Potlatchdeltic Corp (PCH) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen. And welcome to the Third Quarter 2007 Potlatch Earnings Conference Call. My name is Tanya, and I will be your coordinator for today. (OPERATOR INSTRUCTIONS)

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

Well, good morning.

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 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 please note that segment information, as well as a reconcilement of non-GAAP measures, can be found on our website -- www.potlatchcorp.com, as part of the webcast for this call.

I would now like to discuss our third quarter results.

We reported third quarter 2007 net income of $41 million, or $1.04 per fully diluted share, as can be seen on page three of the slides accompanying this presentation. This compares to net income of $34 million, or $0.87 per fully diluted share in the second quarter of 2007; and $25.7 million, or $0.66 per fully diluted share in the third quarter of last year.

I'd now like to shift gears and talk about our third quarter results, broken down by segment. Our Resource segment results in the third quarter were much better than both the second quarter of 2007 and the third quarter of 2006. Operating income in the third quarter totaled $38.2 million, compared to $19.9 million in the second quarter and $24.8 million in the third quarter of last year.

Increased fee volume was a significant contributor to the positive comparisons, with fee volume up 31% in the Northern region and up 77% in the Southern region versus the third quarter of last year. Pricing has been strong in all areas except in Minnesota, which is included in our Northern region. Our Real Estate segment closed sales totaling $3.7 million during the third quarter of 2007, resulting in operating earnings of $2.4 million. These land sales consisted primarily of rural recreational land located in Minnesota. The $2.4 million of operating earnings compares to operating earnings of $7.4 million in the second quarter of 2007 and $800,000 in last year's third quarter.

As we've said previously, our land sales are lumpy in nature, and therefore comparisons are difficult over a short period of time. It is important to note that the level of activity we experienced in the third quarter was consistent with our previous guidance for land sales in 2007. And as Mike will discuss later, we still anticipate reaching our annual sales goal of 15,000 to 20,000 acres.

Wood Products' operating income of $2.4 million for the third quarter of 2007 was lower than last year's operating income of $6.4 million but above last year's third quarter loss of $5.2 million, when we took significant downtime at our two Arkansas saw mills due to poor market conditions. The decline in sequential performance was due primarily to higher log costs, offset somewhat by modestly better pricing in our cedar lumber and plywood product lines.

The Pulp and Paperboard segment had operating earnings of $17.6 million during the third quarter of 2007, versus $17 million during the second quarter and $16.8 million during the third quarter of 2006. The second quarter included a one-time expense of $800,000 in connection with the union contract settlement.

There are three major drivers to our strong performance in this segment -- excellent production and shipments, a favorable pricing environment, and our continuing product mix improvement away from commodity grades towards higher value-add products.

Third quarter 2007 production of 238,700 tons was the second-best operating quarter ever, only surpassed by second quarter 2007 production of 240,000 tons. Consumer products reported third quarter 2007 operating income of $5.1 million, versus $4.1 million last quarter and $6.2 million in last year's third quarter. In the second quarter, the segment incurred $600,000 of costs from the union settlement mentioned previously.

Note that this segment has been undergoing a product mix shift over the past few quarters away from relatively low-margin parent roll sales toward higher-margin finished goods sales.

While overall sales tonnage sequentially increased 1.5%, finished goods sales tonnage increased 7.3%, and parent roll sales tonnage decreased 84%. The year-over-year decline in operating income is primarily driven by higher pulp costs.

Eliminations had an $8.5 million negative impact on operating income during the third quarter, compared to a positive impact of $4 million last quarter and a negative impact of $6.6 million in last year's third quarter.

The main driver for the negative elimination entering the third quarter was the seasonal log inventory build we typically go through this time of year in Idaho, as it gets more challenging to harvest during the winter months, and therefore we typically build inventory this time of year.

Corporate administration, including interest expense, totaled $18.6 million for the quarter, compared to $17.2 million in the second quarter and $18.3 million in last year's third quarter. Interest expense totaled $7.4 million in the third quarter of 2007, compared to $7.3 million in the second quarter and $7.2 million in last year's third quarter. Note that our interest expense is expected to increase as we utilized our revolver for the Central Idaho acquisition, which I will discuss in a moment.

EBITDA totaled $66.8 million in the third quarter, versus $68.3 million in the second quarter and $46.1 million in last year's third quarter. Funds from continuing operations, or FFO, for the quarter totaled $62 million, versus $54.7 million sequentially and $42.4 million a year ago. The Company paid a normal distribution of $19.1 million during the quarter. Pages four, five and six provide additional detail by segment for the variances I have described.

Finally, I'd like to wrap up by commenting on our recent timberland acquisition in Central Idaho. As previously announced we agreed to acquire 179,000 acres for $215 million from Western Pacific Lumber. The acquisition is very complementary to our existing timber and real estate businesses, as we've been operating in Idaho for over 100 years and owned, before the acquisition, over 660,000 acres in the state.

We've agreed with the seller to split the transaction into two pieces, the first of which amounted to $163 million and closed on September 19th, 2007. We paid for the first piece with $53 million of cash on hand and $110 million from our revolver. The second piece, totaling $52 million, is now expected to close in January of 2008, and we anticipate utilizing our revolver and available cash at the time of closing for financing this piece.

Our expectation is that this acquisition will be immediately cash flow-accretive. Our leverage ratios remain well within our debt covenants, with debt-to-capital at 43% at the end of the third quarter.

I would now like to turn the discussion over to Mike to provide some additional comments about our operations and markets.

Good morning. This is Mike Covey, the CEO of the Company.

We were very pleased with our financial performance in the third quarter, which was our strongest operating quarter since the REIT conversion in January of 2006. In addition, we continued to make progress on three key strategic goals, which I'll explain.

First, we've stated consistently our plans to expand our timberland holdings in our key operating areas if we can find cash flow-accretive acquisitions. Specifically, we've targeted our acquisition efforts around the Lake States, the South Central U.S. and the inland West.

As Eric mentioned, we announced our 179,000-acre acquisition in Central Idaho near McCall, which is the heart of Idaho's premiere recreation corridor. The standing timber inventory on this property is nearly one billion board feet and will support long-term sustained harvesting operations.

In addition, we will screen every acre for its highest and best use using our stratification process. Our stratification process identified about 250,000 to 300,000 acres of higher-valued land from our current ownership prior to the acquisition, or about 18 to 20% of our holdings, which we plan to sell over the next decade.

The Central Idaho property likely has a higher portion of recreational land, with attractive real estate values given the proximity to Boise and the resort areas of Tamarack and McCall, Idaho. Importantly, this is a long-term strategic fit for Potlatch and is located in close proximity to our core operations. As we assimilate the acquisition and close on the last phase in January of 2008, we will provide more detail in our management and real estate plans for this property.

The Central Idaho acquisition is our second acquisition this year, following the acquisition of 76,000 acres in Wisconsin for $65 million, which was completed in January of this year. Although the timberland market is very competitive, we believe that strategic acquisitions that meet our investment criteria -- those that are cash flow-accretive -- can still be found.

Our second strategic goal is to optimize planned rotation length using disciplined financial criteria to maximize the net present value from a stand of growing timber. Accordingly, as planned, we increased our harvest levels in Arkansas and Idaho and optimized harvest rotations, in part to sell log volumes in strong markets.

The material step up in harvest can be maintained for several years but will fluctuate with market conditions, just as it did in 2006, when we significantly reduced harvesting in Arkansas due to dry-weather conditions, which resulted in an over-supplied log market.

Our third strategic goal is to execute our land sales plan in a tax-efficient manner through the utilization of 1031 like-kind exchanges to defer built-in gain taxes. With the Idaho acquisition, we can match all of our remaining 2007 sales activity, most of which will occur in the fourth quarter; as well as those sales planned in the first half of 2008.

This year, with the purchase of the Wisconsin property, we're able to defer nearly all of the built-in gains tax on the sale of the 17,000-acre hybrid property tree farm and nearly 10,000 of land sales activity completed through the third quarter of this year.

As Eric outlined earlier, our Wood Products business is profitable and continues to generate meaningful cash flow. However, the outlook for housing and improvement in lumber prices appears to be several quarters out.

To date, we've seen little erosion in log prices in our key markets, and some prices are very strong -- notably Southern pulpwood and cedar in Idaho. However, we do anticipate some erosion of log prices in North Idaho during the fourth quarter and in the first quarter of 2008 -- likely in the range of 5 to 10%. Pricing in the Southern region appears to be firm, especially for pulp logs.

As we did in '06, we will defer harvest activity if log prices deteriorate significantly. Long term, we're very confident that the U.S. economy will support housing starts at levels much higher than the current starts. And therefore we see no reason to sell logs in a down market, should pricing deteriorate.

Addressing the demand in pricing of our recreational real estate offerings in our three operating regions, we see strong demand, firm pricing, and no evidence that the hangover affecting the housing will impact rural land sales. We may experience slippage in planned closings from one quarter to the next, but we foresee no erosion in pricing for recreational land, which makes up all of our planned sales activities in the remainder of 2007.

As you know, pulp pricing and pricing for SBS that serves the folding carton and liquid packaging sector is very strong, partly due to the weakness of the U.S. dollar, but importantly due to very high industry operating rates. We have recorded six months of very strong performance at both our Idaho and Arkansas paperboard mills. During the fourth quarter, we have planned major maintenance in our Pulp and Paperboard and Wood Products segments, which will impact earnings by about $5.6 million.

We're alto anticipating slightly higher wood costs in Idaho during the fourth quarter, due to sawmill curtailments in the region which decrease the availability of chips. Delivered chip prices dropped about 5% during the last quarter, and we expect they will increase about that amount during the fall and winter months.

Our outlook for the Consumer Products business is for stable returns for the balance of 2007. We have improved every aspect of this business year-over-year, but cannot offset a projected $23 million increase in pulp costs during 2007.

Kimberly-Clark, a brand leader in tissue, announced in a press release that they would seek price increases in 2008 for select tissue products to offset inflationary pressures on pulp and energy costs. This gives us some optimism that 2008 will be stronger than 2007.

Finally, I'd like to share a few thoughts about our balance sheet and capital allocation. Our business is generating strong cash flow from both our TRS businesses and the REIT. We are able to pay down the revolver used for the Wisconsin acquisition of $65 million with cash on hand during the year.

Similarly, we expect to pay down our revolver used to finance the Idaho acquisition with internal cash generation. We view our $0.49-per-quarter distribution as a commitment to shareholders. Growing the distribution based on cash generated from our Resource and Real Estate segments, rather than our more cyclical manufacturing businesses, remains our core focus.

Toward that end, we're optimistic about the market for rural recreational land. Moreover, the quality of our species mix and planned harvest levels should support a rising distribution over time, especially as lumber markets improve with the housing rebound.

Tanya, with that, we'll now answer questions from call participants.

(OPERATOR INSTRUCTIONS) Gail Glazerman with [EBS].

Good morning. Just a couple of quick questions.

The strong pickup in fee income from the South that was mainly a factor of deliberate curtailment of harvest last year -- been anything this year, or--?

It was -- it's related to two things. One is that we deferred, as you mentioned, 200,000 tons last year, which we plan to pick up this year if markets were attractive, and we believe they are. We've seen a significant increase in pricing for the saw log material that we deferred. So that's the primary thing. And overall, we've stepped up the harvest level in Arkansas a little bit as well.

Okay. And the strength in the markets, in pulpwood in the South -- is that mainly pulp and paper companies doing whole-log chipping due to limited residual chips in sawmills, or something else?

Well, in the Central U.S. South, pulp logs are the primary source of raw material, both hardwood and softwood pulpwood for the paper mills, much more so than residual chips. The demise of the Wood Products business may have a small amount to do with that, but I think it's more a factor of very strong pulp and paperboard markets -- mills running at full capacity. And earlier this year, we had -- in Arkansas, at least -- weather conditions which caused inventories to drop. It was very wet in the South earlier this year. And so the scramble to build inventories, combined with great operating rates in the pulp and paper business and strong profitability, are what have driven pulpwood pricing.

Okay. And in the tissue business, other than Kimberly-Clark's announcement, has there been any change in the marketplace in the competitive behavior to support your kind of encouraged outlook? I guess some of the producers have actually de-sheeted on some of the premium tissue lines. Have you seen any -- are you seeing any other signs of, I guess, reduced pressure, or not yet?

No. The only thing that -- the only comment that we had was about Kimberly-Clark. I think other than that, there's no significant changes in the business, other than capacity additions, which are coming on in the high-end Through-Air-Dried tissue technology.

Okay. Thank you very much.

Welcome.

Steve Chercover with D. A. Davidson.

Thanks. Good morning, guys.

First question -- on your new Idaho property, can you discuss the stocking levels? Are they consistent with what you have? Or do they kind of fill a hole, either to mature or immature stands?

Steve, this is Mike.

The stocking levels, in terms of just quantity of material, are probably on average about half or less of what we have in the rest of our [rider] ownership. And that's primarily because Northern Idaho -- in the Panhandle of Idaho, where our ownership is concentrated -- is just much more productive land. This is drier site, little bit higher elevation, more of a pine and fur mix.

The H Class distribution -- it was -- the property was well managed by the previous legacy owner, Boise Cascade; and subsequently by Western Pacific. It does not fill any H Class gap. I think we see very steady sustainable harvest there on a very ratable basis for many years to come.

Okay, Western Pacific -- so is that part of Forest Capital (inaudible) --

No, it was not. Forest Capital never owned this land.

Okay. Thanks.

And I also had a couple questions on the tissue business. It's good to hear that KC is looking to price increases. But I think we've also heard anecdotal discussion of increasing competition in the away-from-home market, and I recognize that you're private label. So how does it all shake out? You said modestly better. But have you seen any competitive pressure on your end? Certainly a lot of new capacity coming on-stream.

I'm not sure what you mean by competitive pressure, Steve.

Well, as these -- for instance, as these new Through-Air-Dried machines come on -- I think GP's got one here in Oregon, and the other guys are also building things -- do you expect that to make things more difficult in the private-label arena?

Well, most of the new TAD capacity that's been announced -- and there's several new machines either announced or in startup, between Procter and Gamble, Kimberly-Clark and Georgia-Pacific -- almost all of those are aimed at supporting the brands that those companies serve. None of them are dedicated, that we're aware, to the private-label tissue market, where we have a focus and a presence.

The tissue market remains strong. We have had our highest level of sales, both in TAD and conventional products, that we've ever had. Our finished -- we sold far fewer parent rolls this year than in the prior year. We've increased our converting capacity substantially in -- with the addition of a bathroom tissue line in Elwood, which is outside of Chicago.

So we feel good about the demand for our private-label business. Sales are strong; pricing has held up well. The only thing that -- we have a $23 million headwind in pulp costs blowing against this business, and our operating performance is not down nearly that much. So we've been able to improve our mix, improve our converting efficiency, reduce our freight costs, and do a number of things. But we just can't overcome the $23 million pulp issue.

Sure.

And if your private-label clients asked you to move east with them, how would you address it? I think I know part of the answer. It's clearly -- if you had to build a new Through-Air-Dried machine, you'd probably defer away from that. But would you have to walk away from business if they asked you to come east with them?

Well, I guess that's a bridge we'd have to cross if our large private-label grocery partners, who primarily we serve -- if they came to us and said that. Fortunately, we've positioned the business mostly in the 11 Western states, primarily with three large grocery chains. And we think that there's still growth opportunities in those businesses in the West, and we're very focused there.

But I've said in the past, we have no plans to build another large tissue-converting operation as we did in Las Vegas. It's turned out to be a good project, but I think just our core focus is not in expanding the tissue business.

Understood.

So last question -- do you still have internal capacity from your TAD machine that's still going to the parent roll market? I understand that you diminished the external sales. But is there still some going out?

It's very de minimis this year. We are converting, I think, over 99% of our internally generated TAD product out of Las Vegas into case sales. We are selling almost no parent rolls on the open market. Fact, I'm not aware of any.

I think in the fourth quarter, we're forecast to not sell any parent rolls, external market.

Great. Thanks very much, guys.

You're welcome.

[Mike Roxman] with Bank of America.

Hi, everyone. Thank you for your time.

Just a quick question -- I missed the call a little earlier; I jumped on late. Was wondering if you could tell me -- again, regarding your outlook for trends in tissue, both in price and volume, and how they're [evolving] for next year, if you haven't mentioned that already.

This is Mike Covey. We have not given outlooks for 2008, and nor do we plan to on this call. But that's something that -- we'll provide some color on how things look in our January earnings call.

Got you.

Are you seeing any continued progress in manufacturing at Lewiston, in paperboard?

Well, we made an -- as Eric mentioned in his comments, we've made a number of significant strides. But we had a near-record production output in Lewiston in our Paperboard business in the third quarter. The second quarter was maybe just slightly stronger, but we've had six months of very strong performance there.

We've shifted a lot of the mix both to a coated one-side and coated two-side product, which is a new capability for us. We're just in the process of completing a very extensive new chip-screening system, which we think will improve the yield on the chips and the raw material costs, which are the largest source of our costs in the facility. And we're very satisfied with the performance of the Lewiston mill today.

Got you.

And then, last question -- how pleased are you with the realizations you're currently seeing on real estate?

Well, I think we have to articulate what we sell. We sell a rural recreational land product, for us, that primarily to date has been property that's non-core. We've looked at it and said this is not core to Potlatch's strategy, either for a real estate strategy or for a timber-development strategy. The properties tend to be on the fringe of our ownership or just don't make sense for us to hold. That's pretty much what we've sold so far.

Over time, we'll shift into a little more of a higher -- more traditional, higher and better-use property. It'll have slightly higher values than the non-core property. But we're seeing the sales of our real recreational real estate land. It sells at -- depending on where it's at -- two to four times what it's underlying timber value is, and we're very satisfied with that.

And do you plan on getting into HBU sales beginning next year?

We'll have some. They'll start to increase more next year; probably more the year after that. Certainly, as we get our arms around this new property we've purchased in Idaho, there'll be some that are contributed from that -- maybe not next year, but over the future years.

Got you. Thank you very much.

Welcome.

(OPERATOR INSTRUCTIONS) Mark Weintraub with Buckingham Research.

Thank you.

Mike, as you mentioned, you basically pay the dividend, and then grow the dividend out of the Resource cash flows and the Real Estate. And right now there's obviously a lot of cash flow also being generated by the manufacturing business.

I guess the first question is, how do you think of earmarking those cash flows, at this juncture?

I'll let Eric jump in here.

Well, I think -- we obviously take a look at that cash flow and try to think through what's the best use for it. And we think of it in terms of a couple different ways. One is funding acquisitions. You know, we've completed the Wisconsin acquisition, we've completed the Central Idaho -- or we're mostly partway through, anyway, with the Central Idaho acquisition. So we like to think of utilizing that cash flow for those acquisitions.

We also think of it in terms of increasing potential distributions out of the REIT side of the business, and we also look at potential share buybacks. And we're generating a lot of cash flow right now, and we're well aware of that; the Board is well aware of that. And we're evaluating what's the best use for that cash flow.

And then I guess, as a follow-on -- you've obviously stated in the past that should somebody come and offer you a price for any of your manufacturing assets that you felt was higher than what they were worth to you, you would -- they're not core, like your timberlands.

Given that you're not using the cash flows from these businesses to essentially support the dividend today, how should we think about what would happen if, in fact, somebody were to come to you and offer you a price for the manufacturing asset? Would that, too, likely go into acquisitions of timberlands? And then hence you get more cash flow, and that would enable you to increase the distribution that avenue? Or would you, more realistically, look to return potentially a fairly substantial amount of capital back to shareholders on a more immediate basis?

Mark, this is Mike.

I think -- the way that we've addressed that and thought through it is -- there's a number of choices that we can make. One of those, that perhaps would be very attractive, is to buy our own shares back. And we would look at that at the time, about where the Company trades, and whether or not we think that makes sense.

We would also consider using a portion of it, as you described, to grow the core business of the Company -- the timber and land base. And eventually that throws off -- if its cash flow-accretive, that throws off funds to grow the dividend over time.

I think the use of a special dividend or a special distribution -- if such an event occurred, and we had a pile of cash to sit on -- I don't think -- we would certainly look at it, but that wouldn't have as high a priority, I think, as either share buybacks or expanding this footprint that the Company exists on today.

Great. Thank you.

Welcome.

Sir, there are no further questions in queue at this time.

Well, thank you very much, and we'll look forward to talking to you in January.

This concludes the presentation. You may now disconnect, and have a great day.