Rayonier Advanced Materials Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 29, 2018. Dollar amounts are in millions unless stated otherwise. Results include Tembec, acquired in November 2017; therefore, year-over-year comparisons are materially affected by the acquisition.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $544.3 | $209.7 | $1,608.1 | $612.4 |
| Gross margin | $95.9 (17.6%) | $32.1 (15.3%) | $277.7 (17.3%) | $103.8 (17.0%) |
| Operating income | $56.2 (10.3%) | $18.8 (9.0%) | $168.6 (10.5%) | $60.3 (9.8%) |
| Net income | $37.9 | $15.7 | $115.8 | $29.9 |
| Net income available to common stockholders | $34.5 | $12.2 | $105.5 | $19.8 |
| Diluted EPS | $0.60 | $0.28 | $1.82 | $0.46 |
- Q3 adjusted EBITDA, a non-GAAP measure, was $99 million versus $44 million; nine-month adjusted EBITDA was $291 million versus $134 million. The company attributed the improvement primarily to Tembec.
- For the nine months, operating cash flow was $160.4 million versus $117.6 million. Investing used $76.4 million and financing used $72.9 million. Capital expenditures were $92.6 million.
- Management’s non-GAAP adjusted free cash flow reconciliation reports $97 million for the nine months, versus $77 million in 2017; this measure excludes strategic capital spending.
- Cash was $106.0 million at quarter-end. Total debt was $1.204 billion, down from $1.242 billion at year-end 2017; debt to total capitalization was 61%, versus 64%. Revolving-credit availability was $216 million. The company reported compliance with its debt covenants.
- Cash dividends paid in the first nine months were approximately $11 million on common stock and $10 million on preferred stock. The company repurchased approximately $15 million of common shares year to date under a $100 million authorization.
Material changes and business drivers
- Sales and operating income rose sharply, mainly because the acquired Forest Products, Pulp and Paper businesses were included in 2018 but not in the 2017 comparison. Those acquired segments generated Q3 operating income of $8 million, $26 million and $14 million, respectively.
- High Purity Cellulose Q3 operating income increased to $33.9 million from $30.2 million, but nine-month income declined to $83.3 million from $95.9 million. Excluding the acquisition, cellulose-specialties pricing fell about 9% in Q3 and 8% year to date, which management said was expected.
- Q3 interest expense increased to $15.0 million from $9.3 million, and nine-month expense rose to $45.1 million from $27.4 million, reflecting higher debt balances and interest rates following the acquisition.
- The effective tax rate decreased to 22.8% from 33.0% for Q3 and to 25.7% from 37.6% year to date, primarily reflecting the lower U.S. federal statutory rate following tax reform.
Outlook, risks and unusual items
- For High Purity Cellulose, management expected 2018 combined cellulose-specialties sales prices and volumes to decline about 3%–4% from 2017, with commodity-product volumes down about 2%. It expected the segment’s Q4 adjusted EBITDA to be modestly below Q3, citing higher wood costs, the resin-business sale and an estimated $2 million tariff impact on China-bound U.S. cellulose-specialties sales.
- Management expected Forest Products to be at break-even or incur a modest loss in Q4 as lumber prices had fallen; it anticipated a possible rebound, and said 2018 U.S. lumber duties were expected to reduce segment EBITDA by about $25 million. High-yield pulp prices were expected to remain near historically high levels in Q4, with supportive supply-demand conditions into 2019. Paperboard markets were expected to remain stable; newsprint prices were expected to adjust downward as duties reversed.
- Planned 2018 spending was approximately $100–$110 million of maintenance capital and $45 million of strategic projects, potentially modestly lower depending on timing. Management said it expected to continue dividends and share repurchases. The filing provides no clear consolidated earnings or full-year EBITDA guidance.
- Non-operating bargain-purchase adjustments contributed $20.8 million to nine-month income before tax, including a Q3 adjustment of $6.2 million. The adjustments include acquisition valuation revisions and the resin-operations sale; the sale generated about $16 million of cash proceeds and an approximately $7 million gain, subject to working-capital adjustments.
- Disposed-operation liabilities totaled $162.8 million. The company estimated reasonably possible additional exposure of up to approximately $67 million, with some potential liabilities not currently estimable.
- Collective bargaining agreements covering about 200 employees had expired by quarter-end; the Temiscaming agreement covering about 600 employees expired September 30. Negotiations continued, and management warned a work stoppage could materially affect operations.
- Trade risks include China’s 5% retaliatory tariff on wood pulp and potential further restrictions; the company reported $233 million of 2017 sales of U.S.-manufactured products to China. Separately, the U.S. trade commission eliminated duties on Canadian uncoated groundwood paper, but the decision was appealed.
- A stockholder securities lawsuit and a related derivative demand remain outstanding. The company disputes the claims; it expected a ruling on its motion to dismiss in the first half of 2019.
Most important facts for investors to verify
- How much of reported growth and adjusted EBITDA reflects Tembec rather than comparable organic performance, and how the acquired segments perform through a full cycle.
- Whether lumber-market weakness, U.S. duties and China-related tariffs materially change the stated segment outlook.
- Debt repayment capacity and interest-rate exposure: the filing reports $603 million of variable-rate debt and estimates a 1-percentage-point rate change would affect annual interest expense by about $6 million.
- Potential cash costs beyond the $162.8 million recorded disposed-operation liabilities, including the estimated additional exposure of up to $67 million.
- Outcome of labor negotiations, the stockholder litigation and derivative demand, and any related operational or financial effects.
- Whether acquisition-related bargain-purchase gains and the resin-sale gain recur; these items increased reported pretax income and are not representative of recurring operating performance.