Packaging Corp of America (PKG) 2007 Q1 法說會逐字稿

Thank you for joining Packaging Corporation of America's first-quarter 2007 earnings conference call. Your host today will be Paul Stecko, Chairman and CEO. Upon conclusion of the narrative, there will be a Q&A session.

Good morning. Welcome to PCA's earnings release call. On the call with me today is Rick West, our CFO, and Mark Kowlzan, who runs our mill group and as the operator just said, as usual when we complete the presentation, we will be more than happy to take any calls that you have. So let's begin with the summary of our results and then I will get into some more specific detail.

Yesterday we reported first-quarter earnings of $31 million or $0.30 a share compared to first-quarter 2006 earnings of the $11 million or $0.10 a share. The first-quarter 2006 earnings have been favorably restated by $2 million or $0.01 a share for comparative purposes to reflect the new accounting guidelines for planned maintenance activities. This new accounting guidance no longer allows companies to accrue in advance because the major maintenance outages in any given year before those outages occur.

The $0.20 per share increase in our quarterly earnings compared to last year's first-quarter results was the result of better pricing and mix and lower energy cost which in total improved earnings by $0.32 a share. These earnings improvement items were partially offset by increased labor and benefits, fiber and transportation cost as well as the timing of annual mill maintenance outage costs which when taken all together lowered earnings by about $0.12 a share.

Our net sales for the first quarter increased 10% to $559 million and that is also a first-quarter record for us and that is compared to $508 million for the first quarter of 2006.

We were able to achieve record first quarter earnings despite cost pressures from much higher priced recycled fiber, the limited availability of purchase sawmill chips and lower-than-anticipated corrugated products volume in January and February. This performance clearly demonstrated the value of our operating flexibility and required all aspects of our operations to execute efficiently.

Turning to some specific details of operations, our mills produced 584,000 tons of containerboard, that is up 9/10 of 1% compared to the first quarter of 2006. We completed annual maintenance outages at our two linerboard mills, Counce and Valdosta. Counce was down for about five days; Valdosta was down for eight days. The shutdowns went very well. They were on time within budget and I think most importantly, these mills started up extremely well following their annual shutdowns.

The earnings impact of these two shutdowns from lower production and increased operating cost was about $0.05 a share compared to only about $0.03 a share in last year's first quarter when we had only our Counce mill down for its annual outage. As you may remember, we shifted Valdosta to the second quarter last year because of a low inventory situation.

Our corrugated product shipments in total and per workday were down about 2.7% or 15,000 tons compared to last year's first quarter. If you recall, I stated in our fourth-quarter conference call that we did shed some of our lowest margin business in 2006. This occurred for the most part starting in the second quarter and is one of the reasons why our volume was down compared to last year's first quarter.

On the plus side, we did see our volume improve as the quarter progressed. Our best month shipment-wise was March which on a per workday basis was up 1.6%, 1.6%, and so far April is off to a very good start. Offsetting this lower box demand in January and February, both our domestic and export sales of containerboard remain very strong. With outside domestic shipments up 6500 tons or about 8% and our export shipments almost doubled, up 26,000 tons over last year's first quarter.

Again if you recall in last year's first quarter, we had to significantly reduce our sales to the export market because of our very low inventory situation. With our inventories now improved to a more reasonable level we will finally able to increase our sales into a very strong export market this quarter as well as in the fourth quarter of 2006.

Our containerboard inventories at the end of the first quarter were down about 2000 tons compared to year-end 2006 levels. I should also note that yesterday the Fiber Box Association released industry statistics for the month of March and in our opinion these statistics are very encouraging. Corrugated products demand was up 3.4% per workday and containerboard inventories fell by 75,000 tons to 2.472 million tons or 4.1 weeks of supply. This is 200,000 tons lower than the average March containerboard inventory for the past ten years and on a weeks of supply basis, this is the lowest March ending inventory on record. So pretty healthy statistics.

Moving next to mill costs, we believe our earnings were not impacted by higher fiber cost to the extent that some other containerboard producers may be impacted because of our fiber flexibility. Industry publications reported the U.S. average price per ton before freight of old corrugated containers, OCC, almost doubled from $72 a ton in December to $140 a ton in March which was the highest price of OCC since 1995.

For the quarter, OCC averaged about $105 a ton and again that is before freight, an increase of about $50 a ton over the first quarter of 2006 and about $35 a ton over the fourth quarter of 2006.

Although prices of recycled fiber increased dramatically, PCA relatively speaking, is not a big consumer of recycled fiber with only about 95,000 tons purchased this quarter which represents only about 16% of our total fiber requirements. So the impact to us of higher recycled fiber cost was only about $0.025 per share compared to last year's first quarter and $0.015 a share compared to fourth quarter of 2006.

Also with the slowdown in the wood products industry, less residual wood chips are being produced at sawmills and wood products plants limiting availability and increasing the price of purchased chips. This situation as many of you know is especially acute on the West Coast but is also occurring in other parts of the country. Purchased pine chips costs were higher than last year's first and fourth quarters at our two linerboard mills, Counce and Valdosta, with our Counce Tennessee mill impacted the most.

With our fiber flexibility, however, we were able to decrease our purchased chip usage at both Counce and Valdosta by almost 20% and replace the purchased chips with own-make chips that we produced from pulpwood in our own mill wood yards. This was a significant achievement especially at Counce which consumes about twice as much wood as at Valdosta.

Counce was able to operate a second wood yard, about one-third of the time during the quarter allowing them to produce more own-made chips. In 1995 when we built our new wood yard at Counce, we decided to keep the old wood yard operational for emergency situations or when additional own-made chip capacity might be needed. This has turned out to be a very good decision.

Overall, our cost of virgin fiber both roundwood and purchased chips increased by less than $0.01 per share compared to both last year's first quarter and the fourth quarter of 2006. Hence, what may prove to be a significant cost issue for some in our industry had only fairly minimal cost impact for us and that is one of the reasons why we had such a strong quarter.

Looking at pricing, our corrugated products and containerboard sales prices were significantly higher than the first quarter of 2006 as would be unexpected with the full realization of the 2006 price increases. We also however continue to do a very good job improving both our product and customer mix in our box plants which also contributed to improved earnings.

Looking at other costs, higher labor cost reduced first-quarter earnings by about $0.04 a share compared to last year's first quarter with annual wage increases constituting about $0.02 of this and higher accruals for 2007 incentive compensation representing the other $0.02. With regard to incentive comp, we do prorate that each quarter based on our level of earnings.

Benefit costs were also up about $0.02 a share and this was mainly in the medical expense area. Higher outbound transportation cost for both our mills and box plants lowered earnings by about $0.015 a share compared to last year's first quarter and transportation costs were flat compared to the fourth quarter. According to the U.S. Department of Energy, diesel prices across the U.S. averaged $2.55 a gallon in the first quarter and as of the week of April 16th, that is the latest data we have, diesel costs were at $2.88 a gallon and that is a 13% increase. And if these increases continue, we would expect to see increased transportation costs in the second quarter.

Turning to cash utilization, our capital expenditures were $21 million during the quarter and we made a number of beginning of the year cash payments including the 2006 bonuses paid in 2007; the semiannual interest payment on both our 5- and 10-year notes of $15 million and vacation payments that occur at the beginning of each year at some of our locations. With these higher timing related payments, we ended the quarter with $147 million on cash on hand. That is down about $15 million from year end and long-term debt remained unchanged at $687 million.

To sum it up, I'd say that we are quite pleased with our first-quarter results as they clearly demonstrated the operating strength that we have. This is the third consecutive quarter with record earnings excluding any special items in prior quarters. We also have our two biggest mill shutdowns behind us and through our fiber flexibility; we minimized the impact of higher fiber cost, although it did cost us some money.

I would also have liked to have seen a little better volume in our box plants early in the quarter but we did see shipments pick up nicely in March and our outside sales of containerboard were up significantly with both our domestic and export markets remaining strong.

Looking ahead to the second quarter, our Tomahawk mill is taking its annual maintenance outage in April and this will impact earnings by about $0.02 a share [less] than for our two mill outages in the first quarter. And although recycled fiber prices decreased in April after peaking in March, we do expect that our average cost of recycled fiber will remain about the same as in the first quarter. We should see some seasonal improvement in volume and reduced energy consumption which translates to reduced energy cost but also expect an increase in transportation cost as a result of higher fuel prices.

Considering all these items, we currently expect our second-quarter earnings to be about $0.36 a share.

With that, we would be happy as always to entertain any questions but as always, I must remind you that some of these statements we've made constitute forward-looking statements. These statements were based on our current expectations of the company and involve inherent risks and uncertainties including those identified as risk factors in our annual report on Form 10-K on file with the SEC. Actual results could differ materially from these expressed in these forward-looking statements.

And with that, I would ask the operator to take any questions that we may have.

Mark Weintraub, Buckingham Research.

Thank you. Paul is it possible to get a little bit more specificity or color on your comment that April was off to a very good start?

Yes. We've only got data, Mark, through eight days our systems. And so that is usually -- we usually have about one-third of the month. So one-third of the month does not make a month. But through the first eight days, our bookings are up about 3.3% over last and our billings are up about the same. So that is twice as good as we did in March and of course our demand was down in January and February so we think the trend is pretty positive.

Okay. And also you made no mention of any share repurchase during the quarter so I assume you didn't make any. And can you just update us on your thinking on buyback at this juncture?

You are correct. We did not make any share repurchases during the quarter and there is a lot of pieces moving in the industry as you know with regard to when and if a price increase may or may not materialize and that piece of data is an important one. So with regard to share repurchase, I really don't have any comment at this time.

Okay. And then lastly, a bigger strategic question. A number of observers believe that we could be approaching a consolidation phase for the containerboard industry. I'm just trying to figure how important you think it would be to be part of that process if that were to happen? Or put another way, how much of the benefit in consolidation do you think accrues to the [actors] directly involved versus the synergies etc., versus the industry as a whole benefiting? Any color you can give on that would be interesting.

That is a hard question to get into. I think it depends on who consolidates with who as it benefits those particular individuals. But I think the one thing that I can say that since industry consolidation began '98, '99 -- starting I guess what the Smurfit-Stone merger and then a lot of other things happened, there has been a fairly steady trend line down in the level of industry inventories. And I think there has been a better coupling of supply and demand and I think that has benefited everybody in the industry. In terms of how it benefits specific players, I think it's a function of the players involved and so it is hard to generalize on that question.

Okay. Thanks, Paul.

Thank you.

Edings Thibault, Morgan Stanley.

Thanks very much and good morning. Paul, just a quick clarification on your second-quarter guidance. I know your outside sales have increased but I'm assuming in that guidance you are making no allocation at all or allowance at all for any potential price increase in the second quarter on linerboard?

That is correct. Because even if a price materialized as say as early as next month, when you figure out -- and the way we price the box prices normally follow that and when you put it through to boxes, what you even would realize in the second quarter is not that great. Of course it would be gangbusters in the third quarter. So the answer to you question is there is nothing in our numbers for a price increase which may materialize in the second quarter that is upside to our numbers.

Great, thanks. And then perhaps you can talk about the export market as a whole now that you guys are a little bigger in that market this year versus last year. It has obviously been a great source of support and as the market remains strong, can you talk about pricing trends during the quarter? What are you seeing and what should we look for in the second quarter?

The good news for us is not only was did we finally put ourself in a position where we could capitalize on the export market, our prices also moved up in the export market which is another plus. It's driven by a lot of things. One is, there's been every strong produce crop in South America and South America is one of our major markets.

China is now open for business. As you know we had restrictions last year or two ago with the tariffs that was overturned by the Chinese government. Now we are not big players in China, other people are, but that still benefits us peripherally because they are busy selling in China, we can concentrate on other markets.

Things have picked up in Europe. Business is good in Europe; pricing is improving into Europe. The dollar hit an all-time last -- not all-time but it is up to 135, 136 now so very weak currency into Europe. I was kidding a friend of mine going on vacation, told him he ought to a couple roles of containerboard to Europe with him, use them to barter instead of using the dollar. He got a kick out of that.

So I think across the board export market is attractive and we are glad we had a few tons available for it because the other real benefit of export business is you've got a lower freight out of Valdosta. Our freight to the Port of Jacksonville is very low compared to domestic freights, it could be 50, 60, 70, $80 a ton depending on where you are shipping it in the country. So right now the export market has got some things going for it.

Okay. And just help us -- one of the things that came in this quarter that's a little bit better or more disclosure on internal shipments versus external shipments within your system? Just seasonally what do you think happens in the second quarter? Do you -- obviously the box market is picking up. Would you expect to see your internal shipments tick up dramatically?

I think our internal shipments will move up a little bit but we are back to where we normally are. Again, I don't want to boast too much about how well we've done in export because it is compared to a lousy number last year. We had to pull out of export because the tank was on empty inventory-wise. Now we are back to normal and so we're going to stay at our normal level. We may pick up an incremental 5000 tons or something in that area but it won't be a big number because as I said, we expect higher box volume in the second quarter and there are only so many tons to go around.

Great, thanks very much. Good luck in the quarter.

Chip Dillon, Salomon Smith Barney.

Good morning, how are you, Paul?

Pretty good.

A couple quick questions. You mentioned that your box shipments I think were up 1.6% per workday. I think that was the March number, is that right?

That is correct.

Okay, and when you say eight days in April, that is eight -- that is eight weekdays, is that correct?

That is eight shipping days out of 20, so that is 40% of the month. We are at 20 shipping days, as you know this April. I've got data through eight.

Now it looks like you're helping us in terms of counting the impact of the downtime, it looks like that Valdosta being a large mill is like a $0.03 hit if it is a normal down and we see that Counce and also one of the medium mills -- the one you're taking down I think in the second quarter are each about $0.02 -- Tomahawk. What about Filer City? When do you expect to take that down and is that also kind of a good rule of thumb, $0.02 is the impact when that goes down?

That one will go down in October and that is not a big impact because again, you've got -- it's a semi-chem mill; you don't have the recovery boiler, the liquor cycle, you don't have the things that are as a elaborate. That will probably be about $0.01 a share.

Okay. Now it is interesting how we saw the numbers last year. You were citing how the overall inventories were at a record low in days of supply. I know last year we went actually up from 4.1 to 4.2 weeks from February to March and as you mentioned, the market was so tight that there was no tons to really export hardly. Here we've actually fallen from 4.4 to 4.1 and I take it from your comments that you are still quite involved in the export market and yet what I find interesting is that a year ago you had more inventories and prices were going up and now -- and you were not exporting. Now you are exporting. Inventories are lower and prices aren't going up. Doesn't something have to give here eventually?

Well, we've made more tons. We've been able to make more tons and last year we exited at very low inventories and so we never really had a chance to recover and you've got to protect your box customers. We went out of the year pretty low and then we had two shutdowns planned for the first quarter. That was going to put us under water and that is why we delayed the Valdosta shutdown to the second quarter. So we had to take some preventative measures. We exited a year, we were able to exit the year with better inventories than the last year. And that has helped cushion us.

And then I've got to give Mark a lot of credit, Kowlzan, we had two very smooth shutdowns. And started up without a beep and that made some extra tons available that we probably didn't think would have. And you put that all together, we had some extra tons we could put into the export market.

Got you. Now what about the -- as we look ahead -- in the past as you know the most common times we've seen the industry -- I hate to be I guess blunt, but reduced prices is anytime but the only times we commonly see them raise prices successfully is either in the early to mid spring or in the early to mid fall. And we are kind of past that early to mid spring period. Is that fair to assume that the next chance the industry would have at any kind of price restoration would not be till the August, September period? Or is that looking at things on an overly limited basis given where we are with inventories?

Well as you know, certain rules preclude the fore given price forecast on this call so I'm not going to do that. But I would say that I think in lots of things have changed in the industry and I mentioned that on an earlier question that since consolidation began, inventories have trended down and we did get a price increase last January. So that would historically would not be a normal time.

So I just think it is harder to predict if and when something happens than it was when the industry was very cyclic, very pattern oriented. I think the Internet has had something to do with it now that our sales are much more linear throughout the year, things have changed. And in the end what I think and I can say this, what drives pricing in this industry is supply and demand.

And I don't really think it matters what time of year that supply and demand is in balance or out of balance, things can change. And I think it is a little more dynamic in that regard than it was five, 10 years ago. And so in the end it comes back to supply and demand I think more than the time of year and that is just my opinion.

Totally understand it. And last point question is, we saw in the press the other day that SCA is leading another recycle containerboard price increase, it looks like in Europe. To your knowledge and I haven't studied this and maybe you haven't either, but does this mean with the euro having now moved up to 1.36 that prices there are at a level where the mill nets are as attractive relative to domestic prices as you can remember in quite a while?

The answer is yes. In quite a while they are closer than they have been in quite a while. And again, the freight has something to do with that, Chip, because again, that stuff goes FAS port. Not only is the pricing, you've got to take into account of the freight savings also.

That you. Okay, thank you.

George Staphos, Banc of America Securities.

Thanks. Hey, Paul, good morning. Just a couple of the follow-on questions. Do you expect to see -- should we expect to see an improvement in mix further in the second quarter or have you now pretty much anniversaried all of the culling from last year?

No, we had a fairly big mix change last year probably 4%, 5% of -- of I would say lowest margin business was shed during the three price increases. So anything that could be incremental I don't think would be that order of magnitude but we continue to work on improving our mix both our customer mix and our product mix because our basic strategy is be seek out business that is hard to do where we can add the most value and we get paid for that value.

So if it's easy to do and the commodity of all commodity boxes providing extra value is harder than if you've got special features, quick turnaround, short order runs; so our strategy is to continue to work on mix and I think each year we pick up a couple of percent and a little better mix. I don't think it will be as big a bump as we had during the price increases last year.

Okay, but that explains why it looked like from my numbers your mix moved up. You still have some more traditional brown type of business, so over the years perhaps we could see another percent or two on price per ton independent of pricing? You would agree with that?

Yes, it is in the order of pennies that we can pick up. I'm talking annually maybe $0.02, $0.03, $0.04 improvement in mix annually.

Paul, as far as near-term trends on volumes and we appreciate the color, how do you guard against and what conversations have you had with your customers regarding perhaps a head fake here on demand since we had the spring holidays a little bit early this year and March and April to some degree may blur together. How do guard against that? What are you customers saying about really the outlook into March -- excuse me -- into May and June at this juncture?

The one thing I hate to stiff you on this question but any discussions between -- and I'm being honest with you there -- between us and our customers stays between us and our customers. That's something that I've never gotten into. We've got great relationships with our customers and we want to keep it that way.

Okay. What is your sense then about the ability for demand to continue into later in the second quarter?

Well, based on what we've seen, I'm optimistic. But this economy -- any little thing can change it and I think if you wanted to ask me what I worry about the most, I would say the thing that I worry about the most is where fuel prices are going to go; gasoline prices specifically. Because if they skyrocket, that takes disposable income from the consumer and 80% of what the consumer is buying is packed in a corrugated container. So I like things that protect disposable income and that is probably the one storm cloud that -- and it's hard to predict. That is the thing I worry about the most and that is why I check gasoline prices every day.

So do we. Not always the way we want to. I guess the last question for Rick maybe, Rick, from the numbers that you provided, it looked like you had a pretty good first quarter from a cashflow standpoint despite the typical payments that you make during the quarter. Would you happen to have a preliminary view on what operating cashflow was for 1Q? And if not, were there any things that you were doing really -- I think you're trying to keep perhaps a little bit more inventory on hand to manage through logistical issues that we've had the last couple of years. Were there any particularly good things that you did on a cashflow basis or from a working capital basis in 1Q? Thanks, guys.

No, I think from a working capital standpoint as always, the first quarter is our worst quarter for two reasons. One, generally we do have at least for the past few years a little bit better volume in the first quarter than the fourth quarter. That gives a higher accounts receivable balance which, in turn, keeps your working capital high.

But really the big thing is the beginning of the year cash payments, where we make all the cash payments for our notes, as Paul mentioned, and other things. And once we get behind that, we begin to pick up cash each quarter the remainder of the year.

I understand. But there was nothing unusual in 1Q in terms of things that --?

Nothing unusual; just like last year and any other year.

Okay, thanks, guys. Good luck in the quarter.

Mark Connelly, Credit Suisse First Boston.

Thank you. Paul, just a couple of small things. Obviously, ag is not a big business for you, but it is a big business for some of your competitors. Have you seen from the West Coast any impact sort of backing up onto you, and do you expect any from what has happened in the Southeast over the last couple of months?

Well, we are a big ag player in Florida. Our Winterhaven plant is one of our bigger plants and it's a big participant in the Florida/North Georgia -- excuse me, South Georgia agricultural markets. But as you said, we are not big players on the West Coast. We have a plant in L.A.; it's a big plant in L.A., but it is more manufacturing oriented versus agriculturally oriented.

The answer to the question, no, we've seen no spillover from that on the West Coast. Our West Coast business out of L.A. has remained quite good. Again, it is manufacturing, so maybe we wouldn't see a lot of spill-off from that. But nothing noteworthy that comes to mind. That is about as good as I can do on that, because I really have -- and no one has brought anything to my attention in that regard.

Just sort of a related question. With the decline in box shipments, you made it up on the board side, but is there anything else going on in box shipments? You talked about a couple of things. Is there anything else going on in box shipments that might be related to all of the restructuring and initiatives that so many of your competitors are doing right now?

I don't see anything in that regard that would lead me to believe anything like that. Again, part of the reason our box shipments are down is that in last year's first quarter, we still -- this is when that second price increase was going through and we lost some business. But again, when you lose business, when you take a hard stand on price you expect to lose some business. If you don't take a hard stand on price, I mean if you're not willing to lose some business, then it's hard to take a hard stand on price.

When you lose that business, usually you'll run it for another 30 to 45 days to allow that customer to move that business where they want to. So that is part of the reason for the decline. If you take that out, we are pretty steady volume-wise. So we don't really see anything precipitous happening, other than the fact that we chose to give up some business last year to get price.

Okay, that is helpful. Thanks, Paul.

Richard Schneider, UBS.

Good morning. Just a question on -- asking for a commentary on what you think happened with the softness in the beginning of the first quarter and then the pick-up late in the quarter. I know some of it obviously is seasonal patterns, some of it may have been some inventory reductions on the part of the economy in general in the early part of the quarter, some may have been the ag situation. But could you go through as you see it what has transpired between the softness in the beginning of the quarter to the strengthening situation you are seeing now?

Yes, I would say just to put a little tehnicolor on the thing a little bit from my perspective, you know, we had a strong December, very strong December. January wasn't that bad for the industry. It was only off 1%. So compared to a strong December where a lot of stuff was shipped, off 1% is not too bad. And that is in total, I'm talking total volume.

February was bad, it was off 4.4% in total. And March in total was off about 2.8% in total. So if you just go in totals, I think the economy probably slowed down a touch. We had another spike in oil prices, gasoline prices started to go up. I think when gasoline prices start to go up as we mentioned on the call, diesel fuel jumped up, that spooks the consumer a little bit. They get a little worried about how much they are spending, and I think my own feeling is the economy had a little hiccup in the first part of the year, and now it looks like it may be picking back up.

And again, I think the biggest thing we've got to worry about is what is going to happen to gasoline prices. The other thing in February, it was a very cold February. I don't know if the consumer stays home or what, but hey, when all else fails, you blame it on the economy, right, and that is what I'm doing.

You know, your commentary on gasoline as being one risk, but are there any other risks? Do you see anything further from ag risk or anything else that you would cite here?

If you think I can predict the weather, you are crazy, okay. So I will stay away from ag risk. So, no, I'd say the two things that -- a plus and a minus -- I feel good about where the dollar is in terms of the export markets and the price of oil is it's not something that -- if I can predict the price of oil I'd be doing something else for a living.

Just following up on your commentary on fiber, I will check your crystal ball on that.

It's not good.

What are you -- are you seeing any signs that the wood chip situation may be getting a little better as you're getting into at least a partial pick up in the building season here?

The answer is no. As a matter of fact it could get a touch worse and the reason I -- the only reason I say that we have one sawmill. We were running it one shift. We're probably not going to run it at all the second quarter. Now that doesn't have much of a financial impact on us but it just shows us that it is ridiculous to try to make lumber to get the chips when you are losing a lot of money on the lumber. And we have the -- we can run Counce. We can make those chips ourself and save money.

But that just tells me no -- in the sawmill residuals again, we are not in the wood products business. You are better off talking to people that are to give you a better forecast going forward. Our crystal ball quite frankly in that regard goes out a month. That is as good as we are. And we don't see anything getting better for the next month. So I suggest there are better forecasters than me in that regard.

Okay, and then finally on OCC. I will take a shot at that. Are you seeing inventories of OCC that have been replenished here and at least for the time being look reasonably okay?

Well, again we have a forecast for OCC, I'm not saying it's a good forecast. We don't use that much OCC but prices came down we think and it's going to go down a few more small ticks over the next two months. But we will put a high probability on or a high certainty on that forecast. Or what I've said many, many times is we have displayed and this industry has displayed for a long time a complete inability to predict where OCC is going over the long term and we've taken the so-called cowards way out. We build fiber flexibility in our system so whatever way OCC goes we can use either more or less of it.

So we are not good predictors there. I haven't run into anybody that can really predict where it is going because of how quickly it can move and again, what the Chinese do and when they do it plays a big part of that and I have no way of predicting that.

Which is worse predicting, oil or OCC? Only kidding.

What do you think?

I don't know.

Thank you.

Thanks, Paul.

(OPERATOR INSTRUCTIONS) Richard Skidmore, Goldman Sachs.

Good morning, Paul. A couple of follow-up questions. On the demand side, you mentioned March improving and the first part of April getting better. Any particular areas of the economy where you see that strength? And do you sense that this is industrywide improvement in demand, box demand or is this more of a PKG specific?

The answer is I don't know if it is industry or not. But I will say that we've been tracking the industry more closely over the last 12 months than we say did in the five years before that when our growth trajectory was much stronger than the industry. But I don't know the answer to that question.

Okay, and then just shifting a bit to the use in your thinking of free cash flow going forward, still plans to continue to add a box plant here and there and continue to buy back stock or maybe just help us a little bit more?

What our plans going forward are is a question of how much and when and what we do. We see three main uses for the cash. We would like to continue to increase our integration level, add a few box plants here and there. As I've said many times, you are talking on the order of $40 million, $50 million a year for that.

And then the two other uses of cash are potentially increase the dividend and share buyback and the dividend is a harder thing to call because you've got to have a sustainable dividend. So you've got to raise it. If you do raise at an amount that you can sustain for the long-term and that depends on what you think your cash flow is going to be for the longer-term and that is why where we are going on pricing plays a role in it and I wish I had a better handle on that at this point.

Okay. And then just shifting to the fiber question and the fiber issue you talked about. How much can you actually switch from OCC to more of the internally produced pulp wood chips? If OCC went up enough, can you go entirely virgin or not?

No. The main reason -- most of our OCC and BLK, is consumed in our medium mills and when you run semi-chemical medium, that is basically -- I don't want to uncooked wood but very little cooking goes into the hard wood. That gives you stacking strength in medium but you need tensile strength too and the only way you can get tensile strength is to mix in some longer fiber and the longer fiber that you get comes from the OCC.

And so to run semi-chemical medium and have an outstanding product like we do, you need at least 35% OCC in semi-chemical medium to make the properties that you want to make. And so we've got no flexibility there. Now, when OCC prices are in the tank which hasn't happened in a long time, we will run 45%, 46% OCC in the sheet. But we can only pull it down to about 35% before we get into problems.

Now it's a little different on the linerboard side. Valdosta runs 100% virgin fiber. We run no OCC in there and that is one of the reasons people love that as an export grade. I mean you are getting pure pine fiber. Counce, we run about say 20%, 25%. We can get up to 30% maybe if we pushed it, 32%, 33% and we can probably pull it as low as maybe 17%, 18%. We've got flexibility bare. And the nice thing about Counce is it is located in very plentiful hardwood so our swap is we put in hardwood instead of OCC and hardwood is very inexpensive at Counce. And that is our trade-off. So we've got probably the best pure economic trade-off at Counce which is also our largest mill.

Thanks, Paul.

Chip Dillon, Salomon Smith Barney.

Hi. Going back to the OCC thing and seeing how low you can go, does it really matter if it is 20% or 10% when I think what -- 80% of the global capacity is when 100% OCC based?

What is that, Chip? I don't follow your question.

I know the previous question was sort of splitting hairs whether you could get down to 0% or 10% or 20% purchased OCC in your of fiber. But does it really matter when something like 75% to 80% of the global containerboard capacity out there is 100% dependant on OCC?

What do you mean by matter, you mean in making physical properties?

No, no, in terms of your relative cost position. I mean if the best thing in the world that could happen to you would be for OCC I would think to go up 10 times because it would have a much more dramatic impact on the global cost curve than it would on the PKG cost curve.

I understand. I though you were talking about could you go lower than that and make physical properties on semi-chemical medium; that is not what you are saying. What you are saying is absolutely correct. The higher that OCC goes the larger our competitive advantage because us and one other supplier are I would say fairly low in the usage; everybody else is higher.

And then the people that really get hurt are the so-called mini-mills that run on 100% recycled fiber because not only is recycled fiber a lots more inexpensive today than virgin fiber especially hardwood, and what you put in linerboard, your cost of what we call wet end chemicals, chemicals that you have to put in the paper machine to make that 100% recycled fiber work, you've got a cost penalty there of probably $10, $15 a ton on top of that.

Got you.

So the answer is higher recycled fiber may hurt us a little bit in a quarter's results but over the long-term it is probably beneficial to us.

Got you, thank you.

Edings Thibault, Morgan Stanley.

Thanks, Paul. Just a quick follow-up. CapEx spending plans for the year I think you said this was going to be a little bit of a make up year for you. Is that still in the plans and are you still looking at a number around 125, 130?

Yes, 120 is the number we are using right now. We cut back to I think we ended up near 90 -- what did we end up, Rick? About 90 last year, 88.2 -- they handed me the right number, 88.2 last year. And we will probably go about 120 maybe 122 this year. We've got a couple of exciting projects that we are bringing on. So that is where the money is going toward a couple of big projects and not toward and a lot of little things.

Just a quick follow-up. When you think about big projects just to help us maybe timing a little bit, I guess I would have thought that would have occurred primarily around the downtime period. So to the extent you were putting money in your linerboard mills you would have spent that money in the first quarter, instead it's going to Tomahawk second quarter. Are you spending the capital in your box plants rather than your mills? What is kind of the --?

Both places. But the answer to that is when you do a project there are progress payments and a lot of pieces of big equipment on big projects there are a long lead time. It might take you six to nine months to get a particular piece of equipment and you made progress payments all the year until you get them. And they would be done in next year's -- although they would be installed or started up say during next year's annual outage, you probably spent 3/4 of the money even before you get there.

But with regard to our capital spending between the mills and the box plants, it is fairly evenly divided but I think more important at the box plants we've been spending about 100% of depreciation. In the mills because our mills are in terrific shape, we'll probably only spend 60% of depreciation. So we are spending more money in areas that allow us to grow our box volume and increase our vertical integration and we are fortunate that that level of spending still allowed us to continually set production records in our mills.

But it is maybe close -- not quite even. The mills get a little more money than the box plants but on a percent of depreciation, we spend more in our box plants than our mills.

Got it. Thanks very much.

Christopher Chun, Deutsche Bank.

Good morning, it's Mark Wilde. I wondered following up on that CapEx question, if you can tell us incrementally where you are putting the extra capital in '07? And then also if we were to think about the dollar remaining very weak and OCC remaining very high, is there anything you could do at any of virgin fiber mills to significantly increase capacity short of building a machine or something?

With regard to the first question, we have lots of projects but the best way I could summarize it is most of the money if I had to pick out one category that stands out is in energy projects. We have some very exciting energy projects that we are moving along and although natural gas and oil, if you will, oil is not so well behaved but natural gas is behaved; electricity costs are going up very fast.

I think that is the next great frontier is in purchased electricity. The State of Illinois just raised -- in the State of Illinois, electric prices are going up 30%. We're hearing big price increases elsewhere. So we are trying to stay ahead of the curve in the energy and not let this stability, if you will, on gas prices allow us into a false sense of security. So that is where most of the capital in terms of the bigger projects are going.

And your second question was with regard to capacity. Now one of the problems that we've got with capacity is that you bump up against environmental constraints. You can run a specific piece, your recovery boiler at a certain capacity. That makes it harder and harder to get creep capacity. So we've got nothing there that I would consider very significant.

Okay. One other question. If you were to look at your converting system and just excluding kind of what is going on in the mills with higher costs, any sense over the last three or four years about how much cost per ton have gone up in a box plant because you have to use natural gas for some of the corrugators or you have to pay freight when you ship boxes out?

Yes, I would say that you just answered your own question which shows that you know something about the industry. And that is that energy costs have gone up and the box plants do not have -- they buy gas and oil from utilities. And box plant costs have gone up in that regard. Secondly, freight costs, again, they are not immune from freight costs because again, fuel driven.

And there then, of course labor costs have gone up probably 2%, 3% a year and so they have an increase in labor cost. They would be the three biggest items with transportation and energy being by far the two biggest.

Would you quantify that at all, do you think in terms of a price per ton or a percentage increase?

Not off the top of my head. But you are talking in $20, $30 kind of number.

Okay, great.

I think we have time for one more question. We are out of time. I will take one more.

[Nathan Vislov] from [Jane Goldman]

It's me. I'm sorry. Thanks for the question. I just wanted to confirm what was your integration level on an rough basis for this quarter?

Our integration level is roughly 80%. And I haven't really run the number yet. It might be a touch below that because two things happened this quarter. One, our volume was down a little bit from what we projected and our outside shipments was up a little more. But we will be close to 80%. We got as high as during some quarters last year when we be pulled back on the outside market to like 84%. So it can move around between 80%, 84%. I'd guess we are close to 80% this quarter.

Okay. And just to confirm on the other question that was asked earlier on consolidation. I guess one of the benefits at PKG is your fiber flexibility as well as the local accounts. Would you be willing --

Well, our biggest single advantage I would say is in our energy flexibility. We've got the availability to flex down. Last December we only used the December fuel last -- 3% natural gas in our fuel mix. That is probably the single biggest difference between us and our competitors.

And then when you go through these box plant acquisitions or any other kinds of I guess potential acquisitions, is it okay if you change your energy mix or fiber flexibility? Are those things you consider or how do look at that?

Well, fiber flexibility pertains only to the mills not the box plants and with regard to energy, we don't have a competitive advantage on energy costs in our box plants because again that is a mill thing. Basically our box plants with regard to energy are the same as competitors with regard to the types of fuels we use. But again, you've got to point out that 90% of our energy is consumed in our mills and only 10% in the box plants. So if you want to have an energy advantage someplace, it is obviously in your mills.

But I'm just trying to understand if you are looking -- so you are mainly just looking at box plant acquisitions?

That is correct. Okay?

Good enough.

Listen, thank you. Thanks for the large number of calls. Looking forward to talking to you next quarter. And if I did not get to anybody on the call that has a question, you can give me a call at our offices. I will be glad to talk to you. Take care.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the conference and you may now disconnect.