Clearwater Paper Corporation (NYSE:CLW) Q3 2022 Earnings Conference Call October 31, 2022 5:00 PM ET
Company Participants
Sloan Bohlen – IR
Arsen Kitch – President and CEO
Michael Murphy – CFO
Conference Call Participants
Adam Josephson – KeyBanc Capital Markets
Paul Quinn – RBC Capital Markets
Mark Wilde – BMO Capital Markets
Operator
Good afternoon. My name is Dennis, and I will be your conference operator today. At this time, I would like to welcome everyone to the Clearwater Paper Third Quarter 2022 Earnings Conference Call. All lines have been placed on mute, to prevent any background noise. [Operator Instructions]
I would now like to turn the conference over to Sloan Bohlen, Investor Relations. Please go ahead.
Sloan Bohlen
Thank you, Dennis. Good afternoon, and thank you for joining Clearwater Paper’s Third Quarter 2022 Earnings Conference Call. Joining me on the call today are Arsen Kitch, President and Chief Executive Officer; and Mike Murphy, Chief Financial Officer; Financial results for the third quarter 2022 were released shortly after today’s market close, along with the filing of our 10-Q. You will find the presentation of supplemental information, including a slide providing the company’s current outlook posted on the Investor Relations page of 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 our supplemental information covering forward-looking statements, rather than rereading this slide, we are going to incorporate it by reference in our prepared remarks.
With that, let me turn the call over to Arsen.
Arsen Kitch
Good afternoon, and thank you for joining us today. Before reviewing our third quarter earnings, I wanted to wish everyone a safe and enjoyable Halloween.
Please turn to Slide three. We had a great third quarter, which exceeded our expectations. On a consolidated basis, we reported net sales of $539 million, which was 20% higher than prior year. Adjusted net income was $31 million and adjusted EBITDA was $77 million. Let me share a few highlights.
Both paperboard and tissue demand were strong with increased pricing in both businesses. Inflation remained a headwind across most of our input costs, particularly in pulp, fiber, chemicals and energy.
In addition to price increases, we continue to improve our operating performance to help mitigate the impact of rising costs. We reduced net debt by $6 million in the quarter and $106 million in the first nine-months of the year. We also repurchased $25 million of our outstanding notes due in 2025. And finally, we repurchased $1 million of shares during the quarter for a total of $5 million in the first nine-months of the year. We have $25 million remaining on our buyback authorization.
With that, let’s discuss some additional details about both of our businesses. Let’s start on Slide four with a few comments on our paperboard business. The industry continues to experience strong demand with higher SBS pricing as reported by RISI. Since the beginning of 2021, RISI has reported price increases for the U.S. market that totaled $500 per ton. $250 of increases were reported in 2022, including $20 per tonne in September and $30 in October.
As a reminder, it typically takes us up to two quarters for price changes to be reflected in our financials. It is also worth noting that our portfolio includes additional grades and price mechanisms that are not reflected in RISI’s reporting. We’re monitoring economic trends, given concerns about a global economic slowdown.
Our backlogs remained stable with continued strong demand. Even with the economic uncertainty, we continue to believe that the overall industry demand is robust, as evidenced by RISI’s reported price increases a few weeks ago.
Now please turn to Slide five for some additional comments on our tissue business. The underlying operating performance of our tissue business was very strong, and we continue to observe consumers shifting their demand to our private branded tissue products to help offset inflation. Private branded dollar share of the tissue market climbed to over 35% in September, which is an all-time high.
We shipped 12.6 million cases in the third quarter matching our second quarter shipments and slightly above the third quarter of last year. We believe that we are well positioned to support our customers and their shoppers during this time of economic uncertainty. We recognize that inflation has outpaced price increases in tissue in 2021 and 2022, and we’re diligently working to recover our margins. We’re implementing recently announced price increases that will provide additional benefits in 2023 and are working diligently to continuously lower our cost position.
As discussed in previous quarters, both of our businesses continued to see substantial inflation in the third quarter. In addition to price increases, we continue to focus on improving our operating and supply chain performance. Our focus on pricing and productivity is helping to offset the inflationary headwinds that we cannot control.
I will now ask Mike to discuss our third quarter results in more detail.
Michael Murphy
Thank you, Arsen. Please turn to Slide six. The consolidated company summary income statement shows third quarter for 2022 and 2021. In the third quarter 2022, our net income was $20.6 million. Net income per diluted share was $1.21, and adjusted net income per diluted share was $1.83. We exceeded our third quarter adjusted EBITDA expectations with solid operating performance, strong pricing, lower-than-anticipated natural gas prices and deferred maintenance expenses.
In the third quarter, we effectively settled an open IRS product, which resulted in the reversal of certain net tax credits related to our Lewiston pulp investment from five years ago and increasing our taxes by approximately $8 million in the quarter. The corresponding segment results are on Slide seven.
Slide eight is the year-over-year adjusted EBITDA comparison for our pulp and paperboard business in the third quarter. We benefited from our previously announced price increases, which were partially offset by higher inflation across our spend categories. You’ll recall in the third quarter of 2021, we took a major maintenance outage that impacted adjusted EBITDA by $5 million. There was no outage in the third quarter of 2022. You can review a comparison of our third quarter 2022 performance relative to our second quarter on Slide 14.
Please turn to Slide 9, where we provide a year-over-year comparison for our tissue business in the third quarter. In addition to the implemented price increases, we realized some mix benefit in the quarter. Our production was higher than last year while we were curtailing production to reduce inventory and meet demand, and our sales were modestly higher than last year. These benefits were largely offset by higher costs due to inflationary pressures. You can review a comparison of our third quarter 2022 performance relative to the second quarter on Slide 15.
Slide 10 outlines our capital structure. Our liquidity was $297 million at the end of the third quarter. We reduced net debt by $6 million with our free cash flows in the quarter. We utilized free cash flows and liquidity to repurchase $25 million of our notes that mature in 2025, reducing net principal amount to $270 million.
Additionally, we used approximately $1 million to repurchase 30,000 shares for approximately $34 a share. This increases the total repurchased under our existing stock repurchase program in 2022 to approximately $5 million, with 150,000 shares purchased at an average price just above $33 per share.
We have $25 million remaining on the authorization. We updated our target capital expenditures to $60 million to $70 million per year, absent major projects to reflect the impacts of inflation. Our net debt to adjusted EBITDA at the end of the third quarter of 2022 was 2.0 times, and net debt was $494 million. Additionally, S&P raised our outlook from stable deposits during the third quarter.
Slide 11 provides a perspective on our fourth quarter 2022 outlook and the resulting full year guidance. Our expectations assume that we continue to operate our assets without significant disruptions. We want to reiterate that our price realization and inflation will continue to be difficult to predict. Our current expectation for the fourth quarter is adjusted EBITDA of $38 million to $48 million. The midpoint of that range for the fourth quarter is $34 million lower than the third quarter adjusted EBITDA of $77 million. This is largely due to our planned major maintenance outage.
As a reminder, we had no major maintenance outages in paperboard in the third quarter and expect that the fourth quarter outage will impact adjusted EBITDA by $21 million to $25 million. This is modestly higher impact than previous expectations.
Previously announced price increases are expected to positively impact us during the quarter by $5 million to $9 million. We expect inflation, particularly pulp, fiber, chemicals and energy to cost us an additional $7 million to $11 million. We experienced production issues at our paperboard mills in October, reducing both our pulp and paperboard production and impacting EBITDA by approximately $5 million. Additionally, the fourth quarter tends to be seasonally soft for tissue volumes with retailers focusing on holiday items in their stores.
Our adjusted EBITDA for the first three quarters of 2022 was $199 million and when combined with our fourth quarter guidance, we expect the full year adjusted EBITDA to be $237 million to $247 million, significantly higher than our adjusted EBITDA of $175 million in 2021.
Here are some of those building blocks that compare expected 2022 performance relative to last year. We expect a full year pricing benefit of $274 million to $278 million, which is near the high end of our prior guidance. Commodity cost inflation, including pulp, fiber freight, chemicals and energy is expected to be $187 million to $191 million, which is at the low end of our previous expectations. We expect labor inflation, net of cost mitigation efforts to be approximately $10 million.
We expect growth in converted tissue volume. However, the volume benefits will largely be offset by higher supply chain costs. In our paperboard business, planned major maintenance outages are expected to have a slightly higher financial impact. We are also anticipating the filing for 2022.
Interest expense between $34 million and $36 million, depreciation and amortization between $101 million and $104 million, capital expenditures of around $30 million to $40 million. This is lower than our expected target expenditure levels of $60 million to $70 million. Over the last three years, we’ve cumulatively underspent our target by over $60 million. And you should expect that we will spend over the next several years above that targeted $60 million to $70 million range.
We expect to update you during the fourth quarter earnings call on the timing of the Lewiston recovery boiler tube replacement project, which is expected to require a capital once approaching $40 million and an estimated adjusted EBITDA impact of $30 million. We expect to spend $5 million out of the $40 million capital expenditures in 2022. Our effective tax rate for the full year is expected to be 34% versus the typical rate of 26% to 27%. That rate is being impacted by the reversal of net tax credit taken in 2017 through 2019.
Additionally, our current cash expectations for future years assumes that cash taxes will exceed our statutory taxes as we benefited from accelerated depreciation related to the Shelby expansion and Lewiston pulp optimization projects.
Let me turn the call back over to Arsen.
Arsen Kitch
Thanks, Mike. I want to spend a few minutes discussing our key priorities for shareholder value creation. Since becoming CEO in 2020, we are focused on generating free cash flow, deleveraging our balance sheet and improving financial flexibility. We have recently achieved our leverage target and believe that now is a good time to share our capital allocation framework. This framework has been shaped by investor and analyst input together with a robust dialogue with our Board.
Slide 12 offers a visual depiction of our framework, which is prioritized from top to bottom. Our first priority is to sustain our asset base, which we believe requires an average of $60 million to $70 millions of capital expenditures annually, excluding large projects. We expect to invest above that target level in the near to medium term.
Second, we intend to maintain a balance sheet that provides us with financial flexibility. While we believe that a long-term leverage ratio of 2.5 is appropriate, we may continue to deleverage further to create greater financial flexibility to take advantage of investment opportunities that will create shareholder value in a potential down cycle.
Third, we will evaluate value-accretive internal and external investments. These investments should be strategic in nature and clearly add value by realizing near-term cash flow benefits.
Given the current business environment, we’re likely to prioritize incremental cost reduction projects and add-on acquisitions versus large greenfield or brownfield capacity expansions.
Fourth, we expect to buy back shares to mitigate the impact of dilution from share grants to our employees. We will also be opportunistic with additional share repurchases depending on our share price levels. I would like to emphasize that we will continue to be disciplined allocators of capital, and we’ll seek out the right opportunities to create value across both of our businesses.
In closing, I would like to thank our people for all that they do to keep our operations running safely and efficiently and for servicing our customers. I also want to thank our shareholders for their continued support and our customers for placing their trust in us.
With that, we will end our prepared remarks and take your questions.
Question-and-Answer Session
Operator
[Operator Instructions] Your first question is from the line of Adam Josephson with KeyBanc Capital Markets. Please go ahead.
Adam Josephson
Arsen and Mike, good afternoon. Congratulations on another really good quarter. Arsen, just on the third — your third quarter performance, obviously, you topped your EBITDA guidance. I assume that was mostly or entirely related to higher paperboard prices and demand and I assume the same goes for the implied full year guidance going up by, call it, $10-ish million. Am I right in thinking that? Or if not, what were the sources of upside relative to your EBITDA guidance in the quarter?
Michael Murphy
So it was a range of things, Adam. First and foremost, we had really good operational performance relative to our expectations. Tissue performed very well from a production standpoint and paperboard as well. So I’d say that was the biggest lever relative to guidance. Pricing across the portfolio was probably the second biggest lever for the outperformance. Third one was natural gas prices, which has been pretty difficult to predict the three months ago, the forward curves look pretty ugly. That came down since then. That would have been the third lever.
And then we also noted that we deferred some of our planned maintenance expenses in the quarter to the future. Those would be the four primary buckets, Adam, where we’d be relative to our guidance.
Adam Josephson
Okay, thank you, Mike. I appreciate that. The production issues in October, you mentioned the Pulp and Paperboard, can you be any more specific as to what that was? And I assume that you’re not expecting those to persist into November?
Michael Murphy
Yes. We’re not going to get into the details, but they impacted both mills pulp production in one of the mills and paperboard production at the other mill. We’re still, frankly, working through those issues. So $5 million is an impact that we expect across the quarter, although we think the majority of that impact happened in the month of October, we’re working through them. It’s something we’ll get through and we’ll get back on track, but we thought it was important to call it out here early as it is having an impact on our quarter.
Adam Josephson
I appreciate that. And just a couple more from me. One is towards the end, you mentioned you’re not inclined toward any large greenfield capacity additions as part of your capital allocation strategy which begs the obvious question, you’re pretty much at capacity in your paperboard business. I mean, you’re producing 800,000 tons a year, which is precisely what your paperboard capacity is. If you’re not going to invest in new capacity, how would you be able to grow? I mean where — do you have the capability to grow in your paperboard business? Or are you at capacity? How do you think about growing that business in the future absent any major capacity additions?
Arsen Kitch
So Adam, you’re right. We’ve been at capacity, and we’ve been operating full for a while. Two ways to do that in paperboard. I think the first one is making I would say, medium-sized investments in the mills to improve throughput and increase production. That’s not any paper machine. That’s incremental production to drive some growth. And then we’d be looking externally for acquisition opportunities. And we’re not going to get into a lot of details of what those could look like, but we certainly see potential and some options on the horizon for us to pursue growth through acquisitions.
Adam Josephson
I appreciate that. And just one last related one, which is that there’s been a lot of talk about all the FBB capacity additions that have been announced in Asia and Europe and in the U.S. for that matter, and even some of the U.S. producers are running FBB trials. How are you thinking about the growth in FBB imports, the FBB capacity additions that have been announced? And what long-term impact that might have on your domestic SBS business?
Arsen Kitch
There has been a lot of discussions about FBB recently. So FBB been in this market for many years. We believe there’s about 0.5 million tons of imports and that’s been relatively low for some period of time. I think through this last couple of years, a lot of our customers recognize the benefits of having a domestic supply chain. So I think that’s part of the answer. And the second part is, this is still predominantly an SBS market. And FBB applications require different type — it require different converting processes and for converters to change they run their operations.
So at least I think in the near to medium term, don’t know exactly how those — how the capacity additions will impact imports into the U.S., but they’ve been around for a while. I think domestic FBB production potentially offset some of those imports. But we’re working through various scenarios and planning for how we would react and what we would do.
Adam Josephson
Yes, thanks so much, Arsen.
Operator
Your next question is from the line of Paul Quinn with RBC. Please go ahead.
Paul Quinn
Yes, thanks very much, guys. Just wondering about in terms of your Q4 guidance, have you got — are you assuming that price increases that you’re seeing on both the treatment Board and the tissue side are going to offset the cost inflation you’re seeing?
Michael Murphy
No, I think we had a little bit of a timing issue, Paul. So it’s a good question. Our price increases are going to be just below what we think our raw material cost inflation is going to be. So pricing give you a range, and this is a sequential up $5 million to $9 million. And then from our raw material and freight inputs, that’s going to be up $7 million to $11 million. So a mild margin compression that we’re going to see from the third quarter to the fourth quarter.
Paul Quinn
Okay. That’s helpful. And then on the costs themselves, are you seeing any relief on freight yet?
Michael Murphy
Freight, yes. We saw that a little bit in the third quarter heading into the fourth quarter. So I think that’s 1 area that we’re seeing a positive comparison at least on a sequential basis.
Paul Quinn
And at this fact, you’re starting to see something on pulp, but nothing on energy yet?
Arsen Kitch
Yes. I think on pulp, it’s a tough one because it’s — we saw a little bit of easing on softwood, very minor here into October. Eucalyptus is holding pretty firm. I think if you look back at the forecast into the second half of this year, the forecast we’re indicating an easing in pulp prices. We obviously haven’t seen that. If you look at the forecast into ’23, I think most of them are assuming decreases in pulp pricing. But at this point, I think we’ve been wrong for several years. But we’re at least it’s good to see some easing on softwood. We’re hoping we’re peak, and we’ll see some relief in the coming quarters.
Paul Quinn
Okay. And then just on major maintenance, I mean I see that sort of that slide at the end, saying $35 million to $40 million in ’23, but it could also be postponed to ’24? Or how do you think about ’24 or are we due for another zero major maintenance for the year?
Michael Murphy
Sure. Good question, Paul. So Slide 20, just to clarify, there’s two separate potential outages in 2023. So we’ve called out one that’s in the fourth quarter, that’s about a $5 million outage. The other one, this is related to Lewiston, and this is the screen tube replacement project. And on this one, Paul, we need to get into our outage in Lewiston for the fourth quarter here of 2022, which is going to commence in about a week.
And as we finish up that outage, we’ll be in a much better position to choose which time frame we’re going to take the 2023 or ’24 outage. So this is either late in 2023 or early in 2024, depending upon both the states of the screen tubes, the availability of contractors and the availability of materials.
Paul Quinn
Okay. That’s great. So assuming that you’re going to push through to the — do the screen tubes in ’23. What does the preliminary ’24 look like? Does that cover off Lewiston for a year and then you’re back just basically on cyber defense?
Michael Murphy
Too early to speculate, Paul, but we will anticipate your question when we’re ready to give you guidance on the next outage at the Lewiston once we get through this one here in November.
Paul Quinn
Okay, fair enough. That’s all I had. Thanks.
Operator
Your next question is from the line of Mark Wilde with BMO Capital Markets. Please go ahead.
Mark Wilde
Thanks. Good morning — good afternoon, Arsen and Mike. First one just a kind of a detailed question. The — on Slide number 11, you’ve got major maintenance outage at Lewiston listed is $19 million to $23 million. I think during the commentary, I heard that number go up by a couple of million bucks. Can you just — can you help us with that?
Michael Murphy
Yes. Good question there. I’d have it at the higher end, they’re closer to that $23 million for the major maintenance outage.
Mark Wilde
Okay. All right. And then I think you’ve already talked about sort of what we should expect in pricing in terms of kind of $5 million to $9 million quarter-to-quarter. Is that correct across both of the businesses?
Michael Murphy
Correct.
Mark Wilde
Okay. And is there anything, Mike, outstanding right now, Mike or Arsen, in terms of any contract renewals that you’re working on?
Arsen Kitch
I think we’ve got through the material ones in ’22. I think as you look at — as we look at ’23, it’s a more normal year for us. So the normal risk that we have going into any year, and frankly, we feel pretty good about next year. I think we have opportunities to both optimize and grow our business in tissue.
Mark Wilde
Okay. And Arsen, over the last couple of years, you’ve been quite clear about sort of the need for kind of change in the tissue market and potentially some consolidation. What’s your read on the situation right now?
Arsen Kitch
We still stand by those comments. I think we still — consolidation still needed to improve scale and cost and returns. From our standpoint, we want to make sure we have a strong balance sheet so we can play whatever role we need to play in that consolidation. Right now, margins are depressed in the tissue business and capital markets are somewhat turbulent. But I think we’re well positioned to play a role in that consolidation on both sides.
Mark Wilde
Okay. All right. And then the last one for me, just when you talked about sort of investing kind of incrementally on the two sides of your business. How do you think about sort of tissue versus packaging? And then in packaging, you’ve historically been not integrated in that business. Maybe just any thoughts about investing downstream and packaging?
Arsen Kitch
So first part of your question, I think we’ll be driven by value creation, and we’ll be opportunistic. So I think we’re willing to invest in both sides of our business if we can create value. In terms of packaging, you’re right, we’ve been independent, and that’s part of our value proposition to our customers is that we are focused on them through the ups and downs of the paperboard market. We’re going to — we have and will continue to evaluate if that’s still the right strategy in the long run. But that’s a strategy that we’ve had now for since we’ve become a public company, in 2008, and that’s part of our value proposition. But certainly, we’ll be looking at all options in the coming years to make sure that all of our strategies still makes sense.
Mark Wilde
Okay. And just finally, you talked about the potential look at kind of medium-sized moves on the mill side in SBS. Would it be fair to assume that, that could involve sort of mill or could undergo conversions or might be kind of in the midst of conversions?
Arsen Kitch
No, I think we’ll be open-minded and we’ll look at opportunities where we think we can strategically make sense for us. The quality of the asset is there or has the potential to be there. And the third part is creating optionality for us down the line to create a, I would say, a more scaled and a better paper for business that’s more relevant to our customers.
Mark Wilde
Okay, all right. Sounds good. I’ll turn it over. Thank you.
Operator
Today’s final question is a follow-up from the line of Adam Josephson with KeyBanc Capital Markets. Please go ahead.
Adam Josephson
Thanks, Arsen and Mike, I appreciate it. Just to follow up on one of Mark’s questions about in which segment you’d be more inclined to invest in the years to come. I mean I understand looking at value Arsen, but all else equal, would you be more inclined to invest in paperboards just given the superior market structure or not necessarily for any number of reasons?
Arsen Kitch
So Adam, it’s a good question. I think there’s a number of factors involved. I mean the first obvious one is value creation potential. And then looking at strategic fit, looking at quality of assets. So it’s hard to say that we can find more opportunities on one side of the business or the other. I think it’s going to be siting specific as we look at the potential for growth. You’re absolutely right. We’ve enjoyed a great — we’ve enjoyed good paperboard margins over the years, and tissue is more challenged. But I think each situation is going to be unique. So I think we’ll continue to be opportunistic and look at both sides of the business.
Adam Josephson
No, I appreciate that. Mike, in terms of the CapEx, you mentioned that in the next few years, you’ll be spending above that $60 million to $70 million, just given the degree to which you’ve underspent in recent years. Can you give me some order of magnitude, rough expectations over the next 2, 3, 4 years, whatever you might be thinking along those lines?
Michael Murphy
I think the right way to model it, Adam, is just on average to be in that $60 million to $70 million of codes. So you took the under spend over the last few years, you project that forward as something that will be a bit higher. And when you look at a company like ours, we’re rather small, and so things become a little more episodic. So as an example, the recovery boiler number 5 at Lewiston that project, that’s going to add to that regular way capital expenditures that we have, and that’s something that you should incorporate into your models here for the next couple of years.
Adam Josephson
Yes. No, I appreciate that, Mike. And just thinking about next year, obviously, we don’t know the timing of the major maintenance next year, whether it will be all next year or in 2024. That aside, is there anything that we ought to be aware of as we’re thinking about ’23 versus ’22 at this admittedly early stage?
Michael Murphy
So we want to shy away from giving guidance for 2023. I think what we’ll look to do on the year-end earnings call in February to start giving you those building blocks like we’ve customarily done. But we’ll hold off until then.
Adam Josephson
Yes. No, fair. And just one last point of clarification on the price/mix guidance for the year, the increase of — I think it went up by $11 million. Was that all paperboard? And was that all the September, October SBS increase? Or was that also partly related to previous price increases?
Arsen Kitch
So it’s both businesses. We’re implementing previously announced price increases in both tissue and paperboard. And I think we mentioned on the call, we’ll see benefits from the tissue price increases going into next year. I think if you look at the average selling price on tissue that has been on an upswing. So we are we’re optimistic in our ability to recover those margins from inflation in tissue, although we still have some ways to go.
Adam Josephson
Yes. And Arsen, actually one last 1 before I let you go. You mentioned private brand market share is now above 35%, and obviously, consumer buying behaviors being affected. Can you just give us a little more insight into what you see happening and how high perhaps that private brand market share could go given the pressure that some consumers are under?
Arsen Kitch
Yes. So we’ve seen — so Adam, we’ve seen private brands gain share even when the economy was in really good shape. And so — but we do think there’s an acceleration that’s happening here with inflation and the economic uncertainty. And what we’ve said previously, if you look at some European markets, private branded shares north of 50%.
And there are categories in the North American markets and on the grocery aisles that are north of 50% as well. So do I think we’ll get to 50% here in the near term? That’s probably a bit of a stretch. But I think there’s still plenty of runway to gain for private brands to gain share. We have also noticed consumers gravitating towards lower-cost items, smaller pack sizes. So some of that is happening. But I think that remains to be seen exactly how consumers behave in heading into next year.
Adam Josephson
Thanks so much, Arsen.
Operator
Thank you all for joining. That does conclude today’s conference call. You may now disconnect.
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