UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
For the quarterly period ended June 30, 2012
or
For the transition period from to
Commission File Number: 001-34146
CLEARWATER PAPER CORPORATION
(Exact name of registrant as specified in its charter)
601 West Riverside, Suite 1100
Spokane, Washington
(509) 344-5900
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares of common stock of the registrant outstanding as of July 25, 2012 was 23,253,968.
Index to Form 10-Q
PART I.
FINANCIAL INFORMATION
ITEM 1.
Condensed Consolidated Financial Statements
Condensed Consolidated Statements of Operations for the three months and six months ended June 30, 2012 and 2011
Condensed Consolidated Statements of Comprehensive Income for the three months and six months ended June 30, 2012 and 2011
Condensed Consolidated Balance Sheets at June 30, 2012 and December 31, 2011
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and 2011
Notes to Condensed Consolidated Financial Statements
ITEM 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
ITEM 3.
Quantitative and Qualitative Disclosures About Market Risk
ITEM 4.
Controls and Procedures
PART II.
OTHER INFORMATION
Legal Proceedings
ITEM 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
ITEM 6.
Exhibits
SIGNATURES
EXHIBIT INDEX
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Part I
Clearwater Paper Corporation
Condensed Consolidated Statements of Operations
Unaudited (Dollars in thousands - except per-share amounts)
Net sales
Costs and expenses:
Cost of sales
Selling, general and administrative expenses
Total operating costs and expenses
Income from operations
Interest expense, net
Other, net
Earnings before income taxes
Income tax provision
Net earnings
Net earnings per common share:
Basic
Diluted
The accompanying notes are an integral part of these condensed consolidated financial statements.
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Condensed Consolidated Statements of Comprehensive Income
Unaudited (Dollars in thousands)
Other comprehensive income:
Defined benefit pension and other postretirement employee benefits:
Amortization of actuarial loss included in net periodic cost, net of tax expense of $1,095, $632, $2,381 and $1,634
Amortization of prior service credit included in net periodic cost, net of tax benefit of $289, $58, $403 and $117
Foreign currency translation adjustment
Amortization of deferred taxes related to actuarial gain on other postretirement employee benefit obligations
Other comprehensive income, net of tax
Comprehensive income
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Condensed Consolidated Balance Sheets
Unaudited (Dollars in thousands – except per-share amounts)
ASSETS
Current assets:
Cash
Restricted cash
Short-term investments
Receivables, net
Taxes receivable
Inventories
Deferred tax assets
Prepaid expenses
Total current assets
Property, plant and equipment, net
Goodwill
Intangible assets, net
Other assets, net
TOTAL ASSETS
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities
Current liability for pensions and other postretirement employee benefits
Total current liabilities
Long-term debt
Liability for pensions and other postretirement employee benefits
Other long-term obligations
Accrued taxes
Deferred tax liabilities
Stockholders’ equity:
Preferred stock, par value $0.0001 per share, 5,000,000 authorized shares, no shares issued
Common stock, par value $0.00005 per share, 100,000,000 authorized shares, 23,825,750 and 23,101,710 shares issued
Additional paid-in capital
Retained earnings
Treasury stock, at cost, common shares-571,782 and 333,300 shares repurchased
Accumulated other comprehensive loss, net of tax
Total stockholders’ equity
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
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Condensed Consolidated Statements of Cash Flows
CASH FLOWS FROM OPERATING ACTIVITIES
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization
Deferred tax expense
Equity-based compensation expense
Employee benefit plans
Changes in working capital, net
Change in taxes receivable, net
Excess tax benefits from equity-based payment arrangements
Change in non-current accrued taxes
Funding of qualified pension plans
Net cash provided by operating activities
CASH FLOWS FROM INVESTING ACTIVITIES
Change in short-term investments, net
Additions to plant and equipment
Proceeds from sale of assets
Net cash used for investing activities
CASH FLOWS FROM FINANCING ACTIVITIES
Repayment of Cellu Tissue debt
Purchase of treasury stock
Payment of tax withholdings on equity-based payment arrangements
Net cash (used for) provided by financing activities
Effect of exchange rate changes
Increase in cash
Cash at beginning of period
Cash at end of period
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest, net of amounts capitalized
Cash paid for income taxes
Cash received from income tax refunds
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING ACTIVITIES:
Increase in accrued plant and equipment
Property acquired under capital lease
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Unaudited
NOTE 1 Nature of Operations and Basis of Presentation
GENERAL
We are engaged in the manufacturing and selling of pulp-based products. We currently manufacture quality consumer tissue, away-from-home tissue, parent roll tissue, machine-glazed tissue, bleached paperboard and pulp at 15 manufacturing locations in the U.S. and Canada. Our private label tissue products, such as facial and bath tissue, paper towels and napkins, are used primarily at home and are principally sold to major retailers and wholesale distributors, which include grocery, drug, mass merchant and discount stores. Our paperboard is sold primarily in the high-end segment of the packaging industry and is ultimately used by our customers to make packaging for products ranging from liquids to pharmaceuticals to consumer goods packaging, all of which demand high quality construction and print surfaces for graphics. Our products primarily utilize pulp made from wood fiber. In addition to wood fiber, other major cost categories include chemicals, transportation, energy, packaging, and costs associated with our manufacturing facilities.
On December 27, 2010, we acquired Cellu Tissue Holdings, Inc., or Cellu Tissue, and consolidated the acquisition in our financial statements as of that date. The financial position and results of Cellu Tissue’s operations and cash flows are fully reflected in these condensed consolidated financial statements.
On November 28, 2011, we sold our Lewiston, Idaho sawmill to Idaho Forest Group, or IFG, of Coeur d’Alene, Idaho. The transaction included the sale of our sawmill, planer mill, dry kilns and related assets along with log and finished goods inventories and timber under contract, in the aggregate amount of approximately $30 million. This sawmill was our only wood products facility.
FINANCIAL STATEMENT PREPARATION AND PRESENTATION
The accompanying Condensed Consolidated Balance Sheets at June 30, 2012 and December 31, 2011, the related Condensed Consolidated Statements of Operations and Comprehensive Income for the three months and six months ended June 30, 2012 and 2011, and the Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and 2011, have been prepared in conformity with accounting principles generally accepted in the United States of America, or GAAP. We believe that all adjustments necessary for a fair statement of the results of the interim periods presented have been included. The results of operations for any interim period are not necessarily indicative of the results of operations to be expected for the full year.
This Quarterly Report on Form 10-Q should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the Securities and Exchange Commission, or SEC, on February 24, 2012.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
SIGNIFICANT ESTIMATES
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reporting period. Significant areas requiring the use of estimates and measurement of uncertainty include determination of net realizable value for deferred tax assets, assessment of impairment of long-lived assets and goodwill, assessment of environmental matters, equity-based compensation and pension and postretirement obligation assumptions. Actual results could differ from those estimates and assumptions.
RESTRICTED CASH AND SHORT-TERM INVESTMENTS
As of June 30, 2012, all restricted cash was classified as current and included in “Restricted cash” on our Condensed Consolidated Balance Sheet. Our short-term investments are invested largely in demand deposits, which have very short maturity periods, and they therefore earn an interest rate commensurate with low-risk instruments. We do not attempt to hedge our exposure to interest rate risk for our short-term investments.
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TRADE ACCOUNTS RECEIVABLE
Trade accounts receivable are stated at the amount we expect to collect. Trade accounts receivable do not bear interest. The allowance for doubtful accounts is our best estimate of the losses we expect will result from the inability of our customers to make required payments. We generally determine the allowance based on a combination of actual historical write-off experience and an analysis of specific customer accounts. As of both June 30, 2012 and December 31, 2011, we had an allowance for doubtful accounts of $1.7 million.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost, including any interest costs capitalized, less accumulated depreciation. Depreciation of buildings, equipment and other depreciable assets is determined using the straight-line method. Assets we acquire through business combinations have estimated lives that are typically shorter than the assets we construct or buy new. Accumulated depreciation totaled $1,378.9 million and $1,342.7 million at June 30, 2012 and December 31, 2011, respectively.
For the three months and six months ended June 30, 2012, we capitalized $2.8 million and $4.9 million, respectively, of interest expense associated with the construction of our new tissue manufacturing and converting facilities in Shelby, North Carolina and improvements to our tissue manufacturing facility in Las Vegas, Nevada, compared to $1.0 million and $1.5 million for the same periods in 2011, respectively.
STOCKHOLDERS’ EQUITY
On July 28, 2011, we announced that our Board of Directors had declared a two-for-one stock split of our outstanding shares of common stock, which was effected in the form of a stock dividend distributed on August 26, 2011 to shareholders of record on August 12, 2011. On the August 26, 2011 distribution date, there were 11,373,460 shares of common stock outstanding. Immediately following the distribution date, there were 22,746,920 outstanding shares of common stock. All common share and per share amounts disclosed in our notes to the condensed consolidated financial statements have been adjusted for the stock split effected in the form of a stock dividend.
In addition, we also announced on July 28, 2011, that our Board of Directors had authorized the repurchase of up to $30.0 million of our common stock. Under our stock repurchase program, we may repurchase shares in the open market or as otherwise may be determined by management, subject to market conditions, business opportunities and other factors. We did not repurchase any shares in the first quarter of 2012. During the second quarter of 2012, we repurchased 238,482 shares of our outstanding common stock. As of June 30, 2012, we had $11.2 million of authorization remaining pursuant to our share repurchase program. We account for share repurchases under the program as treasury stock and record the amounts paid to repurchase shares at cost as a component of stockholders’ equity. We have not retired any treasury shares and may choose to reissue shares held in treasury stock in a future period.
DERIVATIVES
We had no activity during the three months and six months ended June 30, 2012 and 2011 that required hedge or derivative accounting treatment. However, to partially mitigate our exposure to market risk for changes in utility commodity pricing, we use firm price contracts to supply a portion of the natural gas requirements for our manufacturing facilities. As of June 30, 2012, these contracts covered approximately 29% of our expected average monthly natural gas requirements for the remainder of 2012, plus lesser amounts for 2013. These contracts qualify for treatment as “normal purchases or normal sales” under authoritative guidance and thus require no mark-to-market adjustment.
NOTE 2 Recently Adopted and New Accounting Standards
There were no new accounting standards adopted during the three months ended June 30, 2012. We reviewed all new accounting pronouncements issued in the period and concluded that there are none that could have a significant or material impact to our current or future financial statements or disclosures.
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NOTE 3 Inventories
Inventories at the balance sheet dates consist of:
(In thousands)
Pulp, paperboard and tissue products
Materials and supplies
Logs, pulpwood, chips and sawdust
Lumber
Inventories are stated at the lower of market or current average cost using the average cost method. The last-in, first-out, or LIFO, method was previously used to determine cost of logs, wood fiber and the majority of lumber until the sale of our sawmill in November 2011. During the period ended March 31, 2012, the remaining lumber inventory from the sawmill was sold. The sale of this inventory, which was valued at costs prevailing in prior years under the LIFO method, had the effect of increasing earnings in the period ended March 31, 2012 by an immaterial amount.
NOTE 4 Intangible Assets
Intangible assets at the balance sheet dates are comprised of the following:
(Dollars in thousands, lives in years)
Customer relationships
Trade names and trademarks
Non-compete agreements
Total intangible assets
NOTE 5 Taxes
Consistent with authoritative guidance, our estimated annual effective tax rate is used to allocate expected annual income tax expense to interim periods. The rate is the ratio of estimated annual income tax expense to estimated pre-tax ordinary income, and excludes “discrete items”, which are significant, unusual or infrequent items reported separately net of their related tax effect. The estimated annual effective tax rate is applied to the current interim period’s ordinary income to determine the income tax expense allocated to the interim period. The income tax effects of discrete items are then determined separately and recognized in the interim period in which the income or expense items arise.
Our estimated annual effective tax rate for the second quarter of 2012 is 35.1%, compared with 35.2% for the comparable interim period in 2011. We recorded income tax expense of $13.9 million and $26.1 million in the three and six months ended June 30, 2012 compared to $8.6 million and $14.8 million in the three and six months ended June 30, 2011. The actual rates for the three and six months ended June 30, 2012 were 39.2% and 50.8%, respectively, compared to rates of 38.3% and 43.1% for the same periods of 2011. As discussed below, the higher rates for the six month periods resulted from the net impact of reporting discrete items in each reporting period totaling net expense of $8.1 million and $2.7 million, respectively.
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The net increase to our tax expense and effective tax rate for the six months ended June 30, 2012 was primarily the result of $5.5 million in tax expense related to our decision to convert certain gallons of alternative fuel originally claimed in 2009 under the Alternative Fuel Mixture Tax Credit, or AFMTC, which had been converted by us in 2010 to the Cellulosic Biofuel Producer Credit, or CBPC, back to gallons under the AFMTC. As further described in our Form 10-Q for the three months ended March 31, 2012, the $5.5 million was comprised of $2.5 million relating to the conversion back to the AFMTC and a resulting additional $3.0 million increase in our liabilities for uncertain tax positions. The remaining discrete expense of $2.6 million recorded in the six months ended June 30, 2012 was primarily interest accrued on uncertain tax positions.
The net increase to our tax expense and effective tax rate in the six months ended June 30, 2011 was primarily the result of discrete expenses for interest accrued on uncertain tax positions and the impact of reevaluating our state tax structure as Cellu Tissue was being integrated into our operations, partially offset by a benefit associated with certain transaction costs relating to the Cellu Tissue acquisition that were determined to be deductible under the Internal Revenue Code.
We have tax benefits relating to excess equity-based compensation that are being utilized to reduce our U.S. taxable income. Our Condensed Consolidated Balance Sheet reflects deferred tax assets comprised of net operating losses and tax credit carryforwards excluding amounts impacted by excess equity-based compensation. We have historically elected to follow the “with-and-without” or “incremental” method for ordering tax benefits derived from employee equity-based compensation awards. As a result of this method, net operating loss carryforwards and tax credit carryforwards not generated from equity-based compensation are utilized before the current period’s equity-based tax deduction (excess tax benefits from equity-based compensation awards are recognized last). Excess tax benefits from equity-based compensation awards that are determined to reduce U.S. taxable income following this method are recognized when realized as increases to additional paid-in capital as a component of stockholders’ equity. During the six months ended June 30, 2012, we generated additional excess tax benefits of $13.9 million relating to the release of vested performance share and restricted stock unit awards to employees. For the six months ended June 30, 2012, $5.8 million of excess tax benefits have been allocated to additional paid-in capital and reduced income taxes payable based on the incremental method. As of June 30, 2012, we had a total amount of excess tax benefits that are not recognized on our condensed consolidated balance sheet of $11.4 million.
NOTE 6 Accounts Payable and Accrued Liabilities
Accounts payable and accrued liabilities at the balance sheet dates consist of:
Trade accounts payable
Accrued wages, salaries and employee benefits
Accrued taxes other than income taxes payable
Accrued utilities
Accrued discounts and allowances
Accrued interest
Accrued transportation
Other
NOTE 7 Debt
$375 MILLION SENIOR NOTES DUE 2018
On October 22, 2010, we sold $375.0 million aggregate principal amount of senior notes, which we refer to as the 2010 Notes. The 2010 Notes mature on November 1, 2018, have an interest rate of 7.125% and were issued at their face value.
The 2010 Notes are guaranteed by certain of our existing and future direct and indirect domestic subsidiaries. The 2010 Notes are equal in right of payment with all other existing and future unsecured senior indebtedness and are senior in right of payment to any future subordinated indebtedness. The 2010 Notes are effectively subordinated to all of our existing and future secured indebtedness, including borrowings under our secured revolving credit facility, which is secured by certain of our accounts receivable, inventory and cash. The terms of the 2010 Notes limit our ability and the ability of any restricted subsidiaries to borrow money; pay dividends; redeem or repurchase capital stock; make investments; sell assets; create restrictions on the payment of dividends or other amounts to us from any restricted subsidiaries; enter into transactions with affiliates; enter into sale and lease back transactions; create liens; and consolidate, merge or sell all or substantially all of our assets.
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Prior to November 1, 2013, we may redeem up to 35% of the 2010 Notes at a redemption price equal to 107.125% of the principal amount plus accrued and unpaid interest with the proceeds from one or more qualified equity offerings. We have the option to redeem all or a portion of the 2010 Notes at any time before November 1, 2014 at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest and a “make whole” premium. On or after November 1, 2014, we may redeem all or a portion of the 2010 Notes at specified redemption prices plus accrued and unpaid interest. In addition, we may be required to make an offer to purchase the 2010 Notes upon the sale of certain assets and upon a change of control.
$150 MILLION SENIOR NOTES DUE 2016
In June 2009, we issued senior unsecured notes, which we refer to as the 2009 Notes, in the aggregate principal amount of $150.0 million. The 2009 Notes are due on June 15, 2016 and have an interest rate of 10.625%. The 2009 Notes were issued at a price equal to 98.792% of their face value.
The 2009 Notes are guaranteed by each of our existing and future direct and indirect domestic subsidiaries. The 2009 Notes are general unsecured obligations and are therefore not secured by our assets and are effectively subordinated to all of our existing and future secured indebtedness, including borrowings under our secured revolving credit facility, which is secured by certain of our accounts receivable, inventory and cash. The terms of the 2009 Notes limit our ability and the ability of any restricted subsidiaries to borrow money; pay dividends; redeem or repurchase capital stock; make investments; sell assets; create restrictions on the payment of dividends or other amounts to us from any restricted subsidiaries; enter into transactions with affiliates; enter into sale and lease back transactions; create liens; and consolidate, merge or sell all or substantially all of our assets.
We have the option to redeem all or a portion of the 2009 Notes at any time prior to June 15, 2013 at a redemption price equal to 100% of the principal amount thereof plus a “make whole” premium and accrued and unpaid interest. On or after June 15, 2013, we may redeem all or a portion of the 2009 Notes at specified redemption prices plus accrued and unpaid interest. In addition, we may be required to make an offer to purchase the 2009 Notes upon the sale of certain assets and upon a change of control.
REVOLVING CREDIT FACILITY
On November 26, 2008, we entered into a $125 million revolving credit facility with certain financial institutions. On September 28, 2011, we amended our revolving credit facility, among other things, (i) to extend the term of the revolving loan to the earlier of September 30, 2016 or 90 days prior to the maturity date of the 2009 Notes; (ii) to increase permitted capital expenditures limits; and (iii) to change the interest rate margins applicable to base rate loans and LIBOR loans in circumstances based on our fixed charge coverage ratio from time to time, and to reduce the fees paid by us on undrawn amounts. The amount available to us under the revolving credit facility is based on the lesser of 85% of our eligible accounts receivable plus approximately 65% of our eligible inventory, or $125 million.
As of June 30, 2012, there were no borrowings outstanding under the credit facility, but approximately $5.9 million of the credit facility was being used to support outstanding standby letters of credit. Loans under the credit facility bear interest at LIBOR plus between 1.75% and 2.25% for LIBOR loans, and a base rate effectively equal to the agent bank’s prime rate plus between 0.25% and 0.75% for other loans. The percentage margin on all loans is based on our fixed charge coverage ratio for the last twelve months, which is recalculated on a quarterly basis. As of June 30, 2012, we would have been permitted to draw approximately $119.1 million under the credit facility at LIBOR plus 1.75%.
A minimum fixed charge coverage ratio is the only financial covenant requirement under our credit facility and is triggered when there are any commitments or obligations outstanding and availability falls below 12.5% or an event of default exists, at which time the minimum fixed charge coverage ratio must be at least 1.0-to-1.0. As of June 30, 2012, the fixed charge coverage ratio for the last twelve months was 3.1-to-1.0.
Our obligations under the revolving credit facility are secured by certain of our accounts receivable, inventory and cash. The terms of the credit facility agreement contain various provisions that limit our discretion in the operations of our business by restricting our ability to, among other things pay dividends; redeem or repurchase capital stock; create, incur or guarantee certain debt; incur liens on certain properties; make capital expenditures in amounts in excess of those permitted under the revolving credit agreement; enter into certain affiliate transactions; enter into certain hedging arrangements; and consolidate with or merge with another entity.
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NOTE 8 Other Long-Term Obligations
Other long-term obligations at the balance sheet dates consist of:
Long-term lease obligations, net of current portion
Deferred proceeds
Deferred compensation
NOTE 9 Pension and Other Postretirement Employee Benefit Plans
The following table details the components of net periodic cost of our pension and other postretirement employee benefit, or OPEB, plans for the periods presented:
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost (credit)
Amortization of actuarial loss (gain)
Net periodic cost
Amortization of actuarial loss
As discussed in the notes to our consolidated financial statements in our 2011 Form 10-K, our company-sponsored pension plans were underfunded by $89.1 million at December 31, 2011. The underfunded status as of December 31, 2011 increased by $33.7 million over the underfunded status as of December 31, 2010, primarily due to lower discount rates and low returns on pension asset investments. As a result of being underfunded, we are required to make contributions to our qualified pension plans. During the six months ended June 30, 2012, we contributed $15.5 million to these pension plans. In July 2012, we contributed an additional $2.1 million. Our remaining required contributions to our qualified pension plans in 2012 are currently expected to be approximately $3.0 million (plus interest).
During the six months ended June 30, 2012, we made approximately $0.1 million of contributions to our non-qualified pension plan, and we estimate contributions will total $0.2 million in 2012. We do not anticipate funding our OPEB plans in 2012 except to pay benefit costs as incurred during the year by plan participants.
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NOTE 10 Earnings per Common Share
Earnings per common share is computed by dividing net earnings by the weighted average number of common shares outstanding in accordance with accounting guidance related to earnings per share. The following table reconciles the number of common shares used in calculating the basic and diluted net earnings per share:
Basic average common shares outstanding1
Incremental shares due to:
Restricted stock units
Performance shares
Diluted average common shares outstanding
Basic net earnings per common share
Diluted net earnings per common share
Anti-dilutive shares excluded from calculation
Basic average common shares outstanding include restricted stock awards that are fully vested, but are deferred for future issuance. See Note 11 “Equity-Based Compensation” for further discussion.
NOTE 11 Equity-Based Compensation
We recognize equity-based compensation expense for all equity-based payment awards made to employees and directors, including restricted stock units and performance shares, based on estimated fair values.
Employee equity-based compensation expense was recognized as follows:
(Dollars in thousands)
Total employee equity-based compensation
As provided for in the Clearwater Paper Corporation 2008 Stock Incentive Plan, the performance measure used to determine the number of performance shares ultimately issued is a comparison of the percentile ranking of our total stockholder return compared to the total stockholder return performance of a selected peer group. The number of shares actually issued, as a percentage of the amount subject to the performance share award, could range from 0%-200%.
On December 31, 2011, the service and performance period for 499,680 outstanding performance shares granted in 2009 ended. Those performance shares were settled and distributed in the first quarter of 2012. The number of shares actually settled, as a percentage of the outstanding amount, was 200%. An additional 257,112 shares of restricted stock units vested in the first quarter of 2012, of which 90,856 shares were settled and distributed during the period and 166,256 shares were deferred for future issuance. After adjusting for the related minimum tax withholdings, and excluding the deferred restricted stock units, a net 724,040 shares were issued in the first quarter of 2012. The related minimum tax withholdings payment made in the first quarter of 2012 relating to issued shares was $13.0 million. Subsequent to the first quarter of 2012, no performance shares or restricted stock units have vested, and no related minimum tax withholding payments have been made.
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The following table summarizes the number of share-based awards granted under our 2008 Stock Incentive Plan during the six months ended June 30, 2012 and the grant-date fair value of the awards:
DIRECTOR AWARDS
We recorded director equity-based compensation expense of $0.3 million for the three months ended June 30, 2012, compared to $0.7 million of income for the three months ended June 30, 2011. For the six month period ended June 30, 2012, we recorded director equity-based compensation income totaling $0.1 million, compared to $0.2 million of compensation expense for the comparable period ended June 30, 2011. The income recorded in the second quarter 2011 and six month 2012 periods were both the result of lower stock prices at the end of the respective periods compared to the beginning of the periods.
NOTE 12 Fair Value Measurements
The estimated fair values of our financial instruments at the dates presented below are as follows:
Cash, restricted cash, and short-term investments (Level 1)
Long-term debt (Level 1)
Accounting guidance establishes a framework for measuring the fair value of financial instruments, providing a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities, or “Level 1” measurements, followed by quoted prices of similar assets or observable market data, or “Level 2” measurements, and the lowest priority to unobservable inputs, or “Level 3” measurements.
The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used should seek to maximize the use of observable inputs and minimize the use of unobservable inputs.
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NOTE 13 Segment Information
The table below presents information about our reportable segments:
Segment net sales:
Consumer Products
Pulp and Paperboard
Total segment net sales
Operating income:
Pulp and Paperboard1
Corporate and eliminations
Depreciation and amortization:
Corporate
Total depreciation and amortization
Results for Pulp and Paperboard for the six months ended June 30, 2012 include income and expenses associated with the November 2011 sale of the Lewiston, Idaho sawmill, the effects of which were immaterial in the aggregate.
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NOTE 14 Supplemental Guarantor Financial Information
On October 22, 2010 we issued the 2010 Notes. Certain of our 100% owned, domestic subsidiaries guarantee the 2010 Notes on a joint and several basis. The 2010 Notes are not guaranteed by Interlake Acquisition Corporation Limited or Cellu Tissue CityForest, LLC. There are no significant restrictions on the ability of the guarantor subsidiaries to make distributions to Clearwater Paper, the issuer of the 2010 Notes. The following tables present the results of operations, financial position and cash flows of Clearwater Paper and its subsidiaries, the guarantor and non-guarantor entities, and the eliminations necessary to arrive at the information for Clearwater Paper on a consolidated basis.
Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
Three Months Ended June 30, 2012
Cost and expenses:
Equity in income (loss) of subsidiary
Net earnings (loss)
Comprehensive income (loss)
Six Months Ended June 30, 2012
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Three Months Ended June 30, 2011
Income tax (provision) benefit
Six Months Ended June 30, 2011
Income (loss) from operations
Earnings (loss) before income taxes
Equity in (loss) income of subsidiary
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Condensed Consolidating Balance Sheet
At June 30, 2012
Intercompany receivable (payable)
Investment in subsidiary
Deferred tax liabilities (assets)
Stockholders’ equity excluding accumulated other comprehensive loss
17
At December 31, 2011
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Condensed Consolidating Statement of Cash Flows
Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:
Deferred tax expense (benefit)
Net cash provided by (used in) operating activities
Proceeds from the sale of assets
Investment from (to) parent
Net cash provided by (used for) financing activities
Increase (decrease) in cash
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Investment (to) from Parent
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FORWARD-LOOKING STATEMENTS
Our disclosure and analysis in this report contains, in addition to historical information, certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding our construction of additional converting and paper making capacity and the cost and timing to complete new facilities, including our facilities in Shelby, North Carolina, the cost and timing to upgrade existing paper making facilities, including those in Las Vegas, Nevada, the integration of and expected benefits from the former Cellu Tissue operations, including expected cost savings from synergies, future growth opportunities, the stock repurchase program, future revenues, cash flows, capital expenditures, tax rates, operating costs, manufacturing capability, liquidity, benefit plan funding levels, total selling, general and administrative costs, interest expenses, the tax treatment of the alternative fuels and cellulosic biofuels tax credits and the conversion of additional gallons of fuel from the Alternative Fuel Mixture Tax Credit to the Cellulosic Biofuel Producer Credit. Words such as “anticipate,” “expect,” “intend,” “plan,” “target,” “project,” “believe,” “schedule,” “estimate,” “may,” and similar expressions are intended to identify such forward-looking statements. These forward-looking statements are based on management’s current expectations, estimates, assumptions and projections that are subject to change. Our actual results of operations may differ materially from those expressed or implied by the forward-looking statements contained in this report. Important factors that could cause or contribute to such differences include those risks discussed in the section entitled “Risk Factors” in our 2011 Form 10-K, as well as the following:
difficulties with the integration process or the realization of the benefits expected from the acquisition of Cellu Tissue;
difficulties with completion, or significant delays in the construction or upgrade of, our new and existing tissue manufacturing and converting facilities, including the completion of our new through-air-dried, or TAD, paper machine;
changes in the cost and availability of wood fiber used in the production of our products;
changes in transportation costs and disruptions in transportation services;
changes in raw material and energy costs and availability;
the loss of business from any large customer;
changes in customer product preferences and competitors’ product offerings;
our qualification to retain, or ability to utilize, tax credits associated with alternative fuels or cellulosic biofuels and the tax treatment associated with receipt of such credits;
labor disruptions;
changes in the U.S. and international economies and in general economic conditions in the regions and industries in which we operate;
changes in expenses and required contributions associated with our pension plans;
cyclical industry conditions;
competitive pricing pressures for our products, including as a result of increased capacity as additional manufacturing sites for consumer tissue products are constructed by our competitors;
changes in exchange rates between the U.S. dollar and other currencies;
reliance on a limited number of third-party suppliers for raw materials;
unforeseen environmental liabilities or expenditures;
unanticipated manufacturing or operating disruptions, including equipment malfunction and damage to our manufacturing facilities caused by fire or weather-related events and IT system failures;
an inability to fund our debt obligations;
restrictions on our business from debt covenants and terms; and
changes in laws, regulations or industry standards affecting our business.
Forward-looking statements contained in this report present management’s views only as of the date of this report. Except as required under applicable law, we do not intend to issue updates concerning any future revisions of management’s views to reflect events or circumstances occurring after the date of this report.
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OVERVIEW
Background
We are engaged in the manufacturing and selling of pulp-based products. We currently manufacture quality consumer tissue, away-from-home tissue, parent roll tissue, machine-glazed tissue, bleached paperboard, and pulp at 15 manufacturing locations in the U.S. and Canada. Our private label tissue products, such as facial and bath tissue, paper towels and napkins, are used primarily at home and are principally sold to major retailers and wholesale distributors, which include grocery, drug, mass merchant and discount stores. Our paperboard is sold primarily in the high-end segment of the packaging industry and is ultimately used by our customers to make packaging for products ranging from liquids to pharmaceuticals to consumer goods packaging, all of which demand high quality construction and print surfaces for graphics. Our products primarily utilize pulp made from wood fiber. Other major cost categories include chemicals, transportation, energy, packaging, and costs associated with our manufacturing facilities.
Recent Developments
Consumer Products Expansion
In 2010, as part of our TAD tissue expansion project, or TAD project, we began construction of new tissue manufacturing and converting facilities in Shelby, North Carolina to expand our Consumer Products segment in the Eastern United States. This site will include a TAD paper machine capable of producing ultra grades of private label tissue products and is currently expected to have five converting lines and two print lines. The first two converting lines became operational during the second quarter of 2011. Two additional converting lines are expected to become operational late in the second half of 2012 and the fifth line in 2013. The new TAD paper machine is scheduled to start-up in the fourth quarter of 2012. Also as part of our TAD project, we are currently improving our TAD tissue manufacturing capabilities in Las Vegas, which we expect to be completed in the third quarter of 2012.
The TAD project will allow us to supply a full range of TAD products, including paper towels and bath tissue, to customers across the U.S., while minimizing transportation costs. We believe this project, along with our existing manufacturing capabilities, will establish us as the only private label tissue products company to offer a full line of products to our customers.
We estimate the TAD project will cost approximately $275 million, excluding capitalized interest. As of June 30, 2012, we have incurred a total of $191.9 million in TAD project costs, of which $43.0 million and $82.6 million were incurred in the three and six months ended June 30, 2012, respectively. We expect approximately $70 million will be spent during the second half of 2012, with the remaining approximately $15 million to be spent in 2013. We have capitalized $9.1 million of interest related to the TAD project to date, of which $2.8 million and $4.9 million were incurred in the three and six months ended June 30, 2012, respectively, and we estimate total capitalized interest for the project will be approximately $19 million.
In August 2011, First Quality Tissue SE, LLC, or First Quality, filed a lawsuit against Metso Paper, the company we contracted with to supply the TAD paper machine to our Shelby facility, seeking to enjoin Metso Paper from delivering the TAD paper machine based on First Quality’s agreement with Metso Paper. On June 20, 2012, the United States District Court for the District of South Carolina ruled in favor of Clearwater Paper and Metso Paper and denied First Quality’s claim to enjoin Metso Paper from delivering the TAD paper machine to us. See Item 1 of Part II of this Report for a description of this legal proceeding.
Integration of Cellu Tissue Holdings, Inc.
On December 27, 2010, we acquired Cellu Tissue, which owned nine tissue manufacturing facilities located in the Southern, Midwestern and Eastern United States and one facility in Eastern Canada. These facilities allow us to better serve existing private label grocery customers by creating a national manufacturing footprint and provide us with the capability to expand into new private label channels. We recognized $6.7 million of cost savings from synergies relating to the acquisition in the second quarter of 2012, and $12.0 million for the first half of 2012. We expect to achieve total net cost savings from synergies of approximately $28 million in 2012, and by the end of 2012 to be on track to achieve $35 to $40 million annually in cost savings from synergies in 2013.
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Components and Trends in our Business
Net sales consist of sales of consumer tissue and paperboard products, as well as pulp, net of discounts, returns and allowances and any sales taxes collected. Prices for our consumer tissue products primarily tend to be driven by the value of our products to our customers, and are generally priced relative to the prices of branded tissue products. Demand and pricing for our pulp and paperboard products are largely determined by general global market conditions and the demand for high quality paperboard.
Operating costs
Purchased pulp
Chemicals
Chips, sawdust and logs
Transportation1
Energy
Maintenance and repairs2
Packaging supplies
Includes internal and external transportation costs.
Excluding related labor costs.
Purchased pulp. We purchase a significant amount of the pulp needed to supply our consumer products, and to a lesser extent our pulp and paperboard, manufacturing facilities from external suppliers. For both the three and six months ended June 30, 2012, total purchased pulp costs were 15.2% of our cost of sales, representing decreases of 1.3 percentage points and 2.4 percentage points, respectively, compared to the same periods in 2011. Our costs for purchased pulp, which escalated in 2011, continue to decrease due to lower average external pulp prices and a continued focus on internally sourced pulp.
Chemicals. We consume a significant amount of chemicals in the production of pulp and paperboard. The chemicals we generally use include polyethylene, caustic, starch, sodium chlorate, latex and specialty paper process chemicals. A large portion of the chemicals used in our manufacturing processes, particularly in the pulp-making process, are petroleum-based and are impacted by petroleum prices. Our chemical costs increased $2.7 million, or 1.6 percentage points, for the three months ended June 30, 2012, compared to the three months ended June 30, 2011. Chemical costs for the six months ended June 30, 2012, increased $10.0 million, or 1.8 percentage points, over the 2011 comparable period. Costs increased during both the three and six month periods primarily as a result of higher caustic and sodium chlorate prices, as well as increased volumes at our Arkansas facility.
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Chips, sawdust and logs. We purchase chips, sawdust and logs used to manufacture pulp. We source these residual wood fibers under both long-term and short-term supply agreements, as well as in the spot market. Overall costs for chips, sawdust and logs for the three and six months ended June 30, 2012, decreased compared to the same 2011 periods, both in dollars and as a percentage of cost of sales, primarily due to the sale of our Lewiston, Idaho sawmill in November 2011. Excluding the effects of our former sawmill, the cost of chips, sawdust and logs increased compared to the prior year periods primarily due to supply limitations at our Arkansas pulp and paperboard mill caused by wet weather conditions.
Transportation. Fuel prices significantly impact transportation costs related to delivery of raw materials to our manufacturing facilities, internal inventory transfers and delivery of our finished products to customers. Changing fuel prices particularly affect our margins for consumer products because we supply customers throughout the U.S., and we transport unconverted parent rolls from our tissue mills to our tissue converting facilities. Our transportation costs for the three and six months ended June 30, 2012, compared to the prior year periods, decreased as less fuel was used due to an overall decline in miles shipped as a result of synergies from the Cellu Tissue acquisition. In addition, the sale of our Lewiston, Idaho sawmill in November 2011 resulted in lower overall transportation costs for the second quarter and first half of 2012 compared to the same periods of 2011.
Energy. We use energy in the form of electricity, hog fuel, steam, natural gas and, to a much lesser extent, coal to operate our mills. Energy prices have fluctuated widely over the past decade. We have taken steps to reduce our exposure to volatile energy prices through conservation. In addition, cogeneration facilities that produce steam and electricity at our East Hartford, Connecticut, Lewiston, Idaho and Menominee, Michigan manufacturing sites help to lower our energy costs. To help mitigate our exposure to changes in natural gas prices, from time to time we have used firm-price contracts to supply a portion of our natural gas requirements. As of June 30, 2012, these contracts covered approximately 29% of our expected average monthly natural gas requirements for our manufacturing facilities for the remainder of 2012, plus lesser amounts for 2013. Energy costs for the three and six months ended June 30, 2012 were lower than the prior year period due to lower natural gas and electricity costs. Our energy costs in future periods will depend principally on our ability to produce a substantial portion of our electricity needs internally, on changes in market prices for natural gas and on our ability to reduce our energy usage.
Maintenance and repairs. We regularly incur significant costs to maintain our manufacturing equipment. We perform routine maintenance on our machines and periodically replace a variety of parts such as motors, pumps, pipes and electrical parts.
Major equipment maintenance and repairs in our Pulp and Paperboard segment also require maintenance shutdowns annually at our Idaho facility and approximately every 18 months at our Arkansas facility, which increases costs and may reduce net sales in the quarters in which the major maintenance shutdowns occur. In the first quarter of 2012, we had 17 combined days of scheduled machine downtime for the two paperboard machines at our Idaho pulp and paperboard mill and incurred approximately $15.5 million in major maintenance costs, excluding labor, compared to major maintenance costs of $11.4 million at the same mill in the first quarter of 2011. There was no major maintenance in the second quarters of 2012 and 2011. We expect to incur an additional $4.3 million of costs for planned major maintenance at our Arkansas facility during the fourth quarter of 2012.
In addition to ongoing maintenance and repair costs, we make capital expenditures to increase our operating capacity and efficiency, to improve our safety and to comply with environmental laws. Excluding $43.0 million and $82.6 million, respectively, of expenditures for our TAD project during the three and six months ended June 30, 2012, we spent $10.0 million and $20.6 million, respectively, on capital expenditures during the three and six months ended June 30, 2012, compared to $12.0 million and $24.1 million in the same periods in 2011. Capital expenditures for 2012 are expected to be between approximately $195 million and $200 million, which include an estimated $145 million to $150 million associated with our TAD project.
Packaging supplies. As a significant producer of private label consumer tissue products, we package to order for retail chains, wholesalers and cooperative buying organizations. Under these agreements, we incur expenses related to the unique packaging of our products for direct retail sale to consumers. For the three and six months ended June 30, 2012, packaging costs were lower than the same period in 2011 primarily due to procurement synergies resulting from the Cellu Tissue acquisition.
Other. Other costs not mentioned in the above table primarily consist of wage and benefit expenses and miscellaneous operating costs. Although period cut-offs and inventory levels can impact other cost of sales amounts, we would expect this amount to be relatively steady as a percentage of costs on a period-to-period basis.
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Selling, general and administrative expenses primarily consist of compensation and associated expenses for sales and administrative personnel, as well as commission expenses related to sales of our products. Our second quarter selling, general and administrative expenses were $30.5 million in 2012 compared to $27.5 million in 2011. The increase was primarily a result of higher incentive compensation expense, legal expense of approximately $1.0 million related to the First Quality/Metso Paper litigation and additional expense associated with the integration of Cellu Tissue information systems.
Interest expense
Interest expense is mostly comprised of interest on our $375.0 million aggregate principal amount 7.125% senior notes due 2018 issued in October 2010, which we refer to as the 2010 Notes, and our $150.0 million aggregate principal amount of 10.625% senior notes due 2016 issued in June 2009, which we refer to as the 2009 Notes. Interest expense also includes amortization of deferred finance costs associated with the 2009 Notes, 2010 Notes, and our revolving credit facility. Interest expense before reductions for capitalized interest in 2012 is expected to decrease slightly compared to 2011 as a result of the 2011 third quarter redemption of our industrial revenue bonds. Interest expense will also be partially offset by our continued capitalization of interest for our TAD project, which we estimate will be $13.9 million in 2012 and $19.0 million over the construction phase of the project.
Income taxes
Income taxes are based on reported earnings and tax rates in the jurisdictions in which our operations occur and offices are located, adjusted for available credits, changes in valuation allowances and differences between reported earnings and taxable income using current tax laws and rates. We generally expect our effective income tax rate, excluding discrete items, to remain fairly constant, but it could fluctuate due to changes in tax law.
We are registered with the Internal Revenue Service, or IRS, as both an alternative fuel mixer and a producer of cellulosic biofuel. During 2009 we received refundable tax credit payments in connection with our use of an alternative fuel mixture to produce energy at our pulp mills. The amount of the refundable tax credit is equal to $0.50 per gallon of alternative fuel mixture used. The Alternative Fuel Mixture Tax Credit, or AFMTC, expired on December 31, 2009.
The Cellulosic Biofuel Producer Credit, or CBPC, enables us to claim $1.01 per gallon in regards to black liquor produced and used as a fuel by us at our pulp mills in 2009. During 2010, the IRS issued guidance clarifying the treatment of the CBPC and the AFMTC in regards to the production or use of black liquor at the same facility, in the same tax year. Under the guidance provided, both credits may be claimed in the same year as long as the credits are not claimed for the same gallons of fuel. Furthermore, the IRS guidance clarified the ability to convert previously claimed gallons from the AFMTC to the CBPC.
In the first quarter of 2012 Congress identified the elimination or modification of the CBPC in connection with black liquor as a possible revenue source. Such proposed legislative action, if enacted, could limit or eliminate our ability to convert AFMTC gallons to CBPC gallons and/or CBPC gallons to AFMTC gallons and, accordingly, limit or eliminate our ability to claim carry forward credits. Although provisions relating to CBPC and AFMTC were removed from the proposed Highway Investment, Job Creation and Economic Growth Act of 2012, the ultimate outcome of these provisions or future provisions could be adverse. As a result, we made the determination to convert all gallons relating to CBPC carryforwards back to AFMTC and as of June 30, 2012 we have no remaining CBPC carryforwards. As a result of this determination, we recorded net discrete expense of $5.5 million in the three months ended March 31, 2012 comprised of $2.5 million relating to the conversion back to the AFMTC and a resulting additional $3.0 million increase in our liabilities for uncertain tax positions. Although under current federal tax law we have the ability to convert gallons of AFMTC to CBPC until 2013, we do not currently intend to do so. See Note 5 “Income Taxes” for further discussion.
There is relatively little guidance regarding the AFMTC and the law governing the issue is complex. Accordingly, there remains uncertainty as to our qualification to receive the tax credit in 2009, as well as to whether we will be entitled to retain the amounts we received upon further review by the IRS. In addition, while it is our position that payments received or credits taken in relation to the AFMTC should not be subject to corporate income tax, there can be no assurance as to whether or not the amounts we have received will be subject to taxation.
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RESULTS OF OPERATIONS
Three Months Ended June 30, 2012 Compared to Three Months Ended June 30, 2011
The following table sets forth data included in our Condensed Consolidated Statements of Operations as a percentage of net sales.
Net sales—Second quarter 2012 net sales decreased by $21.1 million, or 4.3%, compared to the second quarter of 2011, primarily due to the sale of our Lewiston, Idaho sawmill in November 2011. In addition, decreased paperboard and pulp shipments, as well as lower pulp net selling prices, contributed to the decrease in net sales. These unfavorable comparisons were partially offset by increased net selling prices and shipments in our Consumer Products segment. These items are discussed further below under “Business Segment Discussion.”
Cost of sales—Cost of sales was 84.2% of net sales for the quarter ended June 30, 2012 and 87.6% of net sales for the same period in 2011. The favorable comparison was due primarily to the lower costs for purchased pulp, chips, sawdust, logs, transportation and energy, partially offset by higher chemical costs and a $1.0 million loss associated with the sale of legacy Cellu Tissue foam manufacturing assets.
Selling, general and administrative expenses—Selling, general and administrative expenses increased $3.1 million over the prior year period primarily due to higher incentive compensation expense, legal expense of approximately $1.0 million related to the First Quality/Metso Paper litigation and additional expense associated with the integration of Cellu Tissue information systems.
Interest expense—Interest expense decreased $1.8 million in the second quarter of 2012 compared to the same period in 2011. The decrease was attributable to second quarter 2012 capitalized interest of $2.8 million associated with our TAD project, compared to $1.0 million of capitalized interest for the second quarter of 2011. The increase in capitalized interest was due to a higher level of cumulative capital expenditures associated with the TAD project in the 2012 period.
Income tax expense—Our estimated annual effective tax rate for 2012 is 35.1%, compared with 35.2% for the comparable interim period in 2011. We recorded income tax expense of $13.9 million in the three months ended June 30, 2012, compared to $8.6 million in the three months ended June 30, 2011. The actual rate for the three months ended June 30, 2012 was 39.2%, compared to an actual rate of 38.3% for the same period of 2011. The higher actual rates were primarily due to interest accrued on uncertain tax positions in each reporting period.
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Business Segment Discussion
Operating income
Percent of net sales
Our Consumer Products segment reported a $14.0 million, or 5.2%, increase in net sales for the three months ended June 30, 2012, compared to the three months ended June 30, 2011. The higher sales were due to a 3.3% increase in shipments resulting from a full quarter of production capacity at our converting facility in North Carolina, compared to a minimal amount of production included in the second quarter of 2011. Furthermore, net sales were also up as a result of a price increase implemented over the fourth quarter of 2011 and the first quarter of 2012.
Consumer Product’s operating income increased by $18.8 million versus the prior year quarter. The higher income for the segment was primarily attributable to the increased net sales, as well as lower external pulp costs, partially offset by higher incentive compensation expense and the $1.0 million loss associated with the sale of the legacy Cellu Tissue foam manufacturing assets.
Net sales for the Pulp and Paperboard segment were $35.1 million, or 15.5% lower in the three months ended June 30, 2012, compared to the three months ended June 30, 2011. The decrease was primarily due to the sale of our Lewiston, Idaho sawmill in November 2011. In addition, sales of external pulp were down $5.9 million compared to the second quarter of 2011 due to the increased internal usage of pulp we produce and a 30% decline in external pulp sales prices. A 4.3% decline in paperboard volumes, compared to record shipments in the second quarter of 2011, also contributed to the lower overall net sales.
Operating income for the segment decreased $2.5 million in the three months ended June 30, 2012, compared to the three months ended June 30, 2011. The lower operating income was primarily a result of the decrease in net sales, as discussed above, partially offset by lower pulp, energy and transportation costs, as well as the benefits of the sale of our Lewiston, Idaho sawmill.
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Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011
Net sales—Net sales for the six months ended June 30, 2012, decreased by $29.1 million, or 3.0%, compared to the same period in 2011, due to the sale of our Lewiston, Idaho sawmill in November 2011. Excluding net sales from the sawmill in the first half of 2011, overall net sales for the first half of 2012 increased due to higher net selling prices and shipments for tissue. These favorable comparisons were partially offset by lower external pulp shipments, due to the increased internal usage of pulp we produce, as well as lower pulp and paperboard net selling prices, for the six months ended June 30, 2012 compared to the same period for 2011. These items are discussed further below under “Business Segment Discussion.”
Cost of sales—Cost of sales was 86.1% of net sales for the six months ended June 30, 2012, and 88.3% of net sales for the same period in 2011. The favorable change in cost of sales, as a percentage of net sales, was due primarily to lower costs for purchased pulp, chips, sawdust, logs, energy and transportation, partially offset by higher chemical and maintenance costs and a $1.0 million loss on the sale of legacy Cellu Tissue foam manufacturing assets.
Selling, general and administrative expenses—Selling, general and administrative expenses increased 0.7 percentage points as a percentage of sales for the six months ended June 30, 2012, compared to the same period in 2011. The increase over the prior year period was primarily a result of higher incentive compensation expense, legal expense of $1.9 million related to the First Quality/Metso Paper litigation incurred in the first six months of 2012, and additional expenses associated with the integration of Cellu Tissue information systems.
Interest expense—Interest expense decreased $3.5 million during the six months ended June 30, 2012, compared to the same period in 2011. The decrease was largely attributable to capitalized interest of $4.9 million associated with our TAD project in the first half of 2012, compared to $1.5 million for the first half of 2011. The increase in capitalized interest was due to a higher level of cumulative capital expenditures associated with the TAD project in the 2012 period.
Income tax expense—Our effective tax rates were 50.8% and 43.1% for the six months ended June 30, 2012 and 2011, respectively. The net increase to our tax expense and effective tax rate in the six months ended June 30, 2012, was primarily the result of $5.5 million in tax expense related to our decision to convert certain gallons of alternative fuel originally claimed in 2009 under the AFMTC, which had been converted by us in 2010 to the CBPC, back to gallons under the AFMTC. The $5.5 million is comprised of $2.5 million relating to the conversion back to the AFMTC and a resulting additional $3.0 million increase in our liabilities for uncertain tax positions. The net increase to our tax expense and effective tax rate in the six months ended June 30, 2011, was primarily the result of recording three main discrete items. The first was an increase in tax expense based on evaluating our state tax structure as Cellu Tissue is integrated with our operations. The second discrete item was a decrease in tax expense associated with certain transaction costs relating to the Cellu Tissue Acquisition that were determined to be deductible under the Internal Revenue Code. The final discrete item was an increase to tax expense related to interest accrued on uncertain tax positions.
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Our Consumer Products segment reported a $22.6 million, or 4.2%, increase in net sales and a $31.3 million increase in operating income for the six months ended June 30, 2012, compared to the six months ended June 30, 2011. The increase in net sales was due to higher net selling prices and increased shipments. In addition to the increased net sales, operating income was also favorably affected by lower purchased pulp, energy and transportation costs, which were partially offset by higher incentive compensation and commission expense, as well as the $1.0 million loss on the sale of the legacy Cellu Tissue foam manufacturing assets.
Net sales for the Pulp and Paperboard segment were $51.7 million, or 12.2%, lower in the six months ended June 30, 2012 compared to the six months ended June 30, 2011. The decrease was attributable to the sale of our Lewiston, Idaho sawmill in November 2011, decreased external pulp shipments due to increased internal usage of pulp we produce, lower pulp net selling prices and slightly lower paperboard net selling prices.
Operating income decreased $6.4 million in the six months ended June 30, 2012 when compared to the same period in 2011. The decrease was primarily due to higher chemical costs and higher planned major maintenance expense for the first half of 2012, compared to the first half of 2011. Lower energy costs partially offset the unfavorable comparisons.
EARNINGS BEFORE INTEREST, TAX, DEPRECIATION AND AMORTIZATION (EBITDA) AND ADJUSTED EBITDA
We use earnings before interest, tax, depreciation and amortization, or EBITDA, and EBITDA adjusted for certain items, or Adjusted EBITDA, as supplemental performance measures that are not required by, or presented in accordance with generally accepted accounting principles, or GAAP. EBITDA and Adjusted EBITDA should not be considered as alternatives to net earnings, operating income or any other performance measure derived in accordance with GAAP, or as alternatives to cash flows from operating activities or a measure of our liquidity or profitability. In addition, our calculation of EBITDA and Adjusted EBITDA may or may not be comparable to similarly titled measures of other companies.
We present EBITDA and Adjusted EBITDA because we believe they assist investors and analysts in comparing our performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance. In addition, we use EBITDA and Adjusted EBITDA: (i) as factors in evaluating management’s performance when determining incentive compensation, (ii) to evaluate the effectiveness of our business strategies and (iii) because our credit agreement and the indentures governing the 2009 Notes and 2010 Notes use measures similar to EBITDA to measure our compliance with certain covenants.
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The following table provides our EBITDA and Adjusted EBITDA for the periods presented, as well as a reconciliation to net earnings.
Six Months Ended
Depreciation and amortization expense
EBITDA
Loss on sale of foam assets
Expenses associated with Metso litigation
Adjusted EBITDA
LIQUIDITY AND CAPITAL RESOURCES
The following table presents information regarding our cash flows for the six months ended June 30, 2012 and 2011:
Cash Flows Summary
Net cash provided by operating activities for the six months ended June 30, 2012 nearly doubled compared to the same period in 2011. The increase in cash provided by operating activities for the 2012 period was due primarily to cash generated from working capital, compared to cash used for working capital in the first half of 2011, as well as higher earnings, after adjusting for noncash items. This was partially offset by a $7.0 million increase in contributions to our qualified pension plans and an increase in tax receivables for the first six months of 2012 compared to the same period in 2011.
Cash flows used in investing activities increased $34.7 million during the six months ended June 30, 2012, compared to the same period in 2011. The increase was largely due to increased capital spending for plant and equipment during the first six months of 2012, primarily associated with our TAD project. Overall cash expenditures for capital spending during the period ended June 30, 2012, increased by $36.6 million over the same period in 2011.
Net cash used for financing activities was $14.6 million as of June 30, 2012, compared with $1.0 million of net cash provided by financing activities during the same period in 2011. Cash used for financing activities in the first six months of 2012 consisted of a $13.0 million payment of minimum tax withholdings associated with equity-based payment arrangements and $7.5 million in treasury stock purchases, partially offset by an excess tax benefit from equity-based payments of $5.8 million recognized in the same period.
Capital Resources
Due to the competitive and cyclical nature of the markets in which we operate, as well as an uncertain economic environment, there is uncertainty regarding the amount of cash flows we will generate during the next twelve months. However, we believe that our cash flows from operations and our cash on hand and available borrowing capacity under our revolving credit facility will be adequate to fund debt service requirements and provide cash required to support our ongoing operations, capital expenditures, and working capital needs for the next twelve months.
We cannot be certain, however, that our business will generate sufficient cash flow from operations or that future borrowing capacity will be available to us under our revolving credit facility in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. If we make substantial capital expenditures or consummate an acquisition, our debt service requirements could increase. We may choose to refinance all or a portion of our indebtedness on or before maturity. We cannot be certain that we will be able to refinance any of our indebtedness on commercially reasonable terms or at all. As of June 30, 2012, our short-term investments were not restricted and were largely invested in demand deposits.
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Debt Arrangements
Our debt service obligation, consisting of cash payments for interest related to our 2009 Notes and 2010 Notes, is estimated to be $42.6 million annually for 2012 and 2013.
The terms of each of our 2010 Notes and 2009 Notes limit our ability and the ability of any restricted subsidiaries to borrow money; pay dividends; redeem or repurchase capital stock; make investments; sell assets; create restrictions on the payment of dividends or other amounts to us from any restricted subsidiaries; enter into transactions with affiliates; enter into sale and lease back transactions; create liens; and consolidate, merge or sell all or substantially all of our assets.
Credit Arrangements
CONTRACTUAL OBLIGATIONS
As of June 30, 2012, there have been no significant changes to the contractual obligations table as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011.
OFF- BALANCE SHEET ARRANGEMENTS
We currently are not a party to off-balance sheet arrangements that would require disclosure under this section.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in accordance with GAAP requires our management to select and apply accounting policies that best provide the framework to report the results of operations and financial position. The selection and application of those policies requires management to make difficult, subjective and complex judgments concerning reported amounts of revenue and expenses during the reporting period and the reported amounts of assets and liabilities at the date of the financial statements. As a result, it is possible that materially different amounts would be reported under different conditions or using different assumptions.
As of June 30, 2012, there have been no significant changes with regard to the critical accounting policies disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011.
See Note 2 “Recently Adopted and New Accounting Standards” to the condensed consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q for additional information regarding recently adopted and new accounting pronouncements.
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Interest Rate Risk
Our exposure to market risks on financial instruments includes interest rate risk on our secured revolving credit facility. As of June 30, 2012, there were no borrowings outstanding under the credit facility. The interest rates applied to borrowings under the credit facility are adjusted often and therefore react quickly to any movement in the general trend of market interest rates. For example, a one percentage point increase or decrease in interest rates, based on assumed outstanding credit facility borrowings of $10.0 million, would have a $0.1 million annual effect on interest expense. We currently do not attempt to mitigate the effects of short-term interest rate fluctuations on our credit facility borrowings through the use of derivative financial instruments.
Commodity Risk
We are exposed to market risk for changes in natural gas commodity pricing, which we have, from time-to-time, partially mitigated through the use of firm price contracts for a portion of our natural gas requirements for our manufacturing facilities. As of June 30, 2012, we had firm-price contracts for natural gas covering approximately 29% of the expected average monthly requirements for the remainder of 2012, plus lesser amounts for 2013.
We are also subject to commodity price risk associated with pulp costs and take advantage of spot prices on pulp to minimize market risk arising from changes in pulp costs. We have agreements with pulp vendors to purchase pulp at market-based prices covering approximately 36% of our current expected total annual pulp needs in 2012.
Foreign Currency Risk
We have minimal foreign currency exchange risk. Virtually all of our international sales are denominated in U.S. dollars. Due to our Canadian operations, however, we could be adversely affected by unfavorable fluctuations in foreign currency exchange rates.
We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934, or the Exchange Act, that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer, or CEO, and Interim Chief Financial Officer, or Interim CFO, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of disclosure controls and procedures is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Subject to the limitations noted above, our management, with the participation of our CEO and Interim CFO, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the second quarter of 2012. Based on that evaluation, the CEO and Interim CFO have concluded that, as of June 30, 2012, our disclosure controls and procedures were effective to meet the objective for which they were designed and operated at the reasonable assurance level.
Changes in Internal Controls
There was no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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Part II
In 2010, we contracted with Metso Paper USA to construct the TAD paper machine for our North Carolina facilities. On August 2, 2011, First Quality Tissue SE, LLC, or First Quality, filed a complaint against Metso Paper in the Court of Common Pleas of South Carolina, Anderson County alleging breach of contract and requesting a permanent injunction. First Quality contended that Metso Paper’s sale of a TAD paper machine to Clearwater Paper violated the restrictive covenant in First Quality’s agreement with Metso Paper. On September 13, 2011, Metso Paper removed the case to the United States District Court for the District of South Carolina. We filed a motion to intervene in the litigation to protect our interests, which was granted by the court on November 29, 2011. On December 9, 2011, the court denied First Quality’s motion for a preliminary injunction. On June 20, 2012 following a six day trial before a federal magistrate judge that began on May 7, 2012, and post-trial briefing, the court denied First Quality’s request for a permanent injunction and dismissed its amended complaint with prejudice. The court entered judgment in favor of Clearwater Paper and Metso Paper on June 21, 2012. The period for an appeal as of right by First Quality expired on July 23, 2012.
In addition to the matter discussed above, we may from time to time be involved in claims, proceedings and litigation arising from our business and property ownership. We believe, based on currently available information, that the results of such proceedings, in the aggregate, will not have a material adverse effect on our financial condition.
Other than the favorable ruling in the lawsuit between First Quality and Metso Paper, as discussed above in Part II, Item 1, there are no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011. See Part I, Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2011, entitled “Risk Factors.”
Issuer Purchases of Equity Securities
On July 28, 2011, we announced a stock repurchase program approved by our Board of Directors authorizing the company to purchase up to $30 million in shares of our common stock. Under our stock repurchase program, which does not have an expiration date, we may repurchase shares in the open market or as otherwise may be determined by management, subject to market conditions, business opportunities and other factors. During the three months ended June 30, 2012, we repurchased 238,482 shares of our outstanding common stock at an average price of $31.30 per share under this share repurchase program. As of June 30, 2012, approximately $11.2 million of the authorization remains.
The following table provides information about share repurchases that we made during the three months ended June 30, 2012 (in thousands, except share and per share amounts):
Period
April 1, 2012 to April 30, 2012
May 1, 2012 to May 31, 2012
June 1, 2012 to June 30, 2012
Total
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The exhibit index is located on page 36 of this Form 10-Q.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ JOHNATHAN D. HUNTER
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EXHIBITNUMBER
DESCRIPTION
Clearwater Paper Corporation 2008 Stock Incentive Plan—Restricted Stock Unit Award,
dated July 3, 2012, with John D. Hertz.
Management contract or compensatory plan, contract or arrangement.
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