Packaging Corp of America (PKG) 2015 Q2 法說會逐字稿

Thank you for joining Packaging Corporation of America's second quarter 2015 earnings results conference call. Your host today will be Mark Kowzlan, Chief Executive Officer of PCA. Upon conclusion of his narrative, there will be a question-and-answer 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 second quarter 2015 earnings release conference call. I'm 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; Rick West, Chief Financial Officer; and Bob Mundy, who will succeed Rick as CFO effective September 1.

I'll begin the call with an overview of our second quarter results and operations, and then I'll turn the call over to Tom, Judy, and Rick who will provide more details. During our prepared comments, we will be referring to slides that are posted on our website. I'll then wrap things up and we'd be glad to take questions.

Yesterday, we reported second quarter net income of $114 million, or $1.16 per share, compared to last year's second quarter net income of $100 million, or $1.01 per share. Second quarter net income included net charges for the Boise integration and the DeRidder, Louisiana mill restructuring of $2 million, or $0.02 per share. Excluding special items, net income was a record $116 million, or $1.18 per share, compared to last year's net income of $114 million, or [$1.16] (corrected by Company after the call) per share. Net sales were $1.5 billion in both the second quarter of 2015 and 2014.

As shown on slide 4, earnings of $1.18 per share were $0.15 higher than our prior guidance. Higher than guidance earnings of $0.06 per share were driven by outstanding operations in both our mills and box plant, especially considering that five of our mills were down during the quarter for their annual outages. The benefits from the work we completed in the first quarter at the DeRidder mill during its extended annual outage were realized faster than we expected. The ability to produce virgin high performance linerboard grades on D3, plus the improvements we made on D1, allowed us to make more lightweight containerboard and other specialty grades at DeRidder and shift other grades to the Counce and Valdosta mills. This resulted in record productivity on a tons per day basis and lower mill costs at all three of these mills. In corrugated products, our sales mix improved seasonally more than we expected, contributing another $0.05 per share. In addition, with lower mill outage costs, lower purchased pulp costs, a lower tax rate and other items each contributed an additional $0.01 per share in earnings.

Looking at slide 5. Earnings were up $0.02 per share compared to the second quarter of 2014. Production and sales volume increases added $0.10 per share to earnings, a richer mix in corrugated products increased earnings by $0.02 per share, lower energy costs increased earnings $0.07 per share, lower chemical costs increased earnings $0.02 per share, and a lower tax rate improved earnings over last year's second quarter by $0.04 per share. These earnings improvements were partially offset by lower white paper prices and mix changes which reduced earnings by $0.10 per share, higher labor and benefit costs of $0.05 per share, lower export containerboard prices of $0.02 per share, higher annual outage costs $0.03 per share, and higher wood costs of $0.02 per share.

EBITDA and margins in the packaging segments were up over the second quarter of last year, with EBITDA of $267 million and sales of $1.142 billion, or a 23.4% margin, compared to the second quarter of 2014 packaging EBITDA of $259 million, excluding special items, with sales of $1.145 billion, or a 22.6% margin.

Moving into more details of operations, containerboard production in the second quarter was 937,000 tons, up 91,000 tons compared to last year's second quarter, driven primarily by 79,000 tons, or 875 tons per day, produced on the D3 paper machine at DeRidder. The D3 machine produced 59,000 tons of linerboard and 20,000 tons of corrugating medium. With the D3 production, we reduced our outside purchases of containerboard by 56,000 tons compared to last year's second quarter. The D3 machine contributed about $0.06 per share to our second quarter earnings.

We plan to take our D3 paper machine down at DeRidder in September for 13 days to install additional dryers, which will provide the capability to achieve full design capacity of 1,000 tons per day and lower our costs. We pulled up some work from next year's DeRidder annual outage to better utilize the down time and also accrue benefits earlier.

Our containerboard inventory at the end of the second quarter was down 4,000 tons from year-end levels and about 1,400 tons below the end of the first quarter. Our ending inventory level at the end of the quarter is where we wanted it to be to meet our seasonally stronger third quarter demand, especially with the lost production from the planned D3 machine outage in September. Our containerboard inventories at our box plants are also higher than what we've historically carried as a result of transportation issues which I think most of you are familiar with.

Looking at changes in containerboard mill costs, our overall wood costs are up year-over-year, driven exclusively by our northern mills. Wood costs in our southern mills are actually slightly down.

Energy costs in our packaging business were down compared to both the second quarter of last year and the first quarter of this year, driven by lower purchased fuel prices and also by lower usage. Purchased electricity prices were up compared to last year's second quarter, however.

Purchase electricity consumption was down about 20% from both the conversion of the D3 machine from newsprint to containerboard which requires less electricity, and we also self-generated more electricity at our mills which more than offset the higher prices. I'll now turn it over to Tom, who will provide more details on containerboard sales and our corrugated business.

Thank you, Mark. Corrugated product shipments were up 2.1% in total and per work day over a very strong second quarter of last year. As Mark said earlier, in corrugated products, our sales mix was better than we expected when we provided guidance and also compared to last year's second quarter. Part of the richer mix, we believe, is coming from additional higher value-added volume as we migrate the Boise packaging plants towards higher margin business. We are making progress, but the migration takes time to complete, and we have more work to do.

Our outside sales of containerboard were up about 21,000 tons compared to last year's second quarter, with domestic containerboard sales down 4,000 tons and exports up 25,000 tons. Domestic prices were comparable to last year and export prices were lower. I will now turn it back to Mark.

Thank you, Tom. EBITDA and sales were down in our paper segment compared to the second quarter of last year, with EBITDA at $37 million and sales of $281 million, or a 13.2% margin, compared to the second quarter of 2014 with EBITDA of $45 million, excluding special items, and sales of $295 million, or a 15.3% margin. I'm pleased with our paper segment results considering the earnings impact from lower paper prices which we were able to partially offset with improvements in operations. I'll now turn it over to Judy Lassa who will provide more operating details.

Thank you, Mark. Office paper shipments, which represent about 65% of our volume, were up 3,000 tons compared to last year's second quarter, or 1.7%. Printing and converting shipments were also up 6,000 ton over last year's second quarter. Pressure sensitive paper shipments were down about 8,000 tons compared to last year, driven by market conditions, and pulp shipments were up about 2,000 tons versus last year.

Paper prices were down compared to last year's second quarter driven primarily by changes in industry trade publication for major grades and changes in the mix of paper products we sold. With the most recent published paper price decrease of $10 per ton, the current published price per office paper is $35 per ton lower than the average price for the second quarter of 2014. Fortunately, we've been able to offset some of the earnings reductions from lower published paper prices and mix changes with continued improvements in both paper mill costs and productivity. During the second quarter, we also completed annual outages at the International Falls, Minnesota and Wallula, Washington mill.

Wood costs were comparable to last year, while energy, chemical and freight costs were lower than last year's second quarter. I will now turn it over to Rick West.

Thank you, Judy. As mentioned earlier, earnings improved by about $0.04 per share compared to the second quarter of last year from a lower tax rate. Our second quarter 2015 effective tax rate of 35% was about 2% lower than the second quarter last year primarily due to an increased domestic manufacturer's deduction resulting from less tax net operating losses remaining from the acquisition of Boise, Inc. The third quarter tax rate is expected to be about the same as the second quarter of 2015.

As shown on slide 6, cash provided by operations in the second quarter was $196 million after deducting $78 million in cash tax payments for federal and state income taxes. Other uses of cash included capital expenditures of $86 million, common stock dividends of $54 million, share repurchases of $36 million, and a scheduled term loan payment of $2 million. We ended the quarter with $164 million of cash on hand. I'll now turn it back over to Mark.

Thanks, Rick. Before I move to the third quarter outlook, I want to update you on our progress in achieving synergies from the Boise acquisition. As we reported in our fourth quarter earnings call in January, 2015, we realized $100 million in synergies in 2014. The remaining $100 million of targeted synergies consists of both capital project initiatives and other identified opportunities to increase productivity and optimize operations.

Through the first half of 2015, we've realized about an additional $30 million of synergies, with more in the second quarter than the first. This brings our total earnings improvement from synergies to $130 million. At the end of the second quarter, our annual run rate realization of synergies is at about $170 million, or 85% of our $200 million synergy targets.

Looking ahead to the third quarter, we expect higher containerboard, corrugated products, and white paper shipments, and lower mill annual outage costs and lower chemical costs. White paper prices are expected to be lower with announced price changes in industry trade publications. Finally, the September outage on D3 machine at DeRidder will result in about 13,000 tons of lost production. Considering these items, we expect the third quarter earnings of $1.28 per share.

And finally, yesterday we announced that our Board of Directors authorized the repurchase of an additional $150 million of the Company's outstanding common stock. Together with the remaining authority under previously announced programs, the Company can repurchase $205 million of additional shares. This share repurchase program, together with our dividend increases announced earlier this year, demonstrates PCA's strong operating performance and cash generation, as well as our continuing commitment to return value to shareholders.

With that, we would be happy to entertain any questions; but I must remind you that some of the statements we made on the call constituted forward-looking statements. These statements were 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 these forward-looking statements. And with that, Operator, I'd like to open the call to questions, please.

(Operator Instructions)

The first question comes from the line of Anthony Pettinari with Citi.

Good morning, and congratulations to Rick and Bob on their transitions.

Thank you very much.

On DeRidder, I was wondering if you could give some color on what work was completed maybe a little bit faster than expected in the quarter. And then following the installation of the dryers in September, is principally all of the large work on DeRidder done? And then the $60 million EBITDA contribution that you had guided to, I think late last year, is that still intact on an annualized basis?

Anthony, if you go back to the April call when we talked about coming out of the March outage, we explain the problems we had had with the vendor supplied equipment on D1, and so we were essentially running crippled through that period of time until we could get the corrected hardware. And also, we were still ramping up D3 and working on overall cost efficiencies and productivity and continuing to fine tune the grade mix. But we've learned very quickly on D1 how to overcome the vendor issues; and by the end of April, we had the corrected equipment supplied to us. We took the down time and primarily changed out a few of the components that had to be corrected, and then came on strong with the machine for the month of May and June on D1. So D1 is proving to be very successful. We're very pleased with where we are with the work we did.

And then D3, we talked on the call that we are at that basically 80% range in terms of our 1,000 tons a day goal. And so we moved up in productivity and efficiency and achieved our goals in terms of product trialing, and also worked on costs. So D3 is proven to come on very quickly.

And then we also identified, during the same time -- and this is going into your question about the September outage -- we had mentioned that we're going to install probably four dryer cans during the September outage. We realized that with the benefits of the capability to produce linerboard, that we had additional dryers available. So rather than just take an outage and install four dryers, we had the ability to install additional dryers and rearrange the last section on the machine to achieve this. And so we're actually installing six new dryers and we're rearranging some of the earlier section dryer cans, so that we have a fully dedicated high pressure section which will insure that we have the ability to dry 1,000 tons a day.

Okay. That's very helpful. And the initial guidance on $60 million EBITDA, and I think the initial design capacity was 355,000 tons. Are those two still unchanged?

Yes. We're still standing by the $60 million EBITDA which, on a $0.09 per share per quarter basis, we still have that as our target. And the 355,000 tons a year is based on the 1,000 ton a day productivity on the machine.

Great. Great. And just one follow-up on containerboard. During the quarter, Pulp and Paper Week lowered western liner prices $10 a ton. I'm curious if that's something that you saw in the market and if there's any impact to PCA in the second half of the year?

Anthony, this is Tom. I would say that it's very little impact. That was just basically a reflection of what has taken place in the past. So it was no big impact. And of course, we're not big net outside sellers on the West Coast, anyway.

Got it. I'll turn it over.

Thank you. Next question, please.

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

Thanks, everyone. Good morning. Again, congratulations, Rick and Bob. Rick, really appreciate all the help over the years with the Investor Relations. I guess the first question I had, could you give a bit more color, Mark, in terms of -- or Tom -- how you were able to get a richer mix through your efforts within the Boise system, and then more broadly within the legacy PKG system?

Let me start that off and then I'm going to turn it over to Tom. If you think about the acquisition when we acquired Boise, there were a few different parts to Boise. One of them was the Tharco business, which was really a stock box business, and the Hexacomb business, which at the time of the acquisition were being run as separate entities within the Boise system. And so we quickly identified opportunities to integrate that entire system, and I'll let Tom elaborate on that now.

Yes, George. What we basically have been able to do is kind of bring PCA's DNA, if you will, to Boise. And you've heard us over the years talk about the kind of mix we run, the hard to do, the things we want to get paid for, et cetera. And so we've been working hard on both the Boise legacy box plants, the Hexcomb plants and the Tharco plants to be able to do that. There are some segments of the business that, quite frankly, don't make some sense and there are others that need to be enhanced. So we work very hard on doing that. I'm not going to go into great details, but that's essentially what we've done and what we will continue to do.

Was there any operational effort that you brought to improving the mix, as well? So obviously, you always focus on the hard to do content in the market. Was there anything that operationally you did differently that allowed for that, without getting into specifics, or was it really just which markets you targeted?

I think from an operational standpoint, certainly one of the benefits comes in freight. And that's getting the business to run in the right place. So business moves back and forth, depending on best locations. And in addition, - our mix was seasonally stronger in the second quarter than we actually thought. I'll just add that especially in the ag business in the Pacific northwest, with the record heat they had out there, the crops came in earlier than they expected. So that was somewhat of a lift for us, as well.

Okay. I appreciate that. The next question I had, again just on pace of activity early in the third quarter. Can you give us your normal review of shipments and bookings? Are you seeing signs that back-to-school or things like Halloween are trending better than expected, quicker than expected, or being pushed out relative to what your customers have traditionally pulled at?

Our early third quarter trends -- and we've only got about 10 or 11 days of July to base that on -- but we're up about 2% again over the previous year, which of course was a larger number in the previous year. So we're tracking about the same. Regarding some of these promotional trends and things like that, I think we saw a little bit of that a little earlier in the second quarter than we typically would. But I think overall, it's pretty stable.

Okay. Last one housekeeping, and I'll turn it over. Both the D3 ramp and the Boise synergies in total, where would we see those in the Q2 to Q2 bridge table that you provided? Thanks very much and good luck in the quarter.

George, this is Rick. In the Q2 bridge table, if you look at the components that we talked about, it's really in all of the areas. We had said, in fact in our second quarter 2014 conference call, that in the packaging mills, we were looking for productivity optimization and cost reduction. In our white paper mills, we were looking for just basic improvement. In our box plants, we said in the second quarter of 2014, we were looking at optimization of box plant operations. And also, lower corporate overhead. And so when you look at the Q2 over Q2, a lot of that is driven in each of the areas, as you can see in the volume area, in optimization. And as we said on the call, productivity does two things for you. It's not just giving tons. It makes it a cheaper mill cost per ton produced. And I think you can see that in our energy and chemical costs, and somewhat in labor and benefit costs. So in terms of the synergy realization, it's coming in each of those areas as part of the bridge. We don't specifically point it out, because there's other things we do.

And George, this is Paul Stecko. One real simple fact that substantiates what Rick said, once we got DeRidder in a position to make the optimum grade -- not optimum for DeRidder, but optimum for our system -- all three mills, Counce, Valdosta and DeRidder, had all-time production records. And that translates into very good cost, also.

And mix, I would imagine.

So the fact that we can produce that level of efficiency on cost and volume is a testament of the integration that got put into place once DeRidder could do its thing.

Got it. Well, congratulations on the quarter.

The next question comes from the line of Chip Dillon with Vertical Research.

Yes, good morning. Congratulations, Rick and Bob. Good to be catching back up with you again.

Thanks, Chip.

First question has to do with D3, and if you mentioned it added $0.06 in the quarter, so you annualize that, that's about two-thirds, I think, of the ultimate goal. And I was just wondering, I would imagine the other third should come from about another 15% or so of production, and then I would imagine the additional dryers would lower your costs there, especially as you make linerboard. Do you think those two activities, that is the additional dryers plus the production, could actually allow you to exceed your original goal?

You know, where we are, we've committed to the fact that we know we're running the machine obviously better than we did at the beginning of Q2. And as we ended up the quarter and we started Q3, we're somewhere in that 90% of goal range. But more than that, we really worked on the quality and the cost input, the performance of the machine is running extremely well, and we fully expect that the financials will be there. The extra tons, in terms of finishing up the incremental tons to get to the 1,000 target, your overhead is already covered. And so the contribution is very significant. So going from the $0.06 Q2 earnings contribution to the goal of $0.09 is what we're planning on, and we see that as achievable. Again, the machine's performing very well and its cost structure is very competitive with the rest of our system.

Got you. And I know it's early days, but do you see your CapEx edging down further next year, assuming no major obvious changes in your footprint, since you won't be doing as much work at, say, DeRidder? And also, could you talk a little bit about down time? I would imagine -- I think you said in your comments, you're doing some things now that might have been done later. So could that actually reduce the amount of down time you take next year?

Regarding the capital level for next year, until we've had a better chance to really assess what the opportunities are, we're going to say that our CapEx for 2016 would be in the same range of $275 million to $300 million. And that's providing that we have opportunity, which obviously we've identified various things that we're analyzing. That being said, we plan on looking at the shutdown plan for next year. We saw the opportunity to move up some of these items that would have waited until next year, some boiler work, pulp mill work that will give us an immediate advantage in terms of operating efficiency of the mills coming out of September. So again, that does change how we look at the outage plan for 2016. Hopefully, all the work we're doing at DeRidder allows us to get DeRidder going forward into the normal shutdown mode that we see in our legacy system.

Don't forget, this year hasn't been just about D3. We've worked on over 300 various capital projects at the mill that was part of that capital spend for the year. So we've very, very aggressively gone after opportunities to capture the benefits at DeRidder.

Chip, let me just add to that. DeRidder is a huge mill. The good news is we have some problems at DeRidder, and the good news is when we overcome those problems, that's going to get more money to the bottom line. Namely, there's opportunities at DeRidder that we can capitalize down the road that were not in the original synergy plan. In other words, when we put our original synergy plan together to tell you what happens when you put the two companies together immediately, what are the benefits? But after you do that -- and we're pretty close to having that done -- then you get into normal continuous improvement type activities. So just because we'll be done with the $200 million in synergies, that does not mean -- that was just an initial one shot program. You get these synergies, but there will be a long-term operations improvement program at DeRidder, as exists in all of our mills. And we continue to want to take cost out of our system and that will happen.

And that's kind of reflective also on D3. We're highly confident that this dryer change will get us everything we want from that machine. And what's really significant about that, in our original design, we contemplated making a lot more medium than we are. And we complicated the drying situation on that machine when we're making probably two-thirds linerboard on that machine. So not only will we get to the 1,000 tons a day, we'll get to it on a much tougher grade to make than we originally contemplated. Now beyond that, looking down the road a year or two, I certainly feel that I'd be disappointed if we can't get more out of that machine, in terms of lower cost and a little more productivity. But that's down the road a year or so until we get through with the first phase of this operation. And that's the point Mark made earlier, but I wanted to emphasize it.

Got you. And last quick one is, I know you guys, being so largely integrated forward to boxes buying board in the market, you mentioned that you've reduced your purchases. And I sit here and you think on the linerboard side, especially the virgin quality, whether it's recycled that's made at a virgin level or virgin itself, there's just basically no capacity coming on, because we know Pratt doesn't really fit that bill. And yet the market's growing. So I'm just wondering, even with you all backing off the market, are you having any difficulty getting virgin board out there or is that not a problem?

Well, Chip, this is Tom. I'll just say this is the number one reason why we're doing D3 in terms of linerboard. Because we internally need linerboard in our system. And our purchases were very high before. We did the acquisition. We did the D3 conversion, mainly because we needed to supply ourselves. And so we're doing okay, but we think we're definitely in a sweet spot. There's no question about that. And you're absolutely right. There's very little growth, if any, in terms of virgin capacity out there. And yet there is still -- that's the primary market and there's a very large demand for that. And of course, as I think you stated before, the outside market has shrunk dramatically. So the integration in terms of demand -- not necessarily supply, but in terms of demand -- has gotten to the point where anybody looking at doing anything in terms of adding new capacity, if you don't have it internally integrated, there's very few customers out there that are net buyers in the marketplace.

Thank you.

Next question, please.

The next question comes from the line of Mark Weintraub with Buckingham Research.

Thank you. One or two housekeeping first. Can you give us an update on the EPS impact from outages as it rolls through the year?

Yes, Mark. Just to give you what we said previously, we had said of course, it was $0.15 actual in the first quarter. In the second quarter, we had guided to $0.16. We were able to pick up $0.01 with lower costs at our I-Falls mill. So the second quarter was an actual of $0.15. As we go to the third quarter, we were looking at $0.09, but that's up to $0.11 in the third quarter. The DeRidder outage for 13 days is an extra $0.04 per share, but we were able to reduce the Jackson outage by $0.01 per share. So the net difference would be $0.02 lower in the third quarter. And then in the fourth quarter, we had said $0.19 and it's up to $0.20. So we're now at $0.61 of annual outage costs, compared to $0.59. So we'll pick up $0.04 from DeRidder, but a reduction of $0.02 with the I-Falls second quarter and the Jackson third quarter outages.

Okay. Great. And is that a number you'd consider normal for a year, order of magnitude?

No. As we said previously in the second and in our first quarter call, you'd probably look at a normal year of about $0.55 a share, $0.56. It's premature, because it depends upon the amount of work you would do. But considering the fact that we had the extended outage at DeRidder in first quarter, it'd probably be more in line still with about $0.55 or $0.56.

Okay. Great. Now you had mentioned the West Coast liner, really no impact. There were also some shifts in medium pricing. Does that likewise have minimal impact in terms of your corrugated pricing, et cetera?

Yes, Mark. This is Tom. Yes, that was -- I mean, there's some impact. There's no question about it. But it's very, very small for us.

Okay. And then lastly, you did pick up the pace of share repurchase in the quarter. And how should we read that? Is that being opportunistic on stock price or is that just a function of where your financial strength is right now, and you would intend to continue at that type of rate pretty much regardless of share price, in terms of repurchase activity?

Primarily that was based on an opportunistic situation when the stock started dropping.

Okay. Terrific. Thank you. And thank you, Rick, for all your help over the years.

Thank you, Mark.

Next question, please.

Our next question comes from Chris Manuel with Wells Fargo.

Good morning, gentlemen. And congratulations again, Rick, and welcome, Bob.

Thank you.

Couple questions for you. First, let me start with -- just take a step back. It's been a couple years since you bought Boise, and you've done a lot of work; and it sounds like you still have a little bit more on the synergy side you're working through, particularly on the corrugated side. As you take a look at the businesses acquired, getting back into the -- or getting into the papers business that you hadn't done much in the past with, how do you assess that as you look today? You've done some work, you've got what you wanted mostly done there. Is that still something that you view as a long-term fit within the organization or something you're still taking a look at, or how do you think about it?

You know, without getting too far ahead of ourselves, we're continuing to make operational improvements. The business does not require an inordinate amount of capital to take care of. And so it generates a lot of cash -- and we've stated this on prior calls -- in spite of some of the market pressures, it's a good cash generator and it doesn't take a lot of our attention right now in terms of resources. And so that being said, we're going to continue just running the business for the time being. But we will obviously assess all opportunities that come along in the future.

And Chris, just to amplify on it -- this is Paul Stecko. It's only our EBITDA in the white business is only about 12% of our total EBITDA. And that number will decrease over time, if we grow the brown business as we like. But that 12% or 13% of EBITDA doesn't require a lot of capital support, and we like that free cash and we like having the ability to do something with it. And so the white business has performed in line with our expectations and maybe beat it a little bit, because of the synergies.

Okay. That's helpful. The second question I had was as you look at -- you mentioned inventories being a little higher with freight logistics and different elements there and timing of outages. Is there a way to estimate inventories, are you at a level that you're comfortable with, you're happy with as you look through your corrugated operations? Is there a way to estimate how much that's added? Is that the logistics to freight, some of the other problems that will end up staying with you, is that two, three, four days? How do you think about that?

You know, let me go back. And last year, when we were into the full first year of integration of the Boise legacy systems, and giving us a West Coast presence, up in the Pacific Northwest primarily, but a bigger West Coast presence. In looking at how we supplied the system with tons, obviously you're reaching out further on a transportation cost basis. And then with the transportation issues with trucking availability, trucking cost, rail availability, rail cost, we realized, obviously, it made sense to reassess the overall inventory in our box plant system. And so where we had assumed we would run at obviously was not an ideal situation. And so we had talked about this in last October's call, that we intended to move our inventories up to take that into account. And then as we worked through Q1 and Q2, I think where we are today, we're feeling comfortable that this is a manageable inventory at the year-over-year higher level. That being said, it's all being determined by what happens with transportation availability and cost. But again, I think where we are in today's world, our inventories are at a manageable level and a necessary level for us to service our customers.

Okay. That's helpful. Thank you. Good luck in the quarter.

The next question comes from the line of Mark Connelly with CLSA.

Thanks. A couple of things. You've obviously talked a lot about optimization and productivity in the quarter since you did Boise. But as we think about D3 coming online, is it fair to assume that the reoptimization of the containerboard system that happens after D3 settles in is going to be similar order of magnitude opportunity of what you've already accomplished with D1?

You know, that's really speculative. We'll continue to focus and fine tune on the grade mix opportunities. And as Tom grows his business, it gives us that much more flexibility with how we supply the box plants needs now. But truly, I'd only be speculating on anything regarding that question.

Okay. So if we come back to the question of outside board purchases being down, last quarter you said, I think, that D3 could help you eliminate 200,000 tons of outside purchases over time. Can you give us a better sense of what period of time that might be?

We are not purchasing, basically, a commodity grade outside liner. We continue, as we always have purchased small amounts of specialty linerboard, such as a white top grade. But when you think about that the machine itself truly allows us to cease being dependent on the outside market for the brown commodity type linerboard grades. And we've done it for years, we've always gone out and taken advantage of what was available for the specialty type board. Tom, do you want to add to that?

I would just say also, it's provided us an opportunity in the lightweight arena we didn't have before. And that was an area where we purchased and we had a desire for a higher virgin content, obviously. So the work we're doing on D3 is actually satisfying the demands that we have.

And Mark, to get to the bottom line, you mentioned a 200,000-ton a year number we gave you. The actual number for last quarter, which is one-fourth of a year, was 56,000 tons. So if you multiply that by four, you can see if we continue at that rate, we'll exceed the 200,000 tons. And the reason is, we're growing. So not only do you have to add the 200,000 tons of outside, you've got to add the tons we'll need by high growth. And our growth this year is up a couple of percent, and a couple percent on a big number gives you a fair amount of tons to add to that total. So we'll be well over the 200,000-ton target.

Okay. That's what I was looking for. And just one last simple question. What's driving the decline you saw in label paper? Obviously, that's a business Boise has put a lot of effort into building.

This is Judy. So a couple reasons. Q2 of last year, we were still selling discontinued pressure sensitive grades out of high quality, as a result of the closure. Also, the strong dollar is impacting our international sales, as well as having a weaker demand globally. We've also had some mix changes domestically, but we really think this will improve as we ramp up those new products on W3. It's a pretty long transition time. It's a very technical grade. So we've got a lot of things in the hopper right now.

Okay. Super. Thank you, Judy.

Next question, please.

The next question comes from the line of Alex Ovshey with Goldman Sachs.

Thank you. Good morning.

Good morning.

Looking at the balance sheet, you've really delivered since the Boise acquisition. Can you talk about what the appetite is to potentially look for other transformative type of M&A opportunities for you?

Again, historically we've always looked at opportunities. We've always been conservative. We consider what the value of an acquisition would be, what the returns would be, and how much you're going to pay, what multiples. But yes, to your point, -our balance sheet is in good condition, and so if the right opportunity came along, as we've said over the years, we would be evaluating it.

And I guess from my perspective -- I just want to make it very clear, because you raised an important point. We don't let the money burn a hole in our pocket. If we've got a lot of cash, that doesn't mean we're just going to go out and spend it. If we didn't have enough cash and it was a terrific M&A opportunity, we'd borrow the money. So we look at M&A not from the respect that we've got the money, we look at it strictly, is it a good thing to do. So the fact that we have money, it's a consideration, but it is far from the main consideration.

That makes sense. And then in terms of smaller opportunities, you have been active in terms of increasing integration rate with box plant acquisitions. Can you talk about what the marketplace currently looks like in terms of opportunities to pick up box plant assets?

Alex, this is Tom. I would say that there are some opportunities. They are limited. Obviously, we initially started this process quite some time ago. And a number of independents have been bought up over this time period alludes to the fact there's very little outside purchases going on anymore domestically. So they're not as abundant as they used to be, but there are some opportunities. And obviously, as Mark said, we're exploring any of them that make any sense to us.

Got it. And last one for me. Looking at your shipment number for the quarter, it looks like it's about 100 basis points better than where the industry is. Over the years, I think you've grown faster than that relative to the industry. And so the question is given the larger footprint, do you think it becomes more difficult for you to be able to really grow 3% above the market, which is where I think the business has been over the last decade?

Let me answer it this way. We plan on continuing to grow in the manner that we've done over the last 15 years. And again, that's taking advantage of opportunities in terms of being mindful of the margins from the business and looking at what that contribution is from each component of business you take. So yes, the plan hasn't changed, the model hasn't changed. So we certainly have the bigger footprint and that actually gives us more flexibility and more opportunity to go out and continue doing what we've done. So that's our plan.

Thank you.

Next question, please.

The next question comes from Mark Wilde of BMO Capital Markets.

Good morning and congratulations on a very good quarter. Mark, I just wondered, thinking about D3, you were about 75/25 kind of liner/medium. What's the ultimate mix going to look like there?

You know, I think where we are right now, we're satisfying what Tom needs in his box plants. And that being said, we have enormous amount of flexibility on the machine, because of the virgin capability on a machine making the high performance liner. But the 70/30, 75/25 range that we're at is ideal for us right now. But reserving that condition as things change, we certainly have enormous capability to move with whatever Tom needs.

I'd add this, Mark. Your question is hard to answer until you know what the demand situation is out there. But in an ideal world, what D3 should make would be about 75% liner and 25% medium. And the only reason medium fits in there is that it would supply only the very low cost freight on medium. So it's a lot cheaper to ship medium into the metroplex in Dallas from DeRidder than it is from Tomahawk, Wisconsin or Fiber City. So that's a big freight savings when you can do that. And linerboard always wins over medium, unless the freight penalty changed that equation. So if the demand for liner gets higher, you might have to eat some freight. But again, in an ideal world, 75/25 right now, unless the marketplace changes.

Okay. Tom Hassfurther, where is your integration level right now?

We're at 85%, Mark.

And you want to get that north of 90% still, is that right?

Yes, we want to continue to get it up, yes.

That's still our goal, Mark.

Okay. All right. And then the last question I had, Mark, and this isn't specific to PCA, but can you just address the issues of what would be required to convert uncoated white paper capacity over to linerboard? If we've got very little virgin capacity coming into the market, it seems like one of the things you could do is you could take an uncoated free sheet mill, where you've got a craft mill and you've maybe got big paper machines, and look at a conversion there. Any thoughts on the difficulty of that?

I'm going to answer that a couple different ways. We don't have any plans to convert anything. But also, we talked on the last few calls about the complexity of that. And again, I have stated this over a number of years, that you can convert anything to do anything, but again, at what cost and what opportunity. DeRidder was a unique example, because we had the virgin craft fiber that we made available to the machine. And so it not only made sense at the time to convert it to the medium production, as originally planned two years ago, but because we had the virgin craft availability, it was that much more compelling for us. But that being said, it takes a unique set of technical capabilities. A lot of what we did on the machine was our own in-house technical expertise. So again, the degree of difficulty is great, the cost is great, and again, you have to weigh that with the opportunity. So that's how I want to answer that.

Okay. All right. That's helpful. Thanks very much and good luck in the third quarter.

Okay. Thank you. Next question, please.

The next question comes from the line of Philip Ng with Jefferies.

Good morning, guys. Congrats on the quarter. Quick question. Price mix was a wash in Q2, certainly illustrating you're well insulated, due to your integration level. But pricing was a lot more choppy in Q1. So what I'm trying to figure out, on a quarter-to-quarter basis, what's changed? And in your Q3 guidance, are you baking any slippage on export prices or the West Coast price cut?

Well, it's pretty flat actually, Philip. But we did, of course, tell you that exports reduced earnings about $0.02. So that was a bit of a headwind for us. But other than that, we continue, as we talked about, to manage our mix and continue to proceed forward with that and start to transition some of this -- continue to transition this Boise legacy business, Tharco, and Hexacomb, into a little bit more like PCA's model.

Okay. I guess it's that transitioning piece, right? Because Q1 caught us by surprise in some of the volatilities on price. But okay, that's helpful.

I guess a question for Judy, on uncoated free sheet business, I know you took some down time in Q2. But with prices coming down sequentially in Q3, do you expect margins getting back to that double digit level next quarter? And just curious to get your thoughts on -- your outlook on uncoated free sheet prices now that the tariff should be starting to kick in, in the back half of the year?

This is Judy. Third quarter is a seasonally stronger quarter. So our expectation that would still happen, that will help us. It usually has a typically heavier mix to the office side of the business. And of course, with no planned outages and no J1 turbine incident and our mills running better on costs and productivity, we would hope for that to improve.

As far as the tariff situation, the preliminary ruling, cut size imports to date are down about 33,000 tons through June, with about 21,000 of that being in Q2. But we really haven't seen any effects of that in the market yet. But as customer inventories decrease, we expect to see some impact. How much, we're not really sure at this time. That remains to be seen. So the short answer there, it's really too early to tell what's going to happen.

Okay. Very helpful. And just one last one for me. Glad to see the synergy ramp up back on track. Appreciate the color you provided earlier. If we take the first half run rate and just appreciating a slower Q1 ramp, seems like you'll be able to realize most of that $200 million synergy target this year. Can you help frame what the opportunity is for 2015? And is there some opportunities for upside going forward?

Again, we've stated the goal is $200 million of synergies, and we are quickly approaching that on a run rate basis. We've also mentioned in the past, we've got some discrete opportunities. And the biggest opportunity that is looking at us right now is the International Falls turbine generator, which will come on line at the end of the September. That's another example of how we get to the final run rate of $200 million goal of synergy.

But as Paul mentioned earlier also, synergies are typically associated with bringing two companies together and then integrating the companies. So the goal of getting the $200 million by the end of 2016, we see us finishing up the integration into next year and obviously, we're well on our way to accomplishing the $200 million run rate goal. And that being said, after that, the opportunities are just to continue to be accretive for the Company as we go forward as we've done in the legacy business. But I don't want to speculate on anything else on synergies, except that we've identified a number of discrete opportunities that we're very comfortable with.

Appreciate the color, Mark.

Thank you. Next question.

The next question comes from the line of Debbie Jones with Deutsche Bank.

Hello. Good morning.

Good morning, Debbie.

To the extent you can, can you talk about your customer exposure? I know this is very broad based, but which customers would you say in the corrugated market are really either outperforming or underperforming, and then your exposure to e-commerce. I realize it's hard to estimate. But what kind of growth are you seeing or expecting in that market?

I'm going to start off and I'm going to hand it off to Tom. We're not going to get into specific customers. But across the board, we've seen growth in our system. Obviously, a little bit of weakness in the last few years with the West Coast drought. But other than that, I think, again, it's across-the-board growth. Tom, do you want to add a little more color to that?

Debbie, we have thousands and thousands of customers.

14,000 customers.

Yes, I realize that. I thought maybe more housing related versus e-commerce, broader buckets.

Well, I think if you look at some of the industry trends, obviously e-commerce has been strong and continues to grow. The housing market, depending on if you're in straight building materials, that's -- you can just go off housing starts and dictate what kind of demand you're going to have there. I think remodeling and that sort of stuff has probably picked up just a little bit. Those are reasonably strong. But you can go through lots and lots of segments and come up with a lot of different answers here. So I would just leave it at that and say that on an overall basis, you know what the demand is doing for boxes, and it's tracking a lot closer to GDP, certainly very close to the non-durable numbers. And I think that will continue to be the same going forward.

Okay. Thanks. And just one final question. When DeRidder is fully ramped up, what would you expect your OCC virgin fiber mix to be?

You know, that's something that we consider proprietary. But again, we have the capability with the full mill right now to supply, again, the current ratio between OCC and virgin craft. Again, it's no different than what we're doing at Counce. So again, we've got a lot of flexibility there. But I don't want to get into the specific ratios of virgin versus recycle in the sheets.

But an important aspect of that question -- and I'll add to it -- is that we also want to --we're not only working on paper machines, we also working on pulping capacity at DeRidder. Because if and when -- and I think it's more a question when -- OCC prices start to go up again, and if they go up a lot, we like the fiber flexibility being able to put in more virgin and eliminate OCC in the facility and not be dependent on it totally. And so pulp capacity to us, virgin pulp capacity, is another very important part of what DeRidder brought us.

And that's the same model that we use at Counce, same flexibility.

Okay. Thanks. That's helpful. And Rick, congratulations on the retirement.

Thank you.

Next question, please.

And the next question is a follow-up question from George Staphos with Bank of America Merrill Lynch.

Hello, guys.

George, go ahead.

Make it a quick one. As we look at historically what you've done with share repurchase, you always said that you'd be opportunistic. In fact, that's how you framed the second quarter repurchase activity, and we were certainly happy to see it. Considering, though, that a lot of the operating issues in the first quarter were from things that are usually one off, Packaging Corp tends to run very, very well, Q1 wasn't as good of a quarter, would you have wanted to buy back more stock in the quarter, given that you had gotten an opportunity in the market driven by a one-off factor that was operational, or did you really acquire the stock that you would have liked in Q2? If you can frame it any way you can, that would be great. Thank you and good luck in the quarter, again.

I'm going to let Paul get into that. That's a Board matter, and we've discussed that in depth at the Board level.

You know, what we've said, George, is we're opportunistic. And if the stock is down and we think the reason is not a good reason -- and my favorite comparison is every time for the past couple years, there were problems in Greece, we got hit by it, too, and we don't have any plants in Greece. We don't sign any paper to Greece, so why are we being hit? And we used that opportunity to buy stock. So we don't have a list of specific types of opportunities. You look at what's going on at the time and you make a decision. And at times, we have bought stock just to buy some and keep up with our buying program, but we mix that with opportunity. So we just don't sit around and wait for an opportunity that may or may not materialize. We have a plan to buy so much stock over some period of time, but we will accelerate or decelerate that rate depending on what we see in the marketplace. So that's kind of a long winded answer to your question.

All right, Paul. Again, thanks for the thoughts and have a good quarter. Talk to you soon.

With that, Operator, we are out of time. So I'd like to thank everybody for joining us today and look forward to talking with you in October for the third quarter call. Have a good day. Thank you.

Thank you. This will conclude today's conference call. You may now disconnect your line.