WPP plc
Q3 2013 Earnings Call Transcript

Published: 29 Oct 2013

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Wausau Paper 2013 Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, this conference is being recorded. I’d now like to turn the conference over to our host, Mr. Perry Grueber. Please go ahead.

[Perry Grueber:]

Thank you, Stacy. Good morning, everyone. Thank you for joining us. I’m pleased to be here today with Hank Newell, our President and Chief Executive Officer; and Sherri Lemmer, our Chief Financial Officer. After our prepared remarks, we look forward to your questions. This call is being webcast and slides are provided to summarize key elements of our presentation. Your webcast viewer should allow you to download these slides and yesterday’s earnings release, both of which are also available from the Investors section of our website at wausaupaper.com. Statements made during this presentation, other than those that refer to past results, are forward-looking statements made pursuant to the Safe Harbor provisions of the Securities Reform Act of 1995. Such statements, including those concerning expected performance, future earnings or dividends, involve risks and uncertainties that may cause results to differ materially from the expectations set forth during this discussion. Among other things, these risks and uncertainties include the risks and assumptions described in Item 1A and Item 7 of the company’s Form 10-K for the year ended December 31, 2012. The company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events. Additionally, our presentation refers to certain non-GAAP financial measures. A reconciliation of these measures to GAAP is provided in the appendix of this presentation. There you’ll also find a variety of other summary presentations and data points you might find useful. And with that I’ll now turn the call over to Hank Newell, our President and Chief Executive Officer. Hank?

[Hank Newell:]

Good morning. The third quarter represents our first quarter as a 100% tissue company, a major milestone in our multi-year transformation. Over the last 24 months the team has as a part of our strategic repositioning successfully accomplished the divestiture of two major business units, the sale of its timberlands, and completed the closure of two major manufacturing sites. As part of our Tissue expansion we have successfully repositioned the EcoSoft brand in terms of both quality and cost, built a new 70,000 ton ATMOS tissue machine which is capable of making high-quality towel and tissue from 100% recycled fiber, launched a new premium brand family, DublNature, while continuing to grow our tissue volume at two to three times the market. Organizationally during this same period we built a new leadership team that includes the CEO, CFO and Senior Vice President and General Manager of Tissue. We’ve added five new board members with substantial tissue experience and executed an overall realignment of the salaried organization that will result in over a 22% reduction in salaried staffing. We are building a record for execution and have created a new Wausau Paper that is focused on continuing to demonstrate above market growth, industry leading margins, and high returns on capital. In our first quarter as a 100% tissue company we delivered year-over-year case volume growth of 7.4%. This is the strongest volume quarter in our history and well above market growth rates. Revenues were up 5.6% versus last year. A great start for the new Wausau Paper and our team as we build a strong growth oriented company. Our EBITDA margins as we expected continued to expand with Q3 EBITDA margins improving to 11.5% with progress in ramping up the new paper machine and optimizing our operations platform a significant element of the improvement, and we announced the policy to return approximately 50% of our free cash flow to shareholders. In the near term our focus is to deliver on volume growth commitments at target margins. Ramp-up and optimize, this significant investment in a new paper machine and changes we have made in our operations platform demonstrate meaningful growth in free cash flow and increase the return of cash to our shareholders. Our goal is to achieve a 6% compound annual volume growth rate over the coming four to five years. Market acceptance of our new DublNature products has been strong as evidenced by third quarter performance and a strong order profile as we move into the fourth quarter. Approximately 46% of our volume at the end of the third quarter is new as a result of repositioning the EcoSoft brand or the launch of the DublNature family of products. We have a nice pipeline of further product introductions to include new DublNature products using OptiCore proprietary technology, the Artisan brand family of high-end premium products and several new proprietary dispenser innovations that will come to market in the near term. Growth at our target margins is the key driver of value. The scope of operational change and investment has been significant as we build a powerful operations platform. We’ve constructed, started, and commercialized a new towel and tissue machine in Harrodsburg that is utilizing new technology ATMOS. No one else is doing what we do. We’ve retrofitted nine converting lines to cost effectively convert a significantly larger parent rolls produced by the new machine. We’ve upgraded eight converting lines with capabilities required in premium products. And are in the process of starting up a new proprietary converting line that will produce OptiCore products to support the accelerating growth in proprietary towel and tissue. These changes have also driven a major shift in distribution and logistics scale that we will optimize over time. Much of the margin expansion in Q3 and Q4 is from the continued progress and ramping up the new paper machine and optimizing our new operations platform. I would like to share some insights around how the machine is performing. First, it is a uniquely flexible asset that is capable of producing a full range of towel and tissue products in either conventional or ATMOS mode using either virgin or 100% recycled fiber across the full spectrum of quality attributes. It is an asset that enables broader market participation and growth. In conventional mode we are achieving target speeds and cost structure and are displacing higher cost to purchase parent rolls. We are running in ATMOS mode to produce the premium DublNature products and are progressing up the ramp-up curve. As we continue to grow our premium products we will see fewer changeovers, larger run sizes, increased cases per ton, and continued margin expansion. Our premium DublNature products are experiencing excellent market acceptance and the technical capabilities of the machine exceed our expectations. It is a matter of continuing to gain experience and move up the learning curve. Earlier this year we began the major realignment and reduction of salaried staffing. A range of alternatives were considered to include the relocation of functions and operations. Third-party resources have been used to benchmark functional area staffing, cost and effectiveness. And further analysis considered both competitor and broader industry comparables. We have taken a companywide approach to realigning and reducing our overall investment in people that reflects both the new scale of the company and the needs to support our growth objectives. As a result we have consolidated operating functions in Kentucky and taken the final steps to consolidate support functions in Wisconsin. These actions result in over a 22% reduction in total salaried staffing and approximately a 55% reduction in staffing levels based in Wisconsin. The cost to relocate the remaining support functions is substantial with no economic benefit there are no plans to relocate our Wisconsin operations. We also assessed brand positioning of the company. Re-branding would be expensive and have minimal impact on value. There are no plans to change our name. We are targeting SG&A overtime to be 10% to 11% of sales which supports achievement of our stated growth and margin objectives. This range is well below our relevant tissue industry peers. As we announced our strategic repositioning we knew we would be creating the opportunity and need to provide clarity on the future uses for cash. We announced our policy on the return of cash to our shareholders earlier this month. We will support the organic growth needs of our business required to deliver our strategic goals. These needs include the ongoing investment and proprietary dispensers an important element of our business model. As we continue to deliver growth this requires reinvestment of $25 to $30 million a year. This essentially represents the subsidy on placement of dispensers which shows up as other assets on our balance sheet is reflected in our reported operating cash flows and added back as amortization in the calculation of EBITDA. Growth is closely tied to proprietary dispensers and ultimately that growth requires continued investment in converting capacity and proprietary capabilities which on average will be $15 to $20 million a year. In primary the ongoing maintenance capital of the business is in the $8 to $10 million range. We are targeting a leverage ratio total debt to LTM EBITDA of approximately 2.5 times. We have cost effective unsecured credit agreements in place that provide us the flexibility to respond to business conditions and opportunities as they may develop. There are no major capital expansions in the current plan, opportunistic acquisition would be focused on capability or geography and away from home market with strict return criteria. The return of cash to our shareholders is a priority and we announced earlier this month our intent to return approximately 50% of free cash overtime through a growing dividend, share repurchase or both. The future timing and amount of dividends and our share repurchase will be determined by the Board based on expected cash flows, pro forma leverage levels, obligations under credit agreements, evaluation of market conditions, trading price of the stock and other factors. Sherri will now cover financial performance for the quarter in more detail as well as provide guidance for the fourth quarter and for 2014. Sherri.

[Sherri Lemmer:]

Thank you Hank and good morning. With the sale of the technical specialty paper business during the second quarter of this quarter and in accordance with generally accepted account principles, certain restatements have been made between continuing and discontinued operations to reflect the ongoing operations of Wausau Paper. The comments that follow reflect the results of continuing operations for our company. In our second quarter conference call on July 30th we indicated that with a full range of DublNature products available during the third quarter and continued improvements in operating efficiencies we expected improved results over the balance of the year. In the third quarter of 2013 we achieved improvement in sales volume with the record $4,358 million cases shipped representing a 7.4% increase over the third quarter of 2012. Our mix of strategic versus support products increased about 1% point over the previous two quarters in 2013 and in the quarter a strategic mix at 48.4% of total cases shipped in the three month period. We expect to maintain strong performance with 6% case growth in the fourth quarter and total case volume improvement for the full year in the range of 4% to 5% again demonstrating our ability to grow at above market rates which were in the neighborhood of 1.5%. As a result of strong volume net sales were $91.7 million a new quarterly record marketing improvement of 5.6% over the $86.8 million in the prior year third quarter and on a year-to-date basis we are just slightly above where we were in the same time in 2012. Adjusted earnings before interest, taxes, depreciation, amortization or adjusted EBITDA up $10.6 million represented an adjusted margin of 11.5% for the third quarter of 2013 and has improved with each quarter this year. The improvement has been generated as we have delivered on our growth metrics in the form of increased cases shipped to customers coming in 3.6% better than second quarter volume and now with additional new premium products in the market place an improvement in the mix of strategic versus support product sales. Further as we’ve advanced along the startup curve of the new machine converting efficiency of the substrates has improved positively impacting EBITDA generation. We were negatively impacted in the comparison of results between the second quarter and the third quarter given the reclassification of costs associated with continuing obligations posted Wausau Paper like I’m going find benefit pension plan cost and costs that are non-recurring in nature like those associated with salaried staffing reduction and charges for workers compensation related claims that were reopened. As in prior discussion to fully appreciate the adjusted quarterly and year-to-date comparisons it is important to understand the impact has change to our business in 2013 due to the new machine in Harrodsburg and the impacts of the expansion project that we’re not part of last year’s operating results. From a quarter-over-quarter perspective comparing the third quarter of this year with the same quarter in 2012 excluding special items such as the settlement charge recorded for our cash balance pension plan and income tax valuation allowances recorded for net operating loss carry forwards and states where we are no longer required to file returns. We reported an adjusted net loss of $0.9 million or $0.02 per share compared with the third quarter of 2012 adjusted net earnings of $1.7 million or $0.03 per share. Prior year adjustments to reported net earnings included expense related to the new machine construction, charges for settlements in our defined benefit pension plan in various income tax matters. Year-over-year quarterly depreciations expenses increased about $2,5 million or $1.6 million on an after tax basis and due to our policy to capitalize interest on large capital investments and therefore impacting the quarterly comparisons interest expenses increased approximately $1.3 million or about $1 million on an after tax basis. The combination of these two elements accounts for an approximately $0.05 per share charge for the third quarter adjusted net earnings compared to the same period in the prior year. Combined with the first half of 2013 the impact of these two items on the first nine months was approximately $0.15 per share. In the third quarter we saw expected improvement as we progressed along the ramp-up curve with production capabilities and new product introduction, costs that exerted pressure on bottom line results in the first half of the year. For the nine month period this resulted in an impact of approximately $0.11 per share. While volume in the third quarter was strong and base pricing is holding up the fall in overall average net selling price is attributable to continued strong growth and support categories of our product lines with growth of nearly 8% above the prior year third quarter. Strategic case volume in the third quarter grew as well, finishing at more than 7% growth in the quarter-over-quarter comparison. The net impact of volume and average net selling price was unfavorable a combined $0.03 in the quarterly comparison and year-to-date was approximately $0.11 on favorable. Improvements in our overall cost structure as a result of targeted efforts were realized as we move through 2012. The benefit of an overall improved cost structure can be seen in the impact of operations and other on both the quarterly and nine months results. From a debt structure perspective we have a Private Note Shelf Agreement for $200 million that permits issuances under its terms until July 2014 and a $100 million revolving credit facility that expires in June of 2014. Both of these agreements are unsecured and provide a cost effective and flexible structure. At September 30th 2013 the $150 million of total long term debt reflects the senior notes currently outstanding under our Private Note Shelf Agreement the earliest maturity of senior notes from this product in June 30th 2016 and the combined weighted average interest rate of the notes is 4.79%. Including the bank fees associated with our currently undrawn credit facility, our weighted average cost of debt is approximately 5.1%. Net in cash and cash equivalents with total outstanding long-term debt results in a net debt at September 30th of approximately $125 million. This cash reserve along with expected cash generation from our operations provides the resources to fund the priorities as outlined in our capital allocation policy. Turning to current estimates for the upcoming quarter as well as the fourth quarter and full year of 2014, we expect sales volume growth of approximately 6%. In the fourth quarter of 2013, we are currently forecasting an adjusted EBITDA margin in the range of 14% to 16% up from 11.5% in the third quarter. Our previous guidance was for EBITDA margins in the range of 16% to 18%. However, the more measured approach to our premium product launch which delayed product introductions as resulted in a lower expected operating range. Looking ahead to 2014 for the full year, we are estimating at this time EBITDA between $65 million and $70 million and net earnings per share from continuing operations of $0.21 to $0.28 with EBITDA in the fourth quarter of 2014 in a range of $20 million to $24 million. I would like to a moment to step through the results we have seen on EBITDA generation as we progress through 2013 and our expectations as we move to the fourth quarter of 2014. In the first half of 2013 we expected and communicated that there would be pressure on our operating efficiencies and profitability as we started up the new machine and work through the complexity of transitioning the manufacturing and converting capabilities not to mention the pressure created by the overall pace of change that was occurring in our entire organization. In the second quarter while we had originally planned to have to 19 distinct new DublNature products available at the time of the launch we chose a more measured approach in order to better support our distributor base as they roll these products to be ultimate end user and launch the total of 16 new products in that period. In the third quarter we introduced and shift an additional four new products in our Greenfield DublNature family of premium away from home Towel and Tissue product resulting in 20 new tissue roll and folded towel products in the market since our initial launch. We also focused on optimizing our operational efficiencies with the new substrates. Consequently, we reported another step change in financial results. And as we move to the fourth quarter, we expect to continue to focus and execute on our strategic path. Moving forward to the fourth quarter of 2014, we expect to once again deliver on our expected growth target and sales volume and improve strategic mix given the additional planned product introduction Hank mentioned earlier including new DublNature products, the ARTISAN brand family of high-end premium products and several new proprietary dispenser innovations that will come to the market in the near term. Further, since we are currently in the process of optimizing our manufacturing and converting assets and capabilities, we expect that improved operating efficiencies will provide incremental benefit from where we end the fourth quarter of 2013. In our forecast we are currently projecting an unfavorable impact to our results with respect to fiber and other input cost. This is an element of business risk as pressuring areas like fiber pricing is expected but the magnitude and invest timing is uncertain. The result is at 2014 fourth quarter EBITDA in the range of $20 million to $24 million. A closer look at how we currently view 2014 as outlined here. The first half of the year will be pressured by the normal demand seasonality for the Tissue business. The first quarter of the year is an historically low sales demand quarter compared to other quarters in the calendar year. Our maintenance outage in our Middletown, Ohio manufacturing facility in the second quarter and the production trials and launch of the new ARTISAN family of premium products that will likely impact both the first and second quarters. Key assumptions for 2013 and 2014 include our current projection of capital spending in 2013 at approximately $46 million. Approximately $2 million of that reflects first half spending related to the technical specialty business prior to the transactions closing and $16 million represents spending directly tied to the Tissue expansion project. As mentioned earlier, as a general target we would expect maintenance capital which excludes investments and capital like additional converting lines to support demand for our products to be approximately $10 million annually. Given our growth projections, we expect to spend approximately $15 million primarily related to additional converting capacity in 2014. Adding maintenance and converting capital together results in total capital spend next year of approximately $25 million. We expect net dispenser spending to be approximately $23 million in 2013 and $25 million in 2014. Hank discussed this in some detail early in the presentation. When evaluating free cash flows, we have to find it net cash provided by operating activities less spending on plant and equipment, net dispenser spending is included in our net cash provided by operating activities, well capital spending is identified separately in our statement of cash flows. For 2013, depreciation and amortization included in continuing operations is expected to be approximately $40 million and about $41 million for all of 2014. Including those operations that have been discontinued total 2013 depreciation expense is expected to be approximately $82 million. Interest expense for the 2013 calendar year will be approximately $9 million and approximately $8 million in 2014. We would expect interest expense to closely approximate interest paid as the amount of interest capitalized is significantly less than 2012. Well our effective tax rate for financial statement purposes is expected to be above 37%. We have federal net operating losses on a pre-tax basis of approximately $28 million and the cellulosic biofuels credit carry forward of approximately $13 million that will offset cash taxes paid. Non-cash pension expense for continuing operations will be approximately $3 million to $4 million in 2013 and in the range of $2 million to $3 million in 2014. Ongoing pension expense is dependent on several factors, but given the environment we are in today, this should be a good proxy of go forward normal expense. With that I will turn the call back to Hank. Hank?

[Hank Newell:]

Thank you, Sherri. Wausau Paper today is well positioned for a significant earnings expansion and cash flow growth. Sherri took you through our expectations for 2014. We have previously provided EBITDA guidance of approximately $140 million by 2017. Our outlook has not changed but any long-term forecast has uncertainties. Our improvement in earnings and cash flow was a ramp-up curve and that improvement will not be in a straight line. Macro factors such as fiber are expected to increase in both 2014 and as we move towards 2017. We expect product pricing over time to offset these costs but there will be a time lag that can impact results at any given point in time. To wrap-up we are today a company that has 100% focused on Tissue and uniquely positioned to grow and deliver value. We had a third quarter that demonstrated excellent progress delivering volume growth and margin expansion. We are committed to growing free cash and distributing approximately 50% to our shareholders as a priority. We look forward to sharing our continued progress. Thank you very much for your support. And I’d now turn this call over for Q&A to Perry.

[Perry Grueber:]

Thank you, Hank and Sherri. That concludes our comment proportion of today’s call. Stacey will you call for any questions please.

[Operator:]

Sure. (Operator Instructions). We’ll go to Mike Roxland with Bank of America. Please go ahead.

[Mike Roxland:]

Thanks very much. Just want to get a little more clarity on the capital allocation strategy of returning 50% free cash flow to the investors. How does that ultimately jive with your desire to fund growth? I think if it sounds like on this call you changed the – you changed like – you changed your direction because I feel on the last call if I recall correctly you said that the priority for the company was going to be to use future free cash flow for our growth investments. So, now that you’ve laid out this free cash flow target, it sounds like -- correct me if I am wrong, it sounds like you are going to be focused on returning cash to shareholders over growth, would that be correct?

[Hank Newell:]

So, I think the number one priority is to deliver on our stated strategic goals as relates to revenue growth and EBITDA. And what we’ve articulated as it relates to capital allocation priority is that capital required to deliver on those expectations. So, building a strong profitable growth oriented company is our objective. There is level of ongoing dispenser investment and investment in proprietary converting that’s required. And I think with our targeted capital allocation we’ve had an adequate free cash flow that has opportunities for acquisitions in areas that are close to home would become available or that we would have the capacity to execute. So I think what we try to do here Mike is provide more, just more clarity around what those capital and cash needs are and reinforce our commitment to provide a growing dividend and or repurchase shares in a way that continues to return and create value for our shareholders.

[Mike Roxland:]

Okay, I got that, I mean how would you frame, how would you rank it so what’s the order of priority for cash flow, is it the growth, is this dispenser investment, is this proprietary investment is the opportunistic acquisitions or is it really trying to return cash to shareholder through – the higher dividend or through share purchase, how should we think about it in terms of order or priority.

[Hank Newell:]

So I think as you step back and as the board considered it’s announced policy to return 50% of free cash flow to shareholders, we considered all of those factors and ultimately first we need to have a resilient balance sheet that does not constrain us in periods of whether it would be economic uncertainty or if we have an opportunity. Two, we need to have a balance sheet that supports what we know to be the requirements to successfully grow our business. And then as we’ve announced our intent and commitment to return cash to shareholders we feel comfortable that targeting a 50% pay-out ratio free cash as we’ve defined it is appropriate.

[Mike Roxland:]

Got you. I appreciate that. Just a couple more quick questions, in terms of the last one released on the free cash flow at a minimum because of what you laid out there in terms of the dispenser investment, the converting capacity investment, and maintenance cap investment. You are looking at a CapEx hurdle typically of around $50 million, $70 million, would that be – is that fair?

[Hank Newell:]

That’s I think that’s right on, Mike.

[Mike Roxland:]

Okay. Got you. Then just on the new tissue line when do you expect the new line to be running higher quality products to reduce the amount of turnover of the new machine? And secondly if there is such high demand of your new products why did you choose more measured approach to support distributors in the quarter?

[Hank Newell:]

So I think we grew our support categories at over 8% in the quarter and strategic was growing at – in the neighborhood of 7%. So there is a little bit of how much transition and inventory can you manage and how much in the way of new product introductions can your supply chain, your distributors manage. So as we work through and kind of solve for that equation it said we need to take a more measured approach as we introduced product to the marketplace. So we’ve got the full launch out there now. As you look at Q3 an awful lot of the improvement in Q3 was really related to operations as we moved into Q4 and into 2014 you will start to see the full benefit of growth in DublNature products and that shows up in two ways. One, DublNature which is our premium product offering carries a much higher margin. And two, as you get the scale of those premium products on our new machine you get larger run sizes or getting the – getting the experience on those grades, they were getting the experience in converting. So you’re getting kind of a two pluses, one, the higher margin product and two, much more optimized operation and that becomes the source of the real EBITDA expansion as you move into 2014.

[Mike Roxland:]

Got it. And then just can you remind us what you see in terms of new capacity, new tissue capacity which I believe is largely geared for away-from-home. And then why you think your business is particularly defensible versus other competitors. We’ve recently heard from someone else, someone from another company in paper forestland, whose business is also presented as defensible. And your competition appears to have heated up potentially pressuring pricing in that sector and also their margin. So what makes your business so special, why it’s defensible, why couldn’t others replicate the model?

[Hank Newell:]

So I think first I think the first part of your question was around capacity additions and ours is really the only – our investment in the ATMOS technology is really the only investment purely targeted at the premium space of the away-from-home market. There is nobody else that is making the kind of investment in technology that we are. It gives us the ability to produce the full spectrum of quality using our 100% recycled fiber. In terms of what really – you think about what makes us unique, we uniquely view the distributor as our customer and our job in life is to make that our customer successful. We want to help him grow his business, his success is ours. We are the green leader in our space, we offer controlled use proprietary dispensing supported by proprietary converting and now we’re – we’ve invested in technology that provides product attributes that I think are very difficult for our competitor set to approach.

[Mike Roxland:]

Got you. Last question and I’ll just turn it over. The trade press has reported that a buyer who is [indiscernible] buying Brainerd mill recently walked away citing environmental concerns. Can you provide us some color on what those issues are and what steps you’ve taken to address them and ultimately what’s the – can you remind us also what the company’s strategy is now for the mill?

[Hank Newell:]

Yes. So our – first, our ideal objective for Brainerd is to find and operating owner for the site. We have a wide range of interest in the – in liquidating the site so there is a source of cash there for us. But our primary objective there is that we think we can optimize value best by finding an operating owner. So we’re proceeding down that path. As it relates to the comment on environmental, I think that really doesn’t relate as much to the site as it relates to the capital requirements that were required for that potential buyer or two produce what they wanted to produce there. So the – as they looked at the investment required in the site to produce the grades that they wanted I think probably the environmental piece of that equation was larger than they thought.

[Mike Roxland:]

Got it. Thank you very much.

[Hank Newell:]

Thanks, Mike.

[Operator:]

(Operator Instructions) And there are no questions in queue. Please continue.

[Hank Newell:]

All right. Thank you, Stacy. Just to repeat we anticipated earnings, releasing our fourth quarter earnings the afternoon of Monday, February 10 and look forward to our next scheduled conference call which is set for 10

[Operator:]

Thank you ladies and gentlemen. This conference will be available for replay after 11 O’clock A.M. today running through November 5 till midnight. You may access the AT&T replay system at any time by dialing 1-800-475-6701 and when prompted enter the access code of 304-389, those numbers again 1800-475-6701, access code 304-389. That does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.