Rock-Tenn Management Discusses Q4 2013 Results - Earnings Call Transcript

Nov. 5.13 | About: WestRock Company (WRK)

Rock-Tenn (RKT) Q4 2013 Earnings Call November 5, 2013 9:00 AM ET

Executives

Steven C. Voorhees - Chief Executive Officer, President, Chief Operating Officer and Director

Ward H. Dickson - Chief Financial Officer and Executive Vice President

James B. Porter - President of Corrugated Packaging

Michael E. Kiepura - President of Consumer Packaging & Recycling

Analysts

George L. Staphos - BofA Merrill Lynch, Research Division

Phil M. Gresh - JP Morgan Chase & Co, Research Division

Mark A. Weintraub - The Buckingham Research Group Incorporated

Chip A. Dillon - Vertical Research Partners, LLC

Scott L. Gaffner - Barclays Capital, Research Division

Christopher D. Manuel - Wells Fargo Securities, LLC, Research Division

Philip Ng - Jefferies LLC, Research Division

Albert T. Kabili - Macquarie Research

Anthony Pettinari - Citigroup Inc, Research Division

Alex Ovshey - Goldman Sachs Group Inc., Research Division

Steven Chercover - D.A. Davidson & Co., Research Division

Mark W. Connelly - CLSA Limited, Research Division

Adam J. Josephson - KeyBanc Capital Markets Inc., Research Division

Operator

Good morning. My name is Crystal. I will be your conference operator for today. At this time, I would like to welcome everyone to the RockTenn Fourth Quarter Fiscal 2013 Earnings Conference Call. [Operator Instructions]

As a reminder, slides are being presented today as part of the conference call. These slides can be accessed at www.rocktenn.com under the Investors page. Ladies and gentlemen, this call is being recorded today, November 5, 2013. [Operator Instructions]

Your speakers for today's call are Mr. Steve Voorhees, Chief Executive Officer; and Mr. Ward Dickson, Executive Vice President and Chief Financial Officer. Mr. Voorhees, you may begin your conference.

Steven C. Voorhees

Thanks, Crystal. Thank you all for joining our call. This is Steve Voorhees, Chief Executive Officer. I'm joined this morning by Ward Dickson, Chief Financial Officer; Jim Porter, President of our Corrugated Packaging business; Mike Kiepura, President of our Consumer Packaging and Recycling businesses.

This is the first quarterly earnings call since 2000 that I'm not sitting with Jim Rubright. So I think you are all aware, Jim retired from RockTenn last week. Jim guided RockTenn's exceptional business performance and financial results over the past 14 years. When he joined RockTenn, our sales were $1.3 billion, RockTenn's stock price was $14 per share and our equity market capitalization was $500 million. Today, RockTenn's sales are $9.5 billion, our stock price is $109 per share and our equity market capitalization is approximately $8 billion.

During Jim's tenure as RockTenn's CEO, total shareholder return including dividends was 863% for a 17.4% compound annual rate of return. This is an exceptional result. Jim's going to be missed as a mentor, as a colleague and as a friend to us all, and we wish him the best.

Before I turn to our review of the business for the quarter, I need to review our cautionary statements. During the course of the call, we will make forward-looking statements involving our plans, expectations, estimates and beliefs related to future events. These statements involve a number of risks and uncertainties that could cause actual results to differ materially from those that we discuss. We describe these risks and uncertainties in our filings with the SEC, including our most recent 10-Qs and our Fiscal 2012 10-K.

Also, during the call, we will refer to non-GAAP financial measures. We have provided reconciliations of these non-GAAP measures to the most directly comparable GAAP measures in the appendix of the slide presentation. The slide presentation is available on our website.

I'm going to begin with the discussion of our operating results during the quarter. Then Ward Dickson will turn -- will discuss our input costs, balance sheet, pension and other financial measures. I'm going to discuss our capital allocation strategy and outlook. We will then be available for your questions.

Our coworkers continued to make solid progress in improving all aspects of our business and delivered strong financial results during the quarter. We established a RockTenn record for quarterly adjusted earnings per share. Adjusted fourth quarter earnings of $2.66 per share increased by $1.27, 91% over last year. These results reflect strong operating performance, higher pricing and continued productivity improvements, partially offset by higher commodity cost.

Our Corrugated Packaging segment EBITDA was up strongly over the last year. EBITDA margins in our Corrugated segment were 20%, an increase from 17.3% in the June quarter and 13.7% in the September quarter of last year. Included in our results are the following items: first, a pre-tax gain of $12 million related to recording additional value for spare parts at the containerboard mills acquired in the Smurfit-Stone acquisition; second, a $9 million gain net of start-up expenses related to a terminated steam supply contract at the Solvay Mill; and third, an $8 million gain related to a partial insurance settlement of property damage claims associated with the turbine generator failure at our Demopolis Mill in May of 2012.

As background, the failed turbine generator was originally built in the 1950s with a capacity of 17 megawatts. The replacement turbine generator has capacity of 35 megawatts. The additional capacity improves the economics of the upcoming $68 million fluidized bed boiler project at Demopolis. We discussed this project on our July call. The project will provide an attractive return while addressing the Boiler MACT requirements at the mill.

Our effective book tax rate of 30.6% was favorably impacted by various state and international tax items. Our effective book tax rate was 31% in the prior-year quarter.

Our higher earnings drove record quarterly free cash flow available for dividends, pension contributions in excess of expense and debt reduction. Free cash flow totaled $277 million, or $3.78 per share in the quarter. This was $2.02 greater than the $1.76 per share in the prior-year quarter. Free cash flow of $11.16 per share in fiscal '13 was 55% higher than the $7.18 per share in fiscal '12. Net debt reduction was $176 million in the quarter and $567 million for the full year. Our leverage ratio of 1.95x at September 30 is below 2 for the first time since March of '11, the quarter immediately preceding the completion of the Smurfit-Stone acquisition.

Turning to our Corrugated Packaging business. Industry box volumes, as reported by the Fiber Box Association on a per day basis, increased by 0.6% in the September quarter compared to the prior-year quarter, and 0.6% over the June quarter.

Industry inventory levels increased to 2.4 million tons at the end of September, up from 2.2 million tons at the end of June and 2.1 million tons in September of last year. Industry operating rates for the quarter averaged 97% compared to 96% 1 year ago and 97% in the June quarter. Industry operating rates were 98.6% in July, 99.7% in August and 93.8% in September.

RockTenn's inventory has increased by 38,000 tons in the quarter. This is in line with the 25,000- to 50,000-ton increase that we anticipated on our last investor call. We reacted to our customer demand during the quarter by reducing production by 60,000 tons, allowing us to better match our supply with our customer demand. 50,000 of the 60,000 tons of reduced production was taken in the month of September. Much of this reduction was necessary because of our higher productive capacity, resulting from productivity improvements in the containerboard mill system over the past 2 years.

Industry shipments of containerboard to export markets declined by 9% from the prior-year quarter, and declined by 3% from the June quarter. RockTenn's export shipments increased 12% over the June quarter. Our shipments increased in Latin America, Europe and the Middle East. Our average export price declined by $11 per ton compared to the June quarter. Compared to the prior-year quarter, our export containerboard shipments declined by 3% and our average price increased by $83 per ton.

In the September quarter, we averaged $50 -- $54 per ton of incremental pricing from the April containerboard price increase. RockTenn's FBA equivalent per day box shipments for the quarter increased by 0.5% over the prior year, in line with the industry increase of 0.6%.

During the past 12 months, from October of '12 to September of '13, our FBA equivalent per day box shipments increased by 2.6% compared to the industry increase of 0.2%.

Corrugated Packaging segment EBITDA for the September quarter was $349 million. This was $130 million higher than last year. Prices increased by $178 million over last year, domestic corrugated box and board prices increased by $106 per ton or $158 million.

Export containerboard sales accounted for $21 million or $90 per ton. And pulp prices were lower by $19 per ton or $1 million compared to the prior-year quarter. Our volume variance over last year was a negative $11 million, primarily due to the production reductions we took in our mill system.

Moving to input cost. Absent the impact of synergies and performance improvements, recovered fiber prices and wood prices would have increased by $34 million; chemical, energy and freight cost would have increased by approximately $33 million; and labor, SG&A and other expenses would have increased by $23 million, but for the $52 million in synergies and performance improvements, across our integrated corrugated box and mill system.

Our natural gas conversion projects have continued to deliver the expected financial results. The new Solvay natural gas boiler started up in late September, and allowed us to terminate the long-standing contract with the third-party that supplied coal-fired steam to the mills.

Since the completion of the Smurfit-Stone acquisition, we've completed 5 natural gas projects at Stevenson, West Point, Hopewell, Fernandina Beach and Solvay. Over the last 2.5 years, we have invested approximately $33 million in these 5 natural gas conversion projects, and we're capturing annual savings of approximately $47 million.

At the end of September, RockTenn operated 91 corrugated container plants in North America. We've closed 20 container plants since we acquired Smurfit-Stone, and we are now operating 8 fewer plants than we operated in the same quarter 1 year ago. This is consistent with our strategy of operating larger, more efficient box plants.

Our average volumes per plant during the September quarter were 7% higher than last year. Improved product quality, better operational performance and higher customer satisfaction continued to be the highest priorities for our box plant system.

We reduced waste by 42 basis points compared to the prior-year quarter. We've continued to roll out our new box plant operating system. To-date, we've implemented the new operating system in 34 box plants and continue to expect to complete the rollout in fiscal '14.

We will install new modern flexo folder gluers in 6 of our box plants during fiscal '14. We currently operate 6 of these new units in our box plants and have achieved significant productivity and quality increases at each location. The new flexos, manufactured by Mitsubishi, will replace between 2 and 4 existing flexos in each of the box plants where they will be installed.

Moving to current corrugated market conditions. We are seeing some softness in both domestic and export corrugated and containerboard markets. Our recycled containerboard mill in Jacksonville, called Seminole, is our swing facility that we use as one of our primary levers in balancing our containerboard production with our end customer demand.

On November 1, this was last Friday, we temporarily idled 1 of our 2 machines at the Seminole mill. The machine we idled is a 200,000-ton per year machine that produces medium. We continue to operate the second machine, which is capable of producing 400,000 tons per year of a combination of linerboard and medium.

We are also reducing our current mill production to meet current customer demand at several of our other facilities, and we will increase production back to normal levels as our customer demand improves.

We've scheduled major maintenance outages at our Florence and Fernandina Beach mills in the December quarter. With respect to the inventory levels, we intentionally increased inventory levels during the past year to better serve our customer base, to improve delivery times and to reduce additional transportation costs. We're at a good base inventory level now. We will still build inventories as we head into our maintenance outages, then consume those higher inventories during the outage cycles.

Turning to our Consumer Packaging segment. SBS industry backlogs as of October 23 were 565,000 tons, up approximately 75% from the 326,000 tons at the end of December. Backlogs have remained in the 560,000- to 600,000-ton range since the beginning of July.

RockTenn's SBS backlogs now stand at 6 weeks. PPW increased SBS pricing by $25 per ton during the quarter and $60 per ton during the last 2 quarters. We expect the contractual realization of these price increases will be complete by January -- by July of '14.

CRB industry backlogs as of October 23 were 163,000 tons. This is up 26% from the 129,000 tons reported 1 year ago. RockTenn's CRB backlogs now stand at 4.5 weeks. PPW increased CRB pricing by $40 per ton during the quarter, and $75 per ton during the last 2 quarters. We also expect the contractual realization of these price increases to be complete by July of '14.

Sales volumes of our converted products of folding cartons and interior packaging were 5.3 billion square feet during the quarter, up approximately 1.5% from last year. Sales increased by 1.3% over the prior year and would've been higher, but for the flow-through of lower paperboard prices over the past year.

Our Consumer Packaging mills and converting facilities operated well during the quarter. We took no economic downtime at any of our mills. Our specialty paperboard and merchandising displays businesses operated and performed very well. Adjusted for last year's litigation settlement, total segment sales in the fourth quarter were up 4.7% as compared to last year.

Our reported Consumer Packaging business segment income of $89 million in the September quarter increased by $13 million over the June quarter, and declined by $10 million compared to the prior-year quarter.

Last year's segment income included a one-time item of $18 million, received in connection with the termination and settlement of a paperboard supply agreement. This year's September quarter included an $8 million gain related to the insurance settlement previously discussed.

From a mill ton standpoint, recycled paperboard and pulp shipments were up in the quarter, as compared to last year. And SBS shipments were down 5,000 tons, which is in line with our production for the quarter.

Our merchandising displays business achieved record sales and income in the September quarter. New business and promotional activities strengthened as the quarter progressed. We see continued growth opportunities in our merchandising displays business.

Beginning in the December quarter, we will report the merchandising displays business as its own segment, separate from the Consumer Packaging segment. And to help with your modeling, we expect to file an 8-K sometime before the end of the December quarter, which will provide the realigned historical segment sales and segment income for our businesses.

In fiscal '13, merchandising displays sales were approximately $675 million and operating income was $64 million. Comparing this year to last year's September quarter, pricing increases for SBS, URB and pulp grades were partially offset by slightly lower CRB and folding carton pricing. CRB, URB and SBS and market pulp prices increased sequentially as we implemented previous price increases through our converting system, and sold board tons at higher prices.

Even though November and December historically represent the low point of demand for our Consumer Packaging board grades, we see our Consumer Packaging mill system in balance with our customer demand.

Results in our Recycling segment reflect the facility reduction and operational improvements that we've made over the past 15 months. We've now closed 12 recycling facilities, as we continue to emphasize profitability and supply to our mills over volume. Segment income was over $7 million higher than last year. Recovered fiber prices were about $25 per ton higher than last year, and $8 per ton higher than the June quarter. Segment volumes were approximately 200,000 tons lower than last year, and about flat with the June quarter.

The October postings for domestic OCC were flat with September. Export prices increased by up to $10 per ton, depending on grade. We expect continued price moderation during the December quarter.

At the end of September, our run rate of achieved synergies and performance improvements was $525 million, $75 million higher than the rate we reported last quarter. We are achieving the full run rate of $550 million during this quarter and we're moving past that to focus on productivity and performance improvements across our entire business, whether or not the opportunities have been created by the acquisition. We don't plan to report on synergies and performance improvements going forward as we have in the recent past. We will report on our progress in improving the performance of our business over and above what you would expect, given market conditions and normal inflationary trends for commodities and labor costs.

Now, I'm going to turn the call over to Ward, who will take you through input costs, our balance sheet, pension and other financial measures.

Ward Dickson joined us as Chief Financial Officer in September from Cisco Systems, where he was Senior Vice President of Finance for their sales and customer service channels. Ward has extensive experience in domestic and international markets in both operational finance and corporate finance roles. He previously worked at General Electric, Scientific Atlanta and then, Cisco. I'm very pleased to have him on board. Ward?

Ward H. Dickson

Thank you, Steve. I'm pleased to join the RockTenn team. Now turning to input cost. Wood fiber cost increased slightly over $1 per ton, somewhat higher than our expectations entering the quarter. Weather patterns, especially in the southern states, were the primary driver of the increased cost.

Recycled fiber cost increased about $6 per ton, across our mill system. Average natural gas prices were about $0.50 per MMBtu, lower than the June quarter. [indiscernible] month prices are approximately $3.44 per MMBtu, and a 12-month strip of approximately $3.57 per MMBtu compared to an average price of $3.58 in the September quarter.

On the wood and fiber input side, we believe that wood prices will increase moderately, consistent with seasonal trends we typically experience in the December quarter. Recovered fiber markets will be seasonally soft and somewhat lower pricing in the December quarter.

At the end of September, our net debt was over $2.8 billion and we reduced net debt by $176 million during the quarter. Our credit agreement EBITDA was $1.48 billion and our credit agreement debt-to-EBITDA ratio was 1.95x. We had over $1.7 billion in liquidity available to us for general corporate purposes. Our strong balance sheet and credit profile offer a significant flexibility to support our business strategy.

Let me highlight some of the key items within the tables on Slide 14. Depreciation and amortization for fiscal 2014 are expected to be $590 million, approximately $38 million higher than fiscal 2013. D&A should be fairly even throughout the year. Non-allocated expenses of approximately $70 million are about $20 million lower than fiscal 2013, in large part due to a reduction in pension-related items allocated at the corporate level, as well as continuing reductions in corporate overhead cost. Interest expense of $90 million to $95 million is based on our current 50-50 fixed-to-floating interest rate mix.

Our average cost of debt is approximately 3.4%, while our marginal cost of floating rate debt is between 1% and 1.5%. Our effective tax rate for the September quarter was 30.6%, comparable to the effective rate in the prior-year quarter and below the 35% to 37% we estimated for the quarter. This was lower than expected primarily due to the recognition of a benefit related to certain foreign deferred income taxes and a decrease in the valuation allowance associated with state tax credits and NOLs.

We expect a book tax rate for the first quarter in fiscal 2014 to be between 35% and 37%. At September 30, we have recorded unused U.S. federal, state and Canadian net operating losses and tax credits that can be used to offset a total of $553 million in cash taxes.

We expect to use most of the remaining $212 million tax benefit of our U.S. federal net operating losses primarily during fiscal 2014. We will use our remaining tax benefit of $233 million in cellulosic biofuel, Alternative Minimum Tax and other federal credits over the next 2 years, depending on our taxable income.

We estimate our cash taxes at approximately $25 million in fiscal 2014 and a cash tax rate of approximately 10% in fiscal 2015 and 30% in fiscal 2016. After we have utilized all of our federal net operating losses, the cellulosic biofuel credits can be used to offset a maximum of 75% when the federal cash tax is due.

We continue to expect that our 2014 capital expenditures will be in the range of $525 million to $550 million. We continue to focus on strong working capital management and expect no net change to our working capital dollar investment in fiscal 2014.

At September 30, our pension plans were underfunded on a GAAP basis by $1 billion. The nearly $500 million reduction from the prior year to our pension liability was due in large part to the increase in discount rates, as well as continuing contributions into our plans.

Our U.S. pension discount rate at September 30 was 5.19%, a 97-basis-point increase over the prior year. We expect to make total cash contributions of $239 million to our qualified and nonqualified pension plans in fiscal 2014, of which $224 million will be in excess of our estimated pension expense.

Our modeling would indicate future cash contributions into our qualified pension plans in fiscal 2014 through fiscal 2017 of between $200 million and $255 million annually. Contributions will decline to approximately $130 million in fiscal 2018, after which, based on actuarial assumptions, we will be fully funded. Pension expense should also decline each year from fiscal 2014's level of $15 million.

We estimate that the expenses related to deferred outage cost for the containerboard and bleach paperboard mills will be about $100 million for fiscal 2014, as outlined in the table on Page 14.

Now I will turn it back over to Steve, who will address our capital allocation strategy and outlook.

Steven C. Voorhees

Thanks, Ward. Now that our leverage ratio is below 2x, I want to review our priorities for the use of our free cash flow. As we've said for some time, our first priority is to invest in our business for competitive advantage and to lower our cost.

In late October, we increased our annual dividend rate by $0.20 per share to $1.40 per share, an increase of 17%. We've set our dividend in the range of the median dividend yield of the S&P mid-cap 400 index and we intend to maintain a competitive dividend range.

We're going to be operating our business with a targeted leverage ratio of 2x debt-to-EBITDA. We will operate above or below the 2x ratio depending on timing and current opportunities. We're going to continue to evaluate acquisition opportunities that make us a better business, as we have developed a core competency in successfully executing and integrating acquisitions to create shareholder value.

Share buybacks will help provide the balance between the other uses in our 2x leverage ratio target. The RockTenn board has increased our available authorized share repurchases from 1.8 million shares to 5 million shares, providing us additional flexibility to buy back shares. I believe these capital allocation priorities provide a strong basis from which to continue to create shareholder value, while maintaining an investment-grade credit profile.

Now going to turn to the outlook for the December quarter. Overall, we expect seasonal volume trends to affect our businesses in the December quarter, which is typically the softest volume quarter for our businesses. We do have a month's worth of data to look at. So in October, our box volumes increased on an absolute basis compared to September. In October, there's 23 shipping days; in September, there's 20 days. So on an equivalent shipping day basis, our October volumes declined by approximately 2.8%. The decline is due to softness in primary demand for boxes, as well as our box plant consolidation activity and our focus on profitability over volume.

During the December quarter, we expect to see a normal seasonal increase in the portion of our containerboard shipments to lower value products and markets, including export markets.

We expect a reduction in the sequential price per ton in our corrugated business by as much as $10 per ton. Given the actions we've taken to match our supply with our customer demand in our containerboard system, the momentum that we've had in capturing increases in productivity will be offset over the near-term by relatively higher cost due to lower production levels.

Similar to corrugated boxes, folding carton volumes increased on an absolute basis compared to September and declined 2.5% on a per shipping day basis in October compared to September of this year.

We've seen recent increases in promotional activity in our display business. We just followed up a record September in merchandising displays with another record month in October.

For our commodity input cost in the December quarter as compared to the September quarter, we expect seasonal declines in recovered fiber cost to be more than offset by seasonal increases in wood fiber and energy cost. As compared to the prior year December quarter, we expect increases in recovered fiber, wood fiber and energy cost.

For all of fiscal '14, we expect to continue to deliver attractive free cash flow returns to our shareholders. Given recent operating trends and the guidance that we've provided for other balance sheet and cash flow items, we expect free cash flow for fiscal '14 to be in the range of $12.50 to $13.50 per share. This is an increase of 12% to 21% over fiscal '13, provides an attractive return relative to our current stock price.

This concludes our prepared remarks. Ward, Jim, Mike and I are now available to respond to your questions.

Question-and-Answer Session

Operator

Our first question comes from George Staphos, Merrill Lynch.

George L. Staphos - BofA Merrill Lynch, Research Division

I'll ask a couple of questions, then go back in the queue. Steve, I guess, first question for you. Obviously, here we are, in November, there's a long way to go in terms of the upcoming fiscal year. But when we look at the free cash flow per share guidance, I think it's down a little bit from the range you had provided last quarter. What were the key factors, if I'm correct in that premise, in terms of the reduction in the forecast? The follow-on question I had, specific to Florence. I know you've been investing in the wood yard and the chip delivery system. Are you doing any other investment? I remember, it being about a $40 million figure for Florence. Are you doing any other investment at that mill?

Steven C. Voorhees

The wood yard is the primary investment, which is in the $40 million. We spend capital at each of our mills, but that's the big item. I think with the free cash flow guidance, I think it's just an update of our perception of market conditions, input cost and everything else that we look at. If I had to pick one factor, it would be probably the market conditions that were -- that we faced so far this year.

Operator

Our next question comes from Phil Gresh, JPMorgan.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

First question is just a bit of a follow-up there. I think you said sequentially, you're expecting a $10 per ton decrease in pricing. And I wanted to confirm, if that was more on the export front or on the domestic front? And if you could just kind of follow up with -- you've talked about the downtime you're taking, kind of above and beyond Seminole at this point. Could you kind of quantify what we're seeing there in terms of trends so far this quarter, in terms of the downtime?

Steven C. Voorhees

Okay. Just with respect to the downtime in October, we took 15,000 tons in this other category, and we're not in a position to comment on how we're operating our mill system currently, but that's the answer to that question. I think on a sequential basis, the $10 -- if I had to pick one factor, it would be the export market. However, we do sell white top, as an example. We'll sell relatively less of that in the December quarter than other periods during the year. So that serves to -- as that mix. That's the reason I said products as well as markets.

Operator

Our next question comes from Mark Weintraub, Buckingham Research Group.

Mark A. Weintraub - The Buckingham Research Group Incorporated

Steve, during Jim's tenure, you talked about tremendous growth, et cetera, and M&A had certainly been part of RockTenn's DNA. Do you expect -- and, obviously, you were part of that as well as the CFO. Do you expect that to continue to be a driving force to value creation at RockTenn?

Steven C. Voorhees

I think we have capability to do acquisitions to add significant value. We're somewhat -- we need to look at the opportunities as they come up, and we've had, for as long as I've been here, a pretty straightforward test of -- if we're going to make an acquisition, does it make us a better business? And so I think we're going to be very disciplined looking at acquisitions. And as opportunities come up, if they make us a better business, then we're going to evaluate them and we're going to see if we can consummate a transaction.

Operator

Our next question comes from Chip Dillon of Vertical Research Partners.

Chip A. Dillon - Vertical Research Partners, LLC

Question is, I noticed that the pension liability went down quite a bit from the end of '12 to the end of '13, which obviously, I believe was a function of maybe, your performance in your investments, coupled with the higher interest rates. And I was just curious, it seemed like the pension contribution guidance you gave us looking out, I know the next few years are kind of set in stone because of government calculations. But is there room for that $130 million you're talking about beyond fiscal '17 to be lower? And is the amount in fiscal '16 to '17, for example, set in stone at this point?

Steven C. Voorhees

Unfortunately, with respect to pension, nothing is set in stone. So it's just a function of a host of actuarial assumptions. But the drivers you've mentioned, Chip, are the discount rate and then the investment returns. I think we are in a position to where we're not accruing a significant service cost. And so we're really looking at effectively cashing out or -- of the unfunded liability. So the unfunded liability, the change in that on our funding obligations going forward are just a function of the series of assumptions that I think you and I have already discussed.

Operator

Our next question comes from Scott Gaffner, Barclays.

Scott L. Gaffner - Barclays Capital, Research Division

Just wanted to look at the capital returns here for a minute. Two things: one, on the share repurchase authorization you moved from the 1.8 million shares up to 5 million. Can you talk about how you make that decision to go forward with repurchases, is there timing around this 5 million shares? And then also, when you talk about value accreting acquisition opportunities, predominantly North America-based today, how much do you look at international acquisition opportunities?

Steven C. Voorhees

Okay. I think with respect to the share buybacks, we have that queued up after what we need to do to invest in our business. We are investing more capital this year than last year. Our expected capital expenditures of $525 million to $550 million are higher than the $440 million, we still generate significant cash flow. We will look at acquisitions and I think we want to maintain the 2x leverage ratio, so that we can execute on an acquisition as they come up. The share buybacks end up almost being a residual, but we'll make a judgment as we're looking at our cash flow generation. And in the moment, we will execute those from time to time as we think appropriate. I think with respect to acquisition opportunities, we are North American-focused. We do export about 1 million tons overseas. And I think about 2/3 of that is to Central and South America. And so, just if there were an opportunity, I think we would be looking more positively toward opportunities in that area, as compared to either Europe or Asia. But again, anything that we would do, we're going to ask ourselves: are we better off as a result of having made that acquisition? Meaning, it would have to have some fit with our existing businesses.

Operator

Our next question comes from Chris Manuel, Wells Fargo.

Christopher D. Manuel - Wells Fargo Securities, LLC, Research Division

First, I just wanted to get a sense of -- just a clarification question relative with the $10 differential and export pricing. Just to be clear, you're not seeing any reduction in export prices, is that correct? Or is it just a function of mix within your business that you'll more have this quarter?

Steven C. Voorhees

Jim?

James B. Porter

This is Jim Porter. So we're seeing somewhat of a combination. Principally, it is mix as we look at the products we make brown linerboard, corrugating medium and white top linerboard as our principal mix. And as we look at this go-forward quarter, we're seeing no change in the North American domestic markets. However, we are seeing somewhat of a mix shift for less volume in our total sales portfolio of white liner compared to brown liner. And that's -- when we do the math on that, that's where this $10 reduction comes from.

Christopher D. Manuel - Wells Fargo Securities, LLC, Research Division

That's helpful. And Steve, as you've now had a little bit time in your new roles, any changes that you envision or ways that you may approach the business a little differently than in the past?

Steven C. Voorhees

Well, today's the 5th. I think I started on the 1st, so I'm on Day 5. And I've worked here for a long time. I think Jim and I had what I would characterize as a very good, open, candid relationship. So I haven't been sitting around for a long time saying, "Gee, just wait until I get the chance. And we're going to do a lot of changes." So I don't think there's -- there's not a big change agenda. We're going to keep on doing what we've been doing and I expect us to continue to be successful.

Operator

Our next question comes from Philip Ng with Jefferies.

Philip Ng - Jefferies LLC, Research Division

Your box shipments were tracking in line to a little stronger than the industry for most of the year. It seems like it's weakened a bit relative to the industry. Did you lose some market share during the quarter? Or is it more a function of your exposure to the export market? And then separately, you're taking about 100,000 tons of maintenance downtime during fiscal 1Q. Can you give us a little more color on some of the [indiscernible] economic downtimes you're taking?

James B. Porter

This is Jim Porter. Philip, so you ask, really, 2 questions. One is our inventory levels. And I think we shared on last quarter's call that we were going to increase our inventories between 25,000 and 50,000 tons, largely focused on trying to operate our supply chain to our box plant system and our external customers in a better place at levels lower -- the lower levels where we had been operating, we were finding more expediting and tension in the supply chain that we felt would be relieved and better serving our customers with a slightly higher level. So we did build inventories by approximately 35,000 tons. And at this point, we're really where we think we should be. You should see some normal vacillation about our current inventory numbers, building slightly when we go into heavy maintenance downtime periods and falling slightly when we come out of those periods. But I think you can see that where we are now, we're pleased with. Now when you look at the -- I believe your second question, which was relative to maintenance downtime. We've tried to do a better job of matching the planning cycle for our large mill outages to take our downtime in a more pro rata way across the quarter spread, principally to reduce the impact on our supply chain, both internal and external box plant customers. If we can even the amount of downtime we're taking quarter-to-quarter, it creates less change, and therefore, less impact on our customers. We're also moving some volume into the first quarter for us, which is a seasonally softer quarter. So you see a better match of overall supply and demand. So I hope that answers your question.

Operator

Our next question comes from Al Kabili, Macquarie.

Albert T. Kabili - Macquarie Research

And just, Steve, I wanted to follow up on -- you mentioned the competitive or the industry dynamics, I should say, are a little bit worse than you had originally anticipated, say, a quarter ago. And if we look at U.S. box shipments, they were kind of -- they're still kind of tracking flat, maybe modestly up in the quarter. So there doesn't seem to be too much deterioration as far as where volumes are tracking versus the prior quarter. So I just wanted to -- if you could just follow up on where you're seeing some of the downside versus your original assessment? If it's export market, if it's domestic and [indiscernible] any color you can provide there?

James B. Porter

This is Jim Porter again. So as we reflect on our view over the past couple of quarters, looking forward, I think, frankly, we were looking at the economic forecast of those that spend their careers doing that. And I think the overall GDP in nondurable goods forecast a number of months ago were a bit more bullish than what we're feeling now. I think all of the political and global economic impact has somewhat softened consumer confidence, is how I would interpret it. And we're seeing the purchase of nondurable food, beverage products by our large consumer products companies, slowing. I think you all read the outputs of the Kellogg's, the P&Gs and the others, and those are our customers. And so we're seeing just some softening, if you will, in the purchase of those products, which translates into our packaging. So it's generally just a softening of what I think was an overly bullish global domestic economic forecast.

Steven C. Voorhees

[indiscernible] Al, it might be a little bit early to at least project what's going on with respect to consumer products companies. I think we need to wait to see total box numbers come out in October. I think with respect to our business, our operating rates were very strong in July and August. And you just saw operating rates go down by, I think, close to 500 basis points in 1 month. And I think if you're going to look at one factor affecting the near-term environment, it would be that.

Albert T. Kabili - Macquarie Research

Okay, that's helpful. Just a follow-up on that point, do you see -- in an addition with the slowing, do you see incrementally a more competitive dynamic in the industry with some of the capacity additions and creep that we're seeing, just to follow up on the dynamic that both you and Jim are referring to?

Steven C. Voorhees

I think that's hard for us to comment on. I won't say -- we're focused more on the long-term, on sustaining a good business. And so, unfortunately, volume, you can measure like every day. And you look at it and say, you feel good or bad about volume. But volume is relatively down the list for what we focus on because we're trying to focus on improving our cost structure. If you go to one of our box plants, you have big banners of safety, quality, productivity and cost, and we're investing in the box plants. So we're very much focused on trying to do that and finding customers that fit with that philosophy. And we've been doing that very successfully for a year. Box volumes were up over 2% on a year-over-year basis. And we're going to continue to do that. And then the volumes are somewhat going to be the residual output of our execution of all of that -- or all of those strategies.

Operator

Our next question comes from George Staphos, Merrill Lynch.

George L. Staphos - BofA Merrill Lynch, Research Division

Actually, my next question was a segue, I guess, on Al's question. To the extent that you can comment, had you seen up till today any change in pricing dynamic in recycled versus virgin in North America? Realizing, Jim, that overall domestic has been stable. Has there been any differential between recycled and virgin? And then my other question was, aside from just normal seasonality, you have more generation, et cetera, and that's why OCC prices maybe are flat to down in the fourth calendar quarter. Is there any other issue that you're seeing in terms of what's keeping OCC relatively stable or lower at the present time?

Steven C. Voorhees

Yes, I think we haven't seen a differential, at least in North America, with respect to recycle and virgin prices. With respect to recovered fiber prices, we are in our annual period of the year where generation tends to outstrip demand. And so we would expect moderation in prices. And I think when we get out next year, it's going to be a function of a variety of things, which you would expect demand to go up somewhat, and we'll see how supply catches up with it.

Operator

Our next question comes from Phil Gresh, JPMorgan.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

My follow-up question is just regarding acquisition opportunities. If you can discuss how you think about the relative attractiveness of containerboard versus boxboard at this stage? What your pipeline looks like right now? And if an M&A opportunity were to come along, how high would you be willing to go with your leverage before thinking about issuing equity?

Steven C. Voorhees

There's a number of questions there. I think, I can't really differentiate without knowing the specific opportunity, whether containerboard would be rather than -- better than a boxboard. We have made 3 smaller acquisitions from Smurfit and they were on the converting side of containerboard. We've got a very talented management team in both Consumer Packaging and containerboard on corrugated business. I think we're capable of doing acquisitions. I just can't prioritize one over the other. I think the -- how high will it go on leverage before we issued equity is very situation-specific. I think our credit agreement covenant is 3.5x. So if we got to a point to where we're at call it, 2.75x to 3x, I think we'd be looking at probably needing to refinance our balance sheet. I think it would -- it really depends on the opportunity, but I think it would be -- that would be about at our comfort level to where we'd have to scratch our heads and say, "Are we going to issue equity beyond that point?" But again, it's pretty hard to say something absolute without looking at the specific situation.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

Got it. And Steve, how does the pipeline look right now? Would you say, M&A is a priority for you in the next 6 to 9 months?

Steven C. Voorhees

I think we always look at acquisitions. So I think, there is a flow out there. I can't say it's either higher or lower than in my experience. I think there are transactions out there and we look at a lot of them. And back to, if we're a better business, then we try to execute on them. But I'd say deal -- there is deal flow and I can't say whether it's not a lot higher than it's been and it's not a lot lower than it's been.

Operator

Our next question comes from Chip Dillon, Vertical Research Partners.

Chip A. Dillon - Vertical Research Partners, LLC

Just one quick one. You mentioned you're going to break out the merchandise displays business and I think the last numbers we had were for fiscal '10. And it looks like since then, the business has about doubled with a margin staying 9% to 10%. Was there any reason that doubled other than just organic growth? I don't recall if you inherited something from the Smurfit-Stone acquisition? If you could break that growth down for us that would be great.

Steven C. Voorhees

Okay. Sure. It is the Smurfit-Stone acquisition. But we moved, I think, 3 manufacturing plants over to display, 1 in Adams, Wisconsin, 1 in Chicago and 1 in Ohio [ph]. I'm glad you asked because out of all the things that went on in the integration, the integration of the display business worked as well as any aspect of the integration that we had at RockTenn.

Operator

Next question comes from Anthony Pettinari, Citi.

Anthony Pettinari - Citigroup Inc, Research Division

I had a follow-up question on OCC costs. I was wondering if you could give any color on what you're seeing around Solvay. And when you think about that OCC basket in the Northeast, would you expect fiber cost to be elevated moving forward, given you've had a competitor that's brought on a large mill? Or do you think you'll get a little bit of relief there? I'm wondering if you could just comment on that [indiscernible].

Steven C. Voorhees

Yes. We thought with the new mill going there that there'd be some upward pressure on prices. It hasn't been as much as we would've thought because prices in other areas of the country have been low enough to where people can absorb the freight cost and deliver to sell them.

Anthony Pettinari - Citigroup Inc, Research Division

Okay, that's helpful. And then maybe just a follow-up, on Hopewell, I think you have a modernization project scheduled there for April of next year. Can you remind us what the potential net capacity out of that project could be? And then understanding that capacity coming on as sort of dependent on market conditions, when you would make the decision whether or not to utilize that extra capacity?

Steven C. Voorhees

Yes, just the volume number is 120,000 tons. And I think we said on the last call, we'll just look at what market conditions are. The project had some value, even if we operate at the lower rate, because it reduces the overall cost structure of the mill.

Operator

Our next question comes from Alex Ovshey, Goldman Sachs.

Alex Ovshey - Goldman Sachs Group Inc., Research Division

Steve and Ward, on your fiscal 2014 free cash flow per share guidance, can you comment on whether you're including any benefits from share buyback? And what you guys are factoring in for pulp prices?

Steven C. Voorhees

Just that we haven't factored in a number in that guidance for share buyback. I think with respect to pulp prices, it's not a huge impact on us, so I just can't answer that question.

Alex Ovshey - Goldman Sachs Group Inc., Research Division

Okay, Steve. And then you took 60,000 tons of downtime in the fiscal fourth quarter. Would you be able to give us some sense of how to think about the cost of the downtime on your system?

Steven C. Voorhees

It's a tough one because we go up and down on capacity, give me just a minute. Yes, I think if you had to have a range of a number, it would be $200 to $300 per ton. But I'd just caution you that it's very difficult to estimate exactly what the cost is.

Alex Ovshey - Goldman Sachs Group Inc., Research Division

That's helpful, Steve. And maybe just one last question for me on the volume outlook for corrugated. You gave the sequential change in your box shipments in October versus September on a per day basis. Would you be able to give us the year-over-year change for your box shipments in October, relative to last year's October? And then, you talked about some incremental promotional activity happening in the displays business and that [ph] doing well. As you talk to your customer base, I mean, is there any sense that we may see a pickup in box shipments over the next 12 months? Or are we sort of in for more of the same where it's kind of the flattish to slightly positive trend for the industry?

Steven C. Voorhees

I think as far as outlook for shipments, it's -- I don't think we have any better crystal ball than anybody else. We pretty much make boxes based on orders that we get from our customers. And I think going out, there's a series of macroeconomic factors that just affect things. But again, your crystal ball is probably going to be as good or better than mine. I think with respect to the October box shipments, I think we're down around 5% year-over-year, the number of shipping days in October comparable year-over-year.

Operator

Our next question comes from Steve Chercover, D.A. Davidson.

Steven Chercover - D.A. Davidson & Co., Research Division

This is just a simple question. Forgive me if I should know this. But the Seminole mill, is that a recycled fiber facility? Or is it -- does it also have virgin lines?

Steven C. Voorhees

It's 100% recycled.

Steven Chercover - D.A. Davidson & Co., Research Division

Great. I guess that's why it's a swing mill.

Steven C. Voorhees

That's exactly why it's a swing mill.

Operator

Our next question comes from Mark Connelly, CLSA.

Mark W. Connelly - CLSA Limited, Research Division

Steve, 2 things: is it safe to assume that the box plant rationalization process is pretty well over? And second, with all that you've learned in the containerboard and corrugated rationalization and optimization that you've done, is there something similar that you might be able to do with your consumer business beyond everybody just focusing on price to get those margins up?

Steven C. Voorhees

Just I think with respect to the box plant rationalization, I think it is pretty well over. I think the business that we operate in, there's swings in demand and supply and we'll react to those over time. But just generally, if there's something we need to do, we will do it as rapidly as we can. I think just with respect to the box plant system, we are turning very much focused on improving the quality of each one of our operations. And that includes some investment in the converting side of the box plants that I mentioned on the call. I think with respect to consumer, I'm not sure I can -- Mike, do you want to comment on that?

Michael E. Kiepura

Sure. I'm happy to. I would say that prior to the Smurfit-Stone acquisition and the consolidation, on the container -- corrugated container side, we had gone through that folding carton side. Since the Gulf States acquisition 8 years ago now, we have closed 7 or 8 plants and run 20 folding carton plants. So we have largely done that. And then on our Recycling business, a little over 2 years since the Smurfit-Stone acquisition, we've closed 12 recycling plants. So we have applied that same consolidation strategy of fewer, bigger, more cost-effective plants across our businesses.

Mark W. Connelly - CLSA Limited, Research Division

Okay. So we'll focus mostly on price.

Operator

Our next question comes from Adam Josephson, KeyBanc Capital Markets.

Adam J. Josephson - KeyBanc Capital Markets Inc., Research Division

Steve, why the decision to temporarily shut a machine at Seminole as opposed to a more drastic step such as permanently closing the mill? I understand it was 1 particularly bad month, but what conditions would cause you to close the mill as opposed to just temporarily taking down a machine?

Steven C. Voorhees

I think it's hard for us to comment on future decisions. I think just the temporary plan was pretty straightforward decision, given the trends that we see in customer demand relative to our productive capacity. I just don't want to speculate on hypotheticals.

Adam J. Josephson - KeyBanc Capital Markets Inc., Research Division

Sure. Understood. And one other one on buybacks. At what pace do you plan to repurchase shares over the next couple of years? I know Jim said on the last call that he considered your shares attractive and the stock was higher then than it is today.

Steven C. Voorhees

I think we're going to look at it on almost where we are at the time. I think we're trying to balance what we can do inside the business, with respect to acquisition opportunities. And we've only turned the -- this is our first quarter at 2. So I think we'll just see how time progresses, how actively we have -- we execute on the buybacks. The buybacks are a good alternative for us because where investing in yourselves is a good alternative. I think if we can invest and make ourselves even better, that ends up being a better alternative. And we haven't run out of runway to improve yet.

Operator

Our next question comes from Scott Gaffner, Barclays.

Scott L. Gaffner - Barclays Capital, Research Division

Just one quick follow-up on that. If you had 1.8 million shares authorized, that was about 2.5% of the shares outstanding. So you've almost doubled that. So I think that would suggest that maybe something is more imminent. I mean, is there something we should read into this? Or is there any other reason why you would take the authorization up from 1.8 million to 5 million?

Steven C. Voorhees

Yes. I think you look at the authorization in the context for the outlook for fiscal year '14, we expect to generate very strong cash flow. We're at 2x. And you can do your own model for what you project that will be at end of the year. And if -- pending other opportunities coming up, then our leverage would go down and the prospect of us buying back 1.8 million or more shares, given that scenario, would say, well, maybe you'd want to do that. So I think our outlook for the business and the cash flow generation would make 5 million an appropriate authorization to consider. Whether we do that or not, I'd just reiterate what I said before, depends on facts and circumstances.

Scott L. Gaffner - Barclays Capital, Research Division

Understood. Just an operational question. You took your inventories up a little bit this year in order to save some transportation cost. Can you talk about what sort of savings you might realize on transportation cost? And then the second question is sort of a follow-on with that, is that -- with the box plant operating system being in place and being put into more facilities, are you able to respond quicker than you have historically to changes in demand conditions in order to balance supply-demand and maybe gather information and move that up the supply chain?

Steven C. Voorhees

Yes. I think the answer is yes. We do have better information. We have invested in our box system and inventories. And I think we come from a construct of we're in the business to serve our customers. And on-time delivery is probably the most important thing to do. And so if the concept of us increasing inventories is to have more roll stock at the box plants so we can respond to their orders, is just -- all of it lines up. And at least with interest rates, as low as they are -- it's a relatively inexpensive form of investment to increase customer satisfaction. I think with respect to the transportation cost, I don't have that -- I just don't have that number at my fingertips.

Operator

Our next question comes from Chris Manuel, Wells Fargo.

Christopher D. Manuel - Wells Fargo Securities, LLC, Research Division

Just one quick follow-up. With respect to -- I think you gave some commentary earlier with respect to a few of the price increases for CRB and SBS, that there may take as long as July I think to get implemented if I heard you correctly. Can you maybe talk a little bit about dynamics there? Is it -- why maybe that [indiscernible].

Michael E. Kiepura

Well, the dynamics on the consumer side with the CRB and the SBS price increase is that the majority of our business is under contract with a consumer packaged goods company, particularly large consumer goods company. And those contracts vary all across the board. Typically, they're multiyear contracts with 6-month or 1-year openers to adjust for things such as changes in the board market. And I think unlike the corrugated business, the folding carton business doesn't have nearly as much of the short-term transactional, local business. It tends to be bigger segments, under contract for longer period of time. So it typically takes us 6 to 9 months to fully implement a change in board pricing to carry that and transition that through to the converting side.

Christopher D. Manuel - Wells Fargo Securities, LLC, Research Division

And then I guess, I did have one further follow-up, too. When you think -- I recognize October, demand off quite a bit, do you have any sense, I mean maybe this kind of has to bear out over the next few months to really see but any sense as to an impact of government shutdowns or things of that nature may have had that affect -- make this, say, a 1-month blip as opposed to more of an anomaly, as opposed to a fact pattern?

Steven C. Voorhees

Yes. I don't think there's enough information out there to determine whether it's a fact pattern or not. The difference in shipping days, if we recharacterize the numbers as total volume within respect to September and October, we could say our volumes were up 10%. In fact, more than 10%. And so I think, just the -- I think you can be careful as to reading too much into a blip of data. We're just 1 participant in the market. So I think you have to combine that with a host of other data in order to come to a conclusion.

Christopher D. Manuel - Wells Fargo Securities, LLC, Research Division

Does your gut tell you that dialogue you've had with your different consumer products companies that there was an impact from potential government shutdowns?

Steven C. Voorhees

We're far -- we're relatively distant from, I think, that dynamic. So I kind of think it's hard to -- I think it's really hard for us to comment on that. Or in fact, hard for our customers to comment on it.

Operator

Our next question comes from Al Kabili, Macquarie.

Albert T. Kabili - Macquarie Research

Just a quick follow-up for me. It's just on a cost inflation from labor, non-material cost inflation. Any sense for how we should be thinking about how that tracks up year-over-year in '14? And is there enough -- do you see enough from some of the productivity initiatives you outlined earlier in the call to offset that or is there a drag that we should be thinking about?

Steven C. Voorhees

The labor, it's -- I think we look at that as being $60 million, $70 million per year, would be the increase. And that would be salary increases and healthcare increases combined. There are some other cost increases, which are in there, which would be -- the biggest factors would be commodities. I think we've said what we can on the outlook for commodities. I'm glad you asked about the productivity improvements. I think we're -- I think we said we're going to stop reporting on synergies and performance improvements or what we've done in the past. I think we're anticipating that we would show performance improvements across our system in the range of $100 million to $150 million in fiscal '14 over fiscal '13. And that would outstrip the labor, whether it outstrips all of our commodity costs increases or not, I'll revert back to it depends on what the commodity costs are. But we still have significant runway to improve the performance of our existing assets.

Operator

Our last question comes from Alex Ovshey, Goldman Sachs.

Alex Ovshey - Goldman Sachs Group Inc., Research Division

I just had one quick follow-up, and I may have missed this. On the share buyback, have you bought back any stock thus for -- thus far in the quarter? And are there any restrictions in terms of being able to buy back stock here for the balance of the quarter?

Steven C. Voorhees

No, we haven't bought back stock, so far, this quarter. I think with the restrictions going forward, I don't think there are restrictions.

Operator

At this time, there are no other questions.

Steven C. Voorhees

Okay, great. Thank you so much for participating on our call. Thanks.

Operator

Thank you for joining today's conference call. All parties may disconnect at this time.

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