Packaging Corp of America (PKG) 2002 Q2 法說會逐字稿

Good morning. I would like to welcome you to the Packaging Corporation of America's second quarter earnings release conference call. Hosting the call for Packaging Corpration of America this morning is Paul Stecko, Chairman and CEO. At the conclusion of Mr. Stecko's comments, he will be taking questions. Specific directions for asking a question will be given at the conclusion of Mr. Stecko's comments. At this time I will turn the call over to Mr. Stecko. You may begin, sir.

Thank you. And good morning and welcome to PCA's second quarter earnings release conference call. I'm Paul Stecko, Chairman and CEO of PCA. With me today is Rick West, our CFO and Bill Sweeney, who runs our corrugated business. Thanks for participating. And after we complete the call as customary, we'll be glad to take any questions that you might have. So let me get right into it. Today we're reporting second quarter net income of $12 million or 11 cents a share. This compares to second quarter 2001 earnings of $31 million or 29 cents a share. First quarter 2002 net income of $10 million or nine cents a share. Net sales for the second quarter were $447 million, down 4% compared to last year's second quarter of $467 million. [INAUDIBLE] for the second quarter was $74 million versus $105 in the second quarter of last year. The 18 cent per share decline in our earnings compared to last year's second quarter was driven by lower prices for both container board and corrugated products. These reduced earnings by about 19 cents a share. And by higher recycled fiber prices which reduced earnings by about 1 cent a share.

In addition, our medical expenses have been higher than expected, and we increased our provisions for bad debt expense. These last two items taken together reduced earnings by about 2 cents a share. These earnings reductions were partially offset by improved container board and corrugated products volume compared to last year. Which improved earnings by about five cents per share. For the first six months of 2002 the two net income was $21 million or 20 cents a share, compared to $59 million or 54 cents a share for the first six months of last year. Net sales for the first six months of 2002 were $862 million compared to $922 in the first six months of 2001. The reduction in year-to-date earnings and sales compared to last year, also was driven almost exclusively by lower prices for container board and corrugated products. Let me get into a few of the details starting with operations. Our corrugated products volume in the second quarter was up 3.3% per work day compared to the second quarter a year ago. Year-to-date PCA's corrugated products volume per work day is up 3%. Compared to the first half of 2001. I should note that the one reason our corrugated volume has been strong is our continued capital investment in our box plants, in order to provide customers with the best service, products, and value available. And although our overall capital expenditures have averaged a little over 80% of depreciation for the past four years, in the corrugated products segment of our business we've actually kept our cap ex at a little over 100% of depreciation expense. So we've continued to invest and this has always, this has obviously helped us with volume. With our increased corrugated products volume the demand for container board that PCA's mills has also increased. As would be expected.

PCA's container board production for the second quarter was 548,000 tons, up 29,000 tons compared to both last year and the first quarter of 2002. We also lowered our container board inventories by about 24,000 tons below the ending first quarter levels. And 32,000 tons or 17% below our year end, Inventory levels. With our inventory levels now lower than we like -- in fact, we haven't been this low since November, 1998. In the expected seasonal pickup in demand that normally occurs from now through the end of the year, we currently don't see any down time in our mill system during the second half of 2002. And, of course, that's with the possible exception of that last week in December, which if the demand slows more than anticipated during the holiday season, we might need some down time. That week. I should add that if demand proves to be weaker than we anticipate, we will then take mill down time to keep our inventories at the proper level. But looking forward we simply don't see that as being the case.

On the cost side, our mills were impacted by higher recycled fiber prices. Primarily OCC, which is moved from about $60 a ton in February to about $150 a ton delivered now in July. However, we are less effected by the huge increase in OCC costs than most of our major competitors. Only about 22% of the fiber we consume in our mills is recycled, which is significantly less than most others of the major producers that are in the 35-55% usage range. And, of course, the mini mills that use 100% recycled fiber. Also, our high box plant integration level allows to us provide a significant portion of our recycled fiber needs from our own box plant waste. Let me just give you some numbers in this regard. During the quarter, we consumed 136,000 tons of recycled fiber in our mills. Of which about 53,000 tons was provided from our own box plants. Making us a net recycled fiber buyer of about 83,000 tons, or only about 14% of our total fiber requirements. PCA's cost of recycled fiber increased by about $25 a ton, compared to both the first quarter of this year and the second quarter of last year. Which impacted mill costs by about 2 cents a share. Offset by about a 1 cent per share gain on higher recycled fiber sales from our own box plants. So net net higher recycled fiber costs reduced our earnings by about a penny a share during the second quarter. Higher container board production and other mill operating efficiencies partially offset the higher recycled fiber costs in our mills. And PCA's overall mill manufacturing variable cost, if you exclude recycled fiber, was actually down 1% compared to a year ago.

As I stated earlier, the biggest single item negatively impacting second quarter results was pricing. According to industry publications, liner board and medium prices both dropped about $40 per ton compared to the second quarter 2001 average. With even lower prices for export tonage. I think most of you are probably aware. We announced domestic price increase of $30 a ton for liner board and $40 a ton for medium, which began July 1. We also began raising export liner board prices in June. And there are additional increases in July for some export markets. In addition, we have announced an 8% price increase on corrugated container products. I'll talk about these price increases later when I discuss the third quarter outlook. Let me now move on to cash flow and a look at our balance sheet. During the second quarter we continue to improve our financial position. And we think PCA now has one of the stronger financial positions in our industry. We reduced our net debt by an additional $12 million, to $688 million in the second quarter, with $89 million cash on hand as of June 30.

I should point out that this decrease in net debt this quarter occurred despite our semi-annual interest payment on our $550 million of 9 5/8 notes being made April 1. So this was the quarter where we had high interest expense. Next quarter is obviously better in that regard, because we only pay on the $550's twice a year. Net debt to total cap is now at 47%, and we believe our net long term debt to LTM [INAUDIBLE] ratio of 2-1 on our LTM [INAUDIBLE] interest rate of 4.7 are among the best of the credit indicators in the industry. During the quarter we purchased 120,000 100 shares of PCA common stock for about $2.4 million. This brings our total share repurchased to 2.8 million shares or $47.4 million through the end of the second quarter. Capital expenditures in the second quarter were $26.5 million. And we're on target to spend $105 million in 2002 which was our original forecast. Moving now from the second quarter to what we see in the third quarter. PCA's mill container board production should increase by about 15,000 tons compared to the second quarter. As I said earlier, while we don't get hurt as nearly as much as many others by high OCC costs, we are affected. In July OCC has jumped another $40-50 per ton in the Southeast and about $25-30 in the Midwest. Which is the portion of the country where the largest mills are located. Hopefully -- this is a shorter term aberration that resulted in large part from typical pre-Fourth of July buying in order to keep the mills running over the long holiday weekend. And hopefully these prices will start to subside.

But if OCC stays at these July levels for the entire quarter, which is probably unlikely, but if it did, this would hurt our earnings to the tune of 3-4 cents per share. Of course, it hurt a lot others -- a lot of others much more. On the positive side, however, higher OCC costs could obviously expedite another container board price increase. The container board and box price increases announced last month will also improve earnings throughout the third quarter, as these increases are phased in for the various products. With obviously the box pricing taking the longest period to phase in because of the wide variety of contractual agreements. We will not, however, see the full impact of all of these price increases until we begin the fourth quarter. When you consider all of these items, I would expect our earnings to improve in the third quarter to probably 14 cents, maybe 15 cents per share. But a lot depends on what happened to OCC pricing. And we really won't have a good enough handle on that for about another month or so, I would expect. With that, we'd be happy to entertain any questions. But I must remind you that some of the statements we have made on this call constituted forward looking statements. These statements were based on current expectations of the company and involve inherent risks and uncertainties, including those identified as risk factors in our s-1 and is S-4 registration statements, all on file with the SEC. Actual results could differ materially from those expressed in these forward looking statements. With that, I would like to open it up with questions. So I will turn it over to the operator. Let's get into the questions.

Thank you. If you have a question at this time, please press the one key on your touch tone telephone. If your question has been answered, or you wish to remove yourself from the cue, please press the pound key. Once again, if you have a question, please press the one key. One moment for questions. Our first question is from Mark of Goldman Sachs.

Thank you. Paul, first of all, just wanted to understand on the medical expenses and the bad debt. Whether or not for modeling purposes you would expect to have 2 cents less of that or whether or not that's kind of the forward going rate.

We think our best case is that's probably a one-timer. About 2/3 of that was medical. About 1/3 bad debt. With medical, we were not...our costs were higher than we had accrued for by months so we chewed that account up. Historically, medical expenses dropped the second half of the year compared to the first half of the year. A lot of people are going in for surgeries. You get near the holiday periods in the fall. They'll wait until the first of the year. But you never know on that one. And with bad debt, we had a couple of bad debts arise that we had to reserve for. And again with bad debt, you never know. But we would view this as not a continuing drag on earnings.

Ok. And on the guidance you were giving us for this third quarter, were you assuming OCC prices would basically stay where they are or did you assume they were going come back or go up a little bit from where they are.

We assumed they were going to come down a little bit.

And lastly, if I could, could you give us a little sense of how demand was coming along as the quarter ended and perhaps the really early indications from July.

Yeah. Demand was pretty steady. May was, I would say, an exceptionally good month demand wise. And June was not quite as good. But June was a very good month. And July has started off extremely good. But we only have about five days, six days worth of data. And so I would say that May, June, and the first six days of July, have been fairly consistent and pretty good.

Ok. Thank you very much.

Thank you. Our next question is from Chip Dillon of Salomon, Smith, Barny.

Hi, good morning, Paul.

Good morning, chip.

Hi. A question about -- I just want to fill in a couple of gaps. Basically, when you went through the analysis of the changes versus -- I believe this was versus a year ago quarter when you were telling us the improvement -- I'm sorry. When you said prices hurt you by 19 cents. That was year over year. Right?

Yeah. Year over year.

Ok. Then you said volumes help you by a nickle. So that's a negative 14 cents. You dropped 18. Then of the other four you mentioned medical and debt and OCC would be three. You also get interest expense helping you by one. So there's another two pennies. I know that your production -- I believe year over year your production was actually better so that you should have gotten some help there. Were there any other cost items that might account for that two cents?

Yeah. SG&A was about a penny. The other pennies's in a million little areas. We can pull it together and let you know, but there's nothing -- you got to add up three, four, five items to get to another penny.

Gotcha.

And it's more than that. Solid wood was probably the biggest piece of that.

Ok, so the wood... and that would have mainly been in the upper Midwest?

No. Solid wood in terms -- we sell about 3% of our sales, we sell solid wood, the lumber.

OK, gotcha. Ok. Then as you look at your demand situation right now and what your customers are seeing and doing, have you noticed any patterns among the industries out there where you're seeing better demand among certain types of customers and worse demand amongst others?

No. I wish I could give you a more intelligent answer and say I was really on top of this thing. I am on top of this thing. We have about 8,000 customers, Chip. About 45, 48% are in the food service business. And that has held up pretty well. We're seeing high-tech starting to come back just a touch. I mean the body's breathing. It's not moving a lot, but it's breathing now. And we're seeing a little bit. Of course, we're not big players in high-tech. But we've got some things down along the Mexican border. That's getting a little better. But I really could not come up with a definite trend that it's concrete. Would I just say the food service has been hanging in there and it's improved and everything else is up a little bit also. But no, I really can't give you a trend. Because we're so diversified.

Ok. And then lastly on the OCC front. You mentioned a big jump -- which at least, I guess it's a quarterly change from the second quarter average. I know the pulp and paper numbers aren't up nearly as big as what you said for July. But that being said if you could clarify that and then also comment on what we've been hearing for a couple weeks now that things have started to go the other way on the west coast with the threat strike with China, you know, probably having filled up a bit. And even in the interior of the U.S. We hear that OCC, if anything, may start to back off. There's an expectation for that.

Well, I'll give you our OCC numbers. Obviously, you read in the yellow sheet -- hold on. We're getting an echo here. Our OCC costs are up from $107 a ton in June. We're forecasting $153 delivered in July. That's $46 a ton. What's happening in OCC as we see it, that the prices on the coast have stabilized. The west coast is not going up. East coast is finally stabilized. But the pipeline's been pretty empty where the big mills are -- in the South and to the less extent in the Midwest. That pricing took a big jump in the Southern mills in July. Now, again, some of this -- I mean, there are rumors going around that some mills could not get through the Fourth of July weekend because they were running out of the recycled fiber portion of their furnish. They were going to have to slow down after the Fourth of July to catch up. I don't know how much of that is going on, but there's been a lot of price pressure on OCC in the South and in the Midwest. If some mills slow down, that could certainly help the situation. But these are the most cost efficient mills in the country. If you look at where the low cost producers are, they're primarily in the Southeast and in the Midwest. We got Tomahawk and [INAUDIBLE] which are two examples. But there are other big mills. But where most of the tons are being made, there's still pressure on OCC. I think if you dig into this, you'll find that most people will be saying the same things. And pulp and paper is making a point about what's happening on the coast, the export tons to China, etc.. But in the heartland of the country, the pipeline's been sucked pretty dry. My question on OCC is if things get a little better on the coast which it appears to be the case, how long before that backflow gets OCC into the pipeline and brings some costs down into the South and into the Midwest? And like I said, I won't have a handle on that for about a month. Obviously, I'm hoping it falls a little bit. So that's the long-winded answer to a complex question.

I appreciate it. That's very helpful. Thanks, Paul.

Thank you. And our next question is from Matt Burler of Morgan Stanley.

Hey, Paul.

Morning, Matt.

Paul, a couple of questions. First on virgin fiber. How long do you think it will take for the increase in OCC costs to force people to switch away from OCC and use more virgin? And do you expect to see any pickup in your virgin fiber costs? And the second question is on share repurchase. Can you help us with the parameters of your share repurchase program in terms of how aggressive you might be willing to be. You've made such progress in your debt paydown. It seems to me you could even go as far as to borrow some money to accelerate that program if you wanted to.

Yeah. Let me take them one at a time I think a lot of people have already made some shifts in the virgin. Primarily in June. We certainly have, we're down running -- we've got a range. We can get down close to 20%. And we can get as high as maybe 32%. And we're down right on the bottom. We're fortunate in that where our mills are located, we've got abundant fiber. For example, [INAUDIBLE] is part of the country where a lot of mills were shut down and fiber is in pretty good shape. And even though we pick it up 5, 6%, and [INAUDIBLE] we don't use any OCC so that's not a place we shifted. But that's a place where we expect fiber costs to stay low because of supply demand. In the contrary, there's a little more competition for fiber. But again, we've only picked it up a little bit. We haven't seen any fiber price increase to any appreciable extent. There are parts of the country where the switch off isn't as kind to you, and where the cut is not in as good a shape with regard to the [INAUDIBLE] and you could see some increase in virgin fiber costs. But again, the good news is it's in the good part of the year to be buying fiber. Everybody can get out and cut. It would be harder if it were winter, and you had tough logging conditions. But I think ah...I don't think you'll see a big run up this part of the year if the same thing happened in a January, February, you probably could. So that's...that's I think answered that question. In terms of share repurchase, our plan is to repurchase about 100 million of our shares. We're about half way there. And we bought some shares during the quarter. We purchased some shares early in this quarter. Right after the first of July. We don't need to borrow any money. We've got $89 million on cash, on hand sitting here. One of the problems that we've had in buying shares is we can only buy on the down tick. For most of the second quarter our stock was up ticking more than down ticking. And when we buy, we buy a little at a time. If there is weakness in the stock, obviously we're in a good position to have a lot of money in reserve against our $100 million program. We've only purchased $50 million. We've got another $50 to go. We'd like to be steady buyers, a little each month, but we're not adverse to be opportunistic if there's a short-term movement in the stock that makes a good buy for us. Then we would certainly consider that.

Great. And one more question. On the export front. Today the Euro actually pushed up to parody for the first time in several years.

Hey, I want to bet on that by the way. I bet Bill Sweeney a month ago that it was going to hit. He's sitting here, that's why I'm telling you this.

Well, congratulations.

I don't win many bets, but I won that one.

Do you think that with the Euro at parody that that materially improves the industry, the U.S. industry's ability to export excess container board to the rest of the world? And do you think that that could play a role here in helping you raise prices?

I would say the answer to that is yes. But what excites me about the dollar being where it is is the other part that I think is much bigger. And that is that it makes all U.S. exported goods more competitive in foreign markets. And those goods that are being shipped are in corrugated containers. When you only sell more paper to the rest of the world, you only make money on the paper. When you sell more boxes to the rest of the world in terms of finished goods, you make money on the paper and you make money on the boxes. And that gives us more leverage. So when I sit back and look at how I do feel compared to a few months ago, I actually feel pretty good. Because some things have happened that -- four months ago would I not have guessed the dollar being one of them, the fact that OCC went up in price, I view as probably more positive than negative. We got a price increase I think a little earlier than most people would have expected in January or February. And I would say the only slight negative is I don't think the U.S. economy is quite as far along as a lot of us hoped. But I do think there's hope in that area. So, you know of all of them, I've got to probably say that the dollar being where it is, is the one that has the most long-term potential. But in selling boxes as opposed to selling just paper.

Got it thank you.

Thank you. Once again, if you do have a question, please press the one key on your touchtone telephone. And our next question is from Mark Conley of Credit Suites First Boston.

Good morning. This is actually Doyan from Marks team.

Did you get promoted?

Not quite yet. I just had a few questions. First, if you can clarify the down time. Just wondering whether that includes the machine that's been down at [INAUDIBLE] city. Second question is just relating to pricing realizations in the quarter. If you can give us a sense as to where they were on the average during the quarter versus quarter end. That sort of thing. I also want to clarify what kind of pricing assumption you have in your 15 cents guidance. And the third question is really just a housekeeping. If you had your gross margin and SG&A numbers.

That's a long list. Let me start -- if [INAUDIBLE] city has been down for three years now. That's not in the equation. That's down permanently. So that's the first question.

Can you remind us how much tonage that represents.

About 70,000 tons a year. With regard to pricing I think we've given you the paper price decline. Again, we don't normally talk about box price changes. We view that as company confidential information so we've got nothing to comment on that. What was the next part?

Just what your sequential pricing assumption was for your 15 cent guidance.

As I said, we will phase in that price increase. And that price increase is in both boxes and paper. We expect to get -- in the paper, the full amount. But in terms of how and what we're going to get, again, that's not something we'll quantify. We'll give you the answer, but some of the proprietary ways we get to the answer we don't normally talk about. Ok. What we basically said is 14 cents, maybe 15.

Um huh. Ok. And the third question was gross margins and SG&A for the quarter.

I don't have that information.

Ok. Thank you very much.

Thank you. And I'm showing no further questions in the question cue Mr. Stecko.

Ok. Listen. Thank you for listening. And we'll talk to you again in three months.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. And you may disconnect at this time. Have a nice day.