Verso Paper (VRS) Q4 2019 Earnings Call Transcript

Verso Paper (VRS)
Q4 2019 Earnings Call
Feb 27, 2020, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to Verso Corporation's fourth-quarter and full-year 2019 earnings conference call. [Operator instructions] Please note that this conference is being recorded. A replay of this call will be available on the Investors page of Verso's website after 11 a.m. Eastern Time today.

At this time, I'll turn the presentation over to Verso's treasurer, Tim Nusbaum. Please go ahead, sir.

Tim Nusbaum -- Treasurer

Thank you, and good morning. The fourth-quarter and year-end 2019 financial results for Verso Corporation were announced this morning before the market opened. The earnings release, as well as a set of slides that we'll refer to during the call are available on the Investors web page at Verso's website at www.versoco.com. Joining me on the call today are Adam St.

John, chief executive officer; Allen Campbell, senior vice president and chief financial officer; and Mike Weinhold, president of graphic and specialty papers. I would like to remind everyone that in the course of the call, in order to give you a better understanding of our performance, we will be making certain forward-looking statements. These forward-looking statements are subject to risks and uncertainties. Should one or more of these risks or uncertainties materialize or should underlying assumptions or estimates prove incorrect, actual results may vary materially from management's expectations.

If you would like further information regarding various risks and uncertainties associated with our business, please refer to our SEC filings, which are posted on our website, versoco.com, under the Investor tab. Now I'd like to hand the presentation over to Adam St. John.

Adam St. John -- Chief Executive Officer

Thank you, Tim, and good morning, everyone. 2019 was a busy year for Verso. We sold our Androscoggin and Stevens Point Mills in February, closed the Luke Mill in June, planned and implemented term vested pension buyout offers, reduced SG&A, ratified all our union agreements and completed our proxy solicitation efforts. Today, we would like to further update you on the company's fourth-quarter, full-year performance and accomplishments, as well as other matters impacting the company.

Beginning on Slide 3. During all of this activity, we maintained an excellent safety performance. For the year, we achieved an incident rate of 1.23, which keeps us in the top tier of our industry, which is really a nice place to be. I'd like to thank all of our employees for their continued commitment in this critical area.

This level of performance doesn't happen, involved a lot of focus and effort in the middle. So thanks. For the fourth quarter of 2019, our sales were $587 million with an adjusted EBITDA of $74 million or a margin of 12.6%. For the year, sales were at $2.44 billion with an adjusted EBITDA of $251 million for a margin of 10.3%.

The price and mix improvements, the Luke closure and our cost-reduction initiatives partially offset the impact of demand decline. We ended the year well with no debt, $42 million in cash and total liquidity of $318 million. We did see market headwinds in the graphic space with double-digit declines in 2019. We also see near-term pressure on price as a result of the decline in demand, as well as imports continuing to find the U.S.

markets attractive with favorable exchange rates. Based on the previous industry announcements, we expect to see conversions out of graphic papers globally. As we move through 2020, this should help on the supply side of things. The markets we compete in will continue to be challenging, and we're going to face these challenges with efficient low-cost assets along with a dedicated and talented employee base.

Moving forward to Slide 4. With the completion of the Pixelle transaction, our focus is on running an efficient and effective company while providing outstanding products and services for our customers. We expect the business to retain 78% of our top-line revenue and 83% of our adjusted EBITDA. We have a strong streamlined business that is well-positioned to generate attractive returns for our shareholders, fund our pension obligations and maintenance capital while maintaining a strong balance sheet.

Our product mix will continue to include graphic papers, specialty papers, pulp and packaging products. We will focus on the growth within these markets through product development and high-return projects, where it makes sense to offset the decline in the graphic grades. Earlier this month, we completed the sale of Androscoggin and Stevens Point Mills to Pixelle. The execution from my team for the shareholder approval process to get this transaction successfully completed and to manage the business through it all was exceptional.

With that said, the board has authorized a share repurchase of up to $250 million. Additionally, the company plans to initiate a quarterly dividend of $0.10 per share starting in the second quarter. We have begun working with our newly elected board, and really, we're looking forward to getting their support and guidance. They have an enormous amount of experience in paper and other industries and are eager to visit each of our mill sites to get a firsthand look at our operations, and that's going to happen within the next couple of weeks.

With that, I'd like to turn the presentation over to Allen Campbell to discuss our results and financial performance in more detail.

Allen Campbell -- Senior Vice President and Chief Financial Officer

Thank you, Adam. The headwinds in the market coupled with the Luke Mill closure impacted our shipments as we experienced a decline of 11% in the fourth quarter of 2019 versus fourth-quarter 2018. The decline in pulp volumes shown were a result of Androscoggin Mill's No. 3 paper machine start-up, where we were shipping unbleached kraft pulp in the fourth quarter of 2018 and transition the machine to greater share packaging products in 2019.

Additionally, we experienced price pressure in fourth quarter of 2019 across all our product lines. Despite these headwinds, we delivered an adjusted EBITDA margin of 12.6%, which included a gain on pension settlement. Without the gain, we were 10.4% of sales, still a very respectable number. We delivered on our commitment to keep inventories flat year over year despite building a significant balance in the first part of the year.

Turning to Slide 8. It shows our bridge from 2018 to 2019. The impact of demand decline coupled with global capacity overhang was evident in our fourth quarter, with price/mix and volume being down $45 million. This was partially offset by $16 million improvement in input costs as we benefited from deflation across all our direct materials with the exception of wood.

From an operations standpoint, we had some challenges at our Wisconsin Rapids Mill that drove our $9 million negative variance. We're continuing to focus on improving operations and reducing reliability issues at this mill. We continue to benefit from improving freight costs and SG&A cost-reduction initiatives, as we show on the bridge. We executed a pension plan lump sum buyout to qualified vested participants to reduce risk.

This effort resulted in a settlement gain of $13 million, which we booked in the quarter. Switching to Slide 9. I want to highlight the adjustments that we took for the full year and note several one-off events that happened. The Luke Mill restructuring and post-closure-related costs were $61 million, with cash expenses of $41 million.

We do expect continuing ongoing costs at the Luke Mill until final disposition. Between our strategic initiative costs and our contested proxy solicitation expenses, we incurred $7 million, primarily legal costs. We expect a similar number for the first quarter of 2020, excluding investment banker fees for the transaction. The $4 million for severance shown was primarily related to overhead, downsizing and former CEO settlement earlier in 2019.

On to Slide 10. On a year-over-year basis, price/mix was up $20 million, benefiting from early positive price implementation and price carryover from 2018. The capacity loss due to the closure of Luke Mill together with the market decline resulted in reduced volume and increased downtime, which impacted adjusted EBITDA by $53 million. We also had significant reliability events at our Wisconsin Rapids Mill that accounted for nearly all of our $17 million negative performance versus prior year in ops.

We benefited from improved freight costs of $4 million, which was offset by a onetime charge of $7 million relating primarily to our settlement with our union contract. The pension income excluded the settlement and -- excluding the settlement that we made was $7 million less year over year. Moving on to Slide 11. The company has continued to strengthen its cash position in 2019, ending the year with $42 million in cash and available liquidity of $318 million.

The cash flow from operations satisfied all of our operating needs in 2019, even with significant restructuring costs and step-up in capital spending. In 2019, our capital expenditures also included $14 million for strategic projects. These projects included additional capacity for specialty papers at our Andro Mill, the No. 3 paper machine Escanaba Mill, which now is almost all specialty grades and together with some additional investments at our Duluth Mill for our packaging projects.

In addition, as noted, we stepped up our plant maintenance investment across all our mills in 2019. On Slide 12, I just want to take a couple of minutes to highlight what we have done and expectations for our pension liability. Since our emergence, we have reduced our unfunded liability from $647 million to $369 million as of year-end 2019. We have taken several steps along the way to reduce risk and improve our position, such as consolidating plans and moving to a cash flow-driven investment strategy, while at the same time utilizing professional advisors, which helped deliver a strong return last year of 18.7% on our assets.

Looking at the chart on the bottom right, assuming company contributions of $54 million, asset returns of 6.5% and using a 3.1% discount rate and after the transfer of net $35 million liability to Pixelle, our unfunded pension liability is expected to decline to $266 million. With current trends, we believe we can reduce our pension liability to 0 over the next four or five years. Please note that our potential company contribution may increase based upon our 2020 tax position, which will be determined as we go through the year. Any additional contributions can be made prior to quarter 4 2021.

On to Slide 13. We anticipate the market headwinds will continue with demand and price pressures. Industry projections are for mid- to high single-digit demand decline for 2020. The first half of our business is traditionally seasonally weaker, picking up in the second half as it will be this year.

Our major cash commitments around our maintenance capital at our mills of $55 million to $60 million, noting that we have a biannual outage at our Quinnesec Mill in 2020, cash pension contributions of the $54 million mentioned earlier and tax payments projected at $3 million to $6 million, mostly for state and franchise taxes. With that, that completes our formal presentation, and I'd like to open it up for questions.

Questions & Answers:

Operator

Thank you. [Operator instructions] And our first question will come from Jeff Van Sinderen of B. Riley FBR. Please go ahead.

Jeff Van Sinderen -- B. Riley FBR -- Analyst

Good morning. I understand you reduced inventory. Good to see that. Can you maybe give us more on what you're seeing in terms of supply demand, kind of the latest picture, I guess, in Q1? Maybe elaborate on the import pressure.

Is that reducing at all, or is that still a factor similar to Q4? And then what are you seeing on pricing in Q1? I guess maybe anything you can give us in terms of what you expect in pricing for first half overall. And then wondering how we should think about the order of magnitude in organic revenue decline, how that shakes out if you're selling Stevens and Andro. I know that just was completed. And then as a follow-up to that, how we should think about SG&A in Q1 first half?

Mike Weinhold -- President of Graphic and Specialty Papers

OK. It's Mike Weinhold. I'll go ahead and try to tackle some of the marketplace in question. So specific to what we're kind of experiencing currently, you can see some of the industry reports from recent [Inaudible], the operating rates are somewhat weak, more so in the coated mechanical and the uncoated mechanical side.

Operating rates in the coated free sheet, which is a core part of our business, are in the low 90s. The aforementioned operating rates are in the 80s. Imports still weigh heavily on the U.S. markets.

They have abated somewhat. But as the demand decline is tallied up, their share is still probably holding. They certainly gained a few points of share last year, so imports still are a factor. They are more of a factor in some grades and less so in others.

From a pricing standpoint, there's near-term price pressure on our grade categories, again, more so in the coated mechanical side and the uncoated mechanical is pressure in coated freesheet, but it's less than those two grades. And that really is due to supply overhang. So we still have a supply side overhang that's weighing heavily in creating the utilization or operating rates that we're experiencing currently. As we've demonstrated in the past, we're committed to balancing supply and demand to both help us maximize our margins and also to control our inventories.

We also think, near term, as we move through 2020, and Adam had mentioned this earlier, that we will have conversions start to take place globally. Those conversions will impact a lot of the grades I just mentioned in coated freesheets and coated mechanical. So we think that will help some of the supply overhang that we're experiencing globally, should improve the operating rates, and should be positive in regards to pressure on the price.

Allen Campbell -- Senior Vice President and Chief Financial Officer

And then related to SG&A question, we're targeting long term 4% of sales or less. In the first quarter, we may see a slight tick-up in that, but we have a transition services agreement with Pixelle and we're implementing cost initiatives. Even if it does tick up in quarter 1, we expect it to improve over the rest of the year.

Jeff Van Sinderen -- B. Riley FBR -- Analyst

OK. Good to hear. And then can you remind us how much coated freesheet capacity is slated to exit the marketplace this year, I guess, what you think that means for kind of the supply demand picture? I guess as we think about second half, I think that's where most of it's happening by far. And then also what you think that might mean for pricing.

Mike Weinhold -- President of Graphic and Specialty Papers

Sure. If you just look at -- there's quite a few, two to three at least, significant conversions that have been announced to take place sometime in 2020 moving into 2021 on a global basis. First and foremost, of note, would be the Stora Enso conversion of the Oulu Mill, which is 1.1 million tons of coated freesheet sheets. And so I think that will certainly have a positive impact on the global supply overhang and there is imports of sheets that come into the U.S.

market. So one could surmise that that should be an improvement from a trade flow and import standpoint. We have the Catawba conversion that's been announced some time in 2020. That's on the coated mechanical side, about 345,000 tons.

So these conversions, in and of themselves, should help with the supply overhang. And we've had Nine Dragons announced closure or conversion of DM 25, I believe, at Biron and potential action at Rumford, which would hit both, again, coated mechanical and coated freesheets. And so I think the -- my thesis is conversions are very similar to what's happened in the past with machine or mill closures. And generally speaking, as you improve supply versus-demand dynamics, you improve the operating rates.

That, in turn, has a positive effect on price.

Jeff Van Sinderen -- B. Riley FBR -- Analyst

OK. Good. That's helpful. And one more if I could squeeze it in.

I think you mentioned the Wisconsin Mill having some reliability issues. Just wondering if you can elaborate on that. Are those getting behind us at this point?

Adam St. John -- Chief Executive Officer

Yes. This is Adam. We spent quite a bit of money to try to improve on the reliability in that mill. Unfortunately, last year, we had a major event, a hurricane went through there, took the mill down, and the result of that was a collapsed asset sewer line that kept the pulp mill down for about a week or a little more than a week to reroute the line.

So that had a -- that was a significant event that happened last year there. But we're looking to improve the reliability in that mill going forward. We've slated a lot of projects to do that.

Jeff Van Sinderen -- B. Riley FBR -- Analyst

OK. Good to hear. Thanks for taking my questions. And best of luck.

Thanks.

Operator

Thank you. And our next question will come from Hamed Khorsand of BWS. Please go ahead.

Hamed Khorsand -- BWS Financial Inc. -- Analyst

Hey, good morning. So first off, just on the competitive standpoint, how are you guys adjusting as far as inventories goes? I know last year, you were trying to keep it on your balance sheet. Are you taking the same initiatives this year?

Mike Weinhold -- President of Graphic and Specialty Papers

We will continue, as we did last year, Hamed, it's Mike Weinhold, to balance our inventory levels. We, at a certain point, need a certain amount of inventory to service our programs. Our expectation as we move through 2020 is to have similar ending inventory levels that we did in 2019. With that said, we plan on some reductions in certain areas, primarily in coated freesheet web, and so we'll manage our supply to demand in order to manage the inventory levels.

Hamed Khorsand -- BWS Financial Inc. -- Analyst

And these pricing pressures that you're seeing, is this being driven by customers holding back on orders? Or is it purely by competitive reasons?

Mike Weinhold -- President of Graphic and Specialty Papers

I think it's a little bit of that, coupled with imports still weighing heavily, and just generally, overall supply and demand imbalance, which have some pretty low operating rates. And so we had kind of a step-change level set in Q4, which was evidenced in our earnings and that is really on the heels of program and pricing negotiations as you move into 2019. And so currently, it really is, I believe -- customer overhang of inventory, by and large, we believe, has worked itself out. I know we talked a lot about that last year as we move through 2019 and just how much inventory was built on the customer side.

I believe that, for the most part, has worked itself out, so it's really just competitive pressures, import pressures and low operating rate.

Hamed Khorsand -- BWS Financial Inc. -- Analyst

OK. And then lastly, could you provide some details around the stock buyback? Is this at the market? And how fast are you going to implement this?

Mike Weinhold -- President of Graphic and Specialty Papers

Well, the board has authorized program. We put the mount out there. It is open as far as the exact timing and methodology. As you know, there will be some timing issues around when material data is out there or not.

But we have various avenues. We have not stated exact ones we'll use, but there are several available to us.

Hamed Khorsand -- BWS Financial Inc. -- Analyst

OK. Thank you.

Operator

[Operator instructions] Our next question will come from Adam Ritzer, private investor. Please go ahead.

Adam Ritzer -- Private Investor

Hi, good morning. Thanks for taking my call. I had a question about the pension contribution. I guess you guys had said you're going to put in $54 million with the Pixelle proceeds.

But beyond that, what's going to happen in 2021? What's going to be your ongoing pension contribution, do you think?

Mike Weinhold -- President of Graphic and Specialty Papers

OK. So if you look at -- traditionally, we've been in $35 million to $45 million range. If we were to stay in that level, four years, we'll probably be paid off with we have the normal asset returns that we're estimating. We're going to look at our tax situation.

We may kick in a little bit more in '21 to cover -- if we have taxable income that requires it, we'll kick in a little bit more in '21. But our range still long term is $35 million to $45 million and four or five years paid off.

Adam Ritzer -- Private Investor

Got it. OK. That's helpful. Got it.

Thank you. In terms of your capex program, I guess you guys are not talking at all about Duluth. It looks like the maintenance spending is on the three other plants. I know in some of the presentation materials during what's called the hostilities, you guys talked about doing a capex program at Duluth.

Can you talk about that a little bit more?

Adam St. John -- Chief Executive Officer

Yes. Sure. This is Adam. Our approach to Duluth, as you know, the SC market is in a greater decline than actually freesheet, so we're looking at different ways and different things to do this.

So what we did, we took the approach of investing a little bit of capital, around $5 million, to invest in Duluth, and we're making probably 90,000 tons this year of kraft bag, liner and packaging type grades. So our approach is going to be to test the market, see how that small investment did and then make a decision later on whether we're going to do a full conversion of that mill. But right now, we're just kind of testing the waters and see how that project pans out right now. We have not asked for or gotten approval to do anything more than that.

Adam Ritzer -- Private Investor

Got it. So the $14 million of strategic spend includes that $5 million or $10 million at Duluth. Is that the way to look at it?

Adam St. John -- Chief Executive Officer

Yes, it is.

Adam Ritzer -- Private Investor

OK. Then the ongoing maintenance of the $35 million, that is how to look at your maintenance capex going forward?

Adam St. John -- Chief Executive Officer

No. The maintenance capex going forward will be between $55 million and $60 million. There is no strategic capital in that number.

Adam Ritzer -- Private Investor

Yes. OK. So that's your annual maintenance on the other three plants going forward?

Allen Campbell -- Senior Vice President and Chief Financial Officer

That includes some maintenance on the Duluth Mill also.

Adam Ritzer -- Private Investor

OK. OK. Got it.

Allen Campbell -- Senior Vice President and Chief Financial Officer

IT capital, some of that -- it's some of the base capital in there also.

Adam St. John -- Chief Executive Officer

Yes. That is a four-mill system plan.

Adam Ritzer -- Private Investor

OK, understood. OK. That's all I had. Thanks for answering my questions.

Appreciate it.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Adam St. John for any closing remarks. Please go ahead, sir.

Adam St. John -- Chief Executive Officer

Yes. Thank you. I'd like to close by thanking our shareholders for their patience and support. We realize this has been a fairly long strategic process.

As previously announced, we do plan on returning a significant portion of the Pixelle proceeds through the repurchase of shares and a quarterly dividend. We want to state that we continue to have a strong company with a very healthy balance sheet that should benefit shareholders in the future. Lastly, I'd like to thank all the Verso employees for their dedication. They performed really well despite a very challenging market environment and the uncertainty of an extended strategic review, so thank you for that.

Let's keep working together and drive the results. With that, thanks and have a great day.

Operator

[Operator signoff]

Duration: 29 minutes

Call participants:

Tim Nusbaum -- Treasurer

Adam St. John -- Chief Executive Officer

Allen Campbell -- Senior Vice President and Chief Financial Officer

Jeff Van Sinderen -- B. Riley FBR -- Analyst

Mike Weinhold -- President of Graphic and Specialty Papers

Hamed Khorsand -- BWS Financial Inc. -- Analyst

Adam Ritzer -- Private Investor

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