Verso Corporation
Q4 2017 Earnings Call Transcript

Published: 8 Mar 2018

[Operator:]

Good morning, and welcome to Verso Corporation's Fourth Quarter and Year End 2017 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 web site after 11

[Tim Nusbaum:]

Thank you and good morning. The fourth quarter and year-end 2017 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 web site at www.versoco.com. Joining me one 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'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'd like further information regarding various risks and uncertainties associated with our business, please refer to our SEC filings, which are posted on our web site, versoco.com, under the Investors tab. Our 10-K will be released later today. At this point, I'd like to turn over to Chris DiSantis.

[Chris DiSantis:]

Thank you, Tim, and welcome everyone. I am on slide 3 of the deck. So we had a difficult start to 2017 with regard to market challenges. We saw particular erosion in printing and writing grades and challenges from imports. We had a lot of downtime, part of that was intentional, as part of our inventory reduction efforts, and also sort of challenges -- in pricing, challenges and volume. Particularly with respect to the second quarter, where we had a very inflationary price environment. What this resulted in, is in the first half of the year, we only produced $22 million of EBITDA. However we had very strong turnaround of results in the second half, particularly with respect to earnings and cash flow, as you could see in the chart on the page. We got a lot done in 2017. We consolidated our corporate offices. The Memphis office was consolidated into Miamisburg successfully. We subleased the space. We implemented a lot of austerity measures, restructured the organization, and now have significantly lowered SG&A costs as a result. On the last earnings call, I went through a variety of examples of what was happening in the industry with respect to closures and conversions. So won't go through all that again. But the operating rates were difficult last year, but they are improving, and they are expected to continue to improve to the mid to high 90s this year, as we have a correction in the supply and demand balance. Also from an exchange rate standpoint, we saw rates as 1.06 in the exchange rate to the Euro, and we are now at a 1.23, 1.24 range, just far more favorable to Verso. The specialty business was 23% of the revenue last year, and we continue to run full and look for new ways to find additional capacity and deal with the challenges that we have in productivity and throughput. Won a lot of new programs last year, took a lot of market share, particularly with respect to release liner for labels. The team delivered in a variety of very important areas. The operational excellence, our R-gap program was very good. We strengthened our strategic customer partnerships. We had a lot of very good results in negotiations with suppliers, multi-sourcing a lot of products that we were single sourced on, reduces risk. We bought a lot of new suppliers into the fold. We improved efficiency and effectiveness of our IT platform, significantly reducing the amount of costs that we spend on outsourcing, and we created a lot of optionality in terms of levers that we can pull and things that we could do to make the business more money. We now enter 2018 with strong order books and pricing momentum, which I will talk more about in a minute, but we also have higher maintenance costs due to a seasonal outage at Quinnesec and Luke, and we do have widespread inflation that needs to be managed in a variety of cost categories. Turning to the next slide, on 4; so we finished up 2017 very strong in the fourth quarter. So $65 million of adjusted EBITDA. The EBITDA margin was 10.2%. We fared very well versus competition, that's one of the best margins amongst paper producers in the industry. We generated $112 million in cash flow. Working capital was a big contributor of that. Working capital came down $103 million, $60 million of that was inventory. A lot of good success with our supply chain synchronization initiatives, putting good systems in place to match up production of the customer demand, stretched accounts payable and did a good job there, normalizing supplier terms. Liquidity went up from 1.63 to 2.16 by the end of the year, enhances the cushion -- the safety net for the organization. The team did a good job eliminating a lot of letters of credit that were in place, blocking that availability. The net pension underfunding went from 4.91 to 4.57, so came down $34 million, and we had good asset returns in 2017. We achieved SG&A and other overhead cost reductions on a combined basis between those two categories of more than $31 million, reduced 350 positions in the company. We restructured how we do variable comp. We harmonized some benefit programs, reduced our other post employment benefits costs by $3.7 million and our SG&A is now running at less than 4% of our revenue. We successfully expanded the specialty business. We have filled up the A5 to 100% specialty products during the fourth quarter, and the number 4 machine at Andro is on track to be 100% specialty by the end of 2018. So with the business momentum recovered, with better pricing, particularly in the back half of 2017, where we implemented successive increases across every grade. Since the last earnings call, we have had $40 ton increases in uncoated freesheet, and coated freesheet sheets, supercalendered products and in digital products. At the end of January, we launched an incremental $40 a ton increase in coated freesheet rolls and coated groundwood. The pricing initiatives that we launched in 2017 had traction as well as the recently announced increases too as well, and these price increases are warranted, given the inflationary pressures that we are seeing on the cost side of the business. We are quite pleased, that Avery Dennison awarded us its best supplier innovation award. They recognized us as a key partner in successful implementation of new products and ideas. The bottom line is, is we built a better business, a leaner business in 2017 with more optionality, and we have a cleaner sense of direction for Verso going forward. Turning the page to slide 5; strategy for the business is to remain the leader in graphic papers, but we do anticipate a gradual mix migration over time, to more and more specialty and packaging grades. We are going to grow our specialty business in three ways through one, new products, two, enhance market share; and three, by finding low investment, low cost investment solutions to increasing machine throughput, finding ways to serve that incremental tonnage we know we can pickup in the market. But there will not be any debt to company level type investments in this category. We are also going to diversify in low risk ways in the packaging grades. So the Androscoggin Mill, number three paper machine was idle very early in 2017. We are starting that machine back up. That machine will be producing lightweight version craft in the 16 to 35 pound range. 190,000 to 200,000 tons of capacity are going to be on that machine. It's a $17 million capital investment, $13 million on a net basis, thanks to a $4 million grant from the Maine Technology Asset Fund. We also expect about $8 million of startup costs and to be run rate margin profitable by the fourth quarter. Another part of the strategy is, we have got a low SG&A structure, we are going to keep it that way, and we are going to aggressively go after other cost categories. So we've rightsized the SG&A, there is always more you could do there. But we think, there is a lot more opportunity to attack inputs, sourcing and operating costs, to mills in particular. We are going to capitalize on low risk relative to the light investment conversion opportunities. So we are looking at other things in the system, like SBS, bag, liner and other products. But there are some headwinds into 2018, that we have got to develop countermeasures for, that are offsetting some of these improvements we are getting at price. So there are production obstacles. The weather was quite challenging this winter, that affected us in January and February. We have significant input costs and energy increases anticipated. We are seeing record levels of freight costs, and we are having real meaningful availability challenges from a logistic standpoint, and we expect we are going to have higher maintenance expenses and longer outages this year. And lastly, we continue to move forward with the previously announced review of strategic alternatives. But we have nothing to report at this time on this call, and there is no guarantee that this process will result in a transaction. That's all we are going to say on that topic today. With that, I will turn it over to our CFO, Allen Campbell for the financial review.

[Allen Campbell:]

Thank you, Chris. On page 7, we highlight the key metrics for the quarter. Shipments were up 4% on paper, but this more than accounted for by our A3 closure. On the pulp side, we are up 7,000 tons or 13%. What's very encouraging was on pricing, up $21 a ton across our paper products, 2% increase versus the prior year, and pulp was up $88 a ton or 18%. The pulp prices were the lowest we had seen for a while in the second half of 2016, and they have been increasing each quarter since then. Key strategic area for us was our inventory. Our goal was to reduce this significantly, and you see we reduced $60 million of inventory through the year. The top right, we show our mix of businesses. Our graphics is down slightly, pulp up slightly, and specialty is holding at 23 for the fourth quarter. Moving on to page 8; for the quarter, we reported net income of $36 million or $1.04 a share. We benefited from $8 million of tax credits, $6 million of which was related to tax reform and elimination of the corporate AMT. We also had a $7 million gain, due to the unwind of a new market tax credit. Sales were $639 million for the quarter, down $7 million, but up on price, down on volume, as we mentioned earlier. Now, we have provided schedule in the back, which shows our SG&A and COGS on an adjusted basis, so we will talk about that later. We also had a gain in the fourth quarter of $4 million on elimination of certain post retirement benefits. This compares to the same period of the prior year, where we had a $25 million gain. Depreciation and amortization depletion was lower as a result of $43 million in salary depreciation that we booked the prior year, relating to capacity reductions at our Andro mill. On page 9, we walk net income to adjusted EBITDA. We had normal addbacks in the quarter of restructuring severance and non-cash asset write-offs. But we also made adjustments for our strategic cost initiatives, where we spent $3 million in the quarter, and then we also eliminated the gain of the new market tax credits that I mentioned earlier. That brought us to $65 million of adjusted EBITDA for the quarter or 10.2%. The bridge on page 10 walks prior year down too, from 92 to 65. I mentioned the OPEB changes that we have. We have a $25 million gain in 2016 fourth quarter with $4 million in 2017, that's a swing of $21 million, that's for the first box. Price mix, as mentioned earlier, been favorable, been trending up, we are $12 million favorable year-over-year in the quarter. Volume down slightly, hit of $3 million. Logistics, as Chris mentioned, we are seeing rates increase and struggling on availability, that is a $4 million hit to the business. In the fourth quarter, we also had some reliability and production issues at one mill, that more than offset the positive efforts going on in the others. So net-net impact of $11 million negative year-over-year. Input costs, as mentioned, primarily higher chemical and natural gas prices, it is for $4 million and then our efforts to reduce our SG&A and corporate overhead costs, some of this shows in the SG&A line, some shows in cost of goods sold, but the net save for the quarter is $4 million, that bridges you to the $65 million that we had in the fourth quarter. On page 11, we just highlighted quickly the year, since Chris mentioned, it was a rough first half, but improving second half. Sales were $2.461 billion, down from the $2.641 billion prior year. EBITDA, after you adjust for the OPEB, it was $203 million versus $131 million, down $73 million. Key drivers was price and mix down $23 million, volume down $26 million, logistics costs were $13 million higher for the full year. We took some downtime to reduce inventory, and that was a hit of $18 million. Raw material and other input costs were up $24 million. On the positive side, we implemented $27 million of cost saves in our corporate area, and then net operations were favorable $4 million for the year. Point to note that our controllable costs for the year for SG&A was 4.3 as reported. But if we adjust for those EBITDA adjustments mentioned earlier, our SG&A run rate is 3.9% for the year. On page 12, we are extremely proud of our success of our cash flow improvement initiatives. In 2017, we generated $193 million of cash, $94 million of free cash flow from operations, and then $99 million out of our current assets and current liabilities, working capital plus a few other items, that generated $193 million. After paying for net pension contributions, our interest and our costs that we had for restructuring severance, our strategic initiatives mentioned earlier and the Wickliffe ongoing costs. After we paid for those, we still had $114 million of excess cash. So a great effort by the team, and it has really helped us through the process. Continuing to page 13, we ended the year with total liquidity of $216 million, that's $53 million higher than the prior year, same period. That was driven by concerted effort in reducing our letters of credits. They were $38 million less at the end of 2017 than we had in the prior year. We also paid down our revolver of $47 million. We also -- but because of our efforts in inventory, our borrowing base declined. So that was $33 million. You net all that, that gives you the $216 million or $53 million increase over the prior year. If you look at our total net debt, it stood at $204 million at year end, revolving credit was $65 million and our term loan was paid down to $146 million. You net that to the cash, that gets you to $204 million. So we are quite happy with our position there. Turning to page 14, our guidance, as we look into the first quarter, we are projecting sales in the range of $610 million to $625 million. Prices have traction and volume favorable. Capital expenditures are expected to be approximately $10 million. We do have seasonal use of working capital in the first quarter, that should be in the range of $20 million to $30 million. Cash pension funding, first quarter around $5 million to $8 million, and we do expect in excess of $40 million of excess cash flow payments to our term loan lenders. Expectations for the full year, we will have higher sales in 2018 and 2017, driven primarily by pricing, and we will have a little bit of new A3 volumes. We are facing some headwinds, as Chris mentioned earlier, in logistics and freight. Energy, raw materials and some other input costs are headed up. We are going to spend in the range of $60 million to $70 million in CapEx, that includes the A3 project that Chris mentioned, this is up from $40 million that we spent in 2017. Cash pension funding, expected to be in the range of $45 million to $50 million. Cash taxes will be somewhere less than $5 million for the year, and this will be primarily some state income and franchise taxes. The major maintenance versus the prior year expected to be at $14 million to $18 million, and that's more or less the timing we have on some major outages. One of our mills has to take some outage every two years. We did not take one last year, so obviously, going to be an increase this year. Well I'd like at this point to turn it back to the operator, for questions-and-answers.

[Operator:]

[Operator Instructions]. Our first question comes from Jeffrey Van Sinderen of B. Riley FBR. Please go ahead.

[Jeffrey Van Sinderen:]

Hi, good morning. I know you went through a lot of stuff in your prepared comments. Just wondering if there is any more color you can give us on what you are seeing in terms of demand and pricing for the various kind of major segments of your business? And I guess what the outlook is? And also, further detail on input costs and the outlook, that would be helpful?

[Chris DiSantis:]

Yeah. I mean, from a volume standpoint, so we are full. The mills are full and we are running, you know what I mean, at capacity everywhere. So that's a good position to be in. The price increases that we launched in late 2017 or early 2018, they do have traction. This is the best way I can describe it. We don't guide specifically on what we are going to do in terms of capture rate or anything like that to be consistent with past practice. And from an inflationary standpoint, on input costs, it's pretty much everything; pretty much everything that we are buying, whether it's titanium dioxide or whether it's things like caustics or clay, or whether its logistics costs, we are seeing energy input. We are seeing it across the board in a variety of categories. There is not one thing I could pick out for you to kind of isolate the challenge. Although latex -- well I would say that latex is one of our -- I mean, our biggest purchases from an input cost standpoint. It's one of our biggest spend categories.

[Jeffrey Van Sinderen:]

Okay. And then if we could shift over to the facility in Maine. I think you gave the tonnage that's capable of making, maybe you could just go into the type of products that that machine will be producing? So you expect to sell to what sort of margin profile you least expect and the timeframe to get there? I think you said, it could be profitable in Q4? Just any other detail you could share there would be helpful?

[Chris DiSantis:]

Sure. Well Mike Weinhold might answer that for you.

[Mike Weinhold:]

Yeah. So the startup of A3 machine will be on linerboard, lightweight virgin craft linerboard. We model that project to export, as well as selling it to the domestic market. So we have targeted an average basis weight range right around 26 pounds. But as Chris mentioned, we have got capabilities to go heavier, up to 35 pounds and lighter, and we are also working on the capability to push it above 35 pound.

[Jeffrey Van Sinderen:]

Okay. And I know you sort of touched on the fact that there are other facilities you might look at converting? I guess, anything else you can tell us there, in terms of getting some of the other facilities to hire contribution margin business, how we should think about the process and timeframe around that, making decisions around that? And I don't know, if there is anything you want to say about which facilities or which other projects you might tackle next?

[Mike Weinhold:]

Yeah. Again it's Mike Weinhold. We have got to focus on -- as Chris mentioned, trying to increase the productive capabilities for our specialty business, and that would be specifically Stevens Point. We have got some very interesting capital projects for Stevens Point to speed up the equipment and gain incremental volume, as well as A4 machine up at Androscoggin and as Chris mentioned, we have had great success in the release liner area, and so we have got an interesting project to increase productive capacity on that machine, as well as the MG machine A5 at Androscoggin. So we have got a lot of good, as Chris mentioned, low CapEx, but very promising projects in the works.

[Jeffrey Van Sinderen:]

Okay. Good to hear. Thanks for taking my questions. I will take the rest offline.

[Chris DiSantis:]

Thanks Jeff.

[Operator:]

Our next question comes from Hamed Khorsand of BWS. Please go ahead.

[Hamed Khorsand:]

Hey, good morning.

[Chris DiSantis:]

Good morning Hamed.

[Hamed Khorsand:]

So just trying to figure out, how much of the price increases that you have announced are so far being realized?

[Allen Campbell:]

We are not going to guide on the specific rates that we are capturing from a realization standpoint. Again, not to be specific, just to be consistent with how we have addressed the question in the past. But they do act like -- we announced increases, because they are warranted in the cost increases that we are seeing are real, and that's justifying the higher prices than the price that we are selling, and when we announced an increase, I mean we don't announce it just for fun. I mean, we intend to collect on that increase. But there are a lot of factors that go into realization of price. We have contracts in place, that we have to honor and it takes time to grow things out. And so there is a lot of factors that go into managing the pricing side of the equation.

[Hamed Khorsand:]

Okay. So what I am trying to get to is that -- given the guidance of what you are giving for Q1, and then directional commentary about you being at capacity. So how much impact did you face in January and February related to weather, but sequentially down on a revenue basis?

[Allen Campbell:]

It's not the kind of thing that will affect the year that much, you know what I mean, in terms of -- the economics for the year. But I mean, there are some real bumps, because the weather challenges made it just compounded the freight logistics issues. So we were having trouble, getting product in and out to begin with, and throw tough winters in there, particularly in tough winters in places that aren't as well equipped to handle, like the Luke Mill for instance, they are not set up as well to handle the harsh winters. I mean, it affected us. So we don't have a specific number for you, in terms of you know what the impact was. I don't think it'd be material in the sense of a full year's [indiscernible] results. But that did compound the problem.

[Allen Campbell:]

And you saw that in our tempered out first quarter sales forecast.

[Hamed Khorsand:]

Yes. And then, what I was going to ask you is that, do you have visibility as far as your order book goes, given the current state of the market?

[Chris DiSantis:]

Sure. The visibility, you mean like in terms of backlog and stuff?

[Hamed Khorsand:]

Yeah.

[Chris DiSantis:]

Yeah, absolutely. We have visibility and we are full. Yes I mean, customers don't -- it depends on the nature of the product, and who's buying what, and they don't put [ph] in orders for a whole year, but the backlogs are improving and they are increasing and we are running full.

[Hamed Khorsand:]

All right. And then the other question I had was, have you been able to fix that operational problem that you had now in Q4, the reliability issue?

[Chris DiSantis:]

There is some overlap in the first quarter.

[Hamed Khorsand:]

Okay. Is it out of the way, or is it still a drag?

[Chris DiSantis:]

We believe it's getting out of the way.

[Hamed Khorsand:]

Okay. All right. Thank you.

[Chris DiSantis:]

Thank you, Hamed.

[Operator:]

[Operator Instructions]. Our next question comes from Amer Tiwana of Cowen. Please go ahead.

[Amer Tiwana:]

Hi guys. A couple of questions. First one, working capital was a source in 2017. I know you gave some guidance and on the first quarter, anything for the full year, how should we think about that?

[Allen Campbell:]

I think our working capital will be -- I don't think you will see tremendous swings on working capital in 2018. We will end the year building some inventory on the A3 project. We will continue our initiatives to manage it well and especially, looking for extended terms and time on our payables, our mix of business may impact accounts receivable a little bit. So no material changes in 2018.

[Amer Tiwana:]

Okay. And again, CapEx, 60 to 70 guide for the year, that's up from 40. How should we think about -- if I look at the current footprint, what maintenance might be? Is 60 to 70 the right run rate for maintenance?

[Allen Campbell:]

Well the 60-70 also includes some material capital, as mentioned earlier, net of about $14 million for the A3 project. You take 14-15 off that 60 to 70 range, that would be our general maintenance for the amount of mills that we have today.

[Amer Tiwana:]

Got it. And last question, you have sort of given guidance on sales, on what you are seeing on the inflation side for raw materials and other inputs. How should we think about the overall earnings is -- I am just looking for some directional guidance as to whether overall impact will be down slightly or flat or how do we think about that? Or maybe, in other words, where will the balance shake out and what are the major critical things that we should think about, in terms of modeling?

[Allen Campbell:]

I think you need to look at the tailwinds, which would be the pricing, very positive there. We talked about the order book being strong. Those are the two tailwinds as we look going forward. We have reduced our interest costs significantly. So those things are the positive. If I look toward headwinds, we have mentioned a lot of the inflation and the input costs and logistics. Those would be the two headwinds that -- major ones that we are facing.

[Amer Tiwana:]

But in terms of directionally on earnings, any thoughts?

[Allen Campbell:]

Tailwinds are obviously stronger than the headwinds at this point.

[Chris DiSantis:]

We are not putting any guidance out there.

[Amer Tiwana:]

Thank you very much.

[Chris DiSantis:]

Thanks.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Allen Campbell for any closing remarks.

[Allen Campbell:]

So we'd like to thank those participating in the call for your interest in Verso and wish you the best day and thank you very much.

[Chris DiSantis:]

Thank you.

[Tim Nusbaum:]

Thank you.

[Operator:]

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