Ladies and gentlemen, thank you for standing by, and welcome to the Clearwater Paper Third Quarter 2020 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would like to hand the conference over to your speaker today, Sloan Bohlen, Investor Relations. Thank you. Please go ahead.

Thank you, Mike. Good afternoon, and thank you for joining Clearwater Paper's third quarter 2020 earnings conference call. Joining me on the call today are Arsen Kitch, President and Chief Executive Officer; and Mike Murphy, Chief Financial Officer. Financial results for the third quarter of 2020 were released shortly after today's market close. You will find a presentation of supplemental information, including a slide providing the company's current outlook, which is posted on the Investor Relations page at 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. Please note, Slide 2 of our supplemental information covering forward-looking statements. Rather than rereading this slide, we are going to incorporate it by reference into our prepared remarks. With that, let me turn the call over to Arsen.

Good afternoon, and thank you for joining us today. Please turn to Slide 3. As you saw from our press release, Clearwater Paper had another outstanding quarter, driven by strength in our tissue business, stability in paperboard and excellent operational execution. On a consolidated basis, the company reported net sales for the third quarter of $457 million and adjusted EBITDA of $77 million, which represents growth of approximately 3% and 145%, respectively, over the third quarter of last year. A few business highlights to mention. Our tissue business drove results with both higher sales and production volumes to meet elevated demand. Lower input costs, particularly in pulp, were also a tailwind on a year-over-year basis. Our service levels in tissue started to recover to pre-COVID levels as we continued to work with customers to fulfill orders and replenish inventory levels. Our paperboard business continued to deliver stable performance, managing through uneven end market segments with solid execution. Our current backlogs are in line with previous years, and we've successfully launched ReMagine folding carton brand, offering recycled content in an SBS board. In the third quarter, we used the free cash flows generated to reduce our net debt by an additional $40 million, and we refinanced our 2023 notes with the new 2028 notes. On Slide 4, as I noted, these last 2 quarters, we remain focused on our top priorities during COVID, the health and safety of our employees and safely operating our assets to service our customers. We continue to operate with appropriate safeguards against COVID, including temperature checks, quarantine protocols, sanitation practices, social distancing guidelines, face covering requirements, remote work, travel restrictions and enhanced benefits. Our human resources and manufacturing leadership teams are doing an exceptional job of proactively monitoring the health of our workforce and ensuring that…

Thank you, Arsen. Please turn to Slide 7. The consolidated company summary income statement is depicted for the third quarter as well as the first 3 quarters of 2020 and 2019. In the third quarter, diluted net income per share was $1.28 per share, and adjusted EBITDA was $77 million. The corresponding segment results are on Slide 8. Our paperboard business continued its strong adjusted EBITDA performance, while Consumer Products benefited from significant sales growth and fixed cost leverage associated with production growth and favorable input costs. Please turn to Slide 9 where we provide a year-over-year comparison of the third quarter 2020, relative to the third quarter of 2019 for tissue. In the second quarter of 2019, we started our Shelby, North Carolina paper machine and incurred, as anticipated, start-up costs related to lower production throughput, higher waste and other costs, which persisted during the remainder of 2019. As a reminder, we achieved the targeted production rate of our new paper machine in the second quarter of 2020. And we are continuing to capture the benefits associated with the project, including ramping our converting lines, realizing supply chain benefits and achieving sales wins and mix improvements. While we're not providing a specific dollar amount for these costs and benefits, the continued realization of the Shelby investment is an important factor in our performance improvement. Our mix continues to improve as Shelby has come online, more than offsetting some year-over-year price impacts. We're benefiting from the volume increases related to the production ramp, which helped to meet elevated demand. Overall, fixed cost leveraged from increased production, lower input costs and improved mix positively impacted our tissue business in the third quarter of 2020 relative to the third quarter of 2019. You can review a comparison of our third quarter 2020…

Thanks, Mike. Let's turn to Slide 14. I would like to reiterate our value proposition, which we discussed on our previous earnings call and mentioned to investors throughout the quarter. We believe Clearwater Paper is very well positioned across 2 attractive and complementary businesses. Our Consumer Products division is the leader within a growing private brand of tissue market. From our vantage point, we believe the key strengths of this business are the following: first, we have a national footprint with an ability to supply a wide range of product categories and quality tiers, which is an attractive sales proposition to our customers. Our expertise in manufacturing, supply chain and transportation is a key differentiator, especially during challenging times like today; second, there are long-term trends away from branded products to private brands. These have typically been amplified during recessions. Private brand tissue share in the U.S. rose to over 30% in 2019, up from 18% in 2011. While these trends are impressive, we're still a long way from where many European countries are, where private brands represent over half of total tissue share; lastly, tissue is an economically resilient and need-based product. Historically, demand has not been negatively impacted by economic uncertainty. Turning to our paperboard division. We believe that the key strengths of this business are the following: first, we operate well-invested assets with a geographic footprint, enabling us to efficiently service customers on both Coasts. We have a diverse customer base, which serves end markets that have largely stable demand; second, not being vertically integrated, enables us to focus on independent customers with unparalleled service and quality commitment; third, we believe the business is well positioned to take advantage of trends towards more sustainable packaging and food service products; lastly, our paperboard business has demonstrated an ability to generate good margins and solid cash flows. Overall, our large capital investments are behind us, and we're prioritizing cash flows to reduce debt as we demonstrated in the third quarter with a net debt reduction of approximately $40 million, bringing our net reduction thus far in 2020 to over $140 million. We intend to continue to deleverage by delivering benefits from our Shelby investment, continuing with operational improvements, aggressively managing working capital and prudently allocating capital. While we expect to have lower tissue shipments in the coming quarters, we're making sound strategic moves to support our customers and their success and continue to position our business for success in the long run. We believe that this strategy is the best way to create value for our equity and debt holders. Before we take your questions, I again want to thank our people for their integrity and commitment to each other, our company, our customers and our communities during this challenging time for everyone, and to our customers and shareholders for working with and believing in us. So with that, we will end our prepared remarks and take your questions.

[Operator Instructions] Your first question comes from Adam Josephson from KeyBanc Capital Markets.

Congrats on another really good quarter, both of you. On the quarter itself, Mike, this may be better for you. I just want to make sure I heard you. I think you were saying you expected the IRI Panel Data to be up 10% to 15% in the quarter, and it was up 12%, which sounds like it would have been in line with your expectations. So if that was indeed the case, can you just help me with what about your volume and production was appreciably better than you were expecting?

Great question, Adam. There isn't a one-to-one correlation between the IRI Panel Data versus our sales data. The IRI Panel Data is all encompassing and its dollar sales at the retail level, which includes rebates and discounts and all of that. We were encouraged in terms of our own sales in the quarter relative to our initial expectations. So while IRI data came in within the range, we performed a little bit better than we initially anticipated.

Got it. Okay. And just on the same topic, Mike, can you just, again, reiterate what you said about October, why you think shipments were lower in October than the third quarter average? And why you presumably expect that to continue?

Adam, why don't I take that. This is Arsen. If -- what we've seen is some normalization in demand from consumers, and I think there's some consumer destocking taking place. Retailers ordered pretty heavily in Q2 and Q3. If you look at our year-to-date shipments, they're up around 17% versus 2019, and retailers also brought in some tertiary brands and other suppliers to meet peak demand. So what you -- I think what you're seeing right now is an adjustment in their supply chains as their inventories have grown, and I think they are managing through their inventories in certain product categories, and they've reduced their orders in the month of October to adjust their inventories. So I think this is an adjustment month that we've just gone through.

And are you anticipating another demand surge related to this, obviously, surge in COVID cases that we've seen in recent weeks? Or how are you thinking about that issue as it relates to your fourth quarter guidance?

It's hard to predict what consumers will do and what retailers will do. What we're expecting is for our volume to be at or below Q4 2019 levels. So we're anticipating continued normalization and this inventory adjustment by our retailers to continue. And, of course, if there is a dramatic change in consumer demand, that will have an impact on us. But we're expecting continued normalization and inventory management by our retailers.

I appreciate that, Arsen. Just 2 more. One on pulp. I know you said you're expecting it to be up $50 a ton on average next year. Is that just based on a RISI forecast? Or is there anything you're actually seeing in terms of notable pull price inflation?

So Adam, again, it's premature for us to give a lot of guidance for 2021. We look at a composite view of a bunch of different providers of pulp expectations. And we're just pointing out, on average, what we're seeing is expectations in the marketplace of a $50 per ton higher pulp price levels next year versus this year.

Just to be -- is it based on anything you're actually seeing at the moment? Or is it much more about, well, these third-party forecasters are saying, it's going to happen next year, so we'll just assume that for now?

Great clarifying question. We're not seeing anything at the moment. It's just more helping you and the other analysts and investors out there to calibrate what you should be thinking about for 2021.

I appreciate it, Mike. And just last one for me on paperboard. So I appreciate kind of your candor and characterizing the industry as having what you call the uneven end market segments. If just think about what's been happening in the industry since last year, GP shut 40% of its capacity, the largest producer this year, shutting 10% of its capacity. Obviously, the 2 largest producers took significant market downtime in the third quarter. Does the ongoing need among major producers to shut this much capacity, just tell you something about underlying demand patterns in this market? And if so, what is that?

Adam, let me take that. So we won't comment on what our competitors are doing. They have their businesses to run. They're making, I assume good decisions for themselves. What we're seeing is a stable order book. And we're seeing our customers have, especially in the folding carton space, have good solid demand here over the last couple of quarters, and that's continued into October. So that's what we're seeing. We're running our business to our orders and to our customers, and we continue to see a very stable order book.

Your next question comes from Steven Chercover from D.A. Davidson.

So to start, since we have the sense that tissue inventories are normalizing, and you said that demand is still elevated. But I'm almost afraid to ask this question, but at what stage will the new Shelby capacity be sold out? And then how do you contemplate addressing that in that eventuality?

Good question, Steve. As we said previously, we ramped the paper machine in the second quarter of this year, but converting will continue to ramp through 2021. And we're assuming full run rate production and benefits in 2022. So we're continuing on that trajectory. As you may imagine, over the last few quarters, it's been a fairly tumultuous market, and we've done everything we can to service our customers across our network. So with -- what we're not doing right now is splitting out specific Shelby impacts as Shelby is part of our broader network and part of our strategy to service our customers. But we're on pace to ramp the asset, and we're selling through the capacity that's coming off those lines, and we're going to continue to do that. And we'll make the right decisions around our network in terms of loading and where our volume is going to be placed.

So is the tissue machine itself running at design capacity? And that means that you'll be internalizing parent rolls that are currently going to third parties?

So yes. So we ramped the machine at the end of Q2. And with Q2 and Q3 elevated demand and production, we've needed that paper to service our customers. As our production slows in Q4, we will be making good decisions around our network in terms of what we do with paper. And as you recall in previous years, we have used parent roll sales as an outlet for additional inventory. So we'll be looking to make the right financial decisions around our mix of case sales and parent roll sales.

Okay. And switching to paperboard. Hopefully I'm not duplicating Adam's question. But given the proximity of the Texas facility to where you are in Arkansas. I mean in the grand scheme of things, it's reasonably close. Are you seeing any inquiries from folks who might be concerned that their source is going away, are you seeing any outreach?

Yes. Steve, it's a fair question. It's Mike. I think what we're seeing is, again, what Arsen had commented on before, a pretty stable flow of orders and a pretty stable order book. As you recall, as we said in the past, we're an independent player. And so I think that serves to our strength in terms of servicing customers. I can't speak to specific actions by our competitors and how that impacted our customers. But I think our customers recognize that we're here for them and in a very difficult time here with COVID.

Yes. And then last question. I mean, I think your performance in containerboard -- sorry, in bleached board has been superb over the years, and I think it will probably remain that way. So are you satisfied with your results, both operationally and financially from your small independent fleet?

I think, especially in this quarter, Steve, our team had a great quarter in paperboard operationally, which you can't always see in the numbers, it was one of our better quarters. So kudos to our mill managers and the engineering teams. And our sales team really had another great quarter, and I'd say in a very uneven or choppy market that we're in.

Yes. kudos, indeed. Okay. Congratulations.

Thank you.

Your next question comes from Paul Quinn from RBC Capital Markets.

It sounds like Adam and Steve and I are in the same boat. We're kind of confused on the drop in tissue. And I suspect it's around you've adjusted the customer -- your customer mix to improve in 2021. Is that why it's coming down?

I think it's a contributing factor, but I think there's broader trends that are being reflected here in Q4. And as I mentioned previously, I think our customers ordered heavily in Q2 and to meet their peak demand, they also brought in additional suppliers, both domestic and imports as well as tertiary brands to get products on their shelf. So I think they are -- we believe they're working through that inventory. So while demand remains elevated, we're being impacted by that inventory adjustment this quarter.

Okay. And then if I could just try to understand Shelby 2 and the converting capacity there, you've cut converting capacity, how much -- like what percentage of the converting capacity is converting versus a parent roll or so?

Yes. So the facility was designed with a paper machine and adequate converting capacity to convert the paper coming off that machine. So we've ramped we ramped the machine. We're still ramping our converting assets. So some of that paper is moving to other sites for converting. And as we ramp our converting assets, more and more of that paper will stay within Shelby. And we needed that paper the last couple of quarters to service our customers. And as I mentioned previously, we'll be making the right financial decisions here in the next couple of quarters as we adjust our production to maintain the right levels of inventory.

Okay. Maybe just to further clarify then, how much is being converted at Shelby? How much is being converted within the Clearwater network? And what's the percentage of offsite roll sales?

So I believe, if you look at our Q3 results, 96% of our sales were -- shipments were retail sales. So the vast majority of our overall production -- paper production is being converted within our own sites. On the margin, we sold a few tons over the last couple of quarters, but most of that paper was converted internally.

Okay, okay. One last one, just to kill this. But if you're 96% retail in Q3 and you're ramping over 2021 on converting, does that mean you're going from $96 million to $100 million?

I think what we mentioned previously is about 50% of Shelby capacity is going to be dedicated to network optimization. So what we'll be looking to do is to move converting from other geographies into Shelby to be closer to customers and help with our network optimization initiatives.

Okay. I think I'm getting closer to the answer. Let me switch off to something else and just try to understand your capital allocation priorities. I suspect debt is one of them. Leverage is probably somewhere around 3x now, and you've got a goal at 2.5. So is that still number one? And if that's number one, what's number 2, 3 and 4?

So Paul, thanks for the question. So you're right, our leverage has come down. I think we need to look at the leverage target in the context of a normal kind of a non-COVID year in a year in which we have an appropriate amount of outages. So right now, we're closer to 2.8x, but I'd argue on a year where we had a couple of things going in our favor. And so it's going to be a while yet before we reach that 2.5x on, call it, more of a normalized EBITDA.

Okay. That's fair. And then after debt pay down, what are the priorities of cash?

So we're still talking, Paul, to our Board about what's our strategy going forward as we get closer to achieving that target. It's not something that we've disclosed, but it is an entirely fair question, and we look forward to getting it on the next quarterly call as well.

Your next question comes from Mark Wilde from BMO Capital Markets.

Arsen, I wonder if we could start just by talking about tissue imports and also the impact of new entrants into the tissue market. Do you have some way to help us quantify how much you're seeing imports up over the last quarter or 2?

So we'll get back to you with that data here in a moment. So we have seen an increase in imports. It's not a big number, but it is having a bit of an impact. In terms of new entrants, this year, if you look at overall capacity additions, it's about -- the latest is about 160,000 tons net added to tissue capacity this year. As we mentioned previously, this market grows at about 1%, 1.5%, which would indicate it would need about 100,000, 150,000 tons of new tissue capacity to meet demand. And this year, if you look at the puts and takes, it's about 160,000 tons of net adds this year -- 150,000, I mean, net adds this year, another 160,000 next year.

Okay. Is it also possible for you to just help us in general terms, think about what the issues are as we get away-from-home tissue producers trying to toggle some volume over into the consumer market? What are they capable of and what do they have a harder time with?

So a lot of the away-from-home products are not applicable in the at-home retail market. So thinking about the big giant rolls of paper towels, both napkins and so on. So we believe that a large chunk of that capacity is not really applicable to the at-home market. Now there are some higher end away-from-home products, bath tissue, that may be applicable, and I'm assuming that our competitors that have both sides of the business are looking to move some of the capacity to the retail market. It's difficult to say what percentage that is, but we believe that the majority of away-from-home capacity, it'd be rather difficult and costly to convert it to at-home capacity.

Okay. That's fair.

Mark, it's Mike. Just on the import question that you had asked before. I think the best third-party data source that we have to point you to is RISI. And so just looking at the first quarter to the second quarter, there were really notable imported volumes of both the parent rolls and converted tissue product. And kind of eyeballing the graphs here, I think in the quarter, we're up close to 50,000 tons worth of converted product. And on the parent rolls, it looks like we're up close to maybe 20,000, 25,000 tons, first quarter to second quarter. That's the best kind of third-party data that we have. Other than that, we get worried that we're sharing anecdotes in terms of what our customers might have purchased during the period. We'd rather rely on the third-party data.

Yes, I think that's a good practice. If we just toggle over to the bleach board market, I'm just curious about how you think about the knock-on effects from these pricing initiatives that are underway in both CNK Board and CRB Board right now.

So Mark, I don't think that there's a very strong correlation amongst the 3 different markets. It's obviously not a negative for SBS for converters on the margin who can choose amongst the 3 grades. So I went -- we don't comment on forward pricing at all. But I do think that there are 3 reasonably different markets that the folding carton producers purchase from.

Yes. Okay. All right. And it seems like that the CUK guys, in particular, are quite tight right now, and at least 1 of the 2 producers has been talking about trying to toggle people over to SBS as a substitute. Are you getting any benefit from that kind of behavior?

We won't comment on what the competitors are doing. What we will tell you is that we're continuing to service our customers. We're continuing to see some pretty robust demand from our customers and a stable order book. So hard for us to tell what knock-on effect the various moves are making, but what we do know is our customers are seeing good solid end market demand, and it's enabling us to maintain a solid order book as we head into October.

Okay. And then just two final ones. Mike, what was the third quarter benefit from lower pulp cost?

We didn't break that out, Mark. It was one of those -- looking at year-over-year, I put that as less important than the fixed cost leverage that we have. So the Slide 9, we kind of rank-ordered those.

Yes. Okay. All right. And then the last one for me. Did I hear you say that the impact from more normal maintenance next year is about a $25 million to $30 million increase year-to-year. Did I get that correct?

That's correct. We had it on Slide 22 of the deck, Mark, for your reference. And we also put out 2022 estimates as well.

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

What are you expecting in Q4 for working capital, presumably working capital release?

So Roger, it's Mike. We haven't specifically talked to for the quarter network expectations. I think you heard Arsen talk about in the script that we've largely rebuilt our inventory. And so I think that you should expect less of a potential drag there. But other than that, we haven't commented on net working capital expectations for the fourth quarter.

Okay. But when you say less potential drag, that suggests you may be putting -- it will be an outflow as opposed to an inflow. And I would have thought if you are slowing down your machines, you may see less volumes -- of sales volumes, you actually might see an inflow as opposed to an outflow on working capital. Am I thinking about that correctly?

Yes. If that does happen, you are thinking about it correctly, but there's a lot of other puts and takes that happen along the way. And I didn't mean to imply one direction or the other in my previous statement. As you may recall, our bond interest payments are in the first -- in the third quarter. And so generally, you'll expect the accrual for the interest expense to go higher in the fourth quarter. There are some things that you could predict that will naturally happen here in the fourth quarter as you try to predict cash flows, which I think is where ultimately you're trying to go with the question.

Okay. Yes, yes. In terms of the 300,000 tons of purchased pulp, could you remind me what the split is between hardwood and softwood on that?

We don't break it out. The majority of it is going to be hardwood. We're long, to some extent, softwood in our mill in Idaho that we're able to supply the rest of our system with.

And lastly, any impact from the West Coast forest fires on your operations, obviously, Western Idaho?

Nothing of note.

Your next question comes from Adam Josephson from KeyBanc Capital Markets.

Thanks for taking my 2 last questions here. Arsen, not to beat a dead horse too much. But just on the implied 4Q sequential decline in tissue profitability, just in the context of your results in the past 2 quarters, which were above your expectations, would you characterize this guidance any differently perhaps than the last 2 quarterly guidances you gave? And in other words, is there a reason to think that this is the "right guidance", whereas you did considerably better in the last 2 quarters than what you were thinking on the tissue side?

Adam, when we provide guidance, we aim for the center cut, and the last couple of quarters have exceeded our expectations. We're continuing to aim for the center cut, and that's what the $52 million to $62 million guidance is. If tissue demand is more robust than we're anticipating, or our input costs are lower. Certainly, that will be -- that could go higher. But at this point, the way we see it, it's the right range.

Okay. And just last question, Arsen. I think you both took over your current jobs really at the start of the pandemic. So whatever you were expecting this year to be, I'm sure it has not played out quite as you were thinking. But serious question is, how much -- I mean, you've obviously been -- the company has been an enormous beneficiary from this pandemic, both in the form of historically good tissue demand and very low pulp input costs. I mean it's been just a perfect combination. So it's hard to see how much whatever you've implemented has changed the company for the better versus the company simply having benefited from extraordinarily favorable conditions that were out of your control. Can you just talk about what influence you've had thus far? And what the company has done differently before versus just the benefit from these -- the external environment?

Good question. So certainly, the tailwinds from input costs and COVID-related demand are helping this year. But the team has done an outstanding job of continuing to manage our assets, manage this business, work with our customers to take advantage of these trends that we're seeing. Additionally, as you know, Adam, I was in the -- lead up the tissue business before this, and we spent quite a bit of time getting our network right, getting our customer mix, getting the right pipeline of volume and some of that is certainly playing out this year. And our paperboard business continues to execute really well and execute through some really uncertain market conditions. So certainly, the tailwinds are helping, but the team has done an outstanding job of working through a really difficult environment to deliver outstanding results this year.

Our next question comes from Steven Chercover from D.A. Davidson.

Didn't really needed to get back in the queue. But since we were going there in any event, I want to put it in the context of the containerboard market where some producers view the optimal integration level to be 100%, and others want to be 10%, 15% below that. So with respect to your tissue system, do you have an optimal integration level? Would you actually like to be buying parent rolls in a perfect world?

We haven't spoken to that previously. What we've said is, we're in the business of retail case sales. That's our primary business. We will sell parent rolls as necessary to balance our network. But what we're aiming to do is to maximize retail case sales as long as they make economic sense. So we've been over 90% over the last several quarters. We've liked this performance, and we're aiming to continue to drive our case sales over the next couple of years to consume the vast majority of our paper produced.

And that was our last question at this time. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.