Clearwater Paper Corp (CLW) 2016 Q4 法說會逐字稿

Welcome to Clearwater Paper Corporation's fourth quarter 2016 earnings conference call. As a reminder, this call is being recorded today, February 8, 2017. I would now like to turn the conference over to Ms. Robin Yim, Vice President-Investor Relations of Clearwater Paper. Please go ahead.

Thank you, Liz. Good afternoon, and thank you for joining Clearwater Paper's fourth quarter and fiscal year 2016 earnings conference call. Joining me on the call today are Linda Massman, President and Chief Executive Officer, and John Hertz, Chief Financial Officer.

Financial results for the fourth quarter were released shortly after today's market close. Posted on the Investor Relations page of our website at clearwaterpaper.com, you will find both the earnings press release and the presentation of supplemental information, including outlook slides providing the Company's current expectations and estimates as to net sales, operating margin, adjusted EBITDA range, and earnings per fully diluted share for the first quarter of 2017, and certain cost, pricing, shipment, production, maintenance and repairs, and other factors for the first quarter and full year of 2017. In addition, we also issued a press release today announcing the expansion of our Shelby, North Carolina consumer products facility, which is also available on our website. Additionally, we will be providing certain non-GAAP information in this afternoon's discussion. A reconciliation of the non-GAAP information to comparable GAAP information is included in the press release or in the supplemental material provided on our website.

I would like to remind you that during this conference call we will be making forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. These forward-looking statements are based on current expectations, estimates, assumptions and projections that are subject to change, and actual results may differ materially from the forward-looking statements. Factors that could cause actual results to differ materially include those risks and uncertainties described from time to time in our filings with the Securities and Exchange Commission, including our Form 10-K for the year ended December 31, 2015, and our quarterly filings on Form 10-Q. Any forward-looking statements are made only as of this date, and the Company assumes no obligation to update any forward-looking statement.

John Hertz will begin today's call with a review of the financial results for the fourth quarter and fiscal year 2016. Then, Linda Massman will give an overview of 2016's accomplishments, update you with the progress on our previously announced objectives, provide more detail regarding our acquisition of Manchester Industries, and an overview of the business environment and the newly announced expansion in Shelby, North Carolina. That will be followed by our outlook for the year and the first quarter of 2017. Then, we will open up the call for the question-and-answer session. Now, I will turn the call over to John.

Thank you, Robin. In 2016, Clearwater Paper was focused on our strategy to improve our cost structure, particularly in the Consumer Products Division, but the overall company as well. To that end, we made significant progress on warehouse automation, the continuous digester project, and operational efficiency. We have improved our overall adjusted EBITDA margin percentage by 40 basis points over 2015, despite a $57 per ton year-over-year decrease in paperboard pricing.

Within the Consumer Products Division we achieved a 320 basis point improvement in adjusted EBITDA margin percentage since we announced the current three-year strategic plan at the beginning of 2015. With the completion of warehouse automation and the startup of the continuous digester to come in 2017, we believe that we are well on our way to generating the targeted 400- to 600-basis point improvement in CBDs adjusted EBITDA margins as we leave 2017.

The total productive manufacturing journey and focus on overall equipment effectiveness that began in 2015 has allowed us to significantly increase the operating uptime of our tissue converting lines. As a result, we were able to streamline our converting asset base by closing the higher cost Oklahoma City converting operation, and we anticipate easily absorbing that converting capacity across the remaining network. In addition, we took out approximately 32,000 tons of capacity with the shutdown of two of our highest cost paper machines in our Neenah, Wisconsin mill at year-end. We took those actions to optimize our operations for better asset utilization.

As previously announced, we acquired Manchester Industries in December, which gives us approximately 190,000 tons of sheeting capacity to serve the folding and commercial print markets. Linda will provide more details in her remarks. Now, turning to our fiscal year and fourth quarter 2016 results.

First, I'd like to preface my comments by stating that throughout the rest of my remarks, I will be distinguishing between GAAP and non-GAAP or adjusted results. The adjusted results exclude certain charges and benefits that we believe are not indicative of our core operating performance. Reconciliation from GAAP to adjusted results is provided in a press release in supplemental slides posted on our website. For the full year, the EBITDA adjustments netted to $12 million of pre-tax expense and included a $5 million mark-to-market expense associated with directors' cash-settled stock units, $3 million in pension settlement expense, $3 million in costs associated with the Manchester acquisition, $2 million in costs associated with the closure of the Long Island, New York facility, and $1 million of reorganization-related expenses offset by a $2 million benefit related to the release of escrowed sale proceeds associated with the specialty mills sale in 2014.

For the fourth quarter of 2016, the adjustments totaled $5 million of expense and is comprised of costs associated with the acquisition of Manchester Industries, the closure of the Oklahoma City facility, the shutdown of two paper machines in Neenah, Wisconsin, the closure of the Long Island, New York facility, and the mark-to-market of directors' equity-based compensation.

Starting with the full year 2016 results, net sales totaled $1.7 billion, which is down $18 million, or 1% in 2015. While paperboard shipment volumes are relatively stable, their net sales decreased 5.8% due to SBS pricing pressure and less favorable product mix. That was partially offset by 3% increase in Consumer Products net sales due to market share gain and improved product mix, which resulted in a 7.4% growth in retail sales volume.

Adjusted EBITDA came in at $215 million, up 2% versus 2015, and on the high end of our outlook of $210 million to $260 million. We delivered a total of $42 million of EBITDA improvement, of which $8 million was associated with capital projects, and $34 million was associated with operational efficiencies. That was offset primarily by $26 million of paperboard pricing headwinds, as well as $7 million of higher maintenance on the tissue side, and $5 million of increased costs for wages and outside warehousing. As a result, adjusted EBITDA margin improved 36 basis points to 12.4% compared to 2015. Paperboard delivered $140 million, or an 18.7% adjusted EBITDA margin. Consumer Products delivered $129 million, or 13%. 2016 fully diluted adjusted EPS came in at $3.44 compared to $3.13 in 2015.

On the balance sheet side of the equation, working capital improvements led to a two-day improvement in the cash conversion cycle, which helped cash flow from operations to increase 8.2% versus 2015 to $173 million. We purchased 1.4 million shares, or $65 million under the current $100 million stock repurchase authorization at an average price of $48.18 per share. Since the 2011 inception of our stock buyback program, we have repurchased 7.7 million shares for $395 million at an average purchase price of $51.10, and have reduced shares outstanding by 33.6%. Now, turning to the fourth quarter.

Net sales were $426 million. That is down 2.2% from the third quarter, well above the high end of the consolidated outlook range of down 5% to 7%. Paperboard shipment volumes were up 1.6% compared to Q3, and net sales were up 80 basis points due to higher than expected commodity grade paperboard shipment.

On the consumer side, net sales were seasonally down 4.4%. Compared to Q4 2015, net sales were down 1.4% primarily due to a 3.8% decline in paperboard average selling price, and a 1.1% decline in paperboard shipment volumes, which was partially offset by a favorable mix shift toward higher retail shipment volumes on the consumer side.

Fourth quarter adjusted gross margin of 14.1% was up from 9.4% in Q3, as favorable trends in manufacturing input costs and the Q3 completion of the planned maintenance outage in Lewiston were partially offset by lower paperboard prices and weaker product mix. We also experienced a fire at our Las Vegas tissue facility that resulted in the shutdown of production for 17 days. The total cost for damage, repair and lost production was $4 million, and we received $1.5 million from a related insurance claim, and expect to receive another $1 million in Q2. Compared to Q4 2015, adjusted gross margin declined 144 basis points due to lower paperboard prices.

Adjusted SG&A expense was $30 million in the fourth quarter and relatively flat with both Q3 and Q4 2015. Corporate spending was $13 million of the total SG&A spend in the fourth quarter, and flat with Q3 and Q4 2015.

Adjusted operating income of $30 million, or a 7.1% margin was in line with our fourth quarter outlook of 6.5% to 8%, and up from 2.7% in Q3. Adjusted operating margin was impacted by the same factors impacting gross margin. Adjusted operating margin declined 145 basis points compared to the 8.6% that we saw in Q4 of 2015, primarily due to paperboard pricing.

As a result of all that, adjusted EBITDA came in at $54 million, or 12.7% of net sales, which is at the high end of our outlook of $49 million to $55 million. Compared to Q4 2015, adjusted EBITDA is down $5 million primarily due to lower paperboard prices, partially offset by the cost structure improvements delivered in 2016. Net interest expense of $8 million was flat with Q3. Turning to taxes.

On an adjusted basis, our Q4 effective tax rate was 37.8%, which is at the high end of our outlook of 36% plus or minus 2%, down from 41.4% in the third quarter. Our cash tax rate in 2016 was 8% compared to 19% in 2015. We do not expect to pay cash income taxes during 2017 due to the additional tax depreciation on the continuous digester and warehouse automation, and we expect it to be approximately 9% in 2018. The full year adjusted tax rate was 37.6%, and that's at the high end of our outlook of 36% plus or minutes 2 points. Full year and Q4 GAAP tax rate was 38.6% and 41.7%, respectively.

Fourth quarter 2016 adjusted net earnings came in at $14 million, or $0.82 per diluted share. That compares to adjusted net earnings of $2 million, or $0.14 per diluted share in the third quarter, and $13 million, or $0.75 per diluted share in the fourth quarter of 2015. Q4 GAAP EPS was $0.56 per share.

Noncash expenses in the fourth quarter of 2016 included $25 million of depreciation and amortization, $3 million in equity-based compensation, and $400,000 of net noncash pension and retiree medical expenses. Employee headcount at the end of the fourth quarter was approximately 3,370, which is comprised of approximately 170 people that joined us with the Manchester acquisition, and 3,200 legacy Clearwater employees, which reflects the decrease of 100 legacy Clearwater employees compared to the 3,300 at the end of 2015 due to headcount reductions primarily related to warehouse automation and a shutdown of the two paper machines in Neenah. Now I'll discuss the segment results.

Consumer Products net sales were $242 million for the fourth quarter of 2016. That is down 4.4% versus the third quarter but above our outlook of down 6% to 8% as parent roll volumes increased quarter-over-quarter. Consumer Products adjusted operating income in the fourth quarter of 2016 was $17 million, or 7% of net sales versus $16 million, or 6.3% in the third quarter. Operating margin percentage improved because of operational productivity gains, warehouse automation, lower electrical usage, as well as lower electrical rates at our Las Vegas mill, which more than offset the negative impact from the weaker price mix due to higher parent roll sales and the impact of the fire at our Las Vegas mill.

Consumer Products Q4 adjusted EBITDA margin increased $1 million to $32 million, or $13.2% of net sales from $31 million, or 12.2% in the third quarter. Compared to the same period last year, adjusted EBITDA dollars increased by $6 million, or 25% of the adjusted EBITDA margin, improved by 248 basis points to 13.2% from 10.7%. Now turning to the Pulp and Paperboard Division.

Pulp and Paperboard net sales of $183 million for the fourth quarter of 2016 increased 80 basis points versus the third quarter. Q4 net sales volumes increased 1.6% versus our outlook for seasonally lower volumes due to better than expected customer demand. Average sales price was down $7 a ton, or 80 basis points, compared to Q3, due to a higher mix of commodity-grade paperboard sales.

Pulp and Paperboard's Q4 adjusted operating income was $28 million, or 15% of net sales, as compared to $10 million, or 5.5% of net sales in the third quarter. Increase in margin percentage versus Q3 was primarily due to the maintenance outage impact in Q3 at the Lewiston mill. Pulp and Paperboard's Q4 adjusted EBITDA margin of 19.1% remains in line with the 19% divisional objective inherent in our cross-cycle financial model. Now, turning to the balance sheet.

Capital expenditures were $46 million in the fourth quarter, and $156 million for the full year, in line with our Q3 outlook. $97 million of that was spent on strategic projects, and $59 million on maintenance CapEx. Long-term debt outstanding at year-end was $575 million. In addition, we entered into a new $300 million revolving credit agreement with an accordion feature that allows for expansion up to a total $600 million that replaces the previous $125 million asset-backed facility. There was $135 million drawn on the facility at the end of 2016.

As of the most recent measurement date of December 31, 2016, our Company-sponsored pension plans were underfunded by approximately $19 million, a decrease of $6 million from last year due primarily to investment portfolio performance for the year reflective of the 2016 market returns. Turning to stock buyback program.

In the fourth quarter we purchased 257,000 shares of an average purchase price of $53.61. As previously mentioned, $35 million remains available under our current authorization.

With regard to our liquidity, we ended the fourth quarter with $23 million of unrestricted cash and short-term investments, and $165 million available under our revolver. During the fourth quarter we generated $34 million of cash from operating activities, or 8% of net sales. For the year we generated $173 million of cash from operations, or 10% of net sales. With that, I will now turn the call over to Linda Massman, who will discuss the Company's outlook for 2017, and provide an update on both ongoing and newly announced strategic projects.

Thank you, John. Hello, everyone, and thanks for joining us today. We have a lot to get through, so we'll go ahead and get started. I'd like to begin my remarks by sharing with you our excitement in announcing plans for our newest state-of-the-art tissue machine in Shelby, North Carolina. It's a significant step for us and will strengthen the quality of our assets and provide long-term earnings growth. I will provide many more details in a moment, but first I will share 2016 highlights and then discuss our high-level outlook for fiscal 2017, and more specifically for the first quarter of 2017.

2016 was an evolutionary year for Clearwater Paper as we continue down a well-defined path to build a solid foundation for our long-term success. We focus on things we can control to create shareholder value, such as operating results and working capital management that generate strong free cash flow, and returns on invested capital that exceed our weighted average cost of capital, a balanced capital allocation, the return of excess cash to shareholders while investing in the business to grow free cash flow in future years, and maintaining an optimal capital structure that minimizes our cost of capital. And I believe we executed well on those items in 2016. Discretionary free cash flow for 2016 was approximately $113 million, which at our current market value equates to a discretionary free cash flow yield of 10.7%.

Our return on invested capital of 9.3% is well above our cost of capital. As John mentioned, we returned $65 million in cash to shareholders in 2016 via share buyback. And we completed the second year of our three-year strategic capital plan and have delivered 320 basis points of adjusted EBITDA improvement in Consumer Products, which puts us well on our way to deliver the targeted 400 to 600 basis points as we leave 2017.

Our Consumer Products business continues to improve. We gained market share both in private label and against the national brands. Several key customers successfully continued to grow their store brand programs in 2016, and we are pleased to be aligned with customers who are focused on expanding their store brand programs across-the-board.

Regarding warehouse automation, both Shelby, North Carolina and Las Vegas were completed in 2016, along with phase one in Lewiston, Idaho. The remainder of the Lewiston automation is on schedule for completion in the first quarter followed by Elwood, Illinois in the third quarter of 2017.

We have made great progress to improve our operational efficiencies and on our strategic investments, which has delivered significant EBITDA contributions totaling $53 million over the last two years. From our Lean Six Sigma and total productive manufacturing efforts to drive out waste and improve our operating equipment efficiency rate, we delivered $44 million since the beginning of 2015, with two-thirds of that coming in 2016, and the remaining $9 million from our strategic investments, which will gain momentum with the completion of the continuous digester and warehouse automation.

Turning to our Pulp and Paperboard business, our team demonstrated excellent operational execution in all aspects of the business while managing 14 days of downtime for major maintenance and unplanned electrical outage in the third quarter, and dealing with the challenging price environment due to the continued strength of the US dollar. We shipped paperboard volumes equal to 2015, and achieved the targeted cross-cycle adjusted EBITDA margin of 19%, with a contribution of $140 million of adjusted EBITDA.

In December, we announced the acquisition of Manchester Industries for $68 million. Manchester converts paperboard parent rolls to flat sheets and narrow rolls, which expands our capabilities and allows us to support the small and midsize folding carton converters to buy precut sheeted SBS paperboard. The benefit of buying from a sheeter is that you get customer sizes in exact quantities on a just-in-time inventory basis without the need for roll stock inventory and the complexity of converting loss associated with running your own sheeter.

Technological advances in the preprinting process have reduced packaging design and approval times considerably. As a result, companies can change packaging designs more frequently and therefore converters rely more on sheeters to provide smaller volumes of just-in-time inventory of custom sheets. Overall, adding Manchester's capabilities allows us to better serve our folding carton customers, which is our largest customer base in the paperboard business. Expanding our service platform in this way should help grow the key folding carton segment of our business and does not compete with our customers in other key market segments. We believe the acquisition will increase our annual EBITDA run rate by approximately $10 million per year.

Turning to the continuous pulp digester project, it is near completion with a go-live date early in the fourth quarter. The construction of the vessel for pulp processing is expected to be completed in the second quarter, the final installation and testing of equipment will take place throughout the third quarter, ending with a tie-in of the new digester to the mill during the planned major maintenance outage at the end of Q3.

Our tremendous progress in starting our three-year strategic plan in 2015 is driven by the many hardworking and committed employees that embody Clearwater Paper.

Turning to our view of the market environment for each of our businesses and starting with the North America tissue market in 2016, the US tissue market grew approximately 1%, in line with expectations. In 2016, based on dollar sales, IRI estimates the private label share was up approximately 1% versus 2015, while the national brands were down a point. As a result, private label is now 25% of the total retail tissue market, up from 24% a year ago. In 2016, Clearwater Paper gained share both in the brands and other private label competitors. Based on IRI data, our share of the total tissue market was 8.2%, which is up from 7.9% in 2015. And our share of the private label market grew about 1 percentage point to 33.5% largely due to successful growth of store brand programs with existing customers, as well as improved penetration in growing consumer acceptance of national brand equivalent store brand products within retailers.

Looking to 2017, RISI estimates that the US tissue market will grow approximately 1% to 2%, in line with long-term trends, and we believe the private label should continue to gain share. The most current RISI forecast for net new tissue capacity through 2018 is 761,000 tons, which is down 5% from the previous forecast due to Clearwater's announced closure of 32,000 tons at our Neenah, Wisconsin mill in December, and a net 5,000-ton decrease in new capacity, which has been pushed out from 2018 to 2019. Based on the current forecast, the North American demand to capacity ratio, which does not factor in imports through 2018, is 97%. RISI's current forecast supports the balance of supply-and-demand environment in 2017.

Clearwater Paper is a North American private label tissue market share leader with an impressive customer base. Private label is expected to grow 2% to 3% per year on average over the next decade primarily driven by demand for ultra-quality products, which is forecasted to be the fastest growing segment of the North American tissue market at 4% to 5%. Since 2012, the premium and ultra tiers have grown 3.5 times faster than the overall tissue market. As tissue demand grows with population, private label is forecasted to gain share versus the brands. Our customers expect to grow their store brand tissue programs along with customer preference shifts to ultra-quality tissue products.

Our customers want to know that we have the ability to grow with them. As a result, we have come to a point where we need to add ultra-quality tissue capacity to keep pace with our existing customers' growth and have the capacity to add customers. For those reasons, we are taking a significant step forward to build a new paper machine and related converting equipment to produce premium and ultra-grade private label tissue products at a site adjacent to our existing facility in Shelby, North Carolina. It will include a 70,000-ton Valmet NTT tissue machine with related converting capacity. We believe that the NTT tissue machine will allow us to produce premium and ultra-quality tissue products, and we expect to spend approximately $283 million over two years for the paper machine and related converting lines.

Our business in the southeast has grown substantially since we built the Shelby facility, and as we outgrew the space at the Shelby site, we were required to grow third-party warehouse capacity. We will consolidate our southeastern warehouse capacity at a cost of $57 million to achieve operational and logistical savings. This will involve replacing multiple finished goods warehouses currently under operating leases with owned capacity, which will significantly reduce our reliance on third-party warehouses. In addition, we will increase the capacity of our pulp, parent roll and finished goods warehouse to match our requirements to fully automate these new facilities. The warehouse consolidation and automation is expected to reduce logistics complexity, as well as warehousing and transportation costs. This will allow us to reduce transportation miles by allowing us to ship directly from the mill to the customer, which eliminates the added leg of travel from the mill to the outside manual warehouse.

Between the incremental 70,000 tons of tissue capacity and the operational savings from warehouse consolidation and automation, we believe these investments will generate an incremental $55 million to $65 million of annual EBITDA at full shipment run rate. This translates to an internal rate of return on investment of approximately 11%, which is well above our weighted average cost of capital.

We expect construction to be completed in the first quarter of 2019, with production ramping through 2019, and we expect to be at full shipment run rate in late 2020. We believe there is demand for about half of those tons today within our existing customer base. The total $340 million of the new tissue capacity and warehouse consolidation will be financed by the new credit facility that we entered into in October, as well as cash flow from operations. We expect the debt level will peak in Q4 of 2017, and be in the 3.5 to 3.9 times EBITDA range from the second quarter of 2017 through second quarter of 2018, and begin to decrease from that point forward.

We have a strong partnership with North Carolina's government agencies that began when we commenced building the existing Shelby facility in 2010. The city of Shelby, Cleveland County and the state of North Carolina are providing an attractive incentive package valued at approximately $44 million. We are confident in our ability to build the newly announced paper machine on time and within budget given our previous success in building the Greenville paper mill including a 70,000-ton TAD paper machine and related converting lines, which was announced in 2010, commenced operation in 2012, and was operating at full capacity by the third quarter of 2014. Overall, the region has a good transportation infrastructure, tax structure, business-friendly community, and an overall great quality of life for our employees.

Turning to North American paperboard. We see the outlook for 2017 is for a balanced market similar to 2016, with operating rates averaging 93% for the year. RISI forecast demand for SBS to contract by 40 basis points in 2017, following a decline of 1.8% in 2016. 2017 got off to a good start with industry backlogs up approximately 17% higher than levels a year ago. While prices published by RISI have remained stable since April 2016, they are forecasting certain grades of SBS to decline approximately 1% to 3% in 2017.

For 2017, the near-term risk continues to be the strength of the US dollar. While RISI is forecasting a 3.7% decline in export volumes for the year, this is considerably better than compared to the 10.1% decline in 2016. In addition, imports have not gained as much traction as originally expected, only growing from 10% in 2011 to 12% in 2015 and 2016, and they are forecasted to be relatively flat in 2017.

Turning to Clearwater Paper's 2017 outlook, which is provided in slides 21 and 22 in the supplemental earnings presentation. We expect net sales to be flat to up 2% due to higher retail tissue sales, higher paperboard shipments, and revenue from Manchester Industries with offsets from a lower price mix in both paperboard and tissue and reduced volume of tissue parent roll sales due to the December 2016 shutdown of two paper machines at our Neenah mill.

Our consolidated adjusted operating margin is expected to be in the range of 6.5% to 7.5%, based on experienced cost inflation for natural gas, chemicals due to higher oil prices, with fiber due to a higher percentage of whole log chips used resulting from decreased supply of residuals in Idaho, and general annual wage increases. And incremental planned major maintenance expense of $5 million to $10 million compared to 2016 resulting from two major maintenance outages and approximately 27 days of downtime at both our Cypress Bend, Arkansas mill in the second quarter, and the Lewiston, Idaho mill in the third quarter. The Lewiston outage was pulled in from 2018 to coincide with the startup of a new continuous pulp digester. As a result, there will be no planned major maintenance outages in either mill in 2018.

We expect the Manchester acquisition to provide approximately $10 million of incremental EBITDA in 2017, and we believe we are on track to achieve $40 million of productivity gains from strategic investments, operational efficiency, and continuous improvement productivity initiatives.

Our outlook for the 2017 tax rate is 36% plus or minus 2%. All of this is expected to result in adjusted EBITDA of $205 million to $225 million. Capital expenditures for 2017 are expected to total $250 million, which includes $90 million for previously discussed strategic projects, such as the pulp digester and what remains of warehouse automation, $100 million for our new tissue facility in Shelby, and $60 million for maintenance.

We currently have $35 million remaining under our existing stock repurchase authorization. In 2017 and 2018, we will return cash to shareholders via share buyback. Although we will be shifting the mix of our capital allocation towards the capital project that will conclude in 2017 in the paper machine through the end of 2018. Now to our first quarter outlook compared to the fourth quarter of 2016.

We expected consolidated net sales to be up 1% to 3% sequentially due to incremental sales from Manchester Industries offset by lower parent roll shipment volumes due to the shutdown of the two paper machines at our Neenah facility, and slightly lower paperboard shipment volumes with a weaker product mix; consolidated adjusted operating margins to be in the range of 6% to 7.5% based on higher wood fiber prices in Idaho due to a higher percentage of whole-log chips used because of the decrease of supply residual; lower planned maintenance in our Consumer Products division; higher wages and benefits that is typical early in the year; and an adjusted tax rate of 39% plus or minus 2 percentage points primarily due to the impact of new accounting rules for stock payments to employees. We expect this to result in an adjusted EBITDA in the range of $48 million to $56 million, an adjusted net earnings per fully diluted share in the range of $0.62 to $0.90. The key variables we see determining where we land in that range are paperboard market conditions, including fluctuations in the value of the US dollar, brand promotional activities, and changes in customer and consumer demand.

In 2017, we will continue executing our strategic initiative and integrating Manchester Industries into Clearwater, while beginning the important work on the newly announced paper machine, converting lines and warehouse expansion in Shelby. While market conditions for both of our businesses continue to be challenging, we believe we are well positioned to grow our discretionary free cash flow, achieve returns on invested capital well above our costs, and continue to create shareholder value.

In closing, I believe our success is attributed to the quality of the employees we have at Clearwater Paper, exemplified by their unwavering commitment to our customers, communities, environment and each other. Thank you for listening to our prepared remarks and we will now take your questions.

(Operator Instructions) Your first question comes from the line of Paul Quinn with RBC Capital Markets. Your line is now open.

A few questions here. Just on Manchester, maybe you could go through --

Paul, we lost you.

Liz, are you there?

Well, I can hear you.

So, can you repeat your question, please?

Oh, sure. And you can hear me now, right?

We can hear you, yes.

Oh, good, okay. Just on the rationale behind Manchester. I mean, I think you guys were in this type operations a while ago, didn't really signal to the market that you wanted to go downstream. So, what has changed in the market conditions, and are you worried about the lack of downstream customers as thing get more consolidated there?

I think you hit on one of the issues that things have consolidated downstream, but the way we view Manchester is a logical acquisition that enhances the SBS business as it gets us one step closer to that folding carton market, which is our largest segment for SBS. And it's just a -- Manchester is a great company. It creates great value for their customers and it's really a part of the industry that is pretty critical to the smaller folding carton customers, and they do a great job of providing the inventory, the just-in-time inventory, and the narrow rolls on the sheeting that is required to make them successful. So, we just thought it was a pretty logical way to grow the business.

Paul, I'd say some of the logic, why we got out of the converting side while we were under Potlatch was not competing with customers. We don't view this -- this is kind of a halfway step. We won't be competing directly with our converting customers, we'll still be selling them on the sheeted SBS.

Okay. And then just over on the Shelby announcement, it's another one that is a little bit surprising, because over the last couple of years you guys have been talking about all the capacity adds that everybody else has been coming up with. So, I guess the question is, I guess you figure that there is not enough capacity and that this machine is needed. The second part would be why NTT technology as opposed to TAD? What's the difference?

Well, I think I'm going to reframe how you described our decision process for Shelby. So, we look at our business and what our customers' growth demand looks like. They're requiring additional growth, and growth in particular in the premium and ultra segments of tissue. We are currently pretty close to tapped out on the volume we can provide there. I mean, we can see them through for the next couple of years, but post-2019, we'd be in a pretty tough position to provide that ultra capacity to our customers. If we want to remain a good supply partner to them, this was going to be a pretty important part of our strategy. Keeping in mind, we are the leader in private label retail tissue products. We have some of the best customers in the industry and we fully intend to maintain them as customers and service them well over the next decades.

All right. Last question I had. You described paperboard markets as a challenging price environment. Maybe you could give us some color on Q4 price realizations and what your outlook is for 2017?

Yes. So, we talked about the reduction in pricing that we experienced in the fourth quarter in our prepared remarks, and I would say that in our bridge that you see on page 22 in our deck, a lot of that price mix that you're seeing associated with paperboard would be the full year impact of what we saw in 2016 carrying over into 2017.

All right, that's all I had.

Your next question comes from the line of Adam Josephson with KeyBanc Capital Markets. Your line is now open.

One question on the leverage. I think I heard you say, John, you'd be in late 2017, early 2018 levered, I think, 3.5 to 3.9 times just based on the CapEx that you've outlined. That seems like among the most levered you will have been as a public company, if I'm not mistaken. What gives you comfort in operating at such a high leverage range, if indeed I heard you correctly?

Yes, you heard us correctly. It's going to probably be a high watermark and we've always talked in the context of where we'd be comfortable, which was 2.5 to 4X, so it pushes us to kind of the higher end for a short period of time in that space. But when we look at our cash flow, we generate strong cash flow and we feel comfortable with our ability to pay that down rather quickly and kind of get back into the more lower 3s to higher 2 range.

And on CapEx, I think you said $250 million in 2017. Can you give us anything beyond 2017, just in light of the announcement earlier?

I think Linda talked about the fact on the paper machine we'd be spending about one-third of it in 2017, approximately two-thirds in 2018, and some might [lop] over into 2019. So, if I take that in 2018 and we spend $50 million on maintenance CapEx, which is our normal, that would put us at about $270 million in 2018. And then $50 million to $70 million in 2019, depending on if any of the paper machine spend lops over.

Okay. And on the buyback, I know you said you'd still be able to do some buyback over the next three years. Can you give us any sense of how much you will be able to return to shareholders over that period?

Yes, so we will still return some cash to shareholders, but we're changing the mix up a little bit and prioritizing more of the investment of the business through the CapEx. But it will be less than what you've seen. We did $65 million last year; I wouldn't expect to see that much, but there will be some amount.

Okay. Just a couple on cost inflation. It looked like it was actually more subdued in the fourth quarter than what you were expecting, which came as somewhat of a surprise, at least to me, just given everything we're hearing about cost going up. So, can you just talk about what was the positive surprise for you in the fourth quarter on the cost side and, relatedly, of the $20 million to $25 million of cost inflation to which you're guiding for 2017, what your specific assumptions are for some of the big commodities that you're purchasing?

Sure. As it relates to your question on Q4, so we're pretty significantly hedged from a natural gas standpoint, so that's one aspect. So, we were seeing some lower natural gas pricing than I guess what you're seeing in the marketplace. I would say one of the things that is unique for us with our Las Vegas mill was that it tends to really spike in the summertime and into the fall, and so we see electrical usage as well as pricing come down there. From a pulp standpoint, we didn't have any major outages, so we were relying on much more the extent of our internal pulp. And then, finally, where you see a lot of these productivity initiatives and savings that we're getting from that will show up in some of those cost buckets that you're looking at on the bridge.

Got it. And just one on pricing. If you -- what do you have more, just given the price erosion you've experienced over the last couple of years, are you more concerned about further erosion on the boxboard side or the tissue side in 2017, and why?

Well, like Linda said, most of what we see in the bridge there is more like a full year's worth of the lower prices on the SBS side. I mean, SBS is more volatile than tissue and if there is something that is going to move big, it's going to happen more on the SBS side. But --

I think in my prepared remarks we said our total sales will be flat to up 2%, so definitely don't see anything of significance on the pricing side. There is some potential for variability, but not predicting it to be significant.

Would it be fair to say the risks are more skewed to the downside on the boxboard side just given where the dollar is and given your comments about the dollar earlier?

If I had to pick one of the two, I guess that would be the one, yes.

Okay, thank you very much.

Your next question comes from Daniel Jacome with Sidoti & Company. Your line is now open.

I just wanted to turn back to the Shelby expansion, which looks quite interesting. I understand the rationale for the project given the increasing share we're seeing on the private label side. I just wanted to return back to Paul's question. Why the NTT machine exactly? I know when you did the first kind of capacity push, and it was in 2010, you had the TAD machine and everything kind of we've read is that the TAD machine is kind of like the best technology out there. So, I just want to understand just a little more clarity on why NTT? Was it just simply the economics made more sense as you were shaking out the bidding process, or is there something else that maybe you could share?

Thanks for asking that. I realized after we passed off that I hadn't answered that question. So, yes, we looked at all the different technologies and ultimately settled in on NTT, because it gives us the range of products that we're going to need, both premium to ultra-quality products along bath tissue and napkins. And it's going to give us the ultimate flexibility we need to service the customers out of that location in combination with the TAD machine we already have there. And it does also have a pretty superior sustainability footprint, which we're pretty excited about.

That is kind of what I was getting at. So, from a quality perspective, things should remain kind of on par from what you've seen from the TAD machine, I guess was my concern.

Absolutely.

Yes.

Okay, okay. And then I know when you did the TAD machine, you called out the east customers, and then today I think I only heard the southeast. What's happening with your east customers? Has there been kind of -- you're serving that area less or are they just going to be served by the current capacity?

I think it might just be a bad choice of words.

Okay. You know what, moving on, all right. And then moving to capital return, obviously a lot of questions. It sounds like you're going to temper a buyback to CapEx steps up, but you don't have to answer this, but has the board -- I think you've had one new board member in the last 12 months. Has the board -- has there been any incremental discussions about possibly introducing a dividend maybe after this extra CapEx cycle?

We actually have had two new board members in the last year.

Oh, great.

And it's a discussion we have at least once a year at our December meeting. We had that discussion -- obviously, the priority right now from a capital allocation standpoint is more on the CapEx. But it's still on the table.

It's still on the table, okay. That's all I wanted. Okay, appreciate it. Thanks a lot.

Your next question comes from Chip Dillon from Vertical Research Partners. Your line is now open.

First question has to do with just, if you could talk a little bit about a couple of market dynamics. I guess one is, what are you seeing out there in terms of some of the SBB and similar to bleach board offerings coming in from Europe? And what is your expectations in terms of their penetration and how that might particularly affect you all? And then, secondly, we certainly continue to see a long list of projects in the private label tissue world, and I certainly -- you know, you guys are demonstrating that not all private label -- I mean, not all those projects, or all of the production is equal. But I didn't know if that had become more of a concern, less of a concern as we go out over the next couple of years?

Okay, so a couple of those questions, I'll take one at a time here. So, the question on SBS and what kind of an impact are we seeing in some of these different types of paperboard, particularly SBB, which would be imported into the US. If I had my head of sales for pulp and paperboard in the room, he would say SBB board has been around for a long time, so it's nothing to our sales team, to our customers or otherwise. It's definitely getting more press and you hear more about it, but we have been selling our products in comparison to that type of grade for years. And clearly we believe that SBS has characteristics that are important for our customers with regard to printability, the surface standards, and obviously it's working for us, and so it's not a huge impact from what we're seeing. I mean, there is a lot of talk about it, but we're not seeing a big impact yet from a supply perspective and penetration.

Then moving on to the long list of projects in private label tissue. As I said in my remarks, if we look out through 2018, and we add up all the capacity, which we will note that we took out some capacity, as I said in my prepared remarks, we're still running at about a 97% efficiency, if you look at demand to supply. And if you looked a little bit further out and how the market grows, I still don't have a lot of concern over that, because you only have a few more tissue machines, including ours, that are announced and the market is projected to grow in line with population at a minimum, and that's assuming no further private label penetration within retail stores. So, I think the market looks like it's going to be pretty balanced for a while.

And if you separate kind of the ultra-tier tissue from the traditional, conventional, ultra is growing at a much, you know, two to three times growth rate. And so right now you can't go buy ultra-quality paper on the market, and so it's tight and I think it's only going to get tighter.

And I guess on a qualitative basis, that's very helpful. As a follow-up, I kind of imagine there could be a degree of tentativeness among some of the retailers out there toward expanding into private label products. They certainly seem to be incentivized to obviously stock them, but only if their customers obviously adopt as well. And you did mention the 1% increase in the share of private label; how much of that share would you say is -- or much of the market is really at that premium end that you're attacking and also which, you know, there are retailers obviously trying to see -- that they would see as a way to keep their customers who are used to using branded products?

I'll take those two questions. So, the first question on retailer viewpoint on private label, so we are clearly seeing retailers focus on their store brand. I think they absolutely understand the power of their store brands as it relates to their consumers and customers that come into the store. And they have store brands across categories, so tissue obviously isn't the only one, we know that. That is only growing and the data shows that with regard to market share. And you have retailers who are very focused on providing very high quality store brand products that attract foot traffic to their stores. I mean, it's the only place you can get that particular product is their retail store, so it's a huge competitive advantage for these retailers. In addition, you have the couple of retailers from Europe who are beginning their entrance into the US market, and they have a very strong presence with private label, and a very successful presence with private label. And I think that will just further enhance the store brand image with consumers. And the third thing I would say is if you look at millennials, they are much less brand loyal than traditional shoppers. So, they are -- they don't hesitate to use store brands. In fact, in many cases they prefer them. They have a lot of trust with the retailer base and therefore feel very comfortable using their store brands. So, we think there is a lot of opportunity here in the retail sector and we're going to be there to grow with our customers. And I forget what your second question was, so you'll have to remind me.

Oh, no, no, no, and that just in terms of, yes, just talking about the comfort level of the retailers and the customers and -- oh, I'm sorry, the market share of that, the premium end of the market has of the private label market (inaudible) --

Yes. No, and that is growing, so if you look at total tissue, I think since 2012 it's actually grown about 3.5 times faster than the average tissue market, so you do see that top tier premium and ultra category being preferred by the consumer.

I got that, but is that top tier, is that a third of that 25%? Is it half of it? Can you just give us a feel for that?

Almost 50%, I would say, is that top tier, and growing.

Gotcha. Okay, thank you.

(Operator Instructions) Our next question comes from the line of Roger Spitz with Bank of America.

What was Manchester's LTM or 2016 sales and EBITDA?

Unable to disclose based on some -- the purchase agreement. But you can take the $10 million EBITDA and there is probably just a titch less than $1 million of that is synergies.

Okay, thank you. Can you remind me what all in the CapEx what I'll refer to as Shelby 1, which I guess didn't include any CapEx for warehouse?

It is about 360 --

No, 265, but we leased the warehouse with Shelby 1, so that would have been pretty close to that 285. And then we're buying that warehouse that is currently under operating lease as part of this.

Okay. All right, got it. And then maybe I heard incorrectly. I thought in the prepared remarks there was a $44 million package from the local and perhaps state government for, I guess, Shelby 2. How does that interact with the full CapEx here? Is that an offset to that or did I mishear the whole thing?

It's basically a tax credit.

Tax credit, okay. And I guess with the recent price increase on CRB, how do you think SBS pricing will respond to that, if at all? I mean, it doesn't sound like you're thinking it will respond much at all to the CRB price increase announcement recently.

Well, typically that's a positive with something below us there is a price increase in terms of the quality stack, because you get some tradeoff. Are we looking at that saying for sure we're going to -- we're bullish on an SBS price increase? Probably not.

Got it. That's it. Thank you very much.

I'm showing no further questions in queue at this time. I'd like to turn the call back to Linda Massman for closing remarks.

Thank you, I appreciate that. So, we look forward, of course, to another solid year of progress towards obtaining our cross-cycle margin model. We remain excited, energized and ready to embark on our expansion in Shelby to meet the growth needs of our customers and to take on the challenges of 2017. And in particular, we want to thank our customers, who make us better every day, and for the support of our shareholders. Thank you for joining us and your continued interest in Clearwater Paper.

Ladies and gentlemen, that does conclude the Clearwater Paper Fourth Quarter 2016 Earnings Conference Call. We do appreciate your participation.