Orchids Paper Products' (TIS) CEO Jeff Schoen on Q2 2016 Results - Earnings Call Transcript

| About: Orchids Paper (TIS)

Orchids Paper Products Company (NYSEMKT:TIS)

Q2 2016 Earnings Conference Call

July 28, 2016 10:00 ET

Executives

Jeff Schoen - President and Chief Executive Officer

Analysts

Louie Toma - Craig-Hallum Capital

Michael Taglich - Taglich Brothers

Operator

Welcome to the Orchids Paper Second Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode [Operator Instructions] I would now like to turn the conference over to Jeff Schoen. Mr. Schoen, please go ahead.

Jeff Schoen

Thank you, operator. Good morning and thank you to everyone for attending our 2016 second quarter earnings call. With me today is our Director of External Reporting, Kimberly Peak. The agenda for our call today will begin with my review of the second quarter results. I will then provide my perspective on our results and on our business environment. We will conclude with a question and answering session.

I would like to remind you that certain statements made during this conference call are forward-looking statements within 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 risk 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, 2015, and our Form 10-Q for the quarter ended March 31, 2016 as well as our earnings release and any supplemental information.

Any forward-looking statements are made only as of this date, and the company assumes no obligation to update any forward-looking statements. I would like to point out that during my remarks, I’ll be making reference to both GAAP and non-GAAP or adjusted results. The adjusted results exclude certain charges that we believe are not indicative of our core operating performance. The reconciliation between GAAP and non-GAAP measures is included in our earnings press release which is available on our web site.

For the second quarter of 2016 those adjustments to EBITDA include $386,000 of non-cash stock compensation expense and for the quarter included $423,000 of non-cash stock compensation expense. Adjustments to net income for the 2016 and 2015 quarters totaled $504,000 and $14,000 respectively on a tax effected basis. Those tax affected adjustments included just mentioned non-cash stock compensation expense of $255,000 and $280,000 respectively and intangibles amortization of $249,000 and $250,000 respectively.

The 2015 quarter also includes an offsetting adjustment of $516,000 from a change in our estimated state tax liabilities due to the material amount of our intangibles amortization we began using that expense as a net income adjustment beginning in 2016. So with that, let’s discuss the results of the second quarter and our path forward. Following a very strong quarter, the second quarter of 2016 proved to a challenging quarter for the company with adjusted EBITDA of $8 million for the quarter, we reported adjusted EBITDA margin of 20.3% which includes $1.1 million business interruption proceeds for the incident that occurred in our converting operating during the quarter fourth quarter of 2015.

Adjusted diluted earnings per share came in at $0.30 a share. Net sales for the quarter were $39.4 million comprised of $31.3 of converted product and $75,000 of parent roll sales. Net sales of converted products decreased 1% over the prior year quarter and 13% on a sequential quarter basis. Net selling price per ton was flat compared to the prior year and increased 2% on a sequential quarter basis. Converted product tonnage shipped in the quarter totaled 20,000 tons a decrease of 2% over the prior year quarter and a decrease of 14% in comparing the first quarter of 2016. Relative to Q1 the primary reasons for the increase in volume were heavy branded promotional activity and inventory reductions at a large customer. Parent roll sales totaled $75,000 compared to $2.5 million in the second of 2015 and $2.5 million in the first quarter of 2015.

We made a strategic decision in the second quarter of 2016 to utilize excess parent rolls in our South Carolina facility as we believe this will result in future benefits in the form of higher margins on this tonnage due to it being sold as converted product rather than as parent rolls and when you eliminate requirements to purchase equivalent tonnage on the open market to support demands of our converting operations in South Carolina. Adjusted EBITDA for the quarter was $8 million, a decrease of $373,000 or 4% over the prior year quarter. On a sequential quarter basis adjusted EBITDA decreased $3.6 million or 31%. Our adjusted EBITDA margin for the quarter was 20.3% compared with 19.8% in the second quarter of 2015 and in record 24.4% in the first quarter of 2016.

Our second quarter adjusted EBITDA margin was favorably impacted by 2.7% due to the business interruption proceeds previously mentioned. A decrease in adjusted EBITDA margins attributable to several factors including increased promotional activity on branded products by our competitors, inventory reductions by our largest customer and loss margins on parent roll sales as previously mentioned along with higher production cost, start up cost in South Carolina and profit sharing with property plant [ph]. Production cost increased in Q2 2016 compared with Q2 2015 primarily due to higher repairs and maintenance expenditures partially due to plant annual cold mill average, a 30% increase in depreciation expense due to assets placed in service in the second quarter of 2015 including $36.6 million of assets in South Carolina and approximately $300,000 of startup cost in South Carolina including approximately $150,000 of relocation expenses.

Production cost increased on a sequential quarter basis primarily due to higher repairs and maintenance expenditures, depreciation in South Carolina assets placed in service and South Carolina start up cost as previously discussed. And approximately $120,000 of additional outside warehousing costs due to lower sales level in Q2. In addition, the abrupt slowdown in volume related to branded activity left Orchids with a higher cost structure than was required for the volume necessary to support current sales. The cost structure is being re-balanced in Q3. Fiber prices were favorable on an year-over-year basis by approximately $600,000. On a sequential quarter basis, fiber prices remain flat. Margin and the supply agreement were favorably affected on a year-over-year basis due to the favorable U.S. dollar to peso exchange rate and lower overall operating cost in the Mexicali site.

On a sequential quarter basis margins and the supply agreement were unfavorably affected by profit-sharing under the supply agreement which became effective in March of 2016 when we purchased more than the 20,000 tons allowed under the agreement. Keep in mind that the contract reset itself every year on June 1. SG&A in the second quarter of 2016 increased $264,000 or 12% compared to the 2015 quarter to $2.5 million or 6.4% of net sales compared with $2.2 million or 5.3% of net sales in the prior year quarter primarily due to higher professional fees and higher artwork and design fees.

Turning to taxes, our effective rate for the full-year is estimated at 34.1% which is comparable to the 34.2% estimated as of end of the first quarter of 2016. This estimate includes the effects of the Indian Employment Credit, which was extended to the 2016 tax year. While the second quarter was somewhat soft due to the factors described above, on a year-to-date basis, net sales of converted products increased 10% over 2015 while sales of parent rolls increased 2%. Converted product tonnage shipped in 2016 increased 11% over the prior year. Net selling price per ton decreased 1% compared to the prior year. Adjusted EBITDA is up $6.4 million or 49% in 2016 while adjusted EBITDA margin increased to 22.6% in 2016 compared to 16.6% in 2015. Adjusted diluted earnings per share was $0.85 in 2016 compared to $0.59 in 2015. Operating performance rates in our ongoing operations have improved 15% in 2016 and another 3% due to production in our South Carolina facility as we have produced over 5 million cases thus far compared to 4.2 million cases in 2015.

Additionally, our paper mill production has increased 23% year-over-year primarily due to the addition of our new paper machine in March of 2015. Furthermore, tonnage shipped and the supply agreement increased 9% in 2016 as compared to 2015. Now, turning to the balance sheet and cash flow.

Cash flow from operations in the quarter was $7.5 million primarily as a result of cash earnings, a decrease in accounts receivable and $1.8 million of insurance proceeds received related to the fourth quarter incident in our converting operation. These factors were partially offset by increased inventories due to decreased sales during the quarter. Capital expenditures in the quarter were $20.2 million including $70.8 million of expenditures on the Barnwell project. We utilized $2.3 million of restricted cash related to our new market tax credit transaction to fund a portion of the Barnwell expansion and incurred borrowing of $12.7 million on a delayed draw term loan and revolver.

During the quarter, $3.6 million of cash was returned to shareholders in the form of dividends. Total debt outstanding was $104.6 million as of June 30, 2016. Total debt includes about $60 million in borrowings related to Barnwell. Unrestricted cash stood at $6.2 million resulting in net debt outstanding of $98.4 million. Our funded debt to EBITDA ratio was 2.69 times at quarter-end and our fixed charge coverage ratio stood at 2.89 times.

Cash flow from operations is expected to range between $8 million and $10 million per quarter for the remainder of 2016. For 2016, our capital expenditures, expectations are approximately $94 million including $85 million for Barnwell and $9 million for the Oklahoma facility. As we look forward, our priority is to continue to source Barnwell and prior [ph] business from existing customers while also aggressively pursuing new business through bids and branded product introductions. Competitive pressures from both branded and private label competitors are strong as they were this time last year. Inevitably, I believe the retailers will respond to branded promotion pressures and a new balance will be restored. In fact the volume increases Orchids has experienced in the fourth quarter of last year, in the first quarter of this year were partly driven by the response to branded promotional activity at this time in 2015. I expect a similar shift as we move forward.

Orchids is also introducing an expanded branded program that was tried on the West Coast successfully and has led to a national rollout beginning in Q2 that will continue for the rest of the year with additional product introductions. We expect our branded programs to provide additional lift to the business as we compete for new private label business. Relative to the guidance we have given, I would say we are about four months behind where expected as to be but we have plan to get us back on track and continue our profitable growth plan. Finally, keep in mind Orchids has experienced 24% margins in Q1 with margin improvement driven mostly by productivity improvements.

Orchids has the ability to compete effectively we ensure we loads the plants in a way that ensures a very competitive cost structure and healthy margins for the business. Finally, as you know, we are currently in a search process for a CFO. The process having full attention and is moving forward with screening candidates and interviews. With that, I will turn the call back to the operator for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question and answer session [Operator Instructions] And today’s first question comes from Louie Toma of Craig-Hallum Capital. Please go ahead.

Louie Toma

Hi, guys. Thanks for taking my question. Just wanted to get a little bit more insight into the branded promotions that you mentioned, when did they start? We are currently in the one month through the third quarter. So are they still going on at a same level? Can you just give us little bit insight in terms of that, please?

Jeff Schoen

Yes, we started probably early mid second quarter. They are still going on. If you think about what happened a year ago, at this time, you know, branded promotions are something that happen, we don’t always know about them. They typically spend money, you know lot of money to gain share back. In the meantime what happens in private label is they have short term responses to try and increase the price gap and usually what ends up happening as well as they redesign product to make a permanent fix relative to what the brands are doing. That’s what’s happened last year, what’s being worked on right now. So that’s kind of the summary of where I think we are with that particular issue.

Louie Toma

Right, thank you. And just one more question. How should we think about the parent roll shipments to Barnwell over the next couple of quarter? Did you ship enough in this last quarter to last till the new paper machine comes on or do you expect to continue to ship for the next three quarters and you know just give us some insight into what your current sales are coming out of Barnwell and how that balances with the inventory you have? Thanks.

Jeff Schoen

Yes, I would say that, I wouldn’t say that we got enough in Barnwell to last us through the end year, so I expect us to continue to ship. I would say though that our parent roll inventory across the company is high right now, higher than I wanted to be. But I do expect to continue to ship parent rolls to Barnwell this year.

Louie Toma

Is the majority of the – of what you have in inventory, is that parent rolls or some of that converted product?

Jeff Schoen

A lot of it is converted product. We were in the situation in the second quarter, we elected to covert the parent rolls into finished goods based on giving the plants an extra level of inventory to support orders as well as give them flexibility in terms of their production start up curves.

Louie Toma

Got it. Thank you.

Operator

[Operator Instructions] Our next question is from Michael Taglich of Taglich Brothers. Please go ahead.

Michael Taglich

Hi, guys. Tough quarter in a sense, but excited about the progress you are making in Barnwell. Jeff, would you, if you had a look into the second half of this year, calendar year, do you think results closer to the first quarter more likely than results closer to this quarter?

Jeff Schoen

I think – I can answer that say somewhere in between. How about that? I think when you look at, you know, we did 6.3 million cases I think for the first half. We do, if we just do that it’s 12.6 million. I expect us to be – but we always do better in the second half than the first half historically. So plus you got Barnwell adding on production. But I have given you a full added up number that’s kind of the way I would view it right now. Another way to think about it is the lost opportunity from the second quarter if I assume Street numbers of $0.39 versus $0.30 actual that equates to about $1 million of EBITDA at 20% that’s about $5 million in sales approximately 400,000 cases. So you know if the world stay that way we come in probably in the range of 12.5 million to 13 million cases. But as I also stated, I don’t believe that’s if we did nothing and we are not doing nothing. We are continuing to you know grow our business plus we are responding to the branded promotion activity.

Michael Taglich

When you look at selling the additional capacity at a Barnwell obviously you are going to ship some stuff from Barnwell that you were shipping out of prior, right. So you have basically excess capacity prior in Barnwell in reality and the way it shakes out. Like you know what’s your goal as far as selling out this excess capacity? You know, it won’t be a reasonable expectation we should have going forward based on the way the world is today?

Jeff Schoen

The way to think about it is what is the process to add capacity? It’s a combination of the branded roll offset we are doing with the supermarkets. That just started, so I expect that to you know ramp up over time and by the beginning of the year, I expect that to be in full sell mode. So there is active, so you’ve also got bids and there are several very large bids going on with major retailers. And I expect to be very aggressive within those bids given the – we talk about, when I think about the first quarter and I reemphasize the point that we had probably 4% margin point improvement because of productivity improvements. So very important for us to recognize that as we load the plants, we are gaining efficiencies because of that issue. That means Orchids has the ability to be you know more aggressive if you will in these bids to try and get large pieces of business. So that’s an approach there and now with existing suppliers, we are also being aggressive there to add more DCs and you know work towards helping our partners if you will recognize that we add value in other ways than just being a supplier of converted product. So those are the three engines if you will. Right now, you know, lot of the bids are targeted for this fall but they will – the volume will show up in the first quarter of next year, so you got that factor in terms of 2017 that will be in play. Right now, we are rolling out the branded products, far for me to estimate what that looks like right now. So our main focus right now still relative to the plan that I had is to gain additional DCs with existing customers.

Michael Taglich

Ideally, it would be – ideally it would be great to sell to convert to line tomorrow – your capacity tomorrow but I mean is your guess that you will have the converting line sold out-ish, the excess capacity sold out-ish when you turn on sorry when you turn on the mill?

Jeff Schoen

No, my goal. If I am going to commit to something you know the selling process I think that you know we typically use as two years to sell it out. So you know, we got one line in production, the second one is coming into production in August. So my goal, my vision in terms of what we are trying to do is you know all of the objectives I have laid out in terms of long-term come to fruition in 2018. That's my endpoint for the current plan that we have now which would including building up Barnwell and building up prior few well. The rate at which that happened again it will come in slugs, we will get the – a ramp because of the branded. As we add DCs with existing customer that will be a function of somewhat of a big process but really it’s an impromptu bid process and then the form of big processes are timed and when you get the volume, you will get the big slug of volume based on winning a bid.

Michael Taglich

Right.

Jeff Schoen

And again a big part of that for me is in the first half of next year. If we are successful with bids this year, we will see that volume and we will see the lines load up fairly quickly in the first half of next year.

Michael Taglich

One more question, you have got if you take the – how much money is laid out as of the end of the June quarter in capital equipment and therefore debt that’s not yet turned on?

Jeff Schoen

Hold on a second. So Mike, I think the answer to the question is, there is about 60 million that’s not in service, while 36 million of that is being depreciated today.

Michael Taglich

Okay.

Jeff Schoen

The total capital expenditure for Barnwell in the neighborhood of 140 million, which would be paper machine, paper machine building etcetera.

Michael Taglich

But you are not – is the 60 million including the underutilized part of the overall plant if you will or just the machinery itself it’s not yet turned on?

Jeff Schoen

Well if you think about the building in terms of all the assets not being in there, there is a piece of the building that’s underutilized yet.

Michael Taglich

Okay, so not counting that part, it is where it is. Okay, so just 60 million just machinery that’s on a boulder for practically in the building.

Jeff Schoen

In building? No, that 60 million includes the building.

Michael Taglich

Okay, okay. Alright, so that 60 million it’s right now providing zero return. Very good, that’s all I got. I am looking forward to this thing get turned on, thanks.

Jeff Schoen

Thank you.

Operator

And ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Schoen for any closing remarks.

Jeff Schoen

Thank you for your time. We will talk to you in approximately three months.

Operator

Thank you, sir. That concludes today’s conference. Thank you all for attending today’s presentation. You may now disconnect your line and have a wonderful day.

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