Oct 30, 2010
Executives
Eric Cremers - VP of Finance and CFO Mike Covey - Chairman, President and CEO
Analysts
James Armstrong - Credit Suisse Gail Glazerman - UBS Michael Roxland - Bank of America Merrill Lynch Dan Cooney - KBW Steve Chercover - D. A.
Davidson Mark Weintraub - Buckingham Research
Operator
Good morning. My name is [Chasidy] and I will be your conference operator today.
At this time, I would like to welcome everyone to the Potlatch Third Quarter 2010 Earnings Conference Call featuring Eric Cremers, Vice President of Finance and Chief Financial Officer; and Michael Covey, Chairman, President and Chief Executive Officer of Potlatch Corporation. All lines have been placed on mute to prevent any background noise.
After the speaker’s remarks, there will be a question-and-answer-session. (Operator Instructions).
Thank you. I would now like to turn the call over to Mr.
Eric Cremers for opening remarks. Sir, you may proceed.
Eric Cremers
Welcome to Potlatch’s investor teleconference covering our third quarter 2010 earnings. Before we begin, let me remind you that this call may contain forward-looking statements with regard to our business and operations.
Please review the disclaimers regarding forward statements and our press release on the presentation slides and in our filings with the SEC concerning the risks associated with these forward-looking statements. Also, please note that segment information, as well as the reconciliations of non-GAAP measures can be found on our website www.potlatchcorp.com as part of the webcast for this call.
I would now like to turn the call over to Mike Covey, our Chairman and CEO, who will make some introductory remarks and then I’ll review our third quarter results in more detail. Mike?
Mike Covey
Thanks Eric, good morning. Let me begin by stating that business conditions in each of our three business segments are better than one year ago.
Moreover, for our largest business segment Resource, operating income margins improved 1% over the second quarter and was higher than any quarter since Q3 2008. Log prices and demand have held steady since the second quarter especially in Idaho despite a downturn in lumber prices following the unexpected run up and prices earlier this spring.
There are a few bright spots as we look at the macroeconomic environment for wood products. Offshore demand for lumber and logs is increasing, which support stronger pricing in Idaho.
The Canadian dollar remains strong and the mountain pine beetle epidemic in British Columbia is slowly impacting the supply chain. However, it is becoming increasingly clear that housing starts will languish until job creation improves and the backlog of existing homes for sale is reduced.
Until that time, we expect the wood products industry to operated approximately two-thirds of capacity with little price improvement likely to occur in lumber, plywood, and OSB. With that overarching theme in mind, we start fourth quarter with little optimism that business conditions are going to improve meaningfully over the winter months.
However, customer demand is adequate to maintain our current rate of harvest, which we expect to be around $4.1 million to $4.2 million tons for the year, which is well below our maximum sustainable harvest rate. We will continue to defer our sawlog harvest through the fourth quarter of 2010 and most likely into 2011 and reevaluate business conditions next spring.
Before Eric comments on variances and the key drivers behind our Q3 results, let me comment on our balance sheet and the dividend. After closing on the final phase of the land sale to RMK, an Atlanta-based TIMO, earlier this month, we now have a cash balance of approximately a $105 million.
Combined with the completely undrawn revolver as well as expected 2011 earnings in cash flow, we have confidence we can support our current $2.04 per share annual dividend. In fact this past quarter, we generated funds available for distribution or FAD of approximately $44 million, well above our quarterly payout of approximately $20 million.
Similarly over the past 12 months, we have generated FAD of approximately $78 million compared to our dividend payout of approximately $81 million. We continue to be creative about finding ways to generate cash to cover the dividend.
While we are disappointed that the recovery in housing starts is not imminent, nor does it appear that it will be robust, we expect a stronger demand, higher pricing, an increased harvest levels will more than cover our dividend, once the housing recovery is further along. Nonetheless, our board reviews our dividend, our financial position, and our outlook each and every quarter.
I will now turn the call back to Eric, comment on the third quarter results.
Eric Cremers
Thanks Mike. As shown on slide 3, of the slides accompanying this presentation, we reported third quarter 2010 earnings from continuing operations of $18.2 million or $0.45 per diluted share.
This compares to earnings from continuing operations of $46 million or $1.15 per diluted share in the third quarter of last year. As a reminder, our year ago results included a timber deed transaction on about 50,000 acres in Arkansas which provided $1.04 of EPS impact.
Excluding this transaction, EPS in the last year’s third quarter would have been $0.11. Note that in my review of our quarterly results, I will exclude the impact of the timber deed to make comparisons more meaningful.
I’d now like to review our third quarter results broken down by segment. As shown on page 4 of the webcast slides, our Resource segment results for the third quarter of 2010 were significantly better than the second quarter of this year and versus the third quarter of last year.
Operating income in the third quarter totaled $24.3 million compared to $15 million in the second quarter and $13.9 million in the third quarter of last year. The primary driver behind the sequential earnings improvement was higher harvest volumes although the driver behind the year-over-year improvement was due to both volume and pricing.
Our Resource segment had its highest quarterly operating income since the third quarter of 2008. Slide 5 highlights harvest volume and pricing trends for the Northern Region.
Sawlog fee volume was up 25% comparing the third quarter of 2010 to the third quarter of 2009 and was up 86% sequentially. The year-over-year harvest volume improvement is driven by firmer demand for sawlogs and the sequential improvement is driven by the fact that harvesting activity is limited in the second quarter due to the snowmelt in the Northern region.
Sawlog pricing in the Northern region was up 15% year-over-year and increased 1% sequentially. The sequential price improvement for Northern sawlogs was primarily driven by a product mix shift towards higher valued cedar sawlogs.
Regarding pulpwood in the Northern Region, harvest volume was down 42% year-over-year and was up 22% sequentially. Pulpwood remains under pressure in the Northern Region due to the closure of two mills in the Pacific Northwest, with pricing down 6% year-over-year and down 1% compared to second quarter.
Slide 6 highlights harvest volume and pricing trends in the Southern Region. Sawlog fee volumes in the third quarter of 2010 increased 26% from the third quarter of 2009, and increased 10% sequentially.
Sawlog pricing in the Southern Region slipped 5% compared to the second quarter, but is 9% higher than the third quarter of last year. The sequential drop in Southern sawlog pricing is due to the drop in lumber pricing.
Pulpwood volume in the Southern Region was up 9% year-over-year and up 22% sequentially. Pulpwood pricing in the Southern Region was up 13% year-over-year, but fell 6% compared to the second quarter as the effects of the wet spring weather began to wear off.
Next, I’d like to review our real estate business. As shown on slide 7, our real estate segment closed sales totaling $32.3 million during the third quarter up from revenues of $10.5 million in the prior quarter and $5.6 million in last year’s third quarter.
In total, we have 30 real estate transactions in the quarter consistent with our historical results. Slide 8 highlights operating income from our real estate segment and as you can see, we had $9.8 million of operating income in Q3 compared to $5.1 million in the prior quarter and $1.5 million in last year’s third quarter.
Slide 9 highlights our real estate sales by product type. As you can see, we sold nearly 44,600 acres in the quarter, made up of approximately 42,800 acres on non-strategic timberland, 14000 acres of rural recreation land and 400 acres of HBU.
The non-strategic timberland sale is the first phase of the previously announced deal with the TIMO RMK and which we sold them approximately 29,800 acres in Wisconsin and approximately 11,900 acres in Arkansas for nearly $29 million. Phase II of this deal, which includes approximately 29,000 acres in Wisconsin and 17,400 acres in Arkansas recently closed and will boost real estate revenues by approximately $36 million in the fourth quarter.
Slide 10 highlights price trends for our real estate business broken down by product type. As you can see, rural recreational land pricing is stable and continues to sell for $12,000 to $13,000 an acre.
HBU land pricing is also stable at around $2000 an acre. As expected, our wood products business rolled over in the third quarter resulting in an operating loss of $600,000 is shown page 11 of the presentation.
Although our wood product segment and operating loss in the quarter, it’s still $1.4 million of positive EBIDTA. As shown on page 12, lumber prices declined significantly in the third quarter and this decline in pricing was the primary driver behind the downturn in our wood product business.
Returning to slide 3 of the presentation, corporate administration including interest expense totaled $12.9 million for the third quarter compared to $13 million in the second quarter and $14.8 million in last year’s third quarter. Net interest expense totaled $6.5 million in the third quarter compared to $6.7 million last quarter and $5.1 million in last year’s third quarter.
We booked a $1.6 million tax provision in the third quarter as a result of the non strategic timberland sale. It is important to know that this tax provision is non-cash as the land sold was sold out of our taxable REIT subsidiary at a gain and that gain will be offset by NOLs we have in our taxable REIT subsidiary.
EBITDA totaled $56.4 million in the third quarter versus $63 million in last year’s third quarter, and $33.1 million in the second quarter of 2010. As a reminder, last year’s third quarter result includes the timber deed sale, which provided $48.6 million to EBITDA.
Excluding the impact of the deed, EBITDA was $14.4 million in last year’s third quarter. Next, I’d like to make a few comments about our balance sheet and liquidity.
We finished the third quarter with $71 million of cash and short-term investments on our balance sheet and have just $5 million of near-term debt maturities. Furthermore as Mike indicated, we currently have over $105 million of cash in short-term investments on our balance sheet, which is as high as I can recall it’s ever been.
Our debt covenants are in great shape with debt to capital approximately 53% and interest coverage is at a very healthy 4.3 times, significantly higher than the covenant requirement of 2.5 times. More importantly, our net debt as a percent of our enterprise value is just 18%, which is a relatively conservative amount.
Finally, I’d like to make a few comments about our outlook for the fourth quarter. While it is still early in the quarter, our expectation is that our wood product segment will operate with a modest cash loss in the quarter.
Though, we do not expect it to return to poor results seen in the fourth quarter of 2008 and the first quarter of 2009. As a side note, given the relatively weak outlook for housing starts, we have recently executed two lumber hedges in our wood product segment at prices roughly 10% higher than the current cash market.
These hedges will serve as an insurance policy should higher lumber prices not materialized over the next year. In our Resource segment, the fourth quarter will see the typical seasonal slowdown as winter weather moves in and makes harvesting more challenging for our Northern Region.
We are still deferring sawlog harvest volume given the weak market conditions. As Mike indicated, we expect to finish the year having harvested total of 4.1 million to 4.2 million tons during 2010, well below our potential of about 4.7 million tons.
We expect some modest softness in pricing in parts of our resource business in the fourth quarter. In sawlogs, we expect pricing in the north to be down perhaps a $1 or $2 a ton driven by product mix.
In comparison, southern sawlog pricing should remain relatively flat. In Pulpwood, we expect northern region pricing to be relatively flat with Q3, but expect Southern pricing to be down perhaps a $1 or $2 a ton from Q3 when pricing was still relatively elevated due to the wet weather we experienced in the spring.
Our real estate business continues on a remarkably steady pace as we closed 30 to 40 transactions per quarter over the past several years. We don’t expect that trend to change nor do we see material weakness in the demand or price of our rural recreation real estate or HBU prosperities.
We continue to be approached by people interested in buying our non strategic timberland. Setting aside Phase II of our non-strategic timberland sale to RMK here in the fourth quarter, we expect to complete another 30 or so transactions this quarter with typical size, price, and land basis characteristics.
Finally, let me take the opportunity to mention that Mike and I will be attending and presenting at the NAREIT Conference in New York on November 16th and 17th. If interesting in meeting, please give us a call.
[Chasidy], we’ll now take questions from participants on the call.
Operator
(Operator Instructions). Our first question comes from the line of Chip Dillon with Credit Suisse.
James Armstrong - Credit Suisse
This is James for Chip. On the West Coast market, we’ve have been hearing differencing reports from your competitors, one reported much stronger pricing and one reported weaker.
Is this mainly driven by exports? More importantly, are you seeing export pricing up from domestic pricing?
Michael Covey
In Idaho which is as far west as our land ownership pattern goes, we don’t participate directly in export market. I can’t comment on that.
It’s not a market we serve. From what we read and here in trade publications, log demand from Asia, China, Japan, and Korea appears to be strong, weak dollar certainly helps that.
We do see evidence that log prices have gone up over the last year largely driven by the export log market.
James Armstrong - Credit Suisse
Switching topics real quick, on biofuels are you seeing any major projects in the regions that you have land in? If you are seeing projects, are you seeing any increase in localized pulpwood pricing and maybe even sawlog pricing in those regions?
Michael Covey
In our operating regions, there are no installed or new biofuel related projects either for pellets or to burn biomass for electricity. There are several on the drawing board, a number of companies still continue to explore opportunities, but to my knowledge there are no really kind of shovel-ready projects.
As a result, we have not seen pressure on any product prices from demand in our operating areas.
Operator
Our next question comes from the line of Gail Glazerman with UBS.
Gail Glazerman - UBS
Looking at Real Estate, I just wanted to dig into the comments you made about no real change in demand patterns. A couple of your competitors have noted maybe a little bit more hesitancy from buyers, the small buyers in the third quarter.
Did you really not see any of that in any of your markets for real estate?
Eric Cremers
No Gail, this is Eric. We really have not seen a slowdown in the real estate business.
As I mentioned, we had 30 transactions in the third quarter, which is typical for us and our expectation is that we’ll have about another 30 transactions or so in fourth quarter. Really didn’t see a slowdown.
Gail Glazerman - UBS
Eric, you mentioned some comments about interest in some of your non strategic land. Can you just remind us after the second phase of the most recent land sale closed, how much non-strategic land you have left?
Eric Cremers
Yes, it’s around 25,000 to 35,000 acres across the company after taking into consideration the sale to RMK.
Gail Glazerman - UBS
Following on that line, Mike or Eric, can you guys comment about what you’re seeing from TIMOs and if you look back a couple quarters there was a lot of news about incremental cash going into the TIMOs, but we haven’t really seen them deploy much recently. Do you have any sense of kind of what’s going on there?
Michael Covey
Our conversations with TIMOs as they continue to approach us and I’m sure other companies like us for non-strategic timberland sale availability that’s kind of in the $50 million to $100 million range is kind of the sweet spot. There have not been a lot of transactions.
There is a couple that we’ve heard that are under consideration around the country, but there is not lot for sale. The money is still there, it just hasn’t been placed.
Gail Glazerman - UBS
Just one last question. Eric, can you give us a sense of what the land basis would be for the sale that completed in the current quarter and how that might have compared to the prior quarter?
Eric Cremers
Are you talking about is it total, the total mix was around 65%, 64% in the third quarter, we expect that to drop a little bit about 60% or so in the fourth quarter.
Operator
Our next question comes from the line of Michael Roxland with Bank of America Merrill Lynch
Michael Roxland - Bank of America Merrill Lynch
Just one quick question on Phase II, can you just remind us what the value per acre were for the separate pieces for Wisconsin and Arkansas, and if you could also provide the basis for each of them?
Michael Covey
What we know Michael, is the sale price is around $36 million for the two different parcels and is spread over total of 46,000 acres, 29,000 of which is in Wisconsin and 17,000 of which is in Arkansas. This is RMK’s math, not exactly ours.
Our view is that price per acre is probably in the 450 kind of range for Wisconsin and may be in the, I don’t know 1,350 or so, 1,400 for Arkansas. The book basis, to answer the second part of your question, it’s around $20 million for Wisconsin and around $2.3 million for Arkansas.
Operator
Our next question comes from the line of [Dan Cooney] with KBW.
Dan Cooney - KBW
Back on to the dividend, one of your peers laid out a pretty bare scenario for housing starts, guess earlier this week about 700,000 next year, five years to normalize. I mean, one, would you say that you kind of agree with that outlook, and how do you kind of approach the dividend under that scenario?
Thanks.
Michael Covey
Our view of housing is the recovery is playing out slower than we anticipated certainly a year ago, but to set the expectations are the foundation of our discussion about the dividend we’ve always believe since the downturn that we could weather the downturn and hope the dividend at a current level defer harvest and then when the housing recovery happen we pick harvest levels backup and we’d more than support the dividend, if not the generating excess cash flows. We did not want to whipsaw investors by reducing the dividend only to turnaround around and raise it back up.
That’s been the premise of our reason to hold it for these last really two years. Our expectation now is probably something in the order of 700,000 housing starts next year that’s based on a consensus of estimates from the number of economists.
We think that housing starts could be up to a million by 2012. We do not think that housing starts maybe get back to a million and a half or close to that in order for us to see price improvement and therefore volume improvement in our business.
The key driver is what is the demand capacity ratio in the wood products industry in North America. We think that’s currently, as I said earlier, about two-thirds of probably operating at 66% or 65% of capacity today.
We need to see it to get 75% or 80% demand capacity ratios where there tends to be more pricing power in the lumber business and we’re optimistic that our housing start level around a million starts in 2012 we’ll begin to see that.
Dan Cooney - KBW
Just switching gears a little bit. On the remaining 1,200 acres in Wisconsin, I mean do you guys have a feel for the kind of pricing you’d expect to get on that over the next three years?
Would it be comparable to the RMK deal?
Eric Cremers
No, it’d be better than the RMK deal. We held back some of the highest potential real estate in Wisconsin to sell as a real estate play either as HBU or as rural rec.
You can look at the historical numbers we’ve gotten for those two product types, and that’s what you could assume that we get those acres.
Michael Covey
Over the last, I don’t know, two or two and a half years that we owned Wisconsin we sold around 18,000 acres in kind of traditional HBUs, small rural recreational land sales. The price of those transaction is typically was between a $1,000 and $1,500 an acre.
Operator
(Operator instructions). Our next question comes from the line Steve Chercover with D.
A. Davidson.
Steve Chercover - D. A. Davidson
Can you remind us, have you indicated in your Q2 call what the land basis of the RMK deal was going to be?
Eric Cremers
What I indicated back at the last call was that we expected land basis to be about 65% for the back half of the year for Q3 and Q4. Obviously the basis is going to bounce around a lot a bit depending upon what gets transacted.
We came in around 64% for Q3, 64.5% something like that, and our expectation is, as I said, 60% for Q4. We’re in the ballpark.
Steve Chercover - D. A. Davidson
I might have missed this or misheard it. Did you say you only had 25,000 or 30,000 acres of non-strategic timber left?
Eric Cremers
That’s correct.
Steve Chercover - D. A. Davidson
Would we say thereafter that if you continue to sell land, you’re starting to cut into muscle instead of flab?
Michael Covey
Steve, this is Mike. Almost all the transactions that we’ve done had a combination of both land that was stratified in ‘06 be a non-strategic and occasionally some sprinkling of core HBU included with it.
This RMK transaction is no different. It had a combination of all land types in it.
Yes, generally speaking we’re down that what we’ve identified is around 25,000 acres in non-strategic land remaining in the company, that we did identify to sell over a decade beginning in ‘06, we’re about completed with that. If we do so more land it would have more of the core moniker on it.
If it wasn’t already identified as real state or HBU property and then we would have to look at what the company’s harvest levels and are we cutting into muscle.
Steve Chercover - D. A. Davidson
Final question then, if you do start to sell some of your core timberlands, will you not only use it to support the dividend, but perhaps use it to repurchase shares and address the overall capital structure, if you believe that your shares are discounting significantly lower values per acre?
Michael Covey
There is a lot of hypotheticals there. We’ve not had a discussion with our board about selling land that’s non-strategic so that I don’t want to get the cart before the horse.
Our current view is we’ve identified land that to be sold there was non-strategic we’ve execute on most of that. We have over a $100 million on the balance sheet, which we have stated for sometime we would use to help support the dividend through the downturn until we work out the other side.
Capital allocation is always the discussion for the board about the best use of proceeds. We don’t have any looming debt maturities.
Share buybacks and other things are clearly an option. Our highest priority at this point is the dividend.
Operator
Our next question comes from the line of Mark Weintraub with Buckingham Research.
Mark Weintraub - Buckingham Research
Just first following up a little more on the 25,000 or so non-strategic lands that you still have, would those primarily be in Minnesota now or what location would those lands be?
Michael Covey
There mostly in Idaho.
Eric Cremers
Mark, just to clarify, it’s 25 to 35 is a bucket.
Mark Weintraub - Buckingham Research
That would be in Idaho. Presumably, even though they are still non-strategic they have quite different characteristics than the Wisconsin lands that were sold and presumably would typically have higher timber stocking, etcetera, is that fair?
Michael Covey
Yes, that’s correct.
Mark Weintraub - Buckingham Research
I was interested to hear you were talking a little bit about the hedges on lumber that you had put in place. I mean one of the things that’s been noticeable is that the future’s markets have been running fairly different day-to-day than the cash markets.
Do you have any thoughts as to why that’s the case and how this all figures into perhaps your hedging strategies, etcetera?
Eric Cremers
Mark, you know that the lumber features contracts that you can go out and view on the CME are very thinly traded. It’s hard to view that pricing has been realistic for hedging, a significant portion of production.
Because there’s so thinly traded, they’re very volatile. We started with an outlook for what we think next year is going to look like which given all the foreclosed homes hitting the market, given the relatively weak job market, we don’t expect housing starts to be overwhelmingly robust next year.
In that kind of environment, it’s hard to see wood product prices, lumber prices in particular, moving up significantly from where they are today. We put on two different lumber hedges totaling about $47 million board fee covering volume over the next 13 to 14 months.
The prices that are about 10% higher than today’s cash cost. We built the budget around relatively or in the process of performing a budget having a view that lumber prices are not going to move up much from today.
If that’s the case putting on a hedge at prices 10% higher is basically an insurance policy for wood products business. That’s how we think about it.
Mark Weintraub - Buckingham Research
Presumably, you did that in a privately negotiated transaction with a financial institution?
Eric Cremers
That’s correct. It wasn’t a financial institution, but it’s a significant commodity trading firm.
Mark Weintraub - Buckingham Research
There’s just I believe you got a tax holiday on the built-in gains tax for next year, why not slip some of these transactions and even if conceivable the RMK transaction into next year so as to free you up on the tax side?
Eric Cremers
The properties that we are selling to RMK are so down in our TRS today. The gain that we would realize on the sale of those transactions will just offset other NOLs that we have in our TRS.
There won’t be any cash taxes paid on the transaction. Certainly, real estate that we would be thinking about selling out of the REIT, we would be highly motivated to sell next year as opposed to 2012 for example.
We’ll certainly be looking to take advantage of that opportunity next year.
Operator
At this time, they are no future questions. Are there any closing remarks?
Michael Covey
No, thank you. We’ll look forward to talking to you at our earnings call in early February.
Operator
Thank you for joining today’s Potlatch Third Quarter 2010 earnings conference. You may now disconnect.
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