Potlatchdeltic Corp (PCH) 2005 Q1 法說會逐字稿

Good morning ladies and gentleman. Welcome to the First Quarter 2005 Potlatch Corporation earnings conference call. My name is Dylan and I will be your conference coordinator for today. At this time all participants may listen on remote however, we will be facilitating a question and answer session toward the end of today’s conference. As a reminder, today's conference is being recorded for replay purposes. [OPERATOR INSTRUCTIONS].

I would now like to turn the conference to our hosts for today’s presentation, Mr. Gerald Zuehlke, Chief Financial Officer, and Mr. Penn Siegel, Chief Executive Officer. I would like to turn the call first over to Mr. Zuehlke. Please proceed, sir.

Thank you Bill. Before we begin, I remind you this call may contain forward-looking statements within the meaning of the U.S. Securities Laws. These statements include statements about the company’s future business prospects and anticipated performance in upcoming quarters. These statements are not guarantees of future performance, and the company undertakes no duty to update them. Although, these statements reflect management’s expectations today, they are subject to a number of business risks and uncertainties. Actual results may differ materially from those expressed or impliedin this call. For a discussion of certain factors that may cause actual results to differ from the results anticipated, please refer to Potlatch’s recent filing with the SEC.

I would now like to turn the time over to Penn Siegel, who will discuss first quarter results and provide an overview of our operations and markets. Penn.

Thanks Gerry. The release went out this morning. I assume all of you on the call have seen it, so I will not go back to the numbers, as is my normal practice. I will instead go through each of the operations, starting with Resource.

In the Resource Division it was a normal quarter in that we had a very wet period in Arkansas, which is normal. That came off of an usually wet year last year where we had more than double the rainfall in our operating area, double the normal rainfall. So, Resource was unable to deliver as many logs as we would like. That is common in the first quarter, and generally carries into maybe May or June most years. That is in Arkansas.

Minnesota was normal. Idaho was normal. The difference there was, we had fairly substantial land sales last year and not much this year in the first quarter.

In Wood Products thelumber and plywood and particleboard; those markets are quite good, and pricing is better than it was a year ago, but we did have higher log costs. That is in part, that is primarily in Arkansas and Idaho and not so much in Minnesota. The wet weather in Arkansas has caused all wood costs to be substantially higher. On an annual basis, that does not have much effect on Potlatch because of our own supply of logs from our own land, but it did hurt us somewhat in the first quarter in Wood Products given the amount of wood we delivered from our own land.

The market remains strong, as is normal. We have –- will have a 2-3 week strong period, then the market will back off some.

Housing has still not hit its full stride, based on weather, in much of the Southeast. And, that market I would expect to remain strong for most, if not all, of this year. Nothing unusual in those operations.

In the Pulp and Paperboard segment, the earnings were $2.9 million. This year we had something of a different situation. Normally in the first quarter, from December say through March, it is a weaker period for folding carton and certainly weak for cup stock and milk carton, which tends to be more of a summertime, or higher volumes in the summer. And, historically we have taken a fair amount of plate, dish and tray trade volume to keep the machines running. We did a little bit of plate, dish and tray this year, but nowhere near as much as we normally do, and instead, produced higher quality products and built some inventories.

Our inventories of paperboard really went up by roughly 8,000 tons from the end of the year to the end of the first quarter. That was something we did intentionally since we did not have to take the lower priced and lower margined plate, dish, and tray stock. Clearly we do not make any money on those tons we have in inventory until we sell them, but that is something we did intentionally and I think it will bode well for the future.

In Consumer Products we lost money. Not as much as last year, but we lost about $600,000. The pricing of those products continues to rise on a quarterly basis. Our costs were somewhat higher in the winter and we had some unusual costs. As we transition each of our accounts into the TAD towel, we have extra packaging costs there. And more importantly, as we are going through sheet count reductions, since we pay for the packaging, every one of those sheet count reductions requires a package change, and therefore, new packaging for each of them. And so, we had higher packaging costs in the first quarter.

We also had higher employee training costs, which is the result of a new, very high-speed converting line which will start up next week in Chicago. Those employees are all onboard, and have been for sometime, and they are going through training so that when the machine starts up, we can have a quicker start up on the conversion product.

Gerry, I will turn it back to you for any comments on the financial side, and then we will open it to questions.

What I would like to do is, as I normally do each quarter, go through some shipment and realization statistics, and I will start with shipments.

Starting with Lumber, shipments were up 2.5%; Plywood, shipments were down 4.1%; Particleboard up 47.4%; Paperboard, up 1.3%; Pulp, down 74.9%; Tissue, up 16.9%.

Realizations, starting with Lumber up 6.6%; Plywood up 2%; Particleboard down 6.8%; Paperboard up 2.1%; Pulp up 5.4%, and Tissue, flat with the fourth quarter.

I have also given trends, which would be March pricing versus the quarter average for the first quarter. And in that case, Lumber was up; Plywood, flat; Particleboard, flat; Paperboard, up; Pulp, up; and Tissue, up.

I would also tell you that interest expense for the quarter was $7.2 million, which would reflect an ongoing quarterly expectation; so about a little over $28 million and change on an annualized basis. CapEx in the first quarter was $25.5 million, a little bit higher than I would expect on a normal quarterly run-rate. That being because we had a number of projects that were carried over from last year that would have been getting finished up on early in the year this year.

DD&A was $20 million even, which would be reflective of an annualized rate of a little over $80 million.

And that would do it for the statistical part. Bill, we can now open it up to questions if you would like.

Okay sir. Thank you very much. Ladies and gentleman if you do wish to ask a question now. [OPERATOR INSTRUCTIONS]. Our first question comes from Richard Schneider of UBS.

Hi, Penn, I was wondering if you could talk a little bit more in detail about what you are seeing in the Consumer Products area. You mentioned a higher training cost could you give us an idea on how much that is costing you? And the expectation was that when this line started out outside of Chicago, this should be a key to getting this business back into some reasonable shape from a reported earnings standpoint. Could you go through how you are looking at that business currently with the start up of this new line?

Sure, thanks Rich, and good morning. You are correct. That is a line that will run 24/7 so we have all crews onboard and have had during the first quarter for training. The line is expected to start up next Monday. I think I would say, probably, for the first 4-5 weeks, it does not get us a lot, only because we are going through various equipment check outs, and vendors have to meet the specs that they have promised before we sign off on the machine, so that the first 4-5 weeks it is producing, but it is not producing. Our main goal is not production, our main goal at that time is to be sure that the equipment is as warranted.

However, considering the fact that we already have almost all the cost, that is still a plus after it starts up, and by June it should be a significant plus. And the plus is in a number of different areas. It will allow us to cut transportation costs as all of the product converted there will be able to ship in the Midwest into the East as opposed to product now coming out of Las Vegas or Lewiston and there are substantial price savings.

We also, with the start up of that machine, once it has been up and running for 6-8 weeks, we will be for all intents and purposes, out of the outside converting market. We had been doing outside converting for service issues for our customers for about 12 months, and we have been using all the outside converting we could find, just because we had been unable to keep up with demand. That outside converting will be gone before the end of the second quarter. We may still do a little bit on unusual pack sizes, but that is also a significant monthly expense that we are going through.

The ability to have that line up and running is very large for us. It also will allow us to begin to eat into the inventory of parent rolls. We had a substantial parent roll inventory in the TAD area, and our ability to, had we not had this line, Rich, we would have been in a position of having to sell parent rolls which we do not want to do since there really isn’t any TAD available in the marketplace of any decent quality and we certainly want to provide it to competitors. So, with this line, it is a big deal for us in the tissue business.

In terms of actual numbers, that is not the kind of thing we normally talk about.

Is there anything that could be an offset to some of the trends that are developing, pricing that is going up right now. The price increases, are they the carry-overs from last year, or are there more sheet count reduction and do you see any --so that's, I guess, on the positive side, potentially. Do you see anything also potentially on the negative side that could short circuit the improvements that you’re talking about on this issue [inaudible].

There are some additional sheet count reductions, which have been announced by one of our competitors in the bathroom tissue area. We have not yet followed those and won’t until they are pretty widespread. We have additional price increases not tied to sheet count reduction on a customer-by-customer basis, and in a couple of our large customers, we will have substantially higher pricing in the second quarter than we had in the first quarter.

In terms of negatives, for the Tissue segment itself, Rich, natural gas has been quite high. If you were to anticipate it going lots higher than it is right now, then I think that would be a negative, although we don’t look for that. The only other one that I can think of really would be pulp pricing. If pulp becomes much stronger than it is today, that hurts tissue, although from a Potlatch standpoint, it’s by and large irrelevant.

And then just a question on the Paperboard segment. You had a very strong third quarter last year when you earned over 9 million dollars. If you take that –- the 3 million dollar of Beloit income that you received from that settlement. Then the fourth quarter was plagued by a lot of issues –- downtime that got extended and just —you know, you just appeared to not perform too well. I would have expected a bigger up-tick in the first quarter. I mean, is there anything in that business –- if pricing is going up –- is there anything in that business that’s holding you back? You explained you built an inventory –- if you would talk about how you see that segment.

Certainly. The other thing is if you take a look at our quarterly income or losses, as the case may be, in paperboard, there is a seasonal pattern to it. It is tied in part to seasonal demand. It’s also tied to cost. Even the Arkansas mill, but certainly the Idaho mill, in the winter uses more energy just because of weather-related situations. So, it’s colder. We also take our annual maintenance downtime in both the last year and this year in March, and did take it this year, and that always – even though we accrue for it, on a “normalized” basis, there isn’t a real good way to do that, to estimate, Rich, exactly what you’d find when you get in to see what repairs you have to do once everything is shut down on the pulping side. It was a normal maintenance shut down. It lasted a little bit longer than we had planned based on what we found, and the mill came back up and is running quite well. So while we can accrue and we do for the maintenance expenses, we don’t accrue particularly well for lost profit while that downtime is going on.

Having said that, I expect to continue to see substantial improvement in that business, but the improvement I expect to see is year-to-year as opposed to first-to-second or second-to-third quarter even though we will see that –- we’ll see that in this case also. What I look at really is the year-to-year; to compare first quarter against a similar operating set of circumstances with the prior year’s first quarter. So while I expect sequential improvement, I would expect it would be unusual, Rich, not to have a fourth quarter in that business, which is lower than the third quarter just because of the time of year.

Okay. And from an operating standpoint, all the issues that affected you in the fourth quarter were pretty much absent in the first quarter?

Yes.

Thank you very much, sir. [OPERATOR INSTRUCTIONS]. The next question comes from the line, Mr. Steve Chercover of D. A. Davidson & Co. Please proceed.

What is the run rate now of the new Las Vegas tissue machine? Is it running at the full 30,000 tons or close to it?

It’s running somewhat above that.

Is that right? Does that explain why you had to go to third party converters? I’m kind of wondering why the converting capacity didn’t match the output or if there was just kind of a better ramp up?

No, it’s not. We basically made an error in forecasting. When we put in the TAD machine and we looked at our products, we assumed that our major customers would substitute the TAD towel for the premium 2-ply conventional towel that we had.

And that seemed to be a logical assumption; however, that’s not what happened. When we brought the TAD towel on, of our three largest customers, two of them decided they wanted to keep the premium towel and add the TAD as well. As a result, what we -- when we thought we had plenty of converting capacity for the TAD, we did, but then we don’t have converting capacity for conventional. So, it’s something of a viscous circle. Our towel demand in total was substantially greater than we had forecast.

We thought, additionally, Steve, that to the extent that people kept the premium towel on the shelf, that the new TAD towel volume would cannibalize the premium volume, and that has not happened. What has happened is we have gained share in the Towel segment, and that’s a good problem on a long-term basis, but it wasn’t a good problem on a short-term basis.

That then caused problems in other categories because we have -- tissue is sold roughly half in a normal time, roughly half of it is sold under some kind of promotional deal. We clearly did not want to be out promoting towels because we couldn’t convert enough of them, both premium and TAD, and so that shifted promotions into bathroom tissue, which then means you sell more bathroom tissue, or we did under promotion, and that caused service issues there, too. So it was kind of a cascading effect, which is not over. We’ve managed it pretty well from a customer standpoint. While we have had service issues, they have not been severe enough or significant enough to cause us to lose any customers or worry about losing the customers, but it’s cost us a lot of money in outside converting and in freight because we’ve been shipping products from places to other places that you would not do normally if you have converting capacity if you had the inventory on hand. We’ve been shipping some product from the Mid West back to the West; shipping product from the West to the East just to balance all the service on a day-to-day basis.

So you had expected to lose volume in the premium conventional towel market, is that correct?

That’s correct. And we have lost some but we haven’t lost much, and that is a good long-term problem. It will be something we’ll be glad of by the third quarter, but it certainly has given us substantial grief over the last 12 months.

Sure. Do you have any idea since you’re gaining share, at whose expense?

I do, but I would prefer not to comment. We track in each of our customers; we know kind of what products are selling and what shares are, but that’s not one we talk about.

And could you provide us any kind of update on the conversion to REIT?

Certainly. We have -- I am glad you asked that question. We have been doing an awful lot of work and we are convinced that we have the ability to convert to a REIT with the asset mix that we have now, and to do so, and comfortably meet all tests that are required going into a REIT. Having said that, our Board has still not acted on it. We have not taken an action to date until we are through with all considerations and there are clearly pros and there are cons.

I think, as I said, at the last conference call, that we would expect to make a decision no later than the end of the third quarter on conversion. We do have, though, and I think it was unclear in that call, some analysts thought that we said we could convert under our present status, and some were not sure. We clearly have now done enough work to be convinced that we will have no difficulty in converting.

So, well that’s great because that means if you get a good bid for some of your assets, obviously you’ll hit it, but there’s no fire sales.

Correct. I think you could look at the mix of our assets and not unlike the way we look at OSB. OSB was an asset that we liked very much, and didn’t want to sell, but its value was higher to Ainsworth for a number of reasons than it was to us, and so we sold it, and we would look at any other asset in the same way.

And finally, I think I am going to try and paraphrase you, I believe you said it was your opinion that the optimal configuration for REIT would be to have as few operating assets as possible. Is that still your opinion?

I am trying to remember when I may have made that statement. It clearly wasn't in this call.

I think now it might have been two quarters ago.

There are only a couple of timber REITs out there, Rayonier, and Plum Creek, and you can argue I think, with some logic behind it, that the cleaner a REIT is in terms of its non-REITable assets or the lack thereof, the easier it may be for analysts to understand in the REIT market, and therefore it may be afforded a higher multiple. If you look at Plum Creek and Rayonier I can make that argument to some degree, although I am not sure that is a valid argument just looking at those two, but I think I have said something along those lines, and all things being equal, a REIT is probably more valuable if it has less assets in taxable subsidiaries than otherwise.

That's good news.

Thank you very much sir. Ladies and gentlemen, your next question comes from the line of Ms. Heather McPherson, T. Rowe Price, please proceed.

Did I miss this? Did you give an estimate of how much you think this outsourcing cost you over the course, I guess last year, and how much you think you can save by moving to the new converting line?

No we haven't. We actually did not give those numbers. The outsourcing itself is a greater quarterly expense than the loss we had in the first quarter, and the converting line –- and forgetting the outsourcing, the addition of the converting line has a larger effect than eliminating outside sourcing, but we have not given specific numbers.

The other question I have is I think you still have some debt that has a higher interest rate because of your ratings.

We do.

Have you had any conversations with the rating agencies? Do you have any outlooks there that we might potentially see an upgrade and some improvement on your interest expense?

We have ongoing conversations with the rating agencies. If you parse through what they have said at their last movement on our ratings, they all have concern about our structure, and seem to be equating our rating to that concern. So, as long as I think, potentially, as long as we have an unknown in our structure, vis-a-vis a C-Corp or a REIT, there may be some question about the timing of their changing our rating. We will probably go back and have a face to face with them later this spring or early summer to try to get through all of that with them. We obviously don't see why that doubt in their minds should have any impact on our ratings given our balance sheet, but they have a disagreement with us on that.

Can you remind me again, I know I keep blocking out (ph), but you can remind me again how the rates would step up if you were upgraded?

If we were upgraded into investment grade, the very first notch that we would go up would save us $3 million dollars a year.

Okay, and this is Moody's, and S&P?

Moody's and S&P according to our agreement on that particular issue

So they both need to have you –-

They both need to move, yes.

Heather McPherson¨ Okay. All right, I think that's it.

But one addition I might make to what Gerry said earlier in terms of CapEx we did have carryovers. We also though have a heavier capital spending year this year, because with our balance sheet in shape, we are spending money on lots of small projects with high pay backs that we have known about for quite a while but projects in the 40% to 80% DCF range, because in the prior three years, if it didn't have an 80% DCF, unless there was a strategic reason for doing so or necessity, we didn't fund it. So, there are a lot of smaller projects, which we are trying to get in as quickly as possible, because they pay back very fast.

Are these mostly energy related?

They are all over the lot. They really are mostly productivity related. A lot of them would do with updated electronics, and scanning in various places in the lumber side. Some of it is energy related in the pulp side. Trying ways to dry more efficiently as well, so they really run the gamut and there are a lot of projects, almost all of which have been -- gone through our approval process and are in some stage of construction or, in many cases, completion.

Thank you very much. [OPERATOR INSTRUCTIONS] Your next question comes from the line of Mr. Mark Weintraub of Buckingham Research. Please proceed.

Penn, if you were to go the REIT route, can you give us a sense of what metrics you would focus on in deciding what an appropriate distribution level would be?

Rather than giving you a metric Mark, what we would want to be sure to do is have a distribution level which is as high as we can make it without having the risk of as we go through cycles in this business, of having to reduce it in the future. That is kind of a non-answer, but that's the philosophy, and I can't very well give you the metrics without telling you what that number, without leading you towards what that number might be.

Okay, maybe, I don't know if you feel comfortable answering. Would it have to be a number that you could cover at all points in the cycle every year, or is it conceptually possible that you would be willing to set it at a level that, one given year you might not have full cash coverage, but certainly over the course of the business cycle you would expect to be well above it or above it.

I think you would like to do it in a fashion that you can cover it in all points of the cycle, realizing it doesn't, we are not talking solely about income from timberlands. You are also talking about potentially some income from the taxable subsidiaries, income and/or cash flow, because it really is an EBITDA, or FFO kind of a measure, rather than an income measure.

Thank you very much sir. [OPERATOR INSTRUCTIONS] At this time, we have no further questions in queue.

That being the case, we would like to thank everybody for joining us this quarter, and we will talk to you next quarter. Thanks Bill.

Thank you sir, and thank you ladies and gentlemen for your participation in today's conference call. This concludes the presentation, and you may now disconnect. Have a good day.

Thank you.