Rock-Tenn F4Q07 (Qtr End 9/30/07) Earnings Call Transcript

Nov. 8.07 | About: WestRock Company (WRK)

Rock-Tenn Co. (RKT) F4Q07 (Qtr End 9/30/07) Earnings Call November 8, 2007 9:00 PM ET

Executives

Steven Voorhees - CFO

James Rubright - Chairman, CEO

Analysts

Bill Hoffman - UBS

Taylor Hood – J.P. Morgan

Christopher Chun - Deutsche Bank

Operator

Good morning. My name is Rosy and I will be your conferenceoperator today. At this time I would like to welcome everyone to the Rock-TennFourth Quarter 2007 Earnings Call. (Operator Instructions). As a reminder,ladies and gentlemen this call is being recorded today, November 8, 2007. Thankyou.

Your speakers for today's call are Mr. Steven Voorhees,Chief Financial Officer and Mr. James Rubright, Chairman and Chief ExecutiveOfficer. Mr. Voorhees, you may begin your conference.

Steven Voorhees

Thank you. Good morning. Welcome to Rock-Tenn's conferencecall. During the course of the conference call we may make statements that arenot historical in nature and may involve forward-looking statements within themeaning of federal securities laws. For example, statements regarding ourplans, expectations, estimates, and beliefs related to future events areforward-looking statements, which involve a number of risks and uncertainties,many of which are beyond our control and that could cause actual results todiffer materially from those discussed.

Additional information regarding these risks anduncertainties is contained in the documents we filed with SEC. These documentsinclude the Company's Form 10-K filed for the year ended September 30, 2006 andthe 10-Qs filed for the quarters ended December 2006, March 2007, and June2007.

During the call, we will be referring to non-GAAP financialmeasures. Reconciliations of these non-GAAP measures to the most directlycomparable GAAP measures are contained in our press release, which is availableon Rock-Tenn's website at rocktenn.com.

Let me now turn to Rock-Tenn's results for the quarter.Rock-Tenn's fourth-quarter net sales were $605 million, up $35 million or 6.2%when compared to last year's fourth quarter. Segment income of $54.2 millionwas $3.7 million higher than we reported in the same quarter of last year.

Rock-Tenn reported fourth-quarter net income of $19.7million, $0.50 per share.

I'd like to call your attention to two items that areincluded in this quarter's result. The first item is restructuring cost of $2.4million, $0.4 per shares. This is primarily from the closure of the Stone Mountain folding carton plant announced in June ofthis year. The second item is the $1.7 million or $0.3 per share impact of thedowntime associated with planned increase in the capacity of our Battle Creek coatedrecycle board mill. This project increased Battle Creek's annual capacity by 11%. Thisamounts for 16,000 tons per year.

During the September quarter of last year, the companyrecorded $0.1 of expense in restructuring charges and $0.6 of income fromreview of our state tax provision. After adjusting for these items, we arereporting $0.57 on adjusted EPS of $0.5 improvement over the $0.52 adjusted EPSrecorded last year.

Realized prices for all paperboard and pulp grade increased$36 per ton over the last year's fourth quarter. On a sequential quarter basis,average prices for all paperboard and pulp grade increased $9.00 per ton.

Turning to energy cost. Energy cost were up about $1 millionin the quarter. This was primarily due to the expiration of the long-term steamcontract at our St. Paulmill.

Based on current market conditions, the average NYMEXclosing price for the December quarter will be about $0.50 higher than the$6.56 per mmbtu; NYMEX closing price in the December quarter of last year. Wedo not have any natural gas hedge positions on for the winter.

Rock-Tenn's cost of recycle fiber was $137 per ton in thequarter. This is up $36 per ton over the last year, and up $10 per ton from theJune quarter fiber cost of $127 per ton. As a result, our recycled fiber costswere $10 million higher than in the same quarter of last year.

Markets for recycled fiber continued to be higher than lastyear. The November index of OCC in Chicagois $110 per ton, as compared to the average index of $62 in the Decemberquarter of 2006.

[Paper] products were $1.9 million lower than last year.This continues to reflect the trend from previous quarters of our processimprovement programs regarding our transportation management.

The company bought back $2.1 million shares of Rock-Tennstock in the quarter, at an average price of $27.41 per share. We currentlyhave $38 million shares outstanding. This is approximately the same number aswe had outstanding one year ago. Our share repurchases have offset the newshares that we've issued from option exercises.

We generated $97 million of operating cash flow in thequarter. This allowed us to fund the share repurchases of $58.7 million,capital expenditures of $19.3 million, pay our dividend of $4 million and stillpay down $11 million in debt. Rock-Tenn's $97 million in operating cash flow inthe September quarter was $42 million more than in the same quarter of last year.Much of this improvement was from improved working capital management,particularly in the receivables and payables categories.

The Company's credit agreement debt-to-EBITDA ratio was 2.55times as of September 30, 2007. When we filed our 10-K for this fiscal year, wewill have achieved a credit agreement debt-to-EBITDA ratio below 3 points fortwo consecutive quarters. We will have a right to cause the release of the lienon our Senior Credit Facility.

Our capital expenditures for the quarter were $19.3 million.Our capital expenditure for the year was $78 million, which is well below ourannual depreciation and amortization of $104 million. For the fiscal year 2008,we expect capital expenditures to be in the range of $75 million.

Rock-Tenn's financial results for the year reflect recordresults for our business. Rock-Tenn's credit agreement-to-EBITDA is $286.5million, which is 12.4% of sales. Our segment income was $211 million, our netincome was $82 million, and our EPS $2.07 or $2.17 on an unadjusted basis.

We will now turn to our operating results and outlook, andJim will cover that. Jim?

James Rubright

Thank you, Steve. Our business has really performed well inthe fourth quarter. $0.57 in adjusted earnings is at the high end of what we expectedto achieve given the high fiber prices that we saw at the outset of the quarterand that is expected to continue through the quarter.

Our operating result for the segment level was very good,showing continued growth in the underlying profitability of our businesses. AsSteve mentioned, total segment earnings were up in the quarter $3.7 million to$54 million with each of our segments posting higher earnings on year-over-yearquarter basis.

The reduction in segment earnings from third quarter of 2007can really be explained by two events. The fist one is the outage at our BattleCreek Mill, which Steve has mentioned, and the second is higher recycled fiberpricing, which were $10 higher per tone in the fourth quarter than they were inthe third quarter. The results that we produced were really a function ofexcellent execution of our operating strategies.

I want to start with packaging. In folding cartons, we saw asmall improvement in return on sales, even though physical volumes were downslightly. So, we mentioned our strategies to continue to focus on visits thatwe can make money on in connection with the planned rationalization that we putin place, following the Gulf Statesacquisition that was part of our integration plan.

In addition, our cost reduction in productivity initiativeswere mostly evident in the packaging sector, where as I mentioned, wemaintained margins, even though board price increases substantially affected inputcosts.

The issue for cost reduction in our businesses, and what wesee from our competitor is really not how much cost reduction you can get, buthow much net cost reduction you can achieve, net cost reduction versus theunderlying inflation of your businesses. We view inflation not as commodityprice changes, fiber prices and energy prices. Those are commodity input coststhat are in cyclical and which will vary, but the underlying inflation, such aswages, healthcare cost, insurance and alike. We believe that the result of allour cost reduction and productivity initiatives outpaced underlying inflationduring the year by about $14 million, which we think is a significantachievement.

In last quarter's call, we said we expected to see continuedrecovery of paperboard price increases in the fourth quarter. We did achievehigher pricing in the quarter, which as Steve said, was about $9 per ton overall [grades].

The reason, I think, why we are at the high end of ourexpectation going into this quarter, is that we did very well in continuing torecover from price increases from our paperboard mills.

But in addition, the productivity of our mills wasexceptional in a period of strong demand. We again took no economic downturn inour bleached board, coated recycled board, corrugated medium and gypsum linermills. And our total tons produced in the quarter were very strong given theplanned capital outage at our Battle Creek Mill.

Demand for corrugated packaging and merchandizing displayscontinued to be very good during the quarter. And we also did well there,particularly in the corrugated business, passing through higher paper costs, aswe did as well in displays. Volumes at our corrugators and displaymanufacturing continued to grow, and of course in Alliance we had record sales of $85.5million.

As we noted in our press release, we are increasing thestated capacity of our paperboard mills, since we're continuing to producepaperboard at rates that exceed our previously stated capacity. We'reincreasing what we believe to be our stated capacity by 62,500 tons per year,which is a 4% increase.

The largest increase is at our Battle Creek Mill, wherein the Septemberproject we referred to was very successful, increasing capacity by at least the16,000 tons that we stated. Battle Creek manufactures a premium grade of coated recycledboard with what many of our customers tell us was the best recycled printingsurface in the industry.

Fortunately, it’s a big machine, it's just got bigger, andit has very low operating cost that just got lower.

There were a large number of other capital projects andother productive gains that account for the balance of the increase incapacity, all of which is in paperboard grade where we have been sold out forsome time.

As Steve mentioned, we brought back 2 million shares of ourcommon stock at $27.41 per share, which is somewhat above yesterday's closingprice. Put this in perspective, from our view, as we looked at the transaction,$27.41 per share is 13 times 2007 earnings. $27.41 is also only 6.5 times 2007cash flow from operations less CapEx. We saw that the investment on our ownequity is compelling. This raises the question of how we see businessconditions going forward. Demand for paperboard, packaging and displays allstarted out strong in our first quarter and mill backlogs from bleached andcoated recycled board remained strong. We also expect to recover more priceincreases in the next quarter and next year.

First, last quarter we had just begun recovering our Julyannouncement of $40 per ton on bleached paperboard. And as you know, we expectto produce about 330,000 tons of bleached board in 2008. We expect to continueto recover some coated recycled board price from our previous announcementslast year, under deferred price adjustment provisions in some of our larger contracts.

We also have just begun recovering in September the $40 perton increase on corrugated medium that was announced last summer. Our averagecorrugated medium pricing will increase in the December quarter.

Fourth quarter is typically our seasonally weaker salesquarter as in November and December demand for products reduces with outagesand downtime at our customers and our results in that quarter are reduced bythe annual outage of our bleached board mill. But we have completed thatoutage. It was completed in October, and it was very well executed although itwas a large outage and the startup went well. So, the financial impact of the outageshould be consistent with our expectations and consistent with last year'sexperience.

In our folding carton business, demand for our productsstarted out again very strong in the quarter, we were pleased to see, and weessentially have completed the folding carton integration and restructuringthat we undertook following the Gulf States acquisition. So, we do not expect toincur any significant or material restructuring costs in fiscal 2008 from the foldplant closures that we -- affected as a result of the Gulf State'stransaction.

Recycle fiber pricing continues to be relatively high on a historicalbasis, but the most recent market movement was down and therefore in our favor.Currently we are seeing some contraction in transaction spreads of publishedindex prices. So, we expect to see some further moderation in fiber cost nextmonth in November and through the quarter on seasonally stronger generation andcurrent global sourcing trends.

Last, in summary, if demand for our products does not morethan continue at current levels, we believe we are well positioned to post anotheryear of sales and earning growth and strong cash flow.

That concludes the prepared remarks that Steve and I had,and we are now -- would welcome questions.

Question-and-AnswerSession

Operator

Thank you. (Operator Instructions). Our first question comesfrom Mark Connelly of Credit Suisse.

Mark Connelly -Credit Suisse

(inaudible).

Operator

Excuse me sir, we can barely hear you.

Steven Voorhees

Operator we cannot hear the question.

Operator

Our next question comes from Mr. Bill Hoffman of UBS.

Bill Hoffman - UBS

Yes, good morning. Just a couple of questions just on sortof business conditions, you mentioned some of the pricing pass-through here,that you are seeing in the fiscal fourth quarter. Does it feel like businessconditions are tight enough where you can gather further price momentum goinginto 2008? Obviously given the seasonality, it makes it a little more difficultto know that, but we're just trying to get a sense on how tight marketconditions feel in the CRB business?

Steven Voorhees

Right Bill, I cannot comment on the prospect for furtherprice increases for legal reasons, and so I will not do so. But the conditionsin our paperboard mills, with the exception of the uncoated mills, which as youknow, the small exposure that we have are very strong. Our CRB mill backlogs byhistorical standards continue to be very strong, and bleach board have actuallyincreased over the last, I'd say 6 to 8 weeks. So, the underlying demand forpaperboard and the apparent supply-demand balance in North America for the grades that we manufacture appears to be verystrong.

Bill Hoffman - UBS

Thanks. And just with regards to the URB side of theequation, it's obviously a small piece, and you are seeing some softness there.Strategically what are you doing with regards to that market, are youstraddling that capacity or production at this point?

James Rubright

No, about half of our capacity in uncoated recycled boardgoes to our own converting operations and businesses that arestable-to-improving. The largest single exposure that we have in uncoatedrecycled board is into our interior packing joint venture with Sonoco.

Bill Hoffman - UBS

Right.

James Rubright

The area that the end market for that product is the largestend markets or beverage markets for wine and beer, and those markets arehealthy and we continue to grow share in those markets. We also have adedicated mill that is a -- essentially it’s a small mill, it’s a book covermill, which has continued. The markets continue to be fine and our laminatedpaperboard business continues to be okay.

So the weaknesses in that portion of our business thatserves the independent tube and core manufacturers and our operating rates arein the 89%, 90% overall in those mills. So, we are not ready to position ourcapacity rationalization, for us would not make any sense. All of our mills areprofitable and they have cash flowing to us. But I think people are aware thattube and core markets for example, because there are some fairly large publiccompanies where that exposure is material, are probably the weaker sector thatwe have exposure to.

Bill Hoffman - UBS

All right, okay. And then just final question, as you lookforward, you mentioned $75 million of capital spending in 2008. Do you have anyother thoughts on allocations of capital, for your bolt-on type acquisitions orany other direction on further share buybacks?

Steven Voorhees

Yes, we think that there are acquisition opportunities outthere that we will see as we talked about in the past, they tend to beepisodic. But it really is a question of the use of our capital, if the currentmarket conditions prevail it certainly makes our equity a compellingopportunity for us, but we haven’t made a decision at the present timeregarding our plan.

Bill Hoffman - UBS

Okay. Thank you.

Steven Voorhees

Thank you, Bill.

Operator

Our next question comes from Mr. [Taylor Hood] of J.P.Morgan.

Taylor Hood - J.P.Morgan

Good morning.

Steven Voorhees

Hi Taylor.

Taylor Hood - J.P.Morgan

Good morning. I know this place is a little bit of a lumpybusiness. But can you give us a sense of just how things are shaping up to thefirst couple of weeks of the fourth quarter here?

James Rubright

Yes, basically I've said all of our businesses look good andI think Alliancedisplay through growth in its underlying customer base and a strong commitmentof existing customer base. It appears over the last, at least nine to twelvemonths that in-store display will continue to drive that business at a higherlevel of sales than last year, or let's say 2006. So, I think that you areseeing Alliancegrow to new level. It is a little lumpy as you commented.

Margins were not as high at this quarter as they were twoquarter ago in similar sales. We had some larger than expected expenses inconnection with large display program and had some expenses further developingour (inaudible) display program. So, we had some expenses not associated withany revenues that were booked in this quarter. So, that affected the margin. Ithink the overall margin environment for the business is essentially unchanged,but I think that we are probably taking this business to a higher level ofsales than we would have seen in 2005 and 2006.

Taylor Hood - J.P.Morgan

Okay, so if we look in at 2008, that average margin levelfor 2007 would probably be sustainable as you stand here and look out over2008?

James Rubright

Yeah. If we see the sales at the same level, we think themargins are sustainable and we hope to be able to do some cost improvements andactually improve the margins somewhat. The hardest thing for us, Taylor is wedon't have visibility far into the order pattern change. So, but I think if thecustomer behavior continues into 2008, the statement you said about our marginis correct.

Taylor Hood - J.P. Morgan

Okay, great. And then non-allocated expense is a little bithigher than we had in our model this quarter. How should we think about thisrolling into 2008?

Steve Voorhees

It's about $6.5 million this quarter, there were some, kindof true ups of accruals or in some other, what I'd classify as non-recurringexpenses. I think going forward, I would look forward in to a $5.5 to $6million per quarter range, which is a little bit higher than we've had inhistorical period.

Taylor Hood - J.P.Morgan

Okay, great. And just lastly, how many shares are left onyour re-purchase authorization?

Steve Voorhees

That’s 1.9 million.

Taylor Hood - J.P.Morgan

1.9. Thanks very much.

James Rubright

Thank you, Taylor.

Operator

(Operator Instructions). Our next question comes from Mr. ChristopherChun of Deutsche Bank.

Christopher Chun -Deutsche Bank.

Thanks. Good morning guys. Just following up on that lastquestion, with the stock down at current levels, I'm wondering, I know youcan't speak for the entire board but, how do you feel Jim about expanding there-purchase authorization and how would you weigh that, versus other uses ofyour cash?

Steve Voorhees

Well Chris, I'd like amplify that, but I really think Ianswered it before by saying we have not made a specific decision beyond, over2 million shares that we've just purchased. But if it was attractive at 27 it'smore attractive at 25, it's probably more attractive at prices higher than thatgiven the cash flow generation that we've got, what opportunities do you haveat 6.5 time free cash flow.

Christopher Chun -Deutsche Bank.

Okay. And then in terms of your paperboard capacityincrease, can you give you us a little more color on what grade capacityincreasing?

Steve Voorhees

Chris, I am sorry we are having a little difficulty hearingyou. Would you mind repeating that question?

Christopher Chun -Deutsche Bank.

I am sorry. Can you hear me now?

James Rubright

Yes.

Christopher Chun -Deutsche Bank.

I was just wondering about your 62,500 tons per year ofcapacity increase. What grades are those effects?

Steve Voorhees

It is primarily everything other than, primarily everythingother than URB. There is an increase in both bleached and market pulp. Largestsince CRB and then the joint venture with [charge] for this gypsum linermachine, which was increased as a result of the capital project that wecompleted this summer. We have very specific data in our 10-K that we are aboutto file, but and after this call, we will just go over where the specificchanges about what you said.

Christopher Chun -Deutsche Bank.

Okay, great. And Jim, you talked about the fact that thereshould be some tail still left on some previously announced price hikes. Canyou give us an idea of approximately how much, what percentage you've achievedto date and what remains left in the different grades?

James Rubright

The CRB price increases have been pretty much passedthrough, but we will recover, I think, in the $1 million to $2 million range inthe next quarter on CRB. But as I mentioned, the bleached board and medium youshould see the majority of that effect in the December quarter, because theJuly announcement really started to get recovered in early August on bleachedboard and then medium we started to get back either in the end of September orearly October depending. I just can't remember exactly how those contractsflowed in. So on the medium increase of $40 a ton really haven't seen that one,and you are not seeing the majority of the effect on the announced bleachedboard increase.

Christopher Chun -Deutsche Bank.

Okay, and then looking ahead to the December quarter lastyear, your adjusted EPS fell by $0.12 based on seasonal factors and youmentioned that there is still price to come and your outage went well. So,would it be fair to say that the quarter-over-quarter decline might a bit lessthan that this time or is it a too soon to make that call?

James Rubright

Well, first of all, we don't give specific earnings guidanceand we also don't know the extent of the seasonal effect, it is a function of orderpatterns, primarily in our packaging businesses in November and December, towhich we have no visibility. So, you and I can sort of reason out where wethink it is sort of, but it is not something we like to give specific guidanceon.

Christopher Chun -Deutsche Bank.

Okay, fair enough. And then finally Jim, with the EconomicNews lately, there has been a really fast decline of the U.S. dollar relativeto some other major currencies and I was wondering what your perspective was onhow and to what extent that will affect to Rock-Tenn?

James Rubright

It's had a very positive effect over the last 12 to 18months. As you know, the SBS bleached paperboard is an exported commodity. Andthe important thing for that is, it has a larger installed base in either CUKor CRB, and our view is that those grades effectively make up one large foldingcarton board market and, so the – but with a difference that SBS is the premiumgrade and the world assured SBS outside of the United States. The exportabilityof that commodity is one of the principal factors that affect the profitabilityof not only that grade which we make, but also the recycled paperboard. So, thecontinuing weakness of the dollar seems to us to be a positive for Rock-Tenn.

In addition, the strength of the Canadian dollar relative tothe U.S. dollar net, is positive to us, because of its affect, again, onrecycled paperboard pricing. As you know, the Canadian economy has performedvery well, but it's killing its forest products industry and the relativecompetitiveness of the fairly significant amount of coated recycled paperboardcapacity in Canadais affected by the relative dollar movement. So, I think we, I would say thatas a North American, particularly U.S. producer of paperboard of all grades, aweak dollar has certainly continued to have the wind behind the demand, behindour back as far demand and pricing of our paperboard is concerned.

Christopher Chun -Deutsche Bank.

Great. Thanks for your help.

Steve Voorhees

To offer you a perspective, there are potential importsthreats because other people in the world make paperboard, other people in theworld can make folding cartons, but all of those factors, I think, continued toenhance the competitiveness, not only of our own manufacturing but of thedownstream manufacturing in the United States by our customers, which may endup over the long run being the most positive of all the trends.

Christopher Chun -Deutsche Bank.

Right. That’s very helpful Jim. Thank you.

Operator

There are no further questions at this time.

James Rubright

Thank you very much for joining us on our call. We lookforward to speaking with you over the course of the quarter and then nextquarter. Thank you.

Operator

Than you for joining today's conference call. You maydisconnect at this time.

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