Packaging Corp of America (PKG) 2017 Q4 法說會逐字稿

Thank you for joining Packaging Corporation of America's Fourth Quarter and Full Year 2017 Earnings Results Conference Call. Your host today will be Mark Kowlzan, Chief Executive Officer of PCA. (Operator Instructions)

I'll now turn the conference call over to Mr. Kowlzan, and please proceed when you're ready.

Good morning, and thank you for participating in Packaging Corporation of America's Fourth Quarter 2017 and Full Year Earnings Release Conference Call. I'm Mark Kowlzan, Chairman and CEO of PCA, and with me on the call today is Tom Hassfurther, Executive Vice President, who runs our Packaging Business; and Bob Mundy, our Chief Financial Officer.

I'll begin the call with an overview of our fourth quarter and full year results, and then I'll turn the call over to Tom and Bob, who'll provide more details. I'll then wrap things up, and then we'll be glad to take your questions.

Yesterday, we reported fourth quarter net income of $269 million or $2.84 per share. Fourth quarter net income included special items of $122 million, primarily for changes related to the recently enacted tax reform bill, which Bob will discuss further in a few minutes.

Excluding the special items, fourth quarter 2017 net income was $147 million or $1.56 per share compared to fourth quarter 2016 net income of $116 million or $1.23 per share.

Fourth quarter net sales were $1.7 billion in 2017 and $1.5 billion in 2016. Total company EBITDA for the fourth quarter, excluding special items, was $351 million in 2017, and $293 million in 2016.

We also recorded full year earnings, excluding special items, of $569 million or $6.02 per share compared to 2016 earnings, excluding special items, of $462 million or $4.88 per share. Net sales in 2017 were $6.4 billion compared to $5.8 billion in 2016.

Excluding special items, total company EBITDA in 2017 was $1.34 billion compared to $1.15 billion in 2016. Details of special items for both the fourth quarter and full year 2017 were included in the schedules that accompanied the earnings press release.

Excluding special items, the $0.33 per share increase in fourth quarter 2017 earnings compared to the fourth quarter of 2016 was driven primarily by higher prices and mix of $0.51 and higher volumes of $0.12 in the Packaging segment, volumes in our Paper segment were up $0.01 per share, and the final insurance recovery related to the DeRidder Mill incident was $0.07 per share.

Partially offsetting these items were lower prices and mix in our Paper segment of $0.03; higher freight expenses, $0.04; and operating and converting costs were up $0.13 in total primarily due to the higher labor and fringe cost, most of which was the result of working additional hours which included holiday periods to meet our customer needs as well as higher medical costs. We had higher input costs of $0.04 driven by higher recycled fiber and chemical costs, and our annual outage expenses were higher by $0.10 per share. Lastly, corporate costs were up $0.04 per share due to higher depreciation and interest expense.

Comparing our $1.56 per share in the fourth quarter to our guidance of $1.50 per share, although recycled fiber prices were lower than expected, this was offset by higher labor, medical and benefits cost in our box plants. Results were negatively impacted by $0.01 per share due to slightly higher tax rate, and are offset by the final insurance recovery related to the DeRidder Mill incident of $0.07 per share.

Looking at our Packaging business. EBITDA, excluding special items, in the fourth quarter of 2017 of $340 million with sales of $1.4 billion resulted in a margin of 24.4% versus last year's EBITDA of $259 million and sales of $1.2 billion, or a 21.7% margin.

For the full year, excluding special items, packaging EBITDA was $1.3 billion, with sales of $5.3 billion, or a 24% margin, compared to full year 2016 EBITDA of $1 billion with sales of $4.6 billion, or a 22% margin.

Record production of 1,006,000 tons allowed our containerboard mills to support record box shipments, prepare for the integration of our new corrugated plants from the Sacramento Container acquisition, as well as help manage our inventories as we get ready for the scheduled outages at 4 of our mills during the first and second quarters of this year. We ended the year with containerboard inventories, including the inventory needs of our Sacramento Container acquisition, about 48,000 tons above the end of the third quarter and 38,000 tons above last year's level. This year-end inventories level represents our lowest weeks of inventory supply in the last 4 years.

Higher year-over-year inflation came in close to where we expected, and the employees at our containerboard mills and corrugated products facilities did a great job working extra hours during the quarter and over the holiday periods to meet our customer needs in a very timely manner.

Additionally, we are off to a great start with the integration of the Sacramento Container facilities and we were able to finalize our claim related to the DeRidder Mill incident as well as with our insurance carrier which enabled us to offset the negative impact to earnings from earlier in the year.

I'll now turn it over to Tom, who'll provide more details on containerboard sales and our corrugated business.

Thanks, Mark. Overall corrugated products and containerboard demand remained very strong during the quarter. As Mark indicated, in corrugated products we had record box shipments which were up in total by 9.8%, with 1 additional workday, or 8% per workday compared to last year's fourth quarter. For the full year, corrugated product shipments in total were up 8.6% or 9% per workday over 2016.

Continued strong demand in both our domestic and export markets improved our outside sales volume of containerboard by about 26,000 tons versus last year's fourth quarter and over 6,000 tons versus the third quarter of 2017.

Domestic containerboard and corrugated products prices and mix together were $0.40 per share higher than the fourth quarter of 2016 and as we expected, were lower as we moved out of the seasonally stronger mix in the third quarter of 2017. Export containerboard prices were $0.11 per share above fourth quarter 2016 levels and up $0.03 per share compared to the third quarter of this year.

Finally, I would like to add that our fourth quarter 2017 acquisition of Sacramento Container and the 2 sheet feeders have "bolted on" seamlessly. These operations have proven to be an excellent fit and we are off to a great start toward achieving our goals. Of course, this could not have been accomplished without the outstanding effort and dedication of all the employees of PCA, including our newest teams from Sacramento Container, Northern Sheets and Central California Sheets.

I'll now turn it back to Mark.

Thanks, Tom. Looking at our Paper segment, EBITDA, excluding special items in the fourth quarter was $26 million with sales of $267 million or a 10% margin compared to the fourth quarter 2016 EBITDA of $50 million and sales of $254 million or a 20% margin. The decrease in results was primarily due to the scheduled outages at 2 of our three paper mills in this year's fourth quarter, with no outages last year, lower sales prices and mix as well as price inflation on fiber and chemical cost and higher freight expenses.

Paper sales volume was up about 12% as volumes in all 3 of our major paper grades were above last year's fourth quarter levels. However, this was offset somewhat due to no pulp volume this year compared to last year as a result of our exit from the market pulp business.

Paper volumes were about 2% below the seasonally stronger third quarter. We began the implementation of our announced price increases, and we ended the fourth quarter with average prices slightly above third quarter levels. However, price and mix were still about 3.5% below the fourth quarter of 2016.

Full year 2017 EBITDA, excluding special items, was $153 million and sales were $1.1 billion or a 15% margin compared to full year 2016 EBITDA of $199 million with sales of $1.1 billion or an 18% margin.

I'll now turn it over to Bob.

Thanks, Mark. As Mark mentioned earlier, during the quarter, we were able to finalize the insurance recovery related to the incident at the DeRidder Mill. Keep in mind that while we did not include any potential recovery in our fourth quarter EPS guidance of $1.50 per share, this final recovery is included in our recurring earnings for the full year, as it offsets the negative impact to recurring earnings that we experienced in the first half of 2017. The final recovery for our claim is consistent with the estimate range we provided you on our 3 previous earnings calls.

Our fourth quarter 2017 effective tax rate on a recurring basis was just under 35%. Due to delayed December enactment of the tax reform bill, various tax-related items in fourth quarter were impacted, creating a tax benefit that we have excluded from our fourth quarter recurring earnings.

As you may have seen on one of the schedules we provided with yesterday's earnings release, the tax reform benefit we excluded from our fourth quarter recurring income was just over $122 million or $1.29 per share. The primary item that generated this benefit is the revaluation of our net deferred tax liability to the new lower federal tax rate of 21%.

We ended the quarter with $217 million of cash on hand. The primary uses of cash during the quarter included $274 million for the acquisition of Sacramento Container, $90 million for federal and state tax payments, capital expenditures of $117 million, common stock dividends of $59 million and interest payments of $29 million. Total capital spending for 2017 was $343 million.

Regarding full year estimates of certain key items for the upcoming year, we expect total capital expenditures to be between $440 million to $460 million. DD&A is expected to be about $390 million, pension and post-retirement benefit expense of $27 million, and we expect to make cash pension and post-retirement benefit plan contributions of $23 million.

Based on our current long-term debt, including the fourth quarter 2017 refinancing of our 2 term loans to fixed-rate notes and the expected retirement of a $150 million note in March 2018, full year interest expense in 2018 would be approximately $101 million and cash interest payments of about $94 million.

Based on current planned maintenance annual outages at our mills in 2018, the total earnings impact of these outages, including lost volume, direct costs and amortized repair costs, is expected to be $0.60 per share versus the $0.50 per share for 2017.

The current estimated impact by quarter in 2018 is $0.18 per share in the first quarter, $0.11 in the second quarter, $0.15 in the third and $0.16 per share in the fourth quarter.

You will note that the $0.18 per share in the first quarter of 2018 is significantly higher than what you've seen historically due to the heavy scheduled outage work this year, primarily at DeRidder.

Finally, regarding tax reform, based on currently available information, the estimate for our 2008 combined federal and state cash tax rate is in the range of 12% to 14%. I do need to point out though that our 2018 cash tax rate benefits from an overpayment of cash taxes that were due on December 15, 2017, prior to the enactment of tax reform, which will reduce cash taxes paid in 2018. Excluding this overpayment, our federal and state cash tax rate is in the range of 17% to 19%.

Our book effective tax rate for 2018 is expected to be in the range of 24% to 26%. Pre-tax reform, our cash tax rate was approximately 36% and our effective rate was about 35%.

I'll now turn it back over to Mark.

Thank you, Bob. Looking ahead, as we move from the fourth quarter and into the first quarter, we expect continued strong demand, although our corrugated volume and mill operating costs will be impacted due to the extreme early January weather conditions experienced from the Dallas Metroplex across the Gulf Coast states region and up the East Coast.

Also, our containerboard volumes will be lower due to scheduled outages at 3 of our mills during the quarter. We'll continue to implement our recently announced price increases in our Paper segment and we expect volume to be slightly lower. We expect inflation in almost all areas across our entire cost base. We anticipate continued higher freight cost as well as higher labor and benefits cost with annual wage increases and other timing-related expenses.

Although we anticipate price inflation on recycled fiber to be fairly flat, we do expect inflation in our energy costs and most of our chemical and repair and material costs. Also, seasonally colder weather will increase energy usage and wood cost.

Our depreciation and interest expense will be slightly higher as well. Considering these items, we expect first quarter earnings of $1.52 per share. This $1.52 does include our best estimate of the effective tax rate resulting from the tax reform changes.

With that, we'll be happy to entertain any questions, but I must remind you that some of the statements we have made on the call constituted forward-looking statements. These 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 these forward-looking statements.

With that, operator, I'd like to open up the call for questions please.

(Operator Instructions) The first question comes from the line of Chip Dillon with Vertical Research Partners.

First question is, noting really the paper business was certainly a lot lighter than we had expected, but you explained very well that you had the 2 mills down, and I suppose as we move forward, is there -- should we expect any dramatic seasonality this year? What's sort of the downtime schedule looking like for that segment in 2018?

You know, along with what I called out on the outages, and everybody just keep in mind, we talked about this on the October call, we had mentioned this that the declining release liner business, volume and price was going to impact the Wallula profitability, which it did. And at the same time, with that volume decrease and the anticipation of the conversion this spring, we are in a period right now in this first quarter that prices are fairly flat with the lower prices, as price declined last year, and volumes are in that same area. So people just need to understand that we're in a transition year with the Wallula operations. And don't forget that Wallula business was a major contributor to the rich mix component of the paper business over the years. So that is a factor. But also, when you think about the outages year-to-year and the fact that Q3, there was a Jackson outage this year. Bob, are you going to...

Yes. I'll just say, Chip, that with what's going on at Wallula, there is -- from a Paper segment standpoint, there is no scheduled outage impact versus previous year. So obviously, there was a Paper segment impact with Wallula outages, that will show up in the Packaging segment this year. In addition to -- you know, there will be some costs that we call out from the nonrecurring aspect related to the actual conversion activities that we'll be going through as well, but those will be excluded from recurring, obviously.

And just a quick -- That's helpful. A quick follow up. As you finish the second phase of the conversion late this year and obviously, you've refined, I would imagine, the engineering. Can you give us an idea what the ramp up curve looks like? Is it fairly immediate as we get into the first half of '19? Or how should we expect that to ramp up?

Yes, Chip, if we've done our job as well as we should, the ramp up should be very quick. With the first phase, we should have a significant amount of the conversion behind us. The last phase is just some of the new bolt-on equipment we needed to enhance the capability of the machine. So if that equipment's been engineered properly and if we've installed it in a precision manner, we should come up very quickly and get right up on the curve.

Okay. And then -- I'll turn it over. Just as I turn it over, could you just update us on maybe how business looks so far in the first quarter of '18?

Tom, why don't you go ahead?

Yes, Chip. Through 18 days, we're up 6.5% per work day. And I'm going to add something that Mark mentioned in the -- earlier, that is that, we have been impacted by weather. We have a very large footprint of plants through Texas, the Gulf Coast, Florida and up the East Coast. And we have a number of plants and customer plants that were down somewhere between 1 to 3 days during that period. So a pretty significant impact. But still, even with that, we're up 6.5% per workday. So demand remained strong.

Your next question comes from the line of Mark Wilde with BMO Capital Markets.

Mark, I'm just curious, with the change in the tax law, does that shift at all how you think about sort of the attractiveness of M&A versus internal CapEx?

Well, if you think about from the time value of money and in immediate expensing opportunities, there is a value there that we haven't seen. But we're still mindful of overall return metrics and what our hurdle rate needs to be internally. So we're still maintaining the discipline on the quality of projects that we're discussing and entertaining. That will not change in this period. And so, as we continue to go forward, we look at every dollar and penny of earnings is very valuable and precious. So I think that's how we look at current situation.

Okay. That's helpful. Just as a follow on, I wondered if you could just talk about use of the capital? Your leverage is about 2x right now. As Wallula ramps and with some of this pricing activity in the market, looks like your cash flow ought to ramp up as we move through the year. Can you just talk with us about prospective uses?

Yes, and it falls in line with where we've been traditionally. The -- you have dividend considerations, share buyback considerations, acquisition opportunities and in just reinvestment in great high-return projects that enhance our volume on the box plant side and our capabilities on the mill side. So those are the 4 buckets that we'd have to consider and again you'd have to imagine that that's something that, would be discussed it at the Board level.

Your next question comes from the line of George Staphos with Bank of America.

If possible, I was hoping maybe to get a little bit more quantification in bridging either fourth quarter to 1Q or 1Q versus a prior 1Q? If I look at -- and I'll do it sequentially, I think, last year, you said that maintenance would be somewhere around $0.18, $0.19 for the fourth quarter this year, that's just concluded. 1Q, I think, you're guiding, Bob, around that level too. So sequentially, that doesn't impact the numbers that much. Correct me if I'm wrong there. Tax would add something around $0.20. That's really back of the envelope. So is the residual basically -- what you're seeing in terms of inflation, and how would you parse that? And then I had a couple of follow ons.

Yes, George. Using the comparison that you were, we certainly get that benefit, as you mentioned, $0.19, $0.20 from the tax rate this year, 4Q to 1Q, as you know. But pricing is flat. Last year, we picked up $0.21. So those sort of negate each other, if you're sort of looking at that type of comparison. And so what you had, last year, we had a $0.04 increase, 4Q to 1Q, this year. Again, you have to take that into consideration. And you also have to remember that DeRidder, even though from a timing perspective it showed up in our fourth quarter numbers, the impact was actually earlier in the year. So if you're looking at a true 4Q to 1Q, you have to back that $0.07 out. So you back that $0.07 out, and if you look at where we're going to the first quarter, you'll see about a $0.03 increase, which is about the same thing we had last year, 4Q to 1Q. But what makes this is the sequential (inaudible).

Bob, the $0.03 increase you just mentioned, what was that $0.03 related to did you say?

I said if you back out the DeRidder impact that we showed in the fourth quarter, in that $1.56, you're sort of starting at $1.49 going on to $1.52.

Understood.

So a $0.03 increase versus -- and last year it was a sequential $0.04 increase. But this year, we had the more challenging things that you mentioned. The inflation is higher, freight is a bit up, the weather-related things that Tom and Mark mentioned, W3 is a drag sequentially, where it wasn't as much of a drag last year. So you also -- we'd have to overcome those things as well. So when you look at it from that perspective, it fits, it's in line, even considering the tax rate development.

Sure. No, I wasn't complaining. I was just trying to get at the numbers. The things that you've mentioned, in terms of, again, the input inflation, W3, the weather, I think, I left out one as well. Are they equally sized? Or is one particularly penalizing into the first quarter and more than normally would be the case?

No. They're all -- they're more than normal, as I was saying. And they're all within a range of $0.01 to $0.03, each one of those.

Okay. Second question, and I recognize it's difficult to talk live mic about pricing strategy. But just if you could give us a couple of thoughts in terms of your consideration in announcing the containerboard price hike, and broadly, what you'd relay to customers recognizing you typically like to have those conversations one-on-one and not on a conference call. And similarly, within uncoated freesheet, can you comment at all in terms -- of the rationale you're providing to your customers in terms of the need to take prices up?

George, let me handle the Paper side, and I'll let Tom walk through the containerboard side. Again, the price increases from the fall, indexes have picked up what appears to be about $8 on cut-size and probably $13-or-so on offset and converting grades. And so, again, the paper business is based on cost inflation, input factors and demand. And so -- there's not a lot else to say about the Paper side of that business. We're still net-net, down year-over-year about 3.5% on average paper pricing. Tom, do you want to handle the containerboard announcement?

Yes. Let's just, we'll just leave it at this basically. We have notified our containerboard customers that we will implement the $50 a ton increase effective March 1, and we'll begin billing that increase on that day. Regarding the flow-through, as we've always said before, that's really between us and our 17,000-plus customers and we handle that individually with each customer.

Your next question comes from the line of Mark Connelly with Stephens.

Mark, can you remind us of the key deliverables from the DeRidder debottlenecking? And with this new price hike taking profitability even higher, should we expect you to announce more debottlenecking projects there, assuming that the IRRs on those things are going up?

Yes. Well, we announced a year ago, approximately DeRidder opportunities. We talked about 150,000 tons of opportunity coming out of projects on #1 machine, but primarily #3 machine. And so, on a run rate basis, we fully expect to see that achieved. We've got the outage at DeRidder that starts a week after next. And then, when that shutdown is completed at -- by the end of the month, we should be done, technically, with our conversion, and it's just a matter of getting the equipment up and running and then we should be at the annualized 150,000 ton contribution run rate. If you think about last year alone, year-over-year, from 2016 to 2017, we produced 145,000 more tons of containerboard in the system. A significant amount of it did come from DeRidder as well as the other mills just running extremely well. But everything we worked on at DeRidder last year and everything we talked about has occurred as we planned. And DeRidder, again, by the springtime should be at their run rate of the incremental 150,000 tons year-over-year. Very pleased with what we're seeing.

Very helpful. One more question. On Wallula, can you give us a sense of how much exposure you're going to have once that conversion is done to California produce? Thinking about basis weights I assume, it is not that high. But when we think about the long term weather outlook, it seems like the West Coast is not necessarily a market you want to double down if you've -- unless you've got a place to go if produce doesn't come through?

No. It's -- you said something there. We are uniquely in a position that we will be making the heavier weight product on that machine. We are, to my knowledge, the only company in the world that has understood how to convert this type of paper machine to produce not only the lightweight liner mix, but also, the heavier weight mixes that Tom's plants will need in the West Coast. We have a big presence in the Washington state area and the Pacific Northwest in General. So as far as Sacramento Container, when we do come online fully with the Wallula conversion this year, we'll be filling eventually what we would require on the West Coast with key grades.

Your next question comes from the line of Anthony Pettinari with Citi.

Just following up on George's question on the cost inflation you're seeing in 1Q. The reference is to higher labor and benefits cost. Is that just the normal annual wage increases that you would expect? Or are you seeing any incremental wage pressure with a tighter labor market that you might not have normally expected?

Yes. There's 2 pieces. It's the normal inflationary effect that you see every year with our wage increases, benefits and fringes but also, that we are in a tight labor market. And as you would expect, we are going to manage that tight labor market. We have, again, for the first time that I can recall, we have a robust economy that presents an opportunity for us to grow significantly with the customer base. In order to do that, again, you have a labor factor that we haven't seen in this country probably in 20 years.

Okay. That's helpful. And then, Mark, when you talked about capital allocation and you listed your priorities, I think, you talked about acquisitions. I'm just wondering if you'd be potentially open to acquisitions on the mill side as well as the box side? Obviously, you had a major competitor announce an acquisition of another competitor. When you think about the mill side, do you still think there are opportunities out there from an acquisition perspective in North America, or any color you can give?

Yes. We've stated this right along. We would be open to the right acquisition at the right price. We're very mindful of that, but we still have various opportunities on how we grow the system. And again, we're surely not without opportunities. I'll leave it at that.

Okay. And then, maybe just a final one for Bob. In terms of the CapEx guidance for 2018, is it possible to parse out how much of that is related to Wallula that might roll off in '19?

There's about $130 million, maybe just slightly more than that, Anthony, in this year.

Mark W Kowlzan, And Anthony, none of that will be 2019. That CapEx will be finished this year. So it's off as you said.

Next you have Debbie Jones with Deutsche Bank.

I wanted to ask about transport cost and where is there, clearly, an issue for the industry, in some cases, access to transport. Can you just comment on how big of an issue this is for you relative to other things you are concerned about, and just things that you've thought about to kind of eliminate some of the risk around this?

Yes, Debbie. As a matter of fact, with what we saw in the fourth quarter, especially through the robust holiday period, transportation has become my significant #1 concern. The availability and the cost of transportation. On the trucking side, we have the matter of the new laws that have been enacted now as of December, regarding electronic logs. And last year, we worked through the hours of service within the trucking industry. So we've had 2 big factors that have now taken a number of trucks and drivers off the system. And then you combine that with a very robust economy, that's putting the demands on that remaining fleet of tractors and trailers and drivers. And then you also, on the rail side, you have some rail inefficiency, obviously, due to one in particular, Class I rail carrier. And so, transportation cost and availability has become my #1 concern. Tom, do you want to add to this?

Yes. From the -- certainly, from the box plant perspective, rail service is a real issue for us and the -- the quality of rail cars, et cetera, that creates real issues for us. Especially on the trucking side, the new laws that Mark just mentioned, plus the lack of drivers, lack of equipment and, generally, with the boost in the economy, I mean, we're competing with everybody for that same shortage of labor and equipment. So it's a -- clearly a headwind for us that we're going to have to work very hard to manage and minimize as much as we possibly can.

Okay. My second question, on e-commerce. I think on the last call you said that you felt that the impact, if you just look over the last few years, has had kind of a smooth impact in terms of the delta or how it's impacting you. As you went through the fourth quarter and looking into Q1, do you have any updated thoughts on just how e-commerce is impacting the numbers on a year-over-year basis? Do you see the growth accelerating? Or is it kind of similar to what you've seen in the past?

Somewhat. I don't think there's any doubt that it continues to grow. The challenge, I think, for all of us when it comes to e-commerce is, is how seasonally -- how seasonal it is, and how strong it is in the fourth quarter versus the other quarters of the year. So that probably creates the biggest angst for us, but it's clearly a growing part of the economy and it's been good for the box business.

Does it change the way you go to your customers in terms of level of service, whether it'd be helping them with rightsizing, packaging, the type of containerboard that you want exposure to?

We're always working on those things, Debbie. So that doesn't -- it doesn't change the way we do business. I mean, we're always trying to add value for our customers.

Next question comes from Adam Josephson with KeyBanc.

Bob, a couple of questions, Bob or Mark. Just one on the sequential bridge, again. I know you talked about some of the labor costs, I think, being timing related and the seasonally colder weather, is obviously temporary. Can you just give us some sense as to, on a per share basis, how much of that you expect to go away post 1Q?

I'd say probably a couple of cents, Adam. Something in that ballpark.

Okay. And just on this cost inflation issue as well, Bob or Mark. You know, last year, it was OCC, this year, it's transport and energy and chemicals. And it seems like it's something every year, right. So how would you have us think when you announce these price increases, right, of $50 at a time? How would you have us think about the flow through to your earnings or to your EBITDA of these increases, given this constant cost inflation that exists in the business?

I don't want to get into that question and the detail you want, but you have to keep in mind that, if you understand how robust the entire economy is and what it's doing across all input costs, whether it's raw materials and then transporting finished goods to the customer, it is a constant factor now. Now it's -- as I say, it's a high-class factor. And so, I'd rather be in this environment than what we'd experienced for the last 25 years. And it's something that though, as a nation, we have to figure out how to manage. Transportation, the logistics issues, in all -- the labor shortage phenomena, skilled workers. So -- but that -- I look at it as an opportunity. And so we're not going to get into the price and how that rolls in.

Sure. And just one last one, Mark. Someone referred to the acquisition, announced earlier this week, on your call. Can you share any thoughts you have about that deal?

No.

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

I was just trying to parse a little bit. When you have that 4Q to 1Q bridge, and I appreciate all of the color that you've given, I'm just trying to get a sense as to how much, on a percent basis, wherever you might be able to relay, would be normal inflationary pressures from wages, et cetera, which you'd view as a trend line, versus, maybe, what you would term as more exceptional increases above and beyond normal because of freight and not so on the wages that you're talking about. Is there a way to sort of give us a sense as to kind of how much it's just kind of normal inflationary versus what is indicative of what's been a pickup?

Yes, Mark, I'd say, this year, it's $0.03 to maybe $0.04 above what we would normally see is how we're looking at it right now.

Okay, great. That's super helpful. And lastly, just on the uncoated free sheet business, any update on business conditions there for us?

Volume is good. We're very pleased with where we are with the demand. Again, we're winding down the specialty business out of Wallula. So that's pretty well. If you think about the Jackson mill and the I Falls mill producing the cut size and the converting grades, business is -- volume's good. Again, I'm pleased with where we are in the month of January. Volume is lighter than the fourth quarter, but that's normal, but year-over-year we're doing quite well with volume.

And obviously, there is a lot of capacity takeout across the industry going on in uncoated sheet, which presumably is tightening things up. Are there any other factors at play that you think are influencing the market and helping provide support to price initiatives? Be it pulp cost or...

No. Well, again, just overall input cost inflation has a dramatic factor on some peoples decisions on what's happened I think in the industry with some of these shuts that were announced. And if you think about the cost of pulp that have flowed through, some of these mills that are dependent on 100% purchased fiber. So again, other than that. For us, and we've said this before, the paper business generates a lot of cash, and I Falls and Jackson don't require a lot of capital right now. And so we're just -- we've got a tidy little business there, and we don't have an outage this year at Jackson -- at I Falls, rather. And -- so again, shaping up, starting up the year in good shape.

Next you have Chris Manuel with Wells Fargo Securities.

I've got a couple of set questions. First, Bob, if you could just help me a little bit with the tax cut. I think you said, this year would be kind of normalized 17% to 19% on the cash side, if not for the payment that you made in December. Is that a reasonable run rate? 17% to 19% is what we would -- should think about ongoing? Say 19%, 20%, ongoing past that? Or does it kind of creep up closer to the...

Yes, Chris, obviously, we're still -- things can even change this year. But to answer your question, I'd say, that's -- what, I would use it if I were trying to model something right now. But obviously, that can change.

Okay, that's helpful. And then, Mark, if you could help us maybe just a little bit with phasing of stuff. So it sounds like that the W3 machine goes down this week. It will come back on March 1. It would be running at...

The DeRidder will be going down the week after next for its conversion work, and then the DeRidder annual work. The Wallula 3 machine will be down during the month of May.

During the month of May. Okay.

For its first phase.

Then it will be kind of 240,000 ton a year clip until some point in 3Q when you put the rest of the equipment in. Is that right? Or 4Q? Or when is that last piece?

We'll run at the reduced rate through the summer months, and then October, we take the machine down again, and that -- all that was dependent on the deliveries that are -- some of the few pieces of capital long lead items that we had to wait for. And then we come out of that October shutdown, and we should be ready to run at the full rate.

At the full rate. Okay, that's helpful. So I guess, where I'm kind of going with all of this is, if I put this together, if you continue to run at present levels you are, I think, you mentioned up 6% to 7% here through 18 days, this first half of the year is going to be incredibly tight. How do you balance meeting customer demand? Are you having any issues in the marketplace trading for and procuring paper? I'm guessing you probably happen to buy a little bit on the outside as we sit today. Can you maybe give us a little color or some thoughts there?

Yes, and we had talked some more about this last year, and for the year, we purchased about 250,000 tons of containerboard on the outside in a very opportunistic manner, and we'll continue on that pace this year until we get Wallula fully ramped up and behind us. And so, again, taking advantage of transportation opportunities by region within the country. And also, we built some inventory. We ran extremely hard through the latter part of the year and making sure that we were prepared for these early outages i.e. the DeRidder one coming up in a couple of weeks. But to your point, we are going to be very tight, and we have to run well. What is going to run has to run well, and -- Tom, you want to add to that?

Yes. Chris, I'd also like to -- I think another good way to look at it is, is that even after Wallula comes up, we will be at the same integration level, 95% plus integration level that we are -- we were going into that. So those tons are all accounted for, and -- so there's no question. It's going to be -- it's tight. It's going to remain tight, and we're going to have to hit on all cylinders to make sure that there's no blips in the system.

I guess my last question is, how do you think about other opportunities that you have? Do you have other machines that you could target over the next 1 to 2 years to do similar type conversions? Or how do you also balance that with thinking of other assets that you could acquire or, potentially, partner with to convert?

Yes, that's something we think about all the time, and we have plans on how we would go forward and so we have various alternatives. So when we announce something, we will announce it. Other than that, we're not going to start speculating on what's the best direction for us. But we certainly have different opportunities.

Your next question comes from the line of Scott Gaffner with Barclays.

Just a couple of follow-ups. Specifically on transportation, can you sort of parse out your mix between rail versus truck? And how you balance maybe one versus the other?

Well, Scott, obviously, rail is primarily what's used coming out of the mills. Truck is primarily used with -- for our corrugated shipments. If you're looking at it from a dollar standpoint or number of load standpoint, what have you, but...

Dollars would be great.

Certainly, dollars. I think, dollars, it's probably 65%-or-so rail.

Okay. And if I look at your inventory positions then, how is the rising cost and availability affecting your inventory decisions, 2017, and maybe going into 2018?

Containerboard inventory?

Correct.

Again, we have to run hard. In order to satisfy the needs that we had last year, we had to run hard all year long and execute well, which we did. And the big consideration as we were coming into the fourth quarter was, could we build some inventory that would give us a little bit more of an insurance policy during 3 mill outages that we have coming up in this first quarter and the few outages we have in the second quarter. So again, I think, the key is, we have built inventory to the best of our ability to run through this period even then. And Tom just said it, everything else, we have to run extremely well. And -- so it's about -- no other explanation.

Okay. And then on the labor inflation piece. I think, in the prepared remarks or in the press release, you mentioned labor inflation on the box side of the business. Is that -- should we expect the tight labor market to be more acutely felt on the box side of the business, maybe because you don't have as many unionized employees on the box side of the business versus the mill side of the business?

Well, I think -- Scott, this is Tom. I think, one of the things that you're going to find is, number one is, you got a lot more employees when you go through the box plants. So obviously, they're going to be impacted more. But also, you do have a mix of union, nonunion. We try to take care of our people the same way. So we're really a little ambivalent to that. But the fact of the matter is, it is a tight labor market and is becoming tighter. And depending on the marketplace you're in, you could have a lot of competition for that same labor market. So it's -- this is going to be a headwind for a long time, I think, until we get a lot of policies in this federal government straightened out, so that we can figure some of this out. But it's clearly an issue, and even with capital expenditures and the things we do inside these box plants requires a different talent level. And, obviously, that requires some different skill sets and perhaps, some different labor rates. So it's going to be a problem we're going to have in this business for quite some time to come.

All right, Tom. Last one for me is just around some of the consolidation potentially taking place in the Pacific Northwest. Are there any added concerns or considerations that you would take into place with the Wallula conversion, with that potential consolidation on the table?

No. Again, when we announced Wallula, we had already had a home for all these tons in conjunction with the Sacramento Container acquisition, and the existing business that we do in the West Coast. So we don't see that as any issue.

Next you have Steven Chercover with D.A. Davidson.

My principal question was answered, but I was wondering if you could give us a bit of an update on virgin fiber prices, both in the South and the Pacific Northwest?

Virgin fiber prices in the South have been primarily affected by weather, and that's something that we, you know, you always think about as far as, especially during the late fall, winter periods with wet winter weather conditions. And in this case, the first 18 days of January, where with the snow and ice through much of the wood baskets, and in my commentary earlier, from that Dallas Metroplex across the Gulf states, we had the DeRidder mill, the Counce mill and the Valdosta containerboard mills are severely impacted for a number of days, and the Jackson, Alabama, paper mill was severely impacted. And in terms of raw material deliveries, but in particular, wood deliveries and wood cost. And so it's a different scenario right now compared to what we've seen in other years with the way this winter shaped up.

So I guess we'd call that extreme seasonality. But as the sawmills ramp up, will chips become more available? Is that your expectation going forward?

Well, theoretically that's the case. And then regarding the question on the Pacific Northwest, we're seeing pretty stable fiber pricing. It's been up over the last few years, but there is nothing dramatic changing currently. But the big story for us right now is what's happening in the Southeast and Gulf Coastal region with the winter weather phenomena in the last month.

Next you have Gail Glazerman with Roe Equity Business.

May be just sticking on fiber. Can you give us a little bit more perspective on what you're seeing in OCC and how you expect it to play out over the rest of the year? And particularly, are you seeing any kind of structural adjustments to China the shift in policy, like incremental demand for DLK and stuff like that?

Well, regarding year-over-year, OCC, recycled fiber, still on average, about $50 higher than it was a year ago. And then -- and we said this many times, OCC and recycled fiber is very dependent on what China does. China will swing that either way and you would assume, and we see some evidence of this, that they are issuing new licenses and permits, that demand will go up. And so, again, I think it's -- that's always the wildcard. I think, the demand here in the United States is pretty well known, but China is what will move the needle significantly one way or the other, as it did last year in going up and coming down. Tom, you want to?

I think the important thing is to think, when you think about China is, they have to have virgin fiber. And -- so they're going to get it one way or the other, whether it's OCC, DLK or importing linerboard. They've got to have virgin fiber in their system in order to run their system. So it could come from any of those sources, and I think they're -- it's kind of dependent on price. The one thing that's kind of surprising is, if you think about, with as little OCC as they've been importing and how OCC stayed -- the price stayed up and, as Mark indicated, it's even up over the same quarter a year ago. That's kind of surprising, which I think is an indicator of which direction OCC is probably going.

Okay. And then just on box demand, can you give some perspective on, I guess, just what your outlook is, maybe over the medium term in terms of box growth? And beyond just kind of a cyclical pickup in the economy, are you seeing anything structural in terms of investments from your customers, reshoring the manufacturing or just anything structural that would drive demand?

Yes, Gail. I think all of the above what you just said is absolutely true. And as I indicated, I said that demand is -- remains very strong, even though we had some weather related issues earlier this month. But clearly, demand is strong. And we're in a phase now where the box business is tracking the GDP a lot closer than it had been, and that's primarily related to manufacturing. We've definitely seen, number one, you're not seeing manufacturing moving out of this country anymore. So that trend is kind of behind us in a great way. And now you're seeing a lot more onshoring of manufacturing, and we're seeing a lot more investment, that our customers are talking about in terms of what they're going to do with their facilities. So I think, demand is going to be -- is going to remain very, very strong.

Okay. And just on the -- just one last one on the labor side. Are there any kind of capital projects and investments or equipment that you guys could look to invest in as a structural kind of relief on some of the labor tightness?

Well, that's an ongoing opportunity. We do that all the time. But also keeping in mind that there's a limit to how much capital you choose to spend and can justify spending and so -- and also how much you can actually physically deploy in terms of the groups that we have on the box plant side and the mill side and you can only take on so many projects. And so you have to prioritize those opportunities and we do that all the time. And so, that's an ongoing opportunity that we deal with.

I think we have time for one more quick question if anybody needs to ask anything, and then we'll call it.

We have a question from George Staphos with Bank of America.

Just a quick one to clean up. If we look at the Paper segment, 4Q versus 4Q and reflecting on, I think, you said prices are down still 3.5% or so year-on-year. How much of the residual gap in EBITDA would you expect to ultimately go away as we get into 2Q and then the rest of the year. Said differently, is there any way to parse, again, that 4Q to 4Q performance.

George, I don't think we thought about that in those terms yet, so I don't want to answer anything. We don't have that for you.

We'll talk about it, and we'll get back to you after the call.

All right. With that operator -- thank you, everybody, for joining us on the call today, and we look forward to talking with you in April. And with that, thank you.

This concludes today's conference call. We thank you for your participation and ask that you please disconnect your line.