Packaging Corp of America (PKG) 2002 Q3 法說會逐字稿

Good morning, ladies and gentlemen. I would like to welcome you to Packaging Corporation of America third quarter earnings release conference call. Hosting the call for Packaging Corporation 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. As a reminder, this conference call is being recorded. 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 third quarter earnings release conference call. I'm Paul Stecko, Chairman and CEO. And with me today is Rick West, PCA's Chief Operating, Chief Financial Officer, and Bill Sweeney who is Executive Vice President and runs our Corrugated Product System. Thanks for participating and as the operator just said, we will take questions when we conclude.

So let me get right into it. We reported today third quarter net income of $15 million or 14 cents a share. This compared to third quarter 2001 earnings of $29 million or 27 cents a share and second quarter 2002 net income of $12 million or 11 cents a share. As a reminder, I should point out that PCA's 2002 earnings don't reflect any benefit from the changes in the accounting treatment for goodwill. PCA has essentially no recorded goodwill on its balance sheet and also accordingly, we aren't faced with any future potential goodwill impairment charges. Our net sales for the third quarter were $456 million, which compares to $455 million in last year's third quarter. EBITDA for the third quarter was $77 million versus $101 million in the third quarter last year. The 13 cents in earning decline that we experience compared to last year's third quarter was driven by lower prices for both container board and corrugated products which reduced our earnings by about 13 cents a share and higher recycled fiber costs also reduced our earnings by additional 3.5 cents a share. These earnings reductions were partially offset by increased corrugated product sales volume. And container board production volume compared to last year. Together, they improved earnings by 4 cents a share.

For the first nine months of 2002, net income was $36 million or 33 cents a share compared to $88 million or 81 cents a share for the first nine months of last year. Net sales for the first nine months of 2002 were $1.3 billion, compared to $1.4 billion in the first nine months of 2001. The reduction year-to-date earnings in sales compared to last year have also been driven primarily by lower prices for container board and corrugated products.

Let me give you a couple of details, starting with operations. Our corrugated products volume in the third quarter was very strong. Up 6.5% per work day, compared to the third quarter a year ago with August volume per work day an all-time record for PCA. This quarter's volume improvement represented the best year-over-year quarterly increase in volume per work day since the second quarter of 1999. Also, this improvement was coming off a relatively strong third quarter for us in 2001, when our volumes were down only 6-10ths of 1%, compared to 2000. So that is pretty good comparable performance to be up 6.5%.

Year to date, PCA's corrugated products volume per work day is up 4.2%, compared to the first nine months of 2001. With this increased corrugated products volume, the demand for container board at PCA's mills also increased. PCA's container board production for the third quarter was 578,000 tons, up 17,000 tons compared to last year's third quarter, and up 30,000 tons compared to second quarter of 2002. Our container board inventories do remain very tight, going into a seasonally stronger October, a month with 23 corrugated product shipping days.

As a result, we currently don't see any down time during the reminder of 2002. With the obvious possible exception of that last week in December, if demand slows more than anticipated in that after Christmas or during the Christmas week, holiday slow down in manufacturing that usually occurs, as I think as most of you know, predicting the magnitude of any post-holiday slowdown is next to impossible to predict. So, that is the only exception where we may require some downtime at this point. On the cost side, our mills were impacted by higher recycle fiber costs, primarily OCC. The cost of recycled fiber to our mills increased by about $70 a ton, compared to the third quarter of 2001. And was up $50 a ton compared to the second quarter of 2002. Now, OCC prices did fall in August. They fell again in September and October and they now stand about $70 a ton.

During the quarter, during the third quarter, we consumed 135,000 tons of recycled fiber in our mills, of which about 51,000 was provided from our own box plants, making us a net recycled fiber buyer of only 84,000 tons or only about 14% of our total fiber requirements. A higher recycled fiber prices reduce PCA earnings, as I stated earlier, by about 3.5 cents a ton compared to the third quarter of 2001, and 2 cents a share compared to the second quarter of 2002. Our other mill manufacturing costs were essentially flat with last year, which means we offset inflation with our cost reduction and productivity efforts. As I stated earlier, the single biggest item negatively impacting third quarter earnings was pricing, with liner board and median prices about $20 and $15 per ton, respectively, below the third quarter 2001 average. As most of you are probably aware, we announced a $25, excuse me, we announced a $30 a ton price increase for liner board and a $40 a ton price increase for medium which was effective July 1st.

Industry publications subsequently recognized $20 a ton in July for liner board and $25 for medium and then they recognized an additional $5 a ton increase in liner board in September. So, together, both went up $25, according to the publications. I should point out that our price increase was $30 and $40, but we are tied to the publications and of course that brought our number down to that level. With respect to box prices, we did implement a box price increase and as you know that is phased in or staggered over the quarter. We realized a little over $10 a ton in August, about another 10 in September and box prices, we suspect to get 8 or 9 more in October as some of our customers are on quarterly pricing and they have pricing which goes into effect October 1st. This will complete the price increase for us with boxes, and you can see that we have more than covered, slightly more than covered the cost of liner board and medium in our box prices, which is our objective.

Moving now to cash flow. During the quarter, we generated $89 million in cash from operations, before capital expenditures. We used the cash generated for capital expenditures, stock repurchases, debt paydown and we accumulated the rest. Mill and box plant capital expenditures were $20 million in the quarter. We have paid down $9 million in term loans. We have repurchased about 1.1 million shares of PCA common stock for $19 million in the third quarter, and this brings our total share repurchases to 3.9 million shares or $66 million through the end of the third quarter. We ended the quarter with $130 million cash on hand, as of September 30th, up $40 million from June 30th. But I should point out that our semiannual payment of $26 million on our $550 million at 9 and five eight notes was made last week. Which reduced our cash by that amount and we now have $113 million cash on hand.

Moving now from the third quarter to what we see in the fourth quarter. We should essentially realize the full benefit of the price increases in the fourth quarter. As you know, they were staggered through the third quarter so you don't get the entire benefit. PCA's total corrugated products volume should drop 4 to maybe 5% compared to the strong -- compared to our third quarter, considering how very strong our third quarter volume was. The fact in the fourth quarter we have one less work day and it's also a result of the normal seasonal slowdown in business that usually occurs the second half of December. But even that drop in volume will still be up 7% over last year if this projection holds but again, you got to remember last year wasn't the best year in the world.

Finally, our mill cost, specifically energy and virgin fiber normally increase as cold weather approaches. And overall, if you consider all of these factors, the economy stays on track, we'd expect fourth quarter earnings of about 14 to 15 cents per share and that is provided we don't need any downtime in December to balance inventories. We currently don't project any, but our philosophy has always been to run to demand to minimize working capital and keep our inventories at target and we will continue to do that.

And I really can sum up the fourth quarter in another way and that is that the positive effect we are going to get from the price increase for a full quarter is being offset by seasonal factors, namely volume and higher costs with colder weather. With that, we would be happy to entertain any questions but I'm obliged to remind you that some of the statements we have made on this call constitute forward-looking statements. These statements are based on current expectations of the company and involve inherent risks and uncertainties including those identified as risk factors in our S-1 and S-4 registration statement, all of which are on file with the SEC. Actual results could differ material from those expressed in these forward-looking statements. So, Joan, our operator, would you please open the phones up for questions?

Thank you. If you have a question at this time, please press the one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. One moment for questions please. Our first question is from Matt Verler of Morgan Stanley.

Hi. Good morning.

Good morning, Matt.

I wondered if you can just give us a little bit of detail or color on where the source of strength was in your box volumes and clearly your box volumes were ahead of the industry.

That data is coming out tomorrow. I wish it came out today. We could definitely tell you what the comparison was but we don't know it right now. To answer that question, May was across-the-board and the food service business was I think particularly strong, would be the only thing that I would point out one area. Of course, that is -- that's somewhat normal for this time of year.

And then on the price increase, you seem pretty confident that you are going to be able to get prices, box prices up by the amount of the board price increases. To what extent could --

Let me stop you, well, that's what I'm saying we have got in place, that is what we have told customers and we expect that to happen, as -- you know, the -- it's -- you know, I'm kind of reporting history, now there is some projection in October, but I'm pretty confident with that projection. September -- August and September are done. That's what we actually got. And like I said, we have got eight to nine to go. We have things on contract that start October 1st. Although it is a projection the month's not over, it's a fairly firm projection.

Okay. Um, are you trying to say that you might see price increases above and beyond what you mentioned?

No we think that's what it will be, because we are done. We have talked to all of our customers. We, you know, we think we know what we're going to get in October and, you know, we think we are going to get another 8, 9 bucks is what the numbers roll up to, we got 300 and some salesmen, we got 65 sales managers, they all come in with a number and this is their expectation, some will beat it, some will be a little less. We got the magic of big numbers working for us. When you average that many out, you know, usually you don't expect a lot of volatility.

In the past, as you know, we have seen price increases start well and then ultimately crumble. What indicators would you be looking at to give you a sense that maybe the progress you have already gotten in raising prices will be lost if it is going to be lost?

We have seen none. We have seen none in terms of somebody coming back and said, you know, that there is a problem. You know this is a typical first price increase. They usually take a little longer, usually the first one and the last one in a cycle, but I would say from our perspective, we have seen nothing out of the ordinary for a first price increase.

Great, thank you.

Thank you, our next question is from Mark Wilde of Deutsche Banc.

Good morning, Mark.

I wonder if we could talk about a couple of things. First, just the mill volume that looks like that annualizes to about 2.3 million tons of annual mill volume, which is a little higher than I have assumed historically. Is that a -- kind of a new run rate for the company?

No, what you have to do, Mark, that is a good observation, but what you have to do when do you our annual volume, we only run our model when we do our annual mill volume, we run about 355 days a year, because you have mill maintenance downtime, shutdowns. As you recall, we took all of our maintenance downtime in the first or second quarters, so we had none in the third quarter. So those extra days, you know, we average so many tons a day, but it is not linear per quarter.

I got ya.

So that really explains it all. And if you look at our, you know, our first quarter volume, we were only down at -- in the first quarter, we made just 500 and think 520,000 tons, if my memory still good that back. If you multiply 520 by 4, you only get to like 2 million 80,000 tons. So, of course that is not our volume. So it is not linear. It is a function of the month that you take the -- the quarter you take downtime, we choose to try to get all of our downtime in -- most of it in the first quarter, which is the seasonally slowest and also energy costs are the highest so we save on energy by doing it that way and we like it and we pull our inventories down. We tried to like to run -- have the lowest inventories, the lowest production in the period with the lowest demand, so no, if you look -- if you go back and you add up our production by quarter, take the projection we've given for the fourth quarter, you will come pretty close to our -- the number.

Okay. I just -- kind of curious about this production level in the third quarter just because it looks like it is up 5% year-over-year and going back in my notes, doesn't look like you took any market downtime last year. So you really picked up 5% in mill volume, up a pretty good quarter last year. Have you picked up that much productivity in the mills?

No, it is not productivity. It is not productivity. That is only 3% by the way, your number. It is the fact that last year, the same thing. We took no annual mill outages in the third quarter and we take our annual mill outages in earlier quarters.

Okay.

I would point out that we are going into October with about 3.2 weeks of inventory.

Mm-hmm.

We are tight. And we have got to run well in October to keep up, which I think we will. I'm not concerned about it, because the mill, as you can see, we have a good third quarter and, you know, we do some -- run some risk, we are going into October, November, a little low on inventory, but then we have got to run through December and one of the reasons that will run, I'm pretty sure full in December is we then start our shutdowns for the next year in January and February. We have got Valdosta going down end of January. We got counts going down in February. So we need some inventory to get us through those two shutdown months. So, from a balance point of view, you know we kind of like the way we do it 'cause we do -- we do try to balance seasonality with our mill production. And our mill production in the first quarter will be low again next year because that's when we choose to take our bigger mills down.

Okay. Could you just -- can you tell us from a sort of an outside sales standpoint what your export volumes look like in the third quarter?

We are very small export players. I don't have that number handy. I got somebody looking for it. Hold on here. Yeah, we did a -- in the third quarter, about 52,000 tons.

Okay.

So 52,000 is not -- you know, not a lot.

Okay. Final question I have, just coming back to box prices. If you got $10 in August then $10 in September and you think you are going to get about another 8 or 9, would we then be safe in assuming that it looks like you are going to get about $18 or $19 worth of price improvement quarter-to-quarter? Is that a pretty good number from your perspective?

Yeah. That's right. Because basically, again, on boxes [INAUDIBLE] zero, ten and ten divided by -- I mean that is an average of about ten --

For the third quarter.

If you get a 28 or 29, hey, you have done the math as well as the math can be done.

Okay. And how much offsetting benefit from the OCC, do you think in the fourth quarter?

OCC, if you take, you know, roughly 80,000 tons, the price is about 50 bucks better. So 50 times 80,000, if I do the math in my head is about $4 million.

Great, thanks, Paul.

Thank you for the call.

Our next question is from Mark Weintraub of Goldman Sachs.

Good morning, Mark.

A couple of cash flow related questions, one a simple one, just an update on your capital spending expectations for next year and second, cash tax rate expectations and lastly, an update on your box plant acquisition strategy.

Um, okay, let me have that first one again.

Okay, capital spending.

CAPEX, our original projection was $105 million and will now be 105 to 110. I'm looking at spending another $5 million. The reason is I got all this cash and the return on that cash isn't that great. I'm looking at series of projects that, you know, 30, 35% DCF return that involved cost production. They don't count on incremental volume or anything. So, energy savings, et cetera, so I may throw another $5 million in the CAPEX because they are very high return projects and obviously like the higher return compared to what you can get with cash on a balance sheet. So we are probably going to up that from 105 to 110. That's a small change but that's my current thinking. The second part was cash tax rate for next year?

Right.

Um, probably 15% is a guess, now that depends on earnings levels. But you know, as I have told people before we, you know, our cash tax rate is low, would probably be, I'm guessing, 10% this year, Around 10%, 11%. And it should go up 4 to 5% a year for the next three to four years. And again that is a function of earnings level. The third question was --

Box plant acquisition strategy?

Yeah, well, we still -- we are still in the market to add some box plants. We would like to get our integration level up from say 85% into the low 90s. We are still looking for box plants. But as I have told you many times, we are very, very careful in these acquisitions. And I really can't comment on any specific ones, but that still remains as a core strategy of picking up another four or five box plants to try to get into the mid to low 90s on integration level and basically, that's where we're trying to go but we are pretty prudent in our approach and, you know, everything in its due time.

Okay, great. Just let me clarify on the capital spending, the 110 was that for 2003?

No, that is for 2002.

Okay. And how about for 2003?

You know, it is the 105 to 110.

Okay. Thanks, Paul.

Thank you, our next question from Mark Connolly of Credit Suisse First Boston.

A couple of quick things. When you look at your overall capital usage, CAPEX versus repo versus debt repayment, et cetera, does what you did this quarter represent sort of where you are thinking about capital allocation? Should we expect stock repurchases to continue at something like that level, you know, all else equal?

I would say the answer to that is yes. In general, we are about two-thirds into our stock repurchase program that we announced. We've got about another 35 million to go. We plan to basically continue on a fairly steady path, although, you know, we are opportunistic also. There has been days where we don't think our company has changed but for some reason the market's gone crazy and presented a buying opportunity, of course, we are not adverse to capitalizing on that so, we are not as linear in our purchases as we once were, simply because of the volatility in the market. In terms of CAPEX, no we are going to stay about this level, this is the -- this is the level that we think is right for us.

I would point out that even though we are probably at the 80% or so of depreciation on CAPEX, overall, we do spend just a touch over 100% in our box system and obviously lower numbers in our mill system, because our core objective is to grow our box business and we are fortunate that our mill system through investments in the mid-'90s is in pretty darn good shape. And since we don't need any more capacity, we only have to invest in cost reduction and maintenance, we think our mill number is good for the next, you know, four or five years and we can spend more money where it can generate better shareholder value in the box plants. But we think 105 to 110 is the right number for this company.

Okay. Two more questions, Paul. Do you plan to do any more hedging on energy or are you doing more hedging than you were doing last year at this time, given all the uncertainty out there?

We have always hedged on energy. And by hedged, we buy future strips and our theory is, I may buy 20 cents too high, but I'm willing to do that to make sure I didn't buy $3 too high if energy does go up. So you know, we do hedge a portion of our energy, some we let float. But, you know, I don't know how everybody else does it, but we have been comfortable with that. At least for the last few years it has worked out fairly well for us, but you know, you never know.

Is there a baseline of your overall energy costs that you are trying to hedge?

Yeah, we have a percentage that we like to hedge. But again, there's some things, the only thing we hedge, by the way, is natural gas.

Right.

And only about rough number, 10% of our purchase fuel is natural gas. So, if we hedge say half our natural gas to pick a round number in the middle, you are only talking about 5% of our purchase fuel needs. So I don't want to mislead you that, you know, we have a lot of energy that is subject to hedging. Coal's on contract. Bark you don't hedge, you know you buy that, that's day to day pricing and about 77% of our fuel, is purchased fuel is bark and coal and again, a lot of our fuel also is internally generated in the terms of black liquor So if you threw black liquor in, natural gas as a percent of total fuel, down around, I'm guessing now 6% is not a bad guess, so it's not as big a number as some other companies.

One last question, Paul, inventories, why are you keeping your inventories so low right now? I mean after...

Sweeney is selling too many boxes. I told him to slow it down but he wouldn't listen to me. No we are not keeping them low, but we run to demand and our volume was up 6.5% during the quarter and to be honest, we did not expect our volume to be up 6.5% in the third quarter.

Okay.

You know, we were looking at 4, 4.5. You know, the sales guys tell me 5, but I don't believe them all the time, they are born optimists. But they were right, I was wrong this quarter and it is stronger. So we are a little lower than I thought we would be and that is why we ought to run well in October and will get some relief in December because, you know, you got that -- the holiday shutdown period that we will be able to replenish a little bit so we can take our shutdowns in January and February. We ain't keeping this on purpose that I can guarantee you.

We are going to hope that Mr. Sweeney keeps up the good work. Thanks, Paul.

Thank you.

Once again, ladies and gentlemen if you have a question at this time, please press the number one. One moment for questions. Our next question is from Joel Strivalati of Goldman Sachs.

Joel, you there?

Yeah, my question has been answered.

Okay. Thank you.

Our next question is from George Jonas of David L. Babson.

Thank you, my question has been answered. Thank you.

These analysts are asking some good questions.

At this time, I show no further questions in the queue.

Okay, listen, thanks for participating in the call. And we will talk you to next quarter. Take care have a good day.

Ladies and gentlemen this concludes today's conference. Thank you for your participation. You may disconnect at this time and have a great day. Thank you.