Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

MeadWestvaco Corp. (NYSE:MWV)

Q3 2009 Earnings Call

October 28, 2009 9:30 am ET

Executives:

Jason Thompson – Director - Investor Relations

John A. Luke, Jr. – Chairman and Chief Executive Officer

James A. Buzzard – President

Mark Rajkowski – Senior Vice President and Chief Financial Officer

Analysts

Claudia Hueston – JPMorgan

George Staphos – Bank of America

Mark Weintraub – Buckingham Research

Gail Glazerman – UBS

Mark Connelly – Sterne Agee

Peter Ruschmeier – Barclays Capital

Chip Dillon – Credit Suisse

Richard Skidmore – Goldman Sachs

Operator

Ladies and gentlemen thank you for standing by, welcome to MWV's Third Quarter Results Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session, instructions will be given at that time. (Operators Instructions). As a reminder today's conference is being recorded.

I would now like to turn the conference over to your host Director of Investor Relations Mr. Jason Thompson. Please go ahead.

Jason Thompson

Thanks Stacy, and good morning everyone. This morning we announced our results before the market opened. The notification of this morning's call was broadly disclosed. Further, this morning's call is being webcast at mwv.com. And slides that accompany this call are available there as well.

I'll briefly remind you that certain statements we make are forward-looking and are not guarantees of future performance, and are subject to known and unknown risks and uncertainties described in our public fillings. Furthermore, contents contain time sensitive information that although correct today may change with the passage of time.

First, a brief recap of the results we reported this morning. For the third quarter we reported net income of $128 million or $0.74 per share. These results include net after tax benefits from special as described in our press release of $42 million or $0.24 per share. Excluding these items net income as adjusted was $86 million or $0.50 per share.

Now here to tell you more about our results for the third quarter are John Luke, Chairman and CEO, Jim Buzzard our President and Mark Rajkowski CFO. I'll now turn the call over to John.

John A. Luke, Jr.

Jason thanks, and good morning to all of you. We are continuing to deliver solid financial performance by executing our transformation strategies to build a stronger more valuable company. During the third quarter, profitability improved in each of our business as compared to the year ago quarter, a period that’s still predated dramatic decline in demand due to the financial market crisis and the ensuing recession. We are navigating through what remains a challenging economic period by focusing intently on the factors that we can directly influence to generate value for both our customers and our shareholders. This work is driving our progress and our improved results.

Our deliberate strategic path includes priority emphasis on making disciplined market participation choices about our products, customers and operations. As well actions to reduce overhead costs, improved operating productivity and preserve our financial strength. Our progress in these and other areas is generating returns in today’s difficult economy and we will also further expand MWV’s performance and competitive advantage when the economy improves.

In a few moments, Jim will talk about progress on the strategic cost program that we announced earlier this year, as well as the ways we are creating growth opportunities in targeted markets. Following Jim, Mark will discuss the impact of our strategic actions on the quarter’s financial results and on the strength of our business model going forward.

Before turning to them, I’ll highlight a few aspects of our third quarter performance that underscore the changes we have made to strengthen the value profile of our business. First, we have made deliberate choices about market participation. Emphasizing markets and customers where we can be rewarded profitably for the differentiation and the value of our products and services and de-emphasizing or exiting product lines, facilities or business with customers where this is no longer possible.

These steps have had an immediate beneficial impact on our results and have allowed us to focus resources on areas such as the beverage, food, personal care and healthcare markets that can be significant growth engines.

Second, we have eliminated significant overhead costs, those associated with the businesses we’ve exited, as well as other non-essential activities across our company, doing so at a rate that is ahead of our plans for 2009. We also continue to improve our operating productivity, a discipline that will deliver additional savings each and every year.

Lastly, we are doing what is necessary to set the stage for future growth. Investing in innovation and exploring opportunities in both new and existing markets and geographies. This is a decided competitive strength that has been recognized and acknowledged by our current customers and those in markets in which we look to participate. Even during this recession we launched new products during the quarter in the healthcare, tobacco and food service markets that will be cornerstones for profitable growth.

In summary, we are managing successfully through a difficult period. Our strategies are contributing to our current performance and will shape and strengthen our future business model. Our financial position and focus on value are enabling our role as a key partner for our customers and as a sound investment for our shareholders.

I’d now like to turn the call over to Jim Buzzard who will be followed by Mark Rajkowski. Jim?

James A. Buzzard

Thanks John. Each of our businesses reported strong improvements and profitability by executing on the consistent set of strategic initiatives as John mentioned. Especially the combination of our market participation strategies and efforts to reduce overhead costs and improve operating productivity. Overall, profits from our business segments increased 43% compared to the third quarter last year. And our margins grew as a result of actions to reduce costs and focus on higher value products and solutions.

We’ve continued to make progress in our strategic cost management program. As you may recall, this include steps to restructure our manufacturing footprint, improve operating productivity at our facilities, streamline our sourcing and supply chain, and reduce our SG&A and overhead costs. As promised the benefits of this program have been increasing as we move through the year and we had another quarter of strong progress. Collectively these actions delivered a $128 million to the bottom line in the third quarter.

Our strategic cost management program is helping to counter act the effects of under absorption of fixed manufacturing cost at our facilities, and will have an even greater impact in our performance when demand in our markets improve. A word about demand, across many of our different markets, we’re starting to see some stabilization albeit at the lower levels that had become the norm over the past 9 to 12 months.

Order levels are holding steady and following seasonal patterns. We are also starting to have positive conversation with customers about new products and projects that could be entering the pipeline in 2010. While we are seeing some positive signs, we are not waiting for an economic recovery to create opportunities for growth in our business. In the attractive markets we’ve targeted, we are taking share, winning new business and expanding our opportunities by focusing on the right products.

The innovative, cost-effective and high-value solutions our customers need to succeed in their marketplace. I will share some examples of this progress as well as our overall performance in a run down of each of our business segments. As always you’ll find additional information in the slide presentation that accompanies this call. In the Packaging Resources segment sales declined compared to the prior years, but we did see signs of stabilization in the third quarter. Demand trends in this business were substantially similar to the second quarter with modest quarter-over-quarter improvement due to the normal seasonal trends.

Shipments of SBS were down 19% in the third quarter compared to last year, a 3% increases over the second quarter. CNK volumes were down 10% compared to last year representing continued inventory management in some of our beverage customers and weakness in certain markets. We are able to increase profit and margin in this business through continued pricing discipline and operational productivity projects at our mills. Pricing for our mill-based business was up 3% over last year due to actions taken in late 2008, and we had the benefit of lower input costs especially wood and freight.

Earnings in the Packaging Resources group were up 16% based on these gains. On an constant currency basis, earnings were up in PRG’s Brazilian business, Rigesa largely through improved productivity. Rigesa continues to be the strong performer and an attractive opportunity for additional growth in Brazil. The Consumer Solutions segment continued its positive earnings trajectory increasing year-over-year profits for the third consecutive quarter.

Even the sales dipped more than 10%, our actions to reduce costs, increase productivity and exit unprofitable business resulted in increase in profits and margin. The overall improvement in this segment has been strong and we expected to continue as our market choices and cost and product disciplines continue to take hold. Let me go through each of the consumer packaging markets we serve in this business to give you a sense of the performance in the quarter.

Recent global beverage market trends continued during the seasonally strong third quarter. Beer volumes were more stable income than carbonated soft drinks as there was broad based trading down for premium brands and packaging formats to less expensive options for at-home consumption. As such our multi-pack business in North America was stable for beer markets but remained more challenging for soft drinks, where customers are still aiming for higher retail prices than the expense of volume. Beverage sales were lower in Europe where our business has more exposure to premium beer brands. But we continue to have an outstanding [real story] in Asia, where sales were up 17% during the third quarter.

We are expanding our business with existing customers in China, South Korea, Australia and India. And also benefiting from overall growth for the multi-pack format in the emerging markets. Overall there is only a small volume decrease in our beverage markets, which is magnified by additional impact from foreign exchange. This business increased profits compared to last year, thanks to combinations of cost reductions and improved operating productivity.

In Healthcare we continue to grow our business for Shellpak by gaining market shares to Wal-Mart's generic program. Since its commercial launch last year Shellpak has grown from 8 million units to 20 million units each quarter. We also just launched new product called Med-Easy, a patient-inspired convenience package for both prescription and over-the-counter drugs. We have had some initial interest in this new product and expect that to turn into volumes in 2010. The market for pharmaceutical pumps has remained relatively stable. Customers are restocking but not yet building their inventories. We are actually marketing our new preservative-free pump to European customers where regulations encourage manufacturer to take steps to eliminate preservatives that can have potential side effects for patients. In our healthcare business overall, profit doubled compared to last year. A strong performance on slightly lower sales, which reflects some lower return business we exited in North America.

In personal care, the market for luxury applications like fragrance is still very weak. With lower consumer spending on these discretionary items. However, we've seen some limited restocking for mass-market products and even a few signs of new luxury launches in the pipeline, which has helped to stabilize the personal care market though at very low levels.

While we are holding onto our share of profitable business in this market and addressing excess capacity in unattractive segments. We saw some improvements in the second quarter in Europe and Brazil and continued strength in the mass-market for soaps and antibacterials due to concerns about the H1N1 virus, these developments help to improve profitability compared to last year.

In Home & Garden, wet weather extended the lawn maintenance season and the H1N1 virus placed an emphasis on home cleaning and disinfection. These trends led to good sales with our biggest customers, Scosche, Clorox and SC Johnson and a significant improvement and profit growth for this business compared to last year.

We continue to benefit from our scale in the home and garden market. Thanks to our strong position with leading customers and last years acquisition of assets from ContinentalAFA The team has done an excellent job by strengthening our position with the key customer we picked up in that deal.

Lastly, we continue to successfully manage our media business for maximum cash generation. Our sales are down consistent with the overall decline in this market. We've increased earnings by sizing this business properly and by taking some position as a stable partner to the biggest studios.

As I mentioned last quarter to launch our EcoLite DVD package has been a real hit and we remain sold out of our capacity through the end of 2009.

Turning to our non-package businesses both the consumer and office products and specialty chemical segments generated higher earnings compared to last year. The Consumer and Office products segment had a solid performance during the Back-to-school season in North America.

We secured great positioning for our branded products at the leading mass-retailers and sell-through with these products exceeded expectations as notebooks and other school supplies did better than more discretionary Back-to-school categories. Along with aggressive productivity actions and tight cost controls this solid season contributed to a 34% increase in profitability for the C&OP segment.

Overall sales continue to be lower in this business as envelopes and other office supplies have declined with economic conditions. Envelope volumes remain particularly weak as financial services and other customers continue to reduce their direct-mail campaigns.

The C&OP business recently acquired [Grupo ENCE] a high-end stationery company in Brazil's attractive and growing market. The team is working to integrate its valuable products and licensing agreements and to deliver offerings for the upcoming school season in South America.

The process has been smooth to date and we expect a modest favorable impact on results in this segment during the fourth quarter. Sales increased slightly in the specialty chemical segment. And the business posted a strong 50% increase in earnings this quarter driven by productivity improvement, fixed cost reductions and input cost declines. The slow but steady recovering in some of our chemicals markets has been led by sales of innovative products in global markets with more modest progress in North America. The use of our Evotherm Asphalt Additive is extending the paving season in colder climates. And overall asphalt sale grew very strong in China, Brazil and Thailand.

We are also capturing additional market share for Pine chemicals in oil field exploration and adhesives markets. And while the automotive carbon business remains difficult in North America and still below prior year levels, there has been a recent increase in orders as manufacturers have resumed productions after pullbacks earlier this year. We also continue to see increased demand for automotive carbon products in China.

Real estate market conditions for the community development and land management segment were similar to the second quarter with interest and activity for smaller land tracts and industrial sites. We closed 16 small world real estate transactions with a strong average price per acre of more than $2600. We also closed our larger force land sale of 9600 acres in South Carolina during the quarter for $1900 per acre.

Total proceeds from land sales were nearly $23 million in the quarter. And was the primary contributor to segment earnings of $20 million. During the third quarter, we also announced the first industrial tenant at our new distribution center that is part of our joint venture with the Rockefeller Group. TBC Corporation, a producer of replacement tires will expand and locate its East Coast distribution center at this facility near the Port in Charleston, in South Carolina.

The CDLM team continues to work with other prospects for the remaining available space at the site. As the interest in industrial properties is picking up far faster than activity in the commercial real estates sector.

Now I would like to turn the call over to Mark to discuss some of our financial metrics for the third quarter, Mark?

Mark Rajkowski

Thanks Jim. During the third quarter we improved almost every measure of our financial performance by successfully executing our transformation strategies across our businesses. We generated higher profits, expanded our margins and improved cash flow and what remains a difficult demand environment.

This progress has further strengthened our financial position, which continues to be a stabilizing force and competitive advantage. Let me highlight the actions we’ve taken during the third quarter to extend the gains we made through the first half of the year and further improve our business model, which will provide us with even greater operating leverage when the economy recovers.

We are ahead of schedule, executing on the overhead cost reduction in capacity rationalization actions associated with the strategic cost management program we announced at the beginning of this year. This has been a very determined and comprehensive effort across our business to reduce overhead costs and eliminate unnecessary and unprofitable operating capacity.

As promised the benefits from this program have increased from quarter-to-quarter and through the first nine months of 2009, total savings were $90 million. Through the third quarter, we’ve eliminated 1,830 positions and have completed or announced the closure or restructuring of 16 facilities, two more than we originally identified at the beginning of the year. Given the excellent progress to date, we now expect to achieve a $140 million of savings in 2009.

These permanent changes to our organization and manufacturing footprint have helped us significantly improve our business model and the impact is reflected in our increased operating margins. Gross margin as adjusted increased by almost 400 basis points during the third quarter to 21.6%. Our margins benefited from the cost reductions as well as strong productivity performance and input cost deflation. These improvements were more than enough to overcome the impact of under absorbed fixed manufacturing cost due to market related downtime.

Continuing a strong trend, third quarter SG&A of $192 million as adjusted to exclude restructuring charges and one-time items decreased by $18 million or about 9% compared to last year. Executing on our transformation strategies has had a meaningful impact on our cash flows as well as our profitability. Excluding the alternative fuel tax credits and other items, we generated $108 million of free cash flow during the quarter. As a reminder we defined free cash flow as cash after CapEx and dividends. Through September 30th of this year, we’ve generated a $112 million of free cash flow, which represents a $206 million improvement compared to the first three quarters of 2008.

In this difficult and unpredictable economic environment, our top financial priorities remain cash generation and liquidity. And during the third quarter, we continue to strengthen our position. We ended the quarter with $765 million in cash and short-term investments, an increase of a 142 million from the end of the second quarter. We also took advantage of favorable market conditions to improve our liquidity profile by completing a 10 year, $250 million bond offering. We use the proceeds along with about $90 million of cash on hand to reduce the outstanding balance of our 2012, 6.85% notes.

The work we’ve completed through the third quarter, and the priorities we continue to manage had a very positive impact on MWV’s financial performance and overall strength. We remained well positioned for what we expect to be a continued difficult environment. To that end, let me provide you with an outlook for our business in the fourth quarter.

Despite some signs of stability, visibility remains very poor and our customers continue to be cautious about forward-looking demand. Our businesses will experience typical seasonality with lower volumes in the fourth quarter compared to the third quarter. And we expect similar year-over-year volume trends compared to what we saw in the third quarter of this year.

We expect our results in the fourth quarter to benefit from additional cost savings, which will be larger than our third quarter savings. And input cost deflation, which should be at rate similar to what we experienced in the third quarter. These positive factors will be partially offset by modestly unfavorable year-over-year pricing in some markets as we compare to higher prices achieved in the fourth quarter of last year and by lower fixed manufacturing cost absorption as we continue to aggressively manage production to meet demand.

In summary, during the fourth quarter we will continue to execute to build on momentum we’ve established with our transformation strategies. This continued progress will ensure that we preserve our financial strength and further enhance our ability to compete in attractive global markets. With that I’ll turn it back to John.

John A. Luke, Jr.

Mark thanks. In summary, we had another solid quarter in a very difficult environment. The product of our deliberate transformation strategies to make MWV strong and more competitive. Our progress had a measurable impact on our financial performance. We started this work before the recession began and it helped us weather the present storm. These efforts will continue well beyond inevitable end of the current downturn.

Central to this work will be continuing to make choices about marketplace participation all with the goal of delivering value for our customers and our shareholders.

That concludes our prepared remarks this morning, we’ll now be happy to address any questions that you have.

Question-and-Answer Session

Operator

Thank you ladies and gentlemen. (Operator Instructions) And the first question we go to the line of Claudia Hueston from JPMorgan. Please go ahead.

Claudia Hueston – JPMorgan

Thanks very much, good morning and congratulations on the quarter.

John A. Luke, Jr.

Thank you.

Claudia Hueston – JPMorgan

I was hoping if you could provide just a little bit more detail on what drove the margin improvement in the consumer solutions business. And then Jim you are commented on how you expect the improvement to continue, what’s going to drive further improvement and how should we think about the pace of that going forward. Thanks.

John A. Luke, Jr.

Jim you want to take that up

James A. Buzzard

Sure. Claudia, we really have had that we said there is disciplined cost approach and margins were driven by stolid progressional areas so our fixed costs and SG&A was down in the business we saw some benefits from our sourcing and supply chain activities. We’ve made some moves to reduce capacity and closed some facilities, and we’ve got a rigorous operating excellence program, which brings forward the some of the basic tenets of Lean and Six Sigma in each of these facilities. So all those are contributing to the strong performance and margin growth. Clearly, we will continue to focus in each of those areas, we will see less gain from some of them, so the capacity closures are largely behind this. We will get the benefits of those in 2010 for the full year. And the operating excellence program is a discipline that we will continue to drive and that will continue to produce results as we go forward.

John A. Luke, Jr.

Yeah and I would only emphasize just to punctuate what Jim has said because I think he has articulated it well that as our prepared remarks commented whereas in other places we’ve made some very disciplined market participation choices and we have either improved the profile of business that we could in certain areas that was less than satisfactory or we have eliminated those sales all together. So it’s been a combination of those factors. Mark you want to add.

Mark Rajkowski

I think you guys said it well. Through the third quarter we either closed or significantly restructured 10 facilities and that’s a significant amount of capacity either excess or unprofitable capacity that we have taken out of system. So that is a big part.

Claudia Hueston – JPMorgan

So if you think about margins and where they could go in that business over sort of a medium term, is there some sort of target that you have in mind or someplace you’d like to be in terms of returns in that business?

Mark Rajkowski

I think what we have demonstrated is our ability in a sustainable way to improve the margin structure. As John said and I think this is essential to understanding what we are looking to do with our business models. We are making choices in terms of where we want to participate and where we do end up participating and where we will allocate capital in the future, will be in end markets that are profitable and are growing. So we’ll continue to be disciplined on the cost side that business year-over-year through the third quarter is taken out almost 20% of it, it’s SG&A and that’s significant. So with that and the continued OpEx improvements that Jim alluded to with the right market participation choices, we see a substantial upside in terms of improving the margins in that business.

Claudia Hueston – JPMorgan

Okay. And then just to that end, where do you think you are in terms of profits that sort of going through your businesses and making these deliberate choices about the portfolio. Are the businesses that still don’t fit or are there any competencies that you’d like to have that you don’t have right now?

John A. Luke, Jr.

I will ask the others to supplement what I say Claudia, but I think that we’ve made tremendous progress over the past 12 months in making decisions that have both shaped our market participation as we have said and helped us determine where it is we can participate profitability and where we want to grow and emphasize. This is a discipline that is not a one time effort, it is a discipline that we are building into our D&A as if we’re not that we haven’t always looked at these but we’ve got new disciplines and rigors that we are employing now. So this is an ongoing effort and I think frankly how certain businesses markets perform and the opportunities they represent is really pressure test and against where there is clearly an exceptionally difficult external environment will tell us a lot and help shape further decisions as we go forward.

Claudia Hueston – JPMorgan

Thank you.

John A. Luke, Jr.

Thank you Claudia.

Operator

And we go to the line of George Staphos from Bank of America. Please go ahead.

George Staphos – Bank of America

Hi, everyone, good morning. Just wanted to continue with the consumer solutions theme. I think I heard you say that the healthcare packaging profit was up and that beverage was even or slightly up, to correct those or verify those and what were the trends for the other division that you will within consumer solutions from a profit standpoint. And as a related question is you’ve done from your discussion a very good job of cutting the SG&A within the segments to improve profitability, are all divisions also showing increases in year-on-year gross profit, which would validate if you will your market choice discussion earlier John and then I had a couple follow-ons?

James Buzzard

Sure, George this is Jim. Healthcare profits were - actually profits in all the consumer segments were up including beverage. I think the reference I made on beverage was more of a revenue statement, but profitability was up nicely in that businesses as well. In terms of going forward, as we said we will continue to see improvements in all of those business, our gross margins were up across the board. So I think to your question of market participation, we are seeing not only the benefits of those decisions but also as we continue to drive the productivity initiatives as well.

George L. Staphos – Bank of America

Okay. Two quick follow-ons, beverage promotional activity depending on what month and what week we were hearing different things about the business, sometimes better sometimes worse. What’s your sense on your customer’s willingness to prompt more aggressively, specifically within the North American soft drink business? And then how much of your 2010th plan currently rests within consumer solution in total on your customers’ willingness to launch new products?

James A. Buzzard

Sure George, in terms of beverage promotions, my sense has been that there has been less promotion. I think there has been a clear choice in the multi-pack business to go for price and margin by our customers at the expense of volume, and we felt that through the third quarter. To your second question in terms of our 2010 plans, we are not planning on significant launches by our customers. We certainly would be there to support them if those come, but our plans are built on what we expect to be a continued difficult environment going forward.

John A. Luke Jr.

Yeah, I would just add to that George. I think Jim, has characterized our planning exactly right having said that and as I commented innovation appropriately invested is something that we have sustained and it’s proving to be an important competitive advantage, because while our customers with respect to their, their outlook and understandably. So I think to a customer we’ve all found that there is great value of being placed on their own innovation activities recognizing that margin expansion is only going to come by bringing new things to their consumers that differentiate themselves and meet needs that others are not.

George L. Staphos – Bank of America

All right. Thanks. Quick one. I’ll turn it over. Why am I not seeing a bigger drop in corporate expense looking at slide 16 given all the discussion on cost reduction and overhead reduction? Thanks guys. Good luck in the quarter.

James A. Buzzard

Thank you George.

John A. Luke Jr.

Yeah George. It’s primarily related to accruals year-over-year in terms of incentive comp, we as performance decline last year, we started taking the incentive accruals down so we had credits and this year we have some provisions. So year-over-year and even quarter sequential, there is distorting that trend line.

George L. Staphos – Bank of America

Thanks very much.

John A. Luke Jr.

Okay.

Operator

Thank you. We’ll go to the line of Mark Weintraub with Buckingham Research. Please go ahead.

Mark Weintraub – Buckingham Research

Thank you. First, what are you seeing in your media business? Obviously it’s good to see that improvement consumer solution. Are you seeing that in the media business or is there still a lot of work that needs to be done there?

James A. Buzzard

Mark, this is Jim. I think in the media business we are continuing to see volumes decline as DVD sales and music sales have fallen off and we certainly are impacted by that trend, as I mentioned I think we are gaining in share in that business as we have aligned ourselves with several of the strongest studios. But I think the real story there has been a lot around the cost we were talking about and I think we have, in all the areas that I referenced in my comments we’ve done the same work in media and we will continue to focus on those same areas of that business going forward.

Mark Weintraub – Buckingham Research

Is that basically a situation where you are going to be seeking to minimize any degradation or is it an area where you actually think you can turn it around and how that become a meaningful profit contributor again?

James A. Buzzard

Mark I think the markets will obviously play a large role and help us define that and we’re still assessing exactly where those markets are going, but we will continue to do the same things we have been doing. So we’ll focus on our cost, we’ll focus on innovation, it’s still at market that does appreciate innovation and new products. So we are investing in that and being there for our customers.

Mark Weintraub – Buckingham Research

Okay thanks. And I apologize if you already went over this, but did you give us any sense on your cap spending plans for next year of mark.

John A. Luke Jr.

We’re still in the middle of our planning cycle and a lot of that will be a function of what we see coming out us in terms of the economic climate.

Mark Weintraub – Buckingham Research

Okay. And then lastly, can you update us where your pension plan is standing now?

John A. Luke Jr.

We are roughly a 130% overfunded as of the end of September.

Mark Weintraub – Buckingham Research

Thank you.

James A. Buzzard

Thanks Mark.

Operator

Thank you. We’ll go to line of Gail Glazerman with UBS. Please go ahead.

Gail Glazerman – UBS

Hi, good morning. Well I heard the comments about year-over-year deflation and I was wondering if you could give some insights into how you see some of your key cost items moving sequentially into the fourth quarter and perhaps 2010?

James A. Buzzard

Sure, Gail. I think what we are going to begin to see in the fourth quarter is clearly oil prices have moved up, we’re beginning to see some cost increases on outbound freight, certainly ocean being a big example. We’re beginning to see with diesel cost up some impact in our wood cost as well. In other areas we are not yet seeing it broadly. I guess the one exception there would be our resin costs so sequentially we’ve seen some increase in resin and our plastics business, but right now things seem to be flat on the basis of what we are looking at.

Gail Glazerman – UBS

Okay and just if you could make some further some comments on the balance sheet? I don’t know Mark, if you want to handle this or John, but just remind us of any sort of debt goals that you might have and what priorities you might use for cash once you have reached that goal in terms of that?

John A. Luke Jr.

Yeah, let me just offer a couple of thoughts at the outset, Gail and make can follow on. I think that we made good progress in addressing some capital structure requirements as we move through 2000 or as we moved through 2009 and Mark alluded to in his comments and he can elaborate on they are part of an overall debt management efforts that we have underway. I think overall use of cash and management, I think one of the things that you would not be surprised of is the fact that given the continuing very limited visibility they relatively soft markets, its this going to be important for us to work to keep our powder very dry.

James A. Buzzard

Yeah and what I add to that Gail is that in the third quarter, we did use some cash to take down debt. We have certainly been working towards a leverage that’s closer to 40% and we'll - as John said we want to keep our powder dry but if there are opportunities to that are attractive economically to de-lever than we'll look to do that.

Gail Glazerman – UBS

Okay, thank you. And just one last question on the consumer and office business, can you give a little bit more color the strengths and the momentum that you had in the third quarter or something you can continue in the fourth quarter? Is it some volume or strength that might have borrowed from the fourth quarter seasonally or any share gains sustainable?

James A. Buzzard

Gail, as I referenced in my comments we had a good back-to-school season, which ended in September and now we are moving into the calendar and the planning season those businesses historically are driven by white-collar employment and office formation, both of which are obviously much weaker year-on-year. So our sense is going to be that we’ll continue to have pressure on the top line in Q4 in that business and clearly, we don’t see the benefit of anything improving the envelope business at this point of time. So top line growth will be difficult and but we’ll continue to focus on all the other areas that I reference from the cost standpoint and think we can continue to improve our margins.

Gail Glazerman – UBS

Okay. Thank you.

Operator

Thank you. We’ll go to line of Mark Connelly with Sterne Agee. Please go ahead.

Mark Connelly – Sterne Agee

Thank you. Two questions, first in specialty chemicals you referenced the benefits to stimulus activity overseas. I wonder as you look forward for that business, do you think that we’re going to see significant FX sensitivity there? Obviously the stimulus has helped a lot, but I would imagine that the weak dollar is helping too and I am just curious how you are thinking as you look forward in that business about currency sensitivity. And then second question just on the Brazil acquisition I assume this is relatively small dollar amount. John, should we expect to see more of these small tuck-in acquisitions over the next six months or more opportunistically?

John A. Luke Jr.

Mark, let me answer that before turning to Mark on the – Mark and Jim on the other question. I think as Mark in a way suggested, I think we will look where there are opportunities, particularly that this economy provides for us to support our strategies against the business model discipline we’re employing to make attractive small tuck-in acquisitions whether it’s in a place like Brazil or elsewhere that will occur I think will be measured in that activity but while we don’t have any meaningful plans before as right now they will come along. And, so I think you can expect to see them and not be surprised into your point, small, Mark?

Mark Rajkowski

As far as the impact of the currency on our specialty chemicals business, you know that certainly a weaker dollar doesn’t hurt in terms of obviously pricing and non-U.S. locations however those products that we sell from our specialty chemicals business are really sold based upon value, and so it’s not as much a currency game as it is a winning value proposition. So the impact, at least so far has been negligible.

John A. Luke Jr.

Anything else Mark.

Mark Connelly – Sterne Agee

No, that’s good. Thank you.

John A. Luke Jr.

Thank you.

Operator

And we’ll go to line of Peter Ruschmeier from Barclays Capital. Please go ahead.

Peter Ruschmeier – Barclays Capital

Thanks, and congratulations on a very strong quarter. I want to ask a couple of questions. Just as a follow-up to Gail’s question on cost, you mentioned that you had lower wood, freight and resin cost, but those are gone back up, but yet they are flattish. Does that mean they had been going down and now they are back up, net-net they are back to where they started from?

James A. Buzzard

No, Pete let me clarify that, the cost were down year-on-year. What I referenced was what we’re beginning to see was the run-up in oil prices and diesel cost. Some freight impact primarily on inbound wood and our outbound freight and of course resin cost have begun to climb, but there is still below where they were a year ago.

Peter Ruschmeier - Barclays Capital

And if I add up the various slides in terms of deflation, I guess it’s deflation and productivity by segment it looks like $83 million year-on-year benefit; I’m curious to the extent you can help us to understand a sequential basis what that looked like and should we expect that to unwind a little bit as early in the fourth quarter?

Mark Rajkowski

Yeah, Pete, as we look at the fourth quarter as Jim said, while we are starting to see a little bit of flattening in terms of some of the input cost and couple of instances some increases, year-over-year in the fourth quarter we will see similar rates of decline that we saw in the third quarter, okay? So while sequentially things are flattening to maybe up in a couple of those categories year-over-year we are still going to see substantial inflation and on the productivity side, this has been something that Jim and the team have been driving hard. I think the results speak for themselves through the first nine months and we fully expect to see similar levels of OpEx productivity in Q4 and beyond.

Peter Ruschmeier - Barclays Capital

Okay. That’s very helpful. And Jim I was hoping you could provide an update on what do you seeing in the packaging machinery business, how is it operating, what’s your outlook for that business going forward?

James A. Buzzard

As you know those, that business is tied to our beverage business primarily, and we’re continuing to invest in placements of new machines for our customers around the globe. And as I referenced to our growth in some of the emerging markets is where we are seeing real opportunity to take this whole solution and enter the emerging markets and help our customer dramatically grow there. So continuing a pace with where it’s been, and we expect to continue that way in 2010.

Peter Ruschmeier - Barclays Capital

Okay. And maybe just lastly on your strategic cost management program, I am curious if you could help us to understand, of the 16 facilities you rationalized, presumably some of that business that you didn't want and some of the business perhaps you transferred other facilities. How much revenue leakage is there obviously it’s a good P&L choice but how much of the revenue do you keep versus how much the revenues do you just take a pass on?

Mark Rajkowski

You know I think it certainly going to vary by business but as we look at the capacity that we have taken out relative to choices we have made in terms of products and certain customers, the impact is in the low to mid single-digits so it’s certainly is having an impact but it’s in that range.

Peter Ruschmeier - Barclays Capital

Very helpful. Thanks very much.

John A. Luke, Jr

Thank you. Pete

Operator

Thank you. We will go to line of Chip Dillon from Credit Suisse. Please go ahead.

Chip Dillon – Credit Suisse

Hi, good morning.

John A. Luke, Jr

Good morning, Chip.

Chip Dillon – Credit Suisse

First question is on, just if you could just review, this is more for Mark but on the black liquor credits it looks like you are making a full – statutory accrual for those. My guess would be that you haven’t paid any cash taxes against that just looking at the deferred tax line going up on the balance sheet, but what do you think the ultimate taxability in cash terms would be of that and again could you just verify that you really haven’t being paying cash taxes based on that credit.

Mark Rajkowski

In terms of the accounting, we book it as we earn it so while most of that credit has been reflected in the form of cash receipts we do have somewhere where we have made accruals at the end of the third quarter. In terms of taxes, that’s really a function of our overall tax position in U.S. and we are beginning to pay some taxes as we found ourselves in a taxable position in the U.S. now through improved operations as well as some benefit from those credits.

Chip Dillon – Credit Suisse

Got you. And when you look at the tremendous improvement for example in resources – 25 million sequentially I know the reais had jumped up about 20%, 25% I know it’s up from January. Would you say maybe a third of that improvement sequentially could have been just the appreciation in reais or would that be too strong?

Mark Rajkowski

I think that’s too strong. But there is certainly been some benefit, I think when you look at it on average, year-over-year as you look across the entire quarter I think for us as we look at that it’s probably around 10% or so.

Chip Dillon – Credit Suisse

Got you. And then the last question is on the bleached board side, it looks like you are running about 19% less production than last year and I know you just took machine down at Evandale. Could you talk little bit about why demand may be that much slower and it is lot of tied to your decisions to get out of some of the lower-end let’s say cub stock areas?

James A. Buzzard

Chip, this is Jim. A whole host of reasons obviously the economy both in terms of reduced consumption as well our customers destocking and taking inventories out has had an impact. I think we are seeing material substitution so in some cases CNK grades replacing SBS. To your point there clearly is some market participation, decisions we have made around the closure of E-2. So I think those three things are impacting our volumes, but I would say in the markets that we've elected to participate in, we are certainly holding our position very well.

Chip Dillon – Credit Suisse

Gotcha. Thank you very much.

John A. Luke, Jr.

Thank you Chip.

Operator

We'll go to the line of Richard Skidmore from Goldman Sachs. Please go-ahead.

Richard Skidmore – Goldman Sachs

Good morning guys. And just really two quick questions. First is we look at 5/13 the net operating productivity of $28 million year-over-year would that be more like $50 million as you expect if you looked at the fourth quarter? I guess what I'm getting at is that you talked about a $140 million of productivity and your original target I think was 120.

Mark Rajkowski

Rick on that, we have got to make sure we're not mixing apples and oranges. What that $140 relates to specifically is the overhead cost reductions and the benefits from rationalizing our manufacturing capacity. So if you looked at slide 13, you see overhead and capacity actions of $44 million. So that’s what that relates to and as we get into the fourth quarter, we expect that to continue to build.

Richard Skidmore – Goldman Sachs

Okay, it’s something closer to $65 or something as you go into the next quarter?

Mark Rajkowski

Well I kind of helped you do the math because $90 million through Q3 and we expect to be at around $140 through the full year.

Richard Skidmore – Goldman Sachs

Okay and then just a follow-up to that would be as you look at on the productivity gains that you have made and the deflation that you have seen in the business. What have you been doing with your sales people to ensure that pricing is not given back and you away some of this margin improvement that you have been seeing?

John A. Luke, Jr.

Yeah Rick, John. Let me just pick that up. I think across the board with the strategies we've been shaping, the business model discipline we have put in place, in those areas where we have consciously chosen to maintain or increase our participation. Strategies to participate wherever possible with a very disciplined focus on being rewarded for the value that we bring, ensuring that margins are maintained or expanded in the phase of cost pressures has been in every single one of our businesses an absolute priority. It’s awfully easy to fall into the trap of looking at an economy like this and wanting to reduce prices. We have seen that in years going by and clearly in more commoditized businesses the market forces can drive that. I think our discipline and the appeal to us of more attractive markets lets us target those areas where those pressures have minimized and the discipline with which we work with our sales leadership to ensure that, that is maintained is something we address almost on a daily basis.

Richard Skidmore – Goldman Sachs

Operator

Thank you, and at this time there are no questions in questions in queue.

Jason Thompson

Thanks everyone for joining us. We look forward to speaking with you guys next quarter. Stacy, if you could please give the replay information now. Thank you.

Operator

Thank you. Ladies and gentlemen this conference will be available for replay after 11 O'Clock am today, running through November 28 till midnight. You may access the AT&T replay system at anytime by dialing 1320-365-3844, toll free 1800-475-6701 and enter the access code of 117350. Those numbers again 1320-365-3844 or 1800-475-6701 access code of 117350.

That does conclude your conference for today. Thank you for your participation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: MeadWestvaco Corp. Q3 2009 Earnings Call Transcript
This Transcript
All Transcripts