Verso Corporation
Q2 2018 Earnings Call Transcript

Published: 8 Aug 2018

[Operator:]

Good morning, and welcome to Verso Corporation Second 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 at 11

[Clint Landman:]

Thank you, and good morning. The second quarter 2018 financial results for Verso Corporation were announced this morning before the market open. The earnings release as well as the set of slides that we'll refer to during the call are available on the Investor Relations of Verso's website at www.versoco.com. Joining me on the call today are Chris DiSantis, Chief Executive Officer; Allen Campbell, Senior Vice President and Chief Financial Officer; and Mike Weinhold, President of Graphic Papers. I would 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 would like further information regarding the various risks and uncertainties associated with our business, please refer to the SEC filings, which are posted on our website, versoco.com, under the Investor tab. At this time, I will hand the presentation over to Chris DiSantis.

[Christopher DiSantis:]

Thanks and welcome, everyone. We have a lot of good news to report today. So I'm flipping to Page Slide current market overview. So we're seeing continued upward pricing momentum in all the Graphic Paper markets through the second quarter. We have had multiple successive increases across all the grades in our 3 million-ton system year-to-date. The supply side structural continue to benefit the Graphic Papers. On the demand side, we continues to see erosion in with the demand. You can see that in the chart on the bottom right. I'll call your attention to the couple of numbers in particular. One of them is commercial printing, down 1.7%. The other is catalog down 2.8%. I think as you're thinking about, which macroeconomic indicators are tied to our business those are two good ones [indiscernible] is down more significantly down 18.7% versus the prior year, but it's important to note that's 11% of Verso's revenue. Specialty paper industry dynamics continue to be strong. So supply Specialty is tightened due to capacity conversions coupled that with strong demand. The pulp market is very good. Severe restrictions China for covered waste paper. We got very low contamination thresholds there with that market in a strong position. Pulp demand has expanded worldwide growth. Market continues to remain robust. Additional demand globally is growing for. Depending on what happens to the tariffs, generally speaking, certainly changes in trade agreements relationships could impact exports there. The U.S. industry operating rates is operating rate is up significantly versus the first half of 2017. Coated freesheet we've seen a 7-point improvement in operating rate going from 86% to 93%. Coated groundwood, we've seen a 2-point improvement, going from 99% to 101%. The euro ended up the second quarter at $1.16. We continue to see imports gaining domestic share coated papers, especially coated groundwood you can see that in the metrics in the lower right imports up [3.3]%. Coated groundwood imports up 39%. One thing that's important to note is the coated groundwood is a product declining Verso. So give you some numbers on that 3 million ton Verso total paper system less than 10% of it is coated groundwood. Turning the page, second quarter highlights. Some really good numbers in sales and EBITDA, both up significantly versus the second quarter of '17. Sales up 10%, price mix. Adjusted EBITDA of $55 million. And if I do look at the year-to-date, EBITDA first six months of 2018 and first six months of 2017, year-to-date EBITDA is up 689%. We've grown the specialty business to 25% of revenue for the second quarter of 2018. The Specialty sales are up 20% over the second quarter of 2018. Lot of factors contributing to that

[Allen Campbell:]

Thank you, Chris. Turning to Page 8, I'm going to highlight for the value propositions that Chris just went through in a little more detail. Our strong cash flow generation, we have significant earnings momentum, driven by the Graphic Papers supply and demand balance being very favorable. We are improving margin there. Our mix of Specialty paper and Packaging revenue continues to grow. And we believe we have an industry-leading SG&A structure for our business. We have very manageable CapEx, and we've seen significantly lower interest; therefore, strong cash flow generation. We've also been deleveraging our balance sheet. We made significant strides in our working capital management by expanding our payable days, by reducing our inventory and in spite of the changing mix of business still maintaining our accounts receivables days. We are expecting payments in the second half of $42 million from our Canadian trade case settlement. And we reduced our term loan to $50 million in July. As Chris mentioned earlier, we pension position. If you would recall, our accounting under balance at the end of last year was $457 million. We believe with the rise in discount rates, the contribution that we're making and favorable asset returns that just underfunding range will be in the range of $325 million to $350 million by the end of this year, a significant improvement. We're also exploring other alternatives to reduce liability and expenses. Another important value proposition is our available tax yield. We have net operating losses of $100 million. We're able to carry forward without limitation. And we have additional $190 million NOL with the restricted use each of $10 million a year, which will be accumulated to build at least $24 million. So our next of $24 million of earnings would come significant positive for us. Moving forward to Page 9, I'm going to fill through some of our key metrics. On the shipment side, with our improved emphasis on Specialty papers, we're up in volume of just 2,000 tons, but up from prior year significantly. Pulp is down 15,000 and that's because of use more internally to machines during outages. Our selling prices are up $92 of ton on paper, up 11% from second quarter 2017 and we're about $26 per ton from last quarter. For pulp, we're up 20% versus prior year and $31 a ton versus the first quarter. As you can see, inventory is down during this process also, down 9% or $35 million. Top right shows our mix of business, as Chris mentioned earlier, we're proud to see the Specialty business growing up to 25% in the second quarter. Moving forward to Page 10, we show our income statement. First note is our net income for the quarter positive, driven by sales increase of $59 million. You see on to the right some of the notes we have in cost of products sold inflation cost still and freight and chemicals. We're also seeing in purchase pulp, while wood is being recently priced for us energy as a mix and ops spending is favorable. Our SG&A expenses as reported increased to 4.3. These were driven by some onetime cost like $3 million increase and costs associated with strategic alternatives. We also had a $2 million increase in noncash equity award expense. Operating expenses include a $2 million of fees. There is lined up of our 2016 Chapter 11 case just a second. Interest expense lower obviously driven by a reduction in our term loan. We reported $3 million of nonoperating income that's associated with the net periodic pension income adoption of new accounting standard this year. Moving forward to Page 11, we our net income down to adjusted EBITDA. The key adjustments are the ones that you've seen in the past, some restructuring. We had a multiple program catch up on our noncash equity awards with $3 million high for the quarter and it will in drop future periods. [Indiscernible] is primarily our final payment U.S. Trusty [ph] of just over a $1.5 million. Strategic initiatives mentioned earlier are three and then as we are launching our new products at A3 our start-up costs in second quarter were $7 million in annual paper machine number three with the very respectable margin of 7.9%, an improvement of $55 million EBITDA year-over-year. We highlight that in the next page. As you can see, we walk minus 4 to positive 51 adjusted EBITDA, driven primarily by the first box pricing mix $60 million improvement there. We show volume down slightly. And as you saw on prior pages, driven primarily by pulp, which doesn't necessarily carry a lot of margin with volume decline does as much. Operations and downtime is a significant $18 million improvement year-over-year. Major maintenance, as Chris mentioned every two-year major outage at occurred in the second quarter of this year and that's why our major maintenance expenses were higher at $8 million. Inflation, as mentioned earlier, $8 million hit also. And freight costs are still remaining high, $7 million increase year-over-year. SG&A is $2 million down. Higher expense, less profit. It's driven primarily by comp adjustments. We had a reduction in comp approval last year we have a tough second quarter we had an increase this year, that's the major swing. Pension costs running over $3 million favorable year-over-year. We do the same slide for year-to-date. As you can see in the top right, our sales are 1.2 just over that last year where we were up to 12.83, this year 1.283 million. Gross margin 9.4, up from 5.4 the same period. The walk across the page is very similar on the quarter. You see the major maintenance is $14 million. As we told you we will be spending more money in the first half of this year, driven primarily by and outages. Inflation rates same as before. And SG&A, as you can see for six months, we're running $7 million favorable year-over-year despite adjustment pension. Major maintenance on Page 14, has a significant impact on our numbers and feel like it's important that we show the quarter swings on that. We show on the right blue bar 2017 spending, and we expect to spend - we did spend $32 million last year, we expect to spend $49 million this year. As you can see in the first quarter, we spent $30 million - I'm sorry, first half $30 million and we're expecting to spend $19 million in the second half. So the second half is going to be a strong key for us and lighter maintenance than combination for our performance with expectation. We're going to drop in the third quarter from $23 million to $11 million. So $12 million drop in major maintenance. We've included a timing down below by our how they run. Moving on to an area that we're very proud of on Page 15. Very proud of achievements reducing net debt, improving our liquidity. On top left, we show payable on our net debt. We've reduced net debt by $153 million over the last 12 months, $322 million at the end of June. Our seasonal inflow of cash in the second half reduced their net debt last year down to $204 million, and we're down to $169 million as of June and we expect that obviously to go lower with better cash flow in the second half. Reduced net leverage, as talked about earlier, our covenants were 0.84, an excellent number in earnings. We improved liquidity by $23 million in the second quarter, which reduced the decline in the first quarter. Liquidity in the last 12 months is up $45 million. And as mentioned earlier, we paid down the term loan $50 million. So we're rapidly deleveraging, we're decreasing our risk and we're increasing optionally of the business. Moving forward to our guidance. For next quarter, we're expecting sales to be in the range of $700 million to $720 million. Pricing will be favorable to quarter two. We expect capital expenditures to be in the $20 million to $25 million range, including a residual investment in the number three machine as the Androscoggin Mill. Cash pension funding quarter for pension funding we expect that to be in the range of $20 million to $22 million. Major maintenance to decrease as we mentioned earlier. And we expect net income to be positive, earnings up substantially over second quarter seasonal part of the business. For the full year, revenue and pricing should be favorable to prior year. We will face continued headwinds in all of our logistics and freight and other input costs. Capital expenditures, we're expecting to be in the range of $60 million to $70 million, inclusive of all the strategic projects. Cash taxes of $0 million to $2 million, and that's primarily state income and taxes. Major maintenance will be up $17 million versus the prior year. Cash pension funding was approximately $45 million for the year. SG&A will maintain our industry leading structure being less than 4%. Mentioned earlier, we expect to see the $42 million from a trade case settlement before the end of this year. And our second half EBITDA net income will be substantially higher than first half of this year and second half of last year. So with that, that ends the formal part of our presentation. We like to open it up for questions.

[Operator:]

[Operator Instructions]. The first question comes from Jeff Van Sinderen of B. Riley FBR.

[Jeffrey Van Sinderen:]

Congratulations on the strong metrics and really improvement across the board. You guys have done a lot for the last year. My first question just, I guess, trying to get a sense, given the strong pricing environment and you're running at full capacity pretty much. I know you're expecting to grow in the second half. I guess, just any order of magnitude you can give us on the terms of maybe a range of what sort of growth rate you might look for in Q3 or in second half we might contemplate there? And then also if you can maybe touch on the potential expense in second half?

[Christopher DiSantis:]

Yes. No, I can't guide specifically in terms of the range for the back of the year. But I can tell you that there is just a lot of factors. They're all contributed positively to tailwind effect. And so we expect the revenue will be better, the pricing will be better, the cash flow will be better. So better in almost, I mean, every metrics. So we chose the words substantially to describe what we expect in terms of improvement first half of this year and second half. And also if you look at the second half of '17, we expect the numbers to be substantially better. But the back six months of the year are typically. As you can see in 2017 numbers, the back six months of the year are substantially better than the first six months. So we have a lot of tailwinds, a lot of good stuff a lot of opportunities, a lot of important execute along. So we're not ready to give us a specific range will be significantly better.

[Jeffrey Van Sinderen:]

Okay. Fair enough. And then just turning to you mentioned operating costs is an area that your [indiscernible]. Just any more color you can give us there on cost cuts that you're thinking about, what the opportunities are, kind of I guess where the focus is there over next several quarters?

[Christopher DiSantis:]

So for the short-term, I mean, the easy answer is kind of everything that we buy. We're trying to acquire use it more efficiently past and especially in an inflationary environment and we're getting everywhere attempted price increases. In terms of mill cost, those are big projects. There's a lot of different ways to get after mill costs. One of the best ways to get after mill costs, particularly mill costs per ton, is to produce more tons. So you can really lower - they're higher-fixed cost businesses, you can really lower your fixed-cost per ton by lowering your throughput. So there are a lot of throughput projects that we're looking at in terms of how to break bottlenecks. Break bottlenecks on the Specialty side looking to grow that business very well. So we're looking at whole kind of speed up the bottleneck projects there. Pulp, the more pulp that we can produce, the more money we make. So we're looking at projects to debottleneck our ability to produce pulp. So either pulp will be produced for our internally saves us money pulp that we can sell on the outside market that saves us money as well. We're in a sold-out position. So you can expect that we can make more graphic we'll be able to produce more product and make more money there as well. And then there is only utilization side of it. So as we're looking at all these, we consume a lot of resources in mill. As we're looking all these things, we're looking at a lot of projects there all time. And this is, I shouldn't say this is the like we're turning our potential this is something new. We're always looking at mill costs. We have a world-class operational excellence program that's constantly going after continuous improvement in mills. So we're just going to continue to focus on that. So nothing specific effect next few quarters how that trade there, but just a note that there's still a lot to get there.

[Jeffrey Van Sinderen:]

Okay, great. And then just one more for me on A3, just to clarify was it $2 million additional that you put in versus prior expectation?

[Christopher DiSantis:]

Yes. I think the original budget was like $17.4 million something like that. We came in at around $19 million. So we finished with the first phase of capital investment and then this they are. You're going to see when you see the numbers in the future going to see on that as we collect the from the [$44] million as that comes off that $19 million number.

[Jeffrey Van Sinderen:]

Okay. And then so at this point, A3 is up and running, you're running, you're orders and how are you pretty confident that it's producing the quality that you need?

[Christopher DiSantis:]

Yes. I physically saw myself on those locations. So it's.

[Operator:]

The next question comes from Hamed Khorsand with BWS Financial.

[Hamed Khorsand:]

Could you first off talk about the $46 million of paydown July, does that come from working capital improvements or was that mainly the source of free cash flow in the quarter?

[Christopher DiSantis:]

So we have a lot of liquidity under the revolver and we're confidently chasing working capital, constantly chasing the balance sheet, constantly chasing the earnings that drive cash flow. We've been improving our availability just by paying down debt. We will also be doing it by eliminating some letters of credit that not happen more and we just kind of revolver to reduce the term loan because there is plenty available.

[Hamed Khorsand:]

Okay. And then just looking out into the second half and just given what you guys have done so far in Q2. Can you also clarify as far as your EBITDA is concerned? Should we expect EBITDA margins to also improve, given that you're talking about EBITDA being higher from a dollar standpoint as well?

[Christopher DiSantis:]

It would be reasonable. I think that's a reasonable closure.

[Hamed Khorsand:]

And then what kind of contribution are you expecting from the machine three when it comes online Q4? Would it be a full capacity running or is it just a gradual increase?

[Christopher DiSantis:]

It would be gradual increases.

[Hamed Khorsand:]

Okay. And then my final question is, just given the dynamics in the paper industry right now, coated paper, approaching I think one-year mark since we saw this tightness come about. What are your thoughts on the continuation of the supply tightness going forward?

[Christopher DiSantis:]

You mean, just in terms of operating rates for the industry. So whether - talk about we're in multiple segments now. So Specialty and Packaging. I mean, there is plenty of across the in this market. The more we can produce, the more we make. In terms of the Graphic part of the business, 71% of it likely to come down continuously as we grow the other segments. That one, we expect the operating rate continue to be tight. So we don't see - we're full write-down businesses. We've got very good backlogs. We've got very good visibility. There is still a lot of remaining capacity that continues to come off line. And we expect the operating rate going into next year would continue to be tight. But looking out beyond, say the early part of next year, we will wait until the end of this year to will be 2019 so we will be from supply-demand standpoint.

[Hamed Khorsand:]

Okay. And then is there any reason what's going on the business or industry that far specifically and there is an update on the strategic alternatives. Is there something you guys are looking to achieve this year, nothing has happened on that end?

[Christopher DiSantis:]

No. No, we don't have any updates on specifics or type.

[Operator:]

The next question comes from [indiscernible] of Vertical Research.

[Unidentified Analyst:]

I have a couple of questions regarding BM3 conversion. Firstly, with regard to the 40 can you provide a little bit some color in terms of our integrated companies? Are they independent? So are you looking at export side?

[Christopher DiSantis:]

Both integrated, non-integrated, domestic export, all the above.

[Unidentified Analyst:]

Perfect. And with regard to the new machine, can you give us an indication of where do you think it's going to be on the curve and approximately how many tons of greenwood 200,000 tons of will consume every year?

[Christopher DiSantis:]

The capacity we expect to Phase 1 when we're at full run rate is just over 200,000. What was the other part of the question? Second part of the question?

[Unidentified Analyst:]

Where do you believe the machine will be in the curve? And just in terms of the capacity, how much - maybe in terms of greenwood, do you think these 200,000 tons of capacity will require to be produced?

[Christopher DiSantis:]

When you say - let me be clear, it's an integrated machine. So I think it's all product, correct line of light weight.

[Allen Campbell:]

200,000 tons. We haven't put out any information, of where on the cost curve, but it's a good machine.

[Unidentified Analyst:]

Okay, perfect. And just as a last question. Now you're already in the start-up phase. So with this experience, just wondering, I think you took the CapEx slightly high, but I think we're still looking at less than $100,000 a ton. So with this experience essentially now complete, what do you think you've done decently than some of the peers already that are looking at conversions that have costed much more on a per ton basis?

[Christopher DiSantis:]

I will give you a little bit of color. So first off, it comes down to what we're starting with. So we're starting with an excellent machine that had a very good backend. And from a technical standpoint, making the products, of course, typically in terms of is technically more difficult. Those grades are more difficult than making the line of credit. So we started with very good integrated machine. We started with a technical expertise that's our opinion is the higher level than we see in the production line just easier product for us to manufacture. So we started with the good machine we're very creative in terms of pushing the envelope on the cost side equation. There is no limit to what you can spend in a business on mills and conversion. And we were just very creative about it and look at it very much like an entrepreneur would. Let's figure out a way to do this in a very low risk scenario. So we don't have debt $100 million, $150 million. That doesn't mean that we potentially wouldn't invest additional capital debt to speed up the machine through second or third investment to get more tonnage out of it. There are other machines in the system. They could potentially cost more. But it's just really hard philosophy and our approach to help look at capital investment system. When we allocate based on risk-adjusted capital return. And the risk-adjusted return on capital sometimes smaller where just you are looking to speed up, just looking to get more tonnage, you're looking to improve yield, you're looking to start-up an asset that you already have. Those risk-adjusted return on capital position sometimes they point you to low dollar project. And we're going to follow the sequence here. So the best projects that have the best return on adjusted capital, those are the ones that are going to get.

[Unidentified Analyst:]

Yes. Makes sense. Just last thing actually, about the customers you described them as highly interested customers. And I was just wondering besides going through the qualification process, do you have firm orders for later and you just need to calibrate the new machine or are they still evaluating and they're probably - they're likely to place firm orders, but they haven't done so yet?

[Christopher DiSantis:]

Yes. We have both. We have a substantial backlog of qualification orders and a substantial backlog of follow-on LIBORs.

[Operator:]

There are no further questions.

[Christopher DiSantis:]

We would like to thank everybody for your attendance today and good questions we have. So appreciate it. Enjoy the rest of your day. Thank you.

[Allen Campbell:]

Thank you.

[Operator:]

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