Business context and reporting period
Rayonier Advanced Materials Inc. manufactures cellulose specialties and commodity products for industrial, consumer, and other uses. This unaudited Form 10-Q covers the quarter and nine months ended September 23, 2017; comparisons are with the periods ended September 24, 2016. Dollar amounts below are in millions unless noted.
Financial results and liquidity
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $209.7 | $206.5 | $612.4 | $637.9 |
| Gross margin | $31.2 | $50.5 | $100.9 | $139.6 |
| Gross margin % | 14.8% | 24.6% | 16.5% | 21.9% |
| Operating income | $17.7 | $41.4 | $57.0 | $111.9 |
| Operating margin | 8.5% | 19.8% | 9.3% | 17.6% |
| Net income attributable to company | $15.7 | $21.6 | $29.9 | $61.8 |
| Net income available to common stockholders | $12.2 | $19.9 | $19.8 | $60.1 |
| Diluted EPS | $0.28 | $0.44 | $0.46 | $1.38 |
Quarterly sales rose 1%, but gross margin and operating income fell sharply. Cellulose specialties revenue declined, while higher commodity prices and sales supported commodity revenue. Year-to-date sales fell 4%, reflecting lower cellulose-specialties pricing and volumes; commodity prices improved but volumes declined. Management cited higher chemical and production costs, transformation and market-optimization spending, Hurricane Irma disruption, and Tembec acquisition costs as pressures on operating results. Tembec transaction costs were $5 million in the quarter and $13 million year to date.
Cash provided by operations was $117.6 million for the first nine months, versus $181.2 million; capital expenditures were $44.1 million versus $58.5 million. Adjusted free cash flow, a non-GAAP measure, was $77 million versus $123 million. Cash and cash equivalents were $379.2 million at quarter-end, with $243 million available under the revolving credit facility. Debt was approximately $780 million and the debt-to-capital ratio was 77%, versus 79% at year-end 2016. The company reported compliance with debt covenants. Common dividends declared were $0.07 per share for the quarter.
Material changes, outlook, and notable items
On September 26, after quarter-end, the company paid an additional $268 million of term-loan principal in preparation for the Tembec acquisition. This amount was classified as a current maturity at September 23; after the payment, remaining debt principal was reported as approximately $516 million, before acquisition financing and assumed Tembec debt.
The pending Tembec acquisition was valued at approximately $870 million, including assumption of $481 million of Tembec net debt. The stated funding plan included cash, committed bank financing of up to $680 million, and approximately 8.4 million shares. Closing was expected in the second half of Q4 2017, subject to conditions. The company warned that the deal would increase debt and dilute existing holders; Tembec shareholders were expected to own approximately 13% of the combined company.
For full-year 2017, management lowered expectations after Hurricane Irma and a major customer’s production disruption: cellulose-specialties prices and volumes were expected to decline approximately 4% and 5%, respectively, from 2016, and commodity volumes approximately 9%. Guidance was net income of about $25 million, pro forma EBITDA of about $180 million, operating cash flow of $121–$126 million, and adjusted free cash flow of $80–$85 million. Capital expenditures were expected to be about $50 million plus $5 million of strategic LignoTech Florida spending. Management said the disruption’s impact was expected to be limited to 2017; it also cited continued strength in ethers demand and a competitive acetate market.
A foreign-currency collar used to mitigate Tembec purchase-price exposure generated an unrealized gain of $14.1 million in Q3 and $16.1 million year to date, recorded in non-operating income; it was not designated for hedge accounting. The quarter’s reported earnings therefore include a material non-cash derivative gain. Environmental liabilities for disposed operations were $151.7 million; the company estimated reasonably possible additional exposure of up to approximately $67 million, excluding amounts not currently estimable. It was evaluating Washington State Ecology comments on a remediation plan, with evaluation expected to be completed in Q1 2018. Labor agreements covering about 587 Jesup hourly employees had expired, with negotiations continuing; a work stoppage could materially affect operations. A stockholder class action concerning past statements related to Eastman litigation was pending; the company said it believed the suit lacked merit. The Jesup wastewater permit appeal was also ongoing. The filing states the SEC staff would not recommend enforcement in a separate environmental-reserves inquiry and that matter was considered closed.
Most important facts for investors to verify
- Whether the Tembec acquisition closed on schedule, its final consideration mix and financing, and the resulting leverage, dilution, and integration performance.
- Whether the 2017 guidance was achieved, particularly after Hurricane Irma and the customer disruption, and whether margins and volumes recovered.
- How much of reported earnings came from the non-cash currency-collar gain and acquisition-related costs.
- Whether environmental remediation estimates, including the stated potential additional exposure of up to $67 million, changed after the company’s review.
- Developments in Jesup labor negotiations, the permit appeal, and the stockholder lawsuit.