Rayonier Advanced Materials Inc. — Q3 2014 Form 10-Q
Business and period: The quarter ended September 27, 2014; comparisons are with the quarter and nine months ended September 30, 2013. The company manufactures high-value cellulose products at its Jesup, Georgia and Fernandina Beach, Florida facilities. It became an independent public company on June 27, 2014, following its separation from Rayonier. Pre-separation comparative results are historical combined results and include allocations from Rayonier, which may not reflect standalone costs.
Key financial results
Amounts below are in millions of dollars, except per-share data and percentages.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | 253.7 | 225.5 | 709.7 | 764.9 |
| Gross margin | 55.7 | 67.4 | 162.8 | 249.0 |
| Gross margin % | 22.0% | 30.1% | 23.0% | 32.5% |
| Operating income | 41.7 | 59.4 | 91.3 | 218.4 |
| Operating margin % | 16.4% | 26.3% | 12.9% | 28.6% |
| Net income | 19.4 | 40.0 | 54.9 | 169.0 |
| Diluted EPS | $0.46 | $0.95 | $1.30 | $4.01 |
| Cash provided by operations | 127.7 | 188.8 | ||
| Adjusted free cash flow (non-GAAP) | 68 | 88 |
Q3 sales rose about 12% as higher cellulose specialties volumes more than offset lower prices; sales benefited in part from customer-order timing. Nine-month sales declined about 7%, primarily reflecting lower average prices. Management attributed lower earnings and margins to weaker cellulose specialties prices and higher costs. The nine-month operating-income decline also reflects one-time separation and legal costs, higher wood and energy costs, and depreciation following the cellulose specialties expansion startup.
Financial position, debt and liquidity
- At September 27, cash was $28.2 million, total debt was $946.9 million, and total stockholders’ equity was a deficit of $13.4 million.
- Debt comprised $550 million of 5.50% senior notes due 2024 and variable-rate term loans; $8.4 million was current maturities. The company had $223 million available under its $250 million revolving facility, net of letters of credit.
- Operating cash flow was $127.7 million. Investing used $75.9 million, including $60.2 million of capital expenditures and purchases of timber deeds and land. Financing used $23.7 million, including net payments to former parent Rayonier associated with the separation.
- The company said it was in compliance with debt covenants. Its credit facilities require a first-lien secured net leverage ratio no greater than 3.00 to 1.00 and an interest coverage ratio of at least 3.00 to 1.00.
- The company declared dividends of $0.07 per share in the nine-month period. It reported no mandatory pension contribution requirement for 2014 and no expected discretionary contribution.
Separation, unusual items and outlook
- To effect the separation, the company issued approximately $950 million of debt and made a special cash distribution to Rayonier. The net distribution to Rayonier was $956.6 million. The company also assumed specified pension, postretirement and environmental liabilities.
- Nine-month other operating expense was $44.8 million, including $23.5 million of one-time separation and legal costs, an $18.4 million increase in disposed-operations liabilities for required financial assurance, and a $1.5 million environmental reserve adjustment.
- Management expected full-year 2014 cellulose specialties volumes to be comparable to 2013 and projected pro forma EBITDA of approximately $265 million. For Q4, it expected cellulose specialties prices and volumes to increase and production costs to decline.
- Management cautioned that cellulose specialties markets were oversupplied and demand in certain end markets had slowed, citing capacity expansions and competitors shifting production toward cellulose specialties. Approximately 58% of performance fibers sales were exports, primarily to Asia and Europe.
- Full-year capital expenditures were forecast at $75–$85 million; income tax payments at $35–$40 million; and second-half environmental payments for disposed operations at approximately $4 million.
Risks and contingencies
- Disposed-operations liabilities totaled $91.7 million, including $7.5 million current. The company estimated reasonably possible additional environmental losses of up to $33 million beyond established liabilities; remediation estimates may change as investigations, regulations or required remedies evolve.
- The company is defending an environmental citizen suit concerning alleged discharge violations at its Jesup plant. The plaintiff seeks injunctive relief and monetary damages; the amount sought was not determinable in the filing. The company stated it believes it is in compliance and is defending the case.
- Collective bargaining agreements covering approximately 225 Fernandina employees had expired; employees continued under existing contracts while negotiations proceeded after a proposed contract was rejected. The company warned a work stoppage could materially harm results.
- Variable-rate debt of approximately $390 million exposed the company to interest-rate changes; management estimated a 1-percentage-point rate move would change annual interest expense by about $4 million. No derivatives were outstanding at quarter-end.
- Management reported disclosure controls and procedures were effective at September 27, 2014, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the projected $265 million full-year pro forma EBITDA and expected Q4 pricing, volume and cost trends were achieved.
- How cellulose specialties pricing, demand and competitor capacity affect margins, given the sharp year-over-year margin decline.
- The company’s ability to service and refinance its substantial debt while maintaining covenant compliance and adequate liquidity.
- Whether environmental remediation liabilities, including the disclosed potential additional exposure of up to $33 million, require higher cash spending or reserves.
- Developments in the Jesup environmental lawsuit and Fernandina labor negotiations, including any operational or financial impact.