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Buckeye Technologies, Inc. (NYSE:BKI)

F1Q2011 (Qtr End 09/30/10) Earnings Conference Call

October 28, 2010 9 AM ET

Executives

Daryn Abercrombie – IR Manager

John Crowe – Chairman and CEO

Steve Dean – SVP and CFO

Marko Rajamaa – SVP, Nonwovens

Doug Dowdell – SVP, Specialty Fibers

Kris Matula – President and COO

Analysts

Gail Glazerman – UBS

James Armstrong – Credit Suisse

Michael Keith – 12th Street Asset Management

Operator

Good day, and welcome to the Buckeye Technologies first quarter 2011 earnings results conference call. Today’s call is being recorded. Presently all parties participating in this call will listen to remarks made by the company. After the prepared remarks, Buckeye management will answer analyst questions.

At this time, for opening remarks and introductions, I would like to turn the call over to Mr. Daryn Abercrombie, Investor Relations Manager of Buckeye Technologies. Please go ahead.

Daryn Abercrombie

Good morning and welcome to Buckeye’s conference call commenting on our results for the July to September quarter 2010, our fiscal 2011 first 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; Doug Dowdell, Senior Vice President, Specialty Fibers; Marko Rajamaa, Senior Vice President Nonwovens; and Dennis Livingston, Corporate Tax Director. 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 cause 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 slides accompanying this presentation as well as the company’s most recent annual report on Form 10-K and quarterly report on Form 10-Q.

Now I’ll turn it over to John.

John Crowe

Buckeye’s first quarter results were significantly improved when compared to last year’s first quarter and the previous. While sales revenue was down slightly over the previous quarter, sales revenue was up over 14% compared to the July-September quarter last year. During the quarter we recovered from the June power outage at our Florida facility. We did experience additional losses in July due to the power outage in June. We have installed additional protective equipment and we believe that event is well behind us.

We reported yesterday that our first quarter net income was $64.4 million or $0.59 per share. Excluding income from cellulosic biofuels credit and restructuring charges, first quarter’s net income was $13.7 million or $0.34 per share. Excluding special items this quarter and in comparison quarters, our earnings per share compares to earnings per share of $0.26 in the previous quarter and $0.12 for the July-September quarter last year. First quarter sales revenue of $203 million shows a significant improvement on ours markets and product mix compared to $177 million for the same period last year.

In our fourth quarter earnings call, we indicated that we expected to have lower shipments in the first quarter due to the power outage we experienced in June, the seasonal shortage of cotton linters and the need to build an adequate inventory to protect our customers. Shipment volume was down 5% sequentially and year-over-year. However, nonwoven shipment volume was up 9% year-over-year.

With the help of our $67 million income tax refund, we reduced long-term debt during the quarter to $165 million.

Quarter one was a milestone quarter for Buckeye. On September 15, we paid our first ever dividend of $0.04 per share. Also September 1, we announced that we would call the remaining $140 million of our 8.5% 2013 bonds on October 1, which we did with cash and increased borrowing on our revolver. As of October 22, 2010, we have refinanced our remaining debt by establishing a new and larger revolver of $300 million with a five-year tenure and current rate of LIBOR plus 200 basis points. Steve will cover the terms of that new revolver in more detail during his comments.

In summary, we had a good quarter and with most of our markets performing at better than pre-recession conditions, we continue to have low finished goods inventory and our specialty fibers business continues to be sold out and we are not able to meet all the product demands of our customers. This was our best quarter in nearly three years and we are positive about our outlook that we have more to do and we will discuss the outlook going forward after Steve reviews the supplemental financial reconciliation charts. Steve?

Steve Dean

Thank you, John. Good morning. I would like to refer you to the earnings slides, which are posted on our website and on www.streetevents.com, which include more detailed reconciliations of our first quarter earnings versus prior periods. This morning I am going to focus my comments on comparing our results for the just completed July to September quarter, which is our fiscal first quarter to the April-June quarter, our fiscal fourth quarter. We have also included several slides with comparisons against the year-ago quarter in the appendix for your reference.

Starting with number 4, you will see a consolidated earnings summary comparing our earnings for the just completed first quarter to the fourth quarter. First quarter net sales of $202.1 million were up $3 million or 1.5% compared to the fourth quarter. Specialty fiber sales were down $5.9 million or 4.0%. Shipment volume for the segment was up 6% as we rebuilt inventories after the fourth quarter power outage at our Foley mill and limited cotton linter availability constrained shipments from our specialty cotton fibers plants, which only operated at about 30% of capacity during the quarter.

Mix also had a 3% negative impact on sales for this segment during the quarter mainly because higher priced specialty cotton fiber shipments were up 18% while our specialty wood fiber shipments were only up by about 4%.

Selling prices for specialty fibers were up about 5% on the average compared to the fourth quarter. Fluff pulp prices were up $71 per ton, specialty cotton fiber prices were up 7%, and specialty wood fiber prices were up 1% for the quarter.

Nonwoven sales were up $4.2 million or 6.6% on a 4% increase in shipment volume. Selling prices were up about 3% for that segment.

Moving down the chart, you can see that adjusted operating income, excluding the impact of restructuring expenses on our results was up by $5 million compared to the fourth quarter. Operating income was up $2.9 million for specialty fibers and was up $0.9 million for nonwovens. Insider the specialty fibers numbers, wood was up $6.3 million and cotton was down $3.4 million.

As we mentioned during our fourth quarter call, the June power outage at Foley negatively impacted fourth quarter operating income by $4.2 million. This also impacted the first quarter by $2.3 million mainly due to reduced shipment volume as we rebuilt inventories back to sustainable levels. The reduced impact of the power outage on the first quarter relative to the fourth quarter accounted for $1.9 million of the $2.9 million increase in specialty fiber’s operating income between the two quarters. The rest of the improvement for the segment was primarily due to higher selling prices for fluff pulp partially offset by the impact of lower volumes and reduced margins at our specialty cotton fibers facilities.

I should also mention that we completed the filing of all the backup for insurance claim related to the June power outage with our insurance carrier in October and are expecting a final settlement during the current quarter. The amount of the insurance claim was $6.5 million, less the $2 million deductible. The amount of the final settlement will be realized as income in the quarter that the final insurance settlement is reached.

Operating income for nonwovens improved by close to $1 million compared to the fourth quarter as production of shipment volumes were up and selling price increases kept pace with raw material cost increases over the course of the quarter.

You’ll notice that the corporate component of our adjusted operating income was up $1.2 million compared to the fourth quarter. This is mainly due to heavy bonus accruals in the fourth quarter as a result of a strong finish to our fiscal year, which are down to more normal levels again in the first quarter of this year.

Below operating income before the impact of special items, our interest expense was lower compared to the fourth quarter with foreign exchange loss was higher and offset this benefit. Our effective tax rate for the quarter excluding special items was 33%, which was basically unchanged from Quarter four.

Moving further down the page, you can see that we had one very large special item impacting our net earnings for the quarter, which was $51 million benefit, recognized for a portion of the incremental gain from the cellulosic biofuels credit earned in 2009.

I’m sure that most of you have already had a lot about this topic, so I will try to cover this briefly on slides 5 and 6 now, but we have our Tax Director Dennis Livingston on the call with us today, and will be glad to answer any questions you might have during the Q&A session.

Slide number 5 includes the timeline showing the recent sequence of events related to this tax credit and slide 6 summarizes the potential benefits Buckeye could realize from this credit. The IRS approved Buckeye’s application to register as a cellulosic biofuel producer in August and we filed amended tax returns that same month to claim cellulosic biofuel credits on black liquor burned during the January 1 through February 1, 2009 period before we started mixing with diesel fuel and qualifying for the alternative fuel mix describe it.

The next after-tax benefit recorded in our first quarter financial statements related to this period is $21 million. The second piece of the credit available to us is the part that it can be realized by trading the $0.50 per gallon AFMC credits we received in 2009 for the $1.1 per gallon cellulosic biofuels credits. The total available incremental net benefit of trading 100% of our AFMC credits for cellulosic biofuel credits would be $56 million less interest.

We only recorded a $30 million partial benefit in the first quarter related to trading of the credits due to the uncertainty associated with forecasting future taxable earnings over the next six years and these are the complex tax rules governing the realization of these credits. We have until our fiscal year ended June 30, 2016 to realize these credits. We plan to revisit our projections annually and could potentially recognize more of the total potential benefit from this credit in future years.

From a cash flow perspective, we expect to receive a tax refund of about $8 million sometime in our second quarter based on our amended returns filed in August and expect to realize an additional $30 million to $40 million in cash over the rest of this fiscal year through reductions in our quarterly estimated tax payments.

Back to earnings from operations, on slide 7, we have a waterfall chart that explains the $5 million improvement in adjusted operating income between the fourth and first quarters. You can see that sales price improvement of $8 million outpaced the raw material cost increase of $5 million, which was due to higher prices for cotton linters and fluff pulp used as raw material by our nonwovens segment. The $3 million differential is pretty much all due to the $71 per ton increase in fluff pulp prices and our specialty fiber segment compared to the fourth quarter.

To the far right of the right, you have the positive $1.9 million from the lesser impact of the June power outage in Quarter one relative to Quarter four. The only other point I would note on this chart is that direct cost were down $4 million quarter-over-quarter partly due to fewer planned maintenance outages at our Florida mill in the first quarter.

On slide number 8, you can see at a more summary level the drivers behind the $0.08 improvement in adjusted earnings per share between the fourth and first quarters. The first $0.03 of the improvement is explained by the reduced impact of the June power outage on Q1 relative to Q4. Increased prices for fluff pulp is the largest driver behind the rest of the improvement.

Finally, moving ahead to slide number 9, as John mentioned, on October 22 last Friday, we refinanced the remaining outstanding debt drawn on our $200 million bank revolver by establishing a new five-year $300 million revolver. The transaction was led again this time by Bank of America as Left Lead Arranger and Administrative Agent along with JP Morgan and Regents Banks as Joint Lead Arrangers and RBS Citizens Bank as Syndication Agent.

The initial interest rate on the new revolver is LIBOR plus 200 basis points and this will drop to LIBOR plus 175 basis points, which is only 50 basis points higher than our old facility when our leverage gets below 1.0 from today’s level of 1.3.

We have two financial covenants, the consolidated leverage ratio and a consolidated fixed charge coverage ratio. The leverage ratio covenant, which starts at 3.5 times and steps down to 3.25 in year three is a little tighter than the 4.5 covenant we had under our old agreement but is well above our current projected leverage levels. We are very pleased to have this new credit facility in place, which moves our nearest debt maturity out from July 2012 to October 2015 and gives us the flexibility we need to allocated capital in a balanced way between funding high return investments and growth projects, continued debt reduction and returning cash to shareholders.

Now I will turn it back over to John.

Steve Dean

Thank you, Steve. As Steve has shared, we continue to make progress. The outlook for our markets remains solid and in many cases, we can’t meet all of our customers’ volume demand. Our cotton linters inventory has improved. The supply limitations will continue to impact capacity utilization at our two cotton fibers plants. At our Memphis cotton fibers facility, we expect to operate it approximately at 50% of total cotton fiber capacity there and increase capacity utilization as cotton market dynamics allow. We have positioned the plant to operate very efficiently and effective at this configuration.

Americana will operate to match linter availability with customer orders and we anticipate its utilization to be below 50%. We have established balance in our cotton fiber supply chain with longer term commitments from our customers and our suppliers of cotton linters. This is providing better control of cost and flow of products to our customers. Over 70% of our Memphis plant’s cotton fiber’s business is committed to agreements that allow us to commit to long procurement agreements for cotton linters. We expect the percentage of long-term committed agreements to go up.

Key to total company improvements and results are continued strong markets, excellence and operational reliability, the execution of high rate of return projects like our Florida energy project, a stable cotton lint supply and potential growth opportunities. During the remaining three quarters in fiscal 2011, we anticipate our sales revenue and our earnings will grow further due to higher average specialty fiber selling prices, stable cotton specialty volume and a favorable mix in our specialty fibers and nonwovens segments.

We should benefit from reduced interest expense and we expect additional cost benefits like our consolidation of production to one machine at our Delta, British Columbia, Canada, nonwovens facility. During this quarter we made the decision to consolidate all production to the newer of the two machines at that site, which will reduce annual cost by approximately $2.5 million to $3 million per year.

Our absorbent markets continue to experience good demand and our nonwovens markets continue to grow. While cotton linter price have climbed to record levels, most of our other input cost remained stable in both segments. In Steve’s comments, he outlined the cellulosic biofuel tax credit and how we are managing the credit benefit going forward.

On October 26, our Board of Directors approved a $0.04 per share dividend to be paid on December 15 to shareholders of record on November 15. Additionally, the Board of Directors has approved the purchase of 810,000 acres bordering our Florida facility. We expect to close on the property this quarter for a purchase price of approximately $6 million. This property has strategic value to our Florida mill for several reasons. The property is adjacent to our mill water production wells and close to our waste water treatment lagoons allowing for modernization, expansion and continuous improvement. Because the property has good drainage, it can provide flexibility for raw materials supply during wet weather and the land can be used for additional capacity to grow short rotation energy crops to support our bio-energy vision in the future. Including in this purchase, we anticipate our annual CapEx spending will be approximately $63 million this year.

Turning to free cash flow, while we expect to continue to generate strong cash flow, our forecast for debt at the end of this quarter is flat from where we were on September 30 at $163 million. The second quarter is traditionally a high demand quarter for cash due to the last 2013 bond interest expense payment, the annual funding of our employee retirement plan, annual payment of our Florida property taxes in the land purchase that I just discussed. Together these items add up to about $23 million in cash this quarter. We expect to have higher CapEx spending this quarter as we complete Phase I of our energy project.

In closing, we are positive about our outlook and we should continue EBITDA and earnings growth in the next several quarters. We are on schedule to start up the new 20 megawatt steam turbine in November which is a key step in our energy project. This will provide new flexibility to our operation and we should start to benefit from a reduction in purchase power. The savings will start small and we anticipate beginning to receive the full annual savings approximately $15 million at the completion of the project in late calendar year 2011 and full annual savings beginning in calendar year 2012.

We anticipate an upside this quarter compared to the just completed quarter. Earnings per share this quarter from operation is expected to be above $0.40 per share. This doesn’t include any special items and doesn’t include the insurance claim for the power outage. We anticipate positive improvements and results over the next several quarters. We are completing our calendar year 2011 specialty wood contract commitments this quarter and we will benefit from higher prices beginning January 1 reflecting the strong market conditions.

Finally, we are committed to a balanced approach to return cash and value to our shareholders and Buckeye is well positioned to do that.

This completes our prepared remarks and we will turn the call over to the operator and let her queue up the question-and-answer session.

Question-and-Answer Session

Operator

First we will go to Gail Glazerman with UBS.

Gail Glazerman – UBS

Commentary about improving cotton output through the balance of year, how confident are you that you’ll be able to see a material improvement in utilization? And when would you know, like when would you have enough confidence in the supply of long-term since you know you would be able to do that?

John Crowe

Okay, Gail, let me ask Doug Dowdell to answer that one for us.

Doug Dowdell

What we have done is work with our customers and our lint suppliers to align the supply with our customer demand and we have made commitments both with the lint suppliers and our customers. So we have certainty of supply of raw materials and certainty of demand from our customers, and that’s really our model going forward. And as John mentioned, we have signed the contracts for more than 70% of our business from our customers. And with that certainty, we are able to go out and make these commitments with our lint suppliers and in turn they are making those commitments to us.

So we feel very good about that. Our production will be up significantly in Memphis this quarter over the past quarter and we would anticipate Americana remaining about where it is now.

Gail Glazerman – UBS

The restructuring activity at Delta, when do you expect to see that flow through? Is that something that’s kind of already at $2.5 million to $3 million run rate or when should we start looking for that to hit?

John Crowe

Marko?

Marko Rajamaa

We would expect that the savings from the Delta optimization will start ticking in early next year and the full impact of that change will then take effect during our fiscal year 2012.

Gail Glazerman – UBS

Should we be reading if you are idling a line there that you are less optimistic about being able to fill some of that demand? I mean how quickly would you be able to reverse that if you started picking up some new nonwovens business?

Marko Rajamaa

We are fairly optimistic about our future prospects. If I look at our volume, we have been growing quarter-over-quarter and really the driver for this change was our analysis of our credits and customers and we identified an opportunity to consolidate the production on our newer line in Delta. And the shutdown is a temporary one, at least at this time and we are looking at future growth opportunities. This is a savings opportunity, we have to just take on.

Gail Glazerman – UBS

Can you guys talk a little bit about what you’re seeing in terms of the cost environment outside of cotton and should we be looking for any price adjustments due to cost in the wood specialty contracts in the current quarter?

John Crowe

Doug?

Doug Dowdell

Basically, our cost remained relatively flat. So we expect very little increase cost, it goes up just slightly. But we are renegotiating our contracts in specialty wood for beginning calendar year 2011. And we expect a significant increase there that’s a combination of the strength of the market and our anticipation of any cost increases. Additionally, we will have quarterly cost pass-throughs on our specialty business throughout the year just as we did this year.

Gail Glazerman – UBS

Can you talk about in the airlaid business where you stand in terms of passing through fluff pulp cost? And I guess fluff pulp is probably starting to stabilize, are you catching up?

Marko Rajamaa

Prices have been one of our priorities in the past several quarters and it continues to be so. The fluff prices are at the historically high levels and we don’t see any easing in the near horizon. It continues to be a big issue for us in the airlaid, the margins are under pressure and we continue to work very closely with our customers in the coming months to pass on further of those cost increases. So that’s really the focus.

Operator

Now we will go to Chip Dillon with Credit Suisse.

James Armstrong – Credit Suisse

Good morning, this is James for Chip. Quick question on cotton. With the run-up in cotton prices, does this impact your ability to get cotton linters?

Doug Dowdell

What it does do with the cotton market improving, what you would likely see and we saw this year is increased cotton crop, more cotton being planted, especially here in North America. However, the lint supply is quite a bit different from the staple cotton market. And the lint supply is driven by the oil crushing business and it’s pretty much maxed out now, it’s running at 90% to 95% of capacity and we expect the lint supply to be at about this level and stable. So it certainly doesn’t hurt as people plant more cotton, it makes more cotton seed and lint available. So it’s a good thing.

Kris Matula

This is Kris, let me add. We do because of kind of increased plantings of cotton this year, the linter production is going to be up this year versus last year. So it’s going to be a better year from that standpoint.

James Armstrong – Credit Suisse

On the airlaid segment, it came in quite a bit better than we were expecting and mostly driven by higher volumes. Is this volume level sustainable? Are you getting a major customer back? Can you help describe what’s going on in that market?

Marko Rajamaa

We are optimistic about our volume growth. Now this quarter we are on October, November, December is typically a slower quarter for us. So we are expecting little bit lower shipment levels. But then beyond that, again we expect back to these levels, we were during the first quarter or beyond that even. And we are working with a number of our customers on some future projects and I am sure we will be talking about those in the coming conference calls.

John Crowe

Let me just add that when Marko says this volume will be – this is seasonal and a slower period that we do expect year-over-year to be much better.

Marko Rajamaa

That’s right.

James Armstrong – Credit Suisse

With the NBSK prices coming off just lightly, are you seeing any weakness in the fluff market or does that continue to be very strong?

John Crowe

It continues to be very strong and frankly, it continues to outpace our ability to supply our customers. We see that into 2011. So we feel very good about fluff.

Operator

(Operator Instructions) Now we will go to 12th Street Asset Management with Michael Keith.

Michael Keith – 12th Street Asset Management

Outside of linters, how should we think about the sky-high cotton prices? Do you think about the growth of viscose is a replacement for cotton and how that might affect the wood specialty pricing? Is this is a favorable environment for you, net-net or not?

Kris Matula

Certainly as you look at the textile market, which the viscose staple fiber market goes into and competes with cotton fibers as well as synthetic fibers with the cost of staple fibers being very high, that is a favorable dynamic for viscose staple fiber either in demand for volume or giving it ability to have further price increases. So high cotton prices should provide further support in the demand and pricing for viscose staple fiber products, which even though we are not really selling anything into that market, that does pull up all of our specialty markets. So in general, that’s very positive for us.

Michael Keith – 12th Street Asset Management

On transportation cost, are you seeing any relief there, do you still expect those to remain high for the next couple of quarters?

Kris Matula

I think they are going to be pretty flat right now, particularly the next quarter or two. Certainly it’s all about mix too in the quarter. So we have manage the – get to the adoption at the right time with the right product at the right time and make our shift. So we are always mindful that transportation is an issue but we see it flat quarter-over-quarter right now.

Operator

At this time we have no further questions in queue. I would now like to turn the call back over to Mr. Crowe for any additional or closing remarks.

John Crowe

Well, thank you for participating and listening to our conference call this morning. We look forward to sharing our results of our second quarter with you in late January. Have a good day.

Operator

This does conclude today’s conference. We do thank you all for joining us.

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