Smurfit-Stone Container Corp. Q1 2008 Earnings Call Transcript

Smurfit Stone Container Corp. (SSCC)

Q1 FY08 Earnings Call

April 23, 2008, 9:00 AM ET

Executives

John Haudrich - Director of IR

Patrick J. Moore - Chairman and CEO

Steven J. Klinger - President and COO

Charles A. Hinrichs - Sr. VP and CFO

Analysts

Joe Stivaletti - Goldman Sachs

Mark Connelly - Credit Suisse

Gail Glazerman - UBS

George Staphos - Banc of America Securities

Claudia Hueston - JPMorgan

Mark Wilde - Deutsche Bank

Mark Weintraub - Buckingham Research

Chip Dillon - Citigroup

Bruce Klein - Credit Suisse

Presentation

Operator

Ladies and gentlemen thank you for standing by and welcome to the Smurfit-Stone's First Quarter 2008 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode and afterwards we will conduct a question-and-answer session. [Operator Instructions]. And I would now like to turn the conference over to John Haudrich, Investor Relations. Please go ahead sir.

John Haudrich - Director of Investor Relations

Good morning and welcome to Smurfit-Stone's first quarter 2008 earnings conference call. Joining me today are Pat Moore, Chairman and CEO; Steve Klinger, President and COO; and Chuck Hinrichs, our Chief Financial Officer.

Presentation materials for this earnings call are also being simulcast on the company's website, at smurfit.com. Please review the Safe Harbor comments and disclosure of our use of non-GAAP financial measures included in those materials. Unless otherwise noted earnings to adjusted net income or loss which excludes certain unusual items identified in the presentation appendix. Today we will review quarterly earnings, discuss operations including our strategic initiatives program, review financial matters, and share our business outlook. Following the prepared remarks we will host a question-and-answer session. Please note your questions must be submitted through the calling number previously published and not through the webcast. And now I will turn the call over to Pat Moore.

Patrick J. Moore - Chairman and Chief Executive Officer

Thank you John and good morning. Smurfit-Stone's first quarter adjusted net loss was $24 million or $0.09 per share. As chart on page 3 illustrates earnings were down sequentially from $0.09 profit in fourth quarter 2007 and flat with the prior year. The first quarter is typically a challenging period for our business due to the seasonal factors and as such we expected sequentially lower first quarter earnings. However, as the quarter unfolded additional factors negatively affected our results.

We recorded a chart related to Calpine Corrugated. As previously announced, we've signed a letter of intent to take a controlling interest in this company. With Calpine, the premier packaging plant serving the important California agricultural market we will accelerate efforts to optimize our packaging system in Northern California. We expect to close the Calpine transaction in the second quarter and our new LA plant should be operational in the third quarter. With the combination of these two sites we will significantly upgrade our West Coast operations.

Cost inflation was significantly higher than expected. Just in the last quarter natural gas prices increased over 9%, fuel oil was up 12%, and corn starch increased 15%. Higher cost also reflect a charge for prior non-recurring strategic review activities. Box demand was softer than projected due to the slower U.S. economy. Most economists have significantly revised their 2008 economic outlook and just in the past quarter, the Blue Chip consensus for industrial production was cut in half to under 1%. Likewise, Reece [ph] lowered its outlook for 2008 packaging shipments from a growth of 1.2% to a 1.6% decline. So considering the Calpine charge, higher costs, and softer box demand, first quarter results were lower than expected.

Despite a challenging business climate we can point to a number of accomplishments. For the fifth consecutive quarter Corrugated selling prices improved as we successfully completed last falls box price initiatives. Furthermore we believe packaging business fundamentals are supportive of additional price improvement. Supported by a robust export market, our mills ran full and we continue to execute our strategic initiative program. We reduced headcount by 230 positions and upgraded or replaced 19 corrugators and converting machines as part of our container capital program.

Our first quarter results were clearly disappointing as we faced significant cost inflation and a slower economy. We continue to make good progress transforming our operations to deliver long-term shareholder value. I will now turn the call over to Steve who will expand on our operating activities.

Steven J. Klinger - President and Chief Operating Officer

Thanks Pat. Good morning. As you can see on page 4, first quarter operating profits were $108 million down $50 million from the fourth quarter. Higher energy cost represents more than half of this decrease due to seasonally higher energy usage and rising oil prices which impacted energy, freight, and chemical costs. Another 40% of the decrease relates to timing factors primarily higher employee benefit expense. The balance was due to lower than expected box shipments.

As anticipated we successfully completed last falls box price initiatives as average prices improved 1.2%. Packaging demand was softer than we projected in the first quarter and our per day U.S. box shipments were down 4.4% year-over-year. However 4.2% of this decrease related the plant closures and efforts to improve low margin accounts. As such our shipments were essentially flat and like the fourth quarter slightly out performed the overall market which declined 0.7% in the first quarter as reported by the FDA. The strong Canadian dollar and subsequent exit of Canadian jobs have impacted box shipments. This reduced our earnings about $0.01 per share in the first quarter.

Despite lower North American box shipments containerboard exports reached record levels. As a result our mills ran full and containerboard inventories ended the quarter at historically low levels. Both domestic and export line of board prices remain basically flat with the fourth quarter.

Turning to our strategic initiatives on page 5; 2008 represents the peek investment period under our container capital program. We invested $94 million across all our businesses this past quarter. We installed or upgraded six corrugators and 13 converting machines. The progress is visible. We reduced headcount by an additional 230 positions in this quarter for a total of almost 5600 since 2005. We closed an additional box plant for a total of 29.

In addition to raising prices this quarter our sales force focused on eliminating excess warehouse space and improving freight efficiency. Warehouses were down 3% and trailer utilization was up another 5%. We made a lot of progress on our two new Greenfield sites in Chicago and L.A. which we expect will be in operation in the second and third quarter respectively. And we also installed three new corrugators this quarter on time under budget and machine productivity has exceeded my expectations. Annualized initiative benefits totaled $480 million in the first quarter. We remain on target to reach our 525 savings target in 2008 through additional savings from our capital program plant closures and headcount reductions.

Looking forward we will focus on our Greenfield sites in the second and third quarter as we bring the new L.A. and Chicago sites live. We expect to integrate the Calpine operations during the third quarter. By the fourth quarter equipment installations and upgrades in our container business will be largely complete. Focus will shift to optimizing our container network footprint to further improve productivity. While transition cost should remain high through much of '08 I would expect transition cost to improve towards year end.

I will now turn the call over to Chuck who will discuss financial performance.

Charles A. Hinrichs - Senior Vice President and Chief Financial Officer

Thanks Steve, good morning. I will start by reviewing the activities that drove our financial results on slide 6. Fourth quarter 2007 adjusted net profit was $0.09 per share. Earnings declined to a loss of $0.09 in this first quarter driven by the following factors, higher box prices and mix improvements boosted earning $0.03 per share while lower box shipments cost us $0.01. Cost inflations was significantly higher than expected impacting results $0.05. Energy reduced earnings $0.03, freight cost increases were $0.01, and chemical cost increased $0.01.

Timing factors primarily higher energy usage and recognition of employee benefit costs reduced earnings by $0.08. As previously announced first quarter results include a charge to reserve for amounts due from Calpine Corrugated. Other costs were $0.02 negative principally expenses related to prior strategic review activities.

As noted on the previous chart, we are seeing a rapid increase in inflationary cost pressures. Unfortunately these pressures will likely continue through much of 2008. As a result we have revised our full year 2008 inflation outlook. As you can see on page 7 we originally estimated total inflation of $100 million to $150 million for 2008. While we did anticipate higher energy prices this year, fuel costs driven by the price of crude oil have increased faster and by a greater magnitude than projected. Higher fuel prices are also impacting other cost groups including freight, fiber, and chemicals. As result we have increased our 2008 cost inflation outlook by $100 million to between $200 million and $250 million.

Additional financial highlights are shown on page 8. Other expenses was $43 million this quarter and includes the previously announced $22 million Calpine charge and $7 million for strategic review expenses. These costs explain our higher SG&A expenses in the quarter. More details will be shared about Calpine once the transaction is closed in the second quarter.

Capital investments total $94 million in the first quarter and our full year 2008 guidance remains $400 million. Our debt always goes up in the first quarter as a function of working capital increases and the timing of employee benefits. These factors and capital spending in our box plans drove a $122 million increase in our total debt, to $3.481 billion at the end of the quarter. Our off balance sheet debt was stable at $420 million on March 31. Availability under our revolving credit was $223 million at quarter end.

Page 9 provides more information on our debt position. Recent weakness in the credit markets underscores the importance of properly managing debt. We made significant progress over the past few years improving our financial flexibility. In addition to reducing debt, by over $1 billion, we opportunistically refinanced to extend maturities and further reduce interest expense. As you can see on the left chart, our only near term maturity is our revolving credit facility which doesn't mature until November 2009.

In conjunction with launching our three year strategic initiatives program in 2005, we negotiated our financial covenants to provide the needed flexibility to execute our business plans. Our credit agreement has two key financial covenants, a senior debt to EBITDA ratio and an interest coverage ratio. Definitions are provided on the right. The chart breaks out our trailing 12 month EBITDA between the minimum EBITDA required to comply with covenants and additional EBITDA head room. As you can see, we are comfortably in compliance with our financial covenants.

As of December 31, 2007, our actual EBITDA exceeded the covenant minimum by $171 million and head room increased to $214 million at March 31, 2008. We expect to remain in compliance with all our financial covenants in 2008. Reflecting our improved financial flexibility, Standard & Poor's upgraded our corporate credit rating in the fourth quarter. I will now turn the call back to Pat for our business outlook and concluding remarks.

Patrick J. Moore - Chairman and Chief Executive Officer

Thank you Chuck. On page 10, we outlined the key business factors that we expect will drive our second quarter results. Despite a slower U.S. economy we expect box shipments will improve from the first quarter due to seasonally stronger packaging demands. Furthermore, we expect our box volume will again outperform U.S. market trends. Given the continued weak U.S. dollar, containerboard exports should remain strong. As a result we project continued high mill operating rates and low containerboard inventory levels. We anticipate 20,000 tons of additional maintenance downtime which will impact both production and drive higher maintenance expense.

Timing factors such as lower energy usage should also improve second quarter earnings a few cents per share. Yet as Chuck outlined, continued cost inflation is expected. Additional inflation along with the full effect of inflation from the first quarter should impact second quarter results by $0.05 to $0.06 on sequential basis. Considering all these factors we expect earnings will improve sequentially in the second quarter.

To summarize Smurfit-Stone's first quarter results were impacted by the unfavorable economic climate and are clearly disappointing. Nevertheless I remain confident we have the right plan to transform the company to deliver longer term improved profitability and therefore we are staying the course to execute that plan. By implementing multiple price increases and focusing on margin enhancements we have improved box prices for five consecutive quarters. We are optimizing our mills to improve productivity and throughput is up 10% since 2005. We are investing and restructuring our converting operations to reduce cost and box plan productivity is up 15% today and we'll continue to grow. These efforts have lead to a 21% decrease in headcount since 2005.

Finally we have greatly improved our financial flexibility, we have reduced debt by over $1 billion, we have extended bio maturities, and greatly improved our position relative to financial covenant requirements since early 2006. Challenging market conditions underscore the importance of properly executing the final steps of our transformation program and staging Smurfit-Stone for improved financial performance. Thank you for your interest in our company and I'll now turn the call back to John.

John Haudrich - Director of Investor Relations

Thanks Pat. That concludes our prepared remarks. We have set some time aside for questions. Before we get started let me remind you legal considerations require that we refrain for commenting on questions regarding future downtime and pricing strategies. Operator, we are ready to take the first question. Please limit your comments to one initial and one follow-up question if needed. Thank you.

Question And Answer

Operator

Thank you. [Operator Instructions]. And the first question we have comes from Joe Stivaletti from Goldman Sachs. Please proceed with your question.

Joe Stivaletti - Goldman Sachs

Good morning, I was wondering if you could comment on the situation with pricing in your industry given all the cost inflation, sort of what happened with the March increase, and how you... what your expectations are looking forward in terms of an ability to offset some of this cost inflation in the near term?

Patrick J. Moore - Chairman and Chief Executive Officer

Okay, thanks for that question Joe. I can say that I am extremely disappointed that the index did not reflect price improvement in the last publication. As I said in my prepared remarks we really believe that many industry conditions continue to favor improved pricing. We have high operating rate, we have low inventories, the continued strength in the export markets with the continued weakness of the dollar, the global competitive advantage for North American containerboard, and certainly as you articulated the cost inflation that we are facing.

I can only assume that the decision was driven by softer package in demand than expected and any noise that we saw around that during the quarter. With that said it seems to us with inflationary pressures again coupled with the low inventory, low containerboard inventories, and the very healthy export markets that any improving domestic demand environment should really support further price improvement in 2008 and that's what we would look for. I'm going to ask just further to that question, maybe ask Steve to elaborate a little bit on both our box price and containerboard increase activities during the quarter to give you some sense of what we accomplished there as well.

Steven J. Klinger - President and Chief Operating Officer

Thanks Pat. On the box side, we executed the $40 per ton price increase peak-to-peak. As we benchmark against the industry, the FDA provides a price index and we actually whether you compare a third quarter to first quarter or fourth quarter to first quarter, our price index on a percentage basis was 0.3% higher than the average for the industry. And as you know, our selling price generally is higher than the average. So, on both components we exceeded what the industry at least reported as the actual price increase.

Secondarily, on the containerboard price during the quarter, as some of you all may have noted we were down slightly $2 or $3 on a per ton basis. When we really look at what happened during the quarter on that, as we put orders at risk during the March timeframe, obviously on some orders we got additional orders and the price went up. And on other orders we did not receive the orders as they were able to get the containerboard from other folks. So in general, the containerboard price was generally flat except for customer mix and then on the box price increase Pat, we were able to execute the $40 per ton price increase.

Patrick J. Moore - Chairman and Chief Executive Officer

Thank you Steve.

Joe Stivaletti - Goldman Sachs

Okay. Yes, that's very helpful, and on the volume side, I just wanted your perspective, you talked about receipts now being down 1.6% for the year. I wondered if you were... thought that was a good way to be thinking about the industry at this early point in the year and also how your company thought shipments were likely to look relative to the industry given your continued shifts in your converting system?

Patrick J. Moore - Chairman and Chief Executive Officer

Well they... let me take the first part of that question first. It's really hard to keep up with Reece [ph] these days given as I said they lowered their expectation from growth of 1.2% as we started the quarter to a decline of 1.6% now for the full year. So I am not sure we have ever seen those levels of magnitude from a forecasting change in that short period of time. I think the important news coming out of that is that they are forecasting for growth in the business as we move into the second half of the year. And I think that would align closely with what our expectations are as well. As Steve mentioned in his remarks we are slightly outperforming the industry at this point of time when you eliminate the closures and business exits and our expectation given our positioning from our sales excellence standpoint that we will continue that trend as we move through 2008.

Joe Stivaletti - Goldman Sachs

Okay, thank you very much.

Patrick J. Moore - Chairman and Chief Executive Officer

You are welcome.

Operator

Thank you and the next question comes from the line Mark Connelly with Credit Suisse. Please proceed with your questions.

Mark Connelly - Credit Suisse

Thanks. Pat, when you look at these... the size of this cost increases versus what you were anticipating, does the emphasis in your investment and strategic spending now look a little bit different than you might have planned it if you had expected these increases to be so big. Wondering whether you need to start re-jiggering that strategic plan to address other elements of your system, you know other weakness in the system?

Patrick J. Moore - Chairman and Chief Executive Officer

Well, it's obliviously it's, in hindsight Mark you might have done things slightly different but frankly as I told our Board last week it's a very challenging time but both Steve and I feel very strongly that we are on the right path in completion of our initiative program. It is exactly what is in the best interest of our shareholders. It's not to suggest that we are only focused on the box plan system. We are certainly looking at lots of opportunities around mill energy projects. We have been investing in those. In the past our nat gas usage was down almost 25% since 2004. We completed a major project at our Hodge mill last year. We are looking at fuel switching opportunities. But as we all know those things are more longer term in nature and it's very difficult to adjust to the kind of magnitude of changes that we've seen. But we certainly have re-doubled upwards across our organization to look at accelerating cost initiatives wherever possible and we will continue to be focused on that. So I wouldn't do things a lot different than we have. Clearly as Steve mentioned again, we've got... we are right in the midst of the major capital initiatives in our Corrugated system and in hindsight you might have spread those out a little bit more than we did but again we were dealing with what we've committed to here.

Mark Connelly - Credit Suisse

Very good. Thanks Pat.

Patrick J. Moore - Chairman and Chief Executive Officer

You are welcome Mark.

Operator

Thank you and the next question comes from the line of Gail Glazerman with UBS. Please proceed with your question.

Gail Glazerman - UBS

Hi, thank you. I was wondering if you could talk in a little bit more detail about the export volumes and how profitable or attractive those are relative to the opportunities you had domestically in terms of selling independence [ph] or box conversions?

Patrick J. Moore - Chairman and Chief Executive Officer

Gail, I'll ask Steve to comment on that.

Steven J. Klinger - President and Chief Operating Officer

Thanks Gail. We are running about 300,000 tons on our exports and obviously, basically all export markets given the U.S. dollar positions have become in terms of accessible to us. As you know the company historically has had a very good position because of several items being represented. We have some businesses in Asia so we have some good representation there. We do a quite a bit of business in both the Middle East and Europe and of-course Latin America being the largest export market from the United States. So we are represented in all of those export markets and those markets are right now from a demand stand point are pretty good.

Gail Glazerman - UBS

Okay, and on a slightly different topic, can you just talk a little bit on the cost savings program in terms of the timing as an offset to the inflation you are seeing, are you still looking for heavy implementation cost, were those trending as you expected in the first half of the year and still hoping that those go away in the second half?

Steven J. Klinger - President and Chief Operating Officer

Okay, let me talk you through that. We do expect given the capital program that we have ongoing as Pat said, we are front-end loaded on that pretty significantly this year and actually our transition costs are coming in at the dollar amount from an order of magnitude standpoint where we are actually seeing some efficiencies as we have learnt more and more of it the last 2 years in terms of execution skills but we have actually accelerated some of our capital spending because we are seeing better execution to be more emphatic about it. The first three corrugators we have started up is I have said exceeded my expectations based on my previous experience, think our engineering group and our operators working together have done a great job. When you do that, that also diminishes the amount of expenditure that you have on transition cost. But the total amount is about as what we expected for the quarter and what we see forecasted for the year.

Gail Glazerman - UBS

Okay but I am sorry to say if we should see some sort of stake slowing in the second half, relative to the first half on that?

Steven J. Klinger - President and Chief Operating Officer

I would say that's, I don't think that's exactly what we tried to communicate so let me be clear. We expect for 2008 to have about the same amount of transition cost that we had in 2007. They are going to be different, they are more capital expenditure related rather than plant closure related, but we also will have additional plant closure related transition costs that are going to be a part of that. We have gotten better at it so we can do more activities at the same amount of dollars.

Late in 2008 fourth quarter the end of fourth quarter will start to see a significant diminishment of those costs especially going into 2009 where we will see virtually probably 20% or so of what the cost levels we are at now, maybe a little bit higher but about that level.

Gail Glazerman - UBS

Okay, thank you.

Operator

Thank you and your next question comes from the line of George Staphos with Banc of America Securities. Please proceed with your question.

George Staphos - Banc of America Securities

Thanks everyone, good morning.

Patrick J. Moore - Chairman and Chief Executive Officer

Good morning, George.

George Staphos - Banc of America Securities

Just trying to bow on that last comment on Gail's question there. So ultimately, the incremental margin, maybe thinking about it differently Steve on your activity should be higher in 2009. You got more done, you closed more box plans, I think your headcount reductions in line are better and you spent the same amount of money. Should that be fair?

Steven J. Klinger - President and Chief Operating Officer

Yes.

George Staphos - Banc of America Securities

Okay. So should we ultimately see a ratcheting up of the strategic initiative savings that you expect to get or its approximately five fold of target that you want to view?

Steven J. Klinger - President and Chief Operating Officer

525. Well, 525 is the target that we have committed to through the end of the third year. We expect to hit that target. We feel like we are on track to hit that target. Obviously we were slightly ahead going into this year, some of that gets offset in the first half of the year as we have to spend additional money to move things around. But we still expect to hit the 525. George we can and we are always looking for operating improvements. We think a lot of that will come, but I wouldn't call it initiative base as much as I would say our ongoing efforts to improve our operating margins and returns on our assets on a go forward basis.

Patrick J. Moore - Chairman and Chief Executive Officer

And George, just further to that I mean, as we said on our call last quarter, the 525 is net of transition cost. So, clearly based on what Steve just said, our expectations on transition cost flowing back into the income statement at the end of 2008 into 2009 would clearly suggest that we will exceed the 525, but we are focused on that from a standpoint of achieving that net of transition cost.

George Staphos - Banc of America Securities

Okay, fair enough. Two extra questions and one on the credit side and one back to the pricing. Appreciate your detail and patience with this. Given the fact that you have done a good job of improving your head space relative to your covenants and given the fact that the current environment is favorable but you really don't know what's the micro outlook could be no later on and as we get into 2009. Would it not be economic perhaps to get additionally flexibility now when you have the window and just help us think about how you are thinking about it that will get a lot more proximity to the issue than we do? Second question, you know, the paper customers are always complain price hikes but there is really no way to offset inflation variable cost until you get a box price hike and ultimately boxes generally don't go up if they get a boards hike. For you anyway I was thinking you can speak for the industry ultimately how do you resolve that issue and more fairly reflect cost and the value proposition to your customer through your selling prices? Thanks

Patrick J. Moore - Chairman and Chief Executive Officer

Okay, let me ask Chuck to deal with the first part of that question George and then I will handle the second.

George Staphos - Banc of America Securities

It's alright.

Charles A. Hinrichs - Senior Vice President and Chief Financial Officer

Well, George we've spend some extra time on this call to give the data behind the head room that we have in the covenants. So with over $200 million of head room at the end of the first quarter and confidence that we will stay in compliance with all the covenants we don't see the need to proactively go out and amend those covenants today. We will opportunistically look for the right opportunity to work on the refinancing of that revolving credit and of course in that process we will be renegotiating those covenants.

George Staphos - Banc of America Securities

Okay.

Patrick J. Moore - Chairman and Chief Executive Officer

Yeah, the second part of that question I mean, as I articulated earlier I mean we were very, very disappointed in the lack of the index reflecting the increase. But with the said, again when you look back on our prepared remarks, we have increased box prices for five consecutive quarters. As we go back to the beginning of 2007 we were not in a price increase situation as we were continuing to increase box prices. So Steve and I are constantly challenging our organization to improve the mix of business there, to look for ways to lower our cost to surf, to drive, improve margins for Smurfit-Stone. So there are things that we can do on behaviors that we show in the marketplace that allow us to continue to incrementally improve the margins there. It is challenging longer terms to offset the kind of cost inflation that we've seen without significant price improvement there but there are ways that you can go about it individually in each organization to really drive that improvement.

George Staphos - Banc of America Securities

All right, thanks very much.

Operator

Thank you and the next question comes from the line of Claudia Hueston with JPMorgan. Please proceed with your question.

Claudia Hueston - JPMorgan

Thanks very much. Good morning.

Patrick J. Moore - Chairman and Chief Executive Officer

Good morning Claudia.

Claudia Hueston - JPMorgan

Just had a couple of questions on the cost side. One I was just hoping if you could just remind us of your overall energy mix and where your hedges stand for 2008 towards the year.

Patrick J. Moore - Chairman and Chief Executive Officer

Sure. Chuck?

Charles A. Hinrichs - Senior Vice President and Chief Financial Officer

Sure, Claudia for the rest of the year we are hedged 28% on natural gas and for the full year our position was 36%. And we've got profit built into the hedges for those positions for the rest of the year.

Claudia Hueston - JPMorgan

Okay. And natural gas is how much of your overall mix?

Charles A. Hinrichs - Senior Vice President and Chief Financial Officer

Natural gas is about 21% of our total energy spent.

Claudia Hueston - JPMorgan

Okay. And then just on the fiber side, when I looked at the chart on page 7, the fiber, the increase in sort of your expectations for fiber inflation were probably more than you would have expected, and I wondered if you could just comment on that, as sort of more related to transportation or are you seeing something on the actual sort of wood fiber side that might be more significant or really drove that significant increase?

Charles A. Hinrichs - Senior Vice President and Chief Financial Officer

No, it is primarily driven by higher diesel pricing which is really driving up harvesting and delivery cost. So, there are some pockets Claudia where you might see some increase in the actual cost of fiber. But most of the increase that we saw in the first quarter was related to higher diesel price, and again you know a couple of places where weather related activities may have impacted you or other geographic impacts. But generally speaking, its transportation costs that are fueling any increase today.

Patrick J. Moore - Chairman and Chief Executive Officer

The only thing I would add to that is on the saw mill shuts in specific areas. You've seen curtailments that have gone on during the quarter on a historical basis, but looking forward, those are kind of all factored in.

Claudia Hueston - JPMorgan

Okay, great. Thank you very much guys.

Patrick J. Moore - Chairman and Chief Executive Officer

Certainly.

Operator

Thank you. And the next question comes from the line of Mark Wilde of Deutsche Bank. Please proceed with your question.

Mark Wilde - Deutsche Bank

Good morning.

Patrick J. Moore - Chairman and Chief Executive Officer

Hi Mark.

Mark Wilde - Deutsche Bank

I'd like to talk a little bit about the box volumes. I noticed when we actually looked at the data, your per work day was down 5.9% for all of North America versus that 4.4% in the U.S., and I'm assuming that that delta is all Canada and Mexico, and I wondered if you could just give us some order of magnitude on what's happening in both the Canadian and the Mexican markets, and what you are assuming for the balance of the year.

Steven J. Klinger - President and Chief Operating Officer

Yeah, Mark, this is Steve. The Mexican piece is fine, it's about like at the U.S. level. In fact we have had some additional growth in some agricultural markets that have off set the slowness on the border. But on the Canadian piece that's where all of that differential is, in those shipments they are about 10% of our shipments and they are down 9% to 10% depending on how you look at it for the first quarter. You know, 130,000 jobs have come out of Canada from a manufacturing sector when you look at 2007. So those businesses have really been impacted and that's quite different than any of our competitors don't have the same exposure to Canada that we do and that is the entire differential. We try to relate because of the FDA numbers are a comparative, we try to get the U.S. box shipments to understand the performance of the bulk of our box shipments which are about 90% of what we do.

Mark Wilde - Deutsche Bank

Yeah, that's fair enough Steven. Just the delta was widened up that I was a little bit surprised that Canada was down quite that much.

Steven J. Klinger - President and Chief Operating Officer

Yeah and Mark that's why we try to address it in our prepared remarks to make sure that may be we could have just told you how much it was but anyway.

Mark Wilde - Deutsche Bank

Okay, the other thing I want to do Steve on the box side is see if you can talk with us a little bit about what you are doing other than just trying to lower cost and improve efficiencies in the box system and I am thinking particularly what are you doing to try to really sell margin and inset people to sell margin in the box business, to sell more pipe margin business, maybe short to medium sized runs things like that?

Steven J. Klinger - President and Chief Operating Officer

Yes, first of all in our restructuring of our box plants, let me start there we have alpha beta and Charlie plants is what our manufacturing folks call them but if you think about them they are set up, the alpha plants are set up to run high run business on a cost structure that factors on lets say 80,000 square foot and above orders. And then the beta and Charlie plants get more into the lower run, higher margin, more higher customer expectation business and we are setting up our areas so that we are capable of entering each one of those markets. Above and beyond that two things that I would mention is our display and graphics business, which we have leveraged as well as we could have in the past. We are starting to gain some good ground in that. We expect that to be a major contributor going forward. Particularly on the display side we have excellent designers, great capabilities in that business from a manufacturing stand point, both in Canada and in the United States.

I am really excited about that along with our global packaging solutions where we do a lot of graphics over in Asia and getting a common platform there is what we've been working on. We expect that to really accelerate our growth in that business. And then second to that is something that we rolled out about 9 months ago. We had a smallish packaging business where we go into our customers and we help them reduce fiber cost or increase efficiencies by helping them with packaging and machinery. That business has a consumable impact in terms of you sell the machine, you work with your customer to get a contract. So machine sales dollars then translate to consumables and obviously when you are in the back end of the plant whether you are on their manufacturing side and helping them solve their problems that gives you an opportunity to improve your margins as well as gets consumable contracts.

We have seen last year that business doubled and we expect it to nearly double again this year and we have even bigger growth plans over the next several years. We have a really capable management team running that, they are being integrated through our Senior Vice-President, Steve Strickland with our entire sales units. So those are two things that I would point to as being... are three things the manufacturing, the display and graphics, and our ability to sell down stream packaging machinery that overtime will actually increase our margins and give us a different position with our customers in terms of helping them solve problems and make them more profitable.

Mark Wilde - Deutsche Bank

Okay just to be clear Steve, from a comment Pat made earlier you guys are not assuming that you have to have positive box volumes this year to move prices. Is that correct, I mean you guys do... if we wait for positive box volumes and we continue to have the inflationary pressure that we have its just going to continue to eat into the margins through the balance of the year, that would not seem to be acceptable?

Patrick J. Moore - Chairman and Chief Executive Officer

Mark what I said and I don't think we have to have positive growth in box shipment in 2008. I think we need to see some improvement in domestic demand is what I said and any improvement in domestic demand because my only assumption is that the only reason why we didn't see any reflection of price improvement in the index would have been somewhat softer packaging demand. That's the only assumption we could make. So we are also making the assumption that improving domestic demand coupled with everything else we've got going on today will drive that.

Mark Wilde - Deutsche Bank

Okay, thanks Pat.

Patrick J. Moore - Chairman and Chief Executive Officer

You are welcome.

Operator

Thank you and the next question comes from the line of Mark Weintraub with Buckingham Research. Please proceed with your question.

Mark Weintraub - Buckingham Research

Thank you. Just want to follow-up a little bit on that dialogue, so if I understand correctly Pat, what you are saying is that in order for the price increase to be shown in the index you think that you would need positive or an improvement in demand, its not a reflection of your internal commitment to raise pricing, is that a correct interpretation or --?

Patrick J. Moore - Chairman and Chief Executive Officer

That's totally correct, Mark.

Mark Weintraub - Buckingham Research

Okay, so

Patrick J. Moore - Chairman and Chief Executive Officer

Yeah, I mean I think our history as we have said would suggest that we have been successful in doing that. Again we can only make assumptions on how the index is operating and based on everything we know today that's the only component that we can believe throughout their decision,

Mark Weintraub - Buckingham Research

I guess, two follow on one, what can you do so as not to be captive to this index particularly as the market is changing and obviously you are going to want to be able to drive your own destiny? And secondly, I guess I am just trying to understand when you say you are putting orders at risk and that changed the mix of your business if the business is kind of captive to this index what does that mean to be putting orders at risk?

Patrick J. Moore - Chairman and Chief Executive Officer

It means that you call your customer that you don't have a contractual commitment that is not related to the index. So in other words I have customers in our containerboard business where we negotiate on a monthly, quarterly, daily basis on their orders and we go to them and we say your price is up 40, 50, 60, whatever we say their price is up. And then they say, here's my orders or they don't. And what I was trying to indicate is we did that and when we did that, the net effect of some of that was that we lost the orders to other people who were willing to take those orders at that price, and so then that affected some of that $3 change. It was almost the $3 change was all related to customer mix changes, not to any lower prices on domestic liner board, and so in trying to understand that we looked at orders that we lost and some of the orders we lost negatively impacted that price.

Mark Weintraub - Buckingham Research

Okay. And then --

Patrick J. Moore - Chairman and Chief Executive Officer

Yeah, and a further Mark on box contracts as well with large box customers wherever possible we are negotiating box price changes based on what's going on in the market from a cost standpoint, not from an index standpoint. So, as Steve alluded to, we've got a lot of activity going on within our sales force around that, that's not necessarily tied to the index.

Mark Weintraub - Buckingham Research

Okay. And so, when the index didn't show the increase with those customers that you had raised the price with, what happens? Does that just get given back or can you hold on to that price?

Patrick J. Moore - Chairman and Chief Executive Officer

It depends on the customers and we tend to have our conversation about pricing with our customers. But in general, it depends on the customer.

Mark Weintraub - Buckingham Research

And then lastly, I guess, because this is still all quite confusing to me, but what can you do or what are you doing to reduce your dependency on this index or is that something necessarily that you want to do or not to do?

Patrick J. Moore - Chairman and Chief Executive Officer

No, our preference would be to as Steve said have discussions, direct pricing discussions with our customers, and certainly as we have articulated over a period of time moving away from having anything tied to the indexes the direction that we have been moving.

Steven J. Klinger - President and Chief Operating Officer

Yes, we have tripled... over the past two years we have tripled our exposure to non-contractual agreements in our domestic containerboard business. So we are much more what I would call at market with a larger portion of those customers.

Mark Weintraub - Buckingham Research

Okay, great and guess its an open ended question its because you have answered it but I am still not quite sure whether or not you can get pricing on that business because if it's a third and you got $40, $50 it would seem to be substantial enough that it would end up in your numbers if you can hold on to it, if the index doesn't move and I guess I am not quite sure whether or not that can or cannot happen.

Patrick J. Moore - Chairman and Chief Executive Officer

Well lets keep in mind Mark, that if it would have happened at the end of the quarter you would have seen very little impact in the first quarter from that anyhow so that would not have been a meaningful measure for Q1.

Mark Weintraub - Buckingham Research

Okay, thank you.

Operator

Thank you and the next question comes from the line of Chip Dillon with Citigroup. Please proceed with your question your line is now open.

Chip Dillon - Citigroup

Great, thanks, good morning. I wonder as you all think about 2008 and 2009 every day the dollar gets weaker and I know there was a little sluggishness in Europe in testliner but it looks like prices there are stabilizing from what I can tell, you mentioned your export prices were flat in the fourth quarter but Reece [ph] is saying that price in China for kraft liner from the U.S. was actually up and at least looking at some of the historical spreads we are seeing numbers we've never seen before with for example German test liner too on a short term basis $145 and now $150 above our kraft liner here and I just wonder if and as boards become available and if and as customers in these other regions would or could get used to using our better quality board for lower price why wouldn't that help tighten the market, do you have any thoughts on that?

Patrick J. Moore - Chairman and Chief Executive Officer

Chip, I'll ask Steve to address that, thank you

Steven J. Klinger - President and Chief Operating Officer

Okay, you said several things so let me address those. The China demand and pricing that we see there in China because remember we have about $100 to about $120 million business depending on how you look at it from an ownership standpoint in China on boxes. And we are seeing board price increases over there consistent with what you are hearing I am sure. So as the board is going up people are able to export from the United States into China. We didn't participate significantly in that market but we are starting to see... we did previously, then we were out of the market and now we are back in the market is how I would say it. Secondly, we do export into Europe so we do see some of that additional demand coming on board in Europe and in the Middle East because as you know the Middle East is affected really by Scandavian by Europe and what's going on there. So we do see the effects that you think that you are seeing and our exports have been going up from lets say an average of 250-240 somewhere in that range to more like a 300 depending on the month. So we've seen somewhere around the 20% to 25% increase in our shipments as we examine each one of those and from our perspective I can't speak for the rest of the industry but from our perspective as we indicated our inventories continued to be in good shape and the net effect of that is additional export is keeping the... at least from a Smurfit-Stone stand point our inventories are in fairly good shape.

Chip Dillon - Citigroup

And so just as a quick follow up, are you unequivocally still striving to get the price increase you mentioned, you announced for March, and since it's only one follow up it is sort of an add on to the first question. When you look at the OCC situation and given the tightness or difficulty in getting shipping vessels, are you seeing any sign especially given that you are underground in China that OCC here could actually become I guess relatively cheaper than elsewhere because it's difficult to ship it. I would think it's basically the last thing that you would see that would justify taking a valuable space on a ship?

Steven J. Klinger - President and Chief Operating Officer

Yes I will let Pat address the pricing question you did as your follow up with three parts. On the OCC issue, let me say it this way, as you just indicated, there are other commodities grain and coal going in containers so rather than directly into the whole ship. So that's pushing up the price for containers. China had a bad winter so they need more grain. So the bulk price has gone up more than the container so more is going in a container. Okay so that's increase. So they are making the constant trade off on containers in terms of OCC use to be better to put in the container then just shipping it back in terms of offsetting the fuel cost.

Six months ago since the fuel cost started to accelerate, the actual cost of the container going back empty was better than putting OCC in it. So then you saw the prices increase in Europe on the transportation once they increased OCC started to flow from Europe. So it's not so much if there is not the availability of containers to ship back it's the economics of the transportation resulting in that. It is and then just to re-affirm that as we have looked at the OCC for the next quarter other than the transportation thing we think there could be some price depreciation because of just how much is going export versus how much is not going export.

Chip Dillon - Citigroup

Okay.

Patrick J. Moore - Chairman and Chief Executive Officer

Yes, I think Steve presented that well. I mean, the container issues and availability is really cost today Chip and so we expect today OCC prices as Steve said to remain flat to maybe down slightly in the quarter although, again diesel cost variability has a big impact on the delivered cost and we see diesel cost today above $4 a gallon which is being supported by available at above $1.15 today so there is some transportation cost wild card associated with that, but we believe that we'll see flat to maybe slightly down in the quarter.

Chip Dillon - Citigroup

Okay. And then on the price increase?

Patrick J. Moore - Chairman and Chief Executive Officer

Price increase on... sorry.

Steven J. Klinger - President and Chief Operating Officer

You may want to repeat the question.

Chip Dillon - Citigroup

Are you are unequivocally still going for this $50 a ton that you announced for March and it could just be like I guess a couple of years ago where it kind of got pushed out, but eventually happened several months later.

Patrick J. Moore - Chairman and Chief Executive Officer

I mean again, I would repeat that we believe that all of the circumstances within the industry today would support that and yes, we are continuing to try and drive price improvement both on the containerboard standpoint as well corrugated box standpoint.

Chip Dillon - Citigroup

Thank you.

Patrick J. Moore - Chairman and Chief Executive Officer

Operator we have time for one more caller.

Operator

Thank you. The final question comes from the line of Bruce Klein with Credit Suisse. Please proceed with your question.

Bruce Klein - Credit Suisse

Good morning. Just [ph] one last question. The question is the cost savings versus cost inflation, I think you guys said in your slides 200 to 250 a cost inflation, I am trying to square that with cost savings. Is the 520 by year-end '08, I guess versus sort of were 420 end of '07 does that imply a run rate, can you just remind us on a year-end that will be 520, what do you expect actually to realize in cost savings in '08 is maybe a better way to ask the question?

Patrick J. Moore - Chairman and Chief Executive Officer

Let me ask Chuck to walk through that with you.

Charles A. Hinrichs - Senior Vice President and Chief Financial Officer

Firstly, the $525 million goal is the cumulative goal for savings related to the cost initiatives. So we were $438 million at the end of 2007 and we have full confidence of reaching our goal. So the improvement year-over-year will help offset some of the inflation, but as we have increased our forecast for inflation, and inflation will be higher than the benefits in 2008 from the initiatives.

Bruce Klein - Credit Suisse

Okay, so the difference between the $525 million and the $438 million is a number for '08 that you actually will realize net-net.

Charles A. Hinrichs - Senior Vice President and Chief Financial Officer

That's correct, right in that.

Bruce Klein - Credit Suisse

Okay. And that is versus the 250. Okay and then what was the Calpine... the cost of the Calpine purchase, I am assuming it was small but --?

Patrick J. Moore - Chairman and Chief Executive Officer

It was $0.05 a share for the quarter.

Bruce Klein - Credit Suisse

And the purchase price to buy that.

Patrick J. Moore - Chairman and Chief Executive Officer

It was $22 million was the impact on the quarter.

Steven J. Klinger - President and Chief Operating Officer

Bruce, it wasn't a purchase price per say it was a restructuring of the obligations owed with Calpine Corrugated.

Bruce Klein - Credit Suisse

Okay I got it. And last question was just that the base CapEx is 250 once these programs are finished. Is that a reasonable number for your base business these days?

Steven J. Klinger - President and Chief Operating Officer

Yes, I think what we said was 250 plus or minus $25 million depending on what we have in the pipeline.

Bruce Klein - Credit Suisse

Okay, great. Thanks a lot guys.

Patrick J. Moore - Chairman and Chief Executive Officer

Thank you

John Haudrich - Director of Investor Relations

That concludes our first quarter earnings call. Thank you for your interest in Smurfit-Stone.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you very much for your participation and we ask that you please disconnect your lines.

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