Clearwater Paper Corporation

Ladies and gentlemen, thank you for standing by and welcome to the Clearwater Paper Third Quarter 2020 Earnings Conference Call. At this time, all participants are in listening 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. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would like to hand the conference over to your speaker today, Sloan Bowen, Investor Relations. Thank you. Please go ahead.

Thank you, Mike. Good afternoon, and thank you for joining Clearwater Papers' third quarter 2020 earnings conference call. Joining me on the call today are Arsene Kitsch, President and Chief Executive Officer, and Mike Mercy, Chief Financial Officer. Financial results for the third quarter 2020 were released shortly after today's market closed. You will find a presentation of supplemental information, including a slide providing the company's current outlook, which is posted on the investor relations page at our website at clearwaterpaper.com. 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 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 prepared remarks. With that, let me turn the call over to Arsene. Good afternoon, and thank you for joining us today. Please turn to slide three. As you saw from our press release, Clearwater Paper had another outstanding quarter driven by strength in our tissue business, stability in paperboard, and excellent operational execution. On a consolidated basis, the company reported net sales for the third quarter of $457 million and adjusted EBITDA of $77 million, which represents growth of approximately 3% and 145% respectively over the third quarter of last year. A few business highlights to mention. Our tissue business drove results with both higher sales and production volumes to meet elevated demand. Lower input costs, particularly in pulp, were also a tailwind on a year-over-year basis. Our service levels and tissues started to recover to pre-COVID levels as we continued to work with customers to fulfill orders and replenish inventory levels. Our paperboard business continued to deliver stable performance, managing through uneven end-market segments with solid execution. Our current backlogs are in line with previous years, and we successfully launched Reimagine Folding Card brand, offering recycled content in an SPS board. In the third quarter, we used the free cash flows generated to reduce our net debt by an additional $40 million, and we refinanced our 2023 notes with a new 2028 notes. On slide four, as I noted these last two quarters, we remain focused on our top priorities during COVID, the health and safety of our employees, and safely operating our assets to service our customers. We continue to operate with appropriate safeguards against COVID, including temperature checks, quarantine protocols, sanitation practices, social distancing guidelines, face covering requirements, remote work, travel restrictions, and enhanced benefits. Our human resources and manufacturing leadership teams are doing an exceptional job of practically monitoring the health of our workforce and ensuring that we have the proper staffing levels in place. Our efforts and risk mitigation strategies are making a difference in helping to reduce the risk of COVID at our sites. I would like to express my deepest gratitude to all of our people for their extraordinary efforts and perseverance through this challenging time. I will now share what we saw for both the tissue and paperboard businesses in the third quarter. Let's start with our consumer product division on slide five. As we have previously noted, at-home tissue demand remained elevated during the quarter. We continue to believe that this is being driven by the shift from away from home to at-home consumption as many people continue to work and learn from home. We noted on our previous earnings call that because of these consumption changes, we were seeing retail sales per IRI panel data stabilized at above pre-COVID levels. In the third quarter, that resulted in low double-digit retail sales growth relative to the 2019 quarter. We expect that year-over-year increase may continue to moderate as retailers replenish their inventories, consumers destock their pantries, and people adjust to living with a pandemic. Our industry view remains largely the same, which I'll summarize in a few key points to provide some context. First, recall that the market for tissue in the U.S. is traditionally two-thirds at home and one-third away from home. Many state economies began to reopen, which we believe drove some of the normalization in demand in the third quarter. We expect continued uncertainty associated with these reopening and travel patterns, making it challenging to predict demand drivers for these end markets during the next few quarters. It is also difficult to predict what a new normal might look like as the pandemic eventually subsides. Second, while it is too early to discern trends on branded share relative to private branded share, we are noticing that paper towel demand is tracking ahead of the overall tissue category, while facial demand is lagging. We will continue to monitor these trends in the coming months and quarters due to the continued uncertainty in consumer demand associated with COVID. Third, as we noted last quarter, skew rationalization has occurred, aiding additional production. We believe that lower skew counts benefit both retailers and manufacturers like us. While we have seen some customers desiring a recovery of skews, we do not anticipate skew counts to go back to pre-COVID levels in the near to medium term. Our tissue results in the third quarter were robust. We shipped 14.5 million cases, which was up around 10% compared to the third quarter of 2019. but down 9% over the second quarter of 2020, as expected. We continue to execute for our customers and are pleased with production efficiency and fixed cost leverage achieved. We have largely replenished inventories throughout the supply chain and are seeing in-stock conditions improve. In addition, to meet peak demand during the pandemic, we believe that some of our customers made short-term commitments to alternative suppliers and tertiary brands to meet demand, including imported products. As a result, we believe that these customers have greater than normal inventory levels in several product categories that they're now working to reduce. We have also adjusted our sales and customer mix over the last six months to better position our business for growth in the long run. That has led us to exit several customers to reduce complexity and improve our network. While we have a robust pipeline of new business for next year, these strategic moves are expected to have a volume drag in the next couple of quarters. Mike will further address the impact of these trends on our business in the financial outlook section of our discussion. Please turn to slide six so that I can share a few comments on our paperboard business. As you recall, we estimate that approximately two-thirds of paperboard demand is derived from products that are more recession resilient, and one-third is driven by more economically sensitive or discretionary products. Our business, including customer demand, has been stable despite economic uncertainties. Our folding cart customers, especially those with exposure to food and healthcare packaging, continue to see 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, continue to see weaker demand. Our exposure to diverse end market segments help provide stability for our order book in the quarter. We did not have a planned major maintenance outage in the third quarter of 2020 like we did in 2019, which drove improved operations. Our current sales backlogs are consistent with previous years, indicating stable demand. While we're encouraged by our solid performance in the quarter, we're navigating through some uncertain market conditions. On our last earnings call, we introduced the Rematchit brand of SBS folding carton paperboard with up to 30% post-consumer recycled fiber that is FDA compliant for food contact. Together with our Nubo SBS brand of Cove stock with up to 35% post-consumer recycled fiber, We're meeting our customers 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 third quarter results. Thank you, Arson. Please turn to slide seven. The consolidated company summary income statement is depicted under the third quarter as well as the first three quarters of 2020 and 2019. In the third quarter, diluted net income per share was $1.28 per share, and adjusted EBITDA was $77 million. The corresponding segment results are on slide 8. Our paperboard business continued its strong adjusted 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 we provide a year-over-year comparison of the third quarter 2020 relative to the third quarter of 2019 for tissue. In the second quarter of 2019, we started our Shelby, North Carolina paper machine and incurred, as anticipated, startup costs related to lower production throughput, higher waste, and other costs, which persisted during the remainder of 2019. As a reminder, we achieved the targeted production rate of our new paper machine in the second quarter of 2020, and we are continuing to capture the benefits associated with the project, including ramping our converting lines, realizing supply chain benefits, and achieving sales wins and mix improvements. While we're not providing a specific dollar amount for these costs and benefits, the continued realization of the CELB investment is an important factor in our performance improvement. Our mix continues to improve as CELB has come online, more than offsetting some year-over-year price impacts. We're benefiting from the volume increases related to the production ramp, which help to meet elevated demand. Overall, fixed cost leverage from increased production, lower input cost, and improved mix positively impacted our tissue business in the third quarter of 2020 relative to the third quarter of 2019. You can review a comparison of our third quarter 2020 performance relative to the second quarter of 2020 on slide 16 in the appendix. Slide 10 contains some additional context to the outstanding performance in our tissue business. and we are building off the data we shared last quarter. The slide contains IRI panel data, which is a snapshot of retail sales of tissue measured in dollars. The line shows monthly change on a year-over-year basis, while the data in the box shows a quarterly view versus last year. It is estimated that dollar retail sales grew 34% in the first quarter, 23% in the second quarter, and 12% in the third quarter. You can see in the data that pantry loading phenomena at the end of the first and beginning of the second quarters, that has given a way to a more stable demand picture for our retail customers. During our last quarter's call, we anticipated the IRI panel data to be up in the 10% to 15% range in the third quarter, and it was close to 12%. In the fourth quarter, we would expect year-over-year sales growth to continue to moderate. This expectation is highly uncertain and dependent on consumer behavior, retail buying patterns, and COVID-related restrictions. Our sales in the third quarter were 14.5 million cases, representing a unit decline of 9% versus the second quarter and unit growth of 10% versus prior year, as expected. Our production in the quarter was 15.3 million cases. We're down 4% versus the second quarter and up 19% versus prior year. Our production levels have benefited from the Shelby ramp and skew rationalization. The cost leverage from the significant increase in production along with improved costs in freight and logistics led to continued strong results. Slide 11 is a year-over-year adjusted EBITDA comparison for our paper board business. Lower pricing reflected in RACI's reported price decrease in February was partially offset by favorable mix. The absence of a planned major maintenance outage at our Idaho mill was also a major driver of year-over-year improvement. Overall, our team ran our operations well in the quarter and continued to deliver stable results. You can review a comparison of our third quarter 2020 performance relative to the second quarter 2020 performance on slide 17 in the appendix. Our performance in the third quarter exceeded our expectations with stronger sales and production volumes in tissue and continued stability in paperboard despite weak economic conditions. These factors combined with outstanding operational execution delivered robust results. Slide 12 provides a perspective on our fourth quarter outlook. As previously discussed, tissue outlook is largely a function of sales demand As Arson mentioned, we recently exited some customers and specific products to better position us for the future. Additionally, several of our large customers placed heavy orders with us and other suppliers in the third quarter, leaving them with high inventories in several product categories. As a result, we're seeing order pace slow in October as customers are adjusting their supply chains. Our October shipments were around 4 million cases, which is down from an average of 4.8 million cases per month in the third quarter of 2020 and 4.4 million cases per month in the fourth quarter of 2019. We are anticipating our tissue sales to be at or below fourth quarter 2019 levels. Our production will also decline to meet this level of demand so that our inventories do not exceed targeted levels, which will impact our fixed cost absorption that had benefited Clearwater throughout much of 2020. Input costs are expected to continue to be largely benign, except for some increasing freight expenses. As we mentioned previously, our paperboard business remains stable and total. And while we continue to prepare for potential COVID recession-related weakness, our portfolio of customers and end market segment exposure continues to position as well through the end of October. If assumptions around demand as well as largely stable prices and raw material inputs hold, we would anticipate fourth quarter adjusted EBITDA to be in the range of $52 to $62 million. This range also assumes that we continue to operate our assets without significant COVID-related disruptions. For the full year 2020, we anticipate the following. Interest expense between $46 and $48 million, which is a slight decrease to debt repayments. Depreciation is expected to be between 109 and 112 million. Capital expenditures are trending towards 45 million, and we still do not expect to be a net cash taxpayer in 2020. While we're not prepared to provide specific guidance for 2021, there are several variables to keep in mind. Planned major outage expenses are expected to reduce our earnings in 2021 compared to 2020 by $25 to $30 million. We've updated this guidance on slide 22, which represents a slight increase relative to prior guidance of $23 million to $27 million. This is due partly to a new project to replace a head box on one of our Lewiston paper machines, which will require some additional downtime. Based on third-party pulp forecasts, we're anticipating around a $50 per ton increase in pulp. As a reminder, we purchase approximately 300,000 tons of pulp each year. CapEx is expected to trend closer to our historical averages of approximately $60 million. Slide 13 outlines our capital structure. We utilized approximately $40 million in free cash flow to reduce our net debt, which included a $40 million voluntary prepayment of our term loans. And our liquidity was $277 million. In the quarter, we refinanced our 2023 notes with a new 2028 note maturity, providing approximately five and a half additional years of tenor at a rate we deemed to be attractive at 4.75%. We also achieved the most amendment to our ABL facility, providing some reporting and other flexibilities. S&P recognized our improving credit trend and removed us from negative outlook. We continue to make strides in reducing our net debt and increasing our financial flexibility. Let me turn the call back to Arson to conclude our call today with clear allotted paper value proposition as we see it and a few concluding remarks. Thanks, Mike. Let's turn to slide 14. I would like to reiterate our value proposition, which we discussed on our previous earnings call and mentioned to investors throughout the quarter. We believe Clearwater Paper is very well positioned across two attractive and complementary systems. Our consumer products division is a leader within a 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, especially during challenging times like today. Second, there are long-term trends away from branded products to private brands. These have typically been amplified during recessions. Private brand tissue share in the US rose 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 the 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 paperboard 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 serve as customers on both coasts. We have a diverse customer base which 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. Third, we believe the business is well positioned to take advantage of trends towards more sustainable packaging and food service products. Lastly, our paperwork 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 as we demonstrated in the third quarter with a net debt reduction of approximately $40 million, bringing our net reduction thus far in 2020 to over $140 million. We intend to continue to deliver by delivering benefits from our Shelby investment, continuing with operational improvements, aggressively managing working capital, and prudently allocating capital. While we expect to have lower tissue shipments in the coming quarters, we're making sound strategic moves to support our customers and their success and continue to position our business for success in the long run. We believe that this strategy is the best way to create value for our equity and debt holders. Before we take your questions, I again want to thank our people for their integrity and commitment to each other, our company, our customers, and our communities during this challenging time for everyone. And to our customers and shareholders, for working with and believing in us. So with that, we will end our prepared remarks and take your questions.

At this time, I would like to remind everyone, in order to ask a question, press 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 Adam Josephson from KeyBank Capital Markets.