Rayonier Advanced Materials Inc (RYAM) 2017 Q3 法說會逐字稿

Greetings, and welcome to the Rayonier Advanced Materials Third Quarter 2017 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Mickey Walsh, Treasurer and Vice President of Investor Relations for Rayonier Advanced Materials. Thank you. You may begin.

Thank you, Melissa, and good morning, everyone. Welcome again to Rayonier Advanced Materials 2017 Third Quarter Earnings Call and Webcast. Joining me on today's call are Paul Boynton, our Chairman, President and Chief Executive Officer; and Frank Ruperto, our Chief Financial Officer and Senior Vice President of Finance and Strategy. Our earnings release and presentation materials were issued yesterday afternoon and are available on our website at rayonieram.com.

I'd like to remind you that in today's presentation, we will include forward-looking statements made pursuant to the safe harbor provisions of federal securities laws. Our earnings release as well as our filings with the SEC list some of the factors which may cause actual results to differ materially from the forward-looking statements we may make. They are also referenced on Slide 2 of our presentation material.

Today's presentation will also reference certain non-GAAP financial measures, as noted on Slide 3 of our presentation material. We believe non-GAAP financial measures provide useful information for management and investors, but non-GAAP measures should not be considered an alternative to GAAP measures. A reconciliation of these measures to their most directly comparable GAAP financial measures are included on Pages 15 through 19 of our presentation.

At this time, I would like to turn the call over to Paul for his opening remarks.

Thank you, Mickey, and good morning, everyone. I'm going to start off today's call highlighting recent key activities before turning it over to Frank to review our financial results. After, I'll provide an update on our strategic initiatives, including the Tembec acquisition, and provide a current outlook on our business.

Yesterday afternoon, we reported third quarter earnings, which were significantly impacted by a hurricane that shutdown both of our manufacturing facilities for over a week in early September. We were able to start up effectively, but the loss production had an adverse impact on the quarter and will continue to pressure the fourth quarter, as certain cellulose specialty sales shifted into next year and commodity volumes were lost permanently. As you can imagine, it's rare that we purposely discontinue manufacturing activities, but mandatory evacuations in Northeast Florida and parts of Georgia made it impossible for us to run during the storm. As a result, we implemented an orderly shutdown of our operations to protect our assets ahead of the storm and also to allow our employees to take the necessary personal steps to safeguard themselves and their families. Thankfully, our employees and families prevailed safely, and our sites had virtually no impact. In addition to the hurricane, we received further news in October that one of our large customers had an operational incidence that will cause them to reduce their demand for cellulose specialty products in the fourth quarter of 2017, which we expect to impact our revenues by an estimated $15 million to $30 million. We are working closely with this customer to support them through their process upset and to mitigate the impact on both companies.

Absent these 2 events, we were on track to deliver on the high end of our original guidance. However, as a result, we now expect pro forma EBITDA for 2017 to be approximately $180 million and adjusted free cash flow to be $80 million to $85 million.

We continue to make excellent progress on our 4 pillars of strategic growth. Our cost transformation initiative is on target to deliver our forecasted $30 million of cost improvements for the year, and our steady pace of cash generation provides financial flexibility to make investments into our other strategic pillars. Specifically, within our acquisition pillar, we have significantly advanced towards closing our purchase of Tembec. We have nearly all the approvals and consents required with the final items expected to be received in the coming weeks and an anticipated closing shortly thereafter. Later, I'll provide an outlook on our current markets and additional information on our pending acquisition, but first, let me go ahead and turn it over to Frank to review our financials.

Thank you, Paul. Let's look at Slide 4 to review our financial highlights for the third quarter. Sales for the quarter totaled $210 million, up 1% from third quarter 2016. The increase was primarily driven by higher commodity sales volumes, offset by a 2% decline in CS prices and slightly lower CS volumes. As a reminder, the third quarter of 2016 included the planned maintenance outage of our Fernandina facility, which occurs approximately every 18 months. Sales for the 9 months were $612 million, 4% below prior year period, driven by 5% lower CS prices, slightly lower CS volumes and a 7% decline in commodity volumes. Operating income for third quarter 2017 was $18 million. Excluding $5 million of acquisition-related expenses, pro forma operating income for the quarter was $23 million compared to $41 million in the third quarter of 2016. Year-to-date, operating income was $57 million for 2017, while pro forma operating income was $70 million for the first 9 months. Our quarter and year-to-date variance analysis for pro forma operating income and the relevant price and volume statistics are provided on Slides 5 and 6. As shown on Slide 5, price improvements added $1 million to the quarter, primarily driven by higher commodity sales prices, while pricing negatively impacted year-to-date operating income by $13 million. Volumes and sales mix had no impact on the third quarter results and a negative $6 million impact on the 9 months.

As you can see on Slide 6, for the 9-month period, CS volumes were down 4,000 tons due to the timing of revenue recognition, while commodity volumes decreased 12,000 tons from the prior year period, primarily due to a greater percentage of viscose products and discrete production issues at our facilities. For the full year, we expect CS volumes to be down approximately 5%, impacted by Hurricane Irma and the operational incident at a major customer limiting our fourth quarter shipments.

Commodity volumes for the full year are expected to be down 9%, as we shift our mix towards more viscose products, together with the impacts of Hurricane Irma and discrete production issues at our facilities.

Back on Page 5, costs impacted the quarter and year-to-date operating income by $20 million compared to the prior periods. Hurricane Irma, higher raw material inflation, particularly in caustic soda and increased cost from our own discrete production issues account for the majority of the unfavorable impact. Additionally, the results reflect the costs incurred to make investments in strategic growth, including professional fees incurred for a company-wide strategic sourcing project as well as customer driven new product development.

Cost transformation savings helped offset these increases and continue to provide solid benefits for the organization, notably in chemical usage, procurement and wood optimization. As shown on Slide 7, we have captured approximately $23 million of cost improvements through the first 9 months, putting us on track for $30 million in savings in 2017.

Looking forward to 2018, we have an additional $25 million cost transformation target. The investment in our strategic sourcing project is expected to provide a material portion of these cost savings.

Lastly, on Slide 5, SG&A and other costs for the 9-month period was unfavorable by $3 million due to increased non-stock compensation and investments related to new product development, as we increased the scale, expertise and depth of our R&D team.

We also remain focused on driving cash flow throughout the organization. As shown on Slide 8, we generated $118 million of operating cash flow and $77 million of adjusted free cash flow through the first 9 months of 2017.

Quarter end net debt was reduced by $64 million to $408 million since the beginning of the year. Also, subsequent to the end of the third quarter close, we used $268 million of cash to repay predominantly all of our existing term loans. With committed financing in place for the acquisition of Tembec, as laid out on Slide 9, we were able to utilize our cash to reduce interest expense ahead of closing without any risk to funding the acquisition. At this point, let me turn the call back over to Paul.

Thanks, Frank. Turning to our outlook, Slide 11, we continue to see positive signs in most of our end markets. Ethers, filtration and tire cord market segments are strong and should provide for continued growth opportunities. With the acquisition of Tembec and its strong position in ethers, we should benefit from greater diversification into this segment. Commodity markets also remain solid, as viscose pricing has strengthened off of mid-year lows, and absorbent materials pricing has settled well above expectations, given the new capacity announcements. In acetate, due to the combination of excess capacity, flat demand growth in acetate tow end markets and continued pressure from tobacco companies on the tow supply chain, this segment remains very competitive. The challenges of the current quarter highlight the need for the company to grow and diversify its business, so that one event or one market won't have such a large impact on our overall financial performance. The acquisition of Tembec allows us to participate in attractive markets, such as ethers where we see higher demand growth, provides a broad base of assets on which to apply our cost transformation processes to lower operating costs and significantly diversifies our business, both within and outside of cellulose specialties. The acquisition is progressing nicely, and we remain on track to close in the fourth quarter. And while there would be many visible changes, including putting the entire new company under the name Rayonier Advanced Materials and aligning the leadership across the organization, much of the pre-close work has been to ensure that customers are fully supported and production processes remain seamless through closing.

Separately, integration planning teams have been aggressively working to identify synergies and the best ideas from the combined company are surfacing. Over the past few months, I've gotten to know many of the Tembec's exceptional employees, and I'm anxious to realize the abundant opportunities the combination will bring. We look forward to closing and integrating Tembec as quickly and effectively as possible. We expect to provide a further update on the acquisition after the closing on our next earnings call in February.

With that, I'd like to open up the call for questions.

(Operator Instructions) Our first question comes from the line of John Babcock with Bank of America Merrill Lynch.

Just want to start out with the production issues that you talked about. I was wondering if you can provide a little color there since it was a little bit ambiguous.

John, yes, we've had some production issues through the quarter. There's not one single one or one single area, it's just a variety of small ones that affected our production. We always like to think these are behind us, but we continue to work on them, so we don't have those in the future.

All right. Is there any way to quantify the impact of this?

We look at it from time to time. I would say it's a small portion of the increase in cost that you see in the 9-month and quarterly period, somewhere between $5 million and $7 million worth.

Okay. And that's not included in, like, any hurricane impact?

No.

Okay. And then the next question I had was with regards to the volume declines that you now expect for the year. I was wondering if you could talk about what's driving those? I mean particularly -- obviously, you mentioned like the factors from the hurricanes and then the customer issues, et cetera. But I was wondering if you could, kind of, break those down as well?

Go ahead.

Yes, we haven't broken that out separately. What I would tell you is that we've announced that we've got $15 million to $30 million revenue impact from the customer issue. So I think you can look at some of our pricing for that -- for our overall CS business. And that will give you a relatively good gauge of where that number is. I think the -- we did say $3 million EBITDA impact from Hurricane Irma timing of revenue issues and then obviously some of the production issues will force some of the sales out of the end of the year as well and then the customer impact as well. So those are the key drivers of that change in volumes. And if you look at it, CS volumes for the year will be down roughly 5%. So that means Q4 volumes would be around 100,000 tons, and commodity volumes will be down roughly 9%. So full year commodity will be closer to 225,000 to 230,000 versus the 250,000-ish we had originally said at the beginning of the year.

Okay. That makes sense. And then the next question I just want to ask is I guess a little bit more forward looking. Well, rather I guess (inaudible) but I was wondering if you could, kind of, talk about some of your contracts and ultimately if you have any big expires coming up. I realize you have, kind of, 4 big customers, but I was also wondering if you have any others, kind of, below that, that you may have to, kind of, negotiate with this year?

John, we're constantly renewing, updating contracts throughout the year and, particularly, at year-end. So there's quite a variety right now that I'm sure the team is -- well, I know the team is working on. You've mentioned the 3 big ones that we report out there: Eastman, NCFC and Daicel. And you can see that those currently run out into the future: Daicel through 2018; NCFC and Eastman through 2019. So we're always working on updating, changing and modifying based either on customer interest or our interest. And so those are ongoing, but there's nothing else that I can add any color to that you don't already know.

Okay. And the last question I had before I turn it over. I just want to get a sense or rather verify that I'm thinking about this correctly. But so with the change in mix, it sounds like the pricing is going to be a little bit more favorable because of, kind of, the reduction in the acetate volumes with the customer issues there. As we think to next year, does that then make comps a little bit more difficult per se? So I mean, next year, should we think that you could see further decline in CS pricing because of that?

Yes, I think we'll give guidance on next year in our February call, John. Just to clarify though, certainly we're losing CS on the pressure with the customer issues on CS. And so that hurts our mix, and so therefore, is a negative impact to our CS price, so -- our overall pricing. So yes, I think the flavor you're looking for is going to have to just wait to the next call.

And John, I would just add that we said CS pricing is down 2% for this quarter. If you remember, it was down much more in the first -- previous quarters. And we said that mix would improve as the year went on, and that's what you're seeing in this quarter.

Helped by the acetate reduction, right?

No, I would not say that. I'd just say, overall, we had a lot of lower end CS mix in the first 6 months of the year. And then at this, we've had more higher end CS mix.

And so the customer issues, because I mean, that's primarily going to be on the acetate side. So the reduction of acetate volumes there doesn't have a significant impact then. Is that what kind of you're getting out there?

I wouldn't read that in. I wouldn't read anything into the acetate mix. We look at the overall CS mix, and so it's hard to break it all apart.

Yes. Overall, John, we've guided that pricing in cellulose specialties will be down 4% in 2017. So I think that's the number you should kind of focus in on, and we're right on track for that.

Our next question comes from the line of Roger Spitz with Bank of America Merrill Lynch.

How much commodity volume did you lose going from fluff to viscose? Or what was the sales impact? And was this a switch over issue? Or was it more due to the fact that when you produce viscose, the capacity of the facility is just lower than when you're producing fluff?

Yes. Roger, it's the latter, right. So when we run viscose, we have to rerun that slower than we would absorbent material product. So when you switch over, you get fewer tons out. But we are -- this year, we're actually running higher levels of viscose than fluff than we did in 2016. That's -- it's a more profitable move for us. So despite the fact that I commented earlier that actually fluff prices were above what we thought they're going to be, it's still in our interest to run the majority of our commodity volumes with viscose and even though we get less viscose out the door.

Got it. Do you expect any Q1 '18 impact either from Hurricane Irma and/or the large customer outage. Sounds like the customer is saying that his operations that use your CS are back up and running already. Perhaps, he is just running down the inventory he already had on hand of your CS?

So first of all from Hurricane Irma, we said we may lose a little bit out of the year. So that's a small amount. Frank just mentioned that being in the neighborhood of $3 million. With regard to the customer impact, we think that is contained to the fourth quarter. So -- and -- so that's where we'll leave it. We think we're back to normal January 1.

Our next question comes from the line of Chip Dillon with Vertical Research Partners.

This is Salvator Tiano filling in for Chip. Just a couple of questions a little bit on the volume front. So I think at least from our front, we're expecting given that you had some direct costs as well from the hurricane impact, the $12 million EBITDA hit will be a little bit more weighted towards the third quarter than it was, it seems Q4 will have the majority. So can you describe a little bit how did we end up with that breakdown, like, low sales, perhaps inventory went down that didn't happen.

Yes, I can give you a quick breakdown, Salvator. We said it's roughly $12 million in total between both the production issues and the lost sales. $3 million of EBITDA associated with the lost sales volume. We had roughly $5 million of costs in the quarter. So that's really not producing and absorbing the fixed costs right to the P&L. And then the remainder is the higher cost inventory that's built because of the shutdown and startup.

Our next question comes from the line of Steve Chercover with D.A. Davidson.

So first of all, not to suggest that your relationship with your largest customer is acrimonious, but you're working hard to accommodate their operational disruption. And I'm wondering if it'll make things more harmonious and could there be some goodwill, therefore, for negotiations going forward?

Steve, look, we -- as you know, we had a public dispute a couple of years back. We're long past that. We've got great relationship. They're a good solid customer, and we try to be the best supplier that they have. So we're always looking to further our interest with them, and we hope that being flexible in working with them, we earn that right to go forward. But no, it's a good relationship, Steve, and we're proud to have it.

Okay. Cool. And then with respect to the -- there's a merger -- we'll talk about Tembec in a moment, but there's a couple of significant acetate tow producers that are also getting married or hitched, whatever you want to call it. And I believe one was a former customer and the other player, I'm not so sure if they're a current customer. So any comment on how that might impact you?

Look, there are a couple of folks who are combining out there. And obviously, you're referring to the Celanese and Blackstone's, which is Solvay business. Both have been great customers of ours in the past. We don't usually refer to anybody who we don't have to report out as far as exactly where they stand today. But if we look at that as an opportunity, I'd say we're underrepresented in that new combined company in terms of our share, and so we look forward to participating with them in growth as we go forward.

Okay. I love the positivity. And then finally, is it fair to say that some of Tembec's businesses, specifically lumber and maybe their market pulp, are stronger today than when you first announced the deal?

Yes, I would say that's very true. Obviously, we don't give an update on their business. That's theirs until we close. But if you look at the markets they participate in, lumber is very strong right now, high-yield pulp is strong, and even in some areas that are a little more challenged such as newsprint is actually in a positive way. So their business is stronger than when we looked at it at the beginning of the year. So yes, we're pleased to see that, and we're excited to have that on board.

All right. That's encouraging. Last one for me. Just what is the status of LignoTech? Forgive me, if I should know, but when is it starting up?

No. Thanks for asking. It's right on track. We have communicated that it will start-up in mid-year 2019. So right now the projects are right on cost and right on the timing. So we're excited to have that on board and move forward with it.

Our next question comes from the line of Paul Quinn with RBC Capital Markets.

Just a couple of questions, especially on the outlook here. Where you talk about acetate excess capacity, I'm just trying to understand, where you see that excess capacity in the marketplace? Is that -- I mean, is that -- that's not excess capacity from you yourself, but from others and maybe you could help me understand where those others lie?

Yes, I think it's just -- the bottom line is it remains attractive -- an attractive segment for the industry. And therefore, there are folks who would like to have a greater position in that. What makes it -- again, whether that's trading up current production from one area to another area or just it's capacity, maybe they don't have the run rates that they wished they had. So it just makes a very attractive market for most to continue to move into. And given the dynamics we've referenced there, which is our customers having a lot of pressure on them and this interesting opportunity for other players to come into, it just makes a very competitive sales position, and we continue to see that. It's been that way here for a few years. Paul, we talked about a lot of the other issues have been kind of worked away out of the system, particularly the buildup of inventory in China. That seems to have all but stabilized. So that's very positive. We think the actual demand out there is flat at best. So it's not a growing market. But we don't see it dramatically changing negatively either. So there's some positive stability out there as well. But it just remains attractive, and therefore, we're going to continue to see folks trying to move into it. That's just what it is.

Okay then, if I could flip over to the commodity side. Maybe you could give us your sort of -- you bounced back -- I guess, your outlook has bounced back from -- on viscose from Q2 lows. And where do you see that market going in the near term? And then, I was also surprised by your comment that you saw the absorbent as steady where I'm seeing almost monthly price increases on the fluff side.

Yes. Paul, first of all, viscose market, we think, long term represents an attractive market for us, right? We've got -- we think of a really nice commodity product that we can sell into that market. We see it growing along with the rayon textile market, continues to grow at 5% to 7%, 8% a year. We see supply constraints in that segment from some of the traditional cotton linter producers, particularly in China, as there's a lot of environment pressures on the supply side there. So we view that as an overall attractive market for us. And actually, Paul, I'm glad you brought it up because we actually have a new product platform that we are now moving into the market starting this quarter. It's a product platform we call OPTISILK. And essentially, it's the same high-quality product of fiber that we make today for the market but at a much lower cost position. So that will be positive EBITDA for us going forward. So it's an interesting market segment from the commodity perspective. Yes, you see absorbent materials, we -- I referenced above expectation, certainly our expectations. You remember back, we had some capacity announcements into that segment last year and beginning of this year. And so we thought it would come under pressure as did most of the folks who tracked the market out there. And it stayed, again, far more resilient and, as you mentioned, even upward than we anticipated. So we call it steady. Yes, it could be up, including announcements this week by others. So yes, it remains a good market as well. So both commodity markets for us are looking in a positive direction.

Okay. And then just lastly, we expect Tembec to have a monster quarter, and it's too bad they can't report on it. But any ideas how you're going to report in that in the next quarter, their cellulose specialties? I mean, they do some commodity as well. Are you going to merge that into your commodities and leave the cellulose specialties the same, so we're going to have a mix of acetate and ethers plus others within that CS bucket?

Yes, you would -- you should anticipate that we will effectively take our specialty cellulose and put it into their spec cell category. That's the current thinking. It could change, but that's the current thinking.

(Operator Instructions) Our next question comes from the line of Dan Jacome with Sidoti & Company.

Just 2 really small questions on Tembec. I think you already answered this one with Steve's question. But for the sawmills of Tembec, your feeling hasn't changed at all since May. I know when you announced this transaction, you sounded pretty positive on Tembec sawmills. I just want to confirm that it's still the case?

Yes, absolutely. We've made a commitment to run all their assets, and those facilities are producing really positive cash. And so we think they've also got some opportunity for investment in them to make them even more productive. So we look forward to having those as part of our portfolio, and we'll continue to run those going forward. Obviously, Dan, as we move forward, we're going to have a full portfolio of businesses, and we'll always continue, as any company would, to look at them. But going forward, it's our plan to run everything, of course.

Right. I can't remember, are those sawmills going to require any step-up in CapEx, as I think they were making -- I don't not follow Tembec, but I think they were making their own growth -- kind of, discretionary CapEx for the sawmills. Just remind us as much as you can how much CapEx you're going to be inheriting from this company assuming the deal does close? And how much is maybe maintenance? Or is it all going to be maintenance CapEx going forward that you bring on?

Yes, they've looked historically, I'd say, roughly CAD 40 million of maintenance CapEx across their broad business line. With some of the improvement projects and the cash flow generation we have in the combined entity, I think we will look for more strategic projects to invest and significantly enhance the competitive position of assets, and that includes our mills as well as the sawmills. So across the board, we'll have to look at each and every one and say where is the best place to deploy our capital. But we don't see a dearth of opportunities. We think that there's going to be plenty of opportunities to invest and improve the profitability and competitive position of all the assets.

Okay, great. Last one, and you don't have to answer this if you can't, but if this deal closes and it does reduce the volatility of your overall platform, would the board be amenable to maybe something more steady on the common stock dividend or as you get closer to the transaction closing, I guess, I'm asking, has the board maybe looked at things of that nature for a longer term, maybe in 2018?

Yes, we look at asset allocation, cash flow allocation all the time, every time we talk as a management team and, obviously, with our board. I think our focus is on -- in the near term on taking advantage of these high-return projects that we can find to boost cash flow and then deleveraging the business. Those are our 2 key priorities from that. As we move down the road, we'll look more fundamentally, but we've said a number of times what we'd like to do is get the leverage down. And then if we find another opportunity, like Tembec, we'd like to take advantage of that some time in the future.

Mr. Boynton, there are no further questions. I'd like to turn the floor back to you for any final remarks.

Great. Thanks, Melissa, and thanks everyone for joining us today. We look forward to updating you on our progress in a timely manner as we move forward. Have a great day.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.