Sylvamo Corp: Form 10-Q for the period ended Sep 30, 2023

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included in “Financial Information” of this Quarterly Report on Form 10-Q (this “Form 10-Q”) and the Company’s Form 10-K for the three years ended December 31, 2022, 2021 and 2020. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs that involve significant risks and uncertainties. Our actual results could differ materially from those stated and implied in any forward-looking statements. Factors that could cause or contribute to those differences include those discussed below and elsewhere in this Form 10-Q and in our 2022 Form 10-K, particularly under the headings “Risk Factors” and “Forward-Looking Statements.”

EXECUTIVE SUMMARY

Third quarter 2023 net income from continuing operations was $58 million ($1.37 per diluted share) compared with $49 million ($1.14 per diluted share) for the second quarter. Net sales were $897 million in the current quarter compared with $919 million in the second quarter. Cash from operations was $197 million compared to $77 million in the prior quarter. Adjusted EBITDA was $158 million and our adjusted EBITDA margin was 17.6% compared to $124 million and margin of 13.5% in the second quarter. Free cash flow was $155 million compared to $33 million in the prior quarter.

Comparing our performance in the third quarter to the second quarter, price and mix decreased primarily due to lower paper prices in Europe and Latin American export markets, as well as lower global pulp prices. Volume was slightly favorable in Latin America and North America and stable in Europe. Operations and costs were flat, driven by better operating and supply chain results that were offset by higher unabsorbed fixed costs due to increased economic downtime. Additionally, we had no major planned outages in the third quarter. Input and transportation costs improved in the current quarter, driven by favorable fiber, chemical and transportation costs. During the third quarter, we initiated a cost reduction program to streamline our organization and cost structures. Before inflation, we are targeting run rate savings of at least $110 million by the end of 2024. Approximately two-thirds of the target will come from operational improvements in our mills and supply chains. The balance will consist of selling and administrative cost reductions, including the elimination of approximately 150 positions, or nearly 7% of our global salaried workforce.

Looking ahead to the fourth quarter of 2024, we expect price and mix to be unfavorable primarily reflecting prior paper price decreases in Europe and unfavorable geographical mix in Latin America and North America. Volume is expected to improve, reflecting seasonally stronger volume in Latin America, and the completion of destocking in Europe and North America. Operations and costs are expected to increase primarily due to higher seasonal operating costs in Europe and North America. We expect stable unabsorbed fixed costs as we continue to match supply to our customers demand and right-size our inventory levels. Planned maintenance outage expenses will be higher coming out of the third quarter, where we did not have any outages, as we have planned maintenance outages across all three of our business regions. Additionally, input and transportation costs are expected to increase due to seasonally higher energy costs.

Acquisition of Nymölla

On January 2, 2023, the Company completed the previously announced acquisition of Stora Enso’s uncoated freesheet paper mill in Nymölla, Sweden. Sylvamo accounted for the acquisition under ASC 805, “Business Combinations” and the Nymölla mill’s results of operations are included in Sylvamo’s condensed consolidated financial statements from the date of acquisition. See Note 7 Acquisitions for further details.

Divestiture of Russian Operations

During the second quarter of 2022, management committed to a plan to sell the Company’s Russian operations (which were sold on October 2, 2022). As a result, the operating results of the Company’s Russian operations have been classified as “Discontinued operations, net of taxes” for all periods presented in the condensed consolidated statement of operations. See Note 8 Divestiture and Impairment of Business for further details.

BUSINESS SEGMENT RESULTS

Overview

Management provides business segment operating profit, a non-GAAP financial measure, to supplement our GAAP financial information, and it should be considered in addition to, but not instead of, the financial statements prepared in accordance with GAAP. Management believes that business segment operating profit provides investors and analysts useful insights into our operating performance. Business segment operating profit is reconciled to Income from continuing operations before income taxes, the most directly comparable GAAP measure. Business segment operating profit may be determined or calculated differently by other companies and therefore may not be comparable among companies.

The following table presents a comparison of Income from continuing operations before taxes to business segment operating profit:

In millions

(a) We define business segment operating profit as our income from continuing operations before income taxes calculated in accordance with GAAP, excluding net interest expense (income) and net special items. We believe that business segment operating profit is an important indicator of operating performance as it is a measure reported to our management for purposes of making decisions about allocating resources to our business segments and assessing the performance of our business segments.

(b) Net special items represent income or expenses that are incurred periodically, rather than on a regular basis. Net special items in the periods presented primarily include transaction costs related to the Nymölla acquisition, professional and legal fees related to negotiations resulting in a shareholder cooperation agreement, the impact of the step-up of acquired Nymölla inventory sold during the first quarter, certain severance costs related to our salaried workforce and one-time costs incurred in the prior year associated with the spin-off.

Three Months Ended September 30, 2023 Compared to the Three Months Ended September 30, 2022

Nine Months Ended September 30, 2023 Compared to the Nine Months Ended September 30, 2022

The following tables present net sales and operating profit, which is the Company’s measure of business segment profitability, for each of the Company’s segments. See Note 17 Financial Information by Business Segment and Geographic Area for more information on the Company’s segments.

Europe

In millions

Three Months Ended September 30, 2023 Compared to the Three Months Ended September 30, 2022

Our Europe business segment net sales increased $54 million, compared to the same period in 2022, primarily due to net sales contributed by Nymölla ($88 million), which more than offset lower volumes ($5 million) and decreased sales prices and mix ($27 million).

Europe operating profit was $33 million lower than the same period in 2022, driven primarily by lower sales prices and product mix ($27 million), higher unabsorbed fixed costs due to economic downtime ($9 million), lower volumes ($1 million), slightly higher planned maintenance outages ($1 million) and higher operating costs ($6 million), which were partially offset by lower input costs, primarily for energy ($7 million) and operating profit contributed by Nymölla ($4 million).

Nine Months Ended September 30, 2023 Compared to the Nine Months Ended September 30, 2022

Our Europe business segment net sales increased $242 million, compared to the same period in 2022, primarily due to net sales contributed by Nymölla ($305 million), which more than offset decreased sales volumes ($51 million) and decreased sales prices and mix ($4 million).

Europe operating profit was $40 million lower than the same period in 2022, driven primarily by higher planned maintenance outages ($22 million), higher input costs, primarily for purchased fiber and chemicals ($5 million), higher unabsorbed fixed costs due to economic downtime ($20 million), lower volumes ($9 million), lower sales prices and mix ($5 million) and higher operating costs ($9 million) which more than offset operating profit contributed by Nymölla ($30 million).

Latin America

In millions

Three Months Ended September 30, 2023 Compared to the Three Months Ended September 30, 2022

Our Latin America business segment net sales decreased $24 million, compared to the same period in 2022 due to decreased sales volumes ($14 million), as well as decreased sales prices and mix ($15 million).

Operating profit for Latin America was $3 million lower than the same period in 2022, due to lower sales prices and mix ($15 million) and lower volumes ($5 million), which more than offset the benefits of lower planned maintenance outages ($7 million), lower input costs, primarily for chemicals and pulp ($9 million) and slightly lower operating costs ($1 million).

Nine Months Ended September 30, 2023 Compared to the Nine Months Ended September 30, 2022

Our Latin America business segment net sales decreased $16 million, compared to the same period in 2022, primarily driven by lower sales volumes ($54 million) that were partially offset by increased sales prices and mix ($34 million).

Operating profit for Latin America was $7 million lower than the same period in 2022, as increased sales prices and more favorable product mix ($34 million), lower operating costs ($6 million) and lower planned maintenance outages ($2 million), were more than offset by higher input costs, primarily for purchased fiber and pulp ($27 million) and lower volumes ($22 million).

North America

In millions

Three Months Ended September 30, 2023 Compared to the Three Months Ended September 30, 2022

Our North America business segment net sales was $113 million lower, compared to the same period in 2022, due to lower sales volumes ($98 million), as well as decreased sales prices and product mix ($13 million).

Operating profit for North America was $23 million lower than the same period in 2022, primarily due to lower volumes ($33 million), higher unabsorbed fixed costs due to economic downtime ($29 million) and decreased sales price and mix ($13 million), which more than offset the benefits of lower planned maintenance outages ($1 million), lower input costs, primarily for energy and distribution costs, as well as purchased fiber ($51 million).

Nine Months Ended September 30, 2023 Compared to the Nine Months Ended September 30, 2022

Our North America business segment net sales were $191 million lower, compared to the same period in 2022, as lower sales volumes ($264 million) were partially offset by increased sales prices and product mix ($85 million).

Operating profit for North America was $9 million lower than the same period in 2022, primarily due to lower volumes ($85 million) and higher unabsorbed fixed costs due to economic downtime ($61 million), which more than offset the benefits of increased sales prices and more favorable product mix ($85 million), lower operating costs ($7 million) and decreased input costs, primarily for energy and distribution costs ($45 million).

Non-GAAP Financial Measures

Management provides Adjusted EBITDA, a non-GAAP financial measure, to supplement our GAAP financial information, and it should be considered in addition to, but not instead of, the financial statements prepared in accordance with GAAP. Management uses this measure in managing the operating performance of our business and believes that Adjusted EBITDA provide investors and analysts meaningful insights into our operating performance and is a relevant metric for the third-party debt. Adjusted EBITDA is reconciled to Net income, the most directly comparable GAAP measure. Adjusted EBITDA may be determined or calculated differently by other companies and therefore may not be comparable among companies.

In millions

25

(a) Special items represent income or expenses that are incurred periodically, rather than on a regular basis. Net special items in the periods presented primarily include transaction costs related to the Nymölla acquisition, professional and legal fees related to negotiations resulting in a shareholder cooperation agreement, the impact of the step-up of acquired Nymölla inventory sold during the first quarter, certain severance costs related to our salaried workforce and one-time costs incurred in the prior year associated with the spin-off.

(b) We define Adjusted EBITDA (non-GAAP) as net income (GAAP) excluding discontinued operations, net of taxes plus the sum of income taxes, net interest expense (income), depreciation, amortization and cost of timber harvested, transition service agreement expense, stock-based compensation, and, when applicable for the periods reported, special items.

Free cash flow is a non-GAAP measure and the most directly comparable GAAP measure is cash provided by operating activities from continuing operations. Management believes that free cash flow is useful to investors as a liquidity measure because it measures the amount of cash generated that is available, after reinvesting in the business, to maintain a strong balance sheet and service debt, and return cash to shareowners. It should not be inferred that the entire free cash flow amount is available for discretionary expenditures. By adjusting for certain items that are not indicative of the Company’s ongoing performance, free cash flow also enables investors to perform meaningful comparisons between past and present periods.

The following is a reconciliation of Cash provided by continuing operations to Free Cash Flow:

In millions

The non-GAAP financial measures presented in this Form 10-Q as referenced above have limitations as analytical tools and should not be considered in isolation or as a substitute for an analysis of our results calculated in accordance with GAAP. In addition, because not all companies utilize identical calculations, the Company’s presentation of non-GAAP measures in this Form 10-Q may not be comparable to similarly titled measures disclosed by other companies, including companies in the same industry as the Company.

LIQUIDITY AND CAPITAL RESOURCES

Overview

Our ability to fund the Company’s cash needs depends on our ongoing ability to generate cash from operations and obtain financing on acceptable terms. Based upon our history of generating strong operating cash flow, we believe we will be able to meet our short-term liquidity needs. We believe we will meet known or reasonably likely future cash requirements through the combination of cash flows from operating activities, available cash balances and available borrowings through the issuance of third-party debt, as needed.

A major factor in our liquidity and capital resource planning is our generation of operating cash flow, which is highly sensitive to changes in the pricing and demand for our products. While changes in key operating cash costs, such as raw materials, energy, mill outages and distribution expenses do have an effect on operating cash generation, we believe that our focus on commercial and operational excellence, as well as our ability to manage costs and working capital, will provide sufficient cash flow generation to meet our operational and capital spending needs.

The terms of the agreements governing our debt contain customary limitations for the financing as well as other provisions. These provisions may also restrict our business and, in the event we cannot meet the terms of those provisions, may adversely impact our financial condition, results of operations or cash flows.

Operating Activities

Cash provided by operating activities from continuing operations totaled $337 million for the nine months ended September 30, 2023, compared with cash provided by operating activities from continuing operations of $276 million for the nine months ended September 30, 2022. The increase in cash provided by operating activities in 2023 relates primarily to changes in working capital.

Cash provided by working capital components (accounts and notes receivable, inventories, accounts payable and accrued liabilities, and other) was $3 million for the nine months ended September 30, 2023, compared with cash used for working capital components of $86 million for the nine months ended September 30, 2022. The nine months ended September 30, 2023 working capital components primarily reflect $99 million and $72 million of cash provided by our accounts and notes receivable and other operating activities, respectively, offset by $46 million and $122 million in cash used for our inventories and accounts payable and accrued liabilities balances, respectively. The nine months ended September 30, 2022 working capital components primarily reflect $81 million and $76 million of cash used for our accounts and notes receivable and inventories, respectively, offset by $18 million and $53 million of cash provided by our accounts payable and accrued liabilities balances and other operating activities.

Investment Activities

The total cash used for investing activities from continuing operations for the nine months ended September 30, 2023 increased from the nine months ended September 30, 2022, primarily due to the purchase of the Nymölla mill and the increase in capital spending in the current year.

The following table shows capital spending by business segment:

In millions

Capital spending primarily consists of purchases of machinery and equipment related to our global mill operations and reforestation costs in Latin America.

Financing Activities

Cash used for financing activities from continuing operations for the nine months ended September 30, 2023, primarily reflects the payments of $60 million, $34 million, $20 million, and $8 million on our outstanding principal debt balances for the Revolving Credit Facility, AR Securitization, Term Loan F and Term Loan A, respectively. Additionally, $360 million was paid to bond holders as part of our tender offer. These amounts are primarily offset by the issuance of Term Loan A, draws on our Revolving Credit Facility and AR Securitization of $300 million, $70 million and $70 million, respectively. During the nine months ended September 30, 2023, the Company also paid $32 million in dividends and repurchased $53 million of our shares pursuant to our share repurchase program. Cash used for financing activities from continuing operations for the nine months ended September 30, 2022, primarily reflects the payments of $140 million, $20 million and $10 million on our outstanding principal debt balances for Term Loan B, the Revolving Credit Facility and Term Loan F, respectively.

Contractual Obligations

Our 2022 Form 10-K included disclosures of our contractual obligations and commitments as of December 31, 2022. We continue to make the contractually required payments, and, therefore, the 2022 obligations and commitments described in our 2022 Form 10-K have been reduced by the required payments.

Capital Expenditures

For the nine months ended September 30, 2023, we have invested approximately $147 million, or 5.3% of net sales, in total capital expenditures. Over that period, we spent approximately $131 million, or 4.8% of net sales, in maintenance, regulatory and reforestation capital expenditures, and approximately $16 million, or 0.6% of net sales, in high-return capital projects. Our annual maintenance, regulatory and reforestation capital expenditures are expected to be in the range of approximately $175 to $190 million per year for the next several years, which we believe will be sufficient to maintain our operations and productivity. In addition, we expect to spend up to $35 million on high-return projects in 2023.

CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT ACCOUNTING ESTIMATES

The preparation of financial statements in conformity with U.S. GAAP requires the Company to establish accounting policies and to make estimates that affect both the amounts and timing of the recording of assets, liabilities, revenues and expenses. Some of these estimates require subjective judgments about matters that are inherently uncertain.

Accounting policies whose application may have a significant effect on the reported results of operations and financial position of the Company, and that can require judgments by management that affect their application, include the accounting for impairment or disposal of long-lived assets and goodwill, business combinations and income taxes.

The Company has included in the Form 10-K a discussion of these critical accounting policies, which are important to the portrayal of the Company’s financial condition and results of operations and require management’s judgments. The Company has not made any changes in these critical accounting policies during the first nine months of 2023.

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains information that includes or is based upon forward-looking statements. Forward-looking statements forecast or state expectations concerning future events. These statements often can be identified by the fact that they do not relate strictly to historical or current facts. They typically use words such as “anticipate,” “assume,” “could,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe,” “should,” “will” and other words and terms of similar meaning, or they are tied to future periods in connection with discussions of the Company’s performance. Some examples of forward-looking statements include those relating to our business and operating outlook, future obligations and anticipated expenditures.

Forward-looking statements are not guarantees of future performance. Any or all forward-looking statements may turn out to be incorrect, and actual results could differ materially from those expressed or implied in forward-looking statements. Forward-looking statements are based on current expectations and the current economic environment. They can be affected by inaccurate assumptions or by known or unknown risks, uncertainties and other factors that are difficult to predict.

Although it is not possible to identify all of these risks, uncertainties and other factors, the following factors, among others, could cause our actual results to differ from those in the forward-looking statements: the deterioration of economic and political conditions where we operate such as continuing inflation that increases our costs of operating, conditions such as economic recession decreasing demand for our products, and the war in Ukraine potentially spreading or causing significant economic disruption, particularly in Europe where we operate; workforce, natural gas, fuel and transportation shortages experienced by us and our suppliers creating challenges for our and their operations to overcome, increasing suppliers’ prices charged us and increasing our costs of operating; a resurgence of the COVID-19 pandemic or the occurrence of another public health crisis that results in new governmental measures implemented to address it that impede our, our suppliers’ or our customers’ operations, and that exacerbates inflation, workforce and transportation shortages; climate change and physical and financial risks to us associated with fluctuating regional and global weather conditions or patterns; reduced truck, rail and ocean freight availability resulting in higher costs to us or poor service; information technology risks related to potential breaches of security which may result in the distribution of company, customer, employee and vendor information; extensive environmental laws and regulations, as well as tax and other laws, in the United States, Brazil and other countries in which we operate, which could result in substantial costs to us as a result of compliance with, violations of or liabilities under these laws; failure to attract and retain senior management and other key and skilled employees, particularly in the current tight labor market; the loss of our commercial agreements with International Paper; failure of our separation from International Paper to qualify as a tax-free transaction for U.S. federal income tax purposes; our indebtedness and its impact on our ability to operate and satisfy our debt obligations; the limited trading history of our common stock; and the factors disclosed in Item 1A. Risk Factors in our annual report on Form 10-K for the year ended December 31, 2022 (“2022 Form 10-K”), as such disclosures may be amended, supplemented or superseded from time to time by other reports that we file with the Securities and Exchange Commission, including subsequent quarterly reports on Form 10-Q, annual reports on Form 10-K and current reports on Form 8-K.

We assume no obligation to update any forward-looking statements made in this quarterly report to reflect subsequent events or circumstances or actual outcomes.

Information relating to quantitative and qualitative disclosures about market risk is shown on page 44 of the Company’s Form 10-K, which information is incorporated herein by reference. There have been no material changes in the Company’s exposure to market risk since December 31, 2022.

Evaluation of Disclosure of Controls and Procedures:

Management carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of September 30, 2023. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of such date and designed to ensure that information required to be disclosed by us in reports 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 accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

In January 2023, the Company completed the previously announced acquisition of Stora Enso’s uncoated freesheet paper mill in Nymölla, Sweden. Due to the timing of this acquisition, we have excluded this business from our evaluation of the effectiveness of internal control over financial reporting.

Changes in Internal Control over Financial Reporting:

The Company is in the process of integrating the recently acquired Nymölla mill into the Company's internal control over financial reporting. As a result of these integration activities, certain controls may be changed. Excluding the Nymölla acquisition, there were no changes in our internal control over financial reporting that occurred in the third quarter of 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

The risk factors that affect our business and financial results are set forth under Part I, Item 1A, “Risk Factors,” in our 2022 Form 10-K. There have been no material changes to the risk factors described in the 2022 Form 10-K. The risk factors in “Item 1A. Risk Factors,” in our 2022 Form 10-K and the risks described in this Form 10-Q or our other SEC filings could cause our actual results to differ materially from those stated in any forward-looking statements.