Welcome to Clearwater Paper Corporation's Third Quarter Earnings Conference Call. As a reminder, this call is being recorded today, November 8, 2018. 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, Chris. Good afternoon and thank you for joining Clearwater Paper's third quarter 2018 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 third 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 outlook as to certain costs, price mix, shipment volume and other factors for the fourth quarter of 2018, posted on the Investor Relations page of our website at clearwaterpaper.com. 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 information provided on our website. 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. 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 31st, 2017 and our quarterly filings on Form 10-Q, as well as our earnings release and supplemental information. Any forward-looking statements are made only as of this date and the company assumes an obligation to update any forward-looking statements. Linda Massman will begin today's call with a brief review of the third quarter, followed by the Q3 financial results from John Hertz. Then, Linda will conclude our prepared remarks with an overview of the business environment and update on our strategic projects and our outlook for the fourth quarter and 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. I'd like to start with a few opening remarks before John presents the financial results. For the third quarter, we exceeded our financial outlook, thanks in large part to the outstanding results produced by our pulp and paper board team. I want to take this opportunity to thank them for delivering excellent results. Solid production performance, coupled with strong demand, led to another sequential record shipment quarter for the group. Our consumer products business saw improved operating results compared to the second quarter, as the work to improve our operating model has begun to provide benefits. The accelerated startups of two Shelby converting lines, contributed to improved results, while allowing us to take miles off the road and to reduce transportation costs. In the quarter, we completed the sale of a recycle tissue mill located in Ladysmith, Wisconsin. While it was a well-run operation, it was not aligned to our focused strategy of producing premium and ultra-quality tissue for the retail market. In addition, we proactively worked to address our balance sheet and liquidity to provide flexibility to finalize our strategic projects and navigate the current environment. We are confident that changes that John will discuss, provide the flexibility we need in our balance sheet for this foreseeable future. We also remain focused on successfully executing our key capital initiatives, which include achieving the full benefit from the Lewiston continuous pulp digester and the expansion work at our Shelby site. I will provide further details later in today's prepared remarks. For now, I will say that I firmly believe we are focused on the activities that will contribute to the long-term success of Clearwater Paper. Now I will turn the call over to John.

Thanks, Linda. Q3 was a solid quarter from a financial performance perspective as we delivered $49 million of adjusted EBITDA, which exceeded the high end of our outlook range by $3 million. Before I get into the specifics of our third quarter 2018 results, 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. The reconciliation from GAAP to adjusted results is provided in the press release and supplemental information posted on our website. For the third quarter of 2018, those items totaled $22 million of pre-tax benefits of which $23 million was associated with the gain on the sale of Ladysmith mill, which closed in August. That is offset by $1 million of pretax expense primarily related to the mark-to-market adjustments of our directors' equity-based compensation. Turning now to Q3 financial results, net sales came in at $426 million, down 1.3% from the second quarter of 2018 and just below the low end of our outlook range. Lower retail tissue shipment volumes and the impact of the sale of Ladysmith were largely offset by previously announced paperboard and tissue price increases, record shipment volumes in paperboard and improved product mix. Third quarter adjusted gross profit of $50 million or 11.8% margin improved by 1.2 points from the second quarter. The increase was primarily driven by higher paperboard and tissue pricing and progress on our CPD operating model and that was partially offset by seasonally higher energy costs in only two months of Ladysmith contribution in the quarter. SG&A was $26 million or 6.2% of third quarter net sales, which is down $1 million from…

Thanks, John. I will now provide an update on our strategic projects, then discuss the market environment and what we expect for our business segments. Finally, I will give you our outlook for the fourth quarter. I'll start with our Shelby expansion plan, which is nearing completion and on schedule to start producing paper in the first quarter of 2019. As I mentioned, the acceleration of two converting line startups at Shelby has helped to improve the Consumer Products division's operating model by lowering transportation and external warehousing costs. We expect these improvements will continue into the fourth quarter and beyond. Our total Shelby project costs are forecasted to be $40 million to $50 million higher than the original estimate, the majority of which is due to external factors. The revised estimated costs for Shelby is now $380 million to $390 million. To offset the increased costs related to the Shelby project, we proactively and aggressively reduced other capital expenditures in 2018 by approximately $30 million. The external factors that contributed to higher costs include; first, the finalized engineering plans required additional materials, primarily steel that was impacted by the recently imposed tariffs; second, the recent recent hurricanes as well as the wet spring and summer significantly increased overtime costs to maintain the schedule; and last, a very tight construction market in the Southeast, which is driving higher labor costs. While we have been combating rising costs, we believe we are taking the appropriate steps to aggressively mitigate a big portion of those costs by prudently reducing other capital spending. Turning to the continuous pulp digester project in Lewiston, Idaho. The new digester is currently delivering about a third of the expected financial benefits. We believe we have made progress in resolving our digester challenges, and currently have a path…

[Operator Instructions] Our first question comes from Paul Quinn with RBC Capital Markets. Your line is now open.

Just curious, looking back on Q3 outlook from in this summer and when I look at the bridge for the quarter, things didn't pan out exactly as predicted, which often happens, just wondering what the difference was on price and mix, you expected that to be lower, but it was up quite a bit, maybe you could just discuss the differences, what you expected and what you got?

Yes, so Paul, I would say, that's primarily been on the paperboard side is what I'm guessing you're seeing. And I would say we've just had a little bit better ability of push through price and we've also seen improved mix in the product versus what we would have expected a few months ago.

Okay. And then on the volume side, we expected some incremental means, but you didn't get that, what happened on the volume side?

Well, the paperboard volume was up, and that's largely due to the fact that we had some pre-buys happening ahead of the announced price increase. On the tissue side, we expected volume to be down as we have a full quarter without the loss of significant customers after business.

Okay and then just flipping over to the Lewiston pulp digester, what are the parts that you need for -- and why weren't those parts installed when you actually got the new digester up and running?

Yes, so it wasn't that the parts weren't installed. What is required to get the remaining benefit is going to be a modification to the original polysulphide unit and at the same time, we're going to have to optimize the CO2 reactor. The biggest issue is the original polysulfide catalysts that we were using has been proven to be ineffective in our process, and therefore has to be replaced. And the particular catalyst that we need is one of the key congestion points with the solution. There is quite a significant lead time associated with that. We've ordered the catalyst and are now just waiting for that long lead time for its arrival, but in test scenarios, we believe this is the fixed to the promise, it worked well in our testing environment.

What was the catalyst that you're using? Was that something new on the market? Was it unproven technology and then it didn't work for you and then now you're changing or...

I would say there is a variety of catalysts [Indiscernible] yes, there is a variety of catalysts that can be used and the one that our vendor chose has proven to be ineffective. So, we are now moving to a catalyst that I would say is probably a little bit more commonplace in the industry.

Okay and then just looking at the spending, I guess on Shelby 2, the 13% sort of cost bump is unfortunate, so maybe you could outline, John, what -- how you expect the spending -- the remaining spending on the machine to be going forward and then next number of quarters?

Yes, are you interested from a cash standpoint?

Yes, I'm just trying to bridge here, where you get peak debt in Q2. So, I just want to try to be able to do that, but I need to know the kind of the spending on that major item to be able to do it?

Yes, so we'll probably spend $90 million to $95 million cash in the fourth quarter and then, about $50 million-ish in the first quarter of '19 and the balance in Q2 of '19, that's from a cash perspective.

Balance in Q2 '19. All right, that's all I had. Best of luck, guys, thanks.

And our next question comes from Adam Josephson with KeyBanc Capital Markets.

John, on the covenant amendments, how much of that was related to the Shelby cost overrun? I just -- I ask is -- I believe you loosened your covenants as recently as January and then obviously you got $71 million in cash for the sale of Ladysmith. So, I wasn't expecting you to amend your covenants again this quickly. So just help me with what drove the timing and nature of this?

I would say we've been analyzing and considering, switching to the secured only covenant for the past six plus months. I would say, when we kind of came to light after the final engineering drawings were done in August on Shelby, that there was going to be that much more of an overrun that caused us to go from strongly considering that -- let's just go ahead and do this. Just didn't want to have it be that tight as we move through Q1 and Q2.

And just -- you said you'll reach peak debt levels in 2Q. What do you expect your net debt to EBITDA ratio to top out at in 2Q, I presume it will top out in 2Q?

Yes. So, under the revised covenants, the secured only, we expect it to top out around probably 1.2.

And on net debt to EBITDA?

And so that's going to translate to about 4.4.

And then the -- just a couple others, the tax benefit, the alternative energy production credits, obviously, you were not anticipating those three months ago. So can you just help me with what happened there?

Well, with tax -- it was something we're working on, but it's very uncertain as to whether or not. We thought that it would fly or not with IRS. So there is a whole bunch of analysis and then uncertainty at that time. This relates to the continuous digester in Lewiston. We're able to produce a little bit different black liquor and more of it that allows us to produce more energy in the recovery boiler. So that's about as tactical as I can get on it, but that's what drives the tax credit.

The customer pre-buying in your SBS business that you talked about, I assume you were not anticipating that when you gave guidance. So, you came in about $6 million higher than the midpoint of your guidance, how much of that was driven by the pre-buy, just out of curiosity?

I'd say $1 million to $2 million was the pre-buy.

And then, as Paul alluded to, your pricing in SBS was -- Linda just said, it was better than you were expecting. Obviously, there was an SBS price increase you announced $50, RISI recognized just $20 of the $50. So I'm just struggling a little bit to reconcile, you're only getting $20 of an announced $50, at the same time as your pricing in the quarter -- your realized pricing was actually better than you thought it would be. So can you help me square those two things?

Yes, so Adam, I am going to probably take it up a notch with those price increases, and I'm using a combination of what we've seen this year, we'd expect on an annualized basis for that to be about an incremental $30 million and I would say that we expect half of that to be in '18 and about half of that to be in 2019. Hopefully that answers some of the questions you have on pricing.

I just, I am still a little -- pricing was better than you expected in the quarter, but you only got $20 of the $50 announced price increase at the same time, so something clearly fell short in terms of the attempted industry wide price increase. I'm just -- I'm struggling to understand what is fundamentally happening with SBS conditions and pricing given your better-than-expected success by the industries worse-than-expected success at the same time, if you follow my logic.

Well, I think when you look at Q3 and what happened versus what we -- what our outlook was, we are expecting to get more in the way of price increase from the previous price increase, but to have that pretty much fully offset by mix shifts to more [indiscernible] and what transpired was, we got a little bit more in the way of the price increase and we didn't have the mix shift.

Okay, and just lastly, in terms of the guidance, the $40 million to $46 million, where do the Lewiston disruption? Is that coming in the -- are you expecting any sequential improvement in your tissue business. Just out of -- because I know you've previously said that with the cost savings et cetera, you are expecting sequential improvement over the balance of the year, correct me, if I'm wrong there.

Yes, we are expecting a couple of million improvement in the consumer business.

Our next question comes from Steve Chercover with Davidson. Your line is now open.

Thanks, good afternoon, everyone. So John, actually you answered part of my first question, which was with respect to what earnings would have been absent the tax benefit. But I was looking at slide 16, and your adjusted net earnings are close to -- in the current quarter were close to your cross-cycle target. So if everything was normalized, would you be expecting earnings in the $1.30 is at quote?

Everything normalized?

Yes, which will never happen.

I am not sure I am quite following your question.

I guess what I'm saying, if 2Q was at its cross-cycle margin expectation and paperboard was at its cross cycle expectation.

Got it. Okay, I got it.

Would you be expecting to earn $1.25 per quarter?

I think that's probably the way the math works out.

Will look forward to that. And then I also wanted a little more elaboration on this alternative energy. I mean, is there a new black liquor tax bonanza that's pending for the industry?

Well, if they're putting in new continuous digester, then maybe they would, but there's nothing new that I think is broadly applicable across the industry.

Okay. So this is really a Lewiston benefit?

Yes.

Got it. And then I hate to follow on these other questions but -- so as we have stopped out of $20 out of the $50, and yet your realizations in the quarter, your margins were better than your cross-cycle target. So, A, did you push really hard for that increase, and B, is this a testament to your cost position and the quality of your assets?

Well, we always work hard on the price increases, but I think it's more to do with production.

And then on the maintenance front, I think, you really haven't had anything in 2018. When's the next major maintenance for either Lewiston or Cypress Bend?

Q3, it's got to be -- one in Q3 and one in Q4.

In next year, both?

Yes, so there will be two in '19.

So what's the cumulative total of those?

So that can range from, call it $20 million to $30 million depending on what has to be fixed or what they find when they find when they get in there, between the two of them.

Okay. So we got like a $30 million headwind in '19 that's not facing us this year.

Correct.

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

Hi guys, this is Salvator Tiano filling in for Chip, how are you?

Good, thanks. How are you?

Great. So my first question is on tissue and the significant increase in parent roll production. So, first of all, do you have any data that would show, if you can demonstrate a little bit how you're thinking about the loss over the Kruger volumes versus what you're gaining through the strategy. Essentially, how are you mitigating, by how much are you mitigating your operating loss in the segment, if it's something you have and you could provide. And secondly, based on what we're seeing in this quarter, how should we think about the parent roll volumes in Q4 and 2019 and obviously the effect on the weighted average price in tissue.

Yes. So, I would say the increase in parent rolls is related to the large volume of business we lost with the retailer. What we had said previously is still true that we've replaced about 50% of that volume with replacement cases. I think, it was about 60% with replacement cases. The balance of that is shifted into parent rolls. I would say that that's probably a pretty good steady state environment to expect going forward. I mean, we will continue to look for opportunity to convert those parent rolls into finished cases, but at this point, that will be normal course, bringing on new business through bid activity and market opportunity that lines up with what we are producing those parent rolls.

And just following up on tissue, I think one of your competitors has officially started up at least one machine and probably is doing so for the second as we speak. As we look into 2019, do you see within your portfolio, any risk to volumes potentially, any other losses because my understanding is, they may still, both these guys and perhaps some new entrants, they may, still need some new volumes to fill. So is there anything else that should we thinking about in 2019?

I would say, we have been seeing and as new machines come online, we will continue to see pressure in the competitive situation. And like I said in my prepared remarks, that's going to create some near-term volatility, but we are seeing competitive activity both branded and private label. I would say, the activity appears to be trying to drive volume on the branded side and on the private label side, really looking to convert parent rolls into those finished cases, and trying to sell out some of the new capacity. So I think no large step change in market conditions, just more of the same, and I think it will be market conditions, it will be with us here for the foreseeable future as we work through some of this new capacity that's coming online.

And on going back to the tax credit, you already talked where it's coming from so again, looking further out, you had 2 million you mentioned last year. So, is it something that we could see on a recurring annual basis, and if so, is there an estimate that we could put in our models?

Not specifically as it relates to this particular tax credit with the continuous digester in Lewiston, but tax planning is something that we are doing every day and looking for opportunities. It's not something that really lends itself to an outlook, however, but it's something that we're doing all the time.

Our next question comes from Roger Spitz with Bank of America.

Could you repeat the CapEx you gave either, I don't know what that was 2018 or Q4 '18. And did I hear you give a Q4 '18 operating cash flow during your prepared remarks?

We did, yes. So our -- I assume you're focusing on cash CapEx as opposed to GAAP balance sheet?

I'd like the CapEx that you're going to report on your cash flow statement.

Okay, cash CapEx. So, yes. So, we think cash CapEx for 2018 is going to be around $280 million and for 2019, we said between $100 million and $130 million.

And did you -- did I hear you give the Q4 operating cash flow or did I just mishear that?

No, you heard that correct and we said it would be between $55 million and $60 million, cash flow from operations.

$60 million. Right, okay. And then, what did that make an assumption in terms of working cash, excuse me, working capital inflow within that $55 million to $60 million in Q4.

Yes. So, we think we're modeling working capital will be a tailwind in Q4 in the area of $25 million to $30 million.

[Operator Instructions] We do have a follow-up with Adam Josephson with KeyBanc Capital Markets.

Thanks everyone for taking my follow-up. Just, John, one more on the 2019 bridge, someone, it might have been Steve asking about -- your maintenance will be up by about $30 million next year, are there any other big buckets that you would have us be mindful of, I know you -- you're burning on Shelby, you've got ongoing cost savings initiatives, but any big buckets other than the $30 million drag from major maintenance next year?

Well, we'll get the full effect of the paperboard and tissue price increases.

That would be an incremental, what, $15 million, John, next year?

So on the paperboard side $15 million -- no, that's on the tissue side.

No, that's paperboard, $15 million on paperboard and then on the CPD -- on the CPD price increase, which is tissue, we're expecting that to be about $20 million annually, about 25% of that should occur in '18 and the balance will be in '19.

So a different $15 million.

Yes.

Okay. And then, should we, I mean, so that's price, are you thinking of that as net or gross price, because obviously there'll be inflation in the business next year as there is every year. Right?

Yes, that is a gross number.

Yes. Okay. And is there a general inflation number percentage basis or dollar basis that you would have us think about annually?

I think, maybe not a strict percentage, but I'd say the areas that we'll be paying a lot of attention to will be pulp and our wood costs and transportation, which we're working very aggressively to try to offset any increases through our operating model but there's puts and takes there that will try to -- try to beat that inflation environment as much as we can.

Just two others. Linda, just on SBS again, the backlogs are still pretty healthy although they've been coming down really over the past few months and obviously, Sappi added capacity, RISI's been talking about import pressure to some degree. So, and obviously -- the Sappi situation, the import situation was what limited the latest SBS price increase to $20 of the $50, how would you characterize current conditions?

I'd say the current conditions are strong. We are in a decent market. I know the backlogs have actually been declining since July, like you mentioned. So pretty robust demand in the summer months. I'd say, what we're seeing is pretty common with regard to this time of year and seasonality, and we feel good about the paperboard market.

And John, just back to cash CapEx for a moment. So the '19 number of $100 million to $130 million, what should we -- how much of that remind me of Shelby and what would -- I know maintenance is always difficult because companies barely just spend maintenance, but how would you have us think about ongoing CapEx beyond '19, just given the Shelby impact?

Yes, so the Shelby piece of the cash CapEx for '19 is going to be around $85 million and then the balance is going to range between, call it $15 million and $45 million.

Sorry, say that again. I'm a little confused.

Shelby cash CapEx for '19, it's going to be around $85 million.

And your other CapEx...

Then for maintenance and any other strategic capital would range from $15 million to $45 million.

So it's just -- and is that a reasonable number to expect on an ongoing basis just $30 million of CapEx or I mean, that sounds very low.

No, I mean with elevated Shelby CapEx, we are tightening the screws both this year and next year on our other CapEx. What we traditionally have said from a maintenance CapEx standpoint is we spend around $50 million a year and then from a strategic capital standpoint, not in a big major project environment that we spent around $25 million.

So normally, you've spent $75 million and you're saying from this point for post Shelby, it would be not $75 million but more like $30 million?

I would say that would accurate until the balance sheet gets in better condition.

We will be on a CapEx tie-up for the next year plus.

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

Yes, thank you everybody for joining us today and for the great questions. And we do appreciate your continued support and interest in Clearwater Paper.

Ladies and gentlemen, that does conclude the Clearwater Paper Corporation third quarter 2018 earnings conference call. We do appreciate your participation and everyone have a great day.