WPP plc
Q3 2010 Earnings Call Transcript

Published: 31 Oct 2010

[Operator:]

Welcome to the Wausau Paper 2010 Third Quarter Results Conference Call. (Operator instructions). As a reminder, this conference is being recorded. I would now like to turn the conference over to our host Mr. Perry Grueber, Director of Investor Relations. Please go ahead.

[Perry Grueber:]

Thank you Joe, good morning everyone and thank you for joining us for the Wausau Paper's 2010 third quarter analyst and investor call. I am pleased to be here today with Tom Howatt, our President and Chief Executive Officer; Scott Doescher, Executive VP and Chief Financial Officer; and Mike Wildenberg, Senior VP of Tissue Segment. This call is being web cast and slides are provided to summarize key elements of our presentation. The presentation is also downloadable from the investor section of the website wausaupaper.com. In a moment Tom will begin our presentation by reviewing third quarter results for the corporation in our Paper segment. Mike will then review the Tissue segment's financial performance and discuss our current quarter expectations for that business. Following those comments, Scott will provide a high level financial review, and finally, Tom will comment on our strategies, priorities and third quarter outlook, after which we would be happy to address any questions you might have. Statements made during this presentation, other than those that refer to past results are forward-looking statements made pursuant to the Safe Harbor provisions of the Securities Reform Act of 1995. Such statements, including those concerning expected performance, price increases and future earnings or dividends involve risks and uncertainties that may cause results to differ materially from those expectations set forth during this discussion. Among other things, these risks and uncertainties include the risks and assumptions described in item 1A and item 7 of the company's Form 10-K for the year ended December 31, 2009. The company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events. In addition, our presentation refers to certain non-GAAP financial measures. A reconciliation of these measures to GAAP is provided in the appendix of this presentation and is also available on our website. And with those formalities out of the way, I'll now turn the call over to Tom Howatt. Tom?

[Tom Howatt:]

Good morning everyone. I'll begin with highlights of our third quarter performance. Third quarter net earnings of $0.27 per share were modestly below last years $0.30 per share. Adjusted earnings for the quarter were just $0.03 per share below last year despite absorbing record high market pulp prices. Earnings exceeded our earlier guidance of $0.13 to $0.15 per share due to our particularly strong sales mix and full realization of recent selling price increases. And at the October meeting the Board of Directors reinstated a regular quarterly cash dividend of $0.03 per share and recognition of the earnings and balance sheet improvements achieved since the spending the dividend in early 2009. The combination of persistently high unemployment, weak consumer spending and a lack of recovery and housing markets has resulted in an economic recovery that remains quite fragile. That said our market place strategies continue to create opportunities for growth. Our green leader position and away from home Tissue markets remain strong and we are well positioned to grow and select technical paper markets such as food, tape, industrial and coated liner. Finally, while prices for market pulp have begun to decline for record levels, the pace of decline has to-date than far more muted than previously forecasted. Turning to our earnings summary, adjusted net earnings of $0.20 per share for the quarter were achieved despite absorbing year-over-year fiber cost increases equal to $0.27 per share. Results benefited from solid product mix gains in both businesses as well as full realization of recent selling price increases. We believe our favorable performance in the face of exceptional input cost volatility is a direct result of the effective market development strategies coupled with the restructuring and investment actions undertaken in the recent years. Moving to our Paper segment, third quarter adjusted operating profit was $8.3 million versus $9.9 million in the prior year. Earning is still relatively flat despite absorbing $17 million and year-over-year fiber cost increases. Reduced year-over-year shipments reflect the 2009 closure of the Jay main mill as well as concentrated inventory reduction efforts in the prior year. Despite the decline in shipments net sales held even with the prior year as first half pricing action and mixed gains were realized. Demand and consumer oriented markets remained week in the quarter while technical sectors performed more favorably. The rebuild of our Brainerd paper machine remains on schedule for a first quarter 2011 startup and will require 18 days of downtime in the quarter. The rebuilt machine will be cost effective across the full spectrum of premium, intermediate and value tape grades and will also improve the cost position and quality of our print and color grades produced at Brainerd. At this time we're actively engaged with customers and in both our tape and industrial sectors to execute a smooth commercialization plan as we bring capacity online to support their growth. I'd now like to ask Mike Wildenberg to review market conditions and the performance of our Tissue segment.

[Mike Wildenberg:]

Thank you Tom. This morning I'll provide comments on the third quarter performance of the tissue segment, our view on waste paper cost and an overview of key market trends. The tissue segment reported third quarter operating profit of $13.5 million and operating margins of 15%. This was accomplished while absorbing $5 million in year-over-year fiber cost increases. Contributing to the results for the quarter were particularly strong sales mix and record converting efficiencies. This strong performance did however fall somewhat below record prior year profit of $15.9 million and margins of nearly 18%. While total shipments were roughly in line with third quarter away from home market demand, shipments of our higher margin value added products reached record levels. Our success in this important product category continues to be driven by strong growth in our Green Seal certified product line. In fact Green Seal products now represent nearly half of our total shipments, double the rate of five years ago. As I mentioned, third quarter fiber costs were approximately $5 million higher than last year. As you can see from this chart, waste paper prices increased rapidly over the last year and our expectations are that they will remain at elevated levels over the near term. Our Middletown de-inking operation utilized recycled fiber from a range of sources. Depicted on this chart are the five grades that we consume sorted office waste paper, old news paper, coated book, coated ground wood and old corrugated containers. While sorted office papers tend to be the largest volume category for us, we have flexibility of vary paper mix based upon price and availability. This ability allows us to control cost by taking advantage of favorable cost differentials between grades. Next I would like to review current conditions in each of our major in use markets. To frame this discussion here is a chart I've previously used to highlight the market segments in which compete. While away-from-home demand for/and our pricing have been relatively stable through the first nine months of the year, performance varies somewhat by market segment property management is out largest end user segment. Even though occupancy rates have remain depressed, the receptivity of building managers to our green products and control use dispensers is driven by the desire to differentiate there facilities and attract and retain tenants. Our current volume and market share indicate that significant opportunity remains. Working from a modest position we are focused on further penetration of this attractive market category. We enjoy a strong position in the education and government sectors. Here too, green products and control used dispensing systems have been and continue to be well received. In similar fashion we continue to grow in the health care sector thanks to a strong product fit. Given macro demographic trends we are targeting further growth in this market category. Our business in the industrial market has remain stable all be at, at depressed level. While this remains an important sector for us, it's clear that our most significant growth opportunities lay in those markets discussed earlier. Lastly I would like to remind you that our share in the leisure, hospitality and food segments of the away-from-home market is intestinally limited. We have been particularly fortunate in this regard as these markets have been the most severely impacted by consumer behavior and the recessionary environment. Our commitment to accelerating the growth of this business has never been greater. At the most basic level our strategy seeks to maximize the differentiating characteristics of our products and the services we provide to our whole sale customers. To grow the business we continue to focus on leveraging the leadership position we have in creating the Green Crops category by introducing innovating green products such as the OptiSource hand care system. As discussed these products are key to our growth in targeted marketing categories. Emphasizing value added products and dispensing systems that allow us to avoid the more commoditized and price competitive portion of the away-from-home market and enhancing customer service by aligning our products with specific customer needs. We are confident in our strategies and are pursuing initiatives to extent our market position through organic growth and investment opportunities. The forth quarter will provide challenges. Fiber costs are likely to remain at elevated levels and order patterns reflect the impact of a weak domestic economy and continued high unemployment. In addition we experienced an equipment failure that resulted in ten days of down time in our toweling machine in the middle town mill. Although repairs have been completed and operations have return to normal we expect forth quarter operating profits to be impacted by approximately $1.5 million. With all the restricted factors outlined we fully expect continued strong value-added product sales, improved operational performance and in particular, continued growth and demand for our Green-Seal certified line of products. Scott will continue our presentation with the financial review, Scott?

[Scott Doescher:]

Thank you, Mike. Third quarter adjusted earning of $0.20 per share was strong considering the record-high pulp price environment in which we operated. During the period, we sold 4,400 acres of timberlands, achieving an average selling price of approximately $1,000 per acre and an after-tax gain of $2.6 million. We have 8,000 acres of non-strategic timberlands remaining in our sales program. IRS guidance with respect to the calculation of the 2009 alternative fuel mixtures tax credit allowed us to recognize an after-tax gain of $800,000 during the quarter. In addition, we recently received approval and are now registered as a producer of cellulosic biofuel as defined in the Internal Revenue Code. We're currently analyzing the financial impact of converting all or a portion of the previously claimed 2009 alternative fuel mixture tax credit to the cellulosic biofuel producer credit. We expect to conclude our analysis in the fourth quarter and if more beneficial, we'll pursue conversion of the credit. Our balance sheet at mid-year remained solid with a debt-to-capital ratio of 31%. Refinancing activities completed earlier in the year, we have provided the capacity to maintain operations and the flexibility to pursue strategic growth opportunities. Though economic conditions remained sluggish, EBITDA generation has remained healthy, totaling approximately $84 million year-to-date. I would like to review two earnings reconciliation schedules. The first schedule compares second quarter 2010 adjusted earnings of $0.07 per share with third quarter 2010 adjusted earnings of $0.20 per share. Compared with last quarter, sales price, mix and volume variances favorably impacted third quarter earnings by $0.09 per share, while fiber cost increased a penny per share. There were no annual maintenance or adjust executed during the third quarter, improving earnings the equivalent of $0.04 per share. Operations and all of the variances had a positive penny per share impact on earnings. The second reconciliation comparing third quarter 2009 adjusted earnings of $0.23 per share with third quarter adjusted results is dominated by two factors; sales and fiber price. Compared with last year, third quarter sales price, mix and volume variances were a favorable $0.25 per share. The year-over-year improvements reflects substantial gains in both selling price and product mix. Reflecting a rapid escalation in market pulp prices in the preceding fourth quarters, year-over-year fiber costs increased the equivalent to $0.27 per share. And finally, operations and all other variances were combined $0.01 per share on favorable to the last year. Our balance sheet strengthened once again this past quarter with both networking capital and long-term debt showing improvement. Capital spending was $27.5 million through September 30th, with full-year year spending of $41 million expected. In 2011, we expect capital spending to approximate 2010 levels; this estimate includes approximately $15 million associated with the completion of branded machine rebuild. I will now return the call to Tom to discuss our strategic priorities and fourth quarter outlook. Tom?

[Tom Howatt:]

While difficult economic circumstances have resulted in a degree of earnings variability over the last several quarters. We remain focused on three strategy priorities. We continue to work toward achieve a targeted 15% return on capital employed with effective marketplace strategies, restructuring activities and select capital investment driving improved performance over the last two years. By lining our production capacity with attractive core markets such as tissue, food, take and industrial. We benefit in the near term and position ourselves for growth over the long term. And finally the combination as a solid balance sheet coupled with leadership roll in our core markets, positions us to make strategic investments to drive profitable growth in the future. As we begin the fourth quarter we believe that we are well positioned to compete effectively in our core markets. At the same time fiber prices remain at elevated levels and recent order patterns have slowed reflecting seasonal weakness and customers adjusting to more moderate expectations for 2011. In addition, maintenance work complete early in the quarter at Middletown mill is expected to impact earnings by approximately $0.02 per share. As a result we expect fourth quarter adjusted earnings in the range of $0.06 to $0.09 per share as compared to $0.14 per share last year. We would be pleased to answer your questions at this time.

[Operator:]

(Operator Instructions). Our first question is from the line of Michael Roxland with BofA Merrill Lynch. Please go ahead.

[Michael Roxland:]

Thanks very much. Good morning guys. Can you just provide a little more color on your 4Q guidance as $0.06 to $0.09, I mean is there anything that you are currently seeing from your customers that gives you pause and is causing you to come with the forecast that is significantly below last years $0.14.

[Tom Howatt:]

Perhaps I can give a comment on the marketplace Mike and then Scott can perhaps also talk about cost structure differential on a year-over-year basis. Did you look at that 2010 really the first half economy was I would characterize it as blustered by an inventory build from what had been unsustainably low inventory levels and we believe that inventory rebuild had really run it's course by mid-year it now really appears that the pace of growth is slowing in the economy from earlier year levels and the customers are earlier year levels and the customers are really reacting to that and with an expectation of a more modest growth expectations certainly for the first of half of 2011. So, clearly we are starting to see inventories been drawn down once again and order patterns have slowed from customers because of the economy environment. Scott do you want to comment on the cost structure side?

[Scott Doescher:]

Mike if you step back and you take a look at the big picture $0.14 is what we had reported in the fourth quarter a year ago and if you look at the third quarter and compare it to the same period last year that price differential between pulp and selling price was about a negative $0.02 per share differential. We would expect that same dynamic to continue into the fourth quarter or our foreclose to that given the relatively weak market environment that Tom just described. In addition, we do expect about a $0.02 per share unfavorable impact as a result of equipment repairs down at Middletown. It was an unexpected outage. It was just one of those equipment failures that occurs from time to time. We are back up running at normal levels at this point but nevertheless that's about a $0.02 per share impact. So if you do kind of that large reconciliation on a year-over-year basis, ultimately that's helpful in terms of just reasoning through our Q4 guidance.

[Mike Roxland:]

So basically it sounds like -- outside of the pulp sell, the differential between pulp pricing which has accelerated and your selling prices and also the machine being down, if we adjust for that it sounds like earnings would have been flat year-on-year.

[Scott Doescher:]

It would have close to that. Again as Tom has described we've seen some deceleration in terms of orders as we've entered early in the fourth quarter. So that's a contributing factor but I think --I think those large pieces that you mentioned Mike are accurate.

[Mike Roxland:]

Got you. Now, in terms of the declaration is there a particular segment? I recall from the 3Q call that -- actually from the prior call, Q2 call -- that you were seeing some signs of moderation in the industrial and tape business, particularly in Asia. How did things progress within those segments in 3Q and what are you seeing initially in 4Q?

[Tom Howatt:]

So as you mentioned, those markets in particular tend to be leading indicators for us. We look at the Tissue side; demand in that away-from-market has essentially been flat. It's been variable on a month-to-month basis over the course of the year and I can't say that we really expect much different than that really over the course of the fourth quarter here. So the demand situation and that easing that we're seeing is really more related to paper and then more specifically in the technical markets and that would be principally those tape and industrial markets.

[Mike Roxland:]

Got you. And then just last question, when do you -- given you're also such a large buyer of market pulp and given the declines that we have started to see in pulp pricing, even though they are more moderate than some people expected; can you talk about the benefit that either you're going to start to see and how that will flow through your operations at some point?

[Scott Doescher:]

Well Mike if you take a look at our performance again, sequentially Q3 versus Q2, fiber prices peaked in terms of the average for the quarter. In fact prices were roughly equivalent of a $0.01 per share. We have purchased through the first nine months of the year about 288,000 metric tones of market pulp. So to your point, we are a large buyer of market pulp. As we've seen prices begin to edge down and I think edge down is the right description, we are seeing some benefit come back through our cost structure. But it is then slower than what was earlier anticipated. So the extent of the benefit that we see in Q4 and beyond will be determined by a number of market factors that ultimately drive price for pulp.

[Mike Roxland:]

Got you. How much is market versus -- well, how much do you purchase spot versus contract? I guess what I'm trying to get at is I know it may be slow and steady until you start to see some of the price or some of the favorable decline from pulp prices, but you should ultimately see that flow-through your operations given that prices are down off their 3Q peak.

[Scott Doescher:]

Yeah, and that's a good question Mike. I would tell you that the vast majority of what we purchase is under contract as opposed to spot. As a large purchaser of market pulp we align with key suppliers, primarily in North America to give us a steady and a high quality source of fiber with which we produce our papers. So in terms that spotting benefit although we would see some, it would be quiet limited.

[Mike Roxland:]

Got you, thanks very much for looking the quarter.

[Operator:]

And we have in line -- a question from the line of Christopher Chung with Deutsche Bank, please go ahead.

[Christopher Chung:]

Thanks. Good morning, guys.

[Tom Howatt:]

Good morning, Chris.

[Christopher Chung:]

Hey, I was just following up on that market pulp question. Can you let us know what type of market pulp you're buying?

[Tom Howatt:]

Sure Chris, if you step back and you take a look at the mass balance for us; about half of the fiber that we consume is hard wood. Most of that is northern hard wood as opposed to southern. So you got about 50% or so northern -- I'm sorry, hard wood, you have about a third that would be soft wood and then the remaining 16-17% the largest component in there would be post consumer waste fiber and that would be lion's share of the remaining potion.

[Christopher Chung:]

Okay, and then on the wastepaper side, can you tell us how many tons you're buying per quarter and what the mix is?

[Tom Howatt:]

Sure, if you take a look at what we're consuming now, it's in the range of a range of a 135,000 to perhaps 140,000 tons a year of waste paper at current rates and the largest waste paper category for us is sorted office. As Mike mentioned in our prepared comments we do have an ability to flex that flow somewhat based on price initiatives and availability or pricing levels and availability I should say. But sorted office is the largest of the components Chris.

[Christopher Chung:]

And then turning to Tissue, I was a bit surprised to learn that the away-from-home market was down a couple percent year-over-year when I would have thought with a little bit better economy it would have been up. Can you talk about that a little bit?

[Mike Wildenberg:]

Sure this is Mike, Chris. The overall market for the year is down roughly about 0.003% on an annual basis from last year. The third quarter dropped approximately two percent, so the over all market for the away-from-home market has not shown improvement this year over previous years. It's is also as interesting to note that last year was down substantially about 6% year-over-year basis. So we are operating in a relatively stable but certainly at a lower level market in the total away-from-home market.

[Christopher Chung:]

And, broadly speaking, can you talk about the factors that might go into why the price recovery has not been as strong as in some years?

[Mike Wildenberg:]

The price recovery in the away-from-home market?

[Christopher Chung:]

Well, in your Tissue business?

[Mike Wildenberg:]

Well actually our price have remained thoroughly stable as we have gone through this year a great potion of that has been mix enhanced where we focus on our value added products at our controlled system sales. So we -- by improving our mix we've also improved pricing and the over all market being slightly depressing from a volume standpoint, thus certainly we face pricing challenges especially in the lower-end of the more commoditize grades but we've been very effective in basically being able to control our pricing levels at a higher level and especially through mix enhancement.

[Christopher Chung:]

And then on your timberland sale, can you tell us what the per acre prices were that you got?

[Tom Howatt:]

Yeah, we'd be happy to do that, Chris. Before the quarter, we averaged about a $1,000 per acre; 400,000 acres that we sold during the course of the quarter and if you take a look at what we've accomplished since the inception of the sales program which dates back as you recall to 2005 essentially, we've averaged about $1,400 per acre. So this group in these lands that we sold more recently were a bit more lower in terms of absolute value but nevertheless and I think the sale program for us has resulted and if you're at good average price across the acres that we sold.

[Christopher Chung:]

Okay, and the 8,000 acres that you have left, in terms of the quality of those lands, are they similar to the ones that you sold this quarter?

[Tom Howatt:]

Yeah, I think that's probably fair to say, you know, we've got some mix of lands in those remaining 8,000 acres but I think somewhere between that $1,000 and what our average has been over the last several year of near $1,400 is reasonable to expect.

[Christopher Chung:]

Okay, and then on your $27 million CapEx project at Brainerd, what kind of an IRR are you guys expecting?

[Tom Howatt:]

Well, in terms of projects in this nature, Chris, we typically established a hurdle of 17% and in this project we do expect to deliver that type of a return.

[Christopher Chung:]

Okay, thanks for your help.

[Operator:]

(Operators Instructions). Currently there are no questions in queue.

[Tom Howatt:]

Okay. Benefits associated with the restructuring initiative completed over the last few years are clearly evident in our recent financial performance. Our businesses are aligned with attractive core markets that provide opportunity for growth and for the mix enhancement. We're confident in our ability to drive earnings gains over the long-term and remained committed to achieving the return expectations of our shareholders. We look forward to reporting our fourth quarter results on Monday, February 7. Our next scheduled conference call is set for 11 AM Eastern Time on Tuesday, February 8. We appreciate your taking part in today's discussion and your interest in Wausau Paper. Thank you for your participation.

[Operator:]

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