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Buckeye Technologies, Inc. (NYSE:BKI)

F2Q09 Earnings Call

January 27, 2009 11:00 am ET

Executives

Daryn Abercrombie – Senior Finance and Investor Relations Manager

John Crowe – Chairman and Chief Executive Officer

Steve Dean – Senior Vice President and Chief Financial Officer

Kris Matula – President and Chief Operating Officer

Beth Welter – Vice President and Chief Accounting Officer

Analysts

Gail Glazerman – UBS Securities

Napoleon Overton – Morgan, Keegan & Company

Operator

Welcome to Buckeye Technologies Incorporated second quarter earnings results conference result. (Operator Instructions). At this time for opening remarks and introductions I would like to turn the call over to Mr. Dan Abercrombie of Buckeye.

Daryn Abercrombie

Thank you, [Martin]. Good morning and welcome to Buckeye's conference call commenting on our results for the October to December quarter 2008, our fiscal 2009 second quarter. Today I'm joined on this call by John Crowe, Chairman and Chief Executive Officer, Kris Matula, President and Chief Operating Officer, Steve Dean, Senior Vice President and Chief Financial Officer and Beth Welter, Vice President and Chief Accounting Officer.

After John and Steve make some introductory remarks we will respond to your questions. Before we get started, however, I'd like to read our Safe Harbor statement. The matters discussed in this call include forward-looking statements that involve risks and uncertainties that may call the company's actual results to differ materially from those projected in such forward-looking statements. For further information on factors that could impact the company and statements contained herein, please refer to the slide accompanying this presentation as well as the company's most recent annual report on Form 10-K and quarterly report on Form 10-Q. John.

John Crowe

Thanks, Daryn. Good morning. The October-December period was a challenging quarter for Buckeye. In late October the worldwide recession began to have an impact on the demand for some of our products. While the demand for most of our high end specialty wood products was solid and remains solid, demand for specialty cotton fibers has weakened significantly. Demand for our [airlaid] non-wovens product was also down primarily due to customer inventory reduction and the normal seasonal weakness in Europe during December.

We took market downtime at our Foley facility primarily in fluff pulp and at our Memphis and Americana plants in the cotton pulp during the quarter to match production to shipments and to control working capital. We are committed to matching production with sales to insure we minimize our cash investments and inventories.

Primarily due to weak volume demand our net sales of $184.7 million for the October-December quarter were down to 12.4% over the prior year quarter and down 16.6% when compared to our record July-September quarter. Net income for the quarter was $2.6 million, $0.07 per share compared to net income of $13.8 million, $0.35 per share for the same period last year and $8.9 million, $0.23 per share, in a sequential comparison.

As I said earlier the demand for our high-end specialty wood products has held up well aside from some weakness in fluff pulp in the auto filtration markets. But our cotton business has felt the impact of the recession primarily in the LCD, ethers, plastics and nitrates markets.

At the mid-point in our fiscal year our revenue is $406 million compared to $408 million for the same period last year. The growth we delivered in the first quarter has been offset by the impact of this quarter's weaker shipments.

Reduced capacity utilization had a significant impact on our margin reducing mid-year gross margin to 14.4% compared to last year's mid-year gross margin of 20.2%. Year-to-date earnings of $11.5 million, $0.30 per share compares to net earnings of $27.3 million, $0.70 per share the same period last year.

The recent steep decline in the price of our stock has created a significant gap between the book and market value of our equity. This significant gap has been raised as an indicator that potential goodwill impairment exists for the just-completed quarter. As such we are performing an interim goodwill impairment test that we expect to have completed by the first week in February.

In the event that it is determined that goodwill is impaired a non-cash charge will be required which will reduce reported net income and earnings per share for the quarter. The total goodwill balance subject to impairment as of December 31, 2008 is $140 million pre-tax. This impairment test is being prompted by our low stock price. While we do not believe the quality of our assets or our long-term business prospects have meaningfully changed we will likely be unable to reconcile the significant gap between the current market price and book value of our shares.

Now Steve will review the supplemental reconciliation charge that we included in our press release. Steve?

Steve Dean

I would like to refer you to the supplemental slides that we provided with the Webcast and on the company's Website and provide you with some further explanations behind our financial results for the quarter.

I'll plan to focus my comments on comparing our results for the October-December quarter to the July-September quarter, but we have also included several slides with comparisons against the year-ago quarter in the Appendix for your reference. These financial results do not include any potential non-cash goodwill impairment charge that may be reported in our financial results when we file our 10-Q on February 9th.

Starting with slide number 3 you will see a consolidated earnings summary comparing our earnings for the just-completed quarter to the July-September quarter. Operating income in the second quarter was down by $11.3 million or about 50% compared to the first quarter. This reduction in income was just about entirely due to the lower sales volume and associated market related downtime that John discussed in his opening remarks.

The impact of selling prices on our second quarter earnings was actually positive compared to the preceding quarter due to price increases implemented on October 1st on our high-end specialty wood and cotton grades, which more than offset the negative impact of a $9 per ton reduction in our average selling for fluff pulp during the quarter.

We also started to see a reversal in previous upward cost trends as raw material costs were flat, energy and transportation costs started to come down compared to first quarter levels, and the profitability of our plants in Brazil and Canada benefited from the stronger U.S. dollar. Chemical costs however continued to move higher during the quarter.

We had a $1.4 million improvement below operating income primarily due to a swing from a foreign exchange loss in the first quarter to a small gain in the second quarter which accounted for almost $1 million of this improvement. We also had a $0.4 million gain on the repurchase of $5 million of our 2010 bonds at a discount.

Turning to the waterfall chart on slide four you can see that earnings per share of $0.07 were down by $0.16 compared to the July-September quarter. In addition to the $0.07 reduction due to lost margin on lower sales volumes we had a $0.14 unfavorable cost impact primarily caused by lower capacity utilization resulting from production downtime taken by several of our plants during the quarter. This overwhelmed the favorable impacts of lower energy and transportation costs and favorable currency trends in Brazil and Canada.

Slide number five shows in a little more detail the drivers behind the reduction in operating income from $22.7 million in the first quarter of fiscal '09 to $11.4 million in the second quarter. You can see that the lower shipment and production volumes had a negative impact of about $12.5 million on second quarter earnings compared to the first quarter, and this consists of $4 million in loss growth margin due to lower shipment volumes, and $8.5 million in higher costs resulting from under-utilized capacity caused by the market downtime we took during the quarter.

About $1.5 million of this was offset by reductions in salaries and benefits, depreciation and other factory overhead expenses. So you could say that the market downtime we took during the quarter while helping our cash flow generation cost us at least $7 million in reduced operating income.

The $2.7 million increase in energy and chemical usage was also partly related to the production downtime as well as to the planned boiler outage and some lime kiln repairs at Foley during the quarter.

You can also see that we picked up $2.6 million in operating income from higher selling prices. Our chemical costs were up $2.3 million and our energy and transportation costs together were down $3.6 million compared to the preceding quarter.

Finally moving to slide six and seven, I wanted to talk a little bit again this quarter about Buckeye's debt covenants, our debt maturity schedule and our liquidity position. We have two financial covenants in our revolving credit facility which are shown on slide 6. They are a leverage ratio and an interest covered ratio and we are in compliance with each by a large margin.

The leverage ratio is calculated as total debt divided by adjusted EBITDA for trailing 12 months. We are required to keep this ratio below 5.25 until the quarter ending June 30, 2009 when this requirement drops to 4.50. As of December 31, 2008 this ratio for Buckeye was 3.05 based on our total debt plus Letters of Credit commitments of $396 million divided by our trailing 12 month EBITDA of $129.9 million.

The interest coverage ratio is calculated as adjusted EBITDA divided by interest expense for the trailing 12 months. We are required to keep this ratio above 2.0. As of December 31, 2008 this ratio for Buckeye was 4.3.

None of our financial covenants would be affected by a goodwill impairment charge but it would eliminate our ability to repurchase subordinated debt until October 2009 and would also eliminate our ability to pay dividends or repurchase stock under a restricted payments basket until we refinance or renegotiate the terms of our 2013 bonds.

On slide number seven is a chart showing Buckeye's debt maturity schedule. As you can see our earliest debt maturity is 21 months from now when the remaining $110 million of our outstanding senior subordinated notes are due. Our $200 million revolving credit facility matures in July 2012 and our $200 million in senior notes mature in October of 2013. I would also like to point out that as of December 31st we had $114 million of available borrowing capacity on our bank revolver in addition to $8.5 million in cash.

We believe that we're in a favorable position right now with no debt maturities for the next 21 months which gives us time to explore various refinancing options for this debt. Financing alternatives we have available to us include using the $50 million accordion we have as part of our credit facility and/or obtaining project release financing for some of our larger capital projects.

However in order to insure that have a bullet-proof refinancing plan for when these notes come due, regardless of whether the financial markets have started to return to normal by that point or not, we have

established a goal to pay down our debt to $350 million by December, 2009. This will put us in a position where we can use our existing bank revolver to retire the notes when they come due without having to go to the financial markets for new financing while still maintaining adequate available borrowing capacity.

John will address some of the steps we are taking to ensure that we can meet this goal as part of his remaining comments. Now, I'll turn it back over to John.

John Crowe

Thanks, Steve. As previously mentioned we took downtime at our wood fibers facility in Florida, and both cotton fibers facilities to match production to orders. We will continue to match production to orders and not produce for inventory. While our visibility is uncertain into the markets that are weak, we are prepared to ramp up sales in production as those markets stabilize and return to normal.

Although demand visibility is still poor, we currently expect that the January-March quarter will show improved profitability at similar revenue levels when compared to the just completed quarter. While we expect fluff pulp fall prices to decline, we have implemented price increases in our high-end wood specialty markets effective January 1st. Let me add that fluff prices have held up better than most would have expected.

Additionally, energy costs are down and February caustic prices are coming down, albeit caustic still remains at an unusually high price. With lower diesel prices and increasing amounts of pulp mill downtime we also expect some relief in wood prices. The cost of cotton fiber both in Brazil and the U.S. is also falling.

In the January-March quarter compared to the October December quarter, we expect a rebound in sales in our nonwoven segment after the seasonally weak December quarter in Europe. This rebound in nonwovens will help offset continued weakness in sales of specialty cotton fibers.

Our restructuring efforts over the last few years, which included closing high cost capacity, lowering our operating cost, reducing debt from $700 million to less than $400 million, and no near term debt maturities have us well positioned to deal with the economic downturn and recession.

As Steve discussed we have large margins on the required covenant metrics. Our next debt maturity is not until October, 2010. We have ample liquidity. Our pension plan is in good shape, as we have defined contribution plan. However, we are not standing still. We are focused on improving our financial position. The key strategies for Buckeye over the next twelve months include living within our means, generating free cash flow and paying down debt.

Across the organization, our people are focused on reducing costs, maintaining a tight control on working capital and building sales. This makes our focus on lean enterprise methods all that more critical or crucial as we continue to work to reduce costs by eliminating waste throughout our operations.

In addition to the company's focus on cost reduction we have reduced our planned capital spending for the fiscal year from $64 million to $40 million in order to accelerate debt reduction efforts. We remain committed to the energy cost reduction project at Foley and are teaming with local and State of Florida public officials to help assist Buckeye with the necessary capital investments.

As Steve mentioned our strategy for debt reduction, let me reinforce the plan. We have established a goal of paying down our debt from our December 2008 level of $391 million to $350 million by December 31, 2009. By doing so we can insure that we have sufficient borrowing capacity on our $200 million revolving credit facility to pay off the $110 million in bonds that mature in October 2010 without going to the credit markets for new financing.

With an emphasis on further improving the strength of our balance sheet and a focus on cash generation, we will take the necessary steps to live within our means. We are confident we will emerge from this business downturn in an even stronger position that will offer significant value to our shareholders and all of our stakeholders.

This completes the company's prepared remarks and we are now ready to turn the call back to our moderator for questions-and-answers. [Martin]?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Gail Glazerman – UBS.

Gail Glazerman – UBS Securities

For a start, can you talk a little bit more about wood specialties pricing. I had assumed or thought that you were just going to roll over surcharges into price, but it sounds like that you're offsetting a weaker fluff pulp pricing. You got incremental pricing beyond the surcharges?

John Crowe

I'll ask Kris to address pricing.

Kris Matula

Yes, Gail, as you know due to the significant cost escalation for chemicals, energy, transportation and wood fiber costs that occurred in 2008, we implemented cost surcharges totaling $100 per ton by the OND quarter for our high end specialty wood pulps.

Effective January 1, we did two things. One, we rolled this surcharge into the base price of our products and we introduced a quarterly pricing mechanism to pass on reductions or increases in key input costs as we realize these changes going forward. In addition to that, then we increased our specialty wood prices by about 8%.

Gail Glazerman – UBS Securities

Including the $100 surcharge?

Kris Matula

That's correct.

Gail Glazerman – UBS Securities

Okay, and can you talk a little bit about the cotton linter marker in terms of what you're seeing and cost relief in terms of magnitude and how that might compare to what you're seeing in terms of price business?

John Crowe

Kris, do you want to address what the demand –

Kris Matula

Yes, Gail let me talk about the demand for our cotton linter products. If you look at our cotton linter products in general those products go into very high end applications. And so, for example, a good example is our use of our cotton products go into thin films for large screen LCD TVs and in today's environment the purchase of very large screen TVs is discretionary, and as such the demand is down significantly. So hence the demand for our product is down significantly.

Now we certainly believe the demand will rebound once consumer confidence returns, but that's a good example of kind of the weakness that we have in cotton. In addition some of our cotton pulps are used in the construction and automotive applications and obviously you know that both of those areas are extremely depressed. And so if you look at our products and market segments we go into the weakest area we have is in our cotton products currently.

Gail Glazerman – UBS Securities

And, but I'm just trying to figure out the cotton linter prices have come off. Is it anything significant or would you expect it to be significant and would that be an offset to any sort of selling pressure you have in that business?

John Crowe

Well Gail, the cotton linter prices should come down given that we took downtime at our two cotton facilities. We have adequate inventory for the near term. So those lower prices probably won't flow through to us. We won't see them probably into our fourth quarter and April, May, June quarter. Kris, did you want to add anything to that?

Kris Matula

Yes, I think that so from a raw materials standpoint you know as you said we do have decreasing cotton linter prices. John mentioned that's going to be lagged more in Memphis than it will be in Americana. Certainly from a pricing standpoint for our products there's certainly pricing pressure on our products as there's pricing pressure on basically every product that's sold these days, but as our costs come down we will pass through some of that cost to our customers.

Gail Glazerman – UBS Securities

Okay, and just a little bit of color on what you're seeing in the fluff pulp market. Obviously prices are coming down; trade publication over the weekend admitted that's maybe that's not a universal assessment of market balance. If you would just explain whether or not in terms of supply and demand do you think the fluff price weakness is warranted, other than just looking at commodity pricing, I guess?

Kris Matula

Let me try to address that Gail, as you know as we look at kind of fluff pulp since fluff pulp primarily goes into, I'll call them non-discretionary items, feminine hygiene products, diapers, incontinence products, we've really yet to see, and at least from our customers, they've yet to see a large amount of demand destruction with the global recession and now like with most products, we have seen customer inventory reductions particularly in light of the fiscal year end and so it appears, at least at this point in time that tends to be more of a demand driver.

Now if you look at prices, Steve shared that our price is down about $9.00 a ton, the OND quarter versus the prior quarter. You have seen in trade publications that certainly a large supplier of fluff pulp announced a $50.00 per ton list price decline effective January 1, so we would expect prices to come down in fluff pulp in this quarter relative to the OND quarter.

But I think on balance, if you look at the supply and demand fundamentals for fluff pulp, they are relatively in balance because you don't have the large, call it demand side destruction that you might be seeing in other areas, and I think that's providing a little bit more stability in that market and in the pricing of those products.

Gail Glazerman – UBS Securities

Okay and just switching gears John, I just want to clarify on Foley when you look at the cut in CapEx from $64 million down to $40 million, is that assuming Buckeye makes lower contributions to the Foley project?

John Crowe

Well it assumes that the energy project – we're committed to it because it's such an important project, but it's subordinate in terms of debt reduction, so that's – we're looking at alternatives, pursuing alternatives to see other kinds of funding, working with the state and local governments. But given that doesn't happen, we will - that the project will be slower in implementation.

Gail Glazerman – UBS Securities

Okay and I mean based on today's pricing, would that project be a positive contributor?

John Crowe

Yes, with becoming self sufficient of fossil fuels and electricity, one thing we haven't seen is a reduction in electricity, so bringing that project on and becoming pretty much day-to-day, independent of purchased electricity will certainly have a contribution, improve our cost structure long-term.

Operator

(Operator Instructions). Your next question from Nap Overton – Morgan, Keegan & Company.

Napoleon Overton – Morgan, Keegan & Company

Good morning, Steve, did I understand you just stated that there's no potential impact or the potential write down of impairment of good will on any of your debt covenants?

Steve Dean

That is right, Nap, the only impact really is it limits our ability to do some things like repurchase subordinated debt to one year prior to maturity and that sort of thing, but no impact on covenants.

Napoleon Overton – Morgan, Keegan & Company

All right and then are any asset sales required, I mean a $40 million reduction in debt over four quarters is fairly aggressive, even though I know you've been able to do that in recent years, it's fairly aggressive. Are there anything other than cash from operations contemplated in that kind of debt reduction?

John Crowe

No, we don't anticipate selling any assets.

Napoleon Overton – Morgan, Keegan & Company

Okay. I see.

John Crowe

We're going to run to order and maintain low level inventories and manage for cash, generate cash.

Napoleon Overton – Morgan, Keegan & Company

And that's based on about a $40 million CapEx budget.

John Crowe

Yes, sir.

Napoleon Overton – Morgan, Keegan & Company

All right. And then just, I think you already answered this question, but just to specify, the reduction in capital spending from $64 million to $40 million, is that entirely Foley?

John Crowe

No. Not entirely Foley. We're looking at reductions across the board.

Napoleon Overton – Morgan, Keegan & Company

Okay.

John Crowe

Even now if it takes about $30 million to maintain our assets, so it still leaves us some room for some improvement so it still leaves us some room for some improvement, but certainly that will be monitored, too. We're going to live within our means and our depreciation is $50 million and so $40 million is – we're very comfortable at $40 million that we can maintain our assets.

Napoleon Overton – Morgan, Keegan & Company

Okay. And then would you comment on a few market pulp producers have added the flexibility to switch back and forth from market to fluff pulp production over the last what, 18 months, two years? And how do you think that's going to impact fluff pricing through this down cycle that we're getting into?

John Crowe

Nap, I think those that could switch have switched because obviously there has been a large gap between fluff pulp pricing and market pulp. And you know that some of those that can make fluff have even announced downtime. So as Kris said, we believe there was some inventory reductions but the fluff market is pretty well in balance between supply and demand.

Napoleon Overton – Morgan, Keegan & Company

So those, but you believe those that can switch have already done so?

John Dean

That would be my read.

Operator

(Operator Instructions). It appears that there are no further questions at this time. Mr. Crowe, I would like to turn the conference back over to you for any additional remarks.

John Crowe

Thank you, [Martin], and I want to thank the people that joined us today and we look forward to our next conference call when we can share the results of our business. Thank you.

Operator

And this does conclude today's Buckeye Technologies conference call. We appreciate your attendance and have a great day.

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Source: Buckeye Technologies, Inc. F2Q09 (Qtr Ended 12/31/08) Earnings Call Transcript
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