Clearwater Paper Corporation

Gentlemen, thank you for standing by and welcome to the Clearwater Papers second quarter 2020 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to hand the conference over to your host today, Investor Relations, Mr. Shalom Bowen, thank you. Please go ahead.

All right, thank you. Good afternoon, and thank you for joining Clearwater Papers' second quarter 2020 earnings conference call. Joining me on the call today are Arson Kitsch, President and Chief Executive Officer, and Mike Murphy, Chief Financial Officer. Financial results for the second quarter of 2020 will be released shortly after today's market close, or were released shortly after today's market close, You will find a presentation of supplemental information, including a slide providing the company's current outlook, which is posted on the industrial relations page at our website, clearwaterpaper.com. Additionally, we will be providing certain non-GAAP financial 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 information provided on our website. Please note slide two of our supplemental information covering forward-looking statements. Rather than rereading this slide, we are going to incorporate it by reference into our Prepare for March. With that, let me turn the call over to Arson.

Good afternoon, and thank you for joining us today. Please turn to slide three. As you saw from our press release, Clearwater Paper had an outstanding quarter driven by continued strength in our tissue business, stability in paperboard, and excellent operational execution. On a consolidated basis, the company reported net sales for the second quarter of $480 million and adjusted EBITDA of $79 million, which represents growth of approximately 6% and 78% respectively over last year. Our consumer products division drove results with both higher sales and production volumes to meet increased tissue demand. Lower input costs, particularly in pulp, were also a tailwind on a year-over-year basis. Together with our customers, we were able to rationalize our SKU operating, which increased throughput to meet elevated demand. Our supply chain team worked closely with customers to fulfill orders with a depleted inventory position after the consumer-driven pantry loading in March. I will speak in more detail to industry conditions in a minute, and Mike will provide some additional context on operating leverage in his comments. Another important update in the quarter, is that we are at full production run rate for our new Shelby paper machines, which is on target with our mid 2020 expectation. We remain on track to achieve the full benefits of the Shelby investment, which include achieving full run rate on converting equipment, increased sales and supply chain benefits by the end of 2021. Overall, we continue to realize the benefits from the Shelby investment and are utilizing the resulting free cash flows to deliver a balance sheet and increase value for equity holders. Our paper board division produced a stable quarter in Q2, managing through uneven end market segments. Our backlogs were above seasonal averages at the beginning of the quarter, but are now in line with previous years. In the second quarter, we used the free cash flows generated to reduce our net debt by $100 million and increased liquidity to $264 million. As a quick side note, both Mike and I have enjoyed meeting investors and analysts over the past few months, and we appreciate the warm welcome that we have received. We appreciate your feedback, your time, and your interest in our story, and we look forward to our future conversations. On slide four, as I noted last quarter, we continue to focus on our top two priorities, the health and safety of our employees, and the relationships we have with our customers. I'm proud to say that our strong operational execution continues to take care of both. We're continuing to operate with appropriate safeguards against COVID, including temperature checks, sanitation practices, social distancing guidelines, face covering requirements, remote work, travel restrictions, and enhanced benefits. We successfully focused on business continuity and customer service and did not experience any material disruptions in the quarter. I want to commend and thank our employees for their commitment to taking care of each other and our customers and persevering through a challenging period to deliver exceptional results. Our efforts and risk mitigation strategies are making a real difference in helping to reduce the risk of COVID at our sites.

I will now share what we saw for both the tissue and paperboard businesses in the second quarter.

Let's start with our consumer products division on slide five. As we have previously noted, at-home tissue demand has been elevated and has driven unpredictable consumer buying patterns. We believe that this is being driven by the shift from away from home to at-home tissue consumption, as many continue to work from home and state and local economies remain partially closed. In recent weeks, we have seen retail demand stabilize at about 10% to 15% above pre-COVID levels. It remains to be seen how this plays out in the coming months. Our industry view remains largely the same from our comments last quarter, which I'll summarize in a few key points. First, recall that the market for tissue in the U.S. is traditionally two-thirds at home and one-third away from home. Economies began to reopen in many states, which we believe drove some of the normalization in demand in June and July. That said, it appears for much of the country, the paths Back-to-normal work, school, and travel patterns remain uncertain for the rest of this year, and even the definition of normal may change. Second, as we noted last quarter, skew rationalization aids our business from an efficiency and throughput perspective. We are, to some extent, starting to see customers demand some increases in our product offerings. While we believe that our customers benefit equally from a lower SKU assortment, it remains to be seen what this will look like in the future. Lastly, regarding industry capacity, the landscape remains largely the same as at the end of the first quarter. For the industry and Clearwater Paper, inventory levels were drawn down to meet the spike in demand in March and early April as production ramped. Currently, we believe the industry is essentially at full production capacity and inventory levels remain below normal levels. Timing of recovery in inventory levels across the value chain will be driven largely by normalizing demand, likely in the fourth quarter of this year. Now let's turn to our tissue results over the quarter. Recall from the first quarter that we shipped over 15.2 million cases, which was roughly 20% higher than our average run rate last year. In the second quarter, we shipped 16 million cases as demand remained elevated, but we did observe some demand normalization over the back end of the quarter. Compared to the second quarter in 2019, our case sales volume was up 28%. We continue to execute for our customers and are pleased with production efficiency and fixed cost leverage, as I mentioned earlier. We are anticipating both sales and production to be lower in the third quarter versus the second quarter, as in stock conditions are improving and inventories are being rebuilt. As mentioned earlier, the new Shelby paper machine reached full run rate capacity over the last couple of months. I would like to congratulate and thank our Shelby team whose dedication and hard work contributed to us reaching this important milestone. Let me also take a moment to congratulate and recognize our recently appointed Senior Vice President and General Manager of the Consumer Products Division. Joanne Shufeld joined Clearwater Paper in 2012 and has more than 30 years of experience in the paper industry. We're very fortunate to have Joanne in this role, especially during this unique time for our business. Let me now provide a few comments on our paperboard business. Please turn to slide six. As noted earlier, we were pleased to see stable paperboard demand in the quarter, with strength in our core end market segments offsetting recessionary pressures. As you know, we estimate that approximately two-thirds of our paperboard demand is derived from products that are more recession resilient, and one-third is driven by more economically sensitive or discretionary products. Generally, our folding cart and customers, especially those with exposure to food and healthcare packaging, have seen strong demand. And our food service customers, especially those with exposure to quick service restaurants and away from home dining, as well as commercial printers, have seen weaker demand. We know, though, that our drink cup stock sales volumes through June year-to-date were stable to 2019, in part due to sales of the Nuva brand of premium cup stock announced last year. Our exposure to diverse end-market segments helped provide stability to our order book in the quarter. We would characterize paperboard demand in the quarter to be stable, despite sales volume declines of 2% compared to the first quarter of 2020 and 8% relative to the second quarter of 2019. Our production was impacted at Cypress Bend by two separate utility outages in the first and second quarters. Additionally, the second quarter of 2019 benefited from a shift of approximately 5,000 tons from consignment to revenue. While we're encouraged by our stable performance in the quarter, we're navigating through some uncertain market conditions and have seen a softening in our backlogs relative to earlier in 2020. Bring them in line with our historical averages for this time of year. In July, Clearwater Paper introduced their Imagine brand of SBS folding card and paper board with up to 30% post-consumer recycled fiber that is FDA compliant for food contact. This follows the successful launch in March of 2019 of our Nuva SBS brand of Cubstock with up to 35% post-consumer recycled fiber. Clearwater Paper with their Imagine brand, with their Imagine and Nuva brands is meeting our customer and consumer preferences for more recycled content in an already highly sustainable form of paper-based packaging without compromising on consumer safety and product quality. With that, I'll turn it over to Mike to discuss our second quarter results.

Thank you, Arson. Please turn to slide seven. The consolidated company summary income statement is depicted for the second quarter as well as the first half of 2020 and 2019. In the second quarter, diluted net income per share was $1.36 per share, and adjusted EBITDA was $79 million. The corresponding segment results are on slide eight. Our paperboard business continues its steady EBITDA performance, while consumer products benefited from significant sales growth and fixed cost leverage associated with production growth and favorable input costs. Please turn to slide 9, where you'll notice that we will speak about our performance a little differently than before. In addition to addressing second quarter performance relative to the first quarter of this year, we will also compare the current quarter with the quarter from a year ago. In the second quarter of 2019, we started Shelby 2 and incurred as anticipated startup costs related to inefficient staffing, lower production throughput, higher waste, and other costs. While we're not providing a specific dollar amount for these costs, the Shelby ramp is an important factor in our performance improvement. We are benefiting from the volume increases related to the production ramp, which is helping meet some of the COVID-related demand and incremental volume from new customer programs. Partly offsetting the upside on volume and our cost structure is a mildly negative pricing experience during this timeframe. Slide 10 is a good representation of the impact of COVID demand on our cost structure. While higher sales had a positive impact on our financials, our costs were significantly lower. The fixed cost leverage was the most significant driver as we produced almost 2 million cases more in the second quarter versus the first quarter. In addition to the improved cost leverage, we also experienced cost benefits in freight and logistics as our supply chain team continued to find more efficient ways to meet customer demand. Slide 11 contains some additional context to the extraordinary performance in our tissue business. The slide contains IRI data, which is a snapshot of retail sales of tissue. On a year-over-year basis, March sales were 100% higher than the previous year, slowing to 37% growth in April, 19% in May, and 11% in June. We believe that COVID-19 initially drove pantry loading by consumers in March and early April. Elevated demand has subsequently continued due to the shift to at-home consumption. It appears that the demand trends in recent weeks are 10% to 15% higher than the previous year, although we are uncertain whether this is the new normal in the medium term. What we do know is that retail in-stock levels have improved and inventory levels are being rebuilt across the supply chain. We are watching all of this closely on our contingency planning for various demand scenarios in the coming months. Elevated demand drove our sales in the second quarter to 60 million cases, representing a unit growth of 5% versus the first quarter and 28% versus prior year. Our production in the quarter increased to 15.9 million cases, up 14% versus the first quarter and 24% versus prior year. This increase in production was driven by our efforts to rationalize use, eliminate downtime, as well as the blant of our Shelby assets. The cost leverage from this significant increase in production, along with improved cost and phrasing logistics, led to materially better results than initially anticipated. In comparing the second quarter to the first quarter of 2020, more than half the EBITDA increase was driven by fixed cost leverage due to improved production. Slide 12 is a year-over-year EBITDA comparison for our paper board business. Lower pricing, partly driven by VC's reported price decrease in February, was partially offset by favorable mix. Lower volume was a function of moving some inventory from consignment to revenue in the second quarter of last year. Pump demand weakness at our Manchester Industries business and lower production due to utility outages at Cypress Bend. Mostly offsetting EBITDA impact of lower volume or lower input costs, notably in fiber and energy. On slide 13, we compare second quarter to first quarter of 2020. With stable price mix, as we had mostly experienced the VCE reported price impact in the first quarter, volumes were largely flat, and we benefited from lower input costs and operated more efficiently in the quarter. Our performance in the second quarter exceeded our expectations with sales and production volumes in tissue driving significant improvements. Our paperboard business remains largely stable, and our costs were generally below expectations. These factors combined with outstanding operational execution delivered significant upside to our original expectations.

Slide 14 provides a perspective on our third quarter outlook.

Tissue outlook is largely a function of sales demand. While we believe that demand will remain elevated versus historical averages, we do expect about a 10% decline in cases sold in the third quarter versus the second. Relative to the second quarter, we're also anticipating higher supply chain costs as we rebuild finished goods inventories. Input costs are expected to be largely benign. As we previously mentioned, our paper board business remains stable in total, and while we continue to prepare for potential COVID recession-related weakness, our portfolio of customers and end market exposures continues to position us well through the end of July. If assumptions around demand as well as largely stable prices and raw material input tolls, we would anticipate third quarter EBITDA to be in the range of 64 to 74 million. This range also assumes that we continue to operate our assets without significant COVID-related disruptions. Given the current market uncertainties, we are not in a position to confidently share expectations on EBITDA for the full year. For the full year of 2020, we continue to anticipate interest that comes between $48 and $50 million, capital expenditures between $45 and $50 million, appreciation between $109 and $112 million, and not to be a cash taxpayer. As it relates to Shelby, we're on track to achieve our operational production goals for 2020, with more to come in 2021. And given current market conditions, we expect to meet or exceed our impact of $20 to $25 million in 2020 from this project. Slide 15 outlines our capital structure. We utilized approximately $100 million in free cash flow to reduce our net debt, which included a $60 million voluntary repayment to our term loans and improved our liquidity to $264 million. As a result of the strength of the quarter and our debt repayment activities, we wanted to point out a few items. our term loan debt pricing dropped to LIBOR plus 300 basis points from LIBOR plus 325 basis points as a result of our leverage ratio declining to 3.6 times. Second, the debt maturity profile improved with no scheduled principal payments over the next two years. And third, Moody's reiterated their corporate credit rating of VA too stable. It is worth noting that our cash flow in the quarter was aided by substantial net working capital timing, first quarter sales ramp later in the quarter with accounts receivable increasing. This generated cash flow benefits for Clearwater in the second quarter as we collected those abnormally high accounts receivable. Let me turn the call back to Harsin to conclude our call today with Clearwater paper value proposition as we see it and a few concluding remarks.

Thanks, Mike. Let's turn to slide 16. I would like to reiterate our investment proposition, which we discussed in our previous earnings call and mentioned to investors throughout the quarter. First, we believe Clearwater Paper is very well positioned across two attractive and complementary businesses. Our consumer products division is a leader within the growing private branded tissue market. From our vantage point, we believe the key strengths of this business are the following. First, We have a national footprint with an ability to supply a wide range of product categories and quality tiers, which is an attractive sales proposition to our customers. Our expertise in manufacturing, supply chain, and transportation is a key differentiator, especially during challenging times like today. Second, there are long-term trends away from branded products to private brands. This has amplified during recessions. Private brand tissue share in the U.S. has risen to over 30% in 2019, up from 18% in 2011. While these trends are impressive, we're still a long way from where many European countries are, where private brands represent over half of total tissue share. Lastly, tissue is an economically resilient and need-based product. Historically, demand has not been negatively impacted by economic uncertainty. Turning to our paper board division, we believe that the key strengths of this business are the following. First, We operate well-invested assets with a geographic footprint enabling us to efficiently service customers on both coasts. We have a diverse customer base that serves end markets that have largely stable demand. Second, not being vertically integrated enables us to focus on independent customers with unparalleled service and quality commitment. Lastly, we believe the business is well-positioned to take advantage of trends towards more sustainable packaging and food service products. Our paperboard business has demonstrated an ability to generate good margins and solid cash flows. Overall, our large capital investments are behind us, and we're prioritizing cash flows to reduce debt, as we demonstrated in the second quarter with a net debt reduction of approximately $100 million. We intend to continue to do so by delivering benefits from our Shelby investment, continuing with operational improvements, aggressively managing working capital, and prudently allocating capital. We believe that this strategy is the best way to create value for equity and debt holders in the near term. I also want to add that we prioritize the sustainability of both the products we make and the way we make them, which is a key part of our investment proposition. Before we take your questions, I want to express my deepest gratitude to how our employees have responded to the COVID-related issues that are impacting our personal and professional lives. and to our customers, vendors, and local officials, continue to work together with us in partnership and navigate continued uncertainty. So with that, we will end our prepared remarks and take your questions.

As a reminder, to ask a question, you will need to press star 1 on your telephone. Again, star 1 on your telephone. To withdraw your question, press the pound or hash key.

Please stand by while we compile the Q&A roster. Your first question comes from the line of Adam Josephson.

The line is now open.

Arson and Mike, good afternoon.

Good afternoon, Adam.

Congratulations on a nice quarter. A couple on SDS, and then I'll ask one or two on tissue. On the inventory issue in 2Q, I don't recall hearing anything a year ago about the treatment of confined inventory issues. artificially boosting volumes in the release or on the call last year. I appreciate that you guys were not in your same positions a year ago, but can you just help me understand what happened and why there was no mention of this a year ago, if it was a big deal affecting volume?

I think, Adam, to answer your question directly, and then I'll pull back a little bit, it

Roughly 5,000 tons got recognized into revenue in the second quarter of last year. I can't speak to why it was not called out specifically back then. You know, when we look at the period year over year, both from a quarterly standpoint and a six-month standpoint, we don't see huge differences, but that was one thing that popped out when we were looking at the data that we wanted to make sure that we called out. You know, we do have, you know, some mild negatives in the quarter, primarily in the commercial print industry in the second quarter of this year. That's showing up a bit in our Manchester Industries business, as well as a little bit in the food service business. But we've had pretty stable volumes year over year when you isolate that, you know, I call it movement from inventory to revenue last year.

Got it. Thanks, Bacon. And just also on SPS, I mean, you're seeing largely stable trends. You've characterized the industry as largely stable. As you know, industry backlogs are at multi-year lows. Your two largest competitors have both announced market downtime in the third quarter, owing to weakness in commercial print and cup stock. What gives you confidence that market conditions in SPS will hold up through year end, given everything we're hearing and seeing?

So I can't speak to our competitors. What we'll tell you is we started with backlogs. We started in the quarter with backlogs that were higher than historical averages. We've normalized towards the end of the quarter towards historical averages, and we've held around those averages through the month of July. So our end market segments, the strength in folding cartons and food packaging applications, appears to be offsetting some of the weakness in commercial print and food service, although it's pretty hard to predict how this plays out for balance of the year. But as of right now, we're seeing relatively stable backlogs that are comparable to historical averages.

Got it. Thanks, Larson. And on the tissue side, can you just talk about what you were thinking three months ago when you gave the EBITDA guidance of – 50 to 55, and then obviously you upsized it quite a bit, and then you beat even that much higher range. I mean, presumably at the time, I mean, not presumably, you knew how good tissue demand was in May and potentially into June, and yet obviously you ended up dramatically raising your guidance, I guess, because the impact of the higher production on your fixed cost was much greater than what you were expecting. But What exactly played out so much differently on the tissue side than what you were expecting, given how positive you were on tissue demand trends even back then?

So two things. So when we provided that guidance, what we knew is what March and April looked like. May and June were still a bit unknown to us, and we were anticipating June demand to start slowing down, considerably and it didn't. June demand was still very strong and our volumes were very high up quarter over quarter. That's the first piece. The second piece is our production was able to keep up with those elevated orders. So we shipped 16 million and we produced 15.9 million. And the benefit, the cost benefit of that increased production was very substantial. So I think there were two positive surprises for us. It's the continued strength in demand heading into June, as well as our ability to produce to those orders, as well as the cost absorption positives that we experienced.

Thanks. Just last one on just the topic of guidance. So just given what happened at 2Q and the extent to which you put up just dramatically higher EBITDA than what you were guiding to. What is your confidence level in your third quarter guidance range, and do you think it's worth giving EBITDA guidance even for the current quarter given what seems to be a lack of visibility?

Adam, it's Mike. I definitely appreciate the spirit and the intent of the question, and I'm not going to accuse you of not asking for guidance. I think part of what Carson's commentary was, as we learned what we were capable of doing, it's one thing to see it in theory. It's another thing to see it show up on the bottom line. And that's what happened in the second quarter. I think, again, we're pointing to the third quarter. It's largely going to be a function of demand now that we know what we're able to do on the production side of things. And we are calling for the markets to cool off a little bit. Just given the read of what we have in July, I think tissue is coming in a little bit stronger than we would have anticipated. And PPD is kind of in that same ballpark as where we expect it to be. So that's what gives us the uncomfort. But, yeah, I understand, again, the spirit and the intent of your question.

I appreciate it. Just last one on tissue pricing. Pricenix was a drag year over year, and it was pretty flattish sequentially, and I think some investors would have expected you to get more prices given the extraordinary demand that you saw in the last couple quarters. Can you just talk about the relationship between demand and pricing in this industry and how your pricing mechanism works and whether you think you will eventually get pricing as a result of this exceptional demand that you've seen since March?

Adam, generally speaking, we don't talk about future pricing, but let me just comment on the pricing mechanisms in tissue. These are not dynamic spot market prices. These are generally agreements with set pricing that are renegotiated on a regular basis. So as we look into the future, we certainly have – market channel volume strategies around our agreements of how we plan to reshape our business in the future, but we're not going to comment on future pricing.

Thanks, Arson. Appreciate it.

Your next question comes from the line of Kurt Jinger from Davidson. Your line is now open.

Yes, thanks, and good afternoon, everyone.

Hey, Kurt, I just

Hi. I just wanted to start on the guidance. So if we were to try to think about the impact of cost absorption in tissue as demand normalizes, I mean, is that really the biggest driver in the $10 million epidemic line, Q3 versus Q2, or are there any other big moving factors we should be aware of?

I think that, together with freight costs, So we had an interesting dynamic in the second quarter where we were shipping direct to customers more so than we usually would, which cut a lot of freight costs out. As we rebuild inventories to service our customers at the levels they're used to being serviced at, that's going to add back some costs to our freight. And then, you know, we have some other kind of puts and takes in there.

But those are the two big crackers.

Got it. Okay. That's helpful. And I guess kind of sticking with that input cost, I mean, how should we think about fiber and maybe energy in the second half? Should those continue to be pretty nice tailwinds, at least on the fiber side?

If you look at the latest forecast, the public forecast that are out there, pole pricing is expected to be largely flat, maybe down slightly in the second half versus the first half. I think other input costs They're relatively benign. Transportation is relatively benign. We are experiencing an interesting dynamic with some of our wood fiber costs in the paperboard business with lumber mills ramping up to meet increased demand. We're seeing more chips available, more residuals available to us. So that could provide a tailwind for us in the second half. largely benign with maybe some upside on the residual cost in paperboard.

Got it. Okay. And then if we were to look at SG&A, I guess about $6 million year over year, what were kind of the biggest components in that increase?

Sure. One that we're happy to talk about is employee bonus or compensation related to the outstanding performance. And so we have the appropriate accrual in the first quarter, but when you have this amount of beat, if you will, in the second quarter, we're accruing at a much higher level for the rest of the year, and there's a one-time catch-up that you need. You know, we also have some you know, higher than normal professional services fees flowing through during the second quarter. Those were the two primary components.

Got it. Okay. Yeah, I guess the first one's not really that problem to have. Okay. And then I guess lastly, you kind of outlined the major maintenance schedule here for 2021. I mean, are there any smaller projects or impacts we should be mindful of kind of entering the second half, any sort of deferred maintenance activity, just given the strength here in the first half?

We do those pretty regularly.

And we do have, you know, in addition to maintenance, minor hiccups that will happen along the way. That's nothing that I would call out that would be truly noteworthy.

Okay.

That's helpful. All right. Thank you. I'll turn it over.

Your next question comes from the line of Mark Wilt from BMO Capital Markets. Your line is now open.

Good afternoon, Anderson. Good afternoon, Michael.

Hey, good afternoon, Mark. Two questions for you.

Mike, I wonder if you could just give us a little more color on where you see the working capital opportunities that you flagged in the presentation and sort of order of magnitude on them. And then... We just had another big East Coast private label or private brand producer announce a couple of new machines. So I just wondered how directly you competed with them, and maybe if you could just deal with the issue of incremental capacity still coming into the private label market.

Sure. So I'll handle the first one on networking capital. Arson will talk about issues. So in my networking capital commentary, Mark, is maybe backward looking to the second quarter, which is, I hope, covering your question. But we had a networking capital benefit in the second quarter of just under $45 million. The biggest benefit there was accounts receivable, trade accounts receivable coming down by approximately $21 million. We had inventory coming down in the quarter as well, close to $5 million AP accounts payable and crude liabilities went up by $15 million. I'd point out to you, Mark, that if you look at our capital structure, we make our bond interest payments in the first and the third quarter. That's a cash payment of about $14 million. So we're a beneficiary of that from a working capital standpoint in the second quarter. We will be again in the fourth quarter, but in the third quarter, just expect a change by that order of magnitude. Okay. Go ahead. Anything else on the working capital?

No, I was just going to say, you know, kind of looking forward, you know, maybe you could talk about any, you know, additional opportunities you see on the working capital side.

We had started off the year, Mark, thinking that we would need a use of working capital of $20 to $25 million. We withdrew that from our guidance last quarter. We're still trying to sort through what's the right inventory level that we need to service our customers appropriately. I think in the paperboard business, we understand that, and we're pretty close to that level. I think in tissue, we understand it, but we're still operating at a pretty low level. And so the expectation I would have for the back half of the year is that we're going to build inventory, and so we're a net consumer of networking capital.

Okay. All right. Turn it off. Mark, on the tissue capacity, and I'll stay away from commenting on specific announcements by competitors, but more general comments about tissue capacity. The market's about 10 million tons. It grows largely with population, so you see about 100,000, call it 100-ish thousand tons a year of additional capacity needed to meet demand. That's one to two additional paper machines per year to keep the market between supply and demand. So if you look at this year, there's approximately 200,000, 250,000 tons of capacity that's coming online. Next year, it's somewhere in the 150,000, 160,000. And then beyond that in 2022, 2023, it's still largely unknown. But that's how I think about the supply and demand. You need about 100,000, maybe 150,000 tons a year to keep up with demand. In terms of competition, it's a highly competitive market. It has been for a number of years, so I would say you should expect us to be competing across the board. We're a national player across multiple quality tiers, across all channels, so we're constantly competing with many players in this market.

Okay. Just one other question. You mentioned that ramp up in kind of chip supply with kind of more lumber production. I think this is particularly acute over in the Pacific Northwest. Does that wind up rippling back to you guys in the Intermountain region at all or not?

It does. And, Mark, we have some flex capacity as it relates to our fiber within that footprint. So we consume both software chips and sawdust. On the stockwood chips, we have the flexibility to pivot to have up to 50% of whole log chipping. We were close to that level in the first quarter. Now, obviously, given what's happened in that fiber basket, we're able to swing much lower. And so, as you well know, the chip pricing is a lot lower than the whole log pricing that we get.

Yeah, the lumber guys on the coast are moaning this. That's it for me.

All right.

Next question comes from the line of Paul Queen from RBC Capital Markets. Your line is now open.

Yeah, thanks very much, Pauline. Sorry, afternooners and Mike. It's been a long day here. I guess I'll start with Shelby, too. You mentioned you're hitting the run rate. What kind of mix improvement can we see over the next number of quarters or years?

It's a good question.

So we are doing right now, so there's two things happening. So number one, right now our demand in tissue, as you may expect, has far exceeded our historical averages, and frankly, is exceeding our multi-year projections with a Shelby ramp. So what we're trying to sort out right now, what do the next few quarters look like from a volume perspective, and how do we mix out that machine? Right now, every case coming off those lines is spoken for, and we're selling it, and the sales team is working right now on a multi-year strategy of how do we improve the mix on that machine to more ultra as it is an ultra-capable machine. So it's a bit of a complicated answer. There's a short-term need to celebrate a demand and make as many as possible, and then long-term trying to figure out where does demand, where does this growth settle out at, and then how do we mix out that machine from a customer and a product perspective to maximize profitability.

Okay.

And then maybe just stick with tissue, and just inventory in the distribution chain as well as the consumer distribution consumer side, where do you anticipate that is right now? And I guess you're expecting slowdown in Q4, but where are current inventories at?

So probably the right way to think about that is in-stock conditions in stores. So if you look at April, in the paper space, in-stock conditions were somewhere in the 30%, 35% range. They've recovered to about 75% in-stock on the shelf. The normal average in consumer products is about 90%. So I think you're starting to see inventory being rebuilt on the shelf, which means it's going to start being rebuilt at our retailer warehouses, and we're seeing some modest increases in inventory in our own system as well. But I would say we're maybe a third of the way there in terms of our recovery for inventory in tissue. So it's going to take us through at least Q4, we believe, to get back in stock, and it's going to be largely dependent on demand. If demand continues to be very robust, I think that recovery period gets delayed.

Okay, and then just flipping over to paperboard, you guys and others have signaled, you know, commercial print in some areas of food service has been weak. Do you think that does recover, or are we going to recover to a lower normal going forward?

So, Paul, it's Mike. I think I've been more focused on the potential of a recession here. At some point, I think my sales team in TPD will accuse me of being the ECB predicting nine of the last five recessions. So, I think what we've seen in the past is that this market could be down upper single digits, close to 10%. And while the market is stable as we see it, and as we're performing, we're also contingency planning to see if the market or the weekend, you know, here's what will happen. I think it's anybody's guess in terms of how the economy is going to play out. And so I know that's not a direct answer for you, but I think so long as we have COVID hanging over us, I think we're going to have limitations on the commercial print demand and limitations on the food service demand.

Okay, fair enough. Excellent quarter. Good luck going forward. Thank you. Thank you.

You have a follow-up question from Adam Josephson from P-Bank. Your line is now open, Adam.

Arson and Mike, thanks so much for taking my two follow-ups. Arson, back to Foxport for a moment. You talked about your lack of integration actually being, in your mind, a competitive advantage. As you know, some of your larger competitors have made a concerted effort to get as integrated as possible. So can you just talk about, just expand on why that is your strategy and why you think it differs quite considerably from others in the industry along those lines?

Adam, SBF is still, majority of SBF demand is still non-integrated with independent converters. So we're focused squarely on that market, especially in folding cartons. And the value proposition for them is that we are focused on their needs, and we're there for them whether demand is strong or not. So between our service proposition, our ability to deliver volume, and our quality proposition has been an advantage for us because, frankly, if you're an independent converter, you would probably rather not buy from someone who is your competitor. So that has been an advantage. I think as we look into the future, I think we have to continue to reassess, you know, what is the right strategy for our paper board business. But up to this point, we believe it's been an advantage for us.

Got it. No, thanks for that. And just, I know it's early days talking about next year, but You have obviously maintenance expenses going to be quite a bit higher next year, and then you've had this extraordinary year in tissue, obviously. Would you care to share any preliminary thoughts about next year? Is it reasonable to expect this level of tissue performance to persist next year? Is that unreasonable? I guess it all depends on one's view of the economy, as Mike was talking about earlier. But any thoughts you would share with us just about the sustainability of of these earnings levels in your mind based on whatever facts you're aware of at the moment?

Adam, I appreciate the follow-up question in light of the earlier question on how confident are you in your third quarter guidance. I think it's too early to tell, Adam. I know that's something that's important to everybody who's on the line and our investors. I think at the appropriate time we'll come back out and talk to you about it. I think in tissue, it's going to be a demand story and how much of this shift of demand has moved from away from home to at home, and how long is that going to sustain and what the new normal is. And I think as the year plays out, we'll have some better estimates there, but they still will just be estimates. And then as the economy plays out, I think we'll be able to update you on the paperboard business. And, look, we recognize the importance of the question. I think as you think about a model for us, you know, we would, you know, point to that outage number that Kirk had referenced before. But we know that's going to be different in 2021 than 2020. And, you know, we'll talk further about refining that estimate here in the hopefully not too distant future.

Absolutely. Well, again, kudos on a terrific quarter, and best of luck this quarter, both of you.

Thank you.

I don't see any questions from the queue.

I will turn the call over to Mr. Arsene Kitsch for any closing remarks.

Thank you all again. We appreciate your interest and support, and we look forward to speaking again soon. Have a great evening.