Packaging Corp of America (PKG) 2008 Q1 法說會逐字稿

Thank you for joining Packaging Corporation of America's first quarter 2008 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.

I will turn the conference over to Mr. Stecko. Please go ahead when you are ready.

Thank you and good morning and welcome to PCA's first quarter earnings release call. With me on the call today as usual is Bill Sweeney, who runs our corrugated products business, Mark Kowlzan, who runs our mill operations, and Rick West our CFO. I would like to thank you for participating in advance. As always, we'll try to take all of your questions at the end of the presentation.

Let me begin with a summary of our results and then I'll try to provide some detail. Yesterday we reported first quarter earnings of $32 million or $0.31 a share compared to first quarter 2007 earnings of $31 million or $0.30 a share. Net sales for the first quarter were 577 million and that's compared to 559 million in last year's first quarter. Higher containerboard and corrugated products prices improved our earnings by $0.14 a share compared to last year's first quarter. This increase was offset in large part by energy and energy-related cost increases which were $0.07 higher than last year's first quarter and $0.03 per share higher than our original 2008 first quarter forecast. Recycled fiber and labor cost were each $0.02 a share higher than last year's first quarter and chemical cost and bad debt expenses which together totaled $0.02 per share higher than both last year's first quarter and our first quarter 2008 forecast. During the quarter we did complete annual maintenance outages at our two large liner board mills, Counce and Valdosta. Counce was down about six days, reducing production by 18,000 tons, and Valdosta was down for eight days, reducing production by 11,000 tons. The total earnings impacted these two outages from lower production and increased cost was about $0.06 per share.

At our Valdosta mill we completed a major upgrade on one of our combination fuel boilers during the outage that significantly increased the boiler's efficiency. This upgrade, which cost about $3.5 million, has allowed us to completely eliminate the use of all natural gas and oil as boiler fuel at Valdosta. At today's oil prices this will reduce our manufacturing cost at Valdosta by about $4 to $5 million a year or about $8 to $10 per ton cash cost. Our box demand remained pretty steady through the entire quarter and was up six-tenths of 1% per work day compared to the industry which was down seven-tenths of 1% per work day. With one less work day than last year's first quarter, our total shipments were down nine-tenths of 1%. Our box shipments per work day by month were pretty steady with January up 1.7%, February down 0.3% and March up 0.6%.

Our domestic sales of containerboard were down about 4,000 tons and our export shipments were down about 1,000 tons compared to last year's record. Export shipments were affected somewhat by annual outage related scheduling issues as well as by some minor difficulty in arranging ocean transportation. We ended the quarter with our containerboard inventories 5,000 tons below year ending 2007 levels. The FBA released industry inventory statistics last week that I felt were very surprising and I might add very, very encouraging. Because Easter was early this year, March had only 20 box plant work days and 31 mill production days, that's a difference of 11 days. Normally, the difference is only nine days. So we had a potentially -- we had potentially about 200,000 tons of extra mill production in March. However, despite this, industry containerboard inventories rose only 50,000 tons and at 4.1 weeks of supply, they now represent the lowest March ending inventory level ever on a weeks of supply basis. Now the really good news. This calendar situation reverses itself in April and we get two extra box plant work days coming at a time when inventories are sitting at all time lows.

Let me now move to cost. Purchased energy and other energy related costs were higher than both last year's first quarter and what we had originally forecasted for the first quarter of 2008. Purchased fuel consumption at our mills and box plants were up about 4% compared to the first quarter of 2007 and was up about 2% more than we had forecasted due in large part to unusually cold and wet weather. This higher than normal fuel consumption costs us at an additional $0.01 a share and about a penny share more than we had forecasted. In addition, fuel prices were also much higher than last year's first quarter and much higher than we had expected with natural gas up 20% and fuel oil up 70%. Fortunately, our relatively low usage of natural gas and fuel oil helps to minimize the earnings impact of escalating fuel prices. For us, fuel prices were about $0.03 per share higher compared to the first quarter of 2007 and about a penny a share more than we had expected entering the quarter.

Another energy related cost that continues to increase is inbound and outbound freight driven by higher diesel fuel prices. According to the U.S. Department of energy, U.S. diesel prices average about $2.50 a gallon in the first quarter 2007 and in the first quarter of 2008 prices averaged about $3.50 a gallon. That's about a 40% increase and they are now at $4 a gallon. As diesel fuel cost escalates, inbound freight cost increases are being passed on to customers in terms of higher prices for such things as fiber, chemicals and other materials. Higher diesel prices are also increasing the cost to ship our products as truckers add fuel surcharges to freight rates. We estimate our inbound and outbound freight cost are about $0.03 per share higher compared to last year's first quarter and about $0.01 a share higher than our original first quarter forecast.

Looking at wood fiber cost, I think as most of you are probably aware plunging wood products demand has created a significant decline in residual wood chips which reports indicating that chip shortage has worsened since the end of the fourth quarter. Our wood fiber costs in the first quarter were up only about 3.5% compared to the first quarter of 2007, and this is attributed almost exclusively to higher transportation cost. This small increase for us is due in part to the location of our mills and the ability of our Counce mill, our largest mill, to inclemently produce more wood chips from pulp wood to replace residual wood chips from saw mills. Our fiber flexibility will improve even further when a new state-of-the-art contracted wood yard is started up at our Valdosta mill in the second quarter. This new wood yard will be more efficient than our old wood yard and will give us the flexibility to produce essentially all of our chip requirements from pulpwood should the situation at saw mills worsen.

Recycled fiber cost also continued to escalate with industry publications reporting that the U.S. average price per ton before freight of old corrugated containers was $131 a ton in the first quarter of 2008 compared to $106 in the first quarter of 2007, and that's a $25 per ton increase or about 24%. PCA was a net buyer of only 100,000 tons of recycled fiber in the first quarter, or about 16% of our total fiber requirements. So the impact to us of higher recycled fiber cost was only about $0.02 a share compared to last year's first quarter. Looking at other costs, labor and benefit cost were up about $0.02 per share as expected compared to last year's first quarter. Chemical costs were up about $0.01 a share higher than both last year's first quarter and our original first quarter forecast. And our bad debt expense was about $0.01 a share higher driven in large part by a single customer bankruptcy.

Turning next to cash utilization. In the first quarter our capital expenditures were $35 million. We also paid down $20 million in a term loan, made a number of beginning of year cash payments including 2007 bonuses paid in January 2008, and paid our semi annual interest payment on our five and ten year notes of $15 million. Finally, during the quarter we repurchased 886,000 shares of our common stock for $20 million or an average price of $23 per share. With the uncertainty and extreme volatility in the credit markets, we elected in March to issue $150 million in ten-year notes with a coupon rate of 6.5%. The proceeds of this debt offering will be used to pay off our existing $150 million five-year 4-3/8 notes which are due on August 1 of this year. In April we also entered into a new $150 million five-year bank revolving credit agreement. Including the proceeds from the newly issued notes, our total cash on hand at the end of the first quarter was $310 million.

Looking back at the first quarter, price, volume and mix went basically as we had expected. But on the cost side, things proved to be much more difficult, particularly with regard to energy and chemical cost, and weather conditions didn't help either. On the positive side, we were able to complete our two largest annual maintenance outages and our containerboard inventories declined during the quarter as planned. In addition, our load dependence on recycled fiber fuel oil and natural gas helped us minimize our exposure to cost escalation. Looking forward to the second quarter, we expect both higher containerboard production and higher corrugated products shipments. Tomahawk and Filer City median mills will be done for their annual outages; however, the earnings impact will only be about $0.02 a share or $0.04 per share less than the impact of the Counce and Valdosta outages in the first quarter. Warmer weather conditions, and hopefully drier, will lower fuel use in the second quarter but with energy-related costs escalating throughout the first quarter, fuels chemicals and freight costs are expected to be higher by $0.01 a share each.

Finally, we will incur about a $0.02 per share charge in one-time items in the second quarter related to our recent debt refinancing and start-up cost for two major projects at our Filer City and Valdosta mills. Considering all of these, items we currently expect second quarter earnings of about $0.38 per share. With that, we would be happy as always to entertain any questions but, as always, I must remind you that some of the statements we made on this call constitute forward-looking statements. These statements were based on current expectations 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 those expressed in these forward statements. Operator, I would now ask you to open up the phone lines for any questions we might have.

Thank you. (OPERATOR INSTRUCTIONS). Our first question comes from Richard Skidmore of Goldman Sachs.

Good morning, Paul. Just to follow up, you talked a lot about the cost side of the equation in your comments but didn't touch on sort of the revenue side. You mentioned box shipments would be up in the second quarter but you were out there with the price increase in March. Can you just talk about what you need to see in order to see the prices move higher from here? And/or if you are going to get any of that price in the second quarter.

Let me just go back a little bit. One, you talk about the revenue side. We did have all-time record revenues in the first quarter this year. So we were kind of happy about the revenue side of the equation and, as I've said earlier, our demand we thought it was pretty good. It was comparable with the strong level demand we have seen in the last few years. So you are right on the demand side and the price side, it was an acceptable quarter. On the cost side we are like everybody else. Escalation of key cost elements hurts. Fortunately for us we are not hurt as much because of our low dependence on certain of these cost elements.

I can't, for anti-trust reasons, give any forward pricing-type guidance on a call like this because you just can't do that, but I will say that I was very disappointed that the price increase did not materialize in the time frame that it was announced. And the reason for that is when you reflect and you look at the situation, we have an industry that is running at 97% capacity and our inventories are at historically all-time low levels and in the past they were the facts. They drove pricing actions and that didn't happen this time. And I was a little disappointed in reading some of the dialogue in one of the publications that reports on price that some brokers and independents primarily in the northeast said paper is not that tight is what they said. It's just hard for me to believe when you are at 97% at capacity and inventories are all-time low levels. That's not an environment that we could have had a better result. So hopefully the people that analyze this look at the fundamentals as opposed to rhetoric by, quite frankly, people who don't want to see the price go up will get a better result. But all in all I was disappointed and I won't kid you about that.

Thanks for that. Just in terms of maybe on the box side of things, have you seen a lot more intense competition in your box business over the last couple of months?

The box business is always an intense business from a competition point of view, but it's always been that way. Has there been any change in the last couple of months, the short answer to that is no. We haven't seen any dramatic changes in the level of competition. It's always been stiff and it's still stiff.

Great. Thanks, Paul.

Thank you our next question comes from Mark Weintraub of Buckingham Research.

Thank you. Two things. First of all, just wanted to get an update on some of the cash flow items such as cap spending expectations for this year and I don't know if it's too early if you have kind of a read. Should we expect same level next year? Relatedly, it is very striking that your dividend yield at this point is actually higher than your after-tax cost of debt. Does that give you any desire to perhaps leverage up a bit to buy back stock since it would be a cash beneficial action to do or share some of your thoughts if you would on that concept.

Okay. On the first question in terms of CapEx, we reported $35 million in the first quarter. We had given guidance at the beginning of the year of about 110 and that number still looks pretty good. We don't go out more than a year on CapEx, so come near the end of this year I'll give you some updates on CapEx because as soon as give two year's guidance, someone will want five. We go out one quarter in advance on earnings and we go about a year in advance on CapEx. So I'll get you that answer to that question a little later in the year. With regard to the dividend, there's a best way to fix my dividend yield being so high for the stock price go up a little bit. So I'm rooting for that first. Short of that, I agree with you. One of the nice things about having a share buy back in place at this time is that I generate cash also by -- in a way by buying back shares because I eliminate the dividend yield which is higher than the after tax cost of my debt, so that's a plus. And so that is, I think, a benefit that we are going to enjoy going forward unless our stock price trades up a bit more. So in terms of borrowing to do that, we still have a fair amount of money left in our $150 million buy back so we will not consider anything like that until we burn through that first $150 million and we are continuing to generate cash so we may be able -- our goal would be to continue to buy back shares long term but not borrow to do it. We think we have the ability to generate the cash to do it, and that is our primary motive -- motivation going forward.

Okay, great. Could you just remind us where you are on the authorization? How much of that 150 is left?

At the end of the first quarter we had $110 million remaining.

Great. Thank you.

We have a fair amount of fire power left as they say, Mark.

Thank you. Our next question comes from George Staphos of Banc of America.

Good morning. Paul, a question for you. In the quarter that just passed, was there any other nonoperating items that we should be mindful of. I thought I saw a news item recently about you laying off a few people. I can't remember where I saw that. I don't know if that was material or immaterial. I wanted to check on that.

If we laid off a couple of people in one plant, I don't know about it. A few is the operative word and so, no. The long answer -- I don't know of anything other costs that are unusual or noteworthy other than the fact that we did report we got hit with about a penny a share in bad debt. We have always had very, very good bad debt experience. That is not much of it. But we did have one major customer go bankrupt and that was a big surprise for us.

Okay. And out in Valdosta with the wood yard that will not be a change in employment, right? That is just going to make you more efficient and give you more fiber flexibility, correct?

Yes. It will result in a change in employment. It will reduce head count at the Valdosta mill because our old wood yard, which was -- it add added a new dimension to a term old wood yard, it needed replaced, and we were able to secure a contracted wood yard with a long-term chip buy agreement, and the beauty of this is that we made no capital investment sand we will save about $5 million a year in cost, and that's roughly $10 a ton. So a return on investment like that, as you know, is infinite when the denominator is zero.

All right. Maybe that is what we had seen. I guess taking another approach on the question of price versus cost, your paper customers usually don't like price hikes, at least they don't say they do, yet box price isn't moving unless board goes up and you can't offset input costs that are moving higher unless you get a box price hike rhetorically. How can you, I'm not asking you to speak for the industry, but who else can you perhaps fairly get pricing to offset some of these variable costs that continue to head higher in this kind of environment?

Well, this is a democracy and I have to follow all the laws of the land, which I do. The only thing that you can do is hope that the economic gets such that when and if any price action commences it gets accepted into the marketplace and, again, I think an earlier caller hit on this. I just hope that through the journal, through the trade publications, this does not degenerate as it is, I think, in a lobbying exercise where a lot of customers I think are lobbying pulp and paper to be specific and they report all of their sources, but not by name, and quite frankly I think what we have to hope for is that the facts are looked at and the facts are operating great. The facts are inventory levels and in all other industries that I know of that usually results in better economics. Can you name another industry George 97% operating rate lowest inventories on record that would have difficulty getting a price increase?

Yes. The box industry.

I said another one. Other than this one. I know this one. My point is I'm optimistic. Usually the facts, and it may take time, but the facts usually win out over the spin factors. So that's my hope. The only thing that we can do is continue to report to our customers the facts, and I think over time the facts will win out.

Let me leave that with one last question. Rick, do you have any details for working capital for the quarter what the use of cash was in 1Q? Thanks.

Yes. Working capital, George, with all the first quarter payments that we made was a negative 35 million. We do expect that to turn positive in the second quarter as it always does. So that was the big item influencing our cash in the first quarter, but it's no different than any other quarter.

All right. Thanks.

Generally picked up in the third quarter.

I understand. Thank you.

Thank you. (OPERATOR INSTRUCTIONS). Our next question comes from Chip Dillon of Citigroup.

Hi. Good morning, Paul.

Good morning Chip.

I wanted to explore something with you. We've noticed, and I know these prices aren't apples to apples, but spreads are what they are over time. And we noticed that the craft liner price in the U.S. is now up to $145 a ton below what test liner two is quoted for in Germany and, again, I know that is not apples to apples, but normally our craft liner board is $40 a ton higher than what is quoted over there and I am just wondering you mentioned shipping vessels. Is it inevitable that you guys should be getting more board in other parts of the world, or are people who make boxes in other parts of the world happy using and paying more for recycled board which I would guess is lower quality than our virgin board?

Well, I can give you an opinion. You used the right word when you said explored. My feelings are that we have congestion at the ports and when you have congestion at the ports, a lot of the warehouses are the problem, getting ocean bound freight is a problem, but there are a couple of other things going on. If you have any uncertainty over delivery schedule, it's probably a little safer to buy it in your own market until the dependability of exports coming from the U.S. improves and I think over time that will shake out and I think that will be very, very positive for the industry because we do have to congestion at the ports and we've missed some shipments. We had to delay some. Not many, but it doesn't take many to upset somebody. I think the other thing that is going on, too, is that some of the shippers are also deciding to take advantage of the very weak dollar and they know exactly what you said. Our liner board is a real buy in Europe and most of the customers in our case we ship FOB port, customer picks up the freight. So the customers are being gouged a little bit on some ocean bound freight for a lot of the reasons that I talked about in terms of congestion, but I think when that thing works itself out, and it looks like it is working itself out over times as we go, I think that really boades well and people in Europe are like people in the U.S. They are looking for value and you hit the nail right on the head. U.S. craft liner is one heck of a value in Europe and we have to get the doors more open so people can get to the store as they say. And I think that situation is slowly improved.

Right. It makes sense that it will take a while for people to kind of trust the traffic. Now speaking of shipping, could you talk a little bit about the whole OCC situation? I know, fortunately for you, isn't as important, but wouldn't a shipper be much more willing to ship containerboard as opposed to OCC and is it possible we could be seeing as we have seen in some of the stock prices in the margins of some of the Chinese players come down quite hard, is it possible to see a two tier system develop where the price is much higher in places like Asia than here because I would think it is the last thing a shipper would want to send on a boat?

I'm not that familiar, Chip, with the type of boats used for OCC. OCC used to get a favorable rate because there's a lot more empty boats going back to China than full boats coming from China here but with the balance of trade changing, that situation is changing, too, because we are exporting more. So we are not big exporters of anything to China. We basically pulled out of the Chinese market for liner board because we are full and, as you said, we provide great value in Europe and also South America. So it's not that I'm docking the question. I don't think I know enough about it to give you a really good answer.

This last question. In the past you've often given a glimpse into the current month and the economy hasn't been great but then again the mix of the containerboard customers has become less cyclical. What does your April look like so far? Can you tell us?

Yes, sure. I've got data on the first half of the month. That's 11 out of 22 work days. It's basically steady. We are about at the same level as last year, and we had a very good April last year. Our bookings, which reflect orders for the month, are dead flat with last year and our billings, in other words what we bill against those bookings are 1% behind so billing is totally flat, excuse me, bookings is totally flat, and billings down 1%. So all in all flat with last year, but we had a good last year. So our businesses remained quite steady.

Any note in the mix of your customers? Some gotten stronger and some weaker that you can think of? Not by name but by industry.

Yes. I can't. Bill Sweeney is sitting right here. He's a little closer to it than me. Any particular area, Bill?

The durable sector is way down. Building products, siding, things like that, but in the industry durables used to be 35% of the industry. It is now 15% of the industry. So the nondurables are dominating the industry. The future effect today is a lot less than it was in the past. So we would expect industry box shipments should not be that much off even though durables are way down. 15% of the industry is an all time low.

That is a plus because the nondurable tends to go with population growth and, as you know, we are still growing with population.

Yes. Last question. I have to ask you this. In the past, Paul, you've talked about and you've certainly demonstrated a good discipline toward returning very good cash flow to shareholders with a box plan acquisition here or there. If circumstances in the industry force certain parties to have to divest entire mills, is that something that you would look at if you thought the value was good or is that something that you are not inclined to do and you would just mainly look at converting assets?

Well, the answer to that is really it hasn't changed over the last five years. Our primary vehicle to grow is through box plant acquisition because we have been able to make money in both places and that is in the mills and in the box plants, and this is a tough business and you have to make money in both places to get the kind of returns shareholders want. So that is why we want to continue to add to our box plant system and increase our integration level. With regard to adding mill capacity, although that has not been a primary driver of our strategy, the right mill at the right price we would always look at and the right price is a very important part of that equation. If a real value came along, we would look at it. But we don't have a basic strategy of wanting to add capacity. Our basic strategy is wanting to add shareholder value and if an opportunity came along that looked like that would be the case, we would be interested. And again I go back to an old story I like to talk about. We were required by Madison Dearborn. They are no longer holders of company stock but I don't know if I am a good CEO or not but they made me better than I was, let's put it that way. Their mentally is you look for 40 or 50% return on something, not a 20% return like I would look at in the old days. My standard is pretty high if I would look at mill capacity. I want a Madison Dearborn-type return on something that does not core to our central strategy which box plant acquisitions.

Got you. Thank you.

Thank you. Our next question comes from Mark Wilde of Deutsche.

Good morning, Paul. We talked a lot about the mill costs of the industry spacing. I wonder if you can help us understand what is going on down at the converting plant level. A box plant uses energy. A box plant uses a lot of starch. A box plant has to transport the stuff to the customers. Can you give us any sense whether your cost per converting unit has gone up over the last five years or were you able to offset that with productivity?

The answer is our costs have gone up over the last five years and we have offset some of that, but not all of that, with productivity. Just to give you some quantification, about 10% of our energy is in the box plants, and it's generated via either natural gas or oil and you know what has happened to them. So our cost there has gone up and we have no real competitive advantages in that area. We can't burn coal or do some of the things. Starch price is higher, and we expect long-term that starch prices will probably continue to move higher with what is happening in agriculture these days and alternate uses for agricultural products, mainly for the energy arena. Labor costs have gone up, but so has everybody else's, and we ship boxes like everybody else through truckers and those costs have gone up. Now, that's the bad news. All these cost elements have gone up and fortunately for us if you go back, and I think you are familiar with this data, if you go back and look at our volume growth over the last seven, eight years, we are up about 30% at a time that the industry has been flat. So obviously we have with that increased volume been able to do a better job with productivity than most of our competitors because we have been able to grow our volume primarily because of the fact that we provide a best value and Bill Sweeney showed me some data just the other day and it's interesting on how the heck did you grow your volume during this time period. I think it would be good, Bill, you just mention that.

Mark, the way we grow our value is we select the customer that the value is not buying the box but using the box and using the box as promotional material. So we try to select customers that want us to be 100% supplier. Over the last year we've grown with our current customers from 54% of their business 68% of their business. We like to do business with people that we're 100% supplier because of value improvement seems to bring proprietary information which we don't want to share with our competitors and that information is how to design the box, how to use the box, internally reduce your costs if and where appropriate, how to market your product through the box. That's the cheapest form of advertising. So we've been growing with our customer base and obviously is less price pressure in that arena.

But net, net, net, net as they say our costs are going up in the box plants, we probably offset more than most, but we by far has not offset all these costs and that's -- that hurts profitability. We're not hurt as much as most, but we're hurt.

Okay. And then just for the follow-on, Paul. You mentioned this offshore freight issue. I know a lot of your exports go to Latin America I think for the produce box business coming out of Valdosta. Can you give us any sense of how much those costs have gone up and just whether costs of bottlenecks have hurt you at all in terms of export sales?

That's not something I'm willing to share. It's competitive information and I don't mind telling you, but I don't want to tell my competitors.

Fair enough.

Thank you. (OPERATOR INSTRUCTIONS). Our next question comes from John Emerich from Ironworks Capital.

I'm a new shareholder. Just to go back to the price question, if I I remember sitting down with Rick a couple times in the last few months and talking about what was going on with the cost structure, the industry and how prices had to go up and they had to go up more for everybody else because of their relatively greater exposure to the commodities that are moving the most, oil and gas and then, of course, the recycled materials. In your press release you talk about volumes and price being "about what we expected" but then earlier in the call you talked about it being you were disappointed that, I'm guessing, the price increase that Rick was telling me in March didn't go through at all or didn't hold. Could you just clarify those two comments?

Simple. If the price increase had gone through in March since it would have been a past on to boxes yet, we would have gotten very, very little benefit in the first quarter. So my disappointment will be reflected in the second quarter even if you got the price increase in March you would have increased boxes in April and since we are 80 some percent vertically integrated, until we get the box price increase we haven't helped ourselves much earnings wise.

So prices in March is about what you expected.

Speaking of the entire first quarter.

That's what I meant, the March quarter.

So our price forecast for the quarter was basically accurate. We were touched lower but our mix was a touch better so we were about where we thought, but what price benefit we would have received in the first quarter had the March price increase for containerboard gone through would have been relatively small in the first quarter, but relatively large in the second quarter.

I understand. And relative to the second quarter guidance, is 0% of it go through or how much --

Pulp and paper reported that the price increase did not go through.

Didn't go through at all?

Right. That's what they reported.

Okay. Then on the energy side of things I'm looking at this power point presentation you have, it looks like after 65% of your energy coming from renewal resources you have 4 plus 5, it's 9% for natural gas and oil. Incredibly small amount. I know it has gone up a lot. Number one, where else -- I haven't put pencil to paper on this but it seems like you are being hurt more than I would have expected given the fact that I appreciate they have gone up.

You run the numbers again and assume we use 35% and it will bring tears to your eyes. We do use very little and we're going to be using even less because the only place we really burned a lot of fuel in a boiler was at Valdosta where we burned oil. And we've been running Valdosta where we burned oil, and we have been running Valdosta without any oil in the boiler. Now where we do burn gas and oil is in our lime kilns and the lime kilns there is no substitute basically. We have to burn that, but that is a smaller part of it. But the 9% on total fuel. On purchased fuel about 25% of our fuel is in gas and oil, and what brings that down to the 9 or 10% is when you throw in the fact that half our fuel is black liquor and is self-generated and knocks that number way down, but the number most people talk about is how much of your purchased fuel is gas and oil and we are about 25%. But that number is going down probably to 20% after we -- where we are now. We haven't run the new numbers yet because of the fact that we are not burning oil at Valdosta in our boilers anymore, and about 10% of our gas and oil is in the box plants, and there's no substitute there. So those numbers are very accurate. But let me tell you with oil and gas prices where they are today, even a little bit of price increase, even a little bit of consumption hurts you. And so we may be hurting more than you would think, but oil prices are up 70%, gas prices are up 20. They are big numbers. And, again, it was a very wet and cold winter and our consumption was up 4%. That's a lot. I mean 4% is a lot. And hopefully the weather will be a little better the rest of the year.

Second to last question. You do buy more coal than gas and oil. Coal is quite often purchased on relatively long-term contracts, kind of an industry standard by some of the buyers. Coal has moved a fair bit. I'm not sure whether you're --

But coal -- if coal is $3 a million BTUs and goes up 10% it's 330. Gas goes up by an hour in a day. So inflation and coal does hurt you a little bit, but you start with a small number to begin you. Don't get me wrong, I don't like to see any cost go up, but it doesn't nearly hurt you as much as gas and oil.

Can you clarify your buying habits there relative to long-term contracts, buying spot Appalachian coal?

We don't buy very much spot. We have contracts of some duration and the specifics we don't get into.

Fair enough. Thank you.

Thank you. Our next question comes from Michael (inaudible).

How are you doing? I'm curious in terms of this industry is a little bit confusing. Has one of the highest operating rates I have ever looked at in the commodity industry. How can you (inaudible) prices through? Is it discipline within your other competitors? I don't understand.

Well, I would say if you look at operating rates and inventories and you looked at that, you would say this is a fairly disciplined industry. Now that may or may not be the case, but it certainly hasn't translated at least this last time in improved pricing. So my answer to that is I think when the analysis is done, there's got to be more emphasis on fact and not spin that various people put on it, and that's really all I want to say on that.

Thank you. Our next question comes from [David Thomas] of Highside Capital.

Hi, Paul. Good morning. Just to follow up again on this question of pricing because as you can imagine this is first and foremost in our minds. We are all looking around at the rest of the industry and seeing that this is really the only grade of pulp and paper that is not getting price increases right now despite it having the best supply dynamics, high operating rates, a business -- a demand profile that is not going in decline like news print or free sheet and a weaker U.S. dollar which should be benefiting in the export demand, but you guys have got this really bizarre concept in the industry. Obviously this isn't specific to you. It's industry problem.

I'm glad you exclude me interest that because I am truly independent.

I am saying more the way the pricing works in this industry where pricing is not set on a negotiation direct negotiation with buyers and sellers it's set by this sort of referee arbitrator who, at the end of the day has a set of clients who are both buyers and sellers and he or she determines what the price is going to be. And it's not something we see in any other industry, and I think it's pretty clear when you look at the cost pressure the industry is facing and the rest of the pulp and paper industry that it doesn't reflect economic reality. My question is what do we do to fix this? This is beyond what is happening. I know maybe this is a question for some of your other competitors because you are only 7% of the market, but how long can this go on and what are the more radical solutions to fix this? Do we need to go away from the idea of pulp and paper weekly if this will not reflect economic reality in the industry?

Well, the short answer is I don't know. The longer answer is that I am an optimist. I think that eventually the facts win out and quite frankly that happened last year. We had a price increase announced that failed when inventories where very, very low, but it finally did go through and to quota lot of people who reported on it, it went through the boxes "faster than any previous price increase." So I hear what you are saying. I don't disagree with what you said, and my only answer is I think that eventually facts win out over opinion, and in the end you got to go with the facts and I'm optimistic that that will be the case in this industry because if it isn't, there are problems.

From the equity perspective it's a question and you guys turned your cost to capital and the industry doesn't which is why I think a lot of investors look at you as probably the only real investment but at some point I think it is going to be difficult to continue justifying, from equity point of view, subsidizing customers in a market where there is a lot of pricing power it is not being exercised. So I just leave with that thought. Thanks very much.

I appreciate your thoughts.

Thank you. (OPERATOR INSTRUCTIONS). Our next question comes from [Louis Holland] of Highland Capital.

Hi, Paul. I just called to say keep up the good work and look forward to seeing you at your board meeting.

Thank you very much. I do appreciate the call.

As one would say, you are getting better with age.

The age part is true. For listeners out there, [Lou Holland] is a retiring member of our board of directors, been a big asset to the company and despite my strong armed tactics he decided to retire and go on to do other things. [Lou], I do appreciate the call.

But I will still see you at the board meeting.

That's terrific.

Thank you. (OPERATOR INSTRUCTIONS). Our next question comes from John (inaudible) of Ironworks Capital .

Thanks. Just last one and kind of a follow-up to the same idea as the last caller. Given your cost structure advantages relative to your peers, if you are hurt as much as you are, which isn't too dramatic, by recycled costs and energy costs, your peers going to get crushed by this. I don't know how they actually endure much more with out a significant price increase in time. Am I thinking about that right?

Well, we certainly use less recycled fiber than everybody but one company and our energy position is fairly different than other ones in terms of use of gas and oil so on those two cost elements, I think you are right on. The rest of them, who knows, and you are best asking them about their cost other than me because my knowledge of their costs obviously are not very great but it brings me to a point that despite the fact that we had a tough quarter cost-wise, we still did have a first quarter record for earnings, $0.31 to $0.32, excuse me, $0.31, 32 million in income was our first best first quarter ever. We are not satisfied with that but, again, even despite all the bad things that have gone on, we still had a "half decent" quarter. I am hoping for a full decent quarter, but we'll see. Now I guess the outlook is that we are slipping kind of a down year-over-year earnings comparisons and I think unless the profitability level, correct me if I'm wrong, it changes, improves and the rest of the year it looks like your dividend payments may exceed your net income. I know you might have other sources of cash flow, but that kind of changes the whole -- You better check your calculator. I think you pushed a bad button. But we are going to pay out $1.20 in dividends and we are not giving a full year cash flow so I'm not saying it, but double-check your numbers.

You are right. I think I did do --

You have to hit the right numbers. You get better answers that way.

Okay.

Okay.

I am showing there are no further questions.

If that's the case, I want to thank you for your participation on the call. Looking forward to talking to you next quarter and let's all root for the U.S. economy. Thank you much.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Thank you and have a nice day.