Q2 2019 Earnings Call
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Thank you and good morning second quarter 2019 financial results for Bush Airport [laughter] were announced this morning before the market open.
The Irish relations so slide.
During the call available on the investors page at <unk> website, Www Dot first second third dot com.
Joining me on the call today is loves what are your own Chief Executive Officer, Alan Campbell, Senior Vice President and Chief Financial Officer, and Mike Weinhold, President of graphic in specialty papers I'd like to remind everyone that during the course of the call to give you a better understanding are before us 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 managements expectations [laughter], if you'd like further information regarding these risks and uncertainties associated with our business. Please refer to our FCC volumes, which are posted on our website Www <unk> third party investors tab.
At this point I'd like to turn the presentation over to watch world.
Thank you Tim Good morning, everyone and thank you for joining us on this call. This morning.
Hey, Tim indicated with me today is Alan Campbell, who will walk through the financial slides in more fully explained our quarterly results.
Mike Weinhold is also available to respond to questions regarding our commercial efforts.
In my remarks. This morning, I want to review the state of our markets and the challenges we are facing as a result of current market conditions.
Our second quarter results were not only impacted by lower volumes, but was also impacted by a significant planned maintenance downtime.
At her Wisconsin Rapids facility.
Which lowered our second quarter adjusted EBITDA by $19 million.
Turning to page three of the presentation deck.
Net sales for the quarter were $602 million, which were lower than the $620 million to $640 million.
Guidance, which we had provided for the second quarter.
Our adjusted EBITDA for the quarter was $44 million, resulting in an adjusted EBITDA margin of 7.3%.
The year to date adjusted EBITDA through the second quarter was $113 million.
Graphic paper shipments were lower reflecting negative market trends, which were somewhat offset by the growth in our market for specialty and packaging papers and market pulp.
While we expect the third quarter to produce better results in the second quarter of 2019.
Revenues are not however, expect you to meet the 2018 third quarter levels.
[noise] notwithstanding mix issues, we were able to achieve and maintain year over year higher pricing levels in our core graphic products.
The decline in sales for the quarter result in peak inventory levels.
What we are forecasting inventory levels to decline significantly by year end.
Due to the expected seasonal pickup on sales as well as the impact of our look mill closure.
[noise] well demand for graphic products has declined over the years due to the migration to digital offerings.
The most recent demand statistics for these products have decreased at an increasing rate.
However, we believe that the current increased rate of decline has been impacted by the influx of imports.
And the continued higher level of customer inventories.
For the remainder of the year, we expect our volumes to improve both as a result of the seasonal pickup.
At an expected product restocking by our customers with paper prices are expected to remain relatively stable.
We will if necessary however continue to balance our product our production to our customer demand.
[noise], we remain a significant participant in the graphic market.
And we will have we will and why we have in the past undertaken initiatives to reduce our dependence on the graphic paper markets.
We today still have 59% of revenues in this space.
This percentage needs to be further reduced.
Turning to page four of the presentation deck.
We have outlined are past initiatives in both changing our product mix.
As well as focusing on cost and liquidity issues.
Our investments in the specialty packaging and pulp markets have grown or revenue share in these markets from 34% in the second quarter of 2018.
To 41% in the second quarter of 2019.
One of the capital projects initiated to achieve this product diversification.
Well, it's the July 2018 conversion and restart.
With the reconfiguration enhancement of both PM for better and our Skagen mill.
And PM three at Escanaba mill.
Adding to our entry into the packaging space on PM, three and Andrew Skagen.
A capital project in the second quarter of this year was approved for our Duluth mill.
For the production of 48000 tons per year of recycled packaging products.
This project is expected to be completed in the first quarter of 2020.
We also continue to be focused on ESG today as well as other overhead reductions.
And have a current initiative for additional reductions for 2020.
That will remove additional cost in excess of $12 million.
We have previously reduced our adjusted SGN, a as a percentage of revenues from 4.2% in the first half of 2017.
To 3.3% in the first half of 2019.
Finally, we have effectively enhance our financial flexibility.
By repaying and terminating our $220 million term loan in 2018.
Eliminating the company's OPEB liability of $28 million.
And reducing our letter of credit exposure by $42 million.
While these prior initiatives have benefited the company, we will need to continue to be proactive in initiating strategies to produce additional value added products.
With the expected companies.
Cash generation ability and our borrowing capacity as a result of our debt repayment.
We have significant flexibility and undertaking further strategic initiatives that benefit the company in the future.
With the closure of our Luke Mill. We are we believe we are currently balancing supply and demand in the market.
This balance should continue to be maintained by the announced graphic industry capacity conversions.
It is important to note that these conversions are not a permanent panacea to the issues we face.
What will give us the necessary time to invest in capital projects in the company.
To allow us to reposition our assets as the markets for graphic products decline.
Our plan is to make significant capital project investments in the business over the next two years.
This forward this will require a focus to be directed on the growth of specialty products as well as packaging grades.
The senior leadership team and I have spent significant time together.
As well as with other senior managers in the company to address opportunities for the deployment of strategic capital.
To accelerate the move to higher growth product opportunities.
On page five of this presentation.
We outline our current plan for growth and diversification.
Which as strategic capital is deployed and completed in this plan. We were we will reduce our graphic tonnage over the next five years to 44% from the current level of 59%.
Additionally, the graphic products that will continue to be produced that the company will be produced at the most cost effective mills.
We have determined that the planned strategic investments will require up to $120 million over this two year period.
We plan to invest a portion of this capital allocation at our and our Skagen mill, which we believe will enable us to improve the quality and reduce the cost of our unbleached containerboard and Kraft paper grades on the number three machine at Andrich Skagen.
And to increase capacity of specialty products made on our paper machine number four.
We have already begun improvements on Andhra Scoggins PM five machine to improve the capacity of machine glazed products made on this asset.
Additionally, we are planning capital improvements that are Stevens point mill in order to enhance and improve our specialty product offerings.
And as I have already discussed we have invested capital or our Duluth mill to produce 48000 tons annually recycle Kraft paper and containerboard.
Replacing a portion of the graphic raise made at the Duluth mill.
The mill has run trial products of these grades and the customers have been very impressed with the products and are awaiting completion of the project.
We are planning further convicted we are planning further conversions to recycled containerboard.
And recycled crafted to Duluth mill to mitigate the demand loss of the products currently produced at that mill.
Notwithstanding the further planned conversion, we will still have the flexibility to produce supercalendered products.
Dilute.
In conjunction with this additional conversion we have been awarded a grant from the state of Minnesota in the amount of $2 million to assist us in this conversion.
It is important to note that we intend to fund a strategic capital investments to discuss this morning from cash generated from operations.
As I mentioned on the last earnings call I plan to visit all our mill locations in the second quarter.
In my business to our mills I was impressed with the significant engagement of the mills management team.
I believe that with our skill of middle management teams, along with our seasoned commercial organization.
We are well positioned to accomplish our objectives with the planned capital.
Before turning the presentation over to Alan.
I want to mention that since I've joined the company I have worked closely with our board of directors to address and find solutions for our challenges.
On the board and I are committed to continue to focus the company into strategic direction that is necessary to create value to our stakeholders over the long term.
I will now turn over the I will now turn the presentation over Allen Campbell, who will provide financial updates.
I think the last turning to page seven we highlight some key metrics for the quarter.
If you look at paper shipments were down 11% as Les mentioned tough quarter for us in that time period.
Pulp was up 26% as last year, we had an outage it when that precluded us from doing some sales of pulp that were returned this year.
Net selling prices continued to be favorable were up 4% across our paper portfolio.
Versus the prior year.
Down slightly down $19, a ton from the prior quarter and Thats, primarily due to the mix of product.
Pulp was down 9% and I know that's been a.
Rollercoaster up and down on pulp, but as you know we.
Purchased a significant amount of pulp and we sell homes, so were somewhat balance from that standpoint.
Inventory as Les mentioned peaked in the second quarter net should decline through the rest of the year as we convert that inventory into cash.
The mix of business you can see on the chart at the far right that.
We've grown our pulp packaging and specialty business from 34% and second quarter, 18% to 41% in the second quarter of 19.
On page eight we just pull off some of the financial highlights for the quarter, we talked about sales earlier as you can see operating income and net income were hit by a charge. We we had for the loop mill totaled $116 million.
If you adjust that out you would have.
Virtually the same property operating income as you did in the prior year on less sales.
Adjusted EBITDA of 44 placed 51 7.3 versus seven nine.
And making adjustments that you see in our appendix.
Earnings per share adjusted basis, or 42 cents versus 49.
We have a bridge on page nine.
Walking or $51 million as adjusted EBITDA and second quarter last year. The 44 this year.
Price mix still favorable for us over this time period drove an extra $19 million to the bottom line.
Volume since negative, but less than price as you can see so the negative $11 million hit.
As far as downtime and ops, we had a $13 million.
Movement down in the second quarter. This year 9 million that was related to downtime.
When an $8 million a downtime at our Rapids mill, where we had a major maintenance the boiler we spent about $18 million of maintenance $8 million of downtime and we had about 18 million roughly of capital also in that mail. So it was a large.
Investment that we did on the maintenance side that meal, we did take a couple of million dollars additional downtime at our Stevens point mill in the second quarter for inventory adjustment.
Ops was off 4 million as we had a few issues and a couple of our mills.
Inflation.
Still negative for us but the.
Run rate on inflation, the improving so we were just off $2 million versus the prior year same quarter, we offset that by our SGN eight sets and savings of $2 million.
Pension was another $2 million ahead.
This year versus last year last year was more M&A incomes less of this year.
On page 10, we highlight our balance sheet, our position, where we are as far as liquidity very strong liquidity very low leverage.
As it shows we had $41 million in net debt at the end of the second quarter as we had seasonal usage of working capital and we build inventory with the loop closure.
In the second quarter.
Far right hand side shows our net cash generated power, we were down $2 million in the second quarter versus the gain of 42 in the same quarter. Prior year biggest swings. We had was primarily in our working capital.
As mentioned, we build inventory will draw that down as we go forward, but that was the main driver.
The maintenance as highlighted on page 11 to help you understand our flow of numbers.
Second quarter as mentioned earlier was pretty heavy spending we spent $23 million in total and was up $20 million versus the quarter before were routinely in threeq.
We expect to spend less and major maintenance in the third quarter, and then drop off significantly in the fourth.
So thats our expectation as we look going forward, a little bit higher than the prior year in the third quarter, but stepping down and then again stepping down materially in them in the fourth quarter, we highlight our mills below and on what they're doing.
Which ones take the outage, which month.
As far as our guidance for the third quarter as Les mentioned, we're expecting sales to be higher higher than the second.
Not as strong as it was in prior year, primarily due by volume tons.
Net sales in the range of 60 620 to 640 million.
Capital expenditures in the $34 million to $38 million range.
Maintenance and as we talked about just a second ago and then cash Ben.
Funding third quarters are a major funding quarter and so we expect the payments and somewhere nice contributions $17 million to $20 million range.
With that that ends our formal presentation, we'd like to move to the queue in a section and open it up for questions.
At this time I would like to ask a question. Please press Star then one on the questions on you will hear it sounds from your bench.
Alright.
A question. Please press Star then came to remove yourself from the last.
Our first question comes from Jeff Van Sinderen.
Cindy Sheehan from B. Riley.
Please go ahead.
Hi, good morning.
Can you kind of what Jeff could you speak up just a bit.
Sure Hi can you hear me now.
Thats better thank you.
Okay great.
I can speak to what you're seeing so far on price.
Do you anticipate further.
Quarter on currency.
Well.
Are you.
Great and then make sure I heard you went out you are asking about third quarter pricing forecast is that what you're asking.
Yes, I'm not from what you've seen so far on price.
Great. Thanks for the remainder of the quarter.
Well, Mike Weinhold is here and he'll answer that question.
Pricing in Q3.
We as I mentioned in the presentation theres been mix running through our pricing.
And so the mix is having somewhat of a negative impact on pricing overall, but generally speaking pricing is fairly stable through the period.
Okay and then.
Maybe you can just that extent you guys still inventory that maybe just touch.
Current situation.
Channel.
I think given closure from Merck in roughly 400000.
At this time.
What level of capacity utilization do you expect or Ron.
Three legacy graphic paper side.
Are you running close to fully booked there or how should we think about that.
Yes so.
As we've mentioned, we're still seeing somewhat of an overhang in inventory on the customer side that is decreasing and we can see some indications of that through order patterns as we move into Q3, our inventory levels are declining and as Les mentioned, we expect those inventory levels to decline through the balance of the year from an operating rate standpoint, you see the industry numbers would certainly are much less utilization than it was last year. However from a versus standpoint, we have the impact of blue certainly help in the utilization of the rest of the graphic assets. So I would characterize the operating rates within verso as not necessarily fall, but but very healthy.
As indicated earlier, we're committed to balancing supply and demand as we go through the year and we're also committed to reducing our inventories.
Okay and then.
Capacity utilization at the various as far just wondering what you are running there now I think there was some evolution of product.
What could produce.
What we expect for Brian .
Utilization thank you.
Sure, It's Mike Weinhold and the capacity utilization is very strong on Athree machine as mentioned is theres a lot of flexibility inherent in that project.
So we're running Virgin products Virgin Kraft linerboard lightweight both domestic and export we've transitioned into the craft bag segment, and that's going very well with multiwall, we've done some campaigning and trials to get into the loan and lease side.
And as mentioned, we have utilized that asset for Paul from an internal pulp need standpoint.
So again the utilization is very good and the flexibility on that asset continues to evolve and as mentioned additional capital will be spent up in that.
Machine to provide even continued flexibility in migration into the Kraft paper bags.
Okay, and then one more if I could then or.
Lessen.
You can give us any update and give us on the strategic review.
Do you think that there's a buyer on total for the company at this point.
Well you know as Weve mentioned publicly that we retain houlihan.
To look at strategic.
Options.
At this point, we have nothing more to report on that.
Okay.
And then let me just got a follow up on that.
So you're clearly incentivized to sell the company how do you balance that's correct.
With taking on new projects getting I think you said to 44% graphic on over the next five years, if I heard you right.
Correct.
And.
Other than augmenting Andrew staggering I think you mentioned some of those projects and the $120 million capital investments.
What else what other projects do you see undertaking if anything.
Well the 129.
Well as I mentioned in the presentation, we're putting capital into Athree for enhancement of craft the flexibility both in cost.
Projects cost reduction projects and.
The different product products on the craft.
Products scheme, we're also putting money into a four to enhance our release liner and to get more capacity out of that machine for.
Specialty products products.
We're also putting capital into Stevens point to augment and improve our specialty offerings.
And then we're putting money into Duluth.
To enhance our recycled craft capabilities.
As to your first question as to my.
My incentives to sell the company.
My incentive is to provide shareholder value and.
At this point, we have not announced any.
Sale of the company and therefore, we have to make sure that we have options that are available to provide shareholder benefit and at this point in time, we're focusing on strategic.
Initiatives to improve the companys performance away from graphic products.
Got it okay. Thanks, Thanks for taking my questions.
The next question comes from Hormel coarse sand Cws financial please go ahead.
Hi, good morning.
So first off could you.
Just elaborate here on the guidance for Q3.
How much of that increase that you're seeing or expecting sequentially is.
Driven by actual seasonal demand and how much of it is impacted by not having any inventory available from.
Well, we expect seasonal demand to definitely pick up because the third quarters or.
Is there historically stronger quarter strongest quarter.
I'm not sure I understand your reference to Lou could you give me more color on that please.
Well your your production overall is down right from a volume perspective.
So I'm just trying to figure out why if it's supposed to be your peak order wise in sales higher pricing is holding steady.
Well as we mentioned you know.
There is a inventory overhang that is.
Dissipating and we expect customers to restock.
The strength of.
Last year as a comparative.
It's because people were concerned about the lack of supply through a mill closures.
Customers restock their inventory and they're working off that inventory at this point in time.
So the fact that Luke is now close we're not producing those tons.
And therefore, I don't think that there's a correlation between the production and sales we have inventory that was created because of the closure and we're going to.
Utilize that inventory and selling to our customers. So.
It is a typically stronger third quarter, it's not going to be as strong as last year for the reasons that just gave you.
And then how much of competitive pressures are you seeing in the market for graphic papers and do you think you've lost market share.
Well, let me, let Mike respond to that.
Right.
Did competitive pressures.
Obviously exists in the marketplace.
We don't believe we have lost market share.
We will lose a little bit of market share going forward because of the closure of loop and we have seen a pickup of imports uncoated freesheet sheet and those imports have gained market share.
Primarily coming in from the Koreans and from the Europeans.
But by and large we believe we're holding our own within the marketplace.
But the competitive pressures obviously exists.
Okay and then also could you just.
Talk about the returns you're expecting on these new projects that you're planning over the next two years.
And what kind of.
Free cash flow you would expect to regenerate once implemented.
Those are excellent questions I mean, we're not going to disclose the cash flow.
Assumptions, we have on that at this point in time, but I will tell you that the.
Projects exceed our minimum return requirements that we have on allocating capital.
In the company.
And we we are not undertaking these projects in in in any manner, but to improve and to enhance the cash flow and the earnings capability of the company.
But at this point, we're not the.
Ready to share specific items on each of those capital projects.
Okay. So.
My last question just on that comment was.
Is this more of a offensive move or difference of do you think the market's going to deteriorate, even faster and if you look out next two years that you've got to make these moves or this really offensive because no one else doing this.
Take a look at what we are doing specifically, we have a machine that Andrew Skogen that makes kraft products currently in its devoted to those craft products, we're enhancing the cost structure that machine and we're also giving us more product diversification on that machine.
On a four which is especially a machine that makes release Leonard and risk.
We're improving the.
Capabilities that machine to produce more product.
And.
At the Steven's point, we're putting in the capital to improve our product offerings at Stevens point.
And finally, we are taking to Duluth mill, which has had somewhat of a declining demand in converting that to have a product that has greater demand.
Stability some potential in the future.
The opportunities we have on those machines.
Okay. Thank you.
Thanks, Amit.
As a reminder, if you have a question please press star one.
The next question comes from Adam Ritzer, a private Investor. Please go ahead.
Hi, good morning, Thanks for taking my call.
I guess my question fourth course, you know you guys said you're in good <unk>.
You too.
Expected to decline significantly by year end, what do you view as significant how much inventory can be worked out of what we built up the first half of the year do you think.
Well, we're not going to get into specific numbers at this point.
In.
And talking with Mike and the other commercial.
Team members.
The sales that we believe we can generate in the third quarter.
Especially in the months of August and September .
That we will have a significant decline in inventory.
We will have some downtime in the third quarter, which will help in getting some inventory declines as well.
But we're not going to get into specific numbers at this point.
Okay and the other thing you mentioned was the demand decline now is increasing at a faster rate.
And you said it was due to the inventory build and also the imports you know out there, but I know when I talk to you guys you seemed very positive on the import.
Our reductions and the plant closures coming from Europe over the next deal I don't know 12 to 24 months.
We have seen that change.
No again.
Go ahead finish your question I'm, sorry, I'm, just trying to figure out you know.
I know, there's a lot of plant closures coming from Europe .
Like you kind of indicated that the import situation is not changing and year ago affecting the demand declined to increase faster I'm just trying to figure out exactly what's going on.
Well, let's put the.
Let's put it into context imports.
Our imports imports have affected the supply demand dynamic.
The.
The closures and the conversions that have been announced.
Our future issues okay.
And when those conversions in the U.S. at Catawba.
And that.
We had conversions that appreciates mill and well Lula, we have nine Dragons announced conversions appearance.
Those capacity Takeouts will enhance our ability to have a greater.
Lessors supplied to you what the demand.
The issue of imports not only come from Europe , but come from Asia, especially in the sheets market.
So.
You know.
The demand itself.
The.
Movement to digital offerings are increasingly we're not denying that fact.
So when I say demand is declining at an increasing rate if you take a look at the industry statistics and those percentages.
Dropped on demand our reality and that's why we're moving toward other products to give us a less concentration in the graphic markets but.
Imports will decline from Europe as well.
You know of the European companies convert their assets to other products as well but.
On a current basis. It is what it is those conversions will take place over the next.
Two years, possibly.
Okay got it and then I know the prior question was asked on your capital allocation plan.
You wouldn't talk about how much EBITDA, you're expecting but you did say it exceed your minimal returns can you explain what those minimal returns are.
Again, we would like to keep that to ourselves at this point, we we have talk to our board of directors, we've gone through the capital plan with our board.
We have an approved any specific project at this point in time.
But we've gone through with our board the forecast on cash flows and EBITDA.
The board were satisfied that that is a proper allocation of capital at this point in time.
And.
No. They are very serious about making sure that the shareholders get the return that is warranted.
And.
They have had no issue with the presentations we've made.
Okay, but you have a stock now trading no honored by my math, maybe two times EBITDA.
So.
Do you think it's wise to invest $120 million, you're not telling us what kind of EBITDA returns you expect.
But are you, saying thats better than buying back your stock at two times EBITDA I don't I don't really understand it.
Well again I'm not going to go into the issue of whether we should buy back stock. This morning are not the issue is we have gone to our board of directors with a capital plan.
That will enhance our product offerings enhance our cash flows and as your EBITDA.
And.
That's all I can tell you at this point.
Okay. Thanks for taking my questions I appreciate it.
Okay. Thanks, Adam.
The next question comes from Robert Kathy.
CW capital. Please go ahead.
Hey, good morning lots I just want to see if you could.
Comment any further on the conversions and take out and just the timing of those.
Particularly.
The European take out in the us.
That are coming out in the United States.
Well.
Mike you want to take that as far as getting specific we know what you you know as far as public announcement. So our belief is the store a little conversion.
We will take place in 2020.
And that will have about a million ton impact on coated freesheet sheets.
We do not have exact timing on that topic conversion.
Beer and I believe some of the conversion has already started on one of their assets.
So I think as less less characterized it we expect these conversions.
Oh to 24 months to certainly have an impact on the graphic paper paper markets and a positive impact.
Right Okay.
Okay, and then I guess, just what I guess it wouldn't be helpful for us maybe in the future as shareholders to to better understand the return.
Profiles that you guys are looking for I can't I understand the reluctance to not commit to a buyback since the dividend, but I think given the stocks now back close to kind of where it emerged from bankruptcy.
There's maybe some for some investors avoiding information such as what are you guys might provide more on that in the future I think that would be helpful for all of us.
In the meantime, pre should appreciate what you guys are doing.
Okay. Thank you.
Seeing that there are no further questions I would like to turn the conference back over to Mr. Campbell for closing remarks.
We'd like to thank each of you for your interest in Verso and appreciate your time look forward to continue working with you. Thank you very much.
The conference is now concluded. Thank you for attending today's presentation you may now disconnect.
Yes.