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Boise (NYSE:BZ)

Q2 2012 Earnings Call

August 02, 2012 12:00 pm ET

Executives

Greg Jones

Alexander Toeldte - Chief Executive Officer, President, Director, Member of Special Committee and Member of Executive Committee

Samuel K. Cotterell - Chief Financial Officer and Senior Vice President

Analysts

Alex Ovshey Ovshey - Goldman Sachs Group Inc., Research Division

Kurt Schoen - Credit Agricole Securities (NYSE:USA) Inc., Research Division

Phil M. Gresh - JP Morgan Chase & Co, Research Division

Graham Mattison - Lazard Capital Markets LLC, Research Division

Bill Hoffman - RBC Capital Markets, LLC, Research Division

Harrison Wreschner

Operator

Good morning. My name is Michelle, and I will be your conference facilitator today. At this time, I would like to welcome everyone to Boise Inc. Second Quarter 2012 Earnings Conference Call. [Operator Instructions] It is now my pleasure to introduce you to Mr. Greg Jones, Director of Investor Relations, Boise Inc. Mr. Jones, you may begin your conference.

Greg Jones

Thanks, Michelle. Good morning, and welcome to Boise Inc's. Second Quarter 2012 Earnings Call. Joining me today are Alexander Toeldte, our President and CEO; and Sam Cotterell, Senior Vice President and CFO.

Please note that some statements made on this call constitute forward-looking statements within the meaning of the federal securities laws, including statements regarding management's future expectations of company performance. Management believes these forward-looking statements are reasonable. However, the company cannot guarantee that its actual results will be consistent with the forward-looking statements, and you should not place undue reliance on them.

These statements are made on -- are based on current expectations and speak only as of the date they are made. The company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of future events, new information or otherwise. Important risk factors regarding the company that may cause results to differ from expectations are included in the company's filings with the SEC including our quarterly report on Form 10-Q for the quarter ended June 30, 2012.

This morning's call is posted as an audio webcast on our website at boiseinc.com under Webcasts and Presentations, and a replay will be available shortly after the call.

With that introduction, I will now turn the call over to Alexander.

Alexander Toeldte

Thank you, Greg. Welcome to our second quarter 2012 earnings call. I'll start by summarizing some key second quarter results, and I'll make some remarks about the individual performances of our Packaging and Paper segments before turning the call over to Sam Cotterell, who will give you more detail about our financial results.

Boise had a very good second quarter. Our sales, EBITDA and net income were all up over the same quarter last year. Sales were driven by strong volumes in our Packaging segment, and earnings improved due to lower input and maintenance cost, especially in our Paper segment. During the second quarter, we had 3 annual maintenance outages. These were done safely, on time and within budget, and we continue to operate well.

We also continue to see benefits from our acquisitions of Tharco and Hexacomb. In particular, the increased integration of linerboard in our own system insulated us from lower-margin export markets. We are now about 80% vertically integrated and expect to be approximately 85% integrated by fourth quarter 2012 with the expectation of being about 90% integrated by year-end 2013.

Finally, we continue to grow our sales of Label and Release and Premium Office Papers, and these products made up 33% of our uncoated freesheet sales volumes so far this year.

Now let's take a look at our Packaging business. Sales increased over the prior-year quarter due to the acquisition of Hexacomb and due to strong organic growth in sales of our other corrugated products compared to the prior-year quarter, while reported industry volumes were flat year-over-year.

Our second quarter EBITDA was essentially flat compared with the second quarter '11. The benefits of lower energy cost were offset by higher maintenance cost and lower linerboard sales volumes due to lower production as a result of our annual maintenance outage. Last year, as you recall, our maintenance outage at DeRidder occurred mostly in first quarter, while in 2012, the majority of the outage occurred in second quarter. When you look at EBITDA on a half-year basis, our EBITDA for Packaging has grown substantially over the previous year.

In July, we announced a $50-per-short-ton price increase on linerboard sales. Due to our increased vertical integration, we expect to recognize most of the benefits of the price increase in the fourth quarter.

Turning to our Paper business. In the Paper business, revenue for second quarter 2012 was lower compared with second quarter '11 due to lower volumes for market pulp and lower prices for market pulp. Volumes of uncoated freesheet were flat compared with second quarter 2011. We continue to benefit from increased sales volumes and prices in our Label and Release and Premium Office Papers. In contrast, reported industry shipments of uncoated freesheet declined 3% compared with the first half of 2011, and we were -- and they were down 4% compared with the prior-year quarter. Commodity uncoated freesheet prices declined -- decreased slightly. Lower natural gas and fiber costs, along with lower annual maintenance outage cost, helped increase our Paper EBITDA compared with the second quarter '11.

In March, we announced a $60-per-ton price increase across most of our printing and converting products, including offset, forms and envelope papers. In April, we announced a $40-per-ton price increase for our cut-sized papers. We expect to see some benefit from both increases in the second half of the year.

And with that summary, I'll turn the call over to Sam for a more detailed look at the numbers.

Samuel K. Cotterell

Thanks, Alexander. Our net income for second quarter was $14 million or $0.14 per diluted share compared with net income of $12 million or $0.11 per diluted share in the second quarter of 2011. Our diluted shares outstanding in the second quarter 2012 were 101 million shares compared with 112 million shares in the second quarter 2011. Second quarter 2012 EBITDA was $75 million, up 7% from $71 million in the second quarter '11.

Second quarter sales in our Packaging segment were up 17% compared with the second quarter last year and 5% compared with first quarter. Despite higher quarterly maintenance outage cost, Packaging segment DA -- segment EBITDA held steady at $40 million compared with second quarter 2011. For the 6 months of 2012, Packaging segment EBITDA increased 20% year-over-year.

Overall sales of our Paper segment were $363 million, down 2% compared with second quarter 2011, due to decreased volumes and prices for market pulp. Paper segment EBITDA the increased 15% to $41 million compared with second quarter 2011.

Turning now to input cost. Our major input costs, energy, fiber and chemicals, totaled $236 million for second quarter 2012, a decrease of $11 million from last year's second quarter costs and a decrease of $23 million from our first quarter costs. Lower fiber and energy costs accounted for the majority of the decline. Looking ahead, we anticipate that input cost for chemicals and energy will moderately increase during the second quarter -- or excuse me, during the coming quarter.

Free cash flow and liquidity, something I'd like to focus on for a second. During the first 6 months of 2012, we generated free cash flow of $20.7 million compared with $42.4 million for the same period in 2011. The decrease is due primarily to changes in working capital, notably higher inventories. We've restructured our fiber supply chain to lower cost in Wallula. Due to lower production of pulp and long lead times on sourcing wood, we have larger-than-normal inventories there. In the second half of the year, we're focused on bringing our fiber and pulp inventory more in line with historical levels.

In addition to these changes in working capital, during the 6 months of 2012, we also contributed $18 million to our pension plans. Our total net debt at the end of second quarter stood at $736 million or 2.1x our last 12 months of EBITDA. We had no borrowings outstanding under our revolving credit facility and availability of $493 million with $60 million of cash on hand, and we continue to expect capital investments in 2012 to be between $140 million and $145 million, excluding acquisitions.

Our outage cost can have a material impact on the operating performance quarter-over-quarter. The timing of our outages and related expenses shifted in 2012 relative to 2011, but we're not anticipating a significant change in our maintenance cost for the full year 2012. Our total second quarter outage costs were about $16 million compared with $17 million in the second quarter 2011 and $2 million in first quarter 2012.

In our Packaging segment, we spent $6 million at our DeRidder mill in second quarter compared with $3 million in the same quarter last year, and we expect to spend about $4 million more at DeRidder in third quarter. In our Paper segment, our second quarter scheduled outages at International Falls, Minnesota and Wallula, Washington cost $10 million compared with $14 million in second quarter 2011. Our remaining major maintenance outage is scheduled for fourth quarter at our Jackson, Alabama mill, where we expect to incur about $5 million in costs.

And with that, let me turn it over to Alexander for his concluding remarks.

Alexander Toeldte

Thank you, Sam. As I said earlier, second quarter was a very good quarter for Boise Inc.

Looking ahead to third quarter, we expect lower maintenance cost compared with the second quarter and moderately increasing chemical and energy costs. We expect to see some benefits from our announced price increases in the second half of the year. We see continued progress integrating our Tharco and Hexacomb operations, and we see continued growth in our Label and Release and Premium Office Paper businesses.

With that, I thank you for listening. We appreciate your interest in our company, and we'll now take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Alex Ovshey from Goldman Sachs.

Alex Ovshey Ovshey - Goldman Sachs Group Inc., Research Division

A couple of questions for you. Just on the uncoated freesheet volume side, if we have our numbers of [indiscernible] in the model, it looks like your lines are up about 1%, which is much better than the overall industry. Can you just talk about what's driving that, and then how to think about your volume trend in the back half of the year versus the industry for uncoated freesheet?

Alexander Toeldte

Alex, very similar question in Q1 about this. I think we are seeing 2 effects here. Number one, the effect of the portfolio shift towards Label and Release, which continues its growth. And secondly, several of our customers are doing very well in their markets. I think you've seen this morning OfficeMax's results, which are very encouraging, and a number of other -- our customers are also doing well. So that fall through to our numbers, and together, we're succeeding. So we're quite happy about what's going on there and encouraged by the marketing and sales programs they are taking in the market. So we're looking at the rest of the year with some confidence inside whatever the economic development is for the overall economy.

Alex Ovshey Ovshey - Goldman Sachs Group Inc., Research Division

Okay. And then on the linerboard side, it seems like you're pretty confident that there's going to be a price increase that will be successfully implemented. And I'm just curious, to better understand, what really gives you that confidence? Because some of the data points you may look to, to feel better or worse about, the price increase suggests that it may be difficult. You've seen recycled fiber prices come off demands pretty sluggish. So just your view around why you think it gets implemented.

Alexander Toeldte

Well, let me state that we have announced a price increase. Let me talk a little bit about the market. We have seen good demand for our product. We've seen a little bit of price erosion at the downstream, and -- but that in the context of actually pretty strong volume demand, so the -- naturally, that's reasonably somewhat different, the regions in the country where the market is a little bit stronger than elsewhere. But generally, as we look at the demand that materializes for us as Boise Inc., we're pretty optimistic about the third and fourth quarter.

Operator

Your next question comes from Mark Connelly from CLSA.

Kurt Schoen - Credit Agricole Securities (USA) Inc., Research Division

This is Kurt Schoen filling in for Mark. Given your confidence in the successful nature of the containerboard price hike, where do you guys stand in your decision with regard to the D2 conversion at DeRidder?

Alexander Toeldte

It continues to remain an option, continues to be closely evaluated. As you know, we have increased our vertical integration, which increases for us the potential to move volumes off a potential conversion into our own system. And clearly, a good demand outlook and good pricing outlook is a good factor, as in that's all I want to say at this point in time.

Kurt Schoen - Credit Agricole Securities (USA) Inc., Research Division

Okay. And then shifting to Hexacomb. You noted last quarter that Mexico was a strong market. Could you just give an update on what you're seeing in terms of that market for Hexacomb products? Which ones are seeing strength and weaknesses?

Alexander Toeldte

We are seeing strong demand in all of our Mexican sales. We are seeing very strong demand in Hexacomb, particularly, and frankly, it's across the entire product range. Mexico is showing a lot of economic growth. We have a very good sales opportunity pipeline there. So we're quite confident, again, about the Mexican market and are looking to expand Hexacomb's presence with our existing customers but also with new customers in Mexico.

Kurt Schoen - Credit Agricole Securities (USA) Inc., Research Division

Okay.. And then lastly, where do you guys stand in terms of synergies in terms of your previous targets?

Alexander Toeldte

We are well above and well ahead of our synergy targets. Remember that the key source of synergy targets are board, linerboard, and medium-integration benefits, where the acquisition of Tharco and Hexacomb are reducing our exposure to lower-margin export markets. We've done very well with that at Tharco and are nicely ahead of our own targets there. At Hexacomb, we are now, in the second half, beginning to implement the changes that came through the acquisition. And again, early days but nicely ahead of plans.

Operator

Your next question comes from Phil Gresh from JPMorgan.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

So just on the uncoated freesheet. With the euro weakening here kind of in the low $1.20, have you seen any impact from imports at this stage?

Alexander Toeldte

We continue to see Portuguese imports to increase. And if you look at the overall market share that imports have in the overall market, they have been growing simply because of -- the market share for imports over the last few years has been growing simply because imports have held steady or slightly grown overall. There are some shift between varying suppliers doing less and others, more chiefly the Portuguese. We haven't seen as much as one would expect initially. If you look at the price parities, clearly, a higher euro would be better. But if you look at what the Europeans called C grade versus B grade, it's -- the pricing parity is probably still too close for B grade to move in larger numbers over here, but the buffer is getting smaller as the euro declines.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

Is there a level of the euro which you kind of track that might be more of a pain point?

Alexander Toeldte

The euro in itself is not a sufficient indicator because you also have to think through transportation cost and transportation availability and rates are moving enough. But we certainly wouldn't want to see the -- a euro decline any from here.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

Okay. And just with the Paper price increases that you talked about, this quarter, you actually had Paper price decreases. I know some of your peers had increases actually. Is that a function of your lags with the prior decreases we saw on Paper prices, or how should we think about the decreases that we've been seeing in the past couple of quarters? And just on a relative basis, how much of these increases do you think you might be able to achieve at this stage?

Alexander Toeldte

Yes. If you look at our uncoated freesheet price, they've actually been flat on uncoated freesheet in around 0%. There's a bit of a decline in medium from last year by 1% or so. The chief price decline we've experienced as a company has been in the market pulp area. But yes, the delay in our business is always at play here. So you'll always see our price declines come in a little bit later and our price increases a little bit later on average.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

And any thoughts just on how much of these announced increases might succeed at this stage? I know some of your peers have been a bit more cautious about the ability to get these increases.

Alexander Toeldte

I would say that the price increases are clearly running into some resistance. Stating anything else would be just living in denial. We expect to realize, as I said, some benefit from them throughout the second -- sorry, throughout the third and fourth quarter. It won't be a full realization and also expect that it won't be nothing. Don't want to pin it down on a single number, but some part of it is going to come through.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

And, Sam, a question for you. You've mentioned $4 million in maintenance. I wasn't quite clear if you're saying $4 million incremental in the packaging side or $4 million in total.

Samuel K. Cotterell

Yes. We're expecting in the third quarter about an additional $4 million at DeRidder. We have traditionally done all of our outage costs in the first quarter there. It got spread out throughout the year. We're doing some boiler work there in the third quarter, and that'll be about $4 million.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

Okay. So that's incremental to whatever maintenance there was in the second quarter for the Packaging segment.

Samuel K. Cotterell

Correct. About $6 million in the second quarter and another $4 million in the third quarter.

Alexander Toeldte

And if I may, that's the only maintenance outage that we have in the third quarter in the company, because the Paper -- the Jackson outage happens in fourth quarter.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

Okay. And then, Sam, you made the comment about the build of the fiber inventories and kind of working those down in the back half of the year. Is there any kind of EBIT headwind that you would anticipate as a result of that?

Samuel K. Cotterell

Well, the EBIT headwinds that we're having right now relate to market pulp. Market pulp is clearly a product where pricing is down. We built market pulp inventories for a couple of reasons. One is it just didn't make sense to sell it at the prices that they were at, so we built some inventories. We also beat -- built some safety stock for use within our own mills. But we expect to work that down and sell it at a reasonable price where it makes sense to do so.

Operator

Your next question comes from Graham Mattison from Lazard Capital Markets.

Graham Mattison - Lazard Capital Markets LLC, Research Division

Just a question on your balance sheet. You mentioned that your net debt to EBITDA was about 2.1. I know you've mentioned in the past that your sort of comfort range is the 2.5 to 3. Can you just give us some comments or outlook on potential for acquisitions or other, returning to cash to shareholders? Anything on that front?

Samuel K. Cotterell

Sure. We've stated again the numbers that you indicated. We're very comfortable with 2.5 to 3x. We're a little bit under that. We have very good liquidity. We've demonstrated inquisitive nature with Tharco and Hexacomb last year. We continue to evaluate opportunities. We've also been very active at returning capital to shareholders with special dividends and share repurchase. All of those remain in our arsenal for returning capital to shareholders. We also look at internal investments, and we see opportunities and where it makes sense to invest internally. Reference was made earlier to D2 that we continue to evaluate. We'll do that also. So we're very pleased with where we are with the liquidity standpoint and evaluate all of the opportunities that we have to appropriately make capital investments.

Graham Mattison - Lazard Capital Markets LLC, Research Division

All right, great. And then just in terms of your outlook for the third quarter. Are you incorporating -- is there a potential for any impact from the drought and the heatwave going through the country that might impact you guys?

Alexander Toeldte

I don't think that there's anything immediately on our product demand side that we're going to see. Clearly, starch prices and starch cost will be affected. That will be -- starch, currently, is still on the contract for the rest of the year, but it'll affect starch prices going forward in 2013. So I think that's the -- right now, the most immediate impact that we see.

Operator

Your next question comes from Bill Hoffman from RBC Capital Markets.

Bill Hoffman - RBC Capital Markets, LLC, Research Division

Alexander, I just wonder if you would talk a little bit about the capital spending programs, whether you expect to get any additional capacity out of the spend for the rest of the year. And then maybe if you think about 2013, organically, like your strategy for capital spend, whether it'd be in incremental capacity or cost-reduction programs.

Alexander Toeldte

Generally, incremental capacity is not our objective function. Definitely, it's not our objective function on the Paper side. The capital spending separates into a number of buckets. Some of it is base spending, just simply required to keep the operational health and safety integrity of the operations, and then the rest is aimed at varying improvements, be they quality or cost reductions. Sometimes you get minor capacity benefits from that, but they're are certainly, in the Paper business, not the objective against the background of a secular declining market. In Packaging, again, our chief objective is to improve capability, both on the product features and on the service capability for our customer side. We do have, as I said earlier, organic growth in our base business, as well as growth, volume growth in Hexacomb and in Tharco. So we are likely to add some production size at Hexacomb when we are continuing to improve the capability of the rest of the packaging system. And in that process, particularly as we lower breakeven points on our large linerboard machine, D1, there are capacity side effects. But again, capacity is usually not the objective function other than for debottlenecking purposes.

Bill Hoffman - RBC Capital Markets, LLC, Research Division

Great. And then just -- when you think about your -- the M&A pipeline versus special dividends like you did last year, what are you thinking about for the back half of this year? What's sort of the next target?

Alexander Toeldte

Well, we -- let me talk about special dividends and returning capital to shareholders. First, if you look closely, we've basically, in the past, returned a fairly sizable chunk about once a year. So we're trying to be shareholder friendly and build a record on that, but be consistent with the nature of the industry by choosing, at least to this point, in the form of a special dividend. And clearly, that is, as Sam said, part of our arsenal. And at the same time, we're currently looking at a number of acquisition opportunities. Whether they pan out or not is too early to say. We think we've done a good job with the acquisitions we've made, where the industrial rationale and the reasonable price, plus synergy opportunities and growth opportunities, combined, toward acquisition rationale. We continue to look for that. And I have the balance sheet to consider both and, possibly, both together, both being dividends and acquisition. So the solid balance sheet has its advantages for us.

Operator

Your next question comes from Harrison Wreschner from Andalusian Capital.

Harrison Wreschner

Just wanted to ask -- most of my questions have been answered regarding inventory and the general market out there for acquisitions, but just the 2 quick ones, I guess. Should we expect any more cash pension payment throughout the year?

Samuel K. Cotterell

Yes. We've contributed $18 million to date. Last year, in total, we contributed $25 million into our pension plans. Our minimum funding, with changes and recent loss, is somewhere in the neighborhood of $12 million or so, still to be determined. And so we've contributed more than the minimum. We view our pension plans as a form of debt, and we want to pay down that debt. We want to make sure that we're appropriately taking care of our employees with that obligation and would expect to continue to fund our pension plans as we've done in the past.

Harrison Wreschner

Okay, great. Again, in all the questions, you gave some color about the acquisition market out there and your views towards the different uses of capital as you're below your targeted leverage. I'm curious if any potential change in the tax regime towards the end-of-the-year risks on some of the dividends going up in rates affect kind of the timing or the thought process on uses of capital.

Alexander Toeldte

It's a matter of discussion. I think it's an entirely legitimate topic. We are trying to, like everybody, get a reasonable read on the political decision landscape. And when we get closer, we'll see what we then believe to know and make decisions accordingly.

Operator

I have no further questions in queue. I turn the call back over to the presenters for closing remarks.

Alexander Toeldte

Well, if there are no further questions, thanks again for listening. Thank you for your interest in our company, and we'll see you next quarter.

Operator

This concludes today's conference call. You may now disconnect.

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