Potlatchdeltic Corp (PCH) 2010 Q2 法說會逐字稿

Good morning. My name is Stephanie and I will be your conference operator today. At this time, I would like to welcome everyone to the Potlatch second quarter 2010 earnings conference call featuring Eric Cremers, Vice President of Finance and Chief Financial Officer and Michael Covey, Chairman, President, and Chief Executive Officer for Potlatch Corporation.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions)

Thank you. I would now like to turn the call over to Mr. Eric Cremers for opening remarks. Sir, you may proceed.

Thank you and good morning. Welcome to Potlatch's investor teleconference covering our second quarter 2010 earnings. Before we begin, let me remind you that this call may contain forward-looking statements with regard to our business operations. Please review the warning statements in our press release on the presentation slides and in our filings with the SEC concerning the risks associated with these forward-looking statements.

Also, please note that segment information, as well as a reconciliation 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 turn the call over to Mike Covey, our Chairman and CEO, who will make some introductory remarks, and then I'll review our second quarter results in more detail. Mike?

Good morning. Each of our three core businesses performed very well during the quarter in both sequential and year-over-year improvement in each segment. The unexpected run-up in lumber and plywood pricing not only helped our wood product segment results in the second quarter more than we expected; but it also boosted log prices, and therefore, results in our resource segment improved more than we expected. Also, our real-estate business continues to post solid results in spite of weak consumer confidence and the sluggish economy.

As we announced this morning, we have taken additional steps to monetize both core and nonstrategic timberland in Wisconsin and Arkansas. The sale agreement announced this morning with RMK Timberland group in combination with the option agreement for additional land sales in the fourth quarter is expected to provide approximately $63 million of additional cash on our balance sheet by year end. This amount, in combination with our current cash balance of approximately $40 million, as well as an undrawn $250 million revolver, should provide additional insurance--assurance to investors that our current dividend of $0.51 per share per quarter is sustainable, even in the face of an uncertain economic recovery.

Moreover, FFO generated in the second quarter, which is our weakest quarter due to seasonal weather conditions that limit harvesting, covered our second quarter dividend. And we expect a significant surplus in funds available for distribution in Q3 compared to our normal quarterly dividend of approximately $20 million. Next, I'd like to elaborate for a minute on our announced timberland sale. The transaction is somewhat complex as it not only is a two-phase transaction, but it also involves land in two states. So, let me provide some additional details by examining the Q3 transaction.

Calculating the average price per acre, in other words, taking the $29 million sales price and dividing it by the 41,500 acres included in this sale for an average of $700 an acre is very misleading. Wisconsin and Arkansas are completely different timberland properties with completely different timber markets and values. For example, the Wisconsin acreage is primarily a pulp wood and small saw log market, and the land is encumbered by a conservation easement prohibiting development.

As such, these factors make the Wisconsin parcel, which is 71% of the total acreage being sold, worth far less on a per acre basis than the Arkansas acreage. It's also worthwhile to spend a minute delving into the details of the Arkansas acreage as it is the least strategic of all of our acres in Arkansas. The Arkansas land being sold in Q3 is less desirable to us both because it is farther from markets and is of poor quality than the rest of our Arkansas acreage.

The property is generally on steeper slopes, making logging more difficult, and therefore, more expensive. Furthermore, the soil quality is below average compared to our other Arkansas acreage, and thus, has higher replanting costs and has higher tree mortality, thereby reducing comparative value. In summary, we estimate RMK value of the Wisconsin easement land at around $400 an acre, and the Arkansas land at around $1,500 an acre, and both reflect a general 15% or so decline--price decline, from the peak of timberland transaction pricing a few years ago.

And although we are now exiting Wisconsin, a market we entered in 2007, we are doing so with a net cash gain. And while we are very satisfied with the valuations we received in these transactions, we believe the transaction provides us with an enormous amount of financial flexibility going forward. I'll now turn the call over to Eric for his remarks, and then we'll take questions.

Thanks, Mike. We reported second quarter 2010 net earnings from continuing operations of $11.8 million, or $0.29 per diluted share as can be seen on Slide Three of the slides accompanying this presentation. This compares to net earnings from continuing operations of $3.7 million or $0.09 per diluted share in the second quarter of last year, and $1.4 million or $0.03 per share in the first quarter of this year. I'd now like to review our second quarter results broken down by segment.

Slide Four highlights operating income and margin trends in our resource business. As shown on the slide, our resource segment results for the second quarter of 2010 were significantly better than both the first quarter of 2010, as well as the second quarter of 2009. Operating income in the second quarter totaled $15 million, well above the $4.5 million we earned in the second quarter of last year, as well as the $9.9 million we earned in the first quarter. The primary driver behind the earnings variance from the first quarter was higher pricing, while the prior year variance was driven by both price and volume. As a reminder, the second quarter is typically the weakest quarter for our resource business due to the spring break up in the north, so we are very pleased with the strong results from this segment.

Slide Five highlights volume and pricing trends for the northern region of our resource business. Saw log fee volumes were up 148% comparing Q2 of this year to Q2 of last year, and down 6% compared to Q1. As a reminder, in the second quarter of last year, we deferred harvest levels due to the weak demand environment. Saw log pricing in the northern region was very favorable in the second quarter with prices up 23% sequentially and 22% over Q2 of last year. The sharp run-up in lumber prices during the first and second quarters was the primary driver behind the strong log pricing performance.

Regarding pulp wood in the northern region, volume was down 42% compared to Q1 but up 33% over the prior year. Pricing for pulp wood in the northern region continues to be impacted by lackluster demand due to the closure of two liner board mills in the pacific northwest region, with prices lower by 5% compared to Q1 and lower by 4% compared to prior year. Slide Six highlights volume and pricing trends for our resource business in the southern region. Both pricing and harvest volume showed strength in the quarter. Saw log fee volumes in the second quarter increased 16% over the second quarter of 2009, and increased 8% sequentially.

Saw log pricing in the southern region was up 13% year-over-year and up 15% sequentially. Pulp wood volume in the southern region was flat compared to prior year, but was up 13% compared to Q1 when we experienced very wet weather in the South, which made logging very challenging. Pulp wood pricing in the South continued to show strength in Q2 due to the lingering effects of the recent significant wet weather as mills sought to replenish inventories.

Next I'd like to review our real-estate business. As shown on Slide Seven, our real estate segment closed sales totaling $10.5 million during the second quarter, with revenues coming from HBU, rural recreational and non-strategic timberland activity. Slide Eight highlights operating income from our real-estate segment and, as you can see, we had real-estate operating income of $5.1 million in the quarter.

Slide Nine highlights our real-estate sales by product type. In the second quarter, we sold almost 1,900 acres of HBU property, our strongest performance of HBU sales in over three years. In total, we had 47 real estate transactions in the quarter, up from 31 transactions in the first quarter. Slide 10 highlights price trends for our real-estate business broken down by product type. And,as you can see, HBU pricing was firm at around $2,000 an acre, and rural recreational land was in line at around $1,100 an acre.

Page 11 highlights operating income trends for our wood products business. And as you can see, our wood products business showed continued strength in the second quarter producing operating income of $6 million in Q2, which compares to $5.2 million of operating income in Q1 and $3 million--and a $3 million operating loss in last year's second quarter. This is the strongest quarterly performance we have seen from our wood products business in several years.

Slide 12 highlights price and volume trends in the lumber part of our wood products business. And as you can see, both prices and volumes are at the strongest level they have been over the past several years. With the recent downturn in wood products prices, we expect earnings to slip in the third and fourth quarter but the segment should still be cash flow positive.

Returning to Slide Three of the presentation, eliminations and adjustments provided $2.1 million of operating income during the quarter and corporate administration costs, including interest expense totaled $13 million for the second quarter. Finally, we booked a $3.4 million tax provision in the quarter due to the strength of earnings in our taxable REIT subsidiary. Note that this is a book entry only and does not represent actual cash taxes paid, which is just $200,000.

EBITDA totaled $33.1 million in the second quarter versus $7.2 million in last year's second quarter and $18.8 million in the first quarter. Funds from continuing operations for the second quarter totaled $23 million versus $10.3 million a year ago and $9.1 million in the first quarter. The Company paid a $0.51 per share cash distribution in the quarter for a total of $20.4 million.

Next, I'd like to make a few comments about our balance sheet and liquidity. First, regarding our leverage ratios, we continued to have a very solid balance sheet with debt to capital at 53.3% and interest coverage of 4.8 times, as defined in our credit agreement. Also, as indicated in our earnings release, we executed about $68 million of interest rate swaps at the end of the quarter with the new rates effective at the start of Q3. We expect this swap to save us just under $1 million of interest expense over the next year.

We completed the swap to more closely align our cost structure with business conditions. We finished the quarter with over $40 million of cash and equivalents on our balance sheet, very comparable to the $43 million we had on our balance sheet at the end of the first quarter. Yet, in the second quarter we paid over $20 million in cash dividends to shareholders. Furthermore, the second quarter is seasonally a relatively weak quarter for us. We think that this relatively minor drop in our cash -- cash position over a seasonally weak quarter demonstrates that our strategy is working.

Markets are gradually recovering, and as they do, our cash flows from operations are gradually recovering as well. This is in spite of the very low number of housing starts. With the recently announced timberland sale, we are very well positioned for the eventual housing recovery whenever that occurs.

Finally, I'd like to provide a few comments about our outlook for the remainder of the year. Since wood product prices have now rolled over, we expect a more challenging second half of the year in wood product segment. We also expect the lower lumber prices to lower our log prices in the second half, but we don't expect to give up all of the gains we realized in the first half of the year. Also, the third quarter is typically the strongest for our resource segment from a harvest volume standpoint. In total, we expect to harvest at our original guidance level for the year, which was around 4.2 million tons with around 1.4 million tons occurring in the third quarter.

Regarding the outlook for our real-estate segment, we continue to be optimistic. The aforementioned timberland sale in the third quarter should boost results. And assuming the fourth quarter transaction closes as well, Q4 should also be strong. Including these two sales, we expect 90,000 to 95,000 acres will be sold over the next two quarters with a book basis of roughly 65% of sales.

Stephanie, that concludes our prepared remarks, and we will now take questions from call participants.

(Operator Instructions)

Your first question comes from the line of Mike Roxland with Merrill Lynch.

Thanks very much. Congratulations on a good quarter, guys, and on the land sales. Just real quick, on the land sales, if you knew the particular characteristics of the Wisconsin land when you purchased it, why enter into the transaction? Obviously, you must have found something appealing about it originally.

Well, this is Mike Covey. There were a number of factors. First of all, at the time that we executed the Wisconsin transaction in 2007, we had also sold the Company's hybrid poplar tree farm in Oregon for a net gain of around $50 million. We were looking for a like kind exchange opportunity to offset that gain.

That accomplished this. We also bought the Wisconsin property with a plan in mind to sell a good portion of the land that was unencumbered by a conservation easement. We've done that, we've sold, I think, almost 18,000 acres in the last 40 months all at prices well north of $1,000 an acre. So, we feel like our business strategy worked out just fine there.

Got you. Now, any particular reasons why you're doing the option in 4Q? Why don't you just sell the entire acreage together right away alongside the first piece?

Well, Mike, it's Eric. It has to do with the timing of RMK's ability to raise the funds. Between the two transactions, the one that we're entering into in Q3 is the one that's most advantageous to us. So they have verbal commitments for that capital for the fourth quarter, but it hasn't been formalized yet, but we expect that -- them to raise that capital and get the deal closed.

Got you. So basically they haven't raised the capital yet. Any sense on when that capital raise is going to take place? Are they keeping -- are they giving you weekly updates, or what's occurring there?

I can tell you that, yes, they're making progress on it, and we expect those commitments to get finalized by the end of August.

I guess to further, Mike, the first phase of the transaction includes the encumbered land in Wisconsin, which is arguably the least desirable. So I think they're highly motivated to complete the transaction. They should exercise that option by the end of August.

Okay. Great. Last question. What has happened to your operating posture in lumber now that prices have come off a bit? If I recall correctly, on the 1Q call you mentioned that you were operating on the normal two or three shifts, depending on the facility. Have you brought that back a bit given that lumber prices have come down?

No, we've not. We continue to run basically a typical two or three shift configuration depending on the facility. Our experience has been that downtime results in large increase in costs, fixed costs are very hard to eliminate in a mill. We're better off to run and sell the product, which we've been able to do. We're not building inventories.

Got you. Thanks very much. Good luck in the quarter.

Your next question comes from the line of Gail Glazerman with UBS.

Mike, did I hear you right that the Wisconsin land in the second phase of the sale is nonencumbered or -- ?

Yes, the first phase of Wisconsin includes all the land encumbered by a conservation easement. The second phase includes the land that is unencumbered. About half the land in Wisconsin was--fit in each category originally.

Okay. And the land in Arkansas, is that anywhere near the land that you sold to RMK last year?

It is. It's in the same--I don't know if it's in exactly the same county. It's in a county, I think, just north of the property we sold to RMK last year. This is the furthest -- the property farthest north in southern Arkansas that we hold. It would be really directly north of the Prescott, Arkansas sawmill that we closed in 2008.

Okay. And switching to operations a little bit, can you talk about some of the log price trends that you're seeing as they we move through the quarter? For instance, northern saw log, is that at least starting to stabilize? Are you seeing any sign of stabilization or acceleration in the price trends as you move from the second quarter into the third quarter?

Gayle, this is Eric. Our business--we really break it down into the four different buckets - - saw logs in North, South and pulp wood in the North and South. We showed real strength in the second quarter. We expect that strength in saw logs to continue a little bit into the third quarter. We've got pretty firm pricing and volume commitments in the third quarter, and we can see that prices are likely to rise a little bit in the North.

Part of that is driven by a mix issue. If you think about it, we can't get out there and harvest aggressively in Idaho in the second quarter. So, as you move into the third quarter with the really strong harvest schedule, the pricing impact is felt in the third quarter with those higher Idaho volumes, relative to the lake states, which are lesser valued on a per ton basis.

So we are seeing a little bit of strength going into the third quarter in northern saw logs. We do think we'll give a little bit of that up as we get into the fourth quarter. If you go into the south, it's going to be a little bit different there. We'll feel the pricing decline in the third quarter in the South. We expect pricing to come off, maybe in the 30% to 40% kind of range by the end of the year for saw logs, but that's about it.

Okay. And pulp wood pricing, anything going on there?

I'm sorry, 30% to 40% of the recent price increase. No, pulp wood is going to be relatively flat in the North, and it'll -- it'll soften a little bit in the South.

Okay, and just one last question. Can you give an update on what you're seeing or if you've changed your expectations at all for energy demand, given the recent stalling on--in Congress on any renewable energy legislation?

Well, I don't think--we have never had real optimistic outlook that we were going to see facilities built that would result in opportunities for us to take low valued pulp--or low valued slash or residual materials to market. It's very dependent on having a facility located proximate to your timberlands. In most operating areas, we just don't expect that. So, we've not had an outlook that was going to contribute cash flow in the near term the next one to three years. We still remain optimistic that biomass makes a lot of sense, that the nation's energy policy will be resolved in a sensible way; but we don't see this as a pot of gold at the end of a rainbow.

Okay, thank you.

Your next question comes from the line of Chip Dillon with Credit Suisse.

Hey, guys, Eric and Michael. I missed this number. You gave the full year harvest expectation. What did you say it was for the third quarter, and can you sort of just reiterate what you think the mix for the year is going to be between saw logs and pulp wood?

Yes. What I said was that we expect to harvest right around 4.2 million tons for the year, about 1.4 million coming in the third quarter. And that leaves around 1 million in the fourth quarter. I'm sorry, go ahead.

Go ahead, I'm sorry. On the mix?

Well, I was going to say, on the mix what we are seeing is a little bit of a skew more towards saw logs in the North because of the weak pulp wood market. So, you could expect roughly 80% to 85% of the harvest volume in the North to be saw logs and roughly 60% in the South.

Got you. Okay. And then back on the land sale, you gave this mix of 71% Wisconsin. Was that on the entire 86,000, 87,000 acres, or just on the first half?

Well, of the entire roughly 88,000 acres, roughly 59,000 is Wisconsin.

Right. And when you said--so when you gave that split that was for both combined--I guess, doing the math here, not just for the first half. So where you gave--and you mentioned $400 an acre in Wisconsin. I would imagine--that's my question. That was only related to the first half because that's the encumbered acre - acreage, is that right?

Yes. That's correct.

Okay. And, I guess, that must mean, I'm guessing that you're looking at something that's two or three times that for the unencumbered, I'm guessing. Because I know--I guess there was some land sold last year, I know one of your competitors sold some, and it was reported like $850 an acre, then I know--I guess you guys bought the Tomahawk land for $800; and I guess, that was at like kind of an exchange a few years ago. So would we assume something closer to $1,000 on the unencumbered?

No. No, you would not. It's more than the first phase for the Wisconsin. We're guessing, right. This is all RMK's math, not ours. If we had to guess, it's probably in the $450 to $500 an acre range for the second parcel in Wisconsin. The thing to remember, Chip, is that we took a lot of cash off that property over the time that we've owned it. And I can just give you--we've sold almost $20 million worth of acreage since we've owned it. We've taken $6 million off in terms of stumpage. We're obviously going to get the proceeds from this transaction, then our LKE, the Like Kind Exchange that we performed with the Boardman sale, that saved us over $15 million in cash taxes.

Got you. Of course, yes.

A lot of what motivated that move into Wisconsin was LKE.

I'd also say that you have to be careful comparing one property, even in the same state, to another. There's some of our competitors property has a very nice mix of quality northern hardwood saw logs on it. Our property is more represented by aspen, some spruce, and some hardwood saw logs; but the timber resource on the Wisconsin property that we own is not as rich as some ownerships in Wisconsin.

Okay.

And just to elaborate a little bit, Chip, the average, since we've owned it, cash flow that we've gotten off that land--on the resource side, it's been about $1 million to $1.5 million a year.

Got you. Okay. And when you look at the second phase, and I know you mentioned that RMK has yet to raise that money. Is that money that is actually, therefore, coming into a new partnership, or does it represent a call of--from an existing partnership where I know sometimes the investors have to put up money over time?

I can't speak to RMK as an investor and how they intend to fund it. We just don't know that.

Okay. And then, lastly is, when you look at your--I know it's a little early days now, but I--if you could just reiterate what you sort of think your normalized harvest--let's get these lands sold, let's say this year. What would you say your normalized harvest level--sustained level would be across the business in terms of tons starting next year? If, hypothetically, the demand was something even remotely close to normal?

We've said for some time, for the last several quarters prior to this recent announcement that the Company had the capacity to harvest approximately 5 million to 5.1 million tons on a longer term basis in more robust markets. We deferred harvest all the way down to 3.8 million tons. We've now inched it up a little bit to 4.2 million this year on a little bit better pricing, but our expectation after this land sale is our long-term sustainable harvest rate is somewhere between maybe 4.6 million to 4.8 million tons in that range. We haven't refined that yet, but we're obviously going to have come off the 5.1 million target that we had with this land sale of almost 100,000 acres.

Okay. That's very helpful. Thanks, guys.

(Operator Instructions)

Your next question comes from the line of Steve Chercover with D.A. Davidson.

Thank you for the color on the timberland sales thus far. I was wondering, do you have any more chances to do one of those stumpage sales like you did last year?

Well, Steve, the opportunity certainly exists with some of our ownership. We did 50,000 acres of trees--of plantations that were between age, basically, one and ten in Arkansas. We have more land like that in Arkansas. We certainly have a lot of land like that in the other states, in Minnesota, in Idaho, but the species mix is more diverse so it makes it more challenging for an investor to get their arms around. But we felt very good about that transaction, and we'd be happy to do another one similar to it.

So, I mean, obviously it's the NPV, the maximum NPV is what will dictate whether you do a stumpage sale or a free and clear sale. But would we look at the age class, like the age of the plantation as being the criterion, not having an NPV to determine how you approach these things?

Well, I think for the particular fund that bought--and the TMO that bought that--those cutting rights from us, the stumpage last year, they specifically had a fund horizon that they wanted to target, trees that were 10 years old and younger. So, a different investor group may have totally different criteria. So, I think it just all depends on what an investor's objectives are.

And then in the lumber business, was your mix primarily just dimension as opposed to cedar?

It was. We had very little--well, we had a--since the spin-off of Clearwater Paper and the sawmill in Lewiston, Idaho went to Clearwater, we have a relatively small mix of cedar lumber that we produce today. Really just in one facility in St. Mary's, Idaho.

Okay. So that's--this is kind of the new normal. And, so you alluded--it will come as no surprise that profitability is going to diminish, but it'll be more than--it'll be cash flow positive. You expect it'll be earnings positive still, or are we going to see that--the entire $6 million kind of evaporate?

Steve, I think you'll see it hover around breakeven, maybe slightly positive. Obviously it's a very volatile business segment, and things can change on a dime. But our view is that the strong earnings we saw in the first half are not likely to happen in the second half, but we don't think the bottom is going to fall out, either. Pricing has come down but it seems to have hit a floor for lumber.

As well, we have one -- we have one specialty plywood plant that competes in an industrial niche market that has had terrific performance and we expect that to continue. It generates significant earnings as well as cash flow.

Great. Okay. Thanks. Good luck in the quarter.

Thank you.

(Operator Instructions)

At this time there are no additional questions in queue.

Thank you. And thanks for joining us this morning, and we look forward to talking to you in the next quarter.

Thank you. This concludes today's conference call. You may now disconnect.