Potlatchdeltic Corp (PCH) 2005 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2005 Potlatch earnings conference call. My name is Gayle, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question and answer session towards the end of today's conference. [OPERATOR INSTRUCTIONS]. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to you host for today's conference, Mr. Gerald Zuehlke, Chief Financial Officer of Potlatch. Please proceed, sir.

Thank you, Gayle.

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 implied in 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 filings with SEC.

I would like to turn the time over to Pen Siegel, our CEO, who will discuss third quarter results and provide an overview of our operations and markets. Pen?

Thanks, Jerry. Good morning.

The -- I will go through each line of business in terms of what happened in the line of business and what's going on currently and have some additional comments on energy after I go through all segments. In the resource segment, we had a decline in income to 25.9 million from 30.2 a year ago. That's primarily -- or more than all of that decline is the result of a decline in lower land sale revenue. Last year in the third quarter we had a $4 million -- 4.1 million from the sale of conservation easements in Idaho. We continue to work on some conservation easements, but when they close is -- is not forecastable and doesn't occur at the same time each year. The log pricing is actually somewhat better this year than it was last year and remains good today. And that business is tracking, I guess I would say normally. In wood products there was a slightly more than $20 million decline in operating income. That is almost entirely due to lower selling prices for lumber and to a lesser extent panel products. The market continues to fluctuate. Current prices are okay, not great and not bad. Demand has been pretty good. The panel pricing environment has been somewhat better post the two recent hurricanes in that lumber -- lumber had a short run-up and then settled back to, I'd say, a normal level; and panels had a larger run-up and now seem to be settling back to some degree.

In pulp and paperboard, we barely broke even down $12 million from a year ago. That's largely due to higher chemical and energy costs and substantially lower selling prices for pulp, which we sell internally to consumer and we sell externally. And I'll have some other comments on energy and chemicals at the end, kind of across the whole Company. A year ago, that 12.2 million we earned did include a $3 million unusual payment as a result of a liquidation bankruptcy from Beloit Corporation. Consumer products swung to a $2.2 million profit this year from an operating loss of 5 million last year. Better prices and better shipments were largely responsible, as well as some slightly lower per ton costs on the production side, although freight was quite a bit higher. Freight and packaging.

We issued a -- an earnings warning last week, and we mentioned roughly $10 million in energy costs higher in the third quarter than in the third quarter of 2004. If you add in chemicals for pulping, the various chemicals that are used and polyethylene packaging, which is primarily a consumer issue, the increase third quarter to third quarter in those costs was slightly less than $15 million in total. And if you -- as you break down energy, the largest component of that is natural gas, and that is primarily in our pulp and paperboard operations. The fuel surcharges, which were perhaps 40% of the increase in energy, are primarily in consumer products where we still don't have -- although our finished goods inventories are getting close to where we'd like to have them so we can use much more rail shipment, we're still using more truck than we would like and probably will be until sometime around the end of the year when our finished goods inventory should be sufficient to allow much more rail shipment, which is quite a bit more economical.

The -- in terms of energy, one other thing I might mention before I turn it over to Jerry for -- for some statistics, in natural gas usage -- and that, as I said, is primary in our pulp and paperboard operations -- we have seen a 51% decline in per-ton natural gas usage from 2000 to 2005 from roughly 13 million BTUs per ton in 2000 to 6.4 million BTUs per ton in 2005. And looking at what's happened to energy costs and -- an unusually large portion of our capital spending next year will be aimed at further energy reduction processes, both substituting fuels but primarily changing the systems to capture most waste heat so we burn much less natural gas.

And, Jerry, I'll turn it back over to you for statistics.

Okay. Thank you.

As is our normal practice, I would go through third quarter versus second quarter sequential changes in shipments, and sales prices -- net sales prices. I'll do shipments first, and starting with lumber shipments third quarter versus second quarter were up 8%. Plywood was down 14.5%, particleboard was down 7.4%, paperboard was up 5.9%, pulp was up 236.5%, tissue was up 1.7%. In sales prices, lumber sales prices were down 6.2%, plywood was up 1.4%, particleboard was down 2.9%, paperboard was down 0.4%, pulp was down 15.2%, and tissue pricing was up 2.6%. I've also normally given you a trend, which is September in this case versus the third quarter average. With the exception of pulp and tissue, virtually all of them were relatively flat September versus the quarter. In the case of pulp, there was a fair increase in trend from September versus the quarter average, and in tissue, also a upward trend September versus the quarter. In all other cases, they were relatively flat.

With that, we would like to go back, Gayle, and take questions.

[OPERATOR INSTRUCTIONS]. Kuni Chen, Banc of America Securities.

Hi, good morning. Let's see, you touched on some CapEx spending for next year in terms of reducing energy usage. I mean, can you this time give us a kind of full-year forecast for '06 in CapEx, and if you can't, can you just remind us what maintenance capital is then?

Yes. We have talked about in the past and anticipate after the conversion that we would maintain a normal CapEx expectation in the $60 million range per year. We feel that we have the flexibility to go a fair amount lower than that in any one year or even a couple years in a row if need be, maybe into the $30 million range. That $60 million range as we anticipated would be as opposed to around low $80 million DD&A total for this year. We would expect that to -- to go to about the $90 million level next year.

DD&A goes to 90 million?

Roughly, yes.

Okay. And as far as the dividend that you're targeting as a REIT, the $2.60 -- or I guess, the 76 million, can you -- can you give us some metrics perhaps either EBITDA or operating cash flow or FFO that -- that you guys will kind of target around that dividend?

I'm not sure I fully understand the question, Kuni. We do not as a -- as a corporate practice forecast other than the DD&A for people. We do not forecast income publicly, and converting to a REIT will not change that. We will continue not to -- to target that publicly. As we look at dividend payouts and as we expect a pretty substantial increase in EBITDA over the next three to five years for reasons we covered in our September 19th announcement, both Hybrid Poplar at Boardman and a fairly substantial increase in harvest in Idaho, we would expect our payout to an FAD to be comparable to the other companies, Rainier and Plum Creek, that we are -- will be in the same basket with and probably Longview, although I have not studied Longview as much to date.

Right. I mean, I'm not asking for an income forecast. I'm just trying to get a sense as to kind of how much cushion you have in your operations to -- to sustain that dividend, especially if there's perhaps more cost pressure on the -- on the manufacturing side of the business.

We went through -- prior to the Board to making the decision, we went through an awful lot of sensitivities, Kuni, looking at what-if scenarios and picked a dividend rate that we are confident that we can sustain as we go through those sensitivities if they occur and increase over time, primarily because of the two things I mentioned, Hybrid Poplar and Idaho harvest.

Okay. Terrific. And one last question on tissue pricing. Can you just give us an update on how things are going in the market there? I understand that you had some sheet count reductions in the quarter and potentially the industry may look to do more in the way of pricing in the fourth quarter, so can you just remind us of that?

Certainly. We have had -- we've had some actual price increases. Let's forget the sheet counts for a second. We have another price increase going in on facial November 1st, and it will be variable by customer but a fairly substantial increase. The -- with regard to sheet count, there is another sheet count reduction, which is already working its way through where we targeted October 1 and all we're doing now is running out of the old packaging. It's more economic to use up that packaging, given what polyethylene costs are these days, than is to burn it for fuel. So we are -- but we'll see further price increases on a sheet count basis in this -- in this quarter. The pricing Jerry gives you is pricing per ton, and that will, therefore, see further increases in the fourth quarter. And every -- as I look back at the months, every month's price has been somewhat higher than the last -- than the prior month's for at least the last six to nine months.

Okay. Thanks. I'll circle back.

Rich Schneider, UBS.

Hi, Pen.

Good morning, Rich.

Could you give us some general parameters on what increase in harvest levels you may be looking at next year coming out of the Idaho land?

We have -- we have announced it is a substantial increase over -- over the next decade. The question -- one thing we don't want to do is to disrupt markets, so it is -- it relates to capacity of mills to consume additional logs. Since we're a -- in Idaho, we're a very large player. We supply probably about 30% of the timber currently, and that percentage will be going up. There are two -- there's one new mill under construction which starts up earlier in the year -- not ours, and there's another mill making some major increases which goes in. There's also one that's announced it's shutting down, although it's not the species with deal with. At this point in time, I think we can't give you a number, because I don't have a real good number. We will -- we will step up harvest quite substantially as quickly as we can do it without affecting markets. We'll -- we'll keep it there for a decade or so.

And the number that was thrown out is, what, something around 1.5 billion board feet -- 1.5 billion board feet over a decade? Is that what you're looking at?

I don't know where that number came from. That is not -- that's not our number.

Okay.

It may be somebody else's -- somebody else's estimate, but it certainly isn't ours.

Okay. Well, have you given any indications of what -- what it would be over a decade?

We spent a lot of time arguing whether it was material, substantial, or significant, and it's all of the above, but the answer is no. We have not given any numerical. We will continue to report each year what harvest levels were, and we are -- we will start probably to see some harvest increase in the fourth quarter. But -- but we have not given any numerical projections, Rich.

Okay. If you look at the impact with 10 million year-over-year and 15 million if you include chemical and other costs in terms of the cost increase, could you give us some idea of what it was sequentially going from the second to third quarter, with those same input numbers?

I don't have those input numbers in front of me. Sequentially it has clearly been rising. One thing that's unusual is normally energy costs decline second to third quarter just because of weather. We burn -- in Idaho we have changed our systems enough that we burn virtually no natural gas in the summertime. We do burn some in Arkansas, and then we generally -- generally see higher energy costs in the winter, as you would guess, and energy costs and chemicals and poly -- chemicals and poly really are unaffected by seasonality. All three rose from second quarter to third quarter, which is unusual in the case of energy.

And in -- the expectation is fourth quarter this is also going to be higher, I mean, from --

I think that's a very likely -- that's a very likely assumption.

Particularly where natural gas is today?

Yes.

Okay. Talking about the distribution, under what conditions would you be willing to lower your cap spending down to the $30 million level? Is it to make sure you cover the distribution, or would you be willing to borrow instead of taking CapEx down? How do you view that whole CapEx borrowing distribution?

It's really -- we will look at how secure we believe the dividend is, and we think it's quite secure. It does not bother me to borrow some money. I know we'll be borrowing money seasonally, Rich, just because we do have a seasonal business and the dividend will be paid in a -- an even flow standpoint as opposed to a seasonal standpoint. So we will be borrowing money, I'm sure, in the next -- maybe most years in the first half of the year, and then paying back most of that money. It doesn't -- doesn't bother me to borrow a small amount of money in a given year if -- the tradeoff is, Do you want to cut out an 80% DCF project -- internal rate of return project and not borrow money at 7% when that project is an energy-reduction project? At this point in time, I think I'd say -- I'd say no. 60 million is certainly sufficient to allow us to fund everything we should fund, and if necessary, as we've done two or three in the past -- past five years, if necessary we can hold capital down to 30 million. And the -- what determines necessary is really the conditions at that point in time. We don't see that at this point in time, Richard.

And then on the tissue operations -- last question -- even at 2.2 million, obviously, this is below the kind of required level to earn a decent return on those operations. And I know you've made progress from last year in energy and transportation, and particulate's gone against you. But I was expecting -- I guess you were too -- things to go -- to improve quicker back to a better level of profitability. Could you go through some of the other dynamics besides input costs? You mentioned the issue of not having sufficient inventory and having to depend upon trucks as opposed to rail. You had that startup of that tissue line outside of Chicago. I thought that was going to have some more positive impact, particularly now in the third going into the fourth quarter.

Let me -- let me step back. I'll give you a rough number. We have -- we have about the same customer mix we had a year ago. A year ago, we had finished goods inventories of about 1.2 million cases. What we need in the system to minimize freight and to allow us much more freight efficiencies is around 2.2 million cases. We are now at 1.95 or so, Rich. So the Elwood line has helped substantially. We no longer are having service issues, which we had last year, which we really had for a period of time and the new Elwood line is helping us both not have the service issues so we can deliver what our customers want when they want it and where they want it, as well as build the inventory. So it's a combination of the two. We're somewhere like two to four months away from having sufficient finished goods inventory to then begin shipping much more in rail.

And rail, as you know, as we ship from primarily Lewiston but also Las Vegas, as we ship finished goods from those locations, it takes 10 to 14 days on rail, and even then you can't be real sure the rail car will get there in 14 days. The rail system has improved sufficiently so that you know exactly where each car is at all points in time, but that doesn't help us move them. They will get hung up occasionally in a siding. They shouldn't, but they do, and truck shipments is two or three days. So there is a lot -- and the major fuel surcharges really have been on the truck side. That may be -- that may be easing, depending on whether the next hurricane hits the U.S. against or not in the Gulf. But still, I would anticipate that we will see substantial changes on the cost side in freight entering next year, and we still have a number of other initiatives underway to boost production closer to where the end market is. I mean, it is clearly more advantageous for us to ship parent rolls to Elwood, Illinois, outside Chicago, for example, than it is to ship finished goods from either Lewiston or Las Vegas. And we aren't -- we aren't fully there, but we are -- we're getting there. So I would expect to see sequential improvement in consumer going forward, all things being equal, like hurricanes.

Okay. Thanks a lot.

You're welcome.

Frank Dunau, Adage Capital.

Got a question. Could you explain what's going on with Ainsworth now? Are you not allowed --?

Oh, sure, Frank. I'll give a little background. The -- those plants were not for sale. We were approached by a couple of other people at the beginning of '04 at a price that I thought was not sufficient to have us interested in selling the business, and we did not. Ainsworth approached us roughly in May of '04, to my recollection, with a substantially higher price range, and it was a price that I thought because I think there were probably some advantages to them in owning those plants that we didn't have, it was a price that we believe was great than its value to us. And we negotiated, announced a sale in August and closed on September 20th of last year. Now around the September 26th of this year, having heard nothing from them, we were told that they had a large claim on lots of items that they thought were not maintained adequately.

As I look at maintenance, maintenance and repair is always a judgment call, and the key way I try to decide whether we're maintaining things properly is to look at up-time, productivity. And our productivity in those plants had increased each year and was again higher through August of '04 than it was through August of '03. So -- and we believe we maintained the plants very well. We have asked for information from Ainsworth to substantiate their claim and to date haven't gotten it. But from where we sit, and we've looked at all of our records, we believe we maintained the plants quite well and don't believe the claim has much merit. I would point out that some of those -- some of the equipment is old, and -- but all of that was disclosed during due diligence with Ainsworth, the specific age of each machine center bit by bit as you went through all three plants. So until I see some documentation from them, all of our avenues would suggest that they don't have a claim.

I mean, as far as -- I may be simplistic here, but as long as you didn't materially misrepresent anything, it's their fault for not doing proper due diligence?

One would assume so, but that's -- we'll wait and see.

Okay. Thanks.

[OPERATOR INSTRUCTIONS]. Steve Chercover, D.A. Davidson.

Good morning, guys. A couple of questions, please. First of all, with respect to ongoing land sales, will you give us any kind of data on what we should model as a run rate each year, or is it too lumpy to even do that?

I think it's too lumpy to do that. My recollection is that, for example, in 2004 the land sales we had encompass some 300-plus parcels. What we're talking about here primarily are other than conservation easement we're talking about a 20-acre or a 40-acre parcel in northern Minnesota, which has substantially greater value potentially in -- for someone who wants to have a cabin in the woods than it is for growing trees. And so we are -- as we segregate our timberlands in terms of productivity levels, northern Minnesota is about a quarter swamp, and some of the land is a lot more than a quarter, so some is clearly less than a quarter. And so what we are selling is primarily land which does not do much on the timber side, but which people from the originally Twin Cites and more recently most of the buyers are out of the Chicago area. People want a cabin in the woods somewhere. So it is lumpy. We advertise these. We sell them over the internet. We do have some other properties which are closer into fast-growing communities which are sold, and they tend to be lumpy as well. So what happened last quarter, I think, is kind of a normal quarter, but normal in this business is an average of a number of things which may be abnormal.

Well, you're soon-to-be peers both have pretty active and official real estate businesses. Do you anticipate having a subsidiary that's geared towards selling HB real estate?

We will have it. The -- you can actually sell HBU real estate in the REIT, and it is good REIT income, but it's taxable for the fist ten years after conversion. The -- where you run into trouble, Steve, is if you are in the -- doing anything that constitutes development as opposed to -- what I just described is good REIT income and is not development because we're not putting in road systems or underground things. To the extent we do that, that activity will be done in a taxable subsidiary of the REIT.

Okay. And switching gears just a little bit, Pen, you said previously that you believe that the less manufacturing you have within REIT, the better a REIT it is. Is that still your philosophical view?

It's -- it is a -- not a philosophical view so much as a market-related view. The market may value a REIT at a better level to the extent it has less manufacturing assets, and I -- that's a little hard to tell in our business because there only are two REITs out there. One of them's been out there now for almost two years. Plum Creek's been out for quite a while. Longview has announced they're going to convert and we are also. Plum Creek has the least amount of manufacturing assets relative to its size, but Plum Creek is also the company with by far the longest track record, having been a -- an MLP and then a REIT for an extended period of time. So that's -- that is my guess, Steve, but it is -- call it an educated guess. There isn't a lot of data to support one thing or the other.

Got it. Thanks.

You're welcome.

Kuni Chen, Banc of America Securities.

My question was answered. Thanks.

Thanks, Kuni.

Heather McPherson, T. Rowe Price.

Hi, guys. How are you? I was wondering, a couple questions on the corporate expense, it's down year-over-year, but have you guys talked about what you think that might be post REIT conversion? Did I miss that?

We haven't really talked about it necessarily, but we really don't anticipate much difference in corporate expense on an ongoing basis. There will be the need to look at how different costs are apportioned between the REIT and the TRSs, but overall the total corporate expense shouldn't vary too much.

There's probably a little bit of corporate expense. I think we announced in the S-4 we filed, Heather, that we expected REIT conversion costs to run something in excess of 8 million. And we are paying those costs as we go along, so there is something in this year's corporate expense that we would expect not to be a recurring charge.

Okay. And have you guys talked to the rating agencies at all? Because I know that you have that sort of punitive higher cost of debt because of your rating.

Correct.

And I'm wondering, have you kind of walked them through it, and is there an opportunity to maybe get that expense lowered once you get through this?

We have -- we -- Heather, Jerry and Doug Spedden and I visited all the rate agencies here the week after we announced -- the week of September 26, I think, the week after we announced reconversion, and walked them through all numbers including five-year projections by line of business, et cetera. So we spent quite a bit of time with each one. We believe, frankly, looking at our cash flows and looking throughout the industry, we don't agree with our current ratings. But having said that, the rating agencies are paid to create their own ratings, and they will do so. To date, I think none of them have issued a -- any comments and were probably waiting for this earnings call before going final, and we'll see what -- we'll see what develops. We feel very comfortable with our capital structure, though, and you are correct. We don't like paying the interest rate we're paying on the noncallable interest-sensitive debentures.

Yes. That's pretty high. Okay. Thanks. Did you guys talk -- I didn't hear you talk at all about cash level was in the quarter. I can kind of back into it, but can you tell me what maybe working capital did and maybe on the deferred taxes side if there was anything we would need to back out?

No. The EBITDA was around 45 million for the quarter. Deferred taxes was a slight change back, and in fact we are now at same level we were at year-end last year with adjustments both plus and minus. We felt that that was a good tax position as of the end of the quarter. Any further change in deferred taxes between now and year-end ought to be fairly minimal one way or the other, so -- and not a lot of change in working capital.

There is -- as part of our post-conversion, as part of the E&P purge, there will be a fairly substantial deferred tax adjustment because of that purge from deferred taxes into equity.

But no change in cash.

No, it's not a cash event. It's just a balance sheet event.

Okay. All right. I think that's all I have.

Thank you.

Joe DiMassio [ph], Bear Stearns.

Hi, guys. Thank you for the call this morning. I had a question. I was reading through the registration statement, and it says in here that under the code no more than 20% of the value of the assets of a REIT may be represented by securities of one or more of the TRSs. How does that -- so when you were talking about the manufacturing operations and the TRSs earlier, what kind of percentage are you at right now?

The way that test with works -- there are a number of REIT tests, Joe. The way that test works is slightly different from what the words seem to say. It is no more than 20% of the assets in the total REIT can be represented by the equity value of the TRS subs. Not the asset values. So what -- what you do is go through and estimate the value of each asset, and these aren't balance sheet -- these aren't balance sheet items. These are estimate of what's the true value of the timber land, what's the true value of each of the manufacturing assets. The debt that we have outstanding will be pushed down to the TRS assets, as will a fair amount of the other long term liabilities. And once you do that, we meet our 20% tests very, very comfortably. So we don't have to -- there had been some supposition that in order to convert to a REIT, we would have to sell something else. We do not have to sell anything. It doesn't mean we won't if the right opportunity comes along, but we meet that 20% test very comfortably because it is an equity in the TRS.

Okay. Great. I appreciate that clarity there. Thank you.

Sure.

And sir, you have no further questions at this time.

Okay. Thank you very much, Gayle, and thank you all for joining us for this call.

Thanks.

And thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.