Clearwater Paper Corporation — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Clearwater manufactures consumer tissue, pulp, and paperboard at 15 locations in the U.S. and Canada.
Financial results
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $480.2m | $501.1m | $1,411.6m | $1,461.6m |
| Operating income | $39.8m | $25.4m | $109.9m | $82.7m |
| Operating margin | 8.3% | 5.1% | 7.8% | 5.7% |
| Net earnings | $19.1m | $8.6m | $44.3m | $28.2m |
| Diluted EPS | $0.80 | $0.37 | $1.87 | $1.19 |
| Net interest expense | $7.9m | $12.1m | $26.8m | $34.4m |
Cost of sales was 85.3% of sales in Q3 versus 89.6% a year earlier, and 85.8% for the nine-month period versus 88.8%. SG&A rose to $30.6m in Q3 from $26.8m; for nine months it was $90.3m versus $81.7m. The nine-month effective tax rate was 46.7%, including $9.7m of net discrete tax expense.
- Q3 segments: Consumer Products sales were $293.0m and operating income $18.5m, compared with $285.2m and $7.1m. Pulp and Paperboard sales were $187.3m and operating income $34.4m, compared with $215.9m and $26.3m.
- Nine-month segments: Consumer Products sales were $853.9m and operating income $70.4m, versus $823.6m and $27.8m. Pulp and Paperboard sales were $557.7m and operating income $78.1m, versus $638.0m and $76.4m.
Cash flow, balance sheet, and liquidity
- Nine-month operating cash flow was $160.6m, up from $72.3m; working capital provided $51.4m versus using $32.6m in the prior-year period.
- Investing cash outflow was $136.3m, mainly reflecting $155.4m of plant and equipment additions. Financing cash outflow was $13.1m. Cash rose to $19.6m from $8.4m at year-end 2011.
- At September 30, cash was $19.6m and short-term investments $37.0m. Long-term debt was $523.9m, nearly unchanged from year-end. Stockholders’ equity was $526.6m.
- No revolving-credit borrowings were outstanding; $5.9m supported letters of credit, leaving approximately $119.1m available to draw. The trailing fixed-charge coverage ratio was 3.4-to-1.0.
- Management said cash flows, cash and investments, and available revolver capacity should cover debt service, operations, capital expenditures, and working capital for the next 12 months. Annual cash interest obligations for 2012 and 2013 were estimated at $42.6m.
Material changes and management commentary
- Reported sales fell 4.2% in Q3 and 3.4% for nine months, principally because the Lewiston sawmill was sold in November 2011. Excluding the sawmill’s prior-year sales, management said sales were higher, supported by tissue and paperboard shipments.
- Profitability improved as lower purchased pulp, energy, transportation, packaging, and other costs outweighed higher chemical costs and SG&A. Consumer Products benefited from Cellu Tissue synergies; management reported $20.6m of net synergy savings year to date, expected approximately $29m for 2012 and a $35m–$40m annual run rate by year-end 2012 for 2013.
- The Shelby, North Carolina tissue expansion was estimated at approximately $275m, excluding capitalized interest. By September 30, $231.2m had been incurred; management expected about $23m more in Q4 2012 and $21m in 2013. The TAD paper machine was scheduled to start up in Q4 2012; two additional converting lines were expected in Q4, with the fifth in 2013. Las Vegas improvements were completed in October 2012.
- 2012 capital expenditures were forecast at approximately $205m–$210m, including an estimated $145m for the TAD project. A portion of Arkansas facility maintenance was deferred to Q1 2013; expected cost was $4.3m, with $2.0m anticipated in Q4 2012.
Risks, contingencies, and unusual items
- The $6.5m tax expense tied to converting certain 2009 fuel-credit gallons back to the Alternative Fuel Mixture Tax Credit, plus uncertain-tax-position liabilities, contributed to higher nine-month taxes. The IRS began an audit covering 2009–2011 after quarter-end; a Canadian tax audit was also opened. The company noted uncertainty about eligibility to retain fuel-credit amounts and their tax treatment.
- EPA referred alleged Clean Air Act violations at the Lewiston pulp facility to the Department of Justice. Discussions were ongoing under a tolling agreement expiring March 29, 2013, unless extended; no formal action or quantified exposure was stated.
- First Quality’s lawsuit concerning the TAD machine was dismissed with prejudice in June 2012; the appeal period expired in July.
- Company-sponsored pension plans were underfunded by $89.1m at December 31, 2011. Clearwater contributed $17.6m in the first nine months and another $3.0m in October, completing its required 2012 qualified-plan contribution.
- Key stated risks include execution and timing of the TAD expansion, raw-material and energy costs, customer concentration or lost business, competitive pricing and capacity, pension costs, labor or operational disruptions, environmental liabilities, and debt and covenant restrictions.
- The filing reports $1.9m of First Quality/Metso litigation expense in the first half of 2012 and a $1.0m loss on sale of legacy Cellu Tissue foam assets. Q3 income also benefited from increased capitalized project interest versus the prior year.
Investor verification points
- Confirm TAD machine start-up, remaining project spend, and converting-line commissioning against the disclosed schedule and budget.
- Track realized Cellu Tissue savings against the 2012 target and the stated 2013 annual run-rate goal.
- Review resolution and potential financial effects of the IRS and Canadian tax audits, fuel-credit uncertainty, and the EPA/DOJ matter.
- Monitor pension funding needs, maintenance spending, and whether operating cash flow remains sufficient alongside elevated capital expenditures and debt service.
- Assess sales and margins by segment, particularly the effects of tissue pricing and shipments, paperboard pricing, and internal pulp use on reported revenue.