Packaging Corp of America (PKG) 2013 Q2 法說會逐字稿

Thank you for joining Packaging Corporation of America's second-quarter 2013 results earnings conference call. Your host today will be Mark Kowzlan, Chief Executive Officer of PCA. Upon conclusion of his narrative, there will be at Q&A session.

I will now turn the conference over to Mr. Kowzlan, and please proceed when you are ready.

Good morning and welcome to Packaging Corporation of America's second-quarter earnings release conference call. I'm Mark Kowzlan, CEO of PCA. And with me on the call today is Paul Stecko, Executive Chairman of PCA; Tom Hassfurther, who runs our Corrugated Business; and Rick West, PCA's Chief Financial Officer. Thanks for participating in this mornings call, and after the presentation, I will be glad to take any questions.

Yesterday, we reported second-quarter net income of $64 million, or $0.66 per share, which included a one-time after-tax non cash charge of $5 million, or $0.05 per share, for pension plan changes. Excluding this charge, earnings were a record $69 million, or $0.71 per share. This compares to second quarter 2012 net income, excluding special items, of $48 million, or $0.49 per share. Net sales were a record $800 million, up 12% from the second quarter of 2012 net sales of $712 million. The $0.22 per share increase in net income, excluding special items, was driven by higher containerboard and corrugated products prices and mix of $0.27, higher corrugated products sales volume, $0.05. These items were partially offset by higher costs for energy of $0.04, labor and fringe benefits $0.03 and the timing of annual mill maintenance outages $0.03. Excluding special items, net income for the first six months of 2013 was $130 million, or $1.33 per share, compared to net income for the first six months of 2012 of $88 million, or $0.91 per share.

Year-to-date net sales were $1.56 billion, up 12% from $1.38 billion in the first half of 2012. We had an outstanding quarter in all aspects of our operations, with record earnings driven by higher prices for containerboard and corrugated products and higher corrugated product volume. The annual outages at three of our mills went extremely well with very efficient start ups and the mills set a new quarter record for tons produced per operating day. Earnings were higher than our second-quarter guidance, driven by better than forecasted containerboard and corrugated products volume and price and lower than forecasted costs.

Moving to the details of the operations, corrugated product shipments per workday were up 5.2% and total shipments were up 6.8% with one more workday in this year's second quarter. With our last box plant acquisition made in the first quarter of 2012, this is the first quarter where there was no volume contribution from new acquisitions. Demand for both domestic and export containerboard remained strong, however. With higher containerboard consumption in our box plants and with our three mills being down during the quarter for their annual maintenance outages, we reduced our outside containerboard shipments by 9,000 tons compared to last year's second quarter. This allowed us to end the quarter with our containerboard inventories at a more manageable level, about 12,000 tons below the end of this year's first quarter, when we built some inventory for our second quarter planned outages. Our mills will need to continue to run well in the third quarter, however, considering our inventory level and expected demand.

Moving to mill production and performance, our mills ran extremely well producing 629,000 tons of containerboard despite reduced production of about 30,000 tons for mill annual maintenance outages at our three largest mills. This is 7,000 tons more annual maintenance downtime than last year's second quarter. In April, we had the number one paper machine down at our Counce, Tennessee linerboard mill for seven days reducing production by 11,000 tons. In April, we also had the larger number four paper machine down at our Tomahawk, Wisconsin medium mill down for five days, and also the number two paper machine at that mill was down for four days with total production losses of 7,000 tons. In May, our Valdosta, Georgia linerboard mill was down for eight days, reducing production by 12,000 tons.

Each of the mills started up and ran very well after their outages, and as I said earlier, the mills set a new quarter, second-quarter productivity record for total tons produced per operating day. For the quarter, based on days available to operate after taking out a scheduled downtime days, the mills ran at just over 100% of their capacity. The timing of taking more annual maintenance downtime in the second quarter this year reduced our earnings by about $0.03 per share compared to last year's second quarter. We have no more annual outages scheduled in the third quarter, so our mills will have an opportunity to produce more tons. Our remaining 2013 annual mill maintenance outage is in October at our Filer City, Michigan medium mill, which will be a five-day outage.

Looking at prices and mix, prices were higher for both containerboard and corrugated products, improving earnings by $0.27 per share, compared to last year's second quarter. Our corrugated products price increases went as planned and as of today have been essentially completed. Export prices have also increased compared to both last year's second quarter and the first quarter of this year, as prices moved up appreciably in all of our markets. With regards to cost, energy costs were up $0.04 per share compared to last year's second quarter driven by increased prices, paid for purchased fuels. Natural gas prices increased $1.35 per M2BTU and coal prices were up about $0.55 M2BTU compared to prices paid last year during the second quarter. In addition, labor and fringe benefit costs increased $0.03 per share.

Transportation cost increased $0.01 per share, and we did see some railcar shortages and we also had a heavier mix of longer haul destinations. Recycled fiber costs were lower than last year's second quarter, improving earnings by about $0.01 per share as industry published prices for recycled fiber, excluding delivery costs, were down about $15 per ton in the second quarter compared to the second quarter of last year. This benefit was offset by slightly higher wood cost which reduced earnings by $0.01 per share. Our effective tax rate was lower than last year's second quarter from the settlement of certain tax matters, which improved our earnings by about $0.01 per share. I'm now going to turn it over to Rick West, our CFO, who will give you an update on our financial position.

Thank you, Mark. In the second quarter, PCA generated cash from operations of $187 million. Capital expenditures during the quarter were $54 million. We paid our quarterly common stock dividend of approximately $31 million. Cash tax payments of $6 million were made and fuel credits of $66 million were used to offset federal taxes. We currently have estimated remaining fuel tax credits of $4 million, which will be used to partially offset tax payments in the third quarter. However, the final amount of the available fuel tax credits and the final cash tax rate is contingent upon the conclusion of the IRS audit currently underway. We ended the quarter with $370 million of cash on hand of up $102 million from the end of the first quarter. Our total long-term debt outstanding at the end of the quarter, excluding capital leases, was $786 million.

As of June 30, 2013, our diluted shares outstanding were 97.7 million shares. As Mark mentioned earlier, during the second quarter, PCA recorded a one-time, non cash charge of $5 million, which was related to a change in our hourly pension plan. We recently negotiated an agreement involving 25 of PCA's corrugated plants who will transition from a defined benefit pension plan to a defined contribution 401(k) plan. The pension charge is based on accounting guidance which requires us to accelerate the recognition of prior service pension costs for employees affected by this change. With that, I will turn it back over to Mark.

Thank you, Rick. Before discussing the third quarter, I want to mention that based on our strong cash flow and cash position, we are accelerating about $25 million of high-return capital projects from 2014 into the second half of 2013. These projects are all in our corrugated products plants where additional capacity is needed to support anticipated growth. Now moving ahead to the third quarter, we expect higher corrugated products prices, higher sales volume, and with no planned annual outages, increased mill production and lower mill operating costs. We also expect higher purchased electricity costs with summer pricing, higher amortization of annual outage repair costs and a higher tax rate. Considering these items, we expect third-quarter earnings to be about $0.88 a share.

With that we'd be happy to entertain any questions but I must remind you some of the statements we've made on this call constituted forward-looking statements. The statements were based on current estimates, expectations or predictions of the Company, and involve inherent risks and uncertainties including the direction of the economy and those identified as risk factors in our annual report on Form 10-K on file with the SEC. The actual results could differ materially from those expressed in these forward-looking statements. With that, Operator, we'd like to open the call for questions. Thank you.

Thank you.

(Operator Instructions)

George Staphos, Bank of America Securities.

I guess first off, Paul, congratulations to you on the recent announcements and I guess best of luck to everyone in their future roles at PCA. My first question would be, can you comment at all on how early third-quarter bookings and billings have been? And can you comment at all on the June box containerboard data which came out whether the data was more or less in line with your expectations or if there was any variance? And I had a couple of Company specific questions.

Regarding the bookings and billings, for the first seven days, our bookings are up about 18%, billings are up about 11%, and again we're off to a good start but also take into account the fact that the way Fourth of July fell this year on Thursday, Friday in some box plants was an operating day. So even though it was not included as an official day, there was some cut up that day, so the numbers are skewed somewhat but we are off to a strong start, but we do expect those numbers to temper down over the rest of the month. And then, regarding the FBA numbers this morning.

Yes.

The one comment I do want to make, if you look at PCA, we came out of our second quarter and we had the annual shutdowns at three of the mills, we needed to run, we needed to build some inventory but we are actually, for the month of June, we built some inventory, so our PCA number we were up 5,000 tons. But we were still too low after the outages and so for the quarter, we were still down 12,000 tons.

Right.

And so on an industry basis if you think about the month of June and what the FBA numbers were reporting, you're talking about a 30 day mill month as opposed to a 20 day box plant month and again, that's a 10 day differential. Normally you'll see a 9 day differential, so you're talking about 100,000 tons mill contribution from this particular June that typically you wouldn't see. So with that, I really don't have a lot to add to the FBA numbers. Except again, volume has been strong in our case and the inventories have trended at the historically low levels.

Okay, Mark, I appreciate that. One question may be more specifically to PCA, and you alluded to this in your comments, you are accelerating some projects to add some high return or accelerate some high return projects in the box plants over the next 12 months into this year, if we had to stack rank what investors see as the most likely sources of return improvement in PCA from here over the next couple of years, would it be coming from the market development as you see it in the economy? Would it be coming from the capital deployment as you just mentioned for operations? Or would it come from value return to shareholders? How do you -- how would you stack rank the most likely sources of improvement on return to the shareholder from here, from those three sources?

Well, again, if you think about what our strategy has been the last few years, we have a goal of getting our integration level up to the 91% level and continuing to deploy capital especially in the box plants to help in that direction, which we've been very successful at. With that in mind, if you think about where we are, year to date we're sitting about 87% integration. But from a return point of view, again, I think the capital that we are spending in the box plants continues to give us extremely high return opportunities and as you're seeing that in the volume. Tom do you want to add anything else again capital -- we don't really talk about it a lot but your side of the business has been deploying well, good, small pieces that have returned the big volume growth.

Mark, I would just add that yes, we're really a customer-driven Company, a revenue-driven Company. And so we will deploy that cash where that driver can accelerate our earnings. That said, I think we've also taken all of the above approach and we've developed a lot of flexibility and we're pretty opportunistic about where we want to deploy that cash. But right now we have some opportunities in the box plants, as Mark alluded to, that have some good returns and we're accelerating those solely based on the fact that we have some very good customer opportunities and they're coming to us and we're taking advantage of those opportunities.

Okay. Last one -- go ahead --

No you're out of questions, you've have exceeded your limit on the first call, we're going to have to cut you off and move on. But just summarize that last one was a good question. If I ranked the first one, if you had to pick and I think Mark said it, increasing our integration level will be our greatest source of value creation for shareholders. And so, if you don't mind, we'll circle back to you later for other questions, we have 15 analysts now that cover us and we want to give everybody an opportunity. So we're going to have to cut you off, George, no malice intended.

Anthony Pettinari, Citi.

Mark, you referenced improvements and some capacity addition opportunities on the box plants side and given that you're growing faster than the industry and your mills are running full out or near full out, I'm wondering will you consider capacity expansion on the mill side or over the next one to two years how should we think about your mill footprint in terms of capacity as you continue to grow faster than industry?

Well just again the number one priority continues to be the integration level. We've spoken over the last year that we continue to have the tons available that come out of the outside sales both to the export and the domestic sale side of the equation. So with the capacity that we currently have on the mills and the efficiency with which we're running, and then with the opportunity to move tons and rationalize tons longer term out of those export and domestic markets, the mill acquisition, mill incremental capacity is a lesser concern at this point as opposed to the integration itself.

Okay, that's helpful. And then maybe a very quick follow up. You referenced railcar shortages and maybe some higher transportation costs and said some things that other producers have talked about. Is this a problem that's getting worse as you go into the third quarter or is it isolated to a specific region? Or is there any color you can give us about what the pressure is in terms of transportation costs?

It was a combination of we went through the outages in the spring, we obviously had opportunities and issues combined with how to take care of the box plants during that period of time and get the tons moved to the right places from the remaining mills that were running. And, again, we had some spring issues again just with the normal seasonality with regards to rails and trucking. And then just the nature of where we are with the trucking industry. And so that being said, again, the fact that we had compressed our annual shutdowns into the April/May period probably created the most -- the biggest factor in that transportation dilemma.

Okay, that's helpful, I'll turn it over.

Mark Weintraub, Buckingham Research.

With more and more cash flow that you're generating, you have the enviable problem of finding a home for it and I know you've increased your dividend a lot in the recent past. I don't think you were too active on the share repurchase during the quarter, if you could confirm that? And maybe help us understand -- I realize there's the 25 million incremental that you're pulling for but you still seem to have a lot of additional cash beyond homes that have been identified for it. Can you help us on what you're thinking about at this stage?

Yes again, as we've said in the past, if you think about the uses of cash being dividend, share buyback, CapEx, Paul and I speak regularly about this and we're -- in past years we've been opportunistic in buying shares back but it was rather hard to justify these past six months buying shares when the market was performing the way it performed. That being said, and I'm going to have Paul make some comments as we've done the last few quarters, because this is typically a Board matter and we discuss this at every Board meeting, but in regards to uses of cash besides the $25 million, into the third quarter we already have plans to make a $30 million pension plan contribution. And also our federal taxes, we're looking at $31 million of taxes in the third quarter. So again, the benefits of the black liquor credits are -- essentially have run out, we only have $4 million left on those credits going into the third quarter. So again we have roughly $61 million of incremental cash besides the capital. But Paul, do you want to make a comment regarding --

Well Mark, you're right, we're going to continue, we're going to have cash. If things keep going the way they are and this is not a forecast, but we should have strong cash flow generation in the second half which in your terms exacerbates our problem a little bit, what do we do with it. We've had a strategy long term that we want to buy back shares, that's right up high of the things we do. We thought maybe with the Fed talking about tightening up and not easing -- tightening up on the bond buying, not buying back as much, the market may correct -- the market is not corrected so we missed it again. In other words, if we had to do over again, I wish we had bought shares back during the quarter, we didn't. On the other hand the stock kept going up, so I hate to root for the stock to go down just because we want to buy shares, so I'm in a dilemma, I win both ways, you lose both ways, however you want to look at it.

We did increase the dividend, we thought that made a lot of sense and we increased it appreciably to get rid of some cash. We had a strong quarter, and we're back in the dilemma again we've got more cash than we need. We really have two things that we can look at, share buyback and share -- and dividend increases and it's a moving target. We're hoping that something happens that it may make the decision easier, but in the end we're eventually going to have to buy back more shares or increase the dividend and we'll probably do some of each. And when and how much will depend on a lot of things and I'm not prepared, including the Board approval, so I'm not prepared to go much further than that other than we know the situation, we know we have a lot of cash, we know we've got to do something with it, we hadn't quite figured it out yet. That's not the best answer in the world but that's the truth.

Okay that is helpful, thank you.

Chip Dillon, Vertical Research Partners.

First question is you guys put it out a $0.27 improvement from price and mix and just looking at the mill production that would suggest $60 a ton. And I know a lot of that has to be the mix side of it with your forward integration strategy, but could you give us an idea of how much of the price increase you actually realized in the quarter and how much we would expect to see in the third?

Yes let me take this one, Chip, we don't give exact numbers in that regard, we view that as Company confidential information. However, as Mark said on the call, as of roughly today, we're done with the increase and we've achieved a full pass-through. Now we've got no -- obviously none of the increase in the box plants last April because our price increase began May first. So we're going to -- when you throw it all together, we're going to have realized, this is both the mill containerboard increase and box price increase, about 40% of the total in the second quarter and the other 60% in the third quarter. And that's the best way that I can describe it, so if you can figure out, which I know you're capable of, what the total price increase is and how many tons we produced, we got about 40% in the second quarter, we'll get the other 60% in the third quarter. And that's what I've given into specific dollar amounts of increases.

That's very helpful. And second question is, you mentioned you're -- the strong beginning to July and one thing we noticed this morning is in the last couple years, it seems like the box shipments at least when you look year over year and even in absolute terms, seem to be tilted more toward the beginning of a quarter and tend to fall off at the end of a quarter. And we certainly saw that in June, but we've also seen it in March and December and going back to September and June of last year. And I didn't know if something had really changed in the last couple of years that would explain that, and is that good or not good for the industry?

Again, if you just talk about PCA, our numbers are basically flat. If you look at the beginning of the month, beginning of the quarter, we've been seeing the consistent run rates throughout the quarter. What is interesting about this July, and July has started out stronger. Normally the Fourth of July week holiday followed by the second week is typically a big vacation, things are slow but we've seen a good, strong start this year. So, again -- but we're strong but again flat historically through the latest quarters.

Yes, Chip, just to amplify on it, if you look at our monthly box shipments, April, May and June, they're all pretty much the same. There wasn't a lot of volatility month to month, so pretty constant. It's usually more volatile than this and beginning of the month to end of the month, there's not been a lot of volatility there and what you've said, we have seen time to time historically but not in the past quarter.

Got you. I know we're in time constraints, could talk real quickly about what you're accelerating CapEx wise into this year? How much of the dollars and what should we expect in terms of the box plant improvement?

Well, Tom why don't you comment about some of the projects you're looking at there in terms of the opportunities?

Yes, Chip, this is Tom. We're going to accelerate about $25 million into 2013. Now $5 million of it really doesn't have any real return in terms of income but $5 million on infrastructure, which we just need to do and we might as well get that done now. $20 million is spread out in a lot of different projects and a lot of different plants and again, it relates to the previous discussion that we had regarding our customers and their demand and the opportunities they present. And so, that's where those our geared towards and it's a handful of projects really spread out across the country.

Thank you.

Mark Connelly, CASA.

Two things, you generated a lot more cash than we expected you to do this quarter I wonder if Rick could tell us if there's something different going on in working capital or somewhere nearby? And secondly, do you have a view on fiber costs in the second half and whether they're going to be affected much by the volatility you're seeing in lumber prices?

Rick, why don't you talk about cash first and then I'll talk about fiber?

I really didn't see anything that abnormal in the cash flow or the cash we expected. We were targeting a level of cash generation at the level we said, our working capital did not change significantly from the first to the second quarter. So Mark, there was really nothing unusual there. We may -- we do have some larger cash payments in the third quarter, as Mark mentioned earlier.

Right.

But it's really -- it's really nothing unusual.

Okay, thank you.

And regarding fiber, we're seeing basically flat trends currently on virgin fiber pine and hardwood across the country, we have few periods with wet weather that caused some momentary increases in the southern states. But again, as we go into the middle of summer, right now everything's flat with wood-based fibers. A little bit of increase on recycle we're seeing around the country but nothing dramatic.

That's super, thank you.

Phil Gresh, JPMorgan.

On the box plant side, you mentioned that this is the first quarter you didn't have any acquisition impact on the box volume, so I'm curious how you're thinking about the pipeline for any additional box plant opportunities or whether the acceleration on the CapEx side of things means you're going to be more internally focused in the second half?

Again, if you think about, I know Tom is constantly evaluating opportunities and Tom, why don't you add a little color to that?

Well, Phil, I would say that as we've said before, we are always looking at potential acquisition opportunities. We do have a high threshold for what they have to meet in order to make the acquisition. Of course, the quality -- great quality and sustainable customer base, a quality management team and accretion earnings. So there are a lot of factors that have to be met, and it's got to be a size that makes sense to us as well, quite frankly. But we're still looking at them, we're exploring them, we have some opportunities that we're certainly looking at right now. And that's certainly an area that we will continue to deploy our capital.

And I guess the other thing I'd add to that, all things being equal, an internal investment will produce a better return than an acquisition because if you just put a piece of equipment in a box plant, all of the overhead has already been absorbed in that box plant. The only thing you're adding is a little bit of variable labor, a little bit of energy, so the margin on some of the things that we're doing and some of the things we've done in our internal investment program, produced a very, very good return. And we've had a good list of projects to look at. Tom and Mark have gone through them, they've picked the best of the best and said hey, we need to accelerate these, these returns are that good. And that doesn't mean you don't keep looking for acquisitions but an internal project, if it's a good one, because of the overhead absorption benefit, will beat an acquisition.

That makes sense. And then to the extent that mix has been a help, as you look at the numbers year over year, how much of that is driven by using more of that board internally and these initiatives that you had versus some other kind of mix related factor that you've been going after?

Some of the mix improvement is a result of that, Phil, as you mentioned, there's no question about that. We're going to deploy our paper where we have the best returns, there's no question about that. But in addition I think it's representative of the quality of the account base we have, they put a very high demand on us to add value, and as a result of that, we'd expect to get paid for that. So I think it's a combination of all of the above. I think in addition, the improvement in the pricing also was a result of the containerboard increase on the mill side which did go into effect starting in April, so we got some benefit from that as well.

Sure, okay. And then Rick, you had said the last quarter that the maintenance tailwind from 2Q to 3Q I believe would be $0.06 a share and obviously you guys had really strong performance this quarter so is that delta still the same or does that change the delta?

I think the delta is essentially the same, it's going to be somewhere between 2Q to 3Q after you net out the increase in repair job amortization an improvement from $0.06 to $0.08 per share.

Okay. Thanks a lot, I'll turn it over.

Mark Wilde, Deutsche Bank.

Like Connelly, I have two questions. One, Paul could you talk about the topic of a potential special dividend as opposed to just an ordinary dividend? And then Tom Hassfurther, are you benefiting at all in the box business from the consolidation that's taking place among the bigger players and maybe customers wanting to add suppliers, additional suppliers?

On the dividend, we've never done a special dividend and I really can't comment on that more than that because then people will read speculation into that, and I don't want the speculation to occur when I really don't have anything to say on the subject. So we've never done one before, and I'm going to leave it at that. And Tom, you want to take the second part of that?

Yes, Mark I would say that -- I would say we've gained from many reasons not primarily at all because of consolidation, I think more so because of our existing customer base, the fact that we've been able to align with some customers who have been able to grow through this period where the box business has been relatively flat. And I think we've proven to our customers that we provide the best value and that's benefited us greatly.

Okay, fair enough, thanks.

Alex Ovshey, Goldman Sachs.

If you look at the consensus forecast for the US economy, there's hope that we see a pickup in the second half of this year and into '14. As you look at your book of business and talk to your customers, do you see a potential mill pickup in your business in the back half of this year versus the first half?

I don't really have an answer for that, that's just speculative.

We've not seen anything in the market that says one thing or the other. Our business has been stuck in a rut pretty constant. The good news it's a high earnings rut so we're not complaining. But as I said early, we've been pretty consistent, we've not seen any change, we've heard, as you've heard in reports that if the Fed changes its policy, it may have an effect on the economy, et cetera, et cetera. So we're like you, we're waiting to see what happens but we don't know what's going to happen. But if it stays where it is, we'll be pretty happy, if it gets better, we'll be happier. So that's about all we could add on that. We really don't know where the economy is going.

Got you, Paul.

I would add in addition, Paul, that our customers, like ourselves, were hopeful and optimistic.

Okay, fair enough. And well let me ask you a question --

Scott Gaffner, Barclays.

My first question is really a clarification around the capital spending.

Operator are there any more questions in the queue?

Can you hear me?

Can you hear?

Operator?

Yes, we're on, can you hear Scott Gaffner?

Good morning.

We lost the call.

You're still on.

Good morning, can you hear me?

Yes, I can hear you, I believe something happened to their line.

They can't hear me.

Right, one second. Ladies and gentlemen, please stand by the conference will resume momentarily.

Operator, can you hear us?

Yes, we can hear you. Can you hear me?

Yes.

Okay, and Scott Gaffner was on asking his question.

Good morning.

Good morning, Scott.

We are back on.

Go ahead.

First question is really a clarification around capital spending, I think in the fourth quarter you had mentioned $120 million of CapEx and then $50 million for either some box plant acquisitions or some strategic investments. Should we think about the acceleration of the $25 million from 2014 as additive to that number, meaning $195 million in total now versus the $170 million or how should we think about that?

Yes, if you look at it, originally we had $180 million of planned normal capital spending for the mills and box plants. We also had an additional $10 million that we had planned on this year for the Boiler MACT spending, so a total of $190 million. But again for the $180 million plus the $25 million that will be the total CapEx between the mills and box plants. And so, again about $205 million of normal plus the $10 million of the Boiler MACT.

Okay. And then around the capabilities that you're actually adding to the box plants, are these customer specific capabilities? Meaning are you coming up with ways to hold customers accountable for the investments that you're making or are these more broad investments that you can utilize, our broad customer base?

Scott, this is Tom. They're driven primarily by what in essence is customer demands that we don't have the capacity for. So we will -- we obviously would be able to fill the capacity of the customer's demands that we have existing and obviously have some potential to handle some additional demand.

Okay, great. Thanks.

Philip Ng, Jefferies.

Quick question. I mean from a growth standpoint your box plants have obviously out paced the market pretty nicely, I think we're in mid-single digit rate for the last few years. Is the $75 million type of investment the new run rate going forward to sustain that growth rate going forward?

You can't say that, we'll take advantage of opportunities. I think Tom said something that's very important, where we see demand opportunities and growth opportunities based on our customer activity, we'll continue to deploy capital to support that growth need. So in a dynamic manner we will be very flexible in how we deploy capital into the box plant. Again, it's a very, very dynamic process.

Okay.

And that CapEx will slow down as we get towards the 90%, mid- 90% to 93%, 94% integration level. As we approach that obviously our need for additional box plant capacity will diminish unless we add more mill capacity or unless we expand our mills and then you're in again the same cycle because our strategy revolves very strongly around high integration level. So it's dynamic, you would expect it to slow down and then it could pick up again, depending what we do on the mill side of the business.

Got you. And that's actually a great segue. So on the mill side, do you guys have a lot of projects that are still available that you can easily add some capacity down the road or would you actually have to step up spending pretty meaningfully to get that incremental capacity?

We've said this before, it's all related to the amount of capital you want to spend. And so it's capital per ton of capacity. And so you can add capacity virtually to most mills, it's just how much is it going to cost and how much are you willing to spend, how valuable is that incremental ton.

Yes, said another way you can increase capacity as a percent, 2% a year for not a lot of capital. But if you want a big pop in capacity, that costs, that's a big pop in capital. And so, yes you just have to determine as you go through this, what's the best way to do it, maybe accelerate [increasing] a little bit, maybe do a big mill expansion, maybe make an acquisition, that will depend on the factors in play at the time.

Got you. It's probably still too early to call that, right?

Yes, again, as we've said, until we get that 91% integration level, the low '90s, and then understand what our balances going to be for outside sales of remaining tons, we're not making any plans for any large mill expansions.

Got you.

Just to add to that, as you said, we've been -- our demand is and our growth has been I think very good the last three years since we embarked on this project but we're only halfway there. This is an ambitious project to get from 80% integration to the mid- 90s. It's not something you do quickly because on every piece of business we expand we don't want tons for tonnage sake, we want box business that comes from customers who appreciate and pay for the value we provide. And so we're only looking for good business to fill up our system, not business in general and that makes this objective even tougher. But we're on pace, I think we're doing about as we expected, and we're going to finish this before we move onto something else.

Okay, that's really helpful. And switching gears a little bit to broader emerging markets, economies like Brazil, China and Middle East seemed to slowed a little bit. I know you guys don't export too much abroad, but have you seen your export business slow down a little bit on that?

We haven't seen necessarily a slow down but one of the things again, during the second quarter, we intentionally decreased our outside sales, in particular some of the export tons to make sure that we took care of our own internal box plant needs. But, Tom, I mean if you think last year into this year --

We're probably the last guys to answer that question, quite frankly just because of the position we've taken in the export market. We cannot handle the demand we have right now and we've shrunk our supply base to the export market as it is. So all I can tell you is what we see right now, have no idea what somebody who is really large in the export market and participates in all the markets around the world, what they see. In addition, I would just add that as Mark made mention in his comments, the price has risen significantly or certainly appreciably in the export market as well, at least the ones we're involved in.

Got you. Thanks, guys, good luck in the quarter.

Al Kabili, Macquarie.

Two questions. Mark, first if you could help us on the box plant investment, help us frame what that means for your capacity this year, how much that boosts your capacity this year or how does that help your integration rate?

Well if you look at year to date, we're sitting at an average of about 87% integration. And we believe and what we're forecasting internally is that that integration level will remain about 87% through the remainder of the year in that area. So as far as -- but for a full-year average --

Okay, that's really helpful. And is this investment related more to improving throughput or is some of this just increasing your capabilities that's going to help with the mix component of your business?

Both.

And this is Paul Stecko again, back on the CapEx, we had a program where we spent $80 million to $100 million over the last couple of years, so increased our integration level. This is only $25 million of capital, so you're talking about a 2% increase in integration level at most here. So this is not a big, big project, don't misunderstand that, we simply accelerated about $25 million from next year to this year and it's all equipment. It's a piece of equipment that we're out of capacity on, it's a piece of equipment that we need because we've got a new piece of business specific to a customer that we could use in other places. And as Tom mentioned, about $5 million is just for infrastructure improvement, when you're running box plants some of them as hard as we are, you've got to make sure the infrastructure is still able to support it, be that another truck dock or improvement in a bander so we can get more input through the whole plant, et cetera, et cetera. But again, it's only $20 million for equipment probably in seven or eight plants and it's going -- on the margin, increase our integration level 2% but it's not going to increase it 10% because of the amount -- we're only spending $20 million in capital it's not that much money but the returns are all very good.

Okay and that's $20 million on top of the $50 million, so $70 million total?

Yes, you can -- we put that in really on top of the $50 million because we'll do that in lieu of making an acquisition and that's the plan for this year. As Tom said, we're still working on the pipeline, that number could change too if a really good acquisition came up, but we've got no comment on that at this point.

George Staphos, Bank of America Securities.

My third question, only question here is this, if we look at the level of operating profit relative to revenue and subtract one from the other, you get cost both this quarter and the year-ago quarter. Cost went up about $50 million-some odd yet production declined for all the maintenance outage reasons. As you think about it, maybe it's a question more for Tom, as I listen to what you enumerate as the cost factors in the quarter would much of that increase in cost be a function of mix i.e. as you've picked up business, you've picked up more profitable business but business that in turn requires you to add more value to the product before you sell it to the customer? What would drive that increase in cost relative to the lower production year on year that you saw in the quarter? Thanks, guys, and good luck in the second half.

Hello, George, I'll take it this is Paul. No it's not related to that. We've told you where the cost items that went up, obviously energy prices are up, coal, gas, labor and fringes are up, our incentive compensation payments will be up, if we continue with this rate we'll make appreciably more earnings than we did last year and our bonus plan is a function of profitability. The more profitable we are, the higher bonuses we can pay. And so (inaudible) and labor and benefits are up, but there's nothing related to the mix on that is the short answer to your question.

Okay, I'll follow up off line because the numbers on a per share basis don't add up quite to the overall level of cost increase. But in any event, good quarter and good luck in third quarter.

George, let me comment on that. We don't understand the intricacies of every analysts model, so when you throw a model question at us, we don't necessarily agree with what you're saying not because we don't believe you, we just don't understand your model so it's hard to respond to questions like that unless we do it off line and you tell us what your model means and we can respond to that as long as it's publicly available information.

Sure, I was just referring to what you published in terms of revenue and operating profit. But anyway, guys, good luck in the quarter and I'll follow up.

Chip Dillon, Vertical Research Partners.

Yes, thanks and a quick one for Rick. On the black liquor credits, you mentioned there's just a little bit left and could you give us a range of what the possible outcomes would be based on the Filer City audit? Could there be more or could there be where it would be reversed some of these credits?

Chip, as far as any more, no we have recorded on what we expect that we will get and we have the $4 million remaining. And if you look in our 10-K, it does lay out how much we have built in in the event that it is disallowed, which we do not believe that will be the case. And as we said last quarter, we believe the worst case would be $120 million payback if no credits were allowed and we don't anticipate that.

Got you. And when do you think this gets resolved, any update on that?

From our standpoint, we are still hopeful that it will be resolved by the end of the year.

Got you. Okay, thank you very helpful.

Al Kabili, Macquarie.

Hi, thanks. A quick one for you, Rick, on pension. With the changes to the plan, any thoughts on how that influences the pension expense?

It doesn't really influence the pension expense that much, I did mention a voluntary pension contribution that we're making irrespective of the change in the third quarter. But it does not impact the pension expense.

Okay, thanks for the clarification. And with the black liquor, with $4 million left, should we be assuming your cash tax rate goes close to your 36% book tax rate, is that how we should be thinking about it or are there some depreciation items that could change that?

There are some differences between tax depreciation and book depreciation as well as some credits that are available under the normal course. I would see our cash tax rate reverting back to about 32%, probably about 28% in the third quarter and then it'll go to 32%.

Okay, terrific, thanks a lot, Rick, good luck.

Mr. Kowzlan, I see there are no more questions, do you have any closing remarks?

Thanks, everybody for joining us today and we look forward to seeing you on the next call in October. Have a good day, thanks.

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