Packaging Corp of America (PKG) 2008 Q4 法說會逐字稿

Good day, ladies and gentlemen. Thank you for joining Packaging Corporation of America's fourth quarter 2008 earnings conference call. Your host today will be Paul Stecko, Chairman and CEO. Upon conclusion of the narrative, there will be a Q&A session. I'll now turn the conference over to Mr. Stecko. Please go ahead when you are ready.

Thank you, and good morning. Appreciate you tuning into our earnings release call and on the call with me today is Rick West, our CFO, Bill Sweeney, who runs our corrugated products business, and as the operator just said, once we complete the formal part of the presentation, we'll be more than glad to take your questions. I've got a slight bit laryngitis, so Rich is going to help me through some of this script. I'll let him start it off and I'll pick it up.

Thank you, Paul. Yesterday, we reported fourth quarter earnings of $30 million or $0.30 per share. This compares to record 2007 fourth quarter earnings of $44 million or $0.42 per share. Net sales for the fourth quarter were $546 million compared to $580 million in the fourth quarter of 2007. Full year net income was $136 million or $1.31 per share. Full-year net sales for 2008 and 2007 were $2.36 billion and $2.32 billion respectively. Despite unusually high cost inflation in the first half of the year and the severe economic downturn in the fourth quarter, this is our second best earnings year excluding a large Timberland sale in 2000, since becoming a standalone Company in 1999. The only year with higher earnings was 2007 at $170 million or $1.61 per share.

The lower fourth quarter earnings this year were driven by the severe downturn in the economy that significantly lowered our sales volume, lead to record production down time in our mills and increased operating costs, all of which reduced earnings by about $0.21 per share. In addition, higher costs for energy, chemicals, and labor and benefits taken together reduced earnings by about $0.11 per share. These items were partially offset by higher pricing for containerboard and corrugated products that improved earnings by about $0.18 per share and the lower tax rate, which improved earnings by $0.03 per share. We'll break down some of these numbers further a little later in the presentation. And now, I'll turn it back over to Paul.

This past quarter was also the most difficult quarter PCA had spaced operationally. Corrugated products shipments were down about 50,000 tons or 9.9% both in total and on a per workday basis compared to last years fourth quarter. The number of workdays were the same as last October but we had two less workdays this November and had two more workdays in December making it very difficult to assess shipments by month, either using a per workday or a total shipment basis. Nevertheless, our total Corrugated Products shipments were down 7.7% in October, down 19.6% in November, and down only 1.7% in December.

Now, I don't think November was as bad as the total shipments would suggest, nor do I feel December was as good but December was certainly a lot better in total volume, up 6.5% over November. Higher total shipments in December over November is quite rare. For us and the industry, happening only one other time in the last 10 years. For the year, Corrugated Products shipments were down 2.9% and on a per workday basis with one more workday, down 3.3%.

Our outside containerboard sales were also down significantly from last years fourth quarter with domestic containerboard shipments down 27,000 tons and export shipments down 8,000 tons. To match supply with lower demand, we lowered mill operating rates, reducing production 10,000 tons in October, 35,000 tons in November, and 45,000 tons in December, or a total of 90,000 tons for the quarter. This is by far the most down time our mills have ever taken in any quarter for any reason, annual outages or marketing related, dropping mill production to only 533,000 tons. Overall, our system operated at about 85% of capacity during the quarter but we were able to end the year with our containerboard inventories 2,000 tons lower than last year.

I mentioned earlier that higher corrugated and containerboard pricing improved our earnings by about $0.18 a share over last years fourth quarter. As we reported in our third quarter earnings call, our August box price increase was essentially completed by October 1. So we were able to achieve a full quarters price realization in the fourth quarter. This along with an outstanding job managing cost during our slow backs and shut downs, in our mills and in our box plants were major reasons why we were able to earn $0.30 per share this quarter

Looking at some individual costs, total fiber costs were flat. Recycled fiber prices were down about 40% compared to the fourth quarter of 2007, improving our earnings by about $0.03 per share but wood fiber costs were higher reducing earnings by the same $0.03 per share compared to last year. Our wood fiber cost did go down as the quarter progressed. However, with December wood prices about 4% less than the third quarter average. This is somewhat unusual, as wood costs historically go up in December as producers try to build winter inventories but with all of the down time, we were able to cut out a large portion of our highest cost wood and still maintain adequate wooden inventories.

Looking at energy and energy related costs. Transportation costs were up only $0.01 per share compared to last years fourth quarter reflecting both lower diesel costs and the availability of more trucks with the economic downturn. Our fuel costs were up about $0.03 per share over last years fourth quarter and electricity costs were up about $0.01 per share. We realized only modest improvement from lower natural gas and fuel oil prices because of our low usage and in the second quarter with natural gas prices continuing to increase. We did purchase physical contracts with national gas suppliers to deliver some of our natural gas at a set price for the second half of 2008.

Compared to today's natural gas prices, our fuel costs were about $0.015 per share higher in the fourth quarter because of the higher costs of our contracts. Chemical costs were up about $0.03 a share over last years fourth quarter and that was primarily caustic soda. We do not see chemical costs coming down much in the short-term, as caustic soda continues to be in short supply. Higher labor and benefits costs reduced fourth quarter earnings by about $0.03 a share, with medical cost representing $0.01 of this cost increase. Rick, I'll turn it over to you to get through some of the other financial information.

Thank you, Paul. Our tax rate was lower than this years fourth quarter than last year, which benefited earnings by $0.03 per share, also higher interest expense reduced earnings by $0.02 per share, primarily from lower interest income on our cash investments, as we had charged -- and we also had charges of $0.02 per share for higher legal and bad debt reserves compared to last year. Finally, earnings benefited by about $0.02 per share because the higher than normal LIFO inventory valuation charge that occurred in the fourth quarter of 2007 did not repeat this year.

Turning to cash utilization, Capital Expenditures were $35 million for the quarter and for the year, CapEx was $133 million. During the fourth quarter, we repurchased 1.122 million shares of our common stock for $20 million at an average price of $18.11 per share. We ended the year with $149 million cash on hand. We have $109 million drawn on our $150 million on Balance Sheet receivables credit facility and our $150 million bank revolver remains undrawn except for $20 million in letters of credit. We have no long term debt maturities for five years with our $400 million and 5.75% notes due 2013 and our $150 million and 6.5% notes due in 2018.

Our total long-term debt at year end, excluding capital leases was $657 million net of debt discounts of $2 million. At year end, the average cash interest rate on all of our debt was 5.5%, which equates to only $36 million in annual interest expense. Looking ahead to the first quarter, we will take our Valdosta mill down in February for its annual maintenance outage. Normally this would be an eight day outage but with anticipated market related down time, we are spreading this outage to 16 days to eliminate the need for outside contractors and expensive overtime. And we'll do most of the work required with our own employees. It takes longer this way but the labor cost savings helps to significantly reduce the cost of our total down time.

Our Counce mill is normally down in the First Quarter also, but the timing of equipment deliveries for major energy savings project required us to move the counts outage to April. We also expect lower containerboard and corrugated products sales volumes and significant production down time with increased cost until the economy improves. Energy usage will be higher with colder weather and we also expect higher chemical costs. Certain timing related benefits cost are the highest in the first quarter and we expect a higher tax rate.

Finally, we should see some benefit from lower transportation and wood fiber cost. With current economic conditions and the associated level of uncertainty, we estimate our first quarter earnings to be about $0.20 per share. With that, I would be happy to take any questions but as always, I must remind you, that we made some forward-looking statements on this call. These statements are based on current estimates and expectations and projections of the Company and there is all inherent risks and uncertainties, including the direction of the economy and 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 the phone lines and would be happy to take your questions.

(Operator Instructions) Our first question or comment comes from the line of Mark Connelly from Credit Suisse. Your line is open.

Thank you, Paul and Rick. My question is about your customer base and it's got a couple of parts. We think of your customer base as being comprised of smaller and niche orders. Can you talk about the relative cyclicality that you see in your customer base versus the industry data that you're looking at? And can you also comment on the relative credit quality of your accounts receivables right now?

Yes, well let me comment on in terms of the customer base. We don't only deal with small companies. We do a lot of business with big companies but we simply don't have a smaller share of that business. In terms of business that we think that are hard to do things where we can get an adequate price for what we provide. So we do a lot of business with a lot of big companies. We just don't have large positions in that particular company, but except for a few.

With regard to cyclicality. Basically, we're seeing across the board in the bulk of our business, which is food and food service, it's down half, about half as much down maybe 5% but when you get into trouble with the industry, building products, automotive, you're looking at 30, 40, 50% declines. So when you average those, you jump up to maybe the 10% down in terms of our volume. And it's not really dramatically different than the industry. You lead me to a good point.

In November and October, on average, we were down 13.5%. The industry was only down 11.5. So pretty close. And I think the encouraging thing that I've seen is, that as I've said in the call, our December volume was up 6.5% over November and if the industry volume follows, in other words they keep the correlation with us as they did in October-november, then that would bode for a pretty good inventory reduction that could occur in December because not only is production down 340-35,0000 tons, demand on a total volume basis could actually turn out to be up 100-150,000 tons, if that correlation continues but we'll have to wait a little while to get those numbers. So we aren't really that dramatically different than the industry, Mark. It's just, we don't have a lot of large positions in a lot of companies.

Paul, should I infer from those comments then that your customer base didn't change much in December? That you didn't pick up a lot of new customers?

Very little.

Okay.

Very little. Basically, our fall off in volume came from existing customers basically ordering 10% less than they used to because their business is off roughly 10%. Very little turnover in customers.

Very helpful. Thank you.

Our next question or comment comes from the line of George Staphos from Banc of America. Your line is open.

Thanks. Hi, guys. Good morning.

Good morning, George.

Hi, Paul. If we can go back to the more consumer packaged good types of markets. Then, you mentioned food and food service. I guess, food service makes sense in terms of why it would be down but what are your more staple-oriented customers saying about why they'vere seeing demand down.

Is the consumer continuing to just take inventory down within the pantry and how long do they think these - 5% growth rates in food and related might continue? Any sense, and then similarly, you gave us some directional guidance. What do you think early January trends or what are you seeing in early January trends thus far within the business, and I have a couple follow ons.

The first part of that question is pretty easy. There's no consensus. Every customer has an opinion about their business and where things are going. And I would say the general consensus is basically what you read in all of the surveys in the paper. The first half of this year could be slow and people hope things are going to pick up in the second half. I'm not hearing anything out of the ordinary in that regard from our customers. And there's really not much insight simply because you don't know if and when another shoe is going to drop that will disturb the economy and that's a big unknown.

With regard to the second part of your question. I have nine days worth of data January and through the first nine workdays. Our bookings are off 7.5% from last year and our billings are off 10% from last year. So average the two, it gives you probably a pretty good proxy for where the month is going. We're about 8.5% off on a per workday basis. That's 3% better than December.

Now, does that mean things have gotten better? I really don't know because with the long Christmas break and New Years people may have had to catch up and ordered some things quickly or it may be a pick up. But the numbers are the numbers and so when you average the two, we're about 3% better than we were than in December.

Paul, when you look at inventories maybe two questions again, one macro and one more micro at least sector specific within containerboard. What you're saying suggests that your customers are likely going to continue to take their inventories down and perhaps consumption from us, from the consumer is--

George, I didn't say that. I never said our customers were taking their inventories down.

Not of your boxes but what they have in the supply chain to retailers.

Well I didn't say that. I'm not saying it's true or not true. I really don't know. My own guess is that they've got their inventories where they need them to be and they are just matching their supply with demand. So I don't think we're going through an inventory reduction.

I think people are there already and it's just matching supply and demand. And that's my opinion because I don't know for certain.

Understand. Within containerboard and I'll turn it over. We've got inventory -- excuse me -- we've got production down whatever, 300-350,000 tons. Exports are obviously not doing that great right now.

George, when you say they aren't doing that great. They were only off 18,000 tons November over December. To me that was a surprisingly good number.

Okay. But I'm not -- directionally, they aren't as strong as where they had been but I guess the point I'm getting at is, you have an extra day or two of cutoff, you have production down and could inventories drop in the system 100,000, 200,000 tons in December when we're all said and done?

Well, the data that's out so far and we only have certain amounts of it is that we know the production is off. I don't have the numbers in front of me but roughly 350,0000 tons. And exports, when you take them, that's probably 20,000 that they'vere down. So knock 20,000 off that number and you still get to a net supply down 330,000 tons.

Now, you got to guess where demand is and the only data point that I have is our demand was up 6.5% in December versus January. That's primarily --

For November.

Yes, excuse me. December versus November. And that was driven not by per workday numbers but by the fact as you said there were two more days of production. But nevertheless, our cutoff was up 6.7% in December. Now, if the industry follows that and I don't have any idea if they will, then that would translate into increased demand of 130-140,000 tons. You add those together and take them together you get up to a number like 400-420,000 tons. And then, you got to adjust by the fact that inventories went up in November. So that knocks about 80 off but I think, it's possible, again, if industry numbers are compatible with ours. And they have been actually a little better than ours the last two months. Then, it could be a 300,000 plus number.

But we'll have to wait and see. But there's also year-end adjustments made is the way when the numbers are done. This is when you trueup anything but we'll have to wait for the FDA numbers before we know for certain.

Okay, thanks, Paul. I'll turn it over.

Our next question or comment comes from the line of Mr. Mark Weintraub from Buckingham Research. Your line is open.

Two quick ones. First of all, just on capital spending. Do you have a budget you can share with us for '09 yet?

Sure, Mark. We normally spend, and it's been fairly consistent over the last 10-11 years, about 110 million a year. Some years, we've accelerated some projects and spend a little more. Some years, we spend a little less. From my earlier remarks, we spent about 20 million more this year to accelerate some projects.

One of them is a big boiler project, Bark boiler project, that counts to improve the efficiency on that boiler has a very high return. So next year will be a lower spending year for us and our target is 90 million, which is again about 20 million below the norm.

Okay, great. And then second, can you give us any sense as to what you're seeing on the pricing side? It just seems that different types of players are coming to market quite differently and wanted to get your perspective on that. And also, given the fact that you didn't mention pricing in your first quarter guidance, does that mean that that's not a big factor in the delta that you're expecting to see?

Well, talk about pricing in general. I think the one remark I would make. I think in boxes pricing has been pretty stable. And I would also say from our perspective, pricing in containerboard has been pretty stable. I think one phenomenon that's occurring that really I think should be considered and dealt with is the fact with some of the 100% recycled paper, normally, and it goes back a lot of years, with businesses real tight, the price of 100% recycled paper will get close to virgin paper. And then, as you get into a downturn in the economy because of the quality of some of the recycled paper, the price difference could get 30-$50. And I think that's what we may have seen in December that if you read the reports about price erosion, it's been primarily in recycled and the smaller players. And I will tell you that the quality difference varies more widely in recycled than it does in virgin.

As a matter of fact, we will not trade with some suppliers for recycled paper because the quality is just not up to what we need. And so I really think that we really should have a price for virgin paper and the 100% recycled recognizing that some recycled paper is every bit as good as virgin paper. I'm not saying it isn't but there's also a much wider variation. And where I think a lot of the price cutting that may have occurred occurred is on the lower end that some of this recycled paper.

So that's one thing that I think needs to be dealt with but in terms of pricing, we've taken a guess where we think pricing will be in the first quarter and that's baked into our numbers. At this point, obviously, it's a guess.

thank you.

Our next question or comment comes from the line of Mr. Richard Skidmore from Goldman Sachs. Your line is open.

Good morning, Paul. Can you talk about how you're thinking about the dividend currently as well as your cash balance given the current financial market situation?

Well, I'll tell you what. I'll let Rick take the first part on cash balance. Other than -- before I do that. Other than our liquidity, I think is quite good and Rick, you might want to elaborate a little bit on liquidity, cash balance. You covered a lot of it but you might want to comment.

Yes, if you look, Rick, at the liquidity at the end of the fourth quarter. We had about a 325 million in liquidity, if you take into account our ending cash of 149 million and our borrowing capacity on our asset securitization revolver, as well as, our bank revolver.

From a liquidity standpoint, going forward, the only thing I would say traditionally the first quarter has been our highest cash outlay quarter because we pay what annual incentives we have in the first quarter. We also make a semi-annual interest payment on both of our notes, our total in notes. And then, we have a vacation payout payment once a year for a majority of our employees in our mills. So that's the major items in the first quarter that are cash -- I'm not going to say higher cash payments. But we ended the year at 321-325 in liquidity.

But we enter the first quarter, which is our highest cash utilization quarter with plenty of cash. And so we feel pretty good about our liquidity. With regard to the dividend, we view dividends as a long term proposition.

It's not something that we're apt to change our mind about because of one quarter of very good performance or one quarter of very bad performance. A dividend is based on what our longer-term expectations are for this business. And I would say where our dividend goes will be probably correlate better with what happens in the economy and the containerboard business more than any other single thing.

And would you be willing, Paul, if for whatever reason your cash earnings in a given year were less than the dividend. Would you be willing to use some of that cash balance to maintain the dividend through what would be the tough part of the economic cycle? And if so, would you do that -- would you think through doing that for a year or two years? Maybe just a little bit of color around that?

It depends. It depends on how bad I thought things could get and how long it would be. And obviously, if things were going to be bad for another three months that's one thing. If they were going to be bad for another three years, that's something else. But in terms of getting more precise than that, I'm not going to do that.

That's helpful, thank you.

Our next question or comment comes from the line of Mr. Mark Wilde from Deutsche Bank.

Good morning. Couple of questions. It seems like the big delta in your volume is really those outside sales. Your box shipments, which are mostly volume are down about 10% and your mill production down about 15%.

Can you talk about that big drop in outside sales and then can you also just update us on what you figure the effective capacity of the mill system is right now? I think when you came public it was about 2.1-2.2 million tons and based on the figures in the release, it would look to me like it's about 2.45 million tons.

You're in the ballpark. It moves around. 2.4 - 2.45 at the range. I don't have the exact numbers in front of me but it's in that range. Mark, so I think you've covered it. So I'd say between 2.4 and 2.45.

With regard to outside production, it's such a small part of our business. Only 20% of our sales are outside. So it magnifies the percentage change because you lose the denominators much lower. But I think, our outside business has moved in relatively normal proportion to our box business. You're just seeing miracle of a small denominator here.

Okay. Very good.

Our next question or comment comes from the line of Claudia Hueston from JP Morgan. Your line is open.

Thanks very much. Good morning.

Good morning.

I was just hoping you could give some color on the tax rate. Why it was lower in the fourth quarter and what rate we should expect for 2009.

It's normally at the year end we make -- we reconcile all of our state tax rates and our portionments and there was a larger than normal adjustment to that state tax rate and apportionments that we normally see. And that's what drove the rate down in the fourth quarter. And we would expect more of a normal rate going forward in the 38-38.5% federal tax rate for an effective tax rate.

Thank you. And then just on chemical costs. Is it mostly caustic soda that you're still seeing pressure on and what are you seeing in terms of the other chemicals?

It's predominantly caustic soda. There's a few other things that are still up there but 80% of it is caustic soda.

Okay. And then, just finally on the maintenance at Valdosta. I think last year it was maybe about $0.03 or so, with the outage being longer but with cost being a little bit lower because of labor and the other things. How should we think about the impact of the outage there?

Well that's a hard thing to come up with this year because you can't look at it in isolation this year like we always could. Because we took it down, you do how many tons. It was all related to the outage but since we anticipate some market related down time, you got to combine the two. But net-net, we're taking out 22000 tons.

And you got to break that into two pieces, market related and what it would have done anyway. And we don't have that number available and it's kind of irrelevant anyway when you got a fair amount of market-related down time. This is in a way, you could say the down time on the outage isn't costing us anything because we probably would have taken market-related down time anyway. So it's kind of a phantom number this year.

Okay, thank you.

(Operator Instructions). Our next question or comment is a follow up from Mr. Mark Wilde from Deutsche Bank.

Just one other cost issue, Paul. Can you walk us through with oil prices down. As diesel prices come down, how that affects your cost because it would seem like it's got to drop the cost to bringing wood into the mills and it's also got to drop your outbound freight.

Yes. I'm going to let Rick address that.

Well to give you perspective. What it does to us, Mark, in the third quarter, we looked at diesel or fuel transportation costs compared to the third quarter of last year and it was $0.03 per share higher and in the fourth quarter it was only $0.01 per share higher. So you've got a $0.02 per share delta improvement. I do see that being better in the first quarter also. It's not a dramatic amount but probably a cent or so.

Do you have any kind of rule of thumb, Rick, when you kind of look at your wood costs going into the mill like what percent of that really is diesel fuel?

Yes. It's about a third and probably got as high as 45%, when oil hit $4.00. Normally you'd think of it about a third a third a third stumpage, a third fuel, and a third labor to cut the wood and bring it to the mill. And so I think, we're back now in the third a third a third, but the problem is with the turndown in building products, you have to go a little further out to get wood. And the stumpage may not change and the gasoline price may not but you're driving further. So that increases your wood cost a little bit.

So you'll get some fuel savings but you've got higher distances and that offsets it some, but we did say on the call that we saw our wood costs down 4% in December at a time they usually go up. So hopefully, this trend will continue and we could get potentially a little more in that area as you point out.

Yes. And with all of the -- so many mills in the industry taking down time and some mills just closing permanently. Is that affecting your wood price as much?

We think that contributed obviously to the 4% reduction. Especially in December, when there was a lot more down time. Roughly, I think just my guess, at looking what I read in the reports, about 50% of the down time the industry took was in December and the other 50 was spread over two months. So I think it really hit harder in October and I think that's why we did see some pick up and reducing cost in December.

Okay, finally, is there any update on that biofuels refinery?

Coming along.

Okay.

Our next question or comment is from Andrew Klineman from Iridian Asset Management.

Thanks. I'm going to try not to make Paul talk because with that cold I don't want to make you lose your voice. So, Rick, I just wanted to ask you, if you could tell us what depreciation and amortization was for 2008? And what it might be for 2009?

In 2008, Andy, it was about $148 million. You know, we haven't looked at it totally but I don't see it changing from that number in 2009.

Great. Thanks a lot.

(Operator Instructions). I'm showing no additional questions or comments at this time.

Okay. Well, thank you, everyone on the call for participating. I hope my voice wasn't too difficult to put up with. And I'm sure it will be better on the next call. So talk to you again in three months.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone have a wonderful day.