Verso Corporation
Q3 2018 Earnings Call Transcript

Published: 8 Nov 2018

[Operator:]

Good afternoon, and welcome to Verso Corporation’s Third Quarter 2018 Earnings Conference Call. [Operator Instructions] Please note, this conference is being recorded. A replay of this call will be available on the investor page of Verso’s website after 5

[Tim Nusbaum:]

Thank you, and good afternoon. The third 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 page of Verso’s website at www.versoco.com. Turning on the call today is Chris DiSantis, Chief Executive Officer; Allen Campbell, Senior Vice President and Chief Financial Officer; and Mike Weinhold, President of Graphic and Specialty Papers. I would like to remind everyone that during 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 our SEC filings, which are posted on our website, versoco.com, under the Investor tab. At this point, I’d like to turn the call over to Chris DiSantis, our CEO.

[Chris DiSantis:]

Thank you, Tim. I’m on the slide inside of market overview for graphic papers. So the U.S. graphic industry operating rates remained strong due to a lot of the supply changes that we’ve seen. We’re at 91% year-to-date operating rate for coated freesheet, 98% year-to-date for coated groundwood. And we expect the market to remain tight going into 2019. If you look at the box on the right, you can see some specific statistics. These are year-to-date numbers, coated freesheet demand is down 6.5%; coated groundwood is down 6.4%. One thing I’ll note is that the coated groundwood’s is known about 286,000 tons of our total system. It’s part of the business we’ve have been mixed managing that we expect to continue to reduce and move away from over time. Commercial printing and catalog mailings have held up, better magazine ad pages has been a very difficult end market. That one’s weighted heavily to coated groundwood. So these – a variety of these end-use segments are still challenged but the operating rates are very strong. The pricing environment is very favorable, with increases realized within the quarter, and in the third quarter and entering into the fourth quarter. So, we have good momentum on all of the recent announcements that we made, good traction. There is significant M&A in the paper space, which continues with Resolute’s Catawba Mill and Catalyst’s U.S. assets changing hands. We can’t speculate as to what they will do with those assets, but it is notable that the acquirers are containerboard centric companies and investors. The coated paper imports are filling the supply void that was created by much of the U.S. capacity shuts. So if you look at the import data in the right, coated freesheet imports are up 5.6%, coated groundwood imports as a percentage of demand are up 34.8%. I’ve seen a lot of the product coming in from Europe and from Korean producers as well. So flip the page. Specialty papers packaging and pulp. The first thing that’s worth noting on here is we’re at 32% of our revenue being generated from these segments. That is the highest percentage we’ve you ever achieved in those segments, and we expect that to continue to improve over time. If you look at the demand that’s happening in specialty and packaging segments, the end markets are strong. We’re seeing continued economic growth. Evolution of e-commerce markets, sustainability and renewable preferences are making a comeback over plastic. So we think that’s good for – it’s good for bags. It’s good for service food, other items, straws, that kind of thing. GDP growth good in the quarter, up 3.5%. E-commerce numbers are strong, corrugated box shipments up a couple of percent, and hardwood pulp shipments up almost 5% as well. The inflationary costs and higher pulp prices are going to be driving price increases in specialty. There’s really no alternative to that to try and maintain margins. The healthy pulp demand that we see is continuing associated with China’s restrictions on mixed paper imports and the very restrictive contaminant limitations they put on recovered paper that’s driving their need for alternative fiber sources. Container board market remains tight, with linerboard operating rates at 96%. It’s been a significant amount of capacity. Announced it is going to be coming online in the next two to three years. There’s also going to be significant growth as well in that segment. So it will be interesting to see how it all plays out. Turning the page. Some highlights on the third quarter. We’ve had continued strength in sales and adjusted EBITDA in the third quarter of 2018 versus third quarter of 2017, it’s up dramatically. Sales are up 13%, higher price, favorable mix. That 30% is $83 million in incremental revenue. The adjusted EBITDA was up $61 million versus the prior year. Year-to-date, our adjusted EBITDA was up 190% versus the same nine months of 2017. And we’re seeing stronger operational performance across the entire system, but there are some offsets to it. So we’ve got good operating performance, good price, good mix. Some of the takeaways are generally in inflation, in logistics and in weather-related issues, particularly in mill, which is impacting wood cost and availability to the heavy amount of rain there. The logistics is not quite as bad as we expected it to be. A lot of the countermeasures that we put in place to deal with that category have been very effective. So we’ve been doing things like implementing out of geographic charges, having more mill direct shipments and just having lower inventory and less handling, fewer regional warehouses in the system has allowed us to manage that cost down in spite the price inflation. The successful startup of A3 on container board is well underway. And the interesting thing to note about that which we have mentioned before, is that we have a lot of flexibility on that machine. So we could fill the machine up with container board, but to the extent that we want to change products that we run on there. We can run other products on that machine as well. Gives us the opportunity to constantly look at things like profit per hour, profit per ton as market conditions may or may not change to make sure we’re getting the most return possible. We’ve seen continued significant growth in specialty as a whole, particularly in coated one side sales. If you look at just total specialty sales as a category, in the third quarter of 2018, our specialty business has grown 27% over the same quarter in the prior year. Those are the best numbers we’ve ever put up. We collected in the third quarter $20 million on a countervailing duty settlement with the Canadians. An additional $22 million, which would not be reflected in these numbers, was collected in October. So all of the cash is in-house and has been applied to reduce debt. We successfully sold the Wickliffe Mill for $60 million to Global Win. Cash has been collected on that, $9 million gain, also it eliminates about $3 million a year that we had in annual carrying costs. We’re evaluating a variety of long-term, what I describe as interesting capital investment projects in – that touch all the product lines that we have either to drive productivity, cost reduction or growth and solve for the Treadmill effect, the erosion that’s happening in the printing and writing space, all geared towards moving us closer and closer each year to our 50-50 vision as we described in our recent annual shareholders presentation. The bottom line is that we’re well positioned, particularly from a balance sheet standpoint for the future as the debt for the business continues to fall rapidly. And with that, I’ll turn it over to our Chief Financial Officer, Allen Campbell.

[Allen Campbell:]

Thank you, Chris. Moving ahead to Page 7. We’ll go into a little more detail for the quarter. As Chris mentioned, our paper shipments were up as a result of C1S, or specialty business growth. Were up 3% on paper for the quarter versus prior year same quarter. Pulp down 19%, but that’s driven because we used more pulp internally this year than what we did in the past. Pricing has been strong for us. We’re up $26 a ton on paper versus last quarter, and $77 a ton versus the same quarter before prior year. Pulp prices are up $43 a ton sequentially, and up $119 a ton versus the same period last year. If you look at the top right, breaks our business down into the pieces that Chris talked about earlier, 68% graphic; 25% specialty; 5% pulp, and a small sliver now as we’re starting in packaging of 2%. On Page 8, we walk through the income statement. There are several items that impacted the business, and we’ll talk about each – some of these. Inflation continued to be a driver in our operations cost of products sold area. We’re seeing – continue to see increases in fiber and chemicals. But we have seen some easing on freight, some of that in the market and some of that from internal efforts that we’ve done. SG&A expenses on adjusted basis are down to 3.1% or 3.6% on an unadjusted basis as a percent of sales. This is due us – that’s as a result of our continued cost management efforts. Looking in the income statement. We did book the profit on the sale of Wickliffe Mill and other operating income. That’s the $9 million you see in the column third quarter 2018. And the income, where it shows are below the line, below operating income, other income is a countervailing duties pickup. We’re booking that as we collect it. So we booked $20 million in the third quarter. And as Chris mentioned, the rest will be in the fourth quarter. Net income for the quarter was 2.45% on a fully diluted basis. If you take out the big gains that we had and adjusted basis, $1.83. Moving ahead to our adjusted EBITDA bridge. If you look at the pieces reported EBITDA of $129 million, but we had the two big gains, the countervailing duty and the sale of the Wickcliffe Mill that resulted in the gain. We do not count those in our adjusted EBITDA. So we reduced the profit by that amounts. As you can see we spent $3 million on standard Machine number three. That’s now complete, so there’ll be no more start-up costs in the fourth quarter as we are running that effectively, and a small other typical adjustments that we make. This earnings of $108 million of EBITDA obviously exceeded our shareholder meeting guidance of $95 million to $105 million, like sales in this quarter remained – was inline. Moving on to Page 10. We bridge our third quarter last year of $47 million EBITDA to the $108 million this year. Obviously price and mix is a big driver of this business. So we’re up $71 million quarter-over-quarter prior year. We also saw a slight change in our timing of our major maintenance that benefited us $3 million in the quarter. Inflation, as I mentioned earlier, primarily on that chemical side and the pulp and fiber side, $13 million inflation during the time period. Freight up $4 million, but it’s starting to level off as mentioned earlier. Pension has been favorable for us, that was $3 million in the quarter. So LTM is now up to $265 million or 10% of sales. Our bridge and year-to-date is shown on Page 11. Most of the items that I talked about earlier carried over for the remainder of the year, other than major maintenance, we spent a lot more major maintenance now the slide that is coming up, in 2018 versus 2017. Inflation has been hitting us every quarter. Fright has been heavy in the first part, a little bit less in the third quarter. SG&A is related to our cost saving initiatives that we’ve had in place for quite a while. And pensions you can see has been a positive for us year-over-year. Moving ahead to Page 12 to highlight the major maintenance and the projects that we’ve had. In the third quarter of this year, we just had one mill, that’s the Andro Mill, whereas we had two mills that had major outages last year in the same quarter. In the fourth quarter though, we had a relatively small outage at Luke that cost us about $3 million. This year, we’ll have about $8 million of cost primarily related to our Escanaba Mill. So we do – we are impacted by our scheduling major maintenance most of it in the first half as you can see, as we lead into the heavier second selling season, but it does vary a little bit. Page 13 really shows the impact of all the strategic efforts and what’s gone on with the business. If we look at where we were a year ago, on 9/30/2017, we had net debt of $282 million. We dropped that by $179 million to only $103 million at the end of the third quarter. We retired our term loan in the third quarter. And our net leverage ratios of EBITDA over debt is down to 0.4 times. So great numbers for us. Highlighted on the top right, our cash flow from operations for the first nine months, we generated $176 million. In addition to that, we brought in $37 million regarding CBD and the asset sale. So the business had $213 million of inflows of cash. We had normal pension funding expectation of $35 million that we did in the first nine months. CapEx was $60 million and interest was $15 million. We took the remaining $103 million of cash that we generated and we paid down the debt. That was obviously our major initiative, and we’ve done well as you can see in doing that. Those are our key points we’re going to make as far as financially for the first nine months. On Page 14 we show the guidance for the fourth quarter. The full year 2018 is shown for convenience sake of the rate, which is just the third quarter year-to-date plus the forecast or the guidance that we’re providing. Net sales we expect to be in the range of $700 million to $720 million. CapEx in the $12 million to $16 million range. Cash pension funding will be $8 million, and we do not expect to pay cash taxes in the fourth quarter. So with that, that ends our formal presentation. So we’d like to move to the question-and-answers, and we’ll open up the line for questions at this moment.

[Operator:]

[Operator Instructions] Our first question comes from Jeff Van Sinderen with B. Riley. Please go ahead.

[Jeff Van Sinderen:]

First let me say congratulations on the strong Q3 metrics.

[Chris DiSantis:]

Thank you Jeff.

[Jeff Van Sinderen:]

I guess, my first question is really sort of a follow-up to your comment on weather and logistics. Just wondering what is the latest you’re dealing with there. Maybe you can talk more about those and then the impact that we might expect in Q4 from weather and logistics? I mean obviously, don’t know what the weather is going to be like, but kind of what you’ve been seeing so far?

[Chris DiSantis:]

Yes, the logistics one is, I would say, more leveling out with the third quarter in terms of cost for the business. I think the countermeasures that the team has put in place have been very effective, and we’re not seeing the same rate of inflationary increases that we saw early in the year. So yes, I mean, it’s just you’re not going to see as much with us, maybe as you’ll see it with some others because we’ve done a particularly good job from an efficiency standpoint in managing the whole warehouse system and reducing the number of warehouses that we have and reducing the amount of inventory that we’ve got, the amount of square footage that we use. So there’s, call it less touches on a ton of paper than we would have had in the past, when we had a more crowded system with more inventory in it. And then as far as the weather, the weather thing is difficult, what I mean to predict. But just to give you some more color on that, so there is – the general geography, I mean, around the Luke Mill, if you drew a 100, 150-mile type circle around the location in that mill, we’ve had a farmers’ almanac record type season for rain so far this year, and that’s made it very difficult to get the equipment out there and get the wood cut and get us fiber supply. So it’s been an availability issue, it’s been a pricing issue as well. So we’ve had to go and reach out further and further and look for other alternatives for fiber, which has driven up the cost for that at the mill.

[Jeff Van Sinderen:]

And does that – I mean, will that continue into the remainder of Q4 do you think, the higher cost you’re paying there? Or how should we think about that?

[Chris DiSantis:]

Yes, I mean, I would say yes. The reason I would say yes, I’ll say it’s better when it’s – after it’s already happened, that it’s gotten better. But yes, it’s still been a challenge from a weather standpoint through this time as we talk today. So that makes the cost estimate. And that cost estimate…

[Jeffrey Van Sinderen:]

Okay, fair enough. Right. Okay. And then on the A3 line, the container board line, just wondering kind of where it’s stands, I know lodged, and I guess trying to get a sense, give a better sense in terms of run rate? And are you making all the types of product that you’ve targeted? Are customers happy with the quality of the product that’s coming off that line at this point? Just anything else you can give us there.

[Chris DiSantis:]

So lots of customers in the qualification process. No issues with some without the machine. I mean, there’s a couple of hundred thousand tons is kind the run rate. Some things that we’re looking at could potentially improve that, evaluating additional investments down the road in the future, maybe we will make an additional investment in the future to try and get more tons of production out of there. We will see. But for right now, good feedback on the quality of the product from the customers, still lots of trials in process. You don’t run hyper-efficient when you’re running trails and you’re doing a lot of setups and changeovers and that kind of thing. So we’ll definitely be able to run a lot more efficiently in 2019 than we have in 2018. But as far as project going relative to expectation, yes, it’s fine.

[Jeffrey Van Sinderen:]

Okay, great. And then one more if I could just squeeze it in. You guys have paid down a lot of debt. You’re generating really good cash flow. How are you thinking about allocating capital in your projects heading into 2019? Are you inclined to do more conversions do you think? I just, I guess, just trying to get a sense of where the thought process is now and kind of what your leaning forward?

[Allen Campbell:]

Yes, it’s a combination effect. So it’s a lot of what I said before, when I repeat But we look at risk-adjusted return on capital. And we’ve been looking at I mean, a lot of projects, so we’ll be looking at projects to speed up the specialty machines in the business. We’ll be looking at projects to potentially make more SBS. We’ll be looking at all kind of things, maybe make more pulp in the system. All those projects are competing against each other. But one other things that happens when you get to a – head to the situation where you got a little to no debt is you got a lot of optionality. So we’ll be looking at all the return on capital criteria of those projects. And if they’ve got good return on capital, then, yes, we could spend a significantly more amount of capital next year, we will have the flexibility to do that. We also have I mean, a lot of dry powder. I mean, we have a balance sheet with no debt, M&A would still be part of the strategy going forward as we look at other things to do. So we could save it for a deal, could have a more rapid transformation from a project standpoint and conversions, but we’ll see. All those – that opportunity set is in a constant fight with each other month to month for the best possible projects. And we had things with a very heavy level of scrutiny and due diligence before we trigger on anything. But for right now in the interim between now and at the end of the year or early part of next year, we just want get as much debt off the balance sheet as we possibly can give us some best optionality.

[Jeffrey Van Sinderen:]

Okay good appreciate taking my questions. And best of luck rest of the quarter.

[Operator:]

Our next Hamed Khorsand with BWS Financial. Please go ahead.

[Hamed Khorsand:]

So first off, is the A3 line operating to your expectations? I think, you were saying that in Q4 it would be neutral or accretive to earnings?

[Chris DiSantis:]

It’s performing to expectations from the following standpoint, in terms of throughput, in terms of quality, in terms of, and when I say quality, I mean, hitting customers’ performance targets, that kind of thing. Yes, it’s running to expectation. But don’t expect it to generate any meaningful or a significant contribution to cash flow in the fourth quarter because it’s just bumpy. When you’re going through a startup phase and, what are we one months? An you’re going through a startup phase, it’s bumpy. You’ll run hard for a while and then you’ll find a problem. And you got to fix it. So we expect in 2019 to have a lot of the bugs worked out and be running full and be accretive in 2019. But it won’t be a consumer of cash in the fourth quarter.

[Hamed Khorsand:]

All right. And then as far as just the amount of cash you’re generating and you’re probably going to generate in Q4, what do you think the timing is that you would be debt free?

[Chris DiSantis:]

It depends. So some of these capital projects and that sort of thing could affect that. So we didn’t guide specifically on debt, but if you just look at kind of the run rate, I mean, of EBITDA and you look at the cash that came in on the countervailing, duty settlement in October, and you kind of look at the pace of that, it’s probably within months. Barring something strategic. I don’t want to put anything set in stone out there because we might do something if there’s an opportunity that comes up we might pounce on it, but it’s coming down fast.

[Hamed Khorsand:]

Okay. And then just as far as the market dynamics are concerned, we are now a year passed since you had major miles off, and then its been filled in by imports. How much more do you think that there is tightness in this market without any more supply having to come off?

[Chris DiSantis:]

Let me make sure I understand the question.

[Hamed Khorsand:]

How much is it under supplied, right. I mean, we’ve gone through a year. We’ve had demand drop off from the natural progression of this industry on coated paper. So eventually it’s supposed to reach an equilibrium, when you’re passed. So I guess, how much do you think that market is still undersupplied?

[Chris DiSantis:]

Let Michael Weinhold take that. Go ahead.

[Mike Weinhold:]

Yes, I think mathematically if you run the numbers, it’s still undersupplied. Obviously you can see and we spoke to the pace of imports. So imports are coming in to a certain extent trying to fill some of that void, you can see a little bit of acceleration in the declination of demand. So we have seen that pick up pace, but as we sit here today, we have the usual year-end slowdowns that we see, which is seasonally normal. But when we project out moving into 2019, we still see a fairly balanced or undersupplied market still in most of our core categories. So we feel pretty good on the outlook relative to supply and demand and operating rate. So I still think there is some runway there, but with that said, there certainly is the erosion we see in the demand drivers and so that obviously hasn’t been corrected. This is a supply-side issue, but the dynamics still look pretty favorable from just the machine utilization standpoint.

[Hamed Khorsand:]

Do you think that demand will accelerate anytime soon as far dropping off just because pricing has accelerated so much?

[Chris DiSantis:]

You mean demand erosion.

[Hamed Khorsand:]

Erosion, yes?

[Mike Weinhold:]

You can see some of that pace already in the numbers. So to the extent that I can’t say, I can’t predict continued escalation in that demand decline rate. But I can tell you that certainly with the prices and the pressures that are certainly in parts of the segments, you can see some of the end use drivers, the demand side is certainly something to keep a very close eye on.

[Hamed Khorsand:]

Okay. Thank you.

[Operator:]

Our next question comes from Adam Ritzer with Pressprich. Please go ahead.

[Adam Ritzer:]

Thank you. And thanks for taking my call. I think most of my questions were already answered but I’ll make sure I heard them correctly and correct me if I’m wrong. I think you said free cash use going forward looks like you’re going to pay down your debt, and that should be gone pretty close to year-end or early next year. And then look at internal return on capital projects, and you also said you’re still looking for strategic alternatives. I guess, the only question I had left is, like why is it taking so long to do something more strategic?

[Chris DiSantis:]

In what way? You mean strategic from an M&A standpoint?

[Adam Ritzer:]

Yes, an M&A standpoint. Something besides paying down all this debt, which again is almost gone, buying back a chunk of stock, paying a special dividend. That’s what I think is strategic, you might think otherwise, but that’s kind of want I meant.

[Chris DiSantis:]

Yes, so from an M&A standpoint, we looked at a variety of different transactions and a variety of alternatives over the last year. So it’s not for lack of effort. But when it comes to M&A, it takes two, and both parties have to be happy, with pricing terms, that sort of thing. So we have an active corporate development effort, and we look at a lot of different stuff that goes on in the industry, but I think it’s important to remain disciplined. And some of the deals that have gotten done out there you might look at them and kind of been surprised the prices that people are paid for things and kind of stuff. And the reality is, we’re going to be very disciplined about it. We’re going to do things that fit our strategy to either help us diversify our mix or do things that help us capture synergies. But we’re going to be disciplined in our approach about it. So it’s not for like lack of trying and effort, it’s more for lack of fit and lack of finding the right deal. And we no longer have a strategic alternatives committee formed that’s active right now, but I want to assure you that we are active in considering corporate development as a part of our strategy. It’s just a matter of finding them, the right deals.

[Adam Ritzer:]

If you couldn’t find a deal, again the debts going to be pretty much gone at year-end. If things are similar next year, you should generate a $150 million-plus of free cash. Then what do we do?

[Chris DiSantis:]

You’re saying if we generated $150-plus of cash?

[Adam Ritzer:]

Yes. And again, if numbers are similar and the debt that as even you said is going to be gone pretty soon, you can’t do anything strategic, the internal things are I don’t think they’re going to be huge amounts of money. Do you then look at buybacks and dividends or like what else is there left?

[Chris DiSantis:]

Yes, I mean, we consider all of those. It just – it comes down to what has the best return on capital. You got to remember, historically, the company wasn’t in a position financially to be able to look at a lot of these internal projects from a capital standpoint. Either the company had too much debt are it had very tight covenants, those kind of things. So one of the things that being debt free does, it creates a lot more optionality. So it is quite possible that there could be a handful of projects where you’re speeding up some paper machines on the specialty, we’re expanding productivity on containerboard or maybe you’re making a significant investment in pulp, which we think is interesting for a lot of reasons. There’s a lot of potential things in their that could drive excellent returns, better returns than just paying a dividend or buying back stock, for instance. So we’re going to look at all that stuff, and as each quarter passes, you’re not just going to get more of the same every time. I mean, what we hope is that on future earnings calls as we go quarter for quarter, that we can give more specifics and more detail around what those projects are and maybe some more specifics from a corporate development standpoint. But yes, when you have a lot of cash like that, and you have a very healthy company, it gives you a lot of potential things to do, and that’s our job is to find out what those accretive things are.

[Adam Ritzer:]

Right. I guess, we could imagine year or two ago, as basically to guess just standing in the business and pricing increases. I think you’ve done a great job. I appreciate you taken my call, and keep the good work. Thanks very much.

[Operator:]

At this time, there are no more questions in the question queue. This will now conclude our question-and-answer session. And I would like to turn it back over to Tim Nusbaum for any closing remarks.

[Tim Nusbaum:]

Thank you very much. Appreciate your interest and look forward talking next time. Thank you everyone.

[Chris DiSantis:]

Thank you.

[Operator:]

The conference has now concluded. Thank you for attending today’s presentation. And you may now disconnect.