Clearwater Paper's (CLW) CEO Linda Massman on Q4 2016 Results - Earnings Call Transcript

| About: Clearwater Paper (CLW)

Clearwater Paper Corporation. (NYSE:CLW)

Q4 2016 Results Earnings Conference Call

February 08, 2017, 05:00 PM ET


Robin Yim - VP, IR

Linda Massman - President and CEO

John Hertz - CFO


Paul Quinn - RBC Capital Markets.

Adam Josephson - KeyBanc Capital Markets

Dan Jacome - Sidoti & Company

Chip Dillon - Vertical Research Partners

Roger Spitz - Bank of America


Welcome to Clearwater Paper Corporation's Fourth Quarter 2016 Earnings Conference Call. As a reminder, this call is being recorded today, February 08, 2017.

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, Led. Good afternoon and thank you for joining Clearwater Paper's fourth quarter and fiscal year 2016 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 fourth quarter were released shortly after today's market close. Posted on the investors relations page of our website at you will find both the earnings press release and the presentation of supplemental information including outlook slides providing the company’s expectations, and estimates as the net sales, operating margin, adjusted EBITDA range and earnings per fully diluted share for the first quarter of 2017 and certain cost pricing shipment, production, maintenance and repairs and other factors for the first quarter and full year of 2017.

In addition, we also issued a press release today announcing the expansion of our Shelby, North Carolina consumer products facility, which is also available on our website.

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 website.

I would like to remind you that during this conference call, we will be making 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, 2015, and our quarterly filings on Form 10-Q. Any forward-looking statements are made only as of this date, and the company assumes no obligation to update any forward-looking statements.

John Hertz will begin today's call with a review of the financial results for the fourth quarter and fiscal year 2016, then Linda Massman will give an overview of 2016s accomplishments update you with the progress on our previously announced objectives, provide more detail regarding our acquisition of Manchester industry and an overview of the business environment and the newly announced expansion in Shelby, North Carolina. That will be followed by our outlook for the year and the first quarter of 2017.

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. In 2016, Clearwater Paper was focussed on our strategy to improve our cost structure particularly in the consumer products division with the overall company as well. To that end we made significant progress on warehouse automation, the continuous digester project and operational efficiencies.

We’ve improved our overall adjusted EBITDA margin percentage by 40 basis points over 2015 despite a $57 per ton year-over-year decrease in Paperboard pricing. Within the consumer products division, we achieved a 320 basis point improvement and adjusted EBITDA margin percentage since we announced the current three year strategic plan at the beginning of 2015.

With the completion of warehouse automation and the start up of the continuous digester to come in 2017, we believe that we are well on our way to generating the targeted 400 to 600 basis point improvement in CPD’s adjusted EBITDA margins as we leave 2017.

The total productive manufacturing journey and focus on overall – and effectiveness to begin in 2015 has allowed us to significantly increase the operating uptime of our tissue converting lines. As a result we are able to streamline our converting asset base by closing the higher cost Oklahoma City converting operation and we anticipate easily absorbing that converting capacity across the remaining network.

In addition, we took out approximately 32,000 tons of capacity with the shutdown of two of our highest cost paper machines Neenah Wisconsin at year end. We took those actions to optimize our operations through better asset utilization.

As previously announced, we acquired Manchester industries in December which gives us approximately 190,000 tons of sheeting capacity to serve the folding and commercial print markets. Linda will provide more details in her remarks.

Now turning to our fiscal year and fourth quarter 2016 results. First, I’d like to preface my comments by stating that throughout the rest of my remarks, I will be distinguishing between GAAP and non-GAAP or adjusted results. The adjusted results exclude certain charges and benefits that we believe are not indicative of our core operating performance.

Reconciliation from GAAP to adjusted results is provided in the press release and supplemental slides posted on our website.

For the full year, the EBITDA adjustments netted to $12 million of pretax expense and included a $5 million mark-to-market expense associated with directors, cash [Indiscernible] $3 million in pension settlement expense, $3 million in cost associated with the Manchester acquisition, $2 million in costs associated with the closure of the Long Island New York facility and $1 million of re-organization related expenses offset by a $2 million benefit related to release of escrow and sale proceeds associated with the speciality mills sale in 2014.

For the fourth quarter of 2016 the adjustments totalled $5 million of expense and is comprised of costs associated with the acquisition of Manchester industries, the closure of the Oklahoma city facility, the shutdown of two Paper machines in Neenah, Wisconsin, the closure of the Long Island New York facility and the mark-to-market of directors equity based compensation.

Starting with the full year 2016 results, net sales totalled $1.7 billion which is down 480 million or 1% from 2015. While Paperboard shipment volumes are relatively stable, their net sales decreased 5.8% due to SBS pricing pressure and less favourable product mix.

That was partially offset by a 3% increase in consumer products net sales due to market share gains and improved product mix, which resulted in 7.4% growth in retail sales volume.

Adjusted EBITDA came in at $215 million up 2% versus 2015 and on the high-end of our outlook of $210 million to $260 million. We delivered a total of $42 million of EBITDA improvement of which $8 million was associated with capital projects and $34 million was associated with operational efficiencies.

That was offset primarily by $26 million of paperboard pricing headwinds as well as $7 million of higher maintenance on the tissue side and $5 million of increased cost for wages in outside warehousing. As a result, adjusted EBITDA margin improved 36 basis points to 12.4% compared to 2015.

Paperboard delivered $140 million or an 18%, 18.7% adjusted EBITDA margin, consumer products delivered $129 million or 13% .2016 fully diluted adjusted EPS came in at $3.44 compared to $3.13 in 2015.

On the balance sheet side of the equation, working capital improvement led to a two day improvement in the cash conversion cycle, which helped cash flow from operation to increase the 8.2% versus 2015 to $173 million.

We purchased 1.4 million shares for $65 million under the current $100 million stock repurchase authorization at an average price of $48.18 per share. Since the 2011 interception of our stock-buyback program, we have repurchased 7.7 million shares for $395 million at an average purchase price of $51.10 and have reduced shares outstanding by 33.6%.

Now turning to the fourth quarter, net sales were $426 million, that’s down 2.2% from the third quarter but well above the high-end of the consolidated outlook range was down 5% to 7%.

Paperboard shipment volumes were up 1.6% compared to Q3 and net sales were up 80 basis points due to higher than expected commodity grade paperboard shipments. On the consumer side, net sales were seasonally down 4.4%.

Compared to Q4, 2015, net sales were down 1.4% primarily due to a 3.8% decline in paperboard average selling prices and a 1.1% decline in paperboard shipment volumes, which was partially offset by a favourable mix shift towards higher retail shipment volumes on the consumer side.

Fourth quarter adjusted gross margin of 14.1% was up from 9.4% in Q3 as favourable trends in manufacturing input cost and the Q3 completion of the planned maintenance outage at Lewiston were partially offset by lower paperboard prices and weaker product mix.

We also experienced the fire at our Las Vegas tissue facility that resulted in the shutdown of production for 17 days. The total cost for damage, repair and loss reduction was $4 million and we received $1.5 million from related insurance claim and expect to receive another $1 million in Q2.

Compared to Q4, 2015 adjusted gross margin declined 144 basis points due to lower paperboard prices.

Adjusted SG&A expense was $30 million in the fourth quarter and relatively flat with both Q3 and Q4 of 2015. Corporate spending was $13 million of the total SG&A spend in the fourth quarter and was flat with Q3 and Q4 2015.

Adjusted operating income of $30 million or a 7.1% margin was inline with our fourth quarter outlook of 6.5% to 8% and up from 2.7% in Q3. The adjusted operating margin was impacted by the same factors impacting gross margin.

Adjusted operating margin declined 145 basis points compared to 8.6% that we saw in Q4 of 2015, primarily due to paperboard pricing. As a result of all, adjusted EBITDA came in at $54 million or 12.7% of net sales which is at the high end of our outlook of $49 million to $55 million.

Compared to Q4, 2015 adjusted EBITDA is down $5 million primarily due to lower paperboard prices, partially offset by the cost structure improvements delivered in 2016. Net interest expense of $8 million was flat with Q3.

Turning to taxes, on an adjusted basis, our Q4 effective tax rate was 37.8% which is at the high-end of our outlook of 36% plus or minus 2% and down from 41.4% in the third quarter. Our cash tax rate in 2016 was 8% compared to 19% in 2015.

We do not expect to pay cash, income taxes during 2017 due to the additional tax deprecation on a continuous digester and warehouse automation and we expect it to be approximately 9% in 2018.

Full year adjusted tax rate was 37.6% and at the high end of our outlook of 36% plus or minus two point, full year and Q4 GAAP tax rate was 38.6% and 41.7% respectively. Fourth quarter 2016 adjusted net earnings came in at $40 million or $0.82 per diluted share. That compares to adjusted net earnings of $2 million or $0.14 per diluted share in the third quarter and $13 million or $0.75 per diluted share in the fourth quarter of 2015.

Q4 GAAP EPS was $0.56 per share. Non-cash expenses in the fourth quarter of 2016 included $25 million of depreciation and amortization, $3 million in equity base compensation and $400,000 of net non-cash pension and retiree medical expense.

Employee headcount at the end of the fourth quarter was approximately 3370, which is comprised of approximately 170 people that joined us with the Manchester acquisition, and 3200 of Legacy Clearwater employees, which reflects the decrease of 100 Legacy Clearwater employees compared to the 3,300 at the end of 2015 due to headcount reductions primarily related to warehouse automation and the shutdown of the two paper machine at Neena.

Now I will discuss the segment results. Consumer products net sales were $242 million for the fourth quarter of 2016, that’s down 4.4% versus the third quarter but above our outlook but down 6% to 8% as paper roll volumes increased quarter over quarter.

Consumer’s products adjusted operating income for the fourth quarter of 2016 was $17 million or 7% of net sales versus $60 million or 6.3% in the third quarter. Operating margin percentage improved because of operational productivity gains, warehouse automation, lower electrical usage as well as lower electrical rates at our Las Vegas Mill which more than offset the negative impact from the weaker price mix due to higher paper roll sales and the impact of the fire at our Las Vegas mill.

Consumer products Q4 adjusted EBITDA margin increased $1 million to $32 million or 13.2% of net sales from $31 million or 12.2% in the third quarter. Compared to the same period last year last year adjusted EBTIDA dollars increased by $6 million or 25% of the adjusted EBTIDA margin improved by 248 basis points to 13.2% from 10.7%.

Now, turning to the pulp and paperboard division. Pulp and paperboard net sales of $183 million $183 million for the fourth quarter of 2016 increased 80 basis points versus the third quarter. Q4 net sales volumes increased 1.6% versus our outlook for seasonally lower volumes due to better-than-expected customer demand. Average sales price was down $7 a ton or 80 basis points compared to Q3 due to a higher mix of commodity grade paperboard sales

Pulp and paperboards Q4 adjusted operating income was $28 million or 15% of net sales as compared to $10 million or 5.5% of net sales in the third quarter. The increase in margin percentage versus Q3 was primarily due to the maintenance outage impacting Q3 at the Lewiston mill.

Pulp and paperboards Q4 adjusted EBITDA margin of 19.1% remains in line with the 19% divisional objective inherent and across cycle financial model.

Now, turning to the balance sheet. Capital expenditures were $46 million in the fourth quarter and $156 million for the full year in line with our Q3 outlook. $97 million of that was spent on strategic projects and $59 million on maintenance CapEx.

Long-term debt outstanding at year end was $575 million. In addition, we entered into a new $300 million revolving credit agreement with an Accordion feature that allows for expansion up to a total of $600 million that replaces the previous $125 million asset backed facility.

There was $135 million drawn on a facility at the end of 2016. As of the most recent measurement date of December 31, 2016 our company sponsored pension plans were underfunded by approximately $19 million, a decrease of $6 million from last year due primarily to investment portfolio performance for the year reflective of the 2016 market returns.

Turning to stock buyback program, in the fourth quarter we purchased approximately 257,000 shares at an average purchase price of $53.61. As previously mentioned $35 million remains available under our current authorization.

With regard to our liquidity, we ended the fourth quarter with $23 million of unrestricted cash and short term investments and $165 million available under our revolver. During the fourth quarter, we generated $34 million of cash from operating activities for 8% of net sales. For the year we generated $173 million of cash from operations or 10% of net sales.

With that, I will now turn the call over to Linda Massman who will discuss the company's outlook for 2017 and provide an update on both ongoing and newly announced strategic projects.

Linda Massman

Thank you, John. Hello, everyone and thank you for joining us today. We have a lot to get through, so we’ll go ahead and get started. I’d like to begin my remarks by sharing with you our excitement and announcing plans for our newest state-of-the-art tissue machine in Shelby, North Carolina. It’s a significant step for us and will strengthen the quality of our assets and provide long term earnings growth. I’ll provide many more details in a moment.

But first I will share 2016 highlights and then discuss our high level outlook for fiscal 2017 and more specifically for the first quarter of 2017. 2016 was an evolutionary year for Clearwater Paper as we continue down a well-defined path to build a solid foundation for long-term success. We focus on things we can control to create shareholder value such as operating result and working capital management that generates strong free cash flow and returns on invested capital that exceed our weighted average cost of capital.

Our balance capital allocation, the returns excess cash to shareholders while investing in the business to grow free cash flow in future years, and maintaining an optimal capital structure that minimizes our cost to capital, and I believe we executed well on those items in 2016.

Discretionary free cash flow for 2015 was approximately $113 million, which at our current market value equates to a discretionary free cash flow yield of 10.7%. Our return on invested capital of 9.3% is well above our cost of capital. As John mentioned, we return $65 million in cash to shareholders in 2016 via share buyback, and we completed the second year of a three-year strategic capital plan and have delivered 320 basis points of adjusted EBITDA improvement in consumer products, which puts us well on our way to deliver the targeted 400 to 600 basis points as we leave 2017.

Our consumer products business continues to improve. We gained market share, both in private label and against the national brand. Several key customers successfully continued to grow their store brand programs in 2016, and we are pleased to be aligned with customers who are focused on expanding their store brand programs across the board.

Regarding warehouse automation in both Shelby, North Carolina and Las Vegas were completed in 2016 along with Phase 1 in Lewiston and Idaho. The remainder of the Lewiston automation is on schedule for completion in the first quarter followed by Elwood Illinois in the third quarter of 2017.

We’ve made great progress to improve our operational efficiency, the efficiencies on our strategic investment which has delivered significant EBITDA contributions totaling $53 million over the last two years.

From our Lean Six Sigma and total productive manufacturing efforts to drive our waste and improve our operating equipment efficiency rate, we delivered $44 million since beginning of 2015 which two-thirds of that coming in 2016 and the remaining $9 million from our strategic investment which will gain momentum with the completion of the continuous digester and warehouse automation.

Turning to our pulp and paperboard business, our team demonstrated excellent operational execution in all aspects of the business, while managing 14 days of downtime for major maintenance and unplanned electrical outage in their quarter and dealing with the challenging price environment due to the continued strength of the U.S. dollar.

We shift paperboard volume equal to 2015 and achieve the targeted cross cycle adjusted EBITDA margin of 19% with the contribution of $140 million of adjusted EBITDA.

In December we announced the acquisition of Manchester Industries for $68 million. Manchester converts paperboard parent rolls to flat sheet to narrow rolls which expands our capability and allows us to support small and med size folding carton converters to buy pre-cut sheeted SBS paperboard.

The benefit of buying from a sheeter is that you get custom sizes and exact quantity on a just-in-time inventory basis without the need for roll stock inventory and the complexity of converting loss associated with running your own sheeter.

Technological advances in the pre-printing process have reduced packaging design and approval time considerably. As a result company can change packaging designs more frequently and therefore converters rely more on sheeters to provide smaller volume just in time inventory of custom sheet.

Overall adding Manchester's capabilities allow us to better serve our folding carton to customers, which is our largest customer base in the paperboard business. Expanding our service platform in this way should help grow the key folding carton segment of our business and does not compete with our customers and other key market segments. We believe the acquisition will increase our annually EBITDA run rate by approximately $10 million per year.

Turning to the continuous pulp digester project, it is near completion with the go live date early in the fourth quarter. The construction of the vessel for pulp processing is expected to be completed in the second quarter.

The final installation and testing of equipment will take place throughout the third quarter ending with the tie in of the new digester to the mill during the planned major maintenance outage at the end of Q3. Our tremendous progress and starting our three-year strategic plan in 2015 is driven by the many hard-working and committed employees that embody Clearwater paper.

Turning to our view of the market environment for each of our businesses and starting with the North American tissue market in 2016, the U.S. tissue market grew approximately 1% in line with expectations, in 2016 based on dollars sale, IRI estimate the private-label share was up approximately 1% versus 2015, while the national brands were down a point.

As a result private-label is now 25% of the total retail tissue market, up from 24% a year ago. In 2016 Clearwater Paper gain share both from the brands and other private-label competitors.

Based on IRI data our share of the total tissue market was 8.2% which is up from 7.9% in 2015, and our share of the private-label market grew about one percentage point to 33.5%, largely due to successful growth of store brand programs with existing customers, as well as improved product penetration and growing consumer acceptance of national brand equivalent to store brand products within retailers.

Looking to 2017, RISI estimate that the U.S tissue market will grow proximally 1% to 2% in line with long-term trends and we believe the private-label should continue to gain share.

The most current RISI forecast for net new tissue capacity through 2018 is 761,000 tons which is down 5% from their pre previous forecast, due to Clearwater’s announced closure of 32,000 tons at our Neenah, Wisconsin mill in December and a 5000 ton decrease in new capacity which has been pushed out from 2018 to 2019.

Based on the current forecast, the North American demand capacity ratio which does not factoring import through 2018 is 97%. RISI’s current forecast supports the balance supply and demand environment in 2017.

Clearwater Paper is the North American private-label tissue market share leader with an impressive customer base. Private-label is expected to grow 2% to 3% per year on average over the next decade primarily driven by demand for ultra quality product which is forecasted to be the fastest growing segment of the North American tissue market at 4% to 5%.

Since 2012, the premium and ultra peers have grown three and a half times faster than the overall tissue market. As tissue demand grows with population private-label is forecasted a great game share versus the brand.

Our customers expect to grow their store brand tissue programs along with customer preference shift to ultra quality tissue product. Our customers want to know that we have the ability to grow with them.

As a result we've come to a point where we need to add ultra quality tissue capacity to keep pace with our existing customer’s growth and have the capacity to add customers. For those reasons we’re taking the significant step forward to build the new paper machine and related converting equipment to produce premium and ultra grade of private-label tissue product had decided adjacent to our existing facility in Shelby, North Carolina.

You will include a 70,000 ton Valmet NTT tissue machine with related converting capacity. We believe that the NTT tissue machine will allow us to produce premium and ultra quality tissue products and we expect to spend approximately $283 million over two years for the paper machine and related converting lines.

Our business in the Southeast has grown substantially since we built the Shelby facility and as we outgrew this space of Shelby site we were required to grow third-party warehouse capacity.

We will consolidate our South Eastern warehouse capacity at a cost of $57 million to achieve operational and logistical savings. This will involve replacing multiple finished goods warehouses currently under operating leases with owned capacity which will significantly reduce our reliance on third-party warehouses.

In addition, we will increase the capacity of our pulp, parent roll and finished goods warehouse to match our requirements and fully automate these new facilities. The warehouse consolidation and automation is expected to reduce logistics complexity as well as warehousing and transportation cost.

This will allow us to reduce transportation miles by allowing ship directly from the mill to the customer which eliminates the added leg of travel from the mill to the outside manual warehouse.

Between the incremental 70,000 tons of tissue capacity and the operational savings from warehouse consolidation and automation we believe these investments will generate incremental $55 million to $65 million of the annual EBITDA at full shipment run rate.

This translates to an internal rate of return on investment of approximately 11% which is well above our weighted average cost of capital. We expect construction to be completed in the first quarter of 2019 with production ramping through 2019 and we expect to see a full shipment run rate in late 2020. We believe there is demand for about half of those tons today within our existing customer base.

The total $340 million for the new tissue capacity and warehouse consolidation will be financed by the new credit facility that we entered into in October as well as cash flow from operations.

We expect that debt level will peak in Q4 2017 and be in a 3.5 times to 3.9 times EBITDA range from the second quarter of 2017 through second quarter of 2018 and begin to decrease from that point forward.

We have a strong partnership with our North Carolinas government agencies that began when we commenced to building existing Shelby facility in 2010. The City of Shelby, Cleveland County and the State of North Carolina are providing an attractive incentive package valued at approximately $44 million.

We are confident in our ability to build the newly announced paper machine on time and within budget given our previous success in building a Greenfield paper mill including 70,000 ton TAD paper machine and related converting lines which was announced in 2010 commenced operation in 2012 that was operating at full capacity by the third quarter of 2014.

Overall the region has a good transportation infrastructure, tax structure, business-friendly community and an overall great quality of life for our employees. Turning to North American paperboard, RISI’s outlook for 2017 is for a balanced market similar to 2016 with operating rate averaging 93% for the year.

RISI forecast demand for SBS to contract by 40 basis points in 2017 following a decline of 1.8% in 2016. 2017 got after a good start with industry backlogs up approximately 17% higher than levels a year ago.

While prices published by RISI have remained stable since April 2016, they are forecasting certain grades of SBS to decline approximately 1% to 3% from 2017. For 2017 the near-term risk continues to be the strength of the U.S. while RISI’s forecasting 3.7% decline in export volumes for the year, this is considerably better than compared to the 10.1% decline in 2016.

In addition, imports have not gained as much traction as originally expected, only growing from 10% in 2011, 12% in 2015 and 2016 and their forecast to be relatively flat in 2017.

Turning to Clearwater Paper’s 2017 outlook, which is provided in slides 21 and 22 in the supplemental earnings presentation. We expect net sales to be flat, is up 2% due to higher retail tissue sale, higher paperboard shipments and revenue from Manchester industries.

With offsets from a lower price mix in both paperboard and tissue and reduce volume of tissue parent roll sales due to the December 2016 shut down of two paper machines at our Neenah mill.

Our consolidated adjusted operating margin is expected to be in the range of 6.5% to 7.5% based on experience cost inflation for natural gas, chemicals due to higher oil prices, wood fiber due to a higher percentage of whole log chipped used resulting from decreased supply residuals in Idaho and general annual wage increases.

An incremental planned major maintenance expense of $5 million to $10 million compared to 2016 resulting from two major maintenance outages and approximately 27 days of downtime in both are Cypress Bend, Arkansas mill in the second quarter and the Lewiston Idaho mill in the third quarter.

The Lewiston outage was sold [ph] in from 2018 to coincide with the startup as a new continuous pulp digester. As a result there will be no planned major maintenance outages in either mill in 2018.

We expect the Manchester acquisition to provide approximately $10 million of incremental EBITDA in 2017 and we believe we are on track to achieve $40 million of productivity gains from strategic investments, operational efficiency and continuous improvement productivity initiative.

Our outlook for this 2017 tax rate is 36% plus or minus 2%, all of this is expected to result in adjusted EBITDA of $205 million to $225 million. Capital expenditures for 2017 are expected to total $250 million which includes $90 million for previously discussed strategic projects such as the pulp digester and what remains the warehouse automation, $100 million for our new tissue facility in Shelby and $60 million for maintenance.

We currently have $35 million remaining under our existing stock repurchase authorization. In 2017 and 2018 we will continue to return cash to shareholders via share buybacks, although we will be shifting the mix of our capital allocation towards the capital projects that will include in 2017 in the new paper machine through the end of 2018.

Now to our first quarter outlook compared to the fourth quarter of 2016. We expect consolidated net sales to be up 1% to 3% sequentially due to incremental sales for Manchester industries offset by lower parent roll shipment volumes due to the shutdown of the two paper machines at our Neenah facility and slightly lower paperboard shipment volumes with the weaker product mix.

Consolidated adjusted operating margin to be in the range of 6% to 7.5% based on higher wood fiber prices in Idaho due to a higher percentage of whole log chips used because of the decrease of high residuals, lower planned maintenance in our consumer products division, higher wages and benefits that is typical early in the year, and an adjusted tax rate of 39% plus or minus two percentage point primarily due to the impact of new accounting rules for stock payments to employee.

We expect this result in adjusted EBITA in the range of $48 million to $56 million and adjusted net earnings per fully diluted share in the range of $.62 to $0.90. The key variables we see determining where we land in that range are paperboard market conditions including fluctuations in the valley of the U.S. dollar, brand promotional activities and changes in customer and consumer demand.

In 2017, we will continue executing our strategic initiative in integrating Manchester industries into Clearwater. We’re beginning the important work on the newly announced paper machine, converting lines and warehouse expansion in Shelby.

While market conditions for both of our businesses continue to be challenging. We believe we are well-positioned to grow our discretionary free cash flow, achieve returns on invested capital well above our cost and continue to create shareholder value.

In closing, I believe our success is attributed in the quality of employees we have it for water paper exemplified by their unwavering commitment to our customers, communities, environment and each other.

Thank you for listening to our prepared remarks. And we’ll now take your questions.

Question-and-Answer Session


[Operator Instructions] Your first question comes from the line of Paul Quinn with RBC Capital Markets. Your line is now open.

Paul Quinn

Hey, thanks very much and good afternoon. Few questions here, just on Manchester maybe you could go through…

Linda Massman


John Hertz

Paul, we lost you.

Linda Massman

Are you there?

Paul Quinn

Well, I can hear you.

Linda Massman

Okay. We just heard you. It’s okay. So can you repeat your question please.

Paul Quinn

Oh, sure. And you can hear me now right?

John Hertz

We can hear you.

Paul Quinn

Oh, Good. Okay. Just on the rational behind Manchester, I mean, I thing you guys were in this type of operational operations a while ago didn't really signal to the market that that you wanted to go downstream. So what’s change in the market conditions and are you worried about the lack of downstream customers as things get more consolidated there?

Linda Massman

Yes. So I think you hit on one of the issues that things have consolidated downstream, but the way we view Manchester is a logical acquisition that enhances the SBS business as it gets us one step closer to that folding carton market which is our largest segment for SBS and its just a – Manchester is a great company, creates great value for their customers and its really a part of the industry that its pretty critical to the smaller folding carton customers and they do a great job of providing the inventory, the just-in-time inventory and the narrow rolls, the machine that’s required to make them successful. So we just thought as a pretty logical way to grow the business.

John Hertz

And Paul, I’d say, I think some of the logic where we got out of the converting side, [Indiscernible] was not competing with customers, we don't view this, this is kind of a halfway step, we won’t be competing directly with our converting customers we’ll still be selling them on the sheeted SBS.

Paul Quinn

Okay. And just over on the Shelby announcement that’s another one, its a little bit surprising because over the last couple years you guys have been talking about all the capacity adds that everybody else has been coming up with, So just I guess the question is I guess you figure that there's not enough capacity and that this machine isn’t needed. Second part would be why NTT technology as opposed to TAD, what’s the difference?

Linda Massman

Yes. So, Paul, I think I’m going to reframe how you described our decision process for Shelby. So we look at our business and what our customer’s growth demand looks like. They are requiring additional growth and growth in particular in the premium and ultra segment of tissue. We’re currently pretty close to tapped out on the volume we can provide there. I mean, we can see them through for the next couple of years, but post-2019 we’ll be in a pretty tough position to provide that ultra capacity to our customers. And if we want to remain a good supply partners to them, this was going to pretty important part of our strategy.

Keeping in mind, we are the leader in private-label retail tissue products with some of the best customers in the industry and we fully intend to maintain them as customers and service them well over the next decades.

Paul Quinn

All right. Last question I had just you described paperboard market is challenging price environment maybe you could give us some color on Q4 price realizations and what your outlook is for 2017?

Linda Massman

Yes. We talked about the reduction in pricing that we experience in the fourth quarter and our prepared remarks and I would say that in our bridge that you see on page 22 in our deck, a lot of that price mix that you’re seeing associated with paperboard would be the full year impact of what we saw in 2016 carrying over into 2017.

Paul Quinn

All right. That’s all I had. Best of luck.

John Hertz

All right. Thanks Paul.


Your next question comes from the line of Adam Josephson of KeyBanc Capital Markets. Your line is now open.

Adam Josephson

Linda, John, Robin hi, hope you are well.

Linda Massman

Hi, Adam.

Adam Josephson

Welcome. One question on the leverage, I think I heard you say John, you’d be in late 2017, early 2018 levered I think 3.5 to 3.9 times just based on the CapEx that you outlined. That seems like among the most levered you were have been as a public company if I’m not mistaken, what gives you comfort in operating at such a high leverage range if indeed I heard you correctly?

John Hertz

Yes. You heard us correctly, its going to probably be high watermark and we’ve also talked in the context that where we would be comfortable which was 2.5 to 4x sort of pushes us to kind of the higher end for a short period of time in that space, but when we look at our cash flow that we generate strong cash flow, we feel comfortable with our ability to pay that down rather quickly and kind of get back into the more threes to higher two range.

Adam Josephson

And on CapEx I think you said 250 million in 2017, can you give us anything beyond 2017 just in light of the announcement earlier?

John Hertz

I think Linda talked about the fact on the paper machine we’d be spending about one-third of it in 2017 to approximately two-thirds in 2018 and then some might lop over into 2019. So if I take that in 2018 and if we spend $50 million on maintenance CapEx which is our normal that would put us at about $270 million in 2018 and then $50 million to $70 million in 2019 depending on if any of the paper machine spend pops over.

Adam Josephson

Okay. And on the buyback I know you said you'd still be able to do some buyback over the next three years or so, can you give us any sense as to how much you’ll be able to return to shareholders over that period?

John Hertz

Yes. So we will still return some cash to shareholders, but we’re changing the mix up little bit and prioritizing more of the invest in the business through the CapEx, but it will be less than what you’ve seen, we did 65 last year, I wouldn’t expect to see that much, but there will be some amount.

Adam Josephson

Okay. Just a couple on cost inflation, it look like it was actually more subdued in the fourth quarter than what you're expecting which came as somewhat of surprise at least to me just given everything we’re hearing about costs going up, so can you just talk about what was the positive surprise for you in the fourth quarter on the cost side and relatively [ph] of the $20 million to $25 million of cost inflation to which you’re guiding for 2017. What your specific assumptions are for some of the big commodities that you’re purchasing?

John Hertz

Sure. As it relates to your question on Q4, so we were pretty significantly hedged from a natural gas standpoint, so that’s one aspect. So, we were seeing some lower natural gas pricing and I guess what you’re seeing in the marketplace, I would say one of things you need for us with our Las Vegas mill is that it tends to really spike in the summer time and into the fall and so we see electrical usage and as well as pricing come down there.

From the pulp standpoint we didn’t have any major outages, so we were relying on much more external than of our internal pulp. And then finally where you see a lot of these productivity initiatives and savings we’re getting from that we’ll show up in some of those cost buckets that you’re looking at on the bridge.

Adam Josephson

Got it. And just one pricing. If you -- what you have more, just given the price erosion you’ve experienced over the last couple years. Are you more concerned about further erosion on the boxboard side or the tissue side in 2017 and why?

John Hertz

Well, like Linda said, most what we see in the bridge there is more like a full year's worth of the lower prices on the SBS side, I mean SBS is more volatile than tissue and if there it’s stubborn, it’s going to move Vegas, its going to happen more on the SBS side. But…

Linda Massman

And I think in my prepared remarks we said, our total sales will be flat to up 2%, so we definitely don't see anything of significance on the pricing side. I mean, there is some potential variability but not predicting it to be significant.

Adam Josephson

Would be sort of fair to say the risks are more skewed to the downside on the boxboard side just given where the dollar is and given your comments about the dollar earlier?

John Hertz

If I could, I have to pick one of the two I guess that would be the one, yes.

Adam Josephson

Okay. Thank you very much.

John Hertz

All right.


Your next question comes from the line of Dan Jacome with Sidoti & Company. Your line is now open.

Dan Jacome

Hi, how are you?

John Hertz

How are you, Daniel?

Dan Jacome

Not too bad. Appreciate all the details and the time. I just wanted to turn back to the Shelby expansion which looks quite interesting. I understand the rationale for the project giving the increasing share we’re seen on the private-label side, I just wanted to return back to Paul's question why the NTT machine exactly, I know when you did the first kind of capacity pushing because in 2010 you had the TAD machine and everything kind of we've read that the TAD machine is kind of like the best technology out there. So I just want to understand – just a little more clarity on why NTT, was it just simply like the economic made more sense as you were shaking out the bidding process or is there something else that maybe you could share?

Linda Massman

Yes. Thanks for asking that again. I realized after we passed off, I hadn’t answer that question, so yes, we looked at all the different technologies and ultimately settled on NTT because it gives us the range of products that we’re going to need both premium to ultra quality product along that tissue and napkins and that kind of give us the ultimate flexibility we need to service the customers out of that location in combination with the TAD machine we pretty have there. And it does also have a pretty superior sustainability footprint which we’re pretty excited about.

Dan Jacome

Okay. Yes, that was kind of what I was getting at, so like from quality perspective things should remain kind of on par with what you've seen from the TAD machine, I guess that was my concern?

Linda Massman


John Hertz


Dan Jacome

Okay. And then I know when you did the TAD machine you called out the East and Southeast customers and then today I think I only heard the Southeast, what’s happening with your east customers at they are been kind of you are that area less or they just going to be served by the current capacity?

Linda Massman

I think it might just be a bad choice of words.

Dan Jacome

Got it. Okay. Moving on and then one last one. That makes -- that’s fine. And then moving capital return obviously lot of questions, it sounds again a attempt to buy back the CapEx steps up, but you don't have to answer this, but has a board -- that you had one new board member in the last 12 months, has the board -- has there been any incremental discussions about possibly introducing a dividend maybe after this extra CapEx cycle?

John Hertz

We actually had two new board members in the last year.

Dan Jacome


John Hertz

And the discussion we have at least one a year at our December meeting. We have that discussion, obviously the priority right now from a capital allocation standpoint as we’re in the CapEx, but that was still on the table.

Dan Jacome

It’s still on the table. Okay. That’s all I want. All right. Appreciate it. Thanks a lot.


Your next question comes from Chip Dillon with Vertical Research Partners. Your line is now open.

Chip Dillon

Yes. Good afternoon.

John Hertz

Hi, Chip. How are you?

Chip Dillon

Doing well. First question has to do with just if you could talk a little bit about a couple of market dynamics. I guess, one is, what are you seeing out there in terms of some of the FBB and similar to bleached board, you know offerings coming in from Europe, and what is your expectations in terms of their penetration and how that might particularly affect you all?

And then secondly you know we certainly continue to see a long list of projects in the private label tissue world and I certainly, you know you guys are demonstrating that not all private label, I mean not all of those projects or all of the production is equal, and but I didn’t know if that that had become more of a concern, less of a concern as we go out over the next couple of years.

Linda Massman

Okay, so a couple of those questions. We’ll take one at a time here. So the question on SBS and what kind of an impact are we seeing in some of these different types of paperboard particularly FBB which will be imported into the U.S. If I had my head my head for pulp and paperboard in the room, he would say FBB board has been around for a long time, so it’s nothing new to our sales team, to our customers or otherwise. It’s definitely you know getting more oppressed and you’ll hear more about it, but we have been selling our products in comparison to that that type of grade for three years, and clearly we believe that SBS has characteristics that are important for our customers with regard to printability, the surface standards and obviously it’s working for us and so you know just not a huge impact from what we are seeing. I mean there is a lot of talk about it, but we are not seeing a big impact yet from a supply perspective and penetration.

Then moving onto the long list of projects and in private label tissue, as I said in my remarks, if we look out through to 2018and we add up all the capacity which we will note that we took out some capacity, and as I said in my prepared remarks, we’re still running at about a 97% efficiency if you look at demand to supply.

And if you look a little bit further out, and how the market grows, I still don’t have a lot of concern over that because you only have a few more tissue machines including ours that are announced and the market is projected to grow in line with the population at a minimum, and that’s assuming no further private label penetration within retail store.

So I think the market looks like it’s going to be pretty balanced for a while.

John Hertz

And if you separate kind of the ultra tier tissue from the traditional conventional, ultra is going at a much two to three times growth rate. And so, right now you can’t go by ultra quality paper on the market. And so it’s tight and I think it’s only going to get tighter.

Chip Dillon

And I guess on a qualitative basis, that’s very helpful. As a follow up, I kind of imagine there could be a degree of tentativeness among some of the retailers out there toward expanding into private label products. They certainly seem to be incentivized to you to – to obviously stock them, but that, only if their customers obviously adopt as well. And you did mention the 1% increase in the share of private label, how much of that share would you say is or how much of the market is really that premium in that you are attacking and also which – you know there is retailers would are obviously trying to see him that they would see as a way to tell you to keep their customers are used to using branded products.

Linda Massman

So I’ll take those two questions. So the first question on retailer viewpoint on private label. So we are clearly seeing retailers focus on their store brand. I think they absolutely understand the power of their store brand as it relates to their consumers and customers are coming to the store.

And they have store brand across categories, so tissue obviously isn’t the only one we know that. That is only growing, and that the data shows that with regard to market share, and you have retailers who are very focused on providing very high quality store brand products that attract foot traffic to their store.

I mean it’s the only placed you can get that particular product is their retail store. So it’s a huge competitive advantage for these retailers. In addition, you have the couple of retailers from Europe who are beginning their entrance into the U.S. market and they have very strong presence with private label and very successful presence with private label and I think that will just further enhance the store brand image with consumers and the third thing I would say is if you look at millennial they are much less brand loyal than traditional shoppers.

So they are, they don’t hesitate to use store brands infact, in many cases they prefer them. They have a lot of trust with the retailer base and therefore feel very comfortable using their store brands.

But we think there is, there’s a lot of opportunity here in the retail sector and we’re going to be there to grow with our customers. And then I forgot what your second question, so would you like to remind me.

Chip Dillon

Oh and that just in terms of – yes just talking about the comfort level of the retailers and the customers and adopt – oh I’m sorry, the market share of that the premium into the market has of the private-label market. And I’m going to [Indiscernible] the objective.

Linda Massman

Yes, no that is growing. So if you look at total tissue, I think it was since 2012 it’s actually grown about three and half times faster than the average tissue market, so you do see that top-tier premium in ultra category being preferred by the consumer.

Chip Dillon

I got that, but is that top tier, is that a third of that 25%, is it half of it? Can you just give us a feel for that?

Linda Massman

Almost 50% I would say is that top tier, and growing.

Chip Dillon

Got you. Okay, thank you.

Linda Massman

That were – numbers.

Chip Dillon

Thank you.

Linda Massman

Yup, you’re welcome. Thank you.


[Operator Instructions] Our next question comes from the line of Roger Spitz with Bank of America. Your line is now open.

Roger Spitz

Thank you, and good afternoon.

Linda Massman

Hi, Roger.

John Hertz

Hi, Roger.

Roger Spitz

Hey. What was Manchester’s LTM or 2016 sales and EBITDA?

John Hertz

Unable to disclose based on some purchase agreement.

Roger Spitz


John Hertz

But if you can take the $10 million EBITDA and there was probably just a pitch [ph] less than a million about the synergy.

Roger Spitz

Okay. Thank you. And can you remind me what all in the CapEx was what [Indiscernible] shall be one, which I guess didn’t include CapEx for warehouse.

Linda Massman

It’s a 260.

John Hertz

No 265, but we leased the warehouse with Shelby one, so they would have been pretty close to that 285 and then we are buying that warehouse that is currently under operating leases part of this.

Roger Spitz

Okay, all right, got it. And then on maybe I heard him correctly. I heard in the prepared remarks, there was a 44 million package from the local and perhaps state government and first I guess shall be two. How does that interact with the young full CapEx here, is that an offset to that or did I miss here the whole thing?

John Hertz

That’s basically tax credit.

Roger Spitz

Tax credit, okay. And I guess with CRB recent price increase on CRB, how do you think SBS pricing will respond that if at all. I mean it doesn’t sound like you are thinking it or respond much at all to the CRB price increase announcement recently.

John Hertz

Well typically that’s a positive, with something below us there’s a price increase and in terms of the quality stack, because you get some trade off. I am always looking at that, same for sure we are going to bullish on a SBS price increase but we are not.

Roger Spitz

Got it. That’s it. Thank you very much.

John Hertz



I’m showing no further questions in queue at this time. I’d like to turn the call back to Linda Massman for closing remarks.

Linda Massman

Great. Thank you. I appreciate that. So we look forward to of course to another solid year of progress towards training our cross cycle margin model. We remain excited, energized and ready to embark in our expansion in Shelby to meet the growth needs of our customers and to take on the challenges of 2017. And in particular, we want to thank our customers who make it better every day and for the support of our shareholders. So thank you for joining us and your continued interest in Clearwater Paper.


Ladies and gentlemen, that does conclude the Clearwater paper fourth quarter 2016 earnings conference call. We do appreciate your participation.

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