Verso Corporation
Q1 2018 Earnings Call Transcript

Published: 9 May 2018

[Operator:]

Good morning, and welcome to Verso Corporation's First Quarter 2018 Earnings Conference Call. [Operator Instructions] Please note, this conference is being recorded. A replay of this call will be available on the Investors page of Verso's website after 11

[Tim Nusbaum:]

Thank you, and good morning. The first quarter 2018 financial results for Verso Corporation were announced this morning before the market opened. The earnings release as well as the set of slides that we'll refer to during the call are available on the Investors web page, www.versoco.com. Joining me today is Chris DiSantis, Chief Executive Officer; Allen Campbell, Senior Vice President and Chief Financial Officer; and Mike Weinhold, President of Graphic Papers. I'd like to remind everyone that in the course of the call, in order to give you a better understanding of our performance, we will be making certain forward-looking statements. These forward-looking statements are subject to risks and uncertainties. Should one or more of these risks or uncertainties materialize, or should underlying assumptions or estimates prove incorrect, actual results may vary materially from management's expectations. If you like further information regarding the various risks and uncertainties associated with our business, please refer to our SEC filings, which are posted on our website, versoco.com, under the Investor tab. At this point, I'd like to turn it over to Chris DiSantis.

[Chris DiSantis:]

Thank you, Tim, and welcome, everyone to the call. I am on Page 3 of the presentation. I'll start with just some general discussion about the supply and demand dynamics, in particular, of our largest segment in Graphic Papers. If you look at the box to the right of the slide, we've got a variety of data and metrics in there. This is with regard to the major graphic printing and writing grades. This first quarter 2018 data compared to the prior year, you can see the coated freesheet consumption's down 5%. A couple of big drivers of that would be commercial printing down 2%, magazine ad pages down 19.9% and the catalog mailings down 6.7%. On the catalog mailings metrics, I want here just to clarify, just for full year, we don't have the first quarter data. If you look back at the fourth quarter of 2017 versus the fourth quarter of 2016, it would have been down 8.7%. Now despite these long-term recurring demand erosion trends for Graphic Papers, which are obviously going to require continued capacity management as we go forward, there are some real positive supply side structural changes that have occurred or are continuing to occur. I think that's demonstrated very well by looking at operating rates. So if you look at the U.S. graphic industry operating rate over the first quarter of 2018 compared to the same quarter in 2017, coated freesheet is up five points, coated groundwood is up a point. Those are pretty substantial moves. When you get to 97 to 100-type operating rates, those are a result of the announced closures and conversions in 2017 that are indeed happening here in 2018. When you look at the euro, at the end of the first quarter, it was at $1.23. I believe today it's at $1.19. That's a real import deterrent that helps the company. If you look at that comparatively, we saw $1.05 and those types of numbers, particularly in the early part of 2017. And with North American capacity closures and conversions, imports still gained domestic share in coated papers, primarily in coated groundwood. That's best explained by the fact that domestic producers are full, so the demand has to come from somewhere. One thing to keep in mind with coated groundwood, even though the metrics there show that as a percentage of demand is up 14.5%, this is a product line that's had declining economic impact for Verso as times continued to progress. So just to give you an example that if you go back to 2016 and compare it to 2018, right now, in 2018, about 10% of the tons that we produce come – are coated groundwood tons. The only production that we have left of coated groundwood is at our Escanaba Mill, and coated groundwood is down about 30% in tonnage over the last couple years for us. Given the tightening pressure on our mill systems and the increased costs that we've continued to incur in manufacturing, we've been able to get sustained price realization. That sustained realization is helping us enhance our margins and allows us to consistently outpace the cost inflation. And we've had a couple of additional increases as well in other grade lines, such as in supercalendered and sheets. The specialty markets are doing very well. They're benefiting from general continued growth in U.S. manufacturing and spending. A lot of what we make winds up being tied to consumer goods in one way or another. The dramatic trends that you're seeing in e-commerce help our specialty business, particularly when it comes to things like flexible packaging, label papers, that sort of thing. The pulp markets are very strong. China has implemented new restrictions on wastepaper imports. So those markets are going very well right now, but we would expect more balance in that market in the second half of 2018 and going forward as new supply comes online. The containerboard market remains very robust with demand for additional craft liner volumes growing globally, seeing good operating rates that has an impact on pricing, availability, backlog. That's going to be an important end market for us as we go forward with the company's strategy. So turning the page to Slide 4. Our CFO, Allen Campbell, is going to go in much greater detail about the financials in the business. But I just want to give you a few highlights here. So we're off to a pretty fast start in 2018 versus the same quarter in 2017. We've got a 58% earnings improvement, sales up by 4%. Adjusted EBITDA is up $15 million, and it's up $15 million despite some unusual operating challenges I'll mention here below. We, in 2017, had a really ambitious cost-reduction program. There's a lot of just general belt-tightening. There was also restructuring. There was a headquarters consolidation. There were a lot of headcount reductions. We did business process reengineering in a variety of areas, payroll, benefits, information technology, and we're really starting to see that flow through the numbers. So we've got a $9 million adjusted gain in SG&A cost versus the first quarter of 2017. The specialty business is now at 24% of our total revenue. That's the highest it's been. We continue to run full there, good backlogs. If you look at growth in our specialty products, we're up 10% versus the same quarter last year. We got a lot of interesting things we're doing to improve the mix and productivity of the business to be able to service the increasing level of demands we're seeing there. Operations was unfavorable by $10 million in the quarter, primarily due to some unique issues that we had at the Luke and Escanaba Mills. So at Luke, we had a boiler tube failure. That, in combination with some bad really cold weather, led to some freezing problems, and various systems throughout the mill contributed to a lot of downtime. And at the Escanaba Mill, we had an equipment failure on some debarking equipment. The planned outage at Luke went well, on time, on budget. That added $6 million of increased expense to the first quarter. Freight costs continue to be a very difficult challenging area, up $11 million versus the same quarter in 2017. We've developed a variety of countermeasures to that. We just don't take the cost increases without a response. Our net debt is up modestly since the end of the fiscal year 2017. That's pretty typical in the first quarter, but we did make some very good moves. We reduced the term loan by a pretty substantial amount. The term loan has come down by $46 million since the end of the year. A combination of a couple things

[Allen Campbell:]

Thank you, Chris. Turning to Page 7. We show some key metrics. Shipments for the quarter were 722,000 tons, down 3% versus the prior year. While a majority of our markets were off approximately 5% as mentioned earlier, our paper volume was up just 1%. We saw volume increases in specialty paper, CFS web and digital products. These were offset by decreases in sheets, uncoated paper, tablet and support business. Pulp shipments declined as we build inventory to use internally for our second quarter maintenance outage. Pricing has been strong, with paper averaging $905 a ton in the quarter, up $45 a ton from last year and $29 from last quarter. Pulp price has been very favorable as we were up $116 a ton versus first quarter last year and $30 a ton versus the fourth quarter. We built inventory as planned in the first quarter. We were up $13 million as we made significant seasonal purchases of wood and the pulp build mentioned earlier. If you look at us year-over-year, we were down $64 million. Page 8 shows the traditional income statements format. As noted, sales were up $23 million versus prior year first quarter, driven by pricing. Though net income was locked to $2 million, it was an improvement of $19 million and included a $4 million hit for recognition of prepaid debt issuance costs and amortization OID related to our term loan paydown. Cost of products sold was up driven by increases in freight, chemical cost, the planned major outage at Luke Mill and reliability issues also at Luke. Note that the 2018 depreciation is more representative going forward as 2017 included accelerated write-off related to capacity reduction at one of our mills. Interest expense of $11 million included $5 million of cash cost, while the remainder was primarily amortization. Turning to Page 9, we walk from our net income to our adjusted EBITDA. You see our adjusted EBITDA for the first quarter 2018 being $41 million, up $15 million versus the $26 million we had in 2017. We made the traditional adjustments to EBITDA. EBITDA – base EBITDA was $36 million. Restructuring add-back won our strategic initiatives that we're going through as a process. It cost us $2 million. And then we had $2 million of other items that we list below, the legal settlement gain offset by some noncash equity award compensation, other miscellaneous nonrecurring adjustments. Turning to the bridge on Page 10. You see the big drivers of our year-over-year performance. Main driver, obviously, is pricing. We're up $38 million over the same period. This more than offsets the $3 million we saw in inflation and the $11 million we incurred of higher freight. Our volume was off a little bit, primarily pulp that we talked about. Operations, $10 million, virtually, all of that was related to Luke Mill; $4 million of that related to one particular incident, which was a boiler failure that combined with simultaneous weather issues and events, caused a depletion of fuel used to generate steam throughout the mill. So the mill froze out. It then had an impact of about $4 million by itself. We had increased maintenance of $6 million that was planned. So it wasn't anything out of the ordinary. Inflation, we talked about earlier in freight. And then, as Chris mentioned, we've had $9 million on an adjusted basis improvement in SG&A year-over-year. A small amount of other drives the $41 million that we show. Next page is Page 11. We show our liquidity and net position. Seasonally, we expand our working capital in the first quarter. So it's generally a use of cash and it was again this year. So it's more important probably to look at year-over-year comp, versus last year, liquidity has increased $53 million. Our net debt has been reduced by $140 million. Big achievement for the company, and it's from many of the small and large efforts going on across the mills and across headquarters. Net debt increased $7 million in the first quarter, with payments of term loan totaling $46 million. Those included excess cash payment, voluntary payment and some amortization. Our total leverage ratio was only 1.44 at the end of the first quarter. And our fixed cost charge coverage ratio, 1.36. So well above any covenants and a very good performance for our company. Our last slide we'd like to move to would be the guidance. As we look into the second quarter, we're expecting sales in the range of $625 million to $640 million. We expect to pick up our capital spending as we're – most of our initial spending is in the second quarter for number three machine start-up at our Androscoggin Mill. So we're expecting to spend $30 million to $35 million in the CapEx. Cash pension funding in the quarter will be between $7 million and $8 million. And we expect major maintenance to increase by $13 million versus the first quarter. We have a mill, Quinnesec, that has an outage every two years, and this is the year that it occurs. We did not have it last year. That's the main driver of the increase versus the first quarter. But we have one other mill with a similar outage planned. For the full year, as expected, revenue and pricing will be favorable to the prior year. We'll continue to face headwinds, logistics and freight and also some other input cost in raw materials. Capital expenditures for the year is expected to be in the range of $60 million to $70 million. Cash taxes will be a small amount, less than $5 million, primarily state income and franchise taxes. Major maintenance will be year-over-year in the range of $14 million to $16 million higher than 2017. We expect to fund our pension in the amount of $45 million for 2018. And as Chris mentioned earlier, we expect our SG&A to be less than 4% of sales for the full year. With that, that ends our formal presentation. We'd like to move to the question-and-answer period. Chad?

[Operator:]

Thank you. Sure, we will now begin our question-and-answer session. [Operator Instructions] The first question comes from Jeff Van Sinderen with B. Riley FBR. Please go ahead.

[Jeff Van Sinderen:]

Hi, good morning. And let me say congratulations on the improvement in metrics.

[Chris DiSantis:]

Thanks, Jeff. Good morning.

[Jeff Van Sinderen:]

Maybe you can give us just – good morning. Just your latest thoughts on the pricing environment overall. How should we think about increases for Q2? If there's any thoughts there. And then just sort of sustainability in the pricing outlook as it relates to the guidance that I think you inferred for the remainder of the year.

[Chris DiSantis:]

Yes. I mean, I can't say much because we don't guide specifically on pricing, but I can talk just in terms of general dynamics and trends. I mean, we had a couple of additional increases in the quarter for supercalendered and freesheet as smaller tonnages sort of relative scale than what we did in coated freesheet and that kind of thing. And I would say it has traction. I would say that we have momentum in pricing. We feel very good about the pricing environment. We feel good about our ability to outpace the rate of inflation that we're experiencing. And the backlogs are very good for the business. We don't anticipate that we'd be taking any market downtime this year, so we feel good about it.

[Jeff Van Sinderen:]

Okay, good. And then anything you can give us in terms of an update on the main project? And then anything else? I know you touched on this a little bit in your prepared comments, but how should we think about sort of similar projects where you might consider doing conversions? I know that's a little bit of a moving target, but any other thoughts there would be helpful.

[Allen Campbell:]

Yes. I mean, we really view the main project as a validation project. So to the extent that – and we do anticipate on – we do – we believe in the project or else we wouldn't announce it when approve the money wouldn't dip. So we are going forward, and we are going to make it work. We expect to start up in the third quarter. It'll be a couple hundred thousand tons. We have confidence we'll be able to achieve the quality specifications that we need to achieve. There's been a lot of customer interest in the product that will come out of that mill. But it's really a test at the same time of a thesis. And it tells us, you know what I mean, how ambitious because there are a lot of directions we could go from there. So we could look at other mills for conversion projects. We could look at productivity projects that speed up the rate at which we produce specialty and packaging goods. There's a lot of different ways that we could go and don't really have anything to announce yet with regard to the other mills in the system. But as of right now, kind of the way that we're managing the business is that we're being very cautious with regard to capital allocation. There are no big bet-the-company conversion projects that are in the works. The plan right now is this is what we have announced. We're going to go execute on it. We're going to deliver it. We're going to continue to harvest as much cash flow as we possibly can and pay off debt. And then, we'll reassess kind of where we are based on how this project goes.

[Jeff Van Sinderen:]

Okay, good. And then I think the Appleton Coated, you started as, I guess, under Midwest Paper Group. Just wondering how you're thinking about that. Any potential impact from the restart of that?

[Chris DiSantis:]

Well, I mean, they've restarted. I mean, if you look at what's out in the public domain, they've got a focus on different products. So it's not the same. The new Midwest Paper is not the same business that Appleton was if you look at the type of range and grades and those kinds of things. They still retain, you know what I mean, the capabilities that they had before. So should they choose to make, you know what I mean, products that are more competitive with ours, they certainly have the option and the ability, you know what I mean, to do that. But right now, it looks like their focus is in a different direction. So based on what I've read and what I've seen, I don't see it as a real competitive issue for us at this time.

[Jeff Van Sinderen:]

Okay, thanks for taking my questions and best of luck in Q2.

[Chris DiSantis:]

Thank you.

[Allen Campbell:]

Thank you.

[Operator:]

Our next question will come from Hamed Khorsand with BWS Financial.

[Hamed Khorsand:]

Hey, good morning. So first off, could you just talk about the maintenance schedule now given the repairs and so forth at Luke? Is that out of the way? And are you back at full operation there? Or is there more to do there?

[Chris DiSantis:]

Yes. So the outage is done at Luke. So that one's complete. And it is a mill where we've had – we have had some reliability. We have some production issues there. They seem to happen more at that mill than they do with other mills that we have in the system, but that outage is behind us.

[Hamed Khorsand:]

Okay. And then going into Q2, is that where you guys are expecting the bump-up as far as the volume's coming with your guidance? Or is that all price related, what you're guiding to for Q1?

[Chris DiSantis:]

So you're asking about the numbers that we put out in the sales guidance for Q2?

[Hamed Khorsand:]

Yes.

[Mike Weinhold:]

It’s Mike Weinhold. That's – you could attribute that to both volume sequentially from Q1. As an example, we had some outages. We had Quinnesec down, so pulp sales will increase. And then a little bit of price as well, as Chris indicated. So a little bit of both will be helping Q2 and sequentially after that into Q3. Certainly, from a seasonality standpoint, we pick up considerably.

[Chris DiSantis:]

Yes. We do have the Quinnesec outage, which is a big one, in the second quarter. Mostly, you know what I mean, through April, that outage is behind us. And then we have additional outages ahead, which all will be completed by the end of the summer for the rest of the mills in the system.

[Hamed Khorsand:]

Okay. And then could you also talk about these freight countermeasures? I mean, I know you implemented it in Q1. Would that have some positive implication on gross margin Q2 and going forward? And was that widely accepted?

[Chris DiSantis:]

No. I mean, I would just – I would assume, you know what I mean, things stay sort of as they is with the challenging freight environment there. Just in terms of countermeasures, I mean, when they come in and you know what I mean, they hit us with increases, this happens with truck and rail. I mean, what you do is you go back and you look at the whole system. You look at the whole, you know what I mean, way. You map out all of the froms and tos, sort of how you're managing, you know what I mean, the whole supply chain. And you try and come up with, you know what I mean, creative ways to try and you know what I mean, solve the problem. So – and also constantly, you know what I mean, chopping the business around and looking at alternatives.

[Hamed Khorsand:]

Yes. And lastly, as far as supply is concerned, there has been a lot more conversion news and closures and so forth out of Europe. How will that affect your customers if the industry can't get enough imports and if you guys are maxed out here? Is there continued risk of customers trying to look for substitutes?

[Chris DiSantis:]

Yes. I mean, to the extent that – I mean, to give you a straight answer, I mean, to the extent that the customers are constrained, you know what I mean, and the systems are maxed out, whether that be from us or from imports or whatever, yes, I mean, they're forced to look at substitutes. There's only so much paper you can get. And not just substitutes, you know what I mean, across grades and based on what's available on the types of products. But they would look at substitution to digital advertising spend, you know what I mean, as well. So yes, it's a factor.

[Hamed Khorsand:]

Are you still maxed out?

[Chris DiSantis:]

Yes, we're maxed.

[Hamed Khorsand:]

Okay, thank you.

[Chris DiSantis:]

Thank you.

[Mike Weinhold:]

Thanks.

[Operator:]

[Operator Instructions] The next question comes from [indiscernible] with American Wood Fibers. Please go ahead.

[Unidentified Analyst:]

Good morning, gentlemen. Is there any news – or have you heard anything in the works on the Wickliffe, Kentucky paper mill?

[Chris DiSantis:]

So we don't have anything to announce at this time, but we are in discussions with a few different parties who we might be able to get a deal on. It's tough, you know what I mean. Selling idle mills, you know what I mean, is not the – is not an easy thing. But that mill has some really interesting, you know what I mean, capabilities, you know what I mean, to it. So we remain hopeful, you know what I mean, and optimistic that one of several parties that's interested in it right now, particularly given sort of the state of the end markets, you know what I mean, and the tightness that you see in a variety of – just in the variety of segments where that mill potentially produced product. We're hopeful that, that mill will be transacted. But we don't have anything announced there, and I can't give you a sense of timing.

[Unidentified Analyst:]

Sure. Do you – being that you're maxed out on your paper, sales is really good in all areas? And do you see maybe later down the road, if you didn't sell it, it being figured in the equation of what you're all planning on doing?

[Chris DiSantis:]

I doubt it. Yes, I mean, I understand what you're asking. Would we fire that mill back up? I mean, I doubt it, but I don't want to say, you know what I mean, never. We own the asset. Yes, we own the asset, and we're constantly looking at our portfolio of capabilities and trying to figure out given the set of assets what's the ideal, you know what I mean, mix of products, you know what I mean, that we can make to maximize the value for the shareholders. So I wouldn't say never but I don't see that in the short-term.

[Unidentified Analyst:]

Okay, sure. Thank you, I appreciate you taking my questions.

[Chris DiSantis:]

Thank you.

[Allen Campbell:]

Thanks.

[Operator:]

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Chris DiSantis for any closing remarks.

[Chris DiSantis:]

Okay. I just want to thank everyone for your interest and for your support of Verso. Thank you for joining us on the call today. Have a nice day.

[Operator:]

And thank you, sir. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.