Potlatchdeltic Corp (PCH) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2006 Potlatch earnings conference call. My name is Lisa, 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 this conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr. Gerald Zuehlke, Chief Financial Officer. Please proceed.

Thanks, Lisa. Joining me today is Mike Covey, our CEO. And before we begin, let me remind you that 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 the SEC.

Also, before we begin, please note that segment information for shipments and prices per unit can be found on our website in conjunction with this call.

I would now like to discuss our second-quarter results, after which Mike Covey will provide some additional comments, including an overview of our markets. Our second-quarter net income totaled $8 million or $0.21 per share versus 8.2 million for the second quarter of 2005 and 11.6 million last quarter. Revenues were 414.6 million, up 12.5% over last year and 3% over last quarter, driven primarily by increased shipments from our Consumer Products segment.

Our Resource segment earnings for the quarter were 9.8 million versus 13.5 million last year and 14.4 million in the first quarter. The main cause for the lower earnings compared to first quarter was lower fee timber harvest, particularly in Arkansas, where continued dry weather has reduced our ability to market and ship logs. Total fee harvest was down approximately 213,000 tons Company-wide.

Sequentially, second-quarter earnings are typically lower than first quarter due to spring breakup conditions, which limit harvesting in Idaho. We also experienced an operating loss at our hybrid poplar tree farm in Boardman, Oregon, as trees have reached marketable size and we continue the startup phase of marketing logs and chips. Reforestation and management costs, which were capitalized last year, are now being expensed.

Our Land Sales and Development segment closed on a conservation easement for 1.1 million in the second quarter of 2006, which resulted in higher earnings when compared to the first quarter. Most of our land sales activity is on hold pending the completion of an ongoing assessment of all land for alternative value.

The Wood Products segment had earnings of 3.5 million during the quarter versus 13.7 million in last year's second quarter and 7.3 million in the first quarter. Our mills continued to run well during the quarter and shipments were higher than both comparable quarters for all product lines. However, lumber pricing and higher log costs led to lower earnings compared to one year ago.

Lumber pricing in the South has dropped by $49 per thousand board feet when compared to the second quarter -- to the same -- excuse me -- the second quarter to the same period one year ago. Higher log costs, particularly in Idaho, and higher freight expenses from fuel surcharges accounted for most of the variance from the first quarter.

The Pulp and Paperboard segment earned 3.9 million versus a small loss of $100,000 in last year's second quarter and a loss of 1.7 million last quarter. Pulp prices were 4.2% higher than last year's second quarter and up 13.6 compared to the first quarter of 2006. Paperboard prices were 2.6 higher when compared with last year's second quarter and flat when compared to last quarter.

Our Cypress Bend plant had a planned boiler maintenance outage during June that had to be extended for nonplanned maintenance, which led to lower production and approximately $1 million lower earnings than would have been expected during the quarter.

Costs for energy, freight and chemicals, all oil and gas related, remain high. This year, we instituted a natural gas hedging program and we have hedged 50% of our combined Pulp and Paperboard and Consumer Products segments' natural gas usage for the fall and winter months.

The Consumer Products segment had another strong quarter with 7 million in earnings versus 1.8 million of earnings in the second quarter of 2005 and 6.9 million of earnings in the first quarter. When compared to the second quarter of 2005, selling prices were 6.5% higher, which is a combination of price increases and sheet count reductions, and shipments were 20% higher. Shipments were 19.5% higher than last quarter as we continued to reduce surplus inventory. Prices have remained flat quarter over quarter, with a slight reduction in sales returns related to mix.

During the quarter, we made our second quarterly REIT distribution of $19 million. Year to date, we have made 38 million in quarterly distributions, and an additional 89 million of cash was returned to shareholders as part of our earnings and profit distribution in the first quarter. On July 15, we also called the remaining 5.5 million of our 10% senior sub notes at a price of 1.05.

I would now like to turn it over to Mike Covey for some comments, after which we will open it up for questions. Mike?

Thank you, Jerry, and good morning, everyone. Market conditions in most of our business segments remained strong, with the exception of lumber pricing, particularly in the South. Selling prices from our two Southern sawmills were down $11 per thousand board feet for the first quarter and continued to slip in July. We expect the margin squeeze caused by the decrease in Southern lumber prices and relatively strong log pricing to continue for the remainder of the third quarter.

Surprisingly, log prices in south-central Arkansas, where our mills are located, have remained strong, despite quotas which limit deliveries to many of our log customers. Year to date, we have harvested 11% less than planned in Arkansas due to inventory quotas and delivery restrictions at many customers' mills. Without a change in the extremely dry weather pattern across the central southern U.S., we will continue to lag behind delivery plans and defer harvesting until the fourth quarter or into next year, if necessary.

In contrast to our weak Southern lumber prices, our stud business in Minnesota and Michigan and our Idaho cedar business remained strong in the second quarter. However, we expect continued weakness in the broader lumber markets, at least through fall, and have already seen prices slip further in July.

Looking ahead to the third quarter and the balance of 2006 for our resource business, harvests in the second half are expected to increase by 23% or 360,000 tons as we move away from the spring breakup period that impacts the second-quarter activity in our Northern operations. We expect log prices to remain fairly stable unless there is additional significant deterioration in lumber pricing that persists.

In April, we announced plans to seek third-party investors or manufacturers to construct a hardwood sawmill to process hybrid poplar logs from our Boardman, Oregon, tree farm. We have interest from multiple manufacturers that are processing logs harvested at Boardman on a trial basis to assess the marketability of both the lumber and veneer products.

We have also seen increased interest in added value for woodchips. And we're exploring export markets for poplar logs, especially for furniture manufacturing in Asia. Long term, we remain optimistic that Boardman will provide meaningful cash flow as markets develop and manufacturing capacity is deployed to serve customers.

Beginning in June, we began an assessment of our ownership Company-wide to identify lands with alternative value. As mentioned before, we plan to update investors by year end on our first cut at stratifying our land base into nonstrategic recreational and higher and better use categories.

And as part of our conversion to a REIT in January of this year, we have a 10-year built-in gains tax on the sale of any property. Through the use of 1031 exchanges, we can defer the tax and transfer the basis to newly acquired property that has attractive cash flow opportunities from harvesting and management of timber resources.

Through thoughtfully timed land sales and exchanges, we can grow the value of Potlatch in a tax-efficient manner. We have put a number of previously planned transactions on hold until we complete the assessment and identify exchange opportunities that are tax efficient.

Switching to our pulp businesses, as Jerry mentioned, our pulp-based businesses had earnings nearly $6 million higher than the first quarter. Our bleached paperboard business continues to improve due to stronger paperboard and pulp pricing, as well as quality and productivity improvements, primarily in our Idaho mill.

Last month, we completed the installation of additional coaters on one of our Idaho paper machines, which will allow us to penetrate the commercial printing market with a true coated two-sided sheet. We are excited about the quality of this product and expect it to significantly enhance the profitability of our Idaho mill after we begin sales in August of this year.

We see continued upside for the profitability of our bleached paperboard business for the remainder of 2006. By the end of the third quarter, the $40 a ton price increase announced on folding carton stock in April will be fully implemented, resulting in an annual revenue improvement of approximately $11 million.

In the West, the selling price increase in the second half of the year will be partially offset by rising wood costs at our Idaho mill. Persistent chip shortages earlier this year, coupled with the declining lumber market, may drive up the cost of chips in Idaho. Access to pulpwood in Arkansas is excellent and we do not anticipate fiber cost pressure at our Cypress Bend mill in Arkansas.

We have had two strong quarters back-to-back in our Consumer Products tissue business. During the second quarter, revenue was a record $117 million, the first time we have sold more than $100 million of tissue products in any quarter. Year to date, we have reduced inventories of finished goods and parent rolls by $13.6 million. And we are on track to bring inventories down by another $11.4 million by year end.

In December, we will commission a new converting line for bath tissue in our Elwood plant near Chicago, allowing us to further optimize logistics and transportation to serve our private label customers. Increased pulp pricing during the second half of 2006 will add cost pressure to this business, but we expect or performance to be generally in line with results to date.

As Jerry mentioned, it appears we will continue to face energy cost pressure in each of our businesses. -- fuel surcharges for logging and transportation, both rail and truck costs, and continued cost pressure on resins and natural gas. This year, we took the initiative to hedge about 50% of our natural gas needs for the remainder of the year at contract prices locked in during the last quarter. To date, we have hedged 15 million therms at a cost of approximately $6 per million BTUs.

So far this year, we have returned $127 million of cash to shareholders compared to about $8.5 million over the same period one year ago, largely due to our conversion to a Real Estate Investment Trust.

Our capital spending to date has been $27.3 million and we are expecting our total capital spending for the year to be approximately $60 million. Our debt to total capital ratio is less than 34%.

As mentioned, we are seeking suitable timberland acquisitions that we can use in a 1031 exchange process to efficiently manage the sale of lands which have higher values. Suitable transactions will need to be cash flow accretive and complement our existing geographic footprint of operations.

We will continue to invest in the maintenance and improvement of our two pulp-based businesses, but we will not allocate significant amounts of capital to grow these businesses.

Fundamentally, our strategy is to grow the dividend through increased cash flow from our investments in our land-based business segments and opportunistic investments in solid wood manufacturing assets that are coupled with timberland acquisition opportunities.

Lisa, we will now open the call for any questions from investors.

(OPERATOR INSTRUCTIONS). Rich Schneider, UBS.

I was wondering if you could talk about your assessing the outlook and segmenting your land development area? What does that mean this year in terms of what you will be doing for the balance of the year? Is everything pretty much on a hold situation? And how does that work with putting that together with looking at the most efficient way to do this on a tax basis?

Well, as you know, it is hard to build a road to lead this part of our business segment, and to kind of get to the second part of your question, yes, most of our land sales activities, with the exception of conservation easements, which were initiated some time ago, are primarily on hold for the balance of the year. There will be a couple of exceptions to that.

But our plan for the balance of 2006 is basically to scrub and evaluate every single acre using geographic information system technology and on-the-ground truthing, to go through our ownership in Minnesota, Idaho and Arkansas, all three locations, to identify lands which clearly have higher values than timberland uses, as well as those that have nonproductive qualities such that they're not that attractive for growing timber. Maybe they have higher values in a recreational outcome as a lease or just a low-valued land transaction to a hunting club, or something like that.

So we will go through, identify lands which are suitable for added development, those which are just higher and better use that we will sell outright, and those that are nonproductive in each of the three states. We'll get a first run of that completed by the end of this year, which at that point, hopefully in December, we will come back with a presentation to analysts and investors about not only the quantity of what we have in each one of these value buckets, but some sense of timing and how we will go about extracting the value over time. But most of what we've got in the pipeline, it's on hold pending this analysis this year.

I think how that couples with, on the flip side, with the initiatives to grow the Company on a 1031 basis -- we'll try to match up these land sales activities with 1031 exchanges. Some of those will be quite small. They won't necessarily move the needle, but they allow us to do the land sales tax efficiently while we look for and seek larger growth opportunities for the Company and larger timberland transactions. But to match up the real estate activity more effectively, those will be done on a smaller 1031 basis. Does that help?

Yes, that helps. And so, coming out of this thing, you're probably not going to be looking to do much in the way of timberland transactions until you have your plan for HBU and other lands in place. Is that correct?

That is generally correct. And obviously, if some opportunity comes along, we will evaluate that. But our first task is to get our arms around this land analysis side of things.

And then the other implication, if you are not pushing hard on land sale development, it looks like from a cash flow statement basis, you will be close, very close to covering your dividends, but you may have to borrow. Is that possibility out there -- you may have to borrow to pay your dividends in the short term?

Well, we haven't had to yet, as well as -- not only have we made the first two quarterly distributions of roughly $19 million each, but we have also paid the $89 million cash portion of earnings and profit purge -- all out of cash on hand. And we've not dipped into the revolver at all.

I expect just due to the volume of the seasonal nature of our activities, the third quarter should be quite strong. It is not out of the realm of possibility, as we said when we converted to a REIT, that there may be quarters due to a seasonal basis that we do have to use the revolver. But I don't expect that's going to continue anything more than a seasonal nature.

So it's not something we have really contemplated right now. We feel pretty good about the cash flow generation from each of the businesses. And we are not going to sell lands if we don't have it done tax efficiently and if it doesn't suit the right amount of timing. We are not just going to sell land to make the appearance of dividend coverage.

And one question on your hybrid poplar. Could you give us an idea of what the loss was in the quarter? And I guess cash flow, you are positive, but on a reported basis, you booked a loss -- and when that turns profitable?

Well, we are not going to give out the individual -- that portion -- Boardman is concluded within our resource segment. And we did have an operating loss in the quarter. I don't think it was significant to the results of the Company. But we expect -- I expect that loss is going to continue, depending on what happens with chip prices, for a couple more quarters, at least until we get traction behind us with enough manufacturing partnerships or supply agreements or commitment with others that are going to buy logs and convert them either to lumber or veneer. And as you know, since we decided not to build the sawmill, we've had a bit of a setback in timing. It is going to take some time to get that in place.

On the positive side, as I mentioned, there's kind of a looming chip shortage in the West. We're seeing increased cost pressure on chips in our own pulp-based business. And the Boardman business is enjoying a surge in chip pricing for the poplar chips that we produce for a variety of outside customers. We don't use the poplar chips in our own mill at the current time; we sell those to other customers. So that will help the profitability of the Boardman operation over the next couple of quarters.

And just one last question. When do you think -- maybe you have to be a weather forecaster for this -- but when do you think the log inventories that are out there in the South, particularly Arkansas, will be worked down?

There is an old adage that all droughts end in a flood. So I have no idea when that is going to happen. But typically, just seasonally, we wouldn't expect meaningful change in weather pattern until late in the third quarter, the beginning of fourth quarter. So I just think -- I don't think the inventory position in the South is going to change until we get through the early part of the fall and see what happens. I think we are kind of stuck with it for at least another quarter.

George Staphos, Banc of America Securities.

My question for you, just back on Boardman, I know you don't want to share too much in the way of details. You already told Rich, to his question, that you're looking at another two, three quarters, I guess, of startup losses.

But I guess the question is since you began harvesting in late '05, was that in anticipation of the sawmill project going ahead as well? And since that hasn't gone ahead and the effect of that is that you are continuing to incur startup costs, can't you cease operations in Boardman for the time being until you are in a position to, through these partnerships and having more in the way of revenue stream for Boardman, start to absorb those startup costs that you've capitalized?

Well, the timing of the sawmill announcement that was made and subsequently canceled really has to do with the economic age of the trees and the rotation age of their best suits, the hybrid poplar species. And that is roughly in this 10- to 11-, 12-year age category, depending on genetics and past management practices and so on.

But these trees are roughly 95 feet tall, the ones that are in this 10- to 12-year-old age class, or call it 11. They are 10 to 12 inches in diameter. And they have reached a point where they just have to be harvested or they're going begin to deteriorate and will begin to lose value. They have reached their financial optimum rotation age. So that is really what is driving the harvesting activity at Boardman, more so than any sawmill activities had to do with it.

And so once you reach that point, you have to start incurring the costs you had been capitalizing up until now?

That is correct. And of course, the 17,000 acres we own there is roughly divided into 10 blocks of even-aged trees. So we have roughly 1500 or 1600 acres, I think, every year that is in that same age category. So we are harvesting all the 11-year-old trees this year. And next year, there is going to be another 1500 or 1600 acres of 11-year-old trees. So it's set up kind of in perpetuity that way.

Were the capitalized costs more than you would normally see for this type of plantation?

Well, I can't answer that, because this is the only one of those plantations that we have. They are significantly more than what you would expect for a natural forest stand that we might plant in Idaho or Arkansas or someplace like that. And the reason for that is the primary expense that we incur at Boardman for the growth of these trees is really electricity to irrigate the trees. We have a significant irrigation system, a drip irrigation system that not only waters but fertilizes every single one of these trees. So that electricity cost is very, very large.

Fair enough. Last question. Jerry, it would look, back of the envelope, that you generated about 35, 40 million of free cash flow, maybe toward the higher end of that, versus the REIT distribution of 19 million. Is that a comfortable range for you on a going-forward basis -- 1.5, 2 times free cash to dividend on a go-forward basis?

That is about what we would expect, again, given the seasonal nature of our business quarter to quarter. In some quarters, we would expect it to be quite a bit better than that. And then some quarters, depending on weather conditions, it might be worse than that. But yes, we are comfortable with that on an annualized basis.

And that was a decent swag at this current quarter, correct?

Yes.

And last one, and I'll turn it over toward Rich's earlier question -- if you are below 1.5 for a couple quarters, five quarters, is there some sort of interval where you would start to reconsider the dividend?

I will let Mike answer that.

This is Mike. The Board of Directors set the dividend rate at the time of the REIT conversion with the thought being that the dividend was sustainable on the activity that was generated out of the Company's resource business, which is fairly predictable based on volumes and cycles in timberland, earnings from the sale of logs.

Obviously, that could be affected by a prolonged depression in the lumber market or other significant events like what is happening in Arkansas with the drought and so on. But I think over cycles, the Board assumed that the earnings from the resource business would cover the dividends, and the capital needs for the Company for the maintenance and operation of our businesses would be generated by each business.

And I think fundamentally, we still feel very good about that and feel very strongly about it, especially given we have got an increased harvest initiative in Idaho that we talked about last quarter, which was not factored in to the deliberations when the dividend was set. So we have had no discussions about any needs to think about adjusting the dividend.

I understand. Just a hypothetical. Thanks very much. Good luck in the quarter.

(OPERATOR INSTRUCTIONS). Frank Dunau, Adage Capital.

I have a few questions. Could you explain to me -- I am a little confused by what's going on in the market down in Arkansas. The prices are good, but the volumes are bad? Is that just -- is that in timber or lumber or both?

This is Mike. The situation in Arkansas it is a bit odd in that we have seen a dramatic pullback in Southern lumber pricing. That would be for the dimensional lumber products that we make and others, at least in the West -- in Arkansas west of the Mississippi.

But log prices have remained very sticky and have not really rolled back. In fact, we sold a stumpage sale in the last quarter where we did not have to provide delivery of the logs, but we sold the standing stumpage at prices above what we would have expected -- significantly above. So people are evidently speculating about the market or they think it is going to turn around.

But what it has caused us to be -- customers are just full of logs in their yards and they will not accept delivery. So hence, the volume is down, but the price is very good. We would be happy to sell more logs. But we cannot find a home for them. So for that reason, they are being deferred.

If I were just to be, like, teaching Microeconomics 101, given what you just described, one of two things has to happen, at least sometime. Either demand has to pick up for the logs or the lumber, or the price has to come down, right?

Over a long cycle, I would expect that is the case. It is an anomaly right now.

And the other question I have is there's a lot of press now about potential pension law changes. Would that, given what is being proposed now, would that impact you in terms of cash going out the door, maybe, in terms of funding the plan? Or is it more or less a neutral event?

We are comfortably funded on our pension plans. So the change in how it is presented in our financials won't have any impact on cash flow. We did an oversized funding last year, just because we were capable to do so on the tax law change. We would contemplate doing another one, but we will weigh all of those things. But just the change in presentation doesn't require any change from us because we are, on a total pension basis, nicely overfunded.

Steve Chercover, D.A. Davidson.

I don't know if you have ever given this, but could you tell us what your average growth rate would be in each of your geographic locations? So, like, the biological yield of the trees?

This is Mike, Steve. I don't believe we have given that out. I don't think we have disclosed inventories by each of the geographic locations, either. But I guess just a comment -- as you well know, the absolute growth rates biologically are much higher in Arkansas than they are in any of the other Company's holdings. Idaho would be second. Idaho timberland is really quite productive relative to some others in the inland area. Minnesota, even though that is mostly an alder and red pine mix, it would be the lowest.

Well, if you were to just take a swing at it, Company-wide, would you say that the growth rate in aggregate is better than 6 or 7% per annum?

I am not going to take a swing at it without looking at the numbers. On a weighted average basis, I just don't know where we would be. We will look at that and talk about it next quarter if we're going to disclose it.

There are no additional questions at this time. I would now like to turn the presentation back over to management.

Okay. Thank you, Lisa, and thank you all for joining us. We will look forward to talking to you next quarter.

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