Packaging Corp of America (PKG) 2015 Q1 法說會逐字稿

Thank you for joining Packaging Corporation of America's first quarter 2015 earnings result conference call. Your host today will be Mark Kowlzan, Chief Executive Officer of PCA. Upon conclusion of his narrative, there will be a Q&A session.

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

Good morning and thank you for participating in Packaging Corporation of America's first-quarter 2015 earnings release conference call. I am Mark Kowlzan, CEO of PCA and with me on the call today are Paul Stecko, our Chairman; Tom Hassfurther, Executive Vice President who runs our Packaging business; Judy Lassa, Senior Vice President who runs our white papers business; and Rick West, our Chief Financial Officer.

I will begin the call with an overview of our first quarter results and then I'll turn the call over to Tom, Judy and Rick who will provide more details. I'll then wrap things up and then we'd be glad to take any questions.

Yesterday we reported first quarter net income of $91 million, or $0.92 per share compared to last year's first quarter net income of $90 million, or $0.92 per share. First quarter net income included charges for Boise integration and DeRidder mill restructuring of $9 million or $0.09 per share. Excluding these special items, net income was $100 million, or $1.01 per share compared to last year's net income of $106 million, or $1.08 per share. Net sales were $1.4 billion in both first quarter of 2015 and 2014. Excluding special items, the $0.07 per share reduction in first quarter 2015 earnings, compared to the first quarter of 2014, was driven by increased annual mill outage downtime and costs, $0.08; lower white paper prices and changes in mix, $0.05; lower export containerboard prices, $0.02; and higher costs for wood, $0.04; medical, $0.04; labor and benefits, $0.04; and depreciation, $0.02. These items were partially offset by increased volume, for $0.09 and lower costs for energy, $0.06; chemicals, $0.02; and purchased fiber, $0.02 and a state tax credit related to the investments at the DeRidder mill for $0.03.

Lower earnings compared to PCA's guidance of $1.07 to $1.10 per share for the first quarter was the result of extreme weather conditions, $0.03, additional downtime to complete the DeRidder annual outage, $0.03 and lower prices from the retroactive price decrease by trade publications and mix changes in white papers, $0.03.

Extreme weather conditions resulted in higher mill costs and also lower corrugated product shipments with downtime at 20 of our corrugated products plants, including 12 plants with downtime of more than two days during the quarter.

The DeRidder annual mill outage took about six days longer to complete than we expected. The additional downtime was the result of vendor design errors which required equipment to be modified after it was received.

Looking at more details of our operations, packaging EBITDA, excluding special items, was $222 million, and net sales were $1,099 million compared to last year's packaging EBITDA, excluding special items of $244 million and net sales of $1,097 million. The $22 million reduction in EBITDA was the result of this year's extended annual outage at the DeRidder mill which did not have an annual outage in 2014, as well as higher wood, medical, labor and benefits and freight costs and lower export containerboard prices. These items were partially offset by corrugated products volume growth and benefits from the DeRidder No. 3 machine conversion.

Containerboard production in the first quarter was 882,000 tons, up 61,000 tons compared to last year's first quarter, driven by tons produced on the DeRidder No. 3 machine.

We ended the quarter with our containerboard inventories down 3,000 tons from year-end levels.

This was our first annual outage at DeRidder since acquiring Boise in October of 2013. The outage was extensive, including major projects involving the turbine generator, pulp mill, recovery boiler and paper machines. The outage is planned for 16 days due to the length of time required for pulp mill work, but actually required 6 additional days because of the time required to resolve issues involving incorrectly manufactured equipment for the D1 machine that I mentioned earlier.

The D3 machine ran well during the quarter at about 80% of capacity.

This rate will sustain our current demand, and in September we will be installing some additional dryers which will give us the capability to run at 100% capacity on both linerboard and medium grades. Current efforts on D3 involve continued product development and cost optimization.

The No. 1 paper machine at our Counce, Tennessee linerboard mill was also down five days in March for an annual outage.

In early April, we completed the Counce mill outage with the No. 2 machine down for five days. Other second quarter planned outages include five day outages at both or Filer City, Michigan and Tomahawk, Wisconsin medium mills.

Looking at changes in mill costs, the most significant increase was wood with costs up compared to both the first quarter of 2014 and also fourth quarter driven by weather conditions. Our Tomahawk, Wisconsin and the Filer City, Michigan wood costs are higher primarily as a result of extremely wet weather during the second half of 2014 that did not allow us to sufficiently build our winter wood inventories. Wet weather at our Valdosta Georgia mill and four weeks of snow, ice and rain at our Counce, Tennessee mill in the first quarter limited harvesting and drove up wood costs.

Last week there were record setting rainfalls in the south, and the 90-day forecast calls for wetter than normal rainfall, which could continue to impact harvesting and keep wood prices higher. At this time, we do not see wood costs coming down from the first quarter levels. We expect any improvement in wood costs at our northern mills to be offset by higher wood costs at our southern mills, unless weather conditions improve significantly.

I'll now turn it over to Tom Hassfurther, who will provide more details on PCA's containerboard and corrugated packaging sales and demand.

Thank you, Mark. Shipments for the combined PCA and Boise box plants were up 4.4% with one less workday compared to the first quarter of last year, and total shipments were up 2.7%.

Price and mix was down $0.03 per share which was comprised of $0.02 per share in export linerboard and $0.01 per share for domestic medium and corrugated products mix taken together.

Our outside sales for containerboard were up about 15,000 tons compared to last year's first quarter, with domestic containerboard sales down 4,000 tons and exports up 19,000 tons.

I will now turn it over to Judy Lassa who will discuss white papers.

Thank you, Tom. Paper segment EBITDA in the first quarter of 2015 increased to $49 million on sales of $297 million, compared to first quarter 2014 EBITDA of $40 million and sales of $309 million. Our office paper shipment, which represent about 70% of our volume, were up about 400 tons compared to last year's first quarter and printing and converting and pressure sensitive paper shipments were down 5,500 tons compared to last year.

Prices were down compared to last year's first quarter as a result of price changes by industry publications which were retroactive to January 1, and also a less rich mix which is driven by the timing of customer orders.

Despite lower price and changes in mix, our earnings and margins improved as we benefited from operational improvement and synergy realization in our white paper mill. Annual maintenance outages are planned in June at our International Falls, Minnesota mill for nine days and the Wallula, WA No. 3 machine for seven days.

With these outages we expect lower mill productions, higher mill cost and lower sales volumes in the second quarter compared to the first quarter.

Also, on April 14 at our Jackson, Alabama mill, a severe thunder storm caused a power failure and total mill outage resulting in significant damage to the steam turbine drive for the No. 1 paper machine. This machine produces about 325 tons per day of specialty office papers, including colors, and is expected to be down about two weeks. The total cost of the outage including repairs, production losses, and additional operating costs will be covered under our property and business interruption insurance subject to a $3 million deductible, or $0.02 per share. I will now turn it over to Rick West.

Thank you, Judy. Looking at other costs, medical costs were up $0.04 per share over last year's unusually low first-quarter costs, and labor and benefit costs were up $0.04 per share primarily from annual wage increases and higher pension expense.

Energy costs were lower by $0.06 per share, due to both lower purchased fuel prices and reduced consumption, and chemical costs were down by $0.02 per share.

Moving to first quarter cash generation and uses, cash generated from operations was $108 million including a $4 million interest rebate payment on a portion of our bank debt, reducing first quarter interest expense. No additional rebate payments are expected until the first quarter of 2016. Uses of cash included capital expenditures of $56 million, common stock dividends of $39 million, income tax payments of $10 million, share repurchases of $8 million, and a scheduled term loan payment of $2 million.

We ended the quarter with $126 million in cash on hand.

Also, in February we announced an increase in PCA's common stock dividend from an annual pay-out of $1.60 per share to $2.20 per share, a 38% increase, effective with the April 15 dividend payment.

Finally, we do not have anything new to report on MLP except that the IRS lifted the pause on issuing private letter rulings and we're awaiting their further actions.

I'll now turn it back over to Mark.

Thank you, Rick. Looking ahead to the second quarter, we expect earnings improvement from a full quarter of operations at the DeRidder mill, which will increase containerboard production and lower mill costs. We also expect seasonally higher containerboard and corrugated product shipments and some weather related cost improvements. These items, taken together, are expected to improve earnings by about $0.11 per share. We also expect lower wage related benefit costs of about $0.02 per share.

Costs from annual mill maintenance outages, including amortization of repair costs, will be $0.01 per share higher than the first quarter. We also expect a higher tax rate of $0.01 per share, a higher depreciation expense of $0.01 per share, and the insurance deductible from the Jackson turbine drive failure on the No. 1 machine of $0.02 per share.

Finally, we will not receive the earnings benefits from state tax credits and the interest rebate in the second quarter, which together totaled $0.06 per share.

Considering these items, we currently expect second quarter earnings of $1.03 per share.

To put the $1.03 per share in perspective, I think it might be helpful to bridge it to last year's second quarter earnings of $1.16 per share.

Based on current prices and expected changes in mix, earnings are expected to be $0.16 per share lower as follows: $0.09 per share in white papers price and mix; $0.03 per share in export linerboard prices; and $0.04 per share for medium price and corrugated products mix.

Costs are expected to be $0.10 per share higher in total for wood, freight, labor and benefits and medical. In addition, annual outage costs are expected to be $0.04 higher and the cost for our insurance deductible for the Jackson turbine drive is expected to be $0.02 per share. Taken together, these items lower earnings by $0.32 per share.

Partially offsetting these items are projected higher volume of $0.09 per share, which includes additional production from the D3 machine at DeRidder and lower costs of $0.10 per share for chemicals, energy, recycled fiber, and other cost items, or a total benefit from these items of $0.19 per share.

With that we'd be happy to entertain any questions, but I must remind you that some of the statements we have made on the call constitute forward-looking statements. Statements are based on current estimates, expectations and projections 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. Actual results could differ materially from those expressed in the forward-looking statements.

With that, operator, I'd like to open the call up for questions please. Go ahead with the first question please.

(Operator Instructions)

Our first question comes from Chip Dillon from Vertical Research.

Good morning.

Good morning, Chip.

First question is, on kind of shifting gears a little bit, could you update us where we are in the process for the uncoated free sheet duties that I think you guys are involved in, in a petition with the Department of Commerce? My understanding is that the next date is in June, but could you update us on that? It seems like the preliminary determination from the ITC, if I read it correctly, was pretty prohibitive in terms of hundreds of percent of duties they would have to post if certain people kept sending white paper into the US.

I'll let Kent answer that one.

This is Kent Pflederer, General Counsel of the Company. We received a favorable preliminary ruling from the ITC in March in the case. The case is pending through commerce right now against the producers in the five countries. Commerce is expected to make preliminary duty determinations in June. That's about all we're going to say about it at this point.

Okay. Got you. Shifting gears, looking at DeRidder, obviously this was the first full quarter that I believe the D3 conversion had been up and running. Could you talk a little bit about whether you are satisfied with the design of this reconfigured machine and what you feel about the progress it's made so far?

Speaking of where we are, I want to remind everyone that when we originally conceived of the conversion, the machine was intended originally to produce primarily medium. Early on we recognized the opportunities that we could actually produce linerboard and take advantage of the pulp that was available.

We shifted gears into the end of the last year, into the first part of this year with a lot of grade development and fine-tuning the machine. Quite honestly we're very pleased, the machine is primarily producing about 70% of its production of linerboard, but again, we have learned a lot and we've achieved a lot.

We've been working on the costs, but, again, it's a machine that can produce quite a variety of grades from light-weight medium and liner and take advantage of the pulp more. Paul, do you want to expand on that?

The only thing I'd add to that, Chip, and Mark hit it but I'll just amplify it. Most of these newsprint machine conversions are somewhat limited, that they can only run a pretty light weight grade mix. And with the things we did on the machine, we were figuring originally it would probably run 70% medium, 30% liner, but some of the things have turned out better than we anticipated, a lot better, which is a testament to our technology and our people. And we can make higher weight grades than we originally thought we could.

With the fact that the open market price of medium is now $70 lower than liner, and we can move up in higher basis weights, that gave us the opportunity in our system to make a lot more liner than we originally conceived. That's the good news. The bad news is it takes some time.

They are harder grades to develop on the machine but we're well-along on that development and as Mark said, we're making well over half of our production now in medium -- excuse me, in linerboard, and that's going to pay dividends long term. So that's one of the reasons that we're not quite up to capacity.

We need a little more drying because of the heavier weight grade mix and during the annual outage -- not annual outage, during the short outage we're going to take in September, we're going to put in four more dryer cans, which is at a minimal cost and we think we'll be at 100% when we do that on a much heavier grade mix.

Got you. That's helpful. As a quick follow-up. I know that when you did the D3, I believe we were talking about $115 million, $120 million project that was going to create around $60 million in EBITDA on an annualized basis. It sounds to me you still see yourselves getting there.

I don't want to put words in your mouth. But it's more like late in the year after the dryers go in. When we think about the second quarter with the $1.03, what kind of run rate would you say the project would achieve in the second quarter versus that $60 million target?

Without getting specific, we did a lot of work in the first quarter and also with the fact that March was truly an annual shut-down at the mill which skews all of your input costs, and so even though D3 ran during the month, it wouldn't have been a normal comparison in terms of cost per ton produced.

But, again, we've been able to achieve a number of successes with the chemistry that would qualify to hit the target, capital, we're probably going to be right at that $120 million all in, and as we said, we expected the $0.36 per share contribution. As time goes on we fully expect to see that. Again, prior to this year, in the first quarter, we had that contribution that was impacted by the March annual outage. So we're more back-end loaded, but with what Paul said and what I said about the success of the machine, we fully expect it to be there.

The only thing I would add, the way the accounting system works here, we don't split the costs of number 1 machine and number 3. We basically measure mill profitability and then we estimate what we think the costs are on both machines. And so it's not an exact science at this point.

But I would say this, when you bring a machine, when you ramp up you do two things. You get the machine up to total capacity and once you do that and, at the same time, you try to work to optimize costs because as you learn, you build in a lot of conservatism, to run the machine with regard to chemicals and things of that nature. So you've got to do two things, you've go to get up to speed and you've got to optimize the costs. And we've complicated that a little bit by going to a more complex mix. But that's going to pay long-term dividends.

The other thing, we're running about 800 tons out of 1,000, but when you get up to 1,000, that brings your costs down a lot too because those last 200 tons cover all your fixed costs, covers all your direct costs. They have already been covered so you are going to get a nice bump on that.

But our best estimate at this point is that by the end of the second quarter, we'll have a full quarter operation of that machine. We said originally this machine could make $0.09 a share when it was up to speed per quarter, so that's $0.36 per share a year. I think by the end of the second quarter, and this is a guess on our part, we think we'll be about halfway there. That's the best way we can answer the question.

That's very helpful.

When we get up to speed and the new grade mix, I think we have some upside potential to those original numbers, but that remains to be seen.

Chip, just adding to that, and I commented on the first quarter earnings call, I believe the DeRidder number 3 machine is, to our knowledge, the only converted newsprint machine producing virgin liner board grades and so we're quite pleased with that.

But also knowing what we know about the costs at our other legacy mills, we're very pleased with where we are in the total input costs on wet-end chemicals and energy conversion costs on the machine now that we have come to this first quarter. With the shut-down behind us and as the year rolls on, we feel very confident with where we are.

We have learned a lot. This has been a tough start-up, a lot of new technology for us and, we have learned a lot and we think we'll apply that going forward.

Okay. Thank you.

The next question, please?

Our next question is from Mark Weintraub from Buckingham Research.

I appreciate that color on what's going on at DeRidder, that's very helpful and better understanding. Two quick follow ups on that. Will hopefully most of that $0.36 be achievable by 2016 with some of the additional work you are doing at the end of this year, or might it take even a little bit longer than that to get to those targets?

Yes. We're very confident, again with what was accomplished in the -- all of the chemistry fine-tuning, now that the mill is back running and we're coming through getting the mill lined up, we feel comfortable that that's achievable through the course of the year.

Mark, just to amplify on that, as Mark said earlier we thought we'd run primarily medium, 23-pound, and then when we got into it we were amazed at how high we could get the basis weight. And that's why we didn't put in those extra driers. There's spots for four more dryers in the machine, where there was on old breaker stack we removed.

Our theory has been don't spend the money unless you think you have to. We didn't think we had to at the beginning, but we didn't realize that we'd have this opportunity on heavy weight liner either. So when we pop those four dryers in, in September, we're going to feel pretty good about getting where we need to get by the end of the year, for certain.

Okay. That's very hopeful. Presumably, when you said you are at the end of the second quarter, you'll be at halfway, that means during the second quarter you are at that level or even lower so we have a lot more yet to come once all this is put in place.

Correct.

And then if we were to try and assess Boise synergies, second quarter versus the year ago, could you give us a sense of how much benefit you are seeing there and what the progression or the trajectory on the Boise synergies? Has there's been anything that's made that to come in a little bit more slowly or a bit more quickly than you might have been thinking coming into this year.

Rick, why don't you go ahead and address that.

Last year, there was a lot of synergies up front that we were able to take probably in the first three months with the corporate overhead, that was in place. We also were able to significantly improve the earnings in the white papers business, absent price dramatically in the last year with all of the improvements made at the mills, et cetera.

In the Boise converting side of the business, Tom and his team were able to take certain actions across all the plants. It's a little bit more of an in-depth, longer process to optimize the Boise converting plants than in the paper mills, which are more evident up front. But to put the numbers somewhat in perspective, and I think this is what we want to get across, the synergies that we achieved last year and at what we are achieving now, are offsetting the inflation and the price difference year over year.

We gave the bridge from the first quarter year over year and the second quarter year over year, but if you look at what we made in the first half of last year, it was a total of $2.24 per share. If you look at what we had in price differences in mix in the first quarter and then add to that what we had in the bridge for the second quarter for how much earnings has dropped as a result of price and mix, that's $0.23 per share. Then compared to the first half of last year annual outage costs, which would include having DeRidder this year and no outage last year for the entire year, was at $0.12 yet compared to the first half of last year.

So combining price and annual outages alone, before any synergies, and we did have synergies in the first half of last year, as I said earlier, what we achieved up front, we would be at $1.89 per share of earnings. What we've been able to achieve with the synergies that we are continuing to get and what we got last year, is to offset that $1.89 to come back to our guidance of $2.04 with synergies being partially offset by inflation. And we said inflation for the year, we said that was -- we expect that to be 1% or 2% of cost of sales, so the synergies are coming through, but in the first half of the year it's the fact that the outages were more with DeRidder and we've had a significant impact of price and mix.

Mark, this is Paul. Just to add to that, what we have said is that we achieved $100 million in the first year and we expected a total of $200 million, so that's another $100 million to come, but we said we'd get that over the next two years because they were not quick-hits like headcount reduction, where we got basically $30 million, $35 million in corporate overhead right away.

A good example of that is we have been working at DeRidder to increase pulp-making capacity, because that's a pulp-limited mill. And it's taken us a year, but we feel we're about to the point where we think we can produce another 300 tons of pulp a day out of the pulp mill, which again, is a synergy that is baked into our numbers.

The complicated thing, and I don't want to make this too complicated, is how do you value, what's the value of 300 tons? Today the value of 300 tons comes from the fact that you can buy less OCC and you eliminate your highest OCC, and you also can make more linerboard because you've got more virgin fiber. So right now the price between liner and medium open market is about $50 to $70, that's a synergy.

But the big bang for the synergy is if you improve the productivity at DeRidder over the next couple of years and increase its capacity and sell those tons, you're talking $250 a ton or so in synergies. So some of these synergy numbers, you get a bump up front but then you get a bigger bump later when you get a better use for what you have created. So it's a fairly complex thing.

Another example, capital contribution, the I Falls turbine generator that will come online, again that's a distinct capital project that we identified well over a year ago. That will be coming up in September, but that, again, is a significant example.

Recognizing it's very complicated, if we were to think of where we are on that $200 million targeted run rate, say in the first half of 2015, are we closer to the $120 million range now or might we be closer to the $160 million range? Just trying to see the pace of how we go from that $100 million to $200 million.

Anything I say would be speculative. Like I say, it's back-end loaded and we're confident that the number is there. So as the year goes on, they'll be falling to the bottom line. With all the shut-down activity and then with the distinct project-related contributions, it's really, really difficult to try to quantify that.

Mark, when you've got a machine down, when you are down at DeRidder for basically 22 days in a month, you don't get any synergies when you are down. So we need to get up, we need to get our system up and running before we could put together estimates that are of what you are talking about.

So we're going to have to wait a while before we do that. But we'll certainly talk about it on our next earnings call. We'll have hopefully a full quarter of steady operations on the containerboard side of the business behind us.

Also, when we said back at the end of last year that by the end of 2016 we expected to achieve that extra $100 million. Another item, at the end of this year, we'll be taking Jackson mill down, another capital project that we had slated into the capital this year was the rebuild of the recovery boiler that was badly needed. So that's two examples between the turbine at I Falls and the rebuild of the recovery boiler that will contribute nicely to these efficiencies.

Thank you very much.

Next question.

Next we have Mark Wilde from Bank of Montreal.

Judy, I wondered if you could talk about the interplay of price and mix? Because you identify both of them but you do it together, and I wondered if you could particularly talk about the mix side of things and the impact of that? And also the impact of foreign exchange right now as you see it in the white paper business.

Are you talking of first quarter?

Yes. First quarter and if there's going to be, if you foresee any changes as we move into the second quarter.

Certainly. If you look at the price and mix piece for first quarter, again, the cut size index is down about $10 per ton, which we have a lot of index business, which we have mentioned before. Within that office business we had a pretty big swing in commodity versus premium mix, so that's a big piece of it right there. The P&C - printing and converting index is also down about $20 in offsets, and that has impacted us.

Pulp price is down as well, impacting both quarters, about $50 domestically down in RISI and $70 to China. And then if you look at our entire business mix, office is about flat in first quarter. We are down 5,500 tons, like we said in P&C and pressure sensitive. Not so much in P&C, the pressure sensitive is driven heavily by the fact that last year we were still shipping products out of inventory from I Falls to our customers and also we've had some impact internationally at the port slowdown that we're still working through.

If you look at Q2, it's actually more of the same. The cut size index is dropping about $25 per ton. We expect that we still have a higher commodity mix within that business. Offsets can be down year over year $20 a ton. We also have a mix within our printing converting business such that we have more offsets than envelope business and so that takes a bit of the price away, as well.

The pressure sensitive side of things in Q2, we have a couple new contracts that are going to impact us in Q2 which are down in price and also it's been very price competitive in South America. Again, pulp's going to hit us with $50 domestically and $70 to China. Overall business mix is going to be more, printing and converting, we basically use that as a flex grade to balance our assets, less pressure sensitive, we did have some more pressure sensitive sales last year due to selling out of inventory on the I Falls grade, and then we have a little bit more pulp.

Can you expand on what you said about Latin America? Is that a currency related issue, as you said?

It is. Like I said, Latin America is pretty competitive, it's one of the higher margin areas of business and there's been a lot of, because of currency, a lot of exposure from Europe in there.

Tom Hassfurther, any thoughts on how you are seeing converting volumes across the country relative to expectations both in the first quarter and as you move into the second quarter?

Mark, I can just really comment on what PCA has done.

That's all I'm asking.

Yes. Coming out of the first quarter, of course, our numbers were good in spite of the fact we were very much impacted by weather, especially in the south and northeast where we have a large footprint.

Looking at just April and I can only give you an indication of what's happening so far in April for the first 10 shipping days, PCA legacy box plants, bookings are up about 7.5%, shipments are up about 4.2%. Keep in mind on the shipment side, Good Friday did fall early in April and we did have a number of plants working on Good Friday so the shipment number may be a touch high.

The Boise box plants represent about 20% of our shipment and they're not in our numbers yet. Beginning in May, we'll have those fully converted to the PCA systems, so we'll have daily data starting in May and we'll be able to update you much better starting in July of this year. But overall we're off to a good start and I think the demand remains very steady.

Can you give us any sense, Tom, on what you are seeing in terms of export conditions, where we are today versus where we were during the first quarter?

Exports still remain good, remains strong in terms of our opportunity. We do have some currency headwinds of course and some pricing variances around the world. But RISI just announced Europe was up about $20 and that's a positive.

Your volume is mainly in export, mainly skews to Latin America, is that right?

Latin America, south America primarily, yes.

The last question I have is wood costs. I wondered in the southern US is there any impact from these pellet plants which have been opening up? Is that in addition to weather incrementally putting any pressure on fiber costs?

We have seen definitely the trend, over the last couple of years at the pellet plants, particularly in the southeast have been a competitor within the wood basket. And so you combine that with wet weather and the overall harvest conditions. So it definitely has put pressure on the ability to distribute that wood out of those wood baskets into the traditional mill needs.

Very good. I'll turn it over. Thanks

Next question please.

The next question is from George Staphos from Bank of America, Merrill Lynch.

Good morning. Thanks for all the details. I want to try one more crack at the bridge-type questions specific to the packaging segment to the extent that you can answer. Any of the details would be appreciated.

When we look at the $20 million reduction year on year in EBITDA, would it be safe to say roughly half of that was the variance in maintenance outage expense versus first quarter 2014? The rest was the price mix issues that you enumerated and that the various cost factors, labor costs, wood costs, energy and so on were more or less a wash?

I'm just trying to put it in bigger buckets, if that's possible. And you didn't get much synergy because of the fact that you were down so much in the first quarter. Would that be a fair summary of the packaging segment?

Yes, it would, Mark. If you look at last year, we had about $0.07 per share in annual outage costs and that was all in the paper mills. Then we had $0.08 per share more this year, which would equate back to about $12 million.

Then you have the second item, would be what you said was export containerboard prices, plus inflation. And I would point out, especially in our legacy packaging side, we had an unusually low medical cost in the first quarter last year and just in that side alone we were up about $6 million in medical. So you were correct in what you have said about the drop, and that also applies to going from 4Q to 1Q, I think you had read the drop was. We made about $250 million in 4Q and you take off the annual outage costs from that, it was an incremental $12 million off of that. So that's the key buckets and you were correct in your assumptions.

And George, this is Paul, a little bit of technicolor around that number. We did not have an outage at DeRidder last year. We had a huge outage this year, fixed a lot of things that needed fixed for a long time. And when we look at our total maintenance costs, outage costs year over year including amortization, loss production, et cetera, we're going to be up year over year because the addition of the DeRidder outage, we're going to be up $0.11 year over year, and of that $0.11, DeRidder is $0.13, and it hits all in the first half of the year.

Okay. So Paul thanks for that. Rick, thanks for that. You segue to my next question, as we try to again bridge, given that there are a number of moving pieces. I remember that last year, maintenance expense was roughly $0.48, so we're running then if I take that $0.11 closer to $0.59, $0.60 year on year, would you confirm that?

Assuming normal operations, I know there is no way to define normal, but we'll give it a shot, is there a way to take a crack at what the maintenance expense might look like in 2016 versus 2015?

I'll take the first shot. From the standpoint of where we're at right now, for total annual outage cost -- this is Rick West -- annual outage volume losses, direct expenses and repair amortization, the numbers in the first quarter would be $0.15 a share. In the second quarter, $0.16 per share. It drops down to only basically $0.085 per share in the third quarter because we have -- the only outage we have in the third quarter is on the D3 machine, a short outage to replace the dryers.

In the fourth quarter, it goes back up to $0.19 per share because you have to add additional outages in the fourth quarter that we have planned, plus all the remaining repair job amortization. So that should equate to a total for the year of $0.59 per share. Now, we have not done anything to really look at 2016.

This year, for example, we don't have the Valdosta outage. Next year we'll have to have a Valdosta outage in one of the quarters. But in terms of trying to determine an annual outage cost, it is going to be a moving target based upon what we have to take each year. But I would say the DeRidder outage, which is by far probably our most expensive outage, especially with the extended part of it, would cause you to probably have, and I don't want to speculate to any extent, but I would think it's going to be a little bit lighter the next year.

Just adding some color to that, through the course of last year we recognized these opportunities at DeRidder, and if you go back to the legacy history of PCA, we decided, based on the fact that we understood what we needed to do and we had the manpower to do it with the technical resources, we identified a number of these opportunities that historically, if you went back into our Counce mill or Valdosta, we took a number of years to correct.

We corrected, in this one outage in March, a number of items that probably would have taken 5 years worth of outages 10 years ago in our legacy business, so we accomplished a great deal. We took on a great deal, but it's behind us theoretically, and that's where we're obviously getting benefits. But, anything going forward is speculative, next year, in terms of what costs would be.

Just to qualify what Rick said on Valdosta, with the energy project at Valdosta, and other things we've done, we have been able now to go to an annual outage every year and a half instead of every year. And so that's why Valdosta has one, one year, but then it skips, and so you work to a year and a half, and that's the reason there's no Valdosta shut-down this year.

Paul, would an average Valdosta be $0.06 a share roughly in a year?

I'm not sure. We just don't want to throw a number out.

Understood.

Probably closer to a nickel than $0.06.

Thank you. Good luck in the quarter.

The next question is from Anthony Pettinari from Citigroup.

Just to follow up on George's question, if we take your Q2 guidance, your first half earnings are down year over year by about $0.20. As you look into the back half of the year, assuming flat product prices, would you expect earnings to be flat or higher or lower versus the second half of last year? I understand you don't give full-year guidance, but with DeRidder ramping up and some of these synergies flowing through and lower maintenance outages in 3Q, is there a reason to think that second half earnings wouldn't be higher year over year versus last year?

Again, we only give guidance one quarter at a time so I'm not going to speculate.

Okay. Regarding the vendor design errors, is there an insurance recovery associated with that or are you seeking compensation from the vendor? Regarding the dryer installation, is there any incremental CapEx on that in the second half of the year and can you refresh our view on full-year CapEx?

The first question, we've been working with the vendor to obviously correct what needed to be corrected and so rather than get into any legalities or implications there, I would rather not comment. But, again, we're confident that we've been able to rectify the problems that we encountered and do it in a timely manner and take care of the machine.

The second part of your question, refresh my memory, the cost of the dryers, that was baked into the capital, when we said $275 million to $300 million, so that's not additional capital.

Okay. That's helpful. Just a last one. How much free cash did you generate in this quarter?

Rick?

We generated cash from operations of $109 million, and we had $56 million in CapEx, so about $55 million. This is a quarter where we had a lot of working capital hits in the first quarter and our cash generally gets better through the rest of the year.

Great. Okay. That's helpful. I'll turn it over.

The next question, please.

Our next question is from Alex Ovshey from Goldman Sachs.

Thank you. Good morning.

Good morning.

Go back to the input cost side. We didn't really talk about freight, so diesel prices are down very materially year over year. Are you not seeing any benefit of the decline in diesel prices on your business?

The issue has been not just the diesel costs but it's been the availability of truck and rail. And obviously rail rates have not been coming down and truck rates, because of the demand for the truck fleet that's available in this country, prices have remained high and are going higher because they have the ability to command price in terms of the trucking industry. So even though diesel has come down, in general we're not seeing the benefit of it.

Maybe thinking about the balance of the year, is it fair to think about freight as more of a push on the cost side?

It's speculative on my part so I really don't want to comment.

Then just going back to D3, I wanted to clarify a couple of things you said. You said you would be running at about 80% of the stated annual capacity in the second quarter?

We have run at the 80% rate year to date and obviously part of that was because we made the conscious decision to shift the machine over to a predominantly linerboard machine and so the drying rates are a little more demanding in terms of the heavier weight mix we have on the machine. We'll probably be in this 80% range until we add driers in the September outage to take advantage of the incremental dryers opportunity.

Understood. So the mix currently right now is about 70% linerboard and 30% medium?

Correct. That's a good number.

Very helpful. Last question, on the export side, can you remind us what the export position is? A rough number of how many tons you expect to put into the export market on an annual basis and how that breaks out between the different regions around the world?

I am not going to break out the various regions, Alex, but I will say we're about 5% export, so it's a fairly small piece of our total revenue, total output. We are more concentrated in Latin America and South America, and Asia, to some extent and less in Europe, but that's about the best color I can add to that.

Let me clarify that. It's around 5% of our tonnage, but since its paper sales, pick a rough number, about half of what a box cost, is really only 2.5%, or 3% of our sales.

Okay. Thanks for everybody's input. I'll turn it over.

The next question, please?

Our next question is from Mark Connelly from CLSA.

Two questions. Tom, are you making any significant changes in your existing box plant converting capacity to accommodate the new D3 volumes or should we expect you to be spending some money there? I'm just wondering how much your existing system can handle of new tonnage.

And second, a question for Judy. Does the decline in tonnage and white paper help or hurt margins? I'm trying to get a sense of it's specialty volume that was lost but then you have the offset of the purchase pulp.

Mark, this is Tom. I'll take the first question. Let me remind you that we have been purchasing outside 200,000 tons.

Right.

So the D3 output will go into our box plants and that's why it's so vitally important that we were able to produce linerboard as opposed to just light weight mediums, because that's where the important need is in our box plants. And of course, in the conversion process, you use two liners to every one medium. So we'll absorb this D3 output right into our box plants as a result of the outside tonnage that we currently purchase and the growth rates that we've had on a pretty consistent basis.

That rebalancing process is more or less eliminating the issue for you?

Right.

Okay.

Eliminating the issue of having outside purchases.

Right.

And being able to consume internally, yes.

Okay.

In the first quarter, we did not purchase any outside tonnage except for specialty grades, which is what we traditionally have done.

Perfect. Okay.

So the second half, if I understand your question correctly, it's around the impact of pressure sensitive and market on the margins. Pressure sensitive is a pretty small business and so it's not a huge -- like I said, it does take the margins down a little bit, as well as pulp, but it kind of piles onto the bigger thing of what's going on in office.

On balance, it was probably a net positive overall then, just those two items, right?

Yes. Yes.

Perfect. Thank you very much.

Next question, please.

The next question, Philip Ng from Jefferies.

You've highlighted export prices as a headwind, how much of that is tied to you selling more tons into export market post D3, or is that just a function for the erosion in export prices and ultimately what are you baking into your Q2 guidance for export prices?

Again, on the D3 production, it is staying within our own system, so that is not being produced for exports, so where we are in terms of any export domestic sales, just balancing out our system quarter to quarter. Do you want to add to that?

I don't have anything to add.

Okay. Can you provide some color more on the mix headwind that you called out. It's a bit more pronounced than I would have expected.

Rick, go ahead.

I think Judy, in terms of price and mix, we calculated it all together and we gave the numbers and the bridge, $0.09 per share year over year in white papers, and Judy explained all the components and then we gave $0.03 in export liner prices year over year in 2Q. And then in domestic medium and corrugated products mix we had $0.04 per share, which gave us a total in 2Q to 2Q and then you had the amount in the bridge for the first quarter. So it's a combination of price and mix, it's predominantly more price than mix, but in general it's been through the different product lines that Judy expanded upon in white papers.

Got you. On the corrugated and medium side I guess it's a larger hit than I would've expected since most of your business is integrated so. Where there any dynamics, way you're selling in terms of boxes or is it just a function of more -- I'm curious, It seems to be more pronounced than I would've expected. The white paper part I can appreciate.

It's just more a function of when the specialty product happened to ship at a particular quarter or something like that. It was a little lighter in the first quarter in comparison to the same timeframe a year ago. So it's just more timing more than anything else. It's a small number. Medium, obviously those published prices dropped, now up to $20, and as Paul alluded to earlier there's quite a spread now between liner and medium, so that's a larger portion of the $0.04.

Okay. That's helpful. I guess I'll take a crack at what Anthony was trying to parse out earlier. How much of the headwinds that you saw in the first half will dissipate in the back half? I appreciate a big chunk of that is D3, weather and perhaps adjusting for maintenance. Can you help us quantify what could roll off in the back half?

No. It's too speculative.

Just one last one for me on capital deployment. I appreciate you raised your dividend. Historically you have been opportunistic when your stock sells off. Do you view the recent pull back as a buying opportunity, how should we be thinking about stock buy-backs this year?

We talked before, CapEx, acquisitions, dividends and share buy-backs, and it remains those four talking points, again we'll consider all of that and that's generally a Board matter.

To amplify on the dividends, we did announce a dividend increase. We thought in this low-yield environment that we're in that yield would be important to our investors because it's -- you get that while you wait for better things to happen, if you will. So we think having a good yield is important.

And then our story on share buy-backs has never changed. We tend to remain opportunistic in share buy-backs, and if something happens in the world, like Greek debt causes things to happen that we don't think should affect us, that could create a buying opportunity and we have been fairly successful in doing that over the past three or four years. And we're going to continue that sort of philosophy as opposed to steadily buying a little bit every day.

Okay. Thanks for that.

The next question. We'll take one more question if anybody has anything.

Next we have Al Kabili from MacQuarie.

I just wanted to follow up and we really appreciate the bridge that you laid out. You didn't in the second quarter really explicitly talk about the synergies year over year. Are you netting those synergy benefits against inflation, so the underlying inflation is actually higher than what you have in that bridge? I'm trying to understand where the synergies fit in the second quarter bridge that you highlighted to us. Thanks.

This is Rick West. You're absolutely correct. Our accounting systems don't allow us to really bridge the two. Some, you can. But you are definitely right. Had there not been synergies, and that's what I alluded to when I did the first half of the year comparison, the bridge numbers would have been worse, so there's an embedded benefit of synergies in those numbers.

I appreciate that. That helps. My last question, just on DeRidder, and it sounds like we're at 80% production, we're at well below that in terms of expected run rate to full earnings. So is this just higher costs until you optimize it and where -- specifically you mentioned the dryers, but bridging the gap between the 80% production levels and earnings contribution, where that gap really lies and then confirming that you think you're going to get there at the end of the year.

Again, if you go back to a normal start-up curve on the paper machine, or any paper machine, whether it's a new machine or converted machine, in the first quarter we were still on the curve of learning. But also when we shifted the grade mix significantly to liner, liner inherently has a higher input cost, wet-end chemicals, et cetera.

So we very quickly were able to address the input cost, the chemicals and so we feel going forward we have a competitive cost position. But there's inflation at play, and inflation is there but summarizing, we feel confident the machine's going to contribute what we have been saying and it's more back-end loaded.

Let me add to that. You're right on costs, our costs are higher than they will be when we optimize. But don't forget the thing that I mentioned earlier on the call. We're running at 80% of capacity. The last 20% that we get, it probably had a cost of $150 a ton lower than the first 80%. Because all your fixed costs have already been absorbed. All your labor has already been absorbed.

So the last 20%, the cost is really low and that will bring down your costs a lot because the incremental margin is so high because you have already absorbed all these other costs on the first 80%. In the meantime, as we develop the grades and learn to make them better, the costs are coming down. But you are right. Our costs are disproportionally high to the production rate because of the reasons I gave you.

That's really helpful. I appreciate that. Last question for Judy. On the white paper side. The office paper, you guys markedly outperformed the industry in the first quarter and I wondered if you could talk to that and if that outperformance is sustainable.

The shipment piece of the office papers business we have been in strong performance with our key customers and we'll continue with those key customers and hope to see that going throughout the year.

Okay. All right. But any sense of just that level of outperformance, Judy, like I said, being up, in a down market, that's pretty notable. So I don't know if that's something you think you can continue to do, or is there's some timing variances in there.

Like I said, the bulk of our performance in Q1 is synergies. That will continue. From the standpoint of our strong office business, performance with our customers and we expect that to hold.

Got it.

Just to add on that. We've got a lot of synergies in our white paper business on a much smaller volume than is in a brown business. So synergies really made a big difference there because they're substantial, and they're on a lot smaller business than the brown business.

That helps. That's good to see. Thanks. Good luck.

With that, operator, the time is up and we thank everybody for joining us today and we'll talk to you on the 2Q call in July. Thank you very much.

This concludes today's conference call. You may now disconnect your line.