Sonoco Products Co (SON) 2003 Q1 法說會逐字稿

Good day and welcome to the Sonoco Products First Quarter Financial Results conference call. My name is Alicia, and I will be your coordinator today. If you require assistance, press followed by zero. This conference call is being recorded for replay purposes. Now, over to your host for today's call, Mr. Allan Cecil.

Thank you for the promotion. This is Allan glad to you have with us this afternoon. With me today are Harris DeLoach, President and the C.E.O., and Charlie Hupfer, Vice President and CFO.

Let me remind you today's conference contains forward-looking statements based on current expectations and are not guarantees of future performance. Additional information about factors that could cause different results and about the company's use of non-GAAP financial measures is available on forms 10-K, 10-Q and 8-K filed with the SEC.

For those who might not have seen our first quarter release this morning, our reported earnings per diluted share were 30 cents versus 35 cents for the same period in 2002. Reported earnings for the first quarter included restructuring charges of 1 cent per share in both 2003 and 2002. These results are within our previously announced guidance for the quarter.

For the first quarter we saw year-over-year improvement in sales, productivity, a modest increase in volume and a quarter to quarter improvement in gross profit margin for the first time in several quarters. First quarter earnings were hurt by negative price-cost relationship, resulting from lower average selling prices for tubes and cores, coupled with higher OCC resin and energy costs. Pension and post-retirement cost hit our earnings for about 4 cents per share, compared with last year's first quarter.

Looking forward, we currently see no indications of significant general economic improvement that would enhance our operating environment in the second quarter. Therefore, we expect second quarter earnings in the range of 32 to 36 cents. I would remind you that the company's previous guidance for the full year remains unchanged at $1.46 to $1.50. We continue to improve the company's overall cost structure and certainly we remain fully engaged in acquisition activities. We believe we are making continuous, meaningful progress in the areas that we can control and that we will be well positioned to benefit from improved general operating environment.

With that, over to Charlie Hupfer.

Thank you. I will comment about financial results for the quarter. Sales were 681.4 million, up 4.2% above last year. As Allan said, EPS is 30 cents compared with 35 cents last year. EPS did include 1 cent of restructuring in both this year's quarter and last year's quarter. The first quarter of 2003 restructuring totaled around $900,000 after tax, roughly 600,000 related to down sizing of Brussels European headquarters center and remaining roughly 300,000 represented adjustments to previous years plans, true-up adjustments. Last year's restructuring was around $900,000, as well, after tax, or 1 cent a share, and that related to the closure of the tube plant in North Carolina.

To conform with new Reg G, we will no longer exclude restructuring charges to calculate what we used to call comparative earnings. It is important to note, as Allen just mentioned, neither our guidance nor First Call would have factored in the 1 cent restructuring. As a result, we reported a quarter that we believe was very much in line with expectations. As I said, sales were up 4.2%. Net income of 29 million was down 13.6% and EPS at 30 cents was down 14 percent. That's a 5 cent short-fall from last year's first quarter. Incremental pension expense added 4.3 million after tax, or 4 cents per share, to expense. So, that 4 cents accounts for practically all of the year-over-year 5 cent shortfall.

Looking at profit and loss statement, our S&A expenses stands at 10.6% of sales, consistent with last year and suggested that our discretionary spending is still under very good control. We continue to closely monitor and control all of our spending.

As you can see from the profit-loss statement, the profit shortfall is largely attributed to margin squeeze at the gross profit line. This is due to a couple of things. One is higher resin cost. Another is higher energy cost and lastly higher OCC cost. We did see price cost squeeze in this quarter. Margin, however, did show improvement over last year. The first quarter of last year our gross profit margin was 20.7%. In the second quarter, it declined to 20.4 in the third quarter, 18.9, fourth quarter 18.8. This year's first quarter of 19.1, reflects a modest turnaround in that decline in gross profit rate. In fact, the month of March was 19.8, so, we were seeing strengthening as the quarter continued.

When we look at the segment numbers, starting with sales. Sales in the industrial segment were up 16.5 million dollars, or 5.1%. Sales in the consumer segment were up 10.7 million or 3.3%. So, in total, sales were up 27.2 million, or as I said, 4.2%. EBIT on other hand in the industrial segment was down 6.3 million, or 17%, and the consumer segment, EBIT was down 1.9 million, or 7.1%, for a total of decline of 8.2 million, or 12.8%.

Now, what I will give you is the bridge analysis to explain first of all what is going on in sales. You remember a bridge is just a variance analysis where we hold last year constant and look at the year-over-year changes. So, what I will describe now is the chart that I have in front of me that identifies these bridge elements. It has got four columns in it. The first is description, second is total, third is industrial segment and the fourth is consumer segment. I will fill in the chart for you as I go along. First of all, volume/mix is the first descriptive item. The total is 7.7 million dollars. In the industrial column, it is a negative .3. In the consumer column, it is 8.0. The next item is price. That is a total of 6.1 million, with 5.6 million of that in the industrial and .5 in the consumer segment. That is 5.6 and .5. Acquisitions totaled 3.4 million and all 3.4 of that is in the industrial segment. The last element is exchange/other, and that is 10 million, with 7.8 in the industrial column and 2.2 in the consumer column. So, the totals then are 27.2 million made up of industrial, 16.5, and consumer 10.7.

Now, look at some of the specifics behind these numbers in the bridge. Starting with volume and starting with the industrial segment. If we look behind the 300,000 number, we see that we actually had improved tube and core volume, but that was offset by declines in molded plastics and in Baker Reels. In fact, if you adjust out the volume decline from the two businesses, volume actually increased in all the other industrial segment businesses by around 2.4%.

Tube and core business in the US increased around 3 and-a-half percent when measured on comparable per-day basis. Although admittedly, volumes haven't changed an awful lot between this year's first quarter compared with third and fourth quarters of last year. Volume in Europe grew about 2% with volume in Turkey growing at increases of over 20% -- in Turkey and Poland, over 20%. But, we had declines in the UK and Spain in the range of 9 and 5% respectively. Volume in Asia increased around 21%. All operations there showed continued growth. Indonesia had volume growth of 6%, Thailand, 22, Singapore, 35. We had outstanding volume performance from Asian operations this quarter.

Recovered paper volume was strong, which we sell recovered paper to our recovered paper division. That offsets the paper mill volume shortfall. Export was strong for recovered paper as well as domestic demand.

As I said, molded plastic volume was weak, with about 8% year-over-year decline. A lot of that coming in film and filtration. Our Baker Reels business was down 26%. If you remember, Baker Reels sells into cable TV in the fiber-optics markets. They are still what we are describing as in a deep recession. Now, looking at volume and mix on the consumer side, we see it is up in total 8 million dollars. Generally across the board improvement here. In. rigid paper and plastics, our volume was up around 1.2%.

Snack volume was generally good. Caulk volume was up. Those two increases more than offset some declines in frozen juice concentrate and refrigerated dough. Phoenix Metal business volume was up 2.4%. Flexible business reported volume up 3.7%. High density film business showed volume up just a little bit less than 3% with the grocery segment down. That was made up by the other segments that they serve: retail, fast food, and AG film. So, all and all, they were up just a bit under 3% in terms of volume.

Now, looking at the price. As you can see, all of the pricing impact is on the industrial side. And the majority of that is coming from the recovered paper division. Here we have year-over-year increases in OCC of around $17 per ton and in newsprint about $18 a ton. That increased sales volume for the recovered paper group.

Overall, our paper division pricing is up roughly about 3.8%. This increase is the remaining effect from last year's $50 per ton price increase that was effective around the middle of the year. On the other hand, domestic tube and core pricing is down, down around 2%. We saw pricing decline as a result of competitive pressures during the second quarter of last year. Then, prices started to increase through the third quarter as we implemented the price increase in June, July, and August. We saw slippage at the end of the year and saw some slippage in the first quarter. Average selling price in tube and core division were down just a little bit in each successive month of the first quarter.

As you know, we announced $50 price increase in paper to offset higher cost, and those are higher cost across the board: energy, freight, insurance, OCC, everything. This was followed by an 8% increase that was announced in tubes and cores, both of them effective at the first of April. So, we expect improved pricing in the second quarter and second half of the year.

Acquisitions. As the charge shows this accounted for 3.4 million or one half of percent of year-over-year growth. Exchange or other exchange and other, that is mostly exchange, accounted for $10 million. That is largely thanks to the strong Euro, 19% higher than it was last year.

Turning now to the EBIT bridge. I will give you the same chart with same four columns. The description, the first one is volume and mix. Here we have a total of 1.3 million. That is in the total column. Industrial is negative .4 million. The consumer number is 1.7 million. In terms of the next item is price/cost. Price/cost has a total of 8.6 million negative. And in the industrial column, it is a negative 5.2 million. In the consumer column, negative 3.5 million. Productivity is a positive 9.1 million. Industrial 2.7. Consumer 6.4. And inflation is negative 5.3 million. That is in total. Industrial is 3.5. And consumer is negative 1.8. That is negative 3.5 and negative 1.8. And then other, the last item, negative 4.7 million in total column, 1-10th or 100,000 positive in the industrial column and 4.8 million negative in the consumer column. If you add up all of those and what I accounted for is 8.2 million shortfall in EBIT in total. 6.3 million of which is in the industrial segment, and 1.9 is in the consumer segment.

I've already discussed volume and price when I was talking about sales, the other big driver is cost. Of course, you can see that in the negative price cost of 8.6 million. In the industrial segment 5.2 million of 8.6 is found in the industrial segment. Most of the cost increase is recovered paper coming through the paper division. Southeast Yellow Sheet prices are up roughly $55 in this year's quarter compared with 38 last year. So, our total furnished cost, this is furnished, more than OCP, it actually increased about 33% in the paper group. On the consumer -- and that accounts for far and away the majority of the cost that turned it into negative price cost.

On the consumer side, majority is found in high density film, and some in rigid paper and plastics. High density film saw resin increase 22% year-over-year. Rigid paper and plastics also saw some resin increases, as well as some metal increases.

Moving to productivity, productivity was generally strong across the board, but especially in flexibles. 6 of the 9 flexible plants showed year-over-year productivity improvements. Missasagwa (phonetic) plant, one of our previous problem plants, continues to show good improvement. And Winnipeg, the other plant we've talked about, is showing improvement, as well, but has a little ways to go.

Inflation was a total negative of 5.3 million. That consists almost entirely of two things, one is 2 to 3% general wage increase implemented last year. The other is higher energy costs. For example, energy was 14% higher in our paper division. In fact, the energy increase in our two divisions, paper and flexibles, accounted for 1.8 million unfavorable variance alone.

Down in the Other column, Other is made up largely of the year-over-year incremental pension that pre-tax terms was 6.7 million dollars of incremental cost that is found in the other. That actually more than accounts for the negative year-over-year change in the other category.

Interest expense was reduced by about $800,000, roughly one half is due to reduction in commercial paper balances year-over-year. Another $100,000 is due to lower CP rates. Our effective tax rate stayed at 36%, consistent with last year.

Now, let me take just one more minute and talk about cash flow. We have revised the way we talk about cash flow to be in conformity with REG-G. We are not talking about free cash flow in our press release because that is a non-GAAP measure. In the press release, we talked about operating cash flow and compared 40.7 million with 39 million last year. I do need to point out there are two fundamental differences in this year's and last year's numbers. One of them is last year we had as subtraction or use of cash, 27.5 million that related to pension, which we came back and added back in to arrive at our adjusted free cash flow number. We really don't have a pension amount in this year's pension payment in this year's numbers to speak of. But, we do have increase in net working capital of $39 million. So, we had increase of $39 million in this year's numbers and only 12 million was increase in working capital last year. So, to understand the comparison of 40.7 to 39, you also have to take into consideration the networking capital difference and pension difference.

We looked pretty carefully at networking capital to see if there were any issues there because we really spent a lot of time and effort in managing working capital and have effective working capital programs. I believe what we found is we went into a slow December and as a result of that a lot of receivables were turned into cash and new receivables weren't put on the books. So, the receivable balance came down and the cash balance went up. In March, we had a strong March. So, we built the accounts receivable balance. So, most of that networking capital change accounts as accounts receivable. To support that, we looked at daily sales for the company in December and then compared that to daily sales in March and saw daily sales were up 12% between December and March and receivable balances were up 11%. So, you can see what is happening is as volume improves, for right now, it is finding its way into the accounts receivable line as increase in networking capital. As I said, pension last year was 27.5 million and we don't have a comparable number this year. We are still sticking with our guidance of $150 million of what we were calling free cash flow before and I think we will see some of the same phenomenon in this year's fourth quarter, which will help bridge this gap.

Then, the last comment on balance sheet, which is included in the press release, remains strong. Debt to total capital declined. The way we make that calculation, it declines to 46.4% from last year's 48.6. Last year being December's 48.6. So, those are the extent of my comments. Back to Allan.

Ready for questions.

Ladies and gentlemen, if you wish to ask a question at this time, please press star followed by 1 on your touchtone telephone. If you wish to withdraw the question, press star 2.

Our first question comes from Eddings Thibault. Please go ahead, sir.

Good afternoon, gentlemen. Quick question on some of the pricing on the tube and core side. I want to make sure I understand what I am hearing. It sounds as if all of the price increase that was implemented in the back half of 2002 as a result of higher OCC has eroded away over the last month and over the first few months of the year. Despite the rising OCC cost in the first half of 2003, is that an accurate comment?

I don't think that's entirely accurate. I believe we would have seen some erosion in second quarter of last year. We would have then eaten through that erosion through some part of the third quarter and into the fourth quarter. So, we have seen some erosion in pricing in tubes and cores of late. But, I don't think -- we have to take into account, as well, some erosion we would have experienced in the second quarter before the price increases kicked in.

Okay. But, you know, your comment that pricing -- average pricing for cores and tubes is lower first quarter of 2003, than it was in first quarter of 2002, is that correct?

Correct.

Shifting gears. Looking at some of the consumer businesses. This is area of real strength in fourth quarter. It seems to have weakened a little, can you give additional color on is it just lacking flexible contracts or more going on here?

No, actually the volume was up nicely, if I -- looking back through my notes, volume was up in the rigid paper and plastics, which is really composite cans, plus plastics, in metal and flexibles and high-density film. So, volume was okay there. It's the price-cost issue and cost element largely being resin.

You also see a certain amount, a large amount, of seasonality in the business. You have the holiday season in the fourth quarter. You have dough coming on with winter months coming on. We always see a considerably higher fourth quarter than first quarter in the can business and probably the flexible business, as well.

Right. I was thinking volume -- year-over-year volume growth in the fourth quarter last year, I believe was 7%. And it is now 2%. Just year-over-year changes, so, is that that new flexible contracts or have you seen -- doesn't sound like business has slowed down. Have you seen deceleration, perhaps?

I don't think so, probably had something to do with new flexible contracts coming on because we haven't seen a slow down in the business.

One final question, status of announced price increases set to go on April first on the paper board side as well as convert products, can you update?

We are seeing good support for price increases in the market both on the paper side, as well as tube and core side. we also had increases, obviously, I don't think we announced, in some of the plastics businesses and composite cans and they are going reasonably, as well.

Those are more automatic, aren't they?

They are, but we have some that are not on the contract, a percentage of the business we move pricing on.

Thanks.

The next question is from Mark Connelly(ph) from CSFB.

Just a couple of questions. When you look at composite can pick-up in volume, can you talk more broadly about that? Composite can hasn't been a stellar growth area. Can you talk about the pipeline of products in potential for that business?

Mark, I can. Actually, I think I said in the end of the year conference call in January that last year, 2002, was the first year since 1999 that we had seen quarter over quarter improvement in composite can since 1999. The first quarter as Charlie mentioned, was up over the first quarter of last year. We are continuing to see that. Snacks was up. We have probably more product conversions, I think in the pipeline today, than we've have had in several years in that business. We also are working on self-manufacturing opportunities to take folks out of self-manufacturing. So, I feel frankly better about that than I have in the last couple of years.

Now, is this mostly with existing or new customers?

Existing and new customers, Mark. Both.

Okay. And just one other question, Harris. Energy, if we could look at energy and forget about the price of energy, can we talk about your expected consumption given that it is getting warmer out? Should we look for meaningful decline in consumption in Q2?

Yes, but I don't think that will be that meaningful. It is more a pricing issue than consumption.

Fair enough.

The next question comes from Don Ghansham Panjabi(ph) with Lehman Brothers. Please go ahead.

Hi, guys, how are you? Couple of questions. First off, using the mid-point of second quarter guidance, seems like you are expecting 65 cents for the first half, does that sound about right?

Close enough.

Which implies a much stronger second half to meet guidance. Can you give us color on what the potential catalysts are in the second half?

Probably better to talk about the catalysts may be in the second quarter. You know, normally the first quarter of the year is our weakest quarter. And as I look at the first quarter, I saw high energy cost. I saw frankly bad weather that affected the customers and other things. As we look out in our reforecast in the second quarter, what our customers are saying to us is that volumes may be down or slightly like they are or up a bit. It is a mixed bag we are hearing from customers right now. So, I think probably we are realistically saying what we see in the second quarter.

I would expect the second half to see some improvement. We are also concerned about OCC pricing. OCC rose more in the first quarter of the year than we had anticipated and we are concerned that we will see further rises in the second quarter and will not have a full recovery of that in the second quarter. So, that's obviously tempering our second quarter and as we look out we would project a little higher third and fourth quarter. Obviously to meet our guidance.

Okay. And your inventory levels at customer level are still pretty lean and all that stuff?

We haven't seen any changes in that.

Also considering we are three plus years in the downturn, are some of your smaller competitors getting squeezed out or are acquisitions becoming more attractive?

We are seeing more acquisition opportunities than we have seen in the past, what I would call more reasonable multiples.

Good to hear. Thanks a lot. Good luck in the quarter.

The next question comes from Chip Dylan(ph) with Smith Barney.

I know in the past you had a huge exposure to the textiles industry, which I know has been greatly reduced, can you update us as to how big your exposure would be broadly to what is left of the US textiles industry?

I think our total sales in the company today, is something around 9%, if I am not mistaken last time we looked at it about 4 or 6 months ago. That is down significantly from some years ago. We are picking up as US textile industry leaves and goes to Mexico and washes through Mexico to Turkey and Asia and the Eastern block countries, we have facilities there that are picking that up. I think Charlie referenced the type growth we saw in Turkey and Greece in the first quarter of this year.

A lot of the Asian growth is textile this quarter.

The number is still 9%, including that overseas textile exposure?

Correct.

Thank you.

Again, ladies and gentlemen, if you wish to ask a question, press star 1.

We have a follow-up from Edings Thibault from Morgan Stanley.

Just want to touch on a comment, Charlie, on gross margins in March. Sounds as if they strengthened. I think, conservatively, the number was 19.8% in the month of March. Would you care to quantify if that is the base case you are using for second quarter or how much you attribute pre-buying ahead of the price increase to the strength? It doesn't sound from guidance as if you are expecting a particularly strong second quarter.

Eddings, Charlie is over there with a look on his face. We had a relatively strong March. We were very pleased coming out of March. When we talked to our businesses -- I think it is the environment that we are all, not Sonoco, but we all are operating in. As we talk to our customers, they are not giving us -- they are giving us a pessimistic view of the world. So, we are trying to be cautiously realistic with you guys on second quarter and if there is conservatism built in, so be it.

Clearly, there is not -- the underlying guidance for the second quarter wouldn't imply that kind of radical strengthening gross margin?

The starting point for the reforecast was performance up through March. So, we would have factored that into the thinking and into the numbers. It is built up from the divisions and then consolidated at corporate.

Your customers are telling you they won't order, but ordering anyway?

Our customers are telling us, frankly, look at Wall Street Journal last Friday and you see retail sales down I think 2% and pick up the paper on Saturday and see consumer sales up and consumer confidence up. So, I think it is a mixed bag out there. Looking at our reforecast, we are listening to the customers and sort of giving you the same guidance running through our system.

Great. Thanks very much. Good luck in the quarter.

The next question comes from Dan Khoshaba with Deutsche Bank.

Hi, guys. 5.3 million dollars that of inflation that Charlie said you incurred in the quarter, does that include resin cost?

No, Dan, that is the cumulative effect, most is the wages of salary increases we implemented last June. It is year-over-year impact of that number and has some other inflation issues in it. The primary one is wages and salaries.

Follow-up, what is the current status of resin cost increases? Is there anything currently on the table and what is your view about the potential for you know, resin costs?

Dan, resin was up, I think some 38%, if I am not mistaken, in the quarter. Most of that has already taken place. I'm not aware of any resin increases that are in fact on the table. Are you still with me?

Yes, I am.

And you know, depending on what happens in the MidEast with gas prices, I would anticipate resin starting to come down some.

Okay. There are no other resin cost increases on the table as far as you know?

Not that I'm aware of.

I want to follow-up on a question that was asked earlier about second half of the year. You are going to earn probably 65 or 66 cents in the first half of the year, that implies mid-point of the range of $1.48. Let's say 83 cents in second half of the year. Is there assumption the economy is better for that number?

Is our assumption that the economy is better in that number? No, it is not. It is not.

Okay. What, then, are the one or two things that you guys know that is going to happen that will lead to higher level of earnings?

Dan, I think two things. We are looking at the cost side where we are anticipating raw material cost increases in the second quarter that may or may not materialize. If they do materialize, then obviously we have to recover those and there will be a lag in that recovery. The other is we think that in the short-term volumes, if they do materialize, as I mentioned, our customers are telling us they may be slack in the second quarter. It will come back more to first quarter levels. It is volume and price cost piece.

Okay.

And pricing implemented through the quarter.

And the pricing implemented through the quarter.

Okay. Thanks, appreciate it.

The next question comes from Bob Luto(ph) with MD (inaudible)

Yes, just a real quick one. What was your average OCC price per ton during the quarter?

$55 per ton.

Thank you.

We have no more questions at this time, sir.

Thank you very much and thank you for joining us. Good day.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes today's program. You may now disconnect. Good day.