Rayonier Advanced Materials Inc. Q3 FY2022 Earnings Call

Good morning, and welcome to the RYAM Third Quarter 2022 Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to turn the call over to your host, Mr. Mickey Walsh, Treasurer and Vice President of Investor Relations for RYAM. Thank you. Mr. Walsh, you may begin.

Welcome again to RYAM's Third Quarter 2022 Earnings Conference Call and Webcast. Joining me on today's call are De Lyle Bloomquist, our President and Chief Executive Officer; and Marcus Moeltner, our Chief Financial Officer and Senior Vice President of Finance. Our earnings release and presentation materials were issued last evening and are available on our website at ryamglobal.com. I'd like to remind you that in today's presentation, we will include forward-looking statements made pursuant to the safe harbor provisions of federal securities laws. Our earnings release as well as our filings with the SEC list some of the factors which may cause actual results to materially differ from the forward-looking statements we may make. They are also referenced on Slides 2 and 3 of our presentation material. Today's presentation will also reference certain non-GAAP financial measures as noted on Slide 4 of our presentation. We believe non-GAAP measures provide useful information for management and investors, but non-GAAP measures should not be considered an alternative to GAAP measures. A reconciliation of these measures to their most directly comparable GAAP financial measures is included on Slides 18 through 23 of our presentation. I'll now turn the call over to De Lyle.

Thank you, Mickey, and good morning. I would like to start today by providing an update on our near-term initiatives as well as some financial highlights for the third quarter before turning the call to Marcus to provide additional details on each of our businesses. After Marcus' update, I will come back and provide additional perspectives on the business and a market outlook before opening the call for questions. Let's start by turning to Slide 5. We have made very good progress against our near-term initiatives. Our top priority remains the refinancing of our senior notes, which, as you probably know, mature in June 2024, putting us in the best possible position to accomplish this objective. We are working to improve our credit metrics via EBITDA growth and debt reduction. I am pleased to report that we have improved our net leverage to 5.1x by reducing net debt by $16 million and growing EBITDA by $35 million in the third quarter. We will maintain an intense focus on improving our net leverage metric in order to give us the best opportunity to refinance our debt prior to these notes becoming current in 2023. Our EBITDA growth has been driven by success in three areas: First, as we discussed in our last update, we completed extensive planned maintenance outages at all of our facilities in the first half of this year. As a result, we're now realizing improved productivity and reliability, leading to lower unit fixed costs. We believe that we have further opportunities to improve the performance of our facilities, which will likely generate even better results in the future. Our next area of focus is capturing fair value for our unique product offerings. Generally, demand for our products remains strong. We are capturing value for our commodity products from the current market strength. Regarding our cellulose specialty products, we negotiated significant price and volume increases for 2022, and as we saw inflation accelerate, we implemented a $146 per metric ton cost surcharge effective April 1, and have maintained the surcharge as inflationary pressures continued. More recently, we implemented a 20% increase effective August 1 on the small sales volume of cellulose specialties that are not under contract. Currently, we are in negotiations with our cellulose specialty customers for 2023 pricing with the objective to fully capture the fair value of these products. Our final area targets responding to the current inflationary environment and supply chain challenges. While inflation remains persistent, we have a multipronged approach to help mitigate these pressures. As already noted, we implemented a cost surcharge to help offset this extraordinary inflation. We are also leveraging our scale, managing discretionary spending and decreasing the input material usage to reduce our cost. Additionally, we are seeking alternative supply options in wood, chemicals and transportation, including utilizing multiple shipping channels, carriers and shipment modes to reduce shipping delays, improve reliable service to our customers and manage our logistic cost. Let's now turn to Page 6 for an overview of our financial performance. Our revenues increased 25% from the prior year to $466 million as a result of price increases and strong demand across all segments, reflecting a 25% increase for our cellulose specialty products inclusive of our cost surcharge and a 34% increase for our paperboard products. Adjusted EBITDA for the quarter was $68 million, up 106% from the prior year as the price and volume increases more than offset cost inflation. The increases from the prior year were led by our high purity cellulose segment, which delivered $53 million of adjusted EBITDA in the third quarter, an improvement of $21 million or 66% from the prior year. Paperboard delivered $15 million of adjusted EBITDA, which was $9 million or 150% favorable to prior year results, driven by strong demand and higher prices. High-yield pulp contributed positively to the results with $6 million of adjusted EBITDA. Corporate expenses improved $8 million from last year, driven by a change in valuation of the GreenFirst shares, which negatively impacted prior year results by $8 million. With these strong financial results in the third quarter and the solid outlook for the fourth quarter, we are increasing our full year 2022 guidance to now exceed $175 million of adjusted EBITDA, an increase of $15 million from prior guidance. Now I'd like to ask Marcus to take us through the financial details for the quarter. Marcus?

Thank you, De Lyle. Starting with the company's High Purity Cellulose segment on Slide 7. Third quarter sales increased $81 million or 28% to $369 million, driven by a 21% increase in total sales prices, which includes a 25% increase in cellulose specialty prices from the prior year. Sales volumes increased 7% to 240,000 metric tons for the quarter, driven by improved productivity and logistics. Net sales also included $33 million of other sales, primarily from bio-based energy and lignin. EBITDA for the segment improved $21 million to $53 million, driven by higher prices and volumes, which were partially offset by the impact of significant cost inflation. Turning to Slide 8. Our Paperboard segment sales grew $14 million driven by a 34% increase in sales prices, partially offset by a 7% decline in sales volumes. EBITDA for the segment grew by $9 million to $15 million as higher pricing more than offset increased costs for purchased pulp, chemicals and logistics as well as the impact of lower sales volumes. Turning to our high-yield pulp segment on Slide 9. Sales declined by $2 million from the prior year, driven by an 18% decrease in sales volume as a result of productivity challenges in the quarter and supply chain congestion. Sales prices increased 15% due to strong demand for global market pulp. EBITDA for the segment declined $3 million to $6 million for the quarter as the higher prices only partially offset lower volumes and cost increases for chemicals and logistics due to inflation. Turning to Slide 10. On a consolidated basis, operating income improved $26 million from the prior year to $29 million. Sales price increases across each segment and volume improvements in HPC more than offset $63 million of higher costs driven by persistent inflation on key cost inputs and logistic constraints. SG&A and other expenses increased $2 million, primarily driven by higher variable stock compensation. Turning to Slide 11. Our net debt declined $16 million to $748 million as we continue to repay debt. Through October, the company has reduced debt by $59 million, while still preserving adequate liquidity. Liquidity ended the quarter at $283 million, including $132 million of cash. We continue to make solid progress towards our stated goal of $725 million of net debt. With lower debt and improving credit metrics, we continue to monitor capital markets and are prepared to opportunistically refinance our 5.5% senior notes, which mature in June of 2024. We remain confident that the company will obtain an acceptable refinancing at the appropriate time and prior to the notes becoming current in mid-2023. With that, I'd like to turn the call back over to De Lyle.

Thank you, Marcus. Expanding on Marcus' point about reducing debt, we have a target to achieve a 2.5x net debt-to-EBITDA leverage in the next 3 to 5 years. We have made significant progress towards this goal. Turning to Slide 12. We can see that we reduced our leverage from 10x at the end of 2020 to 5.1x as of the third quarter of this year by reducing our debt balance by $215 million and increasing our adjusted EBITDA margin from 7.4% to 10%. We expect that we will achieve a net leverage ratio of 4.1x by year-end 2022. To get to our 2.5 leverage ratio goal, we will focus on further increasing our EBITDA margins while also continuing to pay down our debt. Our objective over the next 3 to 5 years, is to increase EBITDA margins into the 13% to 15% range and reduce debt by another $100 million. Let's now turn to Slide 13. We plan to deliver our EBITDA margin goal by addressing four drivers of total shareholder return. First, we are focused on capturing the fair value for our products. As mentioned earlier, we have already taken positive actions towards this objective. Specifically, we negotiated double-digit price increases for our cellulose specialty products coming into 2022. Then as we saw inflation accelerate, we led the market with a cost surcharge on all our cellulose specialty products. And to top it off, we recently implemented a 20% increase for noncontract cellulose specialty business. Beyond our core cellulose specialty products, we have also led price increases for our paperboard and high-yield pulp products. As for 2023, our objective is to realize further price increases. We will also plan in the years ahead on improving our mix of cellulose specialties and capturing additional value as market demand for sustainable and renewable products increases. The second area to drive shareholder value is around cost reduction. Recently, we have taken several key actions to position us for success. First, we significantly invested in our assets this year to improve reliability, and this investment is yielding results. We expect further benefits of $20 million to $30 million in fixed cost absorption as additional reliability improvement is realized. Second, we are reducing our expenses by closely managing our discretionary spending as well as more efficiently consuming key inputs in production. Looking forward, we have set for ourselves a 2% per annum labor productivity objective, which we can realize through improved reliability and automation. Third, we are diversifying our logistics channels in order to bypass the constraints of a couple of shipping points. This will allow us to reduce our freight cost, improve our on-time shipping experience and reduce our working capital. The next area to improve shareholder value is reducing debt. As discussed, we have reduced debt by $59 million this year, primarily by using the proceeds from the sale of our equity ownership in GreenFirst and the collection of $23 million in cash tax refunds. Looking forward, we plan to repay additional debt in the fourth quarter and then further reduce debt in the next few years with free cash flow from operations and reduced working capital. Our last area of focus is on innovation. We plan on leveraging RYAM's deep experience and capability of developing specialized sustainable products. For example, our second-generation bioethanol facility in France is expected to come online in 2024. It's important to note that though this strategic project is expected to cost $33 million, it will be primarily financed with low-cost green loans. In addition, our world-class R&D labs are working to bring to market very high intrinsic viscosity ethers to compete with cotton linters and unique value-added niche products, such as order control and noncompressible fluff products. Turning to Slide 14. I believe that RYAM offers a very compelling investment proposition. RYAM has been a renewable and sustainable company for over 95 years. And as the world moves away from products made from fossil fuels, the role will demand more and more of our products. Our renewable and sustainable manufacturing process starts with wood harvested from working forests. Working forests are forests that are profitably managed to supply wood-related products not only for today, but for generations to come as new trees are planted as the current crop is harvested. We then utilize the full inherent value of the harvested tree. Today, we develop the world's highest quality cellulose products and utilize much of the lignin, sugars and extractives for our own internal energy needs. In the near future, we believe that we will have many opportunities to extract much greater value from these wood constituents to produce new renewable and sustainable products as customer demand shifts away from current fossil fuel-based products. We also believe that RYAM's assets and know-how are very hard to replicate. We have invested over $2.8 billion in our assets and very few businesses have the technical capabilities and product know-how to compete in this demanding cellulose specialty market. RYAM also is committed to doing its part to reduce its environmental impact. We have committed to reduce our greenhouse gas emissions by 40% from 2020 to 2030. In just our first year, we have reduced total emissions by 8%. Regarding our renewable and sustainable products, our specifications are some of the most demanding in the industry. Our products are used by consumers every day, including LCD screens, plastic acetate eyeglasses, pharmaceuticals, filtration, food, textiles and baby products. Given our success in developing products that meet the exacting specification of our customers, we enjoy many long-term relationships, including some that span over 90 years. We sell our products into over 80 countries with no one country accounting for more than 35% of our revenue. Consequently, we believe that our diversity of customers, end markets and geography helps mitigate our exposure to our potential global recession. Turning to Page 15. I will conclude with an update on each of our segments. We continue to experience strong demand for our High Purity Cellulose products, albeit tempered by a slowing economy. Average sales prices for this segment are expected to decline modestly in the fourth quarter as the greater mix of commodity sales is forecasted as production and logistic constraints improve. We also forecast that key raw material inflation will persist. Consequently, we expect EBITDA to decline slightly in the coming quarter, but will still be well above the prior year. In Paperboard, strong demand for packaging and commercial print products is expected to continue, which will drive higher prices in the fourth quarter. Volumes and costs are expected to hold steady. As such, our paperboard business is expected to deliver strong EBITDA in the coming quarter. In high-yield pulp, though price indices appear to be peaking, we expect to realize higher prices due to the sales timing lag. EBITDA is anticipated to increase as productivity and logistics improve. Corporate expenses are expected to be approximately $45 million for the full year, which is $5 million favorable to our previous expectations, driven by the strength of the U.S. dollar. Lastly, we remain committed to managing our capital expenditures to within our original $140 million to $150 million guidance for the full year. With that, operator, please open the call to questions.

And we'll take our first question from George Staphos from Bank of America.

A couple of questions, and I'll turn it over. First of all, to the extent that you can comment, how are your customer negotiations and discussions going this year? I realize there's not much perhaps you can say, but where you can, what are kind of the key issues that you're reviewing? How might they vary from past negotiations that you had this time of year going back?

George, this is De Lyle. I really can't say much given that discussions have just started, but we do believe that the momentum that we have experienced in 2022 will be sustained as we go into 2023 because the drivers really aren't changing much, other than we're starting to see some softening in the economy. But at the end of the day, we still have to cover inflation. We still believe that many of our products are such that there are few substitutes for them. And we believe that we still have some room to go before we capture full fair value for them. So we will continue to be pressing for some price increases in '23.

Understood. On the capturing a fair value, and again, I realize there's not much you really will say on live mic call, but what are you trying to illustrate to your customers in terms of where you feel there's a gap to fair value? How are you demonstrating that? Are you demonstrating that in terms of the value of their product in the final market relative to the cost of your product, how are you doing that? And then a couple of quick follow-ups.

Well, primarily, the way I look at it is I just look at my EBITDA margin and compare that to the rest of the world. And right now, I believe that there is room to go with respect to that. So that's my principal metric.

Okay. We wish you well in that effort. And then just CS volumes increased 7%. How do you feel about that continuing at that pace recognizing we're seeing a bit of a slowing economy, as you pointed out? Would there be any situation where there might be some pre-buying ahead of the next round of pricing that you're talking about now that would have driven that 7%? How should we think about the sustainability of that growth rate?

With respect to pre-buying, I don't think we've seen that as of yet through the end of the third quarter. There may be some of that in Q4, although I would suspect that folks are probably trying to conserve cash, so they probably wouldn't want to build much inventory. So I don't think that's going to be a big play this year going into '23. With respect to the impact of the economy and general GDP on our business going forward. With respect to cellulose specialty demand, I would say that a good two-thirds of our demand is largely recession-resistant. For example, one of our largest segments is going to acetate that goes into tow applications. And I don't see that, that demand is going to be much impacted by what's going on with respect to the economies right now. And there's a number of other applications, particularly with our ethers and that go into food and pharmaceutical applications. And even in our fluff products, I don't expect that there will be a lot of impact with respect to any decline in the economy. That being said, there's roughly one-third of our business that will be impacted. And so we're not immune to what's going on, but fortunately, I would say that a good chunk of our business is somewhat resistant.

Understood. Just a quick and I'll turn it over. On acetates and screen sales, technology sales, are you seeing any kind of negative effect in your business relative to what we might have seen in headlines?

That's a great question, but I would suspect very little right now. So again, it's a small portion of our business. So a small change in that demand is going to be relatively de minimis.

And we'll take our next question from Paul Quinn from RBC Capital.

Just a follow-up on George's question on the one-third of HPC, where you're sensitive, what are those products? And what are you seeing on the demand side for those products?

Okay. You're talking about the one-third that's exposed or possibly in recession. Yes. So construction ethers, particularly in Europe, as we're seeing exposure there right now. So we're seeing some softness in construction ethers. And now anything that's related to automotive end markets, including tire cord and filtration, we're seeing some softness and expect that, that would be highly correlated to the GDP activity. And then, obviously, viscose right now and the very low operating rates that we're seeing in China is having some impact on demand as well as on pricing. So those are probably the big areas that I would suggest that we're seeing some exposure.

Okay. And then just on the volumes. Last year, you were kind of up in the 913,000 tons on HPC volumes. It's been a down year-to-date, which last year, it's kind of lower for the quarter. Is that something that you're capable of doing? And how weak is the mix shift going to be in Q4?

We believe that for the full year, in terms of HPC demand, we should reach 930. You mentioned 913, which is what you achieved last year. I actually think we will surpass that figure this year. Regarding Q4, we do not anticipate a significant decline in demand compared to Q3. The change in EBITDA would primarily result from a shift in our product mix between the cellulose specialty sector and our commodity business.

I would like to get some background on the refinancing potential. I assume you're in discussions with that group given your expectations for your leverage and net debt. Do you anticipate any concerns, or are they indicating that if you reach your target, everything will be fine? Could you clarify the potential for that refinancing?

Our strategy has been to enhance our credit metrics this year, and we anticipate finishing the year with a 4x leverage ratio. We believe this positions us favorably to enter the credit markets for refinancing the 24 unsecured notes. However, we recognize that the credit markets are currently fragile. Therefore, we are keeping our options open and are in discussions with various parties about different possibilities. We are confident in our ability to refinance the notes, but the details are still being worked out.

Okay, that's good. Lastly, could you provide an update on Anomera, which was an investment a couple of years ago?

Yes. We actually had our first commercial sales this year. Really, the sales were fairly de minimis. But they were sales that we made to customers that needed the product for product qualifications. We expect that we'll go into full commercialization in '23 and '24 with the goal of breakeven in mid-'25.

And next, we'll take Roger Spitz from Bank of America.

First, with the repayment of $9 million of additional debt in October, was that the 5.5s?

Roger, it's Marcus. That was on our cogen facility up in Canada that we paid that principal payment.

Can you share what you expect for working capital inflow in Q4? You're aiming to reduce your balance from $880 million to $725 million, which is a $155 million repayment. With only $9 million repaid in October, it suggests that unless you further reduce your cash balances, you will be generating some free cash from your operating cash flow after accounting for capital expenditures.

Yes. Roger, as you mentioned, we're focused on the working capital item. You can see year-to-date the changes in working capital on our cash flow statement that we disclosed was around $68 million. We're going to be focused on working on our accounts receivable and improving that cash conversion cycle to support that next step to the $725 million target.

Got it. And are there any assets that you could consider selling or perhaps a sale leaseback to further reduce debt?

Roger, this is De Lyle. Not right now. We don't see that we have any assets that are available and readily available to sell. So we're going to have to kind of monetize the working capital, manage and tighten down our custodial CapEx, and other elements to make sure at the end of the day, we'll have the free cash flow to pay down our debt going forward.

And Roger, thanks for the questions. Mickey and I will plan to be down at the conference at the end of the month that you're hosting.

We look forward to that.

And we'll take another question from George Staphos from Bank of America.

I have a few quick points to finish. This has been mentioned in previous calls. Considering the high-yield pulp markets you are involved in, we've experienced a couple of years of exceptionally strong pricing. While earnings have seen some improvement, it appears that pricing has increased significantly more during this cycle, likely closer to a peak rather than a low point. What would you advise us as we attempt to understand your earnings trajectory, especially if we anticipate pricing may be plateauing or even declining in the upcoming quarters?

Yes, it's Marcus. I can touch on the high yield question, certainly. Given our range of products that we produce in the high yield, our customer base is very focused on three-ply board and packaging, which, as you know, in this economy really resonates from a sustainability footprint. And we're seeing our product well placed in that market. You're right, there is more capacity in the future. But given the bulk attributes of our products, we're seeing the ability to perhaps be positioned in a niche where we will, on a mix basis versus BEK, still have a pretty good position.

George, does that answer that one question before we try to address your second question?

Yes, it's helpful. I appreciate it. Why don't we move on to the other ones, guys, that would be great.

All right. George, can you just articulate your first question again just to make sure I got it right?

Well, the first question was on really the high yield outlook, which I thought you were largely covering, but really...

The other question is what I was referring to.

Have you experienced production issues in your non-cellulose specialty markets compared to demand? What kind of additional or latent demand could arise once those issues are resolved, say in the next one to two quarters?

All right. And we're talking about HPC, or kind of our commodity HPC business. Is that your question?

Yes. And also, I think paperboard, you said you've had some issues there.

Sure. Regarding paperboard, most of the issues have been addressed and will be resolved in the fourth quarter. We expect the business to remain fully sold out as we enter 2023. In fact, we are very optimistic about achieving higher prices in 2023 for our paperboard operations. As I mentioned earlier, we anticipate a strong year for that segment. Concerning our HPC, specifically the commodity grades, which includes both the fluff and viscose markets, we've touched on viscose previously. There is significant excess capacity in that market, and prices are declining, so we are not focusing on that segment. We view it more as a means to utilize capacity at our mills if necessary, rather than an attractive business opportunity at the moment. For the fluff business, we have invested considerably to enhance its reliability in 2022. We see potential in differentiating ourselves by introducing new product characteristics, such as order control and non-compressible fluff products, which we aim to launch in 2023. Thus, we consider this segment strategic and will pursue a product differentiation strategy moving forward.

On paperboard, I'll turn it over and wish you good luck for the rest of the quarter. Regarding paperboard pricing, I'm assuming you're referring to pricing that has already been recognized, which will benefit you on average in '23 compared to '22. Are you suggesting that you believe additional pricing increases can be achieved in '23?

I believe the pricing momentum we experienced in 2022 will continue into 2023. However, it is too soon to determine if we will achieve any further price increases in 2023.

And we'll take another question from Paul Quinn from RBC Capital.

Yes. Just one further one. You already stated that you're trying to improve your HPC mix in '23. Just wondering where you're sitting on your commodity mix between fluff and viscose? Where are you heavy to now? And what's your ability to switch from viscose to fluff if viscose markets are really weakening?

Yes. Marcus, you may have a better insight on that.

Well, it's Marcus. So we're definitely a larger weighting to fluff given the demands at Jesup. And then at viscose, it's mainly Temiscaming. So certainly a larger weighting to fluff. And as you know, the market is holding pretty good for fluff right now. And on softwood, we're still getting the premium versus hardwood viscose in the market, even though it's softened a bit.

And there appear to be no further questions at this time. I'd like to turn the floor back over to Mr. Bloomquist for closing remarks.

Well, thank you, everybody, for your time today. I'm very proud of the accomplishments we made this past quarter and confident that we will continue to execute on our near-term initiatives to improve our profitability and to reduce our debt. And I look forward to our next update. Until then, if you have any questions or need to reach out to us, please feel free to do so.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time, and have a great day.