Chesapeake Corporation. Q1 2008 Earnings Call Transcript

Chesapeake Corporation. (CSK)

Q1 2008 Earnings Call

May 7, 2008 11:00 am ET

Executives

Joel Mostrom - EVP and CFO

Andy Kohut - President and CEO

Analysts

Todd Vencil- Davenport & Company

Rob Magnuson - Goldman Sachs

Richard Baldwin - Gartmore Investments

Presentation

Operator

Good day and welcome everyone to this Chesapeake Corporation first quarter 2008 Earnings Call. Today's call is being recorded. At this time, I would like to turn the call over to the Executive Vice President and Chief Financial Officer, Mr. Joel Mostrom. Please go ahead, sir.

Joel Mostrom

Good morning and welcome to Chesapeake Corporation's first quarter conference call. I am Joel Mostrom, and joining me today is Andy Kohut, our President and Chief Executive Officer.

Andy will begin with some overall comments on our business. I will then provide a financial review of the results for the first quarter. After that, we'll be available for questions.

Before we get started, I want to advise all participants that this call is being recorded by Chesapeake Corporation and is copyrighted material. It cannot be recorded or rebroadcast without Chesapeake's express permission.

Furthermore, the comments on this call may include forward-looking statements as defined in the Private Securities Litigation Reform Act. The accuracy of such forward-looking statements is subject to a number of risks, uncertainties and assumptions that may cause Chesapeake's actual results to differ materially from those expressed in the forward-looking statements.

Certain of those risks, uncertainties and assumptions are set forth in the summary of this conference call which will be posted to the Company's website at the conclusion of this call.

Additionally, during this call there will be references to certain non-GAAP financial information. This information has been reconciled to GAAP in the company's earnings release, which will also be posted on the company's website.

Now, I'll turn the call over to Andy.

Andy Kohut

Thanks, Joel. Good morning. Our results for the first quarter of 2008 were disappointing. We anticipated the first half of the year to be below 2007; but the first quarter was worse than expected. Our results reflected the full impact of the loss of our tobacco business with BAT.

In addition, sales were down across most paperboard markets when compared to a fairly strong first quarter, 2007. While we have not lost any significant business, the timing of product launches and de-stocking by some of our customers has adversely impacted our overall sales.

We also continue to experience the residual impact of our prior service issues. However, as I reported during last quarter's conference call, the service issues are behind us; and we have a robust business pipeline that we will expect to begin to see benefits during the second half of the year.

We incurred startup expenses for the consolidation of our supply chain offering for the alcoholic drinks market in Scotland and the relocation of our Long Island, New York facility serving the pharmaceutical and healthcare market.

Additionally, process improvement consulting expenses peaked during the quarter. All told, the startups, relocation and consulting expenses negatively impacted our financial results in excess of $3 million.

Economic conditions are uncertain. We do have select markets that are showing certain weakness and pricing remains competitive. We are currently pushing forward with recovery of raw material cost increases for both paperboard and resin.

Although a significant amount of our business is index-linked to raw material costs. The timing of implementing our price increases tends to lag between 30 and 60 days. We've had a good start to the year in our German confectionary business and specialty chemical plastics business.

Additionally, our key pharma market in the UK and Ireland has started to realize the benefits from improved service and some early benefits from the process improvement initiatives.

Overall, despite a slow start to the year, we continue to believe that the second half will show improvement and that our overall operating results for the year will be ahead of 2007 levels.

Before I turn the call over to Joel, I wanted to highlight our near-term objectives. Our number one priority is to secure refinancing of our revolving credit facility. We have made good progress in this effort. We have a signed commitment letter with GE and expect to have the new credit facility in place by the end of June.

This has been a challenging task in today's credit environment, but we feel this is very good progress. We also had to renegotiate a new recovery plan with the trustee of our largest pension plan in the UK. I am pleased to report that we have reached agreement with the trustee on the principles of a new recovery plan.

The second area of focus is to deliver improved financial results in the second half of 2008. We have clear milestones in place to help ensure the success of our initiatives. Our operating teams are dedicated to improving performance in the second half of the year. The combination of a strong business pipeline and the benefits from the process improvement initiatives are key elements of the recovery.

Our third priority is to sell or close non-core assets or assets which are under-performing and do not have a plan to achieve our growth and profitability expectations. We have a number of initiatives underway at this time, and we'll make definitive announcements at appropriate times in the future.

So, in summary, we're focused on finalizing our refinancing, delivering improved financial results in the second half of 2008, and consummating the sale or closure of non-core under-performing assets.

I'll now turn the call over to Joel.

Joel Mostrom

Thanks, Andy. This morning, we reported a first quarter net loss from continuing operations of $8.4 million, or $0.43 per share, compared to net income from continuing operations of $900,000 or $0.05 per share for the first quarter of 2007.

We incurred charges for special items in both these periods. Special items include goodwill impairments, restructuring expenses, asset impairments, and gains or losses related to divestitures.

Our operating income, exclusive of special items, for the first quarter of 2008 was $100,000, compared to $16 million for the first quarter of 2007. Operating income for the first quarter of 2008 was favorably impacted by the changes in foreign currency exchange rates and decreased pension expense.

Changes in foreign currency exchange rates increased operating income, exclusive of special items, approximately $900,000 for the first quarter of 2008 when compared to the first quarter of 2007. And decreased pension expense increased operating income approximately $1.8 million.

I'll now review our operating results starting with the Paperboard Packaging segment. My discussion of segment operating income excludes the effects of special items. The first quarter net sales of $200 million for the Paperboard Packaging segment were down 11%, compared to net sales for the first quarter of 2007.

Excluding changes in foreign currency exchange rates, net sales were down 16% for the quarter. Sales in both branded products and pharmaceutical and healthcare packaging were down in the first quarter of 2008.

Sales of branded products packaging market were down about 21% for the first quarter, excluding changes in foreign currency exchange rates. The decline was largely due to decreased sales of tobacco packaging.

In addition, sales of UK drinks, confectionary, and food and household packaging were down about 16% for the quarter, primarily due to weaker demand. Sales of German confectionary packaging remained strong through the first quarter of 2008, and increased slightly over the prior year quarter.

Sales of pharmaceutical and healthcare packaging were down about 11% for the first quarter, excluding changes in foreign currency exchange rates. The decline in sales was primarily the result of price declines due to competitive market conditions and, as Andy mentioned, the residual impact of prior customer service issues.

We expect our sales volumes to improve in the second half of 2008 now that our service levels are back on track, and we have secured new business in this area. The Paperboard Packaging segment's operating income for the first quarter of 2008 was a loss of $900,000, which was a decrease of $13.7 million, compared to the first quarter of 2007.

Changes in foreign currency exchange rates increased segment operating income by $200,000 for the quarter. The decrease in operating income for the first quarter was partially due to the decreased sales of tobacco packaging. Lower tobacco packaging sales accounted for about 20% of the operating income decline for the quarter.

The startup expenses related to the multi-shaped tubes production for alcoholic drinks packaging, the relocation of our Long Island facility and the costs associated with recent process improvement initiatives, together accounted for about 20% of the operating decline as well.

The remaining decline in operating income was primarily due to decreased sales of both branded products and pharmaceutical and healthcare packaging as well as increased energy and transport cost.

The Plastic Packaging segment had sales of $53 million in the first quarter of 2008, up 13% from the first quarter of 2007. Excluding changes in foreign currency exchange rates, net sales were up 4% for the quarter. The increase in net sales for the first quarter was primarily due to the partial pass-through of higher raw material costs.

Sales volumes were relatively flat year-over-year with increased volume of specialty chemical packaging offset by a decreased volume of food and beverage packaging. The Plastic Packaging segment's operating income was $5 million for the first quarter of 2008, a decrease of $2 million from the strong first quarter of 2007.

Changes in foreign currency exchange rates increased segment operating income $700,000 for the quarter. The decrease in operating income for the first quarter was primarily due to weakness in the beverage packaging operation in South Africa, which resulted primarily from price declines due to competitive market conditions and from under recovery of increased raw material costs.

Now turning back to our consolidated results. Net cash used in operating activities was $5 million for the first quarter of 2008, a decrease of $19.2 million compared to the first quarter of 2007. The decrease in operating cash flow was primarily due to the decrease in operating income in 2008 and increased working capital requirements.

Total debt at the end of the first quarter, 2008, was $543 million compared to $515 million at the end of 2007. Changes in foreign currency exchange rates increased total debt at the end of the first quarter by approximately $11 million.

Likewise, foreign exchange rates increased interest expense approximately $400,000 for the first quarter of 2008 when compared to 2007. Before I open the call up for questions, I would like to expand on a few points that Andy mentioned in his opening remarks.

With respect to our refinancing initiatives, on May 2, 2008, we entered into a commitment letter with GE Commercial Finance Ltd. and General Electric Capital Corporation to act as the lead arranger and underwriter to provide a $250 million senior secured credit facility to refinance outstanding borrowings under our credit agreement with Wachovia Bank and other lenders, which matures in February, 2009.

The new facility is expected to include revolving credit, as well as amortizing 5 and 7-year term loans. It is expected to be secured by a security interest in substantially all the assets of the company's operations in the US and Europe. The commitment letter is subject to a number of conditions that must be satisfied before the new GE facility is funded. We anticipate closing on the refinancing before the end of June 2008.

The second point involves our negotiations with the trustee of our primary UK pension plan, and we are pleased to report we have reached agreement with the trustee of the pension plan on the principles of amendments to the recovery plan which will reduce the supplemental payment due on or before July 15, 2008, to 6 million pounds sterling and provide additional assurance of and security for ongoing funding of the plan.

We believe the amounts payable under the proposed amended recovery plan can be paid without the company breaching relevant financial covenants. The company and the trustee are in the process of finalizing the provisions of the proposed amended recovery plan and will seek any appropriate approvals required for the amended recovery plan. We believe that it's highly likely that the amended recovery plan will be finalized.

Now, at this time, we would be happy to take your questions.

Questions-and-Answers Session

Operator

Thank you, Mr. Mostrom. (Operator Instructions). We'll take our first question from Todd Vencil with Davenport & Company.

Todd Vencil- Davenport & Company

Thanks very much. Good morning.

Joel Mostrom

Good morning.

Todd Vencil- Davenport & Company

On the letter and the proposed lending package from GE, congratulations, by the way that's good news. Will it effectively cure the sort of covenant issues that you guys are seeing the past couple of quarters?

Joel Mostrom

Todd, yes, it will. The plan is, is to close on that financing by the end of June. And if, in fact, we do consummate that transaction, that will take care of our covenant issues.

Todd Vencil- Davenport & Company

Okay. And, I understand that's a secured facility and, therefore is presumably much broader in terms of requirements that there are any. Can you talk about what type of covenants, in terms of leverage and coverage and things like that maybe associated with the proposed new package?

Joel Mostrom

Todd, at this time, pricing and terms are confidential until closing. However, we believe the terms of the facility are very competitive.

Todd Vencil- Davenport & Company

Is it fair to say that in terms of the covenants, or any covenants that may be applicable will be much more broad than the one you're currently working with?

Joel Mostrom

We're comfortable with the negotiated terms of the new facility and our ability to comply with the covenants.

Todd Vencil- Davenport & Company

Fair enough. And then, you're sort of number three priority, which is selling non-core and under-performing assets, can you help us understand kind of the magnitude in whatever way it might be useful of how to think how much might be being looked at here, in terms of your assets?

Andy Kohut

Todd, this is Andy. It would be premature to provide that type of speculation in the market. But, what I will tell you is that we remain committed to paying down debt. And we also remain committed to exiting in one form or another under-performing or non-core assets.

This same challenging financial market that made it difficult from a refinancing standpoint has made it more time-sensitive regarding when assets can be sold. So, it's taken longer than we had hoped; but we are actively pursuing those types of activities.

Todd Vencil- Davenport & Company

Fair enough. And then, I believe you sort of reiterated what you said before, which is that the operating performance, excluding special items, you still think is going to be better than last year? Did I hear that correctly?

Andy Kohut

Yes.

Todd Vencil- Davenport & Company

And is that, just to sort of nail that down a little bit, at least in the numbers that I'm looking at, ex-items last year looks like operating profit was about $41 million. Am I thinking about those ins and outs the right way?

Joel Mostrom

Excluding the special items, Todd, I think you're probably close. On the EBITDA basis, excluding special items, it was a little over $94 million.

Todd Vencil- Davenport & Company

Okay. Thanks a lot.

Operator

(Operator Instructions).

Our next question comes from Rob Magnuson with Goldman Sachs.

Rob Magnuson - Goldman Sachs

Hi, guys. Thanks for taking the call.

Joel Mostrom

Hi.

Rob Magnuson - Goldman Sachs

I guess, just in terms maybe we could start with operations this quarter, you mentioned below your expectations. I guess why was visibility on this quarter so poor? I think you renegotiated the covenants on March 5th. And, now results as of 330 were below expectations. And, you talk about breaching covenants in the second quarter. I guess what parts of the business that you did not have visibility are overly under-underperformed?

Andy Kohut

We knew going into the year that the first half was going to be below 2007 levels. And, we talked about that at the last conference call. First quarter is also our seasonal low point of the year. So, small changes in volume can have a rather dramatic effect on the bottom line.

We did see some de-stocking with our customers. We also saw some reduced demand. And there is a lot of uncertainty out there. And our customers are speculating the impact of what's going on from a global economic standpoint. And, we are watching that very cautiously, but we are taking appropriate actions from a cost standpoint.

But, the new business that we won, that we spoke about last call and this call really starts to transition to the company in the second half of the year. We feel very good about that. The reason that occurred is because our service levels improved. We've also, as part of this process improvement change, it's not just running a factory better, it's really how we interact with our customers, how we deal with them, being more customer-centric.

Personally, I view that as being very important to the long-term success of the company. And, the key account teams that we've set up are starting to have some significant impact. And that gives me confidence going into the second half of the year.

The only caveat is this uncertain economic environment that we're all facing right now.

Rob Magnuson - Goldman Sachs

Sure. Maybe, just expand on, I guess, the improvement you expect in 2Q in the second half, maybe, by the segments. Could you maybe elaborate on where the opportunity is? Is it plastics? Is there some recovery on the pass-through costs, or is it volume in some of these new areas in the pharma healthcare?

Andy Kohut

I think it's a combination. I expect volume to increase in our pharmaceutical and healthcare area. Also as we said the pass-through on raw materials, both resin and paperboard, we expect to be implemented starting in the second quarter. And, sequentially, the second quarter picks up from a seasonal standpoint, and we expect that to occur as well.

Rob Magnuson - Goldman Sachs

Okay. In terms of the asset sales, I know it's definitely premature to talk about amounts, but could you say if the assets you're looking at would they be more operating assets or is this idle real estate that's excess and not producing for the company?

Andy Kohut

It's both. We do have some real property that is not needed or plants that have been closed in the past that we are actively getting either rezoned or selling. And also, businesses that aren't fitting the criteria that we want from an earnings and growth standpoint are/or our non-core we are looking at, as well.

Rob Magnuson - Goldman Sachs

Great, and, just the new GE, or potentially new GE facility, congratulations in this environment, very challenging and clearly a top priority and a big focus for management. Are there any, outside of the ordinary conditions to be met in terms of funding, are there any specific to Chesapeake?

I imagine formalized agreement on the pension is part of it, perfecting security, is there any other minimum EBIT or EBITDA for the second quarter, say, before funding out of the ordinary conditions?

Joel Mostrom

I think you hit it. Among other things, it's subject to finalizing the loan agreement and the legal documentation related to collateral. And, it includes other conditions that I would say are typical of an asset-based financing arrangement.

Rob Magnuson - Goldman Sachs

Great, and what types of upfront costs are involved with the new facility in terms of hedging or funding costs?

Joel Mostrom

We're not in a position to comment on that. As I said I'm not prepared to remark on either pricing terms or any of the costs associated with the new facility. However, I'll just reiterate, we do believe the terms of the arrangement are competitive.

Rob Magnuson - Goldman Sachs

Fair enough. And finally, if I can on the pension, also, congratulations on reaching what sounds like a fair agreement. To be clear, the 6 million pounds sterling is incremental to the 6 million you had already planned to?

Joel Mostrom

No, it isn't.

Rob Magnuson - Goldman Sachs

It's not?

Joel Mostrom

No, it isn't. No, what that is, we got an agreement whereby we kept the 6 million pounds that is above our required amount the same level, rather than the spike that had occurred because of the actuarial assumption changes. So, it's a very good agreement that makes sense for the trustee on an ongoing basis and it certainly makes sense for the company.

Rob Magnuson - Goldman Sachs

Absolutely, that is good news. And then you mentioned security potentially for the pension fund, what type of security would that be and how does that impact the GE facility?

Joel Mostrom

It would likely include security of a second position relative to the assets that are contemplated as part of the GE package.

Rob Magnuson - Goldman Sachs

Okay. Thank you very much and good luck.

Joel Mostrom

Thank you.

Operator

(Operator Instructions). Our next question comes from Richard Baldwin with Gartmore Investments.

Richard Baldwin - Gartmore Investments

Good afternoon, gentlemen. Just a couple of points, if I can, just upon a couple of points that you made, can you give me some more color, please, about what has caused the increase in cash flow from working capital in the first quarter? And some more color on that would be appreciated.

And then, just a housekeeping point, could you tell me, please, how much the drawings were under the revolving credit facility at the end of first quarter?

Joel Mostrom

I'll take care of the housekeeping item first. The borrowings under the revolving facility at the end of Q1 were approximately $185 million.

Richard Baldwin - Gartmore Investments

Okay.

Joel Mostrom

With respect to working capital, actually, I think there was an interesting article in the Financial Times just within the last month or so, citing a specific company that was attempting to push to its current suppliers extended payment terms. And, I would say that that, in large part, is indicative of some of the pressure that we're getting on our working capital.

Its large customers, in some cases, asking instead of paying us within 15 or 30 days to extend it beyond that amount of time, typically, we're accustomed to. And I think that the second thing would be, too is that because of the refinancing uncertainty, we are having some of our suppliers, in fact, ask that we tighten up a little bit more on some of our payment terms as well.

Richard Baldwin - Gartmore Investments

Yup understood. Okay, well, congratulations on the progress that you've made to date anyway. Thank you for the call.

Operator

At this time, we have no further questions. I would like to turn the call back over to Mr. Mostrom for any additional or closing remarks. Please go ahead, sir.

Joel Mostrom

Thank you. And, I'd like to remind everyone today's call will be available for replay on our website, chesapeakecorp.com, or it can be accessed by calling 888-203-1112, or you can dial 719-457-0820. The access code is 7488892.

This concludes today's call, and thank you for participating.

Operator

Ladies and gentlemen, that does conclude today's teleconference. We appreciate your participation. Everyone, have a great day.

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