Packaging Corp of America (PKG) 2009 Q2 法說會逐字稿

Thank you for joining Packaging Corporation of America's second quarter 2009 earnings conference call. Your host today will be Paul Stecko, Chairman and CEO. Upon conclusion of the narrative, there will be a question-and-answer session.

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

Thank you and good morning, and welcome to Packaging Corporation of America's second quarter earnings release conference call. I am Paul Stecko, and with me on the call today is Bill Sweeney, who runs our corrugated products business; Mark Kowlzan, who runs our mill operations; and Rick West, our CFO. As the operator said, once we conclude the presentation, as always we will open the call -- lines up and take any of your questions. So let me get right to it.

Yesterday, we reported second quarter earnings of $109 million or $1.07 per share. Second quarter earnings included income of $80 million or $0.79 a share from alternative fuel mixture tax credits, for the period from December 13, 2008, through June 30, 2009. Our net sales for the second quarter were $549 million, compared to $616 million in the second quarter of 2008. Excluding income from alternative fuel mixture tax credits, net income was $29 million or $0.28 a share versus second quarter 2008 earnings of $35 million or $0.34 a share. This $0.06 per share decrease in earnings compared to last year was driven primarily by the downturn in the economy, which lowered our containerboard and corrugated products volume and increased down time, thereby reducing earnings by about $0.14 a share; as well as by higher costs for labor and benefits, which reduced earnings by about $0.02 a share; and pricing, which held up quite well, reducing earnings by only $0.02 a share. These items were partially offset by lower costs for recycled fiber of $0.05 a share, lower transportation costs of $0.04 a share, and lower energy costs of $0.03 a share.

Net income for the first six months of 2009 was $135 million or $1.32 per share, excluding the alternative fuel mixture tax credits. Earnings were $54 million or $0.53 a share, compared to $67 million or $0.65 a share in 2008. Year-to-date, net sales were 106 -- excuse me, $1.06 billion, compared to $1.19 billion in 2008. Our earnings were significantly higher than we expected entering the quarter. These higher earnings were basically the result of two things; higher volume, which improved earnings by $0.10 per share more than we originally expected, and lower energy costs, which were $0.05 a share better than expected.

As we reported on our first quarter earnings call, our corrugated products volume had increased significantly during the first half of April over our first quarter shipments. The question at that point was, would this pick-up in volume be sustained? Well, it was sustained, not only in April, but also through the entire quarter. Our corrugated products volume was up 10% or 40,000 tons over the first quarter, which was much higher than our normal seasonal demand pickup of 2.5 to 3% over these two quarters. This pickup in demand has carried into July, and for the first ten workdays our shipments are down about 5.4% compared to July 2008, but this is better than our June shipments year-over-year, which were down 6.5% compared to the previous year.

During the quarter we also saw a significant pickup in outside sales of containerboard, with domestic sales up 24% or 11,000 tons over the first quarter, and export sales up 14% or 5,000 tons. We had originally expected about 90,000 tons of mill down time, comprised of 50,000 tons from our annual mill maintenance outages and 40,000 tons from market-related down time. With a pick-up in demand, we ended up having to take only 10,000 tons of market related down time. This allowed us to increase our mill operating rates from 85% in the first quarter to 91% in the second quarter, while at the same time dropping our containerboard inventories by 2,000 tons. Taken together, all of this improved our earnings by $0.10 a share over our original guidance.

With regard to energy, we ran very well in both our mills and our box plants. What was especially significant this past quarter was that we had to start up three separate mills after annual outages. Starting up and then running well without problems after an outage, which we did, has a very positive effect on efficiency and energy consumption.

We also completed several projects early in the quarter that produced even better results than we had originally assumed. One project involved upgrades to our combustion control capabilities our big bark boilers at both Counce and Valdosta, which allows us to now produce about 25% more steam burning the same amount of bark as before the upgrades. As a result, we can now run Valdosta on 100% wood waste and black liquor, and at Counce we have been able to reduce fossil fuel usage to only about 15% of our boiler's needs. We also completed a project at our Counce mill during its annual outage in April, which allows us to increase our self-generation of electricity and thereby reduce purchased electricity by over 15%.

Finally, energy prices were a little lower than expected, and our box plants ran very efficiently, which also helps reduce energy consumption. Taken together, all of these energy items amounted to about $0.05 a share better than we originally anticipated.

Our mill production was 555,000 tons compared to 614,000 tons in the second quarter of 2008, and that's down 59,000 tons. Annual maintenance outages at our Counce, Tomahawk and Filer City mills reduced production by about 50,000 tons, and market-related down time reduced productions by about 10,000 tons. In the second quarter of 2008 annual maintenance outage down time was only 12,000 tons, and we had no market-related down times. I should add that we now have all of our 2009 annual maintenance outages behind us.

Our corrugated product shipments compared to the second quarter of 2008 were down 7.8% in total and down 6.3% per workday; but as I stated earlier, this was much better than this year's first quarter, where our total shipments were down 12.6%. Outside sales of containerboard were down 30,000 tons below last year's second quarter, with domestic sales down 17,000 tons and export sales down 13,000 tons. The Fibre Box Association reported last Friday that industry corrugated product shipments compared to last year's second quarter were down 8.5% per workday and 9.9% in total. Compared to the first quarter, however, industry shipments were up 5.3% in total, while as I mentioned earlier PCA shipments were up 10%.

With this improvement in demand, industry containerboard inventories fell by 180,000 tons during the quarter, and ended the quarter at 2,246,000 tons, and this is the lowest June-ending inventory in almost 30 years. Industry operating grades also improved each month during the quarter, with April at 79%, May at 83%, and June at 91%. We see these industry results, as well as our results, as positive indications that containerboard supply and demand remains in very good balance, and demand continues to pick up, although still down year-over-year.

Industry published prices for containerboard dropped $15 a ton in April, an additional $10 in May, and were flat in June, ending six consecutive months of price reductions by trade publications. These lower published prices reduced our second quarter earnings by about $0.02 a share compared to last year's second quarter, and will also impact our third quarter, as a full impact of the second quarter price reductions are fully realized.

Turning next to costs, second quarter 2009 recycled fiber, energy, and transportation costs were down significantly from second quarter 2008 levels. Industry published prices for old corrugated containers, or OCC, excluding delivery costs, were down from $126 a ton in the second quarter of 2008 to only $49 a ton in the second quarter of this year, and that's a 60% drop. This reduction in prices improved our earnings by about $0.05 a share compared to last year's second quarter earnings.

As a result of the economic downturn, delivery prices for OCC in the Southeast dropped below $50 per ton in January, a price level not seen since the early 1990s; but by June, as a result of less waste paper collections because of low prices, and greater demand, the price of OCC had risen to about $85 a ton delivered, and has now moved up another $15 a ton to $100 a ton delivered in July. These higher OCC prices will adversely affect our earnings in the third quarter, but fortunately for us PCA will be less affected than most other producers by this increase, as we use much less OCC than most other producers in the industry. Our cost of virgin fiber, on the other hand, was essentially flat with both last year's second quarter and this year's first quarter.

Transportation costs were down about $0.04 a share compared to last year's second quarter, driven more by availability of trucks and rail with the economic downturn, as well as by lower diesel prices. Our energy costs, including both purchased fuels and electricity, were down compared to last year's second quarter, improving earnings by $0.03 a share, driven primarily by operations improvements and lower prices. Chemical costs compared to last year's second quarter were actually up about $0.01 a share. We did not fully realize the benefit of lower caustic soda prices in the second quarter, due to contractual commitments and working off some high-cost inventory on hand. But full realization of low caustic soda prices is expected in the third quarter. Higher labor and benefit costs reduced second quarter earnings by about $0.02 a share compared to last year's second quarter.

Now turning to cash. Capital expenditures were $22 million during the quarter. We ended the quarter with $193 million cash on hand, up $53 million from the end of the first quarter. We received no cash payments from alternative fuel mixture credits during the quarter. However, we did benefit from $19 million of these credits, which were used to reduce our second quarter cash payments -- cash tax payments. Our total available liquidity at the end of quarter was $365 million including cash on hand, and $172 million in borrowings available under our credit facilities. Our total long-term debt at quarter end, excluding capital leases, was $658 million net of debt discounts of $1 million; the same as the end of the first quarter.

You know, to sum up the first half of the year, I would have to say I am pretty pleased that our operating earnings, excluding from alternative fuel mixture credits of $0.53 a share, is down only $0.12 per share from last year's results, despite the did severe downturn in the economy, which has caused us to take record containerboard mill down time. Both our mills and box plants have performed extremely well during these very difficult and challenging market and operating conditions, and the black liquor credits we're receiving may allow us to do important things that otherwise would probably have to be delayed.

Looking ahead to the third quarter, earnings will be impacted by lower selling prices, resulting from previously-published changes in prices for containerboard. Sales volumes are expected to be higher, but some market-related down time is still likely. We also expect the cost of recycled fiber to be significantly higher, with some offset from lower caustic soda prices. Considering all of these items, and excluding any income from alternative fuel mixture tax credits, we estimate our third quarter earnings to be at about $0.24 per share.

With that, we now would be happy to entertain any questions, but I must remind you as always that some of the statements we made on this call constitute forward-looking statements. These statements were based on current estimates, expectations, and projections of the Company, and do involve inherent risks and uncertainties, including the direction of the Company and 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-looking statements.

With that, I would ask the operator to please open up the phone lines, and we will take your questions.

Our first question comes from Chip Dillon with Credit Suisse. Your line is open.

Good morning, Paul. Could you talk a little bit about the timing of the cash payments from the alternative fuels credit? You mentioned -- I think you effectively got 19 of the 80 of benefit in the second quarter. Does that mean that you should -- you already are owed, if you will, $61 million that we haven't seen on your balance sheet yet going forward?

I am going to let Rick take that. I will let him answer that.

That's correct, Chip. We have not received those amounts at this point, and it is sitting as an asset on our balance sheet, but it hasn't -- no cash has been received.

Okay. A real nit-picky question, I noticed it looked like you recognized like $76 million of it sort of above the tax line, and about $4 million or $5 million of it as an offset to taxes. Why was that?

Well, -- go ahead, Rick, why don't you elaborate on that whole point.

Chip, really it was the full amount of 80. The other 5 you're referring to, the net, is what our expense would have been for other expense items, similar to what you saw last year in the second quarter of 2008. You know, what I would say on that is many of the companies that are publicly reported on the alternative fuel mixture tax credit, they have appeared to use the excise tax method, which allows you to apply for an immediate refund of the credit and get the cash, which is taxable. A second method which we are using allows to you take these credits against your income tax owed. As Paul said earlier, we did it to reduce our second quarter cash tax payments. And both our independent public accountants and other advisors have concluded, based on their assessment of similar credits and circumstances, that no provision for income taxes is required at this point, and that these credits may not be taxable.

Got you. Because you have other income you can, in effect, use them against?

That is correct.

Okay. The second question is, it looks like you're getting about $12 million a month. is that a good way to look at it?

We really haven't commented on that, and we started up in the partial month in December, and it probably varies somewhere from $12 million to $18 million a month, dependent on -- as we ramped up and put this in full production. The rate is a little higher than that. I am going to estimate $17 million, $18 million a month.

Okay. And as we look at the third quarter, you mentioned obviously the OCC --

Let me qualify. The reason I was hesitant, to add, you know you don't get as much in a month when you have the mill down for an annual maintenance outage; this assumes you run in full, you don't have any marketing down time. So it is not a steady number, because our production rate obviously affects it, Chip, but in the ballpark $17 million, $18 million a month.

Okay. And I guess to make sure we all understand this on the same page, because of the way your accounting for, which certainly will benefit you more than the excise tax method, is it fair to say that you probably won't really get the full benefit on the balance sheet until probably sometime into 2010, assuming that we're to end at the end of this year?

I think that's a good assumption, Chip.

Okay. And then this last question. As we look at the third quarter, you mentioned the headwinds with the published prices having edged down in April and May, and the OCC going up. Can you give us an idea of how the energy investment you made in Counce and Valdosta will phase into the numbers, like is it pennies a share that we can see, and does it get phased in in the third and fourth quarter, and the same for the cost of chemicals going down? Thanks.

The answer is definitely yes, it gets phased into the first -- to the third quarter. We didn't get a full quarter's worth, but we got almost a full quarter's worth because we took our shutdowns early in the quarter. Counce, which is by far the biggest one, went down in mid-April, and so we got two and-a-half months roughly on that one. And so although we didn't get it all, let's say we got two-thirds of it, to make a rough guess, and that will stay with us in the third quarter.

And beyond?

And beyond, yes.

Got you. Thank you very much.

Thank you. Our next question comes from Mark Weintraub with Buckingham Research. Your line is open.

Thank you. Paul, two things. First, you had mentioned that the black liquor credits were going to enable you to do a few things that you perhaps otherwise were going to be pushing back. If you could elaborate on that, and perhaps more generally with your cash balance growing, with your cash flow still very strong, what are you prioritizing for the use of your cash at this point? And in particular when returning anything to shareholders, what's your thought about share repurchase versus increasing the dividend again?

That's a long answer to a long question, but let me try to do it within some time constraints. I think the good news, we did lower our dividend at the beginning of the year, and for a lot of reasons, one economic uncertainty, bank covenants, we had about $200 million of free bore, if you will, on our covenant of net worth. We had a net worth at the beginning of the year about $684 million. We had a bank covenant to be north of $500 million. That was a fair amount of headroom, but who knew -- who knows how bad things would get. The good news for us is we ended the quarter with a net worth about $794 million, so we're up $110 million, so we're up about $300 million now, and so we have definitely gone in the right direction there.

In terms of cash, we view the alternative -- the funds from the alternate fuel mixture credit as a one-time item; that thing is set to expire at the end of the year, it may end earlier, and so that is not something obviously that's a continuing stream of income, and we treat that as such. In terms of longer-term, the ability to buy back shares, increase the dividend, will come from continuing income. The black liquor credits we've talked about, and I think it's really provided a lot of companies a lot of good. You know, we have some companies in this industry that have teetered on or have gone bankrupt, and I think this credit has arrived at the right time to help them through difficult situations.

In our case, fortunately, we're much stronger financially, and we're looking at using that credit, those black liquor credits, I think in a way the government would have conceived of is a good use of the money, and we think it is a good use of the money. We have a couple of projects, one in Valdosta and one at Counce, that can enable us to, with the same amount of black liquor, produce 50 megawatts more electricity, and we are probably looking very hard to use most of that black, if not all of that black liquor money, to fund these two projects, so it's beyond the order of a $200 million. We think the return is -- on an after-tax basis is over 20%; it could be even higher if some of the energy legislation goes through, specifically Section 45, which gives credit to producers of green electricity, primarily the utilities, but we believe the forest products industry will also be included in this credit, which encourages people to produce and sell green energy. And the energy that we would produce at both Counce and Valdosta would meet the green criteria, in that it is produced solely from black liquor and wood waste, and what this would do is produce then a stream of income for the future that then we could consider operating income and use for such things as share buyback, or increased dividends, and so we're excited about the possibility. We're still studying it. We haven't made a decision. That will happen later in the year. Then we have -- we view that as a fairly low risk investment, because it doesn't involve selling any more tons or things of that nature; it just involves reducing costs, which you can control a lot better, and we think electricity costs are going up a lot.

At that point then you look at all the income you have, and as I've said many times, we view both share buyback and increased dividends as very shareholder-friendly thing to do. A lot will depend in terms of the mix of those two items, and I think we will continue to do both, on what the new tax laws do and how they treat shareholders with regard to both of those things. So that's a long-winded answer, but it is a complex situation.

I appreciate that. Very helpful. Just one quick follow-up. On the electricity you would be producing, would that all be for internal consumption or would you potentially be selling some or a lot of that back into the grid?

No, this would be for internal consumption. It's basically at Counce and Valdosta we can produce 100% of our own electricity, and what the Section 45 legislation is that is being introduced, it gives you the ability to either sell it or use it yourself, because the Congress does understand that if it is produced it doesn't matter if the utility sells it to you, and it is totally green, or if you produce it yourself and it is totally green. The law makes a lot of logic. Again, it is in Congress, you never know where it is going to go, but we're fairly optimistic this thing makes a lot of sense if you're a supporter of green energy, and it doesn't make or break the project, but it really enhances the return.

I appreciate it. Thank you.

Thank you. Our next question comes from Richard Skidmore with Goldman Sachs. Your line is open.

Thank you. Good morning, Paul. Can you just talk about the deflation that you're expecting to see in the third quarter, and specifically are you anticipating that you will see any deflation in the wood fiber costs as you go into the back half of the year?

No. As I said, our wood costs have been fairly stable for about the last year. They're not going up, and they're not going down. So fuel costs have dropped. That's helped, but it kind of reached a plateau, and if anything fuel costs have gone up a bit. We expect higher OCC prices. I mean, our average price was about $75 a ton in the second quarter, it will probably be $100, $105 a ton in the third quarter, so that's roughly $25 to $30 a ton. That's kind of what we're looking at. We'll get some offset in caustic soda. Other than that, we think things cost-wise will be the same quarter over quarter. We may use a lot less -- we may use a little less energy with warmer weather, but not much because where our mills are in the South, the second quarter is already pretty warm. So not a lot of changes in costs, except for those two items.

Just shifting, just one other question. Where did you see the strength in the quarter in your box shipments? Was there any particular area of surprise? And as you look out to the third quarter, do you get the sense that you might see continued surprises on the upside, or are you feeling pretty good about how your volumes are trending here?

Well, I would say -- and, Bill, chip in if you have anything to add, but no, our volume was strong and picked up across -- all over. We didn't have any particular regions that were weak. We got about seven regions of the country, each run by an area General Manager. All performed very, very well, and it has been slow, steady improvement. As I said the last call, it is like a light went on in April and it stayed on. It is getting a little brighter, but it's not blinding yet. We're hoping it gets blinding, but we're not there yet.

So we're just seeing slow, steady improvement, and August and September historically are very strong months for us. July is kind of a normal month, and then we usually get a nice pick-up in August and September. So in April -- in May, we were up about -- April, we were up about 6.7%, May -- excuse me, we were down 6.7% over the previous year. May, down 5.6, and then June down 6.5, but you have to be careful with that, because there is a large difference in the number of days in these months. It is a weird year. But on a total volume point of view, June was by far our strongest month, and I think that's also the case for the industry.

Thanks, Paul.

Thank you.

(Operator Instructions)

Our next question comes from George Staphos with Banc of America. Your line is open.

Thanks. Hi, everyone. Good morning. Paul, I wanted to come back to the energy products, both the ones that you have been working on and the ones that you might work on, funded by the black liquor credit. What type of change might it mean for your mix of energy consumption and source over the next few years if, for example, natural gas was, I don't know, round numbers 25% of volume MBTUs that you used in prior years, what could that number drop down to over time? And how much could coal, bark and steam ultimately reflect -- or represent, in terms of your overall mix?

Well, not much because we're already there on not using much fossil fuel.

Right.

For example, today at Valdosta we use no fossil fuel in our boilers. We do put a touch of diesel in with the black liquor, as is required to qualify for the credit, but other than that, we don't use any fossil fuel. What would happen at Valdosta is that we have three very old recovery boilers that would be replaced by one very high-efficiency recovery boiler, and with the same amount of black liquor we can produce 70% more steam than with the three old boilers. That 70% more steam can drive a turbine generator that would produce about 25 megawatts of electricity. So basically what the investment gets you is 25 megawatts of free electricity that you should also qualify for, if the Section 45 legislation goes through, a tax credit on that in addition to producing it for nothing. So it is really efficiency. That's why there is not a lot of risk in terms of where the prices of things are going.

Then of course there is some other savings there also in the project in terms of manpower required, maintenance costs, et cetera. But primarily it is just a big, big step up in efficiency. And the project at Counce is much smaller, but again we have the ability with the almost -- basically the same amount of steam to produce a lot more electricity. And what is going on in the country, there is a lot of utilities that simply can't get a coal-fired power plant permitted. We think with Government incentives for utilities to burn more wood instead of coal, the cost of that i-- it s more expensive to burn wood than coal, probably today it is twice as expensive, and the utilities will have no recourse but to pass that on to the consumer. We're a consumer. So we see escalating electricity prices, and that's why if things go the way we think, now is the opportune time to become self-sufficient in electricity production at our big liner board mills.

That makes sense, Paul, and that's been a theme you folks have been talking about, I guess, for the last few quarters as well. That's helpful. Just out of curiosity, the net gas consumption in the quarter then, if you pretty much where you would be, were you at 20% of total MMBTUs, just out of curiosity?

No, in our boilers virtually none. Boiler consumption, we don't use any -- during the shutdown we may keep a pilot light in the boiler just for safety reasons, but we are -- Rick is going to look up the number, George, but as soon as we get it I will come back online and report that number. It is so small, Rick can't even find it.

Okay, that's fine. I am just comparing to what you have in your 10-Ks.

He tells me it is about 4% or 5% max, natural gas and fuel oil, and again a lot that is for pilot lights, and a lot of that is when you start up you start up on some gas and oil, but steady state numbers are probably half that.

Okay. Fair enough. Switching gears to just the market, and if we think about your operations and then maybe more broadly if you can think about the industry, we're seeing steady progress. You haven't gotten to, as you put it, a blinding light type of environment, but what do you think about your ability to meet a potential demand surge down the road? Inventories are low, you have seen stabilization in pricing; suppose -- as strange as this might have sounded two or three months ago, suppose see a demand surge and you start to see pricing pick-up, how do you think your operations could handle that kind of environment, a la, say, 2004? And the same, for that matter, from an industry standpoint?

Well, the situation is a lot different than -- let's put it like this, a lot different than 1995, when demand really took off, because the industry didn't have any capacity. The situation here -- and let me comment on inventories. I did read in a trade publication the other day that said, and they were talking about industries, they're a little lower than last year, and that's the mother of all understatements. They're at a 30-year low. So, yes, they're lower than last year, but a 30-year low, every 30 years you get below that. I mean, it's a long time. So inventories are incredibly low. They're not just a little lower than last year, in my opinion.

But I think the good news is if there is a surge in demand, the industry only ran at a 91% operating rate last month -- 85%, so the industry has capacity, we have capacity, we ran at 91%. So if our demand picked up 9%, which would be obviously a mammoth increase, we have the capacity to handle that. So the situation that is different is, if the the industry was running at 98% at this inventory level, I think that would be more cause for concern than when you have some room in your operating rates, and we certainly do.

Okay. Paul, last one, and I will turn it over. Realizing it is tough to project into the future in these businesses, if you keep at this run rate that you're running at in July, are we looking at year-on-year increases in volumes by the time we get into the fourth quarter?

You mean for the year? Or just for the third quarter over the fourth -- over the second quarter?

Either third quarter versus third quarter or fourth quarter versus fourth quarter, when do you think we finally see an actual percentage positive increase in shipments?

I don't know.

Okay. All right, guys, we'll turn it over. Thanks.

Thank you. Our next question comes from Mark Wilde with Deutsche Bank. Your line is open.

Good morning, Paul. Can you give us a little bit of color on that export market, including the export prices? Seems to me it is kind of interesting that export volumes seem to be picking up at a time when we are still seeing trade papers report very low export prices, so would just like to get your perspective on that?

Well, I saw a piece you wrote this morning, and I think you got it just right when you talked about the weak dollar helping, and so I certainly think that after -- over the last few months the dollar weakening after getting real strong, not real strong but relatively strong, that's helped the export business. And there are other countries that have stimulus programs, and in some of those countries stimulus programs actually appear to be working better than ours, and that's helped with the export business.

So it's just picked up, and I think a combination of those things. Other countries have done things to stimulate their economy, they're working to some extent just like ours is working to some extent, and the weaker dollar certainly makes you more competitive in export markets. I think it is a combination of those two things.

Okay. And then you talked about the projects, the energy projects at the two Southern mills, but I wondered if you could update us on any thoughts at the two Northern mills, including that biorefinery up at Filer City?

Sure, well you know the Northern mills, the two medium mills mills, consume a lot less electricity than the big Southern mills, primarily because [semi-cam] to semi-cam it is not cooked fully. You use probably in a typical semi-cam furnish 40% OCC, it is a blend of the two, so your energy needs are lower. And we do not generate as much electricity ourselves, we tend to buy more in the Northern mills simply because of their size, and the fact that they don't have recovery boilers that can churn out loads and loads of energy.

But the biorefinery is doing well. The one thing, I wouldn't call it a disappointment, it is just economic fact, we have not ramped it up to 100 -- we were sitting at about 70% of capacity this time last year, and we're still running at about 70% of capacity, not that it can't run more, but the price of OCC got so inexpensive that it made sense to use more OCC than produce biogas from liquor. And it looks like that situation is turning, with OCC going to now be over -- probably over $100 a ton in the third quarter, and we're looking forward to ramping that up and getting to 100%.

With regard to Tomahawk, I would just comment that as a result of wood costs in that part of the world, upgrades on a wood waste boiler that we're looking at, we're pretty optimistic about the costs for Tomahawk. And last quarter our cash costs at Tomahawk were the lowest in the last five years, as a combination of those things. So it is not as dramatic a picture on energy in the Northern mills just because they're medium mills, but we're fairly pleased with the progress we have been able to make.

Okay. Then just the last detailed question. I was kind of surprised in your comments on virgin fiber, because some of the trade papers are actually showing a reduction in Southern pulpwood costs over the last couple quarters, and it doesn't sound like you're seeing that, and I just -- are there contractual arrangements that are making things different for you? You think the trade papers are a little bit off there? What's the situation?

No, I think -- it is a very regional thing. I think you have to look at where you started and where you are. You want to try to keep your -- our loggers' prices fell. Our prices fell, and then they went back up. I think the one thing that has affected our wood costs, and maybe more than others, is that we had some very, very bad weather in the South in April and May, in terms of rain, wet weather, et cetera. With the Sustainable Forestry Initiative, it is much harder if you want to comply with that, and we certainly do, to get into woods too quickly after wet weather, get too quick -- too close to streams that may have overflowed. And so wet weather can increase your costs, but I don't see anything contractually.

We buy woods -- we don't have a lot of wood under long-term contract. We float with the market. I think it is just where you are in the region. At one time one region is a little lower in costs than the other, and it is hard to pick a point in time and compare companies because they come at it in different ways. So ours is flat. We're pretty happy where they were a year ago, and we're pretty happy that they've stayed where they were.

Okay. Very good. Thanks a lot. Good luck in Q3.

Thank you, Mark, good talking with you.

Thank you.

(Operator Instructions)

Our next question comes from Mark Connelly with Sterne Agee. Your line is open.

Thank you. Paul, I don't think I have ever heard you sound as bullish as you sound right now. A couple of questions. First, on the balance of internal and external sales, can you help us understand where that is? I mean, you like to sell into the outside market, and I am just curious where that balance sits today, and whether it is where you would like it it be given how cruddy the economy is?

Yes, our basic balance has been, you know, rough number about 18%, 18% to 20% of our sales goes to outside. And usually it has been two-thirds domestic, one-third export. And that's where it is basically now. In the export market, we're not as big a spot player as others. We try to have longer-term relationships. Some of the things we like to sell because we have capabilities, and there is not as much supply as some of these products; super heavyweights, for example. We also sell some specialty product, very high quality, to Japan for example, where some of the requirements are exacting.

But our biggest markets have historically been Europe and South America. We do sell some product into China. And obviously of all the markets I've mentioned Europe has been by far the weakest, because of severe over-capacity on the Continent, and so that would be the only noteworthy thing. We're selling less into Europe than we have historically.

Thank you, Paul. And you don't typically tend to give us a whole lot of color on the changes in your mix, but I am curious with the 10% volume pick-up, how much of that is simply increases in volumes on existing orders from existing customers, and how much is that relatively new-ish orders when you think about -- if you think about it that way? Just trying to get a sense of who is doing the order?

The overwhelming majority of our increase in volume is more business from existing customers. They have had more business, they need more boxes, we sell them more boxes. So that would be the vast majority of our increase in demand over the last three months.

Okay. And just one last question, and I'm sorry to beat a dead horse here, but on the virgin fiber issue, we're seeing the same thing with utilities looking more heavily towards solid fuel, and that suggested at some point there is some fiber competition out there. Just specifically in the baskets where you're operating, are you seeing any of that that's going to start competing with you for wood?

Yes, I think we certainly are, as others are. And where wood grows the fastest is in the U.S. Southeast. That's where all the big liner board mills are, and that's where some of these utilities are contemplating adding capacity burning wood. One of the things that the AF&PA has stressed in terms of some of these incentives for people, particularly utilities, to burn wood instead of coal, and get credits for that, we think that incentives need also to be placed on the supply side as well as the demand side; and that is incentives to encourage people, including utilities, to give incentives to people that are growing and selling trees. Because you want to try to obviously keep supply and command in balance, or the price of wood will go up, and it will go up preferentially in regions, and those costs have to be passed on, obviously, to the consumer, and obviously it is a lot easier for a utility to do that than it is for a paper company.

But it didn't sound from your earlier comments, Paul, that you're that worried about virgin fiber price pressure?

In the short-term I was talking, they've stayed the same, and I expect them to stay the same. You're talking about a longer-term phenomena, you know, over the next decade.

Okay.

I think that what you're talking about will certainly put pressure on the price of wood over the next decade. So I was speaking strictly in the -- we're talking quarter to quarter here, you're talking about a decade-long phenomenon.

Got it. Thanks a lot, Paul.

Thank you.

Thank you. Our next question comes from Dan Rohr with Morningstar. Your line is open.

Good morning. I would like to ask a question about your fiber flexibility. As the virgin versus recycled fiber costs differential has varied over the past several quarters and the tax benefits of virgin have come into play, how much have you adjusted your fiber content? Are you still in the range of around, I think it was 17% net recycled in '08?

We were higher than that in the first four or five months of the year in terms of we flexed up to about 25% using more OCC, because it was at 15-year lows in prices. Now that it is up over $100. we're flexing back down towards the 17% number. That's strictly an economic trade-off that the -- that when it was real cheap we used it, and when it gets expensive we try to use as little as possible.

Fantastic. Thanks a lot.

Thank you.

Thank you. Our next question comes from Andy Feinman with Iridian Asset Management. Your line is open.

Thanks. I heard you say that your total long-term debt was $658 million, but I apologize that I missed I think something you said right before that, which may have been current portion of debt, or is that the whole thing, $650 million?

That's the full amount. Let me see. I got my notes here.

Included in that amount, Andy, of $658 million is our asset securitization on our receivables, which is about $109 million that we turn over every month. But we consider that as part of our long-term debt because we keep it, so that's the amount.

Okay. So that includes any current portion?

That's correct.

So that means that your net debt at the end of the quarter was $465 million, and if you include the fact that the government owes you $61 million, then your net debt is $404 million, and the last time your debt was that low --

Do you need a loan, Andy? Is that what you're getting at here?

Your debt hasn't been that low in my spread sheet, there's nothing that's ever been that low, and I guess it is going to be lower at the end of the -- now is when you start to really flow cash in the third and fourth quarter. So would you care to give us any idea of how low that number could get this year? And then the second part of the question is when you start spending the money on the $200 million worth of capital projects you talked about?

As you know, Andy, we give guidance only a quarter in advance, so I can't handle that first part of your question. But -- we're not done studying the project yet, but we would envision possibly taking it to the Board in the fall, and with spending in earnest starting in 2010.

Right. Okay. So, all right, but I have the debt -- so you don't want to talk about how the debt -- but clearly it is going to be lower. I mean, if you're at $404 million now including the $61 million that you're going to get in tax reductions, then it is going to be lower than that every -- you know, this quarter, next quarter?

For the third quarter, obviously, if the guidance we give -- we gave came to fruition it would be lower, yes. You can do the math as well as I can.

Okay. Well, that's great. Thank you.

Thank you.

Thank you.

(Operator Instructions)

Gentlemen, I am showing no further questions.

Okay. Well, again, thanks everyone for participating in the call, and we look forward to speaking to you next quarter. Have a good day.

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