Clearwater Paper Corporation — Q2 2018 Form 10-Q
Business context and period. Clearwater Paper manufactures consumer and away-from-home tissue, paperboard and pulp. This report covers the quarter and six months ended June 30, 2018; comparisons are with the same 2017 periods. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $432.1 million | $429.7 million | $869.1 million | $867.2 million |
| Operating income | $18.4 million | $19.1 million | $29.9 million | $39.7 million |
| Operating margin | 4.3% | 4.5% | 3.4% | 4.6% |
| Net earnings | $7.0 million | $8.0 million | $9.6 million | $15.6 million |
| Diluted EPS | $0.42 | $0.48 | $0.58 | $0.94 |
| Adjusted EBITDA (non-GAAP) | $42.6 million | $45.0 million | $82.4 million | $94.3 million |
Cash flow and investment: First-half operating cash flow was $110.9 million, versus $103.6 million; investing cash outflow was $77.8 million, versus $85.3 million. Cash increased to $53.3 million from $15.7 million at year-end. The company reported $164.3 million of capital expenditures incurred in the first half, excluding capitalized interest; cash paid for property, plant and equipment was $78.6 million, with $88.9 million of accrued additions, largely related to Shelby.
Debt and liquidity: At June 30, revolving borrowings were $160.0 million and long-term debt was $570.9 million, for total reported debt of $730.9 million. Cash was $53.3 million. The company reported $132.4 million of additional availability under its revolving facilities, after letters of credit. Working capital was negative: current assets of $451.1 million compared with current liabilities of $525.2 million.
Material changes and drivers
- Sales were nearly flat year over year, but operating income and net earnings fell. First-half cost of sales increased $11.5 million and rose to 89.7% of sales from 88.6%.
- Consumer Products weakened: Q2 sales declined to $221.6 million from $231.9 million, and the segment recorded a $3.6 million operating loss versus $10.7 million of income. First-half segment operating results shifted to a $2.0 million loss from $16.9 million of income. Lower volumes and prices, product mix, and higher costs weighed on results.
- Pulp and Paperboard improved: Q2 sales rose to $210.5 million from $197.8 million and operating income to $34.2 million from $21.1 million. First-half operating income was $60.3 million versus $48.3 million, helped by higher sales and lower maintenance and energy costs.
- Higher transportation, wood-fiber, chemical and labor costs pressured margins. Management expected 2018 transportation costs to be $14–$16 million higher and pulp and wood-fiber costs $15–$17 million higher than in 2017.
- The lower tax provision partly offset operating weakness. Management attributed the lower effective tax rate primarily to the Tax Cuts and Jobs Act; reported GAAP tax rates were approximately 27% for Q2 and 18% for the first half of 2018.
Outlook, commentary and risks
- Shelby expansion: The tissue machine and related converting project is estimated at approximately $280 million, with an additional approximately $60 million for warehouse purchase and expansion. Completion was projected for early 2019 and full operations for 2020; annual capacity at full production was expected to be about 70,000 tons. The company incurred $146.1 million of construction-related costs on the project in the first half.
- Cost reduction: The SG&A initiative is expected to generate at least $20 million in annual savings beginning in 2019. First-half 2018 related expenses were $6.2 million.
- Demand and competition: Management cited increased tissue-industry capacity, competitive pricing, changing retail channels and customer purchasing patterns. A major tissue customer’s move from single-source to multi-source supply is expected to reduce the company’s 2018 tissue volume, which management does not expect to fully replace.
- Covenants: At June 30, the reported leverage ratio was 3.95 against a maximum of 4.50 for 2018; interest coverage was 2.5 against a minimum of 1.75. Management expected compliance under current projections but warned that weaker market conditions or operating results could threaten compliance.
- Other cited risks include fuel, transportation and input-cost increases; operational disruptions; project execution and customer acceptance; labor issues; pension costs; environmental matters; and dependence on significant customers and limited suppliers. The filing reported no material change to previously disclosed risk factors and no material adverse effect expected from legal proceedings in aggregate.
- Management stated that cash, operating cash flows and available revolver capacity should be adequate for debt service, operations, working capital and capital expenditures over the next 12 months. This is a forward-looking assessment, not a guarantee. No specific earnings guidance was provided.
Important facts for investors to verify
- Whether Consumer Products volumes, pricing and segment profitability stabilize, and the customer’s sourcing change develops as expected.
- Progress, remaining funding needs, timing and projected returns for the Shelby expansion and other strategic capital projects.
- Whether expected SG&A savings are achieved and offset rising transportation, wood-fiber and other input costs.
- Quarterly covenant headroom, borrowing availability, cash generation and the effect of receivable sales on reported operating cash flow. The company sold $22.0 million of receivables in Q2 under an agreement permitting up to $60.0 million outstanding.
- The Consumer Products goodwill review: indicators of possible impairment were identified, but the company concluded fair value exceeded carrying value and recorded no impairment as of June 30, 2018.