Clearwater Paper Corporation

Thank you for standing by. My name is Dina and I will be your conference operator today. At this time, I would like to welcome everyone to the Clearwater Papers second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. I would like to turn the call over now to Sloan Boland, Investors Relations. Sloan, please go ahead.

Thank you, Dina. Good afternoon, and thank you for joining Clearwater Papers' second quarter 2023 earnings conference call. Joining me on the call today are Arsene Kitsch, President and Chief Executive Officer, and Becky Barkley, Corporate Controller and Interim Chief Financial Officer. Financial results for the second quarter of 2023 were released shortly after today's market closed, along with the filing of our 10-Q. You will find a presentation of supplemental information, including a slide providing the company's current outlook, posted in the investor relations page on 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 and in the supplemental information provided on our website. Please note slide two of the supplemental information covering the forward-looking statements. Rather than reread this slide, we are going to incorporate it by reference into our prepared remarks. And with that, let me turn the call over to Arson.

Good afternoon, and thank you for joining us today. As you saw in our press release, we had a great second quarter, which was better than we expected, driven by strong operational execution, lower input costs, and improved tissue margins. Slide 3 of our supplementals provides a summary of our consolidated results. We reported net sales of $525 million and adjusted EBIT of $71 million, which is $8 million higher than the second quarter of last year. Our tissue business drove the improvement by more than doubling its adjusted EBITDA from 19 million in the second quarter of last year to 40 million this year. Let me share a few more highlights with you. Prices increased in both paperboard and tissue as compared to the second quarter of 2022. Lower input costs benefited both of our businesses as compared to the first quarter of 2023, particularly in fiber, energy, and transportation. Operational performance was strong, and we balanced supply and demand to manage our inventories. Tissue private branded share reached an all-time high as consumers continued to look for ways to offset inflation. Our tissue demand remained strong, and we delivered outstanding customer service while improving our supply chain costs. Paperboard demand remained soft as customers reduced their inventories due to slowed consumer spending. And finally, We reduced our net debt by $25 million and repurchased $8 million of shares during the quarter, with $15 million remaining on our buyback authorization. With that overview, let me turn to each of our segments and provide some additional details. Let's begin with our paper board business on slide four. As we noted last year, demand began slowing late in the fourth quarter of last year, with that trend continuing through the second quarter of this year. We believe that this was caused by a slowdown in consumer spending and high inventory levels across the value chain. Industry data reflected these trends, with a 7.1% decrease in operating rates and a 12.6% decrease in shipments year-to-date 2023 versus year-to-date 2022 based on AFMPA data. As further evidence of this trend, RSEI reported a $20 per ton decrease in folding card prices in July. the first decrease in more than three years. Approximately 35 to 40 percent of our volume is under these contracts to be reflected in our financials. While demand remains soft at the beginning of the third quarter, we're expecting an improvement in our volumes in the second half. As I mentioned during our first quarter earnings call, we reduced production in the second quarter to manage our inventories. which resulted in approximately 10% of plant capacity downtime in the second quarter. Our intent is to continue to balance supply and demand for the remainder of the year to get to our targeted inventory levels. While the industry is experiencing a slowdown in demand, we continue to believe that Paperboard is economically resilient, given the end use of the products. Our portfolio in particular skews more heavily towards consumer necessities, such as food packaging, pharmaceuticals, and cosmetics. We also expect the shift to paper-based products to accelerate, with consumers seeking more sustainable packaging and food service products. We believe that this should provide us with more opportunities for growth in the long run. Please turn to slide five for additional comments on tissue. The performance of our business was very strong, with significant improvements in margin driven by higher pricing, higher volume, and lower input costs. Adjusted EBITDA more than doubled year over year and sequentially to $40 million. Input costs eased between the first and second quarter of this year, particularly in pulp, energy, and transportation. Revenue improved by 9% year over year, driven by higher pricing and higher retail shipments. Operating performance was also solid, leading to great customer service results, with an on-time performance rate of over 95% and a fill rate of over 99%. The team delivered these results while maintaining inventories at targeted levels and lowering our overall supply chain costs. Let's turn to some broader market data. Private branded tissue share reached an all-time high of 36.3% in June based on Circana panel data. We believe that consumers are continuing to look for better values in their daily purchases to offset inflation and economic uncertainty. Based on RSEI data from May, tissue capacity utilization rose to 94.2%, which we believe to be a healthy level. We expect continued strength in our tissue business in the coming quarters as we benefit from strong consumer demand, lower input costs, and continued benefits from previously announced price increases. Poll costs have been on a downward trajectory since the first quarter of this year, with RSEI forecasting a continued decline through the rest of the year and relative stability in 2024. As a reminder, it takes approximately three months for changes in poll prices to be fully reflected in our financials. Transportation availability and costs have also improved greatly since last year, with lower line haul rates positively impacting our financials. With that overview, let me introduce our corporate controller and interim CFO, Becky Barkley. Becky is a key leader in our finance team and has long tenured experience in the forest products industry. Thank you, Becky, for supporting us during this transition. With that introduction, I will now ask Becky to discuss our second quarter results in more detail.

Thank you, Arson. Please turn to slide six. The Consolidated Summary Income Statement shows results for the second quarter of 2023 and 2022. In the second quarter of 23, we recorded net income of $29.7 million, net income per diluted share of $1.75, and adjusted net income per diluted share of $1.74. The corresponding segment results are on slide 7. The key takeaway is that on a consolidated basis, the business performed well with lower cost, stronger operating performance, driving a healthy improvement in profitability. Adjusted EBITDA margin rose to 13.6% in the quarter as compared to 12% last year. Slide 8 is a year-over-year comparison of the segment income and adjusted EBITDA for our paper board business. On a year-over-year basis, higher pricing offset higher cost, while lower production volumes impacted cost absorption and our overall cost structure. Slide 14 in the appendix shows a sequential comparison of the second quarter to the first quarter of this year. It reflects a lower sales mix, lower production volumes, with flattening costs. Slide 9 is a year-over-year comparison of segment income and adjusted EBITDA for a tissue business. As Arsene discussed, we are benefiting from previously announced price increases, higher volume, and lower input cost. It is important to note that significant pulp price increases in 2022 did not impact our financials until the second half of the year, leading to a relatively flat cost comparison between the second quarter of this year to last year. Slide 15 in the appendix shows a sequential comparison of the second quarter to the first quarter of this year. It reflects the significant benefits that we are seeing from lower input costs, particularly in PULC, energy, and transportation. Slide 10 outlines our capital structure. Our balance sheet remains very strong and our liquidity improved quarter over quarter, now totaling $313 million. During the quarter, we generated $33 million in free cash flow and reduced net debt by $25 million versus the first quarter. On a year-to-date basis, we generated $3 million in free cash flow. As a reminder, we had negative cash flows during the first quarter due to a higher than normal trade payables balance from the fourth quarter of 2022, as well as typical first quarter outflows. Our net debt to EBITDA ratio was at 2.1 times at the end of the quarter. We used free cash flow to repurchase $8 million of our stock during the quarter. That translates into over 260,000 shares repurchased at an average price of $31.70 per share. We have roughly $15 million left on our share repurchase authorization. Let's now move to slide 11 for an outlook on the third quarter of 2023, as well as some updates to our full-year expectations. Based on the continuing momentum, in tissue and moderating input cost, we expect adjusted EBITDA in the range of $73 to $83 million for the quarter. In terms of our full-year assumptions, we expect that operating results will be favorable relative to 2022 by $42 million due to fewer major maintenance outages and better operating performance. We now expect a benefit of $15 to $25 million due to the impact of previously announced price increases and lower input costs. Lastly, our other key assumptions for the full year remain unchanged. Interest expense should be in the $27 to $25 million range. Depreciation and amortization expense should be $98 to $101 million. Capital expenditures should be between 70 and 80 million, which includes approximately 9 million on our Lewiston recovery boiler tube replacement project and 11 million on the precipitator replacement in Arkansas. As a reminder, the recovery boiler project will require approximately 40 million in total spend, while the precipitator is projected to require 45 million. And finally, our tax rates should be in the mid-20 range. Let me turn the call back over to Arson.

Thanks, Becky. I'd like to conclude the call with a brief overview of how we're prioritizing our capital allocation to create shareholder value. Slide 12 is a framework to our approach. Our top priority is sustaining the competitiveness of our assets. We believe that this requires an average of $60 to $70 million annually. excluding large projects such as the recovery boiler work in Lewiston and the precipitator replacement in Arkansas. Second, we intend to maintain a balance sheet that provides us with financial flexibility. We now have a much stronger balance sheet than we did a few years ago, and we intend to continue to maintain and improve our position. A strong balance sheet provides us with the capacity to take advantage of investment opportunities, including in the potential down cycle. And finally, we will look at various opportunities to create value through return generating investments, opportunistic acquisitions, and returning capital to shareholders. You saw us do that in the second quarter by repurchasing $8 million worth of our shares. We're going to continue to be disciplined allocators of capital and will seek the right opportunities to create value across both of our businesses. The team delivered a strong second quarter and we're optimistic about our business in the second half of this year. Let me close by thanking our people for all that they do to keep our operations running safely and efficiently. I would also like to thank our customers for placing their trust in us and our shareholders for their continued support. With that, we will end our prepared remarks and take your questions.

Thank you. At this time, I would like to remind everyone in order to ask a question, please press star, then the number one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Your first question comes from Paul Quinn from RBC Capital Markets. Paul, please go ahead.

Yeah, thanks very much. Hey, guys. Just maybe start with your consumer product segment. You know, the stats for the second quarter came out this morning. It sort of shows pretty lackluster North American tissue production and drop in operating rates. How are you able to – it sounds like your tissue is going gangbuster, especially in the second quarter. How are you able to out-compete the competition right now?

I think our demand is pretty strong and pretty stable. And as I've mentioned previously, we have no material contract risks this year. So private branded shares up. Our customers, generally speaking, are doing well. And I think we're doing a really good job of supporting them. So we have strong sales. And I think the operating rates in the industry are are also fairly are fairly high. So it's, you know, for us, at least our demand is strong and we're able to we're able to support support that demand.

OK, and then that slide that it gets 15 shows sort of sequential improvement in that $15 million drop in costs. Is that all to do with pulp?

A lot of it is pulp. We're also benefiting from transportation and energy as well in tissues sequentially, but pulp is going to be a big story this year.

Okay. And then, Arson, you mentioned that three-month lag in pulp to really hit the bottom line. So this is really the drop in pulp pricing in Q1 that really comes in to factor that $15 million in Q2?

That's part of the story. So it's, you know, if we go back on pulp, there's two important points there, Paul. You know, the first one is pulp peaked in the second half of last year. And as you mentioned, it takes us approximately three months for that to flow through our P&L. So actually, if you look at the first half of this year versus the first half of last year, our pull prices are actually slightly higher, but we're seeing a meaningful sequential drop in pull prices.

Okay, and then if I just switch over to the paperboard side, you know, you mentioned that drop in folding carton pricing. index pricing. When you mentioned that you're 35% to 40% indexed RISI, is that to that folding carton price or is that to another RISI index price?

I think generally speaking, it's folding carton and cup. I think those are the two prices that RISI indexes. So, depending on the customer and depending on the volume, it's one of those.

Okay, and just on the CapEx projects you've got, I suspect a precipitator down in Arkansas is kind of a maintenance type thing. You're not expected to get any kind of lower costs or benefits as a result of that. What about the recovery boiler? Any pickup in lower costs going forward?

I think generally speaking, both of these are maintenance types of projects. There's probably some mild benefits with a precipitator, but we view that as largely a replacement project. We're replacing something that's decades old, so there should be some better performance coming out of it and better reliability, but largely we view those as the replacement projects.

Okay, then the last question I had just in capital allocation. I mean, you look like your balance sheet's in great shape. When will we purchase a heck of a lot more shares than 263 in the quarter?

You know, Paul, as I mentioned in our framework, I think we take an opportunistic approach to our share buybacks. So we'll, you know, we increase our purchases when we see a better value. So we purchased quite a few more shares this quarter than last quarter. But I'll just leave it at that.

Well, it seems to reckon that given the share price is right about when you purchase the shares in Q2, I suspect you've got quite an opportunity in Q3 as well.

Well, we'll continue to look at that and buy back shares opportunistically, Paul.

I suggest you do. That's all I had. Thank you, Paul.

Ladies and gentlemen, that concludes today's call. Thank you all for joining, and you may now disconnect.