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[Foreign Language] Welcome to the TC Transcontinental First Quarter 2018 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded today, March 1, 2018.I would like to turn the conference over to Shirley Chenny, Advisor, Investor Relations. [Foreign Language] Ms. Chenny, please go ahead.
Thank you, Julia, and good afternoon. Welcome to TC Transcontinental 2018 First Quarter Results Conference Call. The press release and MD&A with complete financial statements and related notes were issued earlier today. For those of you who are not on our distribution list, the documents are posted on our website at tc.tc. With us today are TC Transcontinental's President and Chief Executive Officer, François Olivier; and Chief Financial and Development Officer, Nelson Gentiletti. Before I turn the call over to management, I would like to specify that this conference call is intended for the financial community. Media are in the listen-only mode and should contact Nathalie St-Jean, Senior Advisor, Corporate Communications; for more information or interview requests. Please be reminded that some of the financial measures discussed over the course of this conference call are non-IFRS. Please refer to the MD&A for complete definition and reconciliation of such measures to IFRS financial measures. Also, this conference call might contain forward-looking statements. Such statements, based on the current expectations of management and information available as of today, inherently involve numerous risks and uncertainties, known and unknown. The risks, uncertainties and other factors that could influence actual results are described in the 2017 Annual MD&A, the latest Annual Information Form, and has been updated in the MD&A for the first quarter ended January 28. I would now like to turn the call over to Françoise Oliver.
Thank you, Shirley, and good afternoon, everyone. Overall, we are satisfied with the results of the first quarter of 2018. Our entire team continued to work diligently to deliver our strategic and operational goals. We remain focused and continue to execute on our transformation. I will begin by providing key operational highlights by business segment. As you saw, we had some noise in the reported figures, due mainly to the new agreement we signed with Hearst in December. I will let Nelson provide you with more details on the impact of that deal on our financial statement later on the call.So if we exclude the impact of the new Hearst agreement, of the sale of some of our newspapers and other media assets and the impact of the exchange rate, our adjusted revenues decreased by 1.7% in Q1. On the profitability side, when we also adjust for restructuring costs, impairments of assets and finally, the impact of the share price variation on our stock-based compensation expense, our adjusted operating earnings remained stable at $66 million.Now let me highlight some key factors that impacted our results. In our printing division, demand for our retailer-related services increased again this quarter. We benefited from the additional volume from our expanded agreement with Lowe's Canada, which was partially offset by lower volume in our flyer distribution business due to the bankruptcy of a Canadian retailer. Our offering remains very relevant to Canadian retailers, and on that note, we are pleased to announce that we have expanded our business relationship with Loblaws with a new multiyear agreement. This agreement renews the services we currently provide and adds additional volume for in-store marketing product printing, premedia services and commercial printing.Furthermore, as part of the new Hearst agreement, we will transfer the retail volume from our Fremont facility to our Vancouver printing plant, and we will reallocate some equipment to our Canadian retail printing platform. This equipment is more modern and faster than our other equipment and our -- than other equipment in our platform, which will create substantial efficiency gains as of 2019.As for our nonretailer-related business, which represents 40% of our printing division, volume remained under pressure due to persistent adverse factors in the advertising market and also due to the end of the printing of The Globe and Mail in the Maritimes and Les Affaires in Montréal. To cope with reduced volumes, our team continued to take steps to lower our costs, and we closed our Transcontinental Métropolitain newspaper printing plant and we transferred the remaining volume to other Québec plants. The full benefit from this measure will only start in the second quarter.Turning to our packaging division. We completed the integration of our Flexipak acquisition, and we are pleased with their results so far. The addition of Flexipak leverages our well-established presence and flexible packaging products, servicing consumer goods companies, food processors and retailers across several verticals. The addition of Flexipak enhanced our platform, enabling us to serve customers across Canada and will serve as the basis to increase our servicing offering in Canada, namely to Canadian retailers in combination with our Flexstar facility in Western Canada.In terms of organic sales, our packaging results were mainly affected by timing differences of purchases by customers at one of our plants. This situation has already started to gradually reverse in February. On our other plants, organic sales increased 2% in the quarter. For the full year, we expect our division to achieve organic sales growth similar to last year.With respect to further acquisition opportunities, our pipeline continues to be very robust, and we are optimistic about our ability to conclude some transactions during fiscal 2018. On the Media side, we continued to refocus our activities towards our Business and Education portfolio. First, during the quarter, we sold 34 local and regional newspapers in Québec; second, we also sold our stake at CEDROM-SNi, a Montréal-based firm specializing in digital media monitoring. Finally, we acquired Contech, a leader in the services for construction professionals in Québec. This acquisition is a natural fit for Constructo's offering, which is geared to the same target audience and strengthens our -- its position as a leader in strategic information for the construction sector in Québec. Overall, in the quarter, the Business and Education group continued to perform well.In conclusion, on the print side, measures are continuously being taken to further optimize our platform, and our teams are diligently working on adjusting our cost base to volumes. For our Media group, we will complete the sales process of our local newspapers, and we expect our Business and Education group to perform well again this year.Finally, regarding our packaging division, we remain committed to our strategy, and we will continue to build our division through acquisitions and organic sales growth.With that, I will turn it over to Nelson.
Thank you, François, and good afternoon. Let me take a few minutes to go over the new agreement we signed with Hearst last December as this deal has led to some noise in our results. We announced that our printing agreement with Hearst would end on April 1, and that we would transfer to Hearst the printing of the San Francisco Chronicle, currently done in our facility in Fremont, California. We will continue printing the newspaper in Fremont until April 1, 2018, and provide transitional services until October 31, 2018. With this new agreement, we will receive a cash payment of USD 42.8 million, of which $32.3 million was paid to us in Q1, with the balance to be paid in Q2. The breakdown of the cash payment is as follows: USD 25 million as compensation for the early termination of the 2013 amended agreement; USD 7.3 million for services to be rendered as part of the transitional services agreement; and USD 10.5 million for the sale of some of our printing equipment. In addition, we have also agreed to lease our facility to Hearst until the end of 2024. We will receive $21.3 million over the term of this lease.This agreement leads to a onetime noncash EBITDA gain as we will accelerate the recognition of about USD 80 million of deferred revenues in the first and second quarter of this year. This represents the unamortized deferred revenue from the onetime cash payment of USD 200 million we received in 2013 from Hearst as compensation to amend the original contract. In addition, we will record an accelerated depreciation of our assets of about USD 15 million. The cash impact on our EBITDA will not be significant under this new agreement. In the quarter, the accelerated recognition of deferred revenues related to this agreement represented CAD 40 million, and the accelerated depreciation impacted our operating earnings by $6 million.Finally, our first quarter results were also impacted by the U.S. tax reform, which came into effect January 1. The decrease in the federal statutory tax rate reduced our previously recognized deferred tax assets by close to $37 million in the quarter.Overall, our reported net earnings grew 36% from $43 million to $58 million. This increase is mainly attributable to the increase in operating earnings, partially offset by higher income taxes. Excluding the accelerated recognition of deferred revenues, accelerated depreciation, restructuring and other costs and impairment of assets net of related taxes as well as the impact of the U.S. tax reform on deferred tax, adjusted net earnings increased close to 18% from $41 million in the first quarter of last year to $49 million in Q1 of this year. This increase is partly due to the $7 million decrease in our stock-based compensation expense as a result of the change in the share price in the first quarter of 2018 compared to the same period last year.On the cash flow front, net change in cash amounted to $67 million, and we ended the quarter with $314 million of cash. Close to $134 million came from operations before changes in noncash operating items and income taxes paid. Also, we received $30 million from the sale of certain assets, namely local newspapers and our stake in CEDROM-SNi. We have a negative variance of $31 million from our working capital, due mostly to timing differences for accounts payable and the stock-based compensation to be paid. We paid $12 million in taxes, invested $11 million for acquisitions and allocated $13 million in CapEx. We also distributed $16 million in dividends and repurchased shares for $7 million. At the end of the quarter, our net indebtedness was $34 million, with no significant debt maturities before 2019, and our debt-to-EBITDA ratio stood at 0.1x.Now moving on to the outlook. In our printing division, we expect revenues for our retailer-related services to remain relatively stable when compared to last year even though our distribution business will be impacted by the bankruptcy of a major retailer in Canada. The remaining 40% of our printing portfolio should be affected by expected volume declines due to the same trends in the advertising market and to lower volume in our newspaper printing segment as we no longer print The Globe and Mail in the Maritimes and Les Affaires newspaper. In addition, we will stop printing the San Francisco Chronicle in April. However, pursuant to our agreement with Hearst, we will continue to offer them transition services until October 31, and we will rent them our facility. In terms of our profitability, the printing division will also benefit from the closure of the Transcontinental Métropolitain plant, starting in Q2 of this year.In our packaging division, we will benefit from the contribution of our Flexipak acquisition, and we expect to achieve similar organic sales growth to last year. And finally, we will carry out our M&A plans in this promising market. In the Media Sector, we expect our Business and Education group to continue to perform well. With respect to our local newspaper publishing activities, the sale process is still underway for the remaining newspapers. For the 2018 P&L, assuming the stock price at the average of the last 5 days, you should model for full year corporate costs at the EBITDA level of about $20 million. As a reminder, a change of $1 in our stock price impacts our results by close to $1 million.Our financial expenses are expected to be lower than last year as well as our effective tax rate, which is expected to be at about 26% due to the U.S. tax reform. In terms of use of cash for the year, you can assume CapEx of around $50 million and cash taxes of $55 million.To conclude, TC Transcontinental continues to puts it -- put its efforts towards producing profitable growth through a combination of manufacturing cost leadership, focused business verticals, strong customer relationships as well as select strategic acquisitions. The execution of our strategy continues to generate significant cash flows, which allows us to pursue our transformation and grow our flexible packaging business. Our solid financial position and our approach to capital allocation also enables us to return capital to shareholders in the short term while continuing to invest in our future. As such, today, we announced a 5% increase in our annual dividend, bringing it to $0.84 per share.On that note, we will now proceed with the question period.
[Foreign Language] [Operator Instructions] First question comes from Adam Shine from National Bank Financial.
So first of all, you were talking about, obviously, the sort of timing issue with the one facility. This is clearly not likely to be a repeat of some of the 2016 issues, given that there's already a reversal happening, as you say. But can you maybe just give us a little bit more color on what exactly might have transpired that it catches you by surprise? Or was it largely anticipated? And then just to remind us what organic growth was in 2017, was it closer to 5% or maybe closer to 6%? Because I can't recall if that was officially mentioned.
Yes, the organic growth for last year, we'll start with that, was 6%. And obviously, we did not achieve that in Q1 because of what I'm going to talk about. So we expect, once the year unfolds, to deliver 6%, even though after Q1 suffered from what I'm going to talk about. This is not the same plant. This is another plant, this is another vertical. It's isolated to 1 factory and only 1 vertical, and we only have a few customers in that vertical. And the issue is about a legislative change and the labeling of this product, which force customer if they want to sell their product in the market after a certain date to change all of their label. Obviously, I don't know if they were caught by surprise by this, but a lot of customers are trying to use the inventory that is sitting and they were also even -- and we are, right now, producing full blast in that vertical to produce the packaging with the new label that are required by the law in that vertical in the U.S. And this thing has already started to reverse as we have started to ship a lot of volume. So people were kind of delaying their order to see what the new legislative rules and regulation was going to be. We were manufacturing a lot of stuff in Q1, but we didn't ship anything. And now we're shipping everything. So this thing is going to reverse, but the -- it was a big delta for this factory. So it made our overall organic growth because of that unique situation in 1 vertical and 1 factory being negative for Q1, which we didn't plan for. But we didn't lose any customer, it's just like timing. And we're not used to that. In the print group, all of our product cannot be stored in inventory, so we don't have those situation. But in flexible packaging, obviously, there's a lot of inventory of the customer manufacturing plants. Sometimes they were else, and sometime in our plant. So nothing to be worried about, but this is the color I could give you on that.
No, I appreciate that color. And maybe one just extra question. As it relates to the dividend increase, no surprise that the dividend moved up maybe a little bit of a different magnitude than what we've seen in the past. I'm just curious if there's any board-related thinking that you can tell us about? This would have to do with the fact that you guys are comfortable with the yield that sits in the 3% to 4% range because, obviously, the dividend payout certainly remains quite low and you have a strong enough balance sheet to pursue the M&A opportunities you're talking about in packaging.
Yes. Well, Adam, I think, one, we never look for avid discussion with the board, really, about the yield. Because the yield on the stock is, obviously, tailored to what people are valuing the stock at. And so we generally look at what is the distributable will cash flow, and how much of the cash flow do we pay out? And so your comment is absolutely right. Obviously, we're in our comfort zone. And actually, if you look at our payout now, it's probably a little bit less than what it would be at last year. However, keep in mind what we've always said. We manage the capital allocation and the redistribution to the -- to our shareholders in multiple facets, which, in this case for us, is, one, dividends; and two, share buybacks. So if you were to look at how much the increases on the dividend and factor in what you can see in the financials was the share buyback that we did prior to the quarter ending. And after that, the shares that we've bought back in the period between the quarter-end and today, you would find that the distribution of all of that on a percentage basis is not dramatically lower than what we've historically done.
No, that's -- yes, it's a function of the buyback, yes.
Yes, so it's a question of how much cash we've -- So if you look how much cash we've distributed, it's not out of line. It just wasn't given all in dividend, part of it was given as share buyback.
[Operator Instructions] Our next question comes from Mark Neville from Scotiabank.
I just want to follow up on the organic growth in packaging. I think you said in the prepared remarks that excluding the timing, it was closer to 2% in the quarter. But you're guiding to 6% for the year. I'm just curious to see how firm -- or how much visibility you have into that 6% to this point.
I mean, we feel pretty good about the 6% that -- the thing about this business, as you know, is when are you going to manufacture the product? Like, how this business work is you make a financial deal, then you trial the product in the customer manufacturing plant, then they run their inventory that they have with the other supplier, and then you start to build them. So we feel pretty good about the business. We have already secured and -- what's coming in. Are we going to finish at 6% or 7% or 5%? Because some of the stuff that we see right now being manufactured in Q4 will be actually be manufactured in Q1. But we got 28 reps out there, and we're tracking the sales funnel, I would say, diligently. And we feel pretty good about ending the year at around 6% even though we have a Q1 where, actually, with that situation, we can get it organically. So obviously, we think that in some quarters that are coming that we are actually going to do more than 6% in the quarters to come.
Okay. Also, I believe, last quarter, you were talking about some inflationary pressures in the businesses from resins. I guess, two parts. I guess, just curious if you are actually seeing that. And just a second part to follow up, I'm just curious as to what percentage, if any, of that business is, I guess, there's contractual agreements to pass through that price increase.
Yes, I think we mentioned that in Q4, and it did happen. Our margin in Q1 were slightly affected by the resin price increase that is the backbone of the hurricane and all that. With most customer, we have pass-through, but there's different types of lag, some is a month, some is 2 months, and some is even 3 months. So we've been impacted on our margin a little bit in Q1. Not huge, but yes, there was an impact. Obviously, this is going to reverse when it's going to start to go the other way because when the resin will start to go down, you have the same kind of notice period that will turn to our advantage. So I think over -- when I say, over the next 12 months, I don't see a huge impact. But it did impacted us a little bit negatively in Q1, like we had mentioned in Q4.
And so those adjustments, they're contractual? They're not sort of negotiated as the price moves around?
We have some that are -- we have some of our business that is adjusted, that we have adjustment. There are some others we don't have. So we take the risk. So when it's going up, we reduce our margin. When it's going down, we increase. But there's a fair share where we have pass-through costs.
Okay. Maybe just one last question just on the Loblaw renewal. I understand there's some ancillary business being added, but just so -- I guess, on the base flyer, how worse if, it's for specific volumes? And directionally, if that's up, down, flat? Just any color you can provide on that.
I'm going to specifically talk about one customer in terms of the volume. But like we said in our prepared remark in -- as you recall, last year, retail flyer volume for Transcontinental was up, I think, around 1%, 1.5%. And Q2 -- and Q1 this year, I think we're up close to 3% in our volumes. It was a very solid Q1 for retail flyers and the services around them. So we start the year on a very, very strong foot. Basically, what our plan calls for is a flat volume at year-end. That's what the plan called for last year, and we did plus 1.5%. So we'll see how the years unfold, but it is a very solid start. As far as the contract with Loblaws, we renew it for multiyear, and it's the typical renewal for Transcontinental. We gave some margin away to make the print product more competitive and to support our customer and their objective, and in exchange, they gave us about $10 million of new business that we were not manufacturing for them in exchange for the price concession. And we will start to manufacture that volume very quickly. Most of that volume will transfer. Some of that have already transferred as of last month, and rest of it will transfer and start to hit our P&L in Q2. So it's a typical renewal for Transcontinental, but we're very, very happy because Loblaws is the largest customer of Transcontinental.
Your next question comes from Tim Casey from BMO.
Just looking for clarification, if you could, of the payments you're receiving from Hearst. We see the $39.8 million going through sales in Q1. How will the remaining payments flow through? Will they flow through the income statement or the cash flow statement? Could you just walk us through that?
Well, in fact, what I can give is that -- so that you can model, is you can model what the adjustments, like, the equivalent of the $13 million -- or the $40 million adjustment that we had in Q1, that same adjustment in Q2, assuming the exchange rate is the same as we have at the end of the quarter, is roughly $61 million to the revenues. So that would be the accelerated -- the acceleration of the deferred revenues that we would book in Q2, would be $61 million. And the accelerated depreciation that we would book on the amortization of the fixed assets would be $12 million. So you'd have $61 million -- there's $61 million in revenues that we will normalize and reduce our revenues by if we get the adjusted revenues, and there's $12 million of amortization that's in there that's associated with that. Everything else is just booked as part of regular operating income.
So then -- so that's the bulk of the payments? Is the $40 million and the $61 million, that's everything?
Yes. Well, if you look at -- I mean, if you look at -- because you want -- because the payments -- you need to distinguish the payments between the money we receive and the accounting of what we have. So if you look at the flow of the payments, I think, we explained, I think, earlier -- we have it here in the prepared statements. Hold on one second, I'll give you the exact -- just hold on one second. So if we go to Page 8, what we mentioned is, the total deal that we have is we're getting $42.8 million of an upfront payment, of which we received $32.3 million in Q1. So the balance of it, we're going to get in Q2, right?
I think it is very important to understand this deal. So that -- there was 2 payment. There was 1 payment of $200 million made at 2013, which we received and we put in the bank. But accounting-wise, we were deferring those revenue in this EBITDA through our P&L. So since the contract ends in early April, we have to recognize all this revenue that we needed to recognize until 2020, '24, in Q1 and in Q2. But this is not cash, this is the part of the $200 million, how it's treated from an accounting standpoint. What this new money is the $42.3 million. That's cash, that's new money that we're receiving out of that deal, and Nelson just explained that.
We have $32.2 million...
We have $32 million flow to our P&L in Q1, and the balance will flow to our P&L. So we report as one number, but as part of that number, some is noncash that [ take ] 2013 in the $200 million payment. And some of it is cash, which is the new $42 million we're receiving. So if you want the detail to model your thing, I mean, you can call. Investor Relations will give you the exact number so that you can model reported versus adjusted. So [indiscernible] cash and accounting.
Our next question comes from Matthew Griffiths from Bank of America.
My question is kind of along the same lines, just to make sure that I'm understanding this right. So I understand that the -- there's like a differed component of revenue and then there's the normal revenue that you're booking throughout the course of the year for that San Francisco Chronicle business that you're transferring to Hearst. I was wondering, on a run rate basis for the year, like, what that amounted to? Just ballpark or approximate realized amount of time so that I can gauge my modeling.
Yes, but the run rate of which amount?
Well, both. I guess, the sum together because, I guess, with the $200 million, I can kind of interpolate that because I'm sure it's...
You need to be careful. The USD 200 million was the original payment. What we have left that will be amortized to income to our revenue is we recognize -- is $100 million, of which we recognized $40 million in Q1 and $60 million in Q2. So it might be easier, Matthew, if you call Investor Relations. What we'll do is we can give you and show you the exact accounting treatment because it is complicated.
Ms. Chenny, there are no further questions at this time. Please continue.
Well, thank you, everyone, and talk to you in June.
[Foreign Language] Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. Please disconnect your lines.