Welcome to Clearwater Paper Corporation's Second Quarter 2019 Earnings Conference Call. As a reminder, this call is being recorded today, July 31, 2019. 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, operator, good afternoon, and thank you for joining Clearwater Paper's second quarter 2019 earnings conference call. Joining me on the call today are Linda Massman, President and Chief Executive Officer; and Bob Hrivnak, Chief Financial Officer. Financial results for the second quarter were released shortly after today's market close. You will find a presentation of supplemental information, including an updated outlook slide, providing the company's current expectations and estimates for the range of adjusted EBITDA for the third quarter of 2019 and certain costs, pricing, shipment, production and other factors expected to impact the third quarter of 2019, posted on the Investor Relations page of our website at clearwaterpaper.com. I would like to remind you that this presentation contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 as amended including but not limited to adjusted EBITDA for Q3 2019. 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, 2018 and Form 10-Q for the quarter ended March 31, 2019 as well as our earnings release and supplemental information. Any forward-looking statements are made only as of this date and the company assumes no obligation to update any forward-looking statements. 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. Linda Massman will begin today's call with the highlights of our second quarter, followed by the second quarter financial results from Bob Hrivnak. Then Linda will conclude our prepared remarks with an overview of the business environment, an update on our strategic projects, and our outlook for the third quarter of 2019. Then we'll open the call for the question-and-answer session. Now I'll turn the call over to Linda.

Thank you, Robin. Hello everyone and thanks for joining us today. For the second quarter, I'm happy to share with you some good performance. All metrics were in line or above our outlook for the quarter. Our top-line growth was better than we expected and we generated $44 million of adjusted EBITDA, which is one on the high end of our outlook range. Both the Paperboard and Consumer Products businesses performed well and delivered solid results in the second quarter. First, I'd like to highlight the Pulp and Paperboard achieved record shipments and revenues and was a strong financial contribution in the quarter. Second, our Consumer Products business continued to show improvement with higher shipped volumes of converted retail tissue compared to the first quarter of 2019. In addition, benefits and transportation costs from the implementation of our regional sourcing model continue to contribute cost savings, partially offsetting this where the expected startup costs related to the new paper machine in Shelby, North Carolina. We are pleased with the progress and quality of paper we are producing and are still on track to reach the full production run rate in late 2020. I want to take this opportunity to thank the Pulp and Paperboard team for delivering excellent results and the Consumer Products team for making great progress this past quarter. We also took the opportunity to strengthen our balance sheet, reduce interest cost and term out our debt to give us a flexibility to execute on generating cash flow and paying down debt. We completed the refinancing of our $400 million revolving credit facility with a $300 million covenants like seven-year Term Loan Billion that was rated BB+ and Ba1 by S&P and Moody's respectively. We also effectively utilize the strength of our balance sheet by establishing an asset based revolver to provide working capital liquidity at a lower borrowing cost based on the quality of the underlying short-term assets. While we were approximately one year from refinancing the bank revolver, we took advantage of a favorable interest rate environment to go ahead with these new facilities now. These credit facilities are expected to provide the operational flexibility and liquidity needed as we focused on generating free cash flow to de-lever our balance sheets. I'll provide a more detailed update on our strategic projects and outlook for the third quarter and 2019 later in my prepared remarks. Now, I will turn the call over to Bob.

Thank you, Linda. In summary, and as Linda stated, we had a strong second quarter. The results were in line with our expectations on an adjusted basis for EBITDA, operating income and margin, and our top line came in above our Q2 outlook due to the strength in our pulp and paper board business. The exception was EPS, which came in just under the low end of the range. 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. The reconciliation from GAAP to adjusted results is provided in the earnings release and the supplemental slides posted on our website. For the second quarter of 2019 the adjusted EBITDA items netted to $1.6 million of pretax expense, which was mainly due to $1.5 million of non-operating pension and other post retirement benefit cost. So with that, let's discuss our results for the quarter. A summary of consolidated GAAP results is shown on Slide 18 and non-GAAP adjusted results are shown on Slide 19 of our supplemental slide deck. Our second quarter net sales came in at $452 million up 5.4% over the first quarter, which was better than our outlook range of 3.5% to 4.5%. This was largely due to excellent SBS production levels in the quarter, which led to record paperboard shipment volumes and revenues. Second quarter adjusted gross profit was $42 million or a 9.3% margin, a 106 basis point decrease from the first quarter. This was mainly due to items previously included our Q2 outlook for maintenance and repair costs at the Idaho, Arkansas and North Carolina mills, which came in at $5 million and in line with our outlook. In…

Thanks, Bob. Let me now bring you up-to-date on our strategic projects, provide a brief update on the market environment, and conclude with our outlook for the third quarter. We started up our new Shelby paper machine early in the second quarter. At this early stage, we are producing paper products with quality specs in line with our expectations. As I mentioned last quarter, the 2019 production volume is fully committed and the ramp up cost in total are still expected to be in line with a typical paper machine start-up curve, despite coming in approximately $1 million higher in the second quarter versus our outlook. The final converting line at the facility was installed and started producing cases for customers near the end of the second quarter in line with the plan I discussed on the previous earnings call. I want to take this opportunity to thank our team for their continued hard work and focus. Regarding the continuous pulp digester project in Lewiston, Idaho. The digester continues to run well, and is producing the expected energy savings. This delivery timeline for the new catalyst remains on track for the end of 2019. Once the catalyst is installed and calibrated to optimize the pulp making process, we will work to achieve the remaining estimated $20 million of cost saving benefit in 2020. Turning to our view of the market environment for each of our businesses and starting with the North American tissue market. The IRI panel data estimated in dollar terms reflects positive momentum for the private brands. First, the total tissue market grew approximately 6.5% year-over-year. Second, private brands grew 8.9% versus 5.4% for national brands over the same timeframe. Third, private brands ended the second quarter with 31% market share compared to 30% a year ago. And…

Thank you. [Operator Instructions] And our first question is from Adam Josephson with KeyBanc. Your line is open.

Linda and Bob, good afternoon.

Hi, Adam.

Hi, Linda. Just a couple of questions and I’ll get back in the queue. In terms of the new term loan credit agreement and the asset base revolver, Bob, I know you mentioned there are no maintenance covenant and they are covenant light and I got on late, so I may have missed some of what you said with respect to this debt, but can you just help me with what changes have occurred with respect to your covenants, interest rates, any fees you had to pay, et cetera, I know previously you had 2:s1 leverage ratio with the secured debt and now your covenant will be considerably loosen that up, but just compare and contrast what your covenant situation and fees, interest rates, et cetera used to be and what they are opposed this debt issuance?

Okay. All right. Thank you, Adam. So to start off, we were in compliance with our covenants at the end of Q2. So the key driver for the refinancing, we wanted to take advantage of the current interest rate environment which is very favorable. We also thought about our previous credit facilities, the fact that they mature in 2021, we would need to have refinance in 2020. So we thought, given the favorable market environment, let's move forward on the refinancing now. So I'll talk about term loan B and then the ABL revolver. So with the term loan B, we set up a structure to optimize terms and conditions for the market. And the benefit of the term loan B gives us added financial flexibility to pay down debt in a covenant light manner. So our term loan B has an extended maturity for seven years with prepayment flexibility after six months and a big benefit of this as well is the opportunity to work with a larger group of lenders rather than mainly the commercial banks. With respect to the revolver, the revolver is our working capital facility to help manage our day-to-day operations. And it allows us to utilize the strength of our balance sheet, our strong receivables and high quality inventory in a covenant light manner. And it will also lower our short-term cost of borrowing as we execute our plan to pay down our debt. So overall we thought this was a very positive, project for us and we're very happy with the outcome.

Just to elaborate on that Bob, you mentioned the word “covenant light” a few times can you just be a little more specific?

Okay. So basically with the term loan B, the collateral is primarily our fixed assets, which are high quality. So with the bank facility basically have maintenance covenants, typically the leverage ratio and the interest coverage ratio. So the fact that the term loan B is the security is arranged differently, its covenant light. We don't have the maintenance covenants that we had with the bank facility. And then with the ABL revolver, covenants would only come into play if we had less than 10% capacity left on our borrowing capability. So again, we're collateralizing the debt, utilizing our high quality receivables and our inventory.

Okay. Thanks for that Bob. And I'll just ask a couple on a guidance spreads and that'll I'll get back in the queue. And forgive me Linda if you already went over this, in terms of the price mix being down $2 million to $3 million sequentially is that in tissue or SBS, can you just elaborate on that?

It's a little bit of mix across both parts of the business. And then, Adam it's also a further realization of the received price decline of $20 that was issued back in February that takes into account some contracts that are up for that renegotiated price here as we move into Q3.

And the mix you're talking about is that a seasonal thing or is that specific to this year?

It's specific to this year. It's just a shift across really across both sides of the business.

Okay. And just one other on the bridge, the cost benefits of $4 million to $5 million sequentially, how much of that is pulp versus other, and relatively to what extent did you benefit from these plummeting pulp costs in 2Q?

Yes, I'd say the bulk of the $4 million to $5 million is both pulp and transportation. I guess I would say it's probably somewhat evenly split, maybe three related to pulp.

Got it. Thanks. Then I'll get back in the queue. Thank you.

Thank you.

Thank you. Our next question comes from Paul Quinn with RBC Capital Markets. Your line is open.

Yes, thanks very much. Good afternoon.

Hi Paul.

Hey, just a couple questions on Shelby 2, I see the startup costs were a little bit over your forehead said $1 million, what was the difference between your forecast amount and the actual startup cost. And then if the 3 million to 6 million[ph] is the Q2 cost, what are you expecting in Q3, Q4 and early next year?

Yes. So we thought we would have about $2.6 million of startup costs this quarter, so we're just slightly over that. And I would say that's more of a timing issue. We're not expecting anything significant moving into Q3. And as you know, I'm sure, but I'll just state it so that others on the phone may hear it as well, startup costs are typically – as you're starting up the machine, you do produce some paper that's not sellable. And off grade paper is what we call it. And then, of course, you have the absorption since you're not running all the production tons off that equipment, but you have a lot of the fixed costs associated with it. So that should start balancing out as we move into Q3.

Okay. So we are still expecting a cost on Shelby II in Q3, but it's not going to be in the $3.6 million range. Are you suggesting that's going to be break-even or?

No. There still be some costs, which is not material enough to break it out.

Less than $1 million?

Yes.

Okay. And then I guess flipping over to the paperboard side, you mentioned RISI has the order backlogs around five weeks. What are Clearwater's backlogs?

I'd say we're consistent with what you hear about with RISI. So it was a good quarter for us. We feel real good about how the business has turned out. And have a great customer base and had a really nice quarter, so a huge thank you to our paperboard team for delivering such great results.

Okay. Then just on the Lewiston facility itself, where we with the contract negotiation?

Yes. So we are still making progress. We've been meeting with the union over the last two days, today included. Both parties are continuing to work towards ratifying a contract. I'd say we're committed to reaching agreement. This is consistent with what you've heard before. But we are committed to reaching an agreement that supports the long-term viability of that Lewiston mill operations and of course our employees, so consistent with what we've stated before.

Okay. That's all I had. Thanks very much. Good luck.

Thanks Paul.

Thank you. And our next question comes from Steve Chercover with D.A. Davidson. Your line is open.

Thanks. Good afternoon everyone.

Hi Steve.

So I guess my first two questions I'll also lump under the guise of timing. With respect to Shelby, on the Q4 call you said you expected the new machine would be at full capacity within 12 months. And today you said that it would be the end of 2020. And given the April startup, that sounds more like 21 months. So what's changed? Why is it slower?

Yes. I think we said 12 months to 18 months for – 12 months to 24 months for full production. So I'd say we're on track with what we originally thought with regard to Shelby. We think over the course – I mean, of course we're going to continue to make progress through 2019, but I would say really hitting that full production run rate sometime during 2020. And then, of course, need that full production rate before we can hit the full shipment run rate, which will happen commensurate after that.

Okay, thanks. And also we'll call this a timing question. I was under the impression that 2020 was supposed to be basically a maintenance free year, and now it looks like that's no longer the case. The maintenance is down only $3 million to $8 million, and it's at Lewiston primarily. Does that have something to do with the catalyst and the digester?

We're planning that conservatively right now. Historically, we said Lewiston would be on a maintenance plan, maintenance schedule of every 18 months and then, of course, Arkansas every 24 months. So that would be off cycle. So right now that's our best placeholder, and we're going to continue to assess that as we move through the balance of this year and work on getting that catalyst implemented and seeing what we really need to get done next year.

Okay. Well, I'm used to being wrong, so was I wrong that next year was going to be a very light maintenance year?

No. If we followed the 18 month schedule, there would not have been maintenance next year, yes.

Okay. Thank you. And then in previous presentations, you specifically broke out pulp as an EBITDA item in – or, sorry, as an item in your EBITDA bridges. And since we expected that to be a real tailwind, how come you have now kind of lumped it in with transportation instead of keeping it discrete?

Yes, I'd say once it becomes material, we'll break it out. But this year, and I think we've stated this before but it is a bit confusing, we had a number of contracts last year that were quite favorable that, as we cycle through those, we will definitely be getting the benefit of a pulp cost reduction. But year-over-year, it's relatively flat to slightly better. And then once we get through this cycle, we should start seeing the benefit of pulp.

Okay. And then two more for me, please. So between the sequential price mix and the cost and the lower SG&A that you guys expect, which bucket is most of that going to drop into? Will it be within the tissue business or across both businesses?

Are you talking about the third quarter outlook, Steve?

You can talk about Q3 and then going forward, I'll take all the info you want to offer.

Okay. So going forward into Q3, we talked price mix, that there'd be a little bit of a headwind. And we attributed some of that to mix across both parts of the business, but also that RISI price decline that's just catching up with some of our contracts now. Also for Q3, we have the major planned maintenance in Lewiston that's a big driver, and then we have some tailwinds related to pulp and transportation So that's the big drivers Q2 to Q3 going forward in the next year, we have of course a continuing benefits of Shelby, that will benefit us, as well as working on getting the remaining benefit out of the Lewiston digester once that catalyst is in place and working.

Okay. And then, do you still have cross cycle EBITDA targets by segment and on a consolidated basis?

I think we have removals and those are no longer in the supplementals, yes.

Right. Are they constant from what you had anticipated before?

I think those need to be revisited, given the macroeconomic conditions we've seen over time on the tissue side, still very confident in both sides of our business. I mean, as you know, the tissue business continues to grow, private label trends are all very positive, so we feel good about that side of the business. But with the supplying situation, that really – from what we said it doesn't really stabilize until the end of 2021, when all the capacity works through the system. So once we get through that state, I think it’ll be a lot easier to create those cross cycle targets, again, that’ll be more meaningful. On the paperboard side as you know, we’re well above those cross cycle margins for quite a few years and continue to do quite well on that side of the business as well from our own perspective, as well as market conditions.

It's terrific business. Okay, last question and I won't get back in the queue. Just in terms of the benefits from the capital investments, I'm referring to Slide 8, you've told us $55 million to $65 million from Shelby, $20 million to $35 million from Lewis and I know you can read too. But in the past, you have kind of tethered those benefits to a point in time. And I'm just wondering, are those benefits tethered to 2018 cost structures or, are they just regardless what happened to cost is expect pass through any costs that might encroach and get that EBITDA?

So those would have been timed out at the timing of when the decisions were made. So I think that's the closest timing, but if you were to ask that question about do we still feel confident we can deliver those cost savings on a go forward basis? The answer is yes.

So all things being equal, we should have what, $80 million to $100 million incremental EBITDA by the end of 2021. All right, thank you.

Thank you. Our next question comes from Chip Dillon with Vertical Research. Your line is open.

Yes. Good afternoon, Linda and Bob. First question, just to make sure we have this absolutely right. So the start-up cost were two points – sorry were 3.6 in the second and there’ll be less than 1 in the third. And should that barring any unusual? I mean according to your plan, I should say, should it stay below $1 million per quarter until you get up to full production?

Well, I would say that the bulk of the start-up costs you saw really in this quarter and as things start to line out better they should just see somewhat immaterial for us. But it is a start-up over the timeframe that we talked about. So there are puts and takes that happen over the course of that time, but it should get easier as we get further into the start-up cycle.

Okay. And this is more for Bob. Bob, it looks like working capital which – net working capital was looking obviously very low, when you had a lot of payables for the project. And it looks a little more normalized now, I might be wrong about that. But I was little surprised about the net debt going up. I know the third quarter you have all the maintenance expense. But if I look at CapEx, if you're doing $130 million to $140 million, I mean, you're already within $30 million or so give or take of that already for the whole back half of the year. So how much more should we see net debt go up in the third quarter?

Yes. So basically, yes, just to kind of recap the working capital situation, on Q1 we had a drain of about $62 million, but in Q2 on the payable side, we began to normalize. So we had a net source of cash from working capital of $12 million. And you're right in Q2, we had cash from operations of $44 million. If you look at the supplementals, we have a graph in there, it goes back to like 2015, this would be a more normalized quarter for cash from operations, based on history. So with that background in mind, let's talk about net debt. So we expect our net debt levels to peak in Q3 due to the timing of payments. And the net debt levels, however, should be in line – closely in line with where we were at the end of Q2, which was $890 million. Where you’re going to see some little bit of volatility though is going to be with our leverage ratio. So in the second half of the year, we have the major maintenance outages. So we have the one in Q3 for Lewiston, which is going to cost our last 12 months’ EBITDA to decline and it's going to cause the net debt to EBITDA ratio to rise. So, it's important note though that the net debt levels should start coming down in Q4. So we're going to peak a little bit above the Q2 level, it’s peaking Q3, and then Q4 begin coming down. But our leverage ratio in Q4 is expected to rise, due to the lower last 12 months’ EBITDA. And this is going to be caused by the major maintenance outages in Q3 and Q4.

It does. And by the way, yes I'm just looking at the absolute level. So I will make – you’re still a little above the Q2 level, I mean Q1, it was $872 million. Are you saying we should expect a third quarter to come in as high as $890 million before it starts coming down?

I would say roughly that level maybe slightly higher. And then we anticipate it coming down in Q4.

Okay. And then looking at the interest expense and I would imagine the – I think you're guiding to somewhere around 11 to 12, I just got off that slide. For the third quarter, are you still capitalizing very much or is that kind of what – or maybe it might be a smidge higher because you're going into the fourth quarter with a little higher debt. But should that sort of represent the quarterly peak approaching 12?

Yes. So on the Shelby project, because we're up and running, we're no longer capitalizing metrics.

Got you. And is there any benefit, if – we had a rate cut today, if we – are you sensitive to any of the – if there are further weight rate cuts?

Yes, so our credit facilities are tied to LIBOR, so if there are future rate cuts, whatever impact is on LIBOR, it would be a benefit to us.

Got you. And then last question is, I see – not to be too specific, but you put in one of the slides, I think sort of ongoing CapEx for year 60 is a good number to you. So I kind of thought it was like closer to 70, but you're now saying just so I'm clear that we should see CapEx – there'd be 60 next year and perhaps 21 as well, just as you worked that debt down.

Exactly. Yes, that’s our plan.

All right, got you. And one last one. You gave on one slide the benefits of the project at Lewiston, the EBITDA number, and it starts early next year I believe. Is that fairly immediate or will that have to phase in over a while?

Yes. So that should be pretty much, well, it's hard to say, it should mostly be somewhat immediate, assuming everything starts up well, If there is any unforeseen circumstances that we are contemplated today, then of course it might be a little bit slower. But we would expect that to be the full year.

Okay, great. Thank you.

Thank you. And we have a follow-up from Adam Josephson with KeyBanc. Your line is open.

Linda and Bob, thanks so much for taking my follow-up. Just Linda, one cleaning up question on pulp and then I just have a couple others. So can you just help us, I forget someone else asked you about pulp. Can you quantify to the extent possible, how much of a drag higher pulp was last year? How much of a benefit you're expecting this year? And I think you indicated that you will get even more benefits next year from what's already happened, just based on the nature of your contract. So can you just help me to the extent possible with the impact that pulp had last year, this year and as it could have next year?

So Adam, I might need to get back in touch with you about last year because obviously there was quite a headwind there with regard to pulp. This year it’s really flattish year-over-year, just given the prior year contract versus seeing some declining pulp and based on when it peaked and started to decline, it's really going to be pretty flat this year. And then we should expect some incremental benefit next year. We do have a slide in our supplementals that now includes some of the sensitivities around some of our key commodity items. And in there you could make your own assumptions about where you think pulp is going to go and see how much of an impact it will have on us depending on what your outlook for pulp is. So that is, I think a pretty helpful slide.

Right. Okay. And that would be with – the impact would obviously be with some sort of lag based on the nature of your contracts.

Yes.

Right. Okay. And just a couple on your – on the PACE multiemployer pension fund that's in your K. Can you just talk about, why you haven't withdrawn from that fund as many if not all of your paper industry peers have?

Yes. So thanks for the question. First of all, and you can imagine, we look at this pretty carefully, and have over time we will continue to monitor PACE and we call it PIUMPF, it’s a multiemployer pension plan that covers our USW members out of our Lewiston facility that participate in that plan. We looked at a whole range of options related to PIUMPF or PACE, and obviously, carefully considered those options. At this point, the best course of action for us we believe is to remain in the fund, and so we have not withdrawn or made any plans to withdraw. And you may know this already, but just in case it needs to be highlighted for anybody else on the phone, the decision as to whether or not we continue to participate in the plan is negotiated as part of our collective bargaining agreement. So the decision doesn't rest solely with us, okay. In addition, if we did negotiate to withdraw, we do believe it would require a replacement plan which result in increased costs. So at this point, we're not choosing to move out and withdraw and incur incremental costs. We're just going stay in the plan.

And just – yes, I'm sorry, go ahead, Linda.

No, go ahead Adam.

Yes, I think in your K that you estimated, I think the present value to future payments, if you were to withdraw it would be at $78 million, but as you just mentioned, you'd also have to be a part of a replacement plan which would result in additional costs above and beyond that $78 million. Is that – am I understanding it correctly?

Yes. So if we were to withdraw, we would have to pay that withdrawal liability like you referred to. And then in addition, we would have to negotiate a replacement plan of some amounts – some benefits to replace that plan. So if you just use what we currently have at the annual cost of $5.8 million that's a high watermark, if you negotiate up to a like-to-like replacement plan as an example of an incremental cost.

Got it. Okay. Thank you, Linda.

Thank you. And Ladies and gentlemen, that does conclude our question-and-answer session. At this time, I will turn the call over to Ms. Massman for any closing or additional remarks.

Great. Thank – I just want to say thank you for joining us and your continued interest in Clearwater Paper, and I hope everybody has a great day. Thank you.

And ladies and gentlemen, that does concludes the Clearwater Paper second quarter 2019 earnings conference call. We do appreciate your participation.