Clearwater Paper Corporation — Q2 2019 Form 10-Q
Business context and reporting period
Clearwater Paper manufactures consumer and away-from-home tissue, parent rolls, bleached paperboard and pulp. This unaudited report covers the quarter and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods.
Financial performance
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net sales | $452.0 million | $432.1 million | $880.8 million | $869.1 million |
| Operating income | $15.3 million | $18.4 million | $29.7 million | $29.9 million |
| Net earnings (loss) | $(0.4) million | $7.0 million | $3.4 million | $9.6 million |
| Diluted EPS | $(0.03) | $0.42 | $0.21 | $0.58 |
| Adjusted EBITDA | $43.9 million | $43.8 million | $83.8 million | $84.9 million |
Q2 sales rose 4.6%, but operating margin narrowed to 3.4% from 4.3%; cost of sales increased to 90.7% of sales from 89.6%. Higher sales did not offset higher production and financing costs, and the quarter ended in a net loss. First-half operating margin was 3.4% in both years, while net earnings declined.
- Segments: Q2 Consumer Products sales were $224.3 million, with a $5.1 million operating loss, versus a $3.6 million loss a year earlier. Pulp and Paperboard sales rose to $227.7 million from $210.5 million, while operating income eased to $33.6 million from $34.2 million. For the first half, Consumer Products sales fell to $447.7 million and its operating loss widened to $3.9 million; Pulp and Paperboard sales increased to $433.1 million and operating income rose to $63.0 million.
- Cash flow: First-half operating cash flow was $14.7 million, down from $110.9 million. Working capital absorbed $50.1 million, versus a $36.3 million source in 2018, primarily reflecting higher receivables and inventory and lower payables. Investing cash outflow was $108.4 million, including capital expenditures; financing cash inflow was $113.0 million, largely from net short-term borrowings.
- Liquidity and debt: At June 30, cash and restricted cash totaled $43.2 million on the balance sheet ($44.3 million including restricted cash reported in other assets). Current assets were $519.1 million and current liabilities $543.7 million. Short-term debt was $235.0 million and long-term debt $671.7 million, totaling approximately $906.7 million. The company reported $57.2 million of additional borrowing availability under its then-existing facilities and compliance with debt covenants at quarter-end.
- Margins and costs: Q2 cost pressures included purchased pulp, maintenance, depreciation and Shelby startup costs. First-half purchased pulp and energy costs increased; lower transportation and chemical costs partly offset them. Net interest expense rose to $10.9 million in Q2 from $7.7 million and to $19.4 million in the first half from $15.7 million.
Material changes, outlook and risks
- Production began on the new tissue machine at Shelby, North Carolina, during Q2. The project’s stated estimated cost is approximately $360 million for the machine, converting equipment and buildings, plus approximately $60 million for warehouse expansion. Full production run-rate is expected in late 2020; ramp-up has increased labor, operating, energy and inventory costs. First-half construction-related spending at Shelby was $50.2 million.
- Management expects cash on hand, operating cash flow and borrowing capacity to cover debt service, operations, capital expenditures and working capital needs for the next 12 months, while noting uncertainty from competitive and cyclical markets. Planned major maintenance costs were estimated at $16–$19 million at the Idaho facility in Q3 and $7–$8 million at Arkansas in Q4 2019.
- On July 26, 2019, after quarter-end, the company refinanced its secured revolving facilities with a $300 million term loan, fully advanced at closing, and a $250 million asset-based revolving facility, of which $58 million was advanced. The term loan matures in 2026 and the ABL facility in 2024. The ABL fixed-charge coverage covenant applies when availability falls below a specified threshold; management expected compliance but warned deterioration could create risk.
- The company reported material weaknesses in internal control over financial reporting that remained unremediated at June 30, 2019; disclosure controls were therefore deemed ineffective. Management said the financial statements fairly present results in all material respects and described continuing remediation work.
- Other disclosed risks include competitive pricing and capacity, customer order or pricing changes, Shelby production ramp-up and customer acceptance, input cost and supply volatility, manufacturing disruptions, debt service and covenant compliance, pension obligations, and environmental and cybersecurity risks. No material changes to previously disclosed risk factors were reported. Management said pending legal matters were not expected, in the aggregate, to materially adversely affect financial condition.
- The filing reports a Q2 estimated annual effective tax rate of approximately 59% in the tax note, but an approximately 115% GAAP rate for the quarter in MD&A. It attributes the high percentage impact to relatively low pretax income and tax-effected items; the filing does not reconcile these stated rates clearly in the supplied text.
- Adoption of lease accounting on January 1, 2019 added operating right-of-use assets and lease liabilities to the balance sheet; the initial recognition was $82.5 million and $87.7 million, respectively. Adoption did not materially affect the income or cash flow statements.
Important facts for investors to verify
- Whether Shelby reaches its late-2020 full production run-rate and whether the project’s costs, output and customer demand meet management’s expectations.
- How receivables, inventory and operating cash flow evolve, including the effect of the post-quarter receivables-sale arrangement and its discount cost.
- Debt balances, interest expense, borrowing availability and covenant headroom under the refinancing agreements.
- Whether Consumer Products performance improves and paperboard segment margins withstand pulp, energy and maintenance costs.
- Progress and effectiveness of remediation of the disclosed material weaknesses in internal controls.
- The basis for the differing Q2 tax-rate figures reported in the tax note and MD&A.