Clearwater Paper Corporation (NYSE:CLW) Q3 2023 Earnings Call Transcript
Clearwater Paper Corporation (NYSE:CLW) Q3 2023 Earnings Call Transcript October 31, 2023
Operator: Good afternoon. My name is Briana, and I will be your conference operator today. At this time, I would like to welcome everyone to the Clearwater Paper Third Quarter 2023 Earnings Conference Call. Please note that this call is being recorded. All participants are in listen-only mode at this time. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now turn the call over to Sloan Bohlen, Investor Relations. Please go ahead.
Sloan Bohlen: Thank you, Briana. Good afternoon, and thank you for joining Clearwater Paper's third quarter 2023 earnings conference call. Joining me on the call today are Arsen Kitch, President and Chief Executive Officer; and Sherri Baker, Senior Vice President and Chief Financial Officer. Financial results for the third quarter of 2023 were released shortly after today's market close, 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 on 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 rereading this slide, we are going to incorporate it by reference into our prepared remarks. With that, let me turn the call over to Arsen.
Arsen Kitch: Good afternoon, and thank you for joining us today. As you saw in our press release, we had an outstanding third quarter, driven by good operational execution, lower input costs, and continued strength in our tissue business. Slide three of our supplementals provides a summary of our consolidated results. We reported net sales of $520 million and adjusted EBITDA of $81 million in the quarter, which is at the higher end of our expectations and $3 million higher than the third quarter of last year. Our tissue business drove the improvement by more than doubling its adjusted EBITDA from $21 million in the third quarter of last year to $46 million this year. Our paperboard business delivered $52 million of adjusted EBITDA in the third quarter at a margin of 20%, even with the soft demand that we continue to experience.
Let me share a few highlights with you. Prices increased in tissue as compared to the third quarter of 2022 and decreased in paperboard which reflects market trends as reported by RISI. Lower input costs benefited both of our businesses as compared to the third quarter of 2022, particularly in fiber, energy, and freight. We had good operational performance across both businesses as we balanced supply and demand to manage our inventories. Tissue demand continued to be strong, while paperboard remained soft as destocking continued. We reduced net debt by $69 million in the quarter for a total of $416 million since 2020. Taking that $416 million net debt reduction and dividing it by the current share count equates to approximately $24 per share.
We repurchased $5 million of shares during the quarter for a total of $20 million since 2022 with $10 million remaining on our buyback authorization. And finally, last Friday, we started the redemption of our 2025 notes with a combination of a new term loan using cash on hand and drawing on our existing ABL. This further strengthens our balance sheet, creates flexibility and pushes any material debt maturities out to 2028. With that overview, let me turn to each of our segments and provide some additional details. We continued to be agile and adjusted our production to meet demand and manage our inventory levels. We took approximately 10% downtime on our paper machines to balance supply and demand during the quarter. Despite this downtime, the business performed well and generated a 20% adjusted EBITDA margin in the quarter.
As we noted over the last several quarters, demand began slowing late last year. That trend continued into the third quarter of this year. We believe that this softness is driven by a combination of a slowdown in consumer demand and inventory destocking across the value chain. Industry data reflects these trends with a 9.7% decrease in operating rates and a 15.7% decrease in shipments year-to-date 2023 versus 2022 as reported by AF&PA. As further evidence of this trend, RISI has now reported an $80 per ton decrease in folding carton prices in the third quarter, reflecting the first decrease in more than three years. As a reminder approximately 35% to 40% of our volume is now indexed to RISI and it typically takes us up to two quarters for price changes under these agreements to be reflected in our financials.
If we apply an $80 per ton decrease across all our tons, the annualized impact could be greater than $60 million. These decreases are being partially offset with lower input costs and improved operational performance. We remain optimistic about the long-term prospects for paperboard, but given economic uncertainties we foresee a gradual recovery starting next year. RISI is forecasting a 10.5% decrease in total SBS production this year versus 2022, followed by a 4.2% increase in 2024 and a 5.3% increase in 2025. Please turn to slide five for additional comments on tissue. The performance of our tissue business was very strong. Revenue improved by 8% year-over-year, driven by higher pricing and higher retail shipments. Adjusted EBITDA margin improved to 18%, due to higher pricing and lower input costs, particularly in pulp, energy, and transportation.
With roughly a quarter of our contracted customer volume tied to the RISI pulp index and with lower pulp costs, we're expecting a $4 million to $6 million headwind per quarter moving forward. Even with that impact, we are optimistic that we can retain most of the margin improvement captured as we head into 2024. Let's turn to some industry data. RISI recently reported that tissue capacity utilization is around 94% so far this year, which we believe represents a healthy supply and demand balance. This supports our view that tissue industry conditions are improving. Let's look at some of the high level capacity trends that are driving these numbers. Between 2018 and 2020, nearly 450,000 tons of tissue capacity were added, primarily targeting the private branded space.
That increased supply outpaced demand growth. Between 2021 and 2023, more than 180,000 tons of capacity were reduced. We now believe that around 300,000 tons of capacity will come online between 2024 and 2026, which roughly matches demand growth over that same time horizon. Given these dynamics, we are optimistic that our tissue business will perform well in the near to medium-term. With that overview, let me introduce our new CFO, Sherri Baker. Sherri joined us in August and has hit the ground running. She brings significant experience building and leading finance teams and an extensive background in strategic, financial, and operational decision-making. I'm looking forward to working with Sherri to continue our focus on strengthening our company and creating shareholder value.
Sherri Baker: Thank you, Arsen. I'm excited to be joining the Clearwater Paper team and look forward to working with you, our Board, and our people to continue improving our performance, growing the business and creating shareholder value. Let's cover our financial performance in the third quarter by turning to slide six. The consolidated summary income statement shows results for the third quarter of 2023 and 2022. In the third quarter of 2023, we reported net income of $36.6 million, net income per diluted share of $2.17, and adjusted net income per diluted share of $2.19. The corresponding segment results are on slide seven. The business performed very well on a consolidated basis, with lower input costs and strong operating performance driving a healthy improvement in profitability.
Adjusted EBITDA margin rose to 15.5% in the quarter as compared to 14.3% last year. Slide eight is a year-over-year comparison of segment income and adjusted EBITDA for our paperboard business. The business delivered $52 million of adjusted EBITDA in the quarter with a 20% margin. On a year-over-year basis, lower sales and production volumes impacted cost absorption, which was partially offset by lower input costs. Slide 14 in the appendix shows the sequential comparison of the third quarter to the second quarter of this year. It reflects a lower sales price and mix, flattening volumes, and reduced costs. Slide nine is a year-over-year comparison of segment income and adjusted EBITDA for our tissue business. As Arsen discussed, we are benefiting from previously announced price increases, higher volumes, and lower input cost.
The business delivered $46 million of adjusted EBITDA in the quarter with an 18% margin. As noted on this slide, in the third quarter, we saw the benefit from lower pulp price as it flowed through to our income statement. Slide 15 in the appendix shows a sequential comparison of the third quarter to the second quarter of this year. It reflects the benefits that we are seeing from lower input costs, particularly in pulp. Slide 10 outlines our capital structure. Our balance sheet remains very strong and our liquidity improved quarter-over-quarter, now totaling $370 million. During the third quarter, we generated $74 million in free cash flow and reduced net debt by $69 million versus the second quarter. On a year-to-date basis, we generated $76 million in free cash flow.
Since 2020, we have reduced our net debt by over $416 million. We announced last Friday the addition of a new revolving term loan with borrowing capacity of $270 million. The initial draw on this facility is $150 million. We will use these funds along with cash on hand and drawing on our existing ABL to extinguish our 2025 notes. This new agreement extends any debt maturities to 2028. Given the redemption process for the existing 2025 notes, we will fully extinguish the 2025 notes in late November. The initial draw on the facility is fixed for one year at 9.13%. The revolving credit covenants are similar to our existing ABL and the loan is secured by plant property and equipment. With this new agreement in place, we have strengthened our balance sheet and improved our financial flexibility.
At the end of the third quarter, our net debt to EBITDA ratio was at 1.8 times. We used free cash flows to repurchase $5 million of our stock during the quarter. That translated into over 150,000 shares repurchased at an average price of $33.36 per share. Since we re-instituted the program back in 2022, we have repurchased 614,000 shares at an average price of $32.70 per share. We have roughly $10 million left on our share repurchase authorization. Let's now move to slide 11 for an outlook on the fourth quarter of 2023, as well as some updates to our full-year expectations. With the expected impact of lower market pricing for paperboard, continued soft paperboard demand, and a planned major maintenance outage in our Arkansas mill, we expect adjusted EBITDA in the range of $60 million to $70 million in the fourth quarter.
For full-year 2023, we expect adjusted EBITDA in the range of $278 million to $288 million. This is up from adjusted EBITDA of $227 million in 2022, driven by fewer major maintenance outages, improved operating performance, higher pricing, and lower input costs. Lastly, our other key assumptions for the full year remain unchanged. Interest expense should be in the $28 million to $30 million range. Depreciation and amortization expense should be $97 million to $100 million. Capital expenditures should be between $70 million 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 of total spend, while the precipitator is projected to require $45 million.
And finally, our tax rate should be in the mid 20% range. Let me now turn the call back over to Arsen.
Arsen Kitch: Thanks, Sherri, We have previously discussed our prioritization for capital allocation to create shareholder value. Slide 12 is the framework for our approach. Our top priority is sustaining our assets, followed by maintaining a strong balance sheet and finally evaluating value creating opportunities including returning capital to shareholders. I would like to now spend a few minutes sharing some thoughts about the broader strategy for both of our businesses. To start, operating performance matters greatly in both segments and it's critical to meet customer needs. We have made significant progress over the past few years, improving our operations and becoming a more competitive player in both of our businesses. But given the capital intensive nature of our industry, we believe that scale is needed to be able to invest and grow.
In paperboard, we believe that we're uniquely positioned to become a supplier of choice to independent converters across multiple substrates and product categories. To do that, we will explore offering additional paperboard products such as lightweight FBB, white top poly pre-cup stock, additional recycled grades and other products that meet the needs of our customers. We're currently conducting engineering studies to evaluate the feasibility of investing in our existing assets to expand our product offering. We may also be opportunistic buyers of paperboard mill assets across SBS and other substrates. Our long-term goal is to build a scaled, high performing and diversified paperboard business that is well matched to the needs of independent paperboard converters in North America.
In tissue, we believe that consolidation is needed given the consolidated customer landscape and the fragmented supplier base. The top three or four retailers in the U.S. now account for more than half of the private branded tissue market. Given the size and demands of these customers, private branded tissue manufacturers need to -- need scale to deliver the right combination of cost, quality and service. In addition, manufacturers need scale to be able to make sizable long-term investments in new capacity to keep up with the growth of these retailers. We believe that recent improvements in the tissue industry could facilitate the creation of a scaled private branded tissue manufacturer. As we stated previously, we are willing to participate in this consolidation under the right market conditions and appropriate values.
To be clear, any internal or external investment decisions will be balanced with our goal of maintaining a strong balance sheet and financial flexibility through the cycle. 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. In summary, we have spent significant efforts over the last several years improving our operating performance, especially in areas that matter most to our customers. We have also greatly improved our financial position by focusing on cash flow generation and debt reduction. We are now well-positioned to look at all strategic options for our company to grow and create value for our shareholders. 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.
Operator: [Operator Instructions] Your first question comes from Matthew McKellar with RBC Capital Markets. Your line is open.
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