Packaging Corp of America (PKG) 2008 Q3 法說會逐字稿

Thank you for joining Packaging Corporation of America's Q3 2008 earnings conference call. Your host today will be Paul Stecko, Chairman and CEO. Upon conclusion of the narrative, there will be a question and answer session. As a reminder, this program is being recorded.

I would now turn the conference call over to Mr. Stecko. Please go ahead whenever you are ready.

Thank you. Good morning, on the call with me today is Bill Sweeney, who runs the Corrugated Products business, Mark Kowlzan, who runs our Mill operations, and Rick West, our Chief Financial Officer. Thank you for calling in and participating, and as always, when we complete the presentation, we will be more than happy to take your questions.

Let me start with a summary of the results, and then get into some specific details. Yesterday we reported Q3 earnings of $38 million, or $0.37 a share, compared to 49 million, or $0.46 a share in last year's Q3. Q3 2008 results include after tax expenses of about $1 million, or $0.01 a share, related to the previously reported explosion that we had on a recycled fiber tank at our Tomahawk Mill.

Net sales for the third quarter were 621 million, compared to 591 million in the last year's Q3. Net income for the first nine moths of this year was 105 million, or $1.01 a share, compared to 126 million, or $1.20 a share in 2007. Year-to-date net sales $1.81 billion, compared to 1.74 billion in 2007.

Higher containerboard and corrugated products pricing increased our earnings by $0.21 a share, compared to last year's Q3. This improvement was more than offset by higher cost for fiber of $0.06 a share, energy of $0.05 a share, chemicals of $0.04 a share, transportation, labor, and benefits which were each $0.03 a share, interest and other costs of $0.03 a share, and lower volume of $0.02 a share.

Now some specifics. Our mills produced 621,000 tons of on the containerboard, that is down 11,000 tons, or 1.8% from last year's record Q3 production. Our production was a little lower than planned. As we adjusted operating rates to compensate for much higher wood costs, and slightly lower than expected box volume.

Outside sales of containerboard were up 2000 tons from the second quarter this year, and down 13,000 from last year's all-time record shipments. To put last year's third quarter in a little perspective, it was about 12,500 tons better than the previous Q3 record, so it is obviously a pretty tough comparable.

Our total corrugated product shipments were down 0.5%, and down 2.1% per 1 workday, with 1 more work day this quarter. Year-to-date our total shipments and shipments per workday, are down a modest 0.6% and 1.1% respectively over a strong 2007. We ended the quarter with our containerboard inventories flat with the end of Q2, and were down 8,000 tons for the year.

So you can see that our supply and demand has remained in very good balance. As stated earlier, higher sales prices for containerboard and corrugated products, improved earnings by $0.21 a share over last year's Q3. The higher sales prices were a result of both our second half 2007 containerboard and box price increases, the realization of our July 2008 containerboard price increase, and a partial quarter's realization of our August 2008 box price increase. The August box price increase was essentially completed by the beginning of October, and we achieved our price realization targets. So it went very well.

Shifting to costs. Wood, which is a single largest cost component to make containerboard, was up about 17% compared to Q3 2007, and up about 6.5%, compared to the Q2 of this year. This was higher than we expected. The increase in wood costs is being driven primarily by higher diesel fuel costs, which increased logging and transportation costs, as well as the prolonged downturn in the housing market, which limits residual wood chip availability from sawmills.

In Q3, we saw even more sawmills either slowed back or shutdown, putting additional pressure on the pulp wood market. In addition, our southern mills, in our southern mills we had a lot of rain, which makes logging more difficult, and more expensive. Recycled fiber prices were down this quarter with industry published prices for OCC down 9%, compared to Q3 of last year, and down 11%, compared to the Q2 of this year.

Including both wood and recycled fiber, our total fiber cost increased this quarter by about $0.06 per share compared to last year. With our wood costs being up over $0.07, and our recycled fiber costs down about $0.015 per share. Higher energy costs reduced our earnings by $0.05 per share, compared to Q3 of last year. Fortunately we consumed very little oil and natural gas in our mills.

This quarter our use of gas and oil was only 660,000 m-squared BTUs, down 11% from last year's Q3. The work we did on our bark boiler at Valdosta to improve combustion efficiency, and the start up of the bio-gas refinery at the Filer City mill, have helped us to continue to reduce costly gas and fuel oil consumption.

Speaking of the bio refinery, the start up curve is moving along as expected. We are running at about 80% of capacity. We expect to reach full capacity and full efficiency over the next 6 months, as the bacterial population fully matures. This timeframe is difficult to predict, since to our knowledge, this is the first time that such bacteria have ever been fed pulping liquor, such as ours, so there is more to learn.

Looking at another major cost, transportation, average diesel prices as reported by the US Energy Information Association were up 50% compared to Q3 of last year, and only down about 1% compared to Q2 of 2008. Higher transportation costs reduced our earnings by about $0.03 a share, compared to last year's Q3. But on a positive note, Diesel prices did fall during the quarter from a reported average of $4.70 a gallon in July, to $4.02 in September, and this should help Q4 transportation costs come down some.

Chemical costs were also up, as producers work hard to recover their costs. Increased costs for our primary chemicals, caustic soda, soda ash, sulfuric acid, and wax, reduced earnings by about $0.04 a share compared to last year's Q3. Higher labor costs reduced earnings by $0.03 a share, and higher medical and worker compensation costs reduced earnings also by about $0.03 a share. Both the medical and workers comp costs were a little higher than originally expected, because of some significant medical claims, and a settlement of some older workman compensation claims.

Turning next to cash utilization and our balance sheet, capital expenditures were $33 million in Q3, and are 98 million year-to-date. We repurchased 150,000 shares of our stock, at an average price of $2.21, and ended the quarter with $148 million cash on hand.

Our long-term debt was at 657 million, net of discounts of 2 million, and we paid off 150 million in maturing notes due August 1st. We also renewed our existing $150 million receivables credit facility, which was scheduled to terminate on October 3rd at comparable rates. There is 109 million drawn on the receivables credit facility. We have no note maturities for five years, with our 400 million in notes, or 400 million of 5.75% notes due in 2013, and our 150 million in new 6.5% notes due in 2018. Our $150 million bank revolver remains undrawn. So financially, we like where we are, with good liquidity and about 85% of our debt fixed at a average interest rate of 5.95%, with no maturities for five years.

To sum things up, overall we think we had a pretty good quarter. Earnings remain strong despite significant cost increases, the August box price increase went very well. Volume for the quarter wasn't great, but it wasn't bad either. We were able to keep inventories flat with Q2. I think finally and importantly these days, our balance sheet and liquidity remained strong and stable.

Looking ahead to Q4, we expect higher average box prices, as a result of a full quarter's realization of the August box price increase. This will be partially offset by higher wood costs, and higher energy usage with colder weather. But more importantly, we also expect lower containerboard and corrugated products volume, with a weaker economy, and three less shipping days.

The key variable, and uncertainty of course, is the economy, and it's corresponding impact on our corrugated products demand, and our mill operating rates. This uncertainty makes it more difficult than usual to accurately forecast earnings. At this point, we believe Q4 earnings will be about $0.35 a share.

With that, we would be happy to entertain any questions. As always, I must remind you some of the states we made constitute 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 Annual Report on Form 10-K on file with the SEC. Actual results could differ materially from these expressed in these forward-looking statements.

With that, I would ask the operator to open up the phone lines, and we will be happy to address your questions.

Ladies and gentlemen, (OPERATOR INSTRUCTIONS).

First question from Mark Weintraub from Buckingham Research. Your question please?

Thank you. Paul, with your dividend yield now close to 7%, I guess there are two questions that come to my mind, one is exactly what is your comfort level with the $1.20 dividend that you are paying, if you are comfortable with that, what is your thinking process when you have a lot of cash on hand, you have a lot of liquidity, and basically the after tax return of buying back stock would seem to be extremely high at this juncture, so maybe if you could let us know where you stand on those two issues?

We are comfortable with the dividend, and we continue to buy back stock. Quite frankly we earned $0.35 last quarter, despite rapidly rising costs, and so I think we are pretty pleased that we could sustain the level of earnings, in spite of the cost pressure. So I would say that who knows where the economy is going. That is obviously the big unknown. But based where things are now, we think we are in a position to pay the dividend that we pay, and buy back the shares we said we would buy back.

Curiously, you mentioned you bought 150,000 shares during Q3. Have you been buying stock back in the early part of Q4?

Yes. As a matter of fact, our stocks as you said is paying the 7% dividend, every share we by back we are getting the 7% return too. Rick, do you want to give an update on the share purchases through the first part of the month?

Thus far, Mark we have purchased 858,000 shares for $16 million in Q4. And an average price of $18.89.

Can you remind us how much additional you have on your share repurchase authorization?

About half.

What is that in amount?

$150 million program, we have got about half left.

Lastly, you mentioned you got 148 million of cash on the balance sheet, or had at the end of the quarter, how much of your debt was short-term, or how much of that 148 might you look as dedicated to paying down debt?

The only thing we have Mark, is 109 million in our receivables revolver, we keep that constantly because it is at such a low rate. We would not look to pay down any debt.

Great. Thanks a lot.

Thank you.

Thank you. Our next question comes from Richard Skidmore from Goldman Sachs. Your question please?

Good morning, Paul. Can you talk about what you are seeing in the export markets, and the relationship with customers in the export markets? I think from prior discussions those are relatively longer term in duration, not necessarily spot. Can you talk about given the change in exchange rate, Europe clearly slowing, how you see the export markets.

In a word, stable. We think we are going to sell in Q4 what we thought we would sell in Q4 six months ago.

I think that is driven by the fact that we have long-term relationships with people, we have targets on how much we are going to sell to a lot of customers for the entire year, we have a reputation of honoring those commitments, and so do our customers. So we don't see a big movement there, again I'm not speaking, I can't speak for the broader industry, but in our case stable is the best way I can answer that.

In this environment we are in, from a economy standpoint and weaker box shipments, how do you think about market share in the current environment, versus supply and demand in your system?

I don't know that I understand your question. What I said in the call maybe I can answer this way, and get at what you are trying to determine. We were going to run to meet our demand. One of the things that we did do in Q3 is, we not only pulled our operating rates back to keep supply and demand in balance, we actually are taking a little bit of risk in keeping our inventories probably a little bit lower than they need to be, because of the cost of wood.

This year our Counce shutdown for 2009 moves to April. One of the pressures we always faced in Q4 is to build enough inventory, so we could get through our two first quarter shutdowns next year. But we have got a little relief now, because Counce has moved to April because of some equipment deliveries, and so it does not make a lot of sense to build the inventory too soon when wood costs are high, and could go higher in Q4.

That was one of the reasons that we said and it will affect our Q4 earnings, that we will both run the demand, and run to minimize our incremental costs. That is the highest cost of wood you use, the highest cost energy you use, we do have a little more free bore, to be more aggressive in keeping our inventories to maximize our profitability from a cost point of view.

That answers the question, thanks, Paul.

Thank you. Our next question comes from Mark Connelly from Credit Suisse.

You have spent a fair bit of energy working on the energy issue, and this biorefinery is a part of it, can you give us a update on what the pay back on those projects looks like with energy costs where they are today? This one was sort of a home run when you announced it.

Yes. The answer is the returns are pretty much the same, because we didn't use much gas and oil to begin with, and they have come down. And I will give you a couple of examples, the bark boiler upgrades at Valdosta, they are about a 40% return, the cost of bark hasn't changed very much, but it wasn't that much capital. They are like 35% return projects. At the biorefinery, our original estimates were about a $20 million investment, we thought would have savings of about $10 million, and that gets a 35 type percent return also.

That was based on replacing a little bit of gas that we did use, about 8% of our fuel at Filer City was natural gas. That all got taken out. But then we also reduced the coal usage there. We also reduced our steam consumption, because we don't have to run our evaporators or the Copeland recovery unit for chemical recovery, and that saved a lot of steam, but that is steam on coal. That return has basically hung in there, and maybe down a little bit, because the price of natural gas has come down a little bit. But we were removing more coal.

The other plus to that project is that we think our capital expense will go down there, because we have been pushing our coal boiler very hard for the last five years, and our maintenance expense was very high. We just went in and looked at the boiler last month, since the biorefinery has been up, we have reduced our coal consumption by 30%. And the boiler is in much better shape, since we are not running it as near as hard as we had. That is a long winded answer. The answer is, probably Filer City has come down a touch, but only a touch.

Okay. Another question, Paul, if I try to add up all of the things that are happening on your cost side, you have wood costs up, energy prices down a little bit, OCC down, transportation coming down, you have got chemicals up, where does this balance out for an industry that was trying to convince customers they should pay higher prices, can you walk us through where the costs net out?

I think we did already in the release in terms of --

I am trying to think about the next quarter.

Oh, the next quarter, well, what we think for the next quarter is that we really, other than wood, we don't see prices for most other things going up in Q4. What the big determinant for us in earnings, and really what the swing variable will be in Q4 is our volume. We saw softening in September.

It has continued into the first half of October at about the same pace. So volume is by far the biggest valuable that could move our Q4 earnings. And the only costs that are really going up in Q4 are wood fiber, and that is a couple of cent item, and not energy prices but energy consumption, with higher and price being the same with colder weather. But the big item that could affect our earnings is volume. It is just very hard to predict at this point, due to the nature and instability of the economy.

One last question, Paul, as your customers deal with these credit issues, are you seeing people coming to you worrying about some of your competitors, who may have chosen to weaken their balance sheet, relative to yours? Is that a material impact?

I don't want to comment on the creditworthiness of any competitor, that is just not something that even if I knew something I would comment on it. That is between those companies and everybody else. I am going to pass on that one.

Thanks a lot.

Thank you. Our next question comes from George Staphos from Banc of America Securities.

Thanks. Hi everyone, good morning. Hey, Paul, could you give us a quick read, perhaps you mentioned it earlier, on what volumes looked like early in October from the data that you have seen?

You didn't miss it, but I did allude to it. We saw volumes soften in September, and it when it softened we were down about, rough number 6%, in September over the previous year. And it was pretty steady, it didn't spike or move around, it is just like everybody slowed back in their production rate, and our volume fell 6%. That has continued through the first ten workdays, I only have data for ten workdays in October. We are down about 6% in October compared to last year.

Again, it is steady, it is not volatile, it is not seasonal. It is just we are not losing business, we are not gaining business to any appreciable extent. It is just that people are making 6% less of what they made last year, and so they need 6% less boxes. For the last 6 or 7 weeks, we have been running at about 6% behind last year.

Thanks for that. I know it is hard to speculate, but if you compare the current period to past perhaps recessionary periods, are you seeing the signs that we are going into a recession from your experience, could it be deeper, do you think it could be shallower, any perspective you might have on that? Rick are you seeing any changes in your customer receivables, bad debt expense, et cetera given the environment?

I will answer the first one for Rick, because the answer is no. We seen nothing, no changes. IT is business as usual. Things are just about 6% slower than they have been.

But in terms of have I seen anything that gives me signs of hope, distress, all of the above, none of the above, the answer is none of the above. We are just running a little slower, and I would not think that I could predict where we are going from here. That is one of the things I mentioned earlier. There is a lot of uncertainty about where this economy is going, and 50 people will tell you 50 different opinions. You don't need 51. That is as good as I can do.

At least 50 different opinions. Last question and I will turn it over, if you needed to next year, how quickly could you pull back capital spending? How low could you go realizing that is not your projection yet, and could you give us a bit more color on the equipment you are bringing into Counce, and why that is leading to a pushback in the maintenance until April? Thanks, guys.

Our CapEx, we don't at this point see a need to reduce our CapEx next year. We have been pretty steady in our spending, we are long-term thinkers, and that is why we like to have a stable balance sheet. We have been averaging for the last 6, 7, or 8 years, about 110 to $115 million in capital expenditures. Of that, about 60 million to 65 million, is what I call maintenance. And so if you had to, you could probably get down to that number, and probably go a little lower than that if you wanted to take risk, we don't like to take those kinds of risks with maintenance, but about 65 million of the 110 to 115 is maintenance capital.

With regard to Counce, we have an upgrade on one of our big power boilers, we are going to improve the efficiency, we are changing the air system, it is back on I think the call that Mark Connelly asked about energy projects, we have got a good return on the project.

The problem it is a little longer job than a normal repair, because it is a big boiler, we have had to move that in concert with the best time to buy electricity from our utilities supplier, and when they have the least downtime, and it made the most sense, in terms of getting the best electric rates from uninterruptable power in April instead of March. It is more to minimize the cost of our electricity purchases, than it is on any equipment deliveries.

Okay. Paul, thanks for that.

Sure.

Thank you. Our next question comes from Mark Wilde from Deutsche Bank.

Good morning. Paul a few questions, just on this wood situation, can you give us any color on whether it is hitting certain regions harder than others, and also whether there is anything you can do to mitigate this, say portable chip mills, things like that?

It is hitting wherever there are wood products plants, Mark, it is hitting those regions, where wood products plants coexist with paper mills. That about covers everywhere. Some places were obviously more acute than others, the West Coast being a good example, where a lot of mills don't even have wood yards.

They run on 100% purchased chips. They have been hit the hardest, and that wood costs have gone up the most in those regions, but that happened a while ago. What has continued to worsen is the situation in the South, and more and more chip mills are taking more and more wood products plants, are taking more and more downtime than they had previously had been, just because the housing market has not come back. So that answers the first half of the question.

In terms of chip mills, that is not the problem. We have got adequate chipping capacity at our mills. But as fewer saw logs are cut, there are fewer residual chips, which means that more of the chips must come from pulp wood. Since the demand for pulp wood comes up, it doesn't matter how much chip mills you might disperse, that is not where the cost problem is.

The cost problem is where more and more pulp wood has to be cut, you have got to bring it from further distances, and that drives up the cost. An important source of fiber has been hopefully temporarily lost, with all these wood products plants coming down, and strictly pressure on pulp wood prices, at a time where we have had extremely wet weather in the South, and now we are entering the winter weather season, where logging gets more difficult.

Okay. Another question, it looks like labor and benefits together were up about $0.06 in Q3. I think you identified about $0.02 in Q2. Is the delta just the increased benefit claims that you mentioned?

The biggest pieces of that was, one of the things we are working hard to do is clean out old workman's comp claims, it is just a good business decision, and when you can settle them, you do. Medical costs were higher than we anticipated. That was the single biggest part.

And then obviously you have labor increases, both hourly and salaried labor. Then we also have had our incentive stock award is mid-year. That was in there. So it is a variety of things with the two biggest things being medical and workman's comp.

If you were to look at Q4 on a year-over-year basis, any thought on what we might see in Q4?

In terms of what?

In terms of that increase year-over-year in labor and benefits. I am just trying to figure out how much is one-time stuff, how much is an ongoing increase in costs?

I would not be surprised if that could be another couple of cents.

Okay. Last question, a lot of guys in the industry are putting in these big corrugators, as long as Bill Sweeney is there, any thoughts on your desire, your need to put in some of these bigger, wider, high speed corrugating operations?

I am going to let Bill answer that. But we did that five years ago. Bill, you want to talk about that?

Yes, Mark, we were ahead of the curve, we put in three 110 VHS about five years ago, took two corrugators down to one. We put them in volume plants, where we thought we would get the maximum benefit. And all of those plants are now essentially sold out, running on three shifts. They have been very successful.

Okay. Thank you. (OPERATOR INSTRUCTIONS) Our next question from Andrew [Klineman, Iridian] Asset Management.

Thank you. I noticed Paul, that you are going to be speaking at this containerboard conference about biorefining. And you guys are far ahead of the curve compared to anybody, and the first ones doing it. Does that represent once you are at full capacity and get a quarter under your belt, and things are running smoothly, does that represent potential licensing revenue for Packaging Corp. down the road?

Let me first correct you. I am speaking at the conference you referenced, but my topic is biomass, which is a lot more encompassing than just what we are doing at the biorefinery. There is a movement in not only this country, but the world, to use wood for fuel purposes. And that is becoming a very important subject, it will present many challenges, many opportunities and many problems for our industry, and that is the topic that I am discussing, and biorefinery is a small subset of a much bigger topic.

With regard to where we are going with what we are doing at Filer City, it is just a little premature to adjust that subject, I would feel better discussing it when some issues with proprietary technology are properly protected, and we are a little further up the learning curve. That is the best I can do on that question.

Thank you.

Thank you, Andy.

Thank you Next question comes from Chip Dillon, self employed.

Hi, Paul. How are you?

Chip, good to hear from you. You don't know how happy I am to take this call.

Thank you. Quick question on the chemical side, you mentioned that your costs were going up in a number of areas, or staying flat as you go third to fourth, are you actually seeing declines yet, in things like chemicals?

I think the short answer to that is no, we have not seen any declines. And there may be a few things here and there, but not much. Caustic has actually creeped up a touch, and wax has come down just a touch. But other than that, no, it is fairly stable. But we are optimistic that things will, if this economy slows, there are only two good things about a recession, one they don't last forever, and two, it does tends to bring some costs down.

If this recession does stays where it is or worsen, we would expect to see that but not yet. Hopefully that is a good sign. Maybe we will come out of this thing quicker than we think, but No is the answer to your question.

Then we haven't talked a lot about overseas today, where there is evidence at least I see in places like Asia, where some of the big players might not be as healthy as they once were. Between the decline in OCC, and I believe the decline in recycled containerboard prices overseas, are you seeing impact on export demand from the US for craft liner?

No. We are not, Chip, that question came up earlier in the call, and what we said is again in our book of business we have long-term relationships with most of our export customers. We have I wouldn't say agreements, but we have forecasts that they think they will buy X tons during the year.

We have not had a lot of notification to speak of, that people are going to cut back on what people thought they were going to buy from us. We don't sell a lot of paper in China, however we do sell some, that is our smallest market with Europe, and Latin America, South America being our biggest markets. And business in Latin America has been pretty good.

I guess as a corollary to that, you haven't seen or have you, any evidence whatsoever of actually test liner trying to find it's way into an independent box plant here in the States?

None that I know of.

Got you. Thank you.

(OPERATOR INSTRUCTIONS). There are no further questions.

I appreciate your interest in PCA. Hopefully looking forward to talking to you the first quarter of next year, with this economy a lot further along than any of us might have hoped. Talk to you then.

Thank you ladies and gentlemen for your participation in today's conference. This does concludes the program, you may now disconnect. Good day.