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Executives

Ray Dillon - President and CEO

Ken Mann - VP and CFO

Analysts

Will Hunter - Neuberger Berman

Robert Holt - Holt Capital Partners

Anna Torma - Soleil - Torma Research

Burt Winston - Kedo’s Capital Management

Robert Holt - Holt Capital

Deltic Timber Corp. (DEL) Q3 2008 Earnings Call October 30, 2008 11:00 AM ET

Operator

Good day, ladies and gentlemen and welcome to the third quarter 2008 Deltic Timer earnings conference call. My name is Alicia and I will be your operator for today. (Operator instructions)

I would now like to introduce your host for today's call, Mr. Ray Dillon, President and CEO of Deltic Timber. You may proceed, sir.

Ray Dillon

Good morning. I would like to welcome you to Deltic Timber Corporation's third quarter conference call. We appreciate your interest in and support of Deltic.

I am joined today by Ken Mann, Vice President and Chief Financial Officer. Ken will begin with an opening statement, followed by a review of the financial results released yesterday, and then I will close with some brief comments on current operations and the outlook for the fourth quarter and remainder of 2008, before we open the line for any questions. Ken?

Ken Mann

Thank you, Ray. Deltic issued its news release yesterday announcing earnings for the third quarter of 2008. If you don't have a copy yet, you can download one from the Investor Relations section of our company web site at deltic.com. If you don't have access to the Internet, you can call me to request a copy. My direct telephone number is area code 870-881-6432.

Now, before continuing, I would like to make a statement relating to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Some of the comments made during the course of this conference call will be considered forward-looking statements.

These statements will reflect the company's current views in regard to future events and financial performance. However, no assurance can be given that these events will occur or that the projections will be attained.

Certain important risk factors that may cause actual results to differ materially from those forward-looking statements are identified in Deltic's 2007 Form 10-K, on file with the SEC.

For my financial review, I will focus initially on the results for the third quarter of 2008 and then comment on the first nine months of the year.

For the third quarter, Deltic's net income was $2.5 million, $0.21 a share, a $2.3 million increase from the 2007 third quarter of $200,000, or $0.02 a share. Net sales were some 37% higher at $34.9 million.

The Woodlands segment reported 4.1% higher operating income at $5.1 million in the 2008 quarter, compared to $4.9 million a year ago. For the quarter, we have benefited from a 43,371 ton or 42% increase in the volume of pine soft timber harvested mainly as a result of the curtailment of harvesting from the company's Waldo region free lands during the third quarter of last year that was caused by suspension of production at our Waldo mill for the most of the month of August and the entire month of September due to a fire in the planer mill area there.

Actual 2008 harvest volume was 147,436 tons, some 43,400 tons more than the 104,065 tons harvested in the prior year third quarter. The average stumpage price dropped 26% to $29 per ton compared to $39 per ton in the 2007 third quarter, as area stumpage prices have decreased more than usual during the current downward cycle in the lumber market.

The 2008 third quarter also benefited from a 24% increase in the amount of oil and gas lease rental income recognized to $517,000 combined with the fact that oil and gas royalty revenues received a $513,000 or five times higher than the third quarter a year ago.

Offsetting the favorable variances for the quarter was that the harvest volume of pine pulpwood decreased by almost 21% to 84,138 tons. And that sales of recreational hardwood bottom land totaled 185 acres on an average price of $1,500 per acre compared to 360 acres for $2,000 in the third quarter of 2007.

In the mills segment, operating results improved income of $1.8 million, compared to a loss of $800,000 in the 2007 quarter, a $2.6 million improvement. Average sales realization of 307,000 board feet were about 1%, or $3 higher than the corresponding quarter of last year. The improved results were also positively impacted by increased hourly productivity rates at both of our mills.

This improvement in operating efficiency combined with a two month production suspension at the Waldo mill during the prior year quarter resulted in additional lumber sales volume of 2.38 million board feet, or a 52% increase to a total of 69.5 million board feet.

In addition, our lumber manufacturing operations benefited by a significant reduction in the cost of logs used to produce lumber that Ray will discuss more in his comments.

As expected, residential lot sales continued to be lower than desired. We sold 11 lots in the third quarter of 2008 compared to 24 lots a year ago while the average price of $74,300 a lot compares negatively to the average of $83,900 per lot in last years third quarter due to sales mix. There were no sales of commercial acreage in the third quarter of either year.

Due to the reduction in residential sales activity, the real estate segment reported a loss of $500,000 for the third quarter of 2008, compared to break even results for the third quarter of 2007.

Del-Tin Fiber had another solid quarter contributing $700,000 which compares favorably to $300,000 a year ago. The plant's average sales realizations increased 14% compared to the third quarter of 2007 results, to $558 per thousand square feet, while sales volume rose 12% to 29.7 million square feet for the third quarter of 2008.

Corporate operating expense was $4.4 million in the third quarter of 2008, compared to $2.9 million in the same quarter of last year. The increase was primarily due to higher general and administrative expenses from increased acquisition-related costs. The financial results for the third quarter and the year of 2008 have benefited from reduced federal and state effective income tax rates.

An enactment of the TREE Act portion of the Food Conservation and Energy Act of 2008 during the second quarter has lowered the company's federal tax rate from 35% to 15% and recognition of a previously deferred state tax benefit during the third quarter reduced the overall effective rate even further.

We are obviously in support of the renewal of the TREE Act in May of 2009 as it removes many of the tax disadvantages that a C-corporation would have when compared to a restructure.

Turning to the nine months of 2008, Deltic's net income was $4.6 million, $0.37 a share, compared to the 2007 period of $9.4 million, or $0.76 a share. Net sales were down 5.5% at $98.3 million. The Woodlands segment contributed $20.9 million, some $2 million more than the first nine months of 2007, primarily on the increases in both sales of recreational use hardwood bottom land and revenues from oil and gas lease rentals and royalties.

In the first three quarters of 2008, we have sold about 1,830 acres of non-strategic hardwood timberland for almost $2,200 per acre versus sales of 424 acres for $1,900 per acre in the first nine months of last year.

Oil and gas lease rental income has increased 45% to $1.5 million while royalty income rose to $1.1 million, from $180,000 in the prior year period. While the pine soft timber harvest volume increased about 8% to 471,000 tons due to timing as a result of the previously discussed sawmill downtime, the average sales price per ton dropped 17% to $34 per ton.

The harvest level of pine wood decreased 26% to 273,500 tons as we were able to complete much of our plant thinning program last year. For the mill segment, operating results were a loss of $3.2 million compared to a loss of $3.5 million for the 2007 first nine months largely due to the benefit of lower log cost and improved production efficiencies.

These improvements were partially offset by a lower average sales realization of $280 per thousand board feet, some $20 per thousand board feet lower than last year. Lumber sales volume was about 18% higher than the first nine months of last year, totaling 202 million board feet as the 2007 period was impacted by the two month production suspension.

Real estate operations lost $1.4 million compared to a contribution of $12.6 million a year ago. We have sold 25 residential lots at an average price of $74,300 a lot, compared to 58 lots which averaged $89,200 a lot in the 2007 period.

During the first nine months of 2008, we had no sales of commercial real estate acreage while we sold 26 acres of commercial sales in the first nine months of last year, at an average price of $240,600 per acre. There continues to be significant interest in our remaining commercial property in Shenaw Valley especially for net suitable for multi-family housing usage.

Another real estate transaction having a significant impact on the reported financial results for this segment for last year was the first quarter sale of 680 acres of undeveloped real estate to Central Arkansas Water for $8.2 million, or $12,000 per acre. We have had no sales of undeveloped real estate acreage thus far in 2008.

Deltic's equity in Del-Tin Fiber was $2.1 million for the first nine months of 2008 compared to $1.3 million for the same period in 2007. Average sales realization for the 2008 period was $539 a thousand, compared to $485 a thousand in the 2007 first nine months due to price increases by producers pushing through significant manufacturing component cost increases.

Sales volume was about 1% lower due to softening of the overall MDF marketing resulting from a reduction in housing starts. Capital expenditures have increased some $1.1 million to $16.7 million for the first nine months of 2008, compared to $15.6 million during the same quarter in 2007.

The increase is primarily due to a $1.5 million increase in expenditures for timberland acquisitions as we are acquiring strategic pine timberlands with the proceeds from the sales of hardwood bottom land and doing so in a tax efficient manner.

At September 30th, long term debt was $65.8 million, while our cash balance was $16.5 million. The long term debt to capital employee ratio was 22.7%, still one of the lowest in our industry. Working capital was $7.6 million even with scheduled current maturities of our long term debt of $6.7 million.

With this working capital amount and the cash flow that's generated by our business, combined with the fact that the entire balance of the $300 million credit facility that we have in place is available if needed, Deltic does not have the liquidity issues that many companies are faced with today.

As an update to activity for our open approved stock repurchase program, we have purchased 103,091 shares of Deltic stock since September 30th for approximately $5 million. We will continue to purchase shares as the opportunity presents itself. And now, I'll turn the call over to Ray for his comments.

Ray Dillon

Thank you, Ken. Deltic's reported net income for the third quarter of 2008 was largely impacted by the combined positive impact of improved financial results from our lumber manufacturing operations which I will discuss in more depth and reduced effective income tax rate at both the federal and state levels which Ken commented one earlier.

Tightened credit markets have further depressed the environment that exists for residential real estate construction which has impacted Deltic in the form of fewer residential lot sales in our real estate developments and reduced demand for the dimension lumber produced in our sawmills to be used to construct new homes.

This reduced lumber demand directly impacts the sales realizations received for the lumber that we produce. However, I am pleased that Deltic's middle segment was able to report positive financial results for the third quarter despite this difficult operating environment.

Financial results for our lumber manufacturing operations were income of $1.8 million, a $2.6 million improvement from the third quarter a year ago. This improvement was largely due to slightly improved lumber sales prices of $307 per thousand board feet, up $3 from last year, but still relatively depressed.

Improved hourly productivity for both of our sawmills as a result of the capital we have recently invested in them, allowing us to manufacture more lumber and fewer operating hours.

Tighter control of every component of direct manufacturing costs required to produce finished lumber and reduced cost for the logs used as raw material to make lumber, as pine soft timber stumpage prices in our operating area have decreased as a result of the curtailments and shuttering of some area mills.

Depressed lumber prices have resulted in the shutdown or curtailment of several solid wood manufacturing plants in the Waldo Mills procurement area resulting in reduced demand and stumpage prices paid for soft timber in the area.

Additionally, we plan to continue to strive for marginal improvements in the operating efficiencies at both mills to further improve their respective cost structures. I believe that the efficient producers that survived this extended market downturn will ultimately be rewarded financially when the lumber market recovers from its currently depressed levels.

Lumber sales volume for the second quarter was 69.5 million board feet, an increase of 52% when compared to 2007's third quarter. Most of this increase was due to the two month suspension of production at the Waldo mill during the third quarter of last year as Ken discussed, but a portion of this increase was accomplished by our sawmill as a result of the improved hourly productivity that they have achieved.

Beginning in mid-September, the financial uncertainty in the United States caused further reductions in new construction activity resulting in reduced lumber demand and lower sales realizations. We reacted in early October by reducing the operating hours of both of our sawmills by about 20%.

With this, Deltic's finished lumber sales volume for the fourth quarter is now estimated at 50-70 million board feet and 250-270 million board feet for the year of 2008. However, this estimated volume is highly dependent on market conditions and will be increased or further decreased as needed to react to changes in those market conditions.

During the third quarter of 2008, our Woodlands segment continued to see sales realizations for pine soft timber drop from prior year levels as the depressed lumber market combined with the reduced lumber production levels by sawmills in our operating area have resulted in a reduced price for pine soft timber stumpage due to our reduction in demand.

The historically weak lumber market seen in 2008 has negatively impacted stumpage prices more than during past down cycle periods. During the third quarter, we saw the average sales price for pine soft timber drop $10 from $39 per ton leveled in the third quarter of 2007, to $29 per ton in the current quarter. However, this reduction greatly benefited our lumber manufacturing operations in the form of reduced log costs and helped the mill segment return to profitability.

Consistent with our stated sustainable yield harvest strategy, we plan to keep 2008's annual pine soft timber harvest volume at planned levels of 550,000 to 575,000 tons so the expected harvest volume in the fourth quarter is 80,000 to 100,000 tons.

Demand for pine pulpwood for raw material shipped by area paper mills continues to e relatively strong and the price we received for the pine pulpwood sold by the Woodlands segment remained the same as the third quarter of 2007 at $13 per ton. However, we harvested about 21,900 fewer tons of this pulpwood in this year's third quarter since we performed thinning operations on a large portion of our plantation acreage last year.

Our efforts continued to sell non-strategic hardwood bottom land for recreational use and used the sales proceeds to acquire additional pine timberland in a tax efficient manner. During the third quarter, we sold 185 acres of such land for about $1,500 per acre. An appetite remains for these lands and we're currently negotiating on the sales of additional acreage that would likely be scheduled to close in the fourth quarter.

With regard to the Fayetteville Bischel at September 30th, some 27 wells have been drilled and in production in units in which we have mineral acreage. For the third quarter of 2008, average royalty payment income increased to about $171,000 per month from some $100,000 per month in the second quarter. So the financial impact realized beyond the recognition of the annualized portion of the lease bonus payments already received has begun to more materially impact our reported financial results.

But the estimation of the future potential impact remains difficult due to the number of variables involved, especially at the level of drilling activity by producers. We have seen the announcement of planned reduction of drilling due to current natural gas prices by at least one producer that is active in the Fayetteville Bischel.

In our real estate segment, the lack of residential lot sales activity during the third quarter of 2008 continues to reflect the depressed housing market seen throughout the United States. It is now apparent that this slowdown will continue for some time. Residential lot sales for the third quarter of 2008 decreased to 11 lots from 36 lots in the third quarter of last year.

We anticipate that combined lot closings for our three residential developments for the year of 2008 will be between 35 and 40 lots. We will not be offering any new lots for the remainder of 2008 or during 2009 to allow demand to catch up with current available lot inventory.

Deltic's results for the third quarter of 2008 reflect no commercial acreage sales activity. Last quarter, I reported to you that interest in the commercial acreage that the company has for sale in our Shenaw Valley development was strong and that we were working with potential buyers. This statement remains true as we enter the fourth quarter.

We will continue to work with these buyers to close transactions but the tightened credit market has impacted some of the potential buyers so the timing of such sales is even less predictable than normal.

At Del-Tin Fiber, our joint venture medium density fiber board facility, financial performance is currently acceptable but it is not insulated from the negative pressure that the current lack of housing starts has exerted on manufacturers of building products.

As Ken commented, the plant reported a solid level of income for the third quarter. However, the medium density fiberboard market has now begun to soften, its new home construction levels remain low. The increase in repair and remodel activity that normally occurs when the level of new homes starts decrease, has not been enough to offset the loss and product demand for the use in new homes.

The continued demand for pine pulpwood and residual chips or raw material by area paper mills is keeping the cost of wood fiber used by Del-Tin at elevated level. High manufacturing cost and reduced MDF demand will negatively impact the financial performance of the Del-Tin joint venture for the remainder of 2008 and possibly into 2009.

I’m generally pleased with the company’s reported financial performance for the first nine months of 2008, given the current condition of our business environment. But with a short-term market outlook for the residential and commercial real estate and lumber market, operating in forest products in real estate development business will be very challenging for several quarters.

Despite the fact that certain areas of our business are faced with difficult operating environments, the diversity of Deltic’s assets continue to allow us to focus on other areas where opportunities exist in order to maintain respectable financial results for our shareholders.

We will continue to be good stewards of these assets and maximize the value received in every sales transaction, while concentrating on being even more efficient and cost conscience than ever before in order to weather this period. I also believe that our operations are well-positioned to take advantage of any market recovery.

In these economic conditions, the quality of the assets on Deltic’s balance sheet and the lack of leverage found in the balance sheet are very comforting. If these difficult conditions continue, as some predict, they should eventually present some buying opportunities as we look to wisely grow Deltic’s current asset base.

Alicia, we can now open the lines for any questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator’s Instructions) The first question comes from the line of Anna Torma with Soleil. Please proceed.

Anna Torma - Soleil - Torma Research

Good morning, Ray and Ken. Ray, could you provide a bit of additional color on saw timber pricing? Do you think prices are sort of bouncing along the bottom now or are we going to see further sawmill closures pushing saw log pricing down to yet another new low?

Ray Dillon

As you know, Anna, each one of these sawmills are in a given wood basket and that’s really a micro market. So, in some saw timber markets, depending upon the number of manufacturing facilities that continue to operate will affect saw timber prices.

In those where the supply and demand of saw timber from the wood basket is balanced, I think that we may have found the bottom. But in areas where facilities continue to shut down, you know you could continue to see more saw timber on the market than there is consumption for it.

Anna Torma - Soleil - Torma Research

Great, thanks. And you could also, if i could ask a second question just to comment on whether you’re seeing any downward pressure beginning to emerge on Timberland demand and pricing in the markets that you are looking at?

Ray Dillon

I guess from our hardwood bottom land sales, we continue to see a tremendous amount of interest, I would characterize that as mostly local market conditions as people look to own land that they choose to enjoy from a recreational standpoint.

As it relates to Timberland, we still see the Timberland market’s very competitive in those areas that we’re looking and that we acquire from time to time.

Anna Torma - Soleil - Torma Research

That’s great, thanks Ray.

Operator

The next question comes from the line of Burt Winston with Kedo’s Capital Management. Please proceed.

Burt Winston - Kedo’s Capital Management

Hi guys, morning. You reduced your volume in the mills by about 20% you mentioned. Do you think that’s adequate to keep pricing approximately where it was in 3Q?

Ray Dillon

That’s essentially what we see to balance our output with our customer’s demand at this time, Burt. As I said, we’ll make further either reductions or increases, depending upon what those market conditions did pay but for the moment, we think that’s sufficient.

Burt Winston - Kedo’s Capital Management

Thank you. And on the uses of cash, kind of can you take me through how you weight buying back shares versus making land acquisitions versus other uses?

Ray Dillon

Yes, we evaluate each one of them, tend to look at the net present value of those assets. Certainly we strategically use the cash to either buy back shares, which we feel are significantly discounted or strategic land purchases that we think adds to our asset base. And with our balance sheet, we quite frankly have the capacity to do both.

Burt Winston - Kedo’s Capital Management

Okay, that works. Tthank you.

Operator

The next question comes from the line of Robert Holt with Holt Capital. Please proceed.

Ray Dillon

Good morning, Robert.

Robert Holt - Holt Capital

Morning. In your G&A expense, can you elaborate on your comment about increase acquisition related costs, provide any color on that?

Ray Dillon

Yeah, I’ll let Ken answer that.

Kenneth Mann

Okay. You know with that, we incurred acquisition and (inaudible) related cost. We continue to locate opportunities to grow our business.

So and basically the accounting rules dictate how you would account for that. And accordingly we have accounted for our (inaudible) expenses under those and expense those in the current quarter if we should under current county rules.

That level as you know, just around approximately about $950,000 for the quarter.

Robert Holt - Holt Capital

Would this typically be timberland or private company acquisition opportunities? Or in a public arena?

Kenneth Mann

It could be all three of those.

Robert Holt - Holt Capital

I didn’t think I’d get much color. Thanks guys.

Operator

(Operator’s Instructions) We have no additional questions at this time, I’d like to go ahead and turn the call back over to Mr. Dillon for closing remarks.

Ray Dillon

Thank you for your interest in Deltic Timber and I hope you will join us again next quarter.

Operator

Ladies and gentleman, thank you for joining today’s conference, this concludes your presentation, good day.

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Source: Deltic Timber Corp. Q3 2008 Earnings Call Transcript
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