Packaging Corp of America (PKG) 2003 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Packaging Corporation of America’s second quarter earnings release conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. If anyone should require assistance during the conference please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Mr. Paul Stecko, Chairman and CEO. Mr. Stecko, you may begin.

Good morning, and welcome to Packaging Corporation of America's second quarter earnings release conference call. With me on the call today is Rick West, PCA's Chief Financial Officer. I want to thank you for participating in the call, and as always, after we complete the presentation, we'll be glad to take any questions. So let me begin.

Today, we're reporting second quarter net income of $11m or ten cents a share. This compares to second quarter 2002 earnings of $12m or 11 cents a share. Net sales for the second quarter were $436m. That's down 2% compared to last year's second quarter of $447m. And for the first six months of 2003, net income was $18m or 17 cents a share, compared to $21m or 20 cents a share for the first six months of 2002.

Net sales for the first six months of this year were $860m, compared to $862m in the first six months of 2002. The one cent per share reduction in earnings compared to last year's second quarter was driven primarily by higher wood, higher recycled fiber, and higher fuel costs. The continuing wet weather in the south made logging conditions difficult, which led to higher wood costs, up about 3% compared to last year. Recycled fiber costs were also higher, up about $15 a ton, but here, we're not affected as most of our competitors, because only about 15% of our net recycled fiber usage is purchased compared to much, much higher numbers for most of our competitors. Although PCA's reliance on natural gas as a purchase fuel is relatively low, natural gas prices were up about 60% over last year's second quarter, and that does affect us somewhat. However, over 75% of our purchased fuel in our mills is bark and coal, which, taken together, costs well under $2 per million BTUs. Where higher costs for natural gas and oil hurt us, is in our box plant system. Since these plants run only on either natural gas or coal. Fortunately, our boxed plants consume only about one-tenth as much purchased fuels as our mills. So we're not hurt that bad.

The earnings reduction from higher cost and fiber and energy was partially offset by higher prices for container board and lower interest expense. I should note that, although second quarter containerboard prices were higher on average compared to last year's second quarter, they did trend down slightly during the quarter, and we entered third quarter with prices slightly lower than last year's July pricing.

Total fixed costs across the company were flat for the quarter. However, cash costs were down about a cent per share, and this was offset by higher non-cash depreciation expense, which also increased by about one cent a share. Interest expense was lower by one cent a share this quarter, compared to last year's second quarter.

Let me give a few more details about our second quarter, starting with operations. Our Corrugated Products volume per workday was down about 1% compared to last year. Worth noting, however, is the fact that our second quarter 2002 volume set an all-time record for PCA, and was up 3.3% over 2001's second quarter. Now, obviously, I'd rather be up for the quarter, but I do think we still had a strong quarter volume wise, considering this comparison. Year-to-date, PCA's Corrugated Products volume per workday is up almost 1% compared to the first half of 2002. The fiber box association will release industry-wide statistics tomorrow morning on June and second quarter corrugated demand and containerboard inventory. So I obviously don't have that information yet. But through May industry corrugated demand was down one-tenth of a percent per workday compared to last year, as our economy continues to muddle along.

PCA's containerboard production for the second quarter was about 557,000 tons, that’s up about 9,000 tons compared to last year. During the quarter, we successfully completed our last two annual mill maintenance outages. Tomahawk was down for four days in April and Filer City was down for six days in June. We made some major upgrades to our recycled fiber plant at Tomahawk, which will increase our fiber flexibility there, and that we can now utilize OCC in addition to DLK. I should mention that we have also made some moves recently to increase the size of our Corrugated Products system by adding two sheet plants with plans to open a third.

In March, we acquired a facility in [Dauna], Texas, to take advantage of some opportunities for additional volume in Mexico. Second, in April, we acquired the assets of a sheet plant in Fairfield, Ohio, which is a very good fit with our combining operations in that state. Finally, we have plans to open a new sheet plant in Franklin, Wisconsin, during the month of August, which will complement our combining operations in Milwaukee and Burlington.

Moving on to cash flow and our balance sheet. During the second quarter, we repurchased 769,300 shares of PCA common stock for $13.9m. This brings our total share repurchase to 5.2m shares or $88.8m through the end of the second quarter. Capital expenditures in the second quarter were $29m and we are on track to hit our $115m target in 2003. We ended the quarter with $131m cash on hand. On July 7th, we reduced our debt by $79m to $659m. This $79m debt reduction completed the payoff of our original $1.219b senior secured credit facility. As of July 14th, asset of debt pay down or cash on hand is now $66m.

We have also taken other steps to further improve our already strong financial position and increase our financial flexibility. On June 23rd, 2003, we announced a cash tender offer for all 550m of our 9 5/8% notes. I’m happy to report that over 99% of the notes have been tendered as of July 14th, 2003, with the tender offer expiring at midnight eastern daylight time on July 21st, 2003.

Moving now from the second quarter to some things that we expect in the third quarter. Containerboard pricing, as I mentioned earlier, did trend downward slightly during the second quarter, and we begin the third quarter with pricing in July a bit lower than the second quarter average. We also have not seen much improvement in logging conditions in the south, with the continued extremely wet weather, which could adversely affect both price and availability of virgin fiber. Although we have had some drying the past few days. On the plus side, recycled fiber pricing for July is down slightly compared to the second quarter average, and with more mills taking their annual outages, recycled prices could possibly drop a bit more during the quarter, but who knows?

We do expect to see a seasonal pickup in Corrugated Products volume, and there is one additional shipping day in the third quarter which should improve earnings. The key variable in all of this, of course, continues to be the economy, and the resulting impact on Corrugated Products' demand.

Also, in connection with our tender offer, PCA is conducting a private placement of notes, the details of which were publicly announced in a press release issued yesterday. Because of limitations imposed by federal securities laws, we are unable at this time to comment further on this offering and its anticipated impact on our future financial results. We do plan, however, to report on the results of our refinancing efforts and provide more specific earnings guidance for the third quarter as soon as we complete the tender offer later this month.

With that, we would be happy to entertain any questions, but as always, I must remind you that some of the statements we have made on this call constituted forward-looking statements. These statements were based on our current expectations of the company, and involve inherent risks and uncertainties, including those identified as risk factors in our annual report on Form 10-K, on file with the SEC. Actual results could differ materially from those expressed in these forward-looking statements. With that, I would ask the operator to open up the lines and I would happy and Rick would be happy to take any questions you might have.

Thank you, gentlemen. If you do have a question at this time, please press the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, press the pound key. If you have a question, press the number one. Our first question is from Chip Dillon from Salomon Smith Barney.

Good morning.

Good morning, Chip.

Quite impressive compared to other people in the containerboard business these days. I wanted to ask you about a couple of things. First of all, if you could just clarify, you said 75% of your purchased fuel is bark and coal?

That's correct.

Okay, and then the second question I had was, could you quickly walk through how the cash works with the tender offer? Let's assume, you know, it's all 100%. Now, I don't know if you've already purchased any of these bonds in the open market, so I'm assuming it's 550m. How much will you be paying for the principal and what would the coupon interest be when you do redeem these and when do you expect to pay that off?

The tender offer closes at midnight on July 21st, Chip. And it will be priced as of that date. As Paul said, over 99% of the notes have been tendered. So that would be 99% of the 550m and principle, plus the amount paid above the principle, which will be determined on the closing date.

Okay, so you don't -- okay, you won't know that until the closing date. And will the payment -- and then how -- I assume that the private placement, I know you can't comment on it, but you said you'd use the proceeds for that? You won't have to borrow money from the bank temporarily to bridge this?

What we had said in the tender offer is that the tender is contingent on closing upon the refinancing, which would include the press release that we made yesterday.

Got you, okay. Shifting gears to the business, you mentioned you've gotten your maintenance shutdowns, all of them completed for the year. What how much would you say this costs you in the second quarter, and how much, in other words, how much sort of a head start do we get for the third quarter from that, given that we could certainly use a head start in the third quarter?

Chip, from the standpoint of amortization of the shutdown expense, I believe, and I'm going to confirm this with someone, just the shutdown expense is about one cent. But that will be each quarter, because that's the amount above and over last year's shutdown, because we did more work. So it's not that that would be an increase in the third quarter. It's the fact that that's the amount each quarter for the incremental cost over last year's shutdown.

Chip's asking the total cost of the shutdown.

You would get more tonnage this next quarter both because of the seasonal pickup, as well as the shutdowns, but at this point, we're going to get into that when we give earnings release guidance’s at the next conference call as to the increase in tonnage and what it would be from the second to the third quarter.

Just to make sure I understand this, the actual expense of doing the maintenance is pro-rated throughout the year, but where you do see volatility would be in the volumes that you get?

That is correct.

What we're getting to, the shutdowns this year were bigger than last year. They're not all the same size, so we had a little more expense this year, but you're asking what the total impact is. In the not too distant future we'll be able to go through all of that detail with you. We're not giving earnings guidance today because of what we have going on in the refinancing, but it's not going to be very long before we're able to talk to you about that.

Okay, and then you mentioned in your press release that you had long-term debt of $738m and then of course, if we take away the $79m from the payment, you're down to $659m, and the bonds that you were buying were $550m, what would the other $109m be?

That is our asset securitization, Chip, our revolving credit facility where we basically factor our receivables as a revolver, and that will remain as is.

It's very low cost debt.

Okay, and then I guess one of the last question I'll have is, it seems like you're pretty much refinancing the entire amount of the term that you're buying in or tendering for, even though you're still generating incredible amounts of cash, and so, you know, it's inevitable that you're going to have some free cash flow after this is all said and done and you won't be in a position, I would take it, I would assume, to buy down this debt you're about to sell and it would be kind of crazy for to you sell five-year paper if you intended to buy it back. So any thoughts on what you'll be doing with your free cash flow beyond the current time period?

Well, that's certainly one of the things that we're going to have to figure out. Obviously, we have some ideas. The predicament that I'm in on this call is that we really can't say a lot about what we're doing in the refinancing that will generate some numbers, and, again, Chip, as soon as we get done with that effort, we can have a much more meaningful phone call and that's why we're going to reschedule another one.

Okay. Thank you very much.

Thank you. Our next question is were Mark Connelly of Credit Suisse First Boston.

Thank you. Paul, I wonder if you can talk to us about two sort of seasonal issues. First, as you think about the rest of this summer and going into the fall, what kind of mix issues affect your business relative to the industry? I mean, I know you got piles of small customers, but I'm curious do you see any big seasonal shift? And the second question is, when you talk to your customers, are they seeing any signs of benefit to their business from the weaker dollar? Clearly, containerboard hasn't seen a meaningful benefit yet, but are you seeing anecdotal evidence at your manufacturing customer level?

Okay, let me take them one at a time. There is some seasonality to this business. Third quarter, and then, of course, the first two months of the first quarter are seasonally stronger than the rest of the year. Our business, as you know, we're a big player in food products and food service packaging.

Right.

And of course, that increases with events like Labor Day and of course, Thanksgiving and Christmas. That's seasonally stronger. But the other thing, we're also a big player in point of purchase, point of sale displays. And there's more promotion during the “leading up to the holiday” season so our display business gets stronger and stronger as the year goes on and then it falls off dramatically starting in December, when everything's been shipped, and January, there's not a lot of displays. So that's seasonal.

So we'll see a seasonable pickup, as will most people in the industry, but the two areas we benefit the most in is in food and in the display business. With regard to the pickup, you know, we'll get FDA numbers tomorrow, but my feeling is we have not seen a lot of help yet from the U.S. dollar weakening. We are starting to hear, and again, I talk to sales people who talk to customers all the time, just to try to get a feel of what's going on out there. There is some feeling that people are getting more and more inquiries about business that could translate into exports, and my, again not knowledge, but theory is that when you haven't been that successful in finished goods, exporting, because of an uncompetitive dollar over the years, you just don't turn it on immediately. People have got to make sales calls overseas. They got to line up customers. They got contracts, the whole thing takes some time, and although I have not seen a lot of visibility of it, obviously, demand hasn't picked up, I am hearing rumblings that activity is going on. When that activity comes home to roost, you know, I don't think it's weeks, but I think it's months, and I think we'll start to see the benefit.

Okay, thanks very much, Paul.

Thank you. Our next question is from Lise Shonfield of JP Morgan.

Good morning.

Good morning, Lise.

Just a question on pricing. I think you mentioned containerboard prices slipped a bit since you went through the second quarter and were lower than July for the second quarter average. You didn't mention anything about the box side in terms of what you actually were seeing on the pricing from there. I was wondering if you could address that.

Box pricing has held up pretty well. We have not seen very much slippage in box prices.

Okay, that's right across the country? I was sort of reading today that the northeast was seeing some slippage but that's not what you're seeing?

The northeast has always been the weakest of the regions.

Okay.

And -- but we have seen no meaningful difference in any regions. Now, that doesn't mean everybody's that way, but we've been pretty consistent in all of our regions.

So as we model the third quarter, we shouldn't be anticipating a sort of significant decline in pricing for you on the box side at least?

I don't give forecasting on pricings a quarter ahead. I don't know.

Another issue, there being a pickup again in the anti-trust lawsuits that we've been seeing.

There has been no pickup. Are you talking about the corrugated paper article?

The 1993 to '95 issue. I wondered if you could address that and if there's any implication at all for your business?

Well, I would say that I've had a couple of calls about that as a matter of fact. And unfortunately, that article has confused some people. I read it, and I wasn't that confused, because I'm pretty familiar with it. I think the situation is if you're not familiar with what's going on, it can confuse you. Let me say a few things about that, now that you've brought it up.

We believe that the plaintiff's allegations have absolutely no merit, and we intend to defend this suit vigorously, and as we've said in our form 10-K, we don't believe the outcome of this litigation will have any material adverse effect on PCA. But with regard to the article, there are not more people suing now. All of the people that had filed suit with the plaintiffs were in the original class. And what has happened is there's been a redistribution of the same people. No one new is suing, okay? So nothing's changed. Everybody is musical chairs. They're switching seats. And I don't know why specifically people opted out of the class. I can only surmise that they must think they can get a better representation or maybe pay lower lawyer fees than to have somebody else represent them, but the number of sue-ers has remained constant. They are just picking new lawyers to represent them.

What's the next date appointment we can expect on this issue? Is it a long, drawn out issue or is there a specific timeline that we can be looking at?

Well, these things take a long time.

Okay.

And you know, the definition of long varies, but this is not -- this is a long process.

Okay, thanks very much.

Thank you. Our next question is from Rick Skidmore (ph) of Goldman Sachs.

Good morning Paul. Just one follow-up question. You mentioned the startup of the new box plant in Wisconsin. Can you talk about what potential costs may be coming from that in the third quarter?

Small. Sheet plants, as you know, don't have a corrugator. The beauty of this plant is that we've got two large plants in the area. Milwaukee, which is a big volume plant and Burlington, which also can handle a lot of volume and makes displays, and what we needed in that market is a small sheet plant to handle, you know, the specialty items, the low volume items. And you know, the total cost of that plant will be well under $10m, and it will be funded from free cash. So it's a small investment, but it will create a lot of value for us both at what it can do on its own and what it can do to improve the efficiency of Burlington and Milwaukee. Because all of the slow, the low volume, the special items are the real small boxes, you pull out of those plants, put into a specialty plant and you increase your productivity. So it's not a big investment, but it's an important one.

Thank you.

Again, if you do have a question at this time, please press the number one key on your touchtone telephone. Our next question is from Mark Wilde of Deutsche Bank.

Two follow-up questions. I first wondered if you could talk a little bit about --

Mark, can you speak up? I'm having difficulty hearing you.

Sure. Can you talk a little bit about what you might be seeing right now in terms of the export market for containerboard itself from, you know, a volume standpoint, your ability to maybe tap some markets that you couldn't a year ago with a stronger dollar?

Yes, I can talk about it. As you know, Mark, we are not big export players. About 6% of our volume is exported. So compared to the big guys, we're small. Our volume has been pretty flat. Pricing has moved up as the dollar has started to help us, and we focused more on, I don't want to say specialty grades, that would be pushing it, but high basis weight grades, things that people don't make a lot of, super heavy weights. So our business tends to be more stable, doesn't fluctuate nearly as much as others, and I think, yes, we'll have some opportunities, but they're not large, because, because you know, 10% of 6% is not a large number. And that's directly related to the dollar. So it really doesn't benefit us as much as many of our competitors who are much bigger export player, but every little bit helps.

Okay. One other question. You're adding these little sheet plants, but I wondered in the context of that, if you can talk at all about, you know, where you think the box industry around the country is running from a utilization standpoint? I recognize that it's not the same issue that we have with the mills. But we often hear a lot of talking about an awful lot of excess box plant capacity out there.

Well, it depends how you define excess box plant capacity. You know, paper mills run seven days a week, 24 hours a day, about 355 days a year. The other ten for maintenance outages, and that's pretty easy to define capacity. Box plants typically, most of them, five-day operation, not seven days, and two shifts, and some three shifts. So if you just did the math on that, you would see that box plants in general run at about 65% of theoretical capacity. I could be off a few percent, but that gets you in the ballpark. When you need more capacity, you basically add another shift, and I don't think the box business is one that you necessarily have to have the highest operating rate in the world to be successful.

You could have a very successful box plant running five days, two shifts, and I think most people, and we're certainly in this category, we push for productivity. We push to add new equipment. We like to contain our box plants to run two shifts, and not add that third shift, because that gets expensive. You add a lot more labor. Your newest people are working the graveyard shift. That does have an effect on quality for awhile, and you're better off trying to get done what you can get done in two shifts. That's our opinion. So you're asking a very complex question, and it's really not something that I think in terms about excess box plant capacity, because in the end, it backs up to the mills anyway, and I think the driver on the box plants are, once the mills are filled up, it doesn't matter if you've got excess box capacity. You can't use it anyway. So I think in terms of capacity, the mill numbers are much more meaningful than the box plant numbers.

Okay, and finally, you mentioned that your mill volume in the second quarter was about 557,000 tons. If we assumed that volume at Filer City is about 1,000 tons a day and Tomahawk --

It’s about 800 at Filer City.

And Tomahawk would be about 1,500?

That's in the ballpark.

If we just put that volume in the third quarter, the four days and the six days worth of maintenance down time, would that get us to something that might be close to the volume for the third quarter?

Yes, it gets you very close. The only wildcard is the rain has got to stop eventually or wood could become a problem, and you could slow down just to conserve wood, and figure out you'll pick it up in the fourth quarter, and you know, run your inventories way down low if you thought you could save some money on wood. And, but I'm kind of hopeful that we're going to get back to steady state with this weather. I tell you, the weather has been very difficult for everybody in the south.

So that's the only call we'll make. We've got a lot of fiber flexibility. We've got production flexibility and we've got to make a call. If the weather keeps staying bad that we slow back a little bit, and make it up in the fourth quarter when we think we got a little better wooding conditions, and that net is going to come out between the two quarters, third and fourth. And my own feeling right now is that, hey, the wet weather will be behind us, but a few hurricanes coming up will not help the situation. So I'll tell you, one of the things I do every day, it's new to my routine, I put on a national weather map up the radar and see where it's raining. I haven't done that in my entire career until this year.

Okay, good, thanks, Paul.

Thank you. Our next question is from Bruce Klein (ph) of Credit Suisse First Boston.

Good morning.

Good morning.

I was just wondering if there was any help with regard to sequential change in containerboard prices, kind of 2Q versus 1Q. And secondly, with regard to the sponsors, what might be the strategy or the exit strategy or timing? And lastly, the stock buyback plan. Has there been a public, or have you voiced a plan, what the target is for the year or longer time period?

Let me take them backwards. We announced on the 100m buyback, and over 18 month period or so, and that's still our intent, to complete the 100m share buyback. We ended the quarter at $88.8m, so we got about $11.2m to go. Your second question was, I think you used the word sponsor?

Well, Madison Dearborn.

Okay. We don't have any sponsors, but we do have a large owner in terms of Madison Dearborn, and I would suggest, they're willing to take this question, ask them what their exit strategy is. What they have said publicly, on occasion, is that they like their investment in PCA. They have been in other investments, like Buckeye Cellulose for a long period of time, and typically, when they decide to sell shares, they do it through the market to targeted investors who are interested in the position in the company they want to sell. If you want more specific details, I'd suggest that you give them a call. The first question concerned pricing?

Right.

And that was, what's the difference in pricing over the first quarter versus the second?

Yes.

Let's see --

We'll get the -- you mean containerboard pricing?

Right.

Pulp and paper is, if you’re using list pricing, is down about $7. That's list to list and then pulp and paper has introduced a transaction pricing list also, and I don't recall what that number is, but it's in two weeks ago’s "pulp and paper." If you just pull it up, you can get that number there.

And you guys?

We don't reveal that information.

Okay. Thank you.

And the reason for that is, we’ve got export, but we've got a mix of businesses and the only thing it would do is mislead you.

Thank you.

Thank you. Our next question is from Mark Weintruab of Buckingham Research.

Thank you. Good morning.

Good morning, Mark.

You just mentioned there was a second price series introduced by "pulp and paper week" and you’d also mentioned you hadn't seen much slippage in box prices. Can I draw from that that there has been negligible impact from the introduction of that new price series in “pulp and paper week” to box pricing?

Mark, I would say the in order ‘negligible’ is probably right on. You hit the nail on the head with the hammer. I think it’s negligible. I think most of our customers understand that what we use the list price for to determine whether things went up or down, and I think that's been negligible pushback from the change that pulp and paper made.

Second, you gave us in the call basically the delta for the second quarter of this year versus the second quarter of last year, the earnings drivers. Looking from the first quarter to the second quarter, where pre-tax earnings you were up about $6m, did anything stand out as driving that increase?

Yeah, that's a good question. Three things did stand out comparing first quarter to the second. Volume was up four cents. So quarter over quarter volume helped us by four cents. Energy helped us by two cents, because again, you use a lot less energy in the second quarter than you do in the first quarter, because it's a heck of a lot colder in the first quarter. And price hurt us about three cents. So the net of those is we're up three cents over the first quarter. Volume up four, energy up two, price down three, and net up three.

Great, thank you.

Sure, good question.

Again, if you do have a question at this time, please press the number one key. And our next question is from Mark Rider of Goldman Sachs.

I just had a quick question. I don't know if you mentioned, but what was depreciation amortization during the quarter?

$38.7m.

Thank you.

Thank you. That does conclude our questions. I'll turn the program back to you, Mr. Stecko.

Yes, again, I would like to thank everybody for participating, and again, I do offer my apologies for not being able to go into details on the refinancing, but we will, as we said in our press release, have a follow-up call to discuss the implications and ramifications of this, and that should not be in the too distant future. Thanks again for participating.

Ladies and gentlemen, this does conclude your conference. Thank you for participating today. You may disconnect at this time. Have a great day.