash at the end of Q1. Overall net debt at the end of Q1, stood at $462.5 million or up $54.5 million or -- from $408 million at the end of Q4 2018.Consequently our net debt to latest 12 month adjusted EBITDA ratio is now at 4.2x, up from 3.4x at the end of Q4 2018. Looking forward, the TAD Sherbrooke project will result in a total company leverage increasing as spending on the project occurs over the next 2 years. To conclude, please turn to Slide 18. Our fiscal 2018 CapEx was $62 million, including $27 million from our TAD Sherbrooke project. For fiscal 2019, we expect our CapEx, excluding TAD Sherbrooke, to be between $30 million and $35 million, similar to 2018, and our TAD Sherbrooke CapEx to be between $250 million and $275 million in 2019. Thank you for your attention, and I'll now turn the call back over to Dino.

[Dino J. Bianco, Chief Executive Officer]

Thank you, Mark. Let's turn to Slide 19 and 20, where we write a summary of our market share positions in the Canadian consumer segment. We are the market leader in bathroom tissue with a 34.3% share and after some recent declines, we begin to stabilize our share in this segment. As for the facial tissue and paper towel categories, we've actually registered some market share gains on a 52-week bases after, again, some previous year declines. We plan to continue to build our market share through increased marketing investment, new products, strong customer support and our new NHL multi-year partnership, which was announced a few months ago. Let's now turn to Slide 21, where I'd like to give more context to our AFH results. As discussed in previous calls, our AFH business is critical for Kruger products to leverage our cost structure as it absorbs a high portion of our fixed costs. Nonetheless, Q1 was a challenging quarter for AFH as higher pulp and freight costs combined with a competitive AFH environment and increased outsourcing costs drove the weak performance. On the outsourcing costs, our continued total company growth has created tight product -- capacity across our network and as a result, we have chosen to use most of our internal capacity for our higher-margin Consumer business. This has required our AFH business to source some of its paper in the open market at higher costs. In addition, the variability of paper quality purchased has caused production and logistics inefficiencies in our AFH plants. Going forward, we are focused on increasing the capacity of our paper assets as explained earlier and sourcing more stable and better quality paper externally for AFH. Through these production challenges, we remain focused and committed to servicing our customers with high-quality products. Another factor that will improve AFH results is that we recently announced a price increase that took effect on May 1, 2019. While in the early stages, we should see the benefit of this pricing as we move through 2019. However, we expect continued market outsourcing cost to impact AFH in the year. Our cost structure improvements and our pricing should drive improved results as we move through 2019. I also want to announce that Rob Latter, our General Manager of our AFH business, has announced his retirement after a distinguished 23-year career with Kruger. Replacing Rob will be John O'hara, who currently runs our logistics and product deployment group. John is very familiar with the AFH business, which will ensure a smooth transition with Rob over the coming months. I want to thank Rob for his leadership over the years and wish both Rob and John best wishes in the future. Finally, I will conclude the call with Slide 22. Despite ongoing business challenges, we believe we can drive solid performance from our businesses as we are putting actions in place to stabilize AFH and continue to grow our Consumer segment. More specifically, we continue to grow the top line in volume across all key geographies and segments. We have priced all of our businesses to offset higher fibre costs and restore margins. We are creating a more efficient and capable supply chain network. We are building ultra-premium capacity with the TAD Sherbrooke project to adjust to growing segment of the industry. We continue to invest to build our brands as is the case with the multiyear partnership with the NHL. And perhaps most importantly, we're building organizational capability and culture to meet the needs of today and tomorrow to deliver strong positive results. Looking forward, Kruger Products will benefit from the consumer Canada price increases implemented in Q4 2018, along with the consumer U.S. and Away-From-Home price increases announced in 2019. These price increases combined with our cost reduction initiatives are expected to largely offset the continued high input costs and unfavorable impacts of foreign exchange and outsourcing over the course of 2019. For Q2 2019, adjusted EBITDA is anticipated to show a sequential improvement compared to Q1 2019 and trend lower than Q2 2018 results. In conclusion, we are confident that we have the right vision and strategies to move the company forward, as the North American tissue leader. Thank you for your time and attention. At this point, Mark and I will be pleased to answer any questions you may have.

[Operator]

[Operator Instructions] Your first question comes from the line of Hamir Patel from CBIC Capital Markets (sic) [ CIBC Capital Markets ].

[Hamir Patel]

Dino, could you give us an update on the TAD Sherbrooke. How much of those volumes are already committed and how much are you targeting to have sold by the time the machine starts up?

[Dino J. Bianco, Chief Executive Officer]

Sure, Hamir. So the selling process usually takes 12 to 18 months. So it's a little early to start the official discussion but let me say we've had lots of dialogue with existing customers and new potential customers. As I think I mentioned on a previous call, we did TAD1 in Memphis, we were still a bit of an unknown in the marketplace. It was probably a lot harder to make those calls with customers. Now we've got a proven track record with quality supply and the go-to-market strategy. So we got a lot more interest and credentials when we're talking to customers about supplying them with TAD products out of Sherbrooke. So I would say the -- lots of dialogue, lots of interest, lots of discussion. Probably not till later this year will we start actually getting finalized contracts and our product SKUs known.

[Hamir Patel]

Dino, that's helpful. And could you speak to maybe how is the NTT product that some of your competitors have out there, how is that being perceived in the market today relative to TAD? And does that differ for bath tissue versus towels.

[Dino J. Bianco, Chief Executive Officer]

Sure. I mean, I'll give you -- I'll give you the industry perspective. I mean, I think when you look at TAD by all measures, it is recognized as the ultra-premium product that's out there both in bath tissue and in paper towels. Bulkiness, absorbency, softness all the metrics, no matter what chart you look at TAD tends to be in the top quadrant.And then you've got a range of qualities that go down from there, NTT, QRT, obviously, traditional LDC. So they all vary and some are better at bath tissue, some are better at paper towel. So I would say to you there is a spectrum of quality out there. We know TAD, by all measures, is the best and provides the greatest performance and that's obviously where our focuses is for Sherbrooke.

[Hamir Patel]

And any update on the White Cloud repositioning, how that's been going?

[Dino J. Bianco, Chief Executive Officer]

Yes. Thank you for that question. So White Cloud continues to build distribution more as a customer play right now. So we're launching it selectively at customers where there's a need. As I've mentioned on previous calls, we're looking at a consumer launch of that brand and trying to figure out what's the right positioning, where does it fit in the market place, obviously, it's a very competitive market place but we do know from the research, preliminary research that we've done, there is a lot of consumer equity and knowledge of that brand. So now we're putting together the business plan for that. I hope to share more of that information with you in the future but we are progressing with not only the consumer work, the customer work, the product portfolio work and then ultimately, the business launch.

[Operator]

Your next question comes from the line Sean Steuart from TD Securities.

[Sean Steuart, Research Analyst]

It's Sean, TD. A couple of questions. Following on Hamir's question on Sherbrooke. Any context you can give, Dino, on how much of the product, as you get a sense from your customer build up, how much will go to Canada versus the U.S? And then following on that, updated thoughts on the time to ramp up to what you think is -- will be the machine's full EBITDA capability? Memphis was several years, is your timing thinking on Sherbrooke different from that?

[Dino J. Bianco, Chief Executive Officer]

Sure, it's a good question. Until we get the final orders, I think, it's hard to say. But I think if you use a 40%-60% or 60%-40% range between Canada and the U.S, you're probably in a good place. Obviously, you could get influence one -- by one large customer in a particular geography that can have an impact. But as we're thinking about how we're laying on our warehousing strategy, and our current view of customer interest, we're probably looking 40%-60% or 60%-40% one way. So that's kind of the range you need to think about as that plays out. As far as the ramp-up curve, clearly we're going to be better, I mean, having done it the first time and actually having beaten our own curve when we did Memphis the first time, we were ahead of our curve. We expect to be ahead of the curve on this one as well. I think, we're targeting a 3-year ramp up, I think, Memphis was a 4. And the reality is, we've done it before so we should be faster. We have many people that were involved in the Memphis start up that are actually going to be involved in Sherbrooke, so we've got the institutional knowledge of doing it. And then the other benefit that we've talked about a bit in the past is that with TAD1, we actually have a great training ground to train, people we're bringing on board early to spend time in Memphis, to learn that asset. And the other side of that is with the second TAD machine, we have the benefit of optimizing our network between TAD1 and TAD2, which also should aid in the startup of Sherbrooke.

[Sean Steuart, Research Analyst]

Just one other question. The Away-From-Home hike across North America, is 8% the right number to think about? And should we think of this as fully in by year-end? Is that the time frame to fully implement it with contract rollover?

[Dino J. Bianco, Chief Executive Officer]

I would think the right way to think about the ranges is probably mid-to-high-single-digits. So 8% sits within mid-to-high, so it's more mid-to-high. The price increase took effect May 1. As you know that business is contract-based so as contracts come through, you're able to move the pricing. It depends sometimes on the geography, U.S. versus Canada, it depends sometimes on the category, whether it's towel or bath tissue so those are some variances that exist there. We're starting to get some early traction, which is good. But -- and I think, also there's been public announcements by some of the bigger players of pricing as well and obviously there's been lots of pricing in consumer. So I think, there's a readiness by the market and there's an understanding in the market that the pricing will be moving through. We anticipate, as I mentioned earlier on my call, the Canada consumer started first in Q4 last year. So we're starting to see the benefit of that in Q1. The U.S. consumer price increase started kicking off in Q1, we should see some of those benefits coming through in Q2. And then AFH obviously being the last now in Q2 being announced, we should start to see those play through in Q3 and then ramping up in Q4 and beyond.

[Operator]

Your next question comes from the line of Keith Howlett from Desjardin.

[Keith Howlett]

Yes. I'm wondering if you could just summarized the relationship of AFH to the Consumer business in terms of converting plants. I think they're separate, and I don't know if the sales force is separate but I would have thought so. So I'm just trying to get a sense of where the key cost sharing benefit of the AFH is?

[Dino J. Bianco, Chief Executive Officer]

Sure. So Keith, what I would say is that we have structured AFH as a separate business with a separate P&L, separate leadership. Anything that faces the customer or market is very unique to AFH. So sales would be unique, marketing would be unique, product development would be unique because obviously, it's a different business model. Manufacturing on converting is unique. We started that process a couple years ago because the converting side of AFH is very different than Consumer. So we've been investing in setting up dedicated converting facilities. What it does share is, it shares, obviously, paper from our network. And by the way, AFH has always bought paper on the market so this isn't new. What's happening now is with the growth in our consumer business, it's having to buy more on the market and as many of you know, who follow this market, the market's very tight on paper supply. Parent rolls, depends on the grade but generally very tight. So we're dealing also with a tight market, a higher cost, variable quality and that's been the issue that I talked about it in driving the results on the business. So what we've got to do is, we've got to increase the capacity of our own paper machines. And we're doing that through the work we're doing with the third-party consultant. We're getting our OEs up on our paper, particularly the ones that have an influence on AFH. We used to buy paper more tactically, as we needed we bought it. We're now getting into more of a strategic partnership with suppliers to guarantee volumes and know that we're going to be in this space probably till TAD2 comes on board. And then the other thing we're doing is, when you're trying out capacity, and I didn't mention it in my prepared remarks, is where we have lower margin businesses, we should be pricing them or exiting them. And we're doing that work as well as we're looking at the portfolio.

[Keith Howlett]

And then -- so would you be self-sufficient in parent rolls for Consumer you're short on AFH? And then on converting capacity, do you have sufficient AFH converting capacity or are you contracting any of that as well?

[Dino J. Bianco, Chief Executive Officer]

No. We have sufficient converting capacity. At some times we will use outside converters where we may have -- if there’s a machine downtime or a particular issue, but generally, we are self-sufficient on converting. What has happened here though, and the 2 are interrelated, as we have brought in new suppliers on paper, paper variability, it -- not only do you pay for that paper, it also diminishes your throughput on your converting lines. Because you're tweaking the lines if the quality is not there, so you get inefficiencies on your converting. That shows up as a production inefficiency, but it's driven by outsourcing. So the more we can source internally or stabilize internally, the better we'll have a cost structure and more operating efficiency.

[Keith Howlett]

And then, if I might just ask on the pricing architecture and the private label penetration across paper towels, bathroom tissue and facial tissue. Is there quite a spread on the private label penetration? I presume it's -- I'm guessing it's highest in paper towels, but I'm not sure.

[Dino J. Bianco, Chief Executive Officer]

You're talking about market share?

[Keith Howlett]

Right.

[Dino J. Bianco, Chief Executive Officer]

Yes. I would say, for private label is -- it continues to be a growing segment in the markets. It is represented across all 3 bathroom tissues. Obviously, more overdeveloped the ranges tend to be 30% to 34% on the categories and depending on the customer. But we're looking at about a market place that is 1/3 -- essentially 1/3 private label across the 3 segments. With some continued growth, obviously the U.S. is growing faster in this area. But in Canada, it is growing but at maybe a lower pace because it's overdeveloped versus the U.S. on private label in Canada.

[Keith Howlett]

And does facial tissue have a similar penetration?

[Dino J. Bianco, Chief Executive Officer]

It does a little lower than bath and paper towel.

[Operator]

Your next question comes from the line of Zachary Evershed from National Bank Financial.

[Zachary Evershed, Associate]

I have a more of a broad question. I was hoping you could comment on industry supplying dynamics and how you view them going forward? You're going to be ramping up quite a large machine. We also saw that GP is starting up a TAD machine in Florida as well as another in Alabama the following year. So how do you view supply and demand in the competitive marketplace?

[Dino J. Bianco, Chief Executive Officer]

It's a great question. It's a question that gets talked about a lot. So I guess I would answer it this way, the market place, just based on regular category growth of 1.5%, and I'm talking North America here, because these assets it tend to be North American fungible. The market just to service normal growth, needs about 2 to 3 70,000-ton machines a year. So you think about having to put in 2 to 3, assuming efficiency stay the same across the network you have to put in, 2 to 3 new machines every year just to meet the growth in the category across North America. Which you -- and at any point in time you're going to have a potential imbalance. More machines come on board and then eventually the lower-efficient, higher-cost machines get shut down, if you will. So I see that phenomena continuing to happen. In the short term, there may be a little more excess capacity but what ends up happening is, ourselves included, you announce the shiny new machines 3 years ahead of time and then you're should closing an asset, you announced it 3 months ahead of time. So you don't always get the -- you know when the new one's coming on board, you haven't heard which ones might be coming out of the system because they usually get announced with a shorter lead time in the market place. So I suspect, you'll see the new ones come on board, there might be some excess capacity in the short term and you'll probably see companies, as some have already done so and will continue to do, take inefficient or high cost machines off the grid.

[Zachary Evershed, Associate]

And do you think that the definition of high cost machine will continue to evolve and essentially choke out the more marginal players in the same way that we saw selling prices get stuck for a long period of time?

[Dino J. Bianco, Chief Executive Officer]

Potentially. I mean, if you just look at macroeconomics in supply and demand, scale does matter in this industry, particularly on papermaking. Low cost is so critical, given the thin margin structure. So I think those companies that can convert more of their portfolio on the manufacturing side to higher efficient, large scale, low cost -- low cost meaning fiber, energy, water all factors, obviously labor and other elements. I think you'll get the normal supply and demand and economic impacts of the marginal machines or players. If they're only invested in marginal machines, we may be in trouble.

[Operator]

[Operator Instructions] Our next question comes from the line of Paul Quinn from RBC Capital Markets.

[Paul C. Quinn, Analyst]

Just trying to understand what's going on in AFH, and I appreciate some of the things you're trying to do to turn around. What's your estimate about how long you think that business will take to turn around to get back to sort of a reasonable return on your assets?

[Dino J. Bianco, Chief Executive Officer]

Great question, Paul. I expect, we should see -- we are -- even through the quarter, we saw sequential improvement. We had a rough January, a better Feb, a better March, as it relates to the cost structure side, which is one of the big drivers. So we've seen sequential improvement because we've taken immediate actions. We put OEM contractors in place to help us get our converting lines right. We put resources from our other facilities that know these assets into play, into those facilities. This work that we're doing with the third-party consultant, we're advancing that. So we put a swat team in place to help with the AFH assets. So we're starting to see improvements already. The reality is though, even with ROEs improving on paper, we're going to continue to stay tight. So now it's a matter of being as efficient as we can with respect to knowing that we have a certain part of our paper that's going to be supplied externally. And that's why I talked about linking in with a strategic supplier on paper so that we -- we know until TAD2 comes on board we're likely going to be capacity constrained because our businesses will continue to grow. So I can't give you a specific timeline other than I would say with pricing and the cost curve getting better and if fiber continues to cooperate we're going to see sequential improvements in this business through '19 and into 2020. We are still a very strong healthy business, we're the market leader in Canada and growing quite substantially in the U.S. We've got good-quality products, great customer relationships, great marketing. So all the elements of the business fundamentals and the strength that we have are all there. We just got to fix the back end and get that cost structure cleaner so that we can not only grow but deliver good profit.

[Zachary Evershed, Associate]

Okay. And then we expected slightly better result in Q1. Just wondering if there's a lag on the cost? Like we obviously saw pulp and fiber prices coming down in Q1. Does that take a while before it flows through to your business?

[Dino J. Bianco, Chief Executive Officer]

Yes. Usually there is a 1 month lag, let's say, it could be could be 3 to 6 weeks but usually there's a lag there. It depends on the inventory levels that we've got and what we got it priced at and what segment it's in. But I think a 3 to 6 week, 6 would be the high side, 3 would be low, more normal side.

[Zachary Evershed, Associate]

Okay. And then just if you could give some details on the partnership with the NHL. That sounds great at a high level, just wondering, how -- is that advertising during games? How is that going to incrementally help you going forward?

[Dino J. Bianco, Chief Executive Officer]

Yes. That's a great question. And I didn't talk a lot about it because I talked about it at the last earnings call. But really what the NHL partnership allows us to do and quite frankly, the #1 benefit for us and most partners with the NHL is really to get merchandising activity at store level. I mean, clearly it's good to be associated with such a great brand, and we're proud of that. But for us to be able to sell more tissue by having more merchandising at store level and many of our customers are also supporting the NHL, so it's a symbiotic relationship. It also takes a bit of the pressure off the price point, when you're doing a promotion or a special pack or some sweepstakes or giveaways.We know from the data that the NHL has provided that moms over-index with the NHL, millenials over-index with the NHL, new Canadians are culturating through hockey in the NHL. And these are key targets for us so -- and they're all willing to support a brand that is supporting the NHL. So all those factors work together to help us get more merchandising, more support and then more brand affinity in connection to NHL hockey and quite frankly our Canadian roots. So it's a multi-faceted approach. We started slowly or started small because the NHL play-offs is a big period for the NHL, and our contract just recently came on board. So we did some activation for the play-offs, but we'll do more and bigger events as we move through next year season and then into the new year.

[Zachary Evershed, Associate]

And then just lastly on Sherbrooke, just so I understand, I mean, you're flip-flopping between 60%-40% and 40%-60%. So basically you're not quite sure how might your product sell in the U.S. and Canada but that's kind of the range you fell between 40% and 60% in Canada and I guess, 40% and 60% in the U.S.

[Dino J. Bianco, Chief Executive Officer]

Yes. I wouldn't have used the word flip-flopping. I'm just saying based on a forecast that we have. We have one scenario that has a 40%-60%, we have another scenario that 60%-40%. We're not flip-flopping, we just -- depending on how it plays out, it's going to be one or the other. It's not a 90%-10% scenario or 10%-90% scenario. It’s within a range of 20 point difference between 40%-60% so. And that'll clarify itself out as we solidify the customers and the portfolio later this year.

[Zachary Evershed, Associate]

Okay. So what are the key criterias around those scenarios that moved that dial 20% either way?

[Dino J. Bianco, Chief Executive Officer]

Well, if you pick up a large U.S. customer and it's a product that we can supply economically, geographically and it's not a complicated portfolio, we may push more that way, and it could be more 60%-40%. Or the other way, if that large customer's in Canada with that criteria, and they're a strategic customer of ours, it could go 60%-40% Canada. So it depends on the product portfolio, the geography, the -- if they're an existing, new customer. All those factors will play out. At the end of the day, we want to be as efficient as we can, in not only production but distribution. Try to simplify our portfolio as best we can because I operate -- it creates more capacity and operating efficiency. And obviously, it continues to supply our customer base and our growing customers.

[Zachary Evershed, Associate]

Okay. So I guess, given the fact that you're probably going to go to the market at the end of this year. Start to talk to customers, I guess, it'll be early 2020 before we sort of have a really more narrow idea as to where the product could go.

[Dino J. Bianco, Chief Executive Officer]

Yes. I don't think I'll ever reveal which customers we got because that's obviously pretty confidential still. But I'll be able to tell you better from the macro elements around where the distribution of those and maybe the categories. And don't forget, a lot of that, a big part of that machine is going to go to support our brands in Canada, since we don't have a strong brand business in the U.S. So that also plays at this, where is it a 60%-40%, 40%-60%. Because our Canadian business is obviously a high priority for us to make sure we support our brands from quality and innovation point of view.

[Operator]

Your next question comes from the line of Keith Howlett from Desjardins.

[Keith Howlett]

I was just wondering what the economic shipping distance is from Sherbrooke to a customer?

[Dino J. Bianco, Chief Executive Officer]

I think the rule of 500 miles or, let's say, 800 -- 700, 800 kilometers at the max is probably still fair. Obviously, to [indiscernible] you get different shipping lanes and cost, but I think that's a good rule of thumb. So you can get your protractor out, your compass out and do a kind of a circle around where Sherbrooke is and that will tell you generally, where the best places are. Now in some cases, you can ship by rail at lower costs, ship further, particularly if you got satellite warehouses. So other things come into play, but I think the 400- to 500-mile rule is probably a good starting place.

[Operator]

Your next question comes from the line of Benoit Laprade from Scotiabank.

[Benoit Laprade]

Just a quick one, just one clarification. In your outlook, you mentioned that Q2 should be stronger than Q1, yet not as good as Q2 last year. I assume, you're talking about Q2 last year, where you stated for IFRS 16, which would have added about $4 million to the quarter.

[Dino J. Bianco, Chief Executive Officer]

Yes. That's correct Benoit. We would -- we be comparing with the IFRS lease adjustment in 2018, and it would be in that range. A little shorter than $4 million but close to that, yes.

[Operator]

There are no further questions at this time. I'll turn the call back over to the presenters.

[Dino J. Bianco, Chief Executive Officer]

Okay. Thank you for joining us on this call this morning. We look forward to speaking with you again in August, following the release of our second quarter results. Thank you for your questions and have a great day and a great weekend. We'll see you soon. Thank you.