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[Foreign Language] Welcome to the TC Transcontinental First Quarter 2019 Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded today, February 28, 2019.I would now like to turn the conference over to Katherine Chartrand, Senior Director, Corporate Communications. [Foreign Language] Ms. Chartrand, please go ahead.
Thank you, Gabriel. Good afternoon, everyone. Welcome to TC Transcontinental's 2019 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, Francois Olivier; and Chief Financial Officer, Donald LeCavalier. 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 a listen-only mode and should contact Natalie St-Jean, Senior Advisor, Corporate Communications, for more information or interview request. 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 a complete definition and reconciliation of such measures to IFRS financial measures. In addition, 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 2018 annual MD&A and in the latest Annual Information Form. I would now like to turn the call over to Francois Olivier.
Thank you, Katherine and good afternoon everyone. On the heels of our fourth year of record profitability, we began to scope 2019 with solid growth in our revenues by executing on our plan and building on the momentum in each of our businesses. And while our first quarter profitability was softer than what we would have liked, we have clarity on the dynamics that pressure certain parts of our business, and we continue to work towards our objective for the year. Now, let me highlight some of the key factors that contributed to our results. Starting with the packaging sector, which accounts for 52% of our consolidated revenues, we are pleased with the growth in our revenues for the quarter. Our acquisition of Coveris Americas was a significant contributor to our overall results. In terms of organic sales growth, as expected, we saw our packaging activities acquired prior to Coveris generate solid revenue growth of almost 7% for the quarter. We benefited from higher volumes and the maturity of our plants, as well as a return to strong volumes and the specific market where we had experienced legislation related delays last year. These gains were partially mitigated by a timing issued related to volume from a large customer that will materialize in Q2. Multifilm Packaging, which we acquired in March of last year, has also contributed well to our performance. As we have mentioned before, one of our key priorities is to drive sales growth. Initiatives within our sales organization are bearing fruit, as reflected in our organic growth, and our recent success in renewing and extending many long-term agreements that represent more than 20% of our overall packaging portfolio. Our consolidated platform has the capacity to accommodate additional volumes. In terms of profitability, our Coveris Americas acquisition continued to increase its EBITDA margin quarter-to-quarter, albeit at a modest pace in Q1, moving from 12.1% last quarter to 12.2% this quarter. We expect the improvement to continue to ramp up as the year unfolds and our cost synergies accelerate. For the 3 Coveris plants, as I mentioned earlier, we had good organic revenue growth but we are not satisfied with the overall EBITDA margin sitting at 10.1% for the quarter. We are actively addressing this situation in 2 specific facilities and we expect margins to increase in the coming quarters. As we approach the first year mark of our acquisition of Coveris, our investment thesis remains the same. Our synergies have started to materialize and we feel very comfortable with our previously established targets. On a combined basis, we maintained our guidance of about 1% topline growth in packaging revenues this fiscal year and remain committed to gradually improve margins.Before commenting on our printing sector, I would like to touch on sustainability. This mindset already runs deep within our culture and drives our R&D teams to support our customers and their sustainability commitments. In January, we launched one of the first commercialized, 100% recycled pouches with Barrier in North America. We are accelerating our efforts in this area and we will step our collaboration with industry partners across the value chain to share this responsibility.Turning to our printing sector. It was off to a slower start, partially due to the sales of our newspaper printing activities in California. In addition, revenues from our retailer related services were slightly lower year-over-year, mainly due to a timing issue and our in-store marketing vertical, and to lower than expected flyer printing revenues. Both of these elements had a more direct impact on our profitability since our platform's structural costs were flat compared to last year. However, printed flyers and other related services remain highly relevant and effective for Canadian retailers. Our in-store marketing printing revenues are close to CAD 75 million on an annualized basis and we are on track to achieve our long-term goal of CAD 100 million. We continue to pursue potential opportunities with both retailers and non-retail customers and are exploring product expansion that would add additional source of revenue in that space.It's also worth noting that our book-printing vertical boasted once again another strong revenue growth in the quarter. Regarding our newspaper, magazine, and commercial printing verticals, the decline in revenues follow the same trends as in previous quarters.As I have always done in the past, we will continue to adjust our cost base to anticipate volumes in order to optimize efficiency and protect our sector's profitability. As an example of this is the relocation of our equipment from Fremont, California to a Canadian retail manufacturing platform. This move should drive increased efficiency and contribute to reducing our costs starting at the end of the third quarter of 2019 with the full impact flowing in 2020. And now, a note on our media activities. We are very pleased with our results for the quarter. Our business portfolio, where we have a leadership position, performed very well in Q2, both from a revenue and profitability standpoint. In conclusion, in our packaging sector, we will continue to execute on our 2019 operational plan. We will achieve our synergies target to gradually improve our margins and maintained an increased focus on manufacturing efficiency and sales. On the printing side, we will continue to monitor volume trends and proactively adjust our cost structure in 2019.Moreover, we are stepping up our efforts to tap into new growth opportunities and certain regions and verticals. In addition, automation and other measures are continuously being taken to further optimize our platform. We expect this business to continue to generate significant cash flow. For our media sector, we will continue to focus on further developing our growth verticals and expect continued good performance in 2019. Finally, in terms of capital allocation, our top priority is to use our strong free cash flow generation to continue to deleverage the company.With that, I'll turn it over to Donald.
Thank you, Francois and good afternoon. As Francois pointed out, our first quarter results reflect good growth in our overall revenues with certain elements of pressure on our profitability. In the quarter, our adjusted operating earnings increased by 9%. For our packaging business, the combined EBITDA margin for the sector was 11.7% for the quarter, slightly below our expectation. As Francois mentioned, margin were pressured by 2 isolated plants in our pre-Coveris operations, and the negative impact of our raw material pass-through. We are pleased that the synergies from our Coveris acquisition, realized in the first quarter, came ahead of the plan, contributing nicely to our profitability. These synergies were mainly due to procurement related cost savings. We're still on track to realize more than $20 million of cost savings over the first 24 months post-closing, of which $10 million are expected to be realized in the first 12 months on a run rate basis. We expect this first phase to reach its full impact at the end of Q2 2019. Let me now go over some of the elements that affected our profitability in the printing sector. First, we are getting decline in our revenues at a direct impact of CAD 6.5 million on our adjusted operating earnings. As Francois mentioned, this comes mainly from a softer start in our retailer related verticals. Second, the negative non-cash impact related to the deferred revenues from the end of the printing of the San Francisco Chronicle, La Presse and The Globe and Mail in America accounts for CAD 9.9 million of the decrease in the quarter. You can find more information on this in Table 4 of our MD&A.Now, turning to our cash flow. Net change in cash amounted to an inflow of CAD 13 million. Cash flow from operating activities was about CAD 84 million, which includes CAD 21 million of tax payment. We also allocated CAD 41 million to CapEx. We distributed CAD 18 million in dividends and paid CAD 17 million of interest expense. In fact, as a sign of confidence in the corporation transformations, we announced today a 4.8 increase of our dividend, which translates to CAD 0.88 per share annual dividend. At the end of the quarter, our net debt ratio stood at 3x, down from 3.1x at the end of Q4. On a pro forma basis, it stood at 2.7x at the end of Q1. Now, to our outlook for fiscal 2019. In our packaging sector, on a combined basis, we continue to project organic revenue growth of about 1% this year. We expect our acquisitions, mainly Coveris, to significantly contribute to adjusted revenues and profitability over the next quarter. In terms of Coveris, we expect our profit margin to gradually improve towards our stated targets over the next few quarters. In our packaging operations, other than those at Coveris, we should continue generating organic growth in revenues with the help of our solid sales force, which should also contribute to improved profitability.In our printing sector, we expect revenues for our retainer related service to be slightly lower in fiscal 2019 when compared to last year. We expect continued strong performance in our book vertical, while the remaining portion of our printing portfolio should be affected by expected volume decline due to the same trends seen in recent quarters. We will continue to carefully monitor print volumes and we will adjust our cost base to value accordingly to protect our profitability. We will no longer benefit from the transitional revenues of CAD 9 million coming from Hearst, which ended in Q4 2018. As a reminder, the impact of the Hearst agreement will negatively affect our revenues and profitability in Q2 of 2019 as follows. An non-cash impact of CAD 4.4 million related to the end of the recognition of the deferred revenue from the printing of the San Francisco Chronicle, about CAD 3 million related to the transitional service to Hearst, CAD 8 million related to the risk of our operations sold to Hearst.In the media sector, we expect continued good performance in terms of revenues and profitability in 2019. For 2019 P&L, assuming the stock price at the last 5 days average, you should model for full year corporate costs at the EBITDA level of about CAD 30 million. As a reminder, a change of CAD 1 in our stock impacts our result by close to CAD 1 million. Our financial expense are expected to be about 2 times higher than last year as our debt increased due to the acquisition of Coveris. Our effective tax rate is expected to be in the mid-20s range. In terms of use of cash for the year, you can assume CapEx of about CAD 100 million, including Coveris. This includes operational CapEx of about CAD 80 million and an additional CAD 20 million strategic CapEx projects for this year to capture synergies. As for cash tax for the year, you can assume CAD 75 million. To conclude, Transcontinental continues to focus on delivering profitable Long-term growth and creating value for our stakeholders. We expect to continue to generate significant cash flows, which should enable us to allocate capital toward reducing our debt. On that note, we will now proceed with the question period.
[Foreign Language] [Operator Instructions] Your first question comes from the line of Mark Neville, Scotiabank.
Maybe just first question on the packaging margin. Can you just maybe just elaborate a little bit on what happened in the legacy ops in the quarter?
Yes. There were 6 operations there. We had 2 operations that were below plan. One of them is just a timing issue with a very large customer that the orders are in so they're going to happen in Q1. This is a very important customer that will reverse itself. And we have another plant where we have some work to do to increase the margin. They are below plan and we're working on that.So our expectation was the legacy TC plant to have a higher margin than Coveris. And it's certainly not the case in Q1. So one issue is going to resolve itself in Q2. The other one, we have to work on it and we would expect the TC legacy business to do as good as Coveris.As far as the Coveris acquisition, they've been ramping up every quarter since we owned them. They're up 12.2% and we are forecasting for them to keep improving their margin. But what is driving us down this quarter is Coveris is performing very, very close to our expectation. But the TC legacy assets, because of the 2 things I mentioned, are not. So that's why our overall margin are not up to our expectation.But we're still committed to reach the 13% EBITDA margin this year and we feel that with the momentum that we see building in our synergies and in the business that we'll be in a position to achieve that in the quarters to come.
The 13 is combined or Coveris. I guess it's pretty close, but --
Combined. [Indiscernible] going to be the last quarter when we talked about both, because starting in Q3, it will be a year that we have Coveris. So yes, our objective is obviously combined.
Okay. And I guess I was a little surprised that the improvement in Coveris wasn't a bit more significant in the quarter. Just with some synergies and I would have thought there was some price action taken in response to higher raw material costs later or mid-last year. So I'm just curious, was there actually any -- was raw materials sort of margin dilutive in the quarter? And what point do those pricing actions actually help the margin?
No, they were -- well, let me answer about the pass-through and then the synergies. The pass-through were accretive, albeit on the paper side of the business. Most of the raw material pass-through happened January 1. So we enjoyed that only for 1 month. For the plastics, for the most part, we had -- it was positive. In terms of the contribution of the synergies, they are there. They are a little bit ahead of plan.But we -- some of them have not started to flow to the P&L. A lot of the synergies are on a raw material and a lot of this raw material is sitting on the floor in silos. And until they are used, and converted, and product that those product are shipped to the customer and billed, not all of them are showing to the P&L. But why we're pretty comfortable about our synergies, a lot of the raw material has been bought and we know that the synergies are there. Now, it's a matter of us converting this raw material into final product and billing the customer. And that's why we think that in Q2 and especially Q3, we will have a better impact of our synergy that are sitting on the floor right now.
Maybe, Mark, just to complete on Francois' answer, regarding the pass-through, as you said, we do have some for paper on the Coveris side. Where we have some hit in the first quarter was more on the legacy business, where as you remember, when we did the transaction, we said globally about 70% of our business was hedged by pass-through mechanics. Well, most of it has been Coveris operation and some of the issues we had in Q1 was with specific film that we're buying and some of our legacy but that we were hit. If you go year-over-year, that was one of the impact.Obviously, this is an impact that we're addressing right now, but we go contract by contract and those businesses were managed in the past where they were absorbing the bad time and taking the good side of the good time. So this is one of the issues we have and we work with the team to address that right now.
Okay. Maybe just on the print, it sounds like a good chunk of the margin decline is just revenue related. And again, just sort of based on your sort of qualitative guidance, it sounds like revenues in the business will be down this year. So is there any -- and again, I know you don't necessarily provide this guidance, but some sort of goal post around margin or sort of profitability in the print business for 2019? Maybe just to helps us out. I'm just not sure if it's going to be as pronounced as it was in Q1.
Well, basically, this quarter was a little bit more an expected [ boost ] from the TOP business. If we would have filled that huge order in Q1 instead of Q2, the miss would have been less. But this business is going to bill in Q2. It's already billed. So that part is going to take care of itself.Where we got by surprise a little bit is in the month of January, 2 large customer kind of slowed down a lot on their retail printing program, which has affected us. And as you know, our retail network of plants is working 7 days, 24 hours, which means a lot of fixed costs. So when you have a sudden drop of revenue in 1 month, a lot of it is a big impact to the bottom line.Obviously, we will monitor these 2 customer very carefully and if you look at us historically, I mean I think it's many, many years in a row that every quarter, our revenue is going down. And sometimes when our revenue is going down, our profits are going up, or are the same, or are going down not too much. This quarter was a lot because we got caught by surprise and our fixed costs have not been touched.But you can rest assured that if we see that trend continuing this year as a catalyst, we have the 2 presses that we are installing from San Francisco that are going to start to generate savings in Q2 and in Q4. But we have other ideas for 2020 that are already in the pipeline. And if this trend continue, we will accelerate some of the ability to decrease our costs in the platform beyond installing the 2 presses that we said.So it's something we will monitor. It's 1 month. It's isolated to the customer but we will track it carefully. But rest assured that our revenue continue to track down. The way they are right now, we will make sure that it's not floating to the bottom line, like it did in Q1 for the profitability impact. If you look in the past, we have a pretty good track record of doing that.
Do you have any insight as to why those customers slowed in Q1? Is it sort of temporary structural? Sort of curious as to your thoughts?
Like I mentioned many, many times, we always have 3 group of customers and they move from 1 bucket to another each year. Some decide to do more promotion and be more active. Some decide to do about the same as last year. We always have a few customers that decide that it would be a neat idea to save millions of dollars in their marketing budget. And this year, it seems that some of our large customers are going -- have tried that early in the year.We'll see if that continue or not, but like I said, if it continue, we have the ability to act and remove capacity. But I think strategy in the retail business is managed week by week. So we will see [indiscernible]. One thing that we know is that usually those who cut the spending have issue with their revenue too. And that's affecting that also. If history repeats itself, it's always what happens.
[Foreign Language] [Operator Instructions] [Foreign Language] Your next question comes from the line of Adam Shine of National Bank Financial.
Maybe a couple questions for Donald, and one later for you Francois. With respect to Coveris, if we look to revenue trend, at least as reported, and acknowledge some changes to FX, but CAD 309 million, I think it was in the Q3, CAD 321 million in the Q4, and then we're CAD 306 million. So is there any seasonality or any timing elements that we should be thinking about over coming quarters, let alone as it related to the Q1? Maybe we'll start there.
Not really. I guess, first, I think we were pretty open about Q4, saying that sales were strong in Q4 on the Coveris side. So I won't base my model of using the Q4 numbers. There was maybe some timing on that side. Talking with the guys of operation, sometimes, especially on the [ shrink ] side, they say, well, Q1 can be softer. So maybe Q1 might be the softest one. But I will not say it's a big, big impact regarding the others. It's a pretty stable business.
Fair enough. And then it wasn't mentioned but obviously, you had previously guided to a CAD 22 million EBITDA impact in F19 from the assorted Hearst and other newspaper contract noise from a year ago spilling into this year. Can you give us a sense as to how much of that CAD 22 million skewed into the Q1?
The largest part is in Q1 for sure but you have Q2 -- as I said in my opening remarks, I think we have CAD 4.4 million hitting in Q2. I would say a bunch of it is here in Q1 and the only thing that you will still see in Q3 and Q4 is the service agreement with them, which is equal to, I think it's about CAD 2.5 million per quarter, something like that. So the biggest part for sure was in Q1.
Okay, but you don't want to specify a number. Because I still can' figure out that Table 4.
You can get the numbers in Table 4, which look at Table 4, we say that there's CAD 9.9 million coming from in Q1 -- CAD 7.9 million coming from the impact of the Chronicle. And La Presse and The Globe and Mail is CAD 2 million. So it's CAD 9.9 million. We have a little bit of the service agreement, I think only in January. So then you have, again, Table 4 will give you the Q2 number, which is CAD 5 million. And then the rest is spread through the rest of the year.
Okay. So I had CAD 13 million in this quarter. So I don't think I'm that far off.You're not that far.
Okay. Thank you for that, Donald. Francois, obviously, we saw some follow-up item with respect to that Citizen Group petition regarding the Publisacs pushing for public consultations specifically to the Publisacs. Can you speak at all in terms of what you might be doing in recent weeks or months and sort of what we might expect from this whole process over coming months or through this year? Thanks.
Well, it's not something new to us. It's going to be the fourth time in Canada that we go through a similar [indiscernible] happened in Calgary 2 years ago and in Halifax a couple years ago, and Ottawa as well. We obviously are going to participate whether there's 1 process or 2 processes and make our side of the story known.So we know what to say. We've been here many times and basically, I think we have a good story to tell. Right now, the 10% of the people who don't read the flyer and don't want to receive them are very vocal. We intend to go there and speak for the 87% of the people who wants it and read it, and we have a pretty good story to tell. We're used to deal with that and then we're looking forward to go in these hearing if they happen. And we're in touch with the City of Montreal and have a good relationship. But that's how I feel about it.
Okay. I guess what element to both of the potential consultations that have been talked about in recent months does center on the plastic vessel as it relates to the flyers. Is that something that ultimately you guys address through R&D or other initiatives whereby maybe we ultimately do see a voluntary elimination or alternative to the plastic bags?
Yes, it's a good question and you're quite right. I guess the paper is an example of circular economy. It is -- we start with the paper by using a waste from the sawmill and we repurpose the waste into a newsprint. And then this newsprint is recycled at 87% and so this is pretty good.The plastic is also recyclable. Everything we do. And the plastic we use is not even a fraction of a percent of the plastic issue in the sorting center in Quebec. But nevertheless, the percentage of recycling the plastic in Quebec is not as much as paper. We have ideas not only because TC is now in the flexible packaging business. And then we have alto of knowledge now in our company about this.So we're looking, yes, at ways to improve our product in Publisacs. But also, we are -- ideas to help the city of Montreal and other cities to increase the level of recycling, never mind a fraction of a percent of the Publisacs represent. I think we could have a bigger impact on the overall plastic recyclability in Quebec. And we've got a lot of people in our R&D department working on it and we're probably going to have some ideas to share with some business partner in this value chain in the coming months.So we're excited about that. I think we're going to try to move the thing forward because that's a big part of our business right now, way beyond the Publisacs.
[Foreign Language] There are no further questions at this time. Please continue.
Thank you everyone and we will talk to you in June.
[Foreign Language] Ladies and gentlemen, this concludes today's conference call. Thank you for participating. Please disconnect your lines.