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CLW > SEC Filings for CLW > Form 10-Q on 3-May-2013All Recent SEC Filings

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Form 10-Q for CLEARWATER PAPER CORP


3-May-2013

Quarterly Report

Management's Discussion and Analysis of Financial Condition and Results of Operations

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 stock repurchase program and accelerated stock buyback program, the costs and benefits associated with the closure of our Thomaston, Georgia facility, future growth opportunities, future revenues, cash flows, capital expenditures, tax rates, operating costs, manufacturing capability, liquidity, benefit plan funding levels, capitalized interest, interest expenses, and the tax treatment of the alternative fuels and cellulosic biofuels tax credits. 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 2012 Form 10-K, as well as the following:
difficulties with the optimization and realization of the benefits expected from our new through-air-dried, or TAD, paper machine and converting lines in Shelby, North Carolina;

the loss of business from a significant customer;

increased dependence on wood pulp;

changes in transportation costs and disruptions in transportation services;

manufacturing or operating disruptions, including equipment malfunction and damage to our manufacturing facilities caused by fire or weather-related events and IT system failures;

changes in the cost and availability of wood fiber and wood pulp;

changes in costs for and availability of packaging supplies, chemicals, energy and maintenance and repairs;

competitive pricing pressures for our products, including as a result of increased capacity as additional manufacturing facilities are operated by our competitors;

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;

environmental liabilities or expenditures;

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;

reliance on a limited number of third-party suppliers for raw materials;

labor disruptions;

inability to successfully implement our expansion strategies;

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.


Table of Contents

OVERVIEW
Background
Clearwater Paper Corporation is a leading North American producer of private label tissue and paperboard products. We manufacture quality consumer tissue, away-from-home tissue, parent rolls (non-converted tissue product), machine-glazed tissue, bleached paperboard and pulp at 15 manufacturing locations in the U.S. and Canada. Our private label consumer tissue products - 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, which demands high-quality construction and print surfaces for graphics. Our products are made primarily from wood fiber pulp.
Recent Developments
Thomaston Closure
On March 6, 2013, we announced the planned permanent closure of our Thomaston, Georgia converting and distribution facility. The shutdown will occur gradually as converting lines are relocated and installed at our other facilities, with some operations continuing to run into the first quarter of 2014. We expect the total impact of exit related costs to be approximately $6 million to $7 million, of which approximately $4 million to $5 million is expected to be incurred in 2013. The exit costs are primarily attributable to the costs of relocating the converting lines, which will be expensed as incurred in the Condensed Consolidated Statement of Operations. The cost savings benefits resulting from the equipment relocation and converting facility optimization, which are part of the company's previously announced cost savings programs, are expected to be fully realized beginning in the fourth quarter of 2014. In the first quarter of 2013, we recorded $0.2 million of costs associated with this announcement. Capital Allocation
On January 23, 2013, we issued $275 million aggregate principal amount of 4.5% senior notes, which we refer to as the 2013 Notes. Approximately $166 million of the net proceeds from the issuance was used to redeem all of our $150 million aggregate principal amount of 10.625% senior notes due 2016, which we refer to as the 2009 Notes.
In January 2013, we announced that our Board of Directors approved a common stock repurchase program authorizing the repurchase of up to $100 million of our common stock, to be funded by a portion of the proceeds from the issuance of the 2013 Notes. In connection with this program, on March 1, 2013, we entered into a $50 million accelerated stock buyback, or ASB, agreement with a major financial institution. See Note 1 to the Condensed Consolidated Financial Statements, under the subheading "Stockholders' Equity," for additional discussion of the ASB program.
Components and Trends in our Business
Net sales
Net sales predominantly consist of sales of consumer tissue and paperboard products, net of discounts, returns and allowances and any sales taxes collected. Prices for our consumer tissue products tend to primarily 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
                                        Three Months Ended March 31,
(Dollars in thousands)               2013                           2012
                                       Percentage of                  Percentage of
                            Cost       Cost of Sales       Cost       Cost of Sales
Purchased pulp           $  71,635           17.3 %     $  61,736           15.3 %
Chemicals                   47,447           11.5          45,870           11.4
Transportation1             45,445           11.0          41,698           10.4
Chips, sawdust and logs     37,098            8.9          40,348           10.0
Energy                      31,853            7.7          27,007            6.7
Packaging supplies          24,269            5.9          22,157            5.5
Maintenance and repairs2    22,962            5.5          35,149            8.7
Depreciation                19,750            4.7          17,240            4.2
                         $ 300,459           72.5 %     $ 291,205           72.2 %

1 Includes internal and external transportation costs.

2 Excluding related labor costs.


Table of Contents

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 the three months ended March 31, 2013, total purchased pulp costs were 17.3% of our cost of sales, representing an increase of 2.0 percentage points compared to the same period in 2012, due primarily to increased usage associated with the ramp up of our Shelby, North Carolina TAD paper machine and higher purchased pulp costs as a result of major maintenance downtime taken at our Arkansas pulp and paperboard facility.
Chemicals. We consume a substantial amount of chemicals in the production of pulp and paperboard, as well as in the production of TAD tissue. 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 slightly for the quarter ended March 31, 2013, compared to the same period in 2012, due primarily to the first full quarter of production on our North Carolina TAD paper machine, which resulted in higher chemical consumption. Transportation. Fuel prices largely 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 transport unconverted parent rolls from our tissue mills to our tissue converting facilities. Our transportation costs for the first quarter of 2013, compared to the first quarter of 2012, were higher as a result of increased external shipments and lower than normal inventory levels at our tissue production and converting facilities. The reduced inventory levels required multiple shifts in regional distributions for our tissue product lines, and as a result we incurred an overall increase of internal tons shipped. 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 months ended March 31, 2013, decreased compared to the same 2012 period, both in dollars and as a percentage of cost of sales. The decline in the 2013 period was primarily attributable to lower overall pricing at our Idaho pulp and paperboard mill, partially offset by higher overall usage in the first quarter of 2013 due to less major maintenance related downtime.
Energy. We use energy in the form of electricity, hog fuel, steam and natural gas to operate our mills. Energy prices have fluctuated widely over the past decade. We have taken steps, and intend to continue to take 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. However, TAD tissue production involves greater natural gas usage than conventional tissue manufacturing and, as a result, we expect our natural gas requirements will increase due to the ramp up of our North Carolina TAD paper machine. Energy costs for the three months ended March 31, 2013 were higher than the prior year comparable period due to the first full quarter of production on our North Carolina TAD paper machine, as well as higher natural gas prices. 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 March 31, 2013, we had no firm-price contracts in place. 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.
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 months ended March 31, 2013, packaging costs were $2.1 million higher than the same period in 2012 primarily due to increased retail shipments. 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 approximately every 18 months at our Idaho and Arkansas facilities, which increases costs and may reduce net sales in the quarters in which the major maintenance shutdowns occur. In the first quarter of 2013, we had four days of machine downtime costing $5.0 million, excluding labor, at our Arkansas facility, compared to major maintenance costs of $15.5 million incurred at our Idaho facility in the first quarter of 2012. We expect to spend an additional $11 million to $13 million for planned major maintenance at our Idaho facility during the third quarter of 2013.
In addition to ongoing maintenance and repair costs, we make capital expenditures to increase our operating capacity and efficiency, improve safety at our facilities and comply with environmental laws. Excluding $1.9 million of capital expenditures for our TAD tissue expansion project during the three months ended March 31, 2013, we spent $11.5 million on capital expenditures. During the three months ended March 31, 2012, we spent $10.6 million on capital expenditures, excluding $39.6 million of expenditures for our TAD tissue expansion project.


Table of Contents

Depreciation. We record substantially all of our depreciation expense associated with our plant and equipment in "Cost of sales" on our Condensed Consolidated Statements of Operations. Depreciation expense for the three months ended March 31, 2013 was $2.5 million higher than the 2012 comparable period due primarily to additional depreciation associated with our North Carolina TAD paper machine, which started up in December 2012.
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 cost of sales amounts, we would expect this impact to be relatively steady as a percentage of costs on a period-over-period basis. We experienced an increase in wage and benefit expenses in the first quarter of 2013 compared to the first quarter of 2012 due largely to the startup of our North Carolina TAD facility, as well as an increase in medical costs due primarily to higher medical claims experience. Selling, general and administrative expenses 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 selling, general and administrative expenses for the three months ended March 31, 2013 and 2012 were $34.1 million and $29.1 million, respectively. The higher first quarter 2013 expense was primarily a result of a $3.5 million mark-to-market adjustment in the first quarter of 2013 related to our directors' common stock units, which will ultimately be settled in cash, and higher bad debt expense. Interest expense
Interest expense is mostly comprised of interest on the 2013 Notes and our $375 million aggregate principal amount of 7.125% senior notes due 2018 issued in October 2010, which we refer to as the 2010 Notes. Interest expense also includes amortization of deferred issuance costs associated with all of our notes and our revolving credit facility. As a result of the issuance of the 2013 Notes at an interest rate significantly lower than that of our former 2009 Notes, which were redeemed in the first quarter of 2013 using a portion of the proceeds from the 2013 Notes, our interest expense is expected to decrease by approximately $3.6 million on an annual basis. However, this favorable change in interest expense associated with our notes will be more than offset by a decrease in capitalized interest, as no capitalized interest is expected in 2013 compared to total 2012 capitalized interest of $12.6 million. 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, commonly referred to as "black liquor," 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. Our ability to convert previously claimed gallons from the AFMTC to the CBPC expired on March 15, 2013.
During the first quarter of 2012, we converted certain gallons claimed under the CBPC back to gallons claimed under the AFMTC, which resulted in a net discrete expense of $5.5 million comprised of $2.5 million relating to the conversion back to the AFMTC and an additional $3.0 million increase in our liabilities for uncertain tax positions.
During first quarter of 2013, we reversed our position and converted certain gallons claimed under the AFMTC back to gallons claimed under the CBPC. This reversal allowed us to recognize a net discrete benefit for the quarter of $9.8 million, which was primarily comprised of a $5.6 million benefit relating to the conversion back to the CBPC and a $4.2 million decrease to our liabilities for uncertain tax positions, partially offset by interest accrued on uncertain tax positions. As of March 31, 2013 we have no remaining CBPC carryforwards. There is relatively little guidance regarding the AFMTC and CBPC, and the laws governing these credits are 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.
During the fourth quarter of 2012, the IRS commenced an audit of our tax returns for the tax years ending December 31, 2008 through December 31, 2012. The audit is ongoing, with no defined conclusion date as of March 31, 2013.


Table of Contents

RESULTS OF OPERATIONS
Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012
The following table sets forth data included in our Condensed Consolidated
Statements of Operations as a percentage of net sales.
                                                     Three Months Ended March 31,
(Dollars in thousands)                               2013                    2012
Net sales                                    $ 460,824     100.0 %   $ 457,798     100.0 %
Costs and expenses:
Cost of sales                                 (414,209 )    89.9      (403,076 )    88.0
Selling, general and administrative expenses   (34,132 )     7.4       (29,074 )     6.4
Total operating costs and expenses            (448,341 )    97.3      (432,150 )    94.4
Income from operations                          12,483       2.7        25,648       5.6
Interest expense, net                          (10,982 )     2.4        (9,728 )     2.1
Debt retirement costs                          (17,058 )     3.7             -         -
(Loss) earnings before income taxes            (15,557 )     3.4        15,920       3.5
Income tax (benefit) provision                  14,675       3.2       (12,194 )     2.7
Net (loss) earnings                          $    (882 )     0.2     $   3,726       0.8

Net sales-First quarter 2013 net sales increased by $3.0 million, or 0.7%, compared to the first quarter of 2012, due to increased overall tissue and paperboard shipments, which rose 3.0% and 2.3%, respectively, compared to the prior year period. The increased shipments were partially offset by unfavorable changes in paperboard and non-retail tissue net selling prices, which declined by 3.4% and 2.6%, respectively. These items are discussed further below under "Discussion of Business Segments."
Cost of sales-Cost of sales was 89.9% of net sales for the three months ended March 31, 2013 and 88.0% of net sales for the same period in 2012. The increase was primarily a result of limited inventory in retail tissue caused by a higher than anticipated demand for conventional bathroom tissue, which negatively impacted many of our cost categories by a total of approximately $9 million in the first quarter of 2013, as well as higher external pulp, energy and labor related costs.
Selling, general and administrative expenses-Selling, general and administrative expenses increased $5.1 million primarily due to a $3.5 million mark-to-market adjustment in the first quarter of 2013 related to our directors' common stock units, which will ultimately be settled in cash, and higher bad debt expense. Interest expense-Interest expense increased $1.3 million during the three months ended March 31, 2013, compared to the same period of 2012. The increase was largely attributable to the lack of capitalized interest during the current year period, compared to $2.1 million of capitalized interest associated with our TAD tissue expansion project in the first quarter of 2012. The increase in interest expense was partially offset by the refinancing of the 2009 Notes with proceeds from the issuance of the 2013 Notes, which carry a significantly lower interest rate.
Debt retirement costs-Debt retirement costs include a one-time charge in connection with the complete redemption of the 2009 Notes on February 22, 2013. Total costs of $17.1 million include cash charges of approximately $14 million related to a "make whole" premium plus accrued and unpaid interest and a non-cash charge of approximately $3 million related to the write off of deferred issuance costs and unamortized discounts.
Income tax expense-Our estimated annual effective tax rate for 2013 is approximately 37%, compared with approximately 35% for the comparable interim period in 2012. We recorded an income tax benefit of $14.7 million in the three months ended March 31, 2013, compared to an expense of $12.2 million in the three months ended March 31, 2012. The actual effective rate for the three months ended March 31, 2013 was approximately 94%, compared to an actual rate of approximately 77% for the same period in 2012. The higher actual rates were attributable to the net impact of reporting discrete items totaling a net benefit of $9.0 million and net expense of $6.7 million, respectively, in the first quarters of 2013 and 2012.
After adjusting for the tax benefit (provision) relating to the special items set forth in the table below, the effective tax rate for the quarter would have been approximately 53%, compared to approximately 41% in the first quarter 2012.

                                                                 Three Months Ended March 31,
(In thousands)                                                     2013                2012
GAAP income tax benefit (provision)                          $      14,675       $      (12,194 )
Special items, tax impact:
Expense associated with Metso litigation                                 -                 (343 )
Debt retirement costs                                               (6,277 )                  -
Directors' equity-based compensation expense                        (1,278 )                145
Costs associated with announced Thomaston facility closure             (67 )                  -
Discrete tax items related to credit conversions                    (9,766 )              5,700
Adjusted income tax provision                                $      (2,713 )     $       (6,692 )


Table of Contents

Discussion of Business Segments
Consumer Products

                                      Three Months Ended
                                           March 31,
(Dollars in thousands)                2013          2012
Net sales                          $ 284,902     $ 277,830
Operating income                      10,124        26,271
Percent of net sales                     3.6 %         9.5 %

Tissue shipments (short tons)        132,596       128,768
Tissue sales price (per short ton) $   2,149     $   2,158

Our Consumer Products segment reported an increase in net sales of $7.1 million, or 2.5%, for the three months ended March 31, 2013, compared to the three months ended March 31, 2012. The higher net sales, primarily attributable to higher shipments, were partially offset by a 2.6% decrease in non-retail pricing caused by lower machine-glazed and contract manufacturing pricing.
Segment operating income for the three months ended March 31, 2013, decreased by $16.1 million compared to the same period in 2012. In late 2012 and early 2013, we began seeking to increase our conventional tissue business to help offset expected future displacement by our expanding TAD offerings. We experienced higher than expected customer demand that resulted in inefficient manufacturing and logistics in the first quarter of 2013, which included the need to purchase additional amounts of higher cost external paper, increases in machine changeover costs and higher internal transportation costs as we strove to satisfy this increased demand. Costs associated with our TAD start-up, higher external pulp costs, and increased labor related costs also impacted operating income.

Pulp and Paperboard

                                           Three Months Ended
. . .
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