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Clearwater Paper Corporation (NYSE:CLW)

Q2 2014 Results Earnings Conference Call

July 23, 2014 5:00 p.m. ET

Executives

Linda Massman - President and Chief Executive Officer

John Hertz - Senior Vice President and Chief Financial Officer

Robin Yim - Vice President, Investor Relations

Analysts

Paul Quinn - RBC Capital Markets

James Armstrong - Vertical Research Partners

Operator

Welcome to Clearwater Paper Corporation's second quarter 2014 earnings conference call. As a reminder, this call is being recorded today, July 23, 2014. I would now like to turn the conference over to Ms. Robin Yim, Vice President, Investor Relations of Clearwater Paper. Please go ahead.

Robin Yim

Thank you, Saeed. Good afternoon and thank you for joining Clearwater Paper's second quarter 2014 earnings conference call. Joining me on the call today are Linda Massman, President and Chief Executive Officer, and John Hertz, Chief Financial Officer.

Financial results for the second quarter were released shortly after today's market close. Posted on the Investor Relations page of our Web site at clearwaterpaper.com you will find both the earnings press release and a presentation of supplemental information including an updated outlook slide providing the company's current expectations and estimates as to certain cost, pricing, shipment, production and other factors for the third quarter of 2014.

Additionally, we will be providing certain non-GAAP information in this afternoon’s discussion. A reconciliation of the non-GAAP information to comparable GAAP information is included in the press release or in the supplemental material provided on our Web site.

I would like to remind you that this presentation contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. These forward-looking statements are based on current expectations, estimates, assumptions and projections that are subject to change and actual results may differ materially from the forward-looking statements. Factors that could cause actual results to differ materially include those risks and uncertainties described from time to time in our filings with the Securities and Exchange Commission, including our Form 10-K for the year ended December 31, 2013 and Form 10-Q for the quarter ended March 31, 2014. Any forward-looking statements are made only as of this date and the company assumes no obligation to update any forward-looking statement.

John Hertz will begin today's call with a review of the financial results for the second quarter and Linda Massman will provide an overview of the business environment and our outlook for the third quarter of 2014 and then we will open up the call for the question-and-answer session.

Now, I’ll turn the call over to John.

John Hertz

Thank you, Robin. Before I get to our second quarter 2014 results, I’ll start with a little housekeeping. We are providing both GAAP results and results that are adjusted to exclude certain charges and benefits that we believe are not indicative of our core operating performance. For the second quarter of 2014, those include $2 million of cost associated with the prior closure of our Long Island, New York and Thomaston, Georgia, converting facilities and $1.4 million onetime, non-cash tax expense associated with the change in the New York State tax code. The mark-to-market impact from directors cash settled stock unit was de minimis in the second quarter.

Second quarter net sales came in at $499 million, up 3% versus the first quarter due to a 3% increase in paperboard pricing resulting from previously announced price increases and a 6% increase in tissue shipment volumes which was slightly above the high end of our updated outlook of up 4% to 5%. The higher tissue volumes more than offset a 2% decline in paperboard shipments caused by the previously announced operational issues at our Arkansas pulp and paperboard facility.

In the third quarter, the paper machine at the Arkansas mill has been running well and other than the $1 million cost headwind associated with the recovery boiler, we do not expect those same issues to impact Q3. Versus Q2 2013, net sales were up 6% primarily due to higher paperboard prices and volumes.

Second quarter adjusted gross margin of $67 million or 13.4% which excludes the Thomaston and Long Island shutdown cost, was up 40 basis points from the first quarter due primarily to lower energy prices and usage compared to first quarter as the weather related issues abated towards the end of April as well as lower operating supply cost. That was partially offset by higher external pulp market prices and the Arkansas operational issue.

Versus Q2 2013, gross margin was 120 basis points higher due to strong paperboard pricing on volumes which was partially offset by about 3% higher external pulp prices, higher chemical cost due to increased polyethylene prices, lower conventional paper prices and the operational issues in Arkansas. Adjusted SG&A expense was $32 million or 6.3% of second quarter net sales, which is up approximately $1 million from Q1 primarily due to higher marketing costs in the consumer product division.

Compared to Q2 '13, adjusted SG&A is at $4 million due to higher IT spend related to our ERP implementation and higher profit dependent accruals. Adjusted corporate expense was $13 million of the SG&A spend in the second quarter. Up 3% over Q1 primarily due to planned spending related to our ERP implementation.

Adjusted operating income was $35 million or 7.1% margin, was slightly above the high end of our updated outlook of 6% to 7% and up from 6.7% in Q1. Price increases in paperboard, lower energy prices and usage, medical and workers comp benefits and operating supply costs, realization of cost savings from facility closures, all contributed to operating margin improvement. Versus Q2 '13 adjusted operating income increased 19% and operating margin improved by 80 basis points, primarily due to operating margin gains in our pulp and paperboard division through higher prices of volumes shipped.

Adjusted EBITDA was $57 million or 11.5% of net sales compared to 11.3% in Q1 and 11.2% in Q2 '13. The interest expense of $11 million was flat with the first quarter.

Turning to taxes, on adjusted basis, our Q2 effective tax rate was 38%, on the high end of our outlook of 36%, plus or minus 2%, versus 36% in the first quarter. Second quarter 2014 GAAP net earnings were $12 million or $0.61 per diluted share and on an adjusted basis $15 million or $0.74 per diluted share. That is compared to adjusted net earnings of $14 million or $0.60 per diluted share in the first quarter and $12 million or $0.51 per diluted share in the second quarter of 2013.

Non-cash expenses in the second quarter of 2014 included $22 million of depreciation and amortization, $1.6 million of non-cash pension and retiree medical expense and $2.4 million in equity based compensation. Employee headcount at the end of the second quarter was approximately 3700 or flat with Q1.

Now I will discuss the segment results. Consumer products net sales were $299 million for the second quarter of 2014, up 4.4% versus the first quarter. We shipped 135,000 tons, up 5.5% from Q1 and slightly above the high end of our updated outlook of 3% to 5%. Retail and non-retail tons were up 6% and 5% respectively. Case shipments were up 5% to a record 14.1 million cases shipped in Q2. Tissue pricing was down 1% and in line with our revised outlook.

Contributions to EBITDA resulting from TAD expansion related shipment came in as expected at $9 million in Q2, which was up from $7 million in Q1. Consumer products adjusted operating income for the second quarter of 2014 was $15 million or 5% of net sales versus $9 million or 3% in the first quarter. The improvement was primarily due to the absence of Q1 weather related cost, lower usage of operating supplies and further realized savings from the closure of our Long Island New York converting facility. Those savings were partially offset by lower average sales price per ton and persistently high softwood pulp prices.

Consumer products Q2 adjusted EBITDA margin increased 24% to $30 million or 10% of sales, from $24 million or 8.4% in the first quarter but remains below our CPD model of 17%. Linda will talk about our initiatives to improve operating and EBITDA margins within the consumer products division.

Now turning to pulp and paperboard division. Pulp and paperboard net sales of $200 million for the second quarter of 2014 were up 1% versus the first quarter. Flow through from the previously announced price increases more than offset a 2% decrease in shipment volumes caused by the operational issues at our Arkansas mill. Average pricing of $1017 per ton was up 3% in Q2, which was in line with our expectations.

Pulp and paperboard adjusted operating income for the second quarter of 2014 was $34 million or 16.8% of net sales as compared to $37 million or 18.5% of net sales in the first quarter. The 170 basis point margin decrease versus Q1 was primarily due to $9 million in cost headwinds offset by a $6 million benefit from the price increases. The makeup of the Q2 cost headwinds which were outlined in our June 18 press release include lower production volumes and elevated chemical usage related to the Arkansas operational issues as well as $4 million of increased maintenance cost associated with the planned boiler washes at the Arkansas and Idaho mills. Which was less than the $7 million cost we estimated at the beginning of the quarter.

We expect only $1 million of the $9 million cost headwinds to recur in the third quarter. Pulp and paperboards Q2 EBITDA margin of 20% remains above the 19% divisional objective inherent in our cross cycle financial model but was down 180 basis points from Q1 as price increases weren't able to offset the operational issues in Arkansas and incremental maintenance spending in the quarter.

Now turning to the balance sheet. Capital expenditures were $17 million in the second quarter of 2014 and are expected to total approximately $78 million for 2014. Long-term debt outstanding on June 30, 2014 remains unchanged at $650 million. Turning to the stock buyback program. In Q2 we repurchased approximately 734,000 shares for $45 million under our $100 million share repurchase authorization at an average price of $61.32 per share. Year-to-date through July 22, we have repurchased 1,302,000 shares for $81 million at an average price of $62.21 per share and we remain committed to returning at least 50% of discretionary free cash flow to shareholders via share repurchases for the year.

As a reminder, we define discretionary free cash flow as cash flow from operating activities minus $50 million of maintenance CapEx. As of the most recent measurement date of December 31, 2013, our company sponsored pension plans were underfunded by approximately $7 million. We have contributed $9 million to those plans through Q2 of 2014 and expect to contribute an additional $8 million during the remainder of 2014.

With regard to our liquidity, we ended the first quarter with $81 million unrestricted cash and short-term investments. During the second quarter, we generated $60 million of cash from operating activities or 12% of net sales, that’s up 7.3% in Q1.

Our focus is driving shareholder value. That’s not just an operating results focus but also strong management of the balance sheet and capital structure. We are proud that since 2012 we have tripled the spread between our return on invested capital and the weighted average cost of that capital from 4 percentage points to 12 percentage points.

I will now turn the call over to Linda who will discuss the company's outlook.

Linda Massman

Thanks, John. Hello everyone and thanks for joining us today. On balance, we had a solid quarter despite the operational issues in Arkansas. Our adjusted operating profit came in at $35 million or 7.1% which was slightly above the high end of our revised outlook for Q2 despite coming in at the low end of the range in revenues. This is evidence that the steps we are taking to improve operating efficiencies are beginning to take hold and we are still in the early stages of our planned improvements.

Our EBITDA margin improved modestly in Q2, helped by price increases in SBS, a reduction in weather related energy costs and better operating leverage due to plant closures and consolidation of converting activities. These improvements were offset by some Q2 operational challenges in our Arkansas mill that are largely behind us.

Paperboard market conditions remain tight and pricing firm. Our paperboard backlogs are currently ranging from 4 to 6 weeks. I am very pleased with the progress we have made in our consumer products division. TAD sales grew 15% in Q2 and we had our highest level of TAD product sales this quarter. Our tissue volumes were up nearly 6% quarter-over-quarter which is indicative of our leading supplier position that were solidified during Q1 with key customers.

The volume growth is a result of our overall momentum with customers across all sales channels. The 1% decline in pricing versus Q1 was as expected, driven by the persistently competitive market environment.

Before I address our view of the market environment and outlook, I would like to mention that we have created a new cross-divisional supply chain function to bring increased focus to purchasing and supply management with the goal of driving out costs system wide, achieving greater operational efficiencies and improving customer service performance within our supply chain processes. Joining our team to lead this function is Pat Burke. Pat has more than 25 years of supply chain and manufacturing experience in various Fortune 50 consumer products companies and we are very pleased that he is here.

Our supply chain organization is currently engaged in a national optimization study focused on lowering freight, warehousing costs and inventory levels. You will be hearing more about the things we are doing in this area going forward. Now I will discuss our view of the market environment and our outlook for each of our business segments starting with the consumer products business.

In another move to further streamline and optimize our consumer products business, we are now organized around a retail tissue group and non-retail tissue, which we refer to as specialty products. This group will focus on sales and manufacturing of parent rolls, machine glazed and other specialty paper. The benefits of this change include greater focus and flexibility to manage and run the specialty products business in a way that maximize returns and better serves our customers.

Other optimization opportunities that we are working on include, skew rationalization, pulp optimization, maintenance standardization, leveraging procurement and purchasing power, improve scheduling and asset optimization, uniform engineering standards, and reducing waste in converting supplies to name a few. The overall tissue market remains very competitive with continued verification of increasing tissue capacity coming online in 2015 through 2016. Growth in consumer tissue is tracking as expected at 1% to 2% and we are confident in our ability to grow with our retail customers even the midst of the key braded manufacturer's focus on promotional activity.

We expect to see a continued trend toward expansion and focus on private label products by our customers across all channels. We expect momentum in Q2 TAD shipments to continue into Q3. Additionally, at long last we are beginning to see an improvement in hardwood pulp prices starting in Q3 with the new South American supplies already coming online.

Getting to our third quarter outlook for the consumer products business. We are expecting shipments tons to remain flat with Q2. That being said, we expect our TAD shipments to grow as it centers the percentage of our total consumer products shipment. Therefore, we expect price mix to be up 1% from the second quarter resulting from growing TAD volume. On the cost side of the equation we expect to see lower external hardwood pulp prices from new sources coming on line. Chemicals, energy, operating and packaging supply costs, maintenance and SG&A are expected to be stable.

In addition, transportation costs are expected to be up in Q3 due to continued tightness and seasonality in the carrier market. Finally, I am pleased to report that our TAD EBITDA contribution ramp is back on track. In Q2, we hit our target of $9 million and it looks as though the current momentum with customers coupled with lower pulp prices has us on the path to achieve $11 million to $12 million in Q3. The remaining key risk to this target is the level of promotional activity from brands.

Turning to pulp and paperboard. The paperboard market continues to see strong demand across all product segments. The most notable growth continues to be in food service categories, particularly in cup and to a lesser extent, plates, driven by the trend away from plastic and foam for environmental reasons. As we look into Q3, in addition to strong market conditions in SBS, we are seeing the typical seasonal ramp up of business.

Our pulp and paperboard segment is currently running at historically high production levels and we expect shipment volumes to be higher by 3% to 5% and pricing to be approximately 1% higher as we implement the remainder of previously announced price increases.

Q3's operating productivity is on the upswing in paperboard. For the most part, variable cost per ton are expected to decline and operating leverage is poised to improve as a result of lower maintenance expense compared to Q2 and overall better fixed cost absorption due to higher production volumes. These operating improvements do include incremental chemical and energy costs related to our Arkansas recovery boiler that will remain until March of 2015. Unlike consumer products, pulp and paperboard will also be subject to higher transportation costs due to continued tight market conditions.

Looking at the consolidated business for Q3 versus Q2, we expect net sales to be up 2% to 4% due to higher volumes in paperboard and higher price mix for both divisions. And consolidated operating margin to be in the range of 9% to 10.5%. In addition, we expect adjusted SG&A to be flat, adjusted corporate spending to be $12 million to $13 million, net interest expense to be about $11 million, and the outlook for adjusted tax rate for the third quarter is 36% plus or minus a couple of percent.

All these variables combined are expected to result in a Q3 EBITDA range of $68 million to $76 million. The key variables that will determine where we land in that range are pulp prices, ramp promotional activities, runability of our paperboard machine and our tissue converting productivity. If we consider the changes to input costs and average selling prices between 2011 and quarter two that just ended, that adjusted EBITDA range would be $75 million to $83 million in Q3.

Despite the headwinds in conventional tissue pricing, the proliferation of promotions from the brands and high pulp prices, our $75 million adjusted EBITDA target is still within our expected Q3 EBITDA range.

In conclusion, we are positioned to leverage a strong paperboard market and solid momentum in our consumer products business while continuing to improve operational efficiency across the company. We are already seeing improvements in operating efficiencies but we are still in the very early stages. Our success is all about the hard work of the loyal and committed employees of Clearwater Paper. Thank you for listening to our prepared remarks and we will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from Paul Quinn from RBC Capital Markets. Your line is open, please go ahead.

Paul Quinn - RBC Capital Markets

Just a question on Shelby. Where are you in terms of the ramp up of that facility and when do you expect to have it fully ramped up?

Linda Massman

Yes, I would say the paper mill is performing to full expectation. The biggest factor is what mix we run on the machine. Converting is performing quite well. We still have maybe some opportunities on that side of the equation but for the most part it's up and running where we would expect.

Paul Quinn - RBC Capital Markets

So when you start to look at further capacity expansions, you know at Shelby or other facilities. Is that in the 2014 or is that a 2015 look? Or is that something that you are currently nervous around given the other capacity additions coming to the market?

John Hertz

So, Paul, we have said before that through 2015 we are more focused on internal efficiencies and growing margin and cash flow and at the top of our list would not be a significant capital expansion. So I will stick with that storyline.

Paul Quinn - RBC Capital Markets

Okay. And then just, you mentioned hardwood pulp pricing expected to come down in Q3. We are seeing some pretty strong shipment data today on global stats. What kind of pricing drop are you anticipating?

Linda Massman

It's going to be somewhat modest, Paul. But we are starting to see some of that already and same thing on softwood, we are starting to see of the spot market have a little bit more favorable pricing in some of the contract pricing we have seen. So across the board I guess we would probably expect to see some modest improvement in Q3.

Paul Quinn - RBC Capital Markets

Okay. And that’s baked in your EBITDA guidance of $68 million to $76 million?

Linda Massman

It is.

John Hertz

Yes.

Paul Quinn - RBC Capital Markets

Okay. And then just lastly, just on paperboard. Where we are at or how you guys manage on the recent price increase and it looks like you are guiding prices up 1% for Q3. Does that fully capture the price increase or is it portion of it?

Linda Massman

Yes. That would round out the balance of the price increase that was announced in Q1. And the reason for the delay is just through contractual arrangements with certain customers.

Paul Quinn - RBC Capital Markets

And you guys haven't noticed any additional imports coming in on the paperboard side in North America as of yet?

Linda Massman

I wouldn’t say in any kind of material way. Market is pretty stable, very strong. On concerns from that regard today.

Operator

Thank you. Our next question comes from James Armstrong from Vertical Research. Your line is open. Please go ahead.

James Armstrong - Vertical Research Partners

My first question is on the Arkansas mill issue. Do you still expect that to be resolved early next year and is there an estimate to the additional capital needed to completely fix the issue?

John Hertz

Yes, James, so there is a planned major maintenance in the first quarter where that mill will come down and so we will get in and look at the recovery boiler at that time. You know, we haven't put anything out there in terms of what we think the total cost to that is and I think we will probably learn more as we get closer to that and we would update you maybe at the end of Q4.

James Armstrong - Vertical Research Partners

Okay. That helps. And then switching to consumer products. As you continue to place TAD tons, how was the market acceptance of the private label product. Another way of asking this is, if you had more tons to ship to date, do you think the market would accept the additional tonnage?

Linda Massman

The market is really strong with regard to the TAD products. I would say there has been very good retailer and consumer acceptance of the product. I think the biggest factor with regard to how much this is grow in the next couple of quarters is all around the brand promotion. You know how deep the promotions go, how frequent they are. But I would say we are feeling pretty good about how the TAD shipments are shaping up.

James Armstrong - Vertical Research Partners

Okay. That’s helpful. And then switching gears one more time. The pulp and paperboard segment seems to be running ahead of your boilerplate capacity. Do you think that’s sustainable over the next few quarters? Just the volumes coming out there look very very impressive.

Linda Massman

Yes, they are very impressive. And we do expect that to continue and hopefully even get better from there.

Operator

Thank you. (Operator Instructions) I am showing no further questions. I would like to hand the conference back over to Ms. Massman for any closing or additional remarks.

Linda Massman

Great. Thank you. Just to close out, I would just say we are very excited about the prospects of our business and the opportunities to increase operating efficiency across the company. We really appreciate everybody joining us today for the call and definitely thank you for your continued interest in Clearwater Paper. And then on one final note, we will be presenting at the RBC Global Industrial Conference on September in Las Vegas and hope to see you all there. Thank you.

Operator

Ladies and gentlemen, that does conclude the Clearwater Paper second quarter 2014 earnings conference call. We do appreciate your participation.

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Source: Clearwater Paper's (CLW) CEO Linda Massman on Q2 2014 Results - Earnings Call Transcript

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