Packaging Corp of America (PKG) 2004 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter Earnings Conference Call for Packaging Corporation of America.

(OPERATOR INSTRUCTIONS.)

I would now like to introduce your host for today's conference, Mr. Paul Stecko, Chairman and CEO of Packaging Corporation of America. Sir, you may begin.

Thank you and good morning and welcome to Packaging Corporation of America's fourth-quarter and full-year Earnings Release Conference Call. On this call with me, as usual, is Rick West, our CFO; Bill Sweeney, who runs our corrugated products business; and Mark Kowlzan, who runs our mill operations.

Again, I'd like to thank you for participating, and as the operator just indicated, after the presentation we will take any questions that you might have, so let me get right into it.

Yesterday, we reported fourth-quarter earnings of $38 million, or $0.36 a share. And that excluded income of 17 million, or $0.16 -- excuse me. That included income of 17 million, or $0.16 per share from a dividend paid to PCA from Southern Timber Venture, a joint venture formed with PCA in November 2000, in which PCA holds a 31 percent ownership interest. During the quarter, Southern Timber Venture sold a portion of their Timberland holdings located primarily in Alabama and Mississippi. Excluding the STV dividend income, PCA's earnings were 21 million, or $0.20 a share. This compares to break-even fourth quarter 2003 earnings after taking a one-time after-tax charge of 10 million, or $0.09 a share; and that was to settle several benefit cost-related matters between PCA and Packtiv Corp., which dated back to April 1999 when PCA became a stand-alone company.

The $0.11 per share improvement in our quarterly earnings, again, excluding the 17 million from SPV, was the result of higher prices and volumes for both containerboard and corrugated products, which improved earnings by $0.25 a share. This increase was partially offset by higher wood, recycled fiber prices, energy and transportation costs, and labor and benefit costs, which, when combined, reduced earnings by about $0.13 a share. And I'll give you some details on each of these items later in the presentation.

Full-year net income for 2004 was 69 million, or $0.64 a share. And that compares to a loss of 14 million, or $0.14 a share, in 2003. Full-year 2004 earnings include a decrease of $2 million, or $0.02 a share, to our previously reported results for the nine months ending September 30, 2004, as a result of an understatement of the intercompany profit reserve for products held in inventory. The incorrect amount involved only the portion of inventory that was in transit from our mills to our box plants. And included in our press release is a table which shows this adjustment by quarter.

Our adjusted net income, again, as detailed in the press release, was $52 million, or $0.48 a share, compared to 42 million, or $0.40 a share, in 2003. The adjusted results for 2004 include -- excuse me -- exclude the STV dividend income recorded in the fourth quarter. The 2003 results exclude our third-quarter 2003 debt refinancing charge, and the benefit cost settlement in the fourth quarter. Net sales for the fourth quarter of this year were 493 million, that's up 14 percent, compared to the fourth quarter of last year. And full-year net sales were $1.9 billion in 2004, versus $1.7 billion in 2003.

Cash generated from operating activities remained strong in 2004, with 215 million in cash generated. Of this amount, 109 million was used for Capital Expenditures. And I think you recall we've given guidance at about 110, so we came pretty close. We ended the year with 213 million of cash on hand, and that's up 94 million from the end of the third quarter. And our long-term debt now stands at 695 million. We also reported that our Board of Directors has approved an increase in our common stock dividend to an annual rate of $1 per share. This represents a 67 percent increase from our current dividend of $0.60 a share.

And at yesterday's closing, PCA's stock price at 23.17, the new dividend would represent a yield of 4.3 percent. The first quarterly dividend of $0.25 a share will be paid to shareholders of record as of March 15, 2005 with a payment date of April 15, 2005.

I'd like to add with the current tax treatment on dividends, we believe that dividends are a very effective vehicle to return value to our shareholders. And we're pleased that we have been able to significantly increase our dividend after paying our first dividend only a year ago.

Turning now more to details in operations for the quarter: We saw continued very strong corrugated products volume, up 6.7 percent, compared to last year's record fourth quarter, which, by the way, was up 7.5 percent over 2002. Our October and November volume was about as we expected, up about 4.5 percent over last year; and then December just exploded, up 11 percent. And if you exclude our Acorn Packaging acquisition, December volume was still up 10 percent over last year, very strong. We were surprised by the strength of December. I did see a report out yesterday by the Fed referencing the so-called "Beige Book," which said that they had seen -- 11 of the 12 Fed regions had seen economic expansion between late November and early December, and that would certainly jive with the box-volume increases that we saw.

For the year, our corrugated shipments per work day were up 7 percent, compared to 2003. And just to give you a per-quarter breakdown, we were up 6.7 percent in the first quarter, 9.6 percent in the second quarter, 5.3 percent in the third quarter, and then 6.7 percent in the fourth quarter. So fairly consistent volume growth. The fourth quarter and full year 2004 volume does include Acorn Packaging, which we acquired in mid-February. Acorn's volume improved both the fourth quarter and full-year results by about 1.2 percent.

The strong demand we experienced in the fourth quarter was supported by good performance in our mills, which produced 599,000 tons; that's up 22,000 tons, or 3.8 percent from last year's fourth quarter. And for the year we produced 2,318,000 tons of containerboard in our mills, up 3.8 percent from 2003. Compared to last year's fourth quarter, price and volume improved earnings by about $0.25 a share. I just talked about our volume piece. And on the price side, linerboard prices as reported by Pulp and Paper, are up about $90 a ton compared to last year. On the cost side, compared to last year's fourth quarter, costs were up about $0.13 a share. Fiber costs were up the most, a total of $0.05 a share: $0.02 in recycled fiber and $0.03 in virgin fiber.

Energy costs were also up, reducing earnings by about $0.02 a share, primarily due to natural gas and fuel oil, which were up 13 percent and 18 percent, respectively, over last year for us. While gas and oil are a relatively small part of our purchased fuel mix, it still does impact our earnings.

Transportation costs were also up as a result of both fuel surcharges and having to truck more tons by truck versus shipping by rail; and transportation costs reduced our earnings by $0.03 a share year-over-year.

Finally, the cost of labor and benefits as a result of normal annual increases, as well as incentive bonus payments and higher medical costs, reduced earnings by about $0.03 per share year-over-year.

Our corrugated products pricing continued to improve over the third quarter, as we realized a full-quarter's worth of previously announced price increases. This improvement was partially offset in mix, as our fourth-quarter product mix is seasonally less rich than the third quarter. Our wood, energy, and transportation costs were also up slightly compared to the third quarter. And in the fourth quarter, we also spent over $500,000 to have the required audit and testing of the new control provisions of Sarbanes-Oxley performed by our independent auditors.

Looking back, 2004 turned out to be, I think, a fairly good year for PCA. First, we're very pleased with the acquisition of Acorn Packaging in February of 2004, which significantly added to our high-end graphics capabilities. Our corrugated products business continued to show very strong and consistent growth each quarter during the year. We implemented two price increases in both containerboard and corrugated products, and our mills ran extremely well during the year, which enabled us to support this strong corrugated products growth. This was possible in part because we did complete major projects at our Counce and Valdosta mills in the first quarter of last year that allowed us to run lighter-weight grades much more efficiently. And we're also, obviously, very pleased with the financial returns from our investment in Southern Timber venture.

Finally, we reached the position where we felt it was the right time to raise our dividend to an annual rate of a $1 per share, and we did.

Looking ahead to 2005, I remain optimistic about the general economy, as well as general industry conditions. The dollar is even weaker than I think most people would have guessed a year ago. I think a weak dollar has generally been very positive for our industry. During the first quarter of 2005, we will make a change in our paper machine alignment that will not affect our total capacity. We will start up our number one machine at Filer City, and then shut down our number three machine at Tomahawk. While Tomahawk overall has a lower average cost than Filer City, the incremental costs are lower at Filer City, due primarily to transportation costs and fiber costs. We expect this move to save us about $3 to $4 million annually.

During the first quarter, as is normally our practice, we will be taking our Counce and Valdosta mills down for their annual maintenance outages, which will lower our production and increase our mill operating costs in the first quarter. The effect of these shutdowns will lower first-quarter earnings by about $0.06 per share. And I should point out that our Counce shutdown is a little longer this year than normal. Both wood fiber and energy costs are also generally higher because higher pricing in the first quarter; and in the case of energy, usage with colder weather will also increase our operating costs. Considering all of these items, we currently expect first-quarter earnings to be about $0.12 a share, and that would represent an $0.18 per share improvement over last year's first quarter.

With that, we would be happy to entertain any questions, but as always, I must remind you that some of the statements we've made on this call constituted forward-looking statements. These statements were based on current expectations of the Company and involve inherent risks and uncertainties, including those identified as risk factors in our Annual Report on Form 10K and our Form S4 Registration Statement filed with the SEC on October 3, 2003. Actual results could differ materially from those expressed in these forward-looking statements.

So with that, I would ask the operator to please open up the line for any questions anyone might have.

(OPERATOR INSTRUCTIONS.)

First question comes from Mark Weintraub from Buckingham Research.

What I guess I'm trying to fully understand is the impact of the maintenance shuts. And If you could kind of walk through a little bit of how that gets to $0.06. And are there impacts later in the year when you shut Filer City or Tomahawk?

Yes. Historically, when you look at the costs of the shutdown, it's the work you do and the tons you don't produce, obviously; so you've got two types of costs. Last year, for example, we estimated the cost of that shutdown being about $0.05 a share. This year it's $0.06 a share because it's a bigger shutdown; it's longer; it involves a few more tons. And we're doing some work at Counce to be able run even lighter-weight grades on our number one machine. We don't run any 35-pound on number one. We want to have the flexibility and capability to do that, we could not get down below 42. We'll be able to do this after this outage, but it delays it a little bit.

And that's been fairly constant for us. The shutdowns could cost anywhere from five -- the linerboard shutdowns in the first quarter from about $0.05 to $0.07. And we like to highlight the people, because that does make our earnings, if you will, a little lumpy over the year, because we take, you know, about a 9 percent -- our historic decline, if you look at the last four years, has been about $0.09 a share between the fourth quarter and the first: about $0.06 in shutdown costs and about $0.03 in other seasonal costs.

It's a much, much smaller effect when you get into our medium mills. For one reason is, we only take out about one-fourth as many tons in the medium shutdowns. You only lose about one-fourth as many as the linerboard shutdowns. And again, the medium mills are not as elaborate as a linerboard mill in terms of recovery boilers and all the chemical processing. So typically our second-quarter costs for Tomahawk and Filer City are on the order of a penny or maybe a little bit over a penny. Much, much smaller than our linerboard outages.

Would it be fair in looking from fourth quarter to first quarter to assume that built into your expectation is roughly $0.09: $0.06 from the shuts, another $0.03 from seasonal?

That has been our historic pattern and that's pretty close.

Should one anticipate that there will be some modest improvement in pricing if certain contracts rollover or what have you?

Yes. Let me just elaborate on that a little more. We are going to get some price and volume improvement in the first quarter compared to the fourth. That's our projection, at least, so maybe, $0.02, $0.03 would be a rough guess. But on the negative side, the things that we have annually, about $0.06 will be the shutdowns, $0.03 in seasonal costs; that would be higher energy, higher wood, higher transportation expense. Historically, the fourth quarter, the tax rate is a little lower. Our tax rate in this fourth quarter, excluding STV's, a little over 34 percent. And that tax rate usually costs us about a $0.01 also. We have that in the fourth quarter as you true up things. So we'll pick up about $0.01 in tax rate.

There's two less days in the first quarter than the fourth quarter this year, so that's a $0.01. And you add that all up, you get roughly $0.11 or so, may be $0.02, $0.03 in volume; you get to about a $0.09 swing. And that's been a fairly consistent number.

And then for the second quarter, all else equal, you'd expect to get everything back, except, I guess, $0.01 for the shutdowns and the tax rate, $0.01 on the tax rate; is that fair?

That's fair.

Then lastly, just on cash-flow drivers, can you update us on ranges, at least, for where cash taxes might come out on a percentage basis; and just the DD&A and Cap Ex, just tell us what those numbers will likely be.

Yeah, I'll let Rick get into that. But in general, the tax rate is a direct function of earnings. We do have some loss carry forwards. So depending on the earnings, that tax rate can vary. But I would say that rough numbers, somewhere this year between 5 percent and 15 percent, 16 percent, would be the range. And that's going to depend on earnings. So it would be 5 percent; so let's call it 15 percent to keep it in round numbers. Cash tax rate.

Rick, were you going to talk about DD&A?

Yeah, DD&A, Mark, would be about 160 million; and we would expect Cap Ex to run at about the 110 range, maybe 115 for the year.

Our next question comes from George Staphos from Banc of America Securities.

Maybe one last question on the 4Q-to-1Q bridge. Last year, if I remember and did the numbers right, it was about a $0.09 swing sequentially, but I kind of remember the Pactiv contract being around $0.02 or $0.03.

Last year was a $0.15 swing.

I'll go back and check my numbers, but I thought you did $0.09. $0.00 -- okay, I see what the issue is.

That's $0.15. Trust me.

I got you. We were talking about it last night. On the maintenance accounts in Valdosta, taking a little bit longer this year, is any of that related to getting any inventories out of the system, or is it purely driven by what you need to do on light-weights?

No. I'm happy to say our inventories are pretty close to where I want them to be. I probably wish I had a few more tons, but I think "few" is the operative word. If it was the normal shutdowns, we probably would have hit it right on.

But no, we're just doing some work that requires a little more time. And that's the only reason. It is pouring concrete and do some things that have to cure. We actually took a machine down for a couple of days to pour some concrete, so that it would be fully cured by the outage; but we did have to take a little downtime to do that, and that's included in this year's plan. So it's nothing out of the ordinary, except the work we're doing takes a little more time. And -- but not a lot more, but a little more. So, it's only a $0.01 more, as I said on an earlier caller. It was about $0.05 worth of downtime last year; it's going to be about $0.06 this year. And Mark Kowlzan is sitting here, and I will say, that $0.06 is predicated on him starting his mills up like a top, like he does every year. So that's also assuming good startups. And we're doing a lot of work on that Counce machine, so it's going to be critical we start that up well.

Paul, in the quarter, obviously the mills ran well; variable costs were up. How did you do on the converting side at the box plants? Was there any negative variance there or were those, in aggregate, were those running well in the quarter?

I think we ran typically. I think we did get a little more overtime cost this year, because of the volume fooled us a little bit in December, so some of our overtime costs were up. And then the other problem in the box plants, unfortunately for box plants, they can't burn bark and they don't have a recovery boiler. These poor guys have got to run natural gas and oil as fuel. So our energy costs are up in the box plants much more so than in the mills. The good news is the box plants only consume about 15 percent of our energy. So at least it's on a smaller number. But our energy costs were up in the box plants.

Couple of last quick ones. On pricing sequentially we kind of calculated that maybe you got another $4 or $5 per ton adjusting for mix. Would you agree with that fourth quarter versus third quarter?

We'll have to run -- hold on. You may be a touch low, but you're close.

Okay. And on SG&A, Paul, that moved up probably higher in the fourth quarter than you were seeing in the full year. What was driving that? I mean, that was probably Sarbanes-Oxley but --

That's a little bit -- you know, our -- you know, we accrue for bonuses, and that picked up during the year. When you lose money in the first quarter, you don't accrue a lot for bonuses. As you do better you accrue more. So some of that is in those costs. And they're the main driver. And then selling expense was up a little bit also, and salaries are up a little bit. But, again, that's normal through the year. People get promoted, raised, things of that nature. snd relocation expenses.

Last one, Paul, and I'll turn it over. Transportation has been an issue for the industry and basically for the economy. Do you think there is excess inventory in the system that will ultimately have to be worked off, or do you see it more as a demand opportunity in that people are having a tough time getting tons, they have to carry a little bit more in the way of inventory; so, if anything, that means your demand picks up over the course of the year?

That's an excellent question, and I really should have spent more time on that whole subject in my presentation. And that's one of the reasons we made this paper machine swap, by the way. We used to have a number three years ago; it was Bill Sweeney's number. He runs the boxes. And what he needed -- what was the optimum inventory? And we ran at that number and we performed quite well. I will tell you today that number is 10 percent higher than it was three years ago, because of transportation inefficiencies in both the rail and lack of trucks. As the economy expands, that has put pressure on the trucking system. So we feel that in order to run this business, optimally, we need 10 percent more inventory in our system than we needed three years ago, because the cost of carrying that inventory is very small compared to the additional transportation expense you run into if you don't have that buffer. And I don't know that that's true to everybody, but I would be surprised if I'm the only one affected by this.

One of the reasons that we swap machines and shut down -- we are going to shut down that machine at Tomahawk is that transportation has become a problem incrementally. There have been huge increases in rail costs, short-haul rail costs in the state of Wisconsin. I think that problem is going to have to be dealt with. And we've had to go to even more trucks. The cost, that incremental truck, is getting expensive. We've got much, much better transportation cost at Filer City, especially on an incremental basis. And transportation has been a big cost driver, one of the things that is inflating at a much faster rate than the general economy, and it's something that we're going to have to manage better, both in terms of carrying more inventory, making sure we optimize our rail/truck balance. In the case of Filer and Tomahawk, we've actually -- the main driver for that switch is we've got much lower transportation costs out of Filer City. Right now, transportation is our second biggest cost, only fiber cost is more.

Our next question comes from Chip Dillon from Smith Barney

Listen, I had a question, the main question I have on my mind is -- I was just hoping that you would tell us that volumes in December didn't collapse like UPS and Georgia Pacific has inferred and what's interesting about what you're experiencing is the exact opposite. We're sort of on the edge of our seats wondering how the first part of January looks so far.

Well, obviously, I can't speak for other companies. I only know about us. But I would say, I only read that our volume did jive with that report that came across the AP yesterday and said that the Fed's reporting improved economic activity in this period. So we're in concert with that. And we're also in concert -- the report said the beginning of January. Our -- we have -- and I got it put a little bit of a disclaimer in here just so you understand the information. Our beginning January volume is very strong. And it's probably -- the numbers probably are higher than they should be. You know, quite frankly, we're up about 15 percent in the first ten days. But some of our box plants worked a day that was an FBA shutdown day. We had volume; we had to run it; we worked. So I think our numbers, when you measure them, are a little inflated because we worked more days than the FBA calls workdays; but we had to work them because we had the volume. So if you --.

Did you work that same day last year?

No. No. No. We -- on the FBA days we were down. But we had to work some extra. We had to work -- and the number is coming down a little bit. So, you know, the numbers say we're up 15. I don't believe it. I believe we're up ten. But that's still not bad.

I don't mean to really parse this, but I would just ask you this: If you think about it, if you are up 15 percent in ten days and you had nine days a year-ago, then wouldn't you actually say you were only up five, because you've had 10 percent fewer days last year? Or am I being -- am I studying this too --.

Yes, you've completely lost me.

Well, you have one more day this year than last year, ten versus nine.

No, this is on a per-day basis. All the numbers I always give are on a per-day basis. Not total volume. In total volume, if there's one more day, it would be even more. But no, on a per-day basis, we're up 15; but we worked part of a day we shouldn't count. In other words, that extra day doesn't count in the number. You divide by one less day.

So I just did what you did to adjust the per-day number. I'm saying, hey, although we're up 15, we worked one extra day that doesn't get counted in the numbers; I've got to take 5 percent off of that. We didn't work all of our plants, but we worked some of them. So this number is kind of hard to just take it this year, because we worked some of our plants on a day you're supposed to be down. My gut feeling is we're up about 10 percent.

When you look at the progress we saw last year with pricing, two price increases, first of all, again, it normally does take time to see that in the numbers. And would you expect to have seen some of the normal things you see at the bottom like we saw in '94, where, maybe not in your case, but in other cases people had contracts that deferred or delayed them showing the full increase; and therefore, we might see even more in the first quarter? I don't know if you can speak to your company.

And then secondly, could you talk a little bit about the fact that much of the progress on pricing has been offset by these higher transportation and energy costs. And do you think that, to help offset some of those, that the industry is in strong enough shape to maybe see a price increase in the next six months?

I can only comment on our company and the nature of our contracts with regard to delay pricing. We tend to have smaller customers, more dispersed product base, compared to many of the big integrateds. So we tend to historically, I think, move things through a little quicker, and we don't have many real long delay ones. I did report last quarter that we did have several contracts, but a small number that would kick in annually. Again, we have very few of these. But we do have some contracts that the pricing will go up January the 1st. But of any significance, you can count the number of these on one hand. So very, very small.

You know, with regard to what you said on cost, you're absolutely right on. Pricing's moved up, you know, roughly in paper about 35 percent. And it really, compared to things like plastic, resin, steel, et cetera, that's a small increase in terms of inflation compared to some of these other commodities. And we have experienced inflation, primarily in freight, energy, and wood costs, which has taken away some of the value of some of these price increases. But again, the historic -- I only speak of history. The history in this industry has been that pricing has correlated much, much stronger with supply and demand balance as opposed to the change in cost elements, you know, like the steel industry has been able benefit from with surcharges and things of that nature.

This industry historically has not been a surcharge-type industry. Its dynamics have revolved around supply and demand. Although I must say with this Fed report, as I said on a call, I'm feeling pretty good about the future in terms of what could happen, especially with the dollar in terms of demand and supply.

Our next question comes from Edings Thibault from Morgan Stanley.

First of all, congratulations on the dividend increase. I think it speaks well of your commitment to shareholder value. I think you guys are definitely leading the industry in that one, so let me preface my comments with some congratulations there.

But I would also like to talk about sort of the timing of the machine switch on the medium side. Is that going to occur -- that restart going to occur when you take your annual maintenance downtime?

No. What we've done is, we're going to, well, in the next week or so, try to -- I shouldn't say -- we're going to successfully start up the number one machine at Filer. Mark Kowlzan is laughing here. That machine has been down five years. We've kept it in good shape. But we're going to be running water through it; we're going to do some things, check out all the systems and get it up and running. That may take a couple of weeks. We're not sure. We may -- typically, when a machine is down five years, you may have some bearing failures, et cetera. So getting it up, as Mark points out to me, getting a machine up after five years isn't child's play. It requires a little bit of work.

Once we get that up and running and feel comfortable of its reliability, then we will take down the other machine at Tomahawk, the number two machine; and thatdate will be, again, probably towards the end of the first quarter sometime, unless Mark really starts that machine up without any bumps at Filer, which would nice.

Does that mean -- you mentioned before, 3 to 4 million in incremental savings. Does that really -- do you think that really begins to contribute to the bottom line really in the second quarter or do you think --?

I think, yes. I think we'll probably get a half a year's worth of it this year, in rough number. Because we're going to have some costs. We're going to have a few maintenance problems starting that machine up, et cetera. It's not problems, but you never know about mechanical reliability in something that's been down five years. We feel pretty comfortable it's going to run, it's going to run well. We've had to hire a few people, so we have got new people running that machine at Filer. But we're fairly conservative in our estimates. Mark is on a hook for a half-year's worth of savings this year, and obviously 100 percent of the savings going forward.

And just as the, I guess, the converse of that, you say you're comfortable that all of these potential problems, or at least a realistic assessment of these potential problems is included in your one-quarter guidance?

Yes. Another thing I would point out, the other thing is that we're going to -- 110-inch rolls, that the new BHS corrugater is now basically 110 inch wide. We're going to run that machine -- the machine at Filer is 140 inches wide, but we're going to run basically 110 only and make a lot of 110s there. That machine that we're taking down at Tomahawk is only 85 inches wide. Obviously you can't make 110s on that machine. That's another plus for making this swap.

Finally, just one of the issues you've talked about is your ability to produce more light-weight tonnage. Can you talk about the impact that's had on your integration levels? I mean, your box plants have been selling well; the box growth well ahead of your tonnage production growth. How much of that is due to, let's say, increased light-weighting in (indiscernible) the ton and the Delta between the board feet on the box side and the tons produced on the mill side, and how much of that is due to your -- or what has that done to your level of integration? Has it increased or has it decreased?

What's happened to us is one of the numbers that surprised me, actually, I looked at this about nine months ago, is that our volume was up, like, 7 percent and our integration level was only up 2 percent. The first question I had was, I don't understand this. And as you got into it a couple things are happening. Obviously the mills have produced more. But when you go to a lighter weights, you make more feet, but less tons. And, of course, that hurts your integration level because let's say you make more feet at the same ton, put it that way, so that hurts your integration level.

The other thing that happened to us this year, because of the paper shortages, we bought a fair amount of paper on the outside in order to support our growth. And, you know, we got to periods last April, May, June, where our inventories were dangerously low. And so to be 100 percent certain that we would not let any customers down, we did buy some paper on the outside that we hope we don't have to buy this year on the outside. And that will help our integration level this year. But it hurt last year. But we're still in the low 80s.

Okay. And then just one final note. What should we think about in terms of production goals for 2005? I mean, you're effectively running 100 percent in the fourth quarter of your rated capacity. Given the light-weighting, are we expecting any changes in the rated capacity?

Our production goals are to keep up with box plant growth. It's basically that simple. The changes that we're making in Counce will allow us to -- we won't really increase the tonnage that much, very little, but it will enable us to produce more square footage. We'll get a little more square footage on 35-pound off of number one machine, and it really -- the real reason is to give us the ability to make 35-pound. So we'll get a little incremental capacity, if you will. Not in tons, but in square feet.

Do you anticipate -- I mean, how much more room do you have there given the light-weighting? I mean we are, just as an example, we're forecasting pretty some robust box growth, close to, between 2 percent and 3 percent next year. Do you think you can keep the integration levels up? Or do you think if you end up continuing to run 5 percent, 6 percent in the box plants, effectively, that's more box sales but not necessarily more board or paper production?

We don't have that much -- we have a little bit of production upside, not a lot. If we get another year of -- you know, our volume was up 7 percent last year. If we're up 7, we will continue, then, to have to pull some tons out of the export market.

Our next question comes from Richard Skidmore from Goldman Sachs.

Had a couple of questions just on the revenue side as we look forward. As you just mentioned you had 7 percent volume growth in '04. You back out Acorn really closer to 6 percent, excluding that. As you look forward do you see that kind of potential in '05, assuming that the economy sort of holds in? And if so, do you have that much capacity in your box system currently or does that imply that you're going to have to grow some again in 2005 with additional box acquisitions?

You know, if we had 7 percent growth in demand in 2005, our box system could handle that. One of the things that we do do is even though we only spend roughly 75 percent of depreciation on Cap Ex, we spend over 100 percent of depreciation on Cap Ex in the box system, and we only spend about 60 percent at Cap Ex in the mill system. So we have been spending money where the real growth occurs, and that is in the box system. And that has enabled us to continue to grow our volume internally. And that's one of the reasons that we have, I think, enjoyed a very healthy and better-than-industry growth in our box systems. We have continued to put in new equipment, specialty equipment, do the things that can attract customers. So, yes, we would do that.

I would also say that our goal is to get our integration level from the low 80s to the low 90s. We don't think we can get there fast enough by only internal growth. I wish we could. I think that's the best way to do it. But we will continue to look for good acquisitions that will allow us to get that integration level up.

Okay. Can you just elaborate a little bit more on why you think that your box growth was greater than the industry? Was that more a function of the segments that you service or the extra added-value products that you're providing, or just opportunities because of some of the consolidation that's occurred in the business to just gain additional customers?

Not to sound cavalier, I think we're good at what we do, is the first reason. And secondly, I think we invest in that part of the business more aggressively than some others. And they would be the two things that I think have driven our box volume

Just lastly, if I might, on the cost side, you mentioned wood fiber prices. Can you talk about what you see there in terms of do you expect those to continue to move higher, to moderate a little bit, what you're seeing on the fiber side?

You know, what Yogi Berra said about making predictions -- they're only tough if they involve the future. So with that caveat, let me say, yes, we think they're going to moderate. They may -- I think up a touch or down a touch is the coward's way out to predict that. But I think looking at history is important here. It's been a strange year weatherwise. When you're in the paper business, you're kind of like a squirrel. You've got to put some acorns away for winter when logging conditions are difficult. And that's what we normally do -- the industry normally does. With the hurricanes, with the weather -- bad weather patterns in the spring of last year, we never got to build the inventory to the degree that we have historically going into the fall. So this fall we went in with low inventories, and we had to fight to maintain them. That means you got to go out longer distances to get wood, and wood is a very freight-intensive product. It cost more in freight than the stumpage when you go to the total cost of delivered wood.

So hopefully we'll get a run of good weather; we'll get some wood inventories back in normal fashion; won't have to go out as out as far for wood. I think if Mother Nature cooperates, wood situation could be maybe even a touch better. However, if bad weather continues, it could exacerbate the situation.

Our next question comes from Mark Connelly with Credit Suisse First Boston.

Just a couple of quick clarifications. First, you said you might want your inventories to be a little bit higher, but are they actually higher than Q3 end of quarter?

Yes. We picked up a little bit of inventory Q3 to Q4, which was essential, because we've got two major shutdowns in the first quarter that we've got to have paper for while both Counce in Valdosta are down.

And are inventories down versus last year going into the --

Our inventories are about the same.

Same versus last year.

Yes. Now, the problem with last year is, December was also a big month last year. So when we exited, December was a little less than we wanted, and that started our problems in terms of lack of inventory last year, and that's one of the reasons we had to buy some paper on the outside last year. But, you know, we're about the same, up maybe a few thousand tons. I think we're going to be fine.

Okay. And next question, you talked about the mix effect onto Q4, which we also heard about last year. Is there a similar negative mix effect in the first quarter around your shutdown at all?

No, not around the shutdown, but, you know, the -- I'm going to let Bill Sweeney -- he's sitting here -- comment about the display business, how it ends the year and how it starts the year in terms of seasonality. And that's the main driver; it's in the display and the high-end graphics business.

Bill?

Value-added business doesn't start until people start prepping for the summer and for actually the fall. So it comes into play about the beginning of the second quarter and picks up momentum going into the spring. So the first quarter is fairly similar to the fourth quarter in terms of mix.

And just two related questions, Paul. First, what was your short-term debt at the end of the quarter, end of the year? And also, you're sitting on a fair amount of cash right now; and I'm curious, what sort of a target level do you have for cash?

Rick has got the -- I think it was six --.

The short-term debt, Mark, we have the assets securitization revolver, which is our receivables was 109 million. It does not change. We keep that every quarter and just roll it ever every month. The second amount is our bank term loans, which are currently sitting at about, I think it's around 36 million. 39 million. Excuse me. But they're more longer term, because we don't have any payments for a couple of years. Then, of course, our 550 million in long-term debt.

As far as cash, you know, we ended the year at 213 million. That's where it's going to be. We normally, if you look at our history, we build cash in the fourth quarter, just because of working capital. Then we lose a little bit in the first quarter because of the shutdowns and some other things. So, you know, we make most of our cash in the third and fourth quarters picking up

And in terms of what we have, we don't really have a goal where to keep it. We watch where it's going, and we make some adjustments. But one of our objectives when we looked at this dividend and set it where we did, what we wanted to be able to do -- again, it's based on forecast projections, and you never know how these things are going to turn out. But we would like to pay a dollar and also do what we did this year, is finance any reasonable size acquisition out of free cash flow. Acorn Packaging was roughly 40 million. We didn't do any borrowing to buy that. We funded that out of free cash flow. So we'd like to be able to, at least, on a $40, $50 million acquisition, annual range, be able to be able to pay a dividend and fund those out of free cash. And so we need a little bit of free cash in case we make that acquisition.

Our next question comes from Mark Weintraub from Buckingham Research.

A quick -- two quick follow ups, if I could. First, on the Southern Timber Venture, could you give us a sense as to how much of the Southern Timber Venture got sold and how much might be left, and if there is an opportunity to realize some more value there?

As I said earlier, we're pretty pleased that we decided to participate in Southern Timber Venture. When we sold the Woodlands, we viewed the piece that we sold to them as the choicest piece, and that's one of the reasons that we did keep a little -- an equity stake in it. Just rough numbers, Mark, that thing started out with just under 400,000 acres. I think 390 is the number. In the first four years, they sold, you know, for higher value-added uses, about 80,000 acres of that. And of course, we did receive some payments, some dividends from them, four or five dividends over time from that. And then in December they sold the piece, you know, roughly 150, 160,000 acres. It was a fairly big sale. And the Southern Timber Venture now has roughly 150,000, 160,000 acres that they have that they own and that they manage. And, of course, we have a 31.3 percent equity interest in those remaining acres. So that kind of calibrates you on where they started and where they are. And we've obviously been pretty pleased with that association.

You're getting into this in the previous question from Mark, but can you just walk through again, how you came up with the $1 level for the dividend, what the thought process was.

I'm not really going to do that, Mark. It was a number that we felt was sustainable, and it would fit in where we think the economy is going, the Company. But to get into the nitty-gritty, it's just not something I want to do.

Our next question comes from Mark Wilde from Deutsche Bank.

Can we just come back to the cost issue? It looks like if you kind of back calculate from that $0.13 number that your cost per ton would be up between $35 and $40. A., how much of that do you think is permanent or semipermanent; and do you think that that's probably a pretty good number across the industry right now?

Again, I don't know. I think some of them are. Just, to give you a rough, rough look at this $0.13. As I said on a call, about $0.05 is fiber. So that definitely adds to our cost. About $0.02 is energy. Some of that is seasonal; some of that is price.

That was year-over-year, right?

Yes. That's what I'm talking about. You said $0.13. That's what I'm talking. Year-over-year.

Fiber is 5 of it. Energy is about 2. That's seasonal. That will get better with time in the industry. $0.03 is transportation. And I would guess that everybody's transportation cost is up. Then the other $0.03 is a lot of other things -- labor, benefits, inflation, medical expenses, you know, everything else would be in that. And that would be about $0.03. And I don't expect labor and benefits costs to go down. I don't expect medical costs to go down. Hopefully transportation costs with better management, maybe we can knock some out of that.

And fiber, you know, your guess is as good as mine where fiber goes. We'll just have to wait and see. But that's probably a pretty good shot. I think our mill variable costs, when you look at the variable cost, up on the order of about $10, $12 a ton, not 35.

So the rest of these costs are kind of --.

Spread all over.

(Multiple speakers.) -- overhead and tied to the box plant thing?

Yes. The biggest transportation costs, you know, we ship -- we got more in the box plant than we got in the mills. You ship a lot more trucks of boxes than you do tons of paper, because when you're shipping boxes it's “all air”. So big transportation increase also on the box system.

Just a couple of other questions. You didn't mention chemicals. And I know things like chloroalkalied (ph) is up. Do you guys use much caustic soda?

No. Very little. Our chemical costs are not -- up a touch, but not very much.

Then the other one is, the SG&A, which has been up in the – you it know, was up in the third quarter and then pretty consistent in the fourth; will that come down at all in Q1 or is that level of 35, 36 million kind of a new run rate?

We had heavy relocations in the fourth quarter. That we don't think will happen in the first quarter. Our bonus accrual, we have bonus; we have incentive plans; we have other things related to income; so that will change with income level. And that should come down a touch in the fourth quarter, because we made more money in the fourth quarter. We had higher bonus accrual in the fourth quarter than we'll have in the first. But these things wash out over the year.

Just two other questions. One on foreign exchange. Are you getting any benefit, do you think, at this point in terms of pricing in export markets from the drop in the dollar? Are you getting any incremental demand?

We're not getting a lot of benefit, because we pull -- we had to pull tons out of export this year because we had to satisfy internal demand. But there's no question our products are more competitive in foreign markets because of the exchange rate. But we haven't been a big benefactor for that because we're simply not big export players.

I just -- I guess what I'm wondering, Paul, is the industry in the late nineties and into the early part of this decade shut about 2 million tons of linerboard exports. And I'm just trying to figure out whether we might see any of that come back if the currency remains weak.

Well, I think the answer is yes, except for the fact is if we have very strong domestic growth, there may not be tons available for export -- not as many tons. And that's all going to depend on what the domestic growth is. But, as you point out, export prices are up about $110 from last year. That's a little higher than domestic prices are up for linerboard.

The last question I wanted to ask is, if you could just take kind of two steps back, you were out in front of a lot of the guys in this industry in shutting a lot of your lands. And I wondered if you could just talk a little bit about your experience running as a relatively non-integrated producer? Whether that's been a big disadvantage for you, you know, what the pluses and minuses have been.

Well, I think it's been obviously a big plus for us because of the fact that, you know, quite honestly, managing a large timber base was not one of our core competencies. We think we're really good at making paper and making and selling boxes. We sold our Woodlands for a fairly good EBITDA multiple, and obviously we're happy with that. But really, one of the reasons was that our EBITDA was less on the woodlands than somebody who is really, really good at running woodlands would get. So we think we got the benefits of both, especially with this Southern Timber Venture equity position, because we think they're pretty darn good at running woodlands. We sold woodlands because that's not one of the things that we were really good at doing. Now other companies are probably -- were better than us in that. So we want to concentrate and focus on the things we're really good at.

And we think we can buy wood at marketed competitive prices, and the profitability we give up off that wood is not the place where we can make our real contribution to shareholder value. It's in making and selling paper and boxes.

So for us, and it doesn't apply to everybody, we think selling our woodlands was good. It let us concentrate on what we're good at.

Is that some kind of a surprise to you relative to what you might have thought six or seven years ago before you embarked on this?

You know, I hate to admit this, but I never thought about it seven or eight years ago. You might wonder why -- and I wonder why at times I didn't think of this, but I didn't. That's just as candid an answer as I've ever given anybody.

Our next question comes from Rich Snyder from UBS.

Yes, I'm here. I didn't have a question though. Sorry, I didn't push the button, so I don't know why --.

We apologize for that.

Our next question comes from Chad Brown from XGP.

Congratulations. On the dividend, I know you said this was something you didn't want to address, but let me try the question and see --.

No, I didn't say that. I said I don't want to get into nitty gritty details, but I'll address it.

Okay. If I take your $0.25 per quarter and compare it to, say, the fourth quarter expectations for '05, which is about $0.42 according to --.

You mean fourth quarter expectations for '05?

Yeah, for '05. In other words, look out a year from now, which really incorporates probably another, at least another price increase by the industry, their expectations are about $0.42, so your payout ratio on that basis, looking out a year, is about 60 percent. And I would think most people would agree that a year from now we're above the mid-cycle level of earnings. So what your Board apparently is thinking, if they agree with that kind of an earnings level, is that you'd be paying out well over 60 percent on an over-the-cycle basis. So the question is, what is the Board's thinking behind that? Is it, you know, we're going to be in for a rather lengthy upcycle, or that when the downturn, next downturn comes, you'd be able to borrow to pay the dividend through a downturn? Or maybe the Board's view is that it's not that important to pay out a dividend at the same dollar rate during a downturn, you know, better to give it to the shareholders while it's possible and then take the chance that you'd have to cut the dividend if an unexpected downturn comes along.

So basically that's, what's the Board's thinking about the right payout ratio over the full cycle?

I'll give you my thinking. My thinking has been -- I think I've been fairly public with it -- that we picked a dividend that we thought was meaningful; I think our dividend's meaningful. Sustainable; we think it's sustainable. And growable, and we would hope it's growable. So one of the reasons that we did it when we did it is, is, you know, we've got a couple hundred million of free cash on the balance sheet that's always a buffer. We only give guidance out one quarter in advance, because, quite frankly, you get below that so many -- I mean, longer out than that, so many things can happen. But our thought -- and there's obviously no guarantees for the future -- is that we think this dividend is a sustainable dividend. There will be ups and downs, and our goal is to pay our dividend through free cash flow, while at the same time being able to make a few acquisitions through free cash flow. And if things go up and down, you've got other variables to adjust, including Cap Ex, acquisitions, et cetera.

But, you know, frankly, after, you know, initiating the announcement of a dividend to be paid in April, we really haven't given a lot of thought when we're going to change or up the dividend. That's a long way off in our thought process. It's not something I've thought about. But we think the dividend that we've come out with is the right for us, and we've incorporated in our thinking any variability in economic conditions. We may be right; we may be wrong; but that's the way we think about it.

When you say "sustainable," you mean that to imply including during the next industry downturn?

We mean that it is sustainable for the foreseeable future, and the question is how far is foreseeable.

Is it more than a quarter?

I'm not going to answer that question. I'm not saying it's more or less. I'm not -- Chad, you know this. I've told you this 20 times, but you love this question. We only give guidance a quarter in advance. And that's all I can do. That's all I will do.

But the Board, in making dividend decisions, looks more than a quarter?

Obviously. And, Chad, so do I, by the way. I just don't give guidance for more than a quarter.

(OPERATOR INSTRUCTIONS.) I'm showing no further questions at this time, sir.

Thank you. Listen, I would like to thank everyone for participating. Looking forward to talking to you again next quarter.

(OPERATOR INSTRUCTIONS.)