Packaging Corp of America (PKG) 2003 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter earnings 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 of Packaging Corporation of America. Mr. Stecko, you may begin.

Thank you, and good morning, and welcome to Packaging Corporation of America's third-quarter earnings release conference call. Sitting here with me in the room today are Rick West, our Chief Financial Officer; Bill Sweeney, who runs our corrugated business; and Mark Kowlzan, who runs our mills, and they will also be available for questions during the Q&A. I want to thank you for participating in the call and, as always, we will take questions when I finish. So let me get right into it.

Today, I'm going to review third-quarter earnings and also talk about our recently announced cash dividend. As most of you, I'm sure, are aware, on July 22nd, we announced the successful completion of our debt refinancing, which lowered our annual interest expense by $33 million or $19 per share going forward. As a result of the debt refinancing, we recorded in the third-quarter a $47 million after-tax onetime charge or 44 cents a share, and this included the tender premium offer of 34 million, fees and expenses of $2 million, and an $11 million non-cash charge, for the write-off of deferred financing fees.

Including this refinancing charge, we reported a third-quarter net loss of $32 million or 30 cents a share. Excluding the refinancing charge, earnings were $14 million or 14 cents a share, compared to third-quarter 2002 earnings of 15 million or 14 cents a share, and compared to the second quarter of 11 cents -- $11 million or 10 cents a share. So, we are flat at 14 cents with last year, and we are up 4 cents a share from the second quarter of this year.

Net sales for the third quarter were 445 million compared to last year's third quarter of $456 million. And for the first nine months of 2003, as detailed in our press release, adjusted net income, which excludes the refinancing charge, was 32 million or 30 cents a share, compared to 36 million or 33 cents a share, for the first nine months of 2002. Net sales for both the first nine months of 2002 and 2003 were $1.3 billion.

Overall, we had very good quarter operationally. And we did see a significant pick up in corrugated products volume the last half of the quarter. Lower interest expense as a result of our debt refinancing improved earnings by almost 4 cents a share compared to last year's third quarter. Lower pricing and lower mill containerboard volume reduced earnings by about the same amount -- 4 cents a share.

Prices paid for purchased wood fiber and fuels were both up slightly, but they were essentially offset by lowered recycled fiber costs. Wood fiber costs were up almost 5 percent on average compared to last year, with pine up about 3 percent and hardwood up almost 10 percent.

Because linerboard, as most of you know, is primarily pine, our use of hardwood is much less than others. In the South, hardwood costs have risen dramatically compared to historical prices, and producers of hardwood-based products, such as uncoated white, have been hurt much more by these higher hardwood prices. The price of OCC delivered to our mills was down about $35 a ton in the third quarter compared to the same period last year.

On the energy front, NYMEX natural gas market prices including delivery averaged about $5.70 a million BTUs for the third quarter of 2003, and that's up $1.80 per million BTUs compared to the third quarter of 2002. However, our dependence on natural gas and oil is relatively low, so our purchase fuel costs were only up about 25 cents per million BTUs for the quarter, as most of our purchased energy comes from much lower-priced and much more stable-priced coal and bark. In fact (ph), even with the large run-up in natural gas compared to last ,year our energy costs were only impacted by about 1 cent a share because of our fuel mix.

Our total corrugated product shipments for the third quarter was equal to last year's all-time record volume for us. And we feel pretty good about this, especially in a less-than-robust economy. With one more shipment day in 2003, if you look at shipments on a per day basis, we are actually down about 1.8 percent compared to last year. Again, these results are against PCA's all-time record shipments which occurred in the third quarter of 2002.

Year to date, PCA's total corrugated product shipments are up about 0.5 percent on a per workday basis compared to last year. As I mentioned earlier, it was encouraging for us that shipments improved continually and considerably as we moved through the third quarter. Hopefully, this is a sign that the economy has finally started to improve, at least in terms of box demand. But we'll have to wait and see. The other thing that we'll have to wait and see is if the FBA will be releasing industry box shipments, and I think the industry box shipments overall is a better barometer obviously for economic activity compared to just PCA.

PCA's containerboard production for the third quarter was 567,000 tons. That is down 11,000 tons compared to last year's third quarter, and the main effect of this translated into a reduction in our inventories of about 9,000 tons during the quarter. So you can see we have done a pretty good job of matching supply with demand and not tying up cash and working capital by having excess inventory.

Speaking of cash, the third quarter is traditionally our strongest quarter for cash generation. We have our annual mill maintenance shutdowns behind us and is normally the best quarter year-over-year from a volume standpoint, and that certainly was the case this year. On July 22nd, upon completion of our debt refinancing, we announced our cash on hand at $53 million. As of September 30th, our cash on hand was $117 million. And that is a $64 million increase in just over two months, so the third quarter certainly has remainder our biggest cash generation period. I should point out that PCA didn't repurchase any shares of its common stock in the third quarter, and we still have about 11 million or so remaining on our initial share buyback program. Capital expenditures during the quarter were $27 million, and we are on track to hit our target of about 115 million for the year.

Let me now turn to the announcement of our cash dividend to our shareholders. Before considering the cash dividend, our first goal at PCA was to achieve the proper profile and financial structure. And we have done that. And we think we now have one of the strongest balance sheets in the containerboard industry, with by far the best credit ratios and credit profile. And we have limited exposure to future higher interest rates since the refinancing, with about 80 percent of our debt having fixed interest rates -- and attractive fixed interest rates.

As a result of this, and the new tax treatment on dividends, PCA's Board of Directors has approved the payment of a quarterly cash dividend to our shareholders of 15 cents a share or 60 cents a share annually. The first dividend will be payable to shareholders of record as of December 15th, 2003, with a payment date of January 15, 2004. Based on our current stock price, this represents about a 3-percent yield. And this dividend announcement is another milestone for PCA, as in the last four years, we have been able to transform ourselves from a very highly-leveraged LBO to a company with both the balance sheet and the cash flow to pay a substantial dividend. In addition to the cash dividend, we also plan to complete the remaining $11 million remaining on our current $100 million common stock repurchase program.

Now moving from the third quarter to some of the things we expect in the fourth quarter. Fourth-quarter earnings are currently expected to be lower than third-quarter results excluding the refinancing charge for a number of reasons. We expect to see seasonally lower corrugated product sales volume -- especially in December, which is really a dead month for us -- along with two less shipment days in the fourth-quarter compared to the third-quarter. With lower corrugated products volume, our mill production will also be lower. And if the economy does not improve, we will probably require some downtime in December to keep our inventories at optimum levels. Containerboard pricing going into the fourth quarter is also lower, as we will feel the full effect of the August price decrease. We only had a partial effect of that in the third quarter. Finally, purchased fuel usage will be higher with the onset of cold weather. And if you consider all of those facts, we currently expect our fourth-quarter earnings to be about 6 cents a share, with a lot obviously riding on the strength of the economy as we approach the important Thanksgiving and Christmas holiday season.

One thing that I think I should also note. Our volume is typically a little more seasonal than the rest of the industry, related in large part to the fact that we are larger than average players in the display business, which slows down as you get very close to the holiday season -- December is a very slow month -- and we are not big players in the produce market on the West Coast, we do not have a big presence in the California (technical difficulty) produce market. And just to put that in perspective, last year our volume for the year was up 3.9 percent. The industry was up only 0.4 percent, so we outperformed the industry by a wide margin. But if you look at fourth-quarter volume, our volume last fourth-quarter was down about 8%, and the industry was down only about half as much -- about 4 percent. So we are a little more seasonal than the industry with respect to the fourth quarter.

With that, we would be happy to entertain any questions. But I must remind you that some of the statements that we have made constituted what I call forward-looking statements. These statements were based on current expectations of the company, and involves inherent risks and uncertainties, including those as identified as risk factors in our annual report on Form 10-K, which is on file with the SEC. Actual results could differ materially from those expressed in these forward-looking statements.

One final point before I do open the phone lines, those comparisons on seasonality in the fourth-quarter -- I'm comparing third quarter to fourth quarter. That is where we see the biggest drop, and we do usually see a bigger drop in the industry.

With that, Operator, if you would open the phone lines, I would be more than happy to take questions.

Thank you Mr. Stecko. If you do have a question at this time please press the 1 key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the key. Again if you have a question at this time please press the 1 key our first question comes from Mark Wilde, Deutsche Bank. Please go ahead.

Good morning, Paul.

Good morning Mark.

It looks like a very good quarter here. And we're pleased to see the dividend. I wonder if you could talk with us, first of all, on this whole price issue, just moving quarter to quarter -- if you looked at kind of where your prices were in September versus July and August, how much were they down? And then is that September level sort of what we should anticipate, you think, for the fourth quarter, all things being equal?

Yes, just in rough terms, we think overall our prices in the fourth quarter for containerboard will be down about 2 percent compared to the third-quarter. So it's not a big movement, but it's a couple percent, and it is showing the effects of the August decrease of $10 a ton.

The thing I should note, though -- one of the things that happened last year -- pricing was actually up about 3 percent in the fourth quarter compared to the third. This year, we're looking at maybe down 2. So that's a net swing year-over-year of about 5 percent.

But in terms of us, the volume is much more significant than the price decrease,

Ok

and for the reasons I gave -- that we have got a big, big piece of display business, and we're not big players in produce on the West Coast.

OK. That containerboard drop of 2 percent -- that's kind of across boxes, and a little bit of open-market board sale (ph) -- is that right?

Yes.

Can you also give us some sense of what the downtime number might look like in the fourth quarter?

I don't think it will be large. We obviously don't know, and it's (technical difficulty) a lot is going to be dependent on December. Some years, December is just awful for us and the industry, and some years, it's not so bad. So it is going to depend on that. But, you know I would say it could be anywhere between 10 and 20,000 tons -- it's just a real rough number,

Ok

Paul Stecko; Because we do like to -- we like cash, and we don't like to have a lot of cash tied up in inventory.

Right, and what would that be sort of in terms of mill volume growth into the third quarter?

It will be -- if you just take somewhere between 10 and 20,000 tons less.

Okay. And then finally -- you just talked about sort of this volume building as you went through the second half of this quarter. Can you give us any sense of where that is coming from? Are there particular sectors? Are there particular parts of the country?

You know our September -- Bill Sweeney is sitting here; he has got a smile on his face, because usually when we sit down and look at all the box plants, there's 5 or 6 box plants that I ask him, what is going on here, out of 65? I could not ask him that. All of our plants -- it was across the board. And we just saw general strengthening everywhere. That's why I've read into a little bit that the economy is picking up. And the difference between the first half of the quarter and the second half was substantial. It was a big number. Some of that is obviously some seasonality, but it was bigger than what we have ever seen before. And we have had the first four or five days in October have been pretty good, and you just keep your fingers crossed, because the one difference this year is that volume was decreasing last year continually as we entered the fall. It has turned around here, so we're a little bit off on an upper trajectory, and I'm not sure were going to be able to sustain this. And we haven't factor sustaining this into our estimates. We've gone back to what we historically do in the fourth quarter, and that is the basis of our estimate.

So if this economy is truly picking up, we could have some upside. But it's much too early to claim victory, if you will.

Yes, I suppose that it could be just a little movement in sort of seasonal business, or it could be the cyclical.

Or inventories could have been so low people are building finish good (ph) inventories. It could be a lot of things. And -- or it could be the economy has really decided to get its tail in gear.

Last question -- how big is that energy effect just going from quarter to quarter?

We're probably talking -- you know, not a lot -- maybe a penny, penny and a half. Again, we're not nearly affected as much. The biggest detriment for us quarter to quarter by far would be volume.

Okay, sounds good, thanks.

Thank you , and our next question is from Chip Dillon of Smith Barney. Please go ahead.

Yes, good morning, Paul. First question is -- if you could go back to late July -- and just wanted to congratulate you on actually doing the 3 cents better than what you yourselves saw -- what was different about August and September that allowed you to do the 14 cents versus what you thought would be 11 cents? Was it, was any of it because of where interest cost ended up being, or was it all just because of this better volume trend that you noted as you went through the quarter?

That's a good question. How did I miss an estimate so bad? We have been usually have a pretty good track record within a penny of our estimate. I missed it by 3 cents --

You shouldn't feel bad, because you (multiple speakers) usually get it closer than we do.

I don't feel bad; I guess the accountants should feel bad. I don't feel bad. Let me tell you -- none of it is interest. We had the right interest number in there. We knew what we had hedged at -- at the be -- we hedged early in July -- early in June, excuse me. And we knew what the interest expense was -- so we hit that number right on.

It was really three things that we missed on. One is corrugated volume. The second half of the quarter, our volume was actually about 7 percent higher than the first half of the quarter. That is a big turn -- 7 percent. And it was just very strong. That is by far the biggest item.

The second one -- our costs were better than we thought. The mills had no blips; they ran like a top; the weather improved. We were not affected by the hurricane as some paper mills were. So our costs were a little better and we thought.

And the third area (technical difficulty) is solid wood. We only have about 4 percent of our sales in that segment, but it usually loses money. As you know, the wood products business has not been a barnburner these last two years. We actually paid money in solid wood for the quarter, and that was a turnaround.

So there are the three things that caused us to miss. Volume, by far the biggest; and then cost in the mills and the box plants; and solid wood making a profit.

Ok. That certainly all makes perfect sense. When we go through the press release -- if you could do us a favor and sort of tell us where the numbers are flowing to get to a -- you mentioned 29.5 million in EBIT, and I just want to make sure that number does not include any of these nonrecurring expense items. And assuming -- and then if you could also tell us which of those items are in the 82.5 million interest expense that you gave us?

(technical difficulty) I'm going to let Rick handled that one.

The only item that's in the operating line chip (ph) is in the corporate overhead expense area -- 3.3 million of fees and expenses, which we deducted out in coming up with the 14 cents a share. As far as the interest expense line -- if you take everything out related to the refinancing, the interest expense is 9.2 million. But if I could reconcile that for you a little bit -- you deduct from that 9.2 million 3.1 million, which was the final payment on the 9-5/8 notes applicable to operations, which gives you a net of 6.1. And then you add back the 22 days of interest on the new notes, as if it occurred at July 1st, would get you to 1.5 additional. So our current run rate interest expense is about 7.6 million.

Per quarter, that's great -- that's very helpful. The way you think about the operating income that you had -- it's just 29.5 -- sort of the normal number would be 3.3 million higher, and that the 2 million on the other table was just the after-tax impact of that three point (multiple speakers) million?

That is exactly correct.

And what is the -- do you have the pretax impact of the 34.1 and the 10.6 nonrecurring expenses?

We can get it for you in about 10 seconds.

Okay, and maybe while he is doing that -- you wouldn't also have the breakdown of the other (multiple speakers) cost of goods sold?

We have got it for you.

55.9 and 17.4.

55.9 and 17.4. And then if you have the cost of goods sold and the G&A and the corporate -- normal corporate expense?

We don't have (multiple speakers) that broken out, but we can get it and get it to you.

This information is no problem, but I got -- we don't want to turn this into an accounting call, no malice intended.

Okay, and the tax rate stayed at 39 percent, right?

Correct.

Okay. Just one other thing, Paul, just to make sure we're clear about the fourth quarter -- you mentioned the volume being way up in the second half of the quarter versus the first half, and that you are certainly not building in any sustainability of that. On the other hand, is it just too early to say whether or not we're going to have a normal seasonal drop -- or that we might have a better at the normal seasonal period, or even a worse than normal seasonal period? Is it just too early to know?

We think it's too early to know. And the problem is that the second quarter is very -- excuse me, the fourth quarter is very bimodal. You have a very strong first six weeks. And then we get into November, and November is a very unusual November this year -- only 18 shipping days because of the way the month unfolds. We haven't had an 18-day shipping month since February, and February's usually a slower month. And that means you've got to cover all your fixed expenses and amortize them over fewer days. So November is a particularly bad month this year, with only 18 shipping days. Secondly, Christmas falls -- it's a three-day holiday for most people this year -- Wednesday, Thursday, Friday. So December could be hit also.

So I think we got two things we've got to know. We'll know after we close the books in October a lot, because I think that will give us a pretty good indicator on the strength of the Christmas season, and a lot of people are predicting a pretty good Christmas season -- up 4, 5, 6 percent this year. But then you've got to wait and keep your fingers crossed that the last half of the quarter doesn't die.

And so, you know, I think we've got two gates to go through and I will feel a lot more knowledgeable about that first gate about this time next month. And then we see what happens second year. But we haven't -- we have used in our forecasting what we think the normal thing happens, based on what we've done this year. So we've not made any assumptions that we're going to have a terrific economy or a bad economy. We basically forecasting the economy is going to stay about the same -- maybe a little better as we move on, because I think it's dangerous to get ahead of myself on forecasting where the economy is going.

Ok, Thank you very much.

Thank you. Our next question comes from Mark Weintraub of Buckingham Research.

Thank you. Good morning, Paul.

Good morning Mark.

When you're talking about the sustainability of the demand -- is there anything specifically out there that you're seeing that is making you especially conservative about whether that can be sustained? Or is it just too early to know December, and that's really --?

Yes, that says it all. I will tell you -- with five good days in October, I feel directionally a little better about October than I felt five days ago. But you're not going to know that last half of the quarter till you get into it. It's unpredictable -- unless we start seeing a lot of good data about the Christmas season, etc., etc. -- then you might not have to wait until then to know. But it is too early.

Obviously, you have given us the guidance, which is 6 cents. I just wanted get a sense of the sensitivity. If in fact December were to play out somewhat better -- are we talking about a penny better, or are we talking about -- it could be as much as 3 pennies better?

Well, let me just give you some numbers, okay? Last year, our volume in the fourth quarter was off about 8 percent compared to the previous quarter. Excuse me -- yes, compared to the previous quarter. We were off 8 percent compared to the third quarter. In 2001, we were off 7 percent compared to the third quarter. And again, these are two years we have outperformed the industry on volume for the year.

In 2000, we were only off 3.5 percent fourth quarter over third, and if we got back to 2000 levels, that could be a 4- or 5-cent number. That's if -- and I'm not saying we are, and don't take this as an indication of anything other than if our volume was for 4, 4.5 percent better -- that translates to almost 4 or 5 cents a share.

Okay. And just wanted to quickly follow up -- you mentioned 115 million on cap spending for this year. What is kind of the baseline number we should be using in particular for '04?

110 is our baseline number. And we did a few extra things this year, but -- a few is the operative word, because it's only 5 million more than 110. But 110 is what we basically shoot for every year. We think, at least for the next 2, 3, 4 years -- that is the right number. If anything, we could be a touch lower.

OK thank you Paul.

Thank you and our next question is from George Staphos of Bank of America Securities. Please go ahead..

Hey guys. Good morning.

Good morning George.

Just following up a couple of last questions on volume. Last year's fourth quarter -- wasn't December also a little bit strange in terms of fewer shipping days, in terms of where the holidays (technical difficulty) played out?

Christmas is going in streaks, because you only move one day a year, so until you move through that middle of the week period, you're going to have two or three years were Christmas doesn't fall the best from a box shipment point of view. So that is certainly correct.

As you approached your outlook for the fourth quarter, you did not think that would be an appreciable tailwind (ph) for you as you look at --?

Know, it was bad last year too. When we were off 8 percent last year compared to the third quarter, that's reflective of exactly what you are saying -- but it's a (multiple speakers) better.

But potentially -- currently it's an easy comparison, in any event, for this year in terms of December.

That's correct, I would say last year in terms of the geography -- of the days, it's a pretty good comparison. And I'm not sure on shipping days -- Rick, year-over-year, what have we got? Last year versus --

We have got one more in December (multiple speakers) of this year.

Yes, we will actually have one more, theoretically, in December. But it's -- December is a funny month to play with shipping days, because those last two weeks of the year, a lot of people are off. But I think it's a pretty good comparison -- 2002 versus 2003.

Okay, a quick question here. Stepping away from December, whether it's easy comp or not -- if you have a good holiday selling season -- even with the two fewer shipping days in November -- doesn't that volume ultimately get out the door? Is December, in some ways, kind of irrelevant here in terms of your overall volume if it's a good holiday season?

If it's a good holiday season, it is less relevant, certainly.

Ok

And if it's -- so I would say, that -- matter of fact, it's more than -- it is -- it gets on being fairly irrelevant. On the other hand, if it's a bad holiday season, it goes the other way.

Fair enough. Last questions, since we've already covered the volumes to a great degree -- can you tell us what your expectations are for conversion costs -- controllable conversion costs as you look out to 2004? Any things you're doing in terms of productivity or the like that could help your margins in 2004?

From a productivity point of view, we have done most of the things that we need to do on the main things -- namely, energy and fiber flexibility. If volume picks up -- obviously us, along with everybody else, can make that incremental ton at a much lower cost, because all of our fixed costs are taken care of.

But other than that, there are not many things that I think are real material. We have a few capital projects here and there that are going to help us, but I would not say -- there's nothing -- there's no magic rabbit that's coming out of the hat. Our costs are very low. We will continue to eat away at them, but you will not see any large decrease in our costs in 2004.

Gotcha. Alright guys congrats. Talk to you next quarter.

Thank you.

Ladies and gentlemen again if you have a question at this time please press the 1 key on your touchtone telephone. Our next question is from Richard Skidmore of Goldman Sachs. Please go ahead.

Hi, it's actually Nick Detmer (ph) on behalf of Rick. Just one question this morning -- looking ahead to 2004 -- excluding any impact from a potential cyclical rebound, what are the normal seasonal volume patterns that we should expect in the first quarter versus the fourth quarter?

Usually, our two strongest quarters are the second and third. The fourth is a little weak -- the first is a little weaker and the fourth is little weaker. The other thing that happens to us in the first quarter is -- because it is one of the slower two quarters, we tried to get most of our mill downtime done then, when we are matching the lowest -- one of the lowest demand periods of the year with lower production. And also from an energy point of view, the first quarter is by far the coldest quarter of the year, and we like to take our downtime when energy usage is the highest. So, from an operating point of view, the second and third are our best two quarters, and the first and fourth are our worst two quarters.

Great, Thank you.

Thank you. I'm showing no further questions at this time.

Okay. Again, I would like to thank everyone for participating in the call, and hopefully we can get this economy rolling. And we will find out, and be able to talk to you about it next quarter. Thank you very much.

Ladies and gentlemen, this concludes the conference. Thank you for your participation. You may now disconnect and have a good day.